Position Limit Rule Parsed

Terry Flanagan

Effective date of interim final rule is contingent on CFTC’s definition of “swap.”

The Commodity Futures Trading Commission’s interim final rule on position limits, which was published on Nov. 18 and is due to take effect next year, will impact commodities traders and dealers in several major ways.

The interim final rule is contingent on the CFTC’s definition of the term “swap” under the Dodd-Frank Act.

“The position limit rules are final, but don’t go into place until next year,” Kenneth Raisler, partner in the commodities derivatives practice at Sullivan & Cromwell, told Markets Media.

“One of the issues of greatest concern is the impact on commodity index investing, because the places restrictions on that business, which is increasing the cost of managing commodity index portfolios,” said Raisler.

Although positions in commodity index contracts are not subject to position limits, commodity index swap users, including commodity index funds that rely on swaps, will be directly affected if they seek to offset the commodity index risks with individual commodity swaps or futures, and indirectly if they elect to offset their risk using commodity index swaps.

“Some dealers may be restricted in the volume of commodity index swaps they can carry and effectively offset without exceeding position limits,” said Raisler.

Another issue for dealers are the final rule’s provisions on aggregation of accounts and positions.

The proposed rules would have eliminated the Independent account Controller (IAC) exemption and restricted existing disaggregation provisions. In response to comments, however, the CFTC decided to retain the IAC exemption.

The IAC exemption preserved by the final rule permits disaggregation between proprietary positions and those managed on behalf of clients; the IAC exemption, however, does not permit proprietary positions to be disaggregated from other proprietary positions.

“There are concerns that position will have to be aggregated among companies with common ownership, which will restrict trading behavior and create large infrastructure costs based on the need to monitor positions on an aggregated basis,” said Raisler.

Spot-month position limits will apply separately to physically-settled and cash-settled contracts: a trader may hold positions during the spot-month in physically-settled contracts in an amount up to the spot-month limit (which is set at 25% of deliverable supply), and may separately hold positions in cash-settled contracts up to that limit.

A carve-out has been created for natural gas contracts that reference physically-settled natural gas contracts (Nymex Henry Hub Natural Gas Referenced Contracts).

While the physically-settled spot-month limit for natural gas contracts is set at 25% of deliverable supply, natural gas contracts are subject to a more permissive conditional limit for cash-settled contracts, which is equal to five times the physically-settled limit.

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 it 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 since the conditional limit provision went into effect, natural gas prices have been lower and less volatile than historical levels.

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