COLUMN-What’s in a word? Senate battle on derivatives: John Kemp

May 10, 2010

— John Kemp is a Reuters market analyst. The views expressed are his own —

By John Kemp

LONDON, May 10 (Reuters) – May or shall. Even one small word can make a big difference. Lobbyists for financial services firms and officials from the Commodity Futures Trading Commission (CFTC) and the U.S. Treasury are sparring over a single word in the derivatives reform legislation being considered by the U.S. Senate.

At issue is the Commission’s authority to impose position limits on major energy contracts.

The Commission believes it has all the authority it needs to impose limits on exchange-traded energy contracts under Section 4a of the Commodity Exchange Act. It is currently asking Congress to extend that authority to over-the-counter (OTC) markets and derivatives traded on foreign exchanges so it can impose aggregated limits.

By contrast, industry representatives insist the Commission cannot act because it has made no factual finding that limits are “necessary” to diminish, eliminate or prevent speculation — or even that excessive speculation is a real threat to big and liquid energy markets.

The industry has asked the CFTC to postpone further rule-making until the outcome of the congressional debate is known.

In the meantime, both sides are struggling to change the text of derivatives legislation before Congress in a bid to boost their argument before the Commission takes a final vote, and ahead of any court challenge.


The version passed by the House of Representatives in December 2009 (HR 4173) adds extra language to Section 4a to clarify that:

“the Commission shall by rule, regulation, or order establish limits on the amount of positions, as appropriate, other than bona fide hedge positions, that may be held by any person with respect to contracts of sale for future delivery or with respect to options on the contracts or commodities traded on or subject to the rules of a designated contract market”.

Use of the word “shall” seems to back the Commission’s argument that it has been given a direct instruction by Congress to impose limits. It is not conditional on any fact-finding exercise to prove the threat of excessive speculation is real rather than theoretical.

It gets more support later on, when the text says the Commission “shall set limits … in its discretion”. It is given this power to diminish, eliminate or prevent excessive speculation; deter and prevent corners, squeezes and market manipulation; ensure sufficient liquidity for hedgers; and ensure the market’s price discovery function is not disrupted.

This is a much broader mandate than the Commission currently enjoys and emphasises that Congress is giving the CFTC a lot of flexibility in deciding how to police the market most effectively.


The Senate’s version has undergone a more tortured evolution and remains the subject of fierce lobbying.

The original bill, promoted by Senate Banking Committee Chairman Chris Dodd (S 3217) and reported out of his committee last month, used a weaker formulation: “the Commission may, by rule or regulation, establish limits (including related hedge exemption provisions) on the aggregate number or amount of positions”.

The change from “shall” to “may” is permissive. The Commission can, but need not, impose limits.

This reading does not say whether or not the CFTC must make a necessity finding. But it does suggest the Commission has considerable discretion. Any court reviewing its decision would expect the CFTC to exercise that discretion reasonably and might require it to show necessity before imposing limits.

Dodd’s original bill is much closer to the industry’s viewpoint and shows the impact of fierce lobbying efforts.

The Senate Banking Committee report accompanying the bill confirms this interpretation. “Section 724 Position Limits … authorises the CFTC to establish aggregate position limits”. Note the wording: it authorises but does not compel the CFTC to set limits.

In any litigation, the courts would take the report into account as an indication of what Congress intended when interpreting the law.


But the original Dodd language marked only the beginning. A tug-of-war has broken out as the bill is repeatedly amended on the floor. A flurry of amendments have changed the word from “may” to “shall” and back again.

In an initial amendment proposed by Dodd himself to incorporate the tougher derivatives language drafted by Senator Blanche Lincoln’s Agriculture Committee the instruction was changed back to “shall”: “the Commission shall, by rule or regulation, establish limits”.

A subsequent amendment proposed by Senator Barbara Boxer (D, California) confirmed the “shall” instruction. It was approved by the full Senate by a huge margin of 96-1 on May 5 (Roll Call 130).

That was not the end of the complicated dancing, however. Senator Richard Shelby, the senior Republican on the Banking Committee and the party’s lead negotiator on financial reform, subsequently promoted his own amendment switching the language back to “may”.

Shelby’s amendment was co-sponsored by Dodd. It too was approved by the Senate by a lopsided margin of 93-5 the same day (Roll Call 131).

In the space of a few hours, the Senate voted 96-1 to tell the Commission it “shall” impose limits, and by 93-5 to tell the Commission it “may” do so.


Both were part of comprehensive amendments making other changes, so the inconsistency is not completely surprising. Nonetheless, it shows how fluid the negotiations have become and how much effort is being expended by both sides to control the wording.

For the time being, the Shelby amendment “may” prevails. Unless there is yet another amendment, it is the language the full Senate will eventually be asked to approve when the bill comes to a final vote on the Senate floor.

But it will still have to be reconciled in conference committee with the language in the final House bill which says limits “shall” be imposed.

Meanwhile, the Senate is grinding its way through more than 150 amendments to the bill. Less than a dozen have so far been considered.

The function of most remains obscure. They are “place markers”, allowing interested senators to file amendments later on behalf of interested parties. The purpose will be revealed if and when they are proposed for consideration.

So the switchback ride is set to continue — may versus shall — all the way to the House-Senate conference.

In the end, it may not be decisive. The Commission believes it already has sufficient power under the existing language of Section 4a to go ahead and impose limits, while the industry disagrees.

But both sides clearly think the issue is sufficiently important that they are expending considerable effort to alter the bill’s language back and forth.

(Editing by Keiron Henderson)

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