Position Limits for Futures and Swaps

Federal RegisterNov 18, 2011

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 150 and 151

RIN 3038-AD17

Position Limits for Futures and Swaps

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Final rule and interim final rule.

SUMMARY:

On January 26, 2011, the Commodity Futures Trading Commission (“Commission” or “CFTC”) published in the

Federal Register

a notice of proposed rulemaking (“proposal” or “Proposed Rules”), which establishes a position limits regime for 28 exempt and agricultural commodity futures and options contracts and the physical commodity swaps that are economically equivalent to such contracts. The Commission is adopting the Proposed Rules, with modifications.

DATES:

Effective date:

The effective date for this final rule and the interim rule at § 151.4(a)(2) is January 17, 2012.

Comment date:

The comment period for the interim final rule will close January 17, 2012.

Compliance dates:

For compliance dates for these final rules, see

SUPPLEMENTARY INFORMATION.

FOR FURTHER INFORMATION CONTACT:

Stephen Sherrod, Senior Economist, Division of Market Oversight, at (202) 418-5452,

ssherrod@cftc.gov;

B. Salman Banaei, Attorney, Division of Market Oversight, at (202) 418-5198,

bbanaei@cftc.gov,

Neal Kumar, Attorney, Office of General Counsel, at (202) 418-5353,

nkumar@cftc.gov,

Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

I. Background

A. Introduction

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).

Title VII of the Dodd-Frank Act

amended the Commodity Exchange Act (“CEA”)

to establish a comprehensive new regulatory framework for swaps and security-based swaps. The legislation was enacted to reduce risk, increase transparency, and promote market integrity within the financial system by, among other things: (1) Providing for the registration and comprehensive regulation of swap dealers and major swap participants; (2) imposing clearing and trade execution requirements on standardized derivative products; (3) creating robust recordkeeping and real-time reporting regimes; and (4) enhancing the Commission's rulemaking and enforcement authorities with respect to, among others, all registered entities and intermediaries subject to the Commission's oversight.

See

Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the Dodd-Frank Act may be accessed at

http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm

Pursuant to Section 701 of the Dodd-Frank Act, Title VII may be cited as the “Wall Street Transparency and Accountability Act of 2010.”

7 U.S.C. 1

et seq.

As amended by the Dodd-Frank Act, section 4a(a)(2) of the CEA mandates that the Commission establish position limits for futures and options contracts traded on a designated contract market (“DCM”) within 180 days from the date of enactment for exempt commodities and 270 days from the date of enactment for agricultural commodities.

Under section 4a(a)(5), Congress required the Commission to concurrently establish limits for swaps that are economically equivalent to such futures or options contracts traded on a DCM. In addition, the Commission must establish aggregate position limits for contracts based on the same underlying commodity that include, in addition to the futures and options contracts: (1) Contracts listed by DCMs; (2) swaps that are not traded on a registered entity but which are determined to perform or affect a “significant price discovery function”; and (3) foreign board of trade (“FBOT”) contracts that are price-linked to a DCM or swap execution facility (“SEF”) contract and made available for trading on the FBOT by direct access from within the United States.

Section 1a(20) of the CEA defines the term “exempt commodity” to mean a commodity that is not an excluded or an agricultural commodity. 7 U.S.C. 1a(20). Section 1a(19) defines the term “excluded commodity” to mean, among other things, an interest rate, exchange rate, currency, credit risk or measure, debt or equity instrument, measure of inflation, or other macroeconomic index or measure. 7 U.S.C. 1a(19). Although the CEA does not specifically define the term “agricultural commodity,” section 1a(9) of the CEA, 7 U.S.C. 1a(9), enumerates a non-exclusive list of agricultural commodities, and the Commission recently added section 1.3(zz) to the Commission's regulations defining the term “agricultural commodity.”

See

76 FR 41048, Jul. 13, 2011.

To implement the expanded mandate under the Dodd-Frank Act, the Commission issued Proposed Rules that would establish federal position limits and limit formulas for 28 physical commodity futures and option contracts (“Core Referenced Futures Contracts”) and physical commodity swaps that are economically equivalent to such contracts (collectively, “Referenced Contracts”).

The Commission also proposed aggregate position limits that would apply across different trading venues to contracts based on the same underlying commodity. In addition to developing position limits for the Referenced Contracts, the Proposed Rules would implement a new statutory definition of bona fide hedging transactions, revise the standards for aggregation of positions, and establish position visibility reporting requirements. The Proposed Rules would require DCMs and SEFs that are trading facilities to set position limits for exempt and agricultural commodity contracts and establish acceptable practices for position limits and position accountability rules in other commodities.

See

Position Limits for Derivatives, 76 FR 4752, 4753 Jan. 26, 2011. Specifically, the Commission proposed to withdraw its part 150 regulations, which set out the current position limit and aggregation policies, and replace them with new part 151 regulations.

B. Overview of Public Comments

The Commission received 15,116 comments from a broad range of the industry and other interested persons, including DCMs, trade organizations, banks, investment companies, commercial end-users, academics, and the general public. Of the total comments received, approximately 100 comment letters provided detailed comments and recommendations concerning whether, and how, the Commission should exercise its authority to set position limits pursuant to amended section 4a, as well as other specific aspects of the proposal. The majority of the over 15,000 comment letters received were generally supportive of the proposal. Many urged the Commission promptly to “restore balance to commodities markets.”

On the other hand, approximately 55 commenters requested that the Commission either significantly alter or withdraw the proposal. The Commission considered all of the comments received in formulating the final regulations.

See e.g.,

Letter from Professor Greenberger, University of Maryland School of Law on March 28, 2011 (“CL-Prof. Greenberger”) at 6-7; and Petroleum Marketers Association of America (“PMAA”) and New England Fuel Institute (“NEFI”) on March 28, 2011 (“CL-PMAA/NEFI”) at 5. Also, over 6,000 comment letters urged the Commission to “act quickly” to adopt position limits.

II. The Final Rules

A. Statutory Framework

In the proposal, the Commission provided general background on the scope of its statutory authority under section 4a (as amended by the Dodd-Frank Act), together with the related legislative history, in support of the Proposed Rules.

Many commenters responded with their views and interpretations of the Commission's mandate under the CEA, and in particular whether the Commission must first make findings that position limits are “necessary” to diminish, eliminate, or prevent undue burdens on interstate commerce resulting from excessive speculation before imposing them.

A more detailed background on the statutory and legislative history is provided in the proposal.

See

76 FR at 4753-4755.

See e.g.,

CME Group, Inc. (“CME I”) on March 28, 2011 (“CL-CME I”) at 4, 7.

As discussed in the proposal, CEA section 4a states that “excessive speculation” in any commodity traded on a futures exchange “causing sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity is an undue and unnecessary burden on interstate commerce” and directs the Commission to establish such limits on trading “as the Commission finds necessary to diminish, eliminate, or prevent such burden.”

This basic statutory mandate has remained unchanged since its original enactment in 1936 and through subsequent amendments to section 4a, including the Dodd-Frank Act.

See

section 4a(a)(1) of the CEA, 7 U.S.C. 6a(a)(1).

As further detailed in the Proposed Rules, this long-standing statutory mandate is based on Congressional findings that market disruptions can result from excessive speculative trading. In the 1920s and into the 1930s, a series of studies and reports found that large speculative positions in the futures markets for grain, even without manipulative intent, can cause “disturbances” and “wild and erratic” price fluctuations. To address such market disturbances, Congress was urged to adopt position limits to restrict speculative trading notwithstanding the absence of manipulation. In 1936, based upon such reports and testimony, Congress provided the Commodity Exchange Authority (the predecessor of the Commission) with the authority to impose Federal speculative position limits. In doing so, Congress expressly observed the potential for market disruptions resulting from excessive speculative trading alone and the need for measures to prevent or minimize such occurrences. This mandate and underlying Congressional determination of its need has been re-affirmed through successive amendments to the CEA.

See

76 FR at 4754-55.

In section 737 of the Dodd-Frank Act, Congress made major changes to CEA section 4a; among other things, Congress extended the Commission's reach to the heretofore unregulated swaps market.

In doing so, Congress reinforced and reaffirmed the Commission's broad authority to set position limits to prevent undue and unnecessary burdens associated with excessive speculation. Specifically, section 4a, as amended by the Dodd-Frank Act, provides that the Commission “shall” set position limits “as appropriate” and “to the maximum extent practicable, in its discretion” in order to protect against excessive speculation and manipulation while ensuring that the markets retain sufficient liquidity for bona fide hedgers and that their price discovery functions are not disrupted.

Further, the Dodd-Frank Act amended the CEA to direct the Commission to define the relevant factors to be considered in identifying swaps that serve a “significant price discovery” function and thus become subject to position limits.

Congress also authorized the Commission to exempt persons or transactions “conditionally or unconditionally” from position limits.

In particular, Congress expanded the scope of transactions that could be subject to position limits to include swaps traded on a DCM or SEF, and swaps not traded on a DCM or SEF, but that perform or affect a significant price discovery function with respect to registered entities.

See

section 4a(a)(1) of the CEA, 7 U.S.C. 6a(a)(1). Congress also directed the Commission to establish aggregate limits on the amount of positions held in the same underlying commodity across markets for DCM contracts, FBOTs (with respect to certain linked contracts) and swaps that perform a “significant price discovery function.” section 4a(a)(6) of the CEA, 7 U.S.C. 6a(a)(6).

See

sections 4a(a)(3) to 4a(a)(5) of the CEA, 7 U.S.C. 6a(a)(3) to 6a(a)(5). Additionally, new section 4a(a)(2)(c) states that, in establishing limits, the Commission “shall strive to ensure” that FBOTs trading in the same commodity will be subject to “comparable” limits and that any limits imposed by the Commission will not cause the price discovery in the commodity to shift to FBOTs.

See

section 4a(a)(4) of the CEA, 7 U.S.C. 6a(a)(4).

See

section 4a(a)(7) of the CEA, 7 U.S.C. 6a(a)(7).

In reaffirming the Commission's broad authority to set position limits, Congress also made clear that the Commission must impose them expeditiously. Under amended section 4a(a)(2), Congress directed that the Commission “shall” establish limits on the amount of positions, as appropriate, that may be held by any person in physical commodity futures and options contracts traded on a DCM. In section 4a(a)(5), Congress directed the Commission to establish, concurrently with the limits established under section 4a(a)(2), limits on the amount of positions, as appropriate, that may be held by any person with respect to swaps that are economically equivalent to the DCM contracts subject to the required limits under section 4a(a)(2). The Commission was directed to establish the limits within 180 days after enactment for exempt commodities and 270 days after enactment for agricultural commodities.

As discussed in the proposal, the Commission construes the amended CEA to mandate the Commission to impose position limits at the level it determines to be appropriate to diminish, eliminate, or prevent excessive speculation and market manipulation.

In setting such limits, the Commission is not required to find that an undue burden on interstate commerce resulting from excessive speculation exists or is likely to occur. Nor is the Commission required to make an affirmative finding that position limits are necessary to prevent sudden or unreasonable fluctuations in prices. Instead, the Commission must set position limits prophylactically, according to Congress' mandate in section 4a(a)(2), and, in establishing the limits Congress has required, exercise its discretion to set a limit that, to the maximum extent practicable, will, among other things, “diminish, eliminate, or prevent excessive speculation.”

See

76 FR at 4754.

Section 4a(a)(3)(B)(i) of the CEA, 7 U.S.C. 6a(a)(3)(B)(i).

Commenters were divided on the scope of the Commission's authority under CEA section 4a. A number of commenters supported the view that the Dodd-Frank Act, in extending the Commission's authority to swaps, imposed on the Commission a mandatory obligation to impose position limits.

For example, Professor Michael Greenberger stated that “[s]ection 737 emphatically provides that 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[.]' The language could not be clearer. The Commission is

required to establish position limits

as Congress intentionally used the word, `shall,' to impose the mandatory obligation.”

Professor Greenberger further noted, “the plain reading of the phrase `as appropriate' modifies only those position limits mandated to be imposed,

i.e.,

the mandatory position limits must be promulgated `as appropriate.' The term `as appropriate' does not modify the heavily emphasized

mandate that there `shall' be position limits.”

See e.g.,

American Public Gas Association (“APGA”) on March 28, 2011 (“CL-APGA”) at 2-3; Americans for Financial Reform (“AFR”) on March 28, 2011 (“CL-AFR”) at 5; U.S. Senator Harkin on December 15, 2010 (“CL-Sen. Harkin”).

See also

CL-PMAA/NEFI

supra

note 6 at 4-5.

CL-Prof. Greenberger

supra

note 6 at 4 (emphasis added).

Id.

at 5. In addition, Professor Greenberger noted that

Section 719 of the Dodd-Frank Act specifically requires the Commission `to conduct a study of the effects of the position limits imposed pursuant to the other provisions of this title on excessive speculation and on the movement of transactions.' The Commission is required to submit the report `within 12 months after the imposition of position limits pursuant to the other provisions of this title.' Why would Congress specifically require the Commission to submit a report after imposing position limits if it had provided by statute (as opponents of position limits mistakenly argue) that the data must be available before the position limit rule is finally promulgated? The short answer is that Congress clearly understood the imminent danger excessive speculation and passive betting on price direction had caused by uncontrollable increases in the prices of energy and agricultural commodities. Therefore, the Commission is statutorily obligated to impose the `appropriate' position limits.

Id.

at 6-7.

Other commenters expressed similar views, asserting that the Commission is not required to demonstrate price fluctuations caused by excessive speculation or the efficacy of position limits in reducing excessive speculation or market manipulation. The Petroleum Marketers Association of America and the New England Fuel Institute (“PMAA/NEFI”) in a joint comment letter argued, for example, that

the purpose of position limits is not to punish past wrongdoing, but rather to deter and prevent potential future dysfunctions in the commodity staples derivatives markets and to prevent harm to market participants and burdens on interstate commerce. Because the purpose of position limits is to prevent future violations, the Commission should not be required to appreciate the complete and precise level of excessive speculation prior to taking action.”

CL-PMAA/NEFI

supra

note 6 at 5.

See also

Delta Airlines, Inc. (“Delta”) on March 28, 2011 (“CL-Delta”) at 11. Delta believes that the Commission should instead strive to establish meaningful speculative position limits using sampling and other statistical techniques to make reasonable, working assumptions about positions in various market segments and refining the speculative limits based upon market experience and better data as it is developed.

See also

CL-Sen. Harkin

supra

note 17 at 1 (opposing any delay in the implementation of position limits); and 56 National coalitions and organizations and 28 International coalitions and organizations from 16 countries (“ICPO”) on March 28, 2011 (“CL-ICPO”) at 1 (stating that the proposal regarding position limits should be implemented fully).

On the other hand, numerous commenters posited that the Commission did not adequately demonstrate, or perform sufficient analysis establishing, the need for or appropriateness of the proposed limits and related requirements.

For example, according to the CME Group, Inc. (“CME”),

See e.g.,

CL-CME I

supra

note 8; Commodity Markets Council (“CMC”) on March 28, 2011 (“CL-CMC”); PIMCO on March 28, 2011 (“CL-PIMCO”); Edison Electric Institute (“EEI”) and Electric Power Supply Association (“EPSA”) on March 28, 2011 (“CL-EEI/EPSA”); BlackRock, Inc. (“BlackRock”) on March 28, 2011 (“CL-BlackRock”); International Working Group on Trade-Finance Linkages (“IWGTFL”) on March 28, 2011(“CL-IWGTFL”); Coalition of Physical Energy Companies (“COPE”) on March 28, 2011 (“CL-COPE”); Utility Group on March 28, 2011 (“CL-Utility Group”);ISDA/SIFMA on March 28, 2011 (“CL-ISDA/SIFMA”); Futures Industry Association (“FIA I”) on March 25, 2011 (“CL-FIA I”); Katten Muchin Rosenman LLP (“Katten”) on March 31, 2011 (“CL-Katten”); Colorado Public Employees' Retirement (“PERA”) on March28, 2011 (“CL-PERA”); American Petroleum Institute (“API”) on March 28, 2011 (“CL-API”); Sullivan & Cromwell LLP (“Centaurus Energy”) on March 28, 2011 (“CL-Centaurus Energy”); ICI on March 28, 2011 (“CL-ICI”); Morgan Stanley on March 28, 2011 (“CL-Morgan Stanley”); Asset Management Group (“AMG”), Securities Industry and Financial Markets Association (“SIFMA”) on April 5, 2011(“CL-SIFMA AMG I”); World Gold Council (“WGC”) on March 28, 2011 (“CL-WGC”); and Managed Funds Association (“MFA”) on March 28, 2011 (“CL-MFA”).

the CEA sets up a two-pronged approach for imposing limits on speculative positions. First, [under CEA section 4a(a)(1)] the Commission must `find' that any position limits are `necessary'—a directive that Congress reaffirmed in [the Dodd-Frank Act]. Second, once the Commission makes the `necessary' finding, [CEA sections 4a(a)(2)(A) and 4a(a)(3) provide that the Commission] must establish a particular position limit regime only `as appropriate'—a statutory requirement added by Dodd-Frank.”

CME argued the Commission's interpretation of section 4a(a)(1) of the CEA would render the “as the Commission finds are necessary” language a nullity, effectively replacing it with statutory language imposing a lower threshold than is found elsewhere in the CEA.

See

CL-CME I

supra

note 8 at 3, citing

Keene Corp.

United States,

508 U.S. 200, 208 (1993) (“where Congress includes particular language in one section of a statute but omits it in another * * *, it is generally presumed that Congress acts intentionally and purposely in the disparate inclusion or exclusion” quoting

Russello

United States,

464 U.S. 16, 23 (1983).

In this connection, CME and many other commenters asserted that because the Commission did not make a finding that position limits are necessary to prevent undue burdens on interstate commerce resulting from excessive speculation, it did not satisfy the pre-condition to establishing position limits.

Some of these commenters, such as the International Swaps and Derivatives Association and the Securities Industry and Financial Markets Association (“ISDA/SIFMA”) (in a joint comment letter) and the Futures Industry Association (“FIA”), argued that the Commission is directed to set position limits “as appropriate,” and “as appropriate” requires empirical evidence demonstrating that such limits would diminish, eliminate, or prevent excessive speculation. FIA claimed that in the absence of evidence concerning the impact of excessive speculation, it would be impossible to set position limits that comply with the statutory objectives of section 4a(a)(3). Similarly, Centaurus Energy Master Fund, LP (“Centaurus”) and ISDA/SIFMA commented that the “as appropriate” language in section 4a(a)(2)(A) requires factual support before imposing position limits, and that “the imposition of position limits `prophylactically' is not mandated by Dodd-Frank and is not supported by the facts.”

CL-ISDA/SIFMA,

supra

note 21 at 3; and CL-Centaurus Energy,

supra

note 21 at 2.

See also

CL-COPE

supra

note 21 at 2-3; and CL-Utility Group

supra

note 21 at 3. Along similar lines, COPE and the Utility Group opined that “the deadline of 180 days after the date of enactment in clause (B)(i) is only triggered upon a determination that such limits are appropriate. Congress unambiguously modified the word `shall' with the requirement that limits only be established `as appropriate.”

Id.

CME also contended that imposing position limits on “economically equivalent swaps” would be counter to Dodd-Frank because it will encourage market participants to enter into bespoke, uncleared, non-DCM or SEF-traded swaps.

Finally, CME and other commenters, suggested that position limits and position accountability levels should be set and administered by futures exchanges.

CL-CME I,

supra

note 8 at 11.

Upon careful consideration of the commenters' views, the Commission reaffirms its interpretation of amended section 4a. The Commission disagrees that it must first determine that position limits are necessary before imposing them or that it may set limits only after it has conducted a complete study of the swaps market. Congress did not give the Commission a choice. Congress directed the Commission to impose position limits and to do so expeditiously.

Section 4a(a)(2)(B) states that the limits for physical commodity futures and options contracts “shall” be established within the specified timeframes, and section 4a(a)(2)(5) states that the limits for economically equivalent swaps “shall” be established concurrently with the limits required by section 4a(a)(2). The congressional directive that the Commission set position limits is further reflected in the repeated references to the limits “required” under section 4a(a)(2)(A).

Section 4a(a)(6) similarly states, without qualification, that the Commission “shall” establish aggregate position

limits.

While some commenters seize on the phrase “as appropriate,” which appears in sections 4a(a)(2)(A), 4a(a)(3), and 4a(a)(5), that phrase, when considered in the context of the position limits provisions as a whole, is most sensibly read as directing the Commission to exercise its discretion in determining the extent of the limits that Congress required the Commission to impose.

See also

CL-Sen. Harkin,

supra

note 17 at 1 (opposing any delay in the implementation of position limits); and CL-ICPO,

supra

note 20 at 1 (stating that the Proposed Rules regarding position limits should be implemented fully).

See

sections 4a(a)(2)(B)(i)-(ii), 4a(a)(2)(C), and 4a(a)(3) of the CEA, 7 U.S.C. 6a(a)(2)(B)(i)-(ii), 6a(a)(2)(C), 6a(a)(3).

Section 4a(a)(6) of the CEA directs the Commission to impose aggregate limits for contracts based on the same underlying commodity across: (a) DCM contracts, (b) FBOT contracts offered via direct access from inside the United States that are linked to contracts listed on a registered entity; and (c) swap contracts that perform or affect a significant price discovery function (“SPDF”) with respect to registered entities. 7 U.S.C. 6a(a)(6). Although the scope of SPDF swaps is currently limited to economically equivalent swaps discussed herein, the Commission intends to address in a subsequent rulemaking, as was discussed in the proposal, a process by which SPDF swaps can be identified.

See

Position Limits for Derivatives, 76 FR 4752, 4753, Jan. 26, 2011.

Section 719 of the Dodd-Frank Act requires the Commission to submit a report on the effects of the position limits imposed pursuant to the other provisions of this title. Such a provision gives further support to the Commission's view that Congress mandated that the Commission impose position limits, setting levels as appropriate, because the reporting requirement presupposes that limits will be imposed. Congress did not intend the Commission to have to demonstrate that such limits are “necessary” or that position limits in general are “appropriate” before imposing them and reporting on their operation.

See also

CL-Prof. Greenberger

supra

note 6 at 6-7.

In accordance with the statutory mandate, the Commission has established position limits and has exercised its discretion to set position limit levels to further the congressional objectives set out in section 4a(a)(3)(B) based upon the Commission's experience with existing position limits.

In adding section 4a(a)(3)(B), Congress reaffirmed the Commission's broad discretion to fix position limit levels (and to adopt related requirements) aimed at combating excessive speculation and market manipulation, while also protecting market liquidity (for bona fide hedgers) and price discovery. The provision reflects the Commission's historical approach to setting position limits, and it is consistent with the longstanding congressional directive in section 4a(a)(1) that the Commission set position limits in its discretion to prevent or minimize burdens that could result from excessive speculative trading.

The Commission has applied those limits to specified Referenced Contracts based on their high levels of open interest and significant notional value or their capacity to serve as a reference price for a significant number of cash market transactions.

Consistent with the congressional findings and objectives, the Commission has previously set position limits without finding excessive speculation or an undue burden on interstate commerce, and in so doing has expressly stated that such additional determinations by the Commission were not necessary in light of the congressional findings in section 4a of the Act. In its 1981 rulemaking to require all exchanges to adopt position limits for commodities for which the Commission itself had not established limits, the Commission stated, in response to similar comments that it had not made any factual determinations that excessive speculation had occurred or analytically demonstrated that the proposed limits were necessary to prevent excessive speculation in the future:

[T]he prevention of large or abrupt price movements which are attributable to the extraordinarily large speculative positions is a congressionally endorsed regulatory objective of the Commission. Further, it is the Commission's view that this objective is enhanced by the speculative position limits since it appears that the capacity of any contract to absorb the establishment and liquidation of large speculative positions in an orderly manner is related to the relative size of such positions,

i.e.,

the capacity of the market is not unlimited.

Establishment of Speculative Position Limits, 46 FR 50938, Oct. 16, 1981 (adopting then § 1.61 (now part of § 150.5)). The Commission reiterated this point in the proposed rulemaking in early 2010, before enactment of the Dodd-Frank Act. Federal Speculative Position Limits for Referenced Energy Contracts and Associated Regulations,75 FR 4144, at 4146, 4148-49, Jan. 26, 2010 (“[t] he Congressional endorsement [in section 4a] of the Commission's prophylactic use of position limits rendered unnecessary a specific finding that an undue burden on interstate commerce had actually occurred” because section 4a(a) represents an explicit Congressional finding that extreme or abrupt price fluctuations attributable to unchecked speculative positions are harmful to the futures markets and that position limits can be an effective prophylactic regulatory tool to diminish, eliminate or prevent such activity”); withdrawn, 75 FR 50950, Aug. 18, 2010. During the consideration of the Dodd-Frank Act—as well as in the nearly three decades since the Commission issued its interpretation of section 4a in 1981—Congress was aware of the Commission's longstanding approach to position limits, including its interpretation that the Commission is not required to make a predicate finding prior to establishing limits. Congress did not disturb the language under which the Commission previously acted to impose position limits, and added new language that makes clear that the types of limits described in sections 4a(a)(2), (a)(5), and (a)(6) are required.

In sum, the contention that the Commission is required to demonstrate that position limits (or position limit levels) are necessary is contrary not only to the language of, and congressional objectives underlying, amended section 4a, but also to the regulatory history of position limits and to the choices Congress made in the Dodd-Frank Act in light of that history.

The Commission also notes that Congress has reauthorized the Commission several times, both before and after the Commission established a position limit regime, without making a finding that position limits were “necessary” to combat excessive speculation. In this regard, Congress was aware of the Commission's historical interpretation of section 4a and has not elected to amend the relevant text, including in the Dodd-Frank Act, of that section. If Congress intended a different interpretation, Congress would have amended the language of section 4a.

See Commodity Futures Trading Commission

Schor,

478 U.S. 833, 846 (1986) (“It is well established that when Congress revisits a statute giving rise to a longstanding administrative interpretation without pertinent change, the `congressional failure to revise or repeal the agency's interpretation is persuasive evidence that the interpretation is the one intended by Congress'”) citing

NLRB

Bell Aerospace Co.,

416 U.S. 267, 274-275 (1974).

For the reasons stated above, and for the reasons provided in the proposal, the Commission finds that it has authority under CEA section 4a, as amended by the Dodd-Frank Act, to impose the position limits herein.

Some commenters submitted a number of studies and reports addressing the issue of whether position limits are effective or necessary to address excessive speculation. For the reasons explained above, the Commission is not required to make a finding as to whether position limits are effective or necessary to address excessive speculation. Accordingly, these studies and reports do not present facts or analyses that are material to the Commission's determinations in finalizing the Proposed Rules. A discussion of these studies is provided in section III A

infra.

B. Referenced Contracts

The Commission identified 28 Core Referenced Futures Contracts and proposed to apply aggregate limits on a futures equivalent basis across all derivatives that are (i) Directly or indirectly linked to the price of a Core Referenced Futures Contract; or (ii) based on the price of the same underlying commodity for delivery at the same delivery location as that of a Core Referenced Futures Contract, or another delivery location having substantially the same supply and demand fundamentals (such derivative products are collectively defined as “Referenced Contracts”).

These Core Referenced Futures Contracts were selected on the basis that such contracts: (1) Have high levels of open interest and significant notional value; or (2) serve as a reference price for a significant number of cash market transactions.

76 FR at 4752, 4753. These Core Referenced Futures Contracts are: Chicago Board of Trade (“CBOT”) Corn, Oats, Rough Rice, Soybeans, Soybean Meal, Soybean Oil and Wheat; Chicago Mercantile Exchange Feeder Cattle, Lean Hogs, Live Cattle and Class III Milk; Commodity Exchange, Inc. Gold, Silver and Copper; ICE Futures U.S. Cocoa, Coffee C, FCOJ-A, Cotton No.2, Sugar No. 11 and Sugar No. 16; Kansas City Board of Trade (“KCBT”) Hard Winter Wheat; Minneapolis Grain Exchange Hard Red Spring Wheat; and New York Mercantile Exchange Palladium, Platinum, Light Sweet Crude Oil, New York Harbor No. 2 Heating Oil, New York Harbor Gasoline Blendstock and Henry Hub Natural Gas.

Edison Electric Institute and the Electric Power Supply Association argued that the Commission did not provide a reasoned explanation for selecting the 28 Referenced Contracts.

Other commenters requested that the Commission clarify the definition of Referenced Contracts or restrict it to

those contracts sharing a common delivery point.

CL-EEI/EPSA,

supra

note 21 at 5.

Alternative Investment Management Association (“AIMA”) on March 28, 2011 (“CL-AIMA”) at 2; CL-API

supra

note 21 at 5; BG Americas & Global LNG (“BGA”) on March 28, 2011 (“CL-BGA”) at 18; Chris Barnard on March 28, 2011 at 1; CL-COPE

supra

note 21 at 6; CL-ISDA/SIFMA

supra

note 21 at 20; Shell Trading (“Shell”) on March 28, 2011 (“CL-Shell”) at 7-8; CL-Utility Group

supra

note 21 at 7; and Working Group of Commercial Energy Firms (“WGCEF”) on March 28, 2011 (“CL-WGCEF”) at 22.

Some commenters argued that the Commission should narrow the definition of economically equivalent swaps to cleared swaps.

Conversely, other commenters asked the Commission to broaden its definition of Referenced Contracts. For example, Better Markets asked the Commission to consider a “market-based approach” to determine whether to include a contract within a Referenced Contract category, including hedging relationships used by market participants, cross-contract netting practices of clearing organizations, enduring price relationships, and physical characteristics.

CL-API,

supra

note 21 at 13; and CL-BGA,

supra

note 35 at 18. American Petroleum Institute explained that extending the definition of “Referenced Contract” beyond standardized cleared contracts would not be cost-effective. Similarly, BGA argued that because the Commission cannot identify uncleared contracts until they are executed, the scope of economically equivalent swaps should be limited to only those that are cleared.

Better Markets, Inc. (“Better Markets”) on March 28, 2011 (“CL-Better Markets”) at 68-69.

The Edison Electric Institute and Electrical Power Suppliers Association opined that the Commission should allow market participants to define what constitutes an economically equivalent contract consistent with commercial practices and to allow for a good-faith exemption for market participants relying on their own determination consistent with Commission guidance.

ISDA/SIFMA argued that the Commission should ensure that the concept of an economically equivalent derivative contract covers contracts whose correlation with futures can be established through accepted models that address features such as maturity, payout structure, locations basis, product basis,

etc.

CL-EEI/EPSA,

supra

note 21 at 12.

CL-ISDA/SIFMA

supra

note 21 at 23.

The proposed § 151.1 definition of Referenced Contract excluded basis contracts and commodity index contracts.

Proposed § 151.1 defined basis contract as those contracts that are “cash settled based on the difference in price of the same commodity (or substantially the same commodity) at different delivery points.” Commodity index contracts were defined in the proposal as contracts that are “based on an index comprised of prices of commodities that are not the same nor [sic] substantially the same.” The proposal further excluded intercommodity spread contracts,

calendar spread contracts, and basis contracts from the definition of “commodity index contract.” Many commenters appeared to interpret the proposal as subjecting positions in basis contracts or commodity index contracts to the position limits set forth in proposed § 151.4.

The Coalition of Physical Energy Companies and the Utility Group found that the definition of Referenced Contract was “vague” and “clearly extraordinarily broad” because, inter alia, it appeared to include some over-the-counter (“OTC”) swaps that utilized a Core Referenced Futures Contract price as a component of a floating price calculation.

The Coalition of Physical Energy Companies and the Utility Group opined that even if the proposed class of Referenced Contracts that are priced based on “locations with substantially the same supply and demand fundamentals, as that of any Core Referenced Futures Contract” it is unclear whether the definition of Referenced Contract extends to “those [swaps] that are actually economically equivalent,

e.g.,

look alikes.”

The proposed definition of a Referenced Contract included contracts (i) Directly or indirectly linked, including being partially or fully settled on, or priced at a differential to, the price of any Core Referenced Futures Contract; or (ii) directly or indirectly linked, including being partially or fully settled on, or priced at a differential to, the price of the same commodity for delivery at the same location, or at locations with substantially the same supply and demand fundamentals, as that of any Core Referenced Futures Contract.

Proposed § 151.1 defined “intercommodity spread” contracts as those contracts that “represent[] the difference between the settlement price of a Referenced Contract and the settlement price of another contract, agreement, or transaction that is based on a different commodity.”

See e.g.,

CL-Utility Group

supra

note 21 at 7-8; CL-COPE

supra

note 21 at 6; Commercial Alliance (“Commercial Alliance I”) on June 5, 2011 (“CL-Commercial Alliance I”) at 5-10 (arguing for the extension of the bona fide hedge exemption for physical market transactions and anticipated physical market transactions that could be hedged with a basis contract position).

CL-Utility Group

supra

note 21 at 7-8 (arguing that “virtual tolling swaps” that utilize a Referenced Contract-derived price series as a component of a floating price appear to be covered by the definition of “Referenced Contract”); and CL-COPE

supra

note 21 at 6.

Id.

The Commission is adopting the proposal regarding Referenced Contracts with modifications and clarifications responsive to the comments. The Commission clarifies that the term “Referenced Contract” includes: (1) The Core Referenced Futures Contract; (2) “look-alike” contracts (

i.e.,

those 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); (3) contracts with a reference price 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 as that underlying the relevant Core Referenced Futures Contract;

and (4) intercommodity spreads with two components, one or both of which are Referenced Contracts. These criteria capture contracts with prices that are or should be closely correlated to the prices of the Core Referenced Futures Contract.

E.g.,

a swap with a floating price based on the average of the settlement price of the New York Mercantile Exchange (“NYMEX”) Light, Sweet Crude Oil futures contract and the settlement price of the IntercontinentalExchange (“ICE”) Brent Crude futures contract.

Under amended section 4a(a)(1), the Commission is required to establish aggregate position limits on contracts based on the same underlying commodity, including those swaps that are not traded on a DCM or SEF but which are determined to perform or affect a significant price discovery function (“SPDF”). 7 U.S.C. 6a(a)(1). The Commission currently lacks the data necessary to evaluate the pricing relationships between potential SPDF swaps and Referenced Contracts and therefore has determined not to set forth, at this time, standards for determining significant price discovery function swaps. As the Commission gathers additional data on the effect of position limits on the 28 Referenced Contracts and these contracts' relationship with other contracts, it could, in its discretion, extend position limits to additional contracts beyond the current set of Referenced Contracts. The Commission could determine, for example, that a contract, due to certain shared qualitative or quantitative characteristics with Referenced Contracts, performs a SPDF with respect to Referenced Contracts.

In response to commenters, the Commission is eliminating a proposed category of Referenced Contracts, namely, those based on “substantially the same supply and demand fundamentals.” The Commission notes that the “substantially the same supply and demand fundamentals” criterion would require individualized evaluation of certain trading data to determine whether the price of a commodity may or may not be substantially related to a Core Referenced Futures Contract. Such analysis may require access to, among other things, data concerning bids and offers and transaction information regarding the cash market, which are not readily available to the Commission at this time.

The remaining categories of Referenced Contract,

i.e.,

derivatives that are directly or indirectly linked to or based on the same commodity for delivery at the same delivery location as

a Core Referenced Futures Contract, are based on objective criteria and readily available data, which should provide market participants with clarity as to the scope of economically equivalent contracts.

The Commission clarifies that if a swap contract that utilizes as its sole floating reference price the prices generated directly or indirectly

from the price of a single Core Referenced Futures Contract, then it is a look-alike Referenced Contract and subject to the limits set forth in § 151.4.

If such a swap is priced based on a fixed differential to a Core Referenced Futures Contract, it is similarly a Referenced Contract.

In finalizing the Commission's Large Trader Reporting for Physical Commodity Swaps rulemaking, and also in response to comments, the Commission modified the proposed definition of “paired swap” to exclude contracts based on the same commodity at different locations with substantially the same supply and demand fundamentals as that of any Core Referenced Futures Contract.

See

76 FR 43855, Jul. 22, 2011.

An “indirect” price link to a Core Referenced Futures Contract includes situations where the swap reference price is linked to prices of a cash-settled Referenced Contract that itself is cash-settled based on a physical-delivery Referenced Contract settlement price.

The Commission clarifies, by way of example, that a swap based on the difference in price of a commodity (or substantially the same commodity) at different delivery locations is a “basis contract” and therefore not subject to the limits set forth in § 151.4. In addition, if a swap is based on prices of multiple different commodities comprising an index, it is a “commodity index contract” and therefore is not subject to the limits set forth in § 151.4. In contrast, if a swap is based on the difference between two prices of two different commodities, with one linked to a Core Referenced Futures Contract price (and the other either not linked to the price of a Core Referenced Futures Contract or linked to the price of a different Core Referenced Futures Contract), then the swap is an “intercommodity spread contract,” is not a commodity index contract, and is a Referenced Contract subject to the position limits specified in § 151.4. The Commission further clarifies that a contract based on the prices of a Referenced Contract and the same or substantially the same commodity (and not based on the difference between such prices) is not a commodity index contract and is a Referenced Contract subject to position limits specified in § 151.4.

The Commission has clarified in its definition of “Referenced Contract” that position limits extend to contracts traded at a fixed differential to a Core Referenced Futures Contract (

e.g.,

a swap with the commodity reference price NYMEX Light, Sweet Crude Oil +$3 per barrel is a Referenced Contract) or based on the same commodity at the same delivery location as that covered by the Core Referenced Futures Contract, and not to unfixed differential contracts (

e.g.,

a swap with the commodity reference price Argus Sour Crude Index is not a Referenced Contract because that index is computed using a variable differential to a Referenced Contract).

With respect to comments that the Commission should broaden the scope of Referenced Contracts, the Commission notes that expanding the scope of position limits based, for example, on cross-hedging relationships or other historical price analysis would be problematic. Historical relationships may change over time and, additionally, would require individualized determinations. For example, if the standard for determining economic equivalence was some level of historical correlation, then a commodity derivative might have met the correlation metric yesterday, fail it today, and again meet the metric tomorrow.

Under these circumstances, the Commission does not believe that it is necessary to expand the scope of position limits beyond those proposed. In this regard, the Commission notes that the commenters did not provide specific criteria or thresholds for making determinations as to which price-correlated commodity contracts should be subject to limits.

The Commission further notes that it would consider amending the scope of economically equivalent contracts (and the relevant identifying criteria) as it gains experience in this area. For clarity, the Commission has deleted the definition of the proposed term “Referenced paired futures contract, option contract, swap, or swaption” since that term was only used in the definitions section and incorporated the relevant provisions of that proposed term into the definition of Referenced Contracts. Lastly, the Commission has made amendments in § 151.2 that clarify that “Core Referenced Futures Contracts” include options that expire into outright positions in such contracts.

Nevertheless, a trader may decide to assume the risk that the historical price relationship might not hold and enter into a cross-hedging transaction in a derivative that has been and is expected to be price-fluctuation-related to that trader's cash market commodity and seek (and obtain) a bona fide hedge exemption.

For example, the commenters did not address whether a derivatives contract on a commodity should be included if there were observed historical associated price correlations but no identified causation relationship.

C. Phased Implementation

The Commission proposed to implement the position limit rule in two phases. In the first phase, the spot-month limits for Referenced Contracts would be set at a level based on existing limits determined by the appropriate DCM. In the second phase, the spot-month limits would be adjusted on a regular schedule, set to 25 percent of the Commission's determination of estimated deliverable supply, which would be based on DCM-provided estimates or the Commission's own estimates. The Commission believes that spot-month position limits can be implemented on an advanced schedule, because such limits will initially be based on existing DCM limits or on estimates of deliverable supply for which data is available.

In the proposal, non-spot-month energy, metal, and “non-enumerated”

agricultural Referenced Contract limits would be based on open interest and would be set in the second phase pending the availability of certain positional data on physical commodity swaps.

In the final rulemaking, the term “legacy” replaced the term “enumerated” used in the proposal. The Commission has made this change in order to avoid unnecessary confusion.

As discussed in the proposal, the Commission retained the position limits for the enumerated agricultural Referenced Contracts “as an exception to the general open interest based formula.” 76 FR at 4752, 4760.

In general, commenters were divided on whether the Commission should, in whole or in part, delay the imposition of position limits. Some commenters stated that the Commission should stay or withdraw its proposal until such time that the Commission has gathered and analyzed data to determine if position limits are necessary or appropriate.

CME asserted that the Commission cannot impose spot-month limits until it has received and analyzed data on economically equivalent swaps since the limits cover such swaps.

Conversely, some commenters rejected the phased implementation of non-spot-month position limits and urged the Commission to implement such limits on a more expedited timeframe. One such commenter, Delta, argued “that the Commission should instead strive to establish meaningful speculative position limits using sampling and other statistical techniques to make reasonable, working assumptions about positions in various market segments and refining the speculative limits based upon market experience and better data as it is developed.”

The Commission also received many letters requesting that the Commission impose position limits generally on an expedited basis.

CL-FIA I,

supra

note 21 at 8; CL-COPE,

supra

note 21 at 4; CL-Utility Group,

supra

note 21 at 5; CL-EEI/EPSA

supra

note 21 at 2; CL-Centaurus Energy,

supra

note 21 at 3; CL-PIMCO

supra

note 21 at 6; CL-SIFMA AMG I,

supra

note 21 at 15-16; CL-PERA,

supra

note 21 at 2; CL-Morgan Stanley,

supra

note 21 at 1; and CL-CMC,

supra

note 21 at 2.

CL-CME I,

supra

note 8 at 7-8.

CL-Delta,

supra

note 20 at 11.

See e.g.,

Gary Krasilovsky on February 6, 2011 (“CL-Krasilovsky”); and Alan Murphy (“Murphy”) on January 6, 2011 (“CL-Murphy”).

The Commission is finalizing the phased implementation schedule generally as proposed and in furtherance of the congressional directive that the Commission establishes position limits on an

expedited timeframe. As stated above, spot-month limits, which are based on existing DCM limits and data that is available, can be implemented on an expedited timeframe. In addition, non-spot-month legacy limits do not require swap positional data to set the limits, and, thus, can be set on an expedited timeframe.

With respect to non-spot-month limits for non-legacy Referenced Contracts, which are dependent on open interest levels and thus dependent on swaps positional data, the Commission will initially set such limits following the collection of approximately 12 months of swaps positional data.

Non-spot-month limits for agricultural contracts currently subject to Federal position limits under part 150 are referred to herein as “legacy limits.” As noted earlier, such Referenced Contracts are generally referred to as “enumerated” agricultural contracts. 17 CFR 150.2.

The Commission recently adopted reporting regulations that require routine position reports from clearing organizations, clearing members, and swap dealers.

See

76 FR 43851, Jul. 22, 2011. The swaps positional data obtained through these reports are expected to serve as a primary source for determining open interests.

1. Compliance Dates

In light of the above referenced timeframe for implementation, the compliance date for all spot-month limits and non-spot-month legacy limits shall be 60 days after the term “swap” is further defined pursuant to section 721 of the Dodd-Frank Act (

i.e.,

60 days after the further definition of “swap” as adopted by the Commission and the Securities and Exchange Commission is published by the

Federal Register

). Prior to the Commission further defining the term swap, market participants shall continue to comply with the existing position limits regime contained in part 150 and any applicable DCM position limits or accountability levels. After the compliance date, the Commission will revoke part 150, and persons will be required to comply with all the provisions of this part 151, including § 151.5 for bona fide hedging and § 151.7 related to the aggregation of accounts. For non-spot-month non-legacy Referenced Contracts, the compliance date shall be set forth by Commission order establishing such limits approximately 12 months after the collection of swap positional data.

Prior to the compliance date, persons shall continue to comply with applicable exchange-set position limits and accountability levels.

Although the Commission proposed to revoke part 150 in the Proposed Rules, the Commission is retaining this provision until the compliance dates set forth above.

2. Transitional Compliance

As discussed below in detail in section II.B. of this release, § 151.1 excludes “basis contracts” and “commodity index contracts” from the definition of Referenced Contract. However, part 20 of the Commission's regulations requires reporting entities to report commodity reference price data sufficient to distinguish between basis and non-basis swaps and between commodity index contract and non-commodity index contract positions in covered contracts.

Therefore, the Commission intends to rely on the data elements in § 20.4(b) to distinguish data records subject to § 151.4 position limits from those contracts that are excluded from § 151.4. This will enable the Commission to set position limits using the narrower data set (

i.e.,

Referenced Contracts subject to § 151.4 position limits) as well as conduct surveillance using the broader data set.

See

§ 20.2, 17 CFR 20.11 for a list of covered contracts.

In addition, § 151.9 provides that traders may determine to either exclude (

i.e.,

not aggregate) or net their pre-existing swap positions (as discussed below), while part 20 does not require a distinction to be made for reporting pre-existing swap positions. The Commission believes it is appropriate to include pre-existing swap positions in the basis for setting position limits and, thus, the part 20 data collection will provide this broader data set. This is because limits based on a narrower data set (that is, excluding pre-existing swaps) may be overly restrictive and, thus, may not provide adequate liquidity for bona fide hedgers, in light of the biennial reset of most non-spot-month position limits under § 151.4(d)(3). Nonetheless, and consistent with the statutory exclusion of swaps pre-existing the Dodd-Frank Act, position limits will not apply to such pre-existing swap positions.

While requiring reporting entities to submit data sufficient to allow the Commission to distinguish pre-existing positions from other positions would be helpful to the Commission, the Commission does not currently believe it would be cost-effective to impose this requirement broadly as it would require reporting entities to revisit transaction trade confirmation records that may or may not be readily linked to position-tracking databases. Moreover, the Commission could develop a reasonable estimate of the extent of a trader's pre-existing positions by comparing their positions as of the effective date with the positions held on a date in interest (

e.g.,

when a trader appears to establish a position exceeding a position limit).

The Commission understands that most uncleared swaps are executed opposite a clearing member or swap dealer and would therefore result in positions reportable to the Commission under part 20. Part 20 reports will not provide data on positions where neither party to a swap is a clearing member or swap dealer, but these positions represent a small fraction of all uncleared swaps. Since most uncleared swaps will be reportable under part 20, the Commission believes the swaps' data set will be adequate to set position limits.

Proposed § 151.4(e)(3) based the uncleared swap component of the open interest figure used to set non-spot-month position limits on open interest attributed to swap dealers. Section 20.4 requires position reporting from swap dealers as well as clearing organizations and clearing members. Final rule § 151.4(b)(2)(ii) permits estimation of the uncleared swap component using clearing organization or clearing member data obtained under § 20.4 reports.

In order to determine a trader's compliance with position limits in light of the pre-existing position exemption and the sampling inherent in requiring swap position data reporting from clearing members and swap dealers, the Commission will utilize one existing and one new means to conduct the necessary market surveillance. First, the Commission may issue special calls under § 20.6(b) in instances where traders appear to have positions exceeding part 151 position limits. Traders subject to these special calls would then be afforded an opportunity to provide information on their positions demonstrating compliance with a part 151 position limit. Second, the Commission notes that traders are required to provide position visibility on their uncleared swaps positions under § 151.6(c) in 401 filings that would reflect all of their uncleared swap positions in Referenced Contracts as well as their total positions in Referenced Contracts, irrespective of whether these swaps were executed opposite a clearing member or swap dealer. These filings would allow the Commission to determine whether the trader is in compliance with part 151 position limits. The Commission clarifies that such 401 filings require the reporting of gross long and gross short positions in Referenced Contracts, excluding those positions that are not included in the definition of Referenced Contracts (

e.g.,

excluding those positions arising from basis contract positions, pre-existing swap positions, and diversified commodity index positions).

See supra

under II.B. discussing the definition of Referenced Contract.

D. Spot-Month Limits

Proposed § 151.4 would apply spot-month position limits separately for physically-delivered contracts and cash-settled contracts (

i.e.,

cash-settled

futures and swaps).

A trader could therefore hold positions up to the spot-month position limit in both the physical-delivery and cash-settled contracts but a trader could not net cash-settled contracts with the physical-delivery contracts.

The proposed spot-month position limits for physical-delivery Core Referenced Futures Contracts initially would be set at existing DCM levels; cash-settled Referenced Contracts would be subject to limits set at the same level. As discussed above, during the second phase of implementation, the spot-month limits would be based on 25 percent of estimated deliverable supply, as determined by the Commission in consultation with DCMs. The Commission has determined to adopt the spot-month limits substantially as proposed but with certain changes to address commenters' concerns.

For the ICE Futures U.S. Sugar No. 16 (SF) and CME Class III Milk (DA), the Commission proposed to adopt the DCM single-month limits for the nearby month or first-to-expire Referenced Contract as spot-month limits. These contracts currently have single-month limits that are enforced in the spot month.

Thus, for example, if the spot-month limit for a Referenced Contract is 1,000 contracts, then a trader could hold up to 1,000 contracts long in the physical-delivery contract and 1,000 contracts long in the cash-settled contract. However, the same trader could not hold 1,001 contracts long in the physical-delivery contract and hold 1 contract short in the cash-settled and remain under the limit for the physical-delivery contract. A trader's cash-settled contract position would be a function of the trader's position in Referenced Contracts based on the same commodity that are cash-settled futures and swaps. For purposes of applying the limits, a trader shall convert and aggregate positions in swaps on a futures equivalent basis consistent with the guidance in the Commission's Appendix A to Part 20, Large Trader Reporting for Physical Commodity Swaps.

See

76 FR 43851, 43865 Jul. 22, 2011.

1. Definition of “Deliverable Supply”

In the proposal, the Commission defined “deliverable supply” generally as “the quantity of the commodity meeting a derivative contract's delivery specifications that can reasonably be expected to be readily available to short traders and saleable by long traders at its market value in normal cash marketing channels at the derivative contract's delivery points during the specified delivery period, barring abnormal movement in interstate commerce.”

Several commenters supported “deliverable supply” as an appropriate basis for spot-month limits for physical-delivery contracts.

Other commenters disagreed, stating that “deliverable supply” was inappropriate, even for physical-delivery contracts, because it would result in overly stringent limits.

ISDA/SIFMA suggested that the Commission instead base spot-month limits on “available deliverable supply,” a broader measure of physical supply.

76 FR at 4752, 4757.

See

CL-AFR

supra

note 17 at 7-8; CL-AIMA

supra

note 35 at 2; CL-Prof. Greenberger

supra

note 6 at 17; InterContinental Exchange, Inc. (“ICE I”) on March 28, 2011 (“CL-ICE I”) at 5; and Natural Gas Exchange (“NGX”) on March 28, 2011 (“CL-NGX”) at 3.

CL-ISDA/SIFMA

supra

note 21 at 21; and CL-FIA I

supra

note 21 at 9.

“Available deliverable supply” includes: (1) All available local supply (including supply committed to long-term commitments); (2) all deliverable non-local supply; and (3) all comparable supply (based on factors such as product and location).

See

CL-ISDA/SIFMA

supra

note 21 at 21. Another commenter, the Alternative Investment Management Association, similarly advocated a more expansive definition of “deliverable supply.” CL-AIMA

supra

note 35 at 3 (“This may include all supplies available in the market at all prices and at all locations, as if a party were seeking to buy a commodity in the market these factors would be relevant to the price.”)

Similarly, two commenters suggested that the Commission include supply committed to long-term supply contracts in its definition of “deliverable supply” to avoid artificially reduced spot-month position limits.

In the Commission's experience overseeing the position limits established at the exchanges as well as federally-set position limits, “spot-month speculative position limits levels are `based most appropriately on an analysis of current deliverable supplies and the history of various spot-month expirations.' ”

National Grain and Feed Association (“NGFA”) on March 28, 2011 (“CL-NGFA”) at 5; and CL-CME I

supra

note 8 at 9 (suggesting that if the Commission decides to retain this exclusion, it should define what it understands a “long-term” agreement to be and ensure consistency with the deliverable supply definition in the Core Principles and Other Requirements for Designated Contract Markets proposed rulemaking).

Id.

citing Appendix C of Part 38, 75 FR 80572, 80631, Dec. 22, 2010. (In Appendix C, the Commission states that commodity supplies that are “committed to some commercial use” should be excluded from deliverable supply, and requires DCMs to consult with market participants to estimate these supplies on a monthly basis).

64 FR 24038, 24039, May 5, 1999.

Other commenters argued that “deliverable supply” should not be the basis for position limits on cash-settled Referenced Contracts.

Niska, for example, asked the Commission to explain why spot-month limits for cash-settled contracts should be linked to deliverable supply.

Another commenter, BGA, opined that the Commission should set position limits for cash-settled swap Referenced Contracts based on the size of the swap market because swap contracts do not contemplate delivery of the underlying contract and therefore are not “tied to the physical limits of the market.”

Minneapolis Grain Exchange, Inc. (“MGEX”) on March 28, 2011 (“CL-MGEX”) at 4; CL-MFA

supra

note 21 at 16; Niska Gas Storage LLC (“Niska”) on March 28, 2011 (“CL-Niska”) at 2.

See also

CL-AIMA

supra

note 35 at 2 (asking the Commission to reconsider position limits on cash-settled contracts).

CL-Niska

supra

note 75 at 2.

CL-BGA

supra

note 35 at 19.

See also

Cargill, Incorporated (“Cargill”) on March 28, 2011 (“CL-Cargill”) at 13 (urging the Commission to study the impact of applying any position limit based on “deliverable supply” to the swaps market).

The Commission finds that the use of deliverable supply to set spot-month limits is wholly consistent with its historical approach to setting spot-month limits and overseeing DCMs' compliance with Core Principles 3 and 5.

Currently, in determining whether a physical-delivery contract complies with Core Principle 3, the Commission staff considers whether the specified contract terms and conditions may result in a deliverable supply that is sufficient to ensure that the contract is not conducive to price manipulation or distortion. In this context, the term “deliverable supply” generally means the quantity of the commodity meeting a derivative contract's delivery specifications that can reasonably be expected to be readily available to short traders and saleable by long traders at its market value in normal cash marketing channels at the derivative contract's delivery points during the specified delivery period, barring abnormal movement in interstate commerce.

The spot-month limit pursuant to Core Principle 5 is similarly established based on the analysis of deliverable supplies. The Acceptable Practices for Core Principle 5 state that, with respect to physical-delivery contracts, the spot-month limit should not exceed 25 percent of the estimated deliverable supply.

Lastly, with

respect to cash-settled contracts on agricultural and exempt commodities, the spot-month limit is set at some percentage of calculated deliverable supply. Accordingly, the Commission is adopting deliverable supply as the basis of setting spot-month limits. In response to commenters, the Commission added § 151.4(d)(2)(iv) to clarify that, for purposes of estimating deliverable supply, DCMs may use any guidance issued by the Commission set forth in the Acceptable Practices for Core Principle 3.

Core Principle 3 specifies that a board of trade shall list only contracts that are not readily susceptible to manipulation, while Core Principle 5 obligates a DCM to establish position limits or position accountability provisions where necessary and appropriate “to reduce the threat of market manipulation or congestion, especially during the delivery month.”

See e.g.,

the discussion of deliverable supply in Guideline No. 1. 17 CFR part 40, app. A.

See also

the discussion of deliverable supply in the first publication of Guideline No. 1. 47 FR 49832, 49838, Nov. 3, 1982.

Indeed, with three exceptions, the § 151.2-listed contracts with DCM-defined spot months are currently subject to exchange-set spot-month position limits, which would have been established in this manner. The only contracts based on a physical commodity that currently do not have spot-month limits are the COMEX mini-sized gold, silver, and copper contracts that are cash settled based on the futures settlement prices of the physical-delivery contracts. The cash-settled contracts have position accountability provisions in the spot month, rather than outright spot-month limits. These cash-settled contracts have relatively small levels of open interest.

2. Twenty-Five Percent as the Deliverable Supply Formula

ICE commented that spot-month limits for physical-delivery contracts (but not cash-settled contracts) set at 25 percent of deliverable supply are necessary to prevent corners and squeezes.

Other commenters, however, opined that spot-month position limits based on 25 percent of deliverable supply are insufficient to prevent excessive speculation.

Americans for Financial Reform (“AFR”), for example, argued that while “deliverable supply” is an appropriate basis for setting spot-month limits,

the proposed spot-month limit addresses manipulation by a single actor and would not be set low enough to combat excessive speculation in the market as a whole and the volatility and delinking of commodities prices from economic fundamentals caused by excessive speculation.

Some commenters recommended that the Commission set the spot-month limits based on the “individual characteristics” of each Core Referenced Futures Contract, and not necessarily an exchange's deliverable supply estimate.

CL-ICE I

supra

note 69 at 5.

CL-AFR

supra

note 17 at 5; American Trucking Association (“ATA”) on March 28, 2011 (“CL-ATA”) at 3; Food & Water Watch (“FWW”) on March 28, 2011 (“CL-FWW”) at 10; National Farmers Union (“NFU”) on March 28, 2011 (“CL-NFU”) at 2; and CL-PMAA/NEFI

supra

note 6 at 7.

CL-AFR

supra

note 17 at 7-8.

See

CL-AFR

supra

note 17 at 5, 7.

CL-FIA I

supra

note 21 at 9; CL-ISDA/SIFMA

supra

note 21 at 21; and CL-MFA

supra

note 21 at 18.

The Commission has determined to adopt the 25 percent level of deliverable supply for setting spot-month limits. This formula is consistent with the long-standing Acceptable Practices for Core Principle 5,

which provides that, for physical-delivery contracts, the spot-month limit should not exceed 25 percent of the estimated deliverable supply. The use of the existing industry standard would provide clarity concerning the underlying methodology. Further, the Commission believes that, based on its experience, the formula has appeared to work effectively as a prophylactic tool to reduce the threat of corners and squeezes and promote convergence without compromising market liquidity.

In making an estimate of deliverable supply, the Commission reminds DCMs to take into consideration the individual characteristics of the underlying commodity's supply and the specific delivery features of the futures contract.

Core Principle 5 obligates a DCM to establish position limits and position accountability provisions where necessary and appropriate “to reduce the threat of market manipulation or congestion, especially during the delivery month.”

In this respect, the proposed limits formula is not intended to address speculation by a class or group of traders.

As under current practice, DCM estimates of deliverable supplies (and the supporting data and analysis) will be subject to Commission staff review.

3. Cash-Settled Contracts

With respect to cash-settled contracts, proposed § 151.4 incorporated a conditional spot-month limit permitting traders without a hedge exemption to acquire position levels that are five times the spot-month limit if such positions are exclusively in cash-settled contracts (

i.e.,

the trader does not hold positions in the physical-delivery Referenced Contract) and the trader holds physical commodity positions that are less than or equal to 25 percent of the estimated deliverable supply. The proposed conditional-spot-month position limits generally tracked exchange-set position limits currently implemented for certain cash-settled energy futures and swaps.

For example, the NYMEX Henry Hub Natural Gas Last Day Financial Swap, the NYMEX Henry Hub Natural Gas Look-Alike Last Day Financial Futures, and the ICE Henry LD1 swap are all cash-settled contracts subject to a conditional-spot-month limit that, with the exception of the requirement that a trader not hold large cash commodity positions, is identical in structure to the proposed limit.

Currently, with the exception of significant price discovery contracts, traders' swaps positions are not subject to position limit restrictions. The Commission is aware that counterparties to uncleared swaps may impose prudential credit restrictions that may directly (for example, by one party setting a maximum notional amount restriction that it will execute with a particular counterparty) or indirectly (for example, by one party setting a credit annex requirement such as posting of initial collateral by a counterparty) restrict the amount of bilateral transactions between the parties. However, the proposed spot month limits would be the first broad position limit régime imposed on swaps.

Several commenters questioned the application of proposed spot-month position limits to cash-settled contracts.

Some of these commenters suggested that cash-settled contracts, if subject to any spot-month position limits at all, should be subject to relatively less restrictive limits that are not based on estimated deliverable supply.

BGA, for example, argued that position limits on swaps should be set based on the size of the open interest in the swaps market because swap contracts do not provide for physical delivery.

Further, certain commenters argued that imposing a single speculative limit on all cash-settled contracts would substantially reduce the cash-settled positions that a trader can hold because currently, each cash-settled contract is subject to a separate limit.

Other commenters urged the Commission to eliminate class limits and allow for netting across futures and swaps contracts so as not to impact liquidity.

CL-ISDA/SIFMA

supra

note 21 at 6-7, 19; Goldman, Sachs & Co. (“Goldman”) on March 28, 2011 (“CL-Goldman”) at 5; CL-ICI

supra

note 21 at 10; CL-MGEX

supra

note 74 at 4 (particularly current MGEX Index Contracts that do not settle to a Referenced Contract should be considered exempt from position limits because cash-settled index contracts are not subject to potential market manipulation or creation of market disruption in the way that physical-delivery contracts might be); CL-WGCEF

supra

note 35 at 20 (“the Commission should reconsider setting a limit on cash-settled contracts as a function of deliverable supply and establish a much higher, more appropriate spot-month limit, if any, on cash-settled contracts”); CL-MFA

supra

note 21 at 16-17; and CL-SIFMA AMG I

supra

note 21 at 7.

CL-BGA

supra

note 35 at 19; CL-ICI

supra

note 21 at 10; CL-MFA

supra

note 21 at 16-17; CL-WGCEF

supra

note 35 at 20; CL-Cargill

supra

note 76 at 13; CL-EEI/EPSA

supra

note 21 at 9; and CL-AIMA

supra

note 35 at 2.

CL-BGA

supra

note 35 at 10.

See e.g.,

CL-FIA I

supra

note 21 at 10; and CL-ICE I

supra

note 69 at 6

See e.g.,

CL-ISDA/SIFMA

supra

note 21 at 8.

A number of commenters objected to limiting the availability of a higher limit in the cash-settled contract to traders not holding any physical-delivery contract.

For example, CME argued that the proposed conditional limits would encourage price discovery to migrate to the cash-settled contracts, rendering the physical-delivery contract “more susceptible to sudden price

movements during the critical expiration period.”

AIMA commented that the prohibition against holding positions in the physical-delivery Referenced Contract will cause investors to trade in the physical commodity markets themselves, resulting in greater price pressure in the physical commodity.

American Feed Industry Association (“AFIA”) on March 28, 2011 (“CL-AFIA”) at 3; CL-AFR

supra

note 17 at 6; Air Transport Association of America (“ATAA”) on March 28, 2011 (“CL-ATAA”) at 7; CL-BGA

supra

note 35 at 11-12; CL-Centaurus Energy

supra

note 21 at 3; CL-CME I

supra

note 8 at 10; CL-WGCEF

supra

note 35 at 21-22; and CL-PMAA/NEFI

supra

note 6 at 14.

CL-CME I

supra

note 8 at 10. Similarly, BGA argued that conditional limits incentivize the migration of price discovery from the physical contracts to the financial contracts and have the unintended effect of driving participants from the market and thereby increasing the potential for market manipulation with a very small volume of trades. CL-BGA

supra

note 35 at 12.

CL-AIMA

supra

note 35 at 2.

Some of these commenters, including the CME and the KCBT, argued against the proposed restriction with respect to cash-settled contracts and recommended that cash-settled Referenced Contracts and physical-delivery contracts should be subject to the same position limits.

Two commenters opined that if the conditional limits are adopted, they should be increased from five times 25 percent of deliverable supply.

ICE recommended that they be increased to at least ten times 25 percent of deliverable supply.

CL-CME I

supra

note 8 at 10; Kansas City Board of Trade (“KCBT I”) on March 28, 2011 (“CL-KCBT I”) at 4; and CL-APGA

supra

note 17 at 6, 8. Specifically, KCBT argued that parity should exist in all position limits (including spot-month limits) between physical-delivery and cash-settled Referenced Contracts; otherwise, these limits would unfairly advantage the look-alike cash-settled contracts and result in the cash-settled contract unduly influencing price discovery. Moreover, the higher spot-month limit for the financial contract unduly restricts the physical market's ability to compete for spot-month trading, which provides additional liquidity to commercial market participants that roll their positions forward. CL-KCBT I at 4.

CL-AIMA

supra

note 35 at 2; and CL-ICE I

supra

note 70 at 8.

CL-ICE I

supra

note 69 at 8. ICE also recommended that the Commission remove the prohibition on holding a position in the physical-delivery contract or shorten the duration to a narrower window of trading than the final three days of trading.

In support of their view, the CME submitted data concerning its natural gas physical-delivery contract.

100

The data, however, generally indicates that the trading volume in the contract in the spot month has increased since the implementation of a conditional-spot-month limit, suggesting little (if any) adverse impact on market liquidity for the contract. Moreover, according to the same data set, both the outright volume and the average price range in the settlement period on the last trade day in the closing range have declined.

101

Other measures of average price range in the spot period also have declined.

100

CME Group, Inc. (“CME III”) on August 15, 2011 (“CL-CME III”).

101

“Outright volume” means the volume of electronic outright transactions that the DCM used for purposes of calculating settlement prices and excludes, for example, spread exemptions executed at a differential.

The CME also submitted, for the same physical-delivery contract, a measure of the relative closing range as a ratio to volatility (“RCR”)—that is, the ratio of the closing range to the 20-day standard deviation of settlement prices. The RCR measure has declined on average after implementation of the conditional limits across 17 expirations, while the RCR on two individual expirations was higher after implementation of the conditional limits, indicating a higher relative price volatility on those two days. However, during one of those two days, certain traders were active in the physical-delivery futures contracts and concurrently held cash-settled contracts, in excess of one times the limit on the physical-delivery contract; in the other day, this was not the case. In summary, the Commission does not believe that the data submitted by CME supports the assertion that setting the existing conditional limits on cash-settled contracts in the natural gas market has materially diminished the price discovery function of physical-delivery contracts.

Considering the comments that were received, the Commission is adopting, on an interim final rule basis, the proposed spot-month position limit provisions with modifications. Under the interim final rule, the Commission will apply spot-month position limits for cash-settled contracts using the same methodology as applied to the physical-delivery Core Referenced Future Contracts, with the exception of natural gas contracts, which will have a class limit and aggregate limit of five times the level of the limit for the physical-delivery Core Referenced Futures Contract. As further described below, the Commission is adopting these spot-month limit methodologies as interim final rules in order to solicit additional comments on the appropriate level of spot-month position limits for cash-settled contracts.

Specifically, the Commission is adopting, on an interim final rule basis, a spot-month position limit for cash-settled contracts (other than natural gas) that will be set at 25 percent of estimated deliverable supply, in parity with the methodology for setting spot-month limit levels for the physical-delivery Core Referenced Futures Contracts. The Commission believes, consistent with the comments, that parity should exist in all position limits (including spot-month limits) between physical-delivery and cash-settled Referenced Contracts (other than in natural gas); otherwise, these limits would permit larger position in look-alike cash-settled contracts that may provide an incentive to manipulate and undermine price discovery in the underlying physical-delivery futures contract. However, the Commission has a reasonable basis to believe that the cash-settled market in natural gas is sufficiently different from the cash-settled markets in other physical commodities to warrant a different spot-month limit methodology.

With respect to NYMEX Light, Sweet Crude Oil (“WTI crude oil”), NYMEX New York Harbor Gasoline Blendstock (“RBOB”), and NYMEX New York Harbor Heating Oil (“heating oil”) contracts, administrative experience, available data, and trade interviews indicate that the sizes of the markets in cash-settled Referenced Contracts (as measured in notional value) are likely to be no greater in size than the related physical-delivery Core Referenced Futures Contracts. This is because there are alternative markets which may satisfy much of the demand by commercial participants to engage in cash-settled contracts for crude oil. These include a market for generally short-dated WTI crude oil forward contracts, as well as a well-developed forward market for Brent oil and an active cash-settled WTI futures contract (the cash-settled ICE Futures (Europe) West Texas Intermediate Light Sweet Crude Oil futures contract). That futures contract had, as of October 4, 2011, an open interest of less than one-third that of the physical-delivery NYMEX Light Sweet Crude Oil futures contract, as reported in the Commission's Commitment of Traders Report. That contract is subject to a spot-month limit equal to the spot-month limit imposed by NYMEX on the relevant physical-delivery futures contract, as a condition of a Division of Market Oversight no-action letter issued on June 17, 2008, CFTC Letter No. 08-09. A review of the Commission's large trader reporting system data indicated fewer than five traders recently held a position in that cash-settled ICE contract in excess of 3,000 contracts in the spot month, pursuant to exemptions granted by the exchange. Accordingly, given that the size of the cash-settled swaps market involving WTI does not appear to be materially larger than that of the physical-delivery Core Referenced Futures Contract, parity in spot month limits in WTI crude oil between physical-delivery and cash-settled contracts should ensure sufficient

liquidity for bona fide hedgers in the cash-settled contracts.

With respect to the other energy commodities, based on administrative experience, available data, and trade interviews, the Commission understands the swaps markets in RBOB and heating oil are small relative to the relevant Core Referenced Futures Contracts. In this regard, unlike natural gas, there has been a small amount of trading in exempt commercial markets in RBOB and heating oil. Thus, parity in spot month limits in RBOB and heating oil between physical-delivery and cash-settled contracts should ensure sufficient liquidity for bona fide hedgers in the cash-settled contracts.

With respect to agricultural commodities, administrative experience, available data, and trade interviews indicate that the sizes of the markets in cash-settled Referenced Contracts (as measured in notional value) are small and not as large as the related Core Referenced Futures Contracts. This is likely due to the fact that, currently, off-exchange agricultural commodity swaps (that are not options) may only be transacted pursuant to part 35 of the Commission's regulations. Under current rules, exempt commercial markets and exempt boards of trade have not been permitted to, and have not, listed agricultural swaps (although the Commission has repealed and replaced part 35, effective December 31, 2011, at which point the Commission regulations would permit agricultural commodity swaps to be transacted under the same requirements governing other commodity swaps). Regarding off-exchange agricultural trade options, part 35 is not available; such transactions must be pursuant to the Commission's agricultural trade option rules found in Commission regulation 32.13. Under regulation 32.13, parties to the agricultural trade option must have a net worth of at least $10 million and the offeree must be a producer, processor, commercial user of, or merchant handling the agricultural commodity which is the subject of the trade option. Based on interviews with offerors of agricultural trade options believed to be the largest participants, administrative experience is that the off-exchange markets are smaller than the relevant Core Referenced Futures Contracts. Accordingly, parity in spot month limits in agricultural commodities between physical-delivery and cash-settled contracts should ensure sufficient liquidity for bona fide hedgers in the cash-settled contracts.

With respect to the metal commodities, based on administrative experience, available data, and trade interviews, the Commission understands the cash-settled swaps markets also are small. Based on interviews with market participants, the Commission understands there is an active cash forward market and lending market in metals, particularly in gold and silver, which may satisfy some of the demand by commercial participants to engage in cash-settled contracts. The cash-settled metals contracts listed on DCMs generally are characterized by a low level of open interest relative to the physical-delivery metals contracts. Moreover, as is the case for RBOB and heating oil, there has not been appreciable trading in exempt commercial markets in metals. Accordingly, parity in spot month limits in metals commodities between physical-delivery and cash-settled contracts should ensure sufficient liquidity for bona fide hedgers in the cash-settled contracts.

In contrast, regarding natural gas, there are very active cash-settled markets both at DCMs and exempt commercial markets. NYMEX lists a cash-settled natural gas futures contract linked to its physical-delivery futures contract that has significant open interest. Similarly, ICE, an exempt commercial market, lists natural gas swaps contracts linked to the NYMEX physical-delivery futures contract. Moreover, both NYMEX and ICE have gained experience with conditional spot-month limits in natural gas where the cash-settled limit is five times the limit for the physical-delivery futures contract. In this regard, NYMEX imposed the same limit on its cash-settled natural contract as ICE imposed on its cash-settled natural gas contract when ICE complied with the requirements of part 36 of the Commission's regulations regarding SPDCs. As discussed above, the Commission believes the existing conditional limits on cash-settled natural gas contracts have not materially diminished the price discovery function of physical-delivery contracts. The final rules relax the conditional limits by removing the condition, but impose a tighter limit on cash-settled contracts by aggregating all economically similar cash-settled natural gas contracts.

102

The Commission is removing the proposed restrictions for claiming the higher limit in cash-settled Referenced Contracts in the spot month. Unlike the proposed conditional limit, under the aggregate limit, a trader in natural gas can utilize the five times limit for the cash-settled Referenced Contract and still hold positions in the physical-delivery Referenced Contract. In addition, there is no requirement that the trader not hold cash or forward positions in the spot month in excess of 25 percent of deliverable supply of natural gas. Although the Commission's experience with DCMs using the more restrictive conditional limit in natural gas has been generally positive, the Commission, in agreeing with commenters, will wait to impose similar conditions until the Commission gains additional experience with the limits in the interim final rule. In this regard, the Commission will monitor closely the spot-month limits in these final rules and may revert to a conditional limit in the future in response to market developments.

Thus, the Commission has determined that the one-to-one ratio (between the level of spot-month limits on physical-delivery contracts and the level of the spot-month limits on cash-settled contracts in the agricultural, metals, and energy commodities other than natural gas) maximizes the objectives enumerated in section 4a(a)(3). Specifically, such limits ensure market liquidity for bona fide hedgers and protect price discovery, while deterring excessive speculation and the potential for market manipulation, squeezes, and corners. The Commission further notes that the formula is consistent with the level the Commission staff has historically deemed acceptable for cash-settled contracts, as well as the formula for physical-delivery contracts under Acceptable Practices for Core Principle 5 in part 38. Nevertheless, the Commission recognizes that after experience with the one-to-one ratio and additional reporting of swap transactions, it may be possible to maximize further these objectives with a different ratio and therefore will revisit the issue after it evaluates the effects of the interim final rule.

In addition to the spot-month limit for cash-settled natural gas contracts, the interim final rule also provides for an aggregate spot-month limit set at five times the level of the spot-month limit in the relevant physical-delivery natural gas Core Referenced Futures Contract. A trader therefore must at all times fall within the class limit for the physical-delivery natural gas Core Referenced Futures Contract, the five-times limit for cash-settled Referenced Contracts in natural gas, and the five-times aggregate limit.

To illustrate the application of the spot-month limits in natural gas contracts, assume a physical-delivery Core Referenced Futures Contract limit on a particular commodity is set to a level of 100. Thus, a trader may hold a net position (long or short) of 100 contracts in that Core Referenced Futures Contract and a net position (long or short) of 500 contracts in the cash-settled Referenced Contracts on that same commodity, provided that the total directional position of both contracts is below the aggregate limit. Therefore, to comply with the aggregate

limit, if a trader wanted to hold the maximum directional position of 100 contracts in the physical-delivery contract, the trader could hold only 400 contracts on the same side of the market in cash-settled contracts.

103

Thus, while the aggregate limit in isolation may appear to allow a trader to establish a position of 600 contracts in cash-settled contracts and 100 contracts on the opposite side of the market in the physical-delivery contract (that is, an aggregate net position of 500 contracts), the class limits restrict that trader to no more than 500 contracts net in cash-settled contracts. The aggregate limit is less restrictive than the proposed conditional limit in that a trader may elect to hold positions in both physical-delivery and cash-settled contracts, subject to the aggregate limit.

103

Further to this example, if a trader wanted to hold 100 contracts in the physical-delivery contract in one direction, the trader could hold 500 cash-settled contracts in the opposite direction as the physical-delivery contract.

The Commission believes that, based on current experience with existing DCM and exempt commercial market (“ECM”) conditional limits, the one-to-five ratio for natural gas contracts maximizes the statutory objectives, as set forth in section 4a(a)(3)(B) of the CEA, of preventing excessive speculation and market manipulation, ensuring market liquidity for bona fide hedgers, and promoting efficient price discovery. Nevertheless, the Commission recognizes that after experience with the one-to-five ratio and additional reporting of swap transactions, it may be possible to maximize further these objectives with a different ratio and therefore will revisit the issue after it evaluates the effects of the interim final rule. Accordingly, the Commission is implementing the one-to-five ratio in natural gas contracts on an interim final rule basis and is seeking comments on whether a different ratio can further maximize the statutory objectives in section 4a(a)(3)(B) of the CEA.

The Commission notes that, as would have been the case with the proposed conditional limits, the spot-month limits on cash-settled natural gas contracts will be more restrictive than the current natural gas conditional spot-month limits. The NYMEX Henry Hub Natural Gas (“NG”) physical-delivery futures contract has a spot-month limit of 1,000 contracts. Both the NYMEX cash-settled natural gas futures contract (“NN”) and the ICE Henry Hub Physical Basis LD1 contract (“LD1”) have conditional-spot-month limits equivalent to 5,000 contracts in the NG futures contract. In contrast to the LD1 contract, swap contracts that are not significant price discovery contracts (“SPDCs”) have not been subject to any position limits. However, the final rule aggregates the related cash-settled contracts, whether swaps or futures. For example, a trader under current rules may hold a position equivalent to 5,000 NG contracts in each of the NN and LD1 contracts (10,000 in total), but under the final rule, a speculative trader may hold only 5,000 cash-settled contracts net under the aggregate spot month limit (since a trader must add its NN position to its LD1 position). Further, other economically-equivalent contracts would be aggregated with a trader's cash-settled contracts in NN and LD1.

Proposed § 151.11(a)(2) required that a DCM or SEF that is a trading facility adopt spot-month limits on cash-settled contracts for which no federal limits apply, based on the methodology in proposed § 151.4 (

i.e.,

25 percent of deliverable supply). Proposed § 151.4(a) did not establish spot-month limits in the cash-settled Core Referenced Futures Contracts (

i.e.,

Class III Milk, Feeder Cattle, and Lean Hog contracts). Thus, under the proposal, a DCM or SEF that is a trading facility would be required to set a spot-month limit on such contracts at a level no greater than 25 percent of deliverable supply.

The final rules provide that the spot-month position limit for cash-settled Core Referenced Futures Contracts (

i.e.,

Class III Milk, Feeder Cattle, and Lean Hog contracts) and related cash-settled Referenced Contracts will be set by the Commission at a level equal to 25 percent of deliverable supply.

104

See

§ 151.4(a).

The Commission is also retaining class limits in the spot month for physical-delivery and cash-settled contracts. Under the class limit restriction, a trader may hold positions up to the spot-month limit in the physical-delivery contracts, as well as positions up to the applicable spot-month limit in cash-settled contracts (

i.e.,

cash-settled futures and swaps), but a trader in the spot month may not net across physical-delivery and cash-settled contracts.

105

Absent such a restriction in the spot month, a trader could stand for 100 percent of deliverable supply during the spot month by holding a large long position in the physical-delivery contract along with an offsetting short position in a cash-settled contract, which effectively would corner the market.

106

105

As discussed above, the Commission is eliminating the conditional spot-month limit.

106

As will be discussed further below, the Commission is eliminating class limits outside of the spot month.

In the Commission's view, the aggregate limit for natural gas will ensure that no trader amasses a speculative position greater than five times the level of the physical-delivery Referenced Contract position limit and thereby, the limit “diminishes the incentive to exert market power to manipulate the cash-settlement price or index to advantage a trader's position in the cash-settlement contract.”

107

76 FR at 4752, 4758.

As noted above, the Commission has developed the limits on economically equivalent swaps concurrently with limits established for physical commodity futures contracts and has established aggregate requirements for cash-settled futures and swaps. In establishing the spot-month limits for cash-settled futures, options, and swaps, the Commission seeks to ensure, to the maximum extent practicable, that there will be sufficient market liquidity for bona fide hedgers in swaps, especially those seeking to offset open positions in such contracts. Permitting traders to hold larger positions in natural gas cash-settled contracts near expiration should not materially affect the potential for market abuses, as the current Commission surveillance system serves to detect and prevent market manipulation, squeezes, and corners in the physical-delivery futures contracts as well as market abuses in cash-settled contracts on which position information is collected. In this regard, the Swaps Large Trader Reporting system will enhance the Commission's surveillance efforts by providing the Commission with transparency for the positions of traders holding large swap positions. The Commission will monitor closely the effects of its spot-month position limits to ensure that they do not disrupt the price discovery function of the underlying market and that they are effective in addressing the potential for market abuses in cash-settled contracts.

4. Interim Final Rule

The Commission believes that, based on administrative experience, available data, and trade interviews, the spot month limits formulas for energy, agricultural and metals contracts, as described above, at this time best maximizes the statutory objectives set forth in CEA section 4a(a)(3)(B) of preventing excessive speculation and market manipulation, ensuring market liquidity for bona fide hedgers, and promoting efficient price discovery. However, commenters presented a range of views as to the appropriate formula with respect to cash settled contracts. Some commenters believed that either a

larger ratio was appropriate or there should be no limit on cash-settled contracts at all.

108

Other commenters believed there should be parity in the limits between physical-delivery contracts and cash-settled contracts.

109

Accordingly, the Commission is implementing the spot month limits on an interim rule basis and is seeking comments on whether a different ratio (

e.g.,

one-to-three or one-to-four) can maximize further the statutory objectives in section 4a(a)(3)(B).

108

See e.g.,

CL-ICE I,

supra

note 69 at 8, CL-Centaurus,

supra

note 21 at 3; CL-BGA,

supra

note 35 at 12.

109

See e.g.,

CL-CME I,

supra

note 8 at 10; CL-KCBT,

supra

note 97 at 4; CL-APGA,

supra

note 17 at 6,8.

Specifically, the Commission invites commenters to address whether the interim final rule best maximizes the four objectives in section 4a(a)(3)(B). The Commission also seeks comments on whether it should set a different ratio for different commodities. Should the Commission consider setting the ratio higher than one-to-one and, if so, in which commodities? Commenters are encouraged, to the extent feasible, to be comprehensive and detailed in providing their approach and rationale. Commenters are requested to address how their suggested approach would better maximize the four objectives in section 4a(a)(3).

Additionally, commenters are encouraged to address the following questions:

Should the Commission consider the relationship between the open interest in cash-settled contracts in the spot month and open interest in the physical-delivery contract in the spot month in setting an appropriate ratio?

Are there other metrics that are relevant to the setting of a spot-month limit on cash-settled contracts (

e.g.,

volume of trading in the physical-delivery futures contract during the period of time the cash-settlement price is determined)?

What criteria, if any, could the Commission use to distinguish among physical commodities for purposes of setting spot-month limits (

e.g.,

agricultural contracts of relatively limited supplies constrained by crop years and limited storage life) and how would those criteria be related to the levels of limits?

The Commission also invites comments on the costs and benefits considerations under CEA section 15a. The Commission further requests commenters to submit additional quantitative and qualitative data regarding the costs and benefits of the interim final rule and any suggested alternatives. Thus, the Commission is seeking comments on the impact of the interim final rule or any alternative ratio on: (1) The protection of market participants and the public; (2) the efficiency, competitiveness, and financial integrity of the futures markets; (3) the market's price discovery functions; (4) sound risk management practices; and (5) other public interest considerations.

The comment period for the interim final rule will close January 17, 2012.

After the Commission gains some experience with the interim final rule and has reviewed swaps data obtained through the Swaps Large Trader Reports, the Commission may further reevaluate the appropriate ratio between physical-delivery and cash-settled spot-month position limits and, in that connection, seek additional comments from the public.

5. Resetting Spot-Month Limits

The Proposed Rules required that DCMs submit estimates of deliverable supply to the Commission by the 31st of December of each calendar year. The Proposed Rules also provided that the Commission would rely on either these DCM estimates or its own estimates to revise spot-month position limits on an annual basis.

110

Two commenters commented that the Commission's proposed process for DCMs providing their deliverable supply estimates within the proposed timeframe was operationally infeasible.

111

110

See

§ 151.4(c). Under the Proposed Rules, spot-month legacy limits would not be subject to periodic resets.

111

CL-CME I

supra

note 8 at 9; and CL-MGEX

supra

note 75 at 2. In addition, the MGEX stated that it is impractical to try to ascertain an accurate estimate of deliverable supply because there are too many variable and unknown factors that affect an agricultural commodity's production and the amount that is sent to delivery points. CL-MGEX

supra

note 74 at 2.

Others criticized the setting of spot-month limits on an annual basis. MFA commented that the limits should reflect seasonal deliverable supply by using either data based on the prior year's deliverable supply estimates or more frequent re-setting.

112

The Institute for Agriculture and Trade Policy (“IATP”) commented that the spot-month position limits for legacy agricultural commodities will likely require more than annual revision due to the effects of climate change on the estimated deliverable supply for each Referenced Contract.

113

IATP also urged the Commission to amend the proposal to provide for emergency meetings to estimate deliverable supply if prices or supply become volatile.

114

112

CL-MFA

supra

note 21 at 18.

113

IATP on March 28, 2011 (“CL-IATP”) at 5.

114

Id.

at 3.

Two commenters expressed concern about the potential volatility in the limit levels introduced by the Commission's proposed annual process for setting spot-month limits. BGA commented that spot-month limits that are changed too frequently (annually would be too frequent in their view) could result in a “flash crash” as traders make large position changes in order to comply with a potentially new lower limit.

115

BGA suggested that this concern could be addressed through, among other things, less frequent changes to the spot-month position limit levels and by providing the market a several-month “cure period.”

116

ISDA/SIFMA suggested that year-to-year spot-month limit level volatility could be addressed by using a five-year rolling average of estimated deliverable supply.

117

115

CL-BGA

supra

note 35 at 20.

116

Id.

117

CL-ISDA/SIFMA

supra

note 21 at 22.

The Commission recognizes the concerns regarding the necessity and desirability of an annual updating of the deliverable supply calculations on a single anniversary date, and that under normal market conditions, agricultural, energy, and metal commodities typically do not exhibit dramatic and sustained changes in their supply and demand fundamentals from year-to-year. Accordingly, the Commission has determined to update spot-month limits biennially (every two years) for energy and metal Referenced Contracts instead of annually, and to stagger the dates on which estimates of deliverable supply shall be submitted by DCMs. These changes should mitigate the costs of compliance for DCMs to prepare and submit estimates of deliverable supply to the Commission. Under the final rule, DCMs may petition the Commission to update the limits on a more frequent basis should supply and demand fundamentals warrant it.

Finally, in response to comments, the Commission has made minor modifications to the definition of the “spot month” to provide for consistency with DCMs' current practices in the administration of spot-month limits for the Referenced Contracts.

E. Non-Spot-Month Limits

The Commission proposed to impose aggregate position limits outside of the spot month in order to prevent a speculative trader from acquiring excessively large positions and, thereby, to help prevent excessive speculation and deter and prevent market

manipulations, squeezes, and corners.

118

Furthermore, the Commission provided that the “resultant limits are purposely designed to be high in order to ensure sufficient liquidity for bona fide hedgers and avoid disrupting the price discovery process given the limited information the Commission has with respect to the size of the physical commodity swap markets.”

119

118

76 FR at 4752, 4759.

119

Id.

In the proposal, the formula for the non-spot-month position limits is based on total open interest for all Referenced Contracts in a commodity. The actual position limit is based on a formula: 10 percent of the open interest for the first 25,000 contracts and 2.5 percent of the open interest thereafter.

120

The limits for each Referenced Contracts included class limits with one class comprised of all futures and option contracts and the second class comprised of all swap contracts. A trader could net positions within the same class, but could not net its position across classes. The limits also included an aggregate all-months-combined limit and a single month limit; however, the limit for the single month would be the same size as the limit for all months.

120

By way of example, assuming a Referenced Contract has average all-months-combined aggregate open interest of 1 million contracts, the level of the non-spot-month position limits would equal 26,900 contracts. This level is calculated as the sum of 2,500 (

i.e.,

10 percent times the first 25,000 contracts open interest) and 24,375 (

i.e.,

2.5 percent of the 975,000 contracts remaining open interest), which equals 26,875 (rounded up to the nearest 100 under the rules (

i.e.,

26,900)).

The Commission received many comments about the rationale for and design of the proposed non-spot-month limits. Many commenters opined that the proposed aggregate non-spot-month limits would not be sufficiently restrictive to prevent excessive speculation.

121

Better Markets explained, for example, that the proposed non-spot-month limits address manipulation by limiting the position size of a single individual while position limits intended to reduce excessive speculation should aim to reduce total speculative participation in the market.

122

These commenters recommended that, in order to address excessive speculation, the Commission should set limits designed to limit speculative activity to a target level.

123

121

CL-ATA

supra

note 81 at 3-4; CL-ATAA

supra

note 94 at 7; CL-Better Markets

supra

note 37 at 70-71; CL-Delta

supra

note 20 at 2-6; CL-FWW

supra

note 81 at 11; and CL-PMAA/NEFI

supra

note 6 at 7, 10. 3,178 form comment letters asked the Commission to impose a limit of 1,500 contracts on Referenced Contracts in silver.

122

See e.g.,

CL-Better Markets

supra

note 37 at 61-64.

123

CL-ATA

supra

note 81 at 4-5; CL-AFR

supra

note 17 at 5-6; CL-ATAA

supra

note 94 at 3, 6, 9-10, 12; CL-Better Markets

supra

note 37 at 70-71 (recommending the Commission to limit non-commodity index and commodity index speculative participation in the market to 30 percent and 10 percent of open interest, respectively); CL-Delta

supra

note 20 at 5; and CL-PMAA/NEFI

supra

note 6 at 7.

See also

Daniel McKenzie on March 28, 2011 (“CL-McKenzie”) at 3. The Petroleum Marketers Association of America and the New England Fuel Institute, for example, suggested that the distribution of large speculative traders' positions in the market may be an appropriate factor to be considered in developing these speculative target limits.

Other commenters questioned the utility of non-spot-month limits generally.

124

AIMA, for example, opined that “[a]lthough * * * limits within the spot-month may be effective to prevent `corners and squeezes' at settlement, the case for placing position limits in non-spot-months is less convincing and has not been made by the Commission.”

125

The FIA commented that non-spot-month position limits are not necessary to prevent excessive speculation.

126

124

American Gas Association (“AGA”) on March 28, 2011 (“CL-AGA”) at 13; CL-AIMA

supra

note 35 at 3; CL-BlackRock

supra

note 21 at 18; CL-CME I

supra

note 8 at 21; CL-FIA I

supra

note 21 at 11 (Commission's prior guidance does not provide a basis today for an exemption from hard speculative position limits for markets with large open-interest, high trading volumes and liquid cash markets); CL-Goldman

supra

note 89 at 6; CL-ISDA/SIFMA

supra

note 21 at 18; CL-MGEX

supra

note 74 at 1 (Commission's proposed formulaic approach to non-spot-month position limits seems arbitrary); Natural Gas Supply Association (“NGSA”) and National Corn Growers Association (“NCGA”) on March 28, 2011, (“CL-NGSA/NCGA”) at 4-5 (position limits outside the spot month should be eliminated or be increased substantially because threats of manipulation and excessive speculation are primarily of concern in the physical-delivery spot month contract); CL-PIMCO

supra

note 21 at 6; Global Energy Management Institute, Bauer College of Business, University of Houston (“Prof. Pirrong”) on January 27, 2011 (“CL-Prof. Pirrong”) at para. 21 (Commission has provided no evidence that the limits it has proposed are necessary to reduce the Hunt-like risk that the Commission uses as a justification for its limits); CL-SIFMA AMG I

supra

note 21 at 8; Teucrium Trading LLC (“Teucrium”) on March 28, 2011 (“CL-Teucrium”) at 2 (limiting the size of positions that a non-commercial market participant can hold in forward (non-spot) futures contracts or financially-settled swaps, the Commission will restrict the flow of capital into an area where it is needed most—the longer term price curve); and CL-WGCEF

supra

note 35 at 4.

125

CL-AIMA

supra

note 35 at 3.

126

CL-FIA I

supra

note 21 at 11.

A number of commenters opined that the Commission should increase the open interest multipliers in the formula used in determining the non-spot-month position limits.

127

Other commenters opined that the Commission should decrease the open interest multipliers to 5 percent of open interest for first 25,000 contracts and then 2.5 percent.

128

PMAA and the NEFI commented that the formula, which was developed in 1992 in the context of agricultural commodities, is inappropriate for current markets with larger open interest relative to the agricultural markets.

129

127

See

CL-AIMA

supra

note 35 at 3; CL-CME I

supra

note 8 at 12 (for energy and metals); CL-FIA I

supra

note 21 at 12 (10 percent of open interest for first 25,000 contracts and then 5 percent); CL-ICI

supra

note 21 at 10 (10 percent of open interest until requisite market data is available); CL-ISDA/SIFMA

supra

note 21 at 20; CL-NGSA/NCGA

supra

note 125 at 5 (25 percent of open interest); and CL-PIMCO

supra

note 21 at 11.

128

See

CL-Prof. Greenberger

supra

note 6 at 13; and CL-FWW

supra

note 82 at 12.

129

CL-PMAA/NEFI

supra

note 6 at 9 (PMAA/NEFI commented that as open interest in markets has grown well beyond the open interest assumptions made in 1992, the size of large speculative positions has not grown commensurately and that therefore the Commission should decrease the marginal multiplier in the position limit formula as open interest increases. PMAA/NEFI commented further that the Commission should look at the actual positions by traders and set limits to constrain the largest positions in the resulting distribution).

Goldman Sachs recommended that the Commission use a longer observation period than one year for setting position limits and provided as an example five years in order to reduce pro-cyclical effects (

e.g.,

a decrease in open interest due to decreased speculative activity in one period results in a limit in the subsequent period that is excessively restrictive or vice-versa).

130

See

CL-Goldman

supra

note 90 at 6-7.

As stated in the proposal, the non-spot-month position limits are intended to maximize the CEA section 4a(a)(3)(B) objectives, consistent with the Commission's historical approach to setting non-spot-month speculative position limits.

131

Such a limits formula, in the Commission's view, prevents a speculative trader from acquiring excessively large positions and thereby would help prevent excessive speculation and deter and prevent market manipulations, squeezes, and corners. The Commission also believes, based on its experience under part 150, that the 10 and 2.5 percent formula will ensure sufficient liquidity for bona fide hedgers and avoids disruption to the price discovery process.

131

The Commission has used the 10 and 2.5 percent formula in administering the level of the legacy all-months position limits since 1999.

See e.g.,

64 FR 24038, 24039, May 5, 1999.

See also

17 CFR 150.5(c)(2).

The Commission notes that Congress implicitly recognized the inherent uncertainty regarding future effects associated with setting limits prophylactically and therefore directed the Commission, under section 719(a) of the Dodd-Frank Act, to study on a

retrospective basis the effects (if any) of the position limits imposed pursuant to section 4a on excessive speculation and on the movement of transactions from DCMs to foreign venues.

132

This study will be conducted in consultation with DCMs and is to be completed within 12 months after the imposition of position limits. Following Congress' direction, the Commission will conduct an evaluation of position limits in performing this study and, thereafter, the Commission plans to continue monitoring these limits, considering the statutory objectives under section 4a(a)(3), and, if warranted, amend by rulemaking, after notice and comment, the formula adopted herein to determine non-spot-month position limits. The Commission may determine to reassess the formula used to set non-spot-month position limits based on the study's findings.

132

Dodd-Frank Act,

supra

note 1, section 719(a).

1. Single-Month, Non-Spot Position Limits

Under proposed § 151.4(d)(1), the Commission proposed to set the single-month limit at the same level as the all-months-combined position limit. Several commenters requested that the Commission reconsider this approach.

133

The Air Transportation Association of America, for example, argued that the proposed level would exacerbate the problem of speculative trading in the nearby (next to expire) futures month, the month upon which energy prices typically are determined.

134

133

CL-APGA

supra

note 17 at 2-3; CL-ATAA

supra

note 94 at 6, 13; CL-PMAA/NEFI

supra

note 6 at 11. 6,074 form comment letters asked the Commission to adopt “single-month limits that are no higher than two-thirds of the all-months-combined levels.”

134

CL-ATAA

supra

note 94 at 6. They also asserted that the Commission did not provide adequate justification for substantially raising the single month limit to the same level as the all-months combined limit.

Id.

at 13.

Three commenters, including ICE, cautioned the Commission not to impose position limits that constrain speculative liquidity in the outer month expirations of Referenced Contracts, that is, in contracts that expire in distant years, as opposed to nearby contract expirations.

135

ICE further asked the Commission to consider whether all-months-combined limits are necessary or appropriate in energy markets in the outer months. ICE stated that such limits would decrease liquidity for hedgers in the outer months and, moreover, all-months limits are not appropriate for energy markets where hedging is done on a much longer term basis relative to the agricultural markets where hedging is primarily conducted to hedge the next year's crops.

136

Teucrium Trading argued that by limiting the size of positions that a non-commercial market participant can hold in forward (non-spot) futures contracts or financially-settled swaps, the Commission would restrict the flow of capital into an area where it is needed most—the longer term price curve, that is, contracts that expire in distant years.

137

135

CL-ICE I

supra

note 69 at 9-10; CL-ISDA/SIFMA

supra

note 21 at 19; and CL-Teucrium

supra

note 124 at 2.

136

CL-ICE I

supra

note 69 at 9-10.

137

CL-Teucrium

supra

note 124 at 2.

The Commission has determined to set the single-month position limit levels at the same level as the all-months-combined limits, consistent with the proposal. Under current part 150, the Commission sets a single-month limit at a level that is lower than the all-months-combined limit; it also provides a limited exemption for calendar spread positions to exceed that single-month limit under § 150.4(a)(3), as long as the single month position (including calendar spread positions) is no greater than the level of the all-months-combined limit. Further, the Commission does not have a standard methodology for determining how much smaller the level of the single-month limit is set in comparison to the level of the all-months-combined limit.

The Commission has made this determination for two reasons. First, setting the single-month limit to the same level as that of the all-months-combined limit simplifies the compliance burden on market participants and renders the calendar spread exemption unnecessary. Second, setting the limits at the same level for both spreaders and other speculative traders will permit parity in position size between these speculative traders in a single calendar month and, thus, may serve to diminish unwarranted price fluctuations.

138

The Commission notes that commenters arguing for more restrictive individual month limits did not provide any supporting data.

With respect to objections to deferred-month limits, the Commission notes that Congress instructed the Commission to set limits on the spot month, each other month, and the aggregate number of positions that may be held by any person for all months.

139

CEA section 4a(a)(3)(A), 7 U.S.C. 6a(a)(3)(A).

Finally, the Commission will continually monitor the size, behavior, and impact of large speculative positions in single contract months in order to determine whether it should adjust the single-month limit levels.

2. “Step-Down” Position Limit

Three commenters recommended that the Commission adopt, in addition to the spot-month limit and the single-month and all-months-combined limits, an intermediate “step-down” limit between the spot-month position limit and the single-month non-spot-month position limit.

140

This “step-down” limit would be less restrictive than the spot-month limit, but more restrictive than the single-month limit. BGA recommended that the single-month limit should be scaled down rationally before it reaches the spot month so that the market will not be disrupted by panic selling on the day before the spot-month limit becomes effective.

141

The commenters did not propose alternative criteria for imposing a step-down provision.

140

CL-BGA

supra

note 35 at 11; GFI Group (“GFI”) on January 31, 2011 (“CL-GFI”) at 2 (progressively tighter limits should apply for physically-delivered energy contracts as they near expiration/delivery); and CL-PMAA/NEFI

supra

note 6 at 11.

141

CL-BGA

supra

note 35 at 11.

Currently, the Commission and DCMs establish a single date when the spot-month limit becomes effective. DCMs publicly disseminate this date as part of their contracts' rules. The advance notice provides sufficient time for market participants to reduce their positions as necessary. The Commission is not aware of material issues related to these provisions regarding the implementation of spot month limits. The Commission further believes this practice ensures sufficient market liquidity for bona fide hedgers and helps to deter and prevent squeezes and corners in the spot period while providing trader flexibility to manage positions and remain in compliance with the limits. The Commission notes, however, that it will monitor trading activity and resulting changes in prices in the transition period into the spot month in order to determine whether it should impose a new “step-down” limit for Referenced Contracts nearing the spot-month period.

3. Setting and Resetting Non-Spot-Month Limits

The Commission proposed all-months-combined aggregate limits and single-month aggregate limits in proposed § 151.4(d)(1). The Commission is adopting those proposed limits in final § 151.4(b)(1), which sets forth single-month and all-months-combined position limits for non-legacy Referenced Contracts (

i.e.,

those agricultural contracts that currently are not subject to Federal position limits as well as energy and metal contracts).

These limits would be fixed based on the following formula: 10 percent of the first 25,000 contracts of average all-months-combined aggregated open interest and 2.5 percent of the open interest for any amounts above 25,000 contracts of average all-months-combined aggregated open interest.

Under proposed § 151.4(b)(1)(i), aggregated open interest is derived from month-end open interest values for a 12-month time period. The Commission would use open interest to determine the average all-months-combined open interest for the relevant period, which, in turn, will form the basis for the non-spot-month position limits.

Under the Proposed Rules, the Commission would calculate, for all Referenced Contracts, open interest on an annual basis for a 12-month period, January to December, and then, based on those calculations, publish the updated non-spot-month position limits by January 31st of the following calendar year. The updated limits would become effective 30 business days after such publication. With respect to the initial limits, they would become effective pursuant to a Commission order under proposed § 151.4(h)(3) and would be based on 12 months of open interest data.

Several commenters urged the Commission to use a transparent and accessible methodology to determine non-spot-month position limits.

142

Some of these commenters recommended that updated non-spot-month limits be determined through rulemaking, and not through automatic annual recalculations as proposed.

143

142

CL-FIA I

supra

note 21 at 12; CL-BlackRock

supra

note 21 at 18; CL-CME I

supra

note 8 at 12; CL-EEI/EPSA

supra

note 21 at 11; CL-KCBT I

supra

note 97 at 3; CL-NGFA

supra

note 72 at 3; CL-WGC

supra

note 21 at 5; and CL-ISDA/SIFMA

supra

note 21 at 21.

143

CL-BlackRock

supra

note 21 at 18; CL-CME I

supra

note 8 at 12; CL-EEI/EPSA

supra

note 21 at 11; CL-KCBT I

supra

note 97 at 3; CL-NGFA

supra

note 70 at 3; and CL-WGC

supra

note 21 at 5. BlackRock argued that a formal rulemaking process for adjusting position limit levels would provide market participants with advanced notice of any potential changes and an opportunity to express their views on such changes.

The World Gold Council argued that uncertainty associated with floating, annually-set position limits may inadvertently discourage market participants from providing the requisite long-term hedges.

144

Encana asked the Commission to consider adopting procedures for a periodic reevaluation of the formulas to ensure that they do not reduce liquidity or impair the price discovery function of the markets.

145

144

CL-WGC

supra

note 21 at 5.

145

Encana Marketing (USA) Inc. (“Encana”) on March 28, 2011 (“CL-Encana”) at 2.

Many commenters objected to the proposed timeline for setting initial limits.

146

For example, many comments urged the Commission to act “expeditiously.” Delta recommended the Commission should use sampling and other statistical techniques to make reasonable, working assumptions about positions in various market segments to set initial limits.

146

See e.g.,

CL-Delta

supra

note 20 at 11.

In response to comments, the Commission has determined to amend the proposed process for setting initial and subsequent non-spot-month position limits. With respect to initial non-spot-month position limits, under § 151.4(d)(3)(i) the initial non-spot-month limits for non-legacy Referenced Contracts will be calculated and published after the Commission has received data sufficient to determine average all-months-combined aggregate open interest for a full 12-month period. The aggregate open interest will be derived from various sources, including data received from DCMs pursuant to part 16, swaps data under part 20, and data regarding linked, direct access FBOT contracts under a condition of a no-action letter and subsequently under part 48 regarding FBOT registration with the Commission, when finalized and made effective. The Commission accepts part of Delta's recommendation to utilize reasonable, working assumptions about positions in various market segments to set initial limits. In this regard, the Commission will strive to establish non-spot-month position limits in an expedited manner that complies with the directives of Congress, while ensuring that it has sufficient swaps data to properly estimate open interest levels for Referenced Contracts.

To compute 12 months of open interest data in uncleared all-months-combined swaps open interest, prior to the timely reporting of all swap dealers' net uncleared open swaps and swaptions positions by counterparty, the Commission may estimate uncleared open swaps positions, based upon uncleared open interest data submitted by clearing organizations or clearing members under part 20, in lieu of the aggregate of swap dealers' net uncleared open swaps. In developing accurate estimates of aggregate open interest under § 151.4(b)(2)(i), the Commission will adjust such uncleared open interest data submitted by clearing organizations or clearing members by an appropriate ratio if it determines, using data regarding later periods submitted by swap dealers and clearing members, that the uncleared open interest data submitted by clearing members differ significantly from the open interest data submitted by swap dealers.

147

The Commission has accordingly provided, under § 151.4(b)(2)(ii), that, based on data provided to the Commission under part 20, it may estimate uncleared swaps open positions for the purpose of setting initial non-spot-month position limits.

147

An appropriate ratio is the ratio of uncleared open interest submitted by swap dealers in such later periods to the uncleared open interest submitted by clearing members in such later periods.

Under final § 151.4(d)(3)(i), the Commission will review the staff computations, including the assumptions made in estimating 12 months of uncleared all-months-combined swap open interest, for consistency with the formula in the final rules. Once the Commission determines that the staff computations conform to the established formula, the Commission will approve and issue an order under final § 151.4(d)(3)(iii), publishing the initial levels of the non-spot-month position limits.

Under final § 151.4(d)(3)(ii), subsequent non-spot-month limits for non-legacy Referenced Contracts will be updated and published every two years, commencing two years after the initial determinations. These subsequent position limits would be based on the higher of the most recent 12 months average all-months-combined aggregate open interest or 24 months average all-months-combined aggregate open interest.

148

Under § 151.4(e), these limits would be made effective on the first calendar day of the third calendar month after the date of publication on the Commission's Web site.

148

For example, assume in a particular Referenced Contract that open interest has declined over a 24-month period; the average all-months-combined aggregate open interest levels are 900,000 contracts for the most recent 12 months and 1,000,000 contracts for the most recent 24 months. Position limits would be based on the higher 24-month average level of 1,000,000 contracts. Thereby, the higher level of the position limit may serve to ensure sufficient market liquidity for bona fide hedgers in the event, for example, a decline in use of derivatives occurred in the historical measurement period that may be associated with a recession. Because position limits apply to prospective time periods, the use of the higher level may be appropriate, for example, with a subsequent expansionary period.

This procedure may provide for limits that would be generally less restrictive than the proposed limits, since, by way of example, a continued decline in open interest over two years under the Proposed Rule would result in a lower

limit each year, whereas under the final rule the limit for the first year would not decline and the limit for the second year would be based on the higher 24-month average open interest. The Commission also notes that under § 151.4(e) the public would have notice of updated position limit levels at least two months in advance of the effective date of such limits (

i.e.,

such limits would be made effective on the first calendar day of the third calendar month immediately following the publication of new limit levels).

149

Final § 151.5(e) requires the Commission to provide all relevant open interest data used to derive updated position limit levels. By making public this open interest data, the public can monitor and anticipate future position limit levels, consistent with the transparency suggestions made by several commenters.

149

For example, any limits fixed during the month of October would take effect on January 1.

In addition, § 151.4(b)(2)(i)(C) provides that, upon the entry of an order under Commission regulation 20.9 of the Commission's regulations determining that operating swap data repositories (“SDRs”) are processing positional data that will enable the Commission to conduct surveillance in the relevant swaps markets, the Commission shall rely on such data in order to determine all-months-combined swaps open interest.

4. “Legacy Limits” for Certain Agricultural Commodities

The Proposed Rule would set non-spot-month limits for Reference Contracts in legacy agricultural commodities at the Federal levels currently in place (referred to herein as “legacy limits”). Several commenters recommended that the Commission should keep the legacy limits.

150

The American Bakers Association argued that raising these legacy limits would increase hedging margins and increase volatility which would ultimately undermine commodity producers' ability to sell their product to consumers.

151

Amcot opined that the Commission need not proceed with phased implementation for the legacy agricultural markets because it could set their limits based on existing legacy limits.

152

150

American Bakers Association (“ABA”) on March 28, 2011 (“CL-ABA”) at 3-4; CL-AFIA

supra

note 94 at 3; Amcot on March 28, 2011 (“CL-Amcot”) at 2; CL-FWW

supra

note 81 at 13; CL-IATP

supra

note 113 at 5; and CL-NGFA

supra

note 72 at 1-2.

151

CL-ABA

supra

note 150 at 3-4.

152

CL-Amcot

supra

note 150 at 3.

Several other commenters recommended that the Commission abandon the legacy limits.

153

U.S. Commodity Funds argued that the Commission offered no justification for treating legacy agricultural contracts differently than other Referenced Contract commodities.

154

Some of these commenters endorsed the limits proposed by CME.

155

Other commenters recommended the use of the open interest formula proposed by the Commission in determining the position limits applicable to the legacy agricultural Referenced Contract markets.

156

Finally, four commenters expressed their preference that non-spot position limits be kept consistent for the three wheat Core Referenced Futures Contracts.

157

153

CL-AIMA

supra

note 35 at 4; Bunge on March 28, 2011 (“CL-Bunge”) at 1-2; Deutsche Bank AG (“DB”) on March 28, 2011 (“CL-DB”) at 6; Gresham Investment Management LLC (“Gresham”) on February 15, 2011 (“CL-Gresham”) at 4-5; CL-FIA I

supra

note 21 at 12; CL-MGEX

supra

note 74 at 2; CL-MFA

supra

note 21 at 18-19; and United States Commodity Funds LLC (“USCF”) on March 25, 2011 (“CL-USCF”) at 10-11.

154

CL-USCF

supra

note 153 at 10-11.

155

CL-Bunge

supra

note 153 at 1-2; CL-FIA I

supra

note 21 at 12; and CL-Gresham

supra

note 153 at 5.

See

CME Petition for Amendment of Commodity Futures Trading Commission Regulation 150.2 (April 6, 2010),

available at http://www.cftc.gov/ucm/groups/public/@swaps/documents/file/df26_cmepetition.pdf.

156

CL-CMC

supra

note 21 at 3; CL-DB

supra

note 153 at 10; and CL-MFA

supra

note 21 at 19.

157

CL-CMC

supra

note 21 at 3; CL-KCBT I

supra

note 97 at 1-2; CL-MGEX

supra

note 74 at 2; and CL-NGFA

supra

note 72 at 4.

The Commission has determined to adopt the position limit levels proposed by the CME for the legacy Core Referenced Futures Contracts. Such levels would be effective 60 days after the publication date of this rulemaking and those levels would be subject to the existing provisions of current part 150 until the compliance date of these rules, which is 60 days after the Commission further defines the term “swap” under the Dodd-Frank Act. At that point, the relevant provisions of this part 151, including those relating to bona-fide hedging and account aggregation, would also apply. In the Commission's judgment, the CME proposal represents a measured approach to increasing legacy limits, similar to that previously implemented.

158

The Commission will use the CME's all-months-combined petition levels as the basis to increase the levels of the non-spot-month limits for legacy Referenced Contracts. The petition levels were based on 2009 average month-end open interest. Adoption of the petition levels results in increases in limit levels that range from 23 to 85 percent higher than the levels in existing § 150.2.

158

58 FR 18057, April 7, 1993.

The Commission has determined to maintain the current approach to setting and resetting legacy limits because it is consistent with the Commission's historical approach to setting such limits. To ensure the continuation of maintaining a parity of limit levels for the major wheat contracts at DCMs and in response to comments supporting this approach, the Commission will also increase the levels of the limits on wheat at the MGEX and the KCBT to the level for the wheat contract at the CBOT.

159

For a discussion of the historical approach,

see

64 FR 24038, 24039, May 5, 1999.

5. Non-Spot Month Class Limits

The Commission proposed to create two classes of contracts for non-spot-month limits: (1) Futures and options on futures contracts and (2) swaps. The Proposed Rule would apply single-month and all-months-combined position limits to each class separately.

160

The aggregate position limits across contract classes are in addition to the position limits within each contract class. Therefore, a trader could hold positions up to the allowed limit in each class (futures and options and swaps), provided that their overall position remains within the applicable position limits. Under the proposal, a trader could net positions within a class, such as a long swap position with a short swap position, but could not net positions in different classes, such as a long futures position with a short swap position. The class limits were designed to diminish the possibility that a trader could have market power as a result of a concentration in any one submarket and to prevent a trader that had a flat net aggregate position in futures and swaps combined from establishing extraordinarily large offsetting positions.

160

Within a contract class, the limits would be set at an amount equal to 10 percent of the first 25,000 contracts of average all-months-combined aggregate open interest in the contract and 2.5 percent of the open interest for any amounts above 25,000 contracts. The aggregate all-months-combined limits across contract classes would be set at 10 percent of the first 25,000 contracts of average all-months-combined aggregated open interests, and 2.5 percent of the open interest thereafter. The average all-months-combined aggregate open interest, which is the basis of these calculations, is determined annually by adding the all-months futures open interest and the all-month-combined swaps open interest for each of the 12 months prior to the effective date and dividing that amount by 12. Each trader's positions would be netted for the purpose of determining compliance with position limits.

Several commenters stated that the class limits proposal was flawed and therefore should not be adopted.

161

For

example, the CME argued that because the class limits would not permit netting across contract classes (that is, across futures and swaps), the class limits would not appropriately limit a trader's actual (net) speculative positions. CME further objected to this proposal by stating that the Commission provided no rationale as to why the positions in two futures contracts could be netted but positions in swaps and futures could not be netted.

162

Another commenter similarly argued that economically equivalent contracts (futures or swaps) are simply two components of a broader derivatives market for a particular commodity and, therefore, the concept of establishing limits on a class of economically equivalent derivatives was logically flawed.

163

161

CL-AIMA

supra

note 35 at 3 (they add “an unnecessary level of complexity”); CL-BlackRock

supra

note 21 at 17; CL-Cargill

supra

note 76 at 10; CL-CME I

supra

note 8 at 13; CL-DB

supra

note 153 at 8-9; CL-Goldman

supra

note 89 at 6; CL-ICE I

supra

note 69 at 9; CL-ISDA/SIFMA

supra

note 21 at 23; CL-MFA

supra

note 21 at 18; CL-Prof. Pirrong

supra

note 124 at paras. 24-30; and CL-Shell

supra

note 35 at 6.

162

CL-Shell

supra

note 35 at 6; CL-BlackRock

supra

note 21 at 17 (arguing that the Commission failed to demonstrate that large positions in a submarket implies market power).

See also

CL-Cargill

supra

note 76 at 10; CL-AIMA

supra

note 35 (commenting that the proposed class limits add “an unnecessary level of complexity”); CL-ISDA/SIFMA

supra

note 21 at 23; CL-ICE I

supra

note 69 at 9; CL-CME I

supra

note 8 at 13; CL-DB

supra

note 153 at 8-9; CL-Goldman

supra

note 89 at 6; CL-MFA

supra

note 21 at 18; and CL-Prof. Pirrong

supra

note 124 at paras. 24-30.

163

CL-ICE I

supra

note 69 at pg. 9.

In response to the comments, the Commission has determined to eliminate class limits from the final rules. The Commission believes that comments regarding the ability of market participants to net swaps and future positions that are economically equivalent have merit. The Commission believes that concerns regarding the potential for market abuses through the use of futures and swaps positions can be addressed adequately, for the time being, by the Commission's large trader surveillance program. The Commission will closely monitor speculative positions in Referenced Contracts and may revisit this issue as appropriate.

F. Intraday Compliance With Position Limits

The Commission proposed to apply position limits on an intraday basis, and some commenters urged the Commission to reconsider such a requirement.

164

Barclays commented that the Commission should recognize intraday violations of aggregate limits as a form of excusable overage because of the challenge of sharing and collating position information on a real-time basis.

164

CL-Shell

supra

note 35 at 6-7; CL-API

supra

note 21 at 14 (Commission should engage in a rigorous analysis of the regulatory burdens of intraday limits and ultimately clarify that position limits will only apply at the end of each trading day); Barclays Capital (“Barclays I”) on March 28, 2011 (“CL-Barclays I”) at 4-5 (Commission should reconsider requiring intraday compliance for non-spot-month position limits).

In the Commission's judgment, intraday compliance would constitute a marginal compliance cost and not be overly-burdensome. The Commission notes that firms may impose risk limits (

i.e.,

position limits determined by the internal risk management department or equivalent unit) on individual traders and among related entities required to aggregate positions under § 151.7 to mitigate the need to create systems to ensure intraday compliance. Moreover, the expected levels of limits outside of the spot-month are not expected to affect many firms and those affected firms should have the capability to establish internal risk limits or real-time position reporting to ensure intraday compliance with position limits. Finally, the Commission notes that intraday compliance with position limits is consistent with existing Commission

165

and DCM

166

policy. The Commission's policy on intraday compliance reflects its concerns with very large speculative positions, whether or not they persist through the end of a trading day.

165

Commodity Futures Trading Commission Division of Market Oversight, Advisory Regarding Compliance with Speculative Position Limits (May 7, 2010),

available at

http://www.cftc.gov/ucm/groups/public/@industryoversight/documents/file/specpositionlimitsadvisory0510.pdf.

166

See e.g.,

CME Rulebook, Rule 443,

available at http://www.cmegroup.com/rulebook/files/CME_Group_RA0909-5.pdf”)

(amended Sept. 14, 2009); ICE OTC Advisory, Updated Notice Regarding Position Limit Exemption Request Form for Significant Price Discovery Contracts,

available at https://www.theice.com/publicdocs/otc/advisory_notices/ICE_OTC_Advisory_0110001.pdf

(Jan. 4, 2010).

G. Bona Fide Hedging and Other Exemptions

The new statutory definition of bona fide hedging transactions or positions in section 4a(c)(2) of the CEA generally follows the definition of bona fide hedging in current Commission regulation 1.3(z)(1), with two significant differences. First, the new statutory definition recognizes a position in a futures contract established to reduce the risks of a swap position as a bona fide hedge, provided that either: (1) The counterparty to such swap transaction would have qualified for a bona fide hedging transaction exemption,

i.e.,

the “pass-through” of the bona fides of one swap counterparty to another (such swaps may be termed “pass-through swaps”); or (2) the swap meets the requirements of a bona fide hedging transaction. Second, a bona fide hedging transaction or position must represent a substitute for a physical market transaction.

167

In 1977, the Commission proposed a general or conceptual definition of bona fide hedging that did not include the modifying adverb “normally” to the verb “represent.” 42 FR 14832, Mar. 17, 1977. The Commission introduced the adverb normally in the subsequent final rulemaking in order to accommodate balance sheet hedging that would otherwise not have met the general definition of bona fide hedging. 42 FR 42748, Aug. 24, 1977. The Commission noted that, for example, hedges of asset value volatility associated with depreciable capital assets might not represent a substitute for subsequent transactions in a physical marketing channel.

Id.

at 42749.

Section 4a(c)(1) of the CEA authorizes the Commission to define bona fide hedging transactions or positions “consistent with the purposes of this Act.” Congress directed the Commission, in amended CEA section 4a(c)(2), to adopt a definition of bona fide hedging transactions or positions for futures contracts (and options) for purposes of setting the position limits mandated by CEA section 4a(a)(2)(A). Pursuant to this authority, the Commission proposed a new regulatory definition of bona fide hedging transactions or positions in proposed § 151.5(a).

168

The Commission also proposed § 151.5 to establish five enumerated exemptions from position limits for bona fide hedging transactions or positions for exempt and agricultural commodities.

168

By its terms, the definition of bona fide hedging applies only to futures (and options). Pursuant to section 4a(c), the Commission proposed to extend the definition of bona fide hedging transactions and positions to all Referenced Contracts, including swaps. The Commission is adopting the definition of bona fide hedging substantially as proposed. The Commission believes that applying the statutory definition of bona fide hedging to swaps is consistent with congressional intent as embodied in the expansion of the Commission's authority to swaps (

i.e.,

those that are economically-equivalent and SPDFs). In granting the Commission authority over such swaps, Congress recognized that such swaps warrant similar treatment to their economically equivalent futures for purposes of position limits and therefore, intended that the statutory definition of bona fide hedging also be extended to swaps.

Under the proposal, a trader must meet the general requirements for a bona fide hedging transaction or position in proposed § 151.5(a)(1) and also meet the requirements for an enumerated hedging transaction in proposed § 151.5(a)(2). The general requirements call for the bona fide hedging transaction or position to represent a substitute for transactions in a physical marketing channel (that is, the cash market for a physical commodity), to be economically appropriate to the reduction of risks in

the conduct and management of a commercial enterprise, and to arise from the potential change in the value of certain assets, liabilities, or services. The five proposed enumerated hedging transactions are discussed below. The proposed section did not provide for non-enumerated hedging transactions or positions, which current Commission regulations 1.3(z)(3) and 1.47 permit. Under the proposal, Commission regulation 1.3(z) would be retained only for excluded commodities.

Proposed § 151.5(b) established reporting requirements for a trader upon exceeding a position limit. The trader would be required to submit information not later than 9 a.m. on the business day following the day the limit was exceeded. Proposed § 151.5(c) specified application and approval requirements for traders seeking an anticipatory hedge exemption, incorporating the current requirements of Commission regulation 1.48. Proposed § 151.5(d) established additional reporting requirements for a trader who exceeded the position limits in order to reduce the risks of certain swap transactions, discussed above.

Proposed § 151.5(e) specified recordkeeping requirements for traders that acquire positions in reliance on bona fide hedge exemptions, as well as for swap counterparties for which a counterparty represents that the transaction would qualify as a bona fide hedging transaction. Swap dealers availing themselves of a hedge exemption would be required to maintain a list of such counterparties and make that list available to the Commission upon request. Proposed §§ 151.5(g) and (h) provided procedural documentation requirements for such swap participants.

Proposed § 151.5(f) required a cross-commodity hedger to provide conversion information, as well as an explanation of the methodology used to determine such conversion information, between the commodity exposure and the Referenced Contracts used in hedging. Proposed § 151.5(i) required reports by bona fide hedgers to be filed for each business day, up to and including the day the trader's position level first falls below the position limit that was exceeded.

The Commission has responded to the many comments received by making substantial changes to the Proposed Rules. A full discussion of the comments received and of the Commission's responses is found below. In summary, in the final rules, the Commission: (1) Clarifies that a transaction qualifies as a bona fide hedging transaction without regard to whether the hedger's position would otherwise exceed applicable position limits; (2) expands the list of enumerated hedging transactions to include hedging of anticipated merchandising activity, royalty payments, and service contracts; (3) clarifies the conditions under which swaps executed opposite a commercial counterparty would be recognized as the basis for bona fide hedging; (4) reduces the burden of claiming a pass-through swap exemption; (5) introduces new § 151.5(b) to make the aggregation and bona fide hedging provisions of part 151 consistent; (6) clarifies that cash market risk can be hedged on a one-to-one transactional basis or can be hedged as a portfolio of risk; (7) eliminates the restriction on holding hedges in cash-settled contracts up through the last trading day; (8) reduces the daily filing requirement for cash market information on the Form 404 and Form 404S to a monthly filing of daily reports; (9) allows for self-effectuating notice filings for those hedge exemptions that require such a filing; and (10) provides an exemption for situations involving “financial distress.”

1. Enumerated Hedges

Under proposed § 151.5(a)(1), no transaction or position would be classified as a bona fide hedging transaction unless it also satisfies the requirements for one of five categories of enumerated hedging transactions.

169

Thus, for example, an anticipatory merchandising transaction could only serve as a basis of an enumerated hedge if it,

inter alia,

reduces the risks attendant to transactions anticipated to be made in the physical marketing channel.

The Commission received many comment letters regarding the proposed definition of bona fide hedging, with a number of commenters expressing concern that the proposed definition was ambiguous and overly restrictive.

170

Morgan Stanley, for example, opined that the “very narrow” definition of bona fide hedging in the Proposed Rule would unnecessarily limit the ability of many market participants to engage in “many well-established risk reducing activities.”

171

Several commenters requested bona fide hedging recognition for transactions beyond those expressly enumerated.

172

In this respect, some commenters, including the FIA and Morgan Stanley, urged the Commission to exercise its broad exemptive authority under CEA section 4a(a)(7) to accommodate a wider range of legitimate hedging activities, including the hedging of general swap position risk, otherwise known as a risk management exemption.

173

170

See e.g.,

CL-FIA I

supra

note 21 at 14-15; CL-Morgan Stanley

supra

note 21 at 4, 5; and CL-ISDA/SIFMA

supra

note 21 at 9.

171

CL-Morgan Stanley

supra

note 21 at 5. According to Morgan Stanley, the proposed definition may preclude market participants from (i) netting exposure across different categories of related futures and swaps; (ii) hedging long-term risks in illiquid markets, common in the development of large infrastructure projects; and (iii) assuming the positions of a less stable market participant during times of market distress.

172

See e.g.,

CL-Commercial Alliance I

supra

note 42 at 2-3; CL-FIA I

supra

note 21 at 13; and Economists Inc. on March 28, 2011 (“CL-Economists Inc.”) at 2.

173

See e.g.,

CL-FIA I

supra

note 21 at 13; CL-ISDA/SIFMA

supra

note 21 at 8; CL-BlackRock

supra

note 21 at 16; CL-Barclays I

supra

note 164 at 3; and CL-ICI

supra

note 21 at 9.

Several commenters argued that not permitting a risk management exemption would be inconsistent with other parts of the Act and Commission rulemakings.

174

For example, CME argued that the hedging standard under the major swap participant (“MSP”) definition includes swap positions “maintained by [pension plans] for the primary purpose of hedging or mitigating any risk directly associated with the operation of the plan.”

175

CME also pointed to the commercial end-user exception to mandatory clearing requirements, where the Commission's proposed definition of hedging “covers swaps used to hedge or mitigate any of a person's business risks.”

176

174

See e.g.,

CL-CME I

supra

note 8 at 18.

175

See id.

at 18 citing New CEA

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