Gensler on brink of position limits victory
U.S. Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler appears to be on verge of achieving a big victory in his battle to impose stricter position limits on major energy futures contracts.
Back in January, Gensler unveiled proposals for tough new limits on futures positions in U.S. crude, natural gas, gasoline and heating oil. Unlike previous limits set by exchanges, these would be set by the Commission itself and would aggregate all positions in econoGensler on brink of position limits victorymically equivalent futures and options for a particular commodity.
The proposals were designed to limit exemptions for firms seeking to hedge financial rather than physical exposures and largely restrict financial and physical hedgers from also running speculative positions.
Finally, the proposals contain strict new account aggregation procedures that would cumulate positions based on a minimum 10 percent equity ownership and largely end the present safe harbour for independent account controllers.
Push-back against the proposals has been fierce. The U.S. Futures Industry Association (FIA) and many major swap dealers have argued the CFTC lacks statutory authority to impose limits unless it finds they are necessary to “diminish, eliminate or prevent” the burden imposed on interstate commerce by excessive speculation.
In the absence of a finding that excessive speculation has actually occurred, which the CFTC has carefully not made, the FIA claims the CFTC has no authority to press ahead with limits. Its robust submission could be a prelude to challenge the Commission’s forthcoming decision in court.
Gensler cites the same regulation — Section 4(a) of the Commodity Exchange Act (7 USC Section 6(a).
But he emphasizes the words “shall” and “prevent” to argue Congress has given the CFTC a clear mandatory, not discretionary, instruction to set limits. It can do so to meet the threat of excessive speculation rather than waiting for evidence it has in fact occurred.
CLEAR MANDATE TO SET LIMITS
The scope of the Commission’s authority, whether it must or may set limits and whether there is an evidential trigger it has to meet first, has been the subject of a prolonged battle between the CFTC and industry lobbyists as part of the fiercely contested derivatives section (Title VII) of the Wall Street Reform and Consumer Protection Act (HR 4173).
The portion of the bill dealing with position limits has been repeatedly drafted and redrafted to make subtle changes to the Commission’s authority. The original, House-passed version added extra language to Section 4(a) to clarity that “the Commission shall … establish limits”.
It also added extra text later on to Section 4(a) to state that the Commission “shall set limits … in its discretion”. It is given this power not just to diminish, eliminate or prevent excessive speculation, or prevent corners, squeezes and market manipulation.
The Commission is expressly authorised to set limits to ensure there is sufficient liquidity for bona fide hedgers and to “ensure that the price discovery function of the underlying market is not disrupted”.
This is a much broader mandate than the Commission currently enjoys and emphasizes that Congress is giving the CFTC a lot of flexibility in deciding how to police the market most effectively.
In the Senate, the bill’s language was initially changed from “shall … establish limits” to “may … establish limits”, which is more permissive and closer to the industry’s preferred formulation.
“May” was strengthened again to “shall” in an amendment sponsored by Senate Agriculture Committee Chairman Blanche Lincoln (the derivatives industry’s bete noire). But the Senate version was silent on other objectives the Commission might take into account when setting limits, leaving the CFTC with much narrower authority.
The House-Senate conference committee has finally settled on the House line. The Commission “shall … establish limits” and it includes all the other purposes enumerated in the House bill, considerably broadening the Commission’s authority.
It is a clear victory for the CFTC chairman. The bill clearly expresses the intent of Congress that the Commission will set (aggregated) limits — not that it could do so only if it finds econometric research showing limits are necessary.
In construing a statute, the federal courts will pay great deference not only to the text but also the legislative history of the statute. If it is approved by both houses and signed into law by the president, enactment of HR 4173 should lay to rest any doubts about the CFTC’s statutory authority to press ahead with limits.
OTHER AUTHORITIES STRENGTHENED
Gensler must still win backing from a majority of his fellow commissioners to adopt the proposal sent out to consultation. From their comments in January, it appears he has the firm support of only one other commissioner (Bart Chilton), while one is opposed (Jill Sommers) and two have expressed reservations (Michael Dunn and Scott O’Malia).
Even here Gensler may have made some progress. Both Dunn and O’Malia warned about the risk of pressing ahead with limits on exchange-based positions when the CFTC could not impose limits on equivalent positions in over-the-counter (OTC) markets.
The text adopted by the conference committee makes clear the CFTC shall set aggregate limits applying not just to U.S. exchange positions but also positions held in OTC derivatives or on foreign exchanges based on the same commodity. It should go a long way to meet the reservations raised by Dunn and O’Malia in January.
In a final victory, Gensler has also secured a very strict interpretation for bona fide hedging. Until now there has been some discussion of whether swap dealers are “bona fide hedgers” when they take positions to offset commodity index positions and other total return swaps they offer to pension funds and other institutional investors wanting exposure to commodity prices.
The conference committee text resolves that question clearly. Swap dealers hedging exposure to index products and other total return swaps are not bona fide hedgers; they are risk managers who may benefit from a separate, but more limited exemption granted by the CFTC at its discretion.
The proposed statute is quite clear. Bona fide hedges must use transactions as a substitute for transactions in the physical marketing channel and be economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise.
Swap dealers may claim a bona fide hedging exemption only if their counterparty is itself eligible for a bona fide hedging exemption or if the swap dealer is offsetting physical risks. Index hedges do not count.
These financial hedgers will have to apply for a limited risk management exemption instead. Under current CFTC proposals that would be limited to twice the normal position limit in crude, gasoline, heating oil and natural gas.
Gensler may still have to reshape his position limit proposals to take account of the concerns raised by his fellow commissioners and industry comments submitted during the consultation exercise. But the final version of the derivatives legislation immeasurably strengthens his hand and should give the CFTC strong legal cover in case of any court challenge.