United States: CFTC Update: CFTC Proposes New Position Limits And Aggregation Rules

Background

On November 5, 2013, the Commodity Futures Trading Commission (the "Commission" or "CFTC") approved proposed position limits rules (the "Proposed Position Limits Rules")1 and proposed new aggregation standards for determining compliance with position limits (the "Proposed Aggregation Standards" and, together with the Proposed Position Limits Rules, the "Proposed Rules").2 The CFTC voted three to one in favor of the Proposed Position Limits Rules, with Commissioner Scott O'Malia dissenting, and unanimously in favor of the Proposed Aggregation Standards.3 Both proposals will be open for public comment commencing 60 days after publication in the Federal Register. These proposals are designed to implement certain statutory amendments which were added to the Commodity Exchange Act by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), as interpreted by the Commission.

Please note that this memorandum is based on a preliminary review of the Proposed Rules, the fact sheet and frequently asked questions and answers issued by the CFTC, and comments made by CFTC Commissioners and staff during the public meeting, and is intended to provide a high level overview of various significant aspects of the Proposed Rules in summary form. We expect to issue a more detailed memorandum after the Proposed Rules are published in the Federal Register.

The Proposed Position Limits Rules come after a previous version4 was vacated by a Federal District Court Judge in 2012. Although the Commission had appealed that decision, it ultimately decided instead to propose this new set of rules and dismiss its appeal.5 The Proposed Aggregation Standards are quite similar in most respects to the amendments proposed by the Commission in May 2012, although the new version reflects certain comments received in response to the May 2012 proposal and also includes certain other revisions.6

Summary of Proposed Position Limits Rules

The Proposed Position Limits Rules will, if adopted, establish limits on speculative positions in twenty-eight specified exempt (i.e., energy and metals) and agricultural commodity futures and options contracts traded on a designated contract market (a "DCM") (such contracts are referred to as "core referenced futures contracts" in the Proposed Rules), and their "economically equivalent" futures, options and swaps.

The Proposed Position Limits Rules set forth both spot-month and non-spot-month limits. The proposed spot-month limits will, if adopted, be based on the spot-month limit currently in place at DCMs (or estimates of deliverable supply submitted by one or more DCMs and verified by the CFTC), but will eventually be based on the CFTC's determination of deliverable supply. Such limits will be readjusted no less frequently than every two years and will generally be set at 25% of estimated deliverable supply. Spot-month limits will also apply separately for physical-delivery contracts and cash-settled contracts in the same commodity.

The proposed non-spot-month limits (which include single-month and all-months-combined limits) will, if adopted, be based on open interest in futures and swaps that are significant price discovery contracts and will be readjusted no less frequently than every two years. Non-spot-month limits will be set at 10% of open interest in the first 25,000 contracts and 2.5% above that. It appears that non-spot-month limits will apply across both physical-delivery contracts and cash-settled contracts.

Exemptions from Position Limits

The Proposed Position Limits Rules also provide for a certain number of exemptions from position limits, including:

  • An exemption from the cash-settled spot-month limit up to five times the level of that limit, provided that the relevant trader does not hold any position in the physical delivery spot-month contract in the same commodity.
  • Certain exemptions for bona fide hedging positions in physical commodities based on the Commission's interpretation of the Dodd-Frank Act's new requirements for such positions. These include new exemptions for unfilled anticipated requirements for resale by a utility, royalties and service contracts.
  • A "pass through swap" exemption for a trader when it enters into a swap for a counterparty for whom the swap qualifies as a bona fide hedge, provided the trader offsets the trade subsequently and subject to certain conditions.
  • An exemption for positions established in good faith prior to the effective date of the initial limits.

We expect that commenters will object to the narrow scope of many of these exemptions.

Proposed New Aggregation Standards

The Commission is proposing modifications to the aggregation provisions of the CFTC's Part 150 rules that are substantially similar to the amendments to the aggregation provisions that the CFTC had proposed to be added to the now vacated Part 151 rules in May 2012. The Proposed Aggregation Standards generally require that, absent a specific exemption, a person must treat as its own any positions in any account in which it has, whether directly or indirectly, a 10% or greater ownership or equity interest, even if the person does not control the trading in such account. Also, a person must treat as its own the positions in any account on the basis of control over the trading decisions in the account, or on the basis of trading pursuant to an express or implied agreement or understanding with another person, which is consistent with longstanding CFTC policy. In addition, the Commission is proposing to add a new aggregation provision, which is applicable to positions in accounts with so-called "substantially identical trading strategies," even if apparently a person does not control the trading in such accounts and has less than a 10% interest in such accounts and notwithstanding the availability of an exemption from aggregation which otherwise would be applicable. We expect that commenters will object to this provision and will also request guidance as to its intended meaning and scope.

Exemptions from Aggregation

In addition to existing exemptions from aggregation which are applicable to futures commission merchants, commodity pool operators and pool participants and independent account controllers, the Proposed Aggregation Standards provide for certain other exemptions from aggregation including, but not limited to, situations in which: (i) the sharing of information would violate or create reasonable risk of violating federal, state or foreign laws or regulations; (ii) an ownership interest is no greater than 50% in any other entity whose trading is independently controlled; (iii) an ownership interest is greater than 50% in another non-consolidated entity whose trading is independently controlled and an applicant certifies that such entity's positions qualify as bona fide hedging or do not exceed 20% of any position limit; and (iv) ownership in another entity results from broker-dealer activities in the normal course of business as a dealer, but not greater than 50%.

Notice Filing Relief

Under the Proposed Aggregation Standards, the exemptions are not self-executing for the most part and generally require a notice filing with the Commission. A notice filing must provide a description of the relevant circumstances that warrant an exemption and a statement of a senior officer of the entity certifying that conditions set forth in the applicable aggregation exemption provision have been met. Also, a notice filing must be amended in the event of any material change. Additionally, note that a person with a greater than 50% ownership or equity interest in an owned entity seeking an aggregation exemption must apply to the Commission for relief on a case-by-case basis and relief would not be effective upon filing the notice. Among other things, an applicant must demonstrate that (i) the owned entity is not required to be, and is not, consolidated on the financial statement of the person; (ii) the person does not control the trading of the owned entity, with evidence that it and the owned entity have procedures in place that are reasonably effective to prevent coordinated trading notwithstanding majority ownership; (iii) each representative of the person on the owned entity's board of directors attests that he or she does not control trading of the owned entity; and (iv) the person certifies that either (a) all of the owned entity's positions qualify as bona fide hedging transactions or (b) the owned entity's positions that do not so qualify do not exceed twenty percent of any position limit currently in effect. Thus, this relief would not be automatic, but would be available only if the Commission finds, in its discretion, that the conditions are met.

The Proposed Rules have vast implications for the futures, options and swaps markets and market participants and raise a host of interpretative questions, issues and other concerns.

We will continue to monitor and report on developments in this area.

Footnotes

1 http://www.cftc.gov/PressRoom/Events/ssLINK/federalregister110513c

2 http://www.cftc.gov/PressRoom/Events/ssLINK/federalregister110513

3 The Commission only had four Commissioners at that time and as of today has only has three Commissioners.

4 See 76 Fed. Reg. 71626 (Nov. 18, 2011).

5 See ISDA v.CFTC, 887 F. Supp. 2d 259 (D.D.C. 2012) and ISDA & SIFMA v. CFTC, No. 12-5362 (D.C. Cir.).

6 See 77 Fed. Reg. 31767 (May 30, 2012).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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