By Terry Flanagan

CFTC Position Limits Rule Struck Down

The derivatives industry has scored a major legal victory in its efforts to delay the implementation of position limits by the Commodity Futures Trading Commission (CFTC), the top U.S. derivatives regulator, with the ruling by a federal judge that the Dodd-Frank Act is unclear on whether the CFTC has the authority to impose position limits without first assessing whether they are necessary and appropriate.

The rule had been scheduled to go into effect on October 12.

The judge ruled on a lawsuit filed late last year by the International Swaps and Derivatives Association (ISDA) and the Securities Industry and Financial Markets Association (Sifma), both trade bodies, challenging the position limits rule and requesting that the CFTC stay the effective date of the rule, pending resolution of the lawsuit.

In their lawsuit, Isda and Sifma contended that the CFTC’s decision-making process in enacting the rule was procedurally flawed.

“The court’s ruling vacates the rule and remands it back to the CFTC,” said a joint statement by ISDA and Sifma. “The position limits rule would adversely impact commodities markets and market participants, including end-users, by reducing liquidity and increasing price volatility.”

The legal challenge is the first to arise from the Dodd-Frank rule making process, which aims to monitor and mitigate systemic risk by bringing more transparency to the OTC derivatives markets, and follows similar challenges to other rule makings under securities laws.

“When there has been significant push back from asset managers, it has come from the industry as a whole acting through trade groups, and it typically has occurred when the industry perceives that new regulations would significantly affect a product or service,” said John Hunt, a partner at the Nutter law firm.

Money market fund sponsors, for example, recently were very aggressive in their largely successful efforts to discourage new U.S. Securities and Exchange Commission (SEC) rule making, “and they are likely that to continue to be aggressive if the other regulators look to take up the regulatory sword from the SEC”, said Hunt.

In most respects, the CFTC’s mandate to move the OTC swaps market to a centralized execution and clearing model has been embraced by the industry, with new trading and clearing venues being established.

The CFTC recently approved trueEX, a Dodd-Frank compliant swaps exchange, as a Designated Contract Market (DCM). trueEX serves the $300 trillion global interest rate swaps (IRS) market and plans to expand into other liquid derivatives as appropriate.

As a regulated exchange, trueEX bridges the gap between the swaps and futures markets.

“A DCM can list both swaps and futures,” said Sunil Hirani, chief executive and founder of trueEX. “We have designed our product offering in consultation with major market participants by taking into account their unmet needs.”

trueEX will commence operations in the first quarter of 2013.

By moving the derivatives markets to an exchange-traded and centrally cleared environment it is hoped that it will mitigate systemic risk, reduce execution and processing costs, and provide transparency.

“Regulations will require that commoditized swaps to be traded on regulated markets—our platform helps customers do that,” Hirani said.

Eris Exchange, which also functions as a DCM, provides forward starting interest rate swap futures that are cleared by CME Clearing and traded on Eris SwapBook and Eris BlockBox.

The product design collapses multiple cash flows associated with OTC swaps into a single futures price and cash flow which transfers through variation margin in a futures clearing account, according to the company.

Hirani founded Creditex, the first electronic trading platform for credit default swaps (CDSs), which was sold to IntercontinentalExchange, an operator of futures exchanges, in 2008. He and members of the trueEX management team also launched T-Zero, a platform for CDSs, which is now called ICE Link.

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