Position Limits for Derivatives

Federal RegisterDec 12, 2013

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 15, 17, 19, 32, 37, 38, 140, and 150

RIN 3038-AD99

Position Limits for Derivatives

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Notice of proposed rulemaking.

SUMMARY:

The Commission proposes to amend regulations concerning speculative position limits to conform to the Wall Street Transparency and Accountability Act of 2010 (“Dodd-Frank Act”) amendments to the Commodity Exchange Act (“CEA” or “Act”). The Commission proposes to establish speculative position limits for 28 exempt and agricultural commodity futures and option contracts, and physical commodity swaps that are “economically equivalent” to such contracts. In connection with establishing these limits, the Commission proposes to update some relevant definitions; revise the exemptions from speculative position limits, including for bona fide hedging; and extend and update reporting requirements for persons claiming exemption from these limits. The Commission proposes appendices that would provide guidance on risk management exemptions for commodity derivative contracts in excluded commodities permitted under the proposed definition of bona fide hedging position; list core referenced futures contracts and commodities that would be substantially the same as a commodity underlying a core referenced futures contract for purposes of the proposed definition of basis contract; describe and analyze fourteen fact patterns that would satisfy the proposed definition of bona fide hedging position; and present the proposed speculative position limit levels in tabular form. In addition, the Commission proposes to update certain of its rules, guidance and acceptable practices for compliance with Designated Contract Market (“DCM”) core principle 5 and Swap Execution Facility (“SEF”) core principle 6 in respect of exchange-set speculative position limits and position accountability levels.

DATES:

Comments must be received on or before February 10, 2014.

ADDRESSES:

You may submit comments, identified by RIN number 3038-AD99 by any of the following methods:

•

Agency Web site: http://comments.cftc.gov

•

Mail:

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

•

Hand Delivery/Courier:

Same as mail above.

•

Federal eRulemaking Portal: http://www.regulations.gov

. Follow instructions for submitting comments.

All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be posted as received to

www.cftc.gov

. You should submit only information that you wish to make available publicly. If you wish the Commission to consider information that is exempt from disclosure under the Freedom of Information Act, a petition for confidential treatment of the exempt information may be submitted according to the procedure established in § 145.9 of the Commission's regulations (17 CFR 145.9).

The Commission reserves the right, but shall have no obligation, to review, pre-screen, filter, redact, refuse, or remove any or all of your submission from

http://www.cftc.gov

that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the rulemaking will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under the Freedom of Information Act.

FOR FURTHER INFORMATION CONTACT:

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

ssherrod@cftc.gov;

Riva Spear Adriance, Senior Special Counsel, Division of Market Oversight, at (202) 418-5494,

radriance@cftc.gov;

David N. Pepper, Attorney-Advisor, Division of Market Oversight, at (202) 418-5565,

dpepper@cftc.gov,

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

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Position Limits for Physical Commodity Futures and Swaps

A. Background

1. CEA Section 4a

2. The Commission Construes CEA Section 4a(a) To Mandate That the Commission Impose Position Limits

3. Necessity Finding

B. Proposed Rules

1. Section 150.1—Definitions

i. Various Definitions Found in § 150.1

ii. Bona Fide Hedging Definition

2. Section 150.2—Position Limits

i. Current § 150.2

ii. Proposed § 150.2

3. Section 150.3—Exemptions

i. Current § 150.3

ii. Proposed § 150.3

4. Part 19—Reports by Persons Holding Bona Fide Hedge Positions Pursuant to § 150.1 of This Chapter and by Merchants and Dealers in Cotton

i. Current Part 19

ii. Proposed Amendments to Part 19

5. § 150.7—Reporting Requirements for Anticipatory Hedging Positions

i. Current § 1.48

ii. Proposed § 150.7

6. Miscellaneous Regulatory Amendments

i. Proposed § 150.6—Ongoing Responsibility of DCMs and SEFs

ii. Proposed § 150.8—Severability

iii. Part 15—Reports—General Provisions

iv. Part 17—Reports by Reporting Markets, Futures Commission Merchants, Clearing Members, and Foreign Brokers

II. Revision of Rules, Guidance, and Acceptable Practices Applicable to Exchange-Set Speculative Position Limits—§ 150.5

A. Background

B. The Current Regulatory Framework for Exchange-Set Position Limits

1. Section 150.5

2. The Commodity Futures Modernization Act of 2000 Caused Commission § 150.5 To Become Guidance on and Acceptable Practices for Compliance with DCM Core Principle 5

3. The CFTC Reauthorization Act of 2008

4. The Dodd-Frank Act Amendments to CEA Section 5

i. The Dodd-Frank Act Added Provisions That Permit the Commission To Override the Discretion of DCMs in Determining How To Comply With the Core Principles

ii. The Dodd-Frank Act Established a Comprehensive New Statutory Framework for Swaps

iii. The Dodd-Frank Act Added the Regulation of Swaps, Added Core Principles for SEFs, Including SEF Core Principle 6, and Amended DCM Core Principle 5

5. Dodd-Frank Rulemaking

i. Amended Part 38

ii. Amended Part 37

iii. Vacated Part 151

C. Proposed Amendments to § 150.5

1. Proposed Amendments to § 150.5 To Add References to Swaps and Swap Execution Facilities

2. Proposed § 150.5(a)—Requirements and Acceptable Practices for Commodity Derivative Contracts That Are Subject to Federal Position Limits

3. Proposed § 150.5(b)—Requirements and Acceptable Practices for Commodity Derivative Contracts That Are Not Subject to Federal Position Limits

III. Related Matters

A. Considerations of Costs and Benefits

1. Background

i. Statutory Mandate To Consider Costs and Benefits

2. Section 150.1—Definitions

i. Bona Fide Hedging

ii. Rule Summary

iii. Benefits and Costs

3. Section 150.2—Limits

i. Rule Summary

ii. Benefits

iii. Costs

iv. Consideration of Alternatives

4. Section 150.3—Exemptions

i. Rule Summary

ii. Benefits

iii. Costs

iv. Consideration of Alternatives

5. Section 150.5—Exchange-Set Speculative Position Limits

i. Rule Summary

ii. Benefits

iii. Costs

iv. Consideration of Alternatives

6. Section 150.7—Reporting Requirements for Anticipatory Hedging Positions

i. Benefits and Costs

7. Part 19—Reports

i. Rule Summary

ii. Benefits

iii. Costs

iv. Consideration of Alternatives

8. CEA Section 15(a)

i. Protection of Market Participants and the Public

ii. Efficiency, Competitiveness, and Financial Integrity of Markets

iii. Price Discovery

iv. Sound Risk Management

v. Other Public Interest Considerations

B. Paperwork Reduction Act

1. Overview

2. Methodology and Assumptions

3. Information Provided by Reporting Entities/Persons and Recordkeeping Duties

4. Comments on Information Collection

C. Regulatory Flexibility Act

IV. Appendices

A. Appendix A—Studies Relating to Position Limits Reviewed and Evaluated by the Commission

I. Position Limits for Physical Commodity Futures and Swaps

A. Background

1. CEA Section 4a

Speculative position limits have been used as a tool to regulate futures markets for over seventy years. Since the Commodity Exchange Act of 1936,

Congress has repeatedly expressed confidence in the use of speculative position limits as an effective means of preventing unreasonable and unwarranted price fluctuations.

7 U.S.C. 1

et seq.

See, e.g.,

H.R. Rep. No. 421, 74th Cong., 1st Sess. 1 (1935); H.R. Rep. No. 624, 99th Cong., 2d Sess. 44 (1986).

CEA section 4a, as amended by the Dodd-Frank Act, provides the Commission with broad authority to set position limits. When Congress created the Commission in 1974, it reiterated that the purpose of the CEA was to prevent fraud and manipulation and to control speculation. Later, the Commodity Futures Modernization Act of 2000 (“CFMA”) provided a statutory basis for exchanges to use pre-existing position accountability levels as an alternative means to limit the burdens of excessive speculative positions. Nevertheless, the CFMA did not weaken the Commission's authority in CEA section 4a to establish position limits to prevent such undue burdens on interstate commerce.

More recently, in the CFTC Reauthorization Act of 2008, Congress gave the Commission expanded authority to set position limits for significant price discovery contracts on exempt commercial markets.

See

Commodity Futures Modernization Act of 2000, Public Law 106-554, 114 Stat. 2763 (Dec. 21, 2000).

See

Food, Conservation and Energy Act of 2008, Public Law 110-246, 122 Stat. 1624 (June 18, 2008).

In 2010, the Dodd-Frank Act expanded the Commission's authority to set position limits by amending CEA section 4a(a)(1) to authorize the Commission to establish position limits not just for futures and option contracts, but also for swaps that are economically equivalent to covered futures and options contracts,

swaps traded on a DCM or SEF, swaps that are traded on or subject to the rules of a DCM or SEF, and swaps not traded on a DCM or SEF that perform or affect a significant price discovery function with respect to regulated entities (“SPDF Swaps”).

CEA section 4a(a)(1) further declares the Congressional determination that: “[e]xcessive speculation in any commodity under contracts of sale of such commodity for future delivery made on or subject to the rules of contract markets or derivatives transaction execution facilities, or swaps that perform or affect a significant price discovery function with respect to registered entities causing sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity, is an undue and unnecessary burden on interstate commerce in such commodity.”

See infra

discussion of economically equivalent.

CEA section 4a(a)(1) (as amended 2010) ; 7 U.S.C. 6a(a)(1).

Id.

As described below, amended CEA section 4a(a)(2), Congress directed,

i.e.,

mandated, that the Commission “shall” establish limits on the amount of positions, as appropriate, that may be held by any person in agricultural and exempt commodity futures and options contracts traded on a DCM.

Similarly, as described below, in amended CEA section 4a(a)(5),

Congress mandated that the Commission impose position limits on swaps that are economically equivalent to the agricultural and exempt commodity derivatives for which it mandated position limits in CEA section 4a(a)(2).

CEA section 4a(a)(2); 7 U.S.C. 6a(a)(2).

CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5).

With respect to the position limits that the Commission is required to set, CEA section 4a(a)(3) guides the Commission in setting the level of those limits by providing several criteria for the Commission to address, namely: (i) To diminish, eliminate, or prevent excessive speculation as described under this section; (ii) to deter and prevent market manipulation, squeezes, and corners; (iii) to ensure sufficient market liquidity for bona fide hedgers; and (iv) to ensure that the price discovery function of the underlying market is not disrupted.

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

CEA section 4a(a)(5) requires the Commission to establish, at an appropriate level, position limits for swaps that are economically equivalent to those futures and options that are subject to mandatory position limits pursuant to CEA section 4a(a)(2).

CEA section 4a(a)(5) also requires that the position limits on economically equivalent swaps be imposed at the same time as mandatory limits are imposed on futures and options.

CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5).

See id.

CEA section 4a(a)(6) requires the Commission to apply position limits on an aggregate basis to contracts based on the same underlying commodity across: (1) Contracts listed by DCMs; (2) with respect to foreign boards of trade (“FBOTs”), contracts that are price-linked to a contract listed for trading on a registered entity and made available from within the United States via direct access; and (3) SPDF Swaps.

CEA section 4a(a)(6); 7 U.S.C. 6a(a)(6).

Furthermore, under new CEA section 4a(a)(7), Congress gave the Commission authority to exempt persons or transactions from any position limits it establishes.

CEA section 4a(a)(7); 7 U.S.C. 6a(a)(7).

2. The Commission Construes CEA Section 4a(a) To Mandate That the Commission Impose Position Limits

The Commission concludes that, based on its experience and expertise, when section 4a(a) of the Act is considered as an integrated whole, it is reasonable to construe that section to mandate that the Commission impose position limits. This mandate requires the Commission to impose limits on futures contracts, options, and certain swaps for agricultural and exempt commodities. The Commission also

concludes that the mandate requires it to impose such limits without first finding that any such limit is necessary to prevent excessive speculation in a particular market.

ISDA

CFTC,

the district court concluded that section 4a(a)(1) of the Act “unambiguously requires that, prior to imposing position limits, the Commission find that position limits are necessary to `diminish, eliminate, or prevent' the burden described in [section 4a(a)(1) of the Act].”

But the court further concluded that, even if CEA section 4a(a)(1) standing alone required the Commission to make a necessity determination as a prerequisite to imposing position limits, it was plausible to conclude that sections 4a(a)(2), (3), and (5) of the Act, which were added by Dodd-Frank, constituted a mandate, requiring the Commission to impose position limits without making any findings of necessity. The court ultimately determined that the Dodd-Frank amendments, and their relationship to section 4a(a)(1) of the Act, are “ambiguous and lend themselves to more than one plausible interpretation.”

Thus, the court rejected the Commission's contention that section 4a(a) of the Act unambiguously mandated the imposition of position limits without any finding of necessity.

International Swaps and Derivatives Association

United States Commodity Futures Trading Commission,

887 F. Supp. 2d 259 (D.D.C. 2012).

Id.

at 270.

Id.

at 281.

Having concluded that section 4a(a) of the Act is ambiguous, the court could not rely on the Commission's interpretation to resolve the section's ambiguity. As the court observed, the D.C. Circuit has held that “ `deference to an agency's interpretation of a statute is not appropriate when the agency wrongly believes that interpretation is compelled by Congress.' ”

The court further held that, pursuant to the law of the D.C. Circuit, it was required to remand the matter to the Commission so that it could “fill in the gaps and resolve the ambiguities.”

The court cautioned the Commission that, in resolving the ambiguity of section 4a(a) of the Act, “ `it is incumbent upon the agency not to rest simply on its parsing of the statutory language.' ”

Id.

at 280-82, quoting

Peter Pan Bus Lines, Inc.

Fed. Motor Carrier Safety Admin.,

471 F.3d 1350, 1354 (D.C. Cir. 2006).

887 F. Supp. 2d at 282.

Id.

at n.7, quoting

PDK Labs. Inc.

DEA,

362 F.3d 786, 797 (D.C. Cir. 2004).

The Commission now undertakes the task assigned by the court: using its experience and expertise to resolve the ambiguity the district court perceived in section 4a(a) of the Act. The most important guidepost for the Commission in resolving the ambiguity is section 4a(a)(2) of the Act. That section, which is captioned “Establishment of Limitations,” includes two sections that are critical to understanding congressional intent. Subsection 4a(a)(2)(A) provides that the Commission, in accordance with the standards set forth in section 4a(a)(1) of the Act, shall establish limits on the amount of positions, as appropriate, other than bona fide hedge positions that may be held by any person with respect to physical commodities other than excluded commodities.

Subsection 4a(a)(2)(B) provides that for exempt commodities, the limits “required” under subsection 4a(a)(2)(A) be established within 180 days of the enactment of section 4a(a)(2)(B) and that for agricultural commodities, the limits “required” under subsection 4a(a)(2)(A) be established within 270 days of the enactment of section 4a(a)(2)(B).

CEA section 4a(a)(2)(A); 7 U.S.C. 6a(a)(2)(A).

CEA section 4a(a)(2)(B); 7 U.S.C. 6a(a)(2)(B).

The court concluded that this section was ambiguous as to whether the Commission had a mandate to impose position limits. The court focused on the opening phrase of subsection (A)—“[i]n accordance with the standards set forth in [section 4a(a)(1) of the Act].” The court held that the term “standards” in section 4a(a)(2) of the Act was ambiguous and could refer to the requirement in section 4a(a)(1) of the Act that the Commission impose position limits “as [it] finds are necessary to diminish, eliminate, or prevent” an unnecessary burden on interstate commerce.

Thus, the court held that it was plausible that section 4a(a)(2) of the Act required the Commission to make a finding of necessity as a precondition to imposing any position limit. But the court held that it was also plausible that the reference to “standards” did not incorporate such a requirement.

887 F. Supp. 2d at 274-76.

The Commission believes that it is reasonable to conclude from the Dodd-Frank amendments that Congress mandated limits and did not intend for the Commission to make a necessity finding as a prerequisite to the imposition of limits. The Commission's interpretation of its mandate is also based on congressional concerns that arose, and congressional actions taken, before the passage of the Dodd-Frank amendments. During the years leading up to the enactment, Congress conducted several investigations that concluded that excessive speculation accounted for significant volatility and price increases in physical commodity markets. A congressional investigation determined that prices of crude oil had risen precipitously and that “[t]he traditional forces of supply and demand cannot fully account for these increases.”

The investigation found evidence suggesting that speculation was responsible for an increase of as much as $20-25 per barrel of crude oil, which was then at $70.

Subsequently, Congress found similar price volatility stemming from excessive speculation in the natural gas market.

Thus, these investigations had already gathered evidence regarding the impact of excessive speculation, and had concluded that such speculation imposed an undue burden on the economy. In light of these investigations and conclusions, it is reasonable for the Commission to conclude that Congress did not intend for it to duplicate investigations Congress had already conducted, and did not intend to leave it up to the Commission whether there should be federal limits. Instead, Congress set short deadlines for the limits it “required,” and directed the Commission to conduct a study of the limits

after

their imposition and to report to Congress promptly on their effects. Accordingly, the Commission believes that the better reading of the Dodd-Frank amendments, in light of the congressional investigations and findings made, is the Dodd-Frank amendments require the Commission to impose position limits on physical commodity derivatives as opposed to merely reaffirming the preexisting, discretionary authority the Commission has long had to impose limits as it finds necessary. Congress made the decision to impose limits, and it is for the Commission to carry that decision out, subject to close congressional oversight.

“The Role of Market Speculation in Rising Oil and Gas Prices: A Need to Put the Cop Back on the Beat,” Staff Report, Permanent Subcommittee on Investigations of the Senate Committee on Homeland Security and Governmental Affairs, U.S. Senate, S. Prt. No. 109-65 at 1 (June 27, 2006).

Id.

at 12;

see also

“Excessive Speculation in the Natural Gas Market,” Staff Report, Permanent Subcommittee on Investigations of the Senate Committee on Homeland Security and Governmental Affairs, U.S. Senate at 1 (June 25, 2007) available at

http://www.levin.senate.gov/imo/media/doc/supporting/2007/PSI.Amaranth.062507.pdf

(last visited Mar. 18, 2013) (“Gas Report”).

Gas Report at 1-2.

Based on its experience, the Commission concludes that Congress could not have contemplated that, as a prerequisite to imposing limits, the Commission would first make the sort of

necessity determination that the plaintiffs in

ISDA

CFTC

argue section 4a(a)(2) of the Act requires—

i.e.,

a finding that, before imposing any limit in any particular market, there is a reasonable likelihood that excessive speculation will pose a problem in that market, and that position limits are likely to curtail that excessive speculation without imposing undue costs.

As the district court noted, for 45 years after passage of the CEA, the Commission's predecessor agency made findings of necessity in its rulemakings establishing position limits.

During that period, the Commission had jurisdiction over only a limited number of agricultural commodities. The court cited several orders issued by the Commodity Exchange Commission (“CEC”) between 1940 and 1956 establishing position limits, and in each of those orders, the CEC stated that the limits it was imposing were necessary. Each of those orders involved no more than a small number of commodities. But it took the CEC many months to make those findings. For example, in 1938, the CEC imposed position limits on six grain products.

Proceedings leading up to the establishment of the limits commenced more than 13 months earlier, when the CEC issued a notice of hearings regarding the limits.

Similarly, in September 1939, the CEC issued a Notice of Hearing with respect to position limits for cotton, but it was not until August 1940 that the CEC finally promulgated such limits.

And the CEC began the process of imposing limits on soybeans and eggs in January 1951, but did not complete the process until more than seven months later.

See

887 F. Supp. 2d at 273.

Id.

at 269.

See

3 FR 3145, Dec. 24, 1938.

See

2 FR 2460, Nov. 12, 1937.

See

4 FR 3903, Sep. 14, 1939; 5 FR 3198, Aug. 28, 1940.

See

16 FR 321, Jan. 12, 1951; 16 FR 8106, Aug. 16, 1951;

see also

17 FR 6055, Jul. 4, 1952 (notice of hearing regarding proposed position limits for cottonseed oil, soybean oil, and lard); 18 FR 443, Jan. 22, 1953 (orders setting limits for cottonseed oil, soybean oil, and lard); 21 FR 1838, Mar. 24, 1956 (notice of hearing regarding proposed position limits for onions), 21 FR 5575, Jul. 25, 1956 (order setting position limits for onions).

In the Commission's experience (

i.e.,

in the experience of its predecessor agency), it took at least four months to make a necessity finding with respect to one commodity. The process of making the sort of necessity findings that plaintiffs urged upon the court with respect to all agricultural commodities and all exempt commodities would be far more lengthy than the time allowed by section 4a(a)(3) of the Act,

i.e.,

180 or 270 days.

Dodd-Frank requires the Commission to impose position limits on all exempt commodities within 180 days after enactment, and on all agricultural commodities within 270 days.

Because of these stringent time limits, the Commission concludes that Congress did not intend for the Commission to delay the imposition of limits until it has first made antecedent, contract-by-contract necessity findings.

Although the Commission did not meet these deadlines in its first position limits rulemaking, it completed the task (in which the Commission received and addressed more than 15,000 comments) as expeditiously as possible under the circumstances.

Even if there were no mandate, the Commission would not need to make the sort of particularized necessity findings advocated by the plaintiffs in

ISDA

CFTC,

and discussed by the district court. When the Commission imposed limits pre-Dodd-Frank, it only had to determine that excessive speculation is harmful to the market and that limits on speculative positions are a reasonable means of preventing price disruptions in the marketplace that place an undue burden on interstate commerce. That is the determination that the Commission made in 1981 when it required the exchanges to establish position limits on all futures contracts, regardless of the characteristics of a particular contract market.

See

46 FR 50940 (“[I]t is the Commission's view that this objective [“the prevention of large and/or abrupt price movements which are attributable to extraordinarily large speculative positions”] is enhanced by speculative position limits since it appears that the capacity of any contract market 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.”). In the immediate wake of that decision, Congress enacted legislation to give the Commission the specific authority to enforce those omnibus limits.

See

CEA section 4a(e); 7 U.S.C. 6a(e).

Additional experience of the Commission confirms this interpretation. The Commission has found, historically, that speculative position limits are a beneficial tool to prevent, among other things, manipulation of prices. Limits do so by restricting the size of positions held by noncommercial entities that do not have hedging needs in the underlying physical markets. In other words, markets that have underlying physical commodities with finite supplies benefit from the protections offered by position limits. This will be discussed further, below.

For example, in 1981, the Commission, acting expressly pursuant to,

inter alia,

what was then CEA Section 4a(1) (predecessor to CEA section 4a(a)(1)), adopted what was then § 1.61.

This rule required speculative position limits for “for each separate type of contract for which delivery months are listed to trade” on any DCM, including “contracts for future delivery of any commodity subject to the rules of such contract market.”

The Commission explained that this action was necessary in order to “close the existing regulatory gap whereby some but not all contract markets [we]re subject to a specified speculative position limit.”

Like the Dodd-Frank Act, the 1981 final rule established (and the rule release described) that such limits “shall” be established according to what the Commission termed “standards.”

As used in the 1981 final rule and release, “standards” meant the criteria for determining how the required limits would be set.

“Standards” did not include the antecedent judgment of

whether

to order limits at all. The Commission had already made the antecedent judgment in the rule that “speculative limits are appropriate for all contract markets irrespective of the characteristics of the underlying market.”

It further concluded that, with respect to any particular market, the “existence of historical trading data” showing excessive speculation or other burdens on that market is not “an essential prerequisite to the establishment of a speculative limit.”

The Commission thus directed the exchanges to set limits for all futures contracts “pursuant to the . . . standards of rule 1.61[.]”

And § 1.61 incorporated the standards from then-CEA-section 4a(1)—an “Aggregation Standard” (46 FR at 50943) for applying the limits to positions both held and controlled by a trader and a flexibility standard, allowing the exchanges to set “different and separate position limits for different types of futures contracts, or for different delivery months, or from exempting positions which are normally known in the trade as `spreads, straddles or arbitrage' or from fixing limits which apply to such positions which are different from limits fixed for other positions.”

46 FR 50938, 50944-45, Oct. 16, 1981. The rule adopted in 1981 tracked, in significant part, the language of Section 4a(1).

Compare

17 CFR 1.61(a)(1) (1982)

with

7 U.S.C. 6a(1) (1976).

46 FR 50945.

Id.

50939;

see also

Brief of Senator Levin et al as

Amicus Curiae

at 10-11,

ISDA

CFTC,

no. 12-5362 (D.C. Cir. Apr. 22, 2013), Document No. 1432046 (hereafter “Levin Br.”).

Levin Br. at 11 (citing H.R. 4173, 111th Cong. section 3113(a)(5)(2), (7) (as passed by the House Dec. 11, 2009) (“Engrossed Bill”)).

Id.

at 12. (citing Engrossed Bill at section 3113(a)(5)(3)).

15 U.S.C. 8307.

See

Levin Br. at 13-17;

see also

DVD: October 21, 2009 Business Meeting (House Agriculture Committee 2009),

ISDA

CFTC,

Dkt. 37-2 Exh. B (Apr. 13, 2012) at 59:55-1:02:18.

Levin Br. at 23 (citing H.R. Rep. No. 111-373 at 11 (2009)).

Levin Br. at 17-18.

Considering the text, purpose and legislative history of section 4a(a) as a whole, along with its own experience and expertise, the Commission believes that it is reasonable to conclude that Congress—notwithstanding the ambiguity the district court found to arise from some of the words in the statute—decided that position limits were necessary with respect to physical commodities, mandated the Commission to impose them on physical commodities, and required that the Commission do so expeditiously.

The district court noted that CEA sections 4a(a)(2), (3), and (5)(A) contain the words “as appropriate.” The court held that it was ambiguous whether those words referred to the Commission's obligation to impose limits (

i.e.,

the Commission shall, “as appropriate,” impose limits), or to the level of the limits the Commission is to impose. Because, as explained above, the Commission believes it is reasonable to interpret CEA section 4a(a) to mandate the imposition of limits, the words “as appropriate” must refer to the level of limits,

i.e.,

the Commission must set limits at an appropriate level. Thus, while Congress made the threshold decision to impose position limits on physical commodity futures and options and economically equivalent swaps, Congress at the same time delegated to the Commission the task of setting the limits at levels that would maximize Congress' objectives.

See

CEA sections 4a(a)(3)(A)-(B).

3. Necessity Finding

As explained above, the Commission concludes that the CEA mandates the imposition of speculative position limits. Because of this mandate, the Commission need not make a prerequisite finding that such limits are necessary “to diminish, eliminate or prevent excessive speculation causing sudden or unreasonable fluctuations or unwarranted changes in the prices of” commodities under pre-Dodd-Frank CEA section 4a(a)(1). Nonetheless, out of an abundance of caution in light of the district court decision in

ISDA

CFTC,

and without prejudice to any argument the Commission may advance in any forum, the Commission proposes, as a separate and independent basis for the proposed Rule, a preliminary finding herein that such limits are necessary to achieve their statutory purposes.

The CEA does not define “excessive speculation.” But the Commission has historically associated it with extraordinarily large speculative positions. 76 FR at 71629 (referring to “extraordinarily large speculative positions”).

Historically, speculative position limits have been one of the tools used by the Commission to prevent, among other things, manipulation of prices. Limits do so by restricting the size of positions held by noncommercial entities that do not have hedging needs in the underlying physical markets. By capping the size of speculative positions, limits lessen the likelihood that a trader can obtain a large enough position to potentially manipulate prices, engage in corners or squeezes or other forms of price manipulation. The position limits in this proposal are necessary as a prophylactic measure to lessen the likelihood that a trader will accumulate excessively large speculative positions that can result in corners, squeezes, or other forms of manipulation that cause unwarranted or unreasonable price fluctuations. In the Commission's experience, position limits are also necessary as a prophylactic measure because excessively large speculative positions may cause sudden or unreasonable price fluctuations even if not accompanied by manipulative conduct. Two examples that inform the Commission's determinations are the silver crisis of 1979-80 and events in the natural gas markets in 2006.

Since the 1920's, Congressional and other official governmental investigations and reports have identified other instances of sudden or unreasonable fluctuations or unwarranted changes in the price of commodities.

See

discussion below.

Position limits would help to deter and prevent manipulative corners and squeezes, such as the silver price spike caused by the Hunt brothers and their cohorts in 1979-80.

A market is “cornered” when an individual or group of individuals acting in concert acquire a controlling or ownership interest in a commodity that is so dominant that the individual or group of individuals can set or manipulate the price of that commodity.

In a short squeeze, an excess of demand for a commodity together with a lack of supply for that commodity forces the price of that commodity upward. During a short squeeze, individuals holding short positions,

i.e.,

sales for future delivery of a commodity,

are typically forced to purchase that commodity in situations where the price increases rapidly, in order to exit their short position and/or cover,

i.e.,

be able to deliver the commodity in accordance with the terms of the sale.

See

CFTC Glossary, A Guide to the Language of the Futures Industry (“CFTC Glossary”), available at

http://www.cftc.gov/ConsumerProtection/EducationCenter/CFTCGlossary/glossary,

which defines a corner as “(1) [s]ecuring such relative control of a commodity that its price can be manipulated, that is, can be controlled by the creator of the corner; or (2) in the extreme situation, obtaining contracts requiring the delivery of more commodities than are available for delivery.”

See

CFTC Glossary, which defines a “short” as “(1) [t]he selling side of an open futures contract; (2) a trader whose net position in the futures market shows an excess of open sales over open purchases.”

See

CFTC Glossary, which defines “cover” as “(1) [p]urchasing futures to offset a short position (same as Short Covering); . . . (2) to have in hand the physical commodity when a short futures sale is made, or to acquire the commodity that might be deliverable on a short sale” and offset as “[l]iquidating a purchase of futures contracts through the sale of an equal number of contracts of the same delivery month, or liquidating a short sale of futures through the purchase of an equal number of contracts of the same delivery month.”

See

CFTC Glossary, which defines a “squeeze” as “[a] market situation in which the lack of supplies tends to force shorts to cover their positions by offset at higher prices.”

A rapid rise and subsequent sharp decline in silver prices occurred from the second half of 1979 to the first half of 1980 when the Hunt brothers

and colluding syndicates

attempted to corner the silver market by hoarding silver and executing a short squeeze. Prices deflated only after the Commodity Exchange, Inc. (“COMEX”)

and the Chicago Board of Trade (“CBOT”) imposed a series of emergency rules imposing at various times position limits, increased margin requirements, and trading for liquidation only on U.S. silver futures. It was the consensus view of staffs of the Commission, the Board of Governors of the Federal Reserve System, the Department of the Treasury and the Securities and Exchange Commission articulated in an interagency task force study of events in the silver market during that period that “[r]easonable speculative position limits, if they had been in place before the buildup of large positions occurred, would have helped prevent the accumulation of such large positions and the resultant dislocations created when the holders of those positions stood for delivery.”

That is, speculative position limits would have helped to prevent the buildup of the silver price spike of 1979-80. The Commission believes that this conclusion remains correct. “Moreover, by limiting the ability of one person or group to obtain extraordinarily large positions, speculative limits diminish the possibility of accentuating price swings if large positions must be liquidated abruptly in the face of adverse price movements or for other reasons.”

The primary silver traders in the Hunt family were Nelson Bunker Hunt, William Herbert Hunt, and Lamar Hunt.

A group of individuals and firms trading through ContiCommodity Services, Inc. and ACLI International Commodity Services, Inc., both of which were FCMs.

Commodity Futures Trading Commission, Report To The Congress In Response To Section 21 Of The Commodity Exchange Act, May 29, 1981, Part Two, A Study of the Silver Market, at 173 (“Interagency Silver Study”).

Speculative Position Limits, 45 FR 79831, 79833, Dec. 2, 1980.

The Hunt brothers were speculators

who neither produced, distributed, processed nor consumed silver. The corner began in early 1979, when the Hunt brothers accumulated large physical holdings of silver by purchasing silver futures and taking physical delivery of silver.

By the fall of 1979, they had accumulated over 43 million ounces of physical silver.

In addition to their physical holdings, in the fall of 1979 the Hunts and their cohorts held over 12 thousand contracts for March delivery, representing a potential future delivery to the hoard of another 60 million ounces of silver.

In general, the larger a position held by a trader, the greater is the potential that the position may affect the price of the contract. Throughout late 1979, the Hunts continued to stand for delivery and took care to ensure that their own holdings were not re-delivered back to them when outstanding futures contracts settled.

Thus, through this period, silver prices climbed as the Hunts accumulated more financial and physical positions and the available supply of silver decreased. As the interagency working group observed, “[t]he biggest single source of the change in demand for silver bullion during the last half of 1979 and the first quarter of 1980 came from the silver acquisitions of Hunt family members and other large traders.”

Speculators seek to profit by anticipating the price movement of a commodity in which a futures position has been established.

See

CFTC Glossary, which defines a speculator as, “[i]n commodity futures, a trader who does not hedge, but who trades with the objective of achieving profits through the successful anticipation of price movements.” In contrast, a hedger is “[a] trader who enters into positions in a futures market opposite to positions held in the cash market to minimize the risk of financial loss from an adverse price change; or who purchases or sells futures as a temporary substitute for a cash transaction that will occur later. One can hedge either a long cash market position (e.g., one owns the cash commodity) or a short cash market position (e.g., one plans on buying the cash commodity in the future).” The Hunts had no apparent industrial use for silver, although some attribute their early activities in the silver market to an attempt to hedge against Carter-era inflation and a defense against potential confiscation of precious metals in the event of a national crisis.

Typically, delivery occurs in only a small percentage of futures transactions. The vast majority of contracts are liquidated by offsetting transactions.

See, e.g.,

Matonis, Jon, Hunt Brothers Demanded Physical Silver Delivery Too, available at

http://www.rapidtrends.com/hunt-brothers-demanded-physical-silver-delivery-too/

. To provide context, at this time COMEX and CBOT warehouses held 120 million ounces of silver.

Interagency Silver Study at 18.

It has been reported that they moved vast quantities of silver to warehouses in Switzerland to prevent this possibility.

Interagency Silver Study at 77.

The exchanges and regulators were slow to react to events in the silver market. However, to correct by then evident market imbalances, in late 1979 the CBOT introduced position limits of 3 million ounces of silver (

i.e.,

600 contracts) per trader and raised margin requirements. Contracts over 3 million ounces were to be liquidated by February of 1980. On January 7, 1980, the larger COMEX instituted position limits of 10 million ounces of silver (

i.e.,

2,000 contracts) per trader, with contracts over that amount to be liquidated by February 18. Then, on January 21, COMEX suspended trading in silver and announced that it would only accept liquidation orders. The price of silver began to decline. When the price of a commodity starts to move against the cornerer, attempts by the cornerer to sell would tend to fuel a further price move against the cornerer resulting in a vicious cycle of price decline. The Hunts were eventually unable to meet their margin calls and took a huge loss on their positions. The interagency working group concluded that the data relating to the episode “support the hypothesis that the deliveries and potential deliveries to large long participants in the silver futures markets contributed to the rise and fall in silver prices in both the cash and futures markets. The rise appears to have been caused in part by the conversion of silver futures contracts to actual physical silver. The subsequent fall in prices was then exacerbated by the anticipated selling of some of the Hunt's physical silver by FCMs as well as the liquidation of Hunt group and possibly . . . [other large traders'] futures positions.”

Interagency Silver Study at 133.

Figure 1 illustrates the rapid rise and sharp decline in the price of silver during the period in question.

In January of 1979, the settlement price of silver was approximately $6.00 per troy ounce. By August, the price had risen to over $9.00, an increase of over 50 percent. Through most of October and November 1979, silver traded within a range of $15.00-$17.50 per troy ounce. On November 28, the closing price rose above $18.00. In December of 1979, the price rose above $30.00 and continued to climb until mid-January. On January 17, 1980, the closing price of silver reached its apex at $48.70 per troy ounce, more than five times the August price. On January 21, the price declined to $44.00; on January 22 the closing price slid to $34.00 per troy ounce. Through March 7, 1980, silver traded in an approximate range of $30.00-$40.00 per troy ounce. On March 10, silver closed below $30.00. On March 17 and 18, silver closed below $20.00. After a brief rebound above $22.00, by March 26 the price dropped to $15.80. On March 27, the price of silver hit a low of $10.80 per troy ounce, less than a quarter of the high of $48.70 two months earlier. “After March 28, silver prices stabilized for a while in the $12-$15 range. . . . During April through December 1980, silver prices moved generally in a range between $12 and $20 per ounce.”

See

CFTC Glossary, which defines “spot price” as “[t]he price at which a physical commodity for immediate delivery is selling at a given time and place.” The prompt month is the nearest month to the expiration date of a futures contract.

Interagency Silver Study at 35-36.

EP12DE13.000

Figure 2 shows the distortion in the price of silver futures contracts due to the short squeeze during the run-up to the January 17 high and the effect of “burying the corpse” after the squeeze ended. In January 1980, due to the hoarding of the Hunts and their cohorts, physical supplies of silver were tight and the physical commodity was expensive to deliver. Scarcity in the physical market for silver distorted prices in the silver futures markets. The degree to which the value of the front month contract exceeded the value of other contracts was exaggerated. By April of 1980, because the Hunts and their cohorts were forced to sell, physical supply had increased and silver was comparatively cheaper to deliver. The front month contract was then worth substantially less than other contracts. In contrast, assuming equilibrium in production, use, and storage of silver, one would expect the charted price spreads to look comparatively much flatter. That is, there should not be that much difference between the price of the front month contract and other contracts because silver should not be subject to seasonality such as would affect crops. Moreover, because silver is relatively cheap to store, the difference in the price of the front month and other contracts should also be less sensitive to the cost of carry.

EP12DE13.001

In section 4a(a)(1) of the Act, Congress identifies “sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity”

as an indication that excessive speculation may be present in a market for a commodity. The rapid rise and sharp decline in the price of silver that commenced in August 1979 and was spent by the end of March 1980 certainly fits the description advanced by Congress. Nevertheless, the Commission, based on its experience and expertise, does not believe that the burdens on interstate commerce are limited solely to the temporary and unwarranted changes in price such as those exhibited during the silver price spike that resulted, at least in part, from the deliberate behavior of the Hunt brothers and their cohorts.

Indirect burdens on interstate commerce may arise as a result of unwarranted changes in price such as occurred in this case. Such burdens arise due to manipulation or attempted manipulation, or they may result from the excessive size and disorderly trading of a speculative,

i.e.,

non-hedging, position.

7 U.S.C. 6a(a)(1).

The Interagency Silver Study identified three main factors contributing to the price increases in silver at the time.

First, the state of the economy during the period in question affected all precious metals including silver. . . .

Second, changes in the supply and demand of physical silver affected the price of silver. . . .

Third, the accumulation of large amounts of both physical silver and silver futures by individuals such as the Hunt family of Dallas, Texas, had an effect on the price of silver directly and on the expectations of others who became aware of these actions.

Interagency Silver Study at 2.

Sudden or unreasonable fluctuations or unwarranted changes in the price of a commodity derivative contract may be caused by a trader establishing, maintaining or liquidating an extraordinarily large position whether in a physical-delivery or cash-settled contract. Prices for commodity derivative contracts reflect expectations about the price of the underlying commodity at a future date and, thus, reflect expectations about supply and demand for that underlying commodity. In contrast, the supply of a commodity derivative contract itself is not limited to the supply of the underlying commodity. Rather, the supply of a commodity derivative contract is a function of the ability of a trader to induce a counterparty to take the opposite side of the transaction.

Thus, the capacity of the market (

i.e.,

all participants) to absorb purchase or sale orders for commodity derivative contracts is limited by the number of participants that are willing to provide liquidity,

i.e.,

take the other side of the order at a given price. For example, a trader that demands immediacy in establishing a long position larger than the amount of pending offers to sell by market participants may cause the commodity derivative contract price to increase, as market participants may demand a higher price when entering new offers to sell. It follows that an extraordinarily large position, relative to the size of other participants' positions, may cause an unwarranted price fluctuation.

In a commodity derivative contract, the two parties to the contract have opposite positions. That is, for every long position in a commodity derivative contract held by one trader, there is a short position that another trader must hold.

In the spot month for a physical-delivery commodity derivative contract, concerns regarding sudden or unreasonable fluctuations or unwarranted changes in the price of that contract are heighted because open positions in such a contract either: Must be satisfied by delivery of the underlying commodity (which is of limited supply and, thus, susceptible to corners or squeezes); or must be offset before delivery obligations attach (that requires trading with another participant to offset the open position).

For example, a trader

holding an extraordinarily large long position, absent position limits, could maintain a long position (requiring delivery beyond the limited supply of the physical commodity) deep into the spot month. By maintaining such an extraordinarily large position, such a trader may cause an unwarranted increase in the price of the commodity derivative contract, as holders of short positions attempt to induce a counterparty to offset their position.

Regarding cash-settled commodity derivative contracts, there are a variety of methods for determining the final cash settlement price, such as by reference to (i) a survey price of cash market transactions, or (ii) the final (or daily) settlement price of a physical-delivery futures contract. For example, in the case of a trader who holds an extraordinarily large position in a cash-settled contract based on a survey of prices of cash market transactions, where the price of the spot month cash-settled contract is used by cash market participants in determining or setting their cash market transaction prices, then an unwarranted price fluctuation in that cash-settled commodity derivative contract could result in distorted prices in cash market transactions and, thus, an artificial

final cash settlement price from a survey of such distorted cash market transaction prices. Alternatively, for example, in the case of a trader who holds an extraordinarily large position in a cash-settled contract based on the final settlement price of a physical-delivery futures contract, then a trader has an incentive to mark the close of that physical-delivery futures contract to benefit her position in the cash-settled contract.

Prices that deviate from the natural forces of supply and demand,

i.e.,

artificial prices, may occur when there is hoarding of a physical commodity in an attempted or perfected manipulative activity (such as a corner). If a price of a commodity is artificial, resources will be inefficiently allocated during the time that the artificial price exists. Similarly, prices that are unduly influenced by the size of a very large speculative position, or trading that increases or reduces the size of such very large speculative position, may lead to an inefficient allocation of resources to the extent that such prices do not allocate resources to their highest and best use. These burdens were present during the Hunt brothers episode. The Interagency Silver Study concluded that “the volatile conditions in silver markets and the much higher price levels . . . affected the industrial and commercial sectors of the economy to a greater extent than would have been the case if silver price changes had been less turbulent.”

The Interagency Silver Study described several negative consequences of resource misallocations that occurred during the silver price spike.

Id.

at 150.

Significant changes took place in the use of silver as an industrial input during silver's price oscillation in 1979-80. In the photography industry, the consumption of silver from the first quarter of 1979 to the first quarter of 1980 fell by nearly one third. Similarly, the use of silver in the production of silverware declined by over one half in this period. In addition, numerous other uses of silver exhibited sharp usage declines equivalent to or in excess of these examples. These sharp reductions in silver use are indicative of the general disruption caused by the sharp rise in silver prices. Since the demand for silver in many of these uses is relatively price inelastic, the substantial decline registered in the use of silver for industrial purposes underscores the sizable magnitude of silver price increases and the consequent disruption experienced by the industry.

Individual commercial operations using silver were also disrupted. To illustrate, a major producer of X-ray film discontinued production purportedly as a result of the sharply increased and erratic behavior of the price of silver. In addition, there were reports that trading firms failed financially in early 1980 due to losses incurred in silver markets. Finally, the financial condition of small firms dependent on silver products (hearing aid batteries, printing supplies, etc.) deteriorated as a result of high silver prices and limited supplies.

Id.

(footnotes omitted). James M. Stone, formerly Chairman of the Commission, maintained that the negative effects of the price spike on commercials were borne out in employment figures: “In the case of silver, the employment impacts fell hardest upon the makers of consumer products. According to the Department of Labor's Bureau of Labor Statistics some 6000 jobs in the jewelry, silverware and plateware industries were lost between November of 1979 and February of 1980.” Additional Comments on the Interagency Silver Study at 9 (“Stone Comments”).

Moreover, after the settlement price of silver peaked in mid-January 1980, the ensuing “rapid decline of silver prices subjected several FCMs and their parent companies to considerable financial stress.”

In the view of the Commission and other regulators, “[w]hile all FCMs carrying silver positions appear to have remained solvent during the period in question, the potential for insolvency was significant.”

The Interagency Silver Study described a cascade of undesirable events;

Id.

at 135.

Id.

at 140.

Falling prices reduced the equity in the accounts of some large, net long silver futures positions, necessitating margin calls. Responsibility for the financial obligations of some of these positions had to be assumed by FCMs when large margin calls went unmet. A significant proportion of the loans to major silver longs, collateralized by silver, had been made by some FCMs acting for their parent companies. A major portion of this collateral was rehypothecated for bank loans by these companies. The FCMs and their parent companies were thus exposed to two related problems that threatened them with insolvency—the losses on customer accounts and the possibility that silver prices would fall to a point which would cause the banks to demand payment on the hypothecated loans. . . . The FCM was not only vulnerable because of its customers' losses on the futures contracts, but also because of the potential for a decline in the value of loan collateral.

Id.

at 135-6 (footnote omitted).

The failure of an FCM with large silver exposures could have adversely affected clients without positions in silver and potentially other participants in the futures markets. The failure of a large FCM could have negatively affected the various exchanges and potentially the clearinghouses.

The solvency of FCMs and other Commission registrants crucial to properly functioning futures markets is clearly within the Commission's regulatory ambit. The failure of a commission registrant in the context of unwarranted price spikes would be a burden on interstate commerce.

See id.

at 140-41. “Although the clearinghouses have contingency plans to deal with insolvent members, to date these plans have covered only the collapse of small FCMs. Conceivably, a major default could result in assessments of members that might, in turn, result in the insolvency of some members and the collapse of the exchange.”

Fallout from the silver price spike in late 1979-early 1980 extended beyond the silver markets. “Banks, by extending credit for futures market activity while accepting silver as collateral, exposed themselves to higher than normal risks.”

Unusual activity was also observed in other futures markets, such as precious metals and commodities other than silver in which the Hunts were thought to have had positions.

“On March 27, 1980, the date on which the price of silver dropped to its lowest point, $10.80 an ounce, a combination of factors, including news of the Hunts' problems in meeting margin calls, the efforts of the Hunts to sell positions in various exchange-listed securities in order to meet those calls, and the actions of the SEC in suspending trading in Bache Group stock, appeared to have a direct impact on the securities markets.”

Commenters noted the marked changes in the rate of inflation concomitant with the rapid rise and fall of the price of silver.

Potential bank

failures, disruptions in other futures markets, disruptions in the securities markets and volatile inflation rates would be additional burdens on interstate commerce. In highlighting the ability of market participants to accumulate extraordinarily large speculative positions, thereby demoralizing the silver markets to the injury of producers and consumers, the entirety of the Hunt brothers silver episode called into question the adequacy of futures regulation generally and the integrity of the futures markets.

Interagency Silver Study at 145. “Bank loans to major silver traders were made both directly and indirectly through FCMs. . . . Default on a major portion of these loans could have had a significant effect on the overall banking industry, but particularly on those banks where the loan concentration was the greatest.” Testimony of Philip McBride Johnson, Chairman, Commodity Futures Trading Commission, Before the Subcommittee on Conservation, Credit and Rural Development, Committee on Agriculture, U.S. House of Representatives, Oct. 1, 1981, at 19 (“Johnson Testimony”).

See

Interagency Silver Study at 147-8.

see also

Irwin,

et al.,

“The Performance of CBOT Corn, Soybean, and Wheat Futures Contracts after Recent Changes in Speculative Limits,” July 29, 2007, at 1, 6 (concluding that there was “no

large

change in” price volatility after speculative limits were increased, but cautioning that “[w]ith limited observations available for the period following the change in speculative limits . . . , conclusions about the impact on volatility are tentative. Additional observations will be required across varying scenarios of supply, demand, and price level, to have full confidence in the conclusions.”) (emphasis added); Parsons, John E., “Black Gold & Fool's Gold: Speculation in the Oil Futures Market,” September 1, 2009, at 108 (position limits will not prevent asset bubbles from forming, but they are “necessary to insure the integrity of the market”).

138

See, e.g.,

Hamilton, James D., “Causes and Consequences of the Oil Shock of 2007-08,” April 1, 2009, at 258 (Hamilton raises “the possibility that miscalculation of the long-run price elasticity of oil demand . . . was one factor in the oil shock of 2007-2008, and that speculative investing in oil futures may have contributed to that miscalculation.”); Juvenal, Luciana and Petrella, Ivan, “Speculation in the Oil Market,” June 1, 2012, (“While global demand shocks account for the largest share of oil price fluctuations, speculative shocks are the second most important driver.”).

Several studies did generally address the concept of position limits as part of their discussion of speculative activity. The authors of some of these works expressed views that speculative position limits were an important regulatory tool and that the CFTC should implement limits to control excessive speculation.

139

For example,

one author opined that “ . . . strict position limits should be placed on individual holdings, such that they are not manipulative.”

140

Another stated, “[s]peculative position limits worked well for over 50 years and carry no unintended consequences. If Congress takes these actions, then the speculative money that flowed into these markets will be forced to flow out, and with that the price of commodities futures will come down substantially. Until speculative position limits are restored, investor money will continue to flow unimpeded into the commodities futures markets and the upward pressure on prices will remain.”

141

The authors of one study claimed that “[r]ules for speculative position limits were historically much stricter than they are today. Moreover, despite rhetoric that imposing stricter limits would harm market liquidity, there is no evidence to support such claims, especially in light of the fact that the market was functioning very well prior to 2000, when speculative limits were tighter.”

142

139

See, e.g.,

Greenberger, Michael, “The Relationship of Unregulated Excessive Speculation to Oil Market Price Volatility,” January 1, 2010, at 11 (On position limits: “The damage price volatility causes the economy by needlessly inflating energy and food prices worldwide far outweighs the concerns about the precise application of what for over 70 years has been the historic regulatory technique for controlling excessive speculation in risk-shifting derivative markets.”.); Khan, Mohsin S., “The 2008 Oil Price “Bubble”,” August 2009, at 8 (“The policies being considered by the CFTC to put aggregate position limits on futures contracts and to increase the transparency of futures markets are moves in the right direction.”); U.S. Senate Permanent Subcommittee on Investigations, “Excessive Speculation in the Wheat Market,” June 2009, at 12 (“The activities of these index traders constitute the type of excessive speculation the CFTC should diminish or prevent through the imposition and enforcement of position limits as intended by the Commodity Exchange Act.”); U.S. Senate Permanent Subcommittee on Investigations, “Excessive Speculation in the Natural Gas Market,” June 25, 2007, at 8 (The Subcommittee recommended that Congress give the CFTC authority over ECMs, noting that “[to] ensure fair energy pricing, it is time to put the cop back on the beat in all U.S. energy commodity markets.”); United Nations Conference on Trade and Development, “The Global Economic Crisis: Systemic Failures and Multilateral Remedies,” March 1, 2009, at 14, (The UNCTAD recommends that “ . . . regulators should be enabled to

intervene when swap dealer positions exceed speculative position limits and may represent `excessive speculation'.); United Nations Conference on Trade and Development, “The Financialization of Commodity Markets,” July 1, 2009, at 26 (The report recommends tighter restrictions, notably closing loopholes that allow potentially harmful speculative activity to surpass position limits.).

140

de Schutter, Olivier, “Food Commodities Speculation and Food Price Crises,” September 1, 2010, United Nations Special Report on the Right to Food, at 8.

141

Masters, Michael and White, Adam, “The Accidental Hunt Brothers: How Institutional Investors are Driving up Food and Energy Prices,” July 31, 2008, at 3.

142

Medlock, Kenneth and Myers Jaffe, Amy, “Who is In the Oil Futures Market and How Has It Changed?,” August 26, 2009, Baker Institute for Public Policy, at 8.

Not all of the reviewed studies viewed position limits in a positive light. One study claimed that position limits will not restrain manipulation,

143

while another argued that position limits in the agricultural commodities have not significantly affected volatility.

144

Another study noted that while position limits are effective as an anti-manipulation measure, they will not prevent asset bubbles from forming or stop them from bursting.

145

A study cautioned that while limits may be effective in preventing manipulation, they should be set at an optimal level so as to not harm the affected markets.

146

Another study claimed that position limits should be administered by DCMs, as those entities are closest to and most familiar with the intricacies of markets and thus can implement the most efficient position limits policy.

147

Another study suggested eliminating position limits, arguing that increasing ex-post penalties for manipulation would be more effective at deterring manipulative behavior.

148

One study noted the similar efforts under discussion in European markets.

149

143

Ebrahim, Muhammed and Rhys ap Gwilym, “Can Position Limits Restrain Rogue Traders?,” March 1, 2013, Journal of Banking & Finance, at 27 (“. . . binding constraints have an unintentional effect. That is, they lead to a degradation of the equilibria and augmenting market power of Speculator in addition to other agents. We therefore conclude that position limits are not helpful in curbing market manipulation. Instead of curtailing price swings, they could exacerbate them.”).

144

Irwin, Scott H.; Garcia, Philip; and Good, Darrel L., “The Performance of CBOT Corn, Soybean, and Wheat Futures Contracts after Recent Changes in Speculative Limits,” July 29, 2007, at 16 (“The analysis of price volatility revealed no large change in measures of volatility after the change in speculative limits. A relatively small number of observations are available since the change was made, but there is little to suggest that the change in speculative limits has had a meaningful overall impact on price volatility to date.”).

145

Parsons, John E., “Black Gold & Fool's Gold: Speculation in the Oil Futures Market,” September 1, 2009, at 30 (“Restoring position limits on all nonhedgers, including swap dealers, is a useful reform that gives regulators the powers necessary to ensure the integrity of the market. Although this reform is useful, it will not prevent another speculative bubble in oil. The general purpose of speculative limits is to constrain manipulation . . . Position limits, while useful, will not be useful against an asset bubble. That is really more of a macroeconomic problem, and it is not readily managed with microeconomic levers at the individual exchange level.”).

146

Wray, Randall, “The Commodities Market Bubble: Money Manager Capitalism and the Financialization of Commodities,” October 1, 2008, at 41, 43 (“While the participation of traditional speculators offers clear benefits, position limits must be carefully administered to ensure that their activities do not “demoralize” markets. . . . The CFTC must re-establish and enforce position limits.”).

147

CME Group, Inc., “Excessive Speculation and Position Limits in Energy Derivatives Markets,” CME Group White Paper, at 6 (“Indeed, as the Commission has previously noted, the exchanges have the expertise and are in the best position to fix position limits for their contracts. In fact, this determination led the Commission to delegate to the exchanges authority to set position limits in non-enumerated commodities, in the first instances, almost 30 years ago.”) (available at

http://www.cmegroup.com/company/files/PositionLimitsWhitePaper.pdf

148

Pirrong, Craig, “Squeezes, Corpses, and the Anti-Manipulation Provisions of the Commodity Exchange Act,” October 1, 1994, at 2 (“The efficiency of futures markets would be improved, and perhaps substantially so, by eliminating position limits . . . and relying upon revitalized, harm-based sanctions to deter market manipulation.”).

149

European Commission, “Review of the Markets in Financial Instruments Directive,” December 1, 2010, at 82 note 282 (“European Parliament . . . calls on the Commission to develop measures to ensure that regulators are able to set position limits to counter disproportionate price movements and speculative bubbles, as well as to investigate the use of position limits as a dynamic tool to combat market manipulation, most particularly at the point when a contract is approaching expiry. It also requests the Commission to consider rules relating to the banning of purely speculative trading in commodities and agricultural products, and the imposition of strict position limits especially with regard to their possible impact on the price of essential food commodities in developing countries and greenhouse gas emission allowances.”).

Studies that militate against imposing any speculative position limits appear to conflict with the Congressional mandate (discussed above) that the Commission impose limits on futures contracts, options, and certain swaps for agricultural and exempt commodities. Such studies also appear to conflict with Congress' determination, codified in CEA section 4a(a)(1), that position limits are an effective tool to address excessive speculation as a cause of sudden or unreasonable fluctuations or unwarranted changes in the price of such commodities.

150

7 U.S.C. 6a(a)(1)-(2).

In any case, these studies overall show a lack of consensus regarding the impact of speculation on commodity markets and the effectiveness of position limits. While there is not a consensus, the fact that there are studies on both sides, in the Commission's view, warrants erring on the side of caution. In light of the Commission's experience with position limits, and its interpretation of congressional intent, it is the Commission's judgment that position limits should be implemented as a prophylactic measure, to protect against the potential for undue price fluctuations and other burdens on commerce that in some cases have been at least in part attributable to excessive speculation.

In this regard, the Commission has found two studies of actual market events to be helpful and persuasive in making its alternative necessity finding.

151

The first is the inter-agency report on the silver crisis.

152

This report, by a joint task force of the staffs of the Commission, the Board of Governors of the Federal Reserve System, the Department of the Treasury and the Securities and Exchange Commission, provides an in-depth description and analysis of the silver crisis, the Hunt brothers' build-up of massive positions, the manipulative

conduct that those massive positions enabled, the resulting extreme price volatility, and consequent harms to the economy. The second is the PSI Report on Excessive Speculation in the Natural Gas market.

153

As a Congressional report issued following hearings, it is more helpful and persuasive than academic and other studies in indicating how Congress views limits as necessary to prevent the adverse effects of excessively large speculative positions. The PSI Report is also more helpful because it thoroughly studied actual market events involving a vital energy commodity, natural gas, examined how Amaranth's buildup of massive speculative positions by itself created a risk of market harms, documented how Amaranth sought to avoid existing limits, and analyzed how its ability to do so was a cause of the attendant extreme price volatility documented in the report.

151

Another study of actual market events analyzed position limits in the context of the “Flash Crash” of May 6, 2010. While this study concluded that position limits would not have prevented the crash, and that price limits were more effective, it measured the impacts of potential limits on certain financial contracts not implicated in the instant rulemaking. Lee, Bernard; Cheng, Shih-Fen; and Koh, Annie, “Would Position Limits Have Made any Difference to the 'Flash Crash' on May 6, 2010,” November 1, 2010, at 37.

152

U.S Commodity Futures Trading Commission, “Part Two, A Study of the Silver Market,” May 29, 1981, Report to The Congress in Response to Section 21 of The Commodity Exchange Act.

153

U.S. Senate Permanent Subcommittee on Investigations, “Excessive Speculation in the Natural Gas Market,” June 25, 2007.

The Commission requests comment on its discussion of studies and reports. It also invites commenters to advise the Commission of any additional studies that the Commission should consider, and why.

B. Proposed Rules

1. Section 150.1—Definitions

i. Various Definitions Found in § 150.1

The Commission proposes to amend the definitions of “futures-equivalent,” “independent account controller,” “long position,” “short position,” and “spot month” found in § 150.1 of its regulations to conform them to the concepts and terminology of the CEA, as amended by the Dodd-Frank Act.

154

The Commission also is proposing to add to § 150.1, definitions for “basis contract,” “calendar spread contract,” “commodity derivative contract,” “commodity index contract,” “core referenced futures contract,” “eligible affiliate,” “entity,” “excluded commodity,” “intercommodity spread contract,” “intermarket spread positions,” “intramarket spread positions,” “physical commodity,” “pre-enactment swap,” “pre-existing position,” “referenced contract,” “spread contract,” “speculative position limit,” “swap,” “swap dealer” and “transition period swap.” In addition, the Commission is proposing to move the definition of bona fide hedging from § 1.3(z) into part 150, and to amend and update it. Moreover, the Commission proposes to delete the definition for “the first delivery month of the `crop year.' ” The Commission notes that several terms that are not currently in part 150 are not included in the current rulemaking proposal even though definitions for those terms were adopted in vacated part 151. The Commission does not view definition of these terms as necessary for clarity in light of other revisions proposed herein. The terms not currently proposed include “swaption” and “trader.”

155

Separately, the Commission is making a non-substantive change to list the definitions in alphabetical order rather than by use of assigned letters. This last change will be helpful when looking for a particular definition, both in the near future, in light of the additional definitions proposed to be adopted, and in the expectation that future rulemakings may adopt additional definitions.

154

In a separate proposal approved on the same date as this proposal, the Commission is proposing amendments to § 150.4—aggregation of positions (“Aggregation NPRM”) (Nov. 5, 2013), including amendments to the definitions of “eligible entity” and “independent account controller.”

155

“Swaption” was defined in vacated part 151 to mean “an option to enter into a swap or a physical commodity option.” “Trader” was defined in vacated part 151 to mean “a person that, for its own account or for an account that it controls, makes transactions in Referenced Contracts or has such transactions made.” The Commission notes that while vacated part 151 and several places in current part 150 use the term “trader,” the term “person” is currently used in both § 1.3(z) and in other places in part 150. The amendments in both the Aggregation NPRM and this NPRM use the term “person” in a manner consistent with its current use in part 150.

a. Basis Contract

While the term “basis contract” is not defined in current § 150.1, a definition was adopted in vacated § 151.1. The definition adopted in § 151.1 defined basis contract as “an agreement, contract or transaction that is cash-settled based on the difference in price of the same commodity (or substantially the same commodity) at different delivery locations.” When it adopted part 151, the Commission noted that a swap based on the difference in price of a commodity (or substantially the same commodity) at different delivery locations was a “basis contract and therefore not subject to the limits adopted therein.

156

76 FR 71626, 71631 (n. 49), Nov. 18, 2011.

Under the proposal, the definition for “basis contract” adopted in § 150.1 would expand upon the definition of basis contract adopted in vacated part 151, by defining basis contract to mean “a commodity derivative contract that is cash-settled based on the difference in: (1) The price, directly or indirectly, of: (a) A particular core referenced futures contract; or (b) a commodity deliverable on a particular core referenced futures contract, whether at par, a fixed discount to par, or a premium to par; and (2) the price, at a different delivery location or pricing point than that of the same particular core referenced futures contract, directly or indirectly, of: (a) A commodity deliverable on the same particular core referenced futures contract, whether at par, a fixed discount to par, or a premium to par; or (b) a commodity that is listed in appendix B to this part as substantially the same as a commodity underlying the same core referenced futures contract.”

The Commission notes that the proposal excludes intercommodity spread contracts, calendar spread contracts, and basis contracts from the definition of “commodity index contract.”

The Commission is proposing appendix B to this part, Commodities Listed as Substantially the Same for Purposes of the Definition of Basis Contract. The Commission proposes to expand the definition of basis contract to include contracts cash-settled on the difference in prices of two different, but economically closely related commodities. The basis contract definition in vacated part 151 targeted the location differential. Now the Commission is proposing a basis contract definition that would expand to include certain quality differentials (e.g., RBOB vs. 87 unleaded).

157

The intent of the expanded definition is to reduce the potential for excessive speculation in referenced contracts where, for example, a speculator establishes a large outright directional position in referenced contracts and nets down that directional position with a contract based on the difference in price of the commodity underlying the referenced contracts and a close economic substitute that was not deliverable on the core referenced futures contract. In the absence of this expanded definition, the speculator could then increase further the large position in the referenced contracts. By way of comparison, the Commission preliminarily believes there is greater concern that (i) someone may manipulate the markets by disguise of a directional exposure through netting down the directional exposure using one of the legs of a quality differential (if that quality differential contract were not exempted) than (ii) that someone may use certain quality differential contracts that were exempted from position limits to manipulate the

outright price of a referenced contract. Historically, manipulation has occurred though use of outright positions (as in the case of the Hunt brothers) or time spreads (Amaranth, for example, used calendar month spreads), rather than quality or locational differentials.

157

The expanded basis contract definition is not intended to include significant time differentials in prices of the two commodities (e.g., the expanded basis contract definition would not include calendar spreads for nearby vs. deferred contracts).

The Commission seeks comment on alternatives to the specification of quality standards for substantially the same commodity, such as a methodology to identify and define which differential contracts should be excluded from position limits. (i) Should the Commission expand the definition of basis contract to include any commodity priced at a differential to any of its products and by-products? For example, should a basis contract include a soybean crush spread contract or a crude oil crack spread contract, regardless of the number of components? (ii) Should the Commission expand the definition of basis contract to include a product or by-product of a particular commodity, priced at a differential to another product or by-product of that same commodity? For example, should the basis contract definition include a contract based on jet fuel priced at a differential to heating oil? Jet fuel and heating oil are both products of the same commodity, namely crude oil. (iii) Should the Commission expand the definition of basis contract for a particular commodity to include other similar commodities? For example, should the basis contract definition include a contract based on the difference in prices of light sweet crude oil and a sour crude oil that is not deliverable on the WTI contract?

b. Commodity Derivative Contract

The Commission proposes in § 150.1(l) to define the term “commodity derivative contract” for position limits purposes as shorthand for any futures, option, or swap contract in a commodity (other than a security futures product as defined in CEA section 1a(45)). Part 150 refers only to futures and options, while vacated part 151 was drafted without the use of any similar concise phrase. It was determined during the process of updating part 150 that the use of such a generic term would be a useful way to streamline and simplify references in part 150 to the various kinds of contracts to which the position limits regime applies. As such, this new definition can be found frequently throughout the Commission's proposed amendments to part 150.

158

See, e.g.,

proposed amendments to § 150.1 (the definitions of: “basis contract,” the definition of “bona fide hedging position,” “inter-market spread position,” “intra-market spread position,” “pre-existing position,” “speculative position limits,” and “spot month”), §§ 150.2(f)(2), 150.3(d), 150.3(h), 150.5(a), 150.5(b), 150.5(e), 150.7(d), 150.7(f), appendix A to part 150, and appendix C to part 150.

c. Commodity Index Contract

The term “commodity index contract” is not currently defined in § 150.1; a definition for the term was adopted in vacated part 151.

159

Under the definition adopted in § 151.1, commodity index contract means “an agreement, contract, or transaction that is not a basis or any type of spread contract, based on an index comprised of prices of commodities that are not the same or substantially the same; provided that, a commodity index contract used to circumvent speculative position limits shall be considered to be a Referenced Contract for the purpose of applying the position limits of § 151.4.”

160

159

76 FR at 71685.

160

See id.

The Commission noted in the vacated part 151 final rulemaking that the definition of “Referenced Contract” in § 151.1 expressly excluded commodity index contracts.

161

The Commission also noted that “if a swap is based on prices of multiple different commodities comprising an index, it is a `commodity index contract.' ”

162

As the preamble pointed out, it would not, therefore, be subject to position limits.

163

161

Id.

at 71656.

162

Id.

at 71631 n.49.

163

Id.

The Commission clarifies here, that, as was noted in the vacated part 151 Rulemaking, 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 § 150.2. The Commission further clarifies that, again as was noted in the vacated part 151 Rulemaking, 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 § 150.2.

See id.

The Commission proposes in the current rulemaking to add into § 150.1 substantially the same definition for “commodity index contract” as was adopted in vacated § 151.1, with one change. The proviso included in § 151.1, which required treatment of a position in a commodity index contract as a Referenced Contract if the contract was used to circumvent speculative position limits, acted in the § 151.1 definition as an anti-evasion provision, a substantive regulatory requirement. Consequently, to provide greater clarity as to the effect of the provision, the definition of “commodity index contract” proposed in 150.1 mirrors that of the definition in 151.1, but with no anti-evasion proviso. Instead, an anti-evasion provision, while similar to that contained in § 151.1, is included in proposed § 150.2(h).

164

See

discussion below.

As in vacated part 151, and as noted above, the definition of “referenced contract” proposed in the current rulemaking also expressly excludes commodity index contracts. However, as the Commission noted in the final part 151 Rulemaking, part 20 of the Commission's regulations requires reporting entities to report commodity reference price data sufficient to distinguish between commodity index contract and non-commodity index contract positions in covered contracts.

165

Therefore, for commodity index contracts, the Commission intends to rely on the data elements in § 20.4(b) to distinguish data records subject to § 150.2 position limits from those contracts that are excluded from § 150.2. This will enable the Commission to set position limits using the narrower data set (

i.e.,

referenced contracts subject to § 150.2 position limits) as well as conduct surveillance using the broader data set.

165

76 FR at 71632.

d. Core Referenced Futures Contract

While current part 150 does not contain a definition of the term “core referenced futures contracts,” a definition for the term was adopted in vacated § 151.1 as a simple short-hand phrase to denote certain futures contracts, regarding which several position limit rules were then applied. The definition adopted in § 151.1 provided that a core referenced futures contract was “a futures contract defined in § 151.2”; section 151.2 provided a list of 28 physical commodity futures and option contracts.

166

The Commission clarified in adopting § 151.2, that core referenced futures contracts included options that expire into outright positions in such contracts.

See

76 FR at 71631.

The Commission proposes to include in § 150.1 the same definition as was adopted in vacated § 151.1—such that the definition would cite to futures contracts listed in § 151.2.

167

The selection of the core referenced futures contracts is explained in the discussion of proposed § 150.2.

See

discussion below.

e. Eligible Affiliate

The term “eligible affiliate,” used in proposed § 150.2(c)(2), is not defined in current § 150.1. The Commission proposes to amend § 150.1 to define an

“eligible affiliate” as “an entity with respect to which another person: (1) Directly or indirectly holds either: (i) A majority of the equity securities of such entity, or (ii) the right to receive upon dissolution of, or the contribution of, a majority of the capital of such entity; (2) reports its financial statements on a consolidated basis under Generally Accepted Accounting Principles or International Financial Reporting Standards, and such consolidated financial statements include the financial results of such entity; and (3) is required to aggregate the positions of such entity under § 150.4 and does not claim an exemption from aggregation for such entity.”

168

See

proposed § 150.1.

The definition of “eligible affiliate” proposed in the current NPRM qualifies persons as eligible affiliates based on requirements similar to those recently adopted by the Commission in a separate rulemaking. On April 1, 2013, the Commission provided relief from the mandatory clearing requirement of section 2(h)(1)(A) of the Act for certain affiliated persons if the affiliated persons (“eligible affiliate counterparties”) meet requirements contained in § 50.52.

169

Under both § 50.52 and the current proposed definition, a person is an eligible affiliate if the person, directly or indirectly, holds a majority ownership interest in the other counterparty (a majority of the equity securities of such entity, or the right to receive upon dissolution of, or the contribution of, a majority of the capital of such entity), reports its financial statements on a consolidated basis under Generally Accepted Accounting Principles or International Financial Reporting Standards, and such consolidated financial statements include the financial results of such entity. In addition, for purposes of the position limits regime, an eligible affiliate, as proposed in § 150.1, must be required to aggregate the positions of such entity under § 150.4 and does not claim an exemption from aggregation for such entity.

170

169

See

Clearing Exemption for Swaps Between Certain Affiliated Entities, 78 FR 21749, 21783, Apr. 11, 2013. Section 50.52(a) addresses eligible affiliate counterparty status, allowing a person not to clear a swap subject to the clearing requirement of section 2(h)(1)(A) of the Act and part 50 if the person meets the requirements of the conditions contained in paragraphs (a) and (b) of § 50.52. The conditions in paragraph (a) of § 50.52 specify either one counterparty holds a majority ownership interest in, and reports its financial statements on a consolidated basis with, the other counterparty, or both counterparties are majority owned by a third party who reports its financial statements on a consolidated basis with the counterparties.

The conditions in paragraph (b) of § 50.52 address factors such as the decision of the parties not to clear, the associated documentation, audit, and recordkeeping requirements, the policies and procedures that must be established, maintained, and followed by a dealer and major swap participant, and the requirement to have an appropriate centralized risk management program, rather than the nature of the affiliation. As such, those conditions are less pertinent to the definition of eligible affiliate.

170

See

proposed amendments to the definition of “eligible affiliate” in proposed § 150.1.

The Commission requests comment on the proposed definition. Is the definition an appropriate one for purposes of the position limits regime? Should the Commission consider adopting a definition that more closely tracks the “eligible affiliate counterparties” definition adopted in § 50.52 or is the difference appropriate in light of the differing regulatory purposes of the two regulations?

f. Entity

The current proposal defines “entity” to mean “a `person' as defined in section 1a of the Act.”

171

The term is not defined in either current § 150.1, but was defined in vacated § 151.1; the language proposed here tracks that adopted in § 151.1. The term “entity,” like that of “person,” is used in a number of contexts, and in various definitions. Defining the term, therefore, provides a clear and unambiguous meaning, and prevents confusion.

171

CEA section 1a(38); 7 U.S.C. 1a(38).

g. Excluded Commodity

The phrase “excluded commodity” was added into the CEA in the CFMA, but was not defined or used in part 150. CEA section 4a(a)(2)(A), as amended by the Dodd-Frank Act, utilizes the phrase “excluded commodity” when it provides a timeline under which the Commission is charged with setting limits for futures and option contracts other than on excluded commodities.

172

CEA section 4a(2)(A); 7 U.S.C. 6a(2)(A).

Part 151 included in the definition section of vacated § 151.1, a definition which simply incorporated into part 151 the statutory meaning, as a useful term for purposes of a number of the changes made by part 151 to the position limits regime. For example, the phrase was used in vacated § 151.11, in the provision of acceptable practices for DCMs and SEFs in their adoption of rules and procedures for monitoring and enforcing position accountability provisions; it was also used in the amendments to the definition of bona fide hedging.

173

Similarly, the Commission believes that the adoption into part 150 of the excluded commodity definition will be a useful tool in addressing the same provisions, and so proposes to adopt into § 150.1 the definition used in § 151.1.

174

173

See

17 CFR 1.3(z) as amended by the vacated part 151 Rulemaking.

174

See e.g.,

proposed § 150.1 definitions for bona fide hedging and proposed amendments to § 150.5(b).

h. First Delivery Month of the Crop Year

The term “first delivery month of the crop year” is currently defined in § 150.1(c), with a table of the first delivery month of the crop year for the commodities for which position limits are currently provided in § 150.2. The crop year definition has been pertinent for purposes of the spread exemption to the single month limit in current § 150.3(a)(3), which limits spread positions in a single month to a level no more than that of the all-months limit. The Commission did not adopt this definition in vacated part 151.

175

In the current proposal, the Commission proposes to amend § 150.1 to delete the definition of “crop year.” The elimination of the definition reflects the fact that the definition is no longer needed, since the current proposal, like the approach adopted in part 151, would raise the level of individual month limits to the level of the all-month limits.

175

See

76 FR at 71685.

i. Futures Equivalent

The term “futures-equivalent” is currently defined in § 150.1(f) to mean “an option contract which has been adjusted by the previous day's risk factor, or delta coefficient, for that option which has been calculated at the close of trading and published by the applicable exchange under § 16.01 of this chapter.”

176

The Commission proposes to retain the definition currently found in § 150.1(f), while broadening it in light of the Dodd-Frank Act amendments to CEA section 4a.

177

The proposed amendments would also delete, as unnecessary, the reference to § 16.01 found in the current definition.

176

17 CFR 150.1(f).

177

Amendments to CEA section 4a(1) authorize the Commission to extend position limits beyond futures and option contracts to swaps traded on a DCM or SEF and swaps not traded on a DCM or SEF that perform or affect a significant price discovery function with respect to regulated entities (“SPDF swaps”). 7 U.S.C. 6a(a)(1). In addition, under new CEA sections 4a(a)(2) and 4a(a)(5), speculative position limits apply to agricultural and exempt commodity swaps that are “economically equivalent” to DCM futures and option contracts. 7 U.S.C. 6a(a)(2) and (5).

As proposed, “futures equivalent” would be defined in § 150.1 as “(1) An option contract, whether an option on a future or an option that is a swap, which has been adjusted by an economically reasonable and analytically supported risk factor, or delta coefficient, for that

option computed as of the previous day's close or the current day's close or contemporaneously during the trading day, and; (2) A swap which has been converted to an economically equivalent amount of an open position in a core referenced futures contract.”

Vacated § 151.1 did not retain a definition for “futures-equivalent;” instead final part 151 referred to guidance on futures equivalency provided in appendix A to part 20.

178

The Commission notes that while the part 20 “futures equivalent” definition is consistent with the “futures-equivalent” definition proposed herein, it addresses only swaps, and cites to, and relies on, the guidance provided in appendix A to part 20.

179

The definition proposed herein addresses both options on futures and options that are swaps; it also includes and expands upon clarifications that are incorporated into the current definition regarding the computation time and the adjustment by an economically reasonable and analytically supported risk factor, or delta coefficient.

178

76 FR at 71633 (n. 67) (stating that “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 also

150.5(b)(5)(b)(iv).

l. Intramarket Spread Position

Neither current part 150, nor vacated part 151, includes a definition of the term “intramarket spread contract.” The Commission now proposes to add into § 150.1 the definition, such that “intramarket spread position” means “a long position in a commodity derivative contract in a particular commodity and a short position in another commodity derivative contract in the same commodity on the same designated contract market or swap execution facility.”

Current part 150 includes exemptions for certain spread positions. For example, current § 150.3(a)(3) provides an exemption for spread (or arbitrage) positions, but this exemption is limited to those between single months for futures contracts and/or, options thereon, if outside of the spot month, and only if in the same crop year. While current § 150.3(a)(3) limits the spread

exemption provided thereunder, the exemption under current § 150.5(a) is not so limited. Instead, under current § 150.5(a), exchanges may exempt from position limits “positions which are normally known in the trade as “spreads, straddles, or arbitrage. . . .”

184

The Commission notes that the definition it now proposes for “intramarket spread position” is a generic term, and not limited only to futures and/or options thereon.

185

In a similar manner to adoption of the term “intermarket spread position,” the term “intramarket spread position,” therefore, simplifies the Commissions amendments to exemptions for spread positions, including proposed changes to § 150.5, which, as noted above, provide acceptable exemptions DCMs and SEFs may choose to grant from speculative position limits.

184

The Commission notes that the exemption provided in § 150.5(a) for “positions which are normally known in the trade as `spreads, straddles, or arbitrage,' ” tracks CEA section 4a(a)(1). 7 U.S.C. 6a(a)(1). Also, various DCMs currently have rules in place that provide exemptions for such as “spreads, straddles, or arbitrage” positions.

See, e.g.,

ICE Futures U.S. rule 6.27 and CME rule 559.C.

185

For further discussion regarding the exemptions for intramarket spread positions,

see infra,

discussion regarding § 150.5(a)(2) and (b)(5).

m. Long Position

The term “long position” is currently defined in § 150.1(g) to mean “a long call option, a short put option or a long underlying futures contract,” but the phrase was not retained in vacated § 151.1. The Commission proposes to retain the definition, but to update it to make it also applicable to swaps such that a long position would include a long futures-equivalent swap.

n. Physical Commodity

The Commission proposes to amend § 150.1 by adding in a definition of the term “physical commodity” for position limits purposes. Congress used the term “physical commodity” in CEA sections 4a(a)(2)(A) and 4a(a)(2)(B) to mean commodities “other than excluded commodities as defined by the Commission.” Therefore, the Commission interprets “physical commodities” to include both exempt and agricultural commodities, but not excluded commodities, and proposes to define the term as such.

186

For position limits purposes, proposed § 150.1 would define “physical commodity” to mean “any agricultural commodity as that term is defined in § 1.3 of this chapter or any exempt commodity as that term is defined in section 1a(20) of the Act.”

o. Referenced Contracts

Part 150 currently does not include a definition of the phrase “Referenced Contract,” which was introduced and adopted in vacated part 151.

187

As was noted when part 151 was adopted, the Commission identified 28 core referenced futures contracts and proposed to apply aggregate limits on a futures equivalent basis across all derivatives that [met the definition of Referenced Contracts'].”

188

187

Vacated § 151.1 defined “Referenced Contract” to mean “on a futures-equivalent basis with respect to a particular Core Referenced Futures Contract, a Core Referenced Futures Contract listed in § 151.2, or a futures contract, options contract, swap or swaption, other than a basis contract or contract on a commodity index that is: (1) Directly or indirectly linked, including being partially or fully settled on, or priced at a fixed differential to, the price of that particular Core Referenced Futures Contract; or (2) Directly or indirectly linked, including being partially or fully settled on, or priced at a fixed differential to, the price of the same commodity underlying that particular Core Referenced Futures Contract for delivery at the same location or locations as specified in that particular Core Referenced Futures Contract.”

188

76 FR at 71629.

The vacated § 151.1 definition of Referenced Contracts included: (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. According to the Commission, these criteria captured contracts with prices that are or should be closely correlated to the prices of the Core Referenced Futures Contract, as defined in vacated § 151.1.

189

In addition, the definition included categories of Referenced Contract based on objective criteria and readily available data (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).

190

At that time, the Commission clarified that a swap contract using as its sole floating reference price the prices generated directly or indirectly from the price of a single Core Referenced Futures Contract or a swap priced based on a fixed differential to a Core Referenced Futures Contract, were look-alike Referenced Contracts, and subject to the limits adopted in vacated part 151.

191

In addition, the definition included options that expire into outright positions in such contracts.

192

189

Id.

at 71630.

190

Id.

at 71630-31.

191

Id.

at 71631 n.50 (“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).”).

192

Id.

at 71631.

In response to comments that the Commission should broaden the scope of Referenced Contracts, the Commission noted that expanding the scope of position limits based, for example, on cross-hedging relationships or other historical price analysis would be problematic as historical relationships may change over time and, additionally, would require individualized determinations. In light of these circumstances, the Commission determined that it was not necessary to expand the scope of position limits beyond what was adopted. The Commission also noted 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, further noting that it would consider amending the scope of economically equivalent contracts (and the relevant identifying criteria) as it gained experience in this area.

193

Id.

The definition for “referenced contract” proposed in § 150.1 mirrors the definition proposed in § 151.1, with the delineation of several related terms incorporated into the definition.

194

The

beginning of the current definition parallels the definition in vacated § 151.1, differing only with the addition of a clarification that the definition of “referenced contract” does not include guarantees of a swap. This clarification is added into the list of products that are not included in the definition.

195

In the proposed definition, “referenced contract” would not include “a guarantee of a swap, a basis contract, or a commodity index contract.”

196

In addition, for the sake of clarify, the proposal incorporates into the definition of “referenced contract” several related terms. Consequently, the definition for “referenced contract” delineates the meaning of “calendar spread contract,” “commodity index contract,” “spread contract,” and “intercommodity spread contract.”

197

The incorporation of these terms into the definition of “referenced contract” is intended to retain in one place the various parts and meanings of the definition, thereby facilitating comprehension of the definition.

194

In the current rulemaking, the term “referenced contract” is defined in § 150.1 to mean, on a futures-equivalent basis with respect to a particular core referenced futures contract, “a core referenced futures contract listed in § 151.2(d) of this part, or a futures contract, options contract, or swap, other than a guarantee of a swap, a basis contract, or a commodity index contract: (1) That is: (a) Directly or indirectly linked, including being partially or fully settled on, or priced at a fixed differential to, the price of that particular core referenced futures contract; or (b) Directly or indirectly linked, including being partially or fully settled on, or priced at a fixed differential to, the price of the same commodity underlying that particular core referenced futures contract for delivery at the same location or locations as specified in that particular core referenced futures contract; and (2) Where: (a) Calendar spread contract means a cash-settled agreement, contract, or transaction that represents the difference between the settlement price in one or a series of contract months of an agreement, contract or transaction and the settlement price of another contract month or another series of contract months' settlement prices for the same agreement, contract or transaction; (b) Commodity index contract means an agreement, contract, or transaction that is not a basis or any type of spread contract, based on an index comprised of prices of

commodities that are not the same or substantially the same; (c) Spread contract means either a calendar spread contract or an intercommodity spread contract; and (d) Intercommodity spread contract means a cash-settled agreement, contract or transaction that represents 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.”

195

As defined in vacated § 151.1, “Referenced Contract” excludes “a basis contract or contract on a commodity index.”

See

vacated § 151.1.

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