# Position Limits for Derivatives > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2020-25332 ## Record - **Collection:** Federal Register - **Document type:** Rule - **Published:** January 14, 2021 - **Citation:** 86 FR 3236 ## Text COMMODITY FUTURES TRADING COMMISSION 17 CFR Parts 1, 15, 17, 19, 40, 140, 150 and 151 RIN 3038-AD99 Position Limits for Derivatives AGENCY: Commodity Futures Trading Commission. ACTION: Final rule. SUMMARY: The Commodity Futures Trading Commission (“Commission” or “CFTC”) is adopting amendments in this final rule (“Final Rule”) to conform regulations concerning speculative position limits to the relevant Wall Street Transparency and Accountability Act of 2010 (“Dodd-Frank Act”) amendments to the Commodity Exchange Act (“CEA”). Among other regulatory amendments, the Commission is adopting: New and amended Federal spot-month limits for 25 physical commodity derivatives; amended single month and all-months-combined limits for most of the agricultural contracts currently subject to Federal position limits; new and amended definitions for use throughout the position limits regulations, including a revised definition of “bona fide hedging transaction or position” and a new definition of “economically equivalent swaps”; amended rules governing exchange-set limit levels and grants of exemptions therefrom; a new streamlined process for bona fide hedging recognitions for purposes of Federal position limits; new enumerated bona fide hedges; and amendments to certain regulatory provisions that would eliminate Form 204 while also enabling the Commission to leverage and receive cash-market reporting submitted directly to the exchanges by market participants. DATES: Effective date: This Final Rule will become effective on March 15, 2021. Compliance date: Compliance dates for this Final Rule shall be as follows: • January 1, 2022 in connection with the Federal speculative position limits for the 16 non-legacy core referenced futures contracts subject to Federal position limits for the first time under this Final Rule. This compliance date also applies to any associated referenced contracts other than economically equivalent swaps. Such swaps are subject to a separate compliance date noted below. • January 1, 2022 in connection with an exchange's requirements under § 150.5, as adopted in this Final Rule. • January 1, 2023 in connection with Federal speculative position limits for economically equivalent swaps, as defined under this Final Rule. • January 1, 2023 in connection with the elimination of previously-granted risk management exemptions described in § 150.3(c), as adopted in this Final Rule. FOR FURTHER INFORMATION CONTACT: Dorothy DeWitt, Director, (202) 418-6057, ddewitt@cftc.gov ; Rachel Reicher, Chief Counsel, (202) 418-6233, rreicher@cftc.gov ; Steven A. Haidar, Assistant Chief Counsel, (202) 418-5611, shaidar@cftc.gov ; Aaron Brodsky, Senior Special Counsel, (202) 418-5349, abrodsky@cftc.gov ; Steven Benton, Industry Economist, (202) 418-5617, sbenton@cftc.gov ; Lillian Cardona, Assistant Chief Counsel, (202) 418-5012, lcardona@cftc.gov ; Jeanette Curtis, Assistant Chief Counsel, (202) 418-5669, jcurtis@cftc.gov ; Harold Hild, Policy Advisor, (202) 418-5376, hhild@cftc.gov ; Division of Market Oversight, in each case, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581; Michael Ehrstein, Special Counsel, (202) 418-5957, mehrstein@cftc.gov ; Chang Jung, Special Counsel, (202) 418-5202, cjung@cftc.gov ; Division of Swap Dealer and Intermediary Oversight, in each case, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581; Rachel Hayes, Trial Attorney, (816) 960-7741, rhayes@cftc.gov ; Division of Enforcement, Commodity Futures Trading Commission, 4900 Main Street, Suite 500, Kansas City, MO 64112; or Brigitte Weyls, Trial Attorney, (312) 596-0547, bweyls@cftc.gov ; Division of Enforcement, Commodity Futures Trading Commission, 525 West Monroe Street, Suite 1100, Chicago, IL 60661. SUPPLEMENTARY INFORMATION: Table of Contents I. Background A. Introduction B. Executive Summary C. Section-by-Section Summary of Final Rule D. Effective Date and Compliance Period E. The Commission Construes CEA Section 4a(a) To Require the Commission To Make a Necessity Finding Before Establishing Position Limits for Physical Commodities Other Than Excluded Commodities F. The Commission's Use of Certain Terminology G. Recent Volatility in the WTI Contract H. Brief Summary of Comments Received II. Final Rule A. § 150.1—Definitions B. § 150.2—Federal Position Limit Levels C. § 150.3—Exemptions From Federal Position Limits D. § 150.5—Exchange-Set Position Limits and Exemptions Therefrom E. § 150.6—Scope F. § 150.8—Severability G. § 150.9—Process for Recognizing Non-Enumerated Bona Fide Hedging Transactions or Positions With Respect to Federal Speculative Position Limits H. Part 19 and Related Provisions—Reporting of Cash-Market Positions I. Removal of Part 151 III. Legal Matters A. Interpretation of Statute Regarding Whether Necessity Finding Is Required for Position Limits Established Pursuant to CEA 4a(a)(2) B. Legal Standard for Necessity Finding C. Necessity Finding as to the 25 Core Referenced Futures Contracts D. Necessity Finding as to Linked Contracts E. Necessity Finding for Spot/Non-Spot Month Position Limits IV. Related Matters A. Cost-Benefit Considerations B. Paperwork Reduction Act C. Regulatory Flexibility Act D. Antitrust Considerations I. Background A. Introduction The Commission has long established and enforced speculative position limits for futures contracts and options on futures contracts on nine agricultural commodities as authorized by the CEA. 1 These nine agricultural commodity contracts, which have been subject to Federal position limits for decades, are generally referred to as the “nine legacy agricultural contracts.” Under this Final Rule, the Commission additionally will establish Federal speculative position limits for certain commodity derivatives contracts associated with 16 additional commodities. The Commission refers to these 16 new commodities and their associated commodity derivatives contracts throughout this release as the “non-legacy” contracts since they are subject to Federal position limits for the first time under this Final Rule. Accordingly, under the Final Rule, certain commodity derivatives contracts associated with 25 commodities are subject to Federal position limits. 1 7 U.S.C. 1 et seq. The Commission's existing position limits regulations 2 in existing part 150 of the Commission's regulations include three components: 2 17 CFR part 150. Part 150 of the Commission's regulations establishes Federal position limits (that is, position limits established by the Commission) on the nine legacy agricultural contracts. The nine legacy agricultural contracts are: CBOT Corn (and Mini-Corn) (C), CBOT Oats (O), CBOT Soybeans (and Mini-Soybeans) (S), CBOT Wheat (and Mini-Wheat) (W), CBOT Soybean Oil (SO), CBOT Soybean Meal (SM), MGEX Hard Red Spring Wheat (MWE), CBOT KC Hard Red Winter Wheat (KW), and ICE Cotton No. 2 (CT). See 17 CFR 150.2. The Federal position limits on these agricultural contracts are referred to as “legacy” limits because these contracts have been subject to Federal position limits for decades. First, the Commission's existing regulations establish separate position limit levels for each of the nine legacy agricultural contracts. These Federal position limit levels set the maximum speculative positions in each of the nine legacy agricultural contracts that a person may hold in the spot month, individual month, and all-months-combined. 3 3 See 17 CFR 150.2. Second, the existing Federal position limits framework provides exemptions to the Federal position limit levels for positions that constitute “bona fide hedging transactions or positions” and for certain “spread or arbitrage” positions. 4 4 See 17 CFR 150.3. Third, the Commission's existing regulations determine which accounts and positions a person must aggregate for the purpose of determining compliance with the Federal position limit levels. 5 5 See 17 CFR 150.4. The existing Federal speculative position limits function in parallel to exchange-set position limits and/or exchange-set position accountability required by designated contract market (“DCM”) Core Principle 5. 6 As a result, the nine legacy agricultural contracts are subject to both Federal and exchange-set limits, whereas other exchange-traded futures contracts and options on futures contracts are subject only to DCM-set limits and/or position accountability. 6 7 U.S.C. 7(d)(5); 17 CFR 38.300. Paragraph (A) of DCM Core Principle 5 provides: To reduce the potential threat of market manipulation or congestion (especially during trading in the delivery month), the board of trade shall adopt for each contract of the board of trade, as is necessary and appropriate, position limitations or position accountability for speculators. Position limits generally cannot be exceeded absent an exemption, whereas position accountability allows an exchange to establish a level at which market participants, including those participants who do not qualify for an exemption, are required to: Provide position information to the exchange prior to increasing a position above the accountability level; halt further position increases; and/or reduce positions in an orderly manner. Core Principle 6 in part 37 of the Commission's regulations for swap execution facilities (“SEFs”) contains similar language. 17 CFR 38.600. As part of the Dodd-Frank Act, Congress amended the CEA's position limits provisions, which since 1936 have authorized the Commission (and its predecessor) to impose limits on speculative positions to prevent the harms caused by excessive speculation. As discussed below, the Commission interprets these amendments as, among other things, tasking the Commission with establishing such position limits as it finds are “necessary” for the purpose of “diminishing, eliminating, or preventing” excessive speculation causing sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity. 7 The Commission also interprets these amendments as tasking the Commission with establishing position limits on any “economically equivalent” swaps. 8 7 7 U.S.C. 6a(a)(1); see infra Section III.C. (discussion of the necessity finding). 8 7 U.S.C. 6a(a)(5); see also infra Section II.B.1.iii. The Commission previously issued proposed and final rules in 2011 (“2011 Final Rulemaking”) to implement the provisions of the Dodd-Frank Act regarding position limits and the bona fide hedge definition. 9 A September 28, 2012 order of the U.S. District Court for the District of Columbia vacated the 2011 Final Rulemaking, with the exception of the rule's amendments to 17 CFR 150.2. 10 9 Position Limits for Derivatives, 76 FR 4752 (Jan. 26, 2011) (“2011 Proposal”); Position Limits for Futures and Swaps, 76 FR 71626 (Nov. 18, 2011) (“2011 Final Rulemaking”). 10 Int'l Swaps & Derivatives Ass'n v. U.S. Commodity Futures Trading Comm'n, 887 F. Supp. 2d 259 (D.D.C. 2012) (“ ISDA” ). Subsequently, the Commission proposed position limits regulations in 2013 (“2013 Proposal”), in June of 2016 (“2016 Supplemental Proposal”), and again in December of 2016 (“2016 Reproposal”). 11 The 2016 Reproposal would have amended part 150 of the Commission's regulations to, among other things: Establish Federal position limits for 25 physical commodity futures contracts and their linked futures contracts, options on futures contracts, and “economically equivalent” swaps; revise the existing exemptions from such limits, including for bona fide hedges; and establish a framework for exchanges 12 to recognize certain positions as bona fide hedges and thus exempt from position limits. 11 Position Limits for Derivatives, 78 FR 75680 (Dec. 12, 2013) (“2013 Proposal”); Position Limits for Derivatives: Certain Exemptions and Guidance, 81 FR 38458 (June 13, 2016) (“2016 Supplemental Proposal”); and Position Limits for Derivatives, 81 FR 96704 (Dec. 30, 2016) (“2016 Reproposal”). 12 Unless indicated otherwise, the use of the term “exchanges” throughout this release refers to DCMs and SEFs. To date, the Commission has not issued any final rulemaking based on the 2013 Proposal, 2016 Supplemental Proposal, or 2016 Reproposal. The 2016 Reproposal generally addressed comments received in response to the 2013 Proposal and the 2016 Supplemental Proposal. In a separate 2016 proposed rulemaking, the CFTC also proposed, and later adopted in 2016, amendments to rules in § 150.4 of the Commission's regulations governing aggregation of positions for purposes of compliance with Federal position limits. 13 These aggregation rules currently apply only to the nine legacy agricultural contracts subject to existing Federal position limits. Going forward, these aggregation rules will apply to all commodity derivative contracts that are subject to Federal position limits under this Final Rule. 13 Aggregation of Positions, 81 FR 91454 (Dec. 16, 2016) (“Final Aggregation Rulemaking”); see 17 CFR 150.4. Under the Final Aggregation Rulemaking, unless an exemption applies, a person's positions must be aggregated with positions for which the person controls trading or for which the person holds a 10% or greater ownership interest. The Division of Market Oversight has issued time-limited no-action relief from some of the aggregation requirements contained in that rulemaking. See CFTC Letter No. 19-19 (July 31, 2019), available at https://www.cftc.gov/csl/19-19/download . The Commission published a notice of a proposed rulemaking in the Federal Register on February 27, 2020 for a new position limits proposal (“2020 NPRM”). After reconsidering the prior proposals, including reviewing the comments responding thereto, the Commission in the 2020 NPRM withdrew from further consideration the 2013 Proposal, the 2016 Supplemental Proposal, and the 2016 Reproposal. 14 14 Because the earlier proposals were withdrawn in the 2020 NPRM, comments on the earlier proposals are not part of the administrative record with respect to the 2020 NPRM nor with respect to this Final Rule, except where expressly referenced herein. In the 2020 NPRM, the Commission stated that commenters to the 2016 Reproposal should resubmit comments relevant to the subject proposal; commenters who wish to reference prior comment letters should cite those prior comment letters as specifically as possible. (85 FR at 11597). Accordingly, this Final Rule will not discuss comments submitted in connection with the 2016 Reproposal unless such comments were resubmitted for the 2020 NPRM. In the 2020 NPRM, the Commission intended to: (1) Recognize differences across commodities and contracts, including differences in commercial hedging and cash-market reporting practices; (2) focus on commodity derivative contracts that are critical to price discovery and distribution of the underlying commodities such that the burden of excessive speculation in the commodity derivative contracts may have a particularly acute impact on interstate commerce for the underling commodities; and (3) reduce duplication and inefficiency by leveraging existing expertise and processes at DCMs. The public comment period for the 2020 NPRM ended May 15, 2020, 15 and the Commission received approximately 75 public comment letters. 16 After reviewing these public comment letters, and for the general reasons discussed in this release, the Commission is adopting the 2020 NPRM with certain modifications in this Final Rule. 17 15 Comments were originally due by April 29, 2020. Due to the COVID-19 pandemic, the Commission extended the deadline to May 15, 2020. 16 The Commission states “approximately 75 relevant comment letters” since several commenters submitted additional, or supplemental, comments. As a result, the total could change slightly depending on whether one includes these supplemental comment letters in the total. Thus, for the avoidance of doubt, the Commission uses “approximately.” The Commission received comments from: American Cotton Shippers Association (“ACSA”); American Feed Industry Association (“AFIA”); American Gas Association (“AGA”); AQR Capital Management, LLC (“AQR”); Archer Daniels Midland (“ADM”); AMCOT; Americans for Financial Reform (“AFR”); Arthur Dunavant Investments (“Dunavant”); ASR Group International, Inc. (“ASR”); Atlantic Cotton Association (“ACA”); Barnard, Chris (Individual); Better Markets, Inc. (“Better Markets”); Cargill, Inc. (“Cargill”); Castleton Commodities International LLC (“CCI”); Chevron USA Inc. (“Chevron”); Choice Cotton Company, Inc. (“Choice Cotton”); CHS Inc. (“CHS Inc.”) and CHS Hedging, LLC (“CHS Hedging”) (collectively, “CHS”); Citadel; CME Group Inc. (“CME Group”); Commodity Markets Council (“CMC”); DECA Global LLC (“DECA”); East Cotton Company (“East Cotton”); Ecom Agroindustrial (“Ecom”); Edison Electric Institute (“EEI”) and Electric Power Supply Association (“EPSA”) (collectively, the “Joint Associations” or “EEI/EPSA”); Futures Industry Association (“FIA”); Glencore Agriculture Limited, Glencore Agriculture B.V. (collectively, “Glencore”); ICE Futures U.S. (“IFUS”); IMC Companies (“IMC”); Industrial Energy Consumers of America; Institute for Agriculture & Trade Policy (“IATP”); Intercontinental Exchange, Inc. (“ICE”); International Energy Credit Association (“IECA”); International Swaps and Derivatives Association, Inc. (“ISDA”); Jess Smith & Sons (“Jess Smith”); Lawson/O'Neill Global Institutional Commodity (LOGIC) Advisors (“Lawson/O'Neill”); Long Island Power Authority (“LIPA”); Louis Dreyfus Company (“LDC”); Mallory Alexander International Logistics (“Mallory Alexander”); Managed Funds Association and Alternative Investment Management Association (collectively, the “Associations” or “MFA/AIMA”); Marshal, Gerald (Independent Trader); Matsen, Eric (Individual—Physical Commodity Risk Management Consultant); McMeekin Cotton LLC (“McMeekin”); Memtex Cotton Marketing, LLC (“Memtex”); Minneapolis Grain Exchange, Inc. (“MGEX”); Moody Compress & Warehouse Company (“Moody Compress”); Namoi Cotton Alliance (“Namoi”); National Cotton Council (“NCC”); National Council of Farmer Cooperatives (“NCFC”); National Council of Textile Organizations (“NCTO”); National Energy & Fuels Institute (“NEFI”); National Grain and Feed Association (“NGFA”); National Oilseed Processors Association (“NOPA”); National Rural Electric Cooperative; Association American Public Power Association; and American Public Gas Association (collectively, “NRECA”); Natural Gas Supply Association (“NGSA”); Olam International Limited (“Olam”); Omnicotton Inc. (“Omnicotton”); Pacific Investment Management Company LLC (“PIMCO”); Parkdale Mills (“Parkdale”); Petroleum Marketers Association of America (“PMAA”); Public Citizen; Robert Rutkowski (“Rutkowski”); S. Canale Cotton Co. (“Canale Cotton”); Shell Energy North America (US), L.P. and Shell Trading (US) Company (collectively, “Shell”); SIFMA Asset Management Group (“SIFMA AMG”); Skylar Capital Management LP (“SCM”); Southern Cotton Association (“Southern Cotton”); Southwest Ag Sourcing (“SW Ag”); Suncor Energy Marketing Inc. and Suncor Energy USA Marketing Inc. (collectively, “SEMI”); Texas Cotton Association (“Texas Cotton”); The Coalition of Physical Energy Companies; The Commercial Energy Working Group (“CEWG”); The Walcot Trading Company, LLC (“Walcot”); Toyo Cotton Company (“Toyo”); VLM Commodities (“VLM”); Western Cotton Shippers Association (“WCSA”); White Gold Cotton Marketing, LLC (“White Gold”). 17 The Final Rule's regulations are discussed in detail throughout this release. Before addressing the specifics of the Final Rule, the Commission outlines several themes underscoring the Commission's approach in the Final Rule. First, the Commission believes that any position limits regime must take into account differences across commodities and contract types. The existing Federal position limits regulations apply only to the nine legacy agricultural contracts, all of which are physically-settled futures on agricultural commodities. Limits on these nine legacy agricultural contracts have been in place for decades, as have the Federal rules governing both the exemptions from these Federal position limits and the exchange-set position limits on the nine legacy agricultural contracts. The existing framework is largely a historical remnant of an approach that predates cash-settled futures contracts, institutional-investor interest in commodity indexes, highly liquid energy markets, and the Commission's jurisdiction over certain swaps. Congress has tasked the Commission with establishing such limits as it finds are “necessary” for the purpose of preventing the burdens associated with excessive speculation causing sudden or unreasonable fluctuations or unwarranted changes in the price of an underlying commodity; and establishing limits on swaps that are “economically equivalent” to any futures contracts or options on futures contracts subject to Federal position limits. An approach that is flexible enough to accommodate potential future, unpredictable developments in commercial hedging practices is well-suited for the current derivatives markets by accommodating differences in commodity types, contract specifications, hedging practices, cash-market trading practices, organizational structures of hedging participants, and liquidity profiles of individual markets. The Commission is building this flexibility into several parts of the Final Rule, including: (1) Exchange-set limits or accountability levels outside of the spot month for referenced contracts based on commodities other than the nine legacy agricultural contracts; (2) the ability for exchanges to use more than one formula when setting their own limit levels; (3) an updated formula for Federal non-spot month position limit levels on the nine legacy agricultural contracts that is calibrated to recently observed open interest, which has generally increased over time; (4) a bona fide hedging definition that is broad enough to accommodate common commercial hedging practices, including unfixed-price transactions as well as anticipatory hedging practices, such as anticipatory merchandising; (5) a simplified process for market participants to submit a single application to obtain non-enumerated bona fide hedge recognitions for purposes of Federal and exchange-set position limits that are in line with common commercial hedging practices; (6) the elimination of a restriction for purposes of Federal position limits on holding positions during the last trading days of the spot month; and (7) broader discretion for market participants to measure risk in the manner most suitable for their businesses. Second, the Final Rule establishes position limits with respect to 16 additional commodities during the spot month, for a total of 25 core referenced futures contracts, and certain derivative contracts linked thereto, for which the Commission finds that speculative position limits are necessary. 18 As described below, this necessity finding for the 25 core referenced futures contracts is based on two interrelated factors: (1) The importance of the 25 core referenced futures contracts to their respective underlying cash markets, including that they require physical delivery of the underlying commodity; and (2) the particular importance to the national economy of the commodities underlying the 25 contracts. 19 18 See infra Section III.C.2. 19 Id. Third, there is an opportunity for greater collaboration between the Commission and the exchanges within the statutorily created parallel Federal and exchange-set position limit regimes. Given the exchanges' obligations to carry out self-regulatory responsibilities, resources, deep knowledge of their markets and trading practices, close interactions with market participants, existing programs for addressing exemption requests, and direct ability to leverage these resources to generally act more quickly than the Commission, the Commission believes that cooperation between the Commission and the exchanges on position limits should not only be continued, but enhanced. For example, exchanges are particularly well-positioned to: Provide the Commission with estimates of deliverable supply in connection with their commodity contracts that require physical delivery; recommend limit levels for the Commission's consideration; and help administer the program for recognizing bona fide hedges. Further, given that the Final Rule requires exchanges to collect, and provide to the Commission upon request, cash-market information from market participants requesting recognition of bona fide hedges, the Commission is eliminating the Form 204 and part of the Form 304, which market participants with bona fide hedging positions in excess of position limits currently file each month with the Commission to demonstrate cash-market positions justifying such overages. Under enhanced collaboration, the Commission will maintain its access to such information from the exchanges, which will result in a more efficient administrative process, in part by reducing duplication of efforts. B. Executive Summary This executive summary provides an overview of the key components of the Final Rule. The summary only highlights certain aspects of the final regulations and generally uses shorthand to summarize complex topics. The executive summary is neither intended to be a comprehensive recitation of the Final Rule nor intended to supplement, modify, or replace any interpretive or other language contained herein. Section II of this release includes a more detailed and comprehensive discussion of all of the final regulations. The final regulations and related appendices and guidance follow Section IV (Related Matters) of this release. 1. Contracts Subject to Federal Speculative Position Limits Federal position limits apply to “referenced contracts,” which, as described in turn below, include: (i) 25 “core referenced futures contracts” ( i.e., the nine legacy agricultural contracts together with the new 16 non-legacy contracts); (ii) futures contracts and options on futures contracts directly or indirectly linked to a core referenced futures contract; and (iii) “economically equivalent swaps.” i. Core Referenced Futures Contracts Federal position limits under the Final Rule will apply to the following 25 20 physically-settled core referenced futures contracts: 20 Reference to, or discussion of, derivatives contracts listed on IFUS, the DCM and subsidiary of ICE, will be referred to herein as “ICE [Commodity] [IFUS Commodity Code]” ( e.g., ICE Sugar No. 16 (SF)). Additionally, “CBOT” refers to the DCM Board of Trade of the City of Chicago, Inc.; “CME” refers to the DCM Chicago Mercantile Exchange, Inc.; “COMEX” refers to the DCM Commodity Exchange, Inc.; and “NYMEX” refers to the DCM New York Mercantile Exchange, Inc. ER14JA21.000 ii. Futures Contracts and Options on Futures Contracts Linked to a Core Referenced Futures Contract The term “referenced contract” encompasses any core referenced futures contract as well as any futures contract and any option on a futures contract that is: (1) Directly or indirectly linked to the price of a core referenced futures contract; or (2) directly or indirectly linked to the price of the same commodity underlying the applicable core referenced futures contract, for delivery at the same location as specified in that core referenced futures contract. 22 The term “referenced contract,” however, explicitly excludes location basis contracts, commodity index contracts, contracts that are based on prices across a month ( i.e., contracts commonly referred to as calendar month average contracts, trade month average contracts, or balance of month contracts), outright contracts that are based on a price reporting agency index price, swap guarantees, and trade options that meet certain requirements. 21 While the Final Rule includes Federal non-spot month limits only for referenced cintracts on the nine legacy agricultural contracts, the Final Rule requires exchanges to establish, consistent with Commission standards set forth in this Final Rule, exchange-set position limits and/or position accountability levels in the non-spot months for the 16 non-legacy core referenced futures contracts and for any associated referenced contracts. 22 For clarity, clause (2) is intended to encompass potential physically-settled “look-alike” contracts that do not directly reference a core referenced futures contract but that are nonetheless based on the same commodity and delivery location as a core referenced futures contract. iii. Economically Equivalent Swaps The term referenced contracts also includes economically equivalent swaps, defined as swaps with “identical material” contractual specifications, terms, and conditions to a referenced contract. Swaps in a commodity other than natural gas that have identical material specifications, terms, and conditions to a referenced contract are still deemed economically equivalent swaps even if they differ from the referenced contract with respect to one or more of the following: (a) Lot size specifications or notional amounts, (b) delivery dates diverging by less than one calendar day for physically-settled swaps, or (c) post-trade risk management arrangement ( e.g., uncleared swaps versus cleared futures contracts). The same general definition applies to natural gas swaps, except that the definition is expanded to include swaps with delivery dates diverging from the corresponding core referenced futures contract by less than two calendar days. Instruments that are exempt from Commission jurisdiction or otherwise not deemed to be swaps under the Commission's regulations ( e.g., instruments that are excluded by the CEA's “swap” definition or Commission regulations as physically-settled forward contracts) are not “economically equivalent swaps” even if they otherwise fall within the “economically equivalent swap” definition. 2. Federal Position Limit Levels During the Spot Month Federal spot month position limits apply to all 25 core referenced futures contracts and their associated referenced contracts. The Final Rule establishes the spot month position limit levels summarized in the table below. Each spot month limit is set at or below 25% of deliverable supply, as estimated using recent data provided by the DCM listing the core referenced futures contract, and verified by the Commission. The Federal spot month position limits apply on a futures-equivalent basis based on the size of the unit of trading of the relevant core referenced futures contract. BILLING CODE 6351-01-P ER14JA21.001 ER14JA21.002 BILLING CODE 6351-01-C 23 As of October 15, 2020. 24 The Federal spot month limit for Live Cattle adopted herein features a step-down limit similar to the CME's existing Live Cattle step-down exchange-set limit. The Federal spot month step-down limit is: (1) 600 at the close of trading on the first business day following the first Friday of the contract month; (2) 300 at the close of trading on the business day prior to the last five trading days of the contract month; and (3) 200 at the close of trading on the business day prior to the last two trading days of the contract month. 25 ICE technically does not have an exchange-set spot month position limit level for ICE Sugar No. 16 (SF). However, it does have a single-month position limit level of 1,000 contracts, which effectively operates as a spot month position limit. 26 As discussed below, the NYMEX Henry Hub Natural Gas (NG) Federal spot month limit for cash-settled look-alike referenced contracts will apply on a per-exchange and per-OTC swaps market basis rather than on an aggregate basis across exchanges. 27 Currently, the cash-settled natural gas contracts are subject to an exchange-set spot month position limit level of 1,000 equivalent-sized contracts per exchange. As of publication of the Final Rule, there are three exchanges that list cash-settled natural gas contracts: NYMEX, IFUS, and Nodal. As a result, a market participant may hold up to 3,000 equivalent-sized cash-settled natural gas contracts under existing exchange-set limits. The exchanges also have a conditional position limit framework for natural gas contracts. This exchange-set conditional spot month position limit permits up to 5,000 cash-settled NYMEX NG equivalent-sized referenced contracts per exchange that lists such contracts, provided that the market participant does not hold positions in the physically-settled NYMEX NG referenced contract. 28 The Federal spot month limit for Light Sweet Crude Oil adopted herein features the following step-down limit: (1) 6,000 contracts as of the close of trading three business days prior to the last trading day of the contract; (2) 5,000 contracts as of the close of trading two business days prior to the last trading day of the contract; and (3) 4,000 contracts as of the close of trading one business day prior to the last trading day of the contract. i. Application of Federal Spot Month Limits to Commodities Other Than Natural Gas With the exception of natural gas, the Federal spot month position limit levels apply in the aggregate across exchanges and the over-the-counter (“OTC”) swap markets. During the spot month, Federal position limits apply “separately” to physically-settled and cash-settled referenced contracts. 29 Accordingly, during the spot month, a market participant is required to aggregate its net physically-settled positions, and separately its net cash-settled positions, across exchanges and the OTC swaps markets, but may not net cash-settled referenced contracts with physically-settled referenced contracts. 29 As discussed further under Section II.B.3.vi, cash-settled NYMEX NG referenced contracts under the Final Rule are subject to per-exchange and per-OTC swaps market Federal position limits. As a result, market participants are not required to aggregate their positions in natural gas referenced contracts across different exchanges and the OTC swaps markets but also may not net such positions across different exchanges or the OTC swaps market. ii. Application of Federal Spot Month Limits to Natural Gas For the NYMEX Henry Hub Natural Gas (“NYMEX NG”) physically-delivered core referenced futures contract and its associated cash-settled referenced contracts, the Final Rule modifies the 2020 NPRM by providing that Federal position limits apply to NYMEX NG cash-settled referenced contracts on a per-exchange and per-OTC swaps market basis ( i.e., cash-settled positions are not aggregated across different exchanges and the OTC swaps market). Specifically, a market participant may hold up to 2,000 cash-settled NYMEX NG referenced contracts ( i.e., the NYMEX NG Federal spot month position limit) on each exchange that lists for trading a cash-settled NYMEX NG referenced contract as well as the OTC swap market. Currently, three exchanges (NYMEX, IFUS, and Nodal) 30 list cash-settled “look-alike” NYMEX NG referenced contracts. Thus, a market participant is able to hold 2,000 cash-settled NYMEX NG referenced futures contracts on each exchange, which is 6,000 cash-settled look-alike NYMEX NG referenced contracts in total. In addition, a market participant is able to hold a position of 2,000 cash-settled NYMEX NG equivalent-sized economically equivalent swaps in the OTC swaps markets for a total position of 8,000 cash-settled NYMEX NG referenced contracts across the four markets ( i.e., NYMEX, IFUS, Nodal, and the OTC swaps market). 30 “Nodal” refers to the Nodal Exchange, LLC. As noted above, because Federal spot month position limit levels apply “separately” to cash-settled and physically-settled referenced contracts, a market participant further is able to hold an additional position of 2,000 physically-settled NYMEX NG referenced contracts for a total position of 10,000 NYMEX NG referenced contracts. As discussed further below, market participants may hold additional cash-settled NYMEX NG referenced contracts under the Final Rule's Federal spot month conditional position limit exemption as long as the market participant satisfies certain requirements. However, for the avoidance of doubt, the Commission notes that the per-exchange 2,000 contract Federal spot month position limit level for cash-settled NYMEX NG referenced contracts discussed above is not part of the Federal spot month conditional position limit exemption but rather constitutes the default speculative Federal spot month position limit. 3. Federal Position Limit Levels Outside of the Spot Month Under the Final Rule, Federal position limits outside of the spot month (“non-spot month” position limits) apply only to the nine legacy agricultural contracts and their associated referenced contracts. In contrast, referenced contracts based on the 16 core referenced futures contracts subject to Federal position limits for the first time under the Final Rule are only subject to Federal position limits during the spot month, and are otherwise only subject to exchange-set limits or position accountability outside of the spot month. The following Federal non-spot month position limit levels, summarized in the table below, are set at 10% of open interest for the first 50,000 contracts, with an incremental increase of 2.5% of open interest thereafter, and apply on a futures-equivalent basis based on the size of the unit of trading of the relevant core referenced futures contract: ER14JA21.003 31 With the exception of the ICE Cotton No. 2 (CT) contract discussed below, for each of the legacy agricultural contracts, the single month limit is equal to the all-months-combined limit under the Final Rule. 32 As of October 15, 2020. 33 The single month limit for ICE Cotton No. 2 (CT) is set at 50% of the all-months-combined limit, or 5,950 contracts, as discussed more fully below. 4. Exchange-Set Limits and Exemptions Therefrom i. Contracts Subject to Federal Position Limits An exchange that lists a contract subject to Federal position limits, as specified above, is required to set its own limits for such contracts at a level that is no higher than the Federal level. Exchanges may grant exemptions from their own limits to a level that exceeds the applicable Federal limit, provided the exemption is self-effectuating ( e.g., an enumerated bona fide hedge or a spread that satisfies the “spread transaction” definition) or provided the exemption is recognized by the Commission for purposes of Federal position limits (pursuant to an application submitted either directly to the Commission under § 150.3 or indirectly to the Commission through an exchange under § 150.9, as applicable). Exchanges may grant exemptions that are not recognized by the Final Rule; however, such exemptions must be capped at a level that is not higher than the applicable Federal position limit level. ii. Physical Commodity Contracts Not Subject to Federal Position Limits For physical commodity contracts, for which no necessity finding was supported, and which are therefore not subject to Federal position limits, an exchange is generally required to set spot month position limit levels at no greater than 25% of deliverable supply, but has flexibility to submit other approaches for review by the Commission, provided the approach results in spot month position limit levels that are “necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract's or the underlying commodity's price or index” and complies with all other applicable regulations. Outside of the spot month, an exchange has additional flexibility to set either position limits or position accountability levels, provided the levels are “necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract's or the underlying commodity's price or index.” Non-exclusive Acceptable Practices are included in new Appendix F to part 150 under the Final Rule and provide several examples of formulas that the Commission has determined meet this standard, but an exchange has flexibility to develop other approaches. An exchange has flexibility to grant a variety of exemption types. Exchanges must take into account whether the exemption results in a position that is “not in accord with sound commercial practices” in the market for which the exchange is considering the application, and/or “exceed[s] an amount that may be established and liquidated in an orderly fashion in that market.” 5. Limits on “Pre-Existing Positions” As discussed above, only swaps that qualify as “economically equivalent swaps” are subject to Federal position limits under the Final Rule. However, economically equivalent swaps entered into in good faith prior to the Final Rule's Effective Date, including both “Pre-Enactment Swaps,” which are swaps entered into prior to the Dodd-Frank Act whose terms have not expired, and “Transition Period Swaps,” which are swaps entered into between July 22, 2010 and the Final Rule's effective date, are not subject to Federal position limits. Other pre-existing positions ( i.e., pre-existing positions that are futures contracts or options on futures contracts) will be subject to the Final Rule's Federal position limits. 34 34 However, as discussed further below, the Commission is providing for a compliance period until January 1, 2022 for the 16 non-legacy referenced contracts that will be subject to Federal position limits for the first time under this Final Rule. Similarly, the Commission is providing for a compliance period for any economically equivalent swaps, as well as in connection with the elimination of the risk management exemption, until January 1, 2023. Market participants may net down their post-Effective Date positions in commodity derivatives contracts with any pre-existing swaps (as long as such swaps qualify as economically equivalent swaps) for purposes of complying with non-spot month Federal position limits. In contrast, during the spot month, market participants may not apply these pre-existing swap positions to net down their positions so as to avoid rendering Federal spot month position limits ineffective. The Commission is particularly concerned about protecting the spot month in physically-delivered futures from price distortions or potential manipulation and consequent disruption of the hedging and price discovery utility of the related futures contract. 6. Legal Standards for Exemptions From Federal Position Limits i. Bona Fide Hedge Recognition A bona fide hedging transaction or position may exceed Federal position limits if the hedge position satisfies all three elements of the Final Rule's “general” bona fide hedging definition. That is, (1) the position represents a substitute for transactions or positions made or to be made at a later time in a physical marketing channel (“temporary substitute test”); (2) the position is economically appropriate to the reduction of price risks in the conduct and management of a commercial enterprise (“economically appropriate test”); and (3) the position arises from the potential change in value of actual or anticipated assets, liabilities, or services (“change in value requirement”). The Final Rule makes several changes to the existing bona fide hedging definition, including those described immediately below: First, the Commission is expanding the existing list of “enumerated” bona fide hedges to cover additional hedging practices, including adding a bona fide hedge for anticipated merchandising. 35 To provide greater certainty, the list of enumerated bona fide hedges is now incorporated into the regulation. In contrast, in the 2020 NPRM, this list of enumerated bona fide hedges was proposed in the form of non-binding acceptable practices in Appendix A to part 150. While the enumerated bona fide hedges will remain listed in Appendix A under the Final Rule, Appendix A to part 150 is now explicitly incorporated into Commission regulations and is part of the regulatory text rather than acceptable practices. 35 The existing definition of “bona fide hedging transactions and positions” enumerates the following hedging transactions or positions: (1) Hedges of inventory and cash commodity fixed-price purchase contracts under 1.3(z)(2)(i)(A); (2) hedges of unsold anticipated production under 1.3(z)(2)(i)(B); (3) hedges of cash commodity fixed-price sales and (4) hedges of fixed price sales of their cash products and byproducts contracts under 1.3(z)(2)(ii)(A) and (B); (5) hedges of unfilled anticipated requirements under 1.3(z)(2)(ii)(C); (6) hedges of offsetting unfixed price cash commodity sales and purchases under 1.3(z)(2)(iii); and (7) cross-commodity hedges under 1.3(z)(2)(iv). The following additional hedging practices are not enumerated in the existing regulation, but are included as enumerated hedges in the Final Rule: (1) Hedges of anticipated merchandising; (2) hedges by agents; (3) hedges of anticipated royalties; (4) hedges of services; and (5) offsets of commodity trade options. A person who holds a position that qualifies as a bona fide hedge and that is one of the enumerated hedges in Appendix A to part 150 is not required to request prior approval from the Commission to hold such bona fide hedge position above the Federal position limit. That is, the enumerated bona fide hedges are “self-effectuating” for purposes of Federal position limits. A person with an enumerated bona fide hedge position, however, would still need to request an exemption from the relevant exchange for any exchange-set limits. 36 36 The processes for obtaining bona fide hedge recognitions and non-enumerated bona fide hedge recognitions are summarized in Section 7 below of this executive summary (Processes for Requesting Bona Fide Hedge Recognitions and Spread Exemptions). Second, with respect to the treatment of unfixed-price forward transactions and bona fide hedging under the Final Rule, the Commission clarifies that a commercial market participant may qualify for one of the Final Rule's enumerated anticipatory bona fide hedges ( i.e., enumerated bona fide hedges for unsold anticipated production, unfilled anticipated requirements, and anticipated merchandising) with respect to an unfixed-price forward transaction. The Commission believes that an unfixed-price forward transaction should not preclude a commercial market participant from qualifying for one of these enumerated anticipatory bona fide hedges, because such unfixed-price forward transactions do not give rise to outright price risk for a commercial market participant and do not otherwise fix an outright price. Accordingly, unfixed-price transactions do not “fill” or “address” the hedging need for which the enumerated anticipatory bona fide hedges are predicated. The Commission notes that an unfixed-price forward transaction does not itself allow a market participant to qualify for one of these enumerated anticipatory bona fide hedges, and that a market participant must still satisfy the requirements of the applicable anticipatory bona fide hedge to qualify ( e.g., as an initial matter, by the commercial market participant being able to demonstrate its anticipated unsold production, anticipated unfilled requirements, and/or anticipated merchandising). Third, the Final Rule clarifies whether and when market participants may measure risk on a gross basis rather than on a net basis. Instead of only being permitted to hedge on a “net basis” except in a narrow set of circumstances, a market participant is also able to generally hedge positions on a “gross basis,” provided that the participant has done so over time in a consistent manner and is not doing so to evade Federal position limits. Among other items, the Final Rule differs from the 2020 NPRM in that the Final Rule: (1) Eliminates the requirement that exchanges document their justifications when allowing gross hedging; (2) clarifies that market participants are not required to develop written policies or procedures that set forth when gross versus net hedging is appropriate; and (3) clarifies that gross hedging is permissible for both enumerated and non-enumerated hedges. Fourth, market participants are permitted to hold bona fide hedges in excess of Federal position limits during the last five days of the spot period (or during the time period for the spot month if less than five days). While the Final Rule does not include a Federal restriction on holding bona fide hedging positions in excess of Federal position limits during the spot period, exchanges continue to have the discretion to adopt such restrictions (commonly referred to by market participants as the “Five-Day Rule”), or similar restrictions, for purposes of exchange-set limits. The Final Rule also includes guidance on the application of spot-period restrictions, including factors for exchanges with such restrictions to consider when determining to grant exemptions that are not subject to any such restrictions for purposes of their own limits. Finally, the Final Rule modifies the “temporary substitute test” to require that a bona fide hedging transaction or position in a physical commodity must always, and not just normally, be connected to the production, sale, or use of a physical cash-market commodity. Therefore, a market participant is generally no longer allowed to treat positions entered into for “risk management purposes” 37 as a bona fide hedge, unless the position qualifies as either: (i) An offset of a pass-through swap, where the offset reduces price risk attendant to the pass-through swap executed opposite a counterparty for whom the swap qualifies as a bona fide hedge; or (ii) a “swap offset,” where the offset is used by a counterparty to reduce price risk attendant to a swap that qualifies as a bona fide hedge and that was previously entered into by that counterparty. 37 The phrase “risk management” as used in this instance refers to derivatives positions, typically held by a swap dealer, used to offset a swap position, such as a commodity index swap, with another entity for which that swap is not a bona fide hedge. ii. Spread Exemption A transaction or position may also exceed Federal position limits if it qualifies as a “spread transaction,” which includes the following common types of spreads: Intra-market spreads; inter-market spreads; intra-commodity spreads; inter-commodity spreads; calendar spreads; quality differential spreads; processing spreads (such as energy “crack” or soybean “crush” spreads); product and by-product differential spreads; and futures-options spreads. 38 38 The Final Rule expands the 2020 NPRM's list of exempt spread transactions by also including intra-market spreads, inter-market spreads, and intra-commodity spreads. Spread exemptions may be granted using the process described in Section 7 below of this executive summary (Processes for Requesting Bona Fide Hedge Recognitions and Spread Exemptions). iii. Financial Distress Exemption This exemption allows a market participant to exceed Federal position limits if necessary to take on the positions and associated risk of another market participant during a potential default or bankruptcy situation. This exemption is available on a case-by-case basis, depending on the facts and circumstances involved. iv. Conditional Spot Month Limit Exemption in Natural Gas As long as a market participant holds no physically-settled NYMEX NG contracts, the Final Rule allows that market participant to exceed the NYMEX NG Federal spot month position limit level of 2,000 cash-settled referenced contracts per exchange (and an additional 2,000 equivalent-sized economically equivalent OTC swaps) by holding 10,000 cash-settled NYMEX NG referenced contracts per DCM that lists cash-settled NYMEX NG referenced contracts, as well as an additional 10,000 equivalent-sized cash-settled economically equivalent NYMEX NG swaps. The Final Rule clarifies that market participants may not use a spread exemption to exceed the aforementioned conditional spot month limit for natural gas. 7. Processes for Requesting Bona Fide Hedge Recognitions and Spread Exemptions i. Self-Effectuating Enumerated Bona Fide Hedges A position that complies with the bona fide hedging definition in § 150.1 and falls within one of the enumerated bona fide hedges is self-effectuating for purposes of Federal position limits, provided the market participant separately applies to the relevant exchange for an exemption from exchange-set limits. Such market participants are no longer required to file Form 204/304 with the Commission on a monthly basis to demonstrate cash-market positions justifying Federal position limit overages. Instead, the Commission will have access to cash-market information that such market participants submit as part of their applications to an exchange for an exemption from exchange-set limits, typically filed on an annual basis. ii. Bona Fide Hedges That Are Not Self-Effectuating The Commission may consider adding to the list of enumerated bona fide hedges at a later time, as the Commission may find appropriate. Until that time, all bona fide hedge positions that are not enumerated in Appendix A to part 150 must be granted pursuant to one of the processes for requesting a non-enumerated bona fide hedge recognition, as explained below. A market participant seeking to exceed Federal position limits for a non-enumerated bona fide hedging transaction or position is able to choose whether to apply directly to the Commission or, alternatively, apply indirectly to the Commission through the applicable exchange using a new streamlined process. If applying directly to the Commission, the market participant must also separately apply to the relevant exchange for relief from exchange-set position limits. If applying to an exchange using the new streamlined process, a market participant may file an application with an exchange, generally at least annually, which will be valid both for purposes of Federal and exchange-set position limits. Under this streamlined process, if the exchange determines to grant a non-enumerated bona fide hedge recognition for purposes of its exchange-set position limits, the exchange must notify the Commission and the applicant simultaneously. Then, 10 business days (or two business days in the case of retroactive applications filed late due to sudden or unforeseen bona fide hedging needs) after the exchange issues such a determination, the bona fide hedge exemption may be deemed approved for purposes of Federal position limits unless the Commission (and not Commission staff) notifies the market participant otherwise. That is, after the 10 (or two) business days expire, the bona fide hedge exemption is considered approved for purposes of Federal position limits. Under the Final Rule, once the exchange notifies the Commission and the applicant of the exchange's determination to approve the application, the applicant may, at its own risk, exceed Federal position limits during the Commission's 10 business-day review period. If the Commission determines to deny an exemption application, the applicant will not be subject to any Federal position limits violation, provided the person filed the application in good faith and brings the position into compliance with the applicable Federal position limit within a commercially reasonable amount of time, as applicable. The Final Rule also allows a market participant with sudden or unforeseen hedging needs to file a request for a bona fide hedge exemption within five business days after exceeding the Federal limit ( i.e., commonly referred to as a “retroactive” exemption application). If the Commission denies such application, the market participant will not be subject to a Federal position limit violation, provided the market participant filed the application in good faith and brings the position into compliance with the applicable Federal position limit within a commercially reasonable amount of time, as applicable. Among other changes, market participants are no longer required to file Forms 204 or 304, as applicable, with the Commission on a monthly basis to demonstrate cash-market positions justifying position limit overages. Under the Final Rule, the Commission will instead leverage cash-market information submitted directly to the exchanges. iii. Spread Exemptions For a referenced contract on any commodity, a spread exemption is self-effectuating for purposes of Federal position limits, provided that (1) the position falls within one of the categories set forth in the “spread transaction” definition, and (2) the market participant separately applies to the applicable exchange for a spread exemption from exchange-set position limits. 39 39 The Commission understands that certain exchanges may distinguish between the terms “spread,” “arbitrage,” and “straddle.” For the purposes of the Commission's discussion and the Final Rule in general, the Commission's use of the term “spread” is meant to include all of these related trading strategies, and any Commission reference to “spread” rather than “arbitrage” or “straddle” is not intended to suggest a substantive difference in meaning. A market participant with a spread position that does not fit within the “spread transaction” definition with respect to any of the commodities subject to Federal position limits may apply directly to the Commission, and must also separately apply to the applicable exchange. 8. Compliance Date and Effective Date i. Summary The Final Rule's effective date is March 15, 2021 (the “Effective Date”). This means that all aspects of the Final Rule will be effective as of the Effective Date, including the new enumerated bona fide hedges ( e.g., anticipated merchandising) as well as the higher Federal position limits for the nine legacy agricultural contracts. However, as discussed below, the Commission is also providing for compliance dates that extend beyond the Effective Date in connection with several of the Final Rule's requirements. The Final Rule provides market participants with a compliance date of January 1, 2022 for purposes of compliance with the Federal position limits for the 16 non-legacy core referenced futures contracts that are subject to Federal position limits for the first time under this Final Rule. This compliance date also applies to any referenced contracts (other than economically equivalent swaps, which have a separate compliance date as discussed further below) related to these 16 non-legacy core referenced futures contracts. The Final Rule also provides exchanges with a compliance date of January 1, 2022 for purposes of establishing exchange-set position limits and provisions associated with exemptions therefrom, including certain obligations to collect cash-market information from market participants in connection with market participants' applications for bona fide hedging exemptions to exchange-set limits, and to share the same with the Commission, consistent with the requirements under the Final Rule. Additionally, the Final Rule provides a compliance date of January 1, 2023 with respect to (i) the elimination of previously-granted risk management exemptions, 40 and (ii) Federal position limits for economically equivalent swaps. 40 As discussed above in Section 6 of this executive summary (Legal Standards for Exemptions from Federal Position Limits), the Commission is no longer recognizing risk management exemptions as bona fide hedges under the Final Rule. Because the nine legacy agricultural contracts are currently subject to Federal position limits under the existing Federal framework, the Final Rule does not provide a compliance date for the new Federal position limits under the Final Rule for such contracts, or a formal phase-in period. Therefore, such limits go into effect on the Effective Date. Thus, as of the Effective Date, market participants will be able to avail themselves of the Federal position limits under the Final Rule for the nine legacy agricultural contracts, all of which are higher than the existing Federal position limits (except for CBOT Oats, which will maintain the existing Federal position limit levels). However, the Commission notes that exchange-set position limits will remain at current levels unless and until the relevant exchange submits a rule amendment pursuant to part 40 of the Commission's regulations to amend the relevant exchange-set position limit. Furthermore, the Commission is delaying implementation of exchange-set position limits on swaps since exchanges cannot view market participants' positions in swap positions across the various places they trade, including on competitor exchanges. 41 However, after the January 1, 2023 compliance date for economically equivalent swaps (discussed above), the Commission underscores that it will enforce Federal position limits in connection with swaps. 41 In two years, the Commission will reevaluate the ability of exchanges to establish and implement appropriate surveillance mechanisms to implement DCM Core Principle 5 and SEF Core Principle 6 with respect to swaps. For convenience, the Commission is providing a table below identifying the Final Rule's Effective Date and compliance dates for market participants and exchanges in connection with certain obligations. BILLING CODE 6351-01-P ER14JA21.004 ER14JA21.005 BILLING CODE 6351-01-C C. Section-by-Section Summary of Final Rule 42 As noted above, under the Final Rule the Federal position limit levels for all of the nine legacy agricultural contracts will increase, other than CBOT Oats. However, the Commission notes that exchange-set position limits will remain at current levels unless and until the relevant exchange submits a rule amendment pursuant to part 40 of the Commission's regulations to amend the relevant exchange-set position limit. 43 As discussed further in this release, the Commission will no longer recognize risk management exemptions under the Final Rule. However, positions that are entered into based on a market participant's previously-granted risk management exemptions will be subject to an extended compliance date until January 1, 2023 with respect to Federal position limits. That is, a market participant with a previously granted risk management exemption will have a compliance date of January 1, 2023 with respect to the elimination of such risk management exemption. 44 Form 204 (for all nine legacy agricultural contracts other than cotton) and Parts I and II of Form 304 (for cotton) are submitted by a market participant to the Commission under the existing Federal position limits regulations in connection with Federal enumerated bona fide hedges employed by the market participants. The Commission is adopting revisions to §§ 150.1, 150.2, 150.3, 150.5, and 150.6 and to parts 1, 15, 17, 19, 40, and 140, as well as adding §§ 150.8, 150.9, and Appendices A-G to part 150. 45 Most noteworthy, the Commission is adopting the following amendments to the foregoing rule sections, each of which, along with all other changes in the Final Rule, is discussed in greater detail in Section II of this release. The following summary is not intended to provide a substantive overview of this Final Rule, but rather is intended to provide a guide to the rule sections that address each topic. For an overview of this Final Rule organized by topic (rather than by section number), please see the executive summary above. 45 The 2020 NPRM proposed to remove and reserve part 151. It did not propose to amend current § 150.4 dealing with aggregation of positions for purposes of compliance with Federal position limits, which was amended in 2016 in a prior rulemaking. See Final Aggregation Rulemaking, 81 FR at 91454. • The Commission finds that Federal speculative position limits are necessary for 25 core referenced futures contracts, and for any futures contracts and options on futures contracts linked thereto. The Commission adopts Federal position limits on physically-settled and linked cash-settled futures contracts, options on futures contracts, and “economically equivalent swaps” for such commodities. The 25 core referenced futures contracts include the nine “legacy” agricultural contracts currently subject to Federal position limits and 16 additional non-legacy contracts, which include: Seven additional agricultural contracts, four energy contracts, and five metals contracts. 46 Federal spot and non-spot month limits apply to the nine “legacy” agricultural contracts currently subject to Federal position limits, 47 and only Federal spot-month limits apply to the additional 16 non-legacy contracts. Outside of the spot month, these 16 non-legacy contracts are subject to exchange-set limits and/or accountability levels if listed on an exchange. 46 The seven additional agricultural contracts that are subject to Federal spot month limits are: CME Live Cattle (LC), CBOT Rough Rice (RR), ICE Cocoa (CC), ICE Coffee C (KC), ICE FCOJ-A (OJ), ICE Sugar No. 11 (SB), and ICE Sugar No. 16 (SF). The four energy contracts that are subject to Federal spot month limits are: NYMEX Light Sweet Crude Oil (CL), NYMEX New York Harbor ULSD Heating Oil (HO), NYMEX New York Harbor RBOB Gasoline (RB), and NYMEX Henry Hub Natural Gas (NG). The five metals contracts that are subject to Federal spot month limits are: COMEX Gold (GC), COMEX Silver (SI), COMEX Copper (HG), NYMEX Palladium (PA), and NYMEX Platinum (PL). As discussed below, any contracts for which the Commission is adopting Federal position limits only during the spot month are subject to exchange-set limits and/or accountability levels outside of the spot month. 47 The Commission currently sets and enforces speculative position limits with respect to certain enumerated agricultural products. The “enumerated” agricultural products refer to the list of commodities contained in the definition of “commodity” in CEA section 1a; 7 U.S.C. 1a. These agricultural products consist of the following nine currently traded contracts: CBOT Corn (and Mini-Corn) (C), CBOT Oats (O), CBOT Soybeans (and Mini-Soybeans) (S), CBOT Wheat (and Mini-Wheat) (W), CBOT Soybean Oil (SO), CBOT Soybean Meal (SM), MGEX HRS Wheat (MWE), CBOT KC HRW Wheat (KW), and ICE Cotton No. 2 (CT). See 17 CFR 150.2. • Amendments to § 150.1 add or revise several definitions for use throughout part 150, including: New definitions of the terms “core referenced futures contract” (pertaining to the 25 physically-settled futures contracts explicitly listed in the regulations) and “referenced contract” (pertaining to futures contracts and options on futures contracts that have certain direct and/or indirect linkages to the core referenced futures contracts, and to “economically equivalent swaps”) to be used as shorthand to refer to contracts subject to Federal position limits; an expanded “spread transaction” definition; and a “bona fide hedging transaction or position” definition that is broad enough to accommodate hedging practices in a variety of contract types, including hedging practices that may develop over time. • Amendments to § 150.2 list the 25 core referenced futures contracts which, along with any associated referenced contracts, are subject to Federal position limits; and specify the Federal spot and non-spot month position limit levels. Federal spot month position limit levels are set at or below 25 percent of estimated deliverable supply, whereas Federal non-spot month limit levels are set at 10% of open interest for the first 50,000 contracts of open interest, with an incremental increase of 2.5% of open interest thereafter. • Amendments to § 150.3 specify the types of positions for which exemptions from Federal position limit requirements may be granted, and set forth and/or reference the processes for requesting such exemptions, including recognitions of bona fide hedges and exemptions for spread positions, financial distress positions, certain natural gas positions held during the spot month, and pre-enactment and transition period swaps. For all contracts subject to Federal position limits, bona fide hedge exemptions listed in Appendix A to part 150 as an enumerated bona fide hedge are self-effectuating for purposes of Federal position limits. For non-enumerated bona fide hedges, market participants must submit an application either directly to the Commission under § 150.3 or indirectly through an exchange for Federal position limit purposes under new § 150.9 (discussed below). • Amendments to § 150.5 refine the process, and establish non-exclusive methodologies, by which exchanges may set exchange-level limits and grant exemptions therefrom with respect to futures and options on futures, including separate methodologies for contracts subject to Federal position limits and physical commodity derivatives not subject to Federal position limits. 48 While the Commission will oversee compliance with Federal position limits on swaps, the Commission has also determined to delay the enforcement of exchange-set position limits on swaps otherwise required in amended § 150.5 because exchanges cannot view market participants' positions in swaps across the various places they trade, including on competitor exchanges. 49 48 Rule § 150.5 addresses exchange-set position limits and exemptions therefrom, whereas § 150.3 addresses exemptions from Federal position limits, and § 150.9 addresses a streamlined process for recognizing non-enumerated bona fide hedges for purposes of Federal position limits. Exchange rules typically refer to “exemptions” in connection with bona fide hedging and spread positions, whereas the Commission uses the nomenclature “recognition” with respect to bona fide hedges, and “exemption” with respect to spreads. 49 With respect to exchange-set position limits on swaps, in two years the Commission will reevaluate the ability of exchanges to establish and implement appropriate surveillance mechanisms to implement DCM Core Principle 5 and SEF Core Principle 6. • New § 150.9 establishes a streamlined process for addressing requests for bona fide hedging recognitions for purposes of Federal position limits, and leveraging exchange expertise and resources. This process will be used by market participants with non-enumerated bona fide hedge positions. Under the Final Rule, market participants can provide one application for a non-enumerated bona fide hedge to a DCM or SEF, as applicable, and receive approval of such request based on the same application from both the exchange for purposes of exchange-set limits and from the Commission for purposes of Federal position limits. • New Appendix A to part 150 contains a list of enumerated bona fide hedges. Positions that comply with the bona fide hedging transaction or position definition in § 150.1 and that are enumerated in Appendix A may exceed Federal position limits to the extent that all applicable requirements in part 150 are met. Persons holding such positions enumerated in Appendix A may exceed Federal position limits without being required to request prior approval under § 150.3 or § 150.9. Positions that do not fall within any of the enumerated hedges could still potentially be recognized as bona fide hedging positions, provided the positions otherwise comply with the proposed bona fide hedging definition and all other applicable requirements, including the approval process under § 150.3 or § 150.9. • Amendments to part 19 and related provisions eliminate Form 204 (and corresponding Parts I and II of Form 304 for cotton), enabling the Commission to leverage cash-market reporting submitted directly to the exchanges under §§ 150.5 and 150.9. The Final Rule maintains Part III of Form 304, related to the cotton on-call report. D. Effective Date and Compliance Period The 2020 NPRM included proposed § 150.2(e), which provided that the Federal position limit levels for the 25 core referenced futures contracts would have a compliance date 365 days after publication of the final position limits regulations in the Federal Register . Additionally, proposed § 150.3(c) provided that previously-granted risk management exemptions shall not be effective after the Final Rule's effective date. The Commission is removing from the Final Rule the compliance date requirements in proposed §§ 150.2(e) and 150.3(c) and instead addressing the effective and compliance dates together within this Federal Register release. The Commission is making two modifications from the 2020 NPRM relating to the effective date and compliance period of the Final Rule. First, as noted above in the executive summary, the Commission is providing a general compliance date of January 1, 2022 for both market participants and exchanges. In contrast, the 2020 NPRM did not provide a specific date as the compliance date but rather stated 365 days after publication in the Federal Register . 50 50 The Commission is adopting calendar dates for compliance to provide clarity rather than the 2020 NPRM's approach of stating that the compliance period ends 365 days after publication in the Federal Register since the Commission believes that providing a set calendar date provides greater clarity to market participants. Based on the timing of the Final Rule, the Commission believes that the January 1, 2022 general compliance date will not reduce the compliance period compared to the 2020 NPRM's approach and may provide slightly more time prior to the commencement of the compliance period. This compliance date of January 1, 2022 applies to (i) the Federal position limits set forth in Appendix E to part 150 for only the 16 non-legacy core referenced futures contracts that are subject to Federal position limits for the first time under this Final Rule, and (ii) exchange obligations under final § 150.5. This compliance date also applies to referenced contracts for any of the 16 non-legacy core referenced futures contracts (other than economically equivalent swaps, which have a separate compliance date as discussed immediately below). In contrast, the 2020 NPRM's compliance date applied only to market participants' compliance with the new Federal position limit levels. However, as discussed below, the Final Rule does not provide a separate compliance date for the nine legacy agricultural contracts since they are already subject to existing Federal position limits. Second, the Commission is establishing a separate compliance date of January 1, 2023 in connection with (i) economically equivalent swaps and (ii) the elimination of previously-granted risk management exemptions ( i.e., market participants may continue to rely on their previously-granted risk management exemptions until January 1, 2023). As noted above, the 2020 NPRM only had a single general compliance date and did not provide a separate compliance date for economically equivalent swaps or related to previously-granted risk management exemptions. In this section, the Commission will discuss the following related issues: (i) Compliance with Federal position limits for the nine legacy agricultural contracts; (ii) compliance by exchanges with § 150.5 under the Final Rule and market participants' related obligation to temporarily continue providing Forms 204/304 in connection with bona fide hedges; (iii) exchanges' voluntary implementation of § 150.9 under the Final Rule; and (iv) comments received in connection with the compliance date proposed in the 2020 NPRM. i. Compliance With Federal Position Limits for the Nine Legacy Agricultural Contracts With respect to the nine legacy agricultural contracts, the Commission is not providing a compliance date with respect to the spot month and non-spot month Federal position limit levels. Accordingly, the new Federal position limit levels under the Final Rule will become effective on the Effective Date. The nine legacy agricultural contracts are currently subject to Federal position limits and will continue to be subject under the Final Rule, which, as noted above, is increasing the Federal position limit levels for the nine legacy agricultural contracts (other than CBOT Oats, which will maintain the existing Federal position limit levels). The Commission has determined not to provide a separate compliance date for the nine legacy agricultural contracts since market participants trading in these markets already are familiar with Federal position limits and have established the necessary monitoring and compliance oversight processes, in connection with these legacy contracts. With respect to exchange-set position limits, the Final Rule does not require exchanges to increase their respective exchange-set position limit levels. Rather, the Final Rule only requires that exchange-set position limits are established at a level no higher than the corresponding Federal position limits. As a result, in response to the Final Rule, an exchange may: (1) Raise its exchange-set limits to be as high as (or lower than) the corresponding Federal position limits immediately on the Effective Date or anytime thereafter; (2) implement a phase-in period where exchange-set position limits increase from existing exchange-set levels over time; or (3) not increase the exchange-set position limit levels at all, in each case as the exchange may determine appropriate for its markets. ii. Exchange Implementation of § 150.5 and Market Participants' Obligations To Continue Providing Forms 204 and 304, as Applicable, in Connection With Federal Enumerated Bona Fide Hedges For clarity, in connection with the nine legacy agricultural contracts, market participants may avail themselves of the new enumerated bona fide hedges ( e.g., anticipatory merchandising) immediately upon the Effective Date (market participants will not need to be concerned with availing themselves of bona fide hedge recognitions for the 16 non-legacy contracts upon the Effective Date since these contracts will have a compliance date of January 1, 2022). To the extent that market participants seek to rely on any Federal enumerated bona fide hedges, market participants must continue to provide, as applicable, the Commission with Forms 204/304, which are otherwise eliminated by the Final Rule upon the Effective Date, until the relevant exchange that lists the applicable referenced contract implements § 150.5 under the Final Rule. As discussed below, final § 150.5 governs, among other things, exchange rules and procedures, including (i) the exchange's collection of certain cash-market information from market participants in connection with their bona fide hedge applications for exchange-set limits and (ii) the exchange's sharing of related information with the Commission. As discussed further below, the Final Rule predicates the elimination of Forms 204/304 on the relevant exchange's sharing of the information with the Commission under final § 150.5 (which provides for a new process for the exchange to share data with the Commission similar to data that the Commission previously obtained through Forms 204/304 under the Federal framework existing prior to the Final Rule). 51 Exchanges must implement final § 150.5 by the Final Rule's general compliance date of January 1, 2022. 51 For further discussion of the elimination of Form 204 and Parts I and II of Form 304, see Section II.H.2, infra. iii. Exchange Implementation of § 150.9 in Connection With the Market Participants' Applications Through Exchanges for Non-Enumerated Bona Fide Hedges for Purposes of Federal Position Limits As discussed above, the Final Rule establishes a streamlined process for market participants to apply through exchanges for non-enumerated bona fide hedges for purposes of Federal position limits. That is, a market participant may submit a single non-enumerated bona fide hedge exemption application to an exchange for purposes of both Federal and exchange-set position limits, and the Commission will review, and make a determination based on, the application that the market participant submitted to the exchange. For clarity, the Commission notes that the Final Rule does not require exchanges to participate in such process. However, if an exchange chooses to do so, the Commission is clarifying, for the avoidance of doubt, that the exchange may implement this streamlined process for non-enumerated bona fide hedge applications as soon as the Effective Date, or anytime thereafter (or not at all). In response to certain concerns by market participants and exchanges, discussed immediately below, the Commission believes that, to the extent an exchange chooses to participate in this streamlined application process, the implementation of § 150.9 soon after the Effective Date may help ensure minimal disruption to market participants' existing trading strategies as well as avoid having the potentially unfeasible situation of requiring the exchanges to process a number of non-enumerated bona fide hedge applications simultaneously at the end of the general compliance period on January 1, 2022. Furthermore, the Commission clarifies in Section II.G.3.iii that market participants with existing Commission-granted non-enumerated or anticipatory bona fide hedge recognitions in connection with the nine legacy agricultural contracts under the existing framework are not required to reapply to the Commission for a new recognition under the Final Rule. iv. Comments—Compliance Period Generally, commenters supported the proposed compliance date, noting that an adequate compliance period would afford sufficient time to make necessary business adjustments ( e.g., time to build compliance systems, develop technology, train personnel, etc.). 52 The Commission agrees with these observations and believes that a general compliance date of January 1, 2022, except for economically equivalent swaps and positions based on a previously-granted risk management exemption, will provide exchanges and market participants sufficient time to adjust their operations and compliance and monitoring systems. 52 CME Group at 8; FIA at 2-3; ISDA at 2, 8; Shell at 4; and SIFMA AMG at 2, 9-10. Some commenters also requested an extended compliance date (beyond the general compliance date) for economically equivalent swaps to mitigate the numerous legal, operational, and compliance challenges of implementing position limits for swaps for the first time. 53 Unlike exchange-listed contracts that are currently subject to either Federal position limits or exchange-set limits, commenters noted that exchanges do not have existing compliance and monitoring resources for economically equivalent swaps from which to leverage. The Commission agrees with commenters that additional time for economically equivalent swaps is warranted, and, as discussed above, is thus delaying the compliance date for economically equivalent swaps for an additional year, until January 1, 2023. 53 MFA/AIMA at 8; NCFC at 6; NGSA at 15-16; SIFMA AMG at 9-10; and Citadel at 9-10. CME Group expressed concern that it may receive an influx of exemption applications at the end of the compliance period, and therefore suggested a rolling process where market participants are grandfathered into their current exemptions, permitting them to file for those exemptions on the same annual schedule. 54 The Commission believes this concern is mitigated since exchanges, at their discretion, may implement final § 150.9 as soon as the Effective Date, which will allow exchanges to review non-enumerated bona fide hedge applications on a rolling basis between the Effective Date and the end of the compliance period rather than having to process a large number of applications at once. Furthermore, as noted above, market participants with existing Commission-granted non-enumerated or anticipatory bona fide hedge recognitions are not required to reapply to the Commission for a new recognition under the Final Rule. 54 CME Group at 8. E. The Commission Construes CEA Section 4a(a) To Require the Commission To Make a Necessity Finding Before Establishing Position Limits for Physical Commodities Other Than Excluded Commodities The Commission is required by ISDA to determine whether CEA section 4a(a)(2)(A) requires the Commission to find, before establishing a position limit, that such limit is “necessary.” 55 The provision states in relevant part that “the Commission shall” establish position limits “as appropriate” for futures contracts in physical commodities other than excluded commodities “[i]n accordance with the standards set forth in” the preexisting section 4a(a)(1). 56 That preexisting provision requires the Commission to establish position limits as it “finds are necessary to diminish, eliminate, or prevent” certain enumerated burdens on interstate commerce. 57 In the 2011 Final Rulemaking, the Commission interpreted this language as an unambiguous mandate to establish position limits without first finding that such limits are necessary, but with discretion to determine the “appropriate” levels for each. 58 In ISDA, the U.S. District Court for the District of Columbia disagreed and held that section 4a(a)(2)(A) is ambiguous as to whether the “standards set forth in paragraph (1)” include the requirement of an antecedent finding that a position limit is necessary. 59 The court vacated the 2011 Final Rulemaking and directed the Commission to apply its experience and expertise to resolve that ambiguity. 60 The Commission has done so and determines that section 4a(a)(2)(A) should be interpreted to require that before establishing position limits, the Commission must determine that limits are necessary. 61 A full legal analysis is set forth infra at Sections III.C.-E. 55 ISDA, 887 F.Supp.2d at 281. 56 7 U.S.C. 6a(a)(2)(A). 57 7 U.S.C. 6a(a)(1). 58 76 FR at 71626, 71627. 59 ISDA, 887 F.Supp.2d at 279-280. 60 Id. at 281. 61 See infra Section III.B. The Commission finds that position limits are necessary for the 25 core referenced futures contracts, including certain commodity derivative contracts that are directly or indirectly linked to a core referenced futures contract. The Commission's finding with respect to the 25 core referenced futures contracts is based on two interrelated factors: The particular importance of the 25 core referenced futures contracts to their respective underlying cash markets, including that they require physical delivery of the underlying commodity, and, the commodities' particular importance to the national economy. Separately, the Commission finds that position limits are necessary during the spot month for all 25 core referenced futures contracts and outside of the spot month only for the nine legacy agricultural commodity contracts (in each instance including certain commodity derivative contracts that are directly or indirectly linked to a core referenced futures contract). A full discussion of the necessity findings is set forth infra at Sections III.C.-E. F. The Commission's Use of Certain Terminology The Commission is aware that this Final Rule will likely be reviewed by a diverse range of members of the public from varied backgrounds and industries and with different levels of knowledge and experience with derivatives markets. Furthermore, even among experienced market participants, terminology may differ by industry, commodity, or exchange. The Commission also recognizes that certain terms commonly referenced by market participants may differ from the technical legal terms used in the Commission's regulations and/or the CEA. Accordingly, unless otherwise noted, the Commission will attempt to use terms and phrases in their ordinary, plain English sense. When required, the Commission will explicitly identify technical or nuanced legal/regulatory or industry “terms of art.” The Commission wishes to briefly review certain terms and phrases used throughout this release below, as follows: • Bona fide hedges. The CEA uses the legal term “bona fide hedging transaction or position” in both the singular and plural. The Commission currently defines the term in existing § 1.3 in the plural as “bona fide hedging transactions or positions” while the Final Rule now incorporates the singular “bona fide hedging transaction or position.” The Commission understands that most market participants simply refer to “bona fide hedge(s)” (in both the singular and the plural). Accordingly, for short hand throughout this release, the Commission may refer to “bona fide hedges,” “bona fide hedge positions,” “bona fide hedge transactions,” “bona fide hedges,” “bona fide hedging positions,” and similar phrasing. These terms are meant to apply as short hand and are not intended to imply a substantive difference either with the defined legal term “bona fide hedging transaction or position” or with one another. Similarly, the plural term in the existing Commission regulations and the singular in the Final Rule, as discussed below, are not intended to reflect a substantive difference. • Federal position limits. The Final Rule creates a new defined term, “speculative position limit,” in part 150 of the Commission's regulations to refer to the maximum position, net long or net short, that a market participant may maintain in a referenced contract. Throughout this release, the Commission will use as a general term either “position limits” or “Federal position limits” to refer to the general Federal position limits framework and related regulations, including the defined term “speculative position limit.” When discussing the individual “speculative position limit” levels for each commodity derivative contract, as opposed to the Final Rule's general Federal regulatory framework, the Commission instead may refer to the “Federal position limit levels, ” although all these phrases are intended to refer to the same general concept. The Commission may also specifically refer to exchange-set position limits when referring to the general framework, process, or specific position limit levels established by the respective exchanges. • Exchanges. This Final Rule applies to both DCMs and SEFs. Unless otherwise distinguished, the Commission will refer to “exchanges” throughout this release to refer to any relevant DCM or SEF. • Cash-Settled and Physically-Settled. The Commission throughout this release refers to “cash-settled” and “physically-settled” commodity derivative contracts. When a futures contract expires, all open futures contract positions in such contract are settled by either: (1) Physical delivery, which the Commission refers to as a “ physically-settled” contract, or (2) cash settlement, which the Commission refers to as a “ cash-settled ” contract, in each case depending on the contract terms set by the exchange. Deliveries on “physically-settled” futures contracts are made through the exchange's clearinghouse, and the delivery of the physical commodity must be consummated between the buyer and seller per the exchange rules and contract specifications. On the other hand, other futures contracts are “cash-settled” because they do not involve the transfer of physical commodity ownership and require that all open positions at expiration be settled by a transfer of cash to or from the clearinghouse based upon the final settlement price of the contracts. The Commission further notes that some market participants may instead use the terms “physical-delivery” contracts or “financially-settled” contracts instead of the Commission's terms “physically-settled” contracts and “cash-settled” contracts, respectively. The Commission does not intend a substantive difference in meaning with the choice of its terms. • Spread Positions. The Commission views its use of the term “spread” to mean the same as “arbitrage” or “straddle” as those terms are used in CEA section 4a(a) and existing § 150.3(a)(3) of the Commission's regulations. Consistent with existing regulations, the Commission's sole use of the term “spread” in this Final Rule is intended to also capture arbitrage or straddle strategies referred to in CEA section 4a(a) and existing § 150.3(a)(3), and referring to “spread” rather than “arbitrage” or “straddle” is not intended to be a substantive difference. The Commission notes that certain exchanges may distinguish between “spread” and “arbitrage” positions for purposes of exchange exemptions, but the Commission does not make that distinction here for purposes of its “spread transaction” definition as used in this release. • Unfixed Price Forward Transactions. Throughout this release, the Commission will use as general terms either “unfixed price forward transactions,” “unfixed price transactions,” “unfixed price forward contracts,” and/or “unfixed price contracts” to refer to transactions that are either purchases or sales of a cash commodity where the purchase or sales price, as applicable, is determined based on the settlement price of a benchmark, such as the settlement price of a commodity derivative contract on a certain date ( e.g., the price on the settlement date of a core referenced futures contract) or other index price ( e.g., a spot index price). Market participants may also refer to unfixed price transactions as “floating price” transactions, and the Commission does not intend a substantive difference in meaning with the choice of these terms. G. Recent Volatility in the WTI Contract Several commenters noted the volatility in the NYMEX Light Sweet Crude Oil (CL) contract, also known as the West Texas Intermediate crude oil contract (“WTI contract”), that occurred in April 2020 (subsequent to the issuance of the 2020 NPRM) in their comments to the 2020 NPRM. Some commenters suggested that the volatility may have been caused, in part, by excessive speculation 62 or highly leveraged traders, 63 or both. Better Markets suggested that a combination of passive exchange-traded funds, 64 the use of trading-at-settlement (“TAS”) orders, 65 automated trading, 66 and, according to Better Markets, a lack of “meaningful position limits,” 67 may have contributed to the volatility. Other commenters suggested that this event could have been mitigated through additional liquidity provided by financial end users during the critical time period, among other measures. 68 Commenters also pointed to the event to bolster arguments for and against Commission deference to exchanges in implementing position limits. 69 A few commenters requested that the Commission refrain from finalizing the rule until it better understands this event and other issues. 70 62 PMAA at 2. 63 NEFI at 3-4. 64 Better Markets at 9. 65 Better Markets at 13. A TAS order is an order that is placed during the trading session but is executed at the settlement price (or with a small price range around the settlement price). Trading at Settlement (TAS), https://www.cmegroup.com/trading/trading-at-settlement.html (last visited Aug. 29, 2020); TRADE AT SETTLEMENT (TAS) FREQUENTLY ASKED QUESTIONS July 2020, https://www.theice.com/publicdocs/futures_us/TAS_FAQ.pdf (last visited Aug. 29, 2020). 66 Better Markets at 14-17. 67 Better Markets at 10. 68 AQR at 5-7 (“The inability of position limits themselves to eliminate the unpredictability of commodity futures markets highlights the importance of existing Commission and exchange oversight of these markets and the dangers of overreliance on a single regulatory tool to address market dynamics for which it may not have been designed . . . [W]e encourage the Commission to consider not only concerns around potential manipulation, but also the potential unintended consequences of such limits and the need for liquidity during sensitive time periods for commodity futures markets.”); SCM at 2-3 (“This liquidity, provided by financial trading firms and hedge funds . . ., is essential to balance, check and smooth the otherwise uncontrollable trading that can occur when only commercial firms and unsophisticated trading participants are active in a market.”). 69 IATP suggested that the event demonstrates the problems of Commission deference to DCMs' “experience and capacity” on many of the provisions in the 2020 NPRM. See IATP at 18. Conversely, SEMI stated that a final rule should not be overly restrictive in response to the recent market conditions in WTI oil markets, given that it is the exchanges that “have the expertise, experience and existing tools to effectively manage the orderly expiration of futures contracts that are in the spot month under such circumstances.” SEMI at 13. 70 AFR at 3; Rutkowski at 2; IATP at 2-3. The Commission has been closely examining the circumstances surrounding the volatility in the WTI contract since it occurred in April 2020. The Commission will continue to analyze the events of April 2020 to evaluate whether any changes to the position limits regulations may be warranted in light of the circumstances surrounding the volatility in the WTI contract. Any proposed changes that the Commission finds may be warranted would be subject to public comment pursuant to the requirements of the Administrative Procedure Act. H. Brief Summary of Comments Received As stated previously, the Commission received approximately 75 relevant comment letters in response to the 2020 NPRM. 71 Though several commenters did not support the Commission adopting the 2020 NPRM and requested its withdrawal, 72 most of the 75 comments received generally supported the 2020 NPRM, or supported specific elements of the 2020 NPRM. However, many of these commenters suggested modifications to portions of the 2020 NPRM, which are discussed in the relevant sections discussing the Final Rule below. In addition, several commenters requested Commission action beyond the scope of the 2020 NPRM, also discussed in the relevant sections below. 71 See supra, n.16. 72 E.g. AFR; Better Markets; IATP; Eric Matsen; NEFI; Public Citizen; Robert Rutkowski; SCM; and VLM. II. Final Rule A. § 150.1—Definitions Definitions relevant to the existing position limits regime currently appear in both §§ 1.3 and 150.1 of the Commission's regulations. 73 The Commission proposed to update and supplement the definitions in § 150.1, including moving a revised definition of “bona fide hedging transactions and positions” from § 1.3 into § 150.1. The proposed changes were intended, among other things, to conform the definitions to certain of the Dodd-Frank Act amendments to the CEA. 74 Each proposed defined term is discussed in alphabetical order below. 73 17 CFR 1.3 and 150.1, respectively. 74 In addition to the amendments described below, the Commission proposed to re-order the defined terms so that they appear in alphabetical order, rather than in a lettered list, so that terms can be more quickly located. Moving forward, any new defined terms would be inserted in alphabetical order, as recommended by the Office of the Federal Register. See Document Drafting Handbook, Office of the Federal Register, National Archives and Records Administration, 2-31 (Revision 5, Oct. 2, 2017) (stating, “[i]n sections or paragraphs containing only definitions, we recommend that you do not use paragraph designations if you list the terms in alphabetical order. Begin the definition paragraph with the term that you are defining.”). 1. “Bona Fide Hedging Transaction or Position” i. Background—Bona Fide Hedging Transaction or Position Under CEA section 4a(c)(1), position limits shall not apply to transactions or positions that are shown to be bona fide hedging transactions or positions, as such terms shall be defined by the Commission. 75 The Dodd-Frank Act directed the Commission, for purposes of implementing CEA section 4a(a)(2), to adopt a bona fide hedging definition consistent with CEA section 4a(c)(2). 76 The existing definition of “bona fide hedging transactions and positions,” which first appeared in § 1.3 of the Commission's regulations in the 1970s, 77 is inconsistent, in certain ways described below, with the revised statutory definition in CEA section 4a(c)(2). 75 7 U.S.C. 6a(c)(1). 76 7 U.S.C. 6a(c)(2). 77 See, e.g., Definition of Bona Fide Hedging and Related Reporting Requirements, 42 FR 42748 (Aug. 24, 1977). Previously, the Secretary of Agriculture, pursuant to section 404 of the Commodity Futures Trading Commission Act of 1974 (Pub. L. 93-463), promulgated a definition of bona fide hedging transactions and positions. Hedging Definition, Reports, and Conforming Amendments, 40 FR 11560 (Mar. 12, 1975). That definition, largely reflecting the statutory definition previously in effect, remained in effect until the newly-established Commission defined that term. Id. Accordingly, and for the reasons outlined below, the Commission proposed to remove the existing bona fide hedging definition from § 1.3 and replace it with a revised bona fide hedging definition that would appear alongside all of the other position limits related definitions in proposed § 150.1. 78 This definition would be applied in determining whether a position in a commodity derivative contract is a bona fide hedge that may exceed Federal position limits set forth in § 150.2. 78 In a 2018 rulemaking, the Commission amended § 1.3 to replace the sub-paragraphs that had for years been identified with an alphabetic designation for each defined term with an alphabetized list. See Definitions, 83 FR 7979 (Feb. 23, 2018). The bona fide hedging definition, therefore, is now a paragraph, located in alphabetical order, in § 1.3, rather than in § 1.3(z). Accordingly, for purposes of clarity and ease of discussion, when discussing the Commission's existing version of the bona fide hedging definition, this release will refer to the bona fide hedging definition in § 1.3. Further, the version of § 1.3 that appears in the Code of Federal Regulations applies only to excluded commodities and is not the version of the bona fide hedging definition currently in effect. The version currently in effect, the substance of which remains as it was amended in 1987, applies to all commodities, not just to excluded commodities. See Revision of Federal Speculative Position Limits, 52 FR 38914 (Oct. 20, 1987). While the 2011 Final Rulemaking amended the § 1.3 bona fide hedging definition to apply only to excluded commodities, that rulemaking was vacated, as noted previously, by a September 28, 2012 order of the U.S. District Court for the District of Columbia, with the exception of the rule's amendments to 17 CFR 150.2. Although the 2011 Final Rulemaking was vacated, the 2011 version of the bona fide hedging definition in § 1.3, which applied only to excluded commodities, has not yet been formally removed from the Code of Federal Regulations. The currently-in-effect version of the Commission's bona fide hedging definition thus does not currently appear in the Code of Federal Regulations. The closest to a “current” version of the definition is the 2010 version of § 1.3, which, while substantively current, still includes the “(z)” denomination that was removed in 2018. The Commission proposed to address the need to formally remove the incorrect version of the bona fide hedging definition as part of the 2020 NPRM. This section of the release discusses the bona fide hedging definition and the substantive standards for bona fide hedges. The process for granting bona fide hedge recognitions is discussed later in this release in connection with §§ 150.3 and 150.9. 79 79 See infra Section II.C. (discussing § 150.3) and Section II.G. (discussing § 150.9). The discussion in this section is organized as follows: i. This background section discussion; ii. An overview of the existing “general” elements of the bona fide hedging definition and the specific “enumerated” bona fide hedges listed in the existing bona fide hedge definition; iii. A discussion of each of the elements of the existing “general” bona fide hedging definition, including the (a) temporary substitute test (and the related elimination of the risk management exemption), (b) economically appropriate test, (c) change in value requirement, (d) incidental test, and (e) orderly trading requirement; iv. The treatment of unfixed-price transactions under the Final Rule; v. A discussion of each enumerated bona fide hedge in the Final Rule; vi. A discussion of the elimination of the Five-Day Rule; vii. A discussion of the guidance on measuring risk ( i.e., gross versus net hedging); viii. A discussion of the Final Rule's implementation of the CEA's statutory pass-through swap and pass-through swap offset provisions; and ix. A discussion of the form, location, and organization of the enumerated bona fide hedges. ii. Overview of the Commission's Existing Bona Fide Hedging Definition in § 1.3 Paragraph (1) of the existing bona fide hedging definition in Commission regulation § 1.3 contains what is currently labeled the “general definition” of bona fide hedging. This “general” bona fide hedging definition comprises five key elements which require that in order for a position to be deemed a bona fide hedge for Federal position limits, the position must: • “normally” represent a substitute for transactions to be made or positions to be taken at a later time in a physical marketing channel (“temporary substitute test”); • be economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise (“economically appropriate test”); • arise from the potential change in value of (1) assets which a person owns, produces, manufactures, processes, or merchandises or anticipates owning, producing, manufacturing, processing, or merchandising, (2) liabilities which a person owns or anticipates incurring, or (3) services which a person provides, purchases, or anticipates providing or purchasing (“change in value requirement”); • have a purpose to offset price risks incidental to commercial cash or spot operations (“incidental test”); and • be established and liquidated in an orderly manner (“orderly trading requirement”). 80 80 17 CFR 1.3. As discussed more fully below, the Dodd-Frank Act's amendments to the CEA included the first three factors in the amended CEA, but did not include the last two factors. Additionally, paragraph (2) of the bona fide hedging definition in existing § 1.3 currently sets forth a non-exclusive list of seven total enumerated bona fide hedges, contained in four general bona fide hedging transaction categories, that comply with the general bona fide hedging definition in paragraph (1). These bona fide hedge categories that are explicitly listed in existing § 1.3's bona fide hedging definition are generally referred to as the “enumerated” bona fide hedges, a term the Commission uses throughout in this release. Market participants thus need not seek approval from the Commission of such positions as bona fide hedges prior to exceeding limits for such positions. Rather, market participants must simply report any such positions on the monthly Form 204 (or Form 304 for cotton), as required by part 19 of the Commission's existing regulations. 81 81 17 CFR part 19. The seven existing enumerated hedges fall into the following four categories: (1) Sales of futures contracts to hedge (i) ownership or fixed-price cash commodity purchases and (ii) unsold anticipated production; (2) purchases of futures contracts to hedge (i) fixed-price cash commodity sales of the same commodity, (ii) fixed-price sales of the cash commodity's cash products and by-products, and (iii) unfilled anticipated requirements; (3) offsetting sales and purchases of futures contracts to hedge offsetting unfixed-price cash commodity sales and purchases; and (4) cross-commodity hedges. 82 82 17 CFR 1.3. As discussed further below, market participants may not use either the existing enumerated bona fide hedges for unsold anticipated production or unfilled anticipated requirements to hedge more than twelve-months' unsold production or unfilled requirements, respectively (the “twelve-month restriction”). Further, the existing enumerated bona fide hedges for unsold production and for offsetting sales and purchases of unfixed price transactions do not apply during the five last trading days. Similarly, the existing enumerated bona fide hedge for unfilled anticipated requirements has a modified version of the Five-Day Rule and provides that during the “five last trading days” a market participant may not maintain a position that exceeds the market participant's unfilled anticipated requirement for “that month and for the next succeeding month.” Paragraph (3) of the current bona fide hedging definition states that the Commission may recognize “non-enumerated” bona fide hedging transactions and positions pursuant to a specific request by a market participant using the process described in § 1.47 of the Commission's regulations. 83 83 Id. iii. Amended Bona Fide Hedge Definition for Physical Commodities in § 150.1; “General” Elements of the Bona Fide Hedge Definition Under the Final Rule The Commission is adopting the proposed general elements currently found in the bona fide hedging definition in § 1.3 that conform to the revised statutory bona fide hedging definition in CEA section 4a(c)(2), as amended by the Dodd-Frank Act, and is eliminating the general elements that do not conform. 84 In particular, the Commission is adopting updated versions of the temporary substitute test, economically appropriate test, and change in value requirements that are described below, and eliminating the incidental test and orderly trading requirement, which are not included in the revised statutory text. Each of these changes is discussed in more detail below. 85 84 The Commission is also making a non-substantive change to the introductory language of § 150.3 by referring in the proviso to “such person's transactions or positions.” The Commission views this as a clarifying edit, and does not intend a substantive difference in meaning with the choice of these terms. 85 Bona fide hedge recognition is determined based on the particular circumstances of a position or transaction and is not conferred on the basis of the involved market participant alone. Accordingly, while a particular position may qualify as a bona fide hedge for a given market participant, another position held by that same participant may not. Similarly, if a participant holds positions that are recognized as bona fide hedges, and holds other positions that are speculative, only the speculative positions would be subject to position limits. a. Temporary Substitute Test (1) Background—Temporary Substitute Test The language of the temporary substitute test in the Commission's existing bona fide hedging definition is inconsistent with the language of the temporary substitute test that appears in the CEA, as amended by the Dodd-Frank Act. Specifically, the Commission's existing regulatory definition currently provides that a bona fide hedging position normally represents a substitute for transactions to be made or positions to be taken at a later time in a physical marketing channel. 86 Prior to the enactment of the Dodd-Frank Act, the temporary substitute test in section 4a(c)(2)(A)(i) of the CEA also contained the word “normally,” so that the Commission's existing bona fide hedging definition mirrored the previous section 4a(c)(2)(A)(i) of the CEA prior to the Dodd-Frank Act. The word “normally” acted as a qualifier for the instances in which a position must be a temporary substitute for transactions or positions made at a later time in a physical marketing channel. However, the Dodd-Frank Act removed that qualifier by deleting the word “normally” from the temporary substitute test in CEA section 4a(c)(2)(A)(i). 87 86 17 CFR 1.3. As noted earlier in this release, the currently-in-effect version of the Commission's bona fide hedging definition does not currently appear in the current Code of Federal Regulations. The closest to a “current” version of the definition is the 2010 version of § 1.3, which, while substantively current, still includes the “(z)” denomination that was removed in 2018. The Commission proposed to address the need to formally remove the incorrect version of the bona fide hedging definition as part of the 2020 NPRM. See supra n.74. 87 7 U.S.C. 6a(c)(2)(A)(i). In a 1987 interpretation, the Commission stated that, among other things, the inclusion of the word “normally” in connection with the pre-Dodd-Frank-Act version of the temporary substitute language indicated that the bona fide hedging definition should not be construed to apply only to firms using futures to reduce their exposures to risks in the cash market. 88 Instead, the 1987 interpretation took the view that to qualify as a bona fide hedge, a transaction in the futures market did not necessarily need to be a temporary substitute for a later transaction in the cash market. 89 In other words, that interpretation took the view that a futures position could still qualify as a bona fide hedging position even if it was not in connection with the production, sale, or use of a physical commodity. 88 See Clarification of Certain Aspects of the Hedging Definition, 52 FR 27195, 27196 (July 20, 1987). 89 Id. Commission staff has previously granted so-called “risk management exemptions” on such grounds. In connection with physical commodities, the phrase “risk management exemption” has historically been used by Commission staff to refer to non-enumerated bona fide hedge recognitions granted under § 1.47 to allow swap dealers and others to hold agricultural futures positions in excess of Federal position limits in order to offset their positions in commodity index swaps or related exposure. 90 Risk management exemptions were granted outside of the spot month, and the related swap exposure that was being offset ( i.e., hedged by the futures or options position entered into based on the risk management exemption) was typically opposite an institutional investor for which the swap was not a bona fide hedge. 90 As described below, due to differences in statutory language, the phrase “risk management exemption” often has a broader meaning in connection with excluded commodities than with physical commodities. See infra Section II.A.1.x. (discussing proposed pass-through language). (2) Summary of the 2020 NPRM—Temporary Substitute Test As described above, the Dodd-Frank Act clearly and unambiguously removed the word “normally” from the temporary substitute test in CEA section 4a(c)(2)(A)(i), as amended by the Dodd-Frank Act. As such, in the 2020 NPRM, the Commission interpreted the Dodd-Frank Act's removal of the word “normally” as reflecting Congressional statutory direction that a bona fide hedging position in physical commodities must always (and not just “normally”) be in connection with the production, sale, or use of a physical cash-market commodity. 91 The Commission interpreted this change to signal that the Commission should cease to recognize “risk management” positions as bona fide hedges for physical commodities, unless the positions satisfy the pass-through swap/swap offset requirements in section 4a(c)(2)(B) of the CEA, further discussed below. 92 91 85 FR at 11596. 92 7 U.S.C. 6a(c)(2)(B). In order to implement that statutory change, the Commission: (1) Proposed a narrower bona fide hedging definition for physical commodities in proposed § 150.1 that did not include the word “normally” currently found in the temporary substitute regulatory language in paragraph (1) of the existing § 1.3 bona fide hedging definition; and (2) proposed to eliminate all previously-granted risk management exemptions that did not otherwise qualify for pass-through treatment. 93 Under the 2020 NPRM, any such previously-granted risk management exemption would generally no longer apply 365 days after publication of final position limits rules in the Federal Register . 94 93 See final § 150.3(c). See also infra Section II.A.1.x.b. (discussing proposed pass-through language). Excluded commodities, as described in further detail below, are not subject to the statutory bona fide hedging definition. Accordingly, the statutory restrictions on risk management exemptions that apply to physical commodities subject to Federal position limits do not apply to excluded commodities. 94 See infra Section II.A.1.iii.a(5) (discussing of revoking existing risk management exemptions). (3) Summary of the Commission Determination—Temporary Substitute Test As proposed, the Final Rule eliminates the word “normally” from the Commission's temporary substitute test and eliminates the risk management exemption for contracts subject to Federal position limits. However, as described below, the Final Rule is extending the compliance date for existing risk management exemption holders. (4) Comments—Temporary Substitute Test Commenters were divided regarding the proposed elimination of the risk management exemptions. Some public interest groups and the agricultural industry supported the proposed removal of the word “normally” and/or the accompanying rescission of risk management exemptions. 95 These commenters argued that risk management positions are harmful to the market and can adversely impact price dynamics. 96 95 AMCOT at 1; Ecom at 1; White Gold at 1-2; Walcot at 2; East Cotton at 2; CMC at 11 (stating that the increased limits and allowances for pass-through exemptions will limit any potential loss of liquidity); NCFC at 7 (noting that it supports the elimination in light of the increased limits); NGFA at 3; LDC at 2; PMAA at 4; ACSA at 2, 4; IMC at 2; Mallory at 1; McMeekin at 1-2; Memtex at 2; Omnicotton at 2; NCC at 1; S Canale Cotton at 2; Texas Cotton at 2; SW Ag at 2; Jess Smith at 2; Choice Cotton at 1; Olam at 1-2; Better Markets at 4, 51-54 (agreeing with the proposed interpretation that the Dodd-Frank Act requires the change and stating that the elimination of the risk management exemption may mean very little in light of the increased limits); ACA at 2; Moody Compress at 2; Toyo at 2; and DECA at 1. 96 See, e.g., Mallory Alexander at 1; DECA at 1; Ecom at 2; Southern Cotton at 2; Canale Cotton at 2; ACA at 2; IMC at 2; Olam at 1-2; Moody Compress at 1; SW Ag at 2; East Cotton at 2; Toyo at 2; Jess Smith at 2; McMeekin at 1-2; Omnicotton at 2; Texas Cotton at 2; Walcot at 2; White Gold at 1-2; and PMAA at 3-4 (arguing that risk management positions have the potential to create significant volatility); Better Markets at 9, 17 (noting the distortive effects of risk management positions). Commenters from the financial industry, ICE, and MGEX opposed the proposed removal of “normally” and/or the proposed elimination of the risk management exemption. 97 These commenters contended that the elimination of the risk management exemption will harm the market, including by reducing liquidity, 98 and that even though Congress removed “normally” from the statute, Congress did not use the term “always.” 99 One commenter opposed to the ban claimed that the European Commission is considering revising MiFID II 100 to address a “failure to include an appropriate hedge exemption for financial risks.” 101 97 ICE at 5-8 (noting that risk management positions are non-speculative and arguing that the pass-through provision is not an adequate substitute for such positions); FIA at 10, 21-24; [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2020-25332. Public record. Not legal advice.