[Federal Register: November 27, 2007 (Volume 72, Number 227)]
[Proposed Rules]
[Page 66097-66103]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr27no07-41]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 150
RIN 3038-AC40
Risk Management Exemption From Federal Speculative Position
Limits
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: Section 150.2 of the Commodity Futures Trading Commission's
(``Commission'') regulations imposes limits on the size of speculative
positions that traders may hold or control in futures and futures
equivalent option contracts on certain designated agricultural
commodities named therein. Section 150.3 lists certain types of
positions that may be exempted from these Federal speculative position
limits. The Commission is proposing to provide an additional exemption
for ``risk management positions.'' A risk management position would be
defined as a futures or futures equivalent position, held as part of a
broadly diversified portfolio of long-only or short-only futures or
futures equivalent positions, that is based upon either: A fiduciary
obligation to match or track the results of a broadly diversified index
that includes the same commodity markets in fundamentally the same
proportions as the futures or futures equivalent position; or a
portfolio diversification plan that has, among other substantial asset
classes, an exposure to a broadly diversified index that includes the
same commodity markets in fundamentally the same proportions as the
futures or futures equivalent position. The exemption would be subject
to conditions, including that the positions must be passively managed,
must be unleveraged, and may not be carried into the spot month.
DATES: Comments must be received on or before January 28, 2008.
ADDRESSES: Comments should be submitted to David Stawick, Secretary,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581. Comments also may be sent by
facsimile to (202) 418-5521, or by electronic mail to
[email protected]. Reference should be made to ``Proposed Risk
Management Exemption from Federal Speculative Position Limits.''
Comments may also be submitted by connecting to the Federal eRulemaking
Portal at http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.regulations.gov and following comment submission
instructions.
FOR FURTHER INFORMATION CONTACT: Donald Heitman, Senior Special
Counsel, Division of Market Oversight, Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington,
DC 20581, telephone (202) 418-5041, facsimile number (202) 418-5507,
electronic mail [email protected]; or John Fenton, Director of
Surveillance, Division of Market Oversight, telephone (202) 418-5298,
facsimile number (202) 418-5507, electronic mail [email protected].
SUPPLEMENTARY INFORMATION:
[[Page 66098]]
I. Background
A. Statutory Framework
Speculative position limits have been a tool for the regulation of
the U.S. futures markets since the adoption of the Commodity Exchange
Act of 1936. Section 4a(a) of the Commodity Exchange Act (``Act''), 7
U.S.C. 6a(a), states that:
Excessive speculation in any commodity under contracts of sale
of such commodity for future delivery made on or subject to the
rules of contract markets or derivatives transaction execution
facilities causing sudden or unreasonable fluctuations or
unwarranted changes in the price of such commodity, is an undue and
unnecessary burden on interstate commerce in such commodity.
Accordingly, section 4a(a) of the Act provides the Commission with
the authority to:
Fix such limits on the amounts of trading which may be done or
positions which may be held by any person under contracts of sale of
such commodity for future delivery on or subject to the rules of any
contract market or derivatives transaction execution facility as the
Commission finds are necessary to diminish, eliminate, or prevent
such burden.
This longstanding statutory framework providing for Federal
speculative position limits was supplemented with the passage of the
Futures Trading Act of 1982, which acknowledged the role of exchanges
in setting their own speculative position limits. The 1982 legislation
also provided, under section 4a(e) of the Act, that limits set by
exchanges and approved by the Commission were subject to Commission
enforcement.
Finally, the Commodity Futures Modernization Act of 2000 (``CFMA'')
established designation criteria and core principles with which a
designated contract market (``DCM'') must comply to receive and
maintain designation. Among these, Core Principle 5 in section 5(d) of
the Act states:
Position Limitations or Accountability--To reduce the potential
threat of market manipulation or congestion, especially during
trading in the delivery month, the board of trade shall adopt
position limitations or position accountability for speculators,
where necessary and appropriate.
B. Regulatory Framework
The regulatory structure based upon these statutory provisions
consists of three elements, the levels of the speculative position
limits, certain exemptions from the limits (for hedging, spreading/
arbitrage, and other positions), and the policy on aggregating commonly
owned or controlled accounts for purposes of applying the limits. This
regulatory structure is administered under a two-pronged framework.
Under the first prong, the Commission establishes and enforces
speculative position limits for futures contracts on a limited group of
agricultural commodities. These Federal limits are enumerated in
Commission regulation 150.2, and apply to the following futures and
option markets: Chicago Board of Trade (``CBOT'') corn, oats, soybeans,
wheat, soybean oil, and soybean meal; Minneapolis Grain Exchange
(``MGE'') hard red spring wheat and white wheat; ICE Futures U.S.
(formerly the New York Board of Trade) cotton No. 2; and Kansas City
Board of Trade (``KCBOT'') hard winter wheat. Under the second prong,
individual DCMs establish and enforce their own speculative position
limits or position accountability provisions (including exemption and
aggregation rules), subject to Commission oversight and separate
authority to enforce exchange-set speculative position limits approved
by the Commission. Thus, responsibility for enforcement of speculative
position limits is shared by the Commission and the DCMs.\1\
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\1\ Provisions regarding the establishment of exchange-set
speculative position limits were originally set forth in CFTC
regulation 1.61. In 1999, the Commission simplified and reorganized
its rules by relocating the substance of regulation 1.61's
requirements to part 150 of the Commission's rules, thereby
incorporating within part 150 provisions for both Federal
speculative position limits and exchange-set speculative position
limits (see 64 FR 24038, May 5, 1999). With the passage of the
Commodity Futures Modernization Act in 2000 and the Commission's
subsequent adoption of the Part 38 regulations covering DCMs in 2001
(66 FR 42256, August 10, 2001), Part 150's approach to exchange-set
speculative position limits was incorporated as an acceptable
practice under DCM Core Principle 5--Position Limitations and
Accountability. Section 4a(e) provides that a violation of a
speculative position limit set by a Commission-approved exchange
rule is also a violation of the Act. Thus, the Commission can
enforce directly violations of exchange-set speculative position
limits as well as those provided under Commission rules.
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Commission regulation 150.3, ``Exemptions,'' lists certain types of
positions that may be exempted from (and thus may exceed) the Federal
speculative position limits. For example, under Sec. 150.3(a)(1), bona
fide hedging transactions, as defined in Sec. 1.3(z) of the
Commission's regulations, may exceed the limits. The Commission has
periodically amended the exemptive rules applicable to Federal
speculative position limits in response to changing conditions and
practices in futures markets. These amendments have included an
exemption from speculative position limits for the positions of multi-
advisor commodity pools and other similar entities that use independent
account controllers,\2\ and an amendment to extend the exemption for
positions that have a common owner but are independently controlled to
include certain commodity trading advisors.\3\ In 1987, the Commission
also issued an agency interpretation clarifying certain aspects of the
hedging definition.\4\ The Commission has also issued guidance with
respect to exchange speculative limits, including guidelines regarding
the exemption of risk-management positions from exchange-set
speculative position limits in financial futures contracts.\5\ However,
the last significant amendment to the Commission's exemptive rules was
implemented in 1991.
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\2\ 53 FR 41563 (October 24, 1988).
\3\ 56 FR 14308 (April 9, 1991).
\4\ 52 FR 27195 (July 20, 1987).
\5\ 52 FR 34633 (September 14, 1987).
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C. Changes in Trading Practices
The intervening 16 years have seen significant changes in trading
patterns and practices in derivatives markets, thus prompting the
Commission to reassess its policies regarding exemptions from the
Federal speculative position limits. These changes primarily involve
trading strategies and programs based on commodity indexes. In
particular, pension funds and other investors (including individual
investors participating in commodity index-based funds or trading
programs) have become interested in taking on commodity price exposure
as a way of diversifying portfolios that might otherwise be limited to
stocks and interest rate instruments. Financial research has shown that
the risk/return performance of a portfolio is improved by acquiring
uncorrelated or negatively correlated assets, and commodities
(including agricultural commodities) generally perform that role in a
portfolio of other financial assets.\6\
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\6\ The argument has also been made that commodities act as a
general hedge of liability obligations that are linked to inflation.
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The components of a commodity index-based investment might include
energy commodities, metals (both precious metals and industrial
metals), agricultural commodities that are subject to exchange limits
(including coffee, sugar, cocoa, and orange juice, as well as livestock
and meat), and those agricultural commodities named above that are
subject to Federal speculative position limits (grains, the soybean
complex and cotton). With respect to agricultural commodities subject
to Federal limits, the Commission has responded to various instances
where
[[Page 66099]]
index-based positions in such commodities exceed (or might grow to
exceed) the Federal speculative position limits. In certain cases, the
Commission has granted exemptive or no-action relief from Federal
speculative position limits. In granting such relief, the Commission
has included conditions to protect the market from the potential for
the sudden or unreasonable fluctuations or unwarranted changes in
prices that speculative limits are designed to prevent.
For example, in 1991, the Commission received a request from a
large commodity merchandising firm that engaged in commodity related
swaps \7\ as a part of a commercial line of business. The firm, through
an affiliate, wished to enter into an OTC swap transaction with a
qualified counterparty (a large pension fund) involving an index based
on the returns afforded by investments in exchange-traded futures
contracts on certain non-financial commodities meeting specified
criteria. The commodities making up the index included wheat, corn and
soybeans, all of which were (and still are) subject to Federal
speculative position limits. As a result of the swap, the swap dealing
firm would, in effect, be going short the index. In other words, it
would be required to make payments to the pension fund counterparty if
the value of the index was higher at the end of the swap payment period
than at the beginning. In order to hedge itself against this risk, the
swap dealer planned to establish a portfolio of long futures positions
in the commodities making up the index, in such amounts as would
replicate its exposure under the swap transaction. By design, the index
did not include contract months that had entered the delivery period
and the swap dealer, in replicating the index, stated that it would not
maintain futures positions based on index-related swap activity into
the spot month (when physical commodity markets are most vulnerable to
manipulation and attendant unreasonable price fluctuations). The result
of the hedge was that the composite return on the futures portfolio
would offset the net payments the swap dealer would be required to make
to the pension fund counterparty.
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\7\ A swap is a privately negotiated exchange of one asset or
cash flow for another asset or cash flow. In a commodity swap, at
least one of the assets or cash flows is related to the price of one
or more commodities.
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Because the futures positions the swap dealer would have to
establish to hedge its exposure on the swap transaction would be in
excess of the speculative position limits on wheat, corn and soybeans,
it requested, and was granted, a hedge exemption for those positions.
The swap transaction allowed the pension fund to add commodities
exposure to its portfolio indirectly, through the OTC trade with the
swap dealer--something it could have done directly, but only in a
limited fashion.\8\
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\8\ The pension fund would have been limited in its ability to
take on this commodities exposure directly, by putting on the long
futures position itself, because the pension fund--having no
offsetting price risk incidental to commercial cash or spot
operations--would not have qualified for a hedge exemption with
respect to the position. (See Sec. 1.3(z) of the Commission's
regulations.)
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Similar hedge exemptions were subsequently granted in other cases
where the futures positions clearly offset risks related to swaps or
similar OTC positions involving both individual commodities and
commodity indexes. These non-traditional hedges were all subject to
specific limitations to protect the marketplace from potential ill
effects. The limitations included: (1) The futures positions must
offset specific price risk; (2) the dollar value of the futures
positions would be no greater than the dollar value of the underlying
risk; and (3) the futures positions would not be carried into the spot
month.
The Commission's Division of Market Oversight (``Division'' or
``DMO'') has also recently issued two no-action letters involving
another type of index-based trading.\9\ Both cases involved trading
that offered investors the opportunity to participate in a broadly
diversified commodity index-based fund or program (``index fund''). The
futures positions of these index funds differed from the futures
positions taken by the swap dealers described above. The swap dealer
positions were taken to offset OTC swaps exposure that was directly
linked to the price of an index. For that reason, the Division granted
hedge exemptions to these swap dealer positions. On the other hand, in
the index fund positions described in the no-action letters, the price
exposure results from a promise or obligation to track an index, rather
than from holding an OTC swap position whose value is directly linked
to the price of the index. The Division believed that this difference
was significant enough that the index fund positions would not qualify
for a hedge exemption. Nevertheless, because the index fund positions
represented a legitimate and potentially useful investment strategy,
the Division granted the index funds no-action relief, subject to
certain conditions, described below, that were intended to protect the
futures markets from potential ill effects.
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\9\ CFTC Letter 06-09 (April 19, 2006); CFTC Letter 06-19
(September 6, 2006).
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II. Proposed Amendment
A. Introduction
In light of the changing trading practices and conditions described
above, the Commission is now considering whether to amend its Part 150
regulations to create a new exemption from Federal speculative position
limits. In addition to the above-described policy of granting index-
based hedge exemptions to swap dealers, which policy would remain in
effect, the proposal would create an additional risk management
exemption. That exemption would apply to positions held by: (1)
Intermediaries, such as index funds, who pass price risks on to their
customers; and (2) pension funds and other institutional investors
seeking to diversify risks in portfolios by including an allocation to
commodity exposure. As noted above, pension funds can already benefit
from a hedge exemption indirectly, by entering into an OTC position
with a swap dealer who, in turn, puts on an offsetting futures position
in reliance on the existing hedge exemption policy. The proposed rules
would allow a pension fund to receive an exemption directly, by putting
on a futures position itself pursuant to the new risk management
exemption provision.
In determining whether the new risk management exemption proposed
herein is appropriate, it is important to recall that the purpose of
position limits, as specified in Section 4a(a) of the Act, is to
diminish, eliminate, or prevent sudden or unreasonable fluctuations or
unwarranted changes in the prices of commodities. Within this
constraint, it is appropriate that the Commission (and the exchanges)
not unduly restrict trading activity. A position limit is a means to an
end, not an end in itself. Accordingly, to the extent that a type of
trading activity can be identified that is unlikely to cause sudden or
unreasonable fluctuations or unwarranted changes in prices, it is a
good candidate to qualify for an exemption from position limits.
Commodity index-based trading has characteristics that recommend it on
that score: (1) It is generally passively managed, so that positions
tend not to be changed based on market news or short-term price
volatility; (2) it is generally unleveraged, so that financial
considerations should not cause rapid liquidation of positions; and (3)
it is inherently diversified, in that futures positions are normally
held in many
[[Page 66100]]
different markets, and its purpose typically is to diversify a
portfolio containing assets with different risk profiles.
B. Conditions for the Exemption
To be eligible for an exemption as a ``risk management position''
under the proposed amendments to Part 150, a futures position would
need to comply with several conditions designed to protect the futures
markets from sudden or unreasonable fluctuations or unwarranted changes
in prices. First, Sec. 150.3(a) would be amended to add a requirement
that all positions subject to the exemptive provisions must be
``established and liquidated in an orderly manner.'' This requirement
already applies to the positions referred to in Sec. 150.3(a)(1),
which exempts bona fide hedging transactions, by virtue of similar
language appearing in the bona fide hedging definition (see Sec.
1.3(z)(1)). However, the proposed amendment would clarify that the same
requirement would apply not only to the risk management positions to be
exempted under proposed new Sec. 150.3(a)(2), but also to the spread
or arbitrage positions already exempted under current Sec. 150.3(a)(3)
and the positions carried in the separate account of an independent
account controller already exempted under current Sec. 150.3(a)(4).
Second, the proposed rules would define a ``risk management
position'' as a futures or futures equivalent position, held as part of
a broadly diversified portfolio of long-only or short-only \10\ futures
or futures equivalent \11\ positions, that is based upon either: (1) A
fiduciary obligation to match or track the results of a broadly
diversified index that includes the same commodity markets in
fundamentally the same proportions as the futures or futures equivalent
position; or (2) a portfolio diversification plan that has, among other
substantial asset classes, an exposure to a broadly diversified index
that includes the same commodity markets in fundamentally the same
proportions as the futures or futures equivalent position. The first of
these alternatives covers positions held by index funds, such as those
that were the subject of the Commission No-action letters discussed
above. The second alternative covers positions held directly by pension
funds and other institutional investors.
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\10\ The long-only or short-only qualification would limit risk
management positions to positions offsetting either a long index or
portfolio or a short index or portfolio, and thus would not allow
for spread or straddle positions. With respect to short-only
positions, it should be noted that all the applications for index-
based trading relief received by the Commission to date, whether for
hedge exemptions or no-action relief, have involved long-only
futures positions. However, the proposed rules would also provide
for an entity that might offer investors a ``bear market index.''
Such an index would require the offeror to be long opposite its
customers. It would, therefore, need to offset that exposure with
short futures positions.
\11\ For example, a long call option combined with a short put
option is equivalent to a long futures contract.
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A ``broadly diversified index'' would be defined to limit the
weighting of certain agricultural commodities in the index so that
commodities subject to Federal speculative position limits would not
comprise a disproportionate share of the index. Thus, a ``broadly
diversified index'' would mean an index based on physical commodities
in which: (1) not more than 15% of the index is composed of any single
agricultural commodity named in Sec. 150.2 (for which purposes, wheat
shall be regarded as a single commodity, so that positions in all
varieties of wheat, on all exchanges, combined, may not exceed 15% of
the index, and the soybean complex shall likewise be regarded as a
single commodity, so that positions in soybeans, soybean oil and
soybean meal, on all exchanges combined, may not exceed 15% of the
index); and (2) not more than 50% of the index as a whole is composed
of agricultural commodities named in Sec. 150.2. The Commission
believes that a narrowly based index could be used to evade speculative
position limits. For example, the grains all tend to have similar risk
profiles--i.e, they tend to respond similarly to common market factors,
such as weather. Therefore, the Commission is concerned that an index
composed, for example, of 25% each of corn, wheat, oats and soybeans--
rather than constituting a means of portfolio diversification--could
operate as a mechanism for evading speculative position limits in one
or more of those commodities.
Third, the positions subject to the exemption must be passively
managed. The proposed rules would define a ``passively managed
position'' as a futures or futures equivalent position that is part of
a portfolio that tracks a broadly diversified index, which index is
calculated, adjusted, and re-weighted pursuant to an objective,
predetermined mathematical formula the application of which allows only
limited discretion with respect to trading decisions. This definition
contemplates a certain limited amount of discretion in the manner in
which the futures position tracks the underlying index. For example,
index funds generally provide rules or standards for periodically re-
weighting the index to account for price changes in the commodities
that make up the index, or readjusting the composition of the index to
account for changing economic or market factors. Such discretion would
be permissible. However, the definition contemplates that the position
holder's discretion would not extend to frequently or arbitrarily
changing the composition of the index or the weighting of the
commodities in the index. Such actions would indicate that the position
was being actively managed with a view to taking advantage of short-
term market trends. The definition also contemplates that the position
holder could exercise some discretion as to when to roll futures
positions forward into the next delivery month without violating the
``passively managed'' requirement (provided no positions were carried
into the spot month). The Commission believes that limited discretion
as to when a position must be rolled forward can mitigate the market
impact that might otherwise result from large positions being rolled
forward on a pre-determined date and, consequently, help to avoid
liquidity problems.
Fourth, the futures trading undertaken pursuant to the exemption
must be unleveraged. An unleveraged position would be defined as a
futures or futures equivalent position that is part of a portfolio of
futures or futures equivalent positions directly relating to an
underlying broadly diversified index, the notional value of which
positions does not exceed the sum of the value of: (1) Cash set aside
in an identifiable manner, or unencumbered short-term U.S. Treasury
obligations so set aside, plus any funds deposited as margin on such
position; and (2) accrued profits on such position held at the futures
commission merchant. Because the futures positions would be fully
offset by cash or profits on such positions, financial considerations
(e.g., significant price changes) should not cause rapid liquidation of
positions, which can cause sudden or unreasonable fluctuations or
unwarranted changes in prices.
Finally, positions may not be carried into the spot month, a period
during which physical commodity markets are particularly vulnerable to
manipulations, squeezes and sudden or unreasonable fluctuations or
unwarranted changes in prices.
Entities intending to hold risk management positions pursuant to
the exemption in Sec. 150.3(a)(2) would be required to apply to the
Commission and receive Commission approval in order to receive an
exemption. The applicant would be required to provide the following
information:
[[Page 66101]]
Application for a Risk Management Exemption as Defined in Sec.
150.1(j)
1. Initial application materials:
A. For an exemption related to a ``fiduciary obligation''.
A description of the underlying index or group of
commodities, including the commodities, the weightings, the method and
timing of re-weightings, the selection of futures months, and the
timing and criteria for rolling from one futures month to another;
A description of the ``fiduciary obligation;''
The actual or anticipated value of the underlying funds to
be invested in commodities within the next fiscal or calendar year and
the method for calculating that value, as well as the equivalent
numbers of futures contracts in each of the Sec. 150.2 markets for
which the exemption is sought;
A description of the manner in which the funds to be
invested in commodities will be set aside;
A statement certifying that the requirements of this
exemption are met and will be observed at all times going forward and
that the Commission will be notified promptly of any material changes
in this information; and
Such other information as the Commission may request.
B. For an exemption based upon a ``portfolio diversification
plan''.
A description of the investment index or group of
commodities, including the commodities, the weightings, the method and
timing of re-weightings, the selection of futures months, and the
timing and criteria for rolling from one futures month to another;
A description of the entire portfolio, including the total
size of the assets, the asset classes making up the portfolio, and a
description of the allocation among the asset classes;
The actual or anticipated value of the underlying funds to
be invested in commodities and the method for calculating that value,
as well as the equivalent numbers of futures contracts in each of the
Sec. 150.2 markets for which the exemption is sought;
A description of the manner in which the funds to be
invested in commodities will be set aside;
A statement certifying that the requirements of this
exemption are met and will be observed at all times going forward and
that the Commission will be notified promptly of any material changes
in this information; and
Such other information as the Commission may request.
2. Supplemental Material: Whenever the purchases or sales that a
person wishes to qualify under this risk management exemption shall
exceed the amount provided in the person's most recent filing pursuant
to this section, or the amount previously specified by the Commission
pursuant to this section, such person shall file with the Commission a
statement that updates the information provided in the person's most
recent filing and provides the reasons for this change. Such statement
shall be filed at least ten business days in advance of the date that
such person wishes to exceed those amounts and if the notice filer is
not notified otherwise by the Commission within the 10-day period, the
exemption will continue to be effective. The Commission may, upon call,
obtain such additional materials from the applicant or person availing
themselves of this exemption as the Commission deems necessary to
exercise due diligence with respect to granting and monitoring this
exemption.
Entities holding risk management positions pursuant to the
exemption in Sec. 150.3(a)(2) would also be required to immediately
report to the Commission in the event they know, or have reason to
know,\12\ that any person holds a greater than 25% interest in such
position. The reason for this requirement is to alert the Commission to
the possibility that an individual might be attempting to use the
exemption as a means of avoiding otherwise applicable speculative
position limits.
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\12\ The Commission understands that not every entity that might
qualify for this exemption would necessarily know the identities of
all of the participants in the position. For example, a fund based
on a commodity index may qualify for the exemption but the entity
operating the fund may not know the identities of the owners of
outstanding shares and, therefore, may not know when any given
person had acquired a 25% or more interest in the position held by
the fund.
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C. Questions
The Commission would welcome public comments on any aspect of the
proposed risk management exemption from Federal speculative position
limits. However, the Commission is particularly interested in the views
of commenters on the following specific questions:
(1) Are any of the proposed conditions for receiving a risk
management exemption unnecessary and, if so, why? Alternatively, should
any of the proposed conditions be modified and, if so, why?
(2) Should any other conditions, in addition to those set out in
these proposed rules, be imposed as a prerequisite for receiving a risk
management exemption? If so, what is the rationale for such additional
conditions (i.e., what potential harm would they address)?
(3) Is there any type of index-based trading that should be covered
by the proposed rules, but is not? If so, how should the proposed rules
be revised to apply to such trading?
(4) The proposed rules would allow for a risk management exemption
in the case of short-only futures or futures equivalent positions used
to manage risks in connection with a ``bear market index.'' Would any
of the exemptive rules, as proposed, create potential problems as
applied to such an index? For example, in applying the definition of
``unleveraged position,'' would problems be encountered in comparing
the notional value of an unleveraged short futures position to the
value of the cash, margins and accrued profits on such position?
(5) Should the proposed rules impose any restrictions or conditions
regarding how broad- or narrow-based an index should be if a position
based on the index is to qualify for an exemption? For example, with
respect to narrow-based indices reflecting specific industry or
commodity sectors, should the Commission be concerned that a narrow-
based index composed entirely of agricultural commodities--for example,
25% each of corn, wheat, oats and soybeans--could operate as a
mechanism for evading speculative position limits in one or more of
those commodities?
(6) The proposed rules list the information that must be provided
in an application for a risk management exemption. Are the requirements
set out in the proposed rules appropriate? Should the requirements be
revised and, if so, how?
III. Related Matters
A. Cost Benefit Analysis
Section 15(a) of the Act requires the Commission to consider the
costs and benefits of its action before issuing a new regulation under
the Act. By its terms, section 15(a) does not require the Commission to
quantify the costs and benefits of a new regulation or to determine
whether the benefits of the proposed regulation outweigh its costs.
Rather, section 15(a) requires the Commission to ``consider the costs
and benefits'' of the subject rule.
Section 15(a) further specifies that the costs and benefits of the
proposed rule shall be evaluated in light of five broad areas of market
and public concern: (1) Protection of market participants and the
public; (2) efficiency, competitiveness, and financial integrity of
futures markets; (3) price discovery;
[[Page 66102]]
(4) sound risk management practices; and (5) other public interest
considerations. The Commission may, in its discretion, give greater
weight to any one of the five enumerated areas of concern and may, in
its discretion, determine that, notwithstanding its costs, a particular
rule is necessary or appropriate to protect the public interest or to
effectuate any of the provisions or to accomplish any of the purposes
of the Act.
The proposed rules would provide for a risk management exemption
from the Federal speculative position limits applicable to certain
agricultural commodities, thus giving entities such as index funds and
pension funds an opportunity to more effectively manage risks for their
investors through greater diversification of their portfolios. The
rules would seek to protect the futures markets from potential ill
effects of such risk management positions by imposing conditions on the
exemption and creating an application process (including a requirement
to file updates as necessary) to assure those conditions are met. The
Commission, in proposing these rules, has endeavored to impose the
minimum requirements necessary consistent with its mandate to protect
the markets and the public from ill effects.
The Commission specifically invites public comment on its
application of the cost benefits criteria of the Act. Commenters are
also invited to submit any quantifiable data that they may have
concerning the costs and benefits of the proposed rules with their
comment letter.
B. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq.,
requires Federal agencies, in proposing rules, to consider the impact
of those rules on small businesses. The Commission believes that the
proposed rule amendments to implement a new exemption from Federal
speculative position limits would only affect large traders. The
Commission has previously determined that large traders are not small
entities for the purposes of the RFA.\13\ Therefore, the Chairman, on
behalf of the Commission, hereby certifies, pursuant to 5 U.S.C.
605(b), that the action taken herein will not have a significant
economic impact on a substantial number of small entities.
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\13\ 47 FR 18618 (April 30, 1982).
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C. Paperwork Reduction Act
When publishing proposed rules, the Paperwork Reduction Act of 1995
(44 U.S.C. 3507(d)) imposes certain requirements on Federal agencies
(including the Commission) in connection with their conducting or
sponsoring any collection of information as defined by the Paperwork
Reduction Act. In compliance with the Act, the Commission, through this
rule proposal, solicits comment to: (1) Evaluate whether the proposed
collection of information is necessary for the proper performance of
the functions of the agency, including the validity of the methodology
and assumptions used; (2) evaluate the accuracy of the agency's
estimate of the burden of the proposed collection of information
including the validity of the methodology and assumptions used; (3)
enhance the quality, utility and clarity of the information to be
collected; and (4) minimize the burden of the collection of the
information on those who are to respond through the use of appropriate
automated, electronic, mechanical, or other technological collection
techniques or other forms of information technology, e.g., permitting
electronic submission of responses.
The Commission has submitted the proposed rule and its associated
information collection requirements to the Office of Management and
Budget (``OMB'') for its review.
Collection of Information: Rules Establishing Risk Management
Exemption From Federal Speculative Position Limits, OMB Control Number.
The estimated burden was calculated as follows:
Estimated number of respondents: 6.
Annual responses by each respondent: 1.
Total annual responses: 6.
Estimated average hours per response: 10.
Annual reporting burden: 60 hours.
List of Subjects in 17 CFR Part 150
Agricultural commodities, Bona fide hedge positions, Position
limits, Spread exemptions.
In consideration of the foregoing, pursuant to the authority
contained in the Commodity Exchange Act, the Commission hereby proposes
to amend part 150 of chapter I of title 17 of the Code of Federal
Regulations as follows:
PART 150--LIMITS ON POSITIONS
1. The authority citation for part 150 is revised to read as
follows:
Authority: 7 U.S.C. 6a, 6c, and 12a(5), as amended by the
Commodity Futures Modernization Act of 2000, Appendix E of Pub. L.
106-554, 114 Stat. 2763 (2000).
2. Section 150.1 is amended by adding new paragraphs (j) through
(m) to read as follows:
Sec. 150.1 Definitions.
* * * * *
(j) Risk management position, for the purposes of an exemption
under Sec. 150.3(a)(2), means a futures or futures equivalent
position, held as part of a broadly diversified portfolio of long-only
or short-only futures or futures equivalent positions, that is based
upon either:
(1) A fiduciary obligation to match or track the results of a
broadly diversified index that includes the same commodity markets in
fundamentally the same proportions as the futures or futures equivalent
position; or
(2) A portfolio diversification plan that has, among other
substantial asset classes, an exposure to a broadly diversified index
that includes the same commodity markets in fundamentally the same
proportions as the futures or futures equivalent position.
(k) Broadly diversified index means an index based on physical
commodities in which:
(1) Not more than 15% of the index is composed of any single
agricultural commodity named in Sec. 150.2 (for which purposes, wheat
shall be regarded as a single commodity, so that positions in all
varieties of wheat, on all exchanges combined, may not exceed 15% of
the index, and the soybean complex shall be regarded as a single
commodity, so that positions in soybeans, soybean oil and soybean meal,
on all exchanges combined, may not exceed 15% of the index); and
(2) Not more than 50% of the index as a whole is composed of
agricultural commodities named in Sec. 150.2.
(l) Passively managed position means a futures or futures
equivalent position that is part of a portfolio that tracks a broadly
diversified index, which index is calculated, adjusted, and re-weighted
pursuant to an objective, predetermined mathematical formula the
application of which allows only limited discretion with respect to
trading decisions.
(m) Unleveraged position means:
(1) A futures or futures equivalent position that is part of a
portfolio of futures or futures equivalent positions directly relating
to an underlying broadly diversified index, the notional value of which
positions does not exceed the sum of the value of:
(i) Cash set aside in an identifiable manner, or unencumbered
short-term U.S. Treasury obligations so set aside, plus any funds
deposited as margin on such position; and
[[Page 66103]]
(ii) Accrued profits on such position held at the futures
commission merchant.
(2) [Reserved]
3. Section 150.3 is amended by revising paragraph (a) introductory
text, adding a new paragraph (a)(2), and adding a new paragraph (c) to
read as follows:
Sec. 150.3 Exemptions.
(a) Positions which may exceed limits. The position limits set
forth in Sec. 150.2 of this part may be exceeded to the extent such
positions are established and liquidated in an orderly manner and are:
* * * * *
(2) Risk management positions, as defined in Sec. 150.1(j), that
fulfill the following requirements:
(i) Such risk management positions must comply with the following
conditions:
(A) The positions must be passively managed;
(B) The positions must be unleveraged; and
(C) The positions must not be carried into the spot month.
(ii) Entities intending to hold risk management positions pursuant
to the exemption in Sec. 150.3(a)(2) must apply to the Commission and
receive Commission approval. Such applications must include the
following information:
(A) In the case of an exemption based on a fiduciary obligation, as
described in Sec. 150.1(j)(1), an application must include:
(1) A description of the underlying index or group of commodities,
including the commodities, the weightings, the method and timing of re-
weightings, the selection of futures months, and the timing and
criteria for rolling from one futures month to another;
(2) A description of the ``fiduciary obligation;''
(3) The actual or anticipated value of the underlying funds to be
invested in commodities within the next fiscal or calendar year and the
method for calculating that value, as well as the equivalent numbers of
futures contracts in each of the Sec. 150.2 markets for which the
exemption is sought;
(4) A description of the manner in which the funds to be invested
in commodities will be set aside;
(5) A statement certifying that the requirements of this exemption
are met and will be observed at all times going forward and that the
Commission will be notified promptly of any material changes in this
information; and
(6) Such other information as the Commission may request.
(B) In the case of an exemption based on a portfolio
diversification plan, as described in Sec. 150.1(j)(2), an application
must include:
(1) A description of the investment index or group of commodities,
including the commodities, the weightings, the method and timing of re-
weightings, the selection of futures months, and the timing and
criteria for rolling from one futures month to another;
(2) A description of the entire portfolio, including the total size
of the assets, the asset classes making up the portfolio, and a
description of the allocation among the asset classes;
(3) The actual or anticipated value of the underlying funds to be
invested in commodities and the method for calculating that value, as
well as the equivalent numbers of futures contracts in each of the
Sec. 150.2 markets for which the exemption is sought;
(4) A description of the manner in which the funds to be invested
in commodities will be set aside;
(5) A statement certifying that the requirements of this exemption
are met and will be observed at all times going forward and that the
Commission will be notified promptly of any material changes in this
information; and
(6) Such other information as the Commission may request.
(iii) Whenever the purchases or sales that a person wishes to
qualify under this risk management exemption shall exceed the amount
provided in the person's most recent filing pursuant to this section,
or the amount previously specified by the Commission pursuant to this
section, such person shall file with the Commission a statement that
updates the information provided in the person's most recent filing and
provides the reasons for this change. Such statement shall be filed at
least ten business days in advance of the date that such person wishes
to exceed those amounts and if the notice filer is not notified
otherwise by the Commission within the 10-day period, the exemption
will continue to be effective. The Commission may, upon call, obtain
such additional materials from the applicant or person availing
themselves of this exemption as the Commission deems necessary to
exercise due diligence with respect to granting and monitoring this
exemption.
(iv) Entities holding risk management positions pursuant to the
exemption in Sec. 150.3(a)(2) shall immediately report to the
Commission in the event that they know, or have reason to know, that
any person holds a greater than 25% interest in such position.
* * * * *
(c) The Commission hereby delegates, until such time as the
Commission orders otherwise, to the Director of the Division of Market
Oversight, or the Director's designee, the functions reserved to the
Commission in Sec. 150.3(a)(2) of this chapter.
Issued by the Commission this 20th day of November, 2007, in
Washington, DC.
David Stawick,
Secretary of the Commission.
[FR Doc. E7-22992 Filed 11-26-07; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: November 27, 2007