COLUMN – U.S. futures industry risks Pyrrhic victory in battle with CFTC: Kemp
— John Kemp is a Reuters columnist. The views expressed are his own —
By John Kemp
LONDON, March 19 (Reuters) – By rejecting position limits on energy markets, and calling into question the Commodity Futures Trading Commission’s (CFTC) authority to regulate in this way, the Futures Industry Association (FIA) has dangerously escalated the conflict with its regulator and ultimately with Congress.
It is a sign of the industry’s renewed self-confidence after the crisis, as well as its visceral hostility to restrictions of any sort on position sizes, that the FIA is strenuously opposing limits most observers have described as extremely generous, and has made veiled threats that the position limits could be struck down in court.
This is a high-risk strategy. The FIA’s objections are statutory not constitutional. Even if it forces the Commission to back down, or prevails in court, it would be a relatively simple matter for Congress to amend the 1936 Commodity Exchange Act to give the CFTC more complete authority to impose and enforce the limits FIA has opposed.
SENSE OF CONGRESS
If it blocks the CFTC’s current proposals, the FIA would almost certainly face the threat of new legislation. There is a groundswell of support in Congress for giving the CFTC more power, not less, to regulate energy markets:
(1) The Wall Street Reform and Consumer Protection Act (H 4173) proposed by House Financial Services Committee Chairman Barney Frank and passed by the House of Representatives in December 2009 would significantly reinforce the CFTC’s authority to impose position limits.
Frank’s bill would give the CFTC authority to regulate over-the-counter commodity (OTC) swaps for the first time and apply position limits on an aggregated basis and make it easier for the CFTC to impose conditions on foreign exchanges.
(2) Senate Banking Committee Chairman Christopher Dodd’s recently published financial reform bill would give the CFTC nearly identical powers to apply position limits on an aggregated basis across U.S. exchanges, over-the-counter swaps and foreign markets.
Both bills widen the CFTC’s authority. The CFTC will be able to cite them in any forthcoming court case as evidence of the intent of Congress that it should have broad authority to regulate commodity markets by imposing limits on the size of positions that participants run.
(3) Political pressure for position limits is unabated. The CFTC’s drive to impose tougher position limits was prompted, in part, by pressure from senators concerned about large positions, including Maria Cantwell (D, Washington) and Bernie Sanders (I, Vermont). The Commission’s willingness to take up the issue has temporarily eased up but the pressure will return if the CFTC is thwarted.
If FIA proves the CFTC does not have sufficient authority under existing law, legislators will inevitably try to correct the deficiency by introducing provisions to clarify the CFTC’s authority.
DIALOGUE OF THE DEAF
In its response to the CFTC, FIA cites an impressive list of authorities to support its argument there is an “absence of evidence that any speculation has caused aberrant price fluctuations or changes”.
In a footnote, it references studies performed by the Commission’s own economists as well as a literature review by the Government Accountability Office and a variety of newspaper articles, including one by Nobel Laureate Paul Krugman.
“The available evidence — including the CFTC’s own data and analysis — support the conclusion that market fundamentals drove the 2008 price spikes in various commodities”, according to FIA.
Absence of evidence is not the same as evidence of absence, however; the debate remains inconclusive.
The FIA acknowledges “the Commission is under great pressure from members of Congress and certain market participants to address the volatile energy pricing allegedly caused by speculation”.
That pressure will not go away if the CFTC fails to impose limits. It could rise to a new crescendo if energy and other commodity prices begin to rise sharply again in line with the recovery.
The debate is likely to get more heated in future, in ways that could intensify the pressure on the FIA and its members. Until recently, commodity economics was a backwater.
There were only a few studies looking at the impact of investment inflows and speculation on price formation. Most of those came to the familiar “absence of evidence” conclusion.
But as the field has become more popular, the number of studies has proliferated. New papers published in 2008 and 2009 paint a more nuanced picture. None has yet found an unambiguous relationship between investment flows and outright price levels.
However, it is no longer possible to argue the evidence is entirely in favour of the “no impact” thesis.
THE BURDEN OF PROOF
Careful examination of speculative positions and market behaviour during the three years leading up to the oil price spike in July 2008, and the equally stunning rise in a range of other commodities, has not revealed a “smoking gun”.
Therein lies the problem. It is almost impossible to prove conclusively whether or not a price spike was wholly rational and justified by the fundamentals, or irrationally exuberant and driven by speculation.
The FIA’s insistence that the CFTC must have conclusive evidence of actual episodes of speculation causing price aberrations before it can impose limits is a counsel of perfection meant to deny the CFTC authority to act under any circumstances.
The question here is about the burden of proof.
Should the CFTC have to prove beyond peradventure that speculation actually has created price distortions before it imposes any limits? Or should the industry have to show conclusively prices have always been wholly fundamentally determined before resisting any effort to restrict positions?
In fact the CFTC could argue that Congress has already answered this question: “Excessive speculation … causing sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity, is an undue and unnecessary burden on interstate commerce”. Note the word “is”. Not “might be”. It then goes on to list the steps that the Commission “shall” take to diminish, eliminate or prevent it.
The CFTC does not need to prove speculation adversely impacts prices. Congress has already made that determination.
NEED TO COMPROMISE
At times FIA’s hostility to any sort of limits at all appears to verge on a refusal to compromise. Insisting there is no evidence concentrations of speculative positions pose any threat of disruption it blithely ignores the experience with the failure of hedge fund Amaranth in the natural gas market.
At times the FIA appears to be implying it might be acceptable if one participant held all the open contracts on one side of the market. FIA does acknowledge that “position concentrations should be of market surveillance concern” but “our position is that the blunt instrument of position limits is not suitable in dynamic, ever-changing markets”.
“A position limit formula based on last year’s open interest does not measure accurately the level of concentration in a market today. No formula is an appropriate substitute for an informed market surveillance judgment that market participants have an “excessively concentrated” position in the market”.
So FIA wants a discretionary approach — from the same Commission it would deny any discretion imposing limits.
In fact, FIA is really arguing for no change at all. Existing systems “have worked and worked well”. Searching for something to recommend, it lists a bit more surveillance and a few more intra-month special calls to add to the Commission’s voluminous data collection. No real changes.
The futures industry has been offered very generous position limits many times the current levels, which will be mitigated further when traders are able to net off their on-exchange and OTC positions. It might outrage market purists, but it does not seem such a huge imposition to impose some very relaxed restrictions.
More importantly, complying with position limits would have given the industry a defence against accusations of excessive speculation the next time prices rise sharply. All that will be lost if the industry’s gut hostility derails the current CFTC proposals and pushes the matter back to Congress.
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