CFTC Eases Position Limits Rule

Terry Flanagan

Requirement that positions be held exclusively in cash-settled contracts is dropped.

The Commodity Futures Trading Commission is backing off on a proposal that would have set conditional spot-month limits on derivatives contracts.

A 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, which is to be published in October, 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.

The CFTC and SEC have been criticized in some quarters for taking an overly prescriptive approach to rulemaking, which could U.S. firms to do business elsewhere.

“So far they have written the rules to the edge of what Dodd-Frank allows, but the issue of extraterritoriality is different,” Marvin Goldstein, partner in the derivatives practice at Stroock Stroock and Lavan, told Markets Media.  “If they continue to overregulate, the transition from a derivatives industry invented and based in the United States to one based in London, Switzerland and Asia will be complete.”

CME had objected to both the five-times limit itself as well as the requirement that the position be held “exclusively” in cash-settled contracts.

By definition, the physically-delivered contract and its cash-settled lookalike are linked and arbitrage naturally occurs between the contracts, CME had told the CFTC in a comment letter.

“Providing for a larger limit in the cash-settled contract, and conditioning the larger limit on not participating in the physically-delivered contract, incentivizes participation in the cash-settled contract at the expense of liquidity in the referenced physically-delivered contract,” according to CME.

CME Group and InterContinental Exchange have sparred over the conditional limits rule.
CME, in arguing that the conditional limit be decreased or eliminated, cites data that its says demonstrates that since the conditional limits were introduced in the natural gas market in Feb. 2010, trading volume has decreased in the physically-delivered Nymex natural gas futures contract (NG) in the critical 30-minute settlement period on the last trading day.

ICE, in response, said that CME’s analysis is materially flawed and that in the 17 months since the conditional limit provision went into effect, natural gas prices have been lower and less volatile than historical levels.

Removing or reducing the conditional limit would disrupt market practice for sole purpose of enhancing CME’s competitive position, ICE said. ICE cited data that it says refutes any suggestion that the existence of the conditional limited resulted in increased volume in the ICE Henry Hub Swap at the expense of volume in the Nymex NG contract curing the 30 minutes prior to contract expiration.

CME has also objected to a proposed rule from the CFTC that would require that a minimum of 85 percent of trading in any contract listed on a designated contract market (DCM) must occur on the centralized market. If a contract fails to meet this test, the DCM is required to delist the contract and transfer the open positions in the contract to a swap execution facility (SEF).

The CFTC had proposed the rule last December with a comment deadline of Feb. 22, and then extended the deadline to April 18 to give interested parties the opportunity to comment on off-market volume data on which the CFTC relied upon for its rulemaking.

The off-market volume data, which the CFTC has made public, lists hundreds of futures and options products, along with the percentages of each product that trade off-exchange. The data is apparently intended to bolster the CFTC’s view that a significant percentage of trading in products takes place away from the exchange on which they’re listed.

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