Pending bill clears way for CFTC limits vote
With Congress poised to enact sweeping financial reforms next month, attention will switch back to the Commodity Futures Trading Commission (CFTC) proposals to impose tougher position limits on major energy contracts.
The Commission voted in January to put its proposals out for a major 90-day consultation exercise, which ended in late April. Staff are wading through almost 8,000 written comments. The Commission will then have to decide whether and how to reshape the proposal in the light of comments received, before putting it to a final vote.
The Commission’s 4-1 vote to put proposals out to consultation concealed hesitation about whether they should eventually be approved. Only CFTC Chairman Gary Gensler and Democrat Commissioner Bart Chilton gave the proposals full support.
Two other commissioners (Democrat Michael Dunn and Republican Scott O’Malia) voted to release them for consultation but made clear they did not necessarily endorse adoption. The fifth commissioner, Republican Jill Sommers, voted against even releasing the proposal.
Gensler needs to win the support of one or both of Dunn and O’Malia to put together a 3-vote majority.
While proposed limits have received strong support from members of Congress, fuel retailers, and a grass-roots letter-writing campaign, they are fiercely opposed by futures dealers, most major investment banks, and exchange-traded fund operators, as well as a handful of oil producers and traders. Criticisms fall into three broad categories:
(a) The Commission lacks statutory authority under Section 4(a) of the Commodity Exchange Act to impose regulations until it can show price volatility as a result “excessive speculation” is actually real threat, rather than a theoretical possibility.
(b) The Commission will drive futures trading into less-regulated over-the-counter (OTC) markets and onto foreign exchanges unless the law is amended to extend its authority into these areas and allow it to apply limits on a fully aggregated basis.
(c) Proposals on account aggregation (abandoning the current safe harbor for independent account controllers and requiring positions to be aggregated on the basis of a 10 percent equity rule) and crowding out (banning users of hedging exemptions from running speculative positions) have been described as “unworkable.”
Pending derivatives reform legislation should answer criticisms about lack of authority and jurisdiction over OTC markets and foreign boards of trade.
Details have still to be finalised in conference committee. But the legislation’s eventual scope is in practice bounded by the terms of the separate texts already approved by the House of Representatives and the Senate.
Both House and Senate versions give the CFTC clear power to regulate OTC commodity derivatives and authority to condition foreign exchanges’ access to U.S. customers on meeting appropriate regulatory criteria.
Likely language should answer concerns raised by Dunn and O’Malia in January about adopting limits on exchange-traded contracts when the CFTC does not have similar authority over OTC markets and foreign boards of trade.
The bill should also answer, indirectly, the question of whether the CFTC has authority to set limits at all without showing they are “necessary” to “eliminate, diminish or prevent” excessive speculation.
House and Senate negotiators still have to iron out differences in this area (particularly a disagreement about whether the CFTC “may” set aggregated limits across OTC and foreign contracts or “shall” set them) in the text. But the extensive discussion of how the CFTC should go about setting limits makes it clear Congress is giving the Commission authority and expects it to be used.
If Congress did not intend the CFTC to set limits except if their necessity were “proven” beyond peradventure (something the industry claims has never been done), why would legislators spend so much time crafting complex language on how the limits are to be set? The legislation itself presupposes the Commission has the authority and will set position limits.
ROUNDING UP NUMBER 3
Passage of the derivatives law, probably by the July 4th holiday, will clear the way for Gensler to bring up the rules for a final vote. The key question is where the 3rd vote to adopt them will come from?
Democrat Dunn will come under enormous pressure from his party not to frustrate the party’s reform push by blocking the adoption of limits. Pending legislation goes much of the way to addressing the reservations he raised back in January, which centered on the Commission’s lack of OTC authority and the possible loss of business to foreign exchanges.
As a Republican appointment, O’Malia is less susceptible to pressure. In fact there is some pressure from the GOP to vote against imposing limits. But unlike his fellow-Republican Commissioner Jill Sommers, he did not reject the proposals outright and has seemed open to compromise.
Last week, O’Malia was named as chairman and designated federal official on the CFTC’s relaunched Technology Advisory Committee (TAC). The committee’s previous incarnation expired when its mandate lapsed in 2005. But it has been revived in a bid to revamp the Commission’s antique information systems and strengthen its market oversight function.
The Commission has been open about the shortcomings imposed by its limited staffing and systems, which have not kept pace with the explosive growth in derivatives trading over the past decade. Improvements in real-time information collection and analysis will be central to the CFTC’s agenda in the next couple of years.
Sharp gyrations in U.S. equity and futures markets on May 6 have made the issue pressing, as algorithmic high-frequency trading (HFT) comes back into the spotlight. The Commission currently has only very weak oversight systems in these areas. O’Malia has been put in charge of developing solutions.
It might seem strange for a Democrat-controlled Commission to put a Republican in charge of an important new initiative. But O’Malia has pushed hard for the committee’s re-creation since he was appointed last year.
In a statement earlier this year, O’Malia argued “Technological resources are critical to the Commission’s ability to carry out its mission. For too long the Commission has been playing a game of catch-up. The Commission’s technology has not evolved to that of the marketplace. The result is that the Commission is unable to astutely study and respond to ordinary trading practices or technological trading innovations, such as algorithmic trading.”
The other three commissioners already chair committees (Dunn on agriculture, Chilton on energy and environmental markets, and Sommers on global markets). So O’Malia’s appointment is logical. But it also gives him a leading role shaping the Commission’s response in a crucial area.
Chairing an independent regulatory commission is all about building coalitions. In that sense, O’Malia’s appointment represents something of an outreach by the CFTC chairman and gives him a central role shaping the Commission’s agenda.
So far, O’Malia has been careful not to tip his hand on whether he might vote to enact position limits. At a recent event in Japan, O’Malia would only encourage participants to make their views known before the end of the consultation so the CFTC could consider them.
But the time for a decision is fast approaching. The question is whether O’Malia and Dunn will vote for or against the chairman’s ambitious proposals to reshape energy trading by imposing position limits when they come up later this year.