Aggrieved Over Aggregation

Terry Flanagan

Industry chafes at CFTC final position limits rule that would require account aggregation in many situations.

The derivatives industry is fuming over a final rule on position limits that was adopted by the Commodity Futures Trading Commission, saying that it will limit the use of derivatives for legitimate hedging purposed by corporations.

“This rule is going to put a great deal of strain on anyone working in the asset management community,” Mike Wilkins, product specialist at SunGard Global Trading., told Markets Media.

“Historically, the onus of making sure that a client account for whom [an asset manager] conducts business is compliant with regulations has fallen on the firm where that account is cleared,” said Wilkins. “Now, it seems that with these new regulations, the asset manager themselves, in many cases an independent professional, is going to bear an increased compliance burden.”

The CFTC has dropped a provision on aggregation of positions that was present in the proposed rule that was issued in January, which would have allowed a company to disaggregate the positions of an “owned non-financial entity” in which it owns a 10 percent or greater interest provided that it could demonstrate that the futures and swaps positions of the entities are independently managed and controlled (the “Owned Entity Exemption”).

In the final rule, the CFTC has replaced the Owned Entity Exemption with a provision similar to the current independent account controller (IAC) exemption.

The CFTC itself is divided on the issue.

“While the final rule preserves the IAC exemption, it only does so in response to overwhelming comments arguing against its proposed elimination, which was without any legal rationale,” said CFTC commissioner Scott O’Malia. “And, to be clear, the IAC is only available to ‘eligible entities,’ namely financial entities, and only with respect to client positions.”

Industry participants are concerned that the final rule will limit the IAC exemption to situations in which a professional asset manager (such as a registered commodity trading advisor) is trading on behalf of an eligible entity.

If a fund becomes an owner of ten percent or more of an operating company, then the final rule could be construed as providing that the operating company and their trading personnel may not qualify as an independent account controller, notwithstanding an absence of control over the operating company’s trading activities.

“This rule may leave the impression that asset managers would be required to aggregate positions of operating companies in which the funds and accounts they manger have a 10% or greater ownership interest, even where the ownership in such companies is passive and where the asset managers have absolutely no influence over the trading activities of such company,” according to a letter to the CFTC from Sifma’s Asset Management Group.

A narrow disaggregation provision would require certain commercial entities to coordinate trading with independently managed affiliates, opponents of the rule say.

Some commercial entities share common ownership (greater than 10%) in independently managed and controlled joint ventures, for example.

“If the Owned Entity Exemption is replaced by the IAC Exemption, the commercial owners and the joint venture would be required to coordinate their trading activity by allocating position limits among the aggregated entities and reporting on a consolidated basis, even if all the entities involved art primarily hedgers,” said Paul Pantano, an attorney at Cadwalader, Wickersham & Taft.

The CFTC is backing off on a proposal that would have set conditional spot-month limits on derivatives contracts.

The proposed rule issued by the CFTC in January set spot-month position limits at 25 percent of deliverable supply for a given commodity, with a conditional spot-month limit of five times that amount for entities with positions “exclusively” in cash-settled contracts.

But in its final rule, the CFTC has dropped the requirement that positions be exclusively in cash-settled contracts.

The agency said it agreed with comments it received urging it to gain further experience with swaps to ensure adequate liquidity for bona fide hedging transactions and positions before imposing restrictive conditions on people holding both cash-settled and physical delivery referenced contracts.

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