2020-25332
Federal Register, Volume 86 Issue 9 (Thursday, January 14, 2021)
[Federal Register Volume 86, Number 9 (Thursday, January 14, 2021)]
[Rules and Regulations]
[Pages 3236-3493]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-25332]
[[Page 3235]]
Vol. 86
Thursday,
No. 9
January 14, 2021
Part II
Commodity Futures Trading Commission
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17 CFR Parts 1, 15, 17, et al.
Position Limits for Derivatives; Final Rule
Federal Register / Vol. 86, No. 9 / Thursday, January 14, 2021 /
Rules and Regulations
[[Page 3236]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 15, 17, 19, 40, 140, 150 and 151
RIN 3038-AD99
Position Limits for Derivatives
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is adopting amendments in this final rule (``Final Rule'') to
conform regulations concerning speculative position limits to the
relevant Wall Street Transparency and Accountability Act of 2010
(``Dodd-Frank Act'') amendments to the Commodity Exchange Act
(``CEA''). Among other regulatory amendments, the Commission is
adopting: New and amended Federal spot-month limits for 25 physical
commodity derivatives; amended single month and all-months-combined
limits for most of the agricultural contracts currently subject to
Federal position limits; new and amended definitions for use throughout
the position limits regulations, including a revised definition of
``bona fide hedging transaction or position'' and a new definition of
``economically equivalent swaps''; amended rules governing exchange-set
limit levels and grants of exemptions therefrom; a new streamlined
process for bona fide hedging recognitions for purposes of Federal
position limits; new enumerated bona fide hedges; and amendments to
certain regulatory provisions that would eliminate Form 204 while also
enabling the Commission to leverage and receive cash-market reporting
submitted directly to the exchanges by market participants.
DATES:
Effective date: This Final Rule will become effective on March 15,
2021.
Compliance date: Compliance dates for this Final Rule shall be as
follows:
January 1, 2022 in connection with the Federal speculative
position limits for the 16 non-legacy core referenced futures contracts
subject to Federal position limits for the first time under this Final
Rule. This compliance date also applies to any associated referenced
contracts other than economically equivalent swaps. Such swaps are
subject to a separate compliance date noted below.
January 1, 2022 in connection with an exchange's
requirements under Sec. 150.5, as adopted in this Final Rule.
January 1, 2023 in connection with Federal speculative
position limits for economically equivalent swaps, as defined under
this Final Rule.
January 1, 2023 in connection with the elimination of
previously-granted risk management exemptions described in Sec.
150.3(c), as adopted in this Final Rule.
FOR FURTHER INFORMATION CONTACT: Dorothy DeWitt, Director, (202) 418-
6057, [email protected]; Rachel Reicher, Chief Counsel, (202) 418-6233,
[email protected]; Steven A. Haidar, Assistant Chief Counsel, (202)
418-5611, [email protected]; Aaron Brodsky, Senior Special Counsel,
(202) 418-5349, [email protected]; Steven Benton, Industry Economist,
(202) 418-5617, [email protected]; Lillian Cardona, Assistant Chief
Counsel, (202) 418-5012, [email protected]; Jeanette Curtis, Assistant
Chief Counsel, (202) 418-5669, [email protected]; Harold Hild, Policy
Advisor, (202) 418-5376, [email protected]; Division of Market Oversight,
in each case, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581; Michael Ehrstein,
Special Counsel, (202) 418-5957, [email protected]; Chang Jung,
Special Counsel, (202) 418-5202, [email protected]; Division of Swap
Dealer and Intermediary Oversight, in each case, Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street NW,
Washington, DC 20581; Rachel Hayes, Trial Attorney, (816) 960-7741,
[email protected]; Division of Enforcement, Commodity Futures Trading
Commission, 4900 Main Street, Suite 500, Kansas City, MO 64112; or
Brigitte Weyls, Trial Attorney, (312) 596-0547, [email protected];
Division of Enforcement, Commodity Futures Trading Commission, 525 West
Monroe Street, Suite 1100, Chicago, IL 60661.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Introduction
B. Executive Summary
C. Section-by-Section Summary of Final Rule
D. Effective Date and Compliance Period
E. The Commission Construes CEA Section 4a(a) To Require the
Commission To Make a Necessity Finding Before Establishing Position
Limits for Physical Commodities Other Than Excluded Commodities
F. The Commission's Use of Certain Terminology
G. Recent Volatility in the WTI Contract
H. Brief Summary of Comments Received
II. Final Rule
A. Sec. 150.1--Definitions
B. Sec. 150.2--Federal Position Limit Levels
C. Sec. 150.3--Exemptions From Federal Position Limits
D. Sec. 150.5--Exchange-Set Position Limits and Exemptions
Therefrom
E. Sec. 150.6--Scope
F. Sec. 150.8--Severability
G. Sec. 150.9--Process for Recognizing Non-Enumerated Bona Fide
Hedging Transactions or Positions With Respect to Federal
Speculative Position Limits
H. Part 19 and Related Provisions--Reporting of Cash-Market
Positions
I. Removal of Part 151
III. Legal Matters
A. Interpretation of Statute Regarding Whether Necessity Finding
Is Required for Position Limits Established Pursuant to CEA 4a(a)(2)
B. Legal Standard for Necessity Finding
C. Necessity Finding as to the 25 Core Referenced Futures
Contracts
D. Necessity Finding as to Linked Contracts
E. Necessity Finding for Spot/Non-Spot Month Position Limits
IV. Related Matters
A. Cost-Benefit Considerations
B. Paperwork Reduction Act
C. Regulatory Flexibility Act
D. Antitrust Considerations
I. Background
A. Introduction
The Commission has long established and enforced speculative
position limits for futures contracts and options on futures contracts
on nine agricultural commodities as authorized by the CEA.\1\ These
nine agricultural commodity contracts, which have been subject to
Federal position limits for decades, are generally referred to as the
``nine legacy agricultural contracts.'' Under this Final Rule, the
Commission additionally will establish Federal speculative position
limits for certain commodity derivatives contracts associated with 16
additional commodities. The Commission refers to these 16 new
commodities and their associated commodity derivatives contracts
throughout this release as the ``non-legacy'' contracts since they are
subject to Federal position limits for the first time under this Final
Rule. Accordingly, under the Final Rule, certain commodity derivatives
contracts associated with 25 commodities are subject to Federal
position limits.
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\1\ 7 U.S.C. 1 et seq.
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The Commission's existing position limits regulations \2\ in
existing part 150
[[Page 3237]]
of the Commission's regulations include three components:
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\2\ 17 CFR part 150. Part 150 of the Commission's regulations
establishes Federal position limits (that is, position limits
established by the Commission) on the nine legacy agricultural
contracts. The nine legacy agricultural contracts are: CBOT Corn
(and Mini-Corn) (C), CBOT Oats (O), CBOT Soybeans (and Mini-
Soybeans) (S), CBOT Wheat (and Mini-Wheat) (W), CBOT Soybean Oil
(SO), CBOT Soybean Meal (SM), MGEX Hard Red Spring Wheat (MWE), CBOT
KC Hard Red Winter Wheat (KW), and ICE Cotton No. 2 (CT). See 17 CFR
150.2. The Federal position limits on these agricultural contracts
are referred to as ``legacy'' limits because these contracts have
been subject to Federal position limits for decades.
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First, the Commission's existing regulations establish separate
position limit levels for each of the nine legacy agricultural
contracts. These Federal position limit levels set the maximum
speculative positions in each of the nine legacy agricultural contracts
that a person may hold in the spot month, individual month, and all-
months-combined.\3\
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\3\ See 17 CFR 150.2.
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Second, the existing Federal position limits framework provides
exemptions to the Federal position limit levels for positions that
constitute ``bona fide hedging transactions or positions'' and for
certain ``spread or arbitrage'' positions.\4\
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\4\ See 17 CFR 150.3.
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Third, the Commission's existing regulations determine which
accounts and positions a person must aggregate for the purpose of
determining compliance with the Federal position limit levels.\5\
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\5\ See 17 CFR 150.4.
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The existing Federal speculative position limits function in
parallel to exchange-set position limits and/or exchange-set position
accountability required by designated contract market (``DCM'') Core
Principle 5.\6\ As a result, the nine legacy agricultural contracts are
subject to both Federal and exchange-set limits, whereas other
exchange-traded futures contracts and options on futures contracts are
subject only to DCM-set limits and/or position accountability.
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\6\ 7 U.S.C. 7(d)(5); 17 CFR 38.300. Paragraph (A) of DCM Core
Principle 5 provides: To reduce the potential threat of market
manipulation or congestion (especially during trading in the
delivery month), the board of trade shall adopt for each contract of
the board of trade, as is necessary and appropriate, position
limitations or position accountability for speculators. Position
limits generally cannot be exceeded absent an exemption, whereas
position accountability allows an exchange to establish a level at
which market participants, including those participants who do not
qualify for an exemption, are required to: Provide position
information to the exchange prior to increasing a position above the
accountability level; halt further position increases; and/or reduce
positions in an orderly manner. Core Principle 6 in part 37 of the
Commission's regulations for swap execution facilities (``SEFs'')
contains similar language. 17 CFR 38.600.
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As part of the Dodd-Frank Act, Congress amended the CEA's position
limits provisions, which since 1936 have authorized the Commission (and
its predecessor) to impose limits on speculative positions to prevent
the harms caused by excessive speculation. As discussed below, the
Commission interprets these amendments as, among other things, tasking
the Commission with establishing such position limits as it finds are
``necessary'' for the purpose of ``diminishing, eliminating, or
preventing'' excessive speculation causing sudden or unreasonable
fluctuations or unwarranted changes in the price of such commodity.\7\
The Commission also interprets these amendments as tasking the
Commission with establishing position limits on any ``economically
equivalent'' swaps.\8\
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\7\ 7 U.S.C. 6a(a)(1); see infra Section III.C. (discussion of
the necessity finding).
\8\ 7 U.S.C. 6a(a)(5); see also infra Section II.B.1.iii.
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The Commission previously issued proposed and final rules in 2011
(``2011 Final Rulemaking'') to implement the provisions of the Dodd-
Frank Act regarding position limits and the bona fide hedge
definition.\9\ A September 28, 2012 order of the U.S. District Court
for the District of Columbia vacated the 2011 Final Rulemaking, with
the exception of the rule's amendments to 17 CFR 150.2.\10\
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\9\ Position Limits for Derivatives, 76 FR 4752 (Jan. 26, 2011)
(``2011 Proposal''); Position Limits for Futures and Swaps, 76 FR
71626 (Nov. 18, 2011) (``2011 Final Rulemaking'').
\10\ Int'l Swaps & Derivatives Ass'n v. U.S. Commodity Futures
Trading Comm'n, 887 F. Supp. 2d 259 (D.D.C. 2012) (``ISDA'').
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Subsequently, the Commission proposed position limits regulations
in 2013 (``2013 Proposal''), in June of 2016 (``2016 Supplemental
Proposal''), and again in December of 2016 (``2016 Reproposal'').\11\
The 2016 Reproposal would have amended part 150 of the Commission's
regulations to, among other things: Establish Federal position limits
for 25 physical commodity futures contracts and their linked futures
contracts, options on futures contracts, and ``economically
equivalent'' swaps; revise the existing exemptions from such limits,
including for bona fide hedges; and establish a framework for exchanges
\12\ to recognize certain positions as bona fide hedges and thus exempt
from position limits.
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\11\ Position Limits for Derivatives, 78 FR 75680 (Dec. 12,
2013) (``2013 Proposal''); Position Limits for Derivatives: Certain
Exemptions and Guidance, 81 FR 38458 (June 13, 2016) (``2016
Supplemental Proposal''); and Position Limits for Derivatives, 81 FR
96704 (Dec. 30, 2016) (``2016 Reproposal'').
\12\ Unless indicated otherwise, the use of the term
``exchanges'' throughout this release refers to DCMs and SEFs.
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To date, the Commission has not issued any final rulemaking based
on the 2013 Proposal, 2016 Supplemental Proposal, or 2016 Reproposal.
The 2016 Reproposal generally addressed comments received in response
to the 2013 Proposal and the 2016 Supplemental Proposal. In a separate
2016 proposed rulemaking, the CFTC also proposed, and later adopted in
2016, amendments to rules in Sec. 150.4 of the Commission's
regulations governing aggregation of positions for purposes of
compliance with Federal position limits.\13\ These aggregation rules
currently apply only to the nine legacy agricultural contracts subject
to existing Federal position limits. Going forward, these aggregation
rules will apply to all commodity derivative contracts that are subject
to Federal position limits under this Final Rule.
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\13\ Aggregation of Positions, 81 FR 91454 (Dec. 16, 2016)
(``Final Aggregation Rulemaking''); see 17 CFR 150.4. Under the
Final Aggregation Rulemaking, unless an exemption applies, a
person's positions must be aggregated with positions for which the
person controls trading or for which the person holds a 10% or
greater ownership interest. The Division of Market Oversight has
issued time-limited no-action relief from some of the aggregation
requirements contained in that rulemaking. See CFTC Letter No. 19-19
(July 31, 2019), available at https://www.cftc.gov/csl/19-19/download.
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The Commission published a notice of a proposed rulemaking in the
Federal Register on February 27, 2020 for a new position limits
proposal (``2020 NPRM''). After reconsidering the prior proposals,
including reviewing the comments responding thereto, the Commission in
the 2020 NPRM withdrew from further consideration the 2013 Proposal,
the 2016 Supplemental Proposal, and the 2016 Reproposal.\14\
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\14\ Because the earlier proposals were withdrawn in the 2020
NPRM, comments on the earlier proposals are not part of the
administrative record with respect to the 2020 NPRM nor with respect
to this Final Rule, except where expressly referenced herein. In the
2020 NPRM, the Commission stated that commenters to the 2016
Reproposal should resubmit comments relevant to the subject
proposal; commenters who wish to reference prior comment letters
should cite those prior comment letters as specifically as possible.
(85 FR at 11597). Accordingly, this Final Rule will not discuss
comments submitted in connection with the 2016 Reproposal unless
such comments were resubmitted for the 2020 NPRM.
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In the 2020 NPRM, the Commission intended to: (1) Recognize
differences across commodities and contracts, including differences in
commercial hedging and cash-market reporting practices; (2) focus on
commodity derivative contracts that are critical to price discovery and
distribution of the underlying commodities such that the burden of
excessive speculation in the commodity derivative contracts may have a
particularly acute impact on interstate commerce for the underling
commodities; and (3) reduce duplication and inefficiency by leveraging
existing expertise and processes at DCMs.
The public comment period for the 2020 NPRM ended May 15, 2020,\15\
and
[[Page 3238]]
the Commission received approximately 75 public comment letters.\16\
After reviewing these public comment letters, and for the general
reasons discussed in this release, the Commission is adopting the 2020
NPRM with certain modifications in this Final Rule.\17\
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\15\ Comments were originally due by April 29, 2020. Due to the
COVID-19 pandemic, the Commission extended the deadline to May 15,
2020.
\16\ The Commission states ``approximately 75 relevant comment
letters'' since several commenters submitted additional, or
supplemental, comments. As a result, the total could change slightly
depending on whether one includes these supplemental comment letters
in the total. Thus, for the avoidance of doubt, the Commission uses
``approximately.'' The Commission received comments from: American
Cotton Shippers Association (``ACSA''); American Feed Industry
Association (``AFIA''); American Gas Association (``AGA''); AQR
Capital Management, LLC (``AQR''); Archer Daniels Midland (``ADM'');
AMCOT; Americans for Financial Reform (``AFR''); Arthur Dunavant
Investments (``Dunavant''); ASR Group International, Inc. (``ASR'');
Atlantic Cotton Association (``ACA''); Barnard, Chris (Individual);
Better Markets, Inc. (``Better Markets''); Cargill, Inc.
(``Cargill''); Castleton Commodities International LLC (``CCI'');
Chevron USA Inc. (``Chevron''); Choice Cotton Company, Inc.
(``Choice Cotton''); CHS Inc. (``CHS Inc.'') and CHS Hedging, LLC
(``CHS Hedging'') (collectively, ``CHS''); Citadel; CME Group Inc.
(``CME Group''); Commodity Markets Council (``CMC''); DECA Global
LLC (``DECA''); East Cotton Company (``East Cotton''); Ecom
Agroindustrial (``Ecom''); Edison Electric Institute (``EEI'') and
Electric Power Supply Association (``EPSA'') (collectively, the
``Joint Associations'' or ``EEI/EPSA''); Futures Industry
Association (``FIA''); Glencore Agriculture Limited, Glencore
Agriculture B.V. (collectively, ``Glencore''); ICE Futures U.S.
(``IFUS''); IMC Companies (``IMC''); Industrial Energy Consumers of
America; Institute for Agriculture & Trade Policy (``IATP'');
Intercontinental Exchange, Inc. (``ICE''); International Energy
Credit Association (``IECA''); International Swaps and Derivatives
Association, Inc. (``ISDA''); Jess Smith & Sons (``Jess Smith'');
Lawson/O'Neill Global Institutional Commodity (LOGIC) Advisors
(``Lawson/O'Neill''); Long Island Power Authority (``LIPA''); Louis
Dreyfus Company (``LDC''); Mallory Alexander International Logistics
(``Mallory Alexander''); Managed Funds Association and Alternative
Investment Management Association (collectively, the
``Associations'' or ``MFA/AIMA''); Marshal, Gerald (Independent
Trader); Matsen, Eric (Individual--Physical Commodity Risk
Management Consultant); McMeekin Cotton LLC (``McMeekin''); Memtex
Cotton Marketing, LLC (``Memtex''); Minneapolis Grain Exchange, Inc.
(``MGEX''); Moody Compress & Warehouse Company (``Moody Compress'');
Namoi Cotton Alliance (``Namoi''); National Cotton Council
(``NCC''); National Council of Farmer Cooperatives (``NCFC'');
National Council of Textile Organizations (``NCTO''); National
Energy & Fuels Institute (``NEFI''); National Grain and Feed
Association (``NGFA''); National Oilseed Processors Association
(``NOPA''); National Rural Electric Cooperative; Association
American Public Power Association; and American Public Gas
Association (collectively, ``NRECA''); Natural Gas Supply
Association (``NGSA''); Olam International Limited (``Olam'');
Omnicotton Inc. (``Omnicotton''); Pacific Investment Management
Company LLC (``PIMCO''); Parkdale Mills (``Parkdale''); Petroleum
Marketers Association of America (``PMAA''); Public Citizen; Robert
Rutkowski (``Rutkowski''); S. Canale Cotton Co. (``Canale Cotton'');
Shell Energy North America (US), L.P. and Shell Trading (US) Company
(collectively, ``Shell''); SIFMA Asset Management Group (``SIFMA
AMG''); Skylar Capital Management LP (``SCM''); Southern Cotton
Association (``Southern Cotton''); Southwest Ag Sourcing (``SW
Ag''); Suncor Energy Marketing Inc. and Suncor Energy USA Marketing
Inc. (collectively, ``SEMI''); Texas Cotton Association (``Texas
Cotton''); The Coalition of Physical Energy Companies; The
Commercial Energy Working Group (``CEWG''); The Walcot Trading
Company, LLC (``Walcot''); Toyo Cotton Company (``Toyo''); VLM
Commodities (``VLM''); Western Cotton Shippers Association
(``WCSA''); White Gold Cotton Marketing, LLC (``White Gold'').
\17\ The Final Rule's regulations are discussed in detail
throughout this release.
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Before addressing the specifics of the Final Rule, the Commission
outlines several themes underscoring the Commission's approach in the
Final Rule.
First, the Commission believes that any position limits regime must
take into account differences across commodities and contract types.
The existing Federal position limits regulations apply only to the nine
legacy agricultural contracts, all of which are physically-settled
futures on agricultural commodities. Limits on these nine legacy
agricultural contracts have been in place for decades, as have the
Federal rules governing both the exemptions from these Federal position
limits and the exchange-set position limits on the nine legacy
agricultural contracts. The existing framework is largely a historical
remnant of an approach that predates cash-settled futures contracts,
institutional-investor interest in commodity indexes, highly liquid
energy markets, and the Commission's jurisdiction over certain swaps.
Congress has tasked the Commission with establishing such limits as
it finds are ``necessary'' for the purpose of preventing the burdens
associated with excessive speculation causing sudden or unreasonable
fluctuations or unwarranted changes in the price of an underlying
commodity; and establishing limits on swaps that are ``economically
equivalent'' to any futures contracts or options on futures contracts
subject to Federal position limits. An approach that is flexible enough
to accommodate potential future, unpredictable developments in
commercial hedging practices is well-suited for the current derivatives
markets by accommodating differences in commodity types, contract
specifications, hedging practices, cash-market trading practices,
organizational structures of hedging participants, and liquidity
profiles of individual markets.
The Commission is building this flexibility into several parts of
the Final Rule, including: (1) Exchange-set limits or accountability
levels outside of the spot month for referenced contracts based on
commodities other than the nine legacy agricultural contracts; (2) the
ability for exchanges to use more than one formula when setting their
own limit levels; (3) an updated formula for Federal non-spot month
position limit levels on the nine legacy agricultural contracts that is
calibrated to recently observed open interest, which has generally
increased over time; (4) a bona fide hedging definition that is broad
enough to accommodate common commercial hedging practices, including
unfixed-price transactions as well as anticipatory hedging practices,
such as anticipatory merchandising; (5) a simplified process for market
participants to submit a single application to obtain non-enumerated
bona fide hedge recognitions for purposes of Federal and exchange-set
position limits that are in line with common commercial hedging
practices; (6) the elimination of a restriction for purposes of Federal
position limits on holding positions during the last trading days of
the spot month; and (7) broader discretion for market participants to
measure risk in the manner most suitable for their businesses.
Second, the Final Rule establishes position limits with respect to
16 additional commodities during the spot month, for a total of 25 core
referenced futures contracts, and certain derivative contracts linked
thereto, for which the Commission finds that speculative position
limits are necessary.\18\ As described below, this necessity finding
for the 25 core referenced futures contracts is based on two
interrelated factors: (1) The importance of the 25 core referenced
futures contracts to their respective underlying cash markets,
including that they require physical delivery of the underlying
commodity; and (2) the particular importance to the national economy of
the commodities underlying the 25 contracts.\19\
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\18\ See infra Section III.C.2.
\19\ Id.
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Third, there is an opportunity for greater collaboration between
the Commission and the exchanges within the statutorily created
parallel Federal and exchange-set position limit regimes. Given the
exchanges' obligations to carry out self-regulatory responsibilities,
resources, deep knowledge of their markets and trading practices, close
interactions with market participants, existing programs for addressing
exemption requests, and direct ability to leverage these resources to
generally act more quickly than the Commission, the Commission believes
that cooperation between the Commission and the exchanges on position
limits should not only be continued, but enhanced. For
[[Page 3239]]
example, exchanges are particularly well-positioned to: Provide the
Commission with estimates of deliverable supply in connection with
their commodity contracts that require physical delivery; recommend
limit levels for the Commission's consideration; and help administer
the program for recognizing bona fide hedges. Further, given that the
Final Rule requires exchanges to collect, and provide to the Commission
upon request, cash-market information from market participants
requesting recognition of bona fide hedges, the Commission is
eliminating the Form 204 and part of the Form 304, which market
participants with bona fide hedging positions in excess of position
limits currently file each month with the Commission to demonstrate
cash-market positions justifying such overages. Under enhanced
collaboration, the Commission will maintain its access to such
information from the exchanges, which will result in a more efficient
administrative process, in part by reducing duplication of efforts.
B. Executive Summary
This executive summary provides an overview of the key components
of the Final Rule. The summary only highlights certain aspects of the
final regulations and generally uses shorthand to summarize complex
topics. The executive summary is neither intended to be a comprehensive
recitation of the Final Rule nor intended to supplement, modify, or
replace any interpretive or other language contained herein. Section II
of this release includes a more detailed and comprehensive discussion
of all of the final regulations. The final regulations and related
appendices and guidance follow Section IV (Related Matters) of this
release.
1. Contracts Subject to Federal Speculative Position Limits
Federal position limits apply to ``referenced contracts,'' which,
as described in turn below, include: (i) 25 ``core referenced futures
contracts'' (i.e., the nine legacy agricultural contracts together with
the new 16 non-legacy contracts); (ii) futures contracts and options on
futures contracts directly or indirectly linked to a core referenced
futures contract; and (iii) ``economically equivalent swaps.''
i. Core Referenced Futures Contracts
Federal position limits under the Final Rule will apply to the
following 25 \20\ physically-settled core referenced futures contracts:
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\20\ Reference to, or discussion of, derivatives contracts
listed on IFUS, the DCM and subsidiary of ICE, will be referred to
herein as ``ICE [Commodity] [IFUS Commodity Code]'' (e.g., ICE Sugar
No. 16 (SF)). Additionally, ``CBOT'' refers to the DCM Board of
Trade of the City of Chicago, Inc.; ``CME'' refers to the DCM
Chicago Mercantile Exchange, Inc.; ``COMEX'' refers to the DCM
Commodity Exchange, Inc.; and ``NYMEX'' refers to the DCM New York
Mercantile Exchange, Inc.
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[[Page 3240]]
[GRAPHIC] [TIFF OMITTED] TR14JA21.000
ii. Futures Contracts and Options on Futures Contracts Linked to a Core
Referenced Futures Contract
The term ``referenced contract'' encompasses any core referenced
futures contract as well as any futures contract and any option on a
futures contract that is: (1) Directly or indirectly linked to the
price of a core referenced futures contract; or (2) directly or
indirectly linked to the price of the same commodity underlying the
applicable core referenced futures contract, for delivery at the same
location as specified in that core referenced futures
contract.22 The term ``referenced contract,'' however,
explicitly excludes location basis contracts, commodity index
contracts, contracts that are based on prices across a month (i.e.,
contracts commonly referred to as calendar month average contracts,
trade month average contracts, or balance of month contracts), outright
contracts that are based on a price reporting agency index price, swap
guarantees, and trade options that meet certain requirements.
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\21\ While the Final Rule includes Federal non-spot month limits
only for referenced cintracts on the nine legacy agricultural
contracts, the Final Rule requires exchanges to establish,
consistent with Commission standards set forth in this Final Rule,
exchange-set position limits and/or position accountability levels
in the non-spot months for the 16 non-legacy core referenced futures
contracts and for any associated referenced contracts.
\22\ For clarity, clause (2) is intended to encompass potential
physically-settled ``look-alike'' contracts that do not directly
reference a core referenced futures contract but that are
nonetheless based on the same commodity and delivery location as a
core referenced futures contract.
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iii. Economically Equivalent Swaps
The term referenced contracts also includes economically equivalent
swaps, defined as swaps with ``identical material'' contractual
specifications, terms, and conditions to a referenced contract. Swaps
in a commodity other than natural gas that have identical material
specifications, terms, and conditions to a referenced contract are
still deemed economically equivalent swaps even if they differ from the
referenced contract with respect to one or more of the following: (a)
Lot size specifications or notional amounts, (b) delivery dates
diverging by less than one calendar day for physically-settled swaps,
or (c) post-trade risk management arrangement (e.g., uncleared swaps
versus cleared futures contracts).
The same general definition applies to natural gas swaps, except
that the definition is expanded to include swaps with delivery dates
diverging from the corresponding core referenced futures contract by
less than two calendar days.
Instruments that are exempt from Commission jurisdiction or
otherwise not deemed to be swaps under the Commission's regulations
(e.g., instruments that are excluded by the CEA's ``swap'' definition
or Commission regulations as physically-settled forward contracts) are
not ``economically equivalent swaps'' even if they otherwise fall
within the ``economically equivalent swap'' definition.
2. Federal Position Limit Levels During the Spot Month
[[Page 3241]]
Federal spot month position limits apply to all 25 core referenced
futures contracts and their associated referenced contracts. The Final
Rule establishes the spot month position limit levels summarized in the
table below. Each spot month limit is set at or below 25% of
deliverable supply, as estimated using recent data provided by the DCM
listing the core referenced futures contract, and verified by the
Commission. The Federal spot month position limits apply on a futures-
equivalent basis based on the size of the unit of trading of the
relevant core referenced futures contract.
BILLING CODE 6351-01-P
[GRAPHIC] [TIFF OMITTED] TR14JA21.001
[[Page 3242]]
[GRAPHIC] [TIFF OMITTED] TR14JA21.002
BILLING CODE 6351-01-C
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\23\ As of October 15, 2020.
\24\ The Federal spot month limit for Live Cattle adopted herein
features a step-down limit similar to the CME's existing Live Cattle
step-down exchange-set limit. The Federal spot month step-down limit
is: (1) 600 at the close of trading on the first business day
following the first Friday of the contract month; (2) 300 at the
close of trading on the business day prior to the last five trading
days of the contract month; and (3) 200 at the close of trading on
the business day prior to the last two trading days of the contract
month.
\25\ ICE technically does not have an exchange-set spot month
position limit level for ICE Sugar No. 16 (SF). However, it does
have a single-month position limit level of 1,000 contracts, which
effectively operates as a spot month position limit.
\26\ As discussed below, the NYMEX Henry Hub Natural Gas (NG)
Federal spot month limit for cash-settled look-alike referenced
contracts will apply on a per-exchange and per-OTC swaps market
basis rather than on an aggregate basis across exchanges.
\27\ Currently, the cash-settled natural gas contracts are
subject to an exchange-set spot month position limit level of 1,000
equivalent-sized contracts per exchange. As of publication of the
Final Rule, there are three exchanges that list cash-settled natural
gas contracts: NYMEX, IFUS, and Nodal. As a result, a market
participant may hold up to 3,000 equivalent-sized cash-settled
natural gas contracts under existing exchange-set limits.
The exchanges also have a conditional position limit framework
for natural gas contracts. This exchange-set conditional spot month
position limit permits up to 5,000 cash-settled NYMEX NG equivalent-
sized referenced contracts per exchange that lists such contracts,
provided that the market participant does not hold positions in the
physically-settled NYMEX NG referenced contract.
\28\ The Federal spot month limit for Light Sweet Crude Oil
adopted herein features the following step-down limit: (1) 6,000
contracts as of the close of trading three business days prior to
the last trading day of the contract; (2) 5,000 contracts as of the
close of trading two business days prior to the last trading day of
the contract; and (3) 4,000 contracts as of the close of trading one
business day prior to the last trading day of the contract.
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[[Page 3243]]
i. Application of Federal Spot Month Limits to Commodities Other Than
Natural Gas
With the exception of natural gas, the Federal spot month position
limit levels apply in the aggregate across exchanges and the over-the-
counter (``OTC'') swap markets.
During the spot month, Federal position limits apply ``separately''
to physically-settled and cash-settled referenced contracts.\29\
Accordingly, during the spot month, a market participant is required to
aggregate its net physically-settled positions, and separately its net
cash-settled positions, across exchanges and the OTC swaps markets, but
may not net cash-settled referenced contracts with physically-settled
referenced contracts.
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\29\ As discussed further under Section II.B.3.vi, cash-settled
NYMEX NG referenced contracts under the Final Rule are subject to
per-exchange and per-OTC swaps market Federal position limits. As a
result, market participants are not required to aggregate their
positions in natural gas referenced contracts across different
exchanges and the OTC swaps markets but also may not net such
positions across different exchanges or the OTC swaps market.
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ii. Application of Federal Spot Month Limits to Natural Gas
For the NYMEX Henry Hub Natural Gas (``NYMEX NG'') physically-
delivered core referenced futures contract and its associated cash-
settled referenced contracts, the Final Rule modifies the 2020 NPRM by
providing that Federal position limits apply to NYMEX NG cash-settled
referenced contracts on a per-exchange and per-OTC swaps market basis
(i.e., cash-settled positions are not aggregated across different
exchanges and the OTC swaps market).
Specifically, a market participant may hold up to 2,000 cash-
settled NYMEX NG referenced contracts (i.e., the NYMEX NG Federal spot
month position limit) on each exchange that lists for trading a cash-
settled NYMEX NG referenced contract as well as the OTC swap market.
Currently, three exchanges (NYMEX, IFUS, and Nodal) \30\ list cash-
settled ``look-alike'' NYMEX NG referenced contracts. Thus, a market
participant is able to hold 2,000 cash-settled NYMEX NG referenced
futures contracts on each exchange, which is 6,000 cash-settled look-
alike NYMEX NG referenced contracts in total. In addition, a market
participant is able to hold a position of 2,000 cash-settled NYMEX NG
equivalent-sized economically equivalent swaps in the OTC swaps markets
for a total position of 8,000 cash-settled NYMEX NG referenced
contracts across the four markets (i.e., NYMEX, IFUS, Nodal, and the
OTC swaps market).
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\30\ ``Nodal'' refers to the Nodal Exchange, LLC.
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As noted above, because Federal spot month position limit levels
apply ``separately'' to cash-settled and physically-settled referenced
contracts, a market participant further is able to hold an additional
position of 2,000 physically-settled NYMEX NG referenced contracts for
a total position of 10,000 NYMEX NG referenced contracts.
As discussed further below, market participants may hold additional
cash-settled NYMEX NG referenced contracts under the Final Rule's
Federal spot month conditional position limit exemption as long as the
market participant satisfies certain requirements. However, for the
avoidance of doubt, the Commission notes that the per-exchange 2,000
contract Federal spot month position limit level for cash-settled NYMEX
NG referenced contracts discussed above is not part of the Federal spot
month conditional position limit exemption but rather constitutes the
default speculative Federal spot month position limit.
3. Federal Position Limit Levels Outside of the Spot Month
Under the Final Rule, Federal position limits outside of the spot
month (``non-spot month'' position limits) apply only to the nine
legacy agricultural contracts and their associated referenced
contracts.
In contrast, referenced contracts based on the 16 core referenced
futures contracts subject to Federal position limits for the first time
under the Final Rule are only subject to Federal position limits during
the spot month, and are otherwise only subject to exchange-set limits
or position accountability outside of the spot month.
The following Federal non-spot month position limit levels,
summarized in the table below, are set at 10% of open interest for the
first 50,000 contracts, with an incremental increase of 2.5% of open
interest thereafter, and apply on a futures-equivalent basis based on
the size of the unit of trading of the relevant core referenced futures
contract:
[[Page 3244]]
[GRAPHIC] [TIFF OMITTED] TR14JA21.003
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\31\ With the exception of the ICE Cotton No. 2 (CT) contract
discussed below, for each of the legacy agricultural contracts, the
single month limit is equal to the all-months-combined limit under
the Final Rule.
\32\ As of October 15, 2020.
\33\ The single month limit for ICE Cotton No. 2 (CT) is set at
50% of the all-months-combined limit, or 5,950 contracts, as
discussed more fully below.
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4. Exchange-Set Limits and Exemptions Therefrom
i. Contracts Subject to Federal Position Limits
An exchange that lists a contract subject to Federal position
limits, as specified above, is required to set its own limits for such
contracts at a level that is no higher than the Federal level.
Exchanges may grant exemptions from their own limits to a level that
exceeds the applicable Federal limit, provided the exemption is self-
effectuating (e.g., an enumerated bona fide hedge or a spread that
satisfies the ``spread transaction'' definition) or provided the
exemption is recognized by the Commission for purposes of Federal
position limits (pursuant to an application submitted either directly
to the Commission under Sec. 150.3 or indirectly to the Commission
through an exchange under Sec. 150.9, as applicable). Exchanges may
grant exemptions that are not recognized by the Final Rule; however,
such exemptions must be capped at a level that is not higher than the
applicable Federal position limit level.
ii. Physical Commodity Contracts Not Subject to Federal Position Limits
For physical commodity contracts, for which no necessity finding
was supported, and which are therefore not subject to Federal position
limits, an exchange is generally required to set spot month position
limit levels at no greater than 25% of deliverable supply, but has
flexibility to submit other approaches for review by the Commission,
provided the approach results in spot month position limit levels that
are ``necessary and appropriate to reduce the potential threat of
market manipulation or price distortion of the contract's or the
underlying commodity's price or index'' and complies with all other
applicable regulations.
Outside of the spot month, an exchange has additional flexibility
to set either position limits or position accountability levels,
provided the levels are ``necessary and appropriate to reduce the
potential threat of market manipulation or price distortion of the
contract's or the underlying commodity's price or index.'' Non-
exclusive Acceptable Practices are included in new Appendix F to part
150 under the Final Rule and provide several examples of formulas that
the Commission has determined meet this standard, but an exchange has
flexibility to develop other approaches.
An exchange has flexibility to grant a variety of exemption types.
Exchanges must take into account whether the exemption results in a
position that is
[[Page 3245]]
``not in accord with sound commercial practices'' in the market for
which the exchange is considering the application, and/or ``exceed[s]
an amount that may be established and liquidated in an orderly fashion
in that market.''
5. Limits on ``Pre-Existing Positions''
As discussed above, only swaps that qualify as ``economically
equivalent swaps'' are subject to Federal position limits under the
Final Rule. However, economically equivalent swaps entered into in good
faith prior to the Final Rule's Effective Date, including both ``Pre-
Enactment Swaps,'' which are swaps entered into prior to the Dodd-Frank
Act whose terms have not expired, and ``Transition Period Swaps,''
which are swaps entered into between July 22, 2010 and the Final Rule's
effective date, are not subject to Federal position limits. Other pre-
existing positions (i.e., pre-existing positions that are futures
contracts or options on futures contracts) will be subject to the Final
Rule's Federal position limits.\34\
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\34\ However, as discussed further below, the Commission is
providing for a compliance period until January 1, 2022 for the 16
non-legacy referenced contracts that will be subject to Federal
position limits for the first time under this Final Rule. Similarly,
the Commission is providing for a compliance period for any
economically equivalent swaps, as well as in connection with the
elimination of the risk management exemption, until January 1, 2023.
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Market participants may net down their post-Effective Date
positions in commodity derivatives contracts with any pre-existing
swaps (as long as such swaps qualify as economically equivalent swaps)
for purposes of complying with non-spot month Federal position limits.
In contrast, during the spot month, market participants may not apply
these pre-existing swap positions to net down their positions so as to
avoid rendering Federal spot month position limits ineffective. The
Commission is particularly concerned about protecting the spot month in
physically-delivered futures from price distortions or potential
manipulation and consequent disruption of the hedging and price
discovery utility of the related futures contract.
6. Legal Standards for Exemptions From Federal Position Limits
i. Bona Fide Hedge Recognition
A bona fide hedging transaction or position may exceed Federal
position limits if the hedge position satisfies all three elements of
the Final Rule's ``general'' bona fide hedging definition. That is, (1)
the position represents a substitute for transactions or positions made
or to be made at a later time in a physical marketing channel
(``temporary substitute test''); (2) the position is economically
appropriate to the reduction of price risks in the conduct and
management of a commercial enterprise (``economically appropriate
test''); and (3) the position arises from the potential change in value
of actual or anticipated assets, liabilities, or services (``change in
value requirement'').
The Final Rule makes several changes to the existing bona fide
hedging definition, including those described immediately below:
First, the Commission is expanding the existing list of
``enumerated'' bona fide hedges to cover additional hedging practices,
including adding a bona fide hedge for anticipated merchandising.\35\
To provide greater certainty, the list of enumerated bona fide hedges
is now incorporated into the regulation. In contrast, in the 2020 NPRM,
this list of enumerated bona fide hedges was proposed in the form of
non-binding acceptable practices in Appendix A to part 150. While the
enumerated bona fide hedges will remain listed in Appendix A under the
Final Rule, Appendix A to part 150 is now explicitly incorporated into
Commission regulations and is part of the regulatory text rather than
acceptable practices.
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\35\ The existing definition of ``bona fide hedging transactions
and positions'' enumerates the following hedging transactions or
positions: (1) Hedges of inventory and cash commodity fixed-price
purchase contracts under 1.3(z)(2)(i)(A); (2) hedges of unsold
anticipated production under 1.3(z)(2)(i)(B); (3) hedges of cash
commodity fixed-price sales and (4) hedges of fixed price sales of
their cash products and byproducts contracts under 1.3(z)(2)(ii)(A)
and (B); (5) hedges of unfilled anticipated requirements under
1.3(z)(2)(ii)(C); (6) hedges of offsetting unfixed price cash
commodity sales and purchases under 1.3(z)(2)(iii); and (7) cross-
commodity hedges under 1.3(z)(2)(iv). The following additional
hedging practices are not enumerated in the existing regulation, but
are included as enumerated hedges in the Final Rule: (1) Hedges of
anticipated merchandising; (2) hedges by agents; (3) hedges of
anticipated royalties; (4) hedges of services; and (5) offsets of
commodity trade options.
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A person who holds a position that qualifies as a bona fide hedge
and that is one of the enumerated hedges in Appendix A to part 150 is
not required to request prior approval from the Commission to hold such
bona fide hedge position above the Federal position limit. That is, the
enumerated bona fide hedges are ``self-effectuating'' for purposes of
Federal position limits. A person with an enumerated bona fide hedge
position, however, would still need to request an exemption from the
relevant exchange for any exchange-set limits.\36\
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\36\ The processes for obtaining bona fide hedge recognitions
and non-enumerated bona fide hedge recognitions are summarized in
Section 7 below of this executive summary (Processes for Requesting
Bona Fide Hedge Recognitions and Spread Exemptions).
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Second, with respect to the treatment of unfixed-price forward
transactions and bona fide hedging under the Final Rule, the Commission
clarifies that a commercial market participant may qualify for one of
the Final Rule's enumerated anticipatory bona fide hedges (i.e.,
enumerated bona fide hedges for unsold anticipated production, unfilled
anticipated requirements, and anticipated merchandising) with respect
to an unfixed-price forward transaction. The Commission believes that
an unfixed-price forward transaction should not preclude a commercial
market participant from qualifying for one of these enumerated
anticipatory bona fide hedges, because such unfixed-price forward
transactions do not give rise to outright price risk for a commercial
market participant and do not otherwise fix an outright price.
Accordingly, unfixed-price transactions do not ``fill'' or ``address''
the hedging need for which the enumerated anticipatory bona fide hedges
are predicated.
The Commission notes that an unfixed-price forward transaction does
not itself allow a market participant to qualify for one of these
enumerated anticipatory bona fide hedges, and that a market participant
must still satisfy the requirements of the applicable anticipatory bona
fide hedge to qualify (e.g., as an initial matter, by the commercial
market participant being able to demonstrate its anticipated unsold
production, anticipated unfilled requirements, and/or anticipated
merchandising).
Third, the Final Rule clarifies whether and when market
participants may measure risk on a gross basis rather than on a net
basis. Instead of only being permitted to hedge on a ``net basis''
except in a narrow set of circumstances, a market participant is also
able to generally hedge positions on a ``gross basis,'' provided that
the participant has done so over time in a consistent manner and is not
doing so to evade Federal position limits. Among other items, the Final
Rule differs from the 2020 NPRM in that the Final Rule: (1) Eliminates
the requirement that exchanges document their justifications when
allowing gross hedging; (2) clarifies that market participants are not
required to develop written policies or procedures that set forth when
gross
[[Page 3246]]
versus net hedging is appropriate; and (3) clarifies that gross hedging
is permissible for both enumerated and non-enumerated hedges.
Fourth, market participants are permitted to hold bona fide hedges
in excess of Federal position limits during the last five days of the
spot period (or during the time period for the spot month if less than
five days). While the Final Rule does not include a Federal restriction
on holding bona fide hedging positions in excess of Federal position
limits during the spot period, exchanges continue to have the
discretion to adopt such restrictions (commonly referred to by market
participants as the ``Five-Day Rule''), or similar restrictions, for
purposes of exchange-set limits. The Final Rule also includes guidance
on the application of spot-period restrictions, including factors for
exchanges with such restrictions to consider when determining to grant
exemptions that are not subject to any such restrictions for purposes
of their own limits.
Finally, the Final Rule modifies the ``temporary substitute test''
to require that a bona fide hedging transaction or position in a
physical commodity must always, and not just normally, be connected to
the production, sale, or use of a physical cash-market commodity.
Therefore, a market participant is generally no longer allowed to treat
positions entered into for ``risk management purposes'' \37\ as a bona
fide hedge, unless the position qualifies as either: (i) An offset of a
pass-through swap, where the offset reduces price risk attendant to the
pass-through swap executed opposite a counterparty for whom the swap
qualifies as a bona fide hedge; or (ii) a ``swap offset,'' where the
offset is used by a counterparty to reduce price risk attendant to a
swap that qualifies as a bona fide hedge and that was previously
entered into by that counterparty.
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\37\ The phrase ``risk management'' as used in this instance
refers to derivatives positions, typically held by a swap dealer,
used to offset a swap position, such as a commodity index swap, with
another entity for which that swap is not a bona fide hedge.
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ii. Spread Exemption
A transaction or position may also exceed Federal position limits
if it qualifies as a ``spread transaction,'' which includes the
following common types of spreads: Intra-market spreads; inter-market
spreads; intra-commodity spreads; inter-commodity spreads; calendar
spreads; quality differential spreads; processing spreads (such as
energy ``crack'' or soybean ``crush'' spreads); product and by-product
differential spreads; and futures-options spreads.\38\
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\38\ The Final Rule expands the 2020 NPRM's list of exempt
spread transactions by also including intra-market spreads, inter-
market spreads, and intra-commodity spreads.
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Spread exemptions may be granted using the process described in
Section 7 below of this executive summary (Processes for Requesting
Bona Fide Hedge Recognitions and Spread Exemptions).
iii. Financial Distress Exemption
This exemption allows a market participant to exceed Federal
position limits if necessary to take on the positions and associated
risk of another market participant during a potential default or
bankruptcy situation. This exemption is available on a case-by-case
basis, depending on the facts and circumstances involved.
iv. Conditional Spot Month Limit Exemption in Natural Gas
As long as a market participant holds no physically-settled NYMEX
NG contracts, the Final Rule allows that market participant to exceed
the NYMEX NG Federal spot month position limit level of 2,000 cash-
settled referenced contracts per exchange (and an additional 2,000
equivalent-sized economically equivalent OTC swaps) by holding 10,000
cash-settled NYMEX NG referenced contracts per DCM that lists cash-
settled NYMEX NG referenced contracts, as well as an additional 10,000
equivalent-sized cash-settled economically equivalent NYMEX NG swaps.
The Final Rule clarifies that market participants may not use a spread
exemption to exceed the aforementioned conditional spot month limit for
natural gas.
7. Processes for Requesting Bona Fide Hedge Recognitions and Spread
Exemptions
i. Self-Effectuating Enumerated Bona Fide Hedges
A position that complies with the bona fide hedging definition in
Sec. 150.1 and falls within one of the enumerated bona fide hedges is
self-effectuating for purposes of Federal position limits, provided the
market participant separately applies to the relevant exchange for an
exemption from exchange-set limits. Such market participants are no
longer required to file Form 204/304 with the Commission on a monthly
basis to demonstrate cash-market positions justifying Federal position
limit overages. Instead, the Commission will have access to cash-market
information that such market participants submit as part of their
applications to an exchange for an exemption from exchange-set limits,
typically filed on an annual basis.
ii. Bona Fide Hedges That Are Not Self-Effectuating
The Commission may consider adding to the list of enumerated bona
fide hedges at a later time, as the Commission may find appropriate.
Until that time, all bona fide hedge positions that are not enumerated
in Appendix A to part 150 must be granted pursuant to one of the
processes for requesting a non-enumerated bona fide hedge recognition,
as explained below.
A market participant seeking to exceed Federal position limits for
a non-enumerated bona fide hedging transaction or position is able to
choose whether to apply directly to the Commission or, alternatively,
apply indirectly to the Commission through the applicable exchange
using a new streamlined process. If applying directly to the
Commission, the market participant must also separately apply to the
relevant exchange for relief from exchange-set position limits. If
applying to an exchange using the new streamlined process, a market
participant may file an application with an exchange, generally at
least annually, which will be valid both for purposes of Federal and
exchange-set position limits.
Under this streamlined process, if the exchange determines to grant
a non-enumerated bona fide hedge recognition for purposes of its
exchange-set position limits, the exchange must notify the Commission
and the applicant simultaneously. Then, 10 business days (or two
business days in the case of retroactive applications filed late due to
sudden or unforeseen bona fide hedging needs) after the exchange issues
such a determination, the bona fide hedge exemption may be deemed
approved for purposes of Federal position limits unless the Commission
(and not Commission staff) notifies the market participant otherwise.
That is, after the 10 (or two) business days expire, the bona fide
hedge exemption is considered approved for purposes of Federal position
limits. Under the Final Rule, once the exchange notifies the Commission
and the applicant of the exchange's determination to approve the
application, the applicant may, at its own risk, exceed Federal
position limits during the Commission's 10 business-day review period.
If the Commission determines to deny an exemption application, the
applicant will not be subject to any Federal position limits violation,
provided the
[[Page 3247]]
person filed the application in good faith and brings the position into
compliance with the applicable Federal position limit within a
commercially reasonable amount of time, as applicable.
The Final Rule also allows a market participant with sudden or
unforeseen hedging needs to file a request for a bona fide hedge
exemption within five business days after exceeding the Federal limit
(i.e., commonly referred to as a ``retroactive'' exemption
application). If the Commission denies such application, the market
participant will not be subject to a Federal position limit violation,
provided the market participant filed the application in good faith and
brings the position into compliance with the applicable Federal
position limit within a commercially reasonable amount of time, as
applicable.
Among other changes, market participants are no longer required to
file Forms 204 or 304, as applicable, with the Commission on a monthly
basis to demonstrate cash-market positions justifying position limit
overages. Under the Final Rule, the Commission will instead leverage
cash-market information submitted directly to the exchanges.
iii. Spread Exemptions
For a referenced contract on any commodity, a spread exemption is
self-effectuating for purposes of Federal position limits, provided
that (1) the position falls within one of the categories set forth in
the ``spread transaction'' definition, and (2) the market participant
separately applies to the applicable exchange for a spread exemption
from exchange-set position limits.\39\
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\39\ The Commission understands that certain exchanges may
distinguish between the terms ``spread,'' ``arbitrage,'' and
``straddle.'' For the purposes of the Commission's discussion and
the Final Rule in general, the Commission's use of the term
``spread'' is meant to include all of these related trading
strategies, and any Commission reference to ``spread'' rather than
``arbitrage'' or ``straddle'' is not intended to suggest a
substantive difference in meaning.
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A market participant with a spread position that does not fit
within the ``spread transaction'' definition with respect to any of the
commodities subject to Federal position limits may apply directly to
the Commission, and must also separately apply to the applicable
exchange.
8. Compliance Date and Effective Date
i. Summary
The Final Rule's effective date is March 15, 2021 (the ``Effective
Date''). This means that all aspects of the Final Rule will be
effective as of the Effective Date, including the new enumerated bona
fide hedges (e.g., anticipated merchandising) as well as the higher
Federal position limits for the nine legacy agricultural contracts.
However, as discussed below, the Commission is also providing for
compliance dates that extend beyond the Effective Date in connection
with several of the Final Rule's requirements.
The Final Rule provides market participants with a compliance date
of January 1, 2022 for purposes of compliance with the Federal position
limits for the 16 non-legacy core referenced futures contracts that are
subject to Federal position limits for the first time under this Final
Rule. This compliance date also applies to any referenced contracts
(other than economically equivalent swaps, which have a separate
compliance date as discussed further below) related to these 16 non-
legacy core referenced futures contracts.
The Final Rule also provides exchanges with a compliance date of
January 1, 2022 for purposes of establishing exchange-set position
limits and provisions associated with exemptions therefrom, including
certain obligations to collect cash-market information from market
participants in connection with market participants' applications for
bona fide hedging exemptions to exchange-set limits, and to share the
same with the Commission, consistent with the requirements under the
Final Rule.
Additionally, the Final Rule provides a compliance date of January
1, 2023 with respect to (i) the elimination of previously-granted risk
management exemptions,\40\ and (ii) Federal position limits for
economically equivalent swaps.
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\40\ As discussed above in Section 6 of this executive summary
(Legal Standards for Exemptions from Federal Position Limits), the
Commission is no longer recognizing risk management exemptions as
bona fide hedges under the Final Rule.
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Because the nine legacy agricultural contracts are currently
subject to Federal position limits under the existing Federal
framework, the Final Rule does not provide a compliance date for the
new Federal position limits under the Final Rule for such contracts, or
a formal phase-in period. Therefore, such limits go into effect on the
Effective Date. Thus, as of the Effective Date, market participants
will be able to avail themselves of the Federal position limits under
the Final Rule for the nine legacy agricultural contracts, all of which
are higher than the existing Federal position limits (except for CBOT
Oats, which will maintain the existing Federal position limit levels).
However, the Commission notes that exchange-set position limits will
remain at current levels unless and until the relevant exchange submits
a rule amendment pursuant to part 40 of the Commission's regulations to
amend the relevant exchange-set position limit.
Furthermore, the Commission is delaying implementation of exchange-
set position limits on swaps since exchanges cannot view market
participants' positions in swap positions across the various places
they trade, including on competitor exchanges.\41\ However, after the
January 1, 2023 compliance date for economically equivalent swaps
(discussed above), the Commission underscores that it will enforce
Federal position limits in connection with swaps.
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\41\ In two years, the Commission will reevaluate the ability of
exchanges to establish and implement appropriate surveillance
mechanisms to implement DCM Core Principle 5 and SEF Core Principle
6 with respect to swaps.
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For convenience, the Commission is providing a table below
identifying the Final Rule's Effective Date and compliance dates for
market participants and exchanges in connection with certain
obligations.
BILLING CODE 6351-01-P
[[Page 3248]]
[GRAPHIC] [TIFF OMITTED] TR14JA21.004
[[Page 3249]]
[GRAPHIC] [TIFF OMITTED] TR14JA21.005
BILLING CODE 6351-01-C
C. Section-by-Section Summary of Final Rule
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\42\As noted above, under the Final Rule the Federal position
limit levels for all of the nine legacy agricultural contracts will
increase, other than CBOT Oats. However, the Commission notes that
exchange-set position limits will remain at current levels unless
and until the relevant exchange submits a rule amendment pursuant to
part 40 of the Commission's regulations to amend the relevant
exchange-set position limit.
\43\As discussed further in this release, the Commission will no
longer recognize risk management exemptions under the Final Rule.
However, positions that are entered into based on a market
participant's previously-granted risk management exemptions will be
subject to an extended compliance date until January 1, 2023 with
respect to Federal position limits. That is, a market participant
with a previously granted risk management exemption will have a
compliance date of January 1, 2023 with respect to the elimination
of such risk management exemption.
\44\Form 204 (for all nine legacy agricultural contracts other
than cotton) and Parts I and II of Form 304 (for cotton) are
submitted by a market participant to the Commission under the
existing Federal position limits regulations in connection with
Federal enumerated bona fide hedges employed by the market
participants.
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The Commission is adopting revisions to Sec. Sec. 150.1, 150.2,
150.3, 150.5, and 150.6 and to parts 1, 15, 17, 19, 40, and 140, as
well as adding Sec. Sec. 150.8, 150.9, and Appendices A-G to part
150.\45\ Most noteworthy, the Commission is adopting the following
amendments to the foregoing rule sections, each of which, along with
all other changes in the Final Rule, is discussed in greater detail in
Section II of this release. The following summary is not intended to
provide a substantive overview of this Final Rule, but rather is
intended to provide a guide to the rule sections that address each
topic. For an overview of this Final Rule organized by topic (rather
than by section number), please see the executive summary above.
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\45\ The 2020 NPRM proposed to remove and reserve part 151. It
did not propose to amend current Sec. 150.4 dealing with
aggregation of positions for purposes of compliance with Federal
position limits, which was amended in 2016 in a prior rulemaking.
See Final Aggregation Rulemaking, 81 FR at 91454.
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The Commission finds that Federal speculative position
limits are necessary for 25 core referenced futures contracts, and for
any futures contracts and options on futures contracts linked thereto.
The Commission adopts Federal position limits on physically-settled and
linked cash-settled futures contracts, options on futures contracts,
and ``economically equivalent swaps'' for such commodities. The 25 core
referenced futures contracts include the nine ``legacy'' agricultural
contracts currently subject to Federal position limits and 16
additional non-legacy contracts, which include: Seven additional
agricultural contracts, four energy contracts, and five metals
contracts.\46\ Federal spot and non-spot
[[Page 3250]]
month limits apply to the nine ``legacy'' agricultural contracts
currently subject to Federal position limits,\47\ and only Federal
spot-month limits apply to the additional 16 non-legacy contracts.
Outside of the spot month, these 16 non-legacy contracts are subject to
exchange-set limits and/or accountability levels if listed on an
exchange.
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\46\ The seven additional agricultural contracts that are
subject to Federal spot month limits are: CME Live Cattle (LC), CBOT
Rough Rice (RR), ICE Cocoa (CC), ICE Coffee C (KC), ICE FCOJ-A (OJ),
ICE Sugar No. 11 (SB), and ICE Sugar No. 16 (SF). The four energy
contracts that are subject to Federal spot month limits are: NYMEX
Light Sweet Crude Oil (CL), NYMEX New York Harbor ULSD Heating Oil
(HO), NYMEX New York Harbor RBOB Gasoline (RB), and NYMEX Henry Hub
Natural Gas (NG). The five metals contracts that are subject to
Federal spot month limits are: COMEX Gold (GC), COMEX Silver (SI),
COMEX Copper (HG), NYMEX Palladium (PA), and NYMEX Platinum (PL). As
discussed below, any contracts for which the Commission is adopting
Federal position limits only during the spot month are subject to
exchange-set limits and/or accountability levels outside of the spot
month.
\47\ The Commission currently sets and enforces speculative
position limits with respect to certain enumerated agricultural
products. The ``enumerated'' agricultural products refer to the list
of commodities contained in the definition of ``commodity'' in CEA
section 1a; 7 U.S.C. 1a. These agricultural products consist of the
following nine currently traded contracts: CBOT Corn (and Mini-Corn)
(C), CBOT Oats (O), CBOT Soybeans (and Mini-Soybeans) (S), CBOT
Wheat (and Mini-Wheat) (W), CBOT Soybean Oil (SO), CBOT Soybean Meal
(SM), MGEX HRS Wheat (MWE), CBOT KC HRW Wheat (KW), and ICE Cotton
No. 2 (CT). See 17 CFR 150.2.
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Amendments to Sec. 150.1 add or revise several
definitions for use throughout part 150, including: New definitions of
the terms ``core referenced futures contract'' (pertaining to the 25
physically-settled futures contracts explicitly listed in the
regulations) and ``referenced contract'' (pertaining to futures
contracts and options on futures contracts that have certain direct
and/or indirect linkages to the core referenced futures contracts, and
to ``economically equivalent swaps'') to be used as shorthand to refer
to contracts subject to Federal position limits; an expanded ``spread
transaction'' definition; and a ``bona fide hedging transaction or
position'' definition that is broad enough to accommodate hedging
practices in a variety of contract types, including hedging practices
that may develop over time.
Amendments to Sec. 150.2 list the 25 core referenced
futures contracts which, along with any associated referenced
contracts, are subject to Federal position limits; and specify the
Federal spot and non-spot month position limit levels. Federal spot
month position limit levels are set at or below 25 percent of estimated
deliverable supply, whereas Federal non-spot month limit levels are set
at 10% of open interest for the first 50,000 contracts of open
interest, with an incremental increase of 2.5% of open interest
thereafter.
Amendments to Sec. 150.3 specify the types of positions
for which exemptions from Federal position limit requirements may be
granted, and set forth and/or reference the processes for requesting
such exemptions, including recognitions of bona fide hedges and
exemptions for spread positions, financial distress positions, certain
natural gas positions held during the spot month, and pre-enactment and
transition period swaps. For all contracts subject to Federal position
limits, bona fide hedge exemptions listed in Appendix A to part 150 as
an enumerated bona fide hedge are self-effectuating for purposes of
Federal position limits. For non-enumerated bona fide hedges, market
participants must submit an application either directly to the
Commission under Sec. 150.3 or indirectly through an exchange for
Federal position limit purposes under new Sec. 150.9 (discussed
below).
Amendments to Sec. 150.5 refine the process, and
establish non-exclusive methodologies, by which exchanges may set
exchange-level limits and grant exemptions therefrom with respect to
futures and options on futures, including separate methodologies for
contracts subject to Federal position limits and physical commodity
derivatives not subject to Federal position limits.\48\ While the
Commission will oversee compliance with Federal position limits on
swaps, the Commission has also determined to delay the enforcement of
exchange-set position limits on swaps otherwise required in amended
Sec. 150.5 because exchanges cannot view market participants'
positions in swaps across the various places they trade, including on
competitor exchanges.\49\
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\48\ Rule Sec. 150.5 addresses exchange-set position limits and
exemptions therefrom, whereas Sec. 150.3 addresses exemptions from
Federal position limits, and Sec. 150.9 addresses a streamlined
process for recognizing non-enumerated bona fide hedges for purposes
of Federal position limits. Exchange rules typically refer to
``exemptions'' in connection with bona fide hedging and spread
positions, whereas the Commission uses the nomenclature
``recognition'' with respect to bona fide hedges, and ``exemption''
with respect to spreads.
\49\ With respect to exchange-set position limits on swaps, in
two years the Commission will reevaluate the ability of exchanges to
establish and implement appropriate surveillance mechanisms to
implement DCM Core Principle 5 and SEF Core Principle 6.
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New Sec. 150.9 establishes a streamlined process for
addressing requests for bona fide hedging recognitions for purposes of
Federal position limits, and leveraging exchange expertise and
resources. This process will be used by market participants with non-
enumerated bona fide hedge positions. Under the Final Rule, market
participants can provide one application for a non-enumerated bona fide
hedge to a DCM or SEF, as applicable, and receive approval of such
request based on the same application from both the exchange for
purposes of exchange-set limits and from the Commission for purposes of
Federal position limits.
New Appendix A to part 150 contains a list of enumerated
bona fide hedges. Positions that comply with the bona fide hedging
transaction or position definition in Sec. 150.1 and that are
enumerated in Appendix A may exceed Federal position limits to the
extent that all applicable requirements in part 150 are met. Persons
holding such positions enumerated in Appendix A may exceed Federal
position limits without being required to request prior approval under
Sec. 150.3 or Sec. 150.9. Positions that do not fall within any of
the enumerated hedges could still potentially be recognized as bona
fide hedging positions, provided the positions otherwise comply with
the proposed bona fide hedging definition and all other applicable
requirements, including the approval process under Sec. 150.3 or Sec.
150.9.
Amendments to part 19 and related provisions eliminate
Form 204 (and corresponding Parts I and II of Form 304 for cotton),
enabling the Commission to leverage cash-market reporting submitted
directly to the exchanges under Sec. Sec. 150.5 and 150.9. The Final
Rule maintains Part III of Form 304, related to the cotton on-call
report.
D. Effective Date and Compliance Period
The 2020 NPRM included proposed Sec. 150.2(e), which provided that
the Federal position limit levels for the 25 core referenced futures
contracts would have a compliance date 365 days after publication of
the final position limits regulations in the Federal Register.
Additionally, proposed Sec. 150.3(c) provided that previously-granted
risk management exemptions shall not be effective after the Final
Rule's effective date.
The Commission is removing from the Final Rule the compliance date
requirements in proposed Sec. Sec. 150.2(e) and 150.3(c) and instead
addressing the effective and compliance dates together within this
Federal Register release. The Commission is making two modifications
from the 2020 NPRM relating to the effective date and compliance period
of the Final Rule.
First, as noted above in the executive summary, the Commission is
providing a general compliance date of January 1,
[[Page 3251]]
2022 for both market participants and exchanges. In contrast, the 2020
NPRM did not provide a specific date as the compliance date but rather
stated 365 days after publication in the Federal Register.\50\
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\50\ The Commission is adopting calendar dates for compliance to
provide clarity rather than the 2020 NPRM's approach of stating that
the compliance period ends 365 days after publication in the Federal
Register since the Commission believes that providing a set calendar
date provides greater clarity to market participants. Based on the
timing of the Final Rule, the Commission believes that the January
1, 2022 general compliance date will not reduce the compliance
period compared to the 2020 NPRM's approach and may provide slightly
more time prior to the commencement of the compliance period.
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This compliance date of January 1, 2022 applies to (i) the Federal
position limits set forth in Appendix E to part 150 for only the 16
non-legacy core referenced futures contracts that are subject to
Federal position limits for the first time under this Final Rule, and
(ii) exchange obligations under final Sec. 150.5. This compliance date
also applies to referenced contracts for any of the 16 non-legacy core
referenced futures contracts (other than economically equivalent swaps,
which have a separate compliance date as discussed immediately below).
In contrast, the 2020 NPRM's compliance date applied only to market
participants' compliance with the new Federal position limit levels.
However, as discussed below, the Final Rule does not provide a separate
compliance date for the nine legacy agricultural contracts since they
are already subject to existing Federal position limits.
Second, the Commission is establishing a separate compliance date
of January 1, 2023 in connection with (i) economically equivalent swaps
and (ii) the elimination of previously-granted risk management
exemptions (i.e., market participants may continue to rely on their
previously-granted risk management exemptions until January 1, 2023).
As noted above, the 2020 NPRM only had a single general compliance date
and did not provide a separate compliance date for economically
equivalent swaps or related to previously-granted risk management
exemptions.
In this section, the Commission will discuss the following related
issues: (i) Compliance with Federal position limits for the nine legacy
agricultural contracts; (ii) compliance by exchanges with Sec. 150.5
under the Final Rule and market participants' related obligation to
temporarily continue providing Forms 204/304 in connection with bona
fide hedges; (iii) exchanges' voluntary implementation of Sec. 150.9
under the Final Rule; and (iv) comments received in connection with the
compliance date proposed in the 2020 NPRM.
i. Compliance With Federal Position Limits for the Nine Legacy
Agricultural Contracts
With respect to the nine legacy agricultural contracts, the
Commission is not providing a compliance date with respect to the spot
month and non-spot month Federal position limit levels. Accordingly,
the new Federal position limit levels under the Final Rule will become
effective on the Effective Date. The nine legacy agricultural contracts
are currently subject to Federal position limits and will continue to
be subject under the Final Rule, which, as noted above, is increasing
the Federal position limit levels for the nine legacy agricultural
contracts (other than CBOT Oats, which will maintain the existing
Federal position limit levels). The Commission has determined not to
provide a separate compliance date for the nine legacy agricultural
contracts since market participants trading in these markets already
are familiar with Federal position limits and have established the
necessary monitoring and compliance oversight processes, in connection
with these legacy contracts.
With respect to exchange-set position limits, the Final Rule does
not require exchanges to increase their respective exchange-set
position limit levels. Rather, the Final Rule only requires that
exchange-set position limits are established at a level no higher than
the corresponding Federal position limits. As a result, in response to
the Final Rule, an exchange may: (1) Raise its exchange-set limits to
be as high as (or lower than) the corresponding Federal position limits
immediately on the Effective Date or anytime thereafter; (2) implement
a phase-in period where exchange-set position limits increase from
existing exchange-set levels over time; or (3) not increase the
exchange-set position limit levels at all, in each case as the exchange
may determine appropriate for its markets.
ii. Exchange Implementation of Sec. 150.5 and Market Participants'
Obligations To Continue Providing Forms 204 and 304, as Applicable, in
Connection With Federal Enumerated Bona Fide Hedges
For clarity, in connection with the nine legacy agricultural
contracts, market participants may avail themselves of the new
enumerated bona fide hedges (e.g., anticipatory merchandising)
immediately upon the Effective Date (market participants will not need
to be concerned with availing themselves of bona fide hedge
recognitions for the 16 non-legacy contracts upon the Effective Date
since these contracts will have a compliance date of January 1, 2022).
To the extent that market participants seek to rely on any Federal
enumerated bona fide hedges, market participants must continue to
provide, as applicable, the Commission with Forms 204/304, which are
otherwise eliminated by the Final Rule upon the Effective Date, until
the relevant exchange that lists the applicable referenced contract
implements Sec. 150.5 under the Final Rule. As discussed below, final
Sec. 150.5 governs, among other things, exchange rules and procedures,
including (i) the exchange's collection of certain cash-market
information from market participants in connection with their bona fide
hedge applications for exchange-set limits and (ii) the exchange's
sharing of related information with the Commission. As discussed
further below, the Final Rule predicates the elimination of Forms 204/
304 on the relevant exchange's sharing of the information with the
Commission under final Sec. 150.5 (which provides for a new process
for the exchange to share data with the Commission similar to data that
the Commission previously obtained through Forms 204/304 under the
Federal framework existing prior to the Final Rule).\51\ Exchanges must
implement final Sec. 150.5 by the Final Rule's general compliance date
of January 1, 2022.
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\51\ For further discussion of the elimination of Form 204 and
Parts I and II of Form 304, see Section II.H.2, infra.
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iii. Exchange Implementation of Sec. 150.9 in Connection With the
Market Participants' Applications Through Exchanges for Non-Enumerated
Bona Fide Hedges for Purposes of Federal Position Limits
As discussed above, the Final Rule establishes a streamlined
process for market participants to apply through exchanges for non-
enumerated bona fide hedges for purposes of Federal position limits.
That is, a market participant may submit a single non-enumerated bona
fide hedge exemption application to an exchange for purposes of both
Federal and exchange-set position limits, and the Commission will
review, and make a determination based on, the application that the
market participant submitted to the exchange. For clarity, the
Commission notes that the Final Rule does not require exchanges to
participate in such process.
However, if an exchange chooses to do so, the Commission is
clarifying, for
[[Page 3252]]
the avoidance of doubt, that the exchange may implement this
streamlined process for non-enumerated bona fide hedge applications as
soon as the Effective Date, or anytime thereafter (or not at all). In
response to certain concerns by market participants and exchanges,
discussed immediately below, the Commission believes that, to the
extent an exchange chooses to participate in this streamlined
application process, the implementation of Sec. 150.9 soon after the
Effective Date may help ensure minimal disruption to market
participants' existing trading strategies as well as avoid having the
potentially unfeasible situation of requiring the exchanges to process
a number of non-enumerated bona fide hedge applications simultaneously
at the end of the general compliance period on January 1, 2022.
Furthermore, the Commission clarifies in Section II.G.3.iii that market
participants with existing Commission-granted non-enumerated or
anticipatory bona fide hedge recognitions in connection with the nine
legacy agricultural contracts under the existing framework are not
required to reapply to the Commission for a new recognition under the
Final Rule.
iv. Comments--Compliance Period
Generally, commenters supported the proposed compliance date,
noting that an adequate compliance period would afford sufficient time
to make necessary business adjustments (e.g., time to build compliance
systems, develop technology, train personnel, etc.).\52\ The Commission
agrees with these observations and believes that a general compliance
date of January 1, 2022, except for economically equivalent swaps and
positions based on a previously-granted risk management exemption, will
provide exchanges and market participants sufficient time to adjust
their operations and compliance and monitoring systems.
---------------------------------------------------------------------------
\52\ CME Group at 8; FIA at 2-3; ISDA at 2, 8; Shell at 4; and
SIFMA AMG at 2, 9-10.
---------------------------------------------------------------------------
Some commenters also requested an extended compliance date (beyond
the general compliance date) for economically equivalent swaps to
mitigate the numerous legal, operational, and compliance challenges of
implementing position limits for swaps for the first time.\53\ Unlike
exchange-listed contracts that are currently subject to either Federal
position limits or exchange-set limits, commenters noted that exchanges
do not have existing compliance and monitoring resources for
economically equivalent swaps from which to leverage. The Commission
agrees with commenters that additional time for economically equivalent
swaps is warranted, and, as discussed above, is thus delaying the
compliance date for economically equivalent swaps for an additional
year, until January 1, 2023.
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\53\ MFA/AIMA at 8; NCFC at 6; NGSA at 15-16; SIFMA AMG at 9-10;
and Citadel at 9-10.
---------------------------------------------------------------------------
CME Group expressed concern that it may receive an influx of
exemption applications at the end of the compliance period, and
therefore suggested a rolling process where market participants are
grandfathered into their current exemptions, permitting them to file
for those exemptions on the same annual schedule.\54\ The Commission
believes this concern is mitigated since exchanges, at their
discretion, may implement final Sec. 150.9 as soon as the Effective
Date, which will allow exchanges to review non-enumerated bona fide
hedge applications on a rolling basis between the Effective Date and
the end of the compliance period rather than having to process a large
number of applications at once. Furthermore, as noted above, market
participants with existing Commission-granted non-enumerated or
anticipatory bona fide hedge recognitions are not required to reapply
to the Commission for a new recognition under the Final Rule.
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\54\ CME Group at 8.
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E. The Commission Construes CEA Section 4a(a) To Require the Commission
To Make a Necessity Finding Before Establishing Position Limits for
Physical Commodities Other Than Excluded Commodities
The Commission is required by ISDA to determine whether CEA section
4a(a)(2)(A) requires the Commission to find, before establishing a
position limit, that such limit is ``necessary.'' \55\ The provision
states in relevant part that ``the Commission shall'' establish
position limits ``as appropriate'' for futures contracts in physical
commodities other than excluded commodities ``[i]n accordance with the
standards set forth in'' the preexisting section 4a(a)(1).\56\ That
preexisting provision requires the Commission to establish position
limits as it ``finds are necessary to diminish, eliminate, or prevent''
certain enumerated burdens on interstate commerce.\57\ In the 2011
Final Rulemaking, the Commission interpreted this language as an
unambiguous mandate to establish position limits without first finding
that such limits are necessary, but with discretion to determine the
``appropriate'' levels for each.\58\ In ISDA, the U.S. District Court
for the District of Columbia disagreed and held that section
4a(a)(2)(A) is ambiguous as to whether the ``standards set forth in
paragraph (1)'' include the requirement of an antecedent finding that a
position limit is necessary.\59\ The court vacated the 2011 Final
Rulemaking and directed the Commission to apply its experience and
expertise to resolve that ambiguity.\60\ The Commission has done so and
determines that section 4a(a)(2)(A) should be interpreted to require
that before establishing position limits, the Commission must determine
that limits are necessary.\61\ A full legal analysis is set forth infra
at Sections III.C.-E.
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\55\ ISDA, 887 F.Supp.2d at 281.
\56\ 7 U.S.C. 6a(a)(2)(A).
\57\ 7 U.S.C. 6a(a)(1).
\58\ 76 FR at 71626, 71627.
\59\ ISDA, 887 F.Supp.2d at 279-280.
\60\ Id. at 281.
\61\ See infra Section III.B.
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The Commission finds that position limits are necessary for the 25
core referenced futures contracts, including certain commodity
derivative contracts that are directly or indirectly linked to a core
referenced futures contract. The Commission's finding with respect to
the 25 core referenced futures contracts is based on two interrelated
factors: The particular importance of the 25 core referenced futures
contracts to their respective underlying cash markets, including that
they require physical delivery of the underlying commodity, and, the
commodities' particular importance to the national economy. Separately,
the Commission finds that position limits are necessary during the spot
month for all 25 core referenced futures contracts and outside of the
spot month only for the nine legacy agricultural commodity contracts
(in each instance including certain commodity derivative contracts that
are directly or indirectly linked to a core referenced futures
contract). A full discussion of the necessity findings is set forth
infra at Sections III.C.-E.
F. The Commission's Use of Certain Terminology
The Commission is aware that this Final Rule will likely be
reviewed by a diverse range of members of the public from varied
backgrounds and industries and with different levels of knowledge and
experience with derivatives markets. Furthermore, even among
experienced market participants, terminology may differ by industry,
commodity, or exchange. The Commission also recognizes that certain
[[Page 3253]]
terms commonly referenced by market participants may differ from the
technical legal terms used in the Commission's regulations and/or the
CEA.
Accordingly, unless otherwise noted, the Commission will attempt to
use terms and phrases in their ordinary, plain English sense. When
required, the Commission will explicitly identify technical or nuanced
legal/regulatory or industry ``terms of art.'' The Commission wishes to
briefly review certain terms and phrases used throughout this release
below, as follows:
Bona fide hedges. The CEA uses the legal term ``bona fide
hedging transaction or position'' in both the singular and plural. The
Commission currently defines the term in existing Sec. 1.3 in the
plural as ``bona fide hedging transactions or positions'' while the
Final Rule now incorporates the singular ``bona fide hedging
transaction or position.'' The Commission understands that most market
participants simply refer to ``bona fide hedge(s)'' (in both the
singular and the plural). Accordingly, for short hand throughout this
release, the Commission may refer to ``bona fide hedges,'' ``bona fide
hedge positions,'' ``bona fide hedge transactions,'' ``bona fide
hedges,'' ``bona fide hedging positions,'' and similar phrasing.
These terms are meant to apply as short hand and are not intended
to imply a substantive difference either with the defined legal term
``bona fide hedging transaction or position'' or with one another.
Similarly, the plural term in the existing Commission regulations
and the singular in the Final Rule, as discussed below, are not
intended to reflect a substantive difference.
Federal position limits. The Final Rule creates a new
defined term, ``speculative position limit,'' in part 150 of the
Commission's regulations to refer to the maximum position, net long or
net short, that a market participant may maintain in a referenced
contract. Throughout this release, the Commission will use as a general
term either ``position limits'' or ``Federal position limits'' to refer
to the general Federal position limits framework and related
regulations, including the defined term ``speculative position limit.''
When discussing the individual ``speculative position limit'' levels
for each commodity derivative contract, as opposed to the Final Rule's
general Federal regulatory framework, the Commission instead may refer
to the ``Federal position limit levels,'' although all these phrases
are intended to refer to the same general concept. The Commission may
also specifically refer to exchange-set position limits when referring
to the general framework, process, or specific position limit levels
established by the respective exchanges.
Exchanges. This Final Rule applies to both DCMs and SEFs.
Unless otherwise distinguished, the Commission will refer to
``exchanges'' throughout this release to refer to any relevant DCM or
SEF.
Cash-Settled and Physically-Settled. The Commission
throughout this release refers to ``cash-settled'' and ``physically-
settled'' commodity derivative contracts.
When a futures contract expires, all open futures contract
positions in such contract are settled by either: (1) Physical
delivery, which the Commission refers to as a ``physically-settled''
contract, or (2) cash settlement, which the Commission refers to as a
``cash-settled'' contract, in each case depending on the contract terms
set by the exchange. Deliveries on ``physically-settled'' futures
contracts are made through the exchange's clearinghouse, and the
delivery of the physical commodity must be consummated between the
buyer and seller per the exchange rules and contract specifications. On
the other hand, other futures contracts are ``cash-settled'' because
they do not involve the transfer of physical commodity ownership and
require that all open positions at expiration be settled by a transfer
of cash to or from the clearinghouse based upon the final settlement
price of the contracts.
The Commission further notes that some market participants may
instead use the terms ``physical-delivery'' contracts or ``financially-
settled'' contracts instead of the Commission's terms ``physically-
settled'' contracts and ``cash-settled'' contracts, respectively. The
Commission does not intend a substantive difference in meaning with the
choice of its terms.
Spread Positions. The Commission views its use of the term
``spread'' to mean the same as ``arbitrage'' or ``straddle'' as those
terms are used in CEA section 4a(a) and existing Sec. 150.3(a)(3) of
the Commission's regulations. Consistent with existing regulations, the
Commission's sole use of the term ``spread'' in this Final Rule is
intended to also capture arbitrage or straddle strategies referred to
in CEA section 4a(a) and existing Sec. 150.3(a)(3), and referring to
``spread'' rather than ``arbitrage'' or ``straddle'' is not intended to
be a substantive difference. The Commission notes that certain
exchanges may distinguish between ``spread'' and ``arbitrage''
positions for purposes of exchange exemptions, but the Commission does
not make that distinction here for purposes of its ``spread
transaction'' definition as used in this release.
Unfixed Price Forward Transactions. Throughout this
release, the Commission will use as general terms either ``unfixed
price forward transactions,'' ``unfixed price transactions,'' ``unfixed
price forward contracts,'' and/or ``unfixed price contracts'' to refer
to transactions that are either purchases or sales of a cash commodity
where the purchase or sales price, as applicable, is determined based
on the settlement price of a benchmark, such as the settlement price of
a commodity derivative contract on a certain date (e.g., the price on
the settlement date of a core referenced futures contract) or other
index price (e.g., a spot index price). Market participants may also
refer to unfixed price transactions as ``floating price'' transactions,
and the Commission does not intend a substantive difference in meaning
with the choice of these terms.
G. Recent Volatility in the WTI Contract
Several commenters noted the volatility in the NYMEX Light Sweet
Crude Oil (CL) contract, also known as the West Texas Intermediate
crude oil contract (``WTI contract''), that occurred in April 2020
(subsequent to the issuance of the 2020 NPRM) in their comments to the
2020 NPRM. Some commenters suggested that the volatility may have been
caused, in part, by excessive speculation \62\ or highly leveraged
traders,\63\ or both. Better Markets suggested that a combination of
passive exchange-traded funds,\64\ the use of trading-at-settlement
(``TAS'') orders,\65\ automated trading,\66\ and, according to Better
Markets, a lack of ``meaningful position limits,'' \67\ may have
contributed to the volatility. Other commenters suggested that this
event could have been mitigated through additional liquidity provided
by financial end users during the critical
[[Page 3254]]
time period, among other measures.\68\ Commenters also pointed to the
event to bolster arguments for and against Commission deference to
exchanges in implementing position limits.\69\ A few commenters
requested that the Commission refrain from finalizing the rule until it
better understands this event and other issues.\70\
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\62\ PMAA at 2.
\63\ NEFI at 3-4.
\64\ Better Markets at 9.
\65\ Better Markets at 13. A TAS order is an order that is
placed during the trading session but is executed at the settlement
price (or with a small price range around the settlement price).
Trading at Settlement (TAS), https://www.cmegroup.com/trading/trading-at-settlement.html (last visited Aug. 29, 2020); TRADE AT
SETTLEMENT (TAS) FREQUENTLY ASKED QUESTIONS July 2020, https://www.theice.com/publicdocs/futures_us/TAS_FAQ.pdf (last visited Aug.
29, 2020).
\66\ Better Markets at 14-17.
\67\ Better Markets at 10.
\68\ AQR at 5-7 (``The inability of position limits themselves
to eliminate the unpredictability of commodity futures markets
highlights the importance of existing Commission and exchange
oversight of these markets and the dangers of overreliance on a
single regulatory tool to address market dynamics for which it may
not have been designed . . . [W]e encourage the Commission to
consider not only concerns around potential manipulation, but also
the potential unintended consequences of such limits and the need
for liquidity during sensitive time periods for commodity futures
markets.''); SCM at 2-3 (``This liquidity, provided by financial
trading firms and hedge funds . . ., is essential to balance, check
and smooth the otherwise uncontrollable trading that can occur when
only commercial firms and unsophisticated trading participants are
active in a market.'').
\69\ IATP suggested that the event demonstrates the problems of
Commission deference to DCMs' ``experience and capacity'' on many of
the provisions in the 2020 NPRM. See IATP at 18. Conversely, SEMI
stated that a final rule should not be overly restrictive in
response to the recent market conditions in WTI oil markets, given
that it is the exchanges that ``have the expertise, experience and
existing tools to effectively manage the orderly expiration of
futures contracts that are in the spot month under such
circumstances.'' SEMI at 13.
\70\ AFR at 3; Rutkowski at 2; IATP at 2-3.
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The Commission has been closely examining the circumstances
surrounding the volatility in the WTI contract since it occurred in
April 2020. The Commission will continue to analyze the events of April
2020 to evaluate whether any changes to the position limits regulations
may be warranted in light of the circumstances surrounding the
volatility in the WTI contract. Any proposed changes that the
Commission finds may be warranted would be subject to public comment
pursuant to the requirements of the Administrative Procedure Act.
H. Brief Summary of Comments Received
As stated previously, the Commission received approximately 75
relevant comment letters in response to the 2020 NPRM.\71\ Though
several commenters did not support the Commission adopting the 2020
NPRM and requested its withdrawal,\72\ most of the 75 comments received
generally supported the 2020 NPRM, or supported specific elements of
the 2020 NPRM. However, many of these commenters suggested
modifications to portions of the 2020 NPRM, which are discussed in the
relevant sections discussing the Final Rule below. In addition, several
commenters requested Commission action beyond the scope of the 2020
NPRM, also discussed in the relevant sections below.
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\71\ See supra, n.16.
\72\ E.g. AFR; Better Markets; IATP; Eric Matsen; NEFI; Public
Citizen; Robert Rutkowski; SCM; and VLM.
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II. Final Rule
A. Sec. 150.1--Definitions
Definitions relevant to the existing position limits regime
currently appear in both Sec. Sec. 1.3 and 150.1 of the Commission's
regulations.\73\ The Commission proposed to update and supplement the
definitions in Sec. 150.1, including moving a revised definition of
``bona fide hedging transactions and positions'' from Sec. 1.3 into
Sec. 150.1. The proposed changes were intended, among other things, to
conform the definitions to certain of the Dodd-Frank Act amendments to
the CEA.\74\ Each proposed defined term is discussed in alphabetical
order below.
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\73\ 17 CFR 1.3 and 150.1, respectively.
\74\ In addition to the amendments described below, the
Commission proposed to re-order the defined terms so that they
appear in alphabetical order, rather than in a lettered list, so
that terms can be more quickly located. Moving forward, any new
defined terms would be inserted in alphabetical order, as
recommended by the Office of the Federal Register. See Document
Drafting Handbook, Office of the Federal Register, National Archives
and Records Administration, 2-31 (Revision 5, Oct. 2, 2017)
(stating, ``[i]n sections or paragraphs containing only definitions,
we recommend that you do not use paragraph designations if you list
the terms in alphabetical order. Begin the definition paragraph with
the term that you are defining.'').
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1. ``Bona Fide Hedging Transaction or Position''
i. Background--Bona Fide Hedging Transaction or Position
Under CEA section 4a(c)(1), position limits shall not apply to
transactions or positions that are shown to be bona fide hedging
transactions or positions, as such terms shall be defined by the
Commission.\75\ The Dodd-Frank Act directed the Commission, for
purposes of implementing CEA section 4a(a)(2), to adopt a bona fide
hedging definition consistent with CEA section 4a(c)(2).\76\ The
existing definition of ``bona fide hedging transactions and
positions,'' which first appeared in Sec. 1.3 of the Commission's
regulations in the 1970s,\77\ is inconsistent, in certain ways
described below, with the revised statutory definition in CEA section
4a(c)(2).
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\75\ 7 U.S.C. 6a(c)(1).
\76\ 7 U.S.C. 6a(c)(2).
\77\ See, e.g., Definition of Bona Fide Hedging and Related
Reporting Requirements, 42 FR 42748 (Aug. 24, 1977). Previously, the
Secretary of Agriculture, pursuant to section 404 of the Commodity
Futures Trading Commission Act of 1974 (Pub. L. 93-463), promulgated
a definition of bona fide hedging transactions and positions.
Hedging Definition, Reports, and Conforming Amendments, 40 FR 11560
(Mar. 12, 1975). That definition, largely reflecting the statutory
definition previously in effect, remained in effect until the newly-
established Commission defined that term. Id.
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Accordingly, and for the reasons outlined below, the Commission
proposed to remove the existing bona fide hedging definition from Sec.
1.3 and replace it with a revised bona fide hedging definition that
would appear alongside all of the other position limits related
definitions in proposed Sec. 150.1.\78\ This definition would be
applied in determining whether a position in a commodity derivative
contract is a bona fide hedge that may exceed Federal position limits
set forth in Sec. 150.2.
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\78\ In a 2018 rulemaking, the Commission amended Sec. 1.3 to
replace the sub-paragraphs that had for years been identified with
an alphabetic designation for each defined term with an alphabetized
list. See Definitions, 83 FR 7979 (Feb. 23, 2018). The bona fide
hedging definition, therefore, is now a paragraph, located in
alphabetical order, in Sec. 1.3, rather than in Sec. 1.3(z).
Accordingly, for purposes of clarity and ease of discussion, when
discussing the Commission's existing version of the bona fide
hedging definition, this release will refer to the bona fide hedging
definition in Sec. 1.3.
Further, the version of Sec. 1.3 that appears in the Code of
Federal Regulations applies only to excluded commodities and is not
the version of the bona fide hedging definition currently in effect.
The version currently in effect, the substance of which remains as
it was amended in 1987, applies to all commodities, not just to
excluded commodities. See Revision of Federal Speculative Position
Limits, 52 FR 38914 (Oct. 20, 1987). While the 2011 Final Rulemaking
amended the Sec. 1.3 bona fide hedging definition to apply only to
excluded commodities, that rulemaking was vacated, as noted
previously, by a September 28, 2012 order of the U.S. District Court
for the District of Columbia, with the exception of the rule's
amendments to 17 CFR 150.2. Although the 2011 Final Rulemaking was
vacated, the 2011 version of the bona fide hedging definition in
Sec. 1.3, which applied only to excluded commodities, has not yet
been formally removed from the Code of Federal Regulations. The
currently-in-effect version of the Commission's bona fide hedging
definition thus does not currently appear in the Code of Federal
Regulations. The closest to a ``current'' version of the definition
is the 2010 version of Sec. 1.3, which, while substantively
current, still includes the ``(z)'' denomination that was removed in
2018. The Commission proposed to address the need to formally remove
the incorrect version of the bona fide hedging definition as part of
the 2020 NPRM.
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This section of the release discusses the bona fide hedging
definition and the substantive standards for bona fide hedges. The
process for granting bona fide hedge recognitions is discussed later in
this release in connection with Sec. Sec. 150.3 and 150.9.\79\
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\79\ See infra Section II.C. (discussing Sec. 150.3) and
Section II.G. (discussing Sec. 150.9).
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The discussion in this section is organized as follows:
i. This background section discussion;
[[Page 3255]]
ii. An overview of the existing ``general'' elements of the bona
fide hedging definition and the specific ``enumerated'' bona fide
hedges listed in the existing bona fide hedge definition;
iii. A discussion of each of the elements of the existing
``general'' bona fide hedging definition, including the (a) temporary
substitute test (and the related elimination of the risk management
exemption), (b) economically appropriate test, (c) change in value
requirement, (d) incidental test, and (e) orderly trading requirement;
iv. The treatment of unfixed-price transactions under the Final
Rule;
v. A discussion of each enumerated bona fide hedge in the Final
Rule;
vi. A discussion of the elimination of the Five-Day Rule;
vii. A discussion of the guidance on measuring risk (i.e., gross
versus net hedging);
viii. A discussion of the Final Rule's implementation of the CEA's
statutory pass-through swap and pass-through swap offset provisions;
and
ix. A discussion of the form, location, and organization of the
enumerated bona fide hedges.
ii. Overview of the Commission's Existing Bona Fide Hedging Definition
in Sec. 1.3
Paragraph (1) of the existing bona fide hedging definition in
Commission regulation Sec. 1.3 contains what is currently labeled the
``general definition'' of bona fide hedging. This ``general'' bona fide
hedging definition comprises five key elements which require that in
order for a position to be deemed a bona fide hedge for Federal
position limits, the position must:
``normally'' represent a substitute for transactions to be
made or positions to be taken at a later time in a physical marketing
channel (``temporary substitute test'');
be economically appropriate to the reduction of risks in
the conduct and management of a commercial enterprise (``economically
appropriate test'');
arise from the potential change in value of (1) assets
which a person owns, produces, manufactures, processes, or merchandises
or anticipates owning, producing, manufacturing, processing, or
merchandising, (2) liabilities which a person owns or anticipates
incurring, or (3) services which a person provides, purchases, or
anticipates providing or purchasing (``change in value requirement'');
have a purpose to offset price risks incidental to
commercial cash or spot operations (``incidental test''); and
be established and liquidated in an orderly manner
(``orderly trading requirement'').\80\
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\80\ 17 CFR 1.3.
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As discussed more fully below, the Dodd-Frank Act's amendments to
the CEA included the first three factors in the amended CEA, but did
not include the last two factors.
Additionally, paragraph (2) of the bona fide hedging definition in
existing Sec. 1.3 currently sets forth a non-exclusive list of seven
total enumerated bona fide hedges, contained in four general bona fide
hedging transaction categories, that comply with the general bona fide
hedging definition in paragraph (1). These bona fide hedge categories
that are explicitly listed in existing Sec. 1.3's bona fide hedging
definition are generally referred to as the ``enumerated'' bona fide
hedges, a term the Commission uses throughout in this release. Market
participants thus need not seek approval from the Commission of such
positions as bona fide hedges prior to exceeding limits for such
positions. Rather, market participants must simply report any such
positions on the monthly Form 204 (or Form 304 for cotton), as required
by part 19 of the Commission's existing regulations.\81\
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\81\ 17 CFR part 19.
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The seven existing enumerated hedges fall into the following four
categories: (1) Sales of futures contracts to hedge (i) ownership or
fixed-price cash commodity purchases and (ii) unsold anticipated
production; (2) purchases of futures contracts to hedge (i) fixed-price
cash commodity sales of the same commodity, (ii) fixed-price sales of
the cash commodity's cash products and by-products, and (iii) unfilled
anticipated requirements; (3) offsetting sales and purchases of futures
contracts to hedge offsetting unfixed-price cash commodity sales and
purchases; and (4) cross-commodity hedges.\82\
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\82\ 17 CFR 1.3.
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As discussed further below, market participants may not use either
the existing enumerated bona fide hedges for unsold anticipated
production or unfilled anticipated requirements to hedge more than
twelve-months' unsold production or unfilled requirements, respectively
(the ``twelve-month restriction''). Further, the existing enumerated
bona fide hedges for unsold production and for offsetting sales and
purchases of unfixed price transactions do not apply during the five
last trading days. Similarly, the existing enumerated bona fide hedge
for unfilled anticipated requirements has a modified version of the
Five-Day Rule and provides that during the ``five last trading days'' a
market participant may not maintain a position that exceeds the market
participant's unfilled anticipated requirement for ``that month and for
the next succeeding month.''
Paragraph (3) of the current bona fide hedging definition states
that the Commission may recognize ``non-enumerated'' bona fide hedging
transactions and positions pursuant to a specific request by a market
participant using the process described in Sec. 1.47 of the
Commission's regulations.\83\
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\83\ Id.
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iii. Amended Bona Fide Hedge Definition for Physical Commodities in
Sec. 150.1; ``General'' Elements of the Bona Fide Hedge Definition
Under the Final Rule
The Commission is adopting the proposed general elements currently
found in the bona fide hedging definition in Sec. 1.3 that conform to
the revised statutory bona fide hedging definition in CEA section
4a(c)(2), as amended by the Dodd-Frank Act, and is eliminating the
general elements that do not conform.\84\ In particular, the Commission
is adopting updated versions of the temporary substitute test,
economically appropriate test, and change in value requirements that
are described below, and eliminating the incidental test and orderly
trading requirement, which are not included in the revised statutory
text. Each of these changes is discussed in more detail below.\85\
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\84\ The Commission is also making a non-substantive change to
the introductory language of Sec. 150.3 by referring in the proviso
to ``such person's transactions or positions.'' The Commission views
this as a clarifying edit, and does not intend a substantive
difference in meaning with the choice of these terms.
\85\ Bona fide hedge recognition is determined based on the
particular circumstances of a position or transaction and is not
conferred on the basis of the involved market participant alone.
Accordingly, while a particular position may qualify as a bona fide
hedge for a given market participant, another position held by that
same participant may not. Similarly, if a participant holds
positions that are recognized as bona fide hedges, and holds other
positions that are speculative, only the speculative positions would
be subject to position limits.
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a. Temporary Substitute Test
(1) Background--Temporary Substitute Test
The language of the temporary substitute test in the Commission's
existing bona fide hedging definition is inconsistent with the language
of the temporary substitute test that appears in the CEA, as amended by
the Dodd-Frank Act. Specifically, the Commission's existing regulatory
definition currently provides that a bona fide hedging
[[Page 3256]]
position normally represents a substitute for transactions to be made
or positions to be taken at a later time in a physical marketing
channel.\86\ Prior to the enactment of the Dodd-Frank Act, the
temporary substitute test in section 4a(c)(2)(A)(i) of the CEA also
contained the word ``normally,'' so that the Commission's existing bona
fide hedging definition mirrored the previous section 4a(c)(2)(A)(i) of
the CEA prior to the Dodd-Frank Act. The word ``normally'' acted as a
qualifier for the instances in which a position must be a temporary
substitute for transactions or positions made at a later time in a
physical marketing channel. However, the Dodd-Frank Act removed that
qualifier by deleting the word ``normally'' from the temporary
substitute test in CEA section 4a(c)(2)(A)(i).\87\
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\86\ 17 CFR 1.3. As noted earlier in this release, the
currently-in-effect version of the Commission's bona fide hedging
definition does not currently appear in the current Code of Federal
Regulations. The closest to a ``current'' version of the definition
is the 2010 version of Sec. 1.3, which, while substantively
current, still includes the ``(z)'' denomination that was removed in
2018. The Commission proposed to address the need to formally remove
the incorrect version of the bona fide hedging definition as part of
the 2020 NPRM. See supra n.74.
\87\ 7 U.S.C. 6a(c)(2)(A)(i).
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In a 1987 interpretation, the Commission stated that, among other
things, the inclusion of the word ``normally'' in connection with the
pre-Dodd-Frank-Act version of the temporary substitute language
indicated that the bona fide hedging definition should not be construed
to apply only to firms using futures to reduce their exposures to risks
in the cash market.\88\ Instead, the 1987 interpretation took the view
that to qualify as a bona fide hedge, a transaction in the futures
market did not necessarily need to be a temporary substitute for a
later transaction in the cash market.\89\ In other words, that
interpretation took the view that a futures position could still
qualify as a bona fide hedging position even if it was not in
connection with the production, sale, or use of a physical commodity.
---------------------------------------------------------------------------
\88\ See Clarification of Certain Aspects of the Hedging
Definition, 52 FR 27195, 27196 (July 20, 1987).
\89\ Id.
---------------------------------------------------------------------------
Commission staff has previously granted so-called ``risk management
exemptions'' on such grounds. In connection with physical commodities,
the phrase ``risk management exemption'' has historically been used by
Commission staff to refer to non-enumerated bona fide hedge
recognitions granted under Sec. 1.47 to allow swap dealers and others
to hold agricultural futures positions in excess of Federal position
limits in order to offset their positions in commodity index swaps or
related exposure.\90\ Risk management exemptions were granted outside
of the spot month, and the related swap exposure that was being offset
(i.e., hedged by the futures or options position entered into based on
the risk management exemption) was typically opposite an institutional
investor for which the swap was not a bona fide hedge.
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\90\ As described below, due to differences in statutory
language, the phrase ``risk management exemption'' often has a
broader meaning in connection with excluded commodities than with
physical commodities. See infra Section II.A.1.x. (discussing
proposed pass-through language).
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(2) Summary of the 2020 NPRM--Temporary Substitute Test
As described above, the Dodd-Frank Act clearly and unambiguously
removed the word ``normally'' from the temporary substitute test in CEA
section 4a(c)(2)(A)(i), as amended by the Dodd-Frank Act. As such, in
the 2020 NPRM, the Commission interpreted the Dodd-Frank Act's removal
of the word ``normally'' as reflecting Congressional statutory
direction that a bona fide hedging position in physical commodities
must always (and not just ``normally'') be in connection with the
production, sale, or use of a physical cash-market commodity.\91\ The
Commission interpreted this change to signal that the Commission should
cease to recognize ``risk management'' positions as bona fide hedges
for physical commodities, unless the positions satisfy the pass-through
swap/swap offset requirements in section 4a(c)(2)(B) of the CEA,
further discussed below.\92\
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\91\ 85 FR at 11596.
\92\ 7 U.S.C. 6a(c)(2)(B).
---------------------------------------------------------------------------
In order to implement that statutory change, the Commission: (1)
Proposed a narrower bona fide hedging definition for physical
commodities in proposed Sec. 150.1 that did not include the word
``normally'' currently found in the temporary substitute regulatory
language in paragraph (1) of the existing Sec. 1.3 bona fide hedging
definition; and (2) proposed to eliminate all previously-granted risk
management exemptions that did not otherwise qualify for pass-through
treatment.\93\ Under the 2020 NPRM, any such previously-granted risk
management exemption would generally no longer apply 365 days after
publication of final position limits rules in the Federal Register.\94\
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\93\ See final Sec. 150.3(c). See also infra Section
II.A.1.x.b. (discussing proposed pass-through language). Excluded
commodities, as described in further detail below, are not subject
to the statutory bona fide hedging definition. Accordingly, the
statutory restrictions on risk management exemptions that apply to
physical commodities subject to Federal position limits do not apply
to excluded commodities.
\94\ See infra Section II.A.1.iii.a(5) (discussing of revoking
existing risk management exemptions).
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(3) Summary of the Commission Determination--Temporary Substitute Test
As proposed, the Final Rule eliminates the word ``normally'' from
the Commission's temporary substitute test and eliminates the risk
management exemption for contracts subject to Federal position limits.
However, as described below, the Final Rule is extending the compliance
date for existing risk management exemption holders.
(4) Comments--Temporary Substitute Test
Commenters were divided regarding the proposed elimination of the
risk management exemptions. Some public interest groups and the
agricultural industry supported the proposed removal of the word
``normally'' and/or the accompanying rescission of risk management
exemptions.\95\ These commenters argued that risk management positions
are harmful to the market and can adversely impact price dynamics.\96\
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\95\ AMCOT at 1; Ecom at 1; White Gold at 1-2; Walcot at 2; East
Cotton at 2; CMC at 11 (stating that the increased limits and
allowances for pass-through exemptions will limit any potential loss
of liquidity); NCFC at 7 (noting that it supports the elimination in
light of the increased limits); NGFA at 3; LDC at 2; PMAA at 4; ACSA
at 2, 4; IMC at 2; Mallory at 1; McMeekin at 1-2; Memtex at 2;
Omnicotton at 2; NCC at 1; S Canale Cotton at 2; Texas Cotton at 2;
SW Ag at 2; Jess Smith at 2; Choice Cotton at 1; Olam at 1-2; Better
Markets at 4, 51-54 (agreeing with the proposed interpretation that
the Dodd-Frank Act requires the change and stating that the
elimination of the risk management exemption may mean very little in
light of the increased limits); ACA at 2; Moody Compress at 2; Toyo
at 2; and DECA at 1.
\96\ See, e.g., Mallory Alexander at 1; DECA at 1; Ecom at 2;
Southern Cotton at 2; Canale Cotton at 2; ACA at 2; IMC at 2; Olam
at 1-2; Moody Compress at 1; SW Ag at 2; East Cotton at 2; Toyo at
2; Jess Smith at 2; McMeekin at 1-2; Omnicotton at 2; Texas Cotton
at 2; Walcot at 2; White Gold at 1-2; and PMAA at 3-4 (arguing that
risk management positions have the potential to create significant
volatility); Better Markets at 9, 17 (noting the distortive effects
of risk management positions).
---------------------------------------------------------------------------
Commenters from the financial industry, ICE, and MGEX opposed the
proposed removal of ``normally'' and/or the proposed elimination of the
risk management exemption.\97\ These commenters contended that the
elimination of the risk management
[[Page 3257]]
exemption will harm the market, including by reducing liquidity,\98\
and that even though Congress removed ``normally'' from the statute,
Congress did not use the term ``always.'' \99\ One commenter opposed to
the ban claimed that the European Commission is considering revising
MiFID II \100\ to address a ``failure to include an appropriate hedge
exemption for financial risks.'' \101\
---------------------------------------------------------------------------
\97\ ICE at 5-8 (noting that risk management positions are non-
speculative and arguing that the pass-through provision is not an
adequate substitute for such positions); FIA at 10, 21-24; ISDA at
6; PIMCO at 5-6; SIFMA AMG at 8; MGEX at 2.
\98\ FIA at 23-24 (contending that the 2020 NPRM may harm
pension funds and create a bifurcated liquidity pool since dealers
may need to move their hedges from physically-settled to
financially-settled contracts earlier than they would otherwise);
ISDA at 6, 11; PIMCO at 5-6; and ICE at 5-6.
\99\ ISDA at 6; FIA at 21-22; and ICE at 5, 8.
\100\ According to the European Securities and Market Authority,
``MiFID is the Markets in Financial Instruments Directive (2004/39/
EC). It has been applicable across the European Union since November
2007. It is a cornerstone of the EU's regulation of financial
markets seeking to improve their competitiveness by creating a
single market for investment services and activities and to ensure a
high degree of harmonised protection for investors in financial
instruments.'' MiFID sets out: conduct of business and
organisational requirements for investment firms; authorisation
requirements for regulated markets; regulatory reporting to avoid
market abuse; trade transparency obligation for shares; and rules on
the admission of financial instruments to trading.''
``On 20 October 2011, the European Commission adopted a
legislative proposal for the revision of MiFID which took the form
of a revised Directive and a new Regulation. After more than two
years of debate, the Directive on Markets in Financial Instruments
repealing Directive 2004/39/EC and the Regulation on Markets in
Financial Instruments, commonly referred to as MiFID II and MiFIR,
were adopted by the European Parliament and the Council of the
European Union. They were published in the EU Official Journal on 12
June 2014.'' European Securities and Market Authority website at
https://www.esma.europa.eu/policy-rules/mifid-ii-and-mifir.
\101\ SIFMA AMG at 8.
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Finally, several commenters noted that even if the Commission
finalizes the ban as proposed, the Commission should: (i) Revoke the
exemptions gradually so as to avoid disruption; \102\ (ii) clarify that
the Commission maintains the authority under CEA section 4a(a)(7) to
grant risk management exemptions in the future; \103\ and (iii) allow
exchanges to grant risk management exemptions.\104\
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\102\ ISDA at 7.
\103\ ICE at 6; FIA at 3, 22, 24; ISDA at 6-7; and IECA at 12.
\104\ FIA at 3, 22; ISDA at 6-7; and ICE at 5-6.
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(5) Discussion of Final Rule--Temporary Substitute Test
The Commission is eliminating the word ``normally'' from the
Commission's temporary substitute test and eliminating the existing
risk management exemption for contracts subject to Federal position
limits as proposed. However, as described below, the Commission is
extending the compliance date by which positions based on existing risk
management exemptions must be reduced to levels that comply with the
applicable Federal position limits. While the Commission appreciates
commenter concerns regarding the elimination of the risk management
exemption, the Commission interprets the Dodd-Frank Act's removal of
the word ``normally'' from the CEA's statutory temporary substitute
test as signaling Congressional intent to reverse the flexibility
afforded by the presence of the word ``normally'' prior to the Dodd-
Frank Act. As such, even were the Commission inclined to retain the
status quo of risk management exemptions, the Commission's statutory
interpretation prevents it from doing so.
Further, retaining such exemptions for swap intermediaries, without
regard to the purpose of their counterparties' swaps, would not only be
inconsistent with the post-Dodd-Frank Act version of the temporary
substitute test, but would also be inconsistent with the statutory
restrictions on pass-through swap offsets. In particular, the statutory
pass-through provision requires that the swap position being offset
qualify as a bona fide hedging position.\105\ Many risk management
exemptions have been used to offset swap positions that would not
qualify as bona fide hedging positions.
---------------------------------------------------------------------------
\105\ See 7 U.S.C. 6a(c)(2)(B)(i) (was executed opposite a
counterparty for which the transaction would qualify as a bona fide
hedging transaction). The pass-through swap offset language in the
Final Rule's bona fide hedging definition is discussed in greater
detail below.
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In response to the comment regarding a potential expansion of MiFID
II to accommodate activity akin to risk management exemptions, the
Commission believes that the European Commission's stated posture does
not appear to contemplate a blanket exemption for financial risks as
suggested by the commenter. Instead, the European Commission's approach
appears to be largely consistent with the narrower pass-through
approach adopted by the Commission in this Final Rule.\106\
---------------------------------------------------------------------------
\106\ See MiFID II Review report on position limits and position
management (April 1, 2020), available at https://www.esma.europa.eu/sites/default/files/library/esma70-156-2311_mifid_ii_review_report_position_limits.pdf. The exemption under
consideration for financial counterparties appears to be in line
with the Final Rule's pass-through provision, in that the
``exemption would apply to the positions held by that financial
counterparty that are objectively measurable as reducing risks
directly related to the commercial activities of the non-financial
entities of the group . . . . this hedging exemption should not be
considered as an additional exemption to the position limit regime
but rather as a `transfer' to the financial counterparty of the
group of the hedging exemption otherwise available to the commercial
entities of the group.'' Id. at 32-33.
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The Commission is, however, making several changes and
clarifications to address commenter concerns:
First, the Commission is extending the compliance date by which
risk management exemption holders must reduce their risk management
exemption positions to comply with Federal position limits under the
Final Rule to January 1, 2023.\107\ This provides approximately two
years beyond the Effective Date for the nine legacy agricultural
contracts.\108\ The Commission believes that this will provide
sufficient time for existing positions to roll off and/or be replaced
with positions that conform with the Federal position limits adopted in
this Final Rule, without adversely affecting market liquidity.
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\107\ For clarity, a risk management exemption holder may enter
into new positions based on, and in accordance with, its previously-
granted risk management exemption, during this compliance period,
until January 1, 2023.
\108\ For further discussion of the Final Rule's compliance and
effective dates, see Section I.D. Both existing risk management
exemptions, as discussed herein, and swap positions, will be subject
to the extended compliance data to January 1, 2023.
---------------------------------------------------------------------------
Second, including pass-through swaps and pass-through swap offsets
within the definition of a bona fide hedge will mitigate some of the
potential impact resulting from the rescission of the risk management
exemption. The Final Rule's pass-through provisions should help address
certain of the hedging needs of persons seeking to offset the risk from
swap books, allowing for sufficient liquidity in the marketplace for
both bona fide hedgers and their counterparties.
Third, although the Commission will no longer recognize risk
management positions as bona fide hedges under this Final Rule, the
Commission maintains other authorities, including the authority under
CEA section 4a(a)(7), to exempt risk management positions from Federal
position limits.
Finally, consistent with existing industry practice, exchanges may
continue to recognize risk management positions for contracts that are
not subject to Federal position limits, including for excluded
commodities.
b. Economically Appropriate Test
(1) Background--Economically Appropriate Test
The statutory and regulatory bona fide hedging definitions in
section 4a(c)(2)(A)(ii) of the CEA and in existing Sec. 1.3 of the
Commission's regulations both provide that a bona fide hedging position
must be economically
[[Page 3258]]
appropriate to the reduction of risks in the conduct and management of
a commercial enterprise.\109\ The Commission has, when defining bona
fide hedging, historically focused on transactions that offset price
risk.\110\
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\109\ 7 U.S.C. 6a(c)(2)(A)(ii) and 17 CFR 1.3.
\110\ For example, in promulgating existing Sec. 1.3, the
Commission explained that a bona fide hedging position must, among
other things, be economically appropriate to risk reduction, such
risks must arise from operation of a commercial enterprise, and the
price fluctuations of the futures contracts used in the transaction
must be substantially related to fluctuations of the cash-market
value of the assets, liabilities or services being hedged. Bona Fide
Hedging Transactions or Positions, 42 FR 14832, 14833 (Mar. 16,
1977) (emphasis added). ``Value'' is generally understood to mean
price times quantity. The Dodd-Frank Act added CEA section 4a(c)(2),
which copied the economically appropriate test from the Commission's
definition in Sec. 1.3. See also 78 FR at 75702, 75703 (stating
that the core of the Commission's approach to defining bona fide
hedging over the years has focused on transactions that offset a
recognized physical price risk).
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(2) Summary of the 2020 NPRM--Economically Appropriate Test
In the 2020 NPRM, the Commission proposed to amend the economically
appropriate prong of the bona fide hedge definition with one
clarification: Consistent with the Commission's longstanding practice
regarding what types of risk may be offset by bona fide hedging
positions in excess of Federal position limits,\111\ the Commission
made explicit in the proposed bona fide hedging definition that the
word ``risks'' refers to, and is limited to, ``price risk.'' This
proposed clarification did not reflect a change in policy, as the
Commission has a longstanding policy that hedges of non-price risk
alone cannot be recognized as bona fide hedges.\112\
---------------------------------------------------------------------------
\111\ See, e.g., 78 FR at 75709, 75710.
\112\ See supra n.109 for further discussion on the Commission's
longstanding policy regarding ``price'' risk.
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As stated in the 2020 NPRM, the Commission clarified its view that
risk must be limited to price risk for purposes of the economically
appropriate test due to the difficulty that the Commission or exchanges
may face in objectively evaluating whether a particular derivatives
position is economically appropriate to the reduction of non-price
risks. For example, the Commission or an exchange's staff can
objectively evaluate whether a particular derivatives position is an
economically appropriate hedge of a price risk arising from an
underlying cash-market transaction, including by assessing the
correlations between the risk and the derivatives position. It would be
more difficult, if not impossible, to objectively determine whether an
offset of non-price risk is economically appropriate for the underlying
risk.
Finally, the Commission requested comment on whether price risk is
attributable to a variety of factors, including political and weather
risk, and could therefore allow hedging political, weather, or other
risks, or whether price risk is something narrower in the application
of bona fide hedging.\113\
---------------------------------------------------------------------------
\113\ 85 FR at 11622.
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(3) Summary of the Commission Determination--Economically Appropriate
Test
The Commission is adopting the economically appropriate prong of
the bona fide hedge definition as proposed. However, as discussed
below, the Commission is clarifying in response to commenter requests
that while the Commission is explicitly limiting ``risks'' to ``price
risks'' as used in the economically appropriate test, the Commission
recognizes that price risk can be informed and impacted by various
other types of non-price risk.
(4) Comments--Economically Appropriate Test
The Commission received comments from market participants seeking
greater clarity with respect to the Commission's proposed reference to
``price risk'' in the context of applying the ``economically
appropriate'' test in the bona fide hedging definition. Many commenters
stated that the economically appropriate test should include offsets of
non-price risk.\114\ Other commenters stated that a variety of non-
price risk factors (i) actually affect price risk and therefore are
objective,\115\ or (ii) are simply another form of price risk and
therefore should be permitted.\116\
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\114\ MGEX at 2; NGSA at 5-6; CHS at 3; NCFC at 2; FIA at 10-11;
CMC at 3; LDC at 2; ICE at 4; IFUS at Exhibit 1 RFC (6).
\115\ FIA at 10-11 (Stating that, ``[T]he Commission should
recognize that the statutory definition of a bona fide hedging
position encompasses the reduction of all risks that affect the
value of a cash-market position, including time risk, location risk,
quality risk, execution and logistics risk, counterparty credit
risk, weather risk, sovereign risk, government policy risk (e.g., an
embargo), and any other risks that affect price. These are
objective, rather than subjective, risks that commercial enterprises
incur on a regular basis in connection with their businesses as
producers, processors, merchants handling, and users of commodities
that underlie the core referenced futures contracts'').
\116\ ADM at 5.
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For example, ADM stated that when market participants discuss
``risks'' such as political, weather, delivery, transportation, and
more, they are discussing the impact these factors may have on the
price.\117\ Hence the risk being hedged is price risk as influenced by
these factors.\118\ Other commenters stated that market participants
should have the flexibility to measure risk in the manner most suitable
for their business.\119\ In addition, commenters also stated they were
not opposed to ``price risk'' so long as the Commission clarified that
price risk is not static or an absolute objective measure, and
consequently that the term ``price risks'' incorporates a commercial
hedger's independent assessment of price risk.\120\
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\117\ Id.
\118\ ADM at 5.
\119\ LDC at 2.
\120\ CMC at 3.
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In contrast, Better Markets supported the 2020 NPRM's rationale to
permit only ``price risk.'' \121\ Better Markets also suggested that
the Commission clarify that the term ``commercial enterprise'' refers
to ``solely [a] transaction or position that would be directly and
demonstrably risk reducing to `cash or spot operations' for physical
commodities underlying the contracts'' to be hedged.\122\
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\121\ Better Markets at 52-53.
\122\ Better Markets at 53.
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Finally, ICE, MGEX, and FIA requested that if the Commission adopts
the proposed economically appropriate prong, the Commission should
permit market participants to use the non-enumerated bona fide hedge
process to receive recognition of bona fide hedges of non-price risk on
a case-by-case basis.\123\
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\123\ MGEX at 2; FIA at 11.
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(5) Discussion of the Final Rule--The Bona Fide Hedging Definition's
``Economically Appropriate Test''
The Commission is adopting the economically appropriate prong of
the bona fide hedging definition as proposed, codifying existing
practice, as well as existing Sec. 1.3's treatment of price risk, by
making it explicit in the rule text that the word ``risks'' refers to,
and is limited to, ``price risk.''
The Commission emphasizes that the Final Rule is not intended to
represent a change to the Commission's existing interpretation of the
economically appropriate prong of bona fide hedging, but rather is
maintaining the application of the economically appropriate test in
connection with bona fide hedges on the nine legacy agricultural
contracts to the 16 new non-legacy core referenced futures contracts.
In promulgating existing Sec. 1.3, the Commission explained that a
bona fide hedging position must, among other things, ``be economically
appropriate to risk reduction, such risks must arise from operation of
a commercial
[[Page 3259]]
enterprise, and the price fluctuations of the futures contracts used in
the transaction must be substantially related to fluctuations of the
cash-market value of the assets, liabilities or services being
hedged.'' \124\ (emphasis added). Consistent with this longstanding
policy of the Commission to recognize hedges of price risk of an
underlying commodity position as bona fide hedges (and consistent with
the Commission's existing application of bona fide hedging to the nine
legacy agricultural contracts under the existing Federal position limit
regulations), the Commission is also clarifying further below that
price risk can be informed and impacted by various other types of
risks.
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\124\ Bona Fide Hedging Transactions or Positions, 42 FR 14832,
14833 (Mar. 16, 1977) (emphasis added). ``Value'' is generally
understood to mean price times quantity. The Dodd-Frank Act added
CEA section 4a(c)(2), which copied the economically appropriate test
from the Commission's definition in Sec. 1.3. See also 78 FR at
75702, 75703 (stating that the ``core of the Commission's approach
to defining bona fide hedging over the years has focused on
transactions that offset a recognized physical price risk'').
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As the Commission stated in the 2020 NPRM and continues to believe,
for any given non-price risk, such as geopolitical turmoil, weather, or
counterparty credit risks, there could be multiple commodities,
directions, and contract months which a particular market participant
may subjectively view as an economically appropriate offset for that
non-price risk. Moreover, multiple market participants faced with the
same non-price risk might take different views on which offset is the
most effective.\125\ A system of allowing for bona fide hedges based
solely by reference to such non-price risks would be difficult to
administer on a pragmatic and consistently fair basis.
---------------------------------------------------------------------------
\125\ 85 FR at 11606.
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Further, it also would be difficult to evaluate whether a
particular commodity derivative contract would be the proper offset as
a bona fide hedge, as defined in this Final Rule, to a potential non-
price risk, or would remove exposure to the potential change in value
to the market participant's cash positions resulting from the non-price
risk. Thus, hedging solely to protect against changes in value of non-
price risks would fall outside the category of a bona fide hedge which
offsets the ``price risk'' of an underlying commodity cash position.
However, the Commission agrees with commenters who stated that
market participants form independent economic assessments of how
different possible events might create potential risk exposures for
their business.\126\ Such risks that create or impact the price risk of
underlying cash commodities may include, but are not limited to,
geopolitical turmoil, weather, or counterparty credit risks. The
Commission recognizes that these risks can create price risks and
understands that firms may manage these potential risks to their
businesses differently and in the manner most suitable for their
business. As noted above, by limiting the economically appropriate
prong to price risk, the Commission is reiterating its historical
practice, which has applied well to the legacy agricultural contracts
for decades, to recognize hedges of price risk of an underlying
commodity position as bona fide hedges while acknowledging that price
risk may itself be impacted by non-price risks.
---------------------------------------------------------------------------
\126\ CMC at 3.
---------------------------------------------------------------------------
The foregoing discussion of price risk is limited to the question
of whether a position in a referenced contract meets the economically
appropriate test to satisfy the bona fide hedge requirements. Market
participants may thus continue to manage non-price risks in a variety
of ways, which may include participation in the futures markets or
exposure to other financial products. In fact, market participants may
decide to use futures contracts that are not subject to Federal
position limits (e.g., location basis contracts), if they determine
such contracts will help them manage non-price risks faced by their
businesses.\127\ For example, a market participant seeking to manage
risk, including non-price risk, with positions in contracts that are
not referenced contracts, such as freight or weather derivatives, would
not be subject to Federal speculative position limits and thus would
not need to comply with the economically appropriate test in connection
with such positions in non-referenced contracts.
---------------------------------------------------------------------------
\127\ The enumerated cross-commodity hedge provision adopted
herein and discussed below offers may also offer additional
flexibility to those market participants using referenced contracts
to manage risk, by allowing market participants to hedge price risk
associated with a particular commodity using a derivative contract
based on a different commodity, assuming all applicable requirements
of the cross-commodity enumerated bona fide hedge are met.
---------------------------------------------------------------------------
To satisfy the economically appropriate test, a position must
ultimately offset the price risk of an underlying cash commodity.\128\
Non-price risk may also be a consideration in hedging decisions, but
cannot be a substitute for price risk associated with the cash
commodity underlying the derivatives position. The foregoing view
precludes the Commission from adopting commenter suggestions to permit
market participants to use the non-enumerated hedge process to receive
recognition of hedges of non-price risk on a case-by-case basis
because, while the Commission acknowledges that price risk can be
informed and impacted by non-price risk, price risk is required to
satisfy the economically appropriate test.
---------------------------------------------------------------------------
\128\ This view is consistent with the spirit of Better Market's
comment suggesting a focus on reducing risks associated with a cash-
market position in a physical commodity. See Better Markets at 53.
---------------------------------------------------------------------------
c. Change in Value Requirement
(1) Background--Change in Value Requirement
CEA section 4a(c)(2)(A)(iii) and existing Sec. 1.3 include the
``change in value requirement,'' which provides that the bona fide
hedging position must arise from the potential change in the value of:
(I) Assets that a person owns, produces, manufactures, processes, or
merchandises or anticipates owning, producing, manufacturing,
processing, or merchandising; (II) liabilities that a person owns or
anticipates incurring; or (III) services that a person provides,
purchases, or anticipates providing or purchasing.\129\
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\129\ 7 U.S.C. 6a(c)(2)(A)(iii), 17 CFR 1.3.
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(2) Summary of the 2020 NPRM--Change in Value Requirement
The Commission proposed to retain the substance of the change in
value requirement in existing Sec. 1.3, with some non-substantive
technical modifications, including modifications to correct a
typographical error.\130\ Aside from the typographical error, the
proposed Sec. 150.1 change in value requirement mirrors the Dodd-Frank
Act's change in value requirement in CEA section 4a(c)(2)(A)(iii).
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\130\ The Commission proposed to replace the phrase
``liabilities which a person owns,'' which appears in the statute
erroneously, with ``liabilities which a person owes,'' which the
Commission believed was the intended wording (emphasis added). The
Commission interpreted the word ``owns'' to be a typographical
error. A person may owe on a liability, and may anticipate incurring
a liability. If a person ``owns'' a liability, such as a debt
instrument issued by another, then such person owns an asset. The
fact that assets are included in CEA section 4a(c)(2)(A)(iii)(I)
further reinforces the Commission's interpretation that the
reference to ``owns'' means ``owes.'' The Commission also proposed
several other non-substantive modifications in sentence structure to
improve clarity.
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(3) Summary of the Commission Determination--Change in Value
Requirement
For the same reasons set out in the 2020 NPRM, the Commission is
adopting the change in value
[[Page 3260]]
requirement of the bona fide hedge definition as proposed.
(4) Comments--Change in Value Requirement
No specific comments on the change in value requirement were
received.
d. Incidental Test and Orderly Trading Requirement
(1) Background--Incidental Test and Orderly Trading Requirement
Two general requirements contained in the existing Sec. 1.3
definition of bona fide hedging position include: (I) The incidental
test and (II) the orderly trading requirement. For a position to be
recognized as a bona fide hedging position, the incidental test
requires that the purpose is to offset price risks incidental to
commercial cash, spot, or forward operations.
Under the orderly trading requirement, such position is established
and liquidated in an orderly manner in accordance with sound commercial
practices. Notably, Congress in the Dodd-Frank Act did not include the
incidental test or the orderly trading requirement in the statutory
bona fide hedging definition in CEA section 4a(c)(2).\131\
---------------------------------------------------------------------------
\131\ 7 U.S.C. 6a(c)(2).
---------------------------------------------------------------------------
(2) Summary of the 2020 NPRM--Incidental Test and Orderly Trading
Requirement
While the Commission proposed to maintain the substance of the
three core elements of the existing bona fide hedging definition
described above, with some modifications, the Commission also proposed
to eliminate two elements contained in the existing Sec. 1.3
definition: The incidental test and orderly trading requirement that
currently appear in paragraph (1)(iii) of the Sec. 1.3 bona fide
hedging definition.\132\
---------------------------------------------------------------------------
\132\ 17 CFR 1.3.
---------------------------------------------------------------------------
(3) Summary of the Commission Determination--Incidental Test and
Orderly Trading Requirement
The Commission is eliminating the incidental test and orderly
trading requirement from the bona fide hedge definition as proposed.
(4) Comments--Incidental Test and Orderly Trading Requirement
NGSA supported elimination of the incidental test and orderly
trading requirement, claiming that the changes will facilitate
hedging,\133\ while IATP and Better Markets opposed the removal of
these provisions, contending that the provisions are important for
preventing market disruption.\134\
---------------------------------------------------------------------------
\133\ NGSA at 4.
\134\ IATP at 14-15; Better Markets at 53.
---------------------------------------------------------------------------
(5) Discussion of the Final Rule--Incidental Test and Orderly Trading
Requirement
The Commission is eliminating the incidental test and orderly
trading requirement from the bona fide hedge definition as proposed. As
noted above, neither the incidental test nor orderly trading
requirement is part of the CEA's current statutory definition of bona
fide hedge. The Commission views the incidental test as redundant
because the Commission proposed to maintain both (1) the change in
value requirement (as noted above, the reference to ``value'' in the
change in value requirement is generally understood to mean price per
unit times quantity of units) as well as (2) the economically
appropriate test (which includes the concept of the offset of price
risks in the conduct and management of, i.e., incidental to, a
commercial enterprise).
In response to IATP and Better Markets, the Commission does not
view the orderly trading requirement as needed to prevent market
disruption. The statutory bona fide hedging definition does not include
an orderly trading requirement,\135\ and the meaning of ``orderly
trading'' is unclear in the context of the OTC swap market and in the
context of permitted off-exchange transactions, such as exchange for
physicals. The elimination of the orderly trading requirement does not
diminish an exchange's obligation to prohibit any disruptive trading
practices, including a case where an exchange believes that a bona fide
hedge position may result in disorderly trading. Further, in
eliminating the orderly trading requirement from the definition in the
regulations, the Commission is not amending or modifying
interpretations of any other related requirements, including any of the
anti-disruptive trading prohibitions in CEA section 4c(a)(5),\136\ or
any other statutory or regulatory provisions.
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\135\ The orderly trading requirement was added as a part of the
regulatory definition of bona fide hedging in 1975; see Hedging
Definition, Reports, and Conforming Amendments, 40 FR 11560 (Mar.
12, 1975). Prior to 1974, the orderly trading requirement was found
in the statutory definition of bona fide hedging position; changes
to the CEA in 1974 removed the statutory definition from CEA section
4a(3).
\136\ 7 U.S.C. 6c(a)(5).
---------------------------------------------------------------------------
Taken together, the retention of the updated temporary substitute
test, economically appropriate test, and change in value requirement,
coupled with the elimination of the incidental test and orderly trading
requirement, should reduce uncertainty by eliminating provisions that
do not appear in the statute, and by clarifying the language of the
remaining provisions. By reducing uncertainty surrounding some parts of
the bona fide hedging definition for physical commodities, the
Commission anticipates that, as described in greater detail elsewhere
in this release, it would be easier going forward for the Commission,
exchanges, and market participants to address whether novel trading
practices or strategies may qualify as bona fide hedges.
iv. Treatment of Unfixed Price Transactions Under the Final Rule
a. Background and Summary of Commission Determination--Treatment of
Unfixed Price Transactions
The Commission has a long history of recognizing fixed-price
commitments as the basis for a bona fide hedge.\137\ While the existing
bona fide hedging definition in Sec. 1.3 includes one enumerated hedge
that explicitly mentions ``unfixed'' prices,\138\ the availability of
this hedge is limited to circumstances where a market participant has
both an unfixed-price purchase and an unfixed-price sale on hand,
precluding a market participant with only an unfixed-price purchase or
an unfixed-price sale from qualifying for this particular enumerated
hedge. Further, the extent to which the other existing enumerated
hedges apply to unfixed-price commitments is ambiguous from the plain
reading of the text of the existing bona fide hedging definition.
---------------------------------------------------------------------------
\137\ See, e.g., paragraphs (2)(i)(A) and (2)(ii)(A) of existing
Sec. 1.3.
\138\ See paragraph (2)(iii) of existing Sec. 1.3 (Offsetting
sales and purchases for future delivery on a contract market which
do not exceed in quantity that amount of the same cash commodity
which has been bought and sold at unfixed prices basis different
delivery months of the contract market)
---------------------------------------------------------------------------
However, Commission staff have previously considered the extent to
which market participants with unfixed-price commitments may qualify
for an enumerated hedge. Commission staff issued interpretive letter
12-07 in 2012 (``Staff Letter No. 12-07'') in response to a narrow
question submitted by a market participant regarding qualifying for the
existing enumerated unfilled anticipated requirements bona fide hedge
\139\ while entering into ``unfixed-
[[Page 3261]]
price transactions.'' \140\ In that interpretive letter, staff
clarified that a commercial entity may qualify for the existing
enumerated bona fide hedge for unfilled anticipated requirements even
if the commercial entity has entered into long-term, unfixed-price
supply or requirements contracts because, as staff explained, the
unfixed-price purchase contract does not ``fill'' the commercial
entity's anticipated requirements.\141\ As explained in Staff Letter
No. 12-07, the price risk of such ``unfilled'' anticipated requirements
is not offset by the unfixed-price forward contract because the price
risk remains with the commercial entity, even though the entity has
contractually assured a supply of the commodity.\142\ Instead, the
price risk continues until the unfixed-price contract's price is
fixed.\143\ Once the price is fixed on the supply contract, the
commercial entity no longer has price risk, and its derivative
position, to the extent the position is above an applicable position
limit, and unless the market participant qualifies for another
exemption (as discussed below), must be liquidated in an orderly manner
in accordance with sound commercial practices.\144\
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\139\ Paragraph (2)(ii)(C) of existing Sec. 1.3 provides in
relevant part that the bona fide hedging definition includes
purchases which do not exceed in quantity Twelve months' unfilled
anticipated requirements of the same cash commodity for processing,
manufacturing, or feeding by the same person.
\140\ CFTC Staff Letter 12-07, issued August 16, 2012, https://www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm, title
search ``12-07.''
\141\ CFTC Staff Letter 12-07 at 1.
\142\ CFTC Staff Letter 12-07 at 1-2. In the 2016 Reproposal,
the Commission affirmed staff's interpretation articulated in Staff
Letter No. 12-07. See 81 FR at 96750.
\143\ CFTC Staff Letter 12-07 at 2.
\144\ Id. at 2-3.
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As discussed below, the Commission is affirming this narrow
interpretation for the Final Rule--that commercial entities that enter
into unfixed-price transactions may continue to qualify for the
enumerated bona fide hedge for unfilled anticipated requirements--and
the Commission is adopting this rationale to also apply to: (1) The
existing enumerated bona fide hedge for unsold anticipated production;
\145\ and (2) the new enumerated bona fide hedge for anticipated
merchandising.\146\ In other words, under this Final Rule, a commercial
market participant in the physical marketing channel that enters into
an unfixed-price transaction may qualify for one of these enumerated
anticipatory bona fide hedges, as long as the commercial market
participant otherwise satisfies all applicable requirements for such
anticipatory bona fide hedge.
---------------------------------------------------------------------------
\145\ For further discussion regarding the enumerated bona fide
hedge for ``unsold anticipated production,'' see Section
II.A.1.vi.d.
\146\ For further discussion regarding the new enumerated bona
fide hedge for ``anticipated merchandising,'' see Section
II.A.1.vi.f.
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For this section of the release, the Commission will refer to the
enumerated bona fide hedges for anticipated unfilled requirements,
anticipated unsold production, and anticipated merchandising,
collectively, as the ``anticipatory bona fide hedges.'' Additionally,
by using the term ``unfixed-price transaction,'' the Commission means a
forward contract (i.e., a firm commitment) at an open price or at a
price to be determined at a later date (for example, by reference to an
index based on the settlement price of a corresponding futures
contract).
The Commission discusses the 2020 NPRM's general treatment of
unfixed price transactions below, followed by a summary of comments and
the Commission's determination on the issue of unfixed-price
transactions generally. A more detailed discussion of each specific
enumerated hedge, including the three anticipatory bona fide hedges,
appears further below.
b. Summary of the 2020 NPRM--Treatment of Unfixed Price Transactions
Like the bona fide hedging definition in existing Sec. 1.3, the
proposed bona fide hedging definition in Sec. 150.1 of the 2020 NPRM
included one enumerated hedge addressing unfixed-price transactions,
which required offsetting unfixed-price purchase and sale
transactions.\147\ Aside from that one enumerated bona fide hedge, the
other proposed bona fide hedges did not specify whether a market
participant with an unfixed-price transaction could qualify for a bona
fide hedge exemption, including any of the proposed anticipatory bona
fide hedges.
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\147\ See proposed paragraph (a)(2) of Appendix A to part 150.
Like the existing enumerated hedge in paragraph (2)(iii) of Sec.
1.3, this proposed enumerated hedge was limited to circumstances
where a market participant has both an unfixed-price purchase and an
unfixed-price sale in hand. This specific proposed enumerated bona
fide hedge, along with all other proposed enumerated hedges, is
described in detail further below.
---------------------------------------------------------------------------
However, the 2020 NPRM did preliminarily and indirectly address
previous queries on the matter of unfixed-price transactions. In
particular, the 2020 NPRM addressed a petition for exemptive relief
submitted in response to the 2011 Final Rule. In that petition, the
Working Group of Commercial Energy Firms (which has since reconstituted
itself as the Commercial Energy Working Group, or ``CEWG'') requested
exemptive relief for transactions that are described by 10 examples set
forth therein as bona fide hedging transactions (``BFH
Petition'').\148\
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\148\ The Working Group BFH Petition is available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/wgbfhpetition012012.pdf. In the 2013 Proposal, the Commission
provided that the transactions contemplated under the working
group's examples Nos. 1, 2, 6, 7 (scenario 1), and 8 would be
permitted under the proposed definition of bona fide hedging. In the
2020 NPRM, the Commission preliminarily determined that transactions
described in four additional CEWG examples would comply with the
proposed expanded bona fide hedging definition in the 2020 NPRM:
examples #4 (Binding, Irrevocable Bids or Offers), #5 (Timing of
Hedging Physical Transactions), #9 (Holding a cross-commodity hedge
using a physical delivery contract into the spot month) and #10
(Holding a cross-commodity hedge using a physical delivery contract
to meet unfilled anticipated requirements).
---------------------------------------------------------------------------
In the 2020 NPRM, the Commission preliminarily determined that
commodity derivative positions described in two examples related to
unfixed-price transactions did not fit within any of the proposed
enumerated hedges. Specifically, the Commission preliminarily
determined that the positions described in examples #3 (unpriced
physical purchase or sale commitments) and #7 (scenario 2) (use of
physical delivery referenced contracts to hedge physical transactions
using calendar month average pricing) of the BFH Petition did not fit
within any of the proposed enumerated bona fide hedges, but that market
participants could apply for a non-enumerated exemption.\149\
---------------------------------------------------------------------------
\149\ 85 FR at 11612.
---------------------------------------------------------------------------
The Commission requested comment on the extent to which the
proposed enumerated bona fide hedges should encompass the types of
positions discussed in examples #3 (unpriced physical purchase or sale
commitments) and #7 (scenario 2) (use of physical delivery reference
contracts to hedge physical transactions using calendar month averaging
pricing) of the CEWG's BFH Petition.\150\
---------------------------------------------------------------------------
\150\ 85 FR at 11622.
---------------------------------------------------------------------------
c. Comments--Treatment of Unfixed Price Transactions
In response to the 2020 NPRM, many commenters requested the
Commission either clarify or make explicit that the proposed bona fide
hedge definition would apply to commodity derivatives contracts used to
hedge exposure to price risk arising from unfixed-price
transactions.\151\
---------------------------------------------------------------------------
\151\ See, e.g., Ecom at 1; ACA at 2; CEWG at 22-24; Chevron at
11; CME Group at 8-9; DECA at 2; East Cotton at 2; Gerald Marshall
at 2; IFUS at 5-7; IMC at 2; Jess Smith at 2; LDC at 2; Mallory
Alexander at 2; McMeekin at 2; Memtex at 2; Moody Compress 1; NCC at
1; NGFA at 7; Olam at 2; Omnicotton at 2; Canale Cotton at 2; Shell
at 7; Southern Cotton at 2; Suncor at 7; SW Ag at 2; Toyo at 2;
Texas Cotton at 2; Walcot at 2; White Gold at 2.
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[[Page 3262]]
Several commenters provided various examples in support of their
requests that the Commission recognize that unfixed price transactions
may serve as the basis for an enumerated bona fide hedge position for
purposes of Federal position limits.\152\
---------------------------------------------------------------------------
\152\ CMC at 4; FIA at 16; ICE at 4-5; ACSA at 6-7; ADM at 3;
CME Group at 8-9; CEWG at 19-21.
---------------------------------------------------------------------------
Comments on the treatment of unfixed price transactions often were
submitted in connection with discussions on the scope of the proposed
enumerated bona fide hedge for anticipated merchandising. As discussed
further below, under the Final Rule's enumerated anticipated
merchandising bona fide hedge section, many commenters requested the
Commission clarify whether the proposed enumerated hedge for
anticipated merchandising could be used to manage price risk arising
from unfixed-price physical commodity transactions.
With regards to CEWG's BFH Petition example #3 (unpriced physical
purchase or sale commitments), many commenters disagreed with the
Commission's preliminary determination in the 2020 NPRM that this type
of transaction would not qualify for an enumerated bona fide hedge.
Generally, commenters expressed the view that unfixed-price
transactions for physical commodities are a common and standard market
practice. The CEWG indicated that unfixed physical purchase or sale
commitments are routinely conducted in numerous markets and commodities
on a daily basis.\153\
---------------------------------------------------------------------------
\153\ CEWG at 20 (also providing a similar example as it
submitted in the original petition which included Example #3
(unpriced physical purchase and sale commitments)).
---------------------------------------------------------------------------
Similar to the BFH Petition's example #3 (unpriced physical
purchase or sale commitments), ACSA provided examples intended to
demonstrate that merchants are exposed to calendar spread and supply
price risk because they typically fulfill sales contracts by selling a
commodity for future delivery in advance of purchasing the commodity
needed to fulfill the sale.\154\ ACSA, along with other
commenters,\155\ stated that unfixed-price transactions for the
purchase or sale of the physical commodities are common, where a market
participant buys the commodity at a price that is based on (i.e., is
``indexed'' to) the settlement price of the nearby (or spot) futures
month contract and later sells the commodity at a price that is indexed
to the deferred month futures contract. ACSA and other commenters
indicated that merchants do this to ``effectively bridge the gap
between timing mismatches of supply and demand in the global
marketplace.'' \156\
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\154\ ACSA at 12-14; Several commenters concurred with ACSA
regarding exposure to calendar spread. Mallory Alexander at 2; DECA
at 2; CMC at 4; IMC at 2; Olam at 2; SW Ag at 2; White Gold at 2;
Walcot at 2.
\155\ ACSA at 4-7; CMC at 4; Mallory Alexander at 2; DECA at 2;
IMC at 2; Olam at 2; SW Ag at 2; White Gold at 2; Walcot at 2.
\156\ ACSA at 5.
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Related to the BFH Petition example #7 (scenario 2) (use of
physical delivery reference contracts to hedge physical transactions
using calendar month averaging pricing ``CMA''), commenters requested
that the Commission clarify that hedges of underlying physical
transactions that utilize CMA pricing structures fall within the
enumerated bona fide hedge for anticipated merchandising.\157\ Chevron
requested the Commission clarify that commercial firms that price
commercial transactions to purchase or sell physical crude oil or
natural gas using a CMA pricing structure (whether they are solely
merchants or conduct merchant activities as part of an integrated
energy company), should receive bona fide hedge treatment for their
commodity derivative contract positions that offset the risks arising
from those CMA priced purchases or sales.\158\
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\157\ MGEX at 2; IMC at 2; Mallory Alexander at 2; Walcot at 2;
White Gold at 2; Olam at 2; LDC at 1; Canale at 2; Moody Compress at
1; Gerald Marshall at 2; SW Ag at 2; DECA at 2; Chevron at 12;
Suncor at 11; CEWG at 21.
\158\ Chevron at 11.
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Similarly, other commenters asked for clarification regarding
whether the existing enumerated bona fide hedge for unfilled
anticipated requirement extends to scenarios that involve unfixed-price
contracts that many electric generators enter into to address their
anticipated supply requirements.\159\ These commenters asked for
clarification that unfixed-price purchase commitments do not ``fill''
an anticipated requirement such that the market participant would be
able to still qualify for the enumerated unfilled anticipated
requirement bona fide hedge.\160\
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\159\ EPSA at 5; IECA at 8.
\160\ Id.
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d. Discussion of Final Rule--Treatment of Unfixed Price Transactions
As discussed above, the Commission is affirming and broadening the
application of the interpretation articulated in Staff Letter No. 12-
07. As a result, commercial market participants in the physical
marketing channel that enter into unfixed price transactions may
qualify for bona fide hedge treatment under the enumerated bona fide
hedges for anticipatory merchandising, anticipated unsold production,
or anticipated unfilled requirements because, as discussed below,
unfixed price transactions do not give rise to outright price risk and
do not otherwise fix an outright price.\161\
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\161\ As a result, based on this rationale, a commercial market
participant that has an unfixed-price commitment is treated the same
as a commercial market participant that has no unfixed-price
commitment for purposes of determining whether one qualifies for
these enumerated anticipatory bona fide hedges.
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Consistent with Staff Letter No. 12-07, commercial market
participants in the physical marketing channel that enter into unfixed-
price transactions may continue to qualify for the enumerated bona fide
hedge for unfilled anticipated requirements for those unfixed price
transactions. Further, the Commission is broadening this rationale to
additionally include the existing enumerated bona fide hedge for
``unsold anticipated production'' \162\ and the new enumerated bona
fide hedge for anticipated merchandising.\163\ A commercial market
participant that enters into an unfixed-price transaction may qualify
for one of these enumerated anticipatory bona fide hedges as long as
the commercial entity otherwise satisfies all requirements for such
anticipatory bona fide hedge, including demonstrating its anticipated
need in the physical marketing channel related to either its unsold
production, unfilled requirements, and/or merchandising, as
applicable.\164\
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\162\ For further discussion regarding the enumerated bona fide
hedge for ``unsold anticipated production,'' see Section
II.A.1.vi.d.
\163\ For further discussion regarding the new enumerated bona
fide hedge for ``anticipated merchandising,'' see Section
II.A.1.vi.f.
\164\ As such, merely entering into an unfixed-price transaction
is not alone sufficient to demonstrate compliance with one of the
enumerated anticipatory bona fide hedges. The specific requirements
associated with each enumerated bona fide hedge, including each
anticipatory bona fide hedge, are described in detail further below.
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Under this Final Rule, the Commission is clarifying that a
commercial market participant may still qualify for an enumerated
anticipatory bona fide hedge for an anticipated need, based on a good-
faith expectation of that need, even if the market participant has
entered into an unfixed-price transaction, since the Commission does
not deem the unfixed-price transaction to ``fill'' or ``address'' the
anticipated need. This rationale is predicated on the fact that an
unfixed-price commitment does not offset the price risk associated with
an anticipated need (i.e.,
[[Page 3263]]
anticipated unsold production, anticipated unfilled requirements, and/
or anticipated merchandising, as applicable). This is because unfixed-
price transactions do not give rise to outright price risk and
therefore do not alter the outright price risks faced by a commercial
market participant, even though the market participant has
contractually assured either a supply of the commodity (in the case of
anticipated unfilled requirements), the sale of its output (in the case
of anticipated unsold production), or the purchase or sale of the
commodity to be merchandised (in the case of anticipated
merchandising).\165\
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\165\ Consistent with the existing Federal position limits
framework, under the Final Rule, commercial market participants may
not qualify for any anticipatory bona fide hedge merely to offset
risks associated with non-commercial (i.e., financial) activities.
---------------------------------------------------------------------------
In other words, a trader with an unfixed-price commitment still has
price risk related to its anticipated need until the price is fixed.
Once the price has become fixed, the market participant may no longer
avail itself of the enumerated anticipatory bona fide hedge, but may
potentially avail itself of another enumerated bona fide hedge, (such
as the bona fide hedges for fixed-price purchase contracts or for
fixed-price sales contracts, as applicable), provided all applicable
requirements of such other enumerated bona fide hedges are satisfied.
Under the Final Rule, a commercial market participant must continue
to be able to demonstrate an anticipated need related to unsold
production, unfilled requirements, and/or merchandising.
Accordingly, the Commission determines that the commercial market
participant engaged in unfixed-price transactions in the BFH Petition's
example #3 (unpriced physical purchase or sale commitments) and example
#7 (scenario 2) (use of physical delivery referenced contracts to hedge
physical transactions using calendar month average pricing) can qualify
for one of the enumerated anticipatory bona fide hedges under the Final
Rule to the extent the market participant otherwise complies with the
applicable conditions of the relevant enumerated anticipatory bona fide
hedge in connection with the market participant's commercial
activities.
For clarity, the Commission also underscores that under the
Commission's existing portfolio hedging policy, market participants,
including vertically-integrated firms (i.e., those firms that may
qualify as more than one of a producer; processor, manufacturer, or
utility; and/or merchandiser), may continue to manage their price risks
by utilizing more than one enumerated bona fide hedge (including more
than one anticipatory bona fide hedge).
The Commission recognizes that there are many ways in which market
participants both structure their organizations and engage in
commercial hedging practices. As such, market participants may manage
the price risk from their various commercial activities by utilizing
multiple enumerated bona fide hedge exemptions in the manner that is
most suitable to their particular circumstances. Nevertheless, for
illustrative purposes, the Commission provides a general example of how
market participants may utilize the enumerated anticipatory bona fide
hedges in connection with their unfixed price transactions:
For example, Producer X has the physical capacity to produce
100,000 barrels of physical WTI crude oil on an annual basis. Producer
X agrees to sell 80,000 barrels of WTI crude oil to Merchandiser Y via
a floating/unfixed-price contract in which the delivery will be priced
at the NYMEX March 2020 WTI crude oil futures final settlement price.
Producer X still does not have a buyer for its remaining 20,000
barrels, but anticipates selling all of its production, as it has in
previous years. Under this scenario, Producer X may utilize the
enumerated unsold anticipated production enumerated hedge to offset the
price risk from its unsold production, which includes both the 80,000
barrels of oil sold to Merchandiser Y at an unfixed price, as well as
the unsold 20,000 barrels.\166\ On the other hand, Merchandiser Y may
utilize the enumerated hedge for anticipated merchandising to hedge its
anticipated merchandising transactions, which include the 80,000
barrels it purchased from Producer X at an unfixed price. Because
Merchandiser Y has a history of merchandising more than 80,000 barrels
a year, and it anticipates merchandising more than 80,000 barrels in
the next twelve months, Merchandiser Y's anticipated merchandising
hedge may include the 80,000 barrels it purchased from Producer X at an
unfixed price and its remaining anticipated twelve-months'
merchandising. Separately, assuming Merchandiser Y also has crude oil
it purchased at a fixed price in a storage tank, Merchandiser Y may
also utilize the enumerated hedge for inventory and cash-commodity
fixed-price purchase contracts to hedge the price risk from those fixed
price purchases of crude oil.
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\166\ In the case where Producer X fixes the price of its sale
before delivery, while it no longer holds an anticipatory hedge,
Producer X may qualify for the enumerated hedge for fixed price
sales, assuming all applicable requirements for that hedge are
satisfied.
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In response to commenters requesting that the Commission create a
new enumerated bona fide hedge for unfixed-price transactions, the
Commission does not believe that this is necessary because, as
described above, commercial market participants may qualify for the
enumerated anticipatory bona fide hedges while also entering into
unfixed-price transactions. Further, the Commission believes that it is
not suitable to create a new enumerated bona fide hedge expressly
covering all unfixed price transactions to accomplish the same since
there is an inherent difficulty in evaluating the propriety of a hedge
of an unfixed price obligation with a fixed-price futures contract as
there is basis risk until the unfixed price obligation is fixed. Given
differences among markets, creating a new enumerated bona fide hedge
for any unfixed price transaction could, under certain circumstances,
harm market integrity, enable potential market manipulation, and/or
allow excessive speculation by potentially affording bona fide hedging
treatment for speculative transactions.
For example, assume a market participant enters into an unfixed-
price sales contract (e.g., priced at a fixed differential to a
deferred month futures contract), and immediately enters into a
calendar month spread to reduce the risk of the fixed basis moving
adversely. It may not be economically appropriate to recognize as bona
fide a long futures position in the spot (or nearby) month and a short
futures position in a deferred calendar month matching the market
participant's cash delivery obligation, in the event the spot (or
nearby) month price is higher than the deferred contract month price
(referred to as backwardation, and characteristic of a spot cash market
with supply shortages), because such a calendar month futures spread
would lock in a loss. A position locking in a loss generally is not
economically appropriate to the reduction of risk, as it increases risk
by generating a loss, and such a transaction may be indicative of an
attempt--or at the very least provides inappropriate incentives--to
manipulate the spot (or nearby) futures price.\167\
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\167\ See 81 FR at 96750.
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Finally, the Commission emphasizes that to the extent that a market
participant does not qualify for an enumerated anticipatory bona fide
hedge in connection with an unfixed-price transaction, the market
participant
[[Page 3264]]
could still avail itself of the process under Sec. Sec. 150.3 and
150.9 for requesting approval of non-enumerated bona fide hedges.
v. The Enumerated Bona Fide Hedge Exemptions, Generally
a. Background--Bona Fide Hedge Exemptions, Generally
As discussed earlier in this release, the list of bona fide hedges
explicitly contained in paragraph (2) of the existing bona fide hedging
definition in Sec. 1.3 of the Commission's regulations lists (or
``enumerates'') seven bona fide hedges, which are generally referred to
as the ``enumerated bona fide hedges,'' in four general categories.
These four existing categories of enumerated hedges include: (1) Sales
of futures contracts to hedge (i) ownership or fixed-price cash
commodity purchases and (ii) unsold anticipated production; (2)
purchases of futures contracts to hedge (i) fixed-price cash commodity
sales and (ii) unfilled anticipated requirements; (3) offsetting sales
and purchases of futures contracts to hedge offsetting unfixed-price
cash commodity sales and purchases; and (4) cross-commodity
hedges.\168\
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\168\ 17 CFR 1.3.
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The list of enumerated bona fide hedges found in paragraph (2) of
the existing bona fide hedging definition was developed at a time when
only agricultural commodities were subject to Federal position limits,
and has not been updated since 1987.\169\ The Commission believes, as
discussed further below, that such list is too narrow to reflect common
commercial hedging practices, including for metal and energy contracts.
Numerous market and regulatory developments have taken place since
1987, including, among other things, increased futures trading in the
metals and energy markets, the development of the swaps markets, and
the shift in trading from pits to electronic platforms. In addition,
the Commodity Futures Modernization Act of 2000 \170\ and the Dodd-
Frank Act introduced various regulatory reforms, including the
enactment of position limits core principles.\171\ The Commission thus
proposed in the 2020 NPRM to update its bona fide hedging definition to
better conform to the current state of the law and to better reflect
market developments over time.
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\169\ See Revision of Federal Speculative Position Limits, 52 FR
38914 (Oct. 20, 1987).
\170\ Commodity Futures Modernization Act of 2000, Public Law
106-554, 114 Stat. 2763 (Dec. 21, 2000).
\171\ See 7 U.S.C. 7(d)(5) and 7 U.S.C. 7b-3(f)(6).
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b. Summary of the 2020 NPRM--Bona Fide Hedge Exemptions, Generally
So as not to reduce any of the clarity provided by the existing
list of enumerated bona fide hedges, the Commission proposed to
maintain the existing enumerated bona fide hedges, with some
modifications, and to expand this list.
The existing definition of ``bona fide hedging transactions and
positions'' enumerates the following hedging transactions:
a. Hedges of inventory and cash commodity fixed-price purchase
contracts;
b. hedges of cash commodity fixed-price sales
c. hedges of the cash commodity's cash products and byproducts;
d. hedges of offsetting unfixed price cash commodity sales and
purchases
e. hedges of unsold anticipated production;
f. hedges of unfilled anticipated requirements; and
g. cross-commodity hedges.
The following additional hedging practices are not enumerated in
the existing regulation, but were included in the 2020 NPRM as
additional enumerated bona fide hedges:
a. Hedges by agents;
b. short hedges of anticipated mineral royalties;
c. hedges of anticipated services;
d. offsets of commodity trade option; and
e. hedges of anticipated merchandising.
The Commission also proposed the elimination, for purposes of
Federal position limits, of both the Five-Day Rule and the twelve-month
restriction. However, under the 2020 NPRM, exchanges would be able to
establish their own five-day rule and/or twelve-month restriction, as
applicable for any or all of their respective referenced contracts.
c. Commission Determination--Bona Fide Hedge Exemptions, Generally
First, the Commission is adopting the proposed expanded list of
enumerated bona fide hedges, with the modifications described, as
applicable, in the discussions of the relevant bona fide hedges below.
Second, the Commission is adopting, as proposed, the elimination of
both the existing Five-Day Rule and the twelve-month restriction.\172\
The comments received, and the Commission's corresponding responses, in
connection with these changes are discussed further below in the
corresponding section discussing the applicable enumerated bona fide
hedge.
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\172\ As discussed further below, the Final Rule eliminates the
existing twelve-month restriction with respect to the anticipatory
unsold production and the anticipated unfilled requirements bona
fide hedges. However, the new anticipated merchandising bona fide
hedge would be subject to its own twelve-month restriction.
---------------------------------------------------------------------------
With respect to the treatment of the enumerated bona fide hedges
under the Final Rule, the Commission notes that positions in referenced
contracts subject to Federal position limits that meet any of the
enumerated bona fide hedges will, for purposes of Federal position
limits, be deemed to meet the bona fide hedging definition in CEA
section 4a(c)(2)(A), as well as the Commission's bona fide hedging
definition in Sec. 150.1 under the Final Rule. As a result, enumerated
bona fide hedges are self-effectuating for purposes of Federal position
limits, provided the market participant separately requests an
exemption from the applicable exchange-set limit established pursuant
to Sec. 150.5(a).\173\
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\173\ For further discussion of the exchange exemption process,
see Section II.D.3.i.b.
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The enumerated hedges are each described below, followed by a
discussion of the Five-Day Rule. When first proposed, the Commission
viewed the enumerated bona fide hedges as conforming to the general
definition of bona fide hedging ``without further consideration as to
the particulars of the case.'' \174\ Similarly, the list of enumerated
bona fide hedges under the Final Rule reflects categories of bona fide
hedges for which the Commission has determined, based on experience
over time, that no case-by-case determination or review of additional
details by the Commission is needed to determine that the position or
transaction is a bona fide hedge. This Final Rule does not foreclose
the recognition of other hedging practices as bona fide hedges, as
discussed below.
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\174\ Bona Fide Hedging Transactions or Positions, 42 FR 14832
(Mar. 16, 1977).
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While the enumerated bona fide hedges adopted herein are self-
effectuating for purposes of Federal position limits,\175\ the
Commission and the exchanges will continue to exercise close oversight
over such positions to confirm that market participants' claimed
exemptions are consistent with their cash-market activity. In
particular, because all contracts subject to Federal position limits
are also subject to exchange-set limits, all traders seeking to exceed
Federal position limits must request an exemption from the relevant
exchange for purposes of the exchange
[[Page 3265]]
position limit, regardless of whether the position falls within one of
the enumerated hedges. In other words, enumerated bona fide hedge
exemptions that are self-effectuating for purposes of Federal position
limits are not self-effectuating for purposes of exchange-set position
limits.
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\175\ See infra Section II.C. (discussing Sec. 150.3) and
Section II.G. (discussing Sec. 150.9).
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Exchanges have well-established programs for granting exemptions,
including, in some cases, experience granting exemptions for
anticipatory merchandising for certain traders in markets not currently
subject to Federal position limits. As discussed in greater detail
below, Sec. 150.5 as adopted herein helps ensure that such programs
conform to standards established by the Commission.\176\ The Commission
expects exchanges will continue to be thoughtful and deliberate in
granting exemptions, including anticipatory exemptions. The Commission
predicates this expectation on its decades of experience working
together with the relevant exchanges and observations generally of the
applicable exchange-traded futures markets.
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\176\ See infra Section II.D. For example, Sec. 150.5 requires,
among other things, that: Exemption applications filed with an
exchange include sufficient information to enable the exchange and
the Commission to determine whether the exchange may grant the
exemption, including an indication of whether the position qualifies
as an enumerated hedge for purposes of Federal limits and a
description of the applicant's activity in the underlying cash
markets; and the exchange provides the Commission with a monthly
report showing the disposition of all exemption applications,
including cash-market information justifying the exemption.
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The Commission and the exchanges also have a variety of other tools
designed to help prevent misuse of self-effectuating bona fide hedge
exemptions. For example, market participants who apply to an exchange
as required pursuant to Sec. 150.5 under the Final Rule are subject to
the Commission's false statements authority, which carries substantial
penalties under both the CEA and Federal criminal statutes. Similarly,
the Commission currently employs--and will continue to use under the
Final Rule--surveillance tools, special call authority, rule
enforcement reviews, and other formal and informal avenues for
obtaining additional information from exchanges and market participants
in order to distinguish between true bona fide hedging needs and
speculative trading masquerading as a bona fide hedge.
While positions that fall within the enumerated bona fide hedges,
each discussed in further detail below, are the type of positions that
comply with the bona fide hedging definition, the Commission recognizes
that there may be other positions or hedging strategies that are not
``enumerated'' that similarly could satisfy the bona fide hedge
definition.\177\ These ``non-enumerated'' bona fide hedges may be
granted today under existing Sec. Sec. 1.47 and 1.48, and the
Commission can continue to recognize non-enumerated bona fide hedges
under the Final Rule. For further discussion of the recognition of non-
enumerated bona fide hedges, see infra Sections II.C. and II.G.
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\177\ See infra Section II.G. (discussing Sec. 150.9).
---------------------------------------------------------------------------
With the exception of risk management positions previously
recognized as bona fide hedges, and assuming all regulatory
requirements continue to be satisfied, market participants' existing
bona fide hedging recognitions under existing Federal position limits
are grandfathered upon the Final Rule's Effective Date (i.e., bona fide
hedge exemptions that are currently recognized for purposes of Federal
position limits, other than risk management positions, will continue to
be recognized under the Final Rule).
Last, before describing each individual enumerated hedge, the
Commission also notes that it is adopting certain non-substantive,
technical changes, and such changes are intended only to provide
clarifications. For example, the Commission is making a technical
change to the bona fide hedging definition by adopting the term in the
singular tense in order to conform to the phrasing in CEA section
4a(c)(2).\178\ The Commission is also re-ordering the enumerated bona
fide hedges to place related enumerated bona fide hedges closer
together.
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\178\ The existing definition in Sec. 1.3 of the Commission's
regulations is in the plural: ``bona fide hedging transactions and
positions.'' The 2020 NPRM's proposed definition was similarly
plural.
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vi. Enumerated Bona Fide Hedge Exemptions for Physical Commodities
This Final Rule adopts the list of enumerated bona fide hedge
exemptions as proposed in the 2020 NPRM, with certain amendments
discussed below.\179\
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\179\ Appendix A to part 150 lists the following enumerated bona
fide hedges: (a)(1) Hedges of Inventory and Cash Commodity Fixed-
Price Purchase Contracts; (a)(2) Hedges of Cash Commodity Fixed-
Price Sales Contracts; (a)(3) Hedges of Offsetting Unfixed Price
Cash Commodity Sales and Purchases; (a)(4) Hedges of Unsold
Anticipated Production; (a)(5) Hedges of Unfilled Anticipated
Requirements; (a)(6) Hedges of Anticipated Merchandising; (a)(7)
Hedges by Agents; (a)(8) Short Hedges of Anticipated Mineral
Royalties; (a)(9) Hedges of Anticipated Services; (a)(10) Offsets of
Commodity Trade Options; (a)(11) Cross-Commodity Hedges. As
previously mentioned, the Commission has also reorganized the order
of the list of enumerated hedges. The Final Rule reorders Appendix A
so that the bona fide hedges are listed by hedges of purchases,
sales, anticipated activities, or other new types of hedges.
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a. Hedges of Inventory and Cash Commodity Fixed-Price Purchase
Contracts
(1) Background--Inventory and Cash Commodity Fixed-Price Purchase
Contracts
Inventory and fixed-price cash commodity purchase contracts have
long served as the basis for a bona fide hedging position.\180\ This
bona fide hedge is enumerated in paragraph (2)(i)(A) of the existing
bona fide hedging definition in Sec. 1.3, and recognizes as a bona
fide hedge sales of any commodity for future delivery on a contract
market which do not exceed in quantity ownership (i.e., inventory) or
fixed-price purchase of the same commodity by the same person.
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\180\ See, e.g., 7 U.S.C. 6(a)(3) (1970). That statutory
definition of bona fide hedging included sales of, or short
positions in, any commodity for future delivery on or subject to the
rules of any contract market made or held by such person to the
extent that such sales or short positions are offset in quantity by
the ownership or purchase of the same cash commodity by the same
person.
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Since 2011, the Commission has included hedges of inventory and
cash commodity fixed-price purchase contracts in each of its position
limits rulemakings, with minor proposed modifications to improve
clarity.\181\
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\181\ 81 FR at 96964; 78 FR at 75713; 76 FR at 11609.
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(2) Summary of the 2020 NPRM--Inventory and Cash Commodity Fixed-Price
Purchase Contracts
This proposed enumerated bona fide hedge recognized that a
commercial enterprise is exposed to price risk if it has obtained
inventory in the normal course of business or has entered into a fixed-
price spot or forward purchase contract calling for delivery in the
physical marketing channel of a cash-market commodity (or a combination
of the two), and has not offset that price risk exposure (e.g., that
the market price of the inventory could decrease). In connection with
the proposed enumerated hedge, any such inventory, or a fixed-price
purchase contract, must be on hand, as opposed to a non-fixed purchase
contract or an anticipated purchase.
An appropriate hedge to offset the price risk arising from
inventory or a fixed-price purchase contract under the 2020 NPRM would
be to establish a short position in a commodity derivative contract.
The Commission also stated in the 2020 NPRM that an exchange may
require such short position holders to demonstrate the ability to
deliver against the short
[[Page 3266]]
position in order to demonstrate a legitimate purpose for holding a
position deep into the spot month.\182\
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\182\ 85 FR at 11609-11610. For example, it would not appear to
be economically appropriate to hold a short position in the spot
month of a commodity derivative contract against fixed-price
purchase contracts that provide for deferred delivery in comparison
to the delivery period for the spot month commodity derivative
contract. This is because the commodity under the cash contract
would not be available for delivery on the commodity derivative
contract.
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(3) Summary of the Commission Determination--Inventory and Cash
Commodity Fixed-Price Purchase Contracts
The Commission is adopting the enumerated bona fide hedge of
inventory and cash commodity fixed-price purchase contracts as
proposed.
(4) Comments--Inventory and Cash Commodity Fixed-Price Purchase
Contracts
Aside from ASR, which expressed support for this enumerated hedge,
the Commission did not receive any other specific comments on this
enumerated hedge.\183\
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\183\ ASR at 2.
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b. Hedges of Cash Commodity Fixed-Price Sales Contracts
(1) Background--Cash Commodity Fixed-Price Sales Contracts
Fixed-price cash commodity sales have long served as the basis for
a bona fide hedging position.\184\ This bona fide hedge is enumerated
in paragraphs (2)(ii)(A) and (B) of the existing bona fide hedging
definition in Sec. 1.3. This enumerated bona fide hedge recognizes as
a bona fide hedging transaction or position hedges against purchases of
any commodity for future delivery on a contract market which do not
exceed in quantity: (A) The fixed price sale of the same cash commodity
by the same person; and (B) the quantity equivalent of fixed-price
sales of the cash products and by-products of such commodity by the
same person. Since 2011, the Commission has included hedges of cash
commodity fixed-price sales contracts in its position limits
rulemakings, with no substantive modifications.\185\
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\184\ See, e.g., 7 U.S.C. 6a(3) (1970). That statutory
definition of bona fide hedging includes purchases of, or long
positions in, any commodity for future delivery on or subject to the
rules of any contract market made or held by such person to the
extent that such purchases or long positions are offset by sales of
the same cash commodity by the same person.
\185\ 81 FR at 96964; 78 FR at 75824; 76 FR at 71689.
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(2) Summary of the 2020 NPRM--Cash Commodity Fixed-Price Sales
Contracts
This proposed enumerated bona fide hedge made minor modifications
to the existing bona fide hedge, and recognized that a commercial
enterprise is exposed to price risk if it has entered into a spot or
forward fixed-price sales contract calling for delivery in the physical
marketing channel of a cash-market commodity, and has not offset that
price risk exposure (i.e., that the market price of a commodity might
be higher than the price of its fixed-price sales contract for that
commodity). Under the 2020 NPRM, an appropriate hedge of a fixed-price
sales contract would be to establish a long position in a commodity
derivative contract to offset such price risk.\186\
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\186\ 85 FR at 11610.
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(3) Summary of the Commission Determination--Cash Commodity Fixed-Price
Sales Contracts
The Commission is adopting the enumerated hedge for hedges of cash
commodity fixed-price sales contracts as proposed.
(4) Comments--Cash Commodity Fixed-Price Sales Contracts
Aside from ASR, which expressed support for this enumerated hedge,
the Commission did not receive any other specific comments on this
enumerated hedge.\187\
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\187\ ASR at 2.
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c. Hedges of Offsetting Unfixed Price Cash Commodity Sales and
Purchases
(1) Background--Offsetting Unfixed Price Cash Commodity Sales and
Purchases
Hedges of offsetting unfixed price cash commodity sales and
purchases is currently enumerated in paragraph (2)(iii) of the existing
bona fide hedging definition in Sec. 1.3 and is subject to the Five-
Day Rule. This enumerated hedge is the only existing enumerated hedge
that expressly recognizes hedging the price risk arising from cash
commodity unfixed-price transactions.
This enumerated bona fide hedge allows a market participant to use
commodity derivatives in excess of Federal position limits to offset an
unfixed-price cash commodity purchase coupled with an unfixed-price
cash commodity sale. Specifically, this enumerated bona fide hedge
allows for ``offsetting sales and purchases'' for future delivery on a
contract market which do not exceed in quantity that amount of the same
cash commodity which has been bought and sold by the same person at
unfixed prices basis different delivery months of the contract market.
While not part of the original regulatory bona fide hedge
definition, the Commission adopted this enumerated bona fide hedge in
1987 to ``remove any doubt'' that certain cotton and soybean crush
inter-month spreads were covered under the Commission's bona fide hedge
definition.\188\ Since 2011, the Commission has included this
enumerated bona fide hedge in each of its position limits
rulemakings.\189\
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\188\ The Commission stated when it proposed this enumerated
bona fide hedge, in particular, a cotton merchant may contract to
purchase and sell cotton in the cash market in relation to the
futures price in different delivery months for cotton, i.e., a basis
purchase and a basis sale. Prior to the time when the price is fixed
for each leg of such a cash position, the merchant is subject to a
variation in the two futures contracts utilized for price basing.
This variation can be offset by purchasing the future on which the
sales were based and selling the future on which the purchases were
based. Revision of Federal Speculative Position Limits, 51 FR 31648,
31650 (Sept. 4, 1986).
\189\ 81 FR at 96964; 78 FR at 75714; 76 FR at 71689.
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(2) Summary of the 2020 NPRM--Offsetting Unfixed Price Cash Commodity
Sales and Purchases
The Commission proposed to maintain this bona fide hedge, with a
few modifications.
The 2020 NPRM proposed to expand the existing bona fide hedge,
which currently requires the offsetting purchase and sale to be at
basis to different delivery months of the same commodity derivative
contract, to additionally permit hedges of offsetting unfixed sales and
unfixed purchases for different commodity derivative contracts in the
same commodity (e.g., Brent/WTI), regardless of whether the contracts
are in the same delivery month. This proposed change would permit the
cash commodity to be bought and sold at unfixed prices at a basis to
different commodity derivative contracts in the same commodity, even if
the commodity derivative contracts were in the same calendar month
(i.e., buy Brent in January; sell WTI in January).\190\ The Commission
proposed this change to allow a commercial enterprise to enter into the
described derivatives transactions to reduce the risk arising from
either (or both) a location differential or a time differential in
unfixed-price purchase and sale contracts in the same cash
commodity.\191\
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\190\ 85 FR at 11608.
\191\ Id. In the case of reducing the risk of a location
differential, and where each of the underlying transactions in
separate derivative contracts may be in the same contract month, a
position in a basis contract would not be subject to position
limits, as discussed in connection with paragraph (3) of the
proposed definition of ``referenced contract.''
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[[Page 3267]]
To be eligible for this enumerated hedge, both an unfixed-price
cash commodity purchase ``and'' an offsetting unfixed-price cash
commodity sale would have to be in hand, because having both the
unfixed-price sale and purchase in hand would allow for an objective
evaluation of the hedge.\192\
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\192\ For example, in the case of a calendar spread, having both
the unfixed-price sale and purchase in hand would set the timeframe
for the calendar month spread being used as the hedge.
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(3) Summary of the Commission Determination--Offsetting Unfixed Price
Cash Commodity Sales and Purchases
The Commission is adopting the enumerated bona fide hedge for
offsetting unfixed price cash commodity sales and purchases as
proposed.
(4) Comments--Offsetting Unfixed Price Cash Commodity Sales and
Purchases
There were minimal comments on the proposed amendments to this
hedge. IFUS explicitly supported the allowance of hedges against cash
positions in the same delivery month.\193\ CMC and ACSA requested that
the Commission modify the language of this enumerated bona fide hedge
to include ``offsetting sales or purchases.''\194\ CMC and FIA stated
that because merchants often sell commodities well in advance of
purchasing them, such merchants are exposed to the exact same calendar
spread price risk as merchants that have executed both unfixed price
legs of a transaction, because any futures market calendar spread
convergence or divergence will ``affect both scenarios in exactly the
same manner.''\195\ These commenters contended that changing the
language of the enumerated hedge from ``and'' to ``or'' would allow
merchants to hedge against this exposure.\196\
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\193\ IFUS at 4.
\194\ CMC at 4; ACSA at 6.
\195\ CMC at 4; FIA at 16.
\196\ Id.
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In addition, because this is the only existing enumerated hedge
that expressly recognizes hedging for unfixed price transactions,
several commenters cited to this hedge when requesting that the
Commission explicitly endorse that commercial transactions with
unfixed-prices may serve as the basis for, and satisfy, the bona fide
hedging definition.\197\
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\197\ The Commission's determination on the treatment of
unfixed-price transactions under this Final Rule is in Section
II.A.1.iv.
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(5) Discussion of Final Rule--Offsetting Unfixed Price Cash Commodity
Sales and Purchases
The Commission is adopting the enumerated bona fide hedge for
offsetting unfixed price cash commodity sales and purchases as
proposed. The Commission considered the comments requesting the
Commission to change this bona fide hedge's language from referring to
offsetting unfixed-price purchase ``and'' sale transactions (which
requires both an unfixed purchase price transaction and an unfixed sale
price transaction) to instead refer to unfixed-price purchase ``or''
sales transactions (which would require only either a single unfixed-
price purchase transaction or an unfixed-price sale transaction) to
facilitate hedging calendar spread price risk for those market
participants that have executed only one leg of an unfixed-price
physical transaction (i.e., only a physical purchase or a physical
sale).
The Commission continues to believe that the enumerated bona fide
hedge for offsetting unfixed price cash commodity sales and purchases
should continue to require both an unfixed-price cash commodity
purchase and an offsetting unfixed-price cash commodity sale. For this
particular bona fide hedge, absent either the unfixed-price purchase
leg or the unfixed-price sale leg (or absent both legs), it would be
less clear, and require a facts and circumstances analysis, to
determine how the transaction could be classified as a bona fide hedge,
that is, a transaction that reduces price risk.\198\
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\198\ The contemplated derivative positions will offset the risk
that the difference in the expected delivery prices of the two
unfixed-price cash contracts in the same commodity will change
between the time the hedging transaction is entered and the time of
fixing of the prices on the purchase and sales cash contracts.
Therefore, the contemplated derivative positions are economically
appropriate to the reduction of risk.
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Under the Final Rule, a single-sided unfixed price physical
transaction (i.e., a physical transaction involving an unfixed price
purchase or an unfixed price sale, but not both) cannot be offset with
derivatives in excess of position limits using this particular
enumerated bona fide hedge. However, a market participant with an
unfixed price purchase in the absence of an unfixed-price sale, or vice
versa, could potentially qualify for one or more of the enumerated
anticipatory bona fide hedges.\199\ Additionally, depending on the
facts and circumstances, a single-sided unfixed price contract could
potentially be the basis for a non-enumerated bona fide hedge.
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\199\ Specifically, as discussed above, because the Commission
does not view an unfixed-price commitment as filling, or satisfying,
an anticipated need, market participants with unfixed-price
commitments may qualify for an enumerated anticipatory bona fide
hedge, provided the market participant meets all applicable
requirements and conditions. See Section II.A.1.iv.
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While the Commission acknowledges concerns from commenters that
market participants that have executed only one leg of a physical
transaction (i.e., only an unfixed-price purchase or an unfixed-price
sale) may need to hedge calendar spread price risk, the Commission
believes the Final Rule offers several avenues for hedging such
risks.\200\ For example, under the offsetting unfixed price cash
commodity sales and purchases enumerated bona fide hedge, upon fixing
the price of, or taking delivery on, the purchase contract, the owner
of the cash commodity no longer has offsetting unfixed priced
transactions, but may continue to hold the short derivative leg of the
spread as a hedge against that fixed-price purchase or as inventory
under the enumerated hedge for fixed price transactions.
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\200\ The Final Rule also expands the ``spread transaction''
definition, so a market participant with an unfixed price purchase
or sale may also qualify for a calendar spread exemption, for
example, with one leg in the spot month. For further discussion of
the Final Rule's treatment of spread transactions, see Section
II.A.20.
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Alternatively, under this Final Rule, if the market participant
fixes the price the sales contract first, he or she may continue to
hold the long derivative leg of the spread by qualifying for bona fide
hedge treatment for that long position under another enumerated bona
fide hedge. For example, a market participant who otherwise meets all
applicable requirements of one of the anticipatory bona fide hedges may
qualify for such hedge(s) regardless of whether the market participant
holds an unfixed-price purchase transaction.
d. Hedges of Unsold Anticipated Production
(1) Background--Unsold Anticipated Production
Unsold anticipated production has long served as the basis for an
enumerated bona fide hedging position.\201\ This bona fide hedge is
currently enumerated in paragraph (2)(i)(B) of the bona fide hedging
definition in existing Sec. 1.3, and is subject to the Five-Day Rule.
This
[[Page 3268]]
existing enumerated bona fide hedge includes hedges against the sales
of any commodity for future delivery on a contract market which does
not exceed in quantity twelve months' unsold anticipated production of
the same commodity by the same person.
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\201\ See 7 U.S.C. 6a(3)(A) (1940). That statutory definition of
bona fide hedging, enacted in 1936, included the amount of such
commodity such person is raising, or in good faith intends or
expects to raise, within the next twelve months, on land (in the
United States or its Territories) which such person owns or leases.
---------------------------------------------------------------------------
The bona fide hedge of unsold anticipated production is one of two
existing enumerated anticipatory bona fide hedges currently included in
Sec. 1.3, the other being unfilled anticipated requirements (discussed
further below). The unsold anticipated production bona fide hedge
allows a market participant who anticipates production, but who has not
yet produced anything, to enter into a short derivatives position in
excess of Federal position limits to hedge the price risk arising from
that anticipated production. Since 2011, the Commission has included
hedges of unsold anticipated production in each of its position limits
rulemakings, with some modifications.\202\ The regulatory text for this
existing enumerated bona fide hedge is silent about whether it applies
to unsold anticipated production that is contracted to be sold under an
unfixed-price transaction.
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\202\ 81 FR at 96964; 78 FR at 75714; 76 FR at 71689.
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(2) Summary of the 2020 NPRM--Unsold Anticipated Production
The Commission proposed to maintain the existing enumerated bona
fide hedge of unsold anticipated production, with modifications as
follows. First, the Commission proposed to remove the twelve-month
restriction.\203\ Second, consistent with the treatment for the other
anticipatory bona fide hedges under the 2020 NPRM, the Commission
proposed to eliminate the existing restrictions during the last five
days of trading (i.e., eliminate the ``Five-Day Rule'').\204\
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\203\ 85 FR at 11608.
\204\ For further discussion of the Five-Day rule, see Section
II.A.1.viii, Elimination of Federal Restriction Prohibiting Holding
a Bona Fide Hedge Exemption During Last Five Trading Days, the
``Five-Day Rule,'' below.
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(3) Summary of the Commission Determination--Unsold Anticipated
Production
The Commission is adopting the enumerated bona fide hedge of unsold
anticipated production as proposed.
(4) Comments--Unsold Anticipated Production
Several commenters, including ASR, ADM, and ICE, supported
eliminating the twelve-month restriction.\205\ ASR, for example, noted
that the lifecycle of sugarcane extends beyond a twelve-month
period.\206\
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\205\ ASR at 2; ADM at 2; ICE at 2; IECA at 2; and IFUS at 2.
\206\ ASR at 2.
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Conversely, Better Markets and IATP opposed the elimination of the
twelve-month restriction.\207\ IATP stated that commercial market
participants such as storage facilities should instead use insurance
policies to manage their risks.\208\ Further, IATP stated that if the
Commission extends the duration up to 24 months, the Commission should
retain discretion to require market participants to demonstrate a
production level proportionate to the amount in excess of the Federal
position limit throughout the duration of the bona fide hedge
exemption.\209\
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\207\ IATP at 15-17; Better Markets at 57-58.
\208\ IATP at 15-17.
\209\ Id.
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(5) Discussion of Final Rule--Unsold Anticipated Production
The Commission is adopting the enumerated bona fide hedge of unsold
anticipated production as proposed. This enumerated bona fide hedge
allows a market participant who anticipates production, but who has not
yet produced anything, to enter into a short derivatives position in
excess of Federal position limits to hedge the anticipated unsold
production.\210\
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\210\ Once a market participant finishes its production, the
market participant will no longer qualify for this enumerated bona
fide hedge since its production is no longer anticipatory. Instead,
its completed production is now part of its inventory. However, the
enumerated bona fide hedge for inventory and cash commodity fixed-
price purchase contracts (discussed below) would become available to
the market participant.
---------------------------------------------------------------------------
The Commission clarifies, as discussed above under Section
II.A.1.iv., that the enumerated bona fide hedge for unsold production
is available to a market participant who satisfies all applicable
requirements regardless of whether the market participant has entered
into an unfixed-price sales transaction in connection with its
anticipated unsold production. However, acquiring an unfixed-price
sales contract alone is not a basis for qualifying for this bona fide
hedge. Rather, under the Final Rule, entering into an unfixed-price
sales transaction will not prevent a market participant from qualifying
for the unsold anticipated production bona fide hedge.
As the Commission explains above, an unfixed-price sales commitment
does not address the bona fide hedging need related to anticipated
unsold production because the market participant's price risk to its
anticipated production has not been fixed (i.e., the unfixed-price
sales contract may fall below the cost of production). In other words,
a producer with an unfixed-price sales commitment for its production
still has an anticipated need related to its price risk until the price
of the commitment is fixed. However, once the market participant enters
into a fixed-price sales contract, the market participant no longer has
price risk that needs to be hedged (i.e., its short futures contract is
no longer necessary as a hedge for its anticipated production).
Accordingly, the market participant that enters into the fixed-
price transaction no longer has an anticipated need to hedge the price
risk associated with its unsold production (i.e., the anticipated
production is deemed to be ``sold'' by fixed-price sales transaction)
and would not qualify for this anticipated unsold production bona fide
hedge.
Consequently, if the market participant no longer qualifies for the
unsold anticipated production bona fide hedging recognition (e.g., it
has entered into a fixed-price sales contract), its derivative
position, to the extent the position is above an applicable position
limit, must be reduced in an orderly manner in accordance with sound
commercial practices. However, if the market participant entered into a
fixed-price transaction, while it could not continue to qualify for the
unsold anticipated production bona fide hedge, the market participant
may be able to qualify for the enumerated bona fide hedge for cash
commodity fixed-price sales contracts, assuming all applicable
requirements are met.\211\
---------------------------------------------------------------------------
\211\ For further discussion of the enumerated bona fide hedge
for cash commodity fixed-price sales contracts, see Section
II.A.1.vi.b.
---------------------------------------------------------------------------
While the Commission acknowledges the comments from Better Markets
and IATP opposing the removal of the twelve-month restriction, the
Commission believes that this twelve-month restriction may be
unsuitable in connection with additional core referenced futures
contracts with the underlying agricultural and energy commodities that
would be subject to Federal position limits for the first time under
this Final Rule since these non-legacy commodities may have longer
growth and/or production cycles than the nine legacy agricultural
contracts. The existing twelve-month restriction may thus be
unnecessarily short in comparison to the expected life of investment in
production facilities. While this enumerated bona fide hedge for unsold
production does not have an associated twelve-month restriction under
the Final Rule, the Commission notes that because all bona fide hedges
must be economically appropriate to the
[[Page 3269]]
reduction of price risk pursuant to the CEA, a market participant may
only qualify for this enumerated bona fide hedge for anticipated unsold
production to the extent the market participant has a good faith
anticipation of legitimate anticipated unsold production giving rise to
such price risk.
Further, additional provisions finalized herein under the Final
Rule will help ensure that all bona fide hedges, including bona fide
hedges of unsold anticipated requirements, comport with the CEA and the
Commission's regulations, and are objectively verifiable and free from
abuse.\212\
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\212\ See infra Sec. Sec. 150.5 and 150.9 (reporting and
recordkeeping obligations); Appendix B to part 150.
---------------------------------------------------------------------------
e. Hedges of Unfilled Anticipated Requirements
(1) Background--Unfilled Anticipated Requirements
The existing bona fide hedge for unfilled anticipated requirements
is currently enumerated in paragraph (2)(ii)(C) of the existing bona
fide hedging definition in Sec. 1.3. This bona fide hedge includes
hedges against purchases of any commodity for future delivery on a
contract market which do not exceed in quantity twelve months' unfilled
anticipated requirements of the same cash commodity for processing,
manufacturing, or feeding by the same person.
Consistent with the existing enumerated bona fide hedge for
anticipated unsold production, as discussed above, the existing bona
fide hedge for unfilled anticipated requirements is similarly subject
to the twelve-month restriction as well as a less-restrictive version
of the ``Five-Day Rule.'' With respect to the Five-Day Rule, under
existing Sec. 1.3, the unfilled anticipated requirements bona fide
hedge provides that the size of a market participant's position held
``in the five last trading days'' must not exceed the person's unfilled
anticipated requirements of the same cash commodity for that month and
for the next succeeding month.\213\
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\213\ This is essentially a less-restrictive version of the
five-day rule, allowing a participant to hold a position during the
end of the spot period if economically appropriate, but only up to
two months' worth of anticipated requirements. The two-month
quantity limitation has long-appeared in existing Sec. 1.3 as a
measure to prevent the sourcing of massive quantities of the
underlying in a short period. 17 CFR 1.3.
---------------------------------------------------------------------------
However, the regulatory text in existing Sec. 1.3 is silent about
whether the bona fide hedge applies to unfilled anticipated
requirements that are contracted to be supplied under an unfixed-price
transaction or whether such unfixed-price supply transaction would
``fill'' the anticipated requirements.
As discussed above, staff previously has addressed this question
through Staff Letter No. 12-07, in which staff clarified that a
commercial entity may qualify for the existing enumerated bona fide
hedge for unfilled anticipated requirements even if the commercial
entity has entered into long-term, unfixed-price supply or requirements
contracts because, as staff explained, the unfixed-price purchase
contract does not ``fill'' the commercial entity's anticipated
requirements.\214\ As explained in Staff Letter No. 12-07, the price
risk of such ``unfilled'' anticipated requirements is not offset by the
unfixed-price forward contract because the price risk remains with the
commercial entity, even though the entity has contractually assured a
supply of the commodity. Staff Letter No. 12-07 had the practical
effect of affirming that market participants with firm commitments at
unfixed prices may still be able to avail themselves of this enumerated
anticipatory hedge for unfilled requirements.
---------------------------------------------------------------------------
\214\ CFTC Letter No. 12-07, Interpretation, Request for
guidance regarding meaning of ``unfilled anticipated requirements''
for purposes of bona fide hedging under the Commission's position
limits rules (Aug. 16, 2012).
---------------------------------------------------------------------------
(2) Summary of the 2020 NPRM--Unfilled Anticipated Requirements
The Commission proposed several amendments to the unfilled
anticipated requirements bona fide hedge. First, the Commission
proposed to remove the twelve-month restriction because the Commission
recognized that market participants may have a legitimate commercial
need to hedge unfilled anticipated requirements for a period longer
than twelve months.\215\
---------------------------------------------------------------------------
\215\ See, e.g., 85 FR at 11610.
---------------------------------------------------------------------------
Second, the Commission proposed to remove from the regulatory text
the agricultural-specific term ``feeding,'' and to replace that word
with a reference to ``use by that person.''
Third, recognizing that utilities are not the entities who ``use''
the commodity, the Commission also proposed to add as a permissible
hedge the unfilled anticipated requirements for the contract's
underlying cash commodity for the resale by a utility to meet the
anticipated demand of its customers. This proposed provision is
analogous to the existing unfilled anticipated requirements provision
``for processing, manufacturing or use by the same person[.]'' \216\
Under this proposed new provision, however, the commodity is not for
use by the same person--that is, the utility--but rather the commodity
is for anticipated use by the utility to fulfill its obligation to
serve retail customers.
---------------------------------------------------------------------------
\216\ 17 CFR 1.3.
---------------------------------------------------------------------------
Finally, consistent with the treatment for the other anticipatory
bona fide hedges under the 2020 NPRM, the Commission proposed to
eliminate the existing restrictions during the last five last days of
trading.
(3) Summary of the Commission Determination--Unfilled Anticipated
Requirements
The Commission is adopting the unfilled anticipated requirements
enumerated bona fide hedge as proposed.
(4) Comments--Unfilled Anticipated Requirements
Commenters supported continuing to include this bona fide hedge as
part of the Commission's amended suite of enumerated anticipatory bona
fide hedges.\217\ As described below, commenters also requested the
Commission clarify certain aspects of the proposed version.
---------------------------------------------------------------------------
\217\ e.g., AGA at 6-7; ADM at 2; CEWG at 4; EEI and EPSA
jointly at 5; IECA at 2; NOPA at 2; NGSA at 3.
---------------------------------------------------------------------------
(i) Elimination of Requirement to Hedge Only Twelve Months' Quantity of
Unfilled Anticipated Requirements
Only a small group of commenters directly commented on the
elimination of the twelve-month restriction. ICE, IFUS, IECA, AGA, ADM
and NOPA supported eliminating the twelve-month restriction,\218\ with
ADM stating that there may be times this anticipatory hedge is needed
for ``commercial purposes beyond twelve-months.'' \219\ In contrast,
Better Markets opposed the removal of the restriction, stating that
such removal would make the hedge less reasonably verifiable and open
the hedge to potential abuse.\220\
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\218\ AGA at 6-7, ADM at 2, NOPA at 2, IFUS at 2, ICE at 2, and
IECA at 2.
\219\ ADM at 2.
\220\ Better Markets at 58-59.
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(a) Discussion of Final Rule--Twelve-Month Restriction
After considering public comments, the Commission has determined
that the commercial need to hedge unfilled anticipated requirements for
a period longer than twelve months, along with the Commission's
experience in overseeing exemptions \221\ under this
[[Page 3270]]
enumerated bona fide hedge, suggest in favor of eliminating the twelve-
month restriction. While the Commission acknowledges the comments from
Better Markets opposing the removal of the twelve-month restriction,
the Commission notes that, a twelve-month limitation in connection with
this particular enumerated bona fide hedge may be unsuitable in
connection with commodities other than the nine legacy agricultural
commodities. For example, a processor or utility relying on the
unfilled anticipated requirements bona fide hedge has a physical limit
on processing, or energy generation, respectively, which should
generally result in relatively predictable levels of activity that will
not vary much year to year. Further, additional provisions finalized
herein will help ensure that all bona fide hedges, including hedges of
unfilled anticipated requirements, comport with the CEA and the
Commission's regulations, and are reasonably verifiable and free from
abuse.
---------------------------------------------------------------------------
\221\ The Commission and its predecessor agency, the Commodity
Exchange Authority, has decades of expertise in granting bona fide
exemptions. See 21 FR 6913 (Sep 13, 1956).
---------------------------------------------------------------------------
For example, under Sec. 150.5(a)(2)(ii)(A), finalized herein, all
market participants seeking a bona fide hedge exemption for referenced
contracts subject to Federal position limits, including those market
participants with enumerated bona fide hedges that are self-
effectuating for purposes of Federal position limits, must still file
an application to the exchange requesting an exemption from the
applicable exchange-set position limits prior to exceeding the
exchange-set limits. The application for an exemption from exchange-set
limits must include information the exchange needs to determine, and
the Commission can use that information to independently determine,
whether the facts and circumstances support the exchange granting such
an exemption. The market participant must include a description of the
applicant's activity in the cash markets and swaps markets for the
commodity underlying the position for which the application is
submitted, including, but not limited to, information regarding the
offsetting cash positions.\222\ The exchange is required to take into
account whether the exemption would result in positions that would not
be in accord with sound commercial practices and whether the position
would exceed an amount that may be established and liquidated in an
orderly fashion.\223\ Accordingly, if hedging more than twelve months'
quantity of unfilled anticipated requirements would not be in accord
with sound commercial practices, or would exceed an amount that may be
established and liquidated in an orderly fashion, the exchange would be
prohibited from granting the exemption.
---------------------------------------------------------------------------
\222\ 150.5(a)(2)(ii)(A).
\223\ 150.5(a)(2)(ii)(G).
---------------------------------------------------------------------------
Even in the absence of a Federal twelve-month restriction, when
administering exchange-set limits, exchanges may, as they do today,
implement a variety of restrictions and limitations on position size to
maintain orderly markets and to fulfill their regulatory obligations.
As described in further detail below, the Commission is finalizing
guidance in paragraph (b) of Appendix B to part 150 to help exchanges
determine when any such restrictions during the spot month might be
appropriate, and when such restrictions may not be needed. For example,
consistent with the guidance in Appendix B to part 150, paragraph (b),
an exchange may consider adopting rules to require that during the
lesser of the last five days of trading (or such time period for the
spot month), such positions must not exceed the person's unfilled
anticipated requirements of the underlying cash commodity for that
month and for the next succeeding month.\224\ Depending on the specific
facts and circumstances, and particular market dynamics, any such
quantity limitation may prevent the use of long futures to source large
quantities of the underlying cash commodity. The Commission may be able
to determine that an exchange's adoption of a two-month limitation
would allow for an amount of activity that is economically appropriate
and in line with common commercial hedging practices, without
jeopardizing any statutory objectives.
---------------------------------------------------------------------------
\224\ This is essentially a less-restrictive version of the
Five-Day rule, allowing a participant to hold a position during the
end of the spot period if economically appropriate, but only up to
two months' worth of anticipated requirements. The two-month
quantity limitation has long-appeared in existing Sec. 1.3 as a
measure to prevent the sourcing of massive quantities of the
underlying in a short time period. 17 CFR 1.3.
---------------------------------------------------------------------------
(ii) Scope of Unfilled Anticipated Requirements and Unfixed-Price
Transactions
Commenters questioned the extent to which anticipated requirements
may be considered to be ``filled'' by unfixed-price purchase supply
contracts under the proposed enumerated bona fide hedge for unfilled
anticipated requirements. COPE, IECA, EPSA and EEI requested
clarification on whether this enumerated hedge covers anticipated
requirements ``filled'' by an unfixed-price purchase contract common to
many electric generators.\225\
---------------------------------------------------------------------------
\225\ COPE at 6; IECA at 7-8; EPSA and EEI jointly at 5.
---------------------------------------------------------------------------
IECA recommended the Commission should either (i) adopt a broad
definition of the word ``unfilled'' that would include anticipated
requirements that are ``filled'' by unfixed-price transactions, or (ii)
expand this bona fide hedge to include both ``unfilled'' and
``unpriced'' \226\ anticipated requirements.\227\
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\226\ The Commission recognizes that market participants may
utilize different nomenclature to refer to unfixed-price contracts.
For example, some commenters may refer to these contracts as
``unpriced'' contracts, while others may refer to these physical
contracts as being at an unfixed spot index price. See FIA at 17,
31; COPE at 6.
\227\ IECA at 7-8.
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AGA also requested clarification \228\ regarding the 2020 NPRM's
statement that this bona fide hedge would recognize a position where a
utility is ``required or encouraged'' by its public utility commission
to hedge.\229\ AGA noted that while the ``required or encouraged''
language is not in the proposed regulatory text, clarification of the
scope for the exemption would result in more certainty for those
utilities in states where the public utility commission may not
directly address or require hedging activities, but instead may allow
or permit hedging for the potential benefits to customers.\230\
---------------------------------------------------------------------------
\228\ AGA at 6-7.
\229\ See 7 U.S.C. 6a(c)(2)(A)(iii); 85 FR at 11610 (``This
would recognize a bona fide hedging position where a utility is
required or encouraged by its public utility commission to hedge'').
\230\ AGA at 6-7.
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(a) Discussion of Final Rule--Scope of Unfilled Anticipated
Requirements
Regarding the requests for clarification on the scope of the term
``unfilled'' in this enumerated hedge, the Commission clarifies that
anticipated ``unfilled'' requirements are not ``filled'' by unfixed-
price transactions. Accordingly, a market participant with a purchase
or sale of a physical commodity, entered into at an unfixed price, may
continue to avail itself of this anticipatory hedge even though the
participant has entered into a firm, albeit unfixed-price, commitment,
and provided all applicable requirements are satisfied.\231\
---------------------------------------------------------------------------
\231\ The Commission clarifies that unfixed-price contracts
include physical fuel agreements for power production for security
of supply that are priced at an unfixed spot index price.
---------------------------------------------------------------------------
As discussed above under Section II.A.1.iv., the Commission adopts
the interpretation of Staff Letter No. 12-07.\232\ That is, commercial
entities that
[[Page 3271]]
enter into unfixed-price transactions may continue to qualify for the
enumerated bona fide hedge for unfilled anticipated requirements as
long as the commercial entity otherwise satisfies the criteria for this
hedge. This rationale is predicated on the fact that an unfixed-price
purchase commitment does not fill an anticipated requirement in that
the market participant's price risk to the input has not been fixed.
---------------------------------------------------------------------------
\232\ CFTC Staff Letter No. 12-07.
---------------------------------------------------------------------------
The Commission continues to believe that unfilled anticipated
requirements are those anticipated inputs that are estimated in good
faith and that have not been filled. As such, an anticipated
requirement may be filled by fixed-price purchase commitments, holdings
of commodity inventory, or unsold anticipated production of the market
participant.\233\ Unfixed-price transactions, however, do not fill an
anticipated requirement.
---------------------------------------------------------------------------
\233\ 81 FR at 96752.
---------------------------------------------------------------------------
Under this anticipatory hedge, once the price is fixed on a supply
contract, the market participant holding the anticipatory hedge
position must, to the extent the position is above an applicable
Federal position limit, liquidate the position in an orderly manner in
accordance with sound commercial practices. Nevertheless, subject to
the specific facts and circumstances, the market participant at that
point may have established the basis for a different bona fide hedge
exemption to offset the price risk arising from its fixed price
exposure.
Finally, the Commission agrees with the commenters' request for
clarification that a utility qualifies for the unfilled anticipated
requirements enumerated hedge even if the utility is not ``required or
encouraged'' by its public utility commission to hedge.
f. Hedges of Anticipated Merchandising
(1) Background--Anticipated Merchandising
The existing bona fide hedge definition in Sec. 1.3 includes
enumerated bona fide hedges that recognize offsets of certain
anticipated activities,\234\ but does not currently include an
enumerated bona fide hedge for anticipated merchandising. While the
Commission's 2011 Final Rule included an enumerated hedge for
anticipated merchandising, it was a narrow hedge focused on the leasing
of storage capacity,\235\ and that rulemaking was ultimately vacated.
---------------------------------------------------------------------------
\234\ See, e.g., Sec. Sec. 1.3(z)(2)(i)(B) (unsold anticipated
production) and 1.3(z)(2)(ii)(C) (unfilled anticipated
requirements).
\235\ The 2011 Final Rule was the first time the Commission
recognized that in some circumstances, a market participant that
owns or leases an asset in the form of storage capacity could
establish positions to reduce the risk associated with returns
anticipated from owning or leasing that capacity. In those narrow
circumstances, the Commission found that those transactions
satisfied the statutory definition of a bona fide hedging
transaction.
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(2) Summary of the 2020 NPRM--Anticipated Merchandising
The Commission proposed a new enumerated bona fide hedge for
anticipated merchandising. The proposed anticipated merchandising hedge
recognized long or short positions in commodity derivative contracts
that offset the anticipated change in value of the underlying commodity
that a person anticipates purchasing or selling.\236\
---------------------------------------------------------------------------
\236\ 85 FR at 11727.
---------------------------------------------------------------------------
While the proposed enumerated anticipated merchandising bona fide
hedge would operate as a self-effectuating bona fide hedge, the
proposed bona fide hedge was subject to the following conditions: (1)
The position offsets the anticipated change in value of the underlying
commodity that a person anticipates purchasing or selling; (2) the
position does not exceed in quantity twelve months' of current or
anticipated purchase or sale requirements of the same cash commodity
that is anticipated to be purchased or sold; (3) the person holding the
position is a merchant handling the underlying commodity that is
subject to the anticipated merchandising hedge; (4) that such merchant
is entering into the position solely for purposes related to its
merchandising business; and (5) the person has a demonstrated history
of buying and selling the underlying commodity for its merchandising
business.\237\
---------------------------------------------------------------------------
\237\ Id.
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(3) Summary of the Commission Determination--Anticipated Merchandising
The Commission is adopting the anticipated merchandising enumerated
hedge as proposed, and makes certain clarifications below to respond to
specific questions from commenters summarized below.
The Commission recognizes that anticipated merchandising is a
hedging practice commonly used by some commodity market participants,
and that merchandisers play an important role in the physical supply
chain. The Commission also recognizes that the derivative transactions
utilized by commercial participants to manage such merchandising
activity are beneficial to price discovery.
(4) Comments--Anticipated Merchandising
(i) Generally
A majority of commenters strongly supported the addition of an
enumerated bona fide hedge for anticipatory merchandising.\238\ In
particular, market participants from the energy industry strongly
supported the inclusion of this enumerated hedge, subject to certain
clarifications described in detail further below.\239\ On the other
hand, Better Markets indicated that the enumerated anticipatory bona
fide hedges generally, and particularly the enumerated hedge for
anticipatory merchandising, pose a regulatory avoidance risk.\240\
Better Markets expressed concern that market participants could attempt
to claim an underlying risk is anticipated in a cash commodity in order
to justify positions in referenced contracts that exceed Federal
position limits.\241\
---------------------------------------------------------------------------
\238\ AGA at 1, 8; AFR at 2; Cargill at 4-6; NGSA at 2, 4; CMC
at 4-5, 7-8; ADM at 3; NCFC at 2-4; Chevron at 2, 5; Suncor at 3, 5;
IFUS at 2 (Exhibit 1 RFC 4); ICEA at 2; NGFA at 4, 7; CCI at 7-9;
ASR at 2; FIA at 16; CEWG at 14.
\239\ AGA at 8; AFR at 2; Cargill at 5-6; NGSA at 4; CMC at 5,
7; ADM at 3; NCFC at 3-4; Chevron at 5; Suncor at 5; IFUS at Exhibit
1 RFC 4; ICEA at 2; NGFA at 7; CCI at 7-9.
\240\ Better Markets at 3, 59-60 (stating that ``. . . an
identical conceptual avoidance risk continues to exist across all of
these anticipatory hedges--namely, that firms may claim an
underlying risk is anticipated in order to justify positions well
over the speculative limits in Referenced Contracts'').
\241\ Id.
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In addition to expressing support for the inclusion of this
enumerated bona fide hedge, most commenters also requested clarity or
guidance on the scope of the proposed anticipated merchandising bona
fide hedge. For example, CMC stated that the Commission must be clear
with the exchanges and the end-user community about what activity is
included in the enumerated anticipated merchandising bona fide
hedge.\242\ Similarly, Cargill and NGFA supported the addition of the
enumerated anticipated merchandising bona fide hedge, but urged the
Commission to provide more clarity on how the enumerated bona fide
hedge would be applied.\243\ Cargill and NGFA also requested that the
Commission address language that appeared in footnote 105 of the 2020
NPRM,\244\
[[Page 3272]]
which implied that certain storage hedges and hedges of assets owned or
anticipated to be owned would be evaluated through the non-enumerated
bona fide hedge process, rather than as a self-effectuating enumerated
anticipated merchandising bona fide hedge.\245\
---------------------------------------------------------------------------
\242\ CMC at 5 (stating that n.105 of the 2020 NPRM casts a
significant shadow of uncertainty and that if the Commission
believes limits are necessary, it must be clear with the exchanges
and the end-user community about what activities are enumerated).
\243\ Cargill at 5-6; NGFA at 7.
\244\ 85 FR at 11612. Footnote 105 from the 2020 NPRM provided:
``Similarly, other examples of anticipatory merchandising that have
been described to the Commission in response to request for comment
on proposed rulemakings on position limits (i.e., the storage hedge
and hedges of assets owned or anticipated to be owned) would be the
type of transactions that market participants may seek through one
of the proposed processes for requesting a non-enumerated bona fide
hedge recognition.''
\245\ Cargill at 5-6; NGFA at 7.
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(ii) Requirements for Anticipated Merchandising
(a) Requirement to Hedge Only Twelve Months' Worth of Anticipated
Requirements
Although many public comments addressed the new anticipated
merchandising bona fide hedge, only a few commenters opposed the
proposed requirement to limit this hedge to only twelve months' worth
of current or anticipated purchase or sale requirements of the same
cash commodity that is anticipated to be purchased or sold. FIA opposed
the twelve-month restriction, stating that CEA section 4a(c)(2) does
not tie the validity of a bona fide hedge to the duration of the
commercial requirement being hedged.\246\ FIA also provided an example
pointing out that market participants often need hedges of anticipated
purchases or sales longer than twelve months, such as when a merchant
has a reasonable expectation of anticipated sales beyond a twelve-month
quantity.\247\
---------------------------------------------------------------------------
\246\ FIA at 16-17.
\247\ Id.
---------------------------------------------------------------------------
Similarly, ADM stated that anticipatory merchandising transactions
should be considered similar to ``hedges of anticipated requirements''
and therefore not subject to the twelve-month restriction.\248\
---------------------------------------------------------------------------
\248\ ADM at 3. The 2020 Proposal would remove the existing 12-
month restriction applicable to the existing enumerated hedge for
unfilled anticipated requirements. See 85 FR at 11610.
---------------------------------------------------------------------------
(b) Discussion of Final Rule--Twelve-Month Restriction
After considering the comments on the requirement to hedge only
twelve months' worth of anticipated requirements, the Commission is
adopting the twelve-month restriction as proposed. The Commission
continues to believe that, as stated in the 2020 NPRM, this requirement
is intended to ensure that merchants are hedging their legitimate
anticipated merchandising exposure to the value change of the
underlying commodity, while calibrating the anticipated need within a
reasonable timeframe and subject to the limitations in physical
commodity markets, such as annual production or processing
capacity.\249\ A twelve-month restriction for anticipated merchandising
is suitable in connection with contracts that are based on anticipated
activity on yet-to-be established cash positions due to the uncertainty
of forecasting such activity and, all else being equal, the increased
risk of excessive speculation on the price of a commodity the longer
the time period before the actual need arises.
---------------------------------------------------------------------------
\249\ 85 FR at 11611.
---------------------------------------------------------------------------
Regarding FIA's comment opposing the twelve-month restriction based
on FIA's interpretation of CEA section 4a(c)(2), the Commission is
comfortable that hedging twelve months' or less of current or
anticipated purchase or sale requirements of the same cash commodity
that is anticipated to be purchased or sold is consistent with the CEA
section 4a(c)(2)(A)(ii) requirement that bona fide hedges be
economically appropriate to the reduction of risks in the conduct and
management of a commercial enterprise.\250\ However, hedging more than
twelve months' anticipated purchase or sale requirements could in some
cases be inconsistent with that statutory requirement. Accordingly,
bona fide hedges involving more than twelve months' worth of
anticipated requirements for anticipated merchandising are best
evaluated on a case-by-case basis under the non-enumerated process
adopted herein. The Commission understands that commercial firms may
seek to manage the price risk of more than twelve months' anticipated
merchandising activities; where such situations arise, the Commission
believes a non-enumerated bona fide hedge could be appropriate.
---------------------------------------------------------------------------
\250\ See 7 U.S.C. 6a(c)(2)(A)(ii).
---------------------------------------------------------------------------
The Commission also considered comments that stated that the
Commission should treat the proposed anticipated merchandising bona
fide hedge similar to the other anticipatory bona fide hedges adopted
herein (i.e., the enumerated bona fide hedges for unsold anticipated
production and unfilled anticipated requirements), which are no longer
subject to the twelve-month restriction.\251\ However, the Commission
believes that the enumerated bona fide hedge for anticipated
merchandising, which is a new enumerated bona fide hedge, is
distinguishable from the enumerated bona fide hedges for unsold
anticipated production and unfilled anticipated requirements, which
both have been part of the Federal position limits framework for
decades.
---------------------------------------------------------------------------
\251\ ADM at 3.
---------------------------------------------------------------------------
In particular, the Commission has determined that a twelve-month
restriction is unnecessary for bona fide hedges of unfilled anticipated
requirements and unsold anticipated production in part because
anticipated production and requirements, unlike merchandising, are
linked and subject to inherent physical limits. For example, a
processor has a physical limit on production capacity to support claims
of anticipated unsold production. Likewise, a manufacturer, processor
or utility has a physical limit on manufacturing, processing, or energy
generation, respectively, for similar reasons to tie any claim of
anticipated requirements. In each case, anticipated production or
requirements generally should result in relatively predictable levels
of activity that will not vary much year to year. In contrast, the
amount a given market participant could claim to anticipate
merchandising is potentially unlimited and less connected to physical
production capacity.\252\
---------------------------------------------------------------------------
\252\ To verify market participants' bona fide hedging needs,
the Final Rule's recordkeeping requirements require persons availing
themselves of enumerated bona fide hedge recognitions to maintain
complete books and records concerning all relevant information on
their anticipated requirements, production, and merchandising
activities. See 17 CFR 150.3(d)(1). Furthermore, the Commission
notes that as part of the exemption application process under final
Sec. 150.5, persons seeking exemptions from exchange-set position
limits are required to include a description of its activities in
the cash markets and swap markets for the commodity underlying the
position for which the application is submitted.
---------------------------------------------------------------------------
(iii) Request for Clarification--Meaning of ``Merchant''
Comments from energy market participants requested that the
Commission clarify the meaning of the term ``merchant'' as such term is
used in the regulatory text of the proposed anticipated merchandising
hedge.\253\ Specifically, market participants from the energy industry
expressed concern about whether the Commission would construe the term
``merchant'' such that only entities that are solely merchants, and not
engaged in other business activities, would qualify for the anticipated
merchandising bona fide hedge.\254\ These commenters explained that
large energy companies with
[[Page 3273]]
vertically integrated corporate structures typically have several legal
entities that perform individual business functions, including
merchandising.\255\ As such, these commenters requested the Commission
clarify that integrated energy companies routinely engaged in
merchandising activities, as well as other activities such as
production, processing, marketing and power generation, may utilize the
enumerated hedge for anticipated merchandising in addition to other
bona fide hedges.\256\
---------------------------------------------------------------------------
\253\ CMC at 5; Shell at 8; Chevron at 5-6; Suncor at 5-6; CEWG
at 15-16.
\254\ Shell at 8; Chevron at 5-6; Suncor at 5-6; CEWG at 15-16.
\255\ Id.
\256\ Id.
---------------------------------------------------------------------------
(a) Discussion of Final Rule--Meaning of ``Merchant''
The Commission is adopting the term ``merchant'' in the final
anticipated merchandising bona fide hedge as proposed, but clarifies
here the intended meaning of that term.
In particular, the Commission is clarifying that the term
``merchant'' in the anticipated merchandising enumerated bona fide
hedge is not limited to those entities exclusively engaged in the
business of merchandising. Instead, the term ``merchant'' may include
physical commodity market participants that, in addition to offering or
entering into transactions solely for purposes related to their
merchandising business, may otherwise also be a producer, processor, or
commercial user of the commodity that underlies the anticipated
merchandising transaction.
The Commission's use of the term ``merchant'' is intended to
capture commercial market participants who participate in the physical
commodity market, and does not exclude such participants simply because
they have a vertically integrated corporate structure. That is, energy,
agricultural, or metal companies in the physical commodity market with
vertically-integrated or complex corporate structures are not excluded
as merchants, so long as they otherwise satisfy all applicable
requirements related to the anticipated merchandising bona fide hedge.
The condition requiring the person to be a merchant to qualify for
this enumerated hedge is consistent with the Commission's longstanding
practice of providing commercial market participants relief from
certain regulatory requirements as a way of reducing regulatory
compliance obligations that would otherwise burden a commercial market
participant's physical commodity business.
The Commission has taken a similar approach under the trade option
exemption by exempting the physically delivered commodity options
purchased by commercial users of the commodities underlying the
options. Under the trade option relief, the Commission recognized that
commercial market participants needed relief by generally exempting
qualifying commodity options from the swap requirements of the CEA and
the Commission's regulations.\257\ Unlike in the trade option
requirements, there is no requirement under the anticipated
merchandising enumerated bona fide hedge that both counterparties
qualify as merchants. The anticipated merchandising enumerated bona
fide hedge, however, is intended to generally benefit the same type of
market participants as the trade option exemption, that is, commercial
market participants who participate in the physical commodity market
for the underlying commodity being merchandised. As such, the text of
the anticipated merchandising enumerated bona fide hedge excludes a
party who is not entering into the anticipated merchandising activity
solely for commercial purposes related to its merchandising business,
but instead, to speculate on the price of the underlying commodity. For
example, non-commercial market participants who employ various
arbitrage strategies, including sometimes trading arbitrage positions
in cash commodity markets to speculate on the price of the underlying
commodity, and those market participants with highly leveraged
derivatives portfolios of non-physical commodities, would not qualify
as merchants.
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\257\ Trade Options, Final Rule, 81 FR 14966 (March 21, 2016).
---------------------------------------------------------------------------
Finally, the Commission has determined that it is not necessary to
amend the regulatory text's reference to merchant to expressly include
producers or processors. As clarified above, a producer and a processor
may qualify for the anticipated merchandising bona fide hedge as a
merchant if a part of their business involves merchandising.
Furthermore, such entities that are also producers or processors may
otherwise rely on the enumerated anticipated unsold anticipated
production or unfilled anticipated requirements bona fide hedges, where
applicable. Thus, the Commission is providing these market participants
with ample flexibility to manage the price risks arising from their
anticipated merchandising activity using an expanded suite of
anticipatory bona fide hedges.
(iv) Requirement for a History of Merchandising
The Commission did not receive any specific comments on the
proposed requirement to demonstrate a history of merchandising
activity.
(a) Discussion of Final Rule--History of Merchandising Requirement
The Commission is adopting the requirement to demonstrate a history
of merchandising as proposed.
Such demonstrated history must include a history of making and
taking delivery of the underlying commodity, and a demonstrated ability
to store and move the underlying commodity.\258\ A merchandiser that
lacks the requisite history of anticipated merchandising activity could
still potentially receive bona fide hedge recognition under the non-
enumerated process, so long as the merchandiser can otherwise
demonstrate compliance with the bona fide hedging definition and other
applicable requirements, including demonstrating activities in the
physical marketing channel, including, for example, arrangements to
take or make delivery of the underlying commodity.\259\
---------------------------------------------------------------------------
\258\ 85 FR at 11611.
\259\ Id.
---------------------------------------------------------------------------
(v) Scope of Anticipated Merchandising Activity
In response to comments from the exchanges and market participants,
the Commission is providing further clarity on the scope of the
enumerated anticipated merchandising bona fide hedge. The Commission
discusses below certain non-exclusive types of activities that are
covered by the enumerated anticipated merchandising bona fide hedge.
(a) Request for Clarification--Unfixed-Price Contracts and Enumerated
Anticipated Merchandising Hedge
Commenters requested clarification on whether the enumerated bona
fide hedge for anticipated merchandising may be used to manage price
risk arising from unfixed-price physical commodity transactions.
Specifically, several commenters requested clarification on whether a
firm may use the anticipated merchandising bona fide hedge to manage
the risk associated with a single-sided unfixed purchase or sale at a
moment when the same firm does not have an offsetting sale or
purchase.\260\ In
[[Page 3274]]
addition to commercial market participants, ICE and CME Group also
requested that the Commission recognize single-sided hedges of unfixed-
price purchases or sales. Similar to energy market participants, ICE
noted that pricing physical energy commodity transactions at unfixed
prices is a common pricing mechanism in the energy markets.\261\ CME
Group provided a hypothetical example of a single-side floating or
unfixed-price purchase or sale to demonstrate that derivatives
positions entered into to effectuate that single-sided unfixed-price
purchase or sale would reduce the price risk arising for each
counterparty.\262\
---------------------------------------------------------------------------
\260\ NCFC at 3-4; CMC at 4; IFUS at 4-5; NGSA at 6 (requesting
the Commission unambiguously recognize hedges of index-price risk
(not just fixed-price risk), noting that exchanges currently
recognize these types of hedges).
\261\ ICE at 4.
\262\ CME Group at 8.
---------------------------------------------------------------------------
Some commenters requested the Commission clarify that market
participants can utilize the enumerated anticipatory merchandising
hedge to manage the price risks arising from unfixed-price
transactions.\263\
---------------------------------------------------------------------------
\263\ CEWG at 19; CMC at 8; Shell at 7-8; ACSA at 6; ICE at 5;
CME Group at 8; Ecom at 1; Southern Cotton at 2; Canale Cotton at 2;
Moody Compress at 1; IMC at 2; Mallory Alexander at 2; ACA at 2;
East Cotton at 2; Jess Smith at 2; Olam at 2; McMeekin at 2; Memtex
at 2; Omnicotton at 2; Toyo at 2; Texas Cotton at 2; NCC at 1;
Walcot at 2; White Gold at 2.
---------------------------------------------------------------------------
Other commenters suggested the Commission could create a new
enumerated bona fide hedge category solely to recognize hedges of
unfixed-price transactions.\264\
---------------------------------------------------------------------------
\264\ ACSA at 6-7; NCC at 2.
---------------------------------------------------------------------------
(1) Discussion of Final Rule--Unfixed-Price Contracts and Enumerated
Anticipated Merchandising Hedge
As discussed above under Section II.A.1.iv., the Commission is
clarifying that market participants that enter into unfixed-price
transactions may still be able to qualify for the enumerated bona fide
hedge for anticipated merchandising. In other words, a commercial
entity that enters into an unfixed-price transaction may qualify for an
anticipated merchandising bona fide hedge as long as the market
participant satisfies the other requirements, discussed above and
below, of the final anticipated merchandising bona fide hedge (e.g.,
qualifies as a merchant, demonstrates a history of merchandising and
satisfies the twelve-month restriction). This rationale is predicated
on the fact that an unfixed-price transaction does not address a
merchant's anticipated merchandising need in that the merchant's price
risk to the merchandise has not been fixed. Accordingly, a merchant may
use the anticipated merchandising hedge to manage the risk associated
with a single sided unfixed purchase or sale at a moment when the same
firm does not have an offsetting sale or purchase. The Commission's
treatment of unfixed-price transactions is discussed in more detail in
Section II.A.1.iv.\265\
---------------------------------------------------------------------------
\265\ See Section II.A.1.iv, addressing the treatment of unfixed
price transactions.
---------------------------------------------------------------------------
While the Commission understands market participants' desire for a
standalone exemption for unfixed-price transactions, the Commission
finds that such an exemption is unnecessary. The Commission notes that
the modified and expanded suite of enumerated bona fide hedges,
including enumerated anticipatory bona fide hedges, adequately
facilitates the hedging needs of qualified commercial market
participants.
Finally, the Commission believes that the enumerated anticipated
merchandising bona fide hedge provides for ample flexibility for
hedging. Similar to the enumerated unfilled anticipated requirements
and unsold production bona fide hedges, this bona fide hedge may be
used even when the merchant simply anticipates purchasing or selling
the commodity, and even when the merchant may have yet to enter into an
unfixed-price transaction, as long as the merchant has a good faith
belief that it will enter into the anticipated merchandising
transaction.
(b) Analysis of Examples Preliminarily Recognized as Hedges of
Anticipated Merchandising in the 2020 NPRM
As discussed earlier in this release, in the 2020 NPRM, the
Commission addressed several requests that had been submitted in CEWG's
BFH Petition in response to the 2011 Final Rule, to obtain exemptive
relief for several transactions described by CEWG as bona fide hedging
positions. In the 2020 NPRM, the Commission preliminarily determined
that two CEWG BFH Petition examples complied with the proposed hedge of
anticipated merchandising: Example #4 (Binding, Irrevocable Bids or
Offers); and example #5 (Timing of Hedging Physical Transactions).\266\
---------------------------------------------------------------------------
\266\ 85 FR at 11611.
---------------------------------------------------------------------------
On the other hand, as discussed in Section II.A.1.iv., the
Commission preliminarily determined in the 2020 NPRM that the positions
described in the CEWG's BFH Petition examples #3 (unpriced physical
purchase or sale commitments) and #7 (scenario 2) (use of physical
delivery referenced contracts to hedge physical transactions using
calendar month average pricing) did not satisfy any of the proposed
enumerated hedges.\267\
---------------------------------------------------------------------------
\267\ 85 FR at 11611-11612.
---------------------------------------------------------------------------
(1) Comments--Examples Preliminarily Recognized as Hedges of
Anticipated Merchandising in the 2020 NPRM
The Commission received comments supporting the Commission's
preliminary determination in the 2020 NPRM that CEWG's BFH Petition
example #4 (Binding, Irrevocable Bids or Offers) \268\ and example #5
(Timing of Hedging Physical Transactions) are permitted under the 2020
NPRM's proposed enumerated hedge for anticipated merchandising.\269\
The public comments related to examples #3 and #7 (scenario 2) are
discussed in the preamble at Section II.A.1.iv., addressing the
treatment of unfixed price transactions.
---------------------------------------------------------------------------
\268\ FIA at 16. FIA supported the Commission's preliminary
determination that Examples #4 (Binding, Irrevocable Bids or Offers)
and #5 (Timing of Hedging Physical Transactions) fit within the
newly proposed anticipatory merchandising hedge.
\269\ CEWG at 19.
---------------------------------------------------------------------------
(2) Discussion of Final Rule--Examples Preliminarily Recognized as
Hedges of Anticipated Merchandising in the 2020 NPRM
The Commission has considered the public's response to its
preliminary determination that several of the CEWG BFH Petition
examples fit within the 2020 NPRM. The Commission determines in this
Final Rule that BFH Petition example #4 (Binding, Irrevocable Bids or
Offers) and example #5 (Timing of Hedging Physical Transactions) comply
with the enumerated hedge for anticipated merchandising, so long as all
applicable conditions are met.
In accordance with the Commission's treatment of unfixed-price
transactions under this Final Rule, discussed in Section II.A.1.iv.,
the Commission has determined that BFH Petition examples #3 and #7
(scenario 2) are also permitted under the Final Rule, so long as the
position or transaction complies with the applicable conditions of the
enumerated anticipatory hedge.
(c) Anticipated Merchandising Includes Hedges of Anticipated Storage
and Assets Owned or Anticipated To Be Owned
Several commenters requested the Commission clarify the scope of
the proposed anticipated merchandising bona fide hedge in light of the
Commission's observation in footnote 105 of the 2020 NPRM.\270\ That
footnote stated that certain hedges of storage and
[[Page 3275]]
hedges of assets owned or anticipated to be owned would not be within
the scope of the proposed anticipated merchandising enumerated bona
fide hedge.\271\ However, the plain language of the proposed
anticipatory merchandising bona fide hedge appeared to be broad enough
to cover such activity. Commenters were thus unsure whether the
proposed enumerated anticipated merchandising hedge would apply to
storage transactions and to hedges of assets owned or anticipated to be
owned.
---------------------------------------------------------------------------
\270\ Cargill at 5; CMC at 5; NGFA at 7.
\271\ 85 FR at 11612 n.105.
---------------------------------------------------------------------------
Most commenters from the energy industry requested the Commission
allow for anticipated storage positions to be considered as falling
within the enumerated hedge exemption for anticipated merchandising,
contending that such hedges are recognized as bona fide hedge
exemptions by the exchanges.\272\ Chevron and Castleton requested that
the Final Rule clarify that hedges of storage may qualify for the
enumerated bona fide hedge for anticipated merchandising if applicable
conditions are met.\273\
---------------------------------------------------------------------------
\272\ NGSA at 7; CHS at 4 (requesting to include a winter
storage hedge in the list of enumerated hedges); FIA at 16, 31
(requesting to include a storage hedge as a separate enumerated
BFH); Shell at 7-8 (stating that assets used for the transport and
storage of energy are a critical part of the energy value chain,
including fuel storage tanks and pipeline assets as examples where
time spreads or location basis spreads are used to lock-in the
values of the assets. This commenter stated that with respect to
such infrastructure assets, the Commission should clarify that the
use of the hedges of anticipated storage or other physical assets is
the type of risk activity that falls within the enumerated BFH for
anticipated merchandising); Chevron at 9-11 (requesting that a final
rule clarify that hedges of storage may qualify for the enumerated
BFH for anticipated merchandising if applicable conditions are met.
In the alternative, Chevron requests the Commission identify and
clarify that storage hedges of this nature qualify for another
enumerated exemption, notably the enumerated BFH for unfilled
anticipated requirements); Suncor at 9-10 (requesting that a final
rule clarify that hedges of storage may qualify for the enumerated
BFH for anticipated merchandising if applicable conditions are met);
CCI at 7-9; and CEWG at 16-19 (requesting that the Commission
clarify that the enumerated BFH for anticipatory merchandising
applies to hedges of storage).
\273\ Chevron at 5; CCI at 8-9.
---------------------------------------------------------------------------
In the alternative, Chevron requested the Commission identify and
clarify that storage hedges of this nature qualify for another
enumerated exemption, notably the enumerated bona fide hedge for
unfilled anticipated requirements.\274\ Citadel similarly requested
recognition of offsetting positions related to anticipated changes in
the value of the underlying commodity to be stored in facilities on
lease, and up to the full storage capacity on lease, rather than only
the currently utilized level of leased capacity.\275\ Citadel argued
that storage facilities owned, but not those leased, by the merchant
would be covered by the proposed anticipated merchandising enumerated
bona fide hedge, and that such different treatment depending on whether
the facility was owned or leased did not make sense.\276\
---------------------------------------------------------------------------
\274\ Chevron at 11.
\275\ Citadel at 9.
\276\ Id.
---------------------------------------------------------------------------
(1) Discussion of Final Rule--Anticipated Merchandising Includes Hedges
of Anticipated Storage and Assets Owned or Anticipated To Be Owned
In response to public comments, the Commission determines that both
hedges of storage and hedges of assets owned or anticipated to be owned
can potentially qualify for the enumerated hedge for anticipated
merchandising if the applicable conditions are met.
In footnote 105 of the 2020 NPRM, the Commission observed that
market participants could use the non-enumerated process (rather than a
self-effectuating enumerated hedge) to receive bona fide hedge
recognition for storage hedges and hedges of assets owned or
anticipated to be owned.\277\ This observation was predicated on the
Commission's recognition that different commodities have different
storage roles, manners, and procedures. For example, the use of some
storage facilities is not exclusive to a specific commodity and not all
storage is necessarily tied to anticipated merchandising activity. As
such, the Commission believed that an analysis of facts and
circumstances under the non-enumerated bona fide hedge process would
facilitate a determination on whether to recognize hedges of storage or
assets owned or anticipated to be owned under the proposed enumerated
anticipated merchandising hedge.
---------------------------------------------------------------------------
\277\ 85 FR at 11612.
---------------------------------------------------------------------------
The Commission has considered comments with respect to the
appropriate treatment of storage transactions and hedges of assets
owned or anticipated to be owned under the Commission's anticipated
merchandising enumerated hedge. The Commission agrees that commercial
market participants may utilize storage hedges or hedges of assets
owned or anticipated to be owned as risk reducing practices.\278\ The
Commission believes that such risk reducing hedges may be recognized as
anticipated merchandising bona fide hedges, if all the applicable
conditions of the anticipated merchandising hedge are satisfied. The
Commission clarifies that commercial market participants in the
physical marketing channel that utilize storage hedges or hedges of
assets owned or anticipated to be owned may continue to qualify for the
anticipated merchandising enumerated bona fide hedge, whether the
commercial market participant owns or leases the storage or asset, so
long as the all other applicable requirements for the bona fide hedge
are satisfied.
---------------------------------------------------------------------------
\278\ CEWG at 16.
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g. Hedges by Agents
(1) Background--Hedges by Agents
Existing Sec. 1.3(z)(3) includes certain hedges by agents as an
example of a potential non-enumerated bona fide hedge.\279\ Since 2011,
the Commission has included an enumerated hedge for hedges by agents in
each of its position limits rulemakings.\280\
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\279\ 17 CFR 1.3(z)(3) (``Such transactions and positions may
include, but are not limited to, purchases or sales for future
delivery on any contract market by an agent who does not own or who
has not contracted to sell or purchase the offsetting cash commodity
at a fixed price, provided That the person is responsible for the
merchandising of the cash position which is being offset.'').
\280\ 81 FR at 96964; 78 FR at 75714; 76 FR at 71689.
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Under the existing non-enumerated hedge process, the Commission has
recognized non-enumerated bona fide hedges for parties acting as agents
who had the responsibility to trade cash commodities on behalf of
another party for which such positions qualified as bona fide hedging
positions. Such agents could obtain bona fide hedge treatment to
offset, on a long or short basis, the risks arising from those
underlying cash positions. For example, this hedge has been recognized
in circumstances where a party traded or managed a farmer's,
producer's, or a government entity's inventory in the party's capacity
as agent. In such circumstances, the agent providing services in the
physical marketing channel, such as a commercial firm, did not take
ownership of the commodity and was eligible as an agent for an
exemption to hedge the risks associated with such cash positions.
(2) Summary of the 2020 NPRM--Hedges by Agents
The Commission proposed to include hedges by agents as an
enumerated hedge. The proposed hedge would grant an enumerated hedge to
an agent who (1) did not own or was not contracted to sell or purchase
the offsetting cash commodity at a fixed price, (2) was responsible for
merchandising the cash positions being offset, and (3) had a
[[Page 3276]]
contractual agreement with the person who (i) owned the commodity or
(ii) held cash-market positions being offset.
The proposed hedge of agents would substantively adopt the
Commission's existing practice under the non-enumerated process in
existing Sec. 1.3(z)(3).\281\ The Commission, however, proposed to
include hedges of agents in the list of enumerated hedges because it
preliminarily determined this was a common hedging practice and that
positions which satisfy the requirements of this enumerated hedge
conformed to the general definition of bona fide hedging without
further consideration as to the particulars of the case.\282\
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\281\ For example, the Commission proposed to replace the phrase
``offsetting cash commodity'' with ``contract's underlying cash
commodity'' to use language that is consistent with the other
proposed enumerated hedges.
\282\ 85 FR at 11610.
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(3) Summary of the Commission Determination--Hedges by Agents
The Commission is adopting the enumerated bona fide hedge for
hedges by agents as proposed.
(4) Comments--Hedges by Agents
The Commission received several comments supporting recognition of
the hedge by agents, particularly as included in an expanded list of
enumerated hedges.\283\ ASR identified hedges of agents as a type of
hedge that is of particular importance to them because it is used daily
within its business.\284\ The Commission did not receive any comments
opposed to the enumerated hedge for hedges by agents.
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\283\ FIA at 16; IECA at 2; and ASR at 2.
\284\ ASR at 2.
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(5) Discussion of Final Rule--Hedges by Agents
The Commission recognizes that agents provide important services in
the physical marketing channel across different commodity markets. For
example, in the agricultural sector, this enumerated hedge will
accommodate a common hedging practice in the cotton industry. This
hedge will be particularly useful in connection with cotton equities
purchased by a cotton merchant from a producer, which is commonly done
under the U.S. Department of Agriculture's loan program to facilitate
marketing tools for cotton producers.
Another example of when the enumerated hedge by agents adopted
herein will apply is for those agents who are in the business of
merchandising (selling) the cash grain owned by multiple warehouse
operators and forwarding the merchandising revenues back to the
warehouse operators less the agent's fees. Such agents that satisfy the
requirements of this enumerated hedge, such as not owning any cash
commodity but being responsible for merchandising the cash grain
positions of the warehouse operators pursuant to contractual
agreements, will be able to hedge the price risks arising from their
merchandising activity under those agreements as a bona fide hedge by
agents.
h. Short Hedges of Anticipated Mineral Royalties
(1) Background--Anticipated Mineral Royalties
The Commission's existing bona fide hedging definition does not
include an enumerated hedge for anticipated mineral royalties. Since
2011, the Commission has, however, included such a bona fide hedge in
each of its position limits rulemakings.\285\ While the Commission's
2011 Final Rule initially recognized the hedging of anticipated
royalties generally, each proposal since then, including the latest
2020 NPRM, has proposed that this exemption apply to: (i) Short
positions (ii) that arise from production (iii) in the context of
mineral extraction.
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\285\ 81 FR at 96964; 78 FR at 75715; 76 FR at 71689. In the
2011 Final Rule, the Commission recognized anticipatory royalty
transactions as a bona fide hedge, provided the following conditions
were met: (1) The royalty or services contract arose out of the
production, manufacturing, processing, use, or transportation of the
commodity underlying the Referenced Contract; (2) The hedge's value
was ``substantially related'' to anticipated receipts or payments
from a royalty or services contract; and (3) No such position was
maintained in any physical-delivery Referenced Contract during the
last five days of trading of the Core Referenced Futures Contract in
an agricultural or metal commodity or during the spot month for
other physical-delivery contracts.
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(2) Summary of the 2020 NPRM--Anticipated Mineral Royalties
The Commission proposed a new enumerated bona fide hedge for short
hedges of anticipated mineral royalties that are not currently
enumerated in existing Sec. 1.3. The proposed provision would permit
an owner of rights to a future mineral royalty to lock in the price of
anticipated mineral production by entering into a short position in a
commodity derivative contract to offset the anticipated change in value
of the mineral royalty rights that were owned by that person and arose
out of the production of a mineral commodity (e.g., oil and gas).\286\
The owner of the rights to the future mineral royalty could be a
producer, or, for example, could also be a bank that holds the relevant
royalty rights and that is financing, for example, a drilling well
operation for a producer. The Commission preliminarily believed that
this represents a common hedging practice, and that positions that
satisfied the requirements of this enumerated bona fide hedge conformed
to the general definition of bona fide hedging without further
consideration as to the particulars of the case.\287\
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\286\ 85 FR at 11608-11609. A short position fixes the price of
the anticipated receipts, removing exposure to change in value of
the person's share of the production revenue. A person who has
issued a royalty, in contrast, has, by definition, agreed to make a
payment in exchange for value received or to be received (e.g., the
right to extract a mineral). Upon extraction of a mineral and sale
at the prevailing cash-market price, the issuer of a royalty remits
part of the proceeds in satisfaction of the royalty agreement. The
issuer of a royalty, therefore, does not have price risk arising
from that royalty agreement.
\287\ 85 FR at 11609.
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The Commission proposed to limit this enumerated bona fide hedge
only to mineral royalties, noting that while royalties have been paid
for use of land in agricultural production, the Commission did not
receive any evidence of a need for a bona fide hedge recognition from
owners of agricultural production royalties.\288\ The Commission
requested comment on whether and why such an exemption might be needed
for owners of agricultural production or other royalties.\289\
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\288\ Id.
\289\ Id.
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(3) Summary of the Commission Determination--Anticipated Mineral
Royalties
For the reasons discussed in the NPRM, the Commission is adopting
the enumerated hedge for anticipated mineral royalties as proposed.
(4) Comments--Anticipated Mineral Royalties
The Commission did not receive any comments either opposing the
addition of an enumerated bona fide hedge for anticipated mineral
royalties or requesting modifications to the hedge as proposed.
Further, no commenters requested extending the enumerated hedge to
other types of royalties other than mineral royalties. Several
commenters expressed support for the new enumerated hedge.\290\
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\290\ FIA at 16; IECA at 2.
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i. Hedges of Anticipated Services
(1) Background--Anticipated Services
The Commission's existing bona fide hedging definition does not
include an enumerated hedge of anticipated services. Since 2011,
however, the
[[Page 3277]]
Commission has included an enumerated bona fide hedge exemption for
hedges of anticipated services in each of its position limits
rulemakings.\291\
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\291\ 81 FR at 96810; 78 FR at 75715. See 76 FR at 71646.
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Further, in 1977, the Commission noted that the existence of
futures markets for both source and product commodities, such as
soybeans, soybean oil, and soybean meal, affords business firms
increased opportunities to hedge the value of services.\292\
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\292\ 42 FR 14832, 14833 (Mar. 16, 1977).
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(2) Summary of the 2020 NPRM--Anticipated Services
The Commission proposed a new enumerated bona fide hedge for
anticipated services, not currently enumerated in existing Sec. 1.3.
The proposed provision would recognize as a bona fide hedge a long or
short derivative contract position used to hedge the anticipated change
in value of receipts or payments due or expected to be due under an
executed contract for services arising out of the production,
manufacturing, processing, use, or transportation of the commodity
underlying the commodity derivative contract.\293\
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\293\ 85 FR at 11609.
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(3) Summary of the Commission Determination--Anticipated Services
The Commission is adopting the enumerated bona fide hedge for
anticipated services as proposed.
(4) Comments--Anticipated Services
The Commission received four comments on the proposed enumerated
anticipated services bona fide hedge. ASR and FIA expressed support for
its inclusion as a new enumerated bona fide hedge.\294\ In contrast,
IATP and Better Markets urged the Commission to exclude this hedge from
the list of enumerated bona fide hedges.\295\ IATP stated that the
anticipated services bona fide hedge is ``presumably connected to
hedges of anticipated production'' and that, as a result, it views the
enumerated hedge as ``more vulnerable to deliverable supply estimate
disruption.'' \296\ IATP also contended that, absent a stronger
argument for inclusion of this enumerated bona fide hedge aside from
``such exemptions are granted by exchanges,'' the proposed bona fide
hedge of anticipated services merits greater Commission review before
being included as an enumerated bona fide hedge.\297\ Better Markets
stated that the definition was too vague, and that absent a time
limitation, the hedge could be used as a loophole for speculation.\298\
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\294\ ASR at 2; FIA at 16.
\295\ IATP at 17; Better Markets at 58.
\296\ IATP at 17.
\297\ Id.
\298\ Better Markets at 58.
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(5) Discussion of the Final Rule--Anticipated Services
The Commission is adopting the enumerated bona fide hedge for
anticipated services as proposed.
In response to IATP, the Commission believes that hedging of
anticipated services may be useful to commercial market participants in
a variety of commonly-occurring scenarios. For example, one scenario
may be when a contract for services involves the production of a
commodity such as a risk service agreement to drill an oil well between
two companies where the risk service agreement between the parties
provides that a portion of the revenue receipts to one of the
counterparties depends on the value of the oil produced. To reduce the
risk of lower anticipated revenues resulting from an anticipated lower
price of oil, the company may enter into a short position in the NYMEX
Light Sweet Crude Oil referenced contract.
Under this enumerated bona fide hedge of services, such a short
position fixes the price at the entry price to the commodity derivative
contract. For any decrease in price of the commodity that is the
subject of the executed contract for services, the expected receipts
from the contract for services would decline in value, but the short
commodity derivative contract position would increase in value--
offsetting the price risk from the expected receipts under contract for
services.
On the other hand, this enumerated hedge of anticipated services
may also be utilized when a contract for services involves a contract
where one of the counterparties is responsible for the cost of the
commodity used to provide the service. Such a scenario may occur when a
city contracts with a firm to provide waste management services. The
contract requires that the trucks used to transport the solid waste use
natural gas as a power source. According to the contract, the city
would pay for the cost of the natural gas used to transport the solid
waste by the waste disposal company. In the event that natural gas
prices rise, the city's waste transport expenses would rise. To
mitigate this risk, the city establishes a long position in the NYMEX
natural gas referenced contract that is equivalent to the expected use
of natural gas over the life of the service contract.
In this case, the long position fixes the exit price of the
commodity derivative contract. For any increase in the commodity that
is the subject of the executed contract for services, the payment due
or expected to be due would increase in value, but the long commodity
derivative contract would decrease in value--offsetting the price risk
from the payments under the contract for services. Under both of these
examples, the transactions meet the general requirements for a bona
fide hedging transaction and the specific provisions for hedges of
anticipated services.
Regarding comments contending that deliverable supply estimates are
more vulnerable to disruption under this hedge, the Commission does not
believe that bona fide hedges for anticipated services will impact
actual deliverable supplies. This is because this bona fide hedge
allows a market participant to hedge the anticipated change in value of
receipts or payments due or expected to be due under an executed
contract for services, and is not an alternative means of procuring or
selling the underlying commodity.
In addition, the Commission will continue to have sufficient access
to position and cash-market data to verify all exemptions granted. The
reporting and recordkeeping obligations under Sec. Sec. 150.5 and
150.9 will require exchanges to submit justifications, amendments, and
other necessary information to the Commission on a monthly basis. As
such, exchanges and the Commission will have visibility into the amount
of demand there is for a commodity in the spot month via the delivery
notices. In the rare event that an exchange observes an imbalance, it
has the ability under its rules to require the trader to reduce its
positions.
Finally, the Commission notes that a time limitation is unnecessary
because, among other things, when administering exchange-set limits,
under the Final Rule, exchanges may rely on the Commission's guidance
in Appendix B to part 150 to protect price convergence and ensure an
orderly spot period. Under the guidance in Appendix B adopted herein,
an exchange may adopt rules to impose a restriction on holding a
position in a physically delivered referenced contract during the
lesser of either the last five days of trading or the time period for
the spot month in order to limit such positions to only those that are
economically appropriate for that person's specific anticipated or real
needs.
[[Page 3278]]
j. Offsets of Commodity Trade Options
(1) Background--Offsets of Commodity Trade Options
Commodity trade options are not subject to Federal position limits
under existing regulations.\299\ Generally, a commodity trade option is
a physically-delivered commodity option purchased by commercial users
of the commodities underlying the options. In the 2016 trade options
final rule, the Commission stated that Federal position limits should
not apply to trade options.\300\ Further, in that trade options final
rule, the Commission indicated it would address the applicability of
position limits to trade options in the context of any final rulemaking
on position limits.\301\
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\299\ See 17 CFR 32.3(c).
\300\ Trade Options, 81 FR at 14966, 14971 (Mar. 21, 2016).
Under the trade options final rule, trade options are generally
exempted from the rules otherwise applicable to swaps, subject to
the conditions enumerated in Sec. 32.3. For example, trade options
do not factor into the determination of whether a market participant
is an SD or MSP; trade options are exempt from the rules on
mandatory clearing; and trade options are exempt from the rules
related to real-time reporting of swaps transactions.
\301\ Id.
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(2) Summary of the 2020 NPRM--Offsets of Commodity Trade Options
The Commission proposed a new enumerated hedge for offsets of
commodity trade options not currently enumerated in Sec. 1.3. Under
the 2020 NPRM, a qualifying commodity trade option under Sec. 32.3
\302\ would be treated as a cash position, on a futures-equivalent
basis,\303\ and serve as the basis for a bona fide hedge position.
Treating qualifying commodity trade options as cash positions, either
as a cash commodity purchase or sales contract, would allow the
Commission to extend the existing enumerated hedge exemptions for cash
positions to the offsets of commodity trade options. That is, the
offsets of qualifying commodity trade options would be treated like the
enumerated hedges for cash commodity fixed-price purchase contracts or
hedges of cash commodity fixed-price sales contracts.\304\
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\302\ 17 CFR 32.3. In order to qualify for the trade option
exemption, Sec. 32.3 requires, among other things, that: (1) The
offeror is either (i) an eligible contract participant, as defined
in section 1a(18) of the Act, or (ii) offering or entering into the
commodity trade option solely for purposes related to its business
as a ``producer, processor, or commercial user of, or a merchant
handling the commodity that is the subject of the'' trade option;
and (2) the offeree is offered or entering into the commodity trade
option solely for purposes related to its business as ``a producer,
processor, or commercial user of, or a merchant handling the
commodity that is the subject of the commodity'' trade option.
\303\ It may not be possible to compute a futures-equivalent
basis for a trade option that does not have a fixed strike price. As
discussed in the Section II.A.1.iv., under the Commission's existing
portfolio hedging policy, market participants may manage their price
risks by utilizing more than one enumerated bona fide hedge
(including a commodity trade option hedge and other anticipatory
bona fide hedges, if necessary based on the market participant's
applicable facts and circumstances). For example, a commodity trade
option with a fixed strike price may be converted to a futures-
equivalent basis, and, on that futures-equivalent basis, deemed a
cash commodity sale contract, in the case of a short call option or
long put option, or a cash commodity purchase contract, in the case
of a long call option or short put option.
\304\ 85 FR at 11610.
---------------------------------------------------------------------------
(3) Summary of the Commission Determination--Offsets of Commodity Trade
Options
The Commission continues to believe that Federal position limits
should not apply to trade options. Thus, the Commission is adopting the
enumerated bona fide hedge for offsets of commodity trade options as
proposed, with a few clarifying, non-substantive technical edits in the
regulatory text.
(4) Comments--Offsets of Commodity Trade Options
The Commission did not receive any comments opposing the addition
of an enumerated hedge for offsets of commodity trade options. The
Commission received comments generally supporting the bona fide hedge
for offsets of commodity trade options, particularly as included in an
expanded list of enumerated bona fide hedges.\305\ NGSA stated that
defining bona fide hedging in a way that recognizes that trade options,
adjusted on a futures-equivalent basis, constitute cash commodity
purchase or sale contracts that underlie bona fide hedge positions
should ``facilitate hedging rather than restrict it.'' \306\
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\305\ IECA at 1; CCI at 2; CEWG at 4; Chevron at 3; Suncor at 3;
FIA at 16; and NGSA at 4.
\306\ NGSA at 4.
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k. Cross-Commodity Hedges
(1) Background--Cross-Commodity Hedges
The Commission has long recognized cross-commodity bona fide
hedging under paragraph (2)(iv) of the bona fide hedging definition in
existing Sec. 1.3, which has allowed cross-commodity bona fide hedging
in connection with all of the enumerated bona fide hedges included in
the existing bona fide hedge definition.\307\
---------------------------------------------------------------------------
\307\ 42 FR 14832, 14834 (March 16, 1977).
---------------------------------------------------------------------------
The existing enumerated cross-commodity bona fide hedge recognizes
that risk from some cash commodity price exposures can be practically
and effectively managed through commodity derivative contracts on a
related commodity. As such, positions in any of the existing enumerated
bona fide hedges may be offset by a cash position held in a different
commodity than the commodity underlying the futures contract.
The existing cross-commodity enumerated hedge, however, is subject
to two conditions. First, the fluctuations in value of the position in
the futures contract must be ``substantially related'' to the
fluctuations in value of the actual or anticipated cash position.
Second, under the cross-commodity enumerated bona fide hedge exemption,
a position may not be held in excess of the Federal position limit
during the last five trading days for that futures contract.
Cross-commodity hedging also allows market participants to hedge
the price exposure arising from the products and byproducts of a
commodity where there is no futures contract for those products or
byproducts, but there is a futures contract for the source commodity of
those products or byproducts. Since 2011, the Commission has included
an enumerated cross-commodity bona fide hedge in each of its position
limits rulemakings.\308\
---------------------------------------------------------------------------
\308\ 81 FR at 96752-96753; 78 FR at 75716; 76 FR at 71689.
---------------------------------------------------------------------------
(2) Summary of the 2020 NPRM--Cross-Commodity Hedges
The Commission proposed to include cross-commodity hedges as an
enumerated bona fide hedge, and to expand the application of this bona
fide hedge such that it could be used to establish compliance with: (1)
Each of the proposed enumerated bona fide hedges listed in Appendix A
to part 150 except for unfilled anticipated requirements and
anticipated merchandising, which were excluded from the regulatory text
of the cross-commodity enumerated hedge; \309\ and (2) the proposed
pass-through provisions under paragraph (2) of the proposed bona fide
hedging definition discussed further below; provided, in each case,
that the position satisfied each element of the relevant enumerated
bona fide hedge.\310\ In addition, the
[[Page 3279]]
Commission also proposed to eliminate the Five-Day Rule in connection
with the proposed cross-commodity bona fide hedge (i.e., the 2020 NPRM
eliminated the restriction from holding a position in excess of the
Federal position limit under the enumerated cross-commodity bona fide
hedge during the last five days of trading).
---------------------------------------------------------------------------
\309\ Specifically, the 2020 NPRM allowed for cross-commodity
hedging for any of the following proposed enumerated hedges: (i)
Hedges of unsold anticipated production, (ii) hedges of offsetting
unfixed-price cash commodity sales and purchases, (iii) hedges of
anticipated mineral royalties, (iv) hedges of anticipated services,
(v) hedges of inventory and cash commodity fixed-price purchase
contracts, (vi) hedges of cash commodity fixed-price sales
contracts, (vii) hedges by agents, and (viii) offsets of commodity
trade options.
\310\ 85 FR at 11609. For example, an airline that wishes to
hedge the price of jet fuel may enter into a swap with a swap
dealer. In order to remain flat, the swap dealer may offset that
swap with a futures position, for example, in ULSD. Subsequently,
the airline may also offset the swap exposure using ULSD futures. In
this example, under the pass-through swap language of proposed Sec.
150.1, the airline would be acting as a bona fide hedging swap
counterparty and the swap dealer would be acting as a pass-through
swap counterparty. In this example, provided each element of the
enumerated hedge in paragraph (a)(5) of Appendix A, the pass-through
swap provision in Sec. 150.1, and all other regulatory requirements
are satisfied, the airline and swap dealer could each exceed limits
in ULSD futures to offset their respective swap exposures to jet
fuel. See infra Section II.A.1.c.v. (discussion of proposed pass-
through language).
---------------------------------------------------------------------------
The proposed cross-commodity enumerated bona fide hedge was
conditioned on the existence of a ``substantial relationship'' between
the commodity derivative contract and the related cash commodity
position. Specifically, the fluctuations in value of the position in
the commodity derivative contract, that is, of the underlying cash
commodity of that derivative contract, were required to be
``substantially related'' \311\ to the fluctuations in value of the
actual or anticipated cash commodity position or pass-through
swap.\312\ This was intended to be a qualitative analysis, rather than
quantitative.
---------------------------------------------------------------------------
\311\ See 85 FR at 11726-11727.
\312\ 85 FR at 11609.
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For example, the 2020 NPRM stated that there is a substantial
relationship between grain sorghum, which is used as a food grain for
humans or as animal feedstock, and the corn referenced contracts.
Because there is not a futures contract for grain sorghum grown in the
United States listed on a U.S. DCM,\313\ corn represents a
substantially related commodity to grain sorghum in the United
States.\314\ The 2020 NPRM noted that, in contrast, there did not
appear to be a reasonable commercial relationship between a physical
commodity, say copper, and a broad-based stock price index, such as the
S&P 500 Index, because these commodities were not reasonable
substitutes for each other in that they had very different pricing
drivers.\315\ That is, the price of a physical commodity is based on
supply and demand, whereas the stock price index is based on various
individual stock prices for different companies.\316\
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\313\ This remains true at the publication of this rulemaking.
\314\ 85 FR at 11609. Grain sorghum was previously listed for
trading on the Kansas City Board of Trade and Chicago Mercantile
Exchange, but because of liquidity issues, grain buyers continued to
use the more liquid corn futures contract, which suggests that the
basis risk between corn futures and cash sorghum could be
successfully managed with the corn futures contract.
\315\ 85 FR at 11609.
\316\ Id.
---------------------------------------------------------------------------
The 2020 NPRM also preliminarily determined that CEWG BFH Petition
example #9 (Holding a cross-commodity hedge using a physical delivery
contract into the spot month) and example #10 (Holding a cross-
commodity hedge using a physical delivery contract to meet unfilled
anticipated requirements) were permitted as cross-commodity enumerated
hedges.\317\
---------------------------------------------------------------------------
\317\ 85 FR at 11611.
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(3) Summary of the Commission Determination--Cross-Commodity Hedges
The Commission is finalizing the cross-commodity enumerated bona
fide hedge largely as proposed, with amendments to expand the ability
to use cross-commodity hedges.
(4) Comments--Cross-Commodity Hedges
Commenters generally supported the proposed cross-commodity
enumerated bona fide hedge, and a few commenters explicitly supported
the Commission's decision not to propose a quantitative test
requirement for the proposed enumerated cross-commodity bona fide
hedge.\318\
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\318\ ADM at 2; NGSA at 3-4; NOPA at 2; and ICE at 7. Prior
position limits proposals included a quantitative test, whereas the
2020 NPRM included a qualitative ``substantially related''
requirement.
---------------------------------------------------------------------------
Better Markets stated that it views some cross-commodity hedges as
``appropriate, normal, and legitimate market practices,'' but claimed
that there is a potential for abuse if the bona fide hedge exemption
requires less than a ``demonstrable price relationship'' between the
two commodities.\319\ ICE recommended that the Commission include a
non-exclusive list of commonly-used cross-commodity hedges that satisfy
the ``substantially related'' requirement, which ICE believes should
include the natural gas core referenced futures contract and its linked
referenced contracts as bona fide hedges of electricity price exposure,
and vice versa.\320\
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\319\ Better Markets at 58.
\320\ ICE at 7.
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The majority of energy market participants commented on a separate
item: That the express language of proposed paragraph (a)(5) of
Appendix B to part 150, which sets forth the proposed cross-commodity
bona fide hedge, inappropriately failed to cover bona fide hedges for
unfilled anticipated requirements and anticipated merchandising.\321\
Chevron, Suncor, CCI, and the CEWG requested that the Commission revise
the proposed cross-commodity enumerated bona fide hedge to specifically
clarify that enumerated bona fide hedges for unfilled anticipated
requirements and anticipated merchandising may be utilized as cross-
commodity bona fide hedges in energy markets.\322\ IECA also requested
that the cross-commodity enumerated hedge include bona fide hedges of
anticipated requirements, which would capture bona fide hedges of
anticipated requirements commonly used by many electric utilities that
enter into heat-rate transactions.\323\
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\321\ Chevron at 8-9; Suncor at 6-8; NOPA 2; CCI at 5-9; CEWG at
10-14; NGSA at 4; ICE at 2, 4; Shell at 7-8; ADM at 2; and IECA at
8.
\322\ Chevron at 8; Suncor at 8; NOPA at 2; CCI at 5-7; CEWG at
10-14; NGSA at 4; and IECA at 8.
\323\ IECA at 7-8.
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Suncor and Chevron highlighted an internal inconsistency in the
2020 NPRM. These commenters pointed out that while the 2020 NPRM
preliminarily determined that CEWG BFH Petition Example #10 (Holding a
cross-commodity hedge using a physical delivery contract to meet
unfilled anticipated requirements) satisfies the proposed cross-
commodity hedge, the proposed cross-commodity hedge excluded unfilled
anticipated requirements.\324\
---------------------------------------------------------------------------
\324\ Chevron at 7; Suncor at 7.
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(5) Discussion of Final Rule--Cross-Commodity Hedges
The Commission is finalizing the cross-commodity enumerated bona
fide hedge largely as proposed, with amendments to expand the ability
to use cross-commodity hedges. Specifically, the Commission is amending
the express language of the cross-commodity enumerated hedge in
Appendix B to include the enumerated hedges of unfilled anticipated
requirements and hedges of anticipated merchandising so that the cross-
commodity provision applies to all enumerated hedges adopted herein.
The 2020 NPRM excluded the enumerated bona fide hedges for unfilled
anticipated requirements and for anticipated merchandising from the
cross-commodity provision. As a result, any internal inconsistency
related to example #10 has been resolved.
Separately, as stated in the 2020 NPRM, the Commission reaffirms
that the requirement that the value fluctuations of the commodity
derivatives contract used to hedge and the value fluctuations of the
commodity
[[Page 3280]]
cash position being hedged must be ``substantially related'' is an
important factor in determining whether a cross-commodity hedge
satisfies the requirements to be a bona fide hedge. Accordingly, the
Commission believes that the ``substantially related'' requirement
sufficiently ties derivative and cash positions between two different,
but comparable, commodities that have a reasonable commercial
relationship as a result of their ability to serve as reasonable
substitutes for each other, due to, for example, similar pricing
drivers.
The Commission agrees with commenters who stated that market
participants use cross-commodity hedging to manage their price risk,
particularly when a cash commodity is not necessarily deliverable under
the terms of any derivative contract or the cash-market transactions
are not in the same commodity underlying the futures contract. For
example, an airline that uses a predictable volume of jet fuel every
month may cross hedge its anticipated jet fuel requirements with the
ultralow sulfur diesel (``ULSD'') heating oil commodity derivative
contract because there are no physically-settled jet fuel commodity
derivative contracts available. The value fluctuations in jet fuel are
substantially related to the value fluctuations in the ULSD ``HO''
futures contract.
The Commission believes that a determination of whether commodities
are ``substantially related'' for purposes of the cross-commodity bona
fide hedge depends on a facts and circumstances analysis and that the
relationship between the two is not static, as it may change over time
depending on market factors. Accordingly, the Commission's position is
not to publish a list of cross-commodity hedges satisfying the
``substantially related'' requirement at this time.
vii. Location and Regulatory Treatment of the Enumerated Bona Fide
Hedges
a. Background--Location and Regulatory Treatment of the Enumerated Bona
Fide Hedges
As noted above, the existing enumerated bona fide hedges are
explicitly incorporated in the regulatory bona fide hedging definition
in Sec. 1.3 of the Commission's regulations.
b. Summary of the 2020 NPRM--Location and Regulatory Treatment of the
Enumerated Bona Fide Hedges
In the 2020 NPRM, the Commission proposed to move the expanded list
of the enumerated bona fide hedges from the bona fide hedging
definition in regulation Sec. 1.3 to the proposed acceptable practices
in Appendix A to part 150. The Commission stated that the list of
enumerated bona fide hedges should appear as acceptable practices in an
appendix, rather than as regulations in the regulatory bona fide
hedging definition, because each enumerated bona fide hedge represents
just one way, but not the only way, to satisfy the proposed bona fide
hedging definition and Sec. 150.3(a)(1).\325\ The Commission requested
comment on whether the list of enumerated hedges should be included in
the regulatory text or in an appendix as acceptable practices.\326\
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\325\ As discussed below, proposed Sec. 150.3(a)(1) would allow
a person to exceed position limits for bona fide hedging
transactions or positions, as defined in proposed Sec. 150.1.
\326\ 85 FR at 11622.
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c. Summary of the Commission Determination--Location and Regulatory
Treatment of the Enumerated Bona Fide Hedges
The Commission has determined to incorporate the enumerated bona
fide hedges as part of the regulatory text. While the Final Rule will
maintain the enumerated bona fide hedges in Appendix A to part 150,
Appendix A will be incorporated into final Sec. 150.3, and therefore
under the Final Rule the enumerated bona fide hedges in Appendix A will
be deemed to be part of the regulatory text rather than treated as
acceptable practices.
d. Comments--Location and Regulatory Treatment of the Enumerated Bona
Fide Hedges
FIA and MGEX supported moving the list of enumerated bona fide
hedges to the rule text.\327\ FIA stated that ``including the list in
the regulatory text would provide market participants greater
regulatory certainty by making it clear that it could not be amended
absent notice and comment rulemaking.'' \328\
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\327\ MGEX at 2; FIA at 15-16.
\328\ FIA at 16.
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On the other hand, CMC and the Joint Associations (i.e., EEI and
EPSA) preferred keeping the enumerated hedges in Appendix A to part
150. CMC stated its understanding that an amendment to either Appendix
A or the rule text would require the same formal rulemaking
procedures.\329\ The Joint Associations based their support of Appendix
A because it allows for ``for flexibility'' in their view.\330\
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\329\ CMC at 6.
\330\ EEI/EPSA at 5.
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e. Discussion of Final Rule--Location and Regulatory Treatment of the
Enumerated Bona Fide Hedges
Under the Final Rule, the enumerated bona fide hedges are
incorporated as part of the regulatory text. While the Final Rule will
maintain the enumerated bona fide hedges in Appendix A to part 150,
Appendix A will be incorporated in final Sec. 150.3 as positions that
are deemed to be bona fide hedges that are self-effectuating for
purposes of Federal position limits. In other words, while the Final
Rule will maintain the enumerated bona fide hedges in Appendix A,
Appendix A will be deemed to be part of the regulatory text rather than
treated as acceptable practices as the Commission proposed in the 2020
NPRM.
The Commission agrees that including the enumerated bona fide
hedges as part of the regulations, rather than as acceptable practices,
provides market participants with greater regulatory certainty. To
reflect that Appendix A to part 150 is part of the regulatory text, the
Commission is amending the introductory language to the Appendix to
remove any references to acceptable practices.
In addition, while not a substantive change, the Commission has
also re-ordered the list of enumerated hedges. The Final Rule reorders
Appendix A so that the bona fide hedges are listed by hedges of
purchases, sales, anticipated activities, or other new types of hedges.
Finally, the cross-commodity hedge, which applies to all the enumerated
hedges in the appendix, is listed last.
viii. Elimination of Federal Restriction Prohibiting Holding a Bona
Fide Hedge Exemption During Last Five Trading Days, the ``Five-Day
Rule;'' Proposed Guidance in Appendix B, Paragraph (b)
a. Background--Elimination of the ``Five-Day Rule;'' Proposed Guidance
in Appendix B, Paragraph (b)
Some of the existing enumerated bona fide hedge exemptions in Sec.
1.3 include a restriction on the market participant holding a commodity
derivative contract position in excess of Federal position limits
during the last five days of trading (generally referred to as the
``Five-Day Rule''). The restriction limits the applicability of
exemptions during the last five days of trading because for many
agricultural commodity derivative contracts, those last five days of
trading coincide with the physical-delivery process. The practical
effect of the Five-Day Rule is a winnowing of the universe of market
participants who maintain large positions throughout the last five days
of trading to only those market
[[Page 3281]]
participants who actually intend to make or take delivery at the end of
the spot period. Narrowing the universe of market participants in this
way helps ensure an orderly trading environment and maintains the
integrity of the physical-delivery process for those market
participants who rely on price convergence between the cash and futures
markets during the last days of trading.
When the Commission adopted the Five-Day Rule, it believed that, as
a general matter, there was little commercial need to maintain a large
position that exceeds position limits during or through the last five
days of trading.\331\
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\331\ Definition of Bona Fide Hedging and Related Reporting
Requirements, 42 FR 42748, 42750 (Aug. 24, 1977).
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b. Summary of the 2020 NPRM--Elimination of the ``Five-Day Rule;''
Proposed Guidance in Appendix B, Paragraph (b)
The Commission proposed to eliminate the restriction on holding a
bona fide hedge exemption during the last five days of trading from all
the enumerated hedges to which such five-day rule restriction applies
under existing Sec. 1.3.\332\ Instead, under proposed Sec.
150.5(a)(2)(ii)(D), exchanges could apply a restriction against holding
positions under a bona fide hedge in excess of limits during the lesser
of the last five days of trading or the time period for the spot month
in such physical-delivery contract, or otherwise limit the size of such
position. The exchanges would thus have the ability and discretion, but
not an obligation, to apply a five-day rule or similar restriction to
exemptions on any contracts subject to Federal position limits,
regardless of whether such contracts have been subject to Federal
position limits before.
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\332\ The existing enumerated hedges limited by the Five-Day
rule are as follows: Unsold anticipated production, unfilled
anticipated requirements, offsetting sales and purchases, and cross-
commodity hedges.
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The 2020 NPRM also included guidance for exchanges on factors to
consider when applying a restriction against holding physically
delivered futures contracts into the spot month. The proposed guidance
set forth in Appendix B, paragraph (b) provided that a position held
during the spot period may still qualify as a bona fide hedging
position, provided that: (1) The position complies with the bona fide
hedging transaction or position definition; and (2) there is an
economically appropriate need to maintain such position in excess of
Federal speculative position limits during the spot period, and that
need relates to the purchase or sale of a cash commodity.\333\
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\333\ For example, an economically appropriate need for soybeans
would mean obtaining soybeans from a reasonable source (considering
the marketplace) that is the least expensive, at or near the
location required for the purchaser, and that such sourcing does not
cause market disruptions or prices to spike.
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In addition, the guidance provided several factors the exchange
should weigh when evaluating whether a person wishing to exceed Federal
position limits should be able to do so during the spot period. For
example, whether the person: (1) Intends to make or take delivery
during that period; (2) provided materials to the exchange supporting
the waiver of the Five-Day Rule; (3) demonstrated supporting cash-
market exposure in-hand that is verified by the exchange; (4)
demonstrated that, for short positions, the delivery is feasible,
meaning that the person has the ability to deliver against the short
position; \334\ and (5) demonstrated that, for long positions, the
delivery is feasible, meaning that the person has the ability to take
delivery at levels that are economically appropriate.\335\
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\334\ That is, the person has inventory on-hand in a deliverable
location and in a condition in which the commodity can be used upon
delivery and that it represents the best sale for that inventory.
\335\ That is, the delivery comports with the person's
demonstrated need for the commodity, and the contract is the
cheapest source for that commodity.
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c. Summary of the Commission Determination--Elimination of the ``Five-
Day Rule;'' Proposed Guidance in Appendix B, Paragraph (b)
The Commission is finalizing the proposal to eliminate the
restriction on holding a bona fide hedge exemption during the last five
days of trading from all the enumerated hedges to which such Five-Day
Rule restriction applies under existing Sec. 1.3. Additionally, the
Commission has carefully considered the various comments regarding the
proposed guidance in Appendix B, paragraph (b) and has determined to
finalize the guidance, subject to several amendments and
clarifications.
The Commission discusses and addresses comments on the proposed
elimination of the Five-Day Rule immediately below, followed by a
discussion of comments on the proposed guidance further below.
d. Comments--Elimination of the ``Five-Day Rule;'' Proposed Guidance in
Appendix B, Paragraph (b)
(1) Elimination of the ``Five-Day Rule''
Several public interest commenters opposed the elimination of the
Five-Day Rule.\336\ IATP viewed allowing the exchanges to impose a
five-day rule or similar restriction as relegating the Commission's
function to merely monitoring ``DCM decisions and their consequences
for market participants and the public after the fact.'' \337\
Conversely, commercial market participants and exchanges generally
supported the proposal to eliminate the Five-Day Rule and instead
afford the exchanges the discretion whether to impose restrictions on
holding physically-delivered contracts.\338\
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\336\ IATP at 17-18; Better Markets at 61 (contending that if
the CFTC does eliminate the Five-Day rule, it should at least
formalize the proposed guidance in the rule text).
\337\ IATP at 18.
\338\ ADM at 3; Cargill at 8; CCI at 2, 9; CEWG at 4, 24;
Chevron at 3, 9; CMC at 5; CME Group at 9; ICE at 2, 8; IFUS at 2;
FIA at 3; NGFA at 9; NGSA at 2; Shell at 3; Suncor at 3, 12.
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(i) Discussion of the Final Rule--Elimination of the ``Five-Day Rule''
The Commission is finalizing the proposal to eliminate the
restriction on holding a bona fide hedge exemption during the last five
days of trading from all the enumerated hedges to which such Five-Day
Rule restriction applies under existing Sec. 1.3.
In place of the ``Five-Day Rule,'' the Commission is finalizing
proposed Sec. 150.5(a)(2)(ii)(D), which provides that an exchange may
grant exemptions, subject to terms, conditions, or restrictions against
holding large positions in physically delivered futures contracts, as a
bona fide hedge in excess of limits during the lesser of the last five
days of trading or the time period for the spot month in such physical-
delivery contract, or otherwise limit the size of such position under
that exemption.
For the legacy agricultural contracts, the Five-Day Rule has been
an important way to help ensure that futures and cash-market prices
converge. Price convergence helps protect the integrity of the price
discovery function and facilitates an orderly delivery process, which
overlaps with the last days of trading. As stated in the 2020 NPRM,
however, a strict five-day rule may be inappropriate and unnecessary,
as the Commission expands its Federal position limits beyond the nine
legacy agricultural contracts.\339\
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\339\ 85 FR at 11612.
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[[Page 3282]]
In particular, while the Commission continues to believe that the
justifications described above for the existing Five-Day Rule remain
valid for contracts subject to Federal position limits, the exchanges--
subject to Commission oversight--are better positioned to decide
whether to apply a restriction, such as the Five-Day Rule, in
connection with exemptions to their own exchange-set limits, or whether
to apply other tools that may be equally effective. This Final Rule
affords exchanges with the discretion to apply, and when appropriate,
grant exemptions subject to terms, conditions or limitations like the
Five-Day Rule (or similar restrictions) for purposes of their own
exchange-set limits. Allowing for such discretion when granting
exemptions will afford exchanges flexibility to quickly impose, modify,
or waive any such limitation as circumstances dictate. While a strict
Five-Day Rule may be inappropriate in certain circumstances, including
when applied to energy contracts that typically have a shorter spot
period than agricultural contracts,\340\ the flexible approach adopted
herein may allow for the development and implementation of additional
solutions other than a Five-Day Rule that protect convergence, while
minimizing the impact on market participants.
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\340\ Energy contracts typically have a three-day spot period,
whereas the spot period for agricultural contracts is typically two
weeks.
---------------------------------------------------------------------------
This approach allows exchanges to design and tailor a variety of
limitations to protect convergence during the spot period. For example,
in certain circumstances, a smaller quantity restriction, rather than a
complete restriction on holding positions in excess of limits during
the spot period, may be effective at protecting convergence. Similarly,
exchanges currently utilize other tools to achieve similar policy
goals, such as by requiring market participants to ``step down'' the
levels of their exemptions as they approach the spot period, or by
establishing exchange-set speculative position limits that include a
similar step-down feature. Since Sec. 150.5(a) as adopted herein would
require that any exchange-set limits for contracts subject to Federal
position limits must be less than or equal to the Federal limit, any
exchange application of the Five-Day Rule, or a similar restriction,
would have the same effect as if administered by the Commission for
purposes of Federal speculative position limits, but could be
administered by the exchange in a more tailored and efficient manner.
In response to commenters who stated this approach would relegate
the Commission's functions to merely monitoring the DCMs' decisions
after the fact, the Commission points out that regardless of whether
there is a Federal Five-Day Rule, the Commission will continue to
exercise oversight over exchanges before, during, and after exchange
action relating to position limits. For example, all exchange rules,
including those establishing/modifying exchange-set position limits,
accountability levels, step downs, and five-day rules and similar
restrictions, must be submitted to the Commission in advance pursuant
to part 40 of the Commission's regulations.
Additionally, any exemption granted by an exchange from its own
position limits must meet standards established by the Commission in
Sec. 150.5(a)(ii)(C) of this Final Rule, including considering whether
the requested exemption would result in positions that would not be in
accord with sound commercial practices and/or would exceed an amount
that may be established and liquidated in an orderly fashion. Further,
any waiver of an exchange five-day rule or similar restriction should
consider the Appendix B guidance adopted herein. Additionally, the
Commission will continue to leverage its own market surveillance and
oversight functions to ensure that exchanges continue to comply with
their legal obligations, including with respect to Core Principles 2,
3, 4, and 5, among others.\341\ Finally, under Sec. 150.3(b)(6)
finalized herein, the Commission continues to have the authority to
revoke any bona fide hedge exemption.
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\341\ 7 U.S.C. 7B-3(f)(4)(B); 7 U.S.C. 7B-3(f)(2); 7 U.S.C. 7B-
3(f)(3); 7 U.S.C. 7B-3(f)(5).
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(2) Proposed Guidance in Appendix B, Paragraph (b)
There were several comments on the proposed guidance in Appendix B,
paragraph (b) regarding the circumstances when an exchange may grant
waivers from any exchange-set five-day rule or similar restriction. A
few commenters requested that the Commission eliminate the proposed
guidance altogether.\342\ IFUS stated that the proposed guidance is
unnecessary and should be removed, contending that the guidance
``reflects many of the considerations currently taken by [e]xchange
staff when reviewing exemptions and spot month positions.'' \343\ CME
Group expressed a similar view, stating that in lieu of the proposed
guidance, ``the Commission should allow exchanges to continue to rely
on their established market surveillance expertise and regular
interactions to make decisions around exemptions.'' \344\
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\342\ CMC at 5; CME Group at 9; IFUS at 10.
\343\ IFUS at 3.
\344\ CME Group at 9.
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Most commercial market participants and Better Markets,\345\
however, did not request to eliminate the proposed guidance in Appendix
B, paragraph (b), but instead requested certain changes or
clarifications. These commenters focused on whether the guidance: (i)
Only applies to physically-settled contracts expressly designated by an
exchange as subject to a five-day rule or similar restriction; \346\
and (ii) is too prescriptive by imposing new documentation requirements
on exchanges.\347\ CME Group requested clarification on whether the
proposed guidance applies to all exemptions or only those exemptions
previously subject to a five-day rule.\348\ Several energy market
participants requested the Commission expressly clarify that the
restrictions or guidance do not apply to markets for energy commodity
derivatives.\349\ Alternatively, these energy market participants
stated that if the Commission declined to include in a final rule an
express prohibition on the application of the Five-Day Rule to energy
commodity derivative contracts, the Commission should clarify that an
exchange is not bound to apply the waiver guidance to any physically-
settled referenced contract that has not been expressly designated as
subject to the Five-Day Rule.\350\
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\345\ Better Markets supported the proposed guidance. Better
Markets at 46-48.
\346\ Chevron at 13-14; Suncor at 13-14; CCI at 9-10; CEWG at
25-26.
\347\ CME Group at 9.
\348\ Id.
\349\ Chevron at 13.
\350\ Chevron at 13; Suncor at 14; CCI at 9-10; CEWG at 25-26.
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(i) Discussion of Final Rule--Appendix B, Paragraph (b)
The Commission has carefully considered the various comments
regarding the guidance in Appendix B, paragraph (b) and has determined
to finalize the guidance, subject to several amendments and
clarifications, discussed below.
The Commission is not persuaded by requests to eliminate the
guidance based on arguments that exchanges have current market
surveillance practices or procedures to review the appropriateness of
an exemption during the relevant referenced contract's spot period. The
Commission continues to believe that the justifications described above
for the existing Five-Day Rule
[[Page 3283]]
remain valid. The Commission has determined, however, that with an
expanded list of contracts subject to Federal position limits, it is
best to provide the exchanges additional discretion when granting
exemptions to protect their markets using tools other than a Five-Day
Rule, and to supplement that discretion with guidance highlighting the
importance of the spot month to ensure price convergence and an orderly
delivery process.
For certain referenced contract markets, rather than imposing a
complete restriction on holding positions in excess of limits during
the spot period, an exchange may, when appropriate, grant an exemption
which allows exceeding the position limit by a small increment. Such
approach would be an effective way of protecting convergence while
still maintaining orderly trading. Similarly, exchanges currently
utilize other tools in administering their position limits. For
example, CME and CBOT establish certain exchange-set speculative
position limits that include a ``step down'' feature so that the
permitted position limit level is lower each day as the contract nears
its last trading days. Further, when granting position limit
exemptions, exchanges may grant such exemptions subject to a ``step
down'' level restriction as well. The Commission expects that exchanges
would closely scrutinize any participant who requests recognition
during the last five days of the spot period or in the time period for
the spot month.
The Commission clarifies that any exchange, for the purposes of
exchange-set position limits, that elects to grant an exemption subject
to terms, conditions, or limitations, that restrict the size of a
position during the time period for the spot month of a physically-
settled contract under Sec. 150.5(a)(2)(ii)(H) may do so on any
referenced contract subject to Federal position limits under the Final
Rule, not just the nine legacy agricultural contracts. As such, the
Commission clarifies for the avoidance of doubt that exemptions in
energy contracts may be subject to an exchange's restriction aimed to
monitor the spot period for that energy contract.
Since price convergence and an orderly trading environment serve as
a deterrent or mitigate certain types of market manipulation schemes
such as corners and squeezes, the guidance is intended to include a
non-exclusive list of considerations the Commission expects the
exchanges to consider when determining whether to allow a position in
excess of limits throughout the spot month.
Regarding various comments contending that the proposed guidance
was too prescriptive, the Commission reiterates the appendix is not
intended to be used as a mandatory checklist. Further, the Commission
is finalizing various amendments to Appendix B, paragraph b, to respond
to commenters' requests.
First, the Commission is amending the introductory paragraph of the
guidance to clarify that under Sec. 150.5(a)(2)(ii)(H) as finalized
herein, exchanges may impose restrictions on bona fide hedge exemptions
in the spot month. This discretion does not require any express
designation by the exchange.
Second, the Commission is modifying the proposed guidance to
clarify that the guidance may be used when considering either an
enumerated or non-enumerated bona fide hedge exemption. Third, the
Commission clarifies here that the guidance imposes no additional
reporting requirements on market participants as the factors described
in the guidance apply simply to the exchanges' evaluation of the
specific contract market when considering whether an exemption shall be
granted subject to any condition or limitation in the spot month.
Fourth, the Commission is eliminating the proposed factor which would
have required a market participant to provide materials to the exchange
supporting a classification of the position as a bona fide hedge. The
Commission notes that the exchange application requirements already
require market participants to provide relevant cash-market
information. In addition, the Commission is amending language
throughout the guidance to clarify that exchanges have flexibility when
considering applying the guidance. For example, the Commission is
removing proposed language that would have required the exchange to
verify the market participant's cash-market exposure. The Commission is
comfortable removing this language because the cash-market information
is already required as part of the exemption application process
described elsewhere in this release.\351\ Finally, the Commission is
making technical edits to clarify that any delivery under a physical
delivery contract is economically appropriate and the ``most
economical'' source for that commodity.
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\351\ See Sections II.D. and II.G.
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ix. Guidance on Measuring Risk
a. Background--Measuring Risk
In prior proposals, the Commission discussed the issue of whether
to recognize as bona fide both ``gross hedging'' and ``net hedging.''
\352\ While the Commission has previously expressed a willingness to
consider gross hedging in certain limited circumstances, such proposals
reflected the Commission's longstanding preference for net
hedging.\353\ That preference, although not stated explicitly in prior
releases, has been underpinned by a concern that unfettered recognition
of gross hedging could potentially allow for the cherry picking of
positions in a manner that subverts the position limits rules.\354\
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\352\ 81 FR at 96747-96747.
\353\ See 81 FR at 96747 (stating that gross hedging was
economically appropriate in circumstances where ``net cash positions
do not necessarily measure total risk exposure due to differences in
the timing of cash commitments, the location of stocks, and
differences in grades or the types of cash commodity.'') See also
Bona Fide Hedging Transactions or Positions, 42 FR at 14832, 14834
(Mar. 16, 1977) and Definition of Bona Fide Hedging and Related
Reporting Requirements, 42 FR 42748, 42750 (Aug. 24, 1977).
\354\ For example, using gross hedging, a market participant
could potentially point to a large long cash position as
justification for a bona fide hedge, even though the participant, or
an entity with which the participant is required to aggregate, has
an equally large short cash position. The presence of such
offsetting cash positions would result in the participant having no
net price risk to hedge. Instead, the participant created price risk
exposure to the commodity by establishing the derivative position.
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b. Summary of the 2020 NPRM--Measuring Risk
The Commission recognized in the 2020 NPRM that additional
flexibility to hedge on a gross basis may be warranted given that there
are myriad ways in which organizations, particularly those not
currently subject to Federal position limits, are structured and engage
in commercial hedging practices.\355\ For example, in the energy space,
it is common for market participants to use multi-line business
strategies where risks are managed by trading desk or business line
rather than on a global basis. Accordingly, in an effort to clarify its
view on this issue, the Commission proposed guidance on gross hedging
positions in paragraph (a) to Appendix B.
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\355\ See 85 FR at 11613.
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The proposed guidance provided flexibility for a person to measure
risk either on a net or gross basis, provided that: (A) The manner in
which the person measures risk is consistent over time and follows the
person's regular, historical practice (meaning the person
[[Page 3284]]
is not switching between net hedging and gross hedging on a selective
basis simply to justify an increase in the size of the person's
derivatives positions); (B) the person is not measuring risk on a gross
basis to evade the limits set forth in proposed Sec. 150.2 and/or the
aggregation rules currently set forth in Sec. 150.4; (C) the person is
able to demonstrate (A) and (B) above to the Commission and/or an
exchange upon request; and (D) an exchange that recognizes a particular
gross hedging position as a bona fide hedge pursuant to proposed Sec.
150.9 documents the justifications for doing so and maintains records
of such justifications in accordance with proposed Sec. 150.9(d).
c. Summary of the Commission Determination--Measuring Risk
The Commission is adopting the proposed guidance with modifications
and clarifications to address commenter concerns.
d. Comments--Measuring Risk
While Better Markets expressed concern that gross hedging could be
used to conduct an ``end-run'' around position limits,\356\ many other
commenters expressed support for flexibility to hedge on a net or gross
basis.\357\ Multiple commenters who expressed support for such
flexibility also requested discrete changes to the proposed guidance
and/or associated preamble, including: (i) Elimination of the
requirement that exchanges document their justifications when allowing
gross hedging; \358\ (ii) clarification that gross hedging is
permissible for both enumerated and non-enumerated hedges; \359\ and
(iii) clarification that market participants do not need to develop
procedures setting forth when gross vs. net hedging is
appropriate.\360\ Finally, IFUS requested that the Commission eliminate
the proposed guidance on the grounds that the guidance reflects
considerations currently taken by exchange staff when reviewing
exemptions.\361\
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\356\ Better Markets at 60.
\357\ ASR at 2; LDC at 2; NGSA at 3; COPE at 3; Chevron at 4;
Suncor at 4.
\358\ MGEX at 3; FIA at 14; CEWG at 4.
\359\ Chevron at 4-5; Suncor at 4-5; CCI at 4-5; CEWG at 7-10.
\360\ FIA at 14-15 (stating that risk managers decide on a case-
by-case basis whether to hedge on a net or gross basis).
\361\ IFUS at 3.
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e. Discussion of Final Rule--Measuring Risk
The Commission continues to believe that the guidance on gross
hedging is important because it will allow market participants to
measure risk in the manner most suited to their particular
circumstances, while preventing the use of gross hedging to subvert the
Federal position limits regime.\362\
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\362\ The guidance will help ensure the integrity of the
position limits regime for the reasons discussed below in response
to comments from Better Markets. The Commission thus disagrees with
IFUS that the guidance is unnecessary, but agrees with IFUS that the
proposed guidance reflects considerations currently taken by
exchange staff. In particular, the guidance is consistent in many
ways with the manner in which exchanges require their participants
to measure and report risk, which is consistent with the
Commission's requirements with respect to the reporting of risk. For
example, under Sec. 17.00(d), futures commission merchants
(``FCMs''), clearing members, and foreign brokers are required to
report certain reportable net positions, while under Sec. 17.00(e),
such entities may report gross positions in certain circumstances,
including if the positions are reported to an exchange or the
clearinghouse on a gross basis. 17 CFR 17.00. The Commission's
understanding is that certain exchanges generally prefer, but do not
require, their participants to report positions on a net basis. For
those participants that elect to report positions on a gross basis,
such exchanges require such participants to continue reporting that
way, particularly through the spot period. Such consistency is a
strong indicator that the participant is not measuring risk on a
gross basis simply to evade regulatory requirements.
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First, the Commission is eliminating proposed prong (D) of the
guidance, which provided that an exchange that recognizes a gross
position as a non-enumerated bona fide hedge pursuant to Sec. 150.9
documents the justifications for doing so. Prong (D) is unnecessary
given that the Commission and exchanges have other tools for accessing
such information. In particular, prong (C) of the guidance allows the
Commission and exchanges to request, on an as-needed basis, information
about the manner in which market participants are measuring risk.\363\
To ensure the Commission and exchanges have access to sufficient
information in light of the removal of prong (D), the Commission is
expanding prong (C) to require that a person also demonstrate, upon
request by the Commission or an exchange, justifications for measuring
risk on a gross basis. Additionally, the proposed prong (D) reference
to the non-enumerated process in Sec. 150.9 may have created confusion
regarding the applicability of the proposed gross hedging guidance to
enumerated hedges. Thus, the Commission is also revising the
introductory language of the guidance to clarify that the guidance
applies equally to enumerated and non-enumerated bona fide hedges.
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\363\ Additionally, market participants seeking exemptions
remain subject to a variety of recordkeeping requirements, including
Commission regulation Sec. 1.31, and the Commission will receive
information about all exchange-granted exemptions, including cash-
market information, via the monthly spreadsheet submission required
by Sec. 150.5(a)(4).
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Second, the Commission is clarifying that the guidance does not
require market participants to develop written policies or procedures
setting forth when gross or net hedging is appropriate. However, having
such policies or procedures may help market participants demonstrate
compliance with prongs (A), (B), and (C) of the guidance as finalized
herein.
Finally, the Commission believes the concerns regarding subversion
of position limits raised by Better Markets are already addressed by a
combination of the guardrails in prongs (A)-(C) of the guidance as well
as other Commission provisions, including some finalized herein. First,
to receive recognition as a bona fide hedge, a position must comply
with the bona fide hedging definition, regardless of whether the
underlying risk is measured on a net or gross basis. A market
participant thus may not use gross hedging to receive bona fide hedge
treatment for a speculative position,\364\ and measuring risk on a
gross basis to willfully circumvent or evade speculative position
limits would potentially run afoul of the Sec. 150.2(i)(2) anti-
evasion provision finalized herein. Similarly, market participants must
comply with the Commission's aggregation requirements regardless of
whether the participants are measuring risk on a net or gross
basis.\365\
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\364\ The introductory language to the guidance provides in
relevant part that a person's ``gross hedging positions may be
deemed in compliance . . . provided that all applicable regulatory
requirements are met, including that the position is economically
appropriate to the reduction of risks in the conduct and management
of a commercial enterprise and otherwise satisfies the bona fide
hedging definition . . .''
\365\ Under Sec. 150.4, unless an exemption applies, a person's
positions must be aggregated with positions for which the person
controls trading or for which the person holds a 10% or greater
ownership interest. Commission Regulation Sec. 150.4(b) sets forth
several permissible exemptions from aggregation. See Final Rule,
Aggregation of Positions, 81 FR 91454, (December 16, 2016).
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Second, concerns about cherry-picking are addressed by the
guidance. By focusing on consistency and historical practice with
respect to the manner in which a person measures risk, the guidance
enables market participants to measure risk on a gross basis when
dictated by the nature of the exposure,\366\ but not simply when
[[Page 3285]]
utilizing gross hedging will yield a larger exposure than net hedging
or will otherwise subvert Federal position limit or aggregation
requirements. Use of gross or net hedging that is inconsistent with an
entity's historical practice, or a change from gross to net hedging (or
vice versa), could be an indication that an entity is seeking to evade
position limits regulations.\367\
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\366\ The Commission continues to believe that a gross hedge may
be a bona fide hedge in circumstances where net cash positions do
not necessarily measure total risk exposure due to differences in
the timing of cash commitments, the location of stocks, and
differences in grades or types of the cash commodity. See, e.g.,
Bona Fide Hedging Transactions or Positions, 42 FR at 14834.
However, the Commission clarifies that these may not be the only
circumstances in which gross hedging may be recognized as bona fide.
Like the analysis of whether a particular position satisfies the
proposed bona fide hedge definition, the analysis of whether gross
hedging may be utilized would involve a case-by-case determination
made by the Commission and/or by an exchange using its expertise and
knowledge of its participants.
\367\ If an entity's (including a vertically-integrated
entity's) practice is to switch between net and gross hedging based
on particular circumstances, and those circumstances do not involve
evading position limits or aggregation requirements, then such
switching would not run afoul of prong (A). See Section II.B.9.
(discussing anti-evasion).
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Third, all market participants seeking to exceed Federal position
limits must request hedge exemptions at the exchange level, regardless
of whether they are measuring risk on a gross or net basis, and
regardless of whether they are seeking an enumerated or non-enumerated
exemption at the Federal level. Under the Final Rule, the exchanges
would have an opportunity to confirm whether such participants' use of
gross hedging is consistent with the proposed guidance, including by
reviewing detailed position information. The Commission will also have
access to such information through a variety of means, including:
Records maintained by market participants pursuant to Commission
regulation Sec. 1.31; the monthly spreadsheets that exchanges must
submit to the Commission under Sec. 150.5(a)(4) summarizing exchange-
granted exemptions and related cash-market information; and the ability
for the Commission to request such information directly from a market
participant pursuant to prong (C) of the gross hedging guidance.
x. Pass-Through Swap and Pass-Through Swap Offset Provisions
a. Background--Pass-Through Swap and Pass-Through Swap Offset
As the Commission has noted above, CEA section 4a(c)(2)(B) \368\
contemplates bona fide hedges that by themselves do not meet the
criteria of CEA section 4a(c)(2)(A), but that are used to offset the
swap exposure of a market participant (e.g., a dealer) to the extent
that the swap exposure does satisfy CEA section 4a(c)(2)(A) for such
market participant's counterparty (e.g., a commercial end user).\369\
The Commission believes that, in affording bona fide hedging
recognition for such offsets, Congress in CEA section 4a(c)(2)(B)
intended to: (1) Encourage the provision of liquidity to commercial
entities that are hedging physical commodity price risk in a manner
consistent with the bona fide hedging definition; and (2) only
recognize risk management positions as bona fide hedges when such
positions are opposite a bona fide hedging swap counterparty.\370\ The
Commission has proposed a pass-through swap provision in each of its
position limits rulemakings since 2011.
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\368\ 7 U.S.C. 6a(c)(2)(B).
\369\ CEA section 4a(c)(2)(B)(i) recognizes as a bona fide
hedging position a position that reduces risks attendant to a
position resulting from a swap that was executed opposite a
counterparty for which the transaction would qualify as a bona fide
hedging transaction pursuant to'' 4a(c)(2)(A). 7 U.S.C.
6a(c)(2)(B)(i). CEA section 4a(c)(2)(B)(ii) further recognizes as a
bona fide hedging position a position that ``reduce risks attendant
to a position resulting from a swap that meets the requirements of
4a(c)(2)(A). 7 U.S.C. 6a(c)(2)(B)(ii).
\370\ As described above, the Commission interprets the revised
statutory temporary substitute test as limiting the Commission's
authority to recognize risk management positions as bona fide hedges
unless the position is used to offset exposure opposite a bona fide
hedging swap counterparty.
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b. Summary of the 2020 NPRM--Pass-Through Swap and Pass-Through Swap
Offset
The Commission proposed to implement the statutory pass-through
swap provision in paragraph (2) of the bona fide hedging definition for
physical commodities in proposed Sec. 150.1. Proposed paragraph (2)(i)
of the 2020 NPRM's bona fide hedging definition addressed a situation
where: (a) A particular swap qualifies as a bona fide hedge by
satisfying the temporary substitute test, the economically appropriate
test, and the change in value requirement under proposed paragraph (1)
of the bona fide hedging definition for one of the counterparties (the
``bona fide hedging swap counterparty''), but not for the other
counterparty; and (b) the bona fide hedge treatment ``passes through''
from the bona fide hedging swap counterparty to the other counterparty
(the ``pass-through swap counterparty''). The pass-through swap
counterparty could be an entity that provides liquidity to the bona
fide hedging swap counterparty (such as a swap dealer or a non-dealer
that offers swaps).
Under the 2020 NPRM, the pass-through of the bona fide hedge
treatment from the bona fide hedging swap counterparty to the pass-
through swap counterparty was contingent on: (1) The pass-through swap
counterparty's ability to demonstrate upon request from the Commission
and/or from an exchange that the pass-through swap is a bona fide
hedge; \371\ and (2) the pass-through swap counterparty entering into a
futures, option on a futures, or swap position in the ``same physical
commodity'' as the pass-through swap to offset and reduce the price
risk attendant to the pass-through swap.
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\371\ While the 2020 NPRM's proposed paragraph (2)(i) of the
bona fide hedging definition in Sec. 150.1 required the pass-
through swap counterparty to be able to demonstrate the bona fides
of the pass-through swap upon request, the 2020 NPRM did not
prescribe the manner by which the pass-through swap counterparty
obtains the information needed to support such a demonstration. The
2020 NPRM noted that the pass-through swap counterparty could base
such a demonstration on a representation made by the bona fide
hedging swap counterparty, and such determination may be made at the
time when the parties enter into the swap, or at some later point.
The 2020 NPRM also stated that for the bona fides to pass-through as
described above, the swap position need only qualify as a bona fide
hedging position at the time the swap was entered into.
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If the two conditions above were satisfied, then the bona fides of
the bona fide hedging swap counterparty ``pass through'' to the pass-
through swap counterparty for purposes of recognizing as a bona fide
hedge any futures position, option on futures position, or swap
position entered into by the pass-through swap counterparty to offset
the pass-through swap (i.e., to offset and reduce the risks of the swap
opposite the bona fide hedging swap counterparty). The pass-through
swap counterparty could thus exceed Federal position limits for both:
(1) The swap opposite the bona fide hedging swap counterparty, if
applicable; and (2) an offsetting futures position, option on a futures
position, or swap position in the same physical commodity, even though
any such offsetting position on its own would not qualify as a bona
fide hedge for the pass-through swap counterparty under proposed
paragraph (1) of the bona fide hedging transaction or position
definition. The Commission clarified that once the original bona fide
pass-through swap is settled, positions held under the pass-through
swap provision must be liquidated in an orderly manner in accordance
with sound commercial practices. Further, under proposed Sec.
150.3(d)(2), a pass-through swap counterparty would be required to
maintain any representation it relied on regarding the bona fide hedge
status of the swap for at least two years.
Proposed paragraph (2)(ii) of the bona fide hedging definition
addressed a situation where a market participant who qualifies as a
bona fide hedging swap counterparty (i.e., a counterparty with a
position in a previously-entered into swap that qualified, at the time
the
[[Page 3286]]
swap was entered into, as a bona fide hedge under paragraph (1)) seeks,
at some later time, to offset that bona fide hedge swap position using
a futures position, option on a futures position, or a swap in excess
of Federal position limits. Such step might be taken, for example, to
respond to a change in the bona fide hedging swap counterparty's risk
exposure in the underlying commodity.\372\ Proposed paragraph (2)(ii)
would allow such a bona fide hedging swap counterparty to use a futures
position, option on a futures position, or a swap in excess of Federal
position limits to offset the price risk of the previously-entered into
swap, even though the offsetting position itself does not qualify for
that participant as a bona fide hedge under paragraph (1).
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\372\ Examples of a change in the bona fide hedging swap
counterparty's cash-market price risk could include a change in the
amount of the commodity that the hedger will be able to deliver due
to drought, or conversely, higher than expected yield due to growing
conditions.
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The proposed pass-through exemption under paragraph (2) of the bona
fide hedging or transaction definition would only apply to the pass-
through swap counterparty's offset of the bona fide hedging swap, and/
or to the bona fide hedging swap counterparty's offset of its bona fide
hedging swap. Any further offset would not be eligible for a pass-
through exemption under paragraph (2) unless the offsetting position
itself meets paragraph (1) of the proposed bona fide hedging
definition.
The Commission stated in the 2020 NPRM that it believes the pass-
through swap provision may help mitigate some of the potential impact
resulting from the removal of the ``risk management'' exemptions that
are currently in effect.\373\
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\373\ See supra Section II.A.1.iii.a. (discussion of the
temporary substitute test).
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c. Summary of the Commission Determination--Pass-Through Swap and Pass-
Through Swap Offset; Related Recordkeeping Requirement; Cross-Commodity
Hedging Under the Pass-Through Swap Provision
The Commission is finalizing the pass-through swap and pass-through
swap offset provision of the ``bona fide hedging transaction or
position'' definition largely as proposed, with certain amendments in
response to commenters' requests discussed below:
First, the Commission is amending the 2020 NPRM's proposed
provision that would have required that the pass-through swap
counterparty demonstrate upon request that its offsetting position is
attendant to a position resulting from a bona fide hedging pass-through
swap. Instead, under the Final Rule, in order for a pass-through swap
counterparty to treat a pass-through swap offset as a bona fide hedge,
the pass-through swap counterparty must receive from the bona fide
hedging swap counterparty a written representation that the pass-
through swap qualifies as a bona fide hedge. Under the Final Rule, the
Commission is also amending the proposed regulatory text to add that
the pass-through swap counterparty may rely in good faith on such
written representation(s) made by the bona fide hedging swap
counterparty, unless the pass-through swap counterparty has information
that would cause a reasonable person to question the accuracy of the
representation.
Second, the Commission is adopting a revised paragraph (i)(B) of
the bona fide hedging transaction or position definition in Sec. 150.1
to delete the language in the pass-through swap provision that requires
the offset to be in the ``same physical commodity'' as the pass-through
swap.
d. Comments--Application of Pass-Through Swap Offset to Affiliates;
Recordkeeping; Cross-Commodity Hedging Under the Pass-Through Swap
Provision
Comments generally fell into three categories, each discussed in
turn below: (1) Application of pass-through swap offsets to affiliates;
(2) pass-through recordkeeping requirements; and (3) pass through swaps
and cross-commodity hedging.
(1) Application of Pass-Through Swap Offset to Affiliates
Commenters generally supported amending the bona fide hedge
definition in accordance with the statutory language in CEA section
4a(c)(2)(B) to include a pass-through swap and pass-through swap
offset.\374\ Some commenters requested clarification on the application
of the pass-through swap offset exemption to corporate affiliates. For
example, Shell stated that an overly strict interpretation of ``pass-
through swap counterparty'' may limit the application of the pass-
through swap offset exemption to only one entity within a corporate
structure, and such entity may not be the affiliate entity used by the
firm for its market-facing activities or to execute transactions with
exchanges to manage portfolios and position limits on an aggregated
basis.\375\ NGSA similarly requested that the Commission's
interpretation of a pass-through swap counterparty apply to affiliates
who may pass through their bona fide hedge position exemption to a
market-facing, ``treasury-affiliate'' subsidiary within a corporate
structure.\376\
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\374\ CEWG at 4; CMC at 5-6; FIA at 3; ICE at 6-7; ISDA at 12-
13; and Shell at 2, 4-5.
\375\ Shell at 4.
\376\ NGSA at 8.
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(i) Discussion of Final Rule--Application of Pass-Through Swap Offset
to Affiliates
The Commission clarifies that within a group of entities that
aggregates its positions under Sec. 150.4 \377\ (such as an aggregated
corporate group), any entity that is part of the aggregated group may
avail itself of the pass-through swap offset exemption. For example,
the pass-through swap offset provision extends to market-facing
affiliates that are part of an aggregated group pursuant to Sec.
150.4, such as treasury affiliate subsidiaries that firms commonly use
to manage market-facing activities and portfolios. In such
circumstances, recognition of a secondary pass-through swap transaction
would not be necessary among an aggregated group because an aggregated
group is treated as one person for purposes of Federal position limits.
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\377\ Aggregation of Positions, 81 FR 91454 (Dec. 16, 2016).
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Separately, in response to commenter requests to allow secondary
pass throughs (i.e., the further ``pass-through'' of a pass-through
exemption from one entity to another), the Commission clarifies that
outside the context of an aggregated group, additional positions
entered into as an offset of a pass-through swap would not be eligible
for a pass-through exemption under paragraph (2) of the bona fide
hedging definition unless the offsetting position itself meets the bona
fide hedging definition. Accordingly, the bona fides of a transaction
will not extend to a third-party through the pass-through swap
counterparty. For instance, if Producer A enters into an OTC swap with
Swap Dealer B, and the OTC swap qualifies as a bona fide hedge for
Producer A, then Swap Dealer B could be eligible for a pass-through
exemption to offset that swap in the futures market. However, if Swap
Dealer B offsets its swap opposite Producer A using an OTC swap with
Swap Dealer C, Swap Dealer C would not be eligible for a pass-through
exemption.
(2) Pass-Through Swap Provision and Recordkeeping
Commenters raised concerns with the 2020 NPRM's requirements that
the pass-through swap counterparty
[[Page 3287]]
document, and upon request, demonstrate the bona fides of the pass-
through swap.\378\ Commenters also requested that the Commission
clarify the nature of the required documentation,\379\ and/or eliminate
the required demonstration/documentation altogether, provided that the
pass-through swap counterparty has a legitimate, good-faith belief the
swap is a bona fide hedge.\380\
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\378\ Cargill at 10; FIA at 11-12; CMC at 5; Shell at 6-7; ICE
at 6-7; and ISDA at 11-12.
\379\ ICE at 6-7; Shell at 6.
\380\ Cargill at 10; CMC at 5; FIA at 11-12; and ISDA at 11-12.
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(i) Discussion of Final Rule--Pass-Through Swap Provision and
Recordkeeping
The Commission is amending the 2020 NPRM's proposed provision that
would have required that the pass-through swap counterparty demonstrate
upon request that its offsetting position is attendant to a position
resulting from a bona fide hedging pass-through swap. For the Final
Rule, the Commission is amending the pass-through swap provision's
regulatory text to clarify that in order for a pass-through swap
counterparty to treat a pass-through swap as a bona fide hedge, the
pass-through swap counterparty must receive from the bona fide hedging
swap counterparty a written representation that the pass-through swap
qualifies as a bona fide hedge. The Commission is further amending the
regulatory text to add that the pass-through swap counterparty may rely
in good faith on such written representation(s) made by the bona fide
hedging swap counterparty, unless the pass-through swap counterparty
has information that would cause a reasonable person to question the
accuracy of the representation. The Commission is adding the written
representation requirement to enable to Commission to verify that only
market participants with bona fide hedge exemptions are able to pass-
through those exemptions to their swap counterparties.
The Commission agrees with commenters who stated that the bona fide
hedging counterparty is the suitable party to determine the bona fide
hedging status of the pass-through swap. This is because the bona fide
hedging status is determined based upon the bona fide hedging
counterparty's confidential, proprietary information. The Commission
clarifies that the Commission is not requiring the bona fide hedging
counterparty to share the proprietary, confidential information upon
which it is basing its determination with its counterparties.
Similar to the 2020 NPRM, this Final Rule does not prescribe the
form or manner by which the pass-through swap counterparty obtains the
written representation. The Commission recognizes that the bona fide
hedging counterparty may make such representations on a relationship
basis through counterparty relationship documentation (e.g., through
ISDA documentation or other forms of documentation as agreed upon by
the parties) or on a transaction basis (e.g., through trade
confirmations or in other forms as agreed upon by the parties).\381\
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\381\ The Commission believes that allowing market participants
to determine the form and manner of how they will document the
written representation by the bona fide hedging counterparty and
allowing the pass-through swap counterparty to rely on such
representation addresses NRECA's comments on the pass-through swap
provision recordkeeping obligations. NRECA at 23.
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For example, if agreed to by the counterparties, the pass-through
swap counterparty may rely on a written representation made by the bona
fide hedging swap counterparty that an original pass-through swap and
any subsequent pass-through swaps entered into by and between the bona
fide hedging swap counterparty and the pass-through swap counterparty
are bona fide hedges, unless the bona fide hedging swap counterparty
provides written notice to the pass-through swap counterparty that a
particular swap is not a bona fide hedge. The Commission believes
providing market participants with flexibility recognizes
counterparties' ongoing relationships, while enabling the Commission to
verify that the pass-through swap offset reduces the risks of a bona
fide hedging swap.
The Commission considered comments requesting the elimination of
the pass-through swap provision recordkeeping requirement in Sec.
150.3(d) based on arguments that requiring this recordkeeping was not
practical. The Commission is not persuaded by those arguments as the
recordkeeping requirements assist the Commission in verifying that the
pass-through swap provision is only being utilized to offset risks
arising from bona fide hedges. Accordingly, the Commission is
finalizing the proposed pass-through swap recordkeeping requirement in
Sec. 150.3(d), subject to certain conforming changes to reflect
amendments to the pass-through swap paragraph of the bona fide hedging
definition.
Since not all swaps entered into by a commercial entity would
qualify as a bona fide hedge, the Commission declines commenters'
requests that a pass-through swap counterparty may reasonably rely
solely upon the fact that the counterparty is a commercial end user
and, absent an agreement between the counterparties, that the swap
appears to be consistent with hedges entered into by end users in the
same line of business.
(3) Comments--Pass-Through Swap Provision and Cross-Commodity Hedging
Commenters requested amending paragraph (i)(B) of the proposed bona
fide hedge definition to permit the pass-through swap provision to
apply to cross-commodity hedges by eliminating the proposed requirement
that the pass-through swap offset must be in the ``same physical
commodity'' as the pass-through swap.\382\
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\382\ FIA at 13 (quoting 85 FR at 11614); Shell at 5 (quoting 85
FR at 11614).
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(i) Discussion of Final Rule--Pass-Through Swap Provision and Cross-
Commodity Hedging
The Commission is adopting a revised paragraph (i)(B) of the bona
fide hedging transaction or position definition in Sec. 150.1 to
delete the language in the pass-through swap provision that requires
the offset to be in the ``same physical commodity'' as the pass-through
swap. The Commission's enumerated cross-commodity bona fide hedge
adopted herein thus applies to all the enumerated hedges, as well as to
the pass-through swap provision in the bona fide hedge definition. The
revised regulatory text confirms the Commission's intent to allow a
pass-through swap counterparty to utilize the pass-through swap offset
exemption when the offset itself is a cross-commodity hedge of the
underlying pass-through swap, provided that such cross-commodity hedge
meets all applicable requirements, including being substantially
related to the commodity being offset.
2. ``Commodity Derivative Contract''
i. Summary of the 2020 NPRM--Commodity Derivative Contract
The Commission proposed to create the defined term ``commodity
derivative contract'' for use throughout part 150 of the Commission's
regulations as shorthand for any futures contract, option on a futures
contract, or swap in a commodity (other than a security futures product
as defined in CEA section 1a(45)).
[[Page 3288]]
ii. Comments and Summary of the Commission Determination--Commodity
Derivative Contract
No commenter addressed the proposed definition of ``commodity
derivative contract.'' The Commission is adopting the definition as
proposed, with some non-substantive technical modifications.
These technical changes include the Final Rule's reference to
``futures contract'' rather than merely ``futures,'' and ``swap''
rather than ``swap contract'' to conform to other uses in final Sec.
150.1.\383\
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\383\ The Commission notes that these technical changes are to
conform more closely to CEA section 4a(a), which refers to
``contracts of sale of such commodity for future delivery'' (7
U.S.C. 6a(a)(1) (emphasis added)), ``contracts of sale for future
delivery'' (7 U.S.C. 6a(a)(2)(A) (emphasis added)), or similar
phraseology. Accordingly, the Commission is making the technical
change to refer to ``futures contracts'' rather than merely
``futures'' in order to more closely conform to the CEA's terms.
Similarly, CEA section 4a(a)(6) and section 1a(47) both refer to
``swap'' but not '' swap contract,'' and so the Commission is making
a similar conforming change.
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3. ``Core Referenced Futures Contract''
i. Summary of the 2020 NPRM--Core Referenced Futures Contract
The Commission proposed to create the term ``core referenced
futures contract'' as a short-hand phrase to refer to the futures
contracts listed in proposed Sec. 150.2(d) to which the Federal
position limit rules would apply.\384\ As per the ``referenced
contract'' definition described below, position limits would also apply
to any contract that is directly or indirectly linked to, or that has
certain pricing relationships with, a core referenced futures contract.
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\384\ The selection of the proposed core referenced futures
contracts is explained below in the discussions of Sec. 150.2 at
Section II.B. and the necessity finding infra at Section III.C.
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ii. Comments and Summary of the Commission Determination--Core
Referenced Futures Contract
No commenter addressed the proposed definition of ``core referenced
futures contract.'' The Commission is adopting the definition as
proposed.
4. ``Economically Equivalent Swap''
i. Background--Economically Equivalent Swap
The Commission's existing regulations do not currently subject
swaps to Federal position limits. Similarly, the Commission is unaware
of any exchange-set limits for swaps on any of the 25 core referenced
futures contracts. Pursuant to CEA section 4a(a)(5), when the
Commission imposes position limits on futures and options on futures
pursuant to CEA section 4a(a)(2), the Commission also must develop
limits ``concurrently'' and establish limits ``simultaneously'' for
``economically equivalent'' swaps ``as appropriate.'' \385\ As the
statute does not define the term ``economically equivalent,'' the
Commission must apply its expertise in construing such term, and, as
discussed further below, must do so consistent with the policy goals
articulated by Congress, including in CEA sections 4a(a)(2)(C) and
4a(a)(3).
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\385\ CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5). In addition, CEA
section 4a(a)(4) separately authorizes, but does not require, the
Commission to impose Federal position limits on swaps that meet
certain statutory criteria qualifying them as ``significant price
discovery function'' swaps. 7 U.S.C. 6a(a)(4). The Commission
reiterates, for the avoidance of doubt, that the definitions of
``economically equivalent'' in CEA section 4a(a)(5) and
``significant price discovery function'' in CEA section 4a(a)(4) are
separate concepts and that contracts can be economically equivalent
without serving a significant price discovery function. See 81 FR at
96736 (the Commission noting that certain commenters may have been
confusing the two definitions).
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ii. Summary of the 2020 NPRM--Economically Equivalent Swap
The 2020 NPRM proposed a new term, ``economically equivalent
swap.'' Under the 2020 NPRM, a swap would be deemed an ``economically
equivalent swap'' with respect to a referenced contract so long as the
swap shared identical ``material'' contractual specifications, terms,
and conditions with the referenced contract, and provided that any
differences between the swap and referenced contract with respect to
the following would be disregarded: (i) Lot size or notional amount;
(ii) for a swap and relevant referenced contract that are both
physically-settled, delivery dates diverging by less than one calendar
day, except for a physically-settled natural gas swap which could
diverge by less than two calendar days; and (iii) post-trade risk
management arrangements. Because the proposed ``economically equivalent
swap'' definition referred to ``referenced contracts,'' under the 2020
NPRM's approach a swap could be deemed to be ``economically
equivalent'' to not just a core referenced futures contract, but also
to any cash-settled look alike futures contract or option on a futures
contract.\386\
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\386\ As discussed under the ``referenced contract'' definition,
the term ``referenced contract'' includes core referenced futures
contracts, linked cash-settled futures contracts, and options
thereon. For further discussion, see Section II.A.16.
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iii. Comments and Discussion of Final Rule--Economically Equivalent
Swap
a. The Inclusion of Certain Swaps Within the Federal Position Limits
Framework
Many commenters generally supported the proposed definition.\387\
However, other commenters argued that swaps should not be subject to
Federal position limits at all \388\ or that subjecting swaps to
position limits would increase costs without commensurate
benefits.\389\ Nevertheless, several of these same commenters that
stated that swaps should not be subject to Federal position limits also
generally supported the proposed ``economically equivalent swap''
definition to the extent the Commission determined to include swaps
within Federal position limits.\390\ Similarly, IATP stated that it was
unclear why swaps are part of the 2020 NPRM given the Commission's
limited information on the swaps market.\391\
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\387\ E.g., AQR at 10; FIA at 2-3; NCFC at 5; Suncor at 2; SIFMA
AMG at 7; ISDA at 5; Chevron at 2; CEWG at 3; Citadel at 6.
\388\ SIFMA AMG at 6-8; IATP at 19.
\389\ CHS at 4-5; NCFC at 5; SIFMA AMG at 6-7; and ISDA at 5.
\390\ Chevron at 2; FIA at 2, 3, 5; MFA/AIMA at 3; SIFMA AMG at
7; Suncor at 2; AQR at 10-11; COPE at 3; Better Markets at 4; 31;
NCFC at 5; ISDA at 5; CEWG at 3; and Citadel at 6.
\391\ IATP at 19.
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In response to these comments, as an initial matter, the Commission
emphasizes that Congress has determined, through the Dodd-Frank Act's
amendments to CEA section 4a(a)(5), that the Commission must develop
Federal position limits for economically equivalent swaps
``concurrently,'' and must establish such limits ``simultaneously,''
with the Federal position limits for futures and options on futures.
Accordingly, the Commission has determined that, as a legal matter, a
swap that qualifies as ``economically equivalent'' to any referenced
contract must be included within the Federal position limits framework.
While it did not oppose the proposed definition, NCFC expressed a
similar concern with respect to the costs that the proposed definition
could impose on commercial end users and small- and mid-sized FCMs. To
mitigate these costs, NCFC suggested that any swap that qualifies for
an exception to the Commission's clearing requirement under existing
Sec. 50.50 of the Commission's regulations should not be deemed to be
an ``economically equivalent swap.'' According to NCFC, such ``swap
contracts already must meet the test `to hedge or mitigate commercial
[[Page 3289]]
risk,' and are `not used for a purpose that is in the nature of
speculation, investing, or trading,''' pursuant to Sec. 50.50.\392\
The Commission understands NCFC's concern, but believes NCFC's
alternative is unnecessary for two reasons. First, to the extent a swap
described by NCFC would ``hedge or mitigate commercial risk,'' such
swap likely would qualify for an enumerated bona fide hedge under the
Final Rule and therefore would not contribute to a commercial end-
user's net position for Federal position limits purposes.\393\ Second,
commodity swaps are not required to be cleared under the Commission's
existing regulations, so determining whether the end-user clearing
exemption applies is not necessarily a helpful proxy in determining
whether a swap is ``economically equivalent'' for purposes of CEA
section 4a(a)(5).
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\392\ NCFC at 5-6.
\393\ To the extent an FCM would not be able to qualify for a
bona fide hedge, the Commission believes that excepting such swaps
for purely financial firms would functionally have the same effect
as maintaining the risk-management exemption, which Congress,
through the Dodd-Frank Act's amendments to the CEA, has directed the
Commission to eliminate. See Section IV.A.4.ii.a(1) (discussing
elimination of the risk management exemption).
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b. Statutory Basis for the Commission's ``Economically Equivalent
Swap'' Definition
In promulgating the Federal position limits framework, Congress
instructed the Commission to consider several factors. First, CEA
section 4a(a)(3)(B) requires the Commission when establishing Federal
position limits, to the maximum extent practicable, in its discretion,
to: (i) Diminish, eliminate, or prevent excessive speculation; (ii)
deter and prevent market manipulation, squeezes, and corners; (iii)
ensure sufficient market liquidity for bona fide hedgers; and (iv)
ensure that the price discovery function of the underlying market is
not disrupted. Second, CEA section 4a(a)(2)(C) requires the Commission
to strive to ensure that any limits imposed by the Commission will not
cause price discovery in a commodity subject to Federal position limits
to shift to trading in foreign markets.
Accordingly, any definition of ``economically equivalent swap''
must consider these statutory objectives. The Commission also
recognizes that swaps may include customized (i.e., ``bespoke'') terms
and are largely negotiated bilaterally and traded off-exchange (i.e.,
OTC). In contrast, futures contracts have standardized terms and are
generally exchange-traded or otherwise traded subject to the rules of
an exchange. As explained further below, due to these differences
between swaps and exchange-traded futures and related options, the
Commission has preliminarily determined that Congress's underlying
policy goals in CEA section 4a(a)(2)(C) and (3)(B) are best achieved by
adopting a narrow definition of ``economically equivalent swap,''
compared to the broader definition of ``referenced contract.'' \394\
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\394\ The definition of ``referenced contract'' adopted herein
will incorporate cash-settled look-alike futures contracts and
related options that are either (i) directly or indirectly linked,
including being partially or fully settled on, or priced at a fixed
differential to, the price of that particular core referenced
futures contract; or (ii) directly or indirectly linked, including
being partially or fully settled on, or priced at a fixed
differential to, the price of the same commodity underlying that
particular core referenced futures contract for delivery at the same
location or locations as specified in that particular core
referenced futures contract. See infra Section II.A.16. (definition
of ``referenced contract''). The definition of ``economically
equivalent swap'' adopted herein is a type of ``referenced
contract,'' but, as discussed herein, the ``economically equivalent
swap'' definition includes a relatively narrower class of swaps
compared to other types of ``referenced contracts,'' such as look-
alike futures and options on futures contracts, for the reasons
discussed below.
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The ``referenced contract'' definition adopted in Sec. 150.1 will
include ``economically equivalent swaps,'' meaning any economically
equivalent swap is subject to Federal position limits. Thus, a swap
that is deemed economically equivalent would be required to be added
to, and could be netted against, as applicable, an entity's other
referenced contracts in the same commodity for the purpose of
determining one's aggregate positions for Federal position limits.\395\
Any swap that is not deemed economically equivalent is not a referenced
contract, and thus could not be netted with referenced contracts nor
required to be aggregated with any referenced contract for Federal
position limits purposes.
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\395\ See infra Section II.B.10. (discussion of netting).
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The Commission has determined that the ``economically equivalent
swap'' definition adopted herein supports the statutory objectives in
CEA section 4a(a)(3)(B)(i) and (ii) by helping to prevent excessive
speculation and market manipulation, including corners and squeezes,
respectively, by: (1) Focusing on swaps that are the most economically
equivalent in every significant way to the futures contracts and
options on futures contracts for which the Commission deems position
limits to be necessary; \396\ and (2) limiting the ability of
speculators to obtain excessive positions through netting. Any swap
that meets the economically equivalent swap definition offers identical
risk sensitivity to its associated referenced contract with respect to
the underlying commodity, and thus could be used to effect a
manipulation, benefit from a manipulation, or otherwise potentially
distort prices in the same or similar manner as the associated futures
contract or option on the futures contract. The Commission further has
determined that the relatively narrow definition supports the statutory
objective in CEA section 4a(a)(2)(C) by not causing price discovery to
shift to trading in foreign markets.\397\
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\396\ See infra Section III. (necessity finding).
\397\ For clarity, a swap may be eligible for treatment under
the pass-through swap provision as either a pass-through swap or a
pass-through swap offset, discussed above under the bona fide hedge
definition, and not necessarily be deemed to be an ``economically
equivalent swap'' since the pass-through swap provision focuses on
whether the swap serves as a bona fide hedge to one of the
counterparties. Similarly, status as an economically equivalent swap
is not dispositive for treatment under the pass-through swap
provision.
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c. The Definition Balances Competing Statutory Goals and Is Neither Too
Broad Nor Too Narrow
Several commenters argued that the proposed ``economically
equivalent swap'' definition was too narrow and would therefore allow
market participants to avoid Federal position limits.\398\ In
particular, CME Group and Better Markets requested the general
``referenced contract'' definition that applies to futures and options
on futures also apply to swaps.\399\ The Commission agrees with these
commenters' general concerns that the ``economically equivalent swap''
definition should not allow market participants to avoid Federal
position limits. In fact, the Commission believes that the approach
adopted in this Final Rule achieves that goal better than the approach
proposed by Better Markets and CME Group, first and foremost by
preventing parties from using netting of swaps to create large
positions in the futures market. The Final Rule's definition, compared
to the relatively broader ``referenced contract'' definition that
applies to futures and options on futures, better prevents
inappropriate netting of market participants' positions and advances
Congress's underlying policy goals in
[[Page 3290]]
CEA section 4a(a)(2)(C) and (3)(B) for the following three reasons.
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\398\ CME Group at 3; NEFI at 3; Better Markets at 31-33
(generally arguing that the ``economically equivalent swap'' and
``referenced contract'' definitions should be consistent to prevent
loopholes).
\399\ CME Group at 3-4; Better Markets at 33-34 (arguing that
excluding penultimate swaps creates a technical delineation that is
largely divorced from the economic realities relating to physical
commodities underlying both contracts).
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First, as the Commission stated above, it believes that a narrow
``economically equivalent swap'' definition that focuses on swaps with
identical material terms and conditions reduces the ability of market
participants to structure tangentially-related (i.e., non-identical)
swaps simply to net down large, speculative positions in excess of
Federal position limits in futures or options on futures. Because
referenced contracts in the same commodity are generally netted,\400\
and because OTC swaps are bilaterally negotiated and customizable,
market participants could structure swaps that do not necessarily offer
identical risk or economic exposure or sensitivity simply to net down
large positions in other referenced contracts. This is less of a
concern with exchange-traded futures and related options, which are
subject to exchange rules and oversight, and which have standardized
terms, meaning they cannot be structured simply to net down large
speculative positions in core referenced futures contracts.
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\400\ See Section II.B.10. (discussing the application of
netting).
---------------------------------------------------------------------------
The Commission recognizes as reasonable the concerns of CME Group
and Better Markets that a relatively narrow ``economically equivalent
swap'' definition, compared to a broader definition, could enable
market participants to build excessive speculative risk exposure on one
side of the market through OTC swap transactions. As discussed herein,
the Commission is equally concerned that a broader definition similarly
would permit a market participant to acquire a large position in a core
referenced futures contract through inappropriate netting.\401\
However, the Commission believes that a broader ``economically
equivalent swap'' definition as advocated by these commenters also
would be more likely to lead to the additional harms discussed below.
Accordingly, while the Commission shares the same ultimate concerns as
CME Group and Better Markets with respect to protecting market
integrity, the Commission has determined that the relatively narrow
definition concurrently protects market integrity while also better
supporting the statutory directives in CEA sections 4a(a)(2)(C) and
4a(a)(3)(B) as discussed below.
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\401\ For example, a broader economically equivalent swap
definition would allow a market participant to hold a long position
in a physically-settled futures contract that exceeds the applicable
Federal position limit levels by netting down with an ``offsetting''
short OTC swap, even if the swap has a different material term than
the futures contract. That is, the ``offsetting'' short swap could
have different delivery location(s), delivery date(s), quality
differential(s), or even a different underlying commodity (depending
on how broad the definition would be) than the physically-settled
futures contract. Such an ``offsetting'' short swap would allow the
market participant to more profitably engage in--and therefore more
likely to successfully effect--a corner or squeeze in two respects.
First, the ``offsetting'' short swap would allow the market
participant to obtain a larger long futures position, thus creating
a more dominant position on the long side of the market. Second, the
``offsetting'' short swap would allow the market participant to more
easily ``dispose'' of or ``bury the corpse'' at smaller expense by
enabling the market participant to deliver the underlying physical
commodity, which the market participant received pursuant to its
long physically-settled futures positions, under more profitable
circumstances compared to the terms specified in the futures
contract. For example, the ``offsetting'' short swap could allow the
market participant to deliver the commodity (i.e., ``dispose of'' or
``bury the corpse'') at a different, more profitable (or at least
for less of a loss) delivery location and/or wait for more favorable
delivery dates with more favorable prices.
---------------------------------------------------------------------------
Second, the Commission believes that the Final Rule's definition
addresses statutory objectives by focusing Federal position limits on
those swaps that pose the greatest threat for facilitating corners and
squeezes. That is, the Final rule addresses those swaps with similar
delivery dates and identical material economic terms to futures and
options on futures subject to Federal position limits while also
minimizing market impact and liquidity for bona fide hedgers for other
positions and transactions. For example, if the Commission were to
adopt a broader economically equivalent swap definition that included
delivery dates that diverge by one or more calendar days, perhaps by
several days or weeks, a liquidity provider (including a market maker
or a speculator) with a large portfolio of swaps may be more likely to
be constrained by the applicable position limits and therefore may have
incentive either to minimize its swaps activity or move its swaps
activity to foreign jurisdictions, resulting in reduced liquidity. If
there were many similarly situated market participants, the market for
such swaps could become less liquid, which in turn could harm liquidity
for bona fide hedgers. As a result, the Commission has determined that
the relatively narrow scope of the Final Rule's definition reasonably
balances the factors in CEA section 4a(a)(3)(B)(ii) and (iii) by
decreasing the possibility of illiquid markets for bona fide hedgers on
the one hand while, on the other hand, focusing on the prevention of
market manipulation during the most sensitive period of the spot month.
Third, the ``economically equivalent swap'' definition helps
prevent regulatory arbitrage as required by CEA section 4a(a)(2)(C) and
additionally will strengthen international comity. For example, if the
Commission instead adopted a broader definition, U.S.-based swaps
activity could potentially migrate to other jurisdictions with a
narrower definition, such as the European Union (``EU''). In this
regard, the Final Rule's definition is similar in certain ways to the
EU definition for OTC contracts that are ``economically equivalent'' to
commodity derivatives traded on an EU trading venue.\402\ The
Commission's ``economically equivalent swap'' definition thus furthers
the statutory
[[Page 3291]]
goals set forth in CEA section 4a(a)(2)(C), which requires the
Commission to strive to ensure that any Federal position limits are
``comparable'' to foreign exchanges and will not cause ``price
discovery . . . to shift to trading'' on foreign exchanges.\403\
Further, market participants trading in both U.S. and EU markets should
find the Commission's and the EU's respective definitions to be
familiar, which may help reduce compliance costs for those market
participants that already have systems and personnel in place to
identify and monitor such swaps.
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\402\ See EU Commission Delegated Regulation (EU) 2017/591, 2017
O.J. (L 87). The applicable EU regulations define an OTC derivative
to be ``economically equivalent'' when it has ``identical
contractual specifications, terms and conditions, excluding
different lot size specifications, delivery dates diverging by less
than one calendar day and different post trade risk management
arrangements.'' While the Final Rule's ``economically equivalent
swap'' definition is similar, the Final Rule's definition requires
``identical material'' terms rather than merely ``identical'' terms.
Further, the Final Rule's definition excludes different ``lot size
specifications or notional amounts'' rather than referencing only
``lot size'' since swaps terminology usually refers to ``notional
amounts'' rather than to ``lot sizes.'' The Commission notes that
SIFMA AMG argued in its comment letter that the Commission should
adopt the economically equivalent swap definition proposed by the
EU. See SIFMA AMG at 7. However, while the Commission's definition
will be similar to the EU's definition, to the extent that the
Commission's definition differs from the EU's by requiring
``material identical'' rather than merely ``identical'' terms, the
Commission discusses its reasoning below.
Both the Commission's definition and the applicable EU
regulation are intended to prevent harmful netting. See European
Securities and Markets Authority, Draft Regulatory Technical
Standards on Methodology for Calculation and the Application of
Position Limits for Commodity Derivatives Traded on Trading Venues
and Economically Equivalent OTC Contracts, ESMA/2016/668 at 10 (May
2, 2016), available at https://www.esma.europa.eu/sites/default/files/library/2016-668_opinion_on_draft_rts_21.pdf (``[D]rafting the
[economically equivalent OTC swap] definition in too wide a fashion
carries an even higher risk of enabling circumvention of position
limits by creating an ability to net off positions taken in on-venue
contracts against only roughly similar OTC positions.'').
The applicable EU regulator, the European Securities and
Markets Authority (``ESMA''), released a ``consultation paper''
discussing the status of the existing EU position limits regime and
specific comments received from market participants. According to
ESMA, no commenter, with one exception, supported changing the
definition of an economically equivalent swap (referred to as an
``economically equivalent OTC contract'' or ``EEOTC''). ESMA further
noted that for some respondents, ``the mere fact that very few EEOTC
contracts have been identified is no evidence that the regime is
overly restrictive.'' See European Securities and Markets Authority,
Consultation Paper MiFID Review Report on Position Limits and
Position Management Draft Technical Advice on Weekly Position
Reports, ESMA70-156-1484 at 46, Question 15 (Nov. 5, 2019),
available at https://www.esma.europa.eu/document/consultation-
paper-position-limits.
\403\ 7 U.S.C. 6a(a)(2)(C).
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Each element of the Final Rule's definition, including the
exclusions from the definition, and related comments, is discussed
below.
d. Scope of Identical Material Terms
Under the Final Rule's definition, only ``material'' contractual
specifications, terms, and conditions are relevant to the analysis of
whether a particular swap qualifies as an economically equivalent swap.
The definition thus does not require that a swap be identical in all
respects to a referenced contract in order to be deemed ``economically
equivalent'' to that referenced contract. Under the Final Rule,
``material'' specifications, terms, and conditions are limited to those
provisions that drive the economic value of a swap, including with
respect to pricing and risk. Examples of ``material'' provisions
include, for example: The underlying commodity, including commodity
reference price and grade differentials; maturity or termination dates;
settlement type (i.e., cash-settled versus physically-settled); and, as
applicable for physically delivered swaps, delivery specifications,
including commodity quality standards and delivery locations.\404\
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\404\ In developing its definition of an ``economically
equivalent swap,'' the Commission, based on its experience, has
determined that for a swap to be ``economically equivalent'' to a
futures or option on a futures contract, the material contractual
specifications, terms, and conditions must be identical. In making
this determination, the Commission took into account, in regards to
the economics of swaps, how a swap and a corresponding futures
contract or option on a futures contract react to certain market
factors and movements, the pricing variables used in calculating
each instrument, the sensitivities of those variables, the ability
of a market participant to gain the same type of exposures, and how
the exposures move to changes in market conditions.
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In addition, a swap that either references another referenced
contract, or incorporates by reference the other referenced contract's
terms, is deemed to share identical terms with the referenced contract
and therefore qualifies as an economically equivalent swap.\405\ Any
change in the material terms of such a swap, however, could render the
swap no longer economically equivalent for Federal position limits
purposes.
---------------------------------------------------------------------------
\405\ For example, a cash-settled swap that either settles to
the pricing of a corresponding cash-settled referenced contract, or
incorporates by reference the terms of such referenced contract,
would be deemed to be economically equivalent to the referenced
contract.
---------------------------------------------------------------------------
The Commission recognizes that the material swap terms noted above
are essential to determining the pricing and risk profile for swaps.
However, there may be other contractual terms that also may be
important for the counterparties in determining the pricing and
transaction risks, but that are not necessarily ``material'' for
purposes of position limits. For example, as discussed below, certain
other terms, such as clearing arrangements or governing law, may not be
material for the purpose of determining economic equivalence for
Federal position limits, but may nonetheless affect pricing and risk or
otherwise be important to the counterparties.
Accordingly, the Commission generally considers those swap
contractual terms, provisions, or terminology (e.g., ISDA terms and
definitions) that are unique to swaps (whether standardized or bespoke)
not to be material for purposes of determining whether a swap is
economically equivalent to a particular referenced contract, even
though such terms may be important when negotiating the swap or
contribute to the valuation and/or the counterparties' risk analysis.
For example, the following swap provisions or terms are generally
unique to swaps and/or otherwise not material, and therefore are not to
be dispositive for determining whether a swap is economically
equivalent: Designating business day or holiday conventions; day count
(e.g., 360 or actual); calculation agent; dispute resolution
mechanisms; choice of law; or representations and warranties.\406\
---------------------------------------------------------------------------
\406\ Commodity swaps, which generally are traded OTC, are less
standardized compared to exchange-traded futures and therefore must
include these provisions in an ISDA master agreement between
counterparties. While certain provisions, for example choice of law,
dispute resolution mechanisms, or the general representations made
in an ISDA master agreement, may be important considerations for the
counterparties, the Commission would not deem such provisions
material for purposes of determining economic equivalence under the
Federal position limits framework for the same reason the Commission
would not deem a core referenced futures contract and a look-alike
referenced contract to be economically different, even though the
look-alike contract may be traded on a different exchange with
different contractual representations, governing law, holidays,
dispute resolution processes, or other provisions unique to the
exchanges. Similarly, with respect to day counts, a swap could
designate a day count that is different than the day count used in a
referenced contract but adjust relevant swap economic terms (e.g.,
relevant rates or payments, fees, basis, etc.) to achieve the same
economic exposure as the referenced contract. In such a case, the
Commission would not find such differences to be material for
purposes of determining the swap to be economically equivalent for
Federal position limits purposes.
---------------------------------------------------------------------------
Because the Commission considers settlement type to be a material
``contractual specification, term, or condition,'' a cash-settled swap
could only be deemed to be economically equivalent to a cash-settled
referenced contract, and a physically-settled swap could only be deemed
to be economically equivalent to a physically-settled referenced
contract. However, a cash-settled swap that initially did not qualify
as ``economically equivalent'' due to no corresponding cash-settled
referenced contract (i.e., no cash-settled look-alike futures contract)
could subsequently become an ``economically equivalent swap'' if a
cash-settled futures contract market were to develop.
Commenters had various views on the treatment of cash-settled and
physically-settled swaps. First, certain commenters requested the
Commission exclude physically-settled swaps from Federal position
limits \407\ or at least clarify the class of instruments that would be
deemed to be physically-settled swaps.\408\ Second, other commenters
requested the opposite--that the Commission instead exclude cash-
settled swaps from Federal position limits.\409\ Third, Better Markets
argued that differentiating between cash-settled and physically-settled
swaps by including settlement type as a material term would
``incentivize[ ] speculative liquidity formation away from more liquid,
more transparent, and more restrictive futures exchanges and to the
swaps markets.'' \410\
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\407\ COPE at 4-5.
\408\ ICEA at 3-5; NRECA at 19-20, 27.
\409\ SIFMA AMG at 7; PIMCO at 3; and ISDA at 5.
\410\ Better Markets at 32.
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i. Treatment of Physically-Settled Swaps Under the Final Rule
Several commenters requested that the Commission exclude
physically-settled swaps from Federal position limits,\411\ or at least
clarify the scope of physically-settled swaps that would be subject to
Federal position limits.\412\ However, the Commission has determined
that doing so is inconsistent with the statutory goals in CEA section
[[Page 3292]]
4a(a)(3)(B), especially the mandates to deter corners and squeezes and
to ensure sufficient market liquidity for bona fide hedgers enumerated
in CEA section 4a(a)(3)(B)(ii) and (iii), respectively. For example,
excluding physically-settled swaps could potentially incentivize
liquidity to move from physically-settled core referenced futures
contracts to physically-settled swaps, which could both harm market
liquidity for bona fide hedgers and also enable potential manipulators
to accumulate large directional positions in physically-settled
contracts to effect a corner and squeeze more easily.
---------------------------------------------------------------------------
\411\ COPE at 4-5.
\412\ IECA at 3-5; NRECA at 1, 28.
---------------------------------------------------------------------------
The Commission also received several comments requesting
clarification regarding the Commission's use of the term ``physically-
settled'' swaps in the 2020 NPRM's discussion of the definition.
First, COPE opined that since the 2020 NPRM excluded trade options
from the ``referenced contract'' definition, as a result, only cash-
settled swaps would be deemed to be ``economically equivalent swaps''
for purposes of Federal position limits. The Commission confirms that
under the Final Rule, any swap that qualifies as a trade option under
Sec. 32.3 is ipso facto not subject to Federal position limits.\413\
However, the Commission does not believe this means that only cash-
settled swaps could be deemed ``economically equivalent swaps.'' For
example, it is possible that a physically-settled swap may not qualify
as a trade option, and if it were to otherwise satisfy the
``economically equivalent swap'' definition, it therefore would be
subject to Federal position limits.
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\413\ As discussed under Section II.A.16., the ``referenced
contract'' definition explicitly excludes any ``trade options that
meets the requirements of Sec. 32.3'' of the Commission's
regulations. Accordingly, a ``trade option'' is not subject to
Federal position limits under the Final Rule, even if the trade
option otherwise would satisfy the ``economically equivalent swap''
definition.
---------------------------------------------------------------------------
Second, IECA and NRECA requested the Commission clarify what it
means when using language referring to a ``physically-settled swap,''
and suggested the Commission instead refer to a ``swap that allows for
physical settlement or delivery.'' \414\ IECA stated that ``using this
term in place of the term `physically-settled swaps' in the
Commission's proposed rulemaking will help to avoid confusion and
misinterpretation in the future.'' \415\ While the Commission is
adopting the ``economically equivalent swap'' definition as proposed
(which includes the reference to ``delivery date''), the Commission
agrees with IECA's statement and confirms that when the Commission
refers to ``physically-settled swaps'' for the purpose of this
definition, the Commission means a ``swap that allows for physical
settlement or delivery.'' The Commission agrees with IECA that
referring to ``swaps that allow for physical settlement or delivery''
does not alter the Commission's intended meaning and may avoid
confusion and misinterpretation.\416\ However, the Commission will
continue to refer to ``physically-settled swaps'' in this preamble
discussion because the Commission believes that changing the term for
discussion purposes herein, compared to the 2020 NPRM's preamble
discussion, could raise additional confusion. Further, the Commission
distinguishes between ``cash-settled'' and ``physically-settled''
referenced contracts throughout this preamble discussion, and using
different terms to refer to swaps also could increase confusion.
---------------------------------------------------------------------------
\414\ IECA at 3-5; NRECA at 1, 28.
\415\ IECA at 5.
\416\ IECA at 4-5.
---------------------------------------------------------------------------
IECA was concerned that the term ``physically-settled swap'' could
suggest that the Commission was seeking to regulate a commodity for
deferred delivery as a swap, which is otherwise excluded from the
``swap'' definition under CEA section 1a(47)(B)(ii). The Commission
confirms that neither the use of ``delivery dates'' in the definition
adopted herein nor the Commission's use of the term ``physically-
settled swaps'' for the purposes of this preamble discussion is
intended to capture instruments that are excluded from the Commission's
jurisdiction either by statute (e.g., the CEA's statutory exclusion of
the sale of a non-financial commodity for deferred shipment or delivery
that is intended to be physically-settled) \417\ or otherwise not
deemed to be swaps pursuant to the Commission's rules and regulations,
interpretations, exemption orders, or other guidance.\418\
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\417\ See CEA section 1a(47)(B)(ii).
\418\ See NRECA at 18-19. For clarity, and as requested by
NRECA, the Commission notes that these ``rules and regulations''
include the Commission's trade option rule in Sec. 32.3 as well as
the Commission's forward contract exclusion (i.e., the Brent forward
exclusion) in 55 FR 39188-92 and 77 FR 48,208, 48,246 (August 13,
2012).
---------------------------------------------------------------------------
NRECA additionally requested the Commission clarify that the
``economically equivalent swap'' definition does not include any
``customary commercial agreement, contract or transaction entered into
as part of operations (so long as it is entered into off-facility and
not involving a financial intermediary).'' \419\ As noted, to the
extent such customary commercial agreement, contract, or transaction is
exempt or excluded from either treatment as, or from the definition of,
a ``swap'' by either statute or by the Commission's rules and
regulations, interpretations, exemption orders, or other guidance, the
Commission does not deem it to be an economically equivalent swap or
otherwise subject to Federal position limits under the Final Rule.\420\
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\419\ NRECA at 16-20.
\420\ For example, the Commission's swap definition excludes
certain capacity contracts and peaking supply contracts that qualify
as forward contracts with ``embedded volumetric optionality.'' See
Further Definition of ``Swap,'' ``Security-Based Swap,'' and
``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap
Agreement Recordkeeping, 77 FR 48,246. Since such instruments are
excluded from the Commission's regulatory ``swap'' definition, they
ipso facto will not be deemed to be ``economically equivalent
swaps'' for purposes of Federal position limits.
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ii. Treatment of Cash-Settled Swaps Under the Final Rule
The Commission also received several comments discussing the
treatment of cash-settled swaps under the proposed ``economically
equivalent swap'' definition. Several financial industry commenters
argued that the Final Rule should include only physically-settled swaps
and should exclude cash-settled swaps, contending that cash-settled
swaps do not affect price discovery or contribute to manipulation.\421\
---------------------------------------------------------------------------
\421\ SIFMA AMG at 7; PIMCO at 3; and ISDA at 5 (PIMCO and ISDA
each believe neither cash-settled swaps nor cash-settled futures
should be subject to position limits).
---------------------------------------------------------------------------
The Commission disagrees with the commenters' request to exclude
cash-settled swaps from the final definition, as doing so could
incentivize liquidity to move from cash-settled referenced contracts to
cash-settled OTC swaps, potentially harming the liquidity in the
futures markets, including liquidity for bona fide hedgers. At the very
least, the Commission does not want to preference OTC cash-settled
swaps at the expense of corresponding exchange-traded cash-settled
futures or options on futures contracts.
In contrast, Better Markets objected to the proposed definition
because, according to Better Markets, under the 2020 NPRM cash-settled
swaps would not be able to qualify as economically equivalent to a
physically-settled core referenced futures contract.\422\ As Better
Markets commented, distinguishing between cash-settled and physically-
settled swaps and futures contracts by
[[Page 3293]]
deeming settlement type (i.e., cash-settled vs. physically-settled
settlement) to be a material term would ``incentivize[ ] speculative
liquidity formation away from more liquid, more transparent, and more
restrictive futures exchanges and to the swaps markets.'' \423\
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\422\ Better Markets at 32 (stating that cash-settled swaps
would be ``essentially excluded from Federal position limits).
\423\ Id.
---------------------------------------------------------------------------
The Commission believes Better Markets' concern is mitigated since
under the Final Rule, cash-settled swaps are subject to Federal
position limits only if there is a corresponding (i.e., ``economically
equivalent'') cash-settled futures contract or option on a futures
contract.\424\ That is, cash-settled swaps are not subject to Federal
position limits if there are no corresponding cash-settled futures
contracts or options on a futures contract. In these situations, if no
corresponding futures contract or option thereon exists, then there is
no liquidity formation in cash-settled futures and options on futures
contracts with which a cash-settled swap would be competing for
liquidity in the first place.
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\424\ The Commission notes that a swap could be deemed to be
``economically equivalent'' to any referenced contract, including
cash-settled look-alikes, and that the ``economically equivalent
swap'' definition is not limited to core referenced futures
contracts.
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FIA argued that cash-settled swaps should be subject to a separate
spot-month limit.\425\ However, as discussed in II.A.16.ii.a., the
Commission has determined that FIA's request to establish separate
Federal position limits for cash-settled swaps is not, as a default
rule, consistent with the statutory goals in CEA section 4a(a)(3)(B).
In particular, separate position limits for cash-settled swaps would
make it easier for potential manipulators to engage in market
manipulation, such as ``banging'' or ``marking'' the close, by
effectively permitting higher Federal position limits in cash-settled
referenced contracts. For example, a market participant would be able
to double its cash-settled positions by maintaining positions in both
cash-settled futures and cash-settled economically equivalent swaps
since positions in each class would not be required to be aggregated
for purposes of Federal position limits.
---------------------------------------------------------------------------
\425\ FIA at 7-8.
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Furthermore, the Commission is concerned that class limits could
impair liquidity in futures contracts or swaps, as the case may be. For
example, a market participant (including a market maker or speculator)
with a large portfolio of swaps (or futures contracts) near a
particular class limit would be assumed to have a strong preference for
executing futures contracts (or swaps) transactions in order to
maintain a swaps (or futures contracts) position below the class limit.
If there were many similarly situated market participants, the market
for such swaps (or futures contracts) could become less liquid. The
absence of class limits should decrease the possibility of illiquid
markets for referenced contracts subject to Federal position limits.
Because economically equivalent swaps and the corresponding futures
contracts and option on futures contracts are close substitutes for
each other, the absence of class limits should allow greater
integration between the economically equivalent swaps and corresponding
futures and options markets for referenced contracts and should also
provide market participants with more flexibility whether hedging,
providing liquidity or market making, or speculating.
e. Exclusions From the Definition of ``Economically Equivalent Swap''
As noted above, the Final Rule's definition provides that
differences in lot size or notional amount, delivery dates diverging by
less than one calendar day (or less than two calendar days for natural
gas), or post-trade risk management arrangements do not disqualify a
swap from being deemed ``economically equivalent'' to a particular
referenced contract.
i. Delivery Dates Diverging by Less Than One Calendar Day
The definition as it applies to commodities (other than natural
gas) encompasses swaps with delivery dates that diverge by less than
one calendar day from that of a referenced contract.\426\ As a result,
a swap with a delivery date that differs from that of a referenced
contract by one calendar day or more is not deemed economically
equivalent under the Final Rule, and such swaps are not required to be
added to, nor permitted to be netted against, any referenced contract
when calculating compliance with Federal position limits.\427\ For
example, these include contracts commonly referred to as
``penultimate'' contracts, which settle on the trading day immediately
preceding the final trading day of the corresponding core referenced
futures contract.
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\426\ This aspect of the proposed definition would be irrelevant
for cash-settled swaps since ``delivery date'' applies only to
physically-settled swaps.
\427\ A swap as so described that is not ``economically
equivalent'' would not be subject to a Federal speculative position
limit under the Final Rule.
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In response to the definition's proposed exclusion of physically-
settled penultimate swaps, Better Markets argued, among other things,
that excluding penultimate swaps ``creates technical delineations that
are largely divorced from the economic realities relating to physical
commodities underlying both contracts.'' \428\ In response, the
Commission recognizes that while a penultimate contract may be
significantly correlated to its corresponding spot-month contract, a
penultimate contract does not necessarily offer identical economic or
risk exposure to the spot-month contract, and depending on the
underlying commodity and market conditions, a market participant may
open itself up to material basis risk by moving from the spot-month
contract to a penultimate contract.\429\
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\428\ Better Markets at 32.
\429\ As discussed under Sections II.A.16.iii.a(2)(iii) and
II.B.3.vi.c, the Final Rule includes penultimate look-alike futures
contracts and options on futures contracts as ``referenced
contracts.'' Since futures contracts and options on futures
contracts are standardized and exchange-traded, the Commission is
less concerned about the potential for manipulation or evasion
through inappropriate netting in this context.
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Accordingly, the Commission has determined that it is not
appropriate ex ante to permit market participants to net such
penultimate swap positions (other than natural gas) against their core
referenced futures contract positions since such positions do not
necessarily reflect equivalent economic or risk exposure. However, the
Commission underscores that under the Final Rule, a penultimate swap
still could be deemed economically equivalent to the extent that
another penultimate referenced contract exists (assuming the swap and
other referenced contract share identical material terms and the swap
otherwise satisfies the economically equivalent swap definition). For
example, if a core referenced futures contract has a corresponding
penultimate futures contract that qualifies as a referenced contract,
then a penultimate swap could be deemed economically equivalent to the
penultimate futures contract. In such cases, the penultimate swap would
be an economically equivalent swap subject to Federal position limits.
The Commission acknowledges that liquidity could shift from the
core referenced futures contract to penultimate swaps in cases where
there are no corresponding penultimate futures contracts or options
contracts (and therefore the swap would not be deemed to be an
economically equivalent swap), but the Commission
[[Page 3294]]
believes that this concern is mitigated for two reasons. First, basis
risk may exist between the penultimate swap and the referenced
contract, and so the Commission believes that a market participant is
less likely to hold a penultimate swap the greater the economic
difference compared to the corresponding referenced contract. Second,
the absence of penultimate futures contracts or options contracts may
indicate lack of appropriate penultimate liquidity to hedge or offset
one's penultimate swap position and therefore may militate against
entering into penultimate swaps. However, as discussed below, these
reasons do not necessarily apply to penultimate swaps for natural gas.
ii. Post-Trade Risk Management
The Commission is specifically excluding differences in post-trade
risk management arrangements, such as clearing or margin, in
determining whether a swap is economically equivalent. As noted above,
many commodity swaps are traded OTC and may be uncleared or cleared at
a different clearing house than the corresponding referenced
contract.\430\ Moreover, since the core referenced futures contracts,
along with futures and options on futures contracts in general, are
traded on DCMs with vertically integrated clearing houses, as a
practical matter, it is unlikely that OTC commodity swaps, which
historically have been uncleared, would share identical post-trade
clearing house or other post-trade risk management arrangements with
their associated core referenced futures contracts. However, to the
extent an OTC commodity swap does share the same clearing arrangements
as a corresponding referenced contract, the Commission does not want to
incentivize the switching of cleared swap contracts to non-cleared
status for the sake of avoiding Federal position limits.
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\430\ Similar to the Commission's understanding of ``material''
terms, the Commission construes ``post-trade risk management
arrangements'' to include various provisions included in standard
swap agreements, including, for example: Margin or collateral
requirements, including with respect to initial or variation margin;
whether a swap is cleared, uncleared, or cleared at a different
clearing house than the applicable referenced contract; close-out,
netting, and related provisions; and different default or
termination events and conditions.
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Therefore, if differences in post-trade risk management
arrangements were sufficient to exclude a swap from economic
equivalence to a core referenced futures contract, then such an
exclusion could otherwise render ineffective the Commission's statutory
directive under CEA section 4a(a)(5) to include economically equivalent
swaps within the Federal position limits framework. Accordingly, the
Commission has determined that differences in post-trade risk
management arrangements should not prevent a swap from qualifying as
economically equivalent with an otherwise materially identical
referenced contract.\431\
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\431\ In addition, CEWG asked for clarification that the
Commission would not extend certain preamble language in the 2020
NPRM addressing the exclusion of post-trade risk management
arrangements from consideration when determining whether a swap is
economically equivalent to support a finding that such swaps are
actually off-exchange futures contracts rather than swaps. CEWG at
31. The Commission confirms that excluding post-trade risk
management arrangements from the determination that a swap is
economically equivalent does not extend to supporting a finding that
such swaps are actually off-exchange futures contracts rather than
swaps.
---------------------------------------------------------------------------
iii. Lot Size or Notional Amount
The last exclusion clarifies that differences in lot size or
notional amount do not prevent a swap from being deemed economically
equivalent to its corresponding referenced contract. The Commission's
use of ``lot size'' and ``notional amount'' refer to the same general
concept. Futures terminology usually employs ``lot size,'' and swap
terminology usually employs ``notional amount.'' Accordingly, the
Commission is using both terms to convey the same general meaning, and
in this context does not mean to suggest a substantive difference
between the two terms.
f. Economically Equivalent Natural Gas Swaps
Market dynamics in natural gas are unique in several respects
including, among other things, that ICE and NYMEX both list high volume
contracts, whereas liquidity in other commodities tends to pool at a
single DCM. As expiration approaches for natural gas contracts, volume
tends to shift from the NYMEX NG core referenced futures contract that
is physically-settled, to an ICE look-alike contract that is cash
settled. This trend reflects certain market participants' desire for
exposure to natural gas prices without having to make or take
delivery.\432\ NYMEX and ICE also list several ``penultimate'' cash-
settled referenced contracts that use the price of the physically-
settled NYMEX contract as a reference price for cash settlement on the
day before trading in the physically-settled NYMEX contract
terminates.\433\
---------------------------------------------------------------------------
\432\ In part to address historical concerns over the potential
for manipulation of physically-settled natural gas contracts during
the spot month in order to benefit positions in cash-settled natural
gas contracts, the Commission discusses later in this release that
the Final Rule will allow for a higher ``conditional'' spot month
limit in cash-settled natural gas referenced contracts under the
condition that market participants seeking to utilize such
conditional limit exit any positions in physically-settled natural
gas referenced contracts. See infra Section II.C.2.e. (proposed
conditional spot month limit exemption for natural gas).
\433\ Such penultimate contracts include: ICE's Henry Financial
Penultimate Fixed Price Futures (PHH) and options on Henry
Penultimate Fixed Price (PHE), and NYMEX's Henry Hub Natural Gas
Penultimate Financial Futures (NPG).
---------------------------------------------------------------------------
In order to recognize the existing natural gas markets, which
include active and vibrant markets in penultimate natural gas
contracts, the Final Rule includes a slightly broader economically
equivalent swap definition for natural gas so that physically-settled
swaps with delivery dates that diverge by less than two calendar days
from an associated referenced contract could still be deemed
economically equivalent and would be subject to Federal position
limits. The Commission intends for this provision to prevent and
disincentivize manipulation and regulatory arbitrage and to prevent
volume from shifting away from the NYMEX NG core referenced futures
contract to penultimate natural gas contract futures and/or penultimate
swap markets in order to avoid Federal position limits.
As noted above, the Commission is adopting a relatively narrow
``economically equivalent swap'' definition in order to prevent market
participants from inappropriately netting positions in referenced
contracts against swap positions further out on the curve. The
Commission acknowledges that liquidity could shift to penultimate swaps
as a result but believes that, with the exception of natural gas, this
concern is mitigated since there may be basis risk between the
penultimate swap and the referenced contract and lack of liquidity to
specifically hedge or offset one's penultimate swap position. However,
compared to other contracts, the Commission believes that natural gas
has a relatively liquid penultimate futures market that enables a
market participant to hedge or set-off its penultimate swap position.
The Commission believes that without the exception to the economically
equivalent swap definition for natural gas swaps, liquidity otherwise
could be incentivized to shift from the NYMEX NG core referenced
futures contract to penultimate natural gas swaps in order to avoid
Federal position limits.
CME Group stated in its comment letter that that these concerns
also may apply to other energy core referenced
[[Page 3295]]
futures contracts.\434\ As a result, the Commission intends to observe
the behavior in these other markets in response to the Final Rule, but
the Commission understands that the natural gas markets are likely the
most sensitive to these concerns based on the size of the corresponding
natural gas penultimate market. As a result, the Commission is adopting
the proposed exception for natural gas, but emphasizes that it will
continue to observe the other energy markets in order to determine the
proper course of action with respect to those markets.
---------------------------------------------------------------------------
\434\ CME Group at 4.
---------------------------------------------------------------------------
g. Determination of Economic Equivalence
The Commission is unable to publish a list of swaps it deems to be
economically equivalent swaps because any such determination would
involve a facts and circumstances analysis, and because most physical
commodity swaps are created bilaterally between counterparties and
traded OTC. Absent a requirement that market participants identify
their economically equivalent swaps to the Commission on a regular
basis, the Commission believes that market participants are best
positioned to determine whether particular swaps share identical
material terms with referenced contracts and would therefore qualify as
``economically equivalent'' for purposes of Federal position limits.
However, the Commission understands that for certain bespoke swaps it
may be unclear whether the facts and circumstances demonstrate whether
the swap qualifies as ``economically equivalent'' with respect to a
referenced contract.
MFA/AIMA requested that the Commission facilitate compliance by
providing clearer guidance on terms that would be deemed material for
determining which swaps are ``economically equivalent.'' \435\
Similarly, NCFC requested that the Commission adopt a ``safe harbor''
under which ``demonstrable good faith compliance with respect to
inadvertent violations would not serve as the basis for an enforcement
action.'' \436\ In response, the Commission emphasizes that under the
Final Rule, a market participant will have the discretion to make such
determination as long as the market participant makes a reasonable,
good faith effort in reaching such determination. The Commission will
not pursue any enforcement action for violating Federal position limits
against such market participant with respect to such swaps positions as
long as the market participant (i) performed the necessary due
diligence and is able to provide sufficient evidence, if requested, to
support its reasonable, good faith determination that the swap is or is
not an economically equivalent swap and (ii) comes into compliance with
the applicable Federal position limits within a commercially reasonable
time, as determined by the Commission in consultation with the market
participant, and if applicable, any relevant exchange.\437\ The
Commission anticipates that this should provide a greater level of
certainty to provide market participants with the comfort they need to
enter into swap positions, in contrast to the alternative in which
market participants would be required to first submit swaps to the
Commission staff and wait for feedback before entering into swaps.\438\
---------------------------------------------------------------------------
\435\ MFA/AIMA at 9.
\436\ NCFC at 6.
\437\ As noted below, the Commission reserves the authority
under the Final Rule to determine that a particular swap or class of
swaps either is or is not ``economically equivalent'' regardless of
a market participant's determination. See infra Section
II.A.4.iii.g. (discussion of commission determination of economic
equivalence). As long as the market participant made its
determination, prior to such Commission determination, using
reasonable, good faith efforts, the Commission would not take any
enforcement action for violating the Commission's position limits
regulations if the Commission's determination subsequently differs
from the determination of the market participant and the market
participant comes into compliance with the applicable Federal
position limits within a commercially reasonable time, as determined
by the Commission in consultation with the market participant, and
if applicable, any relevant exchange.
\438\ As discussed under Section II.A.16. (definition of
``referenced contract''), the Commission is including a list of
futures contracts and options on futures contracts that qualify as
referenced contracts because such contracts are standardized and
published by exchanges. In contrast, since swaps are largely
bilaterally negotiated and OTC traded, a swap could have multiple
permutations and any published list of economically equivalent swaps
would be unhelpful or incomplete.
---------------------------------------------------------------------------
While the Commission will primarily rely on market participants to
initially determine whether their swaps meet the proposed
``economically equivalent swap'' definition, the Commission is adopting
paragraph (3) to the ``economically equivalent swap'' definition to
clarify that the Commission may determine on its own initiative that
any swap or class of swaps satisfies, or does not satisfy, the
economically equivalent definition with respect to any referenced
contract or class of referenced contracts. The Commission believes that
this provision will provide the ability to offer clarity to the
marketplace in cases where uncertainty exists as to whether certain
swaps would qualify (or would not qualify) as ``economically
equivalent,'' and therefore would be (or would not be) subject to
Federal position limits. Similarly, where market participants hold
divergent views as to whether certain swaps qualify as ``economically
equivalent,'' the Commission can ensure that all market participants
treat OTC swaps with identical material terms similarly, and serve as a
backstop in case market participants fail to properly treat
economically equivalent swaps as such. As noted above, the Commission
will not take any enforcement action with respect to violating the
Commission's position limits regulations if the Commission disagrees
with a market participant's determination as long as the market
participant is able to provide sufficient support to show that it made
a reasonable, good faith effort in applying its discretion.\439\
---------------------------------------------------------------------------
\439\ See supra Section II.A.4. (discussing market participants'
discretion in determining whether a swap is economically
equivalent).
---------------------------------------------------------------------------
Better Markets encouraged the release of additional guidance,
suggesting that the Commission should delegate its authority to the DMO
Director to issue guidance with respect to specific types of terms and
conditions, and noting that the proposed process for the Commission to
provide clarification is cumbersome.\440\ The Commission does not
believe such delegation is necessary since Commission staff will
continue to have the ability to offer informal guidance as well as
formal no-action relief or interpretive guidance as needed.
---------------------------------------------------------------------------
\440\ Better Markets at 34.
---------------------------------------------------------------------------
Better Markets also suggested that in order to ensure market
participants conduct proper diligence, the Commission should clarify
and codify that a swap dealer must include an appendix in its
reasonably-designed policies and procedures under existing Sec. 23.601
that identifies swaps ``in any manner'' referencing commodities subject
to Federal position limits, regardless of whether the entity deems the
swap to be ``economically equivalent.'' \441\ In contrast, ISDA
believed the obligations in Sec. 23.601 impose costs that are overly
burdensome and are not commensurate with benefits.\442\ ISDA stated
that further guidance is necessary, but noted that even if further
guidance is provided, the regime would still impose unnecessary burdens
on swap dealers.\443\ ISDA requested the Commission consider including
further
[[Page 3296]]
clarification and/or interim relief for swap dealers.\444\
---------------------------------------------------------------------------
\441\ Better Markets at 34.
\442\ ISDA at 10.
\443\ Id.
\444\ Id.
---------------------------------------------------------------------------
At this time, the Commission does not believe it is necessary to
provide further detail with respect to Sec. 23.601 because, as
discussed above, the Commission will defer to a market participant's
determination as long as the market participant is able to provide
sufficient support to show that it made a reasonable, good faith effort
in applying its discretion.\445\
---------------------------------------------------------------------------
\445\ See supra Section II.A.4. (discussing market participants'
discretion in determining whether a swap is economically
equivalent).
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h. Phased Implementation of Federal and Exchange-Set Limits on Swaps
As discussed under Section I.D., the Final Rule generally gives
market participants until January 1, 2022 to comply with Federal
position limits for the 16 non-legacy referenced contracts that are
subject to Federal position limits for the first time under the Final
Rule, and the Final Rule provides an extra year to comply with respect
to economically equivalent swaps (January 1, 2023). After such
compliance period, economically equivalent swaps will be subject to
Federal position limits. In general, commenters supported a phase-in
for such swaps.\446\
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\446\ MFA/AIMA at 8 (requesting an additional 6-12 months phase-
in); SIFMA AMG at 9 (requesting an additional 6-12 months); Citadel
at 9 (requesting an additional 6 months); and NGSA at 15-16
(requesting a general phase-in in order ``to avoid the risk of harm
to market recovery and to facilitate efficiency in market
participant implementation'').
---------------------------------------------------------------------------
As discussed further under Section II.D.4.i, final Sec. 150.5
requires exchanges to establish and enforce exchange-set limits for any
referenced contract, which includes economically equivalent swaps. The
Commission has determined to permit exchanges to delay enforcing their
respective exchange-set position limits on economically equivalent
swaps at this time. Specifically, with respect to exchange-set position
limits on swaps, the Commission notes that in two years (which
generally coincides with the compliance date for economically
equivalent swaps), the Commission will reevaluate the ability of
exchanges to establish and implement appropriate surveillance
mechanisms to implement DCM Core Principle 5 and SEF Core Principle 6
with respect to economically equivalent swaps. However, after the swap
compliance date (January 1, 2023), the Commission underscores that it
will enforce Federal position limits in connection with OTC swaps.
In response to the Commission's proposal to allow exchanges to
delay enforcing exchange-set position limits on swaps, IATP opined that
the Commission's decision to ``[d]elay compliance with position limit
requirement [sic] to avoid imposing costs on market participants makes
it appear that the Commission is serving as a swap dealer booster,
although swaps dealers are amply resourced to provide the necessary
data to the exchanges and to the Commission. The Commission is bending
over backward to avoid requiring swaps market participants from paying
the costs of exchange trading.'' \447\ However, the Commission stated
in the same section of the 2020 NPRM that it would enforce Federal
position limits on swaps even though it would not require exchanges to
enforce position limits on swaps until the Commission determines that
exchanges have had the opportunity to access swaps data and establish
appropriate swaps oversight infrastructure.\448\ Additionally, the
Commission notes that physical commodity swaps are not subject to the
Commission's trade execution mandate to trade on exchanges, and the
Commission understands that most physical commodity swaps are traded
OTC rather than on exchanges. Accordingly, the Commission's rationale
for delaying the requirement that exchanges enforce position limits for
swaps is based on exchanges' existing capabilities and lack of insight
into the OTC swaps markets, rather than for swap dealers who will
remain subject to Federal position limits and Commission
oversight.\449\
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\447\ IATP at 20.
\448\ The 2020 NPRM stated, ``Nonetheless, the Commission's
preliminary determination to permit exchanges to delay implementing
Federal position limits on swaps could incentivize market
participants to leave the futures markets and instead transact in
economically-equivalent swaps, which could reduce liquidity in the
futures and related options markets, although the Commission
recognizes that this concern should be mitigated by the reality that
the Commission would still oversee and enforce Federal position
limits on economically equivalent swaps.'' (emphasis added). 85 FR
at 11680.
\449\ The Commission also notes that IATP quotes from the cost-
benefits considerations section of the 2020 NPRM, and thus the
Commission's focus on benefits and costs to exchanges and market
participants in the excerpt quoted by IATP.
---------------------------------------------------------------------------
i. Cross-Border Application
Several commenters opined that the Commission should address the
cross-border application of the Final Rule, including in connection
with OTC swaps.\450\
---------------------------------------------------------------------------
\450\ FIA at 27-28; ISDA at 11; CHS at 6 (``CHS believes that
global organizations should be in a position to better understand
the Commission's approach with respect to the cross-border
application of the rules to referenced contract positions. In CHS's
view, the proposal does not address whether and how global companies
must aggregate referenced contract positions of affiliates around
the world. As part of the retooling of the position limit regime,
CHS urges the Commission to address such an application'').
---------------------------------------------------------------------------
In response, the Commission makes three observations. First, as
discussed above regarding the treatment of physically-settled swaps, if
a swap is otherwise excluded from the Commission's jurisdiction either
by statute or pursuant to the Commission's rules and regulations,
interpretations, exemption orders, or other guidance, then the swap is
not subject to Federal position limits. Accordingly, while related,
this determination is distinct from the Final Rule's position limits
framework. Second, the Final Rule provides a compliance period for
economically equivalent swaps until January 1, 2023. Accordingly, the
Commission and its staff expect to continue to discuss the status of
OTC swaps with market participants during this compliance period and
provide additional feedback as necessary based on the individual facts
and circumstances. Third, to a certain extent, some of the comments are
more related to the position limit aggregation rules in existing Sec.
150.4, which was finalized in 2016.\451\ Moreover, the 2020 NPRM did
not discuss cross-border application, which is therefore beyond the
scope of this rulemaking.
---------------------------------------------------------------------------
\451\ For further discussion related to the position limits
aggregation rules, see Section II.B.11.
---------------------------------------------------------------------------
5. ``Eligible Affiliate''
i. Summary of the 2020 NPRM--Eligible Affiliate
The Commission proposed to create the new defined term ``eligible
affiliate'' to be used in proposed Sec. 150.2(k). As discussed further
in connection with Sec. 150.2, an entity that qualifies as an
``eligible affiliate'' would be permitted to voluntarily aggregate its
positions, even though it is eligible for an exemption from aggregation
under Sec. 150.4(b).\452\
---------------------------------------------------------------------------
\452\ See Section II.B.11.
---------------------------------------------------------------------------
ii. Comments and Summary of the Commission Determination--Eligible
Affiliate
The Commission received no comments on this definition and is
adopting it as proposed with certain technical changes. The Commission
is making these technical changes to clarify the antecedent to the use
of ``its'' and ``such entity'' in the definition. The Commission
expects these changes will clarify the definition, but do not represent
a substantive change in the meaning.
[[Page 3297]]
6. ``Eligible Entity''
i. Summary of the 2020 NPRM--Eligible Entity
The Commission adopted a revised ``eligible entity'' definition in
the 2016 Final Aggregation Rulemaking.\453\ The Commission proposed no
further amendments to this definition, but is including the revised
definition in this Final Rule given that the definitions for part 150
are set forth or restated in Sec. 150.1, thus ensuring that all
defined terms are included. As noted above, the Commission also
proposed a non-substantive change to remove the lettering from this and
other definitions that appear lettered in existing Sec. 150.1, and to
list the definitions in alphabetical order.
---------------------------------------------------------------------------
\453\ See 17 CFR 150.1(d).
---------------------------------------------------------------------------
7. ``Entity''
i. Summary of the 2020 NPRM--Entity
The Commission proposed defining ``entity'' to mean ``a `person' as
defined in section 1a of the Act.'' \454\ The term ``entity,'' not
defined in existing Sec. 150.1, is used throughout proposed part 150
of the Commission's regulations.
---------------------------------------------------------------------------
\454\ 7 U.S.C. 1a(38).
---------------------------------------------------------------------------
ii. Comments--Entity
The Commission received two comments that recommended clarification
of the proposed definition of ``entity.'' \455\ FIA and MGEX contended
the proposed definition of ``entity'' should not cross-reference the
definition of ``person'' in section 1a of the CEA because the CEA
defines ``person'' to include individuals (i.e., natural persons), as
well as entities.\456\ MGEX argued that the definition of ``entity''
should not apply to individuals.\457\ FIA stated that, for purposes of
the 2020 NPRM, it is unclear whether the cross-reference to the
definition of ``person'' in section 1a of the CEA is meant to be
limited to non-natural persons.\458\ If so, FIA recommended that the
Commission amend the definition of ``entity'' to refer only to the non-
natural persons listed in the definition of ``person'' under section 1a
of the CEA.\459\ Further, FIA suggested that provisions in part 150
that are applicable to both natural and non-natural persons should
refer to ``persons'' and those that apply to only non-natural persons
should refer to ``entity.'' \460\
---------------------------------------------------------------------------
\455\ FIA at 26; MGEX at 2.
\456\ Id.
\457\ MGEX at 2.
\458\ FIA at 26.
\459\ Id.
\460\ Id.
---------------------------------------------------------------------------
iii. Discussion of Final Rule--Entity
The Commission declines to adopt the commenters' suggestion to
carve ``individuals'' out of the proposed definition of ``entity'' or
to otherwise differentiate between ``person(s)'' and ``entity(ies)''
for purposes of part 150 of the Final Rule. The proposed definition of
``entity'' expressly included ``individuals'' and neither commenter
explained why individuals should be excluded from the definition and
why the CEA's statutory definition of ``person'' is inappropriate.
Accordingly, the Commission is adopting the definition of ``entity'' as
proposed.
8. ``Excluded Commodity''
i. Summary of the 2020 NPRM--Excluded Commodity
The phrase ``excluded commodity'' is defined in CEA section 1a(19),
but is not defined or used in existing part 150 of the Commission's
regulations. The Commission proposed including a definition of
``excluded commodity'' in part 150 that references that term as defined
in CEA section 1a(19).\461\
---------------------------------------------------------------------------
\461\ 7 U.S.C. 1a(19).
---------------------------------------------------------------------------
ii. Comments and Summary of the Commission Determination--Excluded
Commodity
No commenter addressed the proposed definition of ``excluded
commodity.'' The Commission is adopting the definition as proposed.
9. ``Futures-Equivalent''
i. Background--Futures-Equivalent
The phrase ``futures-equivalent'' is currently defined in existing
Sec. 150.1(f) and is used throughout existing part 150 of the
Commission's regulations to describe the method for converting a
position in an option on a futures contract to an economically
equivalent amount in a futures contract. The Dodd-Frank Act amendments
to CEA section 4a, in part, direct the Commission to apply aggregate
Federal position limits to physical commodity futures contracts and to
swap contracts that are economically equivalent to such physical
commodity futures contracts.
ii. Summary of the 2020 NPRM--Futures-Equivalent
In order to aggregate positions in futures, options \462\ on
futures, and swaps for purposes of calculating compliance with the
Federal position limits set forth in the 2020 NPRM, the Commission
proposed adjusting position sizes to an equivalent position based on
the size of the unit of trading of the relevant core referenced futures
contract. The phrase ``futures-equivalent'' is used for that purpose
throughout the 2020 NPRM, including in connection with the ``referenced
contract'' definition in proposed Sec. 150.1. The Commission also
proposed broadening the existing ``futures-equivalent'' definition to
include references to the proposed new term ``core referenced futures
contracts.'' Additionally, with respect to options, the proposed
``futures-equivalent'' definition also provided that a participant that
exceeds Federal position limits as a result of an option assignment
would be allowed a one-day grace period to liquidate the excess
position.
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\462\ As stated in this definition, the term ``option'' includes
an option on a futures contract and an option that is a swap.
---------------------------------------------------------------------------
iii. Commission Determination--Futures-Equivalent
The Commission is adopting the proposed definition of ``futures-
equivalent'' with one substantive modification: In addition to the 2020
NPRM's grace period in connection with position limit overages dues to
option assignments, under the Final Rule, the one-day grace period
would also extend to an option position that exceeds Federal position
limits as a result of certain changes in the option's exposure to price
changes of the underlying referenced contract, as long as the
applicable option contract does not exceed such position limits under
the previous business day's exposure to the underlying referenced
contract. This grace period does not apply on the last day of the spot
month for the corresponding core referenced futures contract.
As discussed further below, the Final Rule also includes several
technical changes, including referring to an option's ``exposure'' to
price changes of the underlying referenced contract and eliminating
references to an option's ``risk factors'' and ``delta coefficient.''
As discussed below, the Commission believes these changes will add
flexibility in assessing exposure to price changes of an option to the
underlying futures contract and are not intended to reflect a
substantive difference.
iv. Comments--Futures-Equivalent
Several commenters supported the proposed definition, including the
one-business-day grace period related to position limit overages due to
options assignments.\463\ In addition to
[[Page 3298]]
supporting the proposed definition, CME Group and ICE both supported
expanding the proposed definition's one business day grace period to
include Federal position limit overages resulting from changes in the
option's delta coefficient, noting that such a change is consistent
with their respective exchange rules.\464\ However, CME Group noted
that exercising an in-the-money option that results in a position over
the position limit should be treated as a violation if the futures-
equivalent position was over the position limit based on both the
previous and current day's delta.\465\
---------------------------------------------------------------------------
\463\ MFA/AIMA at 11; CME Group at 14; FIA at 26; and IFUS
Exhibit 1 RFC 23.
\464\ CME Group MRAN 1907-5 states that ``[i]f a position
exceeds position limits as a result of an option assignment, the
person who owns or controls such position shall be allowed one
business day to liquidate the excess position without being
considered in violation of the limits. Additionally, if, at the
close of trading, a position that includes options exceeds position
limits when evaluated using the delta factors as of that day's close
of trading, but does not exceed the limits when evaluated using the
previous day's delta factors, then the position shall not constitute
a position limit violation.'' See CME Group Market Regulation
Advisory Notice RA1907-5 (Aug. 2, 2019), available at: https://www.cmegroup.com/content/dam/cmegroup/notices/market-regulation/2019/08/RA1907-5.pdf; IFUS Rule 6.13(a) similarly provides persons
one business day to bring into position limits compliance any
position that exceeds limits due to changes in the deltas of the
options, or as the result of an option assignment.
\465\ CME Group at 14.
---------------------------------------------------------------------------
FIA sought clarification from the Commission on certain aspects of
the proposed definition. FIA stated that it is unclear how a spread
contract that qualifies as a referenced contract would be converted to
a futures-equivalent position.\466\ FIA also requested the Commission
clarify which calculation method applies to swaps and options that are
swaps.\467\
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\466\ FIA at 7.
\467\ FIA at 6-7.
---------------------------------------------------------------------------
v. Discussion of Final Rule--Futures-Equivalent
The Commission agrees with CME Group and ICE that the one-business-
day grace period also should apply to position overages in connection
with changes in the current day's option's exposure to price changes of
the underlying referenced contract (e.g., option delta coefficient).
The Commission understands that providing a one business day grace
period for these situations is consistent with existing market
practice. Further, consistent with CME Group's comment, a market
participant will not have a grace period if the market participant's
position also exceeded Federal position limits based on the previous
day's exposure (including option delta coefficient). To alleviate
concerns about delivery and to help prevent corners and squeezes, this
one-day grace period does not apply on the last trading day of the spot
month of the option's corresponding core referenced futures contract.
Additionally, the Commission is eliminating references to an
option's ``risk factor'' and ``delta co-efficient'' and instead
referring to an option's ``exposure'' to price changes of the
underlying referenced contract.
The Commission understands that the term ``exposure'' in the
present context is more commonly used by market participants.
Accordingly, the Commission believes that the reference to an option's
``exposure'' to price changes of the underlying referenced contract is
the technically correct term to use over ``risk factor'' or ``delta
coefficient,'' which are used in the existing ``futures-equivalent''
definition. However, the Commission's use of ``exposure'' here is meant
to encompass the concepts of ``risk factor'' and ``delta co-
efficient.'' As a result, the Commission believes that this change
provides flexibility, and is consistent with existing market practice
and understanding, in assessing the exposure of an option to the price
movement of futures contract and is not intended to reflect a
substantive change.
Additional technical changes include the Final Rule's reference to
``futures contract'' rather than merely ``futures'' and ``entity''
rather than ``participant'' since the former terms conform to other
uses in final Sec. 150.1. The Final Rule also makes several technical
changes in connection with the use of ``computed'' in the definition,
and these changes are meant to clarify the meaning rather than imply a
substantive change.
With respect to FIA's request for clarification regarding how a
spread contract that qualifies as a referenced contract would be
converted to a futures-equivalent position, the Commission recognizes
the inherent challenge with converting a spread contract that qualifies
as a referenced contract to a futures-equivalent position.\468\ The
Commission expects that a market participant will adjust such a spread
contract to a futures-equivalent position consistent with existing
exchange practice.
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\468\ FIA at 7.
---------------------------------------------------------------------------
With respect to FIA's question regarding the calculation for swaps
and options that are swaps, subparagraph (1) of the futures-equivalent
definition applies to an option that is a swap, and subparagraph (3) of
the definition applies to a swap that is not an option.
10. ``Independent Account Controller''
i. Summary of the 2020 NPRM--Independent Account Controller
The Commission adopted a revised ``independent account controller''
definition in the 2016 Final Aggregation Rule.\469\ The Commission
proposed no further amendments to this definition, but included that
revised definition in the 2020 NPRM so that all defined terms appeared
together.
---------------------------------------------------------------------------
\469\ See 17 CFR 150.1(e).
---------------------------------------------------------------------------
11. ``Long Position''
i. Summary of the 2020 NPRM--Long Position
The phrase ``long position'' is currently defined in Sec. 150.1(g)
to mean ``a long call option, a short put option or a long underlying
futures contract.'' The Commission proposed to update this definition
to apply to swaps and to clarify that such positions would be on a
futures-equivalent basis. This provision would thus be applicable to
options on futures and swaps such that a long position would also
include a long futures-equivalent option on futures and a long futures-
equivalent swap.
ii. Comments and Summary of the Commission Determination--Long Position
No commenter addressed the proposed definition of ``long
position.'' The Commission is adopting the definition as proposed.
12. ``Physical Commodity''
i. Summary of the 2020 NPRM--Physical Commodity
The Commission proposed to define the term ``physical commodity''
for position limits purposes. Congress used the term ``physical
commodity'' in CEA sections 4a(a)(2)(A) and 4a(a)(2)(B) to mean
commodities ``other than excluded commodities as defined by the
Commission.'' \470\ The proposed definition of ``physical commodity''
thus included both exempt and agricultural commodities, but not
excluded commodities.
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\470\ 7 U.S.C. 6a(a)(2)(A) and (B).
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ii. Comments and Summary of the Commission Determination--Physical
Commodity
No commenter addressed the proposed definition of ``physical
commodity.'' The Commission is adopting the definition as proposed.
[[Page 3299]]
13. ``Position Accountability''
i. Summary of the 2020 NPRM--Position Accountability
Existing Sec. 150.5 permits position accountability in lieu of
exchange position limits in certain cases, but does not define the term
``position accountability.'' The proposed amendments to Sec. 150.5
would allow exchanges, in some cases, to adopt position accountability
levels in lieu of, or in addition to, position limits. The Commission
proposed a definition of ``position accountability'' for use throughout
proposed Sec. 150.5 as discussed in greater detail in connection with
proposed Sec. 150.5.
ii. Comments and Summary of the Commission Determination--Position
Accountability
No commenter addressed the proposed definition of ``position
accountability.'' The Commission is adopting the definition as proposed
with some non-substantive technical changes related to the numbering
structure. The Commission is also changing the reference of ``trader''
to ``entity'' since ``entity'' is the proper defined term in Sec.
150.1 under the Final Rule while ``trader'' is not a defined term under
Sec. 150.1.
14. ``Pre-Enactment Swap''
i. Summary of the 2020 NPRM--Pre-Enactment Swap
The Commission proposed to create the defined term ``pre-enactment
swap'' to mean any swap entered into prior to enactment of the Dodd-
Frank Act of 2010 (July 21, 2010), the terms of which had not expired
as of the date of enactment of the Dodd-Frank Act. As discussed in
connection with proposed Sec. 150.3 later in this release, if acquired
in good faith, such swaps would be exempt from Federal position limits,
although such swaps could not be netted with post-effective date swaps
for purposes of complying with spot month Federal position limits.
ii. Comments and Summary of the Commission Determination--Pre-Enactment
Swap
No commenter addressed the proposed definition of ``pre-enactment
swap.'' The Commission is adopting the definition as proposed. For
further discussion of the treatment of pre-existing positions, see
Sections II.B.7. and II.C.7.
15. ``Pre-Existing Position''
i. Summary of the 2020 NPRM--Pre-Existing Position
The Commission proposed to create the defined term ``pre-existing
position'' to reference any position in a commodity derivative contract
acquired in good faith prior to the effective date of a final Federal
position limit rulemaking. Proposed Sec. 150.2(g) would set forth the
circumstances under which Federal position limits would apply to such
positions.
ii. Comments and Summary of the Commission Determination--Pre-Existing
Position
No commenter addressed the proposed definition of ``pre-existing
position.'' The Commission is adopting the term ``pre-existing
position'' as proposed. However, the Commission did receive comments
related to the treatment of certain pre-existing positions. For further
discussion of the treatment of pre-existing positions and related
comments, see Sections II.B.7. and II.C.7.
16. ``Referenced Contracts''
i. Background--Referenced Contracts
When a futures contract expires, all open futures contract
positions in such contract are settled by physical delivery (which the
Commission refers to as ``physically-settled'' herein) or cash
settlement (which the Commission refers to as ``cash-settled'' herein),
depending on the contract terms set by the exchange. The nine legacy
agricultural contracts currently subject to Federal position limits are
all physically-settled futures contracts. Deliveries on physically-
settled futures contracts are made through the exchange's
clearinghouse, and the delivery of the physical commodity must be
consummated between the buyer and seller per the exchange rules and
contract specifications. On the other hand, other futures contracts are
``cash-settled'' because they do not involve the transfer of physical
commodity ownership and require that all open positions at expiration
be settled by a transfer of cash to or from the clearinghouse based
upon the final settlement price of the contracts.
Market participants may use the settlement price of physically
delivered futures contracts as a key benchmark to price cash-market
contracts and other derivatives, including so-called ``look-alike''
cash-settled derivatives (which could be futures, options on futures,
or swaps contracts). Look-alike cash-settled derivative contracts are
explicitly linked to the physically-settled futures contracts. A look-
alike cash-settled derivatives contract has nearly identical
specifications as its physically-settled counterpart, but rather than
calling for delivery of the underlying commodity at expiration, the
contract terms require a cash payment at expiration. Each look-alike
cash-settled derivatives contract is linked by design to its respective
physically-settled contract in that the final settlement value of the
cash-settled contract is defined as the final settlement price of the
physically-settled contract in the same commodity for the same month.
Additionally, other types of cash-settled derivatives contracts may be
similar to a look-alike, but the final settlement price of such
contracts are determined based on a basis, or differential, to the
final settlement price of the corresponding physically-settled
contract.
Existing Sec. 150.2 applies Federal position limits to the nine
legacy agricultural contracts as well as to options thereon on a
futures-equivalent basis, but the existing Federal framework does not
include provisions to apply Federal position limits to contracts that
are linked in some manner to the nine physically-settled legacy
agricultural contracts. As a result, the existing Federal position
limits do not apply to any cash-settled contracts, including both look-
alike contracts and contracts that settle at a basis or differential to
a physically-settled contract, options on such cash-settled contracts,
or swaps.\471\
---------------------------------------------------------------------------
\471\ Under CEA section 1a(47)(A), an option on a swap is deemed
to be a swap.
---------------------------------------------------------------------------
As the Final Rule is expanding the position limits framework to
cover certain cash-settled futures contracts, options on such futures
contracts, and economically equivalent swaps, for the reasons discussed
below, the Commission is adopting the proposed defined term
``referenced contract,'' with modifications, for use throughout final
part 150 to refer to derivatives contracts that are subject to Federal
position limits.
ii. Summary of the 2020 NPRM--Referenced Contracts
The 2020 NPRM proposed a new ``referenced contract'' definition
that included:
(1) Any core referenced futures contract listed in proposed Sec.
150.2(d); (2) any other contract (futures or option on futures), on a
futures-equivalent basis with respect to a particular core referenced
futures contract, that is directly or indirectly linked to the price of
a core referenced futures contract, or
[[Page 3300]]
that is directly or indirectly linked to the price of the same
commodity underlying a core referenced futures contract (for delivery
at the same location(s)); and (3) any economically equivalent swap, on
a futures-equivalent basis.
The proposed referenced contract definition thus included look-
alike futures contracts and options on look-alike futures contracts (as
well as economically equivalent swaps with respect to such look-alike
contracts), contracts of the same commodity but different sizes (e.g.,
mini contracts), and penultimate contracts.\472\
---------------------------------------------------------------------------
\472\ A penultimate contract is a cash-settled contract in which
trading ceases one business day prior to the settlement date of the
corresponding referenced contract with which the penultimate
contract is linked. With respect to penultimate contracts, the 2020
NPRM stated that ``Federal limits would apply to all cash-settled
futures and options on futures contracts on physical commodities
that are linked in some manner, whether directly or indirectly, to
physically-settled contracts subject to Federal limits.'' Further to
this general statement, the 2020 NPRM provided a footnote example of
a penultimate contact that, because it cash-settles directly to a
core referenced futures contract, the 2020 NPRM explained would
therefore be included as a referenced contract. 85 FR at 11619.
---------------------------------------------------------------------------
Additionally, the 2020 NPRM explicitly excluded from the
``referenced contract'' definition: (1) Commodity index contracts; (2)
location basis contracts; (3) swap guarantees; and (4) trade options
that satisfy the requirement of Sec. 32.3 of the Commission's
regulations. Further, while not in the proposed regulatory text, the
Commission indicated in the preamble to the 2020 NPRM that a contract
for which the settlement price is based on an index published by a
price reporting agency (a ``PRA index contract'') that surveys cash-
market transactions (even if the cash-market practice is to price at a
differential to a futures contract) was not deemed to be ``directly or
indirectly'' linked to a referenced contract, and thus that such PRA
index contract also was excluded from the ``referenced contract''
definition under the 2020 NPRM.\473\
---------------------------------------------------------------------------
\473\ 85 FR at 11620.
---------------------------------------------------------------------------
Under the 2020 NPRM, a position in a referenced contract in certain
circumstances could be netted with a position in another referenced
contract, including a core referenced futures contract, which as noted
above is a type of referenced contract under the proposed ``referenced
contract'' definition. However, to avoid evasion and undermining of the
Federal position limits framework, the 2020 NPRM prohibited the use of
non-referenced contracts to net down positions in referenced
contracts.\474\
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\474\ 85 FR at 11619. For further discussion of the Final Rule's
treatment of the netting of positions, see Section II.B.10.
---------------------------------------------------------------------------
Finally, the 2020 NPRM also stated that, in an effort to provide
clarity to market participants regarding which exchange-traded
contracts would be subject to Federal position limits, the Commission
anticipated publishing, and regularly updating, a list of such
contracts on its website. The Commission thus proposed to publish a
``CFTC Staff Workbook,'' which would provide a non-exhaustive list of
referenced contracts and may be helpful to market participants in
determining categories of contracts that would fit within the
referenced contract definition.
iii. Commission Determination--Referenced Contracts
The Commission is adopting the proposed ``referenced contract''
definition with the modification discussed below, as well as one
technical change that the Commission believes clarifies the
``referenced contract'' definition, consistent with the intent of the
2020 NPRM.\475\ Like the proposed definition, the final ``referenced
contract'' definition also includes (1) the 25 core referenced futures
contracts, (2) futures and options on futures that are directly or
indirectly linked either to (i) the price of any other core referenced
futures contract or (ii) the same commodity underlying a core
referenced futures contract,\476\ and (3) economically equivalent
swaps. Like the 2020 NPRM, the final definition also explicitly
excludes certain contract types so that these contracts may not be
netted against referenced contract positions for purposes of Federal
position limits (but also are not aggregated with referenced contract
positions).
---------------------------------------------------------------------------
\475\ The Commission is providing a clarifying technical change
to the ``referenced contract'' definition in that the final
definition refers to ``an option on a futures contract'' instead of
``options on a futures contract'' as proposed by the 2020 NPRM, to
make clear the original intent of the Commission in the 2020 NPRM
that a single option would qualify as a referenced contract.
\476\ Prong (ii) encompasses physically-settled contracts that
do not directly reference a core referenced futures contract but
that are nonetheless based on the same commodity and delivery
location as the core referenced futures contract.
---------------------------------------------------------------------------
However, in addition to the proposed definition's exclusions of
commodity index contracts, location basis contracts, swap guarantees,
and trade options that satisfy the requirement of Sec. 32.3 of the
Commission's regulations, the Final Rule is modifying the 2020 NPRM's
definition to also exclude two additional contract types: ``outright
price reporting agency index contracts'' and ``monthly average pricing
contracts.''
This section will address the following issues, including related
comments, in the following order:
a. Cash-settled referenced contracts and contracts that are
``directly or indirectly'' linked to a core referenced futures
contract, including cash-settled and penultimate contracts;
b. Contracts explicitly excluded from the ``referenced contract''
definition; and
c. The list of referenced contracts and the related Commission
staff ``Workbook.''
The Commission is also adopting ``economically equivalent swaps,''
as proposed, as part of the final ``referenced contract'' definition.
However, the Commission addresses the final ``economically equivalent
swap'' definition in Section II.A.4.
a. Contracts That Are Directly or Indirectly Linked to a Core
Referenced Futures Contract
(1) Summary of the 2020 NPRM--Linked to a Core Referenced Futures
Contract
Paragraph (1) of the proposed referenced contract definition
provided that a contract would qualify as a referenced contract if it
is a core referenced futures contract, or, with respect to a particular
core referenced futures contract, if it is directly or indirectly
linked, including being partially or fully settled on, or priced at a
fixed differential to, the price of either (i) the core referenced
futures contract itself or (ii) the same commodity underlying the core
referenced futures contract for delivery at the same location or
locations as specified in the core referenced futures contract's
specifications. As the Commission explained in the 2020 NPRM, this
provision included a cash-settled ``look-alike'' future or an option
thereon.\477\
---------------------------------------------------------------------------
\477\ For example, the 2020 NPRM noted that ICE's Henry
Penultimate Fixed Price Future, which cash-settles directly to
NYMEX's Henry Hub Natural Gas core referenced futures contract,
would be considered a referenced contract. 85 FR at 11620.
---------------------------------------------------------------------------
(2) Summary of the Commission Determination--Linked to a Core
Referenced Futures Contract
The Commission is adopting as final the language in paragraph (1)
of the proposed ``referenced contract'' definition. Accordingly, under
paragraph (1) of the final ``referenced contract'' definition,
referenced contracts include a core referenced
[[Page 3301]]
futures contract, and any cash-settled futures and options on futures
that are directly or indirectly linked either to (i) the price of any
other core referenced futures contract or (ii) the same commodity
underlying a core referenced futures contract for delivery at the same
location or locations as specified in the core referenced futures
contract's specifications.\478\
---------------------------------------------------------------------------
\478\ Clause (ii) of this description comprises as referenced
contracts any physically-settled contracts that are linked to the
same commodity for delivery at the same location underlying a core
referenced futures contract. The Commission believes as failure to
do so could undermining this Federal position limits framework
through the creation of physically-settled look-alike contracts by
other exchanges. For example, without including clause (ii) above,
an exchange could create a physically-settled look-alike contract,
but unlike the existing core referenced futures contract, this new
contract would be outside the Federal position limits framework.
Such an outcome would clearly disadvantage the exchange with the
existing core referenced futures contract and harm liquidity for
bona fide hedgers by possibly dividing liquidity among competing
physically-settled look-alike contracts, as well as provide
significant incentives for market participants to trade contracts
that subvert this Federal position limits framework.
---------------------------------------------------------------------------
Further, in response to the comments described below, the
Commission is reaffirming that penultimate futures contracts and
options thereon qualify as referenced contracts because they satisfy
paragraph (1) of the referenced contract definition under the Final
Rule.
(i) Comments--Cash-Settled Referenced Contracts
Commenters provided differing opinions as to whether linked cash-
settled futures and related options should be subject to Federal
position limits.\479\ CME Group and NEFI supported the Commission's
proposal to subject these contracts to Federal position limits.\480\
According to CME Group, absent parity between cash and physically-
settled contracts, artificial distortions on one side of the market
could occur due to manipulations on the other side of the market,
regulatory arbitrage, or liquidity drain.\481\ CME Group warned that,
ultimately, a lack of parity could undermine the statutory goals of
position limits.\482\ NEFI agreed, arguing that applying Federal
position limits to cash-settled contracts is essential to guard against
manipulation by a trader who holds positions in both physically-settled
and cash-settled contracts for the same underlying commodity.\483\
---------------------------------------------------------------------------
\479\ CME Group at 3-4; FIA at 7-8; ICE at 12; ISDA at 3-5; NEFI
at 3; PIMCO at 3; and SIFMA AMG at 4-6.
\480\ CME Group at 3-4 (stating ``CME Group believes that
economically and substantively alike contracts should be accorded
the same regulatory treatment to prevent artificial distortions from
opening doors for manipulators or shifting one market's liquidity to
another. . . In this regard, as noted above, CME Group recommends
that the Commission apply similar provisions to both cash-settled
and physically settled swaps.'').
\481\ CME Group at 6.
\482\ Id.
\483\ NEFI at 3.
---------------------------------------------------------------------------
Other commenters disagreed. PIMCO and SIFMA AMG contended that
cash-settled referenced contracts should not be subject to Federal
position limits at all because cash-settled contracts do not introduce
the same risk of market manipulation. They argued that subjecting cash-
settled referenced contracts to Federal position limits would reduce
market liquidity and depth in these instruments.\484\
---------------------------------------------------------------------------
\484\ PIMCO at 3; SIFMA AMG at 4-6.
---------------------------------------------------------------------------
ISDA argued that cash-settled contracts should not be included in
an immediate Federal position limits rulemaking, and should instead be
deferred until the Commission has adopted Federal limits with respect
to physically-delivered spot month futures contracts, and after which
the Commission should revisit Federal limits for cash-settled
contracts.\485\
---------------------------------------------------------------------------
\485\ ISDA at 3-5.
---------------------------------------------------------------------------
FIA and ICE suggested that Federal position limits for cash-settled
referenced contracts should apply per DCM (rather than in aggregate
across DCMs).\486\ FIA additionally suggested setting a separate
Federal spot-month position limit for economically equivalent
swaps.\487\ FIA and ICE further argued that limits for cash-settled
referenced contracts should be higher relative to Federal position
limits for physically-settled referenced contracts. They similarly
posited that cash-settled referenced contracts are ``not subject to
corners and squeezes'' and higher limits for cash-settled contracts
will `` `ensure market liquidity for bona fide hedgers.' '' \488\
---------------------------------------------------------------------------
\486\ FIA at 7-8; ICE at 12.
\487\ FIA 7-8.
\488\ ICE at 3, 15 (also arguing that cash-settled limits should
apply per exchange, rather than across exchanges); FIA at 7-8; For
further discussion on the Commission's determination to generally
apply Federal position limits on an aggregate basis across
exchanges, see Section II.B.11.
---------------------------------------------------------------------------
(ii) Discussion of Final Rule--Cash-Settled Reference Contracts
As a general matter, the Commission does not agree with FIA and ICE
that Federal position limits should be applied at the DCM level instead
of in the aggregate for the reasons discussed below under Section
II.B.11.\489\
---------------------------------------------------------------------------
\489\ As discussed below, as an initial matter, the Commission
interprets CEA section 4a(a)(6) as requiring aggregate Federal
position limits across exchanges. However, as discussed below, the
Commission is providing an exception to this general rule for
natural gas pursuant to the Commission's exemptive authority under
CEA section 4a(a)(7). For further discussion, see Sections
II.B.3.vi. and II.B.11.
---------------------------------------------------------------------------
Further, the Commission addresses FIA's contention that the
Commission should impose a separate Federal spot-month position limit
for economically equivalent swaps in further detail above under Section
II.A.4.iii.
While the Commission acknowledges commenter views to the effect
that cash-settled contracts are less susceptible to effectuating
corners and squeezes,\490\ the Commission is of the view that generally
speaking, linked cash-settled and physically-settled contracts form one
market, and thus should be subject to Federal position limits. Because
the settlement price of a physically delivered futures contract is used
as a price benchmark in many other derivative and cash-market
contracts, a change in the futures settlement price can affect the
value of a trader's overall portfolio of derivative and cash-market
positions. Accordingly, the link between physically delivered futures
and their cash-settled derivative counterparts can create incentives
for manipulation. This view is informed by the Commission's experience
overseeing derivatives markets, where the Commission has observed that
it is common for the same market participant to arbitrage linked cash-
and physically-settled contracts, and where the Commission has also
observed instances where linked cash-settled and physically-settled
contracts have been used together as part of an attempted
manipulation.\491\
---------------------------------------------------------------------------
\490\ FIA at 7, stating ``Section 4a(a)(3)(B)(ii) directs the
Commission to set limits as appropriate `to deter and prevent market
manipulation, squeezes and corners.' '' The Commission notes that
FIA provides an example as to the effect of squeezes and corners for
cash-settled contracts--only two out of three of the points for
which the Commission should set an appropriate limit--the third
point, which is overlooked by the commenter (market manipulation) is
also a statutory objective, and for the reasons described below,
provides a basis for including cash-settled contracts within the
Federal position limits regime.
\491\ The Commission has previously found that traders with
positions in a cash-settled contract may have an incentive to
manipulate and undermine price discovery in the physically-settled
contract to which the cash-settled contract is linked. See, e.g.,
CFTC v. Parnon Energy Inc. et al., No. 1:11-cv-03543 (S.D.N.Y. 2014)
(alleging defendants amassed sufficient quantity of physical WTI
while contemporaneously purchasing cash-settled WTI derivatives
positions on NYMEX and ICE with the intent to profit on those
positions by manipulating the price of the physically-settled WTI
contract).
---------------------------------------------------------------------------
Applying position limits to both physically delivered futures and
linked cash-settled contracts, including their look-alike cash-settled
derivative contracts, reduces a trader's incentive and ability to
manipulate futures markets. Without position limits on
[[Page 3302]]
both types of futures contracts, traders could amass a substantial
position in the cash-settled look-alike contract and benefit their
position by manipulating the settlement price of the physically
delivered futures contracts.
Additionally, the absence of position limits on look-alike cash-
settled derivative contracts would enable traders to manipulate a
particular cash commodity price to benefit their cash-settled
derivatives position. For example, where market conditions create a
shortage of a particular commodity, that shortage should increase the
price of the commodity. If markets are functioning properly, the price
of the physically delivered futures contract will also increase. A
trader could acquire a massive long position in the look-alike cash-
settled derivative contract and profit by bidding up the cash price of
an already scarce cash commodity. Thus, the trader's cash commodity
positions would directly affect the price of the physically-settled
futures contract and its look-alike cash-settled derivative. The
trader's strategy to purchase the cash commodity and bid up its price
could cause the value of the look-alike cash-settled derivative
position to increase because of the direct links connecting all three
markets (i.e., the positions in the underlying cash commodity, the
physically-settled derivative, and the cash-settled derivative).
Accordingly, the absence of position limits in look-alike cash-settled
derivative contracts would enable traders to effectively influence and
manipulate cash prices to benefit their cash-settled derivatives
position, which could impact the price of the physically-settled
futures contract as well.
Additionally, excessive speculation in cash-settled derivative
contracts can affect the price of the physically-settled futures
contract and the underlying cash commodity and therefore harm the price
discovery function of the underlying markets. That is, futures prices
are determined by immediate cash commodity prices, and therefore the
relationship between cash and futures prices also depends, in part, on
the storage location of a particular commodity in relation to its
delivery point, and should result in the correct amount of a particular
commodity available at the delivery point. Thus, excessive speculation
in cash-settled derivative contracts can produce excessive supplies at
delivery points and a disruption of the flows of money and commodities
exchanged.\492\
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\492\ For example, manipulated ``higher'' futures contract
prices in a cash-settled futures contract can spill over into
``lower'' prices for a physically-settled futures contract through
arbitrage trades between the two futures contracts. Traders
arbitraging between the cash-settled and physically-settled futures
contracts would short the ``higher priced'' cash-settled and long
the ``lower-priced'' physically-settled futures contracts until an
equilibrium price is achieved. However, that equilibrium price may
be distorted due to the manipulation occurring in the higher priced
cash-settled contract, and as a result the physically-settled
contract would have an artificially higher price relative to the
actual cash-market price of the underlying commodity. That higher
futures contract price would then act as a false price signal to the
underlying cash commodity market, thus incentivizing owners of the
cash commodity to increase supplies at the delivery points for the
physically-settled futures contract. Accordingly, excessive
speculation in cash-settled derivative contracts can produce
excessive supplies at delivery points and a disruption of liquidity,
price discovery, and distribution of the underlying cash
commodities.
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Accordingly, the Commission considers cash-settled referenced
contracts to be generally economically equivalent to physical-delivery
contracts in the same commodity. In the absence of position limits, an
entity with positions in both the physically delivered and cash-settled
contracts may have an increased ability and an increased incentive to
manipulate one of these contracts to benefit positions in the other
contract. As such, the Commission believes that it is essential to
apply Federal position limits to cash-settled futures and options on
futures that are directly or indirectly linked to physically-settled
contracts in order to further the statutory objective in CEA section
4a(a)(3)(B)(iv) to deter and prevent market manipulation.
Furthermore, the Commission has determined that including futures
contracts and options on futures contracts that are indirectly linked
to the core referenced futures contract under the ``referenced
contract'' definition will help prevent the evasion of position limits
through the creation of an economically equivalent futures contract or
option on a futures contract, as applicable, that does not directly
reference the price of the core referenced futures contract. Such
contracts that settle to the price of a referenced contract but not to
the price of a core referenced futures contract, for example, would be
indirectly linked to the core referenced futures contract.\493\
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\493\ As discussed above, the Commission adopted an
``economically equivalent swap'' definition that is narrower than
the class of futures contracts and option on futures contracts that
would be included as referenced contracts. For further discussion of
the ``economically equivalent swap'' definition, see Section II.A.4.
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However, a physically-settled derivative contract with a settlement
price that is based on the same underlying commodity at a different
delivery location would not be linked, directly or indirectly, to the
core referenced futures contract. By way of example, a hypothetical
physically-settled futures contract on ultra-low sulfur diesel
delivered at L.A. Harbor instead of the NYMEX ultra-low sulfur diesel
core referenced futures contract delivered in New York Harbor would not
be linked, directly or indirectly, to the core referenced futures
contract because NYMEX's ultra-low sulfur diesel futures contract does
not include L.A. Harbor as a possible delivery point. Therefore, the
contract specification price of the hypothetical physically delivered
L.A. Harbor contract would reflect the L.A. Harbor market price for
ultra-low sulfur diesel and not the NYMEX contract's price.
(iii) Comments and Discussion of Final Rule--Penultimate Contracts Are
a Subset of Cash-Settled Referenced Contracts
Penultimate contracts are a type of cash-settled futures contract
(or an option thereon) that settles the day before the corresponding
physically-settled futures contract. Penultimate contracts therefore
share the same determinative attributes as the other cash-settled look-
alike referenced contracts discussed above, including the fact that the
settlement price of a penultimate contract is linked to the
corresponding physically-settled core referenced futures contract.
In response to certain commenters requesting that the Commission
exclude penultimate contracts from the 2020 NPRM's proposed
``referenced contract'' definition (discussed below), the Commission is
affirming that penultimate contracts, as a type of linked cash-settled
look-alike contracts, fall within the Final Rule's ``referenced
contract'' definition.
Commenters were split as to whether these penultimate contracts
should be included within the ``referenced contract'' definition. ICE
argued that penultimate contracts, and specifically its penultimate
cash-settled natural gas contract, should be excluded from position
limits for several reasons, including that its natural gas penultimate
contract is economically distinct from the NYMEX NG core referenced
futures contract and has no ability to impact settlement of that core
referenced futures contract.\494\ SIFMA AMG and ISDA broadly concurred
with this position.\495\ In contrast, CME Group supported the inclusion
of penultimate contracts within the definition of
[[Page 3303]]
referenced contract.\496\ As the Commission outlined above, its ``one
market'' view applies to cash-settled contracts that are linked in some
manner to physically-settled contracts. Penultimate futures contracts
(including options thereon), as a type of linked cash-settled contract,
have the same relation to their physically-settled counterparts as
discussed above for other linked cash-settled contracts. The Commission
therefore is applying Federal position limits to all of these
instruments.
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\494\ ICE at 13-14.
\495\ ISDA at 9; SIFMA AMG at 10-11.
\496\ CME Group at 3-4 (arguing that ``economically and
substantively alike contracts should be accorded the same regulatory
treatment to prevent artificial distortions from opening doors for
manipulations or shifting one market's liquidity to another.'').
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In support of its view that penultimate contracts should not be
subject to Federal position limits, ICE offered the example of the
Henry Hub LD1 (``H'') futures contract (which has an exchange-set spot-
month position limit) and the Henry Hub Penultimate (``PHH'') futures
contract (which has exchange-set position accountability), stating that
these contracts trade side-by-side, and that there has been no evidence
of a migration to the penultimate contract due to the presence of an
accountability level rather than a hard spot-month position limit.
According to ICE, this suggests that the Commission need not be
concerned about an arbitrage opportunity between the two.\497\
---------------------------------------------------------------------------
\497\ ICE at 14.
---------------------------------------------------------------------------
However, in further support of its argument that penultimate
contracts should not be subject to Federal position limits, ICE
suggested that penultimate contracts ``empirically'' are not
economically the same as the last day contract, as demonstrated by
settlement prices.\498\ To that end, the Commission reviewed the
settlement prices of NYMEX NG (the physically settled natural gas core
referenced futures contract), H (the ICE LD1 natural gas contract cash-
settled to the NYMEX NG), and PHH (the ICE natural gas penultimate
contract cash-settled to the NYMEX NG).\499\ Contrary to the empirical
assertion made by ICE, the prices of the six near-month contracts for
each of the contracts described above settled at identical prices on
the relevant penultimate day for all contracts at all months.\500\ As
reinforced by this observation, the Commission agrees with the
commenter that the penultimate contract is tightly correlated (and
trades side-by-side) with the cash-settled contract, as well as being
demonstrated here, with the physically settled futures contract.
---------------------------------------------------------------------------
\498\ Id.
\499\ Commission review of these contracts as of August 4, 2020,
based on data submitted to the Commission pursuant to part 16 of the
Commission's regulations.
\500\ The six near-month contracts reviewed by the Commission
are as follows: Sep20, Oct20, Nov20, Dec20, Jan21, and Feb21, for
each of NYMEX NG, H, and PHH. The Commission does not compare the
spot-day price on the last day of trading of the NYMEX NG contract
with the penultimate PHH contract since by definition the PHH
contract settles on the penultimate day--that is, PHH settles on the
day before NYMEX NG's last day of trading and therefore there is no
PHH price to compare against the NYMEX NG price on NYMEX NG's last
day of trading.
---------------------------------------------------------------------------
However, it is not in spite of this tight correlation, but rather
because of it, that the Commission considers these contracts to form
one market, and as such, raises the importance of Federal position
limits for these instruments. As noted above, the Commission believes
that Federal position limits should apply to all contracts covered by
the Final Rule's ``referenced contract'' definition, including all
varieties of linked cash-settled contracts, such as linked penultimate
contracts, given the linkages between the physically-settled contract,
the cash-settled contract (including penultimate contracts), and the
underlying cash-market commodity, and the incentives and opportunities
for market manipulation that those linkages create.
b. Exclusions From the Referenced Contract Definition
(1) Summary of the 2020 NPRM--Exclusions From the Referenced Contract
Definition
In the 2020 NPRM, paragraph (3) of the proposed ``referenced
contract'' definition explicitly excluded: (1) A location basis
contract; (2) a commodity index contract; (3) a swap guarantee; and (4)
a trade option that meets the requirements of Commission regulation
Sec. 32.3. The 2020 NPRM also included guidance in proposed Appendix C
setting forth additional clarification regarding the types of contracts
that would qualify as either a location basis contract or a commodity
index contract for purposes of the proposed exclusions from the
``referenced contract'' definition.
(2) Summary of the Commission Determination--Exclusions From the
Referenced Contract Definition
The Commission is adopting paragraph (3) of the 2020 NPRM's
proposed ``referenced contract'' with the following changes. In
addition to excluding the contracts mentioned above, the Final Rule is
modifying paragraph (3) to additionally exclude ``outright price
reporting agency index contracts'' and ``monthly average pricing
contracts'' from the ``referenced contract'' definition. To the extent
a contract fits within one of the excluded contracts in paragraph (3),
such contract is not a referenced contract, is not subject to Federal
position limits, and could not be used to net down positions in
referenced contracts (but also is not required to be added to
referenced contract positions when determining compliance with Federal
position limits).
In order to clarify the types of contracts that qualify as location
basis contracts and commodity index contracts, and thus are excluded
from the ``referenced contract'' definition, the Commission also is
adopting, with modifications described below, the guidance with respect
to these instruments in Appendix C to part 150 of the Commission's
regulations. This guidance includes information to help define the
parameters of the terms ``location basis contract'' and ``commodity
index contract.'' \501\ To the extent a particular contract fits within
this guidance, such contract would not be a referenced contract, would
not be subject to Federal position limits, and could not be used to net
down positions in referenced contracts.\502\ Unlike the 2020 NPRM, the
final guidance in Appendix C will also include additional information
regarding the definition of the terms ``outright price reporting agency
index contracts'' and ``monthly average pricing contracts.''
---------------------------------------------------------------------------
\501\ The Commission notes that the further definition of
parameters regarding a commodity index contract is responsive to the
Better Markets comment letter suggesting such additional
clarifications. Better Markets at 34.
\502\ See infra Section II.B.10. (discussion of netting).
---------------------------------------------------------------------------
Comments on these topics, and the Commission's responses, are set
forth below.
(3) Comments--Exclusions From the Referenced Contract Definition
On balance, commenters were generally supportive of the 2020 NPRM's
proposed exclusions from the referenced contract definition.\503\
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\503\ AGA at 9; CHS at 2; FIA at 2; ICE at 10-11; NCFC at 2.
---------------------------------------------------------------------------
(i) Location Basis Contracts
Commenters that provided an explicit opinion about location basis
contracts were unanimously supportive of the Commission excluding such
contracts from the definition of a referenced contract.\504\
---------------------------------------------------------------------------
\504\ AGA at 9; ICE at 10.
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[[Page 3304]]
(ii) Commodity Index Contracts
Commenters were divided, however, regarding the exclusion of
commodity index contracts. Better Markets and IATP opposed the
exclusion,\505\ while ICE and PIMCO supported it.\506\ Better Markets
concurred with the view expressed by the Commission in the 2020 NPRM
that commodity index contracts should not be permitted to net down
referenced contract positions, but in lieu of the Commission's proposal
to exclude commodity index contracts as referenced contracts, Better
Markets suggested in the alternative that the Commission adopt
individual limits for commodity index contracts for persons also
involved in physically-settled contracts on physical commodities
serving as a constituent in the applicable index.\507\ IATP cited
several studies, including one published by Better Markets, contending
that commodity index contracts have price impacts that are detrimental
to commercial hedgers.\508\ IECA stated that the passive speculation
provided by commodity index contracts is harmful to the price discovery
function of the market.\509\
---------------------------------------------------------------------------
\505\ Better Markets at 34, 46; IATP at 7-8 (citing studies
which they believe demonstrate that commodity index trading harms
commercial hedgers).
\506\ ICE at 2; PIMCO at 5.
\507\ Better Markets at 46.
\508\ IATP at 7-8 (citing David Frenk and Wallace Turbeville,
``Commodity Index Traders: Boom and Bust in Commodity Prices,''
Better Markets, October 2011, at 15). https://bettermarkets.com/sites/default/files/documents/Better%20Markets-%20Commodity%20Index%20Traders%20and%20Boom-Bust%20in%20Commodities%20Prices.pdf.
\509\ Industrial Energy at 3-4, suggesting a ban on natural gas
commodity index contracts, which functionally equates to a Federal
position limit of zero, or alternatively a limit to not exceed the
current percentage of the physical market.
---------------------------------------------------------------------------
In contrast, PIMCO argued in favor of the exclusion for commodity
index contracts, contending that commodity index contracts are useful
tools for investors looking for broad-based portfolio hedging or to
take a view on price trends in the commodity markets.\510\
---------------------------------------------------------------------------
\510\ PIMCO at 5.
---------------------------------------------------------------------------
(iii) Trade Options
All commenters offering a specific opinion regarding trade options
unanimously supported the exclusion of trade options from the
definition of referenced contract.\511\
---------------------------------------------------------------------------
\511\ AGA at 8; CCI at 2; EPSA at 3-4; NGSA at 4; NRECA at 17;
CEWG at 4; Chevron at 3; CHS at 2; FIA at 2; NCFC at 2; NGSA at 4;
and Suncor at 3.
---------------------------------------------------------------------------
(iv) Swap Guarantees
Similarly, commenters supported the exclusion of swap guarantees
from the definition of reference contract.\512\
---------------------------------------------------------------------------
\512\ CHS at 2; FIA at 2; NCFC at 2, offering general support
for excluding swap guarantees, but not providing a specific
rationale for doing so.
---------------------------------------------------------------------------
(v) Outright Price Reporting Agency Index Contracts
FIA and ICE further recommended that the Commission should exclude
any outright contracts whose settlement price is based on an index
published by a price reporting agency that surveys cash-market
transaction prices from the ``referenced contract'' definition.\513\
---------------------------------------------------------------------------
\513\ FIA at 6; ICE at 10-11.
---------------------------------------------------------------------------
(vi) Monthly Average Pricing Contracts
CME Group commented that because a significant amount of commerce
is transacted on a monthly average basis, and that because monthly
average pricing contracts are calculated using the daily prices during
the contract month such that a final settlement price of a core
referenced futures contract would have the same weight as the other
twenty or more daily prices used in the monthly average price
calculation, it would be extremely unlikely for monthly average pricing
contracts to be used to manipulate or benefit from a manipulation
during the spot period. Thus, CME Group argued monthly average pricing
contracts should also be excluded from the definition of referenced
contracts.\514\
---------------------------------------------------------------------------
\514\ CME Group at 13.
---------------------------------------------------------------------------
(vii) Additional Basis, Differential, and Spread Contracts
ICE recommended that certain other contracts, such as additional
basis and spread contracts, should generally be excluded from the
definition of a referenced contract, even if the contracts reference a
core referenced futures contract as one component.\515\
---------------------------------------------------------------------------
\515\ ICE at 12; see also FIA at 4 (recommending that the spread
transaction definition should be expanded to exempt additional,
commonly used spreads). For further discussion on the ``spread
transaction'' definition, see Section II.A.20.
---------------------------------------------------------------------------
(4) Discussion of Final Rule--Exclusions From the Referenced Contract
Definition
The Commission is finalizing as proposed the exclusions from the
referenced contract definition for location basis contracts, commodity
index contracts, swap guarantees, and trade options that meet the
requirements of Sec. 32.3. Further, as noted above, the Commission is
expanding prong (3) of the proposed referenced contract definition to
additionally exclude two other contract types: ``outright price
reporting agency index contracts'' and ``monthly average pricing
contracts.''
(i) Location Basis Contracts
The Commission has determined that, unless location basis contracts
are excluded from the ``referenced contract'' definition, speculators
would be able to net portions of their location basis contracts with
outright positions in one of the locations comprising the core
referenced futures contract, which would permit extraordinarily large
speculative positions in the outright core referenced futures
contract.\516\ For example, the 2020 NPRM explained that a large
outright position in NYMEX Henry Hub Natural Gas (NG) futures contracts
could not be netted down against a location basis contract that cash-
settles to the difference in price between the Gulf Coast Natural Gas
futures contract and the NYMEX NG futures contract.\517\ Absent this
exclusion, a market participant could increase its exposure in the
outright contract by using the location basis contract to net down
against its NYMEX NG futures position, thereby allowing the market
participant to further increase the outright NYMEX NG futures contract
position that would otherwise exceed the Federal position limits.
---------------------------------------------------------------------------
\516\ See infra Section II.B.10. (discussion of netting).
\517\ 85 FR at 11620.
---------------------------------------------------------------------------
While excluding location basis contracts from the referenced
contract definition would prevent the circumstance described above, it
would also mean that location basis contracts would not be subject to
Federal position limits. The Commission is comfortable with this
outcome because location basis contracts generally demonstrate minimal
volatility and are typically significantly less liquid than the core
referenced futures contracts, meaning, in the Commission's estimation,
it is less likely that a potential manipulator would be able to effect
a market manipulation using these contracts. Further, excluding
location basis contracts from the referenced contract definition may
allow commercial end-users to more efficiently hedge the cost of
commodities at their preferred location to the extent they may
frequently require the physical commodity at a location other than the
core referenced futures contract's specified contract delivery point.
(ii) Commodity Index Contracts
With respect to commodity index contracts, the Commission similarly
has
[[Page 3305]]
determined that excluding commodity index contracts from the
``referenced contract'' definition will ensure that market participants
cannot use a position in a commodity index contract to net down an
outright position in a referenced contract that was a component of the
commodity index contract.
Regarding Better Markets' and IATP's requests that the Commission
alter the proposed ``referenced contract'' definition to include
commodity index contracts (i.e., to remove commodity index contracts
from the list of excluded contracts in paragraph (3) of the
``referenced contract'' definition), the Commission notes that if it
did not exclude commodity index contracts, the Commission's rules would
allow speculators to take on massive outright positions in referenced
contracts by netting against a position in a commodity index contract,
which could lead to excessive speculation.
For example, the Commission understands that it is common for swap
dealers to enter into commodity index contracts with participants for
which the contract would not qualify as a bona fide hedging position
(e.g., with a pension fund). Failing to exclude commodity index
contracts from the referenced contract definition could enable a swap
dealer to use positions in commodity index contracts to net down
offsetting outright futures positions in the components of the index.
Additionally, this would have the effect of subverting the statutory
pass-through swap provision in CEA section 4a(c)(2)(B), which is
intended to foreclose the recognition of positions entered into for
risk management purposes as bona fide hedges unless the swap dealer is
entering into positions opposite a counterparty for which the swap
position is a bona fide hedge.\518\
---------------------------------------------------------------------------
\518\ 7 U.S.C. 6a(c)(2)(B).
---------------------------------------------------------------------------
The Commission recognizes that although excluding commodity index
contracts from the ``referenced contract'' definition would prevent the
potentially risky netting circumstance described above, it would also
mean that commodity index contracts would not be subject to Federal
position limits. The Commission concludes that this is an acceptable
outcome because the contracts comprising the index would themselves be
subject to limits, and because commodity index contracts generally tend
to exhibit low volatility since they are diversified across many
different commodities.
With respect to Better Markets', ICEA's, and PMAA's requests to
impose separate standalone, or aggregate, position limits on commodity
index contracts, the Commission does not believe doing so is useful to
the extent that the individual components of a commodity index contract
are subject to Federal position limits under the Final Rule. The
Commission also is concerned that adopting a standalone limit for a
commodity index contract could inadvertently limit transactions in
commodity derivatives contracts outside the Final Rule's scope.
Specifically, a commodity index contract may contain components that
are subject to Federal position limits, as well as additional
components that are not. If the Commission were to place standalone
limits on these commodity index contracts, it would impose de facto
constraints on commodity derivative contracts that are not intended to
be the subject to the Final Rule and for which the Commission has not
found position limits to be necessary.
(iii) Trade Options
The Commission also is finalizing, as proposed, the exclusion of
trade options that meet the requirements of Sec. 32.3 from the
definition of referenced contract. The Commission has traditionally
exempted trade options from a number of Commission requirements because
trade options are typically employed by end-users to hedge physical
risk and thus do not contribute to excessive speculation. Trade options
are not subject to position limits under current regulations, and the
proposed exclusion of trade options from the referenced contract
definition would simply codify existing practice.\519\
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\519\ In the trade options final rule, the Commission stated its
belief that Federal position limits should not apply to trade
options, and expressed an intention to address trade options in the
context of any final rulemaking on position limits. See Trade
Options, 81 FR at 14971.
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(iv) Swap Guarantees
The Commission additionally is excluding, as proposed, swap
guarantees from the ``referenced contract'' definition. In connection
with further defining the term ``swap'' jointly with the Securities and
Exchange Commission in the ``Product Definition Adopting Release,''
\520\ the Commission interpreted the term ``swap'' (that is not a
``security-based swap'' or ``mixed swap'') to include a guarantee of
such swap, to the extent that a counterparty to a swap position would
have recourse to the guarantor in connection with the position.\521\
Excluding guarantees of swaps from the definition of ``referenced
contract'' will help avoid any potential confusion regarding the
application of position limits to guarantees of swaps. The Commission
understands that swap guarantees generally serve as insurance, and, in
many cases, swap guarantors guarantee the performance of an affiliate
in order to entice a counterparty to enter into a swap with such
guarantor's affiliate. As a result, the Commission believes that swap
guarantees do not contribute to excessive speculation, market
manipulation, squeezes, or corners. Furthermore, the Commission
believes that swap guarantees were not contemplated by Congress when
Congress articulated its policy goals with respect to position limits
in CEA section 4a(a).\522\ Accordingly, the Commission is finalizing
the exclusion of swap guarantees from the definition of ``referenced
contract.''
---------------------------------------------------------------------------
\520\ See generally Further Definition of ``Swap,'' ``Security-
Based Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;
Security-Based Swap Agreement Recordkeeping, 77 FR 48208 (Aug. 13,
2012) (``Product Definitions Adopting Release'').
\521\ 77 FR at 48226.
\522\ To the extent that swap guarantees may lower costs for
uncleared OTC swaps in particular by incentivizing a counterparty to
enter into a swap with the guarantor's affiliate, excluding swap
guarantees may improve market liquidity, which is consistent with
the CEA's statutory goals in CEA section 4a(a)(3)(B) to ensure
sufficient liquidity for bona fide hedgers when establishing its
position limit framework.
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(v) New Exclusions from the ``Referenced Contract'' Definition--Price
Reporting Agency Index Contracts and Monthly Average Pricing Contracts
Finally, the Commission is modifying prong (3) of the proposed
``referenced contract'' definition to additionally exclude from the
Final Rule: (a) Monthly average pricing contracts and (b) outright
price reporting agency index contracts.
(a) Monthly Average Pricing Contracts
In response to commenter suggestions, the Commission is providing
non-binding guidance in Appendix C to this Final Rule to assist market
participants and exchanges in determining whether a particular contract
qualifies as a ``monthly average pricing contract,'' that the Final
Rule is excluding from the ``referenced contract'' definition.
Specifically, in response to Question 15 of the 2020 NPRM, CME Group
commented that contract types that are generally referred to in
industry nomenclature as calendar-month average (``CMA''), trade-month
average (``TMA''), and balance-of-the-month (``BALMO'') contracts
should be excluded from the list of referenced contracts and subject
solely to exchange-set position limits.\523\ CME
[[Page 3306]]
Group explains the prevalence of these contracts in the market, and
notes an example of the June 2020 monthly average contract (in which
there are 22 U.S. business days and thus 22 daily referenced prices
incorporated into the calendar month average), concluding that it is
difficult to manipulate a CMA. CME Group thus posits that excluding
CMAs would not incentivize manipulation of the underlying core
referenced futures contract.\524\
---------------------------------------------------------------------------
\523\ CME Group at 13.
\524\ Id.
---------------------------------------------------------------------------
As an initial matter, the Commission's addition of the new term
``monthly average pricing contracts'' to Appendix C of this Final Rule
is intended to generally cover the types of contracts addressed in CME
Group's comments, which are generally referred to in the industry as
``CMAs,'' ``TMAs,'' and ``BALMOs.'' The Commission agrees with CME
Group's rationale. The Commission understands that because the final
settlement price of a core referenced futures contract is only one of
many pricing points that constitute that monthly average, and as such
generally has a relatively insignificant impact on such core referenced
futures contract's monthly average price, it therefore also has a
relatively insignificant impact on the settlement price of the
corresponding monthly average pricing contract. Accordingly, the
Commission concludes that on balance, excluding monthly average pricing
contracts from the definition of referenced contract is consistent with
the statutory goals in CEA section 4a(a)(3), including with respect to
ensuring sufficient market liquidity for bona fide hedgers due to: (1)
The difficulty and expense of any entity artificially moving the price
of the monthly average by manipulating one or more component prices
within the contract; and (2) the widespread use and utility of these
contracts to commercial entities to hedge their risk. The Commission
provides non-binding guidance in Appendix C of the Final Rule to assist
market participants and exchanges in determining whether a particular
contract qualifies as a ``monthly average pricing contract.''
(b) Outright Price Reporting Agency Index Contracts
The Commission is also modifying prong (3) of the proposed
``referenced contract'' definition to explicitly exclude ``outright
price reporting agency index contracts.'' ICE supported the exclusion
of such contracts in its comment letter.\525\ Further, FIA also
commented that it believed that a price reporting agency index contract
is outside the definition of a referenced contract.\526\
---------------------------------------------------------------------------
\525\ ICE at 10.
\526\ FIA at 6.
---------------------------------------------------------------------------
The Commission agrees with ICE and FIA and confirms this
understanding. The Commission explained in the 2020 NPRM that based on
its plain reading, the ``referenced contract'' definition excluded such
contracts because outright price reporting agency index contracts were
not ``directly or indirectly'' linked to the price of a referenced
contract.\527\ The Commission reaffirms its conclusion that an
``outright price reporting agency index contract,'' which is based on
an index published by a price reporting agency that surveys cash-market
transaction prices (even if the cash-market practice is to price at a
differential to a futures contract), is not directly or indirectly
linked to the corresponding referenced contract. The Commission is
modifying the final ``referenced contract'' definition to explicitly
exclude such contracts for the sake of regulatory certainty. Similar to
the other contracts excluded from the ``referenced contract''
definition, the Commission is providing non-binding guidance in
Appendix C of the Final Rule to assist market participants and
exchanges in determining whether a particular contract qualifies as an
``outright price reporting agency index contract'' and therefore is
excluded as a referenced contract. The Commission underscores that this
exclusion applies only to ``outright'' price reporting agency index
contracts, and that a contract that settles to the difference (i.e.,
settled at a basis) between a referenced contract and the price
reporting agency index would be directly linked, and thus would qualify
as a referenced contract, because it settles in part to the referenced
contract price.
---------------------------------------------------------------------------
\527\ 85 FR at 11620.
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Since the Commission stated in the preamble to the 2020 NPRM that
an outright price reporting agency index contract does not qualify as a
``referenced contract,'' the Commission does not believe that the Final
Rule's modification to explicitly exclude the term in the regulatory
definition of ``referenced contract'' represents a change in policy.
Instead, it is merely a technical change to the regulatory text to
provide regulatory clarity to market participants.
(vi) Additional Basis, Differential, and Spread Contracts
Regarding ICE's comment that additional basis, differential, and
spread contracts should generally be excluded from the ``referenced
contract'' definition,\528\ the Commission notes a heightened concern
with potential manipulation through the use of outright positions
(particularly through inappropriate netting) and spreads, compared to
location basis contracts or commodity index contracts.\529\ Notably,
and as described in greater detail above, the Commission views the
constraints on the liquidity and volatility associated with location
basis and commodity index contracts as not present to an equal degree
in other basis and spread contracts. As noted above, while excluding
location basis contracts and commodity index contracts from the
referenced contract definition could permit large outright positions in
such contracts, the Commission believes that excluding these contracts
will nonetheless prevent the potentially risky and inappropriate
netting of a core referenced futures contract described above. Further,
as stated above, the Commission believes that location basis contracts
generally demonstrate minimal volatility and are typically
significantly less liquid than the core referenced futures contracts,
meaning they would be more costly to try to use to manipulate a core
referenced futures contract. Similarly, with respect to commodity index
contracts, commodities comprising the index could themselves be subject
to Federal position limits, and commodity index contracts also
generally tend to exhibit low volatility since they are diversified
across many different commodities.
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\528\ ICE at 12, noting contracts that capture the differential
between different grades of a commodity (e.g., WTI vs. sour crude)
or between different but related commodities (e.g., a crack
differential) as examples of contracts it believes should excluded.
\529\ See 78 FR at 75696-75697.
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Additionally, it is unclear from ICE's discussion what additional
contract types that ICE has in mind, other than outright price
reporting agency index contracts that the Commission discusses above,
since several of the examples provided by ICE may already be exempt
under the ``spread transaction'' definition (e.g., the spread examples
provided by ICE \530\ may qualify for a spread exemption under the
Final Rule as either a quality differential spread or an inter-
commodity spread). ICE also stated that the requirement that a spread
exemption be approved by the exchange seems unnecessary and is probably
unworkable, but did not provide any arguments as to why obtaining
exchange approval would be unnecessary.\531\
[[Page 3307]]
Additionally, the Commission notes that under the Final Rule, an
exemption for any spread that is included in the ``spread transaction''
definition is self-effectuating for purposes of Federal position
limits, and, unlike the role that exchanges may play with respect to
non-enumerated bona fide hedges in final Sec. 150.9, exchanges have no
analogous role with respect to spread exemptions for Federal position
limits purposes under the Final Rule.
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\530\ ICE at 12.
\531\ For further discussion of the ``spread transaction''
definition, see Section II.A.20.
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iv. List of Referenced Contracts
a. Summary of the 2020 NPRM--List of Referenced Contracts
In order to provide clarity to market participants, the Commission
proposed to publish, and anticipated regularly updating, a CFTC Staff
Workbook of Commodity Derivative Contracts under the Regulations
Regarding Position Limits for Derivatives (the ``Staff Workbook'') on
the Commission's website which would list exchange-traded products that
are subject to Federal position limits. In order to ensure that the
list remained accurate, the Commission also proposed changes to certain
provisions of part 40 of its regulations, which pertain to the
collection of position limits information through the filing of product
terms and conditions.
In particular, under existing Sec. Sec. 40.2, 40.3, and 40.4, DCMs
and SEFs must submit certain requirements related to the listing of
certain new products. Many of the required submissions include the
product's ``terms and conditions,'' as defined in Sec. 40.1(j), which
in turn includes under Sec. 40.1(j)(1)(vii) ``Position limits,
position accountability standards, and position reporting
requirements.''
The Commission proposed to expand Sec. 40.1(j)(1)(vii), which
addresses futures contracts and options contracts, to also include an
indication as to whether the submitted contract meets the ``referenced
contract'' definition in proposed Sec. 150.1. If so, proposed Sec.
40.1(j)(1)(vii) required the submission to also include the name of the
core referenced futures contract on which the submitted new product is
based.
The Commission further proposed to expand Sec. 40.1(j)(2)(vii),
which addresses swaps, to require the applicant to indicate whether the
submitted contract meets the proposed ``economically equivalent swap''
definition in Sec. 150.1. If so, proposed Sec. 40.1(j)(2)(vii)
similarly required the submission to include the name of the referenced
contract to which the swap is economically equivalent.
b. Comments and Summary of the Commission Determination--List of
Referenced Contracts
The Commission is adopting as final the 2020 NPRM's amendments to
part 40 of its regulations with one modification that relates to filing
the name of the referenced contract on which the new product is based.
Part 40 and the Commission's amendments pertain to the collection of
position limits information through the filing of product terms and
conditions, and the publication and regular updates of exchange-traded
contracts that are subject to Federal position limits.\532\ The
Commission notes that the Staff Workbook is intended to provide a non-
exhaustive list of exchange-traded referenced contracts that are
subject to Federal position limits. Although the Commission endeavors
to timely update this list of contracts, the omission of a contract
from the Staff Workbook does not mean that such contract is outside the
definition of a referenced contract subject to Federal position limits.
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\532\ As discussed above, the Commission will provide market
participants with reasonable, good-faith discretion to determine
whether a swap would qualify as economically equivalent for Federal
position limit purposes. Due to differences between OTC swaps and
exchange-traded futures contracts and options thereon, the Staff
Workbook would not include a list of economically equivalent swaps.
For further discussion, see supra Section II.A.4. (discussion of
economically equivalent swaps).
---------------------------------------------------------------------------
While proposed Sec. 40.1(j)(1)(vii) required the submitted futures
contract (or option thereon) to also include the name of the core
referenced futures contract on which the submitted new product is
based, final Sec. 40.1(j)(1)(vii) instead requires that the submitted
product includes the name of either the core referenced futures
contract or referenced contract, as applicable, on which the contract
is based. This is because, as discussed above under the ``referenced
contract'' definition, a referenced contract could be indirectly or
directly linked to another referenced contract that is not a core
referenced futures contract. For example, an options contract could be
based on a cash-settled look-alike or penultimate futures contract that
is a referenced contract rather than on the physically-settled core
referenced futures contract.
The Commission's concurrent publication of the Staff Workbook will
provide a non-exhaustive list of exchange-traded referenced contracts,
and will help market participants in determining categories of
contracts that fit within the referenced contract definition. This
effort is intended to provide clarity to market participants regarding
which exchange-traded contracts are subject to Federal position limits.
The proposed amendments to part 40 to specify new referenced
contracts generally received support.\533\ ICE noted the need for clear
guidance on how new contracts will be assessed, in order to determine
whether such contracts will be referenced contracts, and make
consistent determinations with respect to economically similar
products.\534\ Although commenters also generally supported the
publication of the Workbook, many suggested modifications, including
clarifications regarding which contracts are included as referenced
contracts, and the basis for making such determinations.\535\ The
Commission believes that the amendments to part 40 will allow the
Commission to consistently and accurately assess whether contracts
should be included within the Staff Workbook. The Commission also
believes that by providing regular updates to the Staff Workbook,
market participants will have accurate and consistent information to
assess whether such contracts are subject to Federal position limits.
Additionally, the Staff Workbook will provide a linkage between each
referenced contract, and either the core referenced futures contract or
referenced contract, as applicable, to which it is linked, to aid in
market participants' understanding of the Commission's determination.
---------------------------------------------------------------------------
\533\ AGA at 10; MFA/AIMA at 4.
\534\ ICE at 12.
\535\ AGA at 10; MFA/AIMA at 9; FIA at 6; Chevron at 14; Suncor
at 14; and CEWG at 29-30.
---------------------------------------------------------------------------
Alternatively, some commenters suggested that the Staff Workbook
could include a list of all contracts Commission staff finds are not
referenced contracts,\536\ and CME Group and ICE each provided a list
of contracts they believe should be excluded from the Staff
Workbook.\537\
---------------------------------------------------------------------------
\536\ FIA at 6; MFA/AIMA at 9.
\537\ CME Group at 13; ICE at 12.
---------------------------------------------------------------------------
The Commission believes that by providing a Staff Workbook listing
core referenced futures contracts, and the referenced contracts that
are directly or indirectly related to them, the Commission is
presenting a list of contracts subject to Federal position limits in
the clearest possible fashion. Additionally, the amendments to part 40
will allow regular and accurate updates to this list.
Some commenters expressed concern that the Staff Workbook lists
contracts that are not referenced contracts,\538\ or
[[Page 3308]]
provided examples asking for clarification.\539\ One commenter
recommended that the Commission appoint a task force to develop a
comprehensive baseline list of referenced contracts listed for trading
on exchanges.\540\
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\538\ FIA at 6; ICE at 9-12. ICE is specifically concerned that
the proposed workbook contains inconsistencies, such as including
location basis contracts and PRA/Price Index Contracts.
\539\ Chevron at 14; CEWG at 29.
\540\ CEWG at 30.
---------------------------------------------------------------------------
The Commission believes that Commission staff (as opposed to a
taskforce) is best positioned to continually refine the Workbook
through accurate, timely updates, as aided by the additional
information required by the newly adopted amendments to part 40 under
the Final Rule.
Further, some commenters believed that the Commission should
require exchanges to publish and maintain a definitive list of
referenced contracts (other than economically equivalent swaps).\541\
While CME Group did not believe that the Commission should impose such
a requirement on exchanges, it supported coordinating with the
Commission to ensure consistency, and publishing this information on
CME Group's website.\542\
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\541\ MFA/AIMA at 7; Citadel at 4-5; SIFMA AMG at 11-12.
\542\ CME Group at 14.
---------------------------------------------------------------------------
The Commission believes that publication of the Staff Workbook on
the www.cftc.gov website will provide a centralized location for market
participants to assess whether certain instruments are subject to
Federal position limits. Although the Commission is encouraged that
exchanges may provide redundancy in also publishing this list of core
referenced futures contracts and related referenced contracts listed
for trading on their respective exchanges, the Commission is not
adopting a requirement for exchanges to publish this information at
this time.
Finally, CME Group contended that for commodities with only spot
month limits, financially-settled futures and options contracts should
be excluded from the Staff Workbook and not subject to Federal position
limits if the final settlement/expiry of the cash-settled futures or
option occurs before the spot month period of its core referenced
futures contract begins. CME Group additionally asserted that option
contracts that exercise into physically-settled core referenced futures
contracts should be included in the Staff Workbook and subject to
Federal position limits even if final settlement/expiry of the option
occurs before spot month period begins.
The Commission agrees with both of CME Group's assertions with one
exception. While the Commission agrees that cash-settled futures
contracts and options on such futures contracts that are non-legacy
contracts (i.e., the 16 core referenced futures contracts that will not
have Federal non-spot position limits) and settle or expire prior to
when the spot month limits would become effective in the spot period
are not subject to Federal spot month position limits, such futures and
options contracts do qualify as referenced contracts based on the
settlement price being linked to a core referenced futures contract.
However, because the corresponding 16 core referenced futures contracts
are not subject to non-spot month Federal position limits, then these
cash-settled futures contracts and options contracts similarly are also
not subject to Federal position limits during the non-spot month.
Accordingly, as contracts not subject to Federal spot or non-spot month
position limits, these contracts will not be included in the Staff
Workbook, even if such contracts qualify as referenced contracts. The
Commission further agrees that options that exercise into the
physically-settled core referenced futures contract are within the
definition of referenced contract because when the options are
exercised, they become positions in the core referenced futures
contract.
The Commission is clarifying that it will publish a revised Staff
Workbook shortly after the publication of this Final Rule on the
Commission's website and before the Final Rule's Effective Date. This
revised Staff Workbook will reflect the revised ``referenced contract''
definition, clarify CME Group's discussion with respect to options
discussed in the immediately above paragraph, and generally fix any
errors identified by commenters.
17. ``Short Position''
i. Summary of the 2020 NPRM--Short Position
The Commission proposed to expand the existing definition of
``short position,'' currently defined in Sec. 150.1(h), to include
swaps and to clarify that any such positions would be measured on a
futures-equivalent basis.
ii. Comments and Summary of the Commission Determination--Short
Position
No commenter addressed the proposed definition of ``short
position.'' The Commission is adopting the definition as proposed.
18. ``Speculative Position Limit''
i. Summary of the 2020 NPRM--Speculative Position Limit
The Commission proposed to define the term ``speculative position
limit'' for use throughout part 150 of the Commission's regulations to
refer to Federal or exchange-set limits, net long or net short,
including single month, spot month, and all-months-combined limits.
This proposed definition was not intended to limit the authority of
exchanges to adopt other types of limits that do not meet the
``speculative position limit'' definition, such as a limit on gross
long or gross short positions, or a limit on holding or controlling
delivery instruments.
ii. Comments and Summary of the Commission Determination--Speculative
Position Limit
No commenter addressed the proposed definition of ``speculative
position limit.'' The Commission is adopting the definition as proposed
with some non-substantive technical changes related to the numbering
structure.
19. ``Spot Month,'' ``Single Month,'' and ``All-Months''
i. Summary of the 2020 NPRM--Spot Month, Single Month, and All Months
The Commission proposed to expand the existing definition of ``spot
month'' to: (1) Account for the fact that the proposed limits would
apply to both physically-settled and certain cash-settled contracts;
(2) clarify that the spot month for referenced contracts would be the
same period as that of the relevant core referenced futures contract;
and (3) account for variations in spot month conventions that differ by
commodity.
In particular, for the ICE Sugar No. 11 (SB) core referenced
futures contract, the spot month would mean the period of time
beginning at the opening of trading on the second business day
following the expiration of the regular option contract traded on the
expiring futures contract and ending when the contract expires. For the
ICE Sugar No. 16 (SF) core referenced futures contract, the spot month
would mean the period of time beginning on the third-to-last trading
day of the contract month and ending when the contract expires. For the
CME Live Cattle (LC) core referenced futures contract, the spot month
would mean the period of time beginning at the close of trading on the
first business day following the first Friday of the contract month and
ending when the contract expires.
The Commission also proposed to eliminate the existing definitions
of
[[Page 3309]]
``single month'' and ``all-months'' because the definitions for those
terms would be built into the proposed definition of ``speculative
position limit'' described above.
ii. Comments and Summary of the Commission Determination--Spot Month,
Single Month, and All Months
No commenter addressed the proposed definition of ``spot month'' or
the proposed elimination of the existing definitions of ``single
month'' and ``all months.'' The Commission is adopting the definition
of spot month as proposed, but with a correction to reflect the proper
spot month period for the Live Cattle (LC) core referenced futures
contract. Final Sec. 150.1 defines the spot month for the Live Cattle
(LC) core referenced futures contract as the period of time beginning
at the close of trading on the first business day following the first
Friday of the contract month and ending when the contract expires. The
Commission is eliminating the existing definitions of ``single month''
and ``all months'' as proposed. Finally, the Commission is adopting
some non-substantive technical changes related to the numbering
structure.
20. ``Spread Transaction''
i. Background--Spread Transaction, Existing Sec. 150.3(a)(3)
In existing Sec. 150.3(a)(3), the Commission exempts from Federal
position limits ``spread or arbitrage positions,'' subject to certain
restrictions, including the restriction that the spread position be
outside of the spot month.\543\ The existing regulations do not,
however, define ``spread or arbitrage positions.'' Further, under
existing regulations, spread exemptions from Federal positions limits
are self-effectuating and do not require prior Commission approval.
Rather, market participants must request spread exemptions from the
relevant exchange(s) in advance of exceeding exchange limits.
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\543\ See 17 CFR 150.3(a)(3) (permitting spread or arbitrage
positions that are ``between single months of a futures contract
and/or, on a futures-equivalent basis, options thereon, outside of
the spot month, in the same crop year; provided, however, that such
spread or arbitrage positions, when combined with any other net
positions in the single month, do not exceed the all-months limit
set forth in Sec. 150.2.'')
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ii. Summary of the 2020 NPRM--Spread Transaction
The Commission proposed a ``spread transaction'' definition to
exempt from Federal position limits transactions normally known to the
trade as ``spreads.'' The proposed definition would explicitly include
common types of spread strategies, including: Calendar spreads; inter-
commodity spreads; quality differential spreads; processing spreads
(such as energy ``crack'' or soybean ``crush'' spreads); product or by-
product differential spreads; and futures-options spreads. The proposed
spread transaction definition would also eliminate the existing Sec.
150.3(a)(3) restrictions on spread exemptions, including the
restriction that spread positions be outside of the spot-month.
Under proposed Sec. 150.3(a)(2)(i), positions that meet the
``spread transaction'' definition would be self-effectuating for
purposes of Federal position limits. Separately, under proposed Sec.
150.3(a)(2)(ii), the Commission would, on a case-by-case basis, be able
to exempt any other spread transaction that was not included in the
proposed spread transaction definition, but that the Commission has
determined is consistent with CEA section 4a(a)(3)(B),\544\ and
exempted, pursuant to proposed Sec. 150.3(b).
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\544\ As noted above, CEA section 4a(a)(3)(B) provides that the
Commission shall set limits ``to the maximum extent practicable, in
its discretion--(i) to diminish, eliminate, or prevent excessive
speculation as described under this section; (ii) to deter and
prevent market manipulation, squeezes, and corners; (iii) to ensure
sufficient market liquidity for bona fide hedgers; and (iv) to
ensure that the price discovery function of the underlying market is
not disrupted.''
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iii. Summary of the Commission Determination--Spread Transaction
The Commission is adopting the definition of ``spread transaction''
with certain modifications to the definition to include additional
spread types, as described below, to address commenters' views and
other considerations. The Commission is providing additional
clarification with respect to cash-and-carry exemptions as well as the
application of spread exemptions to the NYMEX NG core referenced
futures contract. The Commission is also adopting Appendix G to part
150 under the Final Rule to provide additional clarifications to market
participants in connection with the Commission's treatment of spread
exemptions under the Final Rule.
iii. Comments--Spread Transaction
Generally, commenters requested that the Commission expand or
clarify the ``spread transaction'' definition to ensure that other
commonly-used spread strategies are exempted from Federal position
limits, including: (1) Intra-market and inter-market spread positions;
\545\ (2) inter-market spread positions where the legs of the
transaction are futures contracts in the same commodity and same
calendar month or expiration; \546\ (3) inter-market spreads in which
one leg is a referenced contract and the other is a commodity
derivative contract (including an OTC swap) that is not subject to
Federal positions limits; \547\ (4) a spread between a physically-
settled position and a cash-settled position; \548\ (5) a spread
between two cash-settled contracts in the spot period, even if one leg
is not subject to Federal position limits; \549\ (6) intra-commodity
spreads (including an intra-commodity spread between two cash-settled
contracts or between the cash-settled and related physically-settled
futures contract); \550\ and (7) cash-and-carry exemptions that are
currently permitted under IFUS Rule 6.29(e).\551\
---------------------------------------------------------------------------
\545\ MFA/AIMA at 10; CMC at 7.
\546\ ICE at 7.
\547\ ICE at 7; FIA at 21.
\548\ CME Group at 11.
\549\ Id.
\550\ CEWG at 27; FIA at 20-21 (explaining that the intra-
commodity spread would acknowledge the link between the prices of
cash-settled and physical delivery futures involving the same
commodity). See also CEWG at 27; CCI at 2-3 (requesting an exemption
for intra-commodity spreads that are: (1) In the same class of
referenced contract, (2) across classes of referenced contracts, or
(3) across markets in referenced contracts (i.e., on different
exchanges) in the same or different calendar months); CEWG at 27
(providing proposed revisions to the ``spread transaction''
regulatory text); CME Group at 11.
\551\ FIA at 21; see also, IFUS at 7-9 (providing an example of
a cash-and-carry exemption and describing such exemption as a type
of calendar month spread where a person holds a long position in the
spot month and a short position in the second nearby contract month)
and IFUS Rule 6.29(e) (outlining its strict procedures that set the
terms by which cash-and-carry exemptions may be permitted, including
the following conditions: (i) The person seeking the exemption must
provide the cost of carrying the physical commodity, the minimum
spread differential at which it will enter into a straddle position
in order to obtain profit, and the quantity of stocks currently
owned in IFUS licensed warehouses or tank facilities; (ii) when
granted a cash and carry exemption, the person receiving the
exemption shall agree that before the price of the nearby contract
month rises to a premium to the second contract month, it will
liquidate all long positions in the nearby contract month; and (iii)
block trades may not be used to establish positions upon which a
cash and carry exemption request is based). IFUS further explained
that it has a long history of granting cash and carry exemptions for
certain warehoused contracts (specifically coffee, cocoa, and FCOJ),
and that where there are plentiful supplies, these exemptions serve
an economic purpose in the days leading up to the first notice day
and throughout the notice period, because: (1) They help maintain an
appropriate economic relationship between the nearby and next
successive contract month; (2) they allow commercial market
participants the opportunity to compete for the ownership of
certified inventories beyond the limitations of the spot-month
position limit; and (3) the holder of the exemption provides
liquidity so that traders that carry short positions into the notice
period without capability to deliver may exit their positions in an
orderly manner. According to IFUS, if the appropriate supply and
price relationship exists in a given expiry, and the exchange grants
the application, then proper application of the terms as expiry
approaches will assist in an orderly expiration. IFUS 7-9; FIA at
21.
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[[Page 3310]]
In addition, commenters requested that the Commission clarify that:
(1) The ``spread transaction'' definition is a non-exhaustive list, and
therefore, permit exchanges to grant spread exemptions that are not
covered by Sec. 150.3(a)(2) by using the streamlined process in Sec.
150.9 for recognizing non-enumerated bona fide hedges; \552\ and (2) a
calendar spread would permit a market participant to net down its
positions for the purposes of Federal spot-month and single-month
limits.\553\
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\552\ ICE at 7.
\553\ Citadel at 8-9.
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iv. Discussion of Final Rule--Spread Transaction
The Commission is adopting the proposed definition of ``spread
transaction'' with certain modifications, as described below, to
address commenters' views and other considerations. First, the
Commission is expanding the definition to include additional types of
spreads. Second, the Commission is clarifying the treatment of cash-
and-carry exemptions as permissible calendar spreads and providing
additional guidance to exchanges in connection with such spreads.
Third, the Commission addresses the application of spread exemptions in
connection with the NYMEX NG core referenced futures contract. The
Commission is also providing additional guidance on the use of exempt
spread transactions in Appendix G of this Final Rule.
a. The ``Spread Transaction'' Definition Includes Several Additional
Spread Types Under the Final Rule
First, the Commission is expanding the proposed ``spread
transaction'' definition to make clear that the definition as finalized
includes intra-market, inter-market, and intra-commodity spread
positions in addition to the spread strategies listed in the proposed
definition. The final ``spread transaction'' definition will cover:
Intra-market spreads, inter-market spreads, intra-commodity spreads,
and inter-commodity spreads, including calendar spreads, quality
differential spreads, processing spreads, product or by-product
differential spreads, and futures-options spreads.\554\ The Commission
intends for the spread transaction definition to be sufficiently broad
to capture most, if not all, spread strategies currently granted by
exchanges and used by market participants. The Commission believes this
is consistent with, but provides more clarity than, its existing
approach to spread exemptions in existing Sec. 150.3(a)(3), which
broadly exempts ``spread or arbitrage positions.'' \555\
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\554\ For example, trading activity in many commodity derivative
markets is concentrated in the nearby contract month, but a hedger
may need to offset risk in deferred months where derivative trading
activity may be less active. A calendar spread trader could provide
liquidity without exposing himself or herself to the price risk
inherent in an outright position in a deferred month. Processing
spreads can serve a similar function. For example, a soybean
processor may seek to hedge his or her processing costs by entering
into a ``crush'' spread, i.e., going long soybeans and short soybean
meal and oil. A speculator could facilitate the hedger's ability to
do such a transaction by entering into a ``reverse crush'' spread
(i.e., going short soybeans and long soybean meal and oil). Quality
differential spreads, and product or by-product differential
spreads, may serve similar liquidity-enhancing functions when
spreading a position in an actively traded commodity derivatives
market such as CBOT Wheat (W) against a position in another actively
traded market, such as MGEX Wheat.
\555\ Under existing regulations, the Commission views its use
of the term ``spread'' to mean the same as ``arbitrage'' or
``straddle'' as those terms are used in CEA section 4a(a) and
existing Sec. 150.3(a)(3) of the Commission's regulations.
Consistent with existing regulations, the Commission's sole use of
the term ``spread'' in this rulemaking is intended to also capture
arbitrage or straddle strategies, and is not intended to be a
substantive change from its existing regulations. The Commission
notes that certain exchanges may distinguish between ``spread'' and
``arbitrage'' positions for purposes of exchange exemptions, but the
Commission does not make that distinction here for purposes of its
``spread transaction'' definition.
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In light of the revised ``spread transaction'' definition, the
Commission expects that most spread strategies will qualify as intra-
market, inter-market, inter-commodity, or intra-commodity spreads, and
is providing a non-exhaustive list of the most common specific types of
spread strategies that fall within those four categories. Any requests
for spread exemptions that fall outside of the spread transaction
definition are required to be submitted to the Commission in advance
pursuant to Sec. 150.3(b) of the Final Rule. Accordingly, the
Commission has determined not to allow exchanges to grant new types of
spread exemptions using the streamlined process in Sec. 150.9 for
various reasons explained below in detail under the discussion of Sec.
150.3.\556\
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\556\ See infra Section II.C.4. (discussing statutory and policy
reasons why the Commission will not permit exchanges to process
requests for spread exemptions that are not included in the ``spread
transaction'' definition using the Sec. 150.9 process).
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In addition, considering the significant number of requests for
clarification commenters submitted regarding the spread transaction
definition, the Commission is providing guidance on spread transactions
in Appendix G to part 150 of the Commission's regulations, as adopted
in this Final Rule, to address those questions and other
considerations. In particular, paragraph (a) of the guidance provides
some recommended best practices for exchanges to consider when granting
spread exemptions, especially during the spot period. Paragraph (a) of
the guidance also reminds exchanges of their existing obligations as
self-regulatory organizations, including under DCM Core Principle 5 and
SEF Core Principle 6, as applicable, to implement their exchange-set
limits and exemption granting processes in a way that (consistent with
the rules and procedures in final Sec. 150.5 adopted herein) \557\
reduces the potential threat of market manipulation or congestion.
---------------------------------------------------------------------------
\557\ See infra Section II.D. (discussing exchanges' obligations
when setting exchange position limits and granting exemptions
therefrom).
---------------------------------------------------------------------------
Moreover, paragraph (b) of the guidance clarifies that the
following spread strategies are covered by the ``spread transaction''
definition: (1) Inter-market spread positions where the legs of the
transaction are futures contracts in the same commodity and same
calendar month or expiration; (2) spread positions in which one leg is
a referenced contract and the other is a commodity derivative contract
that is not subject to Federal positions limits (including OTC
commodity derivative contracts, but not including commodity index
contracts); \558\ (3) a spread between a physically-settled position
and a cash-settled position; (4) a spread between two cash-settled
contracts; (5) certain cash-and-carry exemptions, subject to certain
recommendations and considerations outlined in paragraph (c) of the
Commission's guidance in Appendix G of this Final Rule; and (6) spreads
that are ``legged in'' or carried out in two steps.
---------------------------------------------------------------------------
\558\ To avoid subverting the Commission's policy on not
allowing self-effectuating risk management exemptions (except
through the pass-through swap provision), the spread transaction
definition would not cover a spread position in which one leg is a
referenced contract and the other leg is a commodity index contract,
as clarified in Appendix G.
---------------------------------------------------------------------------
b. ``Cash-and-Carry'' Exemptions
Second, as mentioned above, paragraph (c) of the guidance
recommends certain factors for exchanges to consider when granting
cash-and-carry exemptions.\559\ The
[[Page 3311]]
Commission understands that IFUS has granted this type of calendar
spread exemption for some time, and has experience monitoring the use
of such exemptions to ensure that its market operates in a manner that
is consistent with the applicable DCM Core Principles.\560\ The
Commission has, however, previously expressed concern about these
exemptions and their impact on the spot month price for a particular
futures contract.\561\ In particular, the Commission has explained that
a large demand for delivery on cash-and-carry positions might distort
the price of the expiring futures contract upwards.\562\ This would
particularly be a concern in those commodity markets where price
discovery for the cash spot price occurred in the expiring futures
contract.\563\
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\559\ As final Appendix G provides, the spread transaction
definition in Sec. 150.1 permits transactions commonly known as
``cash-and-carry'' trades whereby a market participant enters a long
futures positions in the spot month and an equivalent short futures
position in the following month, in order to guarantee a return
that, at minimum, covers the costs of its carrying charges. With
this exemption, the market participant is able to take physical
delivery of the product in the nearby month and may redeliver the
same product in a deferred month.
\560\ See IFUS at 7-9 and ICE Futures U.S. Rule 6.29(e).
\561\ See 81 FR at 96833.
\562\ Id.
\563\ See 81 FR at 96833.
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The Commission recognizes, however, the importance of cash-and-
carry positions in the price discovery process in certain markets and
reminds exchanges of their responsibility to monitor and safeguard
against convergence issues that could arise related to the use of cash-
and-carry exemptions. Accordingly, the Commission views these
exemptions as a type of calendar spread strategy that warrants
additional guidance to encourage exchanges to have suitable safeguards
in place to ensure that they grant and monitor cash-and-carry
exemptions in a manner that is consistent with their obligation to
reduce the potential threat of market manipulation and congestion.
c. Treatment of Spread Transactions Involving NYMEX NG
Third, the Commission is providing clarification regarding the
intersection of the conditional natural gas spot month limit exemption
and spread exemptions permitted under Sec. 150.3. As set forth in
Appendix G, the Commission reinforces that a spread transaction
exemption would not cover natural gas spot month positions that exceed
the conditional natural gas spot month limit in Sec. 150.3(a)(4) of
this Final Rule. That is, a market participant cannot rely on a spread
transaction exemption to hold a spot month position that would exceed
the equivalent of 10,000 contracts of the NYMEX Henry Hub Natural Gas
core referenced futures contract per exchange that lists a natural gas
cash-settled referenced contract. Additional discussion on the natural
gas conditional spot month limit exemption is provided further
below.\564\
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\564\ See infra Section II.B.3.vi.a. (discussing the Federal
spot-month limit for natural gas under Sec. 150.2) and Section
II.C.6 (discussing the conditional spot-month limit for natural gas
under Sec. 150.3(a)(4)).
---------------------------------------------------------------------------
As discussed further below, in Sec. 150.3, the Commission is
providing an exemption from the Federal spot month position limit level
for natural gas. The natural gas conditional spot month limit exemption
allows a trader to hold up to: (1) 10,000 spot month cash-settled NYMEX
NG referenced contracts per exchange that lists a cash-settled NYMEX NG
referenced contract (of which there are currently three--NYMEX, IFUS,
and Nodal); and (2) an additional position in cash-settled economically
equivalent NYMEX NG OTC swaps that has a notional amount equal to
10,000 equivalent-sized contracts; provided, that the market
participant does not hold positions in the spot month of the
physically-settled NYMEX NG referenced contract.\565\ The Commission
adopted the Federal conditional limit for natural gas in order to avoid
disrupting the well-developed, unique liquidity characteristics of the
natural gas derivatives markets, in which the cash-settled natural gas
referenced contracts, when combined, have significantly higher
liquidity than the physically-settled natural gas contracts. The
Federal conditional limit requires divestiture of the spot month
physically-settled NYMEX referenced contract due to concerns about,
among other things, fostering an environment that incentivizes traders
to manipulate the physically-settled NYMEX NG referenced contract in
order to benefit a larger cash-settled position in natural gas (i.e.,
``bang'' or ``mark'' the close). The Commission intends for the natural
gas conditional limit's position limit levels to serve as a firm cap
for the maximum amount of cash-settled natural gas spot month positions
a trader can hold. The Commission clarifies that a person cannot
circumvent this cap using a spread transaction exemption.
---------------------------------------------------------------------------
\565\ This is different from the final Federal spot month
position limits for NYMEX NG, pursuant to which a trader may hold up
to: (1) 2,000 cash-settled NYMEX NG referenced contracts per
exchange that lists a cash-settled NYMEX NG referenced contract; (2)
an additional position in cash-settled economically equivalent NYMEX
NG OTC swaps that has a notional amount equal to 2,000 equivalent-
sized contracts; and (3) 2,000 physically-settled NYMEX NG
referenced contracts.
---------------------------------------------------------------------------
That is, the Commission believes that cash-settled natural gas
positions that exceed the natural gas conditional limit in the spot
month would be unusually large and could potentially have a disruptive
effect on the physically-settled natural gas contract, including by
inhibiting convergence at expiration. Specifically, by allowing traders
to layer additional cash-settled natural gas spot month positions on
top of the maximum cash-settled natural gas spot month positions
permitted under the natural gas conditional limit, a person could amass
an extremely large cash-settled spot month position in natural gas.
This extremely large cash-settled spot month position could push prices
up for cash-settled spot month contracts vis-[agrave]-vis the
physically-settled spot month contracts. In response, arbitrageurs may
attempt to capitalize on this price discrepancy by going short the
cash-settled spot month contracts, which would have a downward pressure
on the price of these contracts, and going long on the physically-
settled spot month contracts, which would have an upward pressure on
the price of these contracts. This upward price pressure on the
physically-settled contract could potentially push the price of the
physically-settled contract away from the actual cash price for the
natural gas commodity, which could disrupt convergence upon expiration
of the physically-settled contract. As such, the Commission clarifies
that a person cannot layer a spread exemption on top of the conditional
spot month limit in natural gas and thereby circumvent the conditional
spot month limit cap.\566\
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\566\ For the avoidance of doubt, traders who avail themselves
of a spread exemption and enter into spread positions between the
physically-settled NYMEX NG core referenced futures contract during
the spot month and one or more cash-settled natural gas referenced
contracts or cross commodity contracts, are not allowed under the
Final Rule to avail themselves of the natural gas conditional limit
until they exit the above-noted spread position.
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21. ``Swap'' and ``Swap Dealer''
i. Summary of the 2020 NPRM--Swap and Swap Dealer
The Commission proposed to incorporate the definitions of ``swap''
and ``swap dealer'' as they are defined in section 1a of the Act and
Sec. 1.3 of this chapter.\567\
---------------------------------------------------------------------------
\567\ 7 U.S.C. 1a(47) and 1a(49); 17 CFR 1.3.
---------------------------------------------------------------------------
ii. Comments and Summary of the Commission Determination--Swap and Swap
Dealer
No commenter addressed the proposed definitions of ``swap'' or
``swap dealer.'' The Commission is adopting these definitions as
proposed.
[[Page 3312]]
22. ``Transition Period Swap''
i. Summary of the 2020 NPRM--Transition Period Swap
The Commission proposed to create the defined term ``transition
period swap'' to mean any swap entered into during the period
commencing after the enactment of the Dodd-Frank Act of 2010 (July 22,
2010) and ending 60 days after the publication of a final Federal
position limits rulemaking in the Federal Register. As discussed in
connection with proposed Sec. 150.3 later in this release, if acquired
in good faith, such swaps would be exempt from Federal position limits,
although such swaps could not be netted with post-effective date swaps
for purposes of complying with spot month speculative position limits.
ii. Comments and Summary of the Commission Determination--Transition
Period Swap
No commenter addressed the proposed definition of ``transition
period swap.'' The Commission is adopting the definition as proposed,
with two modifications. The Commission is clarifying that a transition
period swap is a swap entered into during the period commencing ``on
the day of,'' rather than ``after,'' the enactment of the Dodd-Frank
Act of 2010 to clarify the ambiguity of the phrase ``after the
enactment.'' The Commission is also adding a phrase to clarify that the
terms of such swaps ``have not expired as of 60 days after the
publication date.'' The Commission intended to include this in the 2020
NPRM, but the language was inadvertently omitted from the proposed
definition. This modification conforms to the definition of ``pre-
enactment swap,'' which also addresses the timeframe for expiration of
a swap's terms.
23. Deletion of Sec. 150.1(i)
i. Summary of 2020 NPRM--Deletion of Sec. 150.1(i)
The Commission proposed to eliminate existing Sec. 150.1(i), which
includes a table specifying the ``first delivery month of the crop
year'' for certain commodities. The crop year definition had been
pertinent for purposes of the spread exemption to the individual month
limit in current Sec. 150.3(a)(3), which limits spreads to those
between individual months in the same crop year and to a level no more
than that of the all-months limit. This provision was pertinent at a
time when the single month and all-months-combined limits were
different, which is no longer the case.
ii. Comments and Summary of the Commission Determination--Deletion of
Sec. 150.1(i)
No commenter addressed the proposed elimination of existing Sec.
150.1(i). The Commission is adopting as proposed. Now that the current
and proposed single month and all months combined limits are the same,
and now that the Commission is adopting new enumerated bona fide hedges
in Sec. 150.1 and Appendix B to part 150 as well as a new process for
granting spread exemptions in Sec. 150.3, this provision is no longer
needed.
B. Sec. 150.2--Federal Position Limit Levels
This section will address the issues related to Federal position
limit levels in final Sec. 150.2 in the following order:\568\
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\568\ In connection with the discussion of Sec. 150.2 that
appears below, for each numbered section, the Commission generally
provides a summary of the proposed approach, a brief overview of the
Commission's final determination, a summary of comments, and the
Commission's response to comments.
---------------------------------------------------------------------------
(1) Background of the existing Federal position limit levels;
(2) identification of contracts subject to both Federal spot and
non-spot month position limits, and contracts subject only to Federal
spot month position limits;
(3) Federal spot month position limit levels;
(4) Federal non-spot month position limit levels;
(5) the establishment of subsequent spot month and non-spot month
position limit levels;
(6) relevant contract months;
(7) limits on ``pre-existing positions'';
(8) positions on foreign boards of trade;
(9) anti-evasion;
(10) netting and Federal position limit levels for cash-settled
referenced contracts; and
(11) ``eligible affiliates'' and position aggregation.
As part of the discussion of Federal spot month position limit
levels (noted as issue (3) above and found in Section II.B.3. below),
the Commission also will address Federal spot month position limit
levels specifically for (i) ICE Cotton No. 2 (CT), (ii) NYMEX Henry Hub
Natural Gas (NG), and (iii) the three wheat core referenced futures
contracts. Similarly, as part of the discussion of Federal non-spot
month position limit levels (noted as issue (4) above and found in
Section II.B.4. below), the Commission will also address Federal non-
spot month position limit levels specifically for (i) ICE Cotton No. 2
(CT) and (ii) the three wheat core referenced futures contracts.
1. Background--Existing Federal Position Limit Levels--Sec. 150.2
Federal spot month, single month, and all-months-combined position
limits currently apply to the nine physically-settled legacy
agricultural contracts listed in existing Sec. 150.2, and, on a
futures-equivalent basis, to options contracts thereon. Existing
Federal position limit levels set forth in Sec. 150.2 \569\ apply net
long or net short and are as follows:
---------------------------------------------------------------------------
\569\ 17 CFR 150.2.
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[[Page 3313]]
[GRAPHIC] [TIFF OMITTED] TR14JA21.006
While not explicitly stated in Sec. 150.2, the Commission's
practice has been to set Federal spot month position limit levels at or
below 25% of deliverable supply based on exchange estimates of
deliverable supply (``EDS'') that are verified by the Commission, and
to set Federal position limit levels outside of the spot month at 10%
of open interest for the first 25,000 contracts of open interest, with
a marginal increase of 2.5% of open interest thereafter.
2. Application of Federal Position Limits During the Spot Month and the
Non-Spot Month
i. Summary of the 2020 NPRM--Application of Federal Position Limits
During the Spot Month and the Non-Spot Month
The 2020 NPRM imposed Federal position limits during all contract
months for the nine legacy agricultural contracts (and their associated
referenced contracts), and only during the spot month for the 16 non-
legacy core referenced futures contracts (and their associated
referenced contracts) that would be subject to Federal position limits
for the first time.\570\ For the 16 non-legacy core referenced futures
contracts (and their associated referenced contracts), the 2020 NPRM
also required that they be subject to exchange-set position limits or
position accountability outside of the spot month.\571\
---------------------------------------------------------------------------
\570\ As noted in further detail in Section II.A.16., their
associated referenced contracts are also subject to Federal position
limits.
\571\ Proposed Sec. 150.5(b)(2). For existing exchange-set
position limits, see Market Resources, ICE Futures U.S. Website,
available at https://www.theice.com/futures-us/market-resources (ICE
exchange-set position limits); Position Limits, CME Group website,
available at https://www.cmegroup.com/market-regulation/position-limits.html; Rules and Regulations of the Minneapolis Grain
Exchange, Inc., MGEX, available at http://www.mgex.com/documents/Rulebook_051.pdf (MGEX exchange-set position limits).
---------------------------------------------------------------------------
The Commission proposed to maintain (rather than remove) Federal
non-spot month position limits for the nine legacy agricultural
contracts, with the modifications described further below, because the
Commission has observed no reason to eliminate them.\572\ These non-
spot month position limits have been in place for decades, and while
the Commission proposed to modify the Federal non-spot month position
limit levels, the Commission believed that removing them entirely could
potentially result in market disruption. The Commission's position was
reinforced by the feedback it received from commercial market
participants trading the nine legacy agricultural contracts who
requested that the Commission maintain Federal position limits outside
of the spot month in order to promote market integrity.\573\
---------------------------------------------------------------------------
\572\ 85 FR at 11628.
\573\ Id.
---------------------------------------------------------------------------
ii. Summary of the Commission Determination--Application of Federal
Position Limits During the Spot Month and the Non-Spot Month
The Commission is adopting the approach that was proposed in the
2020 NPRM. Under the Final Rule, Federal position limits apply to all
25 core referenced futures contracts during the spot month. The 16 non-
legacy core referenced futures contracts subject to Federal position
limits for the first time under the Final Rule are subject to Federal
position limits only during the spot month (and not outside of the spot
month). Outside of the spot month, these 16 core referenced futures
contracts are subject only to exchange-set position limits or position
accountability.
iii. Comments--Application of Federal Position Limits During the Spot
Month and the Non-Spot Month
Many commenters generally agreed with the proposed approach and
supported Federal position limits during the spot month for all 25 core
referenced futures contracts, and outside of the spot month for only
the nine legacy agricultural contracts.\574\ The Commission did not
receive any comments objecting to Federal spot month position limits
for all 25 core referenced futures contracts.
---------------------------------------------------------------------------
\574\ See MGEX at 1; CHS at 2; CME Group at 2; IFUS at 2; ICE at
2, 3-4; Chevron at 2; CMC at 6; EEI at 4; FIA at 2; MFA/AIMA at 2-3;
NCFC at 4; Shell at 3; PIMCO at 4; SIFMA AMG at 4; Suncor at 2; AQR
at 2, 4-5, 7-10; CCI at 2; COPE at 4; IECA at 2; NGSA at 3; CEWG at
3; and AFIA at 2.
---------------------------------------------------------------------------
On the other hand, the Commission received comments expressing
concern over two related issues. First, a few commenters disagreed with
the 2020 NPRM imposing Federal non-spot month position limits on only
the nine legacy agricultural contracts.\575\ NEFI stated that ``the
proposed rule arbitrarily fails to establish limits for non-spot month
referenced energy contracts'' and stated that ``distributing limits
across all
[[Page 3314]]
months is preferable, as it would protect market convergence and mute
disruptive signals from large speculative trades.'' \576\ PMAA echoed
similar concerns by stating that there was ``no data or discussion
provided in the proposal indicating why the Commission believes limits
for non-spot months are not appropriate.'' \577\
---------------------------------------------------------------------------
\575\ In addition to comments from NEFI and PMAA, which are
discussed below, AFR and Rutkowski asserted that the 2020 NPRM will
likely be ``ineffective in controlling excessive speculation'' due,
in part, to its failure to ``impose Federal position limits outside
of the current spot month for most commodities (outside of legacy
agricultural commodities).'' AFR at 2 and Rutkowski at 2.
\576\ NEFI at 3 and PMAA at 3 (with respect to energy commodity
positions, ``[h]istory has shown on a number of occasions that large
trades in non-spot months can distort markets and increase
volatility'').
\577\ PMAA at 3. PMAA also suggested that the Commission apply
the ``traditional 2.5% limit formula to energy contracts and
economically equivalent energy futures, options, and swaps in non-
spot months.''
---------------------------------------------------------------------------
Second, commenters also expressed concern that, by only having
Federal non-spot month position limits for the nine legacy agricultural
contracts, the Commission is relying too much on the exchanges to
address excessive speculation.\578\ In particular, commenters were
concerned about the incentives and other conflicts of interest that
exchanges may have to permit ``higher trading volumes and large numbers
of market participants'' \579\ and about the exchanges' use of position
accountability by alleging that it is a ``voluntary'' limit \580\ and
pointing to ``recent notable failures in exchange accountability
regimes.'' \581\
---------------------------------------------------------------------------
\578\ NEFI at 3; PMAA at 3; and IATP at 10.
\579\ NEFI at 3.
\580\ Id.
\581\ IATP at 10. See also PMAA at 3 (``[u]nfortunately, the
proposal instead finds accountability limits to be sufficient to
manage speculation'').
---------------------------------------------------------------------------
iv. Discussion of Final Rule--Application of Federal Position Limits
During the Spot Month and the Non-Spot Month
The Commission is adopting the approach that was proposed in the
2020 NPRM by applying Federal position limits to all 25 core referenced
futures contracts during the spot month, but only to the existing nine
legacy agricultural contracts outside of the spot month for the reasons
discussed below.
a. Response to Comments Opposing the 2020 NPRM's Approach To Subject
Only the Nine Legacy Agricultural Contracts to Federal Non-Spot Month
Position Limits
The Commission has concluded that, while it may be important and,
as described below, necessary \582\ to impose Federal spot month
position limits on each core referenced futures contract, the analysis
changes with respect to the non-spot month for the following reasons.
---------------------------------------------------------------------------
\582\ See infra Section III.E. (discussing necessity finding for
spot month and non-spot month position limits).
---------------------------------------------------------------------------
First, while the Final Rule only applies Federal position limits to
the 16 non-legacy core referenced futures contracts during the spot
month, the Final Rule requires exchanges to establish either position
limit levels or position accountability outside of the spot month for
all such contracts.\583\ Accordingly, all 16 non-legacy core referenced
futures contracts will be subject to either position limits or position
accountability outside of the spot month at the exchange level. Any
such exchange-set position limit and position accountability must
comply with the standards established by the Commission in final Sec.
150.5(b) including, among other things, that any such levels be
``necessary and appropriate to reduce the potential threat of market
manipulation or price distortion of the contract's or the underlying
commodity's price or index.'' \584\ Exchanges are also required to
submit any rules adopting or modifying such position limit or position
accountability to the Commission in advance of implementation pursuant
to part 40 of the Commission's regulations.\585\ Additionally,
exchanges are subject to DCM Core Principle 5 or SEF Core Principle 6,
as applicable, which establish additional protections against
manipulation and congestion.\586\ These tools and legal obligations, in
conjunction with surveillance at both the exchange and Federal level,
will continue to offer strong deterrence and protection against
manipulation and disruptions outside of the spot month.\587\
---------------------------------------------------------------------------
\583\ Final Sec. 150.5(b)(2).
\584\ Id.
\585\ 17 CFR part 40. Under the final ``position
accountability'' definition in Sec. 150.1, exchange accountability
rules must require a trader whose position exceeds the
accountability level to consent to: (1) Provide information about
its position to the exchange; and (2) halt increasing further its
position or reduce its position in an orderly manner, in each case
as requested by the exchange.
\586\ Commission regulation Sec. 38.300, which mirrors DCM Core
Principle 5, states: ``To reduce the potential threat of market
manipulation or congestion (especially during trading in the
delivery month), the board of trade shall adopt for each contract of
the board of trade, as is necessary and appropriate, position
limitations or position accountability for speculators. For any
contract that is subject to a position limitation established by the
Commission, pursuant to section 4a(a), the board of trade shall set
the position limitation of the board of trade at a level not higher
than the position limitation established by the Commission.'' 17 CFR
38.300 and 7 U.S.C. 7(d)(5). Likewise, Commission regulation Sec.
37.600, which mirrors SEF Core Principle 6, states: ``(a) In
general. To reduce the potential threat of market manipulation or
congestion, especially during trading in the delivery month, a swap
execution facility that is a trading facility shall adopt for each
of the contracts of the facility, as is necessary and appropriate,
position limitations or position accountability for speculators. (b)
Position limits. For any contract that is subject to a position
limitation established by the Commission pursuant to section 4a(a)
of the Act, the swap execution facility shall: (1) Set its position
limitation at a level no higher than the Commission limitation; and
(2) Monitor positions established on or through the swap execution
facility for compliance with the limit set by the Commission and the
limit, if any, set by the swap execution facility.'' 17 CFR 37.600
and 7 U.S.C. 7b-3(f)(6).
\587\ 85 FR at 11629.
---------------------------------------------------------------------------
Second, in response to the concerns expressed by NEFI and PMAA that
a lack of Federal non-spot month position limits could harm market
convergence and lead to disruptive signals from large speculative
trades,\588\ the Commission reiterates that corners and squeezes, and
related convergence issues, do not occur outside of the spot month when
there is no threat of delivery.\589\ Convergence occurs during the spot
month and, specifically, at the expiration of the spot month for a
physically-settled contract. As a result, positions outside of the spot
month have minimal impact on convergence. The Commission, however,
recognizes that it is possible that unusually large positions in
contracts outside of the spot month could distort the natural spread
relationship between contract months. For example, if traders hold
unusually large positions outside of the spot month, and if those
traders exit those positions immediately before the spot month, that
could cause congestion and also affect the pricing of the spot month
contract. While such congestion or price distortion cannot be ruled
out, exchange-set position limits and position accountability function
to mitigate against such risks. Thus, the position limits framework
adopted herein is able to guard against any such possibility through
the tools and legal obligations applicable to exchanges that are
described in the prior paragraph.
---------------------------------------------------------------------------
\588\ NEFI at 3 and PMAA at 3.
\589\ In the case of certain commodities, it may become
difficult to exert market power via concentrated futures positions
in deferred month contracts. For example, a participant with a large
cash-market position and a large deferred futures position may
attempt to move cash markets in order to benefit that deferred
futures position. Any attempt to do so could become muted due to
general futures market resistance from multiple vested interests
present in that deferred futures month (i.e., the overall size of
the deferred contracts may be too large for one individual to
influence via cash-market activity). However, if a large position
that is accumulated over time in a particular deferred month is held
into the spot month, it is possible that such positions could form
the groundwork for an attempted corner or squeeze in the spot month.
---------------------------------------------------------------------------
Third, limiting Federal non-spot month position limits to the nine
legacy agricultural commodities may limit any market disruptions that
could result
[[Page 3315]]
from adding new Federal non-spot month position limits on certain metal
and energy commodities that have never been subject to Federal position
limits.\590\
---------------------------------------------------------------------------
\590\ 85 FR at 11629.
---------------------------------------------------------------------------
b. Response to Comments Regarding the Commission's Reliance on
Exchanges
In response to commenters' specific concerns about the reliance on
exchanges' position accountability, the Commission views position
accountability outside of the spot month as a more flexible alternative
to Federal non-spot month position limits.\591\ Position accountability
establishes a level at which an exchange will start investigating a
trader's current position. This will include, among other things,
asking traders additional questions regarding their strategies and
their purpose for the positions, while evaluating them under current
market conditions. If a position does not raise any concerns, the
exchange will allow the trader to exceed the accountability level. If
the position raises concerns, the exchange has the authority to
instruct the trader to stop adding to the trader's position, or to
reduce the position. Position accountability is a particularly
effective tool because it provides the exchanges with an opportunity to
intervene once a position hits a relatively low level (vis-[agrave]-vis
the level at which a Federal or an exchange position limit level would
typically be set), while still affording market participants with the
flexibility to establish a position that exceeds the position
accountability level if it is justified by the nature of the position
and market conditions. Position accountability applies to all
participants on the exchange, whether commercial or non-commercial, and
regardless of whether the relevant participant would qualify for an
exemption.
---------------------------------------------------------------------------
\591\ Id.
---------------------------------------------------------------------------
The Commission has decades of experience overseeing position
accountability implemented by exchanges, including for all 16 non-
legacy core referenced futures contracts that are not subject to
Federal position limits outside of the spot month.\592\ Based on the
Commission's experience, position accountability has functioned
effectively.\593\ Furthermore, the Commission notes that position
accountability is not the only tool available for exchanges. As noted
previously, exchanges can also utilize exchange-set position limits.
Several exchanges have set non-spot month position limits for contracts
that are not subject to Federal position limits, and all of them appear
to have functioned effectively based on the Commission's observation of
those markets.\594\
---------------------------------------------------------------------------
\592\ See, e.g., 56 FR at 51687 (Oct. 15, 1991) (permitting CME
to establish position accountability for certain financial contracts
traded on CME); Speculative Position Limits--Exemptions from
Commission Rule 1.61, 57 FR 29064 (June 30, 1992) (permitting the
use of accountability for trading in energy commodity contracts);
and 17 CFR 150.5(e) (2009) (formally recognizing the practice of
accountability for contracts that met specified standards).
\593\ 85 FR at 11629.
\594\ For example, exchanges have set non-spot month position
limits for the following core referenced futures contracts, even
though such contracts currently are not subject to Federal non-spot
month position limits (and will continue to be subject only to
Federal spot month position limits under this Final Rule): (1) CME
Live Cattle (LC), which has an exchange-set single month position
limit level of 6,300 contracts, but no all-months-combined position
limit; (2) ICE FCOJ-A (OJ), which has an exchange-set single month
position limit level of 3,200 contracts and an all-months-combined
position limit level of 3,200 contracts; and (3) ICE Sugar No. 16,
which has an exchange-set single month position limit level of 1,000
contracts and an all-months-combined position limit level of 1,000
contracts.
---------------------------------------------------------------------------
With respect to IATP's reference to ``recent notable failures'' in
position accountability levels, IATP appears to be referencing the
events that involve Kraft Foods Group, Inc. and Mondel[emacr]z Global
LLC with respect to the CBOT Wheat (W) contract in 2011\595\ and United
States Oil Fund, LP (``US Oil'') with respect to the WTI contract
earlier this year.\596\ With respect to CBOT Wheat (W), CBOT did not
have position accountability for that contract at that time. With
respect to the WTI contract, IATP does not describe the failure in
position accountability that occurred with respect to US Oil and how
such failure resulted in negative prices in the WTI contract.\597\
---------------------------------------------------------------------------
\595\ CFTC Charges Kraft Foods Group, Inc. and Mondel[emacr]z
Global LLC with Manipulation of Wheat Futures and Cash Wheat Prices
(Apr. 1, 2015), U.S. Commodity Futures Trading Commission website,
available at https://www.cftc.gov/PressRoom/PressReleases/7150-15.
\596\ IATP at 5, 10, and 18.
\597\ Id.
---------------------------------------------------------------------------
With respect to commenter concerns about the incentives of
exchanges, the Commission believes that, although exchanges may have a
financial interest in increased trading volume, whether speculative or
hedging, the Commission closely oversees the establishment,
modification, and implementation of exchange-set position limits and
position accountability. As noted above, both exchange-set position
limits and position accountability must comply with standards
established by the Commission in final Sec. 150.5(b) including, among
other things, that any such levels be ``necessary and appropriate to
reduce the potential threat of market manipulation or price distortion
of the contract's or the underlying commodity's price or index.'' \598\
Exchanges are also required to submit any rules adopting or modifying
exchange-set position limits or position accountability to the
Commission in advance of implementation, pursuant to part 40 of the
Commission's regulations.\599\ Additionally, exchanges are subject to
DCM Core Principle 5 or SEF Core Principle 6, as applicable, which
establishes additional protections against manipulation and
congestion.\600\ Furthermore, exchange-set position limits and position
accountability will be subject to rule enforcement reviews by the
Commission.\601\ Finally, the Commission notes that exchanges also have
significant financial incentives and regulatory obligations to maintain
well-functioning markets. This observation, which has been supported by
studies, is discussed in greater detail below.\602\
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\598\ Final Sec. 150.5(b)(2).
\599\ 17 CFR part 40.
\600\ 17 CFR 38.300 and 17 CFR 37.600.
\601\ The Commission conducts regular rule enforcement reviews
of each exchange's audit trail, trade practice surveillance,
disciplinary, and dispute resolution programs for ongoing compliance
with the Core Principles. See Rule Enforcement Reviews of Designated
Contract Markets, available at https://www.cftc.gov/IndustryOversight/TradingOrganizations/DCMs/dcmruleenf.html.
\602\ Section II.B.3.iii.b.(3)(iii) (Concern over Exchanges'
Conflict of Interest and Improper Incentives in Maintaining Their
Markets).
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3. Federal Spot Month Position Limit Levels
i. Summary of the 2020 NPRM--Federal Spot Month Position Limit Levels
[[Page 3316]]
Under the 2020 NPRM, the Commission proposed applying Federal spot
month position limits to all 25 core referenced futures contracts and
any associated referenced contracts.\603\ The spot month limits would
apply separately to physically-settled and cash-settled referenced
contracts, which meant that a market participant could net positions
across physically-settled referenced contracts and separately net
positions across cash-settled referenced contracts.\604\ However, the
market participant would not be permitted to net cash-settled
referenced contracts with physically-settled referenced contracts.\605\
Proposed Sec. 150.2(e) provided that Federal spot month position limit
levels would be set forth in proposed Appendix E to part 150.\606\ The
proposed spot month position limit levels were as follows:
---------------------------------------------------------------------------
\603\ As described below, under the 2020 NPRM, Federal non-spot
month position limit levels would only apply to the nine legacy
agricultural contracts and their associated referenced contracts.
The 16 non-legacy core referenced futures contracts and their
associated referenced contracts would be subject to Federal position
limits during the spot month, and exchange-set position limits or
position accountability outside of the spot month.
\604\ See Section II.B.10.
\605\ Id.
\606\ Proposed 150.2(e) additionally provided that market
participants would not need to comply with the Federal position
limit levels until 365 days after publication of the Final Rule in
the Federal Register. For further discussion of the Final Rule's
compliance and effective dates, see Section I.D. (Effective Date and
Compliance Period).
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BILLING CODE 6351-01-P
[GRAPHIC] [TIFF OMITTED] TR14JA21.007
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\607\ As of October 15, 2020.
\608\ CBOT's existing exchange-set position limit level for CBOT
Wheat (W) is 600 contracts. However, for its May contract month,
CBOT has a variable spot month position limit level that is
dependent upon the deliverable supply that it publishes from the
CBOT's Stocks and Grain report on the Friday preceding the first
notice day for the May contract month. In the last five trading days
of the expiring futures month in May, the speculative spot month
position limit level is: (1) 600 contracts if deliverable supplies
are at or above 2,400 contracts; (2) 500 contracts if deliverable
supplies are between 2,000 and 2,399 contracts; (3) 400 contracts if
deliverable supplies are between 1,600 and 1,999 contracts; (4) 300
contracts if deliverable supplies are between 1,200 and 1,599
contracts; and (5) 220 contracts if deliverable supplies are below
1,200 contracts.
\609\ The proposed Federal spot month position limit levels for
CME Live Cattle (LC) would feature step-down limit levels similar to
the CME's existing Live Cattle (LC) step-down exchange-set limit
levels. The proposed Federal spot month step down limit level is:
(1) 600 contracts at the close of trading on the first business day
following the first Friday of the contract month; (2) 300 contracts
at the close of trading on the business day prior to the last five
trading days of the contract month; and (3) 200 contracts at the
close of trading on the business day prior to the last two trading
days of the contract month.
\610\ CME's existing exchange-set limit for Live Cattle (LC) has
the following step-down spot month position limit levels: (1) 600
contracts at the close of trading on the first business day
following the first Friday of the contract month; (2) 300 contracts
at the close of trading on the business day prior to the last five
trading days of the contract month; and (3) 200 contracts at the
close of trading on the business day prior to the last two trading
days of the contract month.
\611\ CBOT's existing exchange-set spot month position limit
level for Rough Rice (RR) is 600 contracts for all contract months.
However, for July and September, there are step-down limit levels
from 600 contracts. In the last five trading days of the expiring
futures month, the speculative spot month position limit for the
July futures month steps down to 200 contracts from 600 contracts
and the speculative position limit for the September futures month
steps down to 250 contracts from 600 contracts.
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[[Page 3317]]
[GRAPHIC] [TIFF OMITTED] TR14JA21.008
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\612\ IFUS technically does not have an exchange-set spot month
position limit level for ICE Sugar No. 16 (SF). However, it does
have a single-month position limit level of 1,000 contracts, which
effectively operates as a spot month position limit.
\613\ NYMEX recommended implementing the following step-down
Federal spot month position limit levels with respect to its Light
Sweet Crude Oil (CL) core referenced futures contract: (1) 6,000
contracts as of the close of trading three business days prior to
the last trading day of the contract; (2) 5,000 contracts as of the
close of trading two business days prior to the last trading day of
the contract; and (3) 4,000 contracts as of the close of trading one
business day prior to the last trading day of the contract.
\614\ In Proposed Sec. 150.3(a)(4), the Commission also
proposed an exemption that provided a Federal conditional spot month
position limit for NYMEX Henry Hub Natural Gas (NG) (``NYMEX NG'')
that permits a market participation that does not hold any positions
in the physically-settled NYMEX NG referenced contract to hold: (1)
10,000 NYMEX NG equivalent-sized referenced contracts per exchange
that lists a cash-settled NYMEX NG referenced contract; and (2) an
additional position in cash-settled economically equivalent swaps
with respect to NYMEX NG that has a notional amount equal to 10,000
contracts.
\615\ Currently, the cash-settled natural gas contracts are
subject to an exchange-set spot month position limit level of 1,000
equivalent-sized contracts per exchange. Currently, there are three
exchanges that list cash-settled natural gas contracts--NYMEX, IFUS,
and Nodal. As a result, a market participant may hold up to 3,000
equivalent-sized cash-settled natural gas contracts. The exchanges
also have a conditional position limit framework for natural gas.
The conditional position limit permits up to 5,000 cash-settled
equivalent-sized natural gas contracts per exchange that lists such
contracts, provided that the market participant does not hold a
position in the physically-settled NYMEX NG contract.
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BILLING CODE 6351-01-C
[[Page 3318]]
The proposed Federal spot month position limit levels for all
referenced contracts were set at 25% or less of updated EDS and were
derived from the recommendations by CME Group,\616\ IFUS,\617\ and
MGEX\618\ for each of their respective core referenced futures
contracts. Federal spot month position limit levels for any contract
with a proposed level above 100 contracts were rounded up to the
nearest 100 contracts from the exchange-recommended limit level or from
25% of updated EDS, as applicable.
---------------------------------------------------------------------------
\616\ See Summary DSE Proposed Limits, CME Group Comment Letter
(Nov. 26, 2019), available at https://comments.cftc.gov (comment
file for Proposed Rule 85 FR 11596). CME Group formally provided
recommended Federal spot month position limit levels for each of its
core referenced futures contracts.
\617\ See IFUS--Estimated Deliverable Supply--Softs Methodology,
IFUS Comment Letter (May 14, 2019) and Reproposal--Position Limits
for Derivatives (RIN 3038-AD99) and ICE Comment Letter (Feb. 28,
2017) (attached Sept. 28, 2016 comment letter), available at https://comments.cftc.gov (comment file for Proposed Rule 85 FR 11596 and
Proposed Rule 81 FR 96704, respectively). IFUS did not formally
provide recommended Federal spot month position limit levels for
each of IFUS's core referenced futures contracts. However, ICE had
previously recommended setting Federal spot month position limit
levels for IFUS's core referenced futures contracts at 25% of EDS in
its comment letter in connection with the 2016 Reproposal and
Commission staff also confirmed with ICE/IFUS's representatives that
ICE/IFUS's position has remained the same with respect to the
Federal spot month position limit levels since the 2016 Reproposal.
The Commission notes, however, with respect to ICE Cotton No. 2
(CT), that IFUS has submitted a supplemental comment letter
recommending that the Federal spot month position limit level be set
at 900 contracts, instead of at 25% of EDS. See IFUS--Estimated
Deliverable Supply--Cotton Methodology, August 2020, IFUS Comment
Letter (August 27, 2020), available at https://comments.cftc.gov
(comment file for Proposed Rule 85 FR 11596).
\618\ See Updated Deliverable Supply Data--Potential Position
Limits Rulemaking, MGEX Comment Letter (Aug. 31, 2018), available at
https://comments.cftc.gov (comment file for Proposed Rule 85 FR
11596). MGEX did not formally provide a recommended Federal spot
month position limit level for its core referenced futures contract
(MGEX Hard Red Spring Wheat (MWE)) because it was opposed to
providing a static number for the Federal spot month position limit
level that was based on a fixed formula. Instead, MGEX sought to be
able to adjust the Federal spot month position limit level based on
updated EDS figures and market conditions. However, MGEX stated that
the Federal spot month position limit level for MGEX Hard Red Spring
Wheat (MWE) should be no lower than 1,000 contracts and also
submitted calculations for setting the Federal spot month position
limit level at 25% of EDS. Furthermore, MGEX supported setting the
Federal spot month position limit level for MGEX Hard Red Spring
Wheat (MWE) at 25% of EDS level in its comment letter. MGEX at 3.
---------------------------------------------------------------------------
As discussed in the 2020 NPRM, the existing Federal spot month
position limit levels have remained constant for decades, but the
markets have changed significantly during that time period.\619\ As a
result, some of the deliverable supply estimates on which the existing
Federal spot month position limits were originally based were decades
out of date.\620\
---------------------------------------------------------------------------
\619\ 85 FR at 11625.
\620\ Id.
---------------------------------------------------------------------------
ii. Summary of the Commission Determination--Federal Spot Month
Position Limit Levels
a. Federal Spot Month Position Limit Levels Adopted as Proposed, Except
for ICE Cotton No. 2 (CT) and NYMEX Henry Hub Natural Gas (NG)
The Commission is adopting the Federal spot month position limit
levels as proposed, except for modifications with respect to ICE Cotton
No. 2 (CT) and NYMEX NG. Specifically, the Federal spot month position
limit levels for all 25 core referenced futures contracts are set at or
below 25% of EDS, except for the cash-settled NYMEX NG referenced
contracts.
With respect to ICE Cotton No. 2 (CT), the Commission is adopting a
lower Federal spot month position limit level of 900 contracts instead
of the proposed 1,800 contracts. The reasons for this change are
discussed in Section II.B.3.v.
With respect to NYMEX NG, the Final Rule is adopting the same
Federal spot month position limit level as proposed in the 2020 NPRM,
but the Final Rule is applying the cash-settled portion of the Federal
spot month position limit for NYMEX NG separately for each exchange
that lists a cash-settled NYMEX NG referenced contract, as well as the
cash-settled NYMEX NG OTC swaps market, rather than on an aggregate
basis across all exchanges and the OTC swaps market as it does for each
of the other core referenced futures contracts. The reasons for this
change are discussed in Section II.B.3.vi.
(1) The Final Rule Achieves the Four Statutory Objectives in CEA
Section 4a(a)(3)(B)
Before summarizing and addressing comments below regarding the
proposed Federal spot month position limit levels, the Commission
states at the outset that the final Federal spot month position limit
levels, in conjunction with the rest of the Federal position limits
framework, will achieve the four policy objectives in CEA section
4a(a)(3)(B). Namely, they will: (1) Diminish, eliminate, or prevent
excessive speculation; (2) deter and prevent market manipulation,
squeezes, and corners; (3) ensure sufficient market liquidity for bona
fide hedgers; and (4) ensure that the price discovery function of the
underlying market is not disrupted.\621\
---------------------------------------------------------------------------
\621\ 7 U.S.C. 6a(a)(3)(B).
---------------------------------------------------------------------------
In achieving these four statutory objectives, the Commission first
believes that the Federal spot month position limit levels are low
enough to prevent excessive speculation and also protect price
discovery. Setting the Federal spot month position limit levels at or
below 25% of EDS is critically important because it would be difficult,
in the absence of other factors, for a market participant to corner or
squeeze a market if the participant holds less than or equal to 25% of
deliverable supply.\622\ This is because, among other things, any
potential economic gains resulting from the manipulation may be
insufficient to justify the potential costs, including the costs of
acquiring and ultimately offloading the positions used to effectuate
the manipulation.\623\ By restricting positions to a proportion of the
deliverable supply of the commodity, the Federal spot month position
limits require that no one speculator can hold a position larger than
25% of deliverable supply, reducing the possibility that a market
participant can use derivatives, including referenced contracts, to
affect the price of the cash commodity (and vice versa). Limiting a
speculative position based on a percentage of deliverable supply also
restricts a speculative trader's ability to establish a leveraged
position in cash-settled derivative contracts, reducing that trader's
incentive to manipulate the cash settlement price. Further, by
finalizing levels that are sufficiently low to prevent market
manipulation, including corners and squeezes, the levels also help
ensure that the price discovery function of the underlying market is
not disrupted, because markets that are free from corners, squeezes,
and other manipulative activity reflect fundamentals of supply and
demand, rather than artificial pressures.
---------------------------------------------------------------------------
\622\ 85 FR at 11625-11626.
\623\ Id.
---------------------------------------------------------------------------
The Commission also believes that the Federal spot month position
limit levels adopted herein are high enough to ensure that there is
sufficient market liquidity for bona fide hedgers.\624\ The
[[Page 3319]]
Commission has not observed a general lack of liquidity for bona fide
hedgers in the markets for the 25 core referenced futures contracts,
which are some of the most liquid markets overseen by the
Commission.\625\ By generally increasing the existing Federal spot
month position limit levels for the nine legacy agricultural contracts
based on updated data, and by adopting Federal spot month position
limit levels that are generally equal to or higher than existing
exchange-set levels for the 16 non-legacy core referenced futures
contracts, the Commission does not expect the final Federal position
limit levels to reduce liquidity for bona fide hedgers.\626\
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\624\ CEA section 4a(a)(1) requires the Commission to address
``[e]xcessive speculation . . . causing sudden or unreasonable
fluctuations or unwarranted [price] changes . . . .'' Speculative
activity that is not ``excessive'' in this manner is not a focus of
CEA section 4a(a)(1). Rather, speculative activity may generate
liquidity, including liquidity for bona fide hedgers, by enabling
market participants with bona fide hedging positions to trade more
efficiently. Setting position limits too low could result in reduced
liquidity, including for bona fide hedgers. 85 FR at 11626.
\625\ 85 FR at 11626. The Commission notes that it has observed
a brief period of illiquidity during the early part of the spot
month for ICE Cotton No. 2 (CT), which is discussed in Section
II.B.3.v.
\626\ Id. Eighteen of the core referenced futures contracts will
have Federal spot month position limit levels that are higher than
current exchange-set spot month position limit levels. CME Live
Cattle (LC), COMEX Gold (GC), COMEX Copper (HG), CBOT Oats (O),
NYMEX Platinum (PL), and NYMEX Palladium (PA) will have Federal spot
month position limit levels that are equal to the current exchange-
set spot month position limit levels. Finally, although currently
there is technically no exchange-set spot month position limit for
ICE Sugar No. 16 (SF), this contract is subject to a single month
position limit level of 1,000 contracts, which effectively serves as
its spot month position limit level. As a result, the Federal spot
month position limit level for ICE Sugar No. 16 (SF) will
effectively be higher than its current exchange-set spot month
position limit level.
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Furthermore, the Commission has previously stated that ``there is a
range of acceptable limit levels,'' \627\ and continues to believe that
is true.\628\ There is no single ``correct'' spot month position limit
level for a given contract, and it is likely that a number of limit
levels within a certain range could effectively achieve the four policy
objectives in CEA section 4a(a)(3)(B).\629\ The Commission believes
that the spot month position limit levels adopted herein fall within a
range of acceptable levels.\630\ This determination is based on the
Commission's experience in administering its own Federal position
limits regime, overseeing exchange-set position limits, and being
closely involved in determining the EDS figures underlying the position
limit levels, as well as the fact that the Federal spot month position
limit levels are generally set at or below 25% of EDS.\631\
---------------------------------------------------------------------------
\627\ See, e.g., Revision of Federal Speculative Position
Limits, 57 FR 12766, 12770 (Apr. 13, 1992).
\628\ 85 FR at 11627.
\629\ Id.
\630\ Id.
\631\ The exception to this is the cash-settled NYMEX NG
referenced contracts, which is discussed in detail in Section
II.B.3.vi.
---------------------------------------------------------------------------
In addition, the Federal spot month position limit levels are
properly calibrated to account for differences between markets. For
example, the Commission considered the unique delivery mechanisms for
CME Live Cattle (LC) and the NYMEX metals core referenced futures
contracts in calibrating the Federal spot month position limit levels
for those contracts.\632\ The Commission also considered the volatility
of the EDS for COMEX Copper (HG) in determining its limit level.\633\
Furthermore, with respect to NYMEX NG, the Commission, in fine-tuning
the proposed limits, considered: the underlying natural gas
infrastructure vis-[agrave]-vis commodities underlying other energy
core referenced futures contracts; the relatively high liquidity in the
cash-settled markets; and the public comments received in response to
the 2020 NPRM.\634\
---------------------------------------------------------------------------
\632\ 85 FR at 11627.
\633\ Id. at 11628.
\634\ Id.
---------------------------------------------------------------------------
(2) Federal Position Limit Levels Operate as Ceilings
Finally, consistent with the 2020 NPRM and the Final Rule's
position limits framework that leverages existing exchange-level
programs and expertise, the Federal position limit levels operate as
ceilings. This framework, with Federal spot month limits layered over
exchange-set limits, achieves the Commission's objectives in preventing
market manipulation, squeezes, corners, and excessive speculation while
also ensuring sufficient market liquidity for bona fide hedgers and
avoiding a disruption of the price discovery function of the underlying
market. This is, in part, because a layered approach facilitates more
expedited responses to rapidly evolving market conditions through
exchange action. Under the Final Rule, exchanges are required to set
their own spot month position limit levels at or below the respective
Federal spot month position limit levels.\635\ They are also permitted
to adjust those levels based on market conditions as long as they are
set at or below the Federal spot month position limit levels. Exchanges
may also impose liquidity and concentration surcharges to initial
margin if they are vertically integrated with a derivatives clearing
organization.\636\ All of these exchange actions can be implemented
significantly faster than Commission action, and an immediate response
is critical in managing rapidly evolving market conditions. As a
result, by having the Federal position limit levels function as
ceilings, the position limits framework adopted in this Final Rule will
allow exchanges to lower or raise their position limit levels across a
greater range of acceptable Federal position limit levels, which will
facilitate a faster response to more varied market conditions than if
the Federal position limit levels did not operate as ceilings.
---------------------------------------------------------------------------
\635\ Final Sec. 150.5(a). For the nine legacy agricultural
contracts, the Final Rule also requires exchanges to set their own
non-spot month position limit levels at or below the respective
Federal non-spot month position limit level. For the 16 non-legacy
core referenced futures contracts, final Sec. 150.5(b)(2) requires
exchanges to implement either position limits or position
accountability during the non-spot month for physical commodity
derivatives that are not subject to Federal position limits ``at a
level that is necessary and appropriate to reduce the potential
threat of market manipulation or price distortion of the contract's
or the underlying commodity's price or index.''
\636\ 85 FR at 11633.
---------------------------------------------------------------------------
iii. Comments and Discussion of Final Rule--Federal Spot Month Position
Limit Levels
Many commenters supported the proposed Federal spot month position
limit levels and the method by which the Commission determined those
limit levels.\637\ However, some commenters raised concerns or
otherwise commented with respect to: (1) The proposed Federal spot
month position limit levels and the methodology used to arrive at those
levels generally; (2) the Commission's review of exchanges' EDS figures
and their recommended spot month position limit levels; (3) a lack of a
phase-in for Federal spot month position limit levels; (4) the proposed
spot month position limit level for ICE Cotton No. 2 (CT); (5) the
proposed spot month position limit level for NYMEX NG and other issues
relating to NYMEX NG; and (6) the issue of parity among the proposed
Federal spot month position limit levels for the three wheat core
referenced futures contracts. The Commission will discuss each of these
issues, the related comments, and the Commission's corresponding
determination in greater detail below.
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\637\ See ASR at 2; CCI at 2; Shell at 3; EEI/EPSA at 3; Suncor
at 2, CEWG at 3; COPE at 2, 4; SIFMA AMG at 3-4; MGEX at 1; 3; MFA/
AIMA at 1; AFIA at 1; CMC at 6; NGFA at 3; PIMCO at 6; CME Group at
4-6; NOPA at 1; FIA at 2; and AQR at 8-10.
---------------------------------------------------------------------------
a. Federal Spot Month Position Limit Levels and the Commission's
Underlying Methodology, Generally
(1) Comments--Federal Spot Month Position Limit Levels and the
Commission's Underlying Methodology, Generally
Better Markets objected to the Commission's proposed Federal spot
month position limit levels and
[[Page 3320]]
suggested that there should be a presumption that the Federal spot
month position limit levels be set at 10% of EDS, which could be
adjusted as needed.\638\ Another commenter, PMAA, requested Federal
spot month position limit levels of less than 25% of EDS, but did not
provide a specific level or a range of levels.\639\ Other commenters
believed that the proposed spot month levels were generally too high
merely because they were higher than existing levels.\640\
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\638\ Better Markets at 41.
\639\ PMAA at 2.
\640\ AFR at 2 and Rutkowski at 2.
---------------------------------------------------------------------------
In support of its suggestion, Better Markets claimed that,
``speculative trading has been sufficient to accommodate legitimate
hedging at currently permissible levels,'' noting that the Commission
has previously stated that ``open interest and trading volume have
reached record levels'' and ``the 25 [core referenced futures
contracts] represent some of the most liquid markets overseen by the
[CFTC].'' \641\ Better Markets also claimed that, if the Commission
conducted a study as to whether the increase in open interest for
``particular [core referenced futures contracts] would warrant lower
speculative position limits,'' those studies would have shown that
substantially lower position limit levels would be warranted.\642\
Better Markets also took issue with the Commission's 25% or less of EDS
formula as a basis for determining Federal spot month position limit
levels by stating, ``while deliverable supply must be one key measure
for constraining speculation, it is not sufficient to address all
statutory objectives for Federal position limits.'' \643\
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\641\ Better Markets at 37-38.
\642\ Id. at 38.
\643\ Id. at 37.
---------------------------------------------------------------------------
(2) Discussion of Final Rule--Federal Spot Month Position Limit Levels
and the Commission's Underlying Methodology, Generally
The Commission declines to adopt a 10% of EDS across-the-board
Federal spot month position limit level, or a general reduction in
Federal spot month position limit levels to a level below 25% of EDS
for those core referenced futures contracts with a proposed position
limit level set at 25% of EDS.
In response to Better Markets' suggestion to adopt Federal spot
month position limit levels set at 10% of EDS, the Commission first
notes that, although Better Markets provided some arguments for why the
Commission should consider lower Federal position limit levels, Better
Markets did not provide any support for the 10% level that it
suggested, including any support for the comment letter's implication
that setting limits at or below 25% of EDS is insufficient to prevent
corners and squeezes. Likewise, PMAA did not provide any support for
adopting Federal spot month position limit levels of less than 25% of
EDS, other than claiming that a ``spot month limit of 25 percent of
deliverable supply is not sufficiently aggressive to deter excessive
speculation'' and ``prevent market manipulation.'' \644\
---------------------------------------------------------------------------
\644\ PMAA at 2.
---------------------------------------------------------------------------
The 25% or less of EDS formula that the Commission is utilizing,
and has utilized for many years, is a longstanding methodology that was
adopted to address corners and squeezes based on the Commission's
experience.\645\ Also, as described in detail above, the Commission
believes that the position limits framework in both the 2020 NPRM and
the Final Rule that incorporates the 25% or less of EDS formula
achieves the Commission's statutory objectives in preventing market
manipulation, squeezes, corners, and excessive speculation while also
ensuring sufficient market liquidity for bona fide hedgers and avoiding
a disruption of the price discovery function of the underlying market.
---------------------------------------------------------------------------
\645\ See e.g., Chicago Board of Trade Futures Contracts in Corn
and Soybeans; Order To Change and To Supplement Delivery
Specifications, 62 FR 60831, 60838 (Nov. 13, 1997) (``The 2,400-
contract level of deliverable supplies constitutes four times the
speculative position limit for the contract, a benchmark
historically used by the Commission's staff in analyzing the
adequacy of deliverable supplies for new contracts'').
---------------------------------------------------------------------------
In addition, the Final Rule's position limits framework further
addresses the statutory objectives of CEA section 4a(a)(3)(B) by
utilizing the Federal position limit levels as a ceiling and leveraging
the exchanges' expertise and experience in determining and adjusting
exchange-set position limit levels for their referenced contracts as
appropriate, as long as they are under the Federal position limit
levels.\646\ This exchange action can be effectuated significantly
faster than a Federal position limit level adjustment, which requires
the Commission to engage in a rulemaking process that includes a
notice-and-comment period. As a result, compared to the alternative
approaches suggested by commenters, this framework will generally
facilitate a more expedited response to a more varied set of market
conditions, because the exchanges can lower or raise their position
limit levels across a greater range of acceptable Federal position
limit levels.
---------------------------------------------------------------------------
\646\ See 85 FR at 11629, 11633.
---------------------------------------------------------------------------
In response to Better Markets' claim that the Federal spot month
position limit levels should not be adjusted upward as a result of the
higher open interest levels and trading volumes that exist today
because they demonstrate that there are sufficient levels of
speculation and liquidity under the current rules, the Commission first
notes that Better Markets did not provide a methodology based on open
interest and/or trading volume that the Commission should consider as
an alternative to the Commission's 25% or less of EDS approach.
Regardless, the Commission believes that EDS is the more
appropriate basis by which the Commission should adjust Federal spot
month position limit levels, rather than open interest and/or trading
volume, because the likelihood of a corner or squeeze occurring in the
spot month is more closely correlated with the percentage of
deliverable supply that a market participant controls. Corners and
squeezes are possible in the spot month only because of the imminent
prospect of making or taking delivery in the physically-settled
contract. Therefore, understanding the amount of deliverable supply in
the spot month is critically important.\647\ Accordingly, the
Commission, in consultation with the exchanges, estimated the amount of
the underlying commodity available at the specified delivery points in
the core referenced futures contract that meet the quality standards
set forth in the core referenced futures contract's terms and
conditions in order to understand the size of the relevant commodity
market underlying each core referenced futures contract. Once the
Commission determined that information in the form of an EDS figure,
the Commission was able to determine whether a Federal spot month
position limit level would advance the statutory objectives of CEA
section 4a(a)(3)(B), including preventing corners and squeezes.
---------------------------------------------------------------------------
\647\ Deliverable supply is the quantity of the commodity that
meets contract specifications that is reasonably expected to be
readily available to short traders and salable by long traders at
its market value in normal cash-marketing channels at the contract's
delivery points during the specified delivery period, barring
abnormal movements in interstate commerce. 17 CFR part 38, Appendix
C.
---------------------------------------------------------------------------
A spot month position limit methodology based on open interest and/
or trading volume does not take into account the central factors that
make corners and squeezes possible (i.e., the imminent prospect of
delivery on a physically-settled contract and the deliverable supply of
an underlying
[[Page 3321]]
commodity). Also, open interest and trading volume in an expiring
physically-settled contract generally declines as the contract nears
expiration, as most traders are not looking to make or take delivery of
the underlying commodity. As a result, they would likely not provide
additional insights that would materially inform the Commission's
determination of Federal spot month position limit levels in a way that
is responsive to CEA section 4a(a)(3)(B).
Furthermore, the Commission did not adjust the Federal spot month
position limit levels merely by applying a percentage to EDS. As
discussed in further detail below, the Commission proposed Federal spot
month position limit levels only after the Commission: (1) Extensively
reviewed and verified the underlying methodology for each core
referenced futures contract's EDS figure; and (2) reviewed the
recommended Federal spot month position limit levels from exchanges
that are thoroughly knowledgeable about their own respective core
referenced futures contracts' markets in order to determine whether
they advanced the policy objectives of CEA section 4a(a)(3)(B). Also,
in adopting the final Federal spot month position limit levels, the
Commission also considered comments from market participants, including
comments from the end-users of these markets.
On a related note, Better Markets and PMAA appear to have
misunderstood the proposed Federal spot month position limit levels and
the methodology on which they were based.\648\ The Commission did not
propose an across-the-board Federal level set at 25% of EDS. As noted
above, the Commission's methodology sets Federal spot month position
limit levels at or below 25% of EDS for each particular commodity.\649\
As a result, under the Final Rule, only seven of 25 core referenced
futures contracts have Federal spot month position limit levels at 25%
of EDS. With respect to the 18 remaining core referenced futures
contracts, all 18 are set below 20% of EDS, 14 are below 15% of EDS,
and eight are already below the 10% of EDS threshold recommended by
Better Markets.\650\ With respect to the petroleum core referenced
futures contracts with which PMAA is most likely concerned (i.e., NYMEX
Light Sweet Crude Oil (CL), NYMEX NYH ULSD Heating Oil (HO), and NYMEX
RBOB Gasoline (RB)), all three levels are at or below 11.16% of EDS.
---------------------------------------------------------------------------
\648\ See Better Markets at 39-40 and PMAA at 2.
\649\ 85 FR at 11624.
\650\ For CME Live Cattle (LC) and NYMEX Light Sweet Crude Oil
(CL), which have step-down Federal spot month position limit levels,
these percentages were calculated using the first and highest step.
---------------------------------------------------------------------------
b. Commission Review of Exchanges' EDS Figures and Recommended Federal
Spot Month Position Limit Levels
(1) Additional Background Information--Commission Review of Exchanges'
EDS Figures and Recommended Federal Spot Month Position Limits
In connection with the 2020 NPRM, the Commission received
deliverable supply estimates and recommended Federal spot month
position limit levels from CME Group, ICE, and MGEX for their
respective core referenced futures contracts.\651\ Commission staff
reviewed these recommendations and conducted its own analysis of them
using its own experience, observations, and knowledge.\652\ This
included closely and independently assessing the EDS figures upon which
the recommended limit levels were based.\653\ In reviewing the
recommended spot month position limit levels, the Commission considered
the four policy objectives in CEA section 4a(a)(3)(B) and preliminarily
determined that none of the recommended levels appeared improperly
calibrated such that they might hinder liquidity for bona fide hedgers
or invite excessive speculation, manipulation, corners, or squeezes,
including activity that could impact price discovery.\654\ As a result,
the Commission proposed to adopt each of the exchange-recommended spot
month position limit levels as Federal spot month position limit
levels.\655\
---------------------------------------------------------------------------
\651\ See supra n.616, n.617, and n.618.
\652\ 85 FR at 11625.
\653\ Id. at 11625-11626.
\654\ Id. at 11625.
\655\ Id. Also, a more detailed discussion about the methodology
employed by the Commission in determining proposed Federal spot
month position limit levels can be found at 85 FR at 11625-11628.
---------------------------------------------------------------------------
(2) Comments--Commission Review of Exchanges' EDS Figures and
Recommended Federal Spot Month Position Limit Levels
The Commission received several comments concerning the
Commission's review and verification of the EDS figures and the
rationale used by the Commission in accepting the spot month position
limit levels that were recommended by exchanges.
One commenter, EPSA, supported adopting CME Group's EDS figures for
energy commodities, stating that exchanges are in the ``best position
to provide accurate and current information on the markets.'' \656\
However, other commenters expressed concerns. Better Markets commented
that the Commission failed to ``explain the means by which the DCM-
provided data was collected and later `verified' in arriving at
proposed spot month position limits, nor the dependencies of the DCM
methodologies employed to arrive at those estimates.'' \657\ Similarly,
IATP commented that the 2020 NPRM provided insufficient detail about
how the Commission concluded that the exchange-recommended spot month
position limit levels were appropriate and how the Commission
determined that the EDS figures submitted by the exchanges were
reasonable.\658\ On a related note, PMAA commented that the exchanges
should not be providing EDS figures and that the Commission instead
should ``retain exclusive discretion in determining `deliverable
supply' for the purposes of establishing speculative position limits''
and ``consult with . . . market experts when determining `deliverable
supply' and formulating limits.'' \659\ Furthermore, CME Group
recommended ``that the Commission not adopt final spot month position
limit levels at 25% of deliverable supply as a rigid formula and . . .
work with the exchange to determine an appropriate limit based on the
market dynamics.'' \660\ Likewise, MGEX commented that it
``fundamentally disagrees with the 25% formulaic calculation for the
spot month position, especially if a limit is codified by rule and does
not allow for adjustments as deliverable supply changes.'' \661\
---------------------------------------------------------------------------
\656\ EPSA at 3.
\657\ Better Markets at 36.
\658\ IATP at 9.
\659\ PMAA at 2-3 (these market experts include governmental
entities, such as the Department of Energy's Energy Information
Administration and the U.S. Department of Agriculture, academics,
and representatives of industries that produce, refine, process,
store, transport, market, and consume the underlying commodity).
\660\ CME Group at 5-6. Specifically, CME Group believed that
using a 25% of EDS formula ``as a fixed formula for establishing
recommended limits . . . is unsound as a matter of policy and
incompatible with the Commission's statutory authority to determine
that a specific position limit is necessary and set it at an
appropriate level.''
\661\ Updated Deliverable Supply Data--Potential Position Limits
Rulemaking, MGEX Comment Letter (Aug. 31, 2018) at 2, available at
https://comments.cftc.gov (comment file for Proposed Rule 85 FR
11596).
---------------------------------------------------------------------------
Finally, Better Markets also raised concerns about the incentives
of exchanges as public, for-profit enterprises, presumably, in part,
because the exchanges submitted the EDS figures, upon which the Federal
spot month position limit levels are
[[Page 3322]]
based.\662\ Specifically, Better Markets stated that exchanges ``must
balance the interests of their shareholders against the public interest
and their commercial interests in market integrity'' and, as a result,
may be incentivized to permit ``speculation--even excess speculation,''
because it ``is a key revenue driver.'' \663\
---------------------------------------------------------------------------
\662\ Better Markets at 22.
\663\ Id. at 22-23. Better Markets referenced CME Group Inc.'s
Form 10-K filings, which stated that ``[t]he adoption and
implementation of position limits rules . . . could have a
significant impact on our commodities business if Federal rules for
position limit management differ significantly from current
exchange-administered rules.''
---------------------------------------------------------------------------
(3) Discussion of Final Rule--Commission Review of Exchanges' EDS
Figures and Recommended Federal Spot Month Position Limit Levels
The Commission declines to utilize a different methodology and
process for determining EDS figures and Federal spot month position
limit levels.
(i) Determination of EDS Figures
In response to comments concerning the Commission's EDS
determinations, the Commission notes that its process for reviewing and
verifying the EDS figures provided by exchanges entailed extensive
independent review and analysis of each EDS figure and its underlying
methodology, and the Commission retained exclusive discretion to
determine the reasonableness of the EDS figures. This review and
analysis by Commission staff occurred prior to the exchanges' formal
EDS submissions, during which time Commission staff verified that each
exchange's EDS figure for each commodity underlying a core referenced
futures contract was reasonable. In doing so, Commission staff
confirmed that the methodology and the data \664\ for the underlying
commodity for each core referenced futures contract reflected the
commodity characteristics \665\ described in the core referenced
futures contract's terms and conditions, while also recognizing that
more than one methodology and one set of assumptions, allowances, and
data sources could result in a reasonable EDS figure for a commodity.
In addition, Commission staff replicated the exchanges' EDS figures
using the methodology provided. For some commodities, Commission staff
also determined the reasonableness of an exchange's EDS by constructing
an alternate EDS using an alternate methodology using other available
data and comparing that internal EDS with the exchange's EDS. In some
cases, Commission staff consulted industry experts and market
participants to verify that the assumptions and allowances used by the
EDS methodology were reasonable and that the EDS figure itself was
reasonable.
---------------------------------------------------------------------------
\664\ The data underlying the EDS figures are from sources that
Commission staff had determined as accurately representing the
underlying commodity. These were typically from publicly available
sources. For example, these include data published by the U.S.
Department of Energy for NYMEX Light Sweet Crude Oil (CL), data
published by the U.S. Department of Agriculture for CBOT Soybeans
(S), data published by the Florida Department of Citrus for ICE
FCOJ-A (OJ), and data published by CME Group concerning the gold
inventories at its approved depositories for COMEX Gold (GC).
Furthermore, most data sources were also adjusted based on
interviews with market experts and market participants in order to
better reflect the actual deliverable supply by taking into
consideration the amount of time it takes to move the commodity to/
from the delivery points, quality standards, and supplies that are
not readily available due to being tied up in long-term contracts.
\665\ These characteristics are provided in the guidance in
section (b)(1)(i) of Appendix C to part 38, and include, among other
things, the commodity's quality and grade specifications, delivery
points (including storage capacity), historic storage levels,
processing capacity, and adjustments to remove supply that is
committed for long-term contracts and not available to underlie a
futures contract. The verified EDS for each commodity reflects the
quantity of the commodity that can be reasonably expected to be
readily available to short traders and salable by long traders at
its market value in normal cash-marketing channels at the contract's
delivery points during the specified delivery period, barring
abnormal movements in interstate commerce.
---------------------------------------------------------------------------
When Commission staff identified any issues during the review
process, they raised those concerns with the exchanges in order to
revise the methodologies, including the assumptions, allowances, and
data sources used therein. As a result, when the exchanges formally
submitted their EDS figures, both the EDS figures and the methodologies
underlying their calculations had been thoroughly reviewed and analyzed
by Commission staff, and some had been refined based on input from
Commission staff. The EDS figures and the methodologies used were
published in the comment section of the 2020 NPRM on the Commission's
website and have been available for review by the public.\666\
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\666\ See IFUS--Estimated Deliverable Supply--Softs Methodology,
IFUS Comment Letter (May 14, 2019); Updated Deliverable Supply
Data--Potential Position Limits Rulemaking, MGEX Comment Letter
(Aug. 31, 2018); and Summary DSE Proposed Limits, CME Group Comment
Letter (Nov. 26, 2019) (CME Group also provided separate EDS
methodology submissions for each of its 18 core referenced futures
contracts, which can also be found in the comment file), all
available at https://comments.cftc.gov (comment file for Proposed
Rule 85 FR 11596).
---------------------------------------------------------------------------
Additionally, for the past 10 years, commenters to previous Federal
position limits rule proposals have consistently recommended that the
EDS figures should be supplied by exchanges, given the exchanges'
expertise with their own contract markets and because of the experience
they have in producing such figures.\667\ The Commission has agreed and
continues to agree with those comments. As a result, Commission staff
has also previously worked in collaboration with the exchanges as part
of an iterative process to review and refine the methodologies,
assumptions, allowances, and data sources used in calculating the EDS
figure for each commodity underlying a core referenced futures
contract.
---------------------------------------------------------------------------
\667\ See e.g. 81 FR at 96754, n.495 (listing the commenters
that expressed the view that exchanges are best able to determine
appropriate spot month position limits and that the Commission
should defer to their expertise).
---------------------------------------------------------------------------
(ii) Determination of Federal Spot Month Position Limit Levels
In response to comments concerning the Commission's determination
of the Federal spot month position limit levels, the Commission first
notes that exchanges were invited to submit their recommended Federal
spot month position limit levels for their respective core referenced
futures contracts. In response, CME Group,\668\ ICE,\669\ and MGEX
\670\ provided recommended levels for their core referenced futures
contracts.
---------------------------------------------------------------------------
\668\ See supra n.616.
\669\ See supra n.617.
\670\ See supra n.618.
---------------------------------------------------------------------------
When deciding whether to adopt, reject, or modify the exchange-
recommended position limit levels, the Commission considered a variety
of factors, including whether the recommended level: (i) Was consistent
with the 25% or less of EDS formula, as provided in the guidance in
Appendix C to part 38; (ii) reflected changes in the EDS of the
underlying commodity and trading activity in the core referenced
futures contract; and (iii) achieved the four policy objectives in CEA
section 4a(a)(3)(B). Furthermore, as described in detail above, the
Commission also thoroughly reviewed the methodologies for determining
the EDS figures upon which the exchange-recommended spot month position
limit levels are based.
Finally, the Commission also considered input from market
participants concerning the EDS figures and the exchange-recommended
Federal position limit levels in recalibrating the Federal position
limit levels, as it has done for ICE Cotton No. 2 (CT) and NYMEX Henry
Hub Natural Gas (NG) in this Final Rule, as discussed further below.
[[Page 3323]]
(iii) Concern Over Exchanges' Conflict of Interest and Improper
Incentives in Maintaining Their Markets
In response to Better Markets' concern about the incentives of
exchanges as public, for-profit businesses, as a preliminary matter,
the Commission acknowledges that exchanges have a financial interest in
increased trading volume, whether speculative or hedging, and, as a
result, may be incentivized to increase EDS figures and recommend
higher position limit levels. However, as previously discussed, the
Commission independently assessed and verified the exchanges' EDS
estimates. Specifically, the Commission: (1) Worked closely with the
exchanges to independently verify that all EDS methodologies and
figures were reasonable; \671\ and (2) reviewed each exchange-
recommended level for compliance with the requirements established by
the Commission and/or by Congress, including those in CEA section
4a(a)(3)(B).\672\ Also, as discussed at length above, the Commission
conducted its own analysis of the exchange-recommended Federal spot
month position limit levels and determined that the levels adopted
herein: (1) Are low enough to diminish, eliminate, or prevent excessive
speculation and also protect price discovery; (2) are high enough to
ensure that there is sufficient market liquidity for bona fide hedgers;
(3) fall within a range of acceptable limit levels; and (4) are
properly calibrated to account for differences between markets. Thus,
the Commission believes that the impact, if any, of such financial
incentives were sufficiently mitigated through the Commission's close
review of the methodology underlying the EDS figures, the EDS figures
themselves, and the recommended Federal position limit levels.
---------------------------------------------------------------------------
\671\ As discussed in detail above, the verification involved:
Confirming that the methodology and data for the underlying
commodity reflected the commodity characteristics described in the
core referenced futures contract's terms and conditions; replicating
exchange EDS figures using the methodology provided by the exchange;
and working with the exchanges to revise the methodologies as
needed.
\672\ See Section II.B.3.iii.b.(3).
---------------------------------------------------------------------------
The Commission also notes that exchanges have significant
incentives and obligations to maintain well-functioning markets as
self-regulatory organizations that are themselves subject to regulatory
requirements. Specifically, the DCM and SEF Core Principles, as
applicable, require exchanges to, among other things, list contracts
that are not readily susceptible to manipulation, and surveil trading
on their markets to prevent market manipulation, price distortion, and
disruptions of the delivery or cash-settlement process.\673\ Exchanges
also have significant incentives to maintain well-functioning markets
to remain competitive with other exchanges. Market participants may
choose exchanges that are less susceptible to sudden or unreasonable
fluctuations or unwarranted changes caused by excessive speculation or
corners, squeezes, and manipulation, which could, among other things,
harm the price discovery function of the commodity derivative contracts
and negatively impact the delivery of the underlying commodity, bona
fide hedging strategies, and market participants' general risk
management.\674\ Furthermore, several academic studies, including one
concerning futures exchanges and another concerning demutualized stock
exchanges, support the conclusion that exchanges are able to both
satisfy shareholder interests and meet their self-regulatory
organization responsibilities.\675\
---------------------------------------------------------------------------
\673\ 17 CFR 38.200; 17 CFR 38.250; 17 CFR 37.300; and 17 CFR
37.400.
\674\ Kane, Stephen, Exploring price impact liquidity for
December 2016 NYMEX energy contracts, n.33, available at https://www.cftc.gov/sites/default/files/idc/groups/public/@economicanalysis/documents/file/oce_priceimpact.pdf.
\675\ See David Reiffen and Michel A. Robe, Demutualization and
Customer Protection at Self-Regulatory Financial Exchanges, Journal
of Futures Markets, Vol. 31, 126-164, Feb. 2011 (in many
circumstances, an exchange that maximizes shareholder (rather than
member) income has a greater incentive to aggressively enforce
regulations that protect participants from dishonest agents); and
Kobana Abukari and Isaac Otchere, Has Stock Exchange Demutualization
Improved Market Quality? International Evidence, Review of
Quantitative Finance and Accounting, Dec 09, 2019, https://doi.org/10.1007/s11156-019-00863-y (demutualized exchanges have realized
significant reductions in transaction costs in the post-
demutualization period).
---------------------------------------------------------------------------
iv. Phase-In of Federal Spot Month Position Limit Levels
a. Summary of the 2020 NPRM--Phase-In of Federal Spot Month Position
Limit Levels
The 2020 NPRM did not include a phase-in mechanism in which the
Commission would gradually adjust the Federal position limit levels
over a period of time. As a result, under the 2020 NPRM, the proposed
Federal spot month position limit levels for all core referenced
futures contracts would immediately go into effect on the proposed
effective date.
b. Summary of the Commission Determination--Phase-In of Federal Spot
Month Position Limit Levels
The Commission declines to adopt a formal phase-in for the Federal
spot month position limit levels, because it believes that the markets
would operate in an orderly fashion with the Federal position limit
levels adopted under this Final Rule. However, as a practical matter,
the Commission notes that the operative spot month position limit
levels for market participants trading in exchange-listed referenced
contracts will be the exchange-set spot month position limit levels,
which will continue to remain at their existing levels unless and until
an exchange affirmatively modifies its exchange-set spot month position
limit levels pursuant to part 40 of the Commission's regulations.\676\
---------------------------------------------------------------------------
\676\ 17 CFR part 40.
---------------------------------------------------------------------------
c. Comments--Phase-In of Federal Spot Month Position Limit Levels
The Commission received comments requesting that the Commission
``consider phasing in these adjustments for agricultural commodities to
assess the impacts of increasing limits on contract performance.''
\677\ CMC also noted that, ``A phased approach could provide market
participants, exchanges, and the Commission a way to build in scheduled
pauses to evaluate the effects of increased limits, thereby fostering
confidence and trust in the markets.'' \678\
---------------------------------------------------------------------------
\677\ AFIA at 2 and CMC at 6.
\678\ CMC at 6. Although commenters did not provide specific
details about what they meant by ``phase-in,'' the Commission
understands these comments to mean that they are requesting a
gradual, step-up increase in Federal spot month and non-spot month
position limit levels over time for agricultural core referenced
futures contracts, instead of having an abrupt change to the new
Federal position limit levels. This section only addresses the
Commission's response to commenters' request for phased-in Federal
spot month position limit levels. The Commission separately
addresses commenters' request for phased-in Federal non-spot month
position limit levels below in Section II.B.4.iv.a.(2)(v).
---------------------------------------------------------------------------
d. Discussion of the Final Rule--Phase-In of Federal Spot Month
Position Limit Levels
In response to comments, the Commission first notes that, although
the Federal spot month position limit levels will generally be higher
than existing Federal and/or exchange-set spot month position limit
levels, the Commission believes that the referenced contract markets
will be able to function in an orderly fashion when the final Federal
spot month position limit levels
[[Page 3324]]
go into effect.\679\ This is because, among other things, these final
Federal spot month position limit levels are supported by the updated
EDS figures and are set at or below 25% of EDS.\680\
---------------------------------------------------------------------------
\679\ A phase-in is unnecessary with respect to the Federal spot
month position limit level for CBOT Oats (O), because the Federal
spot month position limit level for the contract remains at the
current level.
\680\ The final Federal spot month position limit levels for
cash-settled NYMEX NG referenced contracts may exceed 25% of EDS
because the Federal spot month position limit level is being applied
separately for each exchange and OTC swaps market, but the
Commission believes that this approach will not cause any issues, in
part, because of the highly liquid nature of that particular market.
For additional details concerning the NYMEX NG market, see Section
II.B.3.vi.a.
---------------------------------------------------------------------------
However, as a practical matter, the operative spot month position
limit level for market participants with respect to exchange-listed
referenced contracts is not the Federal spot month position limit
levels, but the exchange-set spot month position limit levels, which
must be set at or below the corresponding Federal spot month position
limit levels. As a result, despite the changes in the Federal spot
month position limit levels (or the imposition of a Federal spot month
position limit level for the first time) in this Final Rule, there will
be no practical impact on market participants trading in exchange-
listed referenced contracts unless and until an exchange affirmatively
modifies its exchange-set spot month position limit levels through a
rule submission to the Commission pursuant to part 40 of the
Commission's regulations.\681\
---------------------------------------------------------------------------
\681\ 17 CFR part 40.
---------------------------------------------------------------------------
v. ICE Cotton No. 2 (CT) Federal Spot Month Position Limit Level
a. Summary of the 2020 NPRM--ICE Cotton No. 2 (CT) Federal Spot Month
Position Limit Level
The Commission proposed to increase the Federal spot month position
limit level for ICE Cotton No. 2 (CT) from the existing Federal
position limit of 300 contracts to 1,800 contracts. Like all of the
Federal spot month position limit levels, the Commission's proposed
level for ICE Cotton No. 2 (CT) was based on Commission staff's review,
analysis, and verification of IFUS's updated EDS figure and Commission
staff's review and analysis of IFUS's initial recommended Federal spot
month position limit level.\682\
---------------------------------------------------------------------------
\682\ See IFUS--Estimated Deliverable Supply--Softs Methodology,
IFUS Comment Letter (May 14, 2019) and Reproposal--Position Limits
for Derivatives (RIN 3038-AD99); ICE Comment Letter (Feb. 28, 2017)
(attached Sept. 28, 2016 comment letter), available at https://comments.cftc.gov (comment file for Proposed Rule 85 FR 11596 and
Proposed Rule 81 FR 96704, respectively). IFUS did not formally
provide recommended Federal spot month position limit levels for
each of its core referenced futures contracts. However, ICE had
previously recommended setting Federal spot month position limit
levels for IFUS's core referenced futures contracts at 25% of EDS in
its comment letter in connection with the 2016 Reproposal and
Commission staff also confirmed with ICE/IFUS's representatives that
ICE/IFUS's position has remained the same with respect to the
Federal spot month position limit levels since the 2016 Reproposal.
The Commission notes, however, with respect to ICE Cotton No. 2
(CT), IFUS submitted an updated recommended Federal spot month
position limit level recommending a Federal spot month position
limit level of 900 contracts. See IFUS--Estimated Deliverable
Supply--Cotton Methodology, August 2020, IFUS Comment Letter (August
27, 2020), available at https://comments.cftc.gov (comment file for
Proposed Rule 85 FR 11596).
---------------------------------------------------------------------------
b. Summary of the Commission Determination--ICE Cotton No. 2 (CT)
Federal Spot Month Position Limit Level
In the Final Rule, the Commission is adopting a Federal spot month
position limit level of 900 contracts instead of the proposed level of
1,800 contracts for ICE Cotton No. 2 (CT). The reasons for this change
are based on the comments received in response to the 2020 NPRM.
c. Comments--ICE Cotton No. 2 (CT) Federal Spot Month Position Limit
Level
The Commission received numerous comments objecting to the higher
proposed Federal spot month position limit level for ICE Cotton No. 2
(CT) in the 2020 NPRM.\683\ The commenters requested that the
Commission either maintain the current 300 contract limit level or
drastically lower the limit from the proposed 1,800 contract limit
level.\684\ In doing so, commenters argued that they disagreed with the
EDS figure for ICE Cotton No. 2 (CT) because it does ``not reflect the
cotton industry's historical ability to deliver the physical
commodity.'' \685\ AMCOT similarly noted that the ``methodology used in
determining the limits is flawed and lacks consideration of the
industry's intricacies including the non-fungible quality as well as
warehousing, location, and logistical challenges.'' \686\ Furthermore,
AMCOT believed that the Federal spot month position limit level ``would
likely be disruptive to orderly market flows.'' \687\ Likewise, ACSA
noted that, ``[i]n a smaller market like cotton, such a drastic
increase and high limit will cause excessive volatility and hinder
convergence in the spot month.'' \688\
---------------------------------------------------------------------------
\683\ AMCOT at 1-2; ACSA at 8; Ecom at 1; Southern Cotton at 2;
NCC at 1; Mallory Alexander at 2; Canale Cotton at 2; IMC at 2; Olam
at 3; DECA at 2; Moody Compress at 1; ACA at 2; Choice at 1; East
Cotton at 2; Jess Smith at 2; McMeekin at 2; Memtex at 2; NCC at 2;
Omnicotton at 2; Toyo at 2; Texas Cotton at 2; Walcot at 2; White
Gold at 1; LDC at 1; SW Ag at 2; NCTO at 2; and Parkdale at 2.
\684\ Id.
\685\ See, e.g., ACA at 2.
\686\ AMCOT at 1.
\687\ Id.
\688\ ACSA at 8.
---------------------------------------------------------------------------
In addition to the market participants, IFUS also submitted a
comment letter with respect to ICE Cotton No. 2 (CT), in which it
provided an updated recommended Federal spot month position limit level
of 900 contracts.\689\
---------------------------------------------------------------------------
\689\ IFUS--Estimated Deliverable Supply--Cotton Methodology,
August 2020, IFUS Comment Letter (Aug. 14, 2020), available at
https://comments.cftc.gov (comment file for Proposed Rule 85 FR
11596).
---------------------------------------------------------------------------
d. Discussion of Final Rule--ICE Cotton No. 2 (CT) Federal Spot Month
Position Limit Level
As a preliminary matter, and as discussed previously, the
Commission believes that there is a range of acceptable Federal
position limit levels that will achieve the objectives of CEA section
4a(a)(3)(B). Thus, the Commission acknowledges that there may be other
acceptable Federal spot month position limit levels in addition to the
proposed 1,800 contract level for ICE Cotton No. 2 (CT). Commenters to
the 2020 NPRM suggested three alternatives to the proposed Federal spot
month position limit level for ICE Cotton No. 2 (CT): (1) 300
contracts; (2) 900 contracts; or (3) a level ``drastically lower'' than
1,800 contracts. All of these alternatives are below 25% of EDS. The
Commission considered the two specifically enumerated levels (i.e., 300
contracts and 900 contracts) and the proposed 1,800 contract level, and
has determined that the 900 contract level is the most appropriate
among the three for ICE Cotton No. 2 (CT).
(1) ICE Cotton No. 2 (CT) Federal Spot Month Position Limit Level
Should Be Above 300 Contracts
The Commission believes that it is more appropriate to raise the
Federal spot month position limit level than to maintain its existing
level of 300 contracts, as long as that level is set at or below 25% of
EDS. One reason is because the current 300 contract Federal spot month
position limit level for ICE Cotton No. 2 (CT) has been in place since
at least 1987 while the size of the ICE Cotton No. 2 (CT) market has
significantly increased over the years, as evidenced by the material
increases in deliverable supply and open interest.\690\
---------------------------------------------------------------------------
\690\ For example, between the periods of 1994-1999 and 2015-
2018, the maximum open interest in ICE Cotton No. 2 (CT) increased
from 122,989 contracts to 344,302 contracts. Also, the EDS for ICE
Cotton No. 2 (CT) increased from 6,005 contracts to 6,948 contracts
between 2016 and 2019.
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[[Page 3325]]
A second reason why the Commission believes that it is appropriate
to raise the Federal spot month position limit level above the existing
level of 300 contracts for ICE Cotton No. 2 (CT) is because of
potential liquidity concerns. At 300 contracts, the Federal spot month
position limit level for ICE Cotton No. 2 (CT) would be set at 4.32% of
EDS, which would be the lowest Federal spot month position limit level,
by far, in terms of percentage of EDS among all core referenced futures
contracts.\691\ At such a low level, the Commission is concerned that
this could hamper liquidity in the market, especially if the ICE Cotton
No. 2 (CT) market continues to grow as it has done over the years. This
concern is supported by the Commission's observation that there has
been a lack of liquidity at the start of the spot month period in
recent years as speculative traders exited the market or reduced their
positions to the Federal spot month position limit level of 300
contracts. The Commission's observation is based on its assessment of
the daily price impact liquidity in basis points with the gauge: \692\
---------------------------------------------------------------------------
\691\ CBOT KC HRS Wheat (KW) generally has the lowest Federal
spot month position limit level in terms of percentage of EDS at
6.82%, which is 58% higher than 4.32%. However, following the close
of trading on the business day prior to the last two trading days of
the contract month, CME Live Cattle (LC) has the lowest Federal spot
month position limit level in terms of percentage of EDS at 5.29%,
which is 22% higher than 4.32%.
\692\ Pi is the price of trade i. Pi* is the proxy for the
current market price (the price of the last trade,
Pi--1). Q1 is the quantity traded (the number of futures
contracts traded in trade i). See Kane, Stephen, Exploring price
impact liquidity for December 2016 NYMEX energy contracts, p.5-6,
available at https://www.cftc.gov/sites/default/files/idc/groups/public/@economicanalysis/documents/file/oce_priceimpact.pdf.
[GRAPHIC] [TIFF OMITTED] TR14JA21.030
Raising the limit level above 300 contracts to a higher level, such
as 900 contracts, should help alleviate some of the liquidity problems
that market participants have experienced because they will not have to
reduce their positions to such a low level (i.e., 300 contracts).
A third reason for raising the Federal spot month position limit
level above its existing level of 300 contracts is because a 300
contract level may not provide adequate headroom under which exchanges
may set and adjust their own position limit levels, up or down, in
response to market conditions within this position limits framework.
This is an especially acute issue because, as noted above, a Federal
spot month position limit level of 300 contracts is extremely low in
terms of percentage of EDS when compared to other core referenced
futures contracts, and there is no market-based reason (e.g., higher
susceptibility for corners and squeezes) for why the level should be
set so low.
A final reason for supporting a Federal spot month position limit
level higher than 300 contracts is because IFUS, which is the exchange
that lists ICE Cotton No. 2 (CT), has recommended a level higher than
300 contracts.\693\ This is significant because exchanges have deep
knowledge about their markets and are particularly well-positioned to
recommend position limit levels for the Commission's
consideration.\694\
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\693\ IFUS--Estimated Deliverable Supply--Cotton Methodology,
August 2020, IFUS Comment Letter (Aug. 14, 2020), available at
https://comments.cftc.gov (comment file for Proposed Rule 85 FR
11596).
\694\ 85 FR at 11598. However, as noted before, the Commission
independently reviewed and analyzed the exchange-recommended levels,
including the EDS figures that support such levels.
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The Commission recognizes that the comments from the end-users of
ICE Cotton No. 2 (CT) unanimously requested that the Commission
consider, among other options, maintaining the 300 contract Federal
position limit level. The main justifications underlying this request
are that: (1) The ICE Cotton No. 2 (CT) market is small; and (2) the
EDS figure is extremely high. In response to commenters' claim about
the size of the market, the Commission notes that the market for ICE
Cotton No. 2 (CT) is not as small as suggested. Open interest data
indicate that the ICE Cotton No. 2 (CT) futures market had a larger
average notional open interest in 2019 than nine other core referenced
futures contracts.\695\ Six of these contracts have higher Federal
position limit levels in terms of percentage of EDS in this Final
Rule.\696\
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\695\ These are CBOT Oats (O), CBOT KC HRW Wheat (KW), MGEX HRS
Wheat (MWE), CBOT Rough Rice (RR), ICE Cocoa (CC), ICE FCOJ-A (OJ),
ICE Sugar No. 16 (SF), NYMEX Platinum (PL), and NYMEX Palladium
(PA). See Section III.C.
\696\ These are CBOT Oats (O), MGEX HRS Wheat (MWE), ICE Cocoa
(CC), ICE FCOJ-A (OJ), ICE Sugar No. 16 (SF), and NYMEX Platinum
(PL).
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In response to commenters' issue with the EDS, the Commission notes
that the cotton merchants may have focused on too narrow of a scope in
their comment letters. The commenters appear to focus on the actual
cotton that was delivered pursuant to holding the physically-settled
ICE Cotton No. 2 (CT) core referenced futures contract to expiration,
and they use that data as evidence that the EDS is extremely high.\697\
The Commission's EDS figures are not meant to reflect the actual
commodity delivered. Rather, as the term estimated deliverable supply
indicates, it is the quantity of the commodity that meets contract
specifications that is reasonably expected to be readily available to
short traders and salable by long traders at its market value in normal
cash-marketing channels at the contract's delivery points during the
specified delivery period, barring abnormal movements in interstate
commerce.\698\ The Commission believes that limiting a speculative
trader from controlling more than 25% of this supply, and not the
actual commodity delivered, is critical for ensuring that corners and
squeezes do not happen.\699\
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\697\ See ACSA at 7-8.
\698\ 17 CFR part 38, Appendix C.
\699\ Generally, only a small percentage of futures contracts
actually go to delivery. Basing a speculative position limit on past
deliveries for a futures contract would be far too limiting for a
speculative position limit and would not reasonably achieve the four
policy objectives of CEA section 4a(a)(3)(B).
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[[Page 3326]]
Furthermore, commenters did not provide specific issues with
respect to the methodology used to determine EDS for ICE Cotton No. 2
(CT), which has been available for review by the public since the 2020
NPRM was published.\700\ As a result, the Commission believes that the
EDS for ICE Cotton No. 2 (CT) is appropriate and reasonable based on
its review and analysis of the methodology used.\701\
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\700\ IFUS--Estimated Deliverable Supply--Softs Methodology,
IFUS Comment Letter (May 14, 2019), available at https://comments.cftc.gov (comment file for Proposed Rule 85 FR 11596).
\701\ Specifically, the estimate took into account cotton
certified stocks, which are reported daily for the five delivery
points specified in the contract specifications, as well as the
exchange estimated deliverable stocks close to the delivery points
that are not included as certified stocks based on the USDA's Weekly
Bales Made Available to Ship (``BMAS'') Summary report. The exchange
estimated the deliverable stocks contained in or near exchange
warehouses, both certified and non-certified, during notice and
delivery periods for the futures contract. BMAS deliverable stocks
data was also adjusted to exclude cotton at locations that were far
away from the delivery points.
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(2) ICE Cotton No. 2 (CT) Federal Spot Month Position Limit Level
Should Be Below 1,800 Contracts
However, the Commission believes that it is appropriate to lower
the Federal spot month position limit for ICE Cotton No. 2 (CT) from
the proposed 1,800 contract level. First, as noted previously, the
Commission received an updated recommended Federal spot month position
limit level from IFUS that is lower than 1,800 contracts.\702\ Second,
although the Commission believes that there are issues with the cotton
industry commenters' justifications for lowering the Federal spot month
position limit level, the Commission still believes that their comments
are informative. Specifically, the Commission believes that the
unanimous comments from the end-users of the ICE Cotton No. 2 (CT) core
referenced futures contract suggest that lowering the Federal spot
month position limit level from 1,800 contracts will not have a
material detrimental effect on liquidity for bona fide hedgers in the
market. All things being equal, a lower spot month position limit level
will better protect the markets against corners and squeezes, but at
the expense of a reduction in liquidity for bona fide hedgers as
positions held by speculators will be more constrained. However, in
this instance, the Commission believes that it could improve
protections against corners and squeezes without materially impacting
liquidity for bona fide hedgers by adopting a Federal spot month
position limit level that is lower than 1,800 contracts, based on the
comments received.\703\
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\702\ IFUS--Estimated Deliverable Supply--Cotton Methodology,
August 2020, IFUS Comment Letter (Aug. 14, 2020), available at
https://comments.cftc.gov (comment file for Proposed Rule 85 FR
11596).
\703\ However, for the reasons discussed previously, the
Commission does not believe that lowering the Federal spot month
position limit level to 300 contracts is appropriate, given the
observed issues in liquidity during the early part of the spot month
period.
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(3) ICE Cotton No. 2 (CT) Federal Spot Month Position Limit Level
Should Be Set at 900 Contracts
Given that the Commission believes that it is preferable to set a
Federal spot month position limit level higher than 300 contracts but
lower than 1,800 contracts for the aforementioned reasons, the
Commission believes that a Federal position limit level of 900
contracts is preferable to those alternatives. Specifically, the
Commission notes that IFUS, which has deep knowledge about the ICE
Cotton No. 2 (CT) market and is particularly well-positioned to
recommend the position limit level for the Commission's consideration,
has recommended a Federal spot month position limit level of 900
contracts. This is also supported by commenters who requested a
``drastically lower'' Federal spot month position limit level as an
alternative to maintaining a Federal spot month position limit level of
300 contracts.
The Commission also believes that a level of 900 contracts is
sufficiently high to address concerns about a lack of liquidity. This
is, in part, because a Federal spot month position limit level of 900
contracts would result in a level that is set at 12.95% of EDS, which
would coincidentally place ICE Cotton No. 2 (CT) exactly at the median
among the legacy agricultural contracts and all core referenced futures
contracts in terms of percentage of EDS. Finally, based on the comments
received and because, all things being equal, lower spot month position
limit levels provide better protection against corners and squeezes,
the Commission believes that a level of 900 contracts will provide
stronger protection against corners and squeezes without materially
impacting liquidity for bona fide hedgers vis-[agrave]-vis a level of
1,800 contracts.\704\
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\704\ The Commission recognizes that this will limit the range
through which an exchange may set and adjust its own exchange-set
position limit level. However, based on the comments received, the
Commission believes that the stronger protections against corners
and squeezes is appropriate.
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vi. NYMEX Henry Hub Natural Gas (NG)
This section will address the following issues concerning NYMEX NG:
(i) The Federal spot month position limit level for NYMEX NG; (ii) the
conditional spot month position limit exemption for positions in
natural gas referenced contracts, which is located in final Sec.
150.3(a)(4); and (iii) NYMEX NG penultimate referenced contracts. The
Commission is addressing the latter two issues in this section in order
to allow the reader to review all discussions regarding natural gas in
one place in this Final Rule.
a. NYMEX Henry Hub Natural Gas (NG) Federal Spot Month Position Limit
Level
(1) Summary of the 2020 NPRM and Additional Background Information--
NYMEX NG Federal Spot Month Position Limit Level
Under the existing Federal position limits framework, there are no
Federal position limits for NYMEX NG in either the spot month or the
non-spot month. There is, however, an exchange-set spot month position
limit for NYMEX NG, which is set at 1,000 contracts for the physically-
settled NYMEX NG contract and 1,000 contracts per exchange for cash-
settled equivalent-sized natural gas contracts. Because there are three
exchanges that list such cash-settled natural gas contracts (NYMEX,
IFUS, and Nodal), a market participant can currently hold up to 3,000
such cash-settled contracts during the spot month.
In the 2020 NPRM, the Commission proposed a Federal spot month
position limit level of 2,000 contracts for NYMEX NG. The 2,000
contract level was determined based on 25% of updated EDS and was
recommended by CME Group. Consistent with the other core referenced
futures contracts, the proposed netting and aggregation requirements
permitted a market participant to hold up to 2,000 physically-settled
NYMEX NG referenced contracts and another 2,000 cash-settled NYMEX NG
referenced contracts across all exchanges and in the OTC swaps
market.\705\
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\705\ For further discussion of netting and aggregation, see
Section II.B.10. (Application of Netting and Related Treatment of
Cash-settled Referenced Contracts).
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(2) Summary of the Commission Determination--NYMEX NG Federal Spot
Month Position Limit Level
The Commission is adopting its proposed approach with respect to
physically-settled NYMEX NG referenced contracts, but is modifying its
proposed approach with respect to cash-settled NYMEX NG referenced
contracts, as discussed below.
[[Page 3327]]
(3) Comments--NYMEX NG Federal Spot Month Position Limit Level
With respect to the proposed NYMEX NG Federal spot month position
limit level, NGSA requested that the Commission ``increase the spot
month limit on the NG Contract by recognizing the transportation
capacity available now at Henry Hub provided by displacement and the
increasing capacity which is coming from future but imminent
displacement.'' \706\ In support, NGSA noted that CME Group's EDS
figure has ``incorporated displacement into its estimate of deliverable
supply at Henry Hub for years.'' \707\
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\706\ NGSA at 10-11.
\707\ Id. at 11.
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MFA/AIMA, Citadel, and SIFMA AMG requested that the Commission
raise the Federal spot month position limit level for NYMEX NG
referenced contracts to at least 3,000 contracts, because the 2020 NPRM
effectively decreases the total number of exchange-traded cash-settled
NYMEX NG referenced contracts that a market participant may hold in the
spot month from the current level of 3,000 contracts to 2,000
contracts.\708\ In support of this request, MFA/AIMA argued that the
2020 NPRM ``could adversely affect the ability of traders to optimize
the proportion of physically-settled and cash-settled natural gas
contracts that they wish to hold in their portfolio.'' \709\ SIFMA AMG
argued that the 2020 NPRM ``would disrupt existing trading practices
and business models without any corresponding regulatory or policy
benefit.'' \710\
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\708\ MFA/AIMA at 11-12; Citadel at 7-8; and SIFMA AMG at 10-11
(SIFMA AMG supported the 2,000 contract limit level for physically-
settled NYMEX NG referenced contracts, but requested at least a
3,000 contract limit level for the cash-settled NYMEX NG referenced
contracts).
\709\ MFA/AIMA at 11-12.
\710\ SIFMA AMG at 11.
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(4) Discussion of Final Rule--NYMEX NG Federal Spot Month Position
Limit Level
Under the Final Rule, market participants may hold up to 2,000
cash-settled NYMEX NG referenced contracts per exchange during the spot
month and an additional 2,000 cash-settled economically equivalent OTC
swaps, rather than being subject to an aggregate position limit level
of 2,000 cash-settled NYMEX NG referenced contracts across all
exchanges and the OTC swaps market as proposed under the 2020 NPRM.
Because there are currently three exchanges that list natural gas
referenced contracts, this will allow market participants to hold a
total of 8,000 cash-settled NYMEX NG referenced contracts between
positions held in cash-settled futures and in cash-settled economically
equivalent OTC swaps.\711\ This is in addition to the 2,000 physically-
settled NYMEX NG referenced contracts a market participant may hold
during the spot month. These amendments to the proposal are reflected
in a revised Appendix E to part 150 that the Commission is adopting in
this Final Rule.
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\711\ 2,000 cash-settled referenced contracts multiplied by
three exchanges plus 2,000 cash-settled economically equivalent OTC
swaps equals 8,000 cash-settled NYMEX NG referenced contracts.
---------------------------------------------------------------------------
(i) Request To Increase the Federal Spot Month Position Limit Level To
Account for Displacement
In response to NGSA's request, the Commission first notes that CME
Group provided the EDS figure that was used as a basis for determining
its exchange-recommended Federal spot month position limit level, which
the Commission ultimately used as a basis for its own proposed Federal
spot month position limit level for NYMEX NG after independently
reviewing and assessing the methodology underlying the EDS figure and
the EDS figure itself.\712\ As NGSA noted, CME Group's EDS has
``incorporated displacement into its estimate of deliverable supply at
Henry Hub for years,'' \713\ which means that the EDS figure on which
the proposed Federal spot month position limit level was based already
``recogniz[ed] the transportation capacity available now at Henry Hub
provided by displacement.'' \714\ As a result, the proposed Federal
spot month position limit level took this into account as well. With
respect to future increases in EDS based on ``future but imminent
displacement,'' \715\ in the event that this occurs, CME Group may
submit an updated EDS figure pursuant to Sec. 150.2(f), at which time
the Commission would consider whether to modify the Federal spot month
position limit level.
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\712\ Summary DSE Proposed Limits, CME Group Comment Letter
(Nov. 26, 2019), available at https://comments.cftc.gov (comment
file for Proposed Rule 85 FR 11596).
\713\ NGSA at 11.
\714\ Id. at 10. Furthermore, CME Group's methodology for
determining EDS for NYMEX NG explicitly states, ``Additionally, the
Exchange has taken into consideration backhaul in estimating the
deliverable supply.'' New York Mercantile Exchange, Inc., Analysis
of Deliverable Supply Henry Hub Natural Gas Futures, December 2018
(Dec. 1, 2018), available at https://comments.cftc.gov (comment file
for Proposed Rule 85 FR 11596).
\715\ NGSA at 10.
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(ii) Request To Increase the Cash-Settled Federal Spot Month Position
Limit Level
As previewed above, in response to comments from MFA/AIMA, Citadel,
and SIFMA AMG, the Commission is modifying the proposed NYMEX NG
Federal spot month position limit level for cash-settled NYMEX NG
referenced contracts, so that the Federal spot month position limit
applies separately per each exchange and the OTC swaps market, rather
than across exchanges and the OTC swaps market.
The Commission believes that this modification is warranted in
order to avoid disrupting the well-developed, unique liquidity
characteristics of the natural gas derivatives markets. As detailed
below, the cash-settled natural gas market is significantly more liquid
than the physically-settled natural gas market during the spot month.
This is in contrast with typical commodity markets, in which the
physically-settled contracts are generally more liquid than the cash-
settled contracts during the spot month.\716\
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\716\ Typically, this is because the physically-settled contract
is established first and the natural formation of liquidity in the
physically-settled contract historically stays in the established
contract due to first mover advantage. More liquid markets provide
for better bid/ask spreads and can execute larger transaction sizes
without substantial effects on the price of the contract. Thus, in
the past, cash-settled look-alike contracts historically have not
been as liquid as the original physically-settled futures contract.
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The unique nature of the natural gas markets is reflected in the
current exchange-set natural gas position limit framework, in which
market participants may hold up to 1,000 cash-settled natural gas
contracts per exchange, which can result in a position of up to 3,000
cash-settled natural gas contracts (instead of 1,000 cash-settled
natural gas contracts altogether), despite only being able to hold up
to 1,000 physically-settled NYMEX NG contracts. The Commission believes
that, absent the modification adopted herein to apply the spot month
limit to NYMEX NG on a per exchange basis, the proposed Federal spot
month position limit level could disrupt the cash-settled natural gas
markets, in part, because, as commenters have noted: (1) Market
participants would be able to hold fewer cash-settled NYMEX NG
referenced contracts (i.e., 2,000 contracts) than they were previously
permitted under the exchange-set position limit framework (i.e., 3,000
contracts); and (2) some market participants may not be able to hold
the same proportion of physically-settled to cash-settled NYMEX NG
referenced contracts that they are
[[Page 3328]]
currently able to hold if they wish to maximize their positions in
physically-settled NYMEX NG referenced contracts. The Commission also
believes that it is appropriate to maintain consistency vis-[agrave]-
vis the exchange-set position limit framework in order to minimize
disruptions, since the Commission has not observed any issues with the
exchange-set position limit framework with respect to natural gas.
Accordingly, under the Final Rule, market participants (that are
not availing themselves of the Federal spot month conditional position
limit exemption for NYMEX NG, which is discussed below) may hold up to
2,000 cash-settled NYMEX NG referenced contracts on each exchange that
lists a cash-settled NYMEX NG referenced contract (which is currently
NYMEX, IFUS, and Nodal), a total position of 6,000 exchange-listed
cash-settled NYMEX NG referenced contracts.\717\ Furthermore, under the
Final Rule, traders may also hold an additional position in cash-
settled economically equivalent NYMEX NG OTC swaps that has a notional
amount of up to 2,000 equivalent-sized contracts. The Commission is
separately permitting up to 2,000 referenced contracts in the NYMEX NG
OTC swaps market in order to avoid disruptions to that market, given
that traders may be currently participating in that market as well. As
a result, under the Final Rule, traders may hold up to a total of 8,000
cash-settled NYMEX NG referenced contracts \718\ and 2,000 physically-
settled NYMEX NG referenced contracts.\719\
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\717\ The Commission notes that market participants are not
permitted to net cash-settled NYMEX NG referenced contract positions
across exchanges or the OTC swaps market for Federal spot month
position limit purposes.
\718\ 2,000 cash-settled NYMEX NG referenced contracts
multiplied by three exchanges plus 2,000 cash-settled economically
equivalent NYMEX NG OTC swaps equals 8,000 cash-settled NYMEX NG
referenced contracts.
\719\ CME Group also commented that it ``objects to any
disparities in the spot-month limits and would rigorously disagree
if the Commission adopts any other disparities in treatment between
physically-settled and cash-settled contracts,'' in the context of
the proposed Federal conditional limit, which is discussed in the
section below. CME Group at 6. This comment could also be viewed as
an objection to the Final Rule's Federal spot month position limit
level for cash-settled NYMEX NG referenced contracts. The Commission
believes that the rationale set forth in this section and the
Federal conditional limit section below is responsive to CME Group's
possible concern with respect to the Final Rule's Federal spot month
position limit level for cash-settled NYMEX NG referenced contracts.
---------------------------------------------------------------------------
The Commission notes that, as discussed further below, as an
initial legal matter, the Commission interprets CEA section 4a(a)(6) as
generally requiring aggregate Federal position limits across
exchanges.\720\ Notwithstanding the requirements of CEA section
4a(a)(6), the Commission is adopting this approach with respect to
NYMEX NG referenced contracts pursuant to its exemptive authority in
CEA section 4a(a)(7). In doing so, the Commission believes that, based
on the foregoing reasons, applying the Federal spot month position
limit level for cash-settled NYMEX NG referenced contracts separately
per exchange and the OTC swaps market does not undermine the purposes
of the Federal position limits framework pursuant to CEA section 4a.
---------------------------------------------------------------------------
\720\ For further discussion of the Commission's aggregation and
netting rules, see Section II.B.10. (application of netting
section).
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b. NYMEX NG Federal Spot Month Conditional Position Limit Level
(1) Summary of 2020 NPRM and Additional Background Information--NYMEX
NG Federal Spot Month Conditional Position Limit Level
In addition to the proposed 2,000 contract Federal spot month
position limit level for NYMEX NG, proposed Sec. 150.3(a)(4) also
included a spot month conditional position limit exemption (``Federal
conditional limit'') from the standard Federal spot month position
limit level for NYMEX NG for market participants that do not hold a
position in the physically-settled NYMEX NG referenced contract.\721\
The proposed Federal conditional limit would allow, during the spot
month, market participants that do not hold a position in the
physically-settled NYMEX NG referenced contract to hold: (1) Up to
10,000 cash-settled NYMEX NG referenced contracts per exchange that
lists a cash-settled NYMEX NG referenced contract; and (2) an
additional position in cash-settled economically equivalent NYMEX NG
OTC swaps that has a notional amount of up to 10,000 equivalent-sized
contracts. As a result, the proposed Federal conditional limit would
permit a market participant that does not hold a physically-settled
NYMEX NG referenced contract to hold a total of 40,000 cash-settled
NYMEX NG referenced contracts (up to 10,000 contracts on each of the
three exchanges (NYMEX, IFUS, and Nodal) that lists a cash-settled
NYMEX NG referenced contract and in the OTC swaps market) during the
spot month.
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\721\ The Commission is adopting the Federal conditional limit
pursuant to its exemptive authority in CEA section 4a(a)(7). 7
U.S.C. 6a(a)(7).
---------------------------------------------------------------------------
The proposed framework for the Federal conditional limit was
derived from the existing exchange-set spot month conditional position
limit framework that has been in place for approximately a decade. This
existing conditional position limit framework permits, during the spot
month, up to 5,000 equivalent-sized cash-settled natural gas contracts
per exchange that lists a cash-settled natural gas contract, provided
that the market participant does not hold a position in the physically-
settled NYMEX NG contract.\722\ The 5,000 contract conditional spot
month position limit level equals five-times the existing exchange-set
1,000 contract spot month position limit level for the physically-
settled NYMEX NG contract.\723\ Noting the unique circumstances of the
natural gas futures markets, the Commission's proposed Federal
conditional limit level applied the same multiplier of five to its
proposed Federal spot month position limit level for the physically-
settled NYMEX NG contract in order to arrive at the 10,000 contract
Federal conditional limit level that applies for each exchange and OTC
swaps market.
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\723\ See IFUS Rule 6.20(c), NYMEX Rule 559.F, and Nodal Rule
6.5.7. The spot month for such contracts is three days. See also
Position Limits, CMG Group website, available at https://www.cmegroup.com/market-regulation/position-limits.html (NYMEX
position limits spreadsheet); Market Resources, IFUS website,
available at https://www.theice.com/futures-us/market-resources
(IFUS position limits spreadsheet). NYMEX rules establish an
exchange-set spot month limit of 1,000 contracts for its physically-
settled NYMEX NG core referenced futures contract and a separate
spot month limit of 1,000 contracts for its cash-settled Henry Hub
Natural Gas Last Day Financial Futures contract. IFUS's natural gas
contract is one quarter the size of the NYMEX contract. IFUS thus
has rules in place establishing an exchange-set spot month limit of
4,000 contracts (equivalent to 1,000 NYMEX NG contracts) for its
cash-settled Henry Hub LD1 Fixed Price Futures contract.
---------------------------------------------------------------------------
The 2020 NPRM included the Federal conditional limit to accommodate
certain trading dynamics unique to the natural gas contracts.\724\ For
example, the Commission has observed that, as the physically-settled
NYMEX NG core referenced futures contract approaches expiration, open
interest tends to decline in NYMEX NG and tends to increase rapidly in
ICE's cash-settled Henry Hub LD1 contract.\725\ This is in contrast
with other commodities in which the physically-settled markets are more
liquid than the cash-settled markets during the spot month. These
dynamics suggest that cash-settled natural gas contracts serve an
important function for hedgers and speculators who wish to recreate
and/or hedge the physically-settled NYMEX NG contract price during the
spot month without being required to make or take
[[Page 3329]]
delivery.\726\ In addition, the Commission also proposed the
divestiture requirement in the Federal conditional limit in order to
address historical concerns over the potential for manipulation of
physically-settled natural gas contracts during the spot month in order
to benefit positions in cash-settled natural gas contracts.\727\
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\724\ 85 FR at 11641.
\725\ Id.
\726\ Id.
\727\ Id.
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(2) Summary of the Commission Determination--NYMEX NG Federal Spot
Month Conditional Position Limit Level
The Commission is adopting the Federal conditional limit as
proposed.
(3) Comments--NYMEX NG Federal Spot Month Conditional Position Limit
Level
With respect to the proposed Federal conditional limit, several
commenters generally supported its adoption.\728\ COPE believed that
the proposed conditional limit ``permits market liquidity . . . without
sacrificing the benefits of position limits.''\729\ ICE supported the
Federal conditional limit, noting that ``cash-settled contracts present
a reduced potential for manipulation of the price of the physically-
settled contract.'' \730\ CME Group, on the other hand, objected to the
proposal, arguing that it could ``drain liquidity for bona fide hedgers
in the physically-settled market and could prevent physical delivery
markets from serving the price discovery function that they have long
provided'' and believed that it ``could incentivize the manipulation of
a cash commodity price in order to benefit a position in a cash-settled
contract.'' \731\
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\728\ COPE at 2-3; EEI/EPSA at 4; and ICE at 13.
\729\ COPE at 2-3.
\730\ ICE at 13 (referencing a sentiment previously expressed by
the Commission).
\731\ CME Group at 6.
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A number of commenters also requested that the Federal conditional
limit levels be available to market participants that do not exit
positions in the physically-settled NYMEX NG referenced contract during
the spot month, which would effectively establish the Federal
conditional limit level as the operative Federal spot month limit level
for cash-settled NYMEX NG referenced contracts. In support of this
request, several commenters argued that the 2020 NPRM's approach to the
Federal conditional limit would result in liquidity leaving the
physically-settled NYMEX NG referenced contract when it is needed the
most.\732\ EEI/EPSA also commented that the Federal conditional limit
framework in the 2020 NPRM is ``excessive and is an overly rigid
solution that may unnecessarily restrict legitimate trading activity.''
\733\ NGSA commented that the 2020 NPRM ``removes important hedging
optionality for physical market participants.'' \734\ Citadel argued
that the 2020 NPRM would limit flexibility and impair market efficiency
by preventing ``market participants with a meaningful position in the
cash-settled market from participating in the physically-settled
market--limiting flexibility and impairing market efficiency.'' \735\
CCI also believed that the 2020 NPRM would ``impair price discovery''
and ``negatively impact price convergence.'' \736\
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\732\ ISDA at 8; SIFMA AMG at 10-11; FIA at 7-8; NGSA at 12-14;
Citadel at 7; and CCI at 4.
\733\ EEI/EPSA at 4.
\734\ NGSA at 12.
\735\ Citadel at 7.
\736\ CCI at 4.
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Finally, ICE requested that ``the Commission revert back to the
five-time conditional limit for cash settled contracts . . . instead of
the conditional limit of 10,000 contracts in the Proposed Rule,''
because ``[a]pplying a five-time multiplier versus a hard limit, would
allow the conditional limit to track any changes in the spot month
limits over time, which in turn will reflect changes in deliverable
supply.'' \737\
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\737\ ICE at 13.
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(4) Discussion of Final Rule--NYMEX NG Federal Spot Month Conditional
Position Limit Level
(i) Availability of the Federal Conditional Limit for NYMEX NG
In response to CME Group's comment supporting the elimination of
the Federal condition limit, the Commission is concerned that
eliminating the proposed conditional limit could result in potential
market disruptions, given that a conditional limit framework for
natural gas has been in place at the exchange level for many years. For
example, eliminating the existing conditional limit structure could
restrict the positions that market participants may hold in cash-
settled NYMEX NG referenced contracts during the spot month, resulting
in reduced liquidity, including for commercial hedgers seeking to
offset price risks but not necessarily looking to make or take
delivery. Additionally, since it was instituted approximately a decade
ago, the exchange-set conditional limit framework has functioned
well.\738\ The Commission has not observed any of the concerns raised
by CME Group come to fruition, and the physically-settled NYMEX NG
referenced contract remains highly liquid. Furthermore, as discussed
above, other commenters supported the availability of the Federal
conditional limit.
---------------------------------------------------------------------------
\738\ 85 FR at 11640.
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(ii) Federal Conditional Limit's Divestiture Requirement
In response to comments requesting that the Federal conditional
limit be available to market participants that do not exit the spot
month physically-settled NYMEX NG referenced contract, the Commission
first notes that the requirement that market participants exit the
physically-settled NYMEX NG referenced contract has been reflected in
exchange rulebooks for many years, in part because the requirement is
critically important to discouraging manipulation.\739\ Without this
requirement, a trader could hold up to 40,000 cash-settled NYMEX NG
referenced contracts (or more, if additional exchanges list cash-
settled NYMEX NG referenced contracts in the future), which is at 500%
of EDS, and 2,000 physically-settled NYMEX NG referenced contracts,
which is at 25% of EDS. At these levels, it may not require much
movement in the physically-settled markets to disproportionately
benefit the cash-settled holdings. As a result, the requirement to exit
the physically-settled contract is critical for reducing the market
participant's incentive to manipulate the cash settlement price by, for
example, banging-the-close or distorting physical delivery prices in
the physically-settled contract to benefit leveraged cash-settled
positions.\740\
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\739\ 85 FR at 11641.
\740\ See 85 FR 11626, 11641.
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With respect to commenters' concerns about removing flexibility and
options for market participants, as well as a potential decrease in
liquidity in the physically-settled NYMEX NG referenced contract, the
Commission notes that the physically-settled NYMEX NG referenced
contract remains highly liquid even in spite of the implementation of
the exchange-set conditional limit framework instituted approximately a
decade ago. Also, market participants should have more flexibility and
options than before because the Federal spot month position limit level
for NYMEX NG adopted herein will now permit up to 8,000 cash-settled
NYMEX NG referenced contracts, even if the market participant holds
2,000 physically-settled NYMEX
[[Page 3330]]
NG referenced contracts.\741\ Finally, the Commission reiterates that
Federal position limit levels only apply to speculative positions and,
as a result, bona fide hedging positions will continue to be allowed to
exceed the Federal position limit levels, including the Federal
conditional limit level, from the Federal position limits
perspective.\742\
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\741\ Under the Final Rule's Federal spot month position limit
level for NYMEX NG, a trader may hold 2,000 physically-settled NYMEX
NG referenced contracts, 2,000 cash-settled NYMEX NG referenced
contracts per exchange that lists such contracts, and 2,000 cash-
settled economically equivalent NYMEX NG OTC swaps. Currently, there
are three exchanges that list cash-settled NYMEX NG referenced
contracts--NYMEX, IFUS, and Nodal. As a result, a trader may hold up
to 6,000 exchange-listed cash-settled NYMEX NG referenced contracts
and 2,000 cash-settled economically equivalent NYMEX NG OTC swaps,
which brings the total number of cash-settled NYMEX NG referenced
contracts a trader may hold to 8,000 under the Federal spot month
position limit level.
\742\ This also answers EEI/EPSA's request to confirm ``that a
participant may rely upon the conditional limit in the first
instance but may also utilize a hedge exemption to exceed the
conditional limit.'' EEI/EPSA at 4. However, the Commission notes
that exchanges have rarely, if ever, allowed a market participant to
exceed the exchange-set natural gas conditional limit by layering a
bona fide hedge position on top of the cash-settled natural gas
contract position permitted under the natural gas conditional limit.
Similar to this existing practice, the Commission expects that,
under the Final Rule, a market participant will rarely be permitted
to hold: (1) A bona fide hedge position in the physically-settled
NYMEX NG referenced contract while taking advantage of the
conditional limit for cash-settled NYMEX NG referenced contracts; or
(2) a bona fide hedge position in cash-settled NYMEX NG referenced
contracts on top of the maximum position permitted under the
conditional limit for cash-settled NYMEX NG referenced contracts.
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(iii) Application of a Five-Times Multiplier for the Federal
Conditional Limit Level
The Commission clarifies that, in accordance with historical
practice, if the Federal spot month position limit level for the
physically-settled NYMEX NG referenced contract is updated in the
future through rulemaking, the Commission expects to simultaneously
adjust the Federal conditional limit in the same rulemaking, such that
the Federal conditional limit level is set at a multiple of five of the
new Federal spot month position limit level for NYMEX NG, provided that
the Commission does not observe any issues in the markets.
c. NYMEX NG Penultimate Referenced Contracts
(1) Summary of the 2020 NPRM and Additional Background Information--
NYMEX NG Penultimate Referenced Contracts
With respect to NYMEX NG, the Commission proposed that penultimate
contracts, which are cash-settled contracts that settle on the trading
day immediately preceding the final trading day of the corresponding
referenced contract, are also considered referenced contracts that are
subject to Federal spot month position limits.\743\ The Commission also
proposed a slightly broader economically equivalent swap definition for
natural gas, so that swaps with delivery dates that diverge by less
than two calendar days (instead of one calendar day) from an associated
referenced contract could still be deemed economically equivalent and
therefore subject to Federal position limits. The Commission made these
adjustments to: Recognize the active and vibrant penultimate natural
gas contract markets; prevent and disincentivize manipulation and
regulatory arbitrage; and prevent volume from shifting away from non-
penultimate cash-settled NYMEX NG markets to penultimate NYMEX NG
contract futures and/or penultimate NYMEX NG swaps markets in order to
avoid Federal position limits.\744\
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\743\ Such penultimate contracts include: ICE's Henry Financial
Penultimate Fixed Price Futures (PHH) and options on Henry
Penultimate Fixed Price (PHE), and NYMEX's Henry Hub Natural Gas
Penultimate Financial Futures (NPG).
\744\ The Commission proposed a relatively narrow ``economically
equivalent swap'' definition in order to prevent market participants
from inappropriately netting positions in core referenced futures
contracts against swap positions further out on the curve. The
Commission acknowledges that liquidity could shift to penultimate
swaps as a result, but believes that, with the exception of natural
gas, this concern is mitigated since certain constraints exist that
militate against this from occurring, including basis risk between
the penultimate swap and the core referenced futures contract.
However, this constraint does not necessarily apply to the natural
gas futures markets, because natural gas has a relatively liquid
penultimate futures market that enables a market participant to
hedge or off-set its penultimate swap positions. As a result, the
Commission believes that liquidity may be incentivized to shift from
NYMEX NG to penultimate natural gas swaps in order to avoid Federal
position limits in the absence of the Commission's exception for
natural gas in the ``economically equivalent swap'' definition.
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(2) Comments--NYMEX NG Penultimate Referenced Contracts
In response to this part of the 2020 NPRM, ICE requested ``that the
Commission continue to allow exchanges to impose spot month
accountability levels which expire during the period when spot month
limits for the Henry Hub core-referenced futures contract are in effect
and to not aggregate penultimate options into the Henry Hub LD1 cash-
settled limit.'' \745\ One of the ways in which ICE supported this
request was by claiming that, ``The Commission states that penultimate
contracts are economically the same as the last day contract, however,
empirically, this statement is not correct as settlement prices have
demonstrated.'' \746\
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\745\ ICE at 14.
\746\ Id.
---------------------------------------------------------------------------
(3) Discussion of Final Rule--NYMEX NG Penultimate Referenced Contracts
The Commission declines to exclude NYMEX NG penultimate contracts
from Federal position limits for the reasons set forth in this Final
Rule's section addressing ``Referenced Contract.'' \747\ In doing so,
the Commission notes, in particular, that ICE's specific assertion that
penultimate natural gas contracts are not economically the same as last
day contracts based on settlement prices runs counter to the
Commission's review of a sample of the daily settlement prices for
NYMEX NG (the physically-settled natural gas contract), ICE Henry Hub
LD1 (the ICE natural gas contract cash-settled to NYMEX NG), and ICE
Henry Hub Penultimate (the ICE penultimate natural gas contract cash-
settled to NYMEX NG).\748\
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\747\ For further discussion of the Commission's determination
to include penultimate contracts within the Federal position limits
framework, see Section II.A.16.iii.a.(2)(iii).
\748\ Id.
---------------------------------------------------------------------------
vii. Wheat Core Referenced Futures Contracts' Federal Spot Month
Position Limit Levels
a. Summary of the 2020 NPRM and Additional Background Information--
Wheat Federal Spot Month Position Limit Levels
The Commission proposed to increase the Federal spot month position
limit levels for all three wheat core referenced futures contracts
(CBOT Wheat (W), CBOT KC HRW Wheat (KW), and MGEX HRS Wheat (MWE)) from
600 contracts to 1,200 contracts. The proposed Federal limit levels
were based on the underlying EDS figures for each wheat core referenced
futures contract and CME's and MGEX's recommended Federal spot month
position limit levels of 1,200 contracts for each of their respective
wheat core referenced futures contracts.
b. Summary of the Commission Determination--Wheat Federal Spot Month
Position Limit Levels
The Commission is adopting the Federal spot month position limit
levels for all three wheat core referenced futures contracts as
proposed.
c. Comments--Wheat Federal Spot Month Position Limit Levels
The Commission received one comment, from MGEX, fully supporting
[[Page 3331]]
the 2020 NPRM's Federal spot month parity among the three wheat core
referenced futures contracts.\749\
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\749\ MGEX at 3.
---------------------------------------------------------------------------
4. Federal Non-Spot Month Position Limit Levels
i. Background--Federal Non-Spot Month Position Limit Levels
The Commission most recently updated the Federal non-spot month
position limit levels in 2011.\750\ At that time, the Commission
utilized a formula that was called the ``10/2.5% formula,'' \751\ which
calculated the Federal non-spot month position limit levels by
multiplying the first 25,000 contracts in open interest by 10% and
multiplying the remaining contracts by 2.5% and adding the two numbers
together.\752\ The 10/2.5% formula was first adopted in 1999 based on
two primary factors: Growth in open interest and the size of large
traders' positions.\753\ The existing Federal non-spot month position
limit levels that were adopted in 2011 have not been updated to reflect
changes in open interest data in over a decade.\754\
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\750\ The Commission notes that the 2011 Final Rulemaking that
adopted the most recent Federal non-spot month position limit levels
was vacated by an order of the U.S. District Court for the District
of Columbia on September 28, 2012. However, that order did not apply
with respect to the 2011 Final Rulemaking's amendments to the
Federal non-spot month position limit levels in Sec. 150.2. ISDA,
887 F.Supp.2d 259 (2012).
\751\ See, e.g., Revision of Federal Speculative Position Limits
and Associated Rules, 64 FR at 24038 (May 5, 1999) (increasing
deferred-month limit levels based on 10% of open interest up to an
open interest of 25,000 contracts, with a marginal increase of 2.5%
thereafter). Prior to 1999, the Commission had given little credence
to the size of open interest in the contract in determining the
position limit level. Instead, the Commission's traditional standard
was to set limit levels based on the distribution of speculative
traders in the market. See, e.g., 64 FR at 24039; Revision of
Federal Speculative Position Limits and Associated Rules, 63 FR at
38525, 38527 (July 17, 1998).
\752\ For example, assume a commodity contract has an aggregate
open interest of 200,000 contracts over the past 12 month period.
Applying the 10/2.5% formula to an aggregate open interest of
200,000 contracts would yield a non-spot month position limit level
of 6,875 contracts. That is, 10% of the first 25,000 contracts would
equal 2,500 contracts (25,000 contracts x 0.10 = 2,500 contracts).
Then add 2.5% of the remaining 175,000 of aggregate open interest or
4,375 contracts (175,000 contracts x 0.025 = 4,375 contracts) for a
total non-spot month position limit level of 6,875 contracts (2,500
contracts + 4,375 contracts = 6,875 contracts).
\753\ See 64 FR at 24038. See also 63 FR at 38525, 38527 (The
1998 proposed revisions to non-spot month levels, which were
eventually adopted in 1999, were based upon two criteria: ``(1) The
distribution of speculative traders in the markets; and (2) the size
of open interest.'').
\754\ In setting the Federal non-spot month position limit
levels in 2011, the Commission used open interest data from 2009. 76
FR at 71642.
---------------------------------------------------------------------------
ii. Summary of the 2020 NPRM--Federal Non-Spot Month Position Limit
Levels
Proposed Sec. 150.2(e) provided that Federal non-spot month
position limit levels were set forth in proposed Appendix E to part 150
and were as follows: \755\
---------------------------------------------------------------------------
\755\ 85 FR at 11624. As discussed above, the proposed Federal
non-spot month position limits would apply to only the nine legacy
agricultural contracts and any associated referenced contracts. All
other referenced contracts subject to Federal position limits would
be subject to Federal position limits only during the spot month, as
specified above, and would only be subject to exchange-set position
limits or position accountability levels outside of the spot month.
[GRAPHIC] [TIFF OMITTED] TR14JA21.009
[[Page 3332]]
In generally calculating the above levels, the Commission proposed
to maintain the existing 10/2.5% formula for non-spot month position
limit levels, but with the following limited changes: (1) The 10% rate
would apply to the first 50,000 contracts of open interest (instead of
the first 25,000 contracts); (2) the 2.5% rate would apply to open
interest above 50,000 contracts (rather than above the current level of
25,000 contracts); and (3) the modified 10/2.5% formula would apply to
updated open interest data for the applicable futures and delta-
adjusted options for the periods from July 2017 to June 2018 and July
2018 to June 2019.\756\ All Federal non-spot month position limit
levels that were calculated based on the 10/2.5% formula (i.e., all
legacy agricultural contracts, with the exception of CBOT Oats (O),
CBOT KC HRW Wheat (KW), MGEX HRS Wheat (MWE), and the single month
position limit level for ICE Cotton No. 2 (CT)) were rounded up to the
nearest 100 contracts.
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\756\ The 12-month period yielding the higher open interest
level is selected as the basis for the Federal non-spot month
position limit level.
---------------------------------------------------------------------------
As outlined in the table above, the proposed Federal non-spot month
position limit levels are generally higher than the existing Federal
non-spot month position limit levels, with the exception of CBOT Oats
(O), CBOT KC HRW Wheat (KW), and MGEX HRS Wheat (MWE), for which the
proposed limit levels would remain at existing levels. As described in
detail below, this proposed general increase is primarily due to the
increases in open interest that have occurred since the Federal non-
spot month position limit levels were last updated approximately a
decade ago.\757\
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\757\ See 85 FR at 11630. The 2020 NPRM's proposed modification
to the 10/2.5% formula from 25,000 to 50,000 contracts results in a
modest increase in the Federal non-spot month position limit level
of 1,875 contracts over what the limit level would be if the 10/2.5%
formula were applied at 25,000 contracts, assuming that the market
for the core referenced futures contract has an open interest of at
least 50,000 contracts.
---------------------------------------------------------------------------
iii. Summary of the Commission Determination--Federal Non-Spot Month
Position Limit Levels
The Commission is adopting each of the Federal non-spot month
position limit levels as proposed in Sec. 150.2(e) and Appendix E to
part 150, with the exception of setting a lower single month position
limit for ICE Cotton No. 2 (CT). The Commission will first describe the
general rationale for the final Federal non-spot month position limit
levels that are being adopted. Next, the Commission will describe the
comments it received in connection with the proposed Federal non-spot
month position limit levels. Finally, the Commission will provide
responses to such comments, including further rationale for the
Commission's position concerning the final Federal non-spot month
position limit levels.
a. Rationale for the Final Federal Non-Spot Month Position Limit Levels
As explained below, the Commission believes that the final Federal
non-spot month position limit levels, in conjunction with the rest of
the Federal position limits framework, will achieve the four policy
objectives in CEA section 4a(a)(3)(B). Namely, they will: (1) Diminish,
eliminate, or prevent excessive speculation; (2) deter and prevent
market manipulation, squeezes, and corners; (3) ensure sufficient
market liquidity for bona fide hedgers; and (4) ensure that the price
discovery function of the underlying market is not disrupted.\758\
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\758\ 7 U.S.C. 6a(a)(3)(B).
---------------------------------------------------------------------------
As a preliminary matter, the Commission continues to believe that a
formula based on a percentage of open interest, such as the 10/2.5%
formula, will permit position limit levels to better reflect the
changing needs and composition of the futures markets.\759\ Open
interest is a measure of market activity that reflects the number of
contracts that are ``open'' or live, where each contract of open
interest represents both a long and a short position.\760\ The
Commission believes that limiting positions to a percentage of open
interest: (1) Helps ensure that positions are not so large relative to
observed market activity that they risk disrupting the market; (2)
allows speculators to hold sufficient contracts to provide a healthy
level of liquidity for bona fide hedgers; and (3) allows for increases
in position limits and position sizes as markets expand and become more
active.\761\
---------------------------------------------------------------------------
\759\ 85 FR at 11630.
\760\ Id.
\761\ Id.
---------------------------------------------------------------------------
(1) Modification of the 10/2.5% Formula
However, the Commission believes that the current 10/2.5% formula
should be updated based on market developments since it was adopted in
1999. As a result, the Commission proposed modifying the 10/2.5%
formula by adjusting the inflection point between the 10% rate and the
2.5% rate from 25,000 contracts to 50,000 contracts.\762\ The
Commission also proposed applying updated open interest data to the
modified 10/2.5% formula.
---------------------------------------------------------------------------
\762\ This results in a modest increase in the Federal non-spot
month position limit level of 1,875 contracts over what the limit
level would be if the 10/2.5% formula were applied at 25,000
contracts, assuming that the market for the core referenced futures
contract has an open interest of at least 50,000 contracts.
---------------------------------------------------------------------------
The Commission is adopting these changes as proposed because: (1)
Open interest has increased significantly since the 10/2.5% formula was
originally adopted in 1999; and (2) futures market composition has
changed significantly since 1999. The Commission discusses both
developments in turn below.
(i) Increases in Open Interest
As noted in the 2020 NPRM, there has generally been a significant
increase in maximum open interest for each of the legacy agricultural
contracts (except for CBOT Oats (O)) since the existing 10/2.5% formula
was first adopted in 1999.\763\ Under the existing 10/2.5% formula,
because the 2.5% incremental increase applies after the first 25,000
contracts of open interest, limit levels with respect to contracts with
open interest above 25,000 contracts (i.e., all applicable core
referenced futures contracts other than CBOT Oats (O)) continue to
increase at the much slower rate of 2.5% rather than the 10% rate
that's applicable for the first 25,000 contracts. As a result, the
existing 10/2.5% formula has become proportionally more restrictive as
the percentage of open interest above 25,000 contracts increased.
---------------------------------------------------------------------------
\763\ 85 FR at 11631.
---------------------------------------------------------------------------
The table below provides data that describes the market environment
during the period prior to, and subsequent to, the adoption of the
existing 10/2.5% formula by the Commission in 1999. The data includes
futures contracts and the delta-adjusted options on futures open
interest.\764\ The first column of the table provides the maximum open
interest in the nine legacy agricultural contracts over the five year
period ending in 1999. The CBOT Corn (C) contract had a maximum open
interest of approximately 463,000 contracts, and the CBOT Soybeans (S)
contract had a maximum open interest
[[Page 3333]]
of approximately 227,000 contracts. The other seven contracts had
maximum open interest figures that ranged from less than 20,000
contracts for CBOT Oats (O) to approximately 172,000 for CBOT Soybean
Oil (SO). Hence, when adopting the 10/2.5% formula in 1999, the
Commission's experience in these markets was of aggregate futures and
options on futures open interest well below 500,000 contracts.
---------------------------------------------------------------------------
\764\ Delta is a ratio comparing the change in the price of an
asset (a futures contract) to the corresponding change in the price
of its derivative (an option on that futures contract) and has a
value that ranges between zero and one. In-the-money call options
get closer to 1 as their expiration approaches. At-the-money call
options typically have a delta of 0.5, and the delta of out-of-the-
money call options approaches 0 as expiration nears. The deeper in-
the-money the call option, the closer the delta will be to 1, and
the more the option will behave like the underlying asset. Thus,
delta-adjusted options on futures will represent the total position
of those options as if they were converted to futures.
[GRAPHIC] [TIFF OMITTED] TR14JA21.010
The table also displays the maximum open interest figures for
subsequent periods up to, and including, 2018. The maximum open
interest for all legacy agricultural contracts, except for CBOT Oats
(O), generally increased over the period. By the 2015-2018 period
covered in the last column of the table, five of the contracts had
maximum open interest greater than 500,000 contracts. Also, the
contracts for CBOT Corn (C), CBOT Soybeans (S), and CBOT Hard Red
Winter Wheat (KW) saw maximum open interest increase by a factor of
four to five times the maximum open interest observed during the 1994-
1999 period when the Commission adopted the 10/2.5% formula in 1999.
As open interest has increased, the current Federal non-spot month
position limit levels have become significantly more restrictive over
time. In particular, as discussed above, because the 2.5% incremental
increase applies after the first 25,000 contracts of open interest
under the existing 10/2.5% formula, Federal non-spot month position
limit levels on legacy agricultural contracts with open interest above
25,000 contracts (i.e., all contracts other than CBOT Oats (O))
continue to increase at a much slower rate of 2.5% rather than the 10%
that applies for the first 25,000 contracts.
The existing 10/2.5% formula's inflection point of 25,000 contracts
was less of a problem in the latter part of the 1990s, for example,
when open interest in each of the nine legacy agricultural contracts
was below 500,000, and in many cases below 200,000. More recently,
however, open interest has grown above 500,000 for a majority of the
legacy agricultural contracts. The existing 10/2.5% formula has thus
become more restrictive for market participants, including, as
discussed immediately below, certain banks and dealers with positions
that may not be eligible for a bona fide hedging exemption, but who
might otherwise provide valuable liquidity to commercial firms.
(ii) Changes in Market Composition
The potentially restrictive nature of the existing Federal non-spot
month position limit levels has become more problematic over time
because dealers play a much more significant role in the market today
than at the time the Commission adopted the 10/2.5% formula. Prior to
1999, the Commission regulated physical commodity markets where the
largest participants were often large commercial interests who held
short positions. The offsetting positions were often held by small,
individual traders, who tended to be long.\765\
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\765\ Stewart, Blair, An Analysis of Speculative Trading in
Grain Futures, Technical Bulletin No. 1001, U.S. Department of
Agriculture (Oct. 1949). See also Draper, Dennis, ``The Small Public
Trader in Futures Markets'', pp. 211-269, Futures Markets:
Regulatory Issues (ed. Anne Peck, 1985): American Enterprise
Institute.
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Several years after the Commission adopted the 10/2.5% formula, the
composition of futures market participants changed as dealers began to
enter the physical commodity futures market in larger size. These
dealers, including ones affiliated with banks or large financial
institutions that are now provisionally registered and regulated as
swap dealers, sometimes held significant positions in these markets by
acting as aggregators or market makers and providing swaps to
commercial hedgers and to other market participants.\766\ The existing
10/2.5% formula has thus become particularly restrictive for dealers,
including those with positions that may not be eligible for a bona fide
hedging exemption, but
[[Page 3334]]
that might otherwise provide valuable liquidity to commercial
firms.\767\
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\766\ Staff Report on Commodity Swap Dealers & Index Traders
with Commission Recommendations, U.S. Commodity Futures Trading
Commission (Sept. 2008), available at https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/cftcstaffreportonswapdealers09.pdf.
\767\ The Commission notes that this issue with respect to swap
dealers is being addressed through a combination of a modification
of the 10/2.5% formula and the pass-through swap provision, the
latter of which is described in Section II.A.1.x. (Pass-Through Swap
and Pass-Through Swap Offset Provisions).
---------------------------------------------------------------------------
The table below demonstrates the trend of increased dealer
participation by presenting data from the Commission's publicly
available ``Bank Participation Report'' (``BPR''), as of the December
report for 2002-2018.\768\ The table displays the number of banks
holding reportable positions for the seven futures contracts for which
Federal position limits apply and that were reported in the BPR.\769\
The report presents data for every market where five or more banks hold
reportable positions. The BPR is based on the same large-trader
reporting system database used to generate the Commission's Commitments
of Traders (``COT'') report.\770\
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\768\ Bank Participation Reports, available at https://www.cftc.gov/MarketReports/BankParticipationReports/index.htm.
\769\ The term ``reportable position'' is defined in Sec.
15.00(p) of the Commission's regulations. 17 CFR 15.00(p).
\770\ Commitments of Traders, available at www.cftc.gov/MarketReports/CommitmentsofTraders/index.htm. Commitments of Traders
reports indicate that there are generally still as many large
commercial traders in the markets today as there were in the 1990s.
---------------------------------------------------------------------------
No data was reported for the seven futures contracts in December
2002, indicating that fewer than five banks held reportable positions
at the time of the report. The December 2003 report shows that five or
more banks held reportable positions in four of the commodity futures.
The number of banks with reportable positions generally increased in
the early to mid-2000s, which included dealers that operated in the
swaps markets by acting as aggregators or market makers, providing
swaps to commercial hedgers and to other market participants while
using the futures markets to hedge their own exposures.\771\ When the
Commission adopted the 10/2.5% formula in 1999, it had limited
experience with physical commodity derivatives markets in which such
banks were significant participants.
---------------------------------------------------------------------------
\771\ Staff Report on Commodity Swap Dealers & Index Traders
with Commission Recommendations, U.S. Commodity Futures Trading
Commission (Sept. 2008), available at https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/cftcstaffreportonswapdealers09.pdf.
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BILLING CODE 6351-01-P
[GRAPHIC] [TIFF OMITTED] TR14JA21.011
For 2003, which was the first year in the report with reported data
on the futures for these physical commodities, the BPR showed, as
displayed in the table below, that the reporting banks held modest
positions, totaling 3.4% of futures long open interest for CBOT Wheat
(W) and smaller positions in other futures. The positions displayed in
the table below increased over the next several years, generally
peaking around 2005/2006 as a percentage of the long open interest.
[[Page 3335]]
[GRAPHIC] [TIFF OMITTED] TR14JA21.012
BILLING CODE 6351-01-C
The Commission believes that the application of the modified 10/
2.5% formula adopted herein to updated open interest data will prevent
the Federal non-spot month limits from becoming overly restrictive by
providing an appropriate increase in the non-spot month position limit
levels for most contracts to better reflect the above-described changes
in market dynamics observed since the late 1990s.
(2) Non-Spot Month Position Limit Levels for CBOT Oats (O), CBOT KC HRW
Wheat (KW), and MGEX HRS Wheat (MWE)
The Commission is adopting the proposed Federal non-spot month
position limit levels with respect to CBOT Oats (O), CBOT KC HRW Wheat
(KW), and MGEX HRS Wheat (MWE). These remain at the current Federal
non-spot month position limit levels, which are 2,000 contracts for
CBOT Oats (O) and 12,000 contracts for both CBOT KC HRW Wheat (KW) and
MGEX HRS Wheat (MWE). These Federal non-spot month position limit
levels are higher than the levels that would have been determined using
the modified 10/2.5% formula and updated open interest data, which
would have resulted in 700 contracts for CBOT Oats (O), 11,900
contracts for CBOT KC HRW Wheat (KW), and 5,700 contracts for MGEX HRS
Wheat (MWE). However, the Commission saw no reason to reduce these
Federal non-spot month position limit levels in accordance with the 10/
2.5% formula because the Commission has observed that the existing
limit levels have functioned well for these core referenced futures
contracts and the Commission believes that strictly following the 10/
2.5% formula to determine Federal non-spot month position limit levels
could harm liquidity in those markets.
(3) Single Month Position Limit Level for ICE Cotton No. 2 (CT)
The Commission is adopting a modified single month Federal position
limit level for ICE Cotton No. 2 (CT). The Commission proposed a
uniform single month and all-months-combined position limit for the ICE
Cotton No. 2 (CT) contract, as well as uniform single month and all-
months-combined position limits for the eight other legacy agricultural
contracts. However, in the 2020 NPRM the Commission requested comments
from the public concerning whether the Commission should adopt a lower
single month position limit level for ICE Cotton No. 2 (CT) compared to
the all-months-combined position limit level.\772\
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\772\ 85 FR 11637 (Request for Comment #26).
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The Commission received numerous comments from the end users of ICE
Cotton No. 2 (CT) in the cotton industry, including growers and
merchants, who requested that the Commission establish a lower Federal
single month position limit level for ICE Cotton No. 2 (CT) compared to
the all-months-combined position limit level, including establishing
the single month position limit level at 50% of the all-months-combined
position limit level.\773\ The Commission did not receive any comments
from commercial end-users opposing a lower Federal single month
position limit level for ICE Cotton No. 2 (CT) compared to the all-
months-combined position limit level. In response to the comments
received, the Commission is adopting a lower Federal single month
position limit level of 5,950 contracts for ICE Cotton No. 2 (CT),
which is 50% of the proposed Federal non-spot month position limit
level. However, the Commission is adopting the proposed all-months-
[[Page 3336]]
combined position limit level of 11,900 contracts, which is based on
the modified 10/2.5% formula. This change is discussed further below.
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\773\ ACSA at 2, 8; LDC at 2; Olam at 2; Ecom at 1; ACA at 2;
Canale Cotton at 2; Choice at 2; Jess Smith at 2; East Cotton at 2;
Memtex at 2; NCC at 1-2; Southern Cotton at 2-3; Texas Cotton at 2;
Toyo Cotton Co. at 2; WCSA at 2; and Omnicotton at 2.
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(4) The Final Rule's Federal Non-Spot Month Position Limits Achieve the
Four Statutory Objectives in CEA Section 4a(a)(3)(B)
As noted above, in the Final Rule, the Commission is not reducing
Federal non-spot month position limit levels for any of the legacy
agricultural contracts and will be raising them for six of the nine
such contracts in accordance with the updated open interest data and
the modified 10/2.5% formula.\774\ As a result, the Commission believes
that the final Federal non-spot month position limit levels will
generally improve liquidity for bona fide hedgers and, at the very
least, not harm liquidity compared to the status quo.
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\774\ As noted previously, the Commission is not following the
modified 10/2.5% formula for determining the single month position
limit level for ICE Cotton No. 2 (CT). However, the Final Rule still
increases that limit level compared to its existing limit level.
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The Commission also believes that the final Federal non-spot month
position limit levels remain low enough to diminish, eliminate, or
prevent excessive speculation, and to deter and prevent market
manipulation. This is because, as discussed above, by taking into
account the amount of observed market activity through open interest,
the modified 10/2.5% formula adopted herein helps ensure, among other
things, that positions are not so large relative to observed market
activity that they risk disrupting the market.\775\ This, in turn, also
helps ensure that the price discovery function of the underlying market
is not disrupted, because markets that are free from manipulative
activity reflect fundamentals of supply and demand rather than
artificial pressures. The Commission also notes that the 10/2.5%
formula has functioned well, based on the Commission's decades of
experience administering the formula.\776\
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\775\ 85 FR at 11630.
\776\ Id. at 11675.
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The Commission reiterates that the modified 10/2.5% formula
provided in this Final Rule is generally a continuation of the same
approach the Commission has taken for decades. The increased levels
adopted herein are primarily driven by utilizing updated open interest
figures. With respect to the slight modification to the 10/2.5%
formula, the Commission does not believe that the modification will
negatively impact the formula's effectiveness in ensuring that the
Federal non-spot month position limit levels remain low enough to
diminish, eliminate, or prevent excessive speculation, and to deter and
prevent market manipulation. This is because the difference between
utilizing the existing 10/2.5% formula and the modified 10/2.5% formula
results in a modest increase in Federal non-spot month position limit
level of 1,875 contracts, which is generally counterbalanced by the
increased amount of open interest that is subject to the 2.5%
rate.\777\ Additionally, the Commission has previously studied prior
increases in Federal non-spot month position limit levels and concluded
that the overall impact was modest, and that any changes in market
performance were most likely attributable to factors other than changes
in the Federal position limit rules.\778\ The Commission has since
gained additional experience which supports that conclusion, including
by monitoring amendments to position limit levels by exchanges.
Further, given the significant increases in open interest and changes
in market composition that have occurred since the 1990s, the
Commission is comfortable that the Federal non-spot month position
limit levels adopted herein will adequately address each of the policy
objectives set forth in CEA section 4a(a)(3)(B), including preventing
manipulation and excessive speculation.
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\777\ When the Commission adopted the existing Federal non-spot
month position limit levels in 2011, the Federal non-spot month
position limit levels for four of the nine legacy agricultural
contracts were based on the existing 10/2.5% formula and utilized
open interest data from 2009. These were CBOT Corn (C), CBOT
Soybeans (S), CBOT Wheat (W), and CBOT Soybean Oil (SO). For those
four contracts, the ratio of Federal non-spot month position limit
level to open interest changes as follows: CBOT Corn (C) (the ratio
increases from 0.026 to 0.027); CBOT Soybeans (S) (the ratio
increases from 0.028 to 0.029); CBOT Wheat (W) (the ratio increases
from 0.029 to 0.031); and CBOT Soybean Oil (SO) (the ratio increases
from 0.030 to 0.032).
The other five legacy agricultural contracts' Federal non-spot
month position limit levels deviated from the 10/2.5% formula. The
ratio changes for these five contracts are as follows (based on 2009
open interest data): ICE Cotton No. 2 (CT) (the ratio increases from
0.025 to 0.037 for the all-months-combined and decreases from 0.025
to 0.018 for the single month); CBOT Soybean Meal (SM) (the ratio
decreases from 0.038 to 0.032); CBOT Oats (O) (the ratio increases
from 0.130 to 0.291); MGEX Hard Red Spring Wheat (MWE) (the ratio
decreases from 0.323 to 0.162); and CBOT KC Hard Red Winter Wheat
(KW) (the ratio decreases from 0.113 to 0.037).
\778\ 64 FR at 24039.
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(5) Federal Non-Spot Month Position Limits as Ceilings
The Commission reiterates that, under this position limits
framework, the Federal non-spot month position limit levels serve as
ceilings. Exchanges are required to establish their own non-spot month
position limit levels with respect to the nine legacy agricultural
contracts pursuant to final Sec. 150.5(a)(1). A discussion of the
implications of this approach is provided above in Section
II.B.3.ii.a(2).
iv. Comments and Discussion of Final Rule--Federal Non-Spot Month
Position Limit Levels
Most commenters did not express concerns with respect to the
proposed Federal non-spot month position limit levels and the method by
which the Commission determined those levels.\779\ However, some
commenters raised concerns with respect to: (1) The Federal non-spot
month position limit levels, generally; (2) the proposed non-spot month
position limit level for ICE Cotton No. 2 (CT); and (3) the issue of
partial parity for the three wheat core referenced futures contracts
with respect to their Federal non-spot month position limit levels. The
Commission will discuss each of these issues, the related comments, and
the Commission's corresponding determination in greater detail below.
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\779\ See, e.g., COPE at 2; CMC at 6; CCI at 2; and CHS at 2.
---------------------------------------------------------------------------
a. Federal Non-Spot Month Position Limit Levels, Generally
(1) Comments--Federal Non-Spot Month Position Limit Levels, Generally
Several commenters raised concerns about the proposed Federal non-
spot month position limit levels generally. Two commenters, NGFA and
LDC, advocated for lowering the Federal non-spot month position limit
levels for the nine legacy agricultural contracts.\780\ NGFA stated
that the proposed increases are ``very large'' and that the Commission
should not view increasing non-spot month position limit levels as a
``tradeoff'' for eliminating the risk management exemption, but should
instead establish limits that ``will telescope down to relatively much-
smaller spot-month limits in an orderly fashion.'' \781\ LDC and
several others
[[Page 3337]]
believed that adopting lower Federal single month position limit levels
would ``prevent speculative activity from concentrating in a single
contract month and thus jeopardizing convergence.'' \782\ NGFA and LDC
also offered the following alternatives to the proposed Federal non-
spot month position limit levels: (1) Set single-month limits at some
percentage of the all-months-combined limit, such as 50%; or (2)
maintain existing single-month limits while adopting the proposed all-
months-combined limits.\783\ NGFA also offered a third alternative,
which was to adopt a phased-in approach to the higher non-spot month
position limits, ``together with very active monitoring of contract
performance, though NGFA does not favor this option.'' \784\
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\780\ NGFA at 3 and LDC at 2.
\781\ NGFA at 3. NGFA also commented that, ``NGFA still is not
completely convinced that open interest is the best yardstick for
this exercise,'' because ``[a]s volume and open interest grow,
Federal non-spot limits expand correspondingly . . . which leads to
yet higher volume and open interest. . .which again prompts expanded
Federal non-spot limits . . . and so on.'' However, NGFA did not
provide any alternatives to utilizing open interest for determining
Federal non-spot month position limit levels. As discussed
previously, the Commission believes that open interest is an
appropriate means of measuring market activity for a particular
contract and that a formula based on open interest, such as the 10/
2.5% formula: (1) Helps ensure that positions are not so large
relative to observed market activity that they risk disrupting the
market; (2) allows speculators to hold sufficient contracts to
provide a healthy level of liquidity for hedgers; and (3) allows for
increases in position limits and position sizes as markets expand
and become more active. Furthermore, the Commission notes that under
the Final Rule, Federal non-spot month position limit levels do not
automatically increase with higher open interest levels. In order to
make any amendments to the Federal position limit levels, the
Commission is required to engage in notice-and-comment rulemaking.
\782\ LDC at 2. See also e.g., Moody Compress at 1; ACA at 2;
Jess Smith at 2; McMeekin at 2; Memtex at 2; Mallory Alexander at 2;
Walcot at 2; and White Gold at 1.
\783\ NGFA at 4 and LDC at 2.
\784\ NGFA at 4. IATP also provided a similar suggestion, by
stating that, ``it is prudent to phase in new non-spot month limit
levels so that the Commission can acquire data and experience with
how the new Federal non-spot limits are working for the commercial
hedging of those legacy contracts.'' IATP at 11.
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On the other hand, ISDA requested higher Federal non-spot month
position limit levels.\785\ ISDA stated that the proposed levels ``for
the legacy agricultural contracts are not high enough to provide [ ]
significant liquidity to these markets based on the experience of
market participants and anticipated growth in these markets.'' \786\
ISDA also appeared to suggest that higher levels could ``help markets
offset any liquidity that may be lost if the risk management exemption
is not retained.'' \787\ Finally, ISDA also provided a table with
suggested Federal non-spot month position limit levels that ranged from
18% to 191% higher than the proposed levels, except for CBOT Oats (O),
which remained the same.\788\
---------------------------------------------------------------------------
\785\ ISDA at 7.
\786\ Id.
\787\ Id.
\788\ Id.
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Another commenter, MGEX, disagreed with the 10/2.5% formula,
stating that ``a formulaic approach is too rigid and inflexible'' and
that the ``Commission needs to be flexible in the future and should not
preclude further limits or discussion.'' \789\
---------------------------------------------------------------------------
\789\ MGEX at 3.
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(2) Discussion of Final Rule--Federal Non-Spot Month Position Limit
Levels, Generally
With the exception of ICE Cotton No. 2 (CT), as discussed below,
the Commission declines to modify the proposed Federal non-spot month
position limit levels or the general methodology underlying the
determination of those levels for the remaining legacy agricultural
contracts, and also declines to adopt a phase-in for Federal non-spot
month position limit levels.
(i) Request To Generally Lower Federal Non-Spot Month Position Limits
In response to these comments, the Commission believes that the
modified 10/2.5% formula is generally an appropriate way to calculate
Federal non-spot month position limit levels. The Commission also
believes that the final non-spot month position limit levels are
supported by updated open interest data, some of which have increased
significantly since 2009.
The Commission continues to believe that a formula based on a
percentage of open interest, such as the 10/2.5% formula, is
appropriate for establishing limit levels outside of the spot month, as
discussed above and in the 2020 NPRM.\790\ The Commission believes that
limiting positions to a percentage of open interest, such as through
the 10/2.5% formula: (1) Helps ensure that positions are not so large
relative to observed market activity that they risk disrupting the
market; (2) allows speculators to hold sufficient contracts to provide
a healthy level of liquidity for bona fide hedgers; and (3) allows for
increases in position limits and position sizes as markets expand and
become more active.\791\ Furthermore, the 10/2.5% formula has
functioned well for Federal non-spot month position limit purposes for
many years.\792\ Also, the Commission does not believe that the slight
modification to the 10/2.5% formula materially impacts the formula's
efficacy in determining an appropriate Federal non-spot month position
limit level as well,\793\ because the modification is modest and is
supported by the general increase in open interest among the legacy
agricultural contracts and the change in the composition of market
participants in those markets, as discussed above.\794\
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\790\ See 85 FR at 11630-11633.
\791\ Id.
\792\ See id. at 11675.
\793\ The Commission notes, as discussed elsewhere in this Final
Rule, that CBOT KC HRW Wheat (KW), MGEX HRS Wheat (MWE), CBOT Oats
(O), and ICE Cotton No. 2 (CT) (single month limit only) are subject
to unique circumstances or other factors that counsel in favor of
deviating from the 10/2.5% formula.
\794\ The modification results in a modest increase in the
Federal non-spot month position limit level of 1,875 contracts over
what the limit level would be if the inflection point for the 10/
2.5% formula was set at 25,000 contracts, assuming that the market
for the core referenced futures contract has an open interest of at
least 50,000 contracts.
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(ii) Request To Generally Lower Single Month Position Limit Levels
In response to comments generally requesting lower single month
position limit levels, the Commission first acknowledges that it has
set single-month position limit levels lower than all-months-combined
position limit levels in the past. However, since the Commission set
both single month and all-months-combined levels set at the same level
in 2011, the Commission has not observed any issues with respect to the
nine legacy agricultural contracts as a result of that change.
In response to commenters' concern about possible convergence
issues from setting the single-month and all-months-combined levels set
at the same level, the Commission notes that positions in the non-spot
months have minimal impact on convergence. This is because convergence
occurs in the spot month, and, specifically, at the expiration of the
physically-settled spot month contract.\795\
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\795\ The Commission, however, recognizes that it is possible
that unusually large positions in contracts outside of the spot
month could distort the natural spread relationship between contract
months. For example, if traders hold unusually large positions
outside of the spot month, and if those traders exit those positions
immediately before the spot month, that could cause congestion and
also affect the pricing of the spot month contract. While such
congestion or price distortion cannot be ruled out, exchange-set
position limits and position accountability function to mitigate
against such risks.
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Furthermore, the Commission notes that an important benefit of
having a single Federal non-spot month limit level for both the single-
month and all-months-combined is the ability for market participants to
enter into calendar spread transactions that would normally be
constrained by the lower single month position limit level. However,
the Commission notes that, in response to comments received, it is
adopting a lower Federal single month position limit level for ICE
Cotton No. 2 (CT), the reasons for which is discussed below.
[[Page 3338]]
(iii) Request To Increase Federal Non-Spot Month Position Limit Levels
In response to ISDA's comment that the proposed Federal non-spot
month position limit levels should be higher to compensate for the
proposed loss of risk management exemptions for swap dealers, the
Commission believes that any potential impact on existing risk
management exemption holders may be mitigated by the finalized pass-
through swap provision, to the extent swap dealers can utilize it.\796\
The Commission believes that this is a preferable approach to either a
hypothetical alternative formula or ISDA's own suggested Federal non-
spot month position limit levels that would allow higher limit levels
beyond those adopted in this Final Rule for all market participants.
This is because, while the pass-through swap provision adopted herein
is narrowly-tailored to enable liquidity providers to continue
providing liquidity to bona fide hedgers, higher limit levels beyond
those adopted in this Final Rule for all market participants could also
permit excessive speculation and increase the possibility of market
manipulation or harm to the underlying price discovery function.\797\
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\796\ See 85 FR at 11676. See also Section II.A.1.x. (Pass-
Through Swap and Pass-Through Swap Offset Provisions).
\797\ See 85 FR at 11676.
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(iv) Concern With the Commission's ``Formulaic'' Approach
In response to MGEX's concern that the Commission's approach is too
formulaic and rigid, the Commission notes that the Federal non-spot
month position limit levels will operate as ceilings within a broader
Federal position limits framework in which exchanges, including MGEX,
are always free to determine their own exchange-set position limit
levels and position accountability levels below the Federal position
limit levels as they see fit based on market conditions. In fact, by
having the Federal position limit levels operate as ceilings, this
framework will enable exchanges to respond to market conditions through
a greater range of acceptable position limit levels than if the Federal
position limit levels did not operate as ceilings.
In addition, as described further below, the Commission has
deviated from the 10/2.5% formula with respect to CBOT Oats (O), ICE
Cotton No. 2 (CT) (single month only), CBOT KC HRW Wheat (KW), and MGEX
HRS Wheat (MWE) based on the unique circumstances concerning those core
referenced futures contracts. Furthermore, the Commission also notes
that this Final Rule does not ``preclude further limits or
discussion.'' \798\ The Commission is also continually monitoring
market conditions to evaluate whether different Federal position limit
levels may be warranted.
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\798\ MGEX at 3.
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(v) Request To Implement a Phase-In Period
The Commission declines to adopt a formal phase-in period for
Federal non-spot month position limits, in which the Commission
gradually implements the Federal non-spot month position limit levels
over a period of time. The Commission believes that the markets will
operate in an orderly fashion with the Federal position limit levels
adopted under this Final Rule, because the final Federal non-spot month
position limit levels are supported by increased open interest and are
generally set pursuant to the modified 10/2.5% formula, which, as
discussed above, achieves the policy objectives set forth in CEA
section 4a(a)(3)(B).\799\
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\799\ A phase-in is not necessary with respect to the Federal
non-spot month position limit levels for CBOT Oats (O), KC HRW Wheat
(KW), and MGEX HRS Wheat (MWE), because the Federal non-spot month
position limit levels will remain at the current levels.
---------------------------------------------------------------------------
However, as noted in the Federal spot month position limit level
phase-in discussion above, as a practical matter, the Commission
emphasizes that the operative non-spot month position limit levels for
a market participant trading in exchange-listed referenced contracts is
not the Federal non-spot month position limit levels, but the exchange-
set non-spot month position limit levels. As a result, despite the
changes in the Federal non-spot month position limit levels in this
Final Rule, there will be no practical impact on market participants
trading in exchange-listed referenced contracts unless and until an
exchange affirmatively modifies its exchange-set non-spot month
position limit levels through a rule submission to the Commission
pursuant to part 40 of the Commission's regulations.\800\
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\800\ 17 CFR part 40.
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c. ICE Cotton No. 2 (CT) Federal Non-Spot Month Position Limit Level
(1) Summary of the 2020 NPRM and Additional Background Information--ICE
Cotton No. 2 (CT) Federal Non-Spot Month Position Limit Level
In the 2020 NPRM, the Commission proposed to increase both the
Federal single month and all-months-combined position limit levels for
ICE Cotton No. 2 (CT) from the existing Federal level of 5,000
contracts to 11,900 contracts by applying the updated open interest
data into the proposed modified 10/2.5% formula. The Commission also
solicited comments asking whether the Commission should consider
lowering the Federal single month position limit level to a percentage
of the Federal all-months-combined position limit level for ICE Cotton
No. 2 (CT), and if so, what percentage of the all-months-combined
position limit level should be used.\801\
---------------------------------------------------------------------------
\801\ 85 FR at 11637 (Request for Comment #26).
---------------------------------------------------------------------------
(2) Comments--ICE Cotton No. 2 (CT) Federal Non-Spot Month Position
Limit Level
In response to the 2020 NPRM, numerous commenters from the cotton
industry, including growers and merchants, requested that the
Commission ``maintain its single-month limit, particularly for smaller
markets like cotton,'' \802\ or, in the alternative, set a Federal
single month position limit level of 50% of the all-months-combined
limit (i.e., 5,950 contracts).\803\ In support, commenters also noted
that the proposed non-spot month position limit level for ICE Cotton
No. 2 (CT) was ``not in line with historical limits.'' \804\ One
commenter also stated, ``Experience with modern trading has shown a
propensity by speculators to focus too heavily on the nearest futures
contract, leaving later months with poor liquidity from time to time.''
\805\ In contrast, ISDA argued that the proposed Federal non-spot month
position limit levels, including that for ICE Cotton No. 2 (CT), were
too low and asserted that the level for ICE Cotton No. 2 (CT) should be
increased to 24,000 contracts to make up for the elimination of the
risk management exemption.\806\
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\802\ See e.g., East Cotton at 2; Omnicotton at 2; Choice at 2;
Canale Cotton at 2; Ecom at 1; Olam at 2; Texas Cotton at 2; Toyo
Cotton at 2; Walcot Trading at 2; White Gold at 2; and NCTO at 2.
See also ACA at 2; Gerald Marshall at 1-2; Jess Smith at 2; LDC at
2; Mallory Alexander at 2; McMeekin at 2; MemTex at 2; Moody
Compress at 2; Parkdale at 2; Southern Cotton at 2-3; SW Ag at 2;
and ACSA at 8.
\803\ ACSA at 8; LDC at 2; and Olam at 2. The following
commenters also supported ACSA's comment letter: ACA at 2; Ecom at
1; East Cotton at 2; Jess Smith at 2; IMC at 2; Mallory Alexander at
2; McMeekin at 2; Memtex at 2; Moody Compress at 2; Omnicotton at 2;
Canale Cotton at 2; SW Ag at 2; Texas Cotton at 2; Toyo Cotton at 2;
Walcot at 2; and White Gold at 2.
\804\ AMCOT at 1-2 and Parkdale at 2.
\805\ Gerald Marshall at 2.
\806\ ISDA at 7 (providing specific alternative levels).
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(3) Discussion of Final Rule--ICE Cotton No. 2 (CT) Federal Non-Spot
Month Position Limit Level
The Commission is adopting the proposed all-months-combined
position limit level of 11,900 contracts, but is
[[Page 3339]]
adopting a modified single month position limit level of 5,950
contracts for ICE Cotton No. 2 (CT).
The Commission is adopting the proposed 11,900 contract Federal
all-months-combined position limit level for ICE Cotton No. 2 (CT)
because, as discussed earlier, the Commission believes that a formula
based on a percentage of open interest--specifically the modified 10/
2.5% formula--is an appropriate tool for establishing limits outside of
the spot month. However, the Commission does not believe that it is
appropriate to raise either the Federal single month or all-months-
combined position limit level for ICE Cotton No. 2 (CT) to 24,000
contracts as suggested by ISDA, because the open interest levels do not
support such a drastic increase and there is no other reason to deviate
so significantly upward from the modified 10/2.5% formula.\807\
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\807\ The Commission acknowledges ISDA's comment that the
proposed Federal non-spot month position limit levels should be
higher to compensate for the proposed loss of risk management
exemptions for swap dealers. However, as noted previously, the
Commission believes that any potential impact on existing risk
management exemption holders may be mitigated by the pass-through
swap provision adopted herein, and that this is a preferable and
more tailored approach than increasing the non-spot month position
limit levels for all market participants.
---------------------------------------------------------------------------
On the other hand, the Commission believes that it is appropriate
to adopt a lower Federal single month position limit level at this
time. As noted in the Commission's request for comment in the 2020
NPRM, the Commission believed that there could be concerns with respect
to the Federal single month position limit level for ICE Cotton No. 2
(CT), especially from the commercial end-users of the core referenced
futures contract.\808\ In response to the Commission's request for
comment, the Commission received approximately 25 comment letters from
the cotton industry (out of approximately 75 comment letters on the
2020 NPRM from all commenters) unanimously requesting a lower Federal
single month position limit level compared to the Federal all-months-
combined position limit level for ICE Cotton No. 2 (CT). The Commission
believes that these unanimous comments from the commercial end-users of
the ICE Cotton No. 2 (CT) core referenced futures contract are
informative, because they suggest that lowering the 2020 NPRM's Federal
single month position limit level from the proposed 11,900 contract
level to either the existing 5,000 contract level or a 5,950 contract
level (which is 50% of the all-months-combined position limit level of
11,900 contracts) may not have a material detrimental effect on
liquidity for bona fide hedgers in the market.
---------------------------------------------------------------------------
\808\ 85 FR 11637 (Request for Comment #26).
---------------------------------------------------------------------------
All things being equal, a lower single month position limit level
will better protect the markets against manipulation and price
distortion,\809\ but at the expense of reduced liquidity for bona fide
hedgers. However, in this instance, in light of the comments received,
the Commission believes that it could improve protections against
manipulation and price distortion without materially impacting
liquidity for bona fide hedgers by adopting a lower Federal single
month position limit level of either 5,000 contracts or 5,950
contracts. Of these two suggested levels, the Commission believes that
it is more appropriate to adopt the 5,950 contract level over the
existing 5,000 contract level to account, in part, for the increase in
open interest levels since the single month position limit level of
5,000 contracts was adopted in 2011.\810\
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\809\ Specifically, the Commission is referring to the price
distortion that could be caused by a speculative trader who, after
amassing a large position during the non-spot month, exits the
entire position immediately before the spot month.
\810\ The maximum open interest for ICE Cotton No. 2 (CT) was
197,191 contracts in 2009, 161,582 contracts in 2011, and 324,952
contracts in 2019.
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d. Wheat Core Referenced Futures Contracts' Federal Non-Spot Month
Position Limit Levels
(1) Summary of the 2020 NPRM and Additional Background Information--
Wheat Federal Non-Spot Month Position Limit Levels
There are three wheat contracts: CBOT Wheat (W), CBOT KC HRW Wheat
(KW), and MGEX HRS Wheat (MWE). Currently, the Federal non-spot month
position limit levels for all three are set at 12,000 contracts. This
has been referred to as ``full wheat parity.''
In the 2020 NPRM, the Commission proposed ``partial wheat parity''
by increasing the Federal non-spot month position limit level for CBOT
Wheat (W) from 12,000 contracts to 19,300 based on the application of
the modified 10/2.5% formula and updated open interest levels, while
maintaining the existing levels of 12,000 contracts for CBOT KC HRW
Wheat (KW) and MGEX HRS Wheat (MWE). The 12,000 contract Federal non-
spot month position limit levels for CBOT KC HRW Wheat (KW) and MGEX
HRS Wheat (MWE) are above the levels that would be calculated based on
the application of the modified 10/2.5% formula and recent open
interest levels, which would be 11,900 contracts for CBOT KC HRW Wheat
(KW) and 5,700 contracts for MGEX HRS Wheat (MWE).
The Commission proposed partial wheat parity between CBOT KC HRW
Wheat (KW) and MGEX HRS Wheat (MWE) at 12,000 contracts for two
reasons. First, both contracts provide exposure to hard red wheats. As
a result, the Commission believed that drastically decreasing the
Federal non-spot month position limit level for MGEX HRS Wheat (MWE)
vis-[agrave]-vis CBOT KC HRW Wheat (KW) by following the 10/2.5%
formula could impose liquidity costs on the MGEX HRS Wheat (MWE) market
and harm bona fide hedgers, which could further harm liquidity for bona
fide hedgers in the related CBOT KC HRW Wheat (KW) market.\811\ Second,
the existing Federal non-spot month position limit levels for CBOT KC
HRW Wheat (KW) and MGEX HRS Wheat (MWE) appear to have functioned well,
and the Commission saw no market-based reason to reduce those levels
based on recent open interest data.\812\
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\811\ 85 FR at 11633.
\812\ Id. at 11632.
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(2) Comments--Wheat Federal Non-Spot Month Position Limit Levels
The Commission received several comments concerning the proposed
Federal non-spot month position limit levels with respect to the three
wheat core referenced futures contracts. One commenter, MGEX, stated
that it ``supports maintaining partial wheat parity by keeping the
existing non-spot month limits for [MGEX HRS Wheat (MWE)] and CBOT KC
Hard Red Wheat at 12,000.'' \813\ Another commenter agreed ``with the
increase in the non-spot month for CBOT Wheat (W).'' \814\
---------------------------------------------------------------------------
\813\ MGEX at 3.
\814\ MFA/AIMA at 12.
---------------------------------------------------------------------------
However, other commenters requested that the Federal non-spot month
position limit level for CBOT KC HRW Wheat (KW) be at least the same as
CBOT Wheat (W) (i.e., raise it to 19,300 contracts).\815\ In support,
commenters contended that the ``physical market for the wheat crop that
is deliverable under [CBOT KC HRW Wheat (KW)] is much larger than the
wheat crop that is deliverable under [CBOT Wheat (W)].'' \816\ Also,
commenters stated that the ``characteristics of the physical wheat that
is deliverable under [CBOT KC HRW Wheat (KW)] is more similar to the
global wheat crop than the wheat that is deliverable under [CBOT Wheat
[[Page 3340]]
(W)].'' \817\ As a result, commenters stated that, ``[CBOT KC HRW Wheat
(KW)] may be important for hedging for many market participants.''
\818\ Similarly, MFA/AIMA stated that ``open interest data and supply
data published by the USDA for hard red winter wheat, which is the
underlying commodity for [CBOT KC HRW Wheat (KW)], would also justify
an increase in the [CBOT KC HRW Wheat (KW)] non-spot month limit.''
\819\
---------------------------------------------------------------------------
\815\ SIFMA AMG at 3-4; ISDA at 12; PIMCO at 4-5; MFA/AIMA at
12; and Citadel at 6-7.
\816\ PIMCO at 4. See also ISDA at 12 and SIFMA AMG at 3-4.
\817\ SIFMA AMG at 3. See also ISDA at 12 and PIMCO at 4.
\818\ SIFMA AMG at 4. See also ISDA at 12.
\819\ MFA/AIMA at 12. See also Citadel at 6-7.
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(3) Discussion of Final Rule--Wheat Federal Non-Spot Month Position
Limit Levels
The Commission declines to raise the proposed 12,000 contract
Federal non-spot month position limit level for CBOT KC HRW Wheat (KW)
to match the final Federal non-spot month position limit level of CBOT
Wheat (W) at 19,300 contracts.
First, as noted earlier, the Federal non-spot month position limit
level for CBOT KC HRW Wheat (KW) is already set higher, albeit
slightly, than the limit level calculated under the updated open
interest figure and 10/2.5% formula, which, as discussed previously, is
a formula that the Commission believes is generally proper for
determining Federal non-spot month position limit levels.\820\ Raising
the Federal non-spot month position limit level for CBOT KC HRW Wheat
(KW) to 19,300 contracts would be a drastic increase over the existing
level that is not supported by the 10/2.5% formula or by the
Commission's observations of how that market has functioned under the
12,000 contract Federal non-spot month position limit level. As a
result, the Commission is concerned that this could result in excessive
speculation and increase the possibility of market manipulation or harm
to the underlying price discovery function with respect to that
contract.
---------------------------------------------------------------------------
\820\ 85 FR at 11630.
---------------------------------------------------------------------------
Second, the Commission believes that maintaining partial wheat
parity between CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) is
appropriate because the commodities underlying both of those wheat core
referenced futures contracts are hard red wheats that, together,
represent the majority of the wheat grown in both the United States and
Canada, which results in those markets being closely intertwined.\821\
This is in contrast with CBOT Wheat (W), which typically sees
deliveries of soft white wheat varieties (even though it allows for
delivery of hard red wheat).\822\
---------------------------------------------------------------------------
\821\ Id. at 11632.
\822\ Id.
---------------------------------------------------------------------------
Finally, the Commission reiterates that bona fide hedging positions
will continue to be allowed to exceed the Federal position limit
levels. Intermarket spreading is also permitted as well, which should
address any concerns over the potential for loss of liquidity in the
spread trades among the three wheat core referenced futures contracts
during the non-spot months.\823\
---------------------------------------------------------------------------
\823\ Id. at 11633.
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5. Subsequent Spot and Non-Spot Month Limit Levels
i. Summary of the 2020 NPRM--Subsequent Spot and Non-Spot Month Limit
Levels
Unlike in previous iterations of the position limit rules, the 2020
NPRM did not require the Commission to periodically review and revise
EDS figures or adjust the Federal spot month position limit
levels.\824\ Instead, under proposed Sec. 150.2(f), an exchange
listing a core referenced futures contract would be required to provide
EDS figures only if requested by the Commission. Proposed Sec.
150.2(j) delegated the authority to make such requests to the Director
of the Division of Market Oversight.\825\ The 2020 NPRM also allowed
exchanges to voluntarily submit EDS figures to the Commission at any
time, and encouraged them to do so.\826\ When submitting EDS figures,
exchanges would be required to provide a description of the methodology
used to derive the EDS figures, as well as all data and data sources
used to calculate the estimate, so that the Commission could verify
that the EDS figures are reasonable.\827\
---------------------------------------------------------------------------
\824\ See e.g., 81 FR at 96769-96771.
\825\ 85 FR at 11633.
\826\ Id. at 11633-11634.
\827\ Id. at 11634.
---------------------------------------------------------------------------
Likewise, the 2020 NPRM also did not require the Commission to
periodically review the open interest data and update the non-spot
month position limit levels for the legacy agricultural core referenced
futures contracts, unlike in previous iterations of the position limit
rules.\828\
---------------------------------------------------------------------------
\828\ See e.g., 81 FR at 96769, 96771-96773.
---------------------------------------------------------------------------
ii. Summary of the Commission Determination--Subsequent Spot and Non-
Spot Month Limit Levels
The Commission is adopting Sec. 150.2(f) as proposed and will not
include a formal mechanism to periodically renew or revise EDS figures
or otherwise review and update the Federal spot month or non-spot month
position limit levels. The Commission is also adopting the delegation
provision in Sec. 150.2(j) as proposed.\829\
---------------------------------------------------------------------------
\829\ The Commission did not receive any comments on proposed
Sec. 150.2(j).
---------------------------------------------------------------------------
iii. Comments--Subsequent Spot and Non-Spot Month Limit Levels
The Commission received several comments concerning updates to the
Federal position limit levels, with commenters requesting that the
Commission periodically review the levels and revise them if
appropriate.\830\ One commenter was concerned that the Federal position
limit levels could become too high over time,\831\ while the rest were
concerned that the levels could become too low.\832\ In addition, CME
Group also suggested that exchanges should update the EDS figures
``every two years [and] . . . DCMs should be provided the opportunity
to submit data voluntarily to the Commission on a more frequent
basis.'' \833\
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\830\ MFA/AIMA at 5 (``the Commission should direct exchanges to
periodically monitor the proposed new position limit levels'');
PIMCO at 6 (``we urge the CFTC to include . . . a mandatory
requirement to regularly (and at least annually) review and update
limits as markets grow and change''); SIFMA AMG at 10 (the Final
Rule should require ``that the Commission regularly consult with
exchanges and review and adjust position limits when it is necessary
to do so based on relevant market factors''); ISDA at 10 (``the
Commission must regularly convene and consult with exchanges on
deliverable supply and, if appropriate, propose notice and comment
rulemaking to adjust limit levels''); and IATP at 16-17 (the
Commission should engage in ``an annual review of position limit
levels to give [commercial hedgers] legal certainty over that
period'' and also retain ``the authority to revise position limits .
. . if data monitoring and analysis show that those annual limit
levels are failing to prevent excessive speculation and/or various
forms of market manipulation'').
\831\ IATP at 16-17.
\832\ MFA/AIMA at 5-6; PIMCO at 6; SIFMA AMG at 10; and ISDA at
10.
\833\ CME Group at 5.
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iv. Discussion of Final Rule--Subsequent Spot and Non-Spot Month Limit
Levels
The Commission declines to implement a periodic, predetermined
schedule to review Federal position limits because the Commission
believes that it is more appropriate to retain flexibility for both the
exchanges and the Commission itself in updating the Federal position
limit levels.
Reviewing and adjusting the Federal spot month position limit
levels requires the Commission to review, among other things, updated
EDS figures for the core referenced futures contracts. Having worked
closely with
[[Page 3341]]
exchanges to analyze and independently verify the methodology
underlying the EDS figures and the EDS figures themselves, the
Commission recognizes that estimating deliverable supply can be a time
and resource consuming process for both the exchanges and the
Commission.\834\ Furthermore, periodic, predetermined review intervals
may not always align with market changes or other events resulting in
material changes to deliverable supply that would warrant adjusting
Federal spot month position limit levels. As a result, the Commission
believes that it would be more efficient, timely, and effective to
review the EDS figure and the Federal position limit level for a core
referenced futures contract if warranted by market conditions,
including changes in the underlying cash market, which the Commission
and exchanges continually monitor.
---------------------------------------------------------------------------
\834\ 85 FR at 11633.
---------------------------------------------------------------------------
Reviewing and adjusting the Federal non-spot month position limit
levels requires the Commission to review, among other things, open
interest data for the relevant core referenced futures contracts.
Unlike EDS figures, open interest is easily obtainable because it is
regularly updated by the exchanges. As a result, the output of the 10/
2.5% formula can be quickly calculated. However, the Commission does
not believe that it is appropriate to update the Federal non-spot month
position limit levels separately from the Federal spot month position
limit levels. The Commission has historically reviewed all of the
Federal position limit levels--spot month and non-spot month--together
for a particular contract because all months of a particular contract
are part of the same market. As a result, updating both the spot and
non-spot month position limits levels at the same time provides a
holistic and integrated position limit regime for each commodity
contract because the limits are based upon updated data covering the
same or overlapping time period.
Final Sec. 150.2(f) provides flexibility and authority for the
Commission to be able to request an updated EDS figure, along with the
methodology and underlying data, for a core referenced futures contract
whenever market conditions suggest that a change in Federal position
limit levels may be warranted. The exchanges are also encouraged to
submit such information at any time as well under final Sec.
150.2(f).\835\ Once the Commission receives the updated EDS figures,
then the Commission can undertake the appropriate review and analysis
of the EDS figures and any additional information, such as exchange
recommendations, to adjust the Federal spot month position limit
levels, if necessary, through rulemaking. At that time, the Commission
would also review the open interest data for the core referenced
futures contract and undertake the necessary analysis to ensure that
the Federal non-spot month position limit levels are set at appropriate
levels as well.
---------------------------------------------------------------------------
\835\ In providing an updated EDS figure, exchanges should
consult the guidance concerning estimating deliverable supply set
forth in section (b)(1)(i) (``Estimating Deliverable Supplies'') of
17 CFR part 38, Appendix C.
---------------------------------------------------------------------------
Finally, the Commission notes that, under this position limits
framework, the exchanges always have the freedom to set their exchange-
set position limit levels lower than the Federal position limit levels.
Adjusting the Federal position limit levels necessarily requires the
Commission to engage in rulemaking with notice-and-comment, which can
take a significant amount of time.\836\ Thus, an exchange may adjust
its exchange-set position limit levels lower in response to market
conditions, while waiting for the Commission to adjust the Federal
position limit levels.\837\
---------------------------------------------------------------------------
\836\ Market participants may petition the Commission to adjust
Federal position limit levels, subject to the Commission's notice-
and-comment rulemaking, under existing Sec. 13.1, which provides
that any ``person may file a petition with . . . the Commission . .
. for the issuance, amendment or repeal of a rule of general
application.''
\837\ However, an exchange cannot set its exchange-set position
limit levels above the Federal position limit levels, even if market
conditions may warrant raising the levels. Thus, in order to allow
market participants to hold positions higher than the Federal
position limit levels (absent an exemption), the Commission would
need to raise the Federal position limit levels through rulemaking.
---------------------------------------------------------------------------
6. Relevant Contract Month
Proposed Sec. 150.2(c) clarified that the spot month and single
month for any given referenced contract is determined by the spot month
and single month of the core referenced futures contract to which that
referenced contract is linked.
The Commission did not receive any comments and is adopting as
proposed. Final Sec. 150.2(c) requires that referenced contracts be
linked to the core referenced futures contract in order to be netted
for position limit purposes.
For example, for the NYMEX NY Harbor ULSD Heating Oil (HO) core
referenced futures contract, the spot month period starts at the close
of trading three business days prior to the last trading day of the
contract. The spot month period for the NYMEX NY Harbor ULSD Financial
(MPX) futures referenced contract would thus start at the same time--
the close of trading three business days prior to the last trading day
of the core referenced futures contract.
7. Limits on ``Pre-Existing Positions''
i. Summary of the 2020 NPRM--Pre-Existing Positions
Under proposed Sec. 150.2(g)(1) Federal spot month position limits
applied to ``pre-existing positions, other than pre-enactment swaps and
transition period swaps,'' each defined in proposed Sec. 150.1.
Accordingly, Federal spot month position limits would not apply to any
pre-existing positions in economically equivalent swaps. The 2020 NPRM
defined ``pre-existing positions'' in proposed Sec. 150.1 as positions
established in good faith prior to the effective date of a final
Federal position limits rulemaking.
In contrast, proposed Sec. 150.2(g)(2) provided that Federal non-
spot month limits would not apply to pre-existing positions, including
pre-enactment swaps and transition period swaps, if acquired in good
faith prior to the effective date of such limit. However, other than
pre-enactment swaps and transition period swaps, any pre-existing
positions held outside the spot month would be attributed to such
person if the person's position is increased after the effective date
of a final Federal position limits rulemaking.
The 2020 NPRM's disparate treatment of pre-existing positions
during and outside the spot month was predicated on the concern that
failing to apply spot month limits to such pre-existing positions could
result in a large, preexisting position either intentionally or
unintentionally causing a disruption to the price discovery function of
the core referenced futures contract as positions are rolled into the
spot month. In contrast, outside the spot month, large, pre-existing
positions may have a relatively less disruptive effect given that
physical delivery occurs only during the spot month.
ii. Summary of the Commission Determination--Pre-Existing Positions
The Commission is adopting Sec. 150.2(g)(1) as proposed, and is
adopting Sec. 150.2(g)(2) with the following two changes:
First, the Commission is amending proposed Sec. 150.2(g)(2) to
provide that non-spot month limits shall apply to pre-existing
positions, other than pre-enactment swaps and transition period swaps.
As noted above, proposed Sec. 150.2(g)(2) in the 2020 NPRM exempted
pre-existing positions from the Final Rule's Federal non-spot month
position limits. However, as discussed below, the nine legacy
agricultural
[[Page 3342]]
contracts currently are subject to the Commission's existing non-spot
month position limits, and the Commission did not intend to exclude
existing non-spot month positions in the nine legacy agricultural
contracts that would otherwise qualify as ``pre-existing positions''
under the Final Rule. As discussed, the other 16 non-legacy core
referenced futures contracts that are subject to Federal position
limits for the first time under the Final Rule are not subject to
Federal non-spot month position limits and therefore proposed Sec.
150.2(g)(2) would not have applied to these contracts in any event.
The Commission based the language in proposed Sec. 150.2(g) on
similar language found in the 2016 Reproposal, which imposed Federal
non-spot month position limits on all of the proposed core referenced
futures contracts (as opposed to only on the nine legacy agricultural
contracts under the Final Rule). In the context of the 2016 Reproposal,
the Commission believed it made sense to exempt pre-existing positions
in non-spot months in core referenced futures contracts that would have
been subject to Federal position limits for the first time under the
2016 Reproposal. However, as noted above, such core referenced futures
contracts that are subject to Federal position limits for the first
time under the Final Rule are not subject to Federal non-spot month
position limits. Accordingly, the Commission is modifying Sec.
150.2(g) so that pre-existing positions in the nine legacy agricultural
contracts remain subject to Federal non-spot month position limits
under the Final Rule, as the Commission had originally intended.
Second, since the Commission is clarifying that pre-existing
positions in the nine legacy agricultural contracts, other than pre-
enactment swaps and transition period swaps, are subject to Federal
non-spot month position limits under the Final Rule, the language in
proposed Sec. 150.2(g)(2) that would attribute to a person any
increase in their non-spot month positions after the effective date of
the Final Rule's non-spot month limits is no longer necessary. The
Commission is therefore removing this language from final Sec.
150.2(g)(2).
iii. Comments--Pre-Existing Positions
Commenters generally supported proposed Sec. 150.2(g), although
several commenters asked for additional clarity.\838\ MGEX and FIA both
argued that the provision could be simplified by creating only two
categories: ``pre-existing swaps'' (exempt from all spot/non-spot
Federal position limits) and ``pre-existing futures'' (exempt from all
non-spot Federal position limits, provided there is no increase in such
non-spot positions), stating that relying upon the proposed relief as
structured will be ``operationally challenging'' for market
participants.\839\ MGEX and FIA also requested that the Commission
clarify that a market participant is not required to rely upon the
exemption so that its pre-existing positions could be netted, as
applicable, with the market participant's other referenced
contracts.\840\ ISDA encouraged the Commission to provide that the
Final Rule's new Federal position limits do not apply to any pre-
existing positions, whether in futures contracts or swaps.\841\
Finally, CHS encouraged the Commission to adopt a ``safe harbor''
provision where participants could demonstrate a ``good-faith'' effort
at compliance so ``inadvertent'' violations would not trigger possible
enforcement action.\842\
---------------------------------------------------------------------------
\838\ MGEX at 4; FIA at 9; ISDA at 8.
\839\ FIA at 8-9; MGEX at 4.
\840\ MGEX at 3-4; FIA at 8-9, 18-19.
\841\ ISDA at 2, 8.
\842\ CHS at 5.
---------------------------------------------------------------------------
iv. Discussion of Final Rule--Pre-Existing Positions
As stated in the 2020 NPRM, the Commission believes that the
absence of spot-month limits on pre-existing positions, other than pre-
existing swaps and transition period swaps, could render the Federal
spot month position limits ineffective. Failure to apply spot month
limits to such pre-existing positions, particularly for the 16
commodities that are not currently subject to Federal position limits
and where market participants may have pre-existing positions in excess
of the spot-month position limits adopted herein, could result in a
large, pre-existing position either intentionally or unintentionally
causing a disruption to the price discovery function of the core
referenced futures contract as positions are rolled into the spot
month.\843\ The Commission is particularly concerned about protecting
the spot month in physically delivered futures contracts from price
distortions or manipulation that would disrupt the hedging and price
discovery utility of the futures contract.\844\
---------------------------------------------------------------------------
\843\ 85 FR at 11634.
\844\ Id.
---------------------------------------------------------------------------
With respect to non-spot month position limits, only the nine
legacy agricultural contracts are currently subject to such limits
under the existing Federal position limits framework and will continue
to be subject to Federal non-spot month position limits under the Final
Rule. The Commission did not intend in the 2020 NPRM to exclude such
pre-existing positions in the nine legacy agricultural contracts from
non-spot month limits. Accordingly, for the Final Rule the Commission
is modifying final Sec. 150.2(g)(2) to make clear that Federal non-
spot month position limits do apply to these pre-existing positions.
However, as noted above, the 16 non-legacy core referenced futures
contracts that are subject to Federal position limits for the first
time under this Final Rule are not subject to Federal non-spot month
position limits and so are not affected by the Commission's change in
final Sec. 150.2(g)(2).
The Commission agrees with MGEX's and FIA's comments that pre-
existing positions can be netted. The Commission confirms that market
participants may continue to net their pre-existing positions, as
applicable, with market participants' post-effective date referenced
contract positions. In the 2020 NPRM, the Commission made explicit in
proposed Sec. 150.3(a)(5) that market participants would be permitted
to net pre-existing swap positions with post-effective date referenced
contract positions (to the extent such pre-existing swap positions
qualify as ``economically equivalent swaps'' under the Final
Rule).\845\ The Commission adopted this clarification in final Sec.
150.3(a)(5) for the avoidance of doubt. The Commission believes this
explicit clarification with respect to swaps is helpful to market
participants since swaps are subject to Federal position limits for the
first time under this Final Rule and since it may not otherwise be
clear whether a market participant could net a pre-enactment swap or
transition period swap given that such pre-enactment and transition
period swaps are exempt from Federal position limits under final Sec.
150.3(a)(5).
---------------------------------------------------------------------------
\845\ Pre-existing swap positions (i.e., pre-enactment swaps and
transition period swaps) would otherwise be exempt from Federal
position limits.
---------------------------------------------------------------------------
However, the Commission similarly intended that market participants
also would be able to net pre-existing futures contracts and option on
futures contracts against post-effective date positions. The Commission
did not feel such a clarification was necessary since futures contracts
and options thereon have been subject to the existing Federal position
limits framework. Accordingly, for the avoidance of doubt, the
Commission is affirming that market participants may continue to net
pre-existing futures contracts and option on
[[Page 3343]]
futures contracts with post-effective date positions in referenced
contracts.
In response to ISDA's request for clarification, the Commission
notes that Federal non-spot month position limits will apply to pre-
existing positions in the nine legacy agricultural contracts (but not
to the 16 non-legacy core referenced futures contracts). However, for
the reasons articulated above, Federal position limits will apply
during the spot month for futures contracts and options on futures
contracts for all 25 core referenced futures contracts, other than pre-
enactment swaps and transition period swaps.
While the Commission is not adopting a ``safe harbor'' provision,
it is providing a transition period, as requested by CHS,\846\ so that
market participants will have until January 1, 2022 (or January 1, 2023
for economically-equivalent swaps or positions relying on the risk-
management exemption) to comply with the Final Rule. The Commission
believes this will provide sufficient time for market participants to
implement and test new systems and processes that have been established
to comply with the Final Rule.
---------------------------------------------------------------------------
\846\ CHS at 5.
---------------------------------------------------------------------------
8. Positions on Foreign Boards of Trade
i. Background
CEA section 4a(a)(6)(B) directs the Commission to establish limits
on the aggregate number of positions in contracts based upon the same
underlying commodity that may be held by any person across contracts
traded on a foreign board of trade (``FBOT'') with respect to a
contract that settles against any price of at least one contract listed
for trading on a registered entity.\847\
---------------------------------------------------------------------------
\847\ 7 U.S.C. 6a(a)(6)(B). The CEA's definition of ``registered
entity'' includes DCMs and SEFs. 7 U.S.C. 1a(40).
---------------------------------------------------------------------------
ii. Summary of the 2020 NPRM--Foreign Boards of Trade
Proposed Sec. 150.2(h) applied the proposed Federal position
limits to a market participant's aggregate positions in referenced
contracts executed on a DCM or SEF and on, or pursuant to the rules of,
an FBOT, provided that (1) the referenced contracts settle against a
price of a contract listed for trading on a DCM or SEF and (2) the FBOT
makes such contract available in the United States through ``direct
access.'' \848\ In other words, a market participant's positions in
referenced contracts listed on a DCM or SEF and on an FBOT registered
to provide direct access would collectively have to stay below the
Federal position limit for the relevant core referenced futures
contract.
---------------------------------------------------------------------------
\848\ Commission regulation Sec. 48.2(c) defines ``direct
access'' to mean an explicit grant of authority by an FBOT to an
identified member or other participant located in the United States
to enter trades directly into the trade matching system of the FBOT.
17 CFR 48.2(c).
---------------------------------------------------------------------------
iii. Summary of the Commission Determination--Foreign Boards of Trade
The Commission is adopting Sec. 150.2(h) as proposed.
iv. Comments--Foreign Boards of Trade
The Commission received comments from CEWG, Chevron, and Suncor
regarding proposed Sec. 150.2(h) and its possible effects with respect
to certain contracts listed on ICE Futures Europe (``IFEU'') that are
price-linked to the energy core referenced futures contracts.\849\ Each
of the commenters expressed concern that the extension of the proposed
Federal position limits regime to referenced contracts listed for
trading on IFEU could have unintended consequences, such as: (1)
Requiring U.S.-based market participants to comply with potentially
conflicting requirements of multiple regulators and position limits
regimes; and (2) incentivizing foreign regulators to extend their reach
into the Commission's jurisdictional markets.\850\
---------------------------------------------------------------------------
\849\ CEWG at 28-29; Chevron at 15-16; Suncor at 14-15.
\850\ CEWG at 28; Chevron at 16; Suncor at 15.
---------------------------------------------------------------------------
Chevron and Suncor requested that the Commission reconsider what
they perceive to be the potential regulatory conflicts and burdens that
could be imposed on market participants who transact referenced
contracts listed on IFEU, and adopt a policy of substituted compliance
to minimize such conflicts.\851\ CEWG recommended that the Commission
adopt an approach based on substituted compliance with respect to
referenced contracts listed on FBOTs similar to that adopted for swaps
under CEA section 2(i).\852\
---------------------------------------------------------------------------
\851\ Chevron at 16; Suncor at 15.
\852\ CEWG at 29.
---------------------------------------------------------------------------
v. Discussion of Final Rule--Foreign Boards of Trade
As stated above, the Commission is adopting Sec. 150.2(h) as
proposed. As stated in the 2020 NPRM,\853\ CEA section 4a(a)(6)(B)
requires the Commission to establish limits on the aggregate number or
amount of positions in contracts based upon the same underlying
commodity that may be held by any person across certain contracts
traded on an FBOT with linkages to a contract traded on a registered
entity. Final Sec. 150.2(h) simply codifies requirements set forth in
CEA section 4a(a)(6)(B), and will lessen regulatory arbitrage by
eliminating a potential loophole whereby a market participant could
accumulate positions on certain FBOTs in excess of limits in referenced
contracts.\854\
---------------------------------------------------------------------------
\853\ 85 FR at 11634.
\854\ In addition, CEA section 4(b)(1)(B) prohibits the
Commission from permitting an FBOT to provide direct access to its
trading system to its participants located in the United States
unless the Commission determines, in regards to any FBOT contract
that settles against any price of one or more contracts listed for
trading on a registered entity, that the FBOT (or its foreign
futures authority) adopts position limits that are comparable to the
position limits adopted by the registered entity. 7 U.S.C.
6(b)(1)(B).
---------------------------------------------------------------------------
Accordingly, the Commission believes that Sec. 150.2(h) is
consistent with the goal set forth in CEA section 4a(a)(2)(C) to ensure
that liquidity does not move to foreign jurisdictions or place U.S.
exchanges at a competitive disadvantage to foreign competitors. If the
Commission did not attribute positions held in referenced contracts on
FBOTs, the Commission inadvertently could incentivize market
participants to shift trading and liquidity in referenced contracts to
FBOTs in order to avoid Federal position limits.
9. Anti-Evasion
i. Summary of the 2020 NPRM--Anti-Evasion
Pursuant to the Commission's rulemaking authority in section 8a(5)
of the CEA,\855\ the Commission proposed Sec. 150.2(i), which was
intended to deter and prevent a number of potential methods of evading
Federal position limits. The proposed anti-evasion provision provided:
(1) A commodity index contract and/or location basis contract, which
would otherwise be excluded from the proposed referenced contract
definition, would be considered a referenced contract subject to
Federal position limits if used to willfully circumvent position
limits; (2) a bona fide hedge recognition or spread exemption would no
longer apply if used to willfully circumvent speculative position
limits; and (3) a swap contract used to willfully circumvent
speculative position limits would be deemed an economically equivalent
swap, and thus a referenced contract, even if the swap does not meet
the economically equivalent swap definition set forth in proposed Sec.
150.1.
---------------------------------------------------------------------------
\855\ 7 U.S.C. 12a(5).
---------------------------------------------------------------------------
ii. Summary of the Commission Determination--Anti-Evasion
The Commission is adopting Sec. 150.2(i) as proposed with
conforming changes that reflect revisions to the ``referenced
contract'' definition adopted herein in
[[Page 3344]]
which the Final Rule additionally is excluding ``monthly average
pricing contracts'' and ``outright price reporting agency index
contracts'' from the ``referenced contract'' definition.\856\ A
discussion of these conforming changes appears immediately below,
followed by a summary of the comments, which addressed different
aspects of the proposed anti-evasion provision.
---------------------------------------------------------------------------
\856\ See supra Section II.A.16.iii.b. (explanation of proposed
exclusions from the ``referenced contract'' definition).
---------------------------------------------------------------------------
a. Discussion of Conforming Changes--Anti-Evasion
The Commission is revising proposed Sec. 150.2(i)(1), which
addressed evasion of Federal position limits by using commodity index
contracts and location basis contracts, to also cover monthly average
pricing contracts and outright price reporting agency index contracts.
This change is needed to conform the anti-evasion provision to the
``referenced contract'' definition adopted herein. In particular, while
the 2020 NPRM would exclude commodity index contracts and location
basis contracts from the ``referenced contract'' definition, the Final
Rule excludes those contracts as well as monthly average pricing
contracts and outright price reporting agency index contracts from the
``referenced contract definition.'' \857\
---------------------------------------------------------------------------
\857\ See Section II.A.16.iii.b.
---------------------------------------------------------------------------
Because contracts that are excluded from the final ``referenced
contract'' definition are not subject to Federal position limits, the
Commission intends that final Sec. 150.2(i)(1) will prevent a
potential loophole whereby a market participant who has reached its
limits could otherwise utilize these contract types to willfully
circumvent or evade speculative position limits. For example, a market
participant could purchase a commodity index contract in a manner that
allowed the participant to exceed limits when taking into account the
weighting in the component commodities of the index contract. The Final
Rule also will avoid creating what could otherwise be similar potential
loopholes with respect to monthly average pricing contracts, outright
price reporting agency index contracts, and location basis contracts.
Additionally, the Commission is adopting Sec. 150.2(i)(2) as
proposed. This provision provides that a bona fide hedge recognition or
spread exemption will no longer apply if used to willfully circumvent
speculative position limits. This provision is intended to help ensure
that bona fide hedge recognitions and spread exemptions are granted and
utilized in a manner that comports with the CEA and Commission
regulations, and that the ability to obtain bona fide hedge
recognitions and spread exemptions does not become an avenue for market
participants to inappropriately exceed speculative position limits.
The Commission is also adopting Sec. 150.2(i)(3) as proposed.
Under this provision, a swap contract used to willfully circumvent
speculative position limits is deemed an economically equivalent swap,
and thus a referenced contract, even if the swap does not meet the
economically equivalent definition set forth in final Sec. 150.1. This
provision is intended to deter and prevent the structuring of a swap in
order to willfully evade speculative position limits.
iii. Comments--Anti-Evasion
Several commenters stated that the anti-evasion provision is
prudent, but would be difficult to apply in practice, in part due to
the subjective ``willful circumvention'' standard.\858\ FIA recommended
that, instead, the anti-evasion analysis should be based on the
presence of ``deceit, deception, or other unlawful or illegitimate
activity'' so market participants will be better equipped to evaluate
the surrounding facts and circumstances in making an evasion
determination.\859\ FIA further expressed that, because markets evolve,
it is inadvisable to consider ``historical practices behind the market
participant and transaction in question.'' \860\ FIA also asked the
Commission to confirm that it is not evasion for a market participant
to consider ``costs or regulatory burdens, including the avoidance
thereof,'' if that participant has a legitimate business purpose for a
transaction.\861\
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\858\ SIFMA AMG at 7, n.16 (noting that the anti-evasion
provision makes the application of the proposed ``economically
equivalent swap'' definition less clear because it incorporates a
subjective measure of intent); see also FIA at 25 (questioning how a
participant would distinguish a strategy that minimizes position
size with an evasive strategy); Better Markets at 33 (describing the
anti-evasion provision as a ``useful deterrent,'' but noting that
the willful circumvention standard would be difficult to meet and
partially turns on the Commission's consideration of the legitimate
business purpose analysis).
\859\ FIA at 25-26.
\860\ Id.
\861\ Id.
---------------------------------------------------------------------------
Specific to swaps, ISDA encouraged the Commission to expressly
acknowledge and confirm that an out-of-scope swap transaction would not
be considered evasion under any set of circumstances.\862\ FIA
recommended that, for structured swaps, the anti-evasion analysis
should ask whether the swap serves the market participant's commercial
needs or objectives.\863\ Finally, FIA suggested that the Final Rule
should provide an automatic safe harbor from a retroactive evasion
determination for all swaps entered into prior to the compliance
date.\864\
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\862\ ISDA at 5, n.7
\863\ FIA at 25.
\864\ Id.
---------------------------------------------------------------------------
iv. Discussion of Final Rule--Anti-Evasion
The Final Rule's anti-evasion provision is not intended to capture
a trading strategy merely because the strategy may result in a smaller
position size for purposes of position limits. Instead, the anti-
evasion provision is intended to deter and prevent cases of willful
evasion of speculative position limits, the specifics of which the
Commission may be unable to anticipate. The Federal position limit
requirements adopted herein will apply during the spot month for all
referenced contracts subject to Federal position limits, while non-spot
month Federal position limit requirements will only apply for the nine
legacy agricultural contracts. Under this framework, and because the
threat of corners and squeezes is the greatest in the spot month, the
Commission anticipates that it may focus its attention on anti-evasion
activity during the spot month.
The determination of whether particular conduct is intended to
circumvent or evade requires a facts and circumstances analysis. In
interpreting these anti-evasion rules, the Commission is guided by its
interpretations of anti-evasion provisions appearing elsewhere in the
Commission's regulations, including the interpretation of the anti-
evasion rules that the Commission adopted in its rulemakings to further
define the term ``swap'' and to establish a clearing requirement under
section 2(h)(1)(A) of the CEA.\865\
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\865\ See Further Definition of ``Swap, ``Security-Based Swap,''
and ''Security-Based Swap Agreement;'' Mixed Swaps; Security-Based
Swap Agreement Recordkeeping, 77 FR 48208, 48297-48303 (Aug. 13,
2012); Clearing Requirement Determination Under Section 2(h) of the
CEA, 77 FR 74284, 74317-74319 (Dec. 13, 2012).
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Generally, consistent with those interpretations, in evaluating
whether conduct constitutes evasion, the Commission will consider,
among other things, the extent to which the person lacked a legitimate
business purpose for structuring the transaction in that particular
manner. For example, an analysis of how a swap was structured could
reveal that a person or persons crafted derivatives transactions,
structured entities, or conducted
[[Page 3345]]
themselves in a manner without a legitimate business purpose and with
the intent to willfully evade position limits by structuring one or
more swaps such that such swap(s) would not meet the ``economically
equivalent swap'' definition in final Sec. 150.1.
In response to FIA's comment that the Commission should confirm
that it is not evasion for a market participant with a legitimate
business purpose for a transaction to consider ``costs or regulatory
burdens,\866\ the Commission acknowledges that it fully expects that a
person acting for legitimate business purposes within its respective
industry will naturally consider a multitude of costs and benefits
associated with different types of financial transactions, entities or
instruments, including the applicable regulatory obligations.\867\ As
stated in a prior rulemaking, a person's specific consideration of, for
example, costs or regulatory burdens, including the avoidance thereof,
is not, in and of itself, dispositive that the person is acting without
a legitimate business purpose in a particular case.\868\
---------------------------------------------------------------------------
\866\ FIA at 25.
\867\ See 77 FR at 48301.
\868\ See 77 FR at 74319.
---------------------------------------------------------------------------
In response to FIA's comment \869\ that an anti-evasion analysis of
a structured swap should evaluate whether the transaction serves the
market participant's commercial needs or objectives, as stated in the
2020 NPRM, the Commission will view legitimate business purpose
considerations on a case-by-case basis in conjunction with all other
relevant facts and circumstances. Additionally, the Commission
disagrees with FIA's comment \870\ that an historical practices inquiry
is inadvisable. Because transactions and instruments are regularly
structured, and entities regularly formed, in a particular way and for
various, often times multiple, reasons, the Commission believes it is
essential that all relevant facts and circumstances be considered,
including historical practices.\871\ While historical practice is a
factor the Commission will consider as part of its facts and
circumstances analysis, it is not dispositive in determining whether
particular conduct constitutes evasion.
---------------------------------------------------------------------------
\869\ FIA at 25.
\870\ Id. at 25-26.
\871\ See 77 FR at 48302.
---------------------------------------------------------------------------
As part of its facts and circumstances analysis, the Commission
will look at factors such as the historical practices behind the market
participant and transaction in question. For example, with respect to
Sec. 150.2(i)(2) (i.e., bona fide hedges or spreads used to evade),
the Commission is adopting guidance in Appendix B to part 150 with
respect to gross versus net hedging. As discussed elsewhere in this
release, the Commission believes that measuring risk on a gross basis
to willfully circumvent or evade speculative position limits would
potentially run afoul of Sec. 150.2(i)(2).\872\ Use of gross or net
hedging that is inconsistent with an entity's historical practice, or a
change from gross to net hedging (or vice versa), could be an
indication that an entity is seeking to evade position limits
regulations.\873\ With respect to Sec. 150.2(i)(3) (i.e., swaps used
to evade), the Commission will consider whether a market participant
has a history of structuring its swaps one way, but then starts
structuring its swaps a different way around the time the participant
risked exceeding a speculative position limit as a result of its swap
position, such as by modifying the delivery date or other material
terms and conditions such that the swap no longer meets the definition
of an ``economically equivalent swap.''
---------------------------------------------------------------------------
\872\ See Section II.A.1.ix.
\873\ Id.
---------------------------------------------------------------------------
Consistent with interpretive language in prior rulemakings
addressing evasion,\874\ when determining whether a particular activity
constitutes willful evasion, the Commission will consider the extent to
which the activity involves deceit, deception, or other unlawful or
illegitimate activity. Although it is likely that fraud, deceit, or
unlawful activity will be present where willful evasion has occurred,
the Commission disagrees with FIA's comment \875\ that these factors
should be a prerequisite to an evasion finding. A position that does
not involve fraud, deceit, or unlawful activity could still lack a
legitimate business purpose or involve other indicia of evasive
activity. The presence or absence of fraud, deceit, or unlawful
activity is one fact the Commission will consider when evaluating a
person's activity. That said, the final anti-evasion provision does
require willfulness, i.e. ``scienter.'' In response to commenters \876\
who expressed concern regarding the practical application of this
intent standard, the Commission will interpret ``willful'' consistently
with how the Commission has done so in the past, i.e., that acting
either intentionally or with reckless disregard constitutes acting
``willfully.'' \877\
---------------------------------------------------------------------------
\874\ See 77 FR at 48297-48303; 77 FR at 74317-74319.
\875\ FIA at 25.
\876\ SIFMA AMG at 7, n.16; see also FIA at 25; Better Markets
at 33.
\877\ See In re Squadrito, [1990-1992 Transfer Binder] Comm.
Fut. L. Rep. (CCH) ] 25,262 (CFTC Mar. 27, 1992) (adopting
definition of ``willful'' in McLaughlin v. Richland Shoe Co., 486
U.S. 128 (1987)).
---------------------------------------------------------------------------
In determining whether a transaction has been entered into or
structured willfully to evade position limits, the Commission will not
consider the form, label, or written documentation as dispositive. The
Commission also is not requiring a pattern of evasive transactions as a
prerequisite to prove evasion, although such a pattern may be one
factor in analyzing whether evasion has occurred. In instances where
one party willfully structures a transaction to evade but the other
counterparty does not, Sec. 150.2(i) will apply to the party who
willfully structured the transaction to evade.
Further, entering into transactions that qualify for the forward
exclusion from the swap definition, standing alone, shall not be
considered evasive. However, in circumstances where a transaction does
not, in fact, qualify for the forward exclusion, the transaction may or
may not be evasive depending on an analysis of all relevant facts and
circumstances.
The Commission declines to adopt ISDA's request \878\ to carve out-
of-scope swap transactions from the anti-evasion provision. This
request was unsupported and did not address whether an out-of-scope
swap could be used to evade position limits.
---------------------------------------------------------------------------
\878\ ISDA at 5, n.7.
---------------------------------------------------------------------------
Finally, the Commission declines to adopt FIA's request \879\ that
all swaps entered into prior to the compliance date be granted an
automatic safe harbor from a retroactive finding of evasion. This
change is unnecessary given that under final Sec. 150.3, pre-enactment
swaps and transition period swaps will not be subject to Federal
position limits at all during or outside the spot month.\880\
---------------------------------------------------------------------------
\879\ FIA at 25.
\880\ See final Sec. 150.3(a)(5).
---------------------------------------------------------------------------
10. Application of Netting and Related Treatment of Cash-Settled
Referenced Contracts
i. Background
Under the existing Federal framework, Federal position limits apply
only to the nine legacy agricultural contracts, which are all
physically-settled. However, existing part 150 does not include the
equivalent concept of a ``referenced contract,'' and therefore existing
Federal position limits do not apply to any cash-settled look-alike
contracts as they would under the Final Rule. Accordingly, the issue of
netting across look-alike contracts that may be located across
[[Page 3346]]
different exchanges is not addressed under the existing framework.
ii. Summary of the 2020 NPRM--Netting and Related Treatment of Cash-
Settled Referenced Contracts
Under the 2020 NPRM, the referenced contract definition in proposed
Sec. 150.1 included, among other things, (i) cash-settled contracts
that are linked, either directly or indirectly, to a core referenced
futures contract, and (ii) ``economically equivalent swaps.'' \881\
---------------------------------------------------------------------------
\881\ See Section II.A.16. (discussion of the proposed
referenced contract definition).
---------------------------------------------------------------------------
Proposed Sec. 150.2(a) provided that during the spot month,
Federal position limits would apply ``separately'' to physically
delivered referenced contracts and cash-settled referenced contracts.
Under the 2020 NPRM, positions in a physically-settled core referenced
futures contract would not be required to be added to, nor permitted to
be netted down by, positions in corresponding cash-settled referenced
contracts (and vice-versa).
Proposed Sec. 150.2(b), in contrast, provided that during the non-
spot months, including the single month and all-months-combined,
Federal position limits would apply in the aggregate to both
physically-delivered referenced contracts and cash-settled referenced
contracts. This meant that for the purposes of determining whether a
market participant complies with the Federal non-spot month position
limits, a person's physically-settled and cash-settled referenced
contract positions would be added together and could net against each
other.
Under both proposed Sec. Sec. 150.2(a) and (b), positions in
referenced contracts would be aggregated across exchanges for purposes
of determining one's net position for Federal position limit purposes.
iii. Summary of the Commission Determination--Netting and Related
Treatment of Cash-Settled Referenced Contracts
The Commission is finalizing Sec. 150.2(a) and (b) of the 2020
NPRM as proposed.\882\
---------------------------------------------------------------------------
\882\ As discussed above, the Commission is making an exception
for natural gas referenced contracts to the general netting rules
discussed below. For further discussion on the Final Rule's
treatment of natural gas referenced contracts, see Section
II.B.3.vi.
---------------------------------------------------------------------------
iv. Comments--Netting and Related Treatment of Cash-Settled Referenced
Contracts
PIMCO, SIFMA AMG, and ISDA contended that cash-settled referenced
contracts should not be subject to Federal position limits at all
because cash-settled contracts do not introduce the same risk of market
manipulation. They argued that subjecting cash-settled referenced
contracts to Federal position limits would reduce market liquidity and
depth in these instruments.\883\
---------------------------------------------------------------------------
\883\ PIMCO at 3; SIFMA AMG at 4-7; ISDA at 3-5. These entities
did not specifically argue that cash-settled contracts should be
excluded from the ``referenced contract'' definition, but rather in
general that such instruments should not be subject to Federal
position limits. The Commission noted that this is technically a
different argument since cash-settled instruments could be exempt
from position limits while still technically qualifying as
``referenced contracts,'' but the end result is the same as a
practical matter.
---------------------------------------------------------------------------
FIA and ICE argued that limits for cash-settled referenced
contracts should be higher relative to Federal position limits for
physically-settled referenced contracts. They similarly argued that
cash-settled referenced contracts are ``not subject to corners and
squeezes'' and will `` `ensure market liquidity for bona fide hedgers.'
'' \884\ FIA and ICE further suggested that Federal position limits for
cash-settled referenced contracts should apply per DCM (rather than in
aggregate across DCMs).\885\ FIA additionally suggested setting a
separate Federal spot-month position limit for economically equivalent
swaps.\886\
---------------------------------------------------------------------------
\884\ ICE at 3, 15 (also arguing that cash-settled limits should
apply per exchange, rather than across exchanges); FIA at 7-8.
\885\ FIA at 7-8; ICE at 13.
\886\ FIA 7-8.
---------------------------------------------------------------------------
In contrast, CME Group supported the Commission's approach for
spot-month parity for physically-settled and cash-settled referenced
contracts across all commodity markets. CME Group explained that absent
such parity, one side of the market could be vulnerable to: Artificial
distortions from manipulations on the other side of the market;
regulatory arbitrage; and liquidity drain to the other side of the
market.\887\ CME Group warned that, ultimately, a lack of parity could
undermine the statutory goals of position limits.\888\ NEFI agreed,
arguing similarly that ``this move is essential to guard against
manipulation by a trader who holds positions in both physically-settled
and cash-settled contracts for the same underlying commodity.'' \889\
---------------------------------------------------------------------------
\887\ CME Group at 3-4.
\888\ Id. at 6.
\889\ NEFI at 3.
---------------------------------------------------------------------------
v. Discussion of Final Rule--Netting and Related Treatment of Cash-
Settled Referenced Contracts
The Commission is finalizing Sec. Sec. 150.2(a) and (b) as
proposed. Under final Sec. 150.2(a), Federal spot month limits apply
to physical-delivery referenced contracts ``separately'' from Federal
spot month limits applied to cash-settled referenced contracts, meaning
that during the spot month, positions in physically-settled contracts
may not be netted with positions in linked cash-settled contracts but
also are not required to be added to linked cash-settled contracts for
the purposes of determining compliance with Federal position limits.
Specifically, all of a trader's positions (long or short) in a given
physically-settled referenced contract (across all exchanges and OTC as
applicable) \890\ are netted and subject to the spot month limit for
the relevant commodity, and all of such trader's positions in any cash-
settled referenced contracts (across all exchanges and OTC as
applicable) linked to such physically-settled core referenced futures
contract are netted and independently (rather than collectively along
with the physically-settled positions) subject to the Federal spot
month limit for that commodity.\891\
---------------------------------------------------------------------------
\890\ In practice, the only physically-settled referenced
contracts subject to the Final Rule will be the 25 core referenced
futures contracts, none of which are listed on multiple DCMs,
although there could potentially be physically-settled OTC swaps
that would satisfy the ``economically equivalent swap'' definition
and therefore would also qualify as referenced contracts. For
further discussion on economically equivalent swaps, see Section
II.A.4.
\891\ Consistent with CEA section 4a(a)(6), this would include
positions across exchanges. However, for the reasons discussed in
Section II.B.3.vi., the Commission is exercising its exemptive
authority under CEA section 4a(a)(7) to provide an exception for
natural gas to the general aggregation rule in CEA section 4a(a)(6).
As discussed above, the Commission has concluded that the natural
gas market is well-established with contracts that currently trade
across several exchanges, and is relatively liquid with significant
open interest. Accordingly, the Commission is exercising its
judgment to establish Federal position limits on a per-exchange (and
OTC as applicable) basis in order to maintain the status quo rather
than risk disturbing the existing natural gas market.
---------------------------------------------------------------------------
Additionally, a position in a commodity contract that is not a
referenced contract, and therefore is not subject to Federal position
limits, as a consequence, cannot be netted with positions in referenced
contracts for purposes of Federal position limits.\892\ For example, a
swap that is not a referenced contract because it does not meet the
economically equivalent swap definition could not be netted with
positions in a referenced contract.
---------------------------------------------------------------------------
\892\ Proposed Appendix C to part 150 provides guidance
regarding the referenced contract definition, including that the
following types of contracts are not deemed referenced contracts,
meaning such contracts are not subject to Federal position limits
and cannot be netted with positions in referenced contracts for
purposes of Federal position limits: Location basis contracts;
commodity index contracts; swap guarantees; trade options that meet
the requirements of 17 CFR 32.3; monthly average pricing contracts;
and outright price reporting agency index contracts.
---------------------------------------------------------------------------
[[Page 3347]]
Allowing the netting of linked physically-settled and cash-settled
contracts during the spot month could lead to disruptions in the price
discovery function of the core referenced futures contract or allow a
market participant to manipulate the price of the core referenced
futures contract. Absent separate spot month position limits for
physically-settled and cash-settled contracts, the spot month position
limit would be rendered ineffective, as a participant could maintain
large positions in excess of limits in both the physically-settled
contract and the linked cash-settled contract, enabling the participant
to disrupt the price discovery function as the contracts go to
expiration by taking large opposite positions in the physically-settled
core referenced futures and cash-settled referenced contracts, or
potentially allowing a participant to effect a corner or squeeze.\893\
Consistent with current and historical practice, the Federal position
limits adopted herein apply to positions throughout each trading
session (i.e., on an intra-day basis during each trading session), as
well as at the close of each trading session.\894\
---------------------------------------------------------------------------
\893\ For example, absent such a restriction in the spot month,
a trader could stand for 100 percent of deliverable supply during
the spot month by holding a large long position in the physical-
delivery contract along with an offsetting short position in a cash-
settled contract, which effectively would corner the market.
\894\ See, e.g., Elimination of Daily Speculative Trading
Limits, 44 FR 7124, 7125 (Feb. 6, 1979).
---------------------------------------------------------------------------
In response to the comments from PIMCO, SIFMA AMG, and ISDA that
cash-settled referenced contracts should not be subject to position
limits at all because such contracts do not introduce the same risk of
market manipulation, as discussed above under Section II.A.16.iii.a.,
the Commission has concluded that cash-settled referenced contracts
should be subject to Federal position limits since they form one market
with their corresponding physically-settled core referenced futures
contracts.\895\
---------------------------------------------------------------------------
\895\ For further discussion, see Section II.A.16.iii.a(2).
---------------------------------------------------------------------------
In response to ISDA's recommendation that the Final Rule only
include physically-settled referenced contracts and that the Commission
apply Federal position limits on cash-settled referenced contracts at a
later time, the Commission notes that as discussed under Section I.D.,
the Final Rule will be subject to a general compliance period until
January 1, 2022. During this period, exchanges may choose to implement
exchange-set position limits that provide for a different phased-in
approach for cash-settled versus physically-settled referenced
contracts as the exchanges may find appropriate for their respective
markets. Additionally, the compliance period will be further extended
until January 1, 2023 for economically equivalent swaps and positions
held in reliance on a risk-management exemption, which in each case the
Commission notes include mostly cash-settled positions. Accordingly, as
a practical matter, many cash-settled contracts will be subject to a
longer compliance period. However, as discussed further above under
Section II.A.16.iii.a, the Commission has determined that it is
appropriate to include cash-settled referenced contracts in Federal
position limits under this Final Rule.\896\
---------------------------------------------------------------------------
\896\ For further discussion of the Commission's rationale for
including cash-settled referenced contracts under the Final Rule,
see Section II.A.16.iii.a.
---------------------------------------------------------------------------
FIA and ICE similarly argued that cash-settled referenced contracts
should be subject to higher Federal position limits compared to the
physically-settled core referenced futures contracts. Their arguments
were predicated, in part, on their conclusions that market participants
cannot use cash-settled contracts to effect a corner or squeeze.\897\
---------------------------------------------------------------------------
\897\ FIA at 7; ICE at 12-13.
---------------------------------------------------------------------------
The Commission declines to adopt higher Federal position limits for
cash-settled referenced contracts for several reasons. First, as an
initial matter, the Commission acknowledges that preventing corners and
squeezes is a crucial focus of the Commission. However, in response to
FIA's and ICE's arguments that cash-settled referenced contracts should
be subject to higher Federal position limits compared to physically-
settled futures contracts because cash-settled contracts cannot be used
to effect a corner or squeeze, the Commission notes that there are
other forms of manipulation, such as ``banging'' or ``marking'' the
close, that cash-settled referenced contracts can effect, and the
Commission emphasizes that it endeavors to prevent all such market
manipulation, consistent with CEA section 4a(a)(3)(B)(ii).\898\ While
CEA section 4a(a)(3)(B)(ii) specifically references corners and
squeezes, the CEA section also references ``manipulation'' generally,
and neither FIA nor ICE recognized the existence of other types of
market manipulation, such as ``banging'' the close, in their analysis.
---------------------------------------------------------------------------
\898\ For further discussion, see Sections II.A.16.,
II.A.4.iii.d(2), and II.B.10.iv.
---------------------------------------------------------------------------
Second, the Commission believes that FIA's and ICE's arguments for
higher Federal position limits for cash-settled referenced contracts is
intrinsically related to the comments from PIMCO, SIFMA AMG, and ISDA
discussed above arguing that cash-settled referenced contracts should
not be subject to Federal position limits at all. That is, the higher
the Federal position limits for cash-settled referenced contracts that
FIA or ICE recommend establishing, the closer, as a practical matter,
it is to having no Federal position limits for cash-settled referenced
contracts.\899\ As a result, the Commission believes that its general
rationale for including cash-settled referenced contracts within the
Federal position limits framework similarly supports parity between
cash-settled and physically-settled referenced contracts.
---------------------------------------------------------------------------
\899\ See Section II.A.16.iii.a.
---------------------------------------------------------------------------
Third, the Commission generally agrees with the reasons articulated
in the comments from CME Group and NEFI that it is appropriate to
establish spot-month parity for physically-settled and cash-settled
referenced contracts across all commodity markets. While FIA argued
that higher position limits for cash-settled referenced contracts could
ensure liquidity for bona fide hedgers,\900\ the Final Rule has
established the Federal position limit levels in general for the 25
core referenced futures contracts (including increases for many of the
nine legacy agricultural contracts) and has expanded the enumerated
bona fide hedges and streamlined the related application process under
final Sec. Sec. 150.3 and 150.9 in order to ensure sufficient
liquidity for bona fide hedgers.
---------------------------------------------------------------------------
\900\ FIA at 7-8.
---------------------------------------------------------------------------
FIA and ICE similarly argued that market participants should not be
required to aggregate cash-settled positions across all exchanges but
rather should be subject to a disaggregated Federal position limit that
applies per-exchange. In other words, as the Commission understands
FIA's and ICE's request, if the Federal position limit is 1,000
contracts, FIA and ICE believe that a market participant should be able
to hold 1,000 cash-settled referenced contracts per exchange rather
than being required to aggregate positions across all exchanges. Under
this approach, a long position of 1,000 contracts on Exchange A would
not be aggregated with a long position of 1,000 contracts on Exchange
B. However, under this approach, a long position on Exchange A also
would not net with a short position on Exchange B.
ICE specifically argued that a single, aggregate Federal position
limit for all
[[Page 3348]]
referenced contracts across exchanges may make it difficult for an
exchange to launch a new referenced contract since the hypothetical new
referenced contract would be aggregated with an existing referenced
contract for purposes of Federal position limits.\901\ According to
ICE, establishing new exchanges and/or new contracts is made more
difficult under the Commission's aggregated approach, since it is
purportedly more difficult to attract sufficient liquidity to establish
a sustainable exchange or contract.\902\ ICE also references the
Commission's obligations under CEA section 15 to consider the public
interest and antitrust laws.\903\ ICE recommends a more flexible
approach to allow an exchange to develop its own liquidity and
establish its own limits, even for similar or look-alike cash-settled
referenced contracts, to help develop robust and liquid markets while
protecting against excessive speculation.\904\
---------------------------------------------------------------------------
\901\ ICE at 12-13.
\902\ ICE at 12-13.
\903\ Id.
\904\ Id.
---------------------------------------------------------------------------
In response to FIA and ICE, as discussed immediately below, the
Commission believes that, as a general matter, establishing aggregate
limits across exchanges promotes competition and innovation while also
better addressing the statutory goals in CEA section 4a(a)(3) as
compared to ICE's request to establish disaggregated, per-exchange
position limits. However, before discussing the Commission's underlying
policy rationale supporting aggregate Federal position limits, the
Commission has determined that as an initial legal matter that CEA
section 4a(a)(6)(B) requires the Commission to establish the
``aggregate number or amount of positions . . . that maybe held by any
person . . . for each month across . . . contracts listed by [DCMs] . .
. .'' (emphasis added).\905\ While ICE cites CEA section 15 in its
comment letter, ICE does not address CEA section 4a(a)(6)'s requirement
that the Commission generally must establish aggregate position limits
across exchanges. Accordingly, in addition to the policy rationale
discussed immediately below, the Commission further has determined that
the Final Rule's requirement to aggregate positions across exchanges
does not on its face violate CEA section 15.\906\
---------------------------------------------------------------------------
\905\ 7 U.S.C. 6a(a)(6); CEA 4a(a)(6).
\906\ See Section IV.D. As discussed elsewhere in this release,
the Commission is exercising its exemptive authority pursuant to CEA
Section 4a(a)(7) to establish an exception to this rule in
connection with, and based on the particular circumstances of the
natural gas market. See Section II.B.3.iv (discussing natural gas).
---------------------------------------------------------------------------
As noted above, the Commission also believes it is appropriate to
aggregate positions across exchanges for Federal position limit
purposes for the same general reasons that the Commission has
determined both to include cash-settled referenced contracts within the
Federal position limits framework and also to maintain parity for
Federal position limit levels between physically-settled and cash-
settled referenced contracts. For example, applying a per-exchange
Federal position limit, rather than aggregating across exchanges,
effectively increases the applicable Federal position limit.
Accordingly, the Commission likewise believes it generally is
inappropriate to permit per-exchange Federal position limits for cash-
settled referenced contracts.
In response to ICE's concern regarding liquidity formation and that
aggregating cash-settled positions across exchanges would harm
competitiveness and innovation by making it more difficult to attract
enough liquidity to become sustainable on an ongoing basis,\907\ the
Commission believes that to the extent Federal position limit levels
under the Final Rule have been correctly calibrated, the Federal
position limits framework should promote--or at least not
disincentivize--liquidity formation.
---------------------------------------------------------------------------
\907\ ICE at 12-13.
---------------------------------------------------------------------------
However, ICE's proposal to allow Federal position limits to apply
on a disaggregated, per-exchange basis risks dividing liquidity among
several liquidity pools, which itself could harm liquidity for bona
fide hedgers and reduce price discovery. The Commission also observes
that, as a practical matter, ICE's request to disaggregate positions
across exchanges would significantly increase the applicable position
limit (possibly by a multiple of two or three--or more--depending on
the number of exchanges that list referenced contracts). Consequently,
if the Commission assumes, in arguendo, that Federal position limit
levels are reasonably calibrated under the Final Rule, then applying a
per-exchange limit by definition would increase the potential risks of
excessive speculation and possible manipulation as market participants
are permitted to hold larger directional positions in referenced
contracts. Moreover, to the extent Federal position limits under this
Final Rule are not reasonably calibrated to ensure necessary liquidity
for bona fide hedgers, then the Commission, as a general matter, would
prefer to address the lack of liquidity by adjusting the Federal
position limit levels to appropriate levels rather than applying
Federal position limits on a per-exchange basis for the reasons
discussed in the paragraphs above and as discussed in the paragraph
immediately below.
Last, the Commission believes that ICE's approach could actually
harm innovation since under ICE's rationale, Federal position limit
levels would need to be set lower than the Federal levels adopted
herein. For example, if the Commission were to allow disaggregated
netting across exchanges as a general rule, then it would likely lead
to increased excessive speculation and possible manipulation, as
discussed above.
Accordingly, in order to avoid the threat of excessive speculation
and manipulation, the Commission would be obligated to set Federal
position limits sufficiently low in order to compensate for a per-
exchange position limit disaggregated approach. However if the
Commission were to establish Federal position limits sufficiently low
to prevent these concerns from happening, then innovation could be
adversely affected since it means that the concomitant lower Federal
position limit levels likely would make it difficult for exchanges to
develop sufficient liquidity for a new product--unless other competing
exchanges offered linked contracts to add sufficient liquidity to the
market. In such a case, the success of any new product offered by the
initial exchange could be dependent upon competing exchanges offering
competing look-alike contracts to allow for sufficient liquidity. In
contrast, the Commission believes that the Final Rule's approach to
make the full aggregated Federal position limit available to the
contract is more responsive to the needs of the market compared to a
disaggregated approach, and the Commission believes that the Final
Rule's aggregated approach promotes innovation and competition in the
marketplace. Accordingly, the Commission does not believe that applying
netting on an aggregate basis harms competition and innovation. Rather,
the Commission believes its approach supports healthy competition and
innovation while ICE's approach could harm liquidity and innovation.
While the Commission believes the above rationale generally
applies, the Commission notes that for the reasons discussed in Section
II.B.3.vi., the Commission is exercising its exemptive authority under
CEA section 4a(a)(7) to provide an exception for natural gas to the
general aggregation rule in CEA section 4a(a)(6). The Commission does
[[Page 3349]]
not believe that the rationale above necessarily applies to the natural
gas market. As discussed above, the natural gas market has existing
natural gas commodity derivatives contracts that are well-established
with liquidity, trading, and open interest currently across several
exchanges. Accordingly, the Commission is exercising its judgment to
establish Federal position limits on a per-exchange basis in order to
maintain the status quo rather than risk disturbing the structure of
the existing natural gas market, which could harm liquidity for bona
fide hedgers or price discovery.
In response to FIA's suggestion that economically equivalent swaps
should be subject to separate Federal spot-month position limits, as
discussed under Section II.A.4.iii., the Commission does not believe
doing so would be appropriate.\908\ As discussed above, the Commission
believes that establishing separate class position limits for futures
contracts and swaps could harm liquidity formation while establishing a
single Federal position limit promotes integration between the futures
and swaps markets.
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\908\ FIA 7-8.
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11. ``Eligible Affiliates'' and Position Aggregation
i. Background
In 2016, the Commission amended Sec. 150.4 to adopt new rules
governing the aggregation of positions for purposes of compliance with
Federal position limits.\909\ These aggregation rules currently apply
only to the nine legacy agricultural contracts previously subject to
Federal position limits, but now will also apply to the 16 new
contracts subject to Federal position limits for the first time under
this Final Rule. Under the existing aggregation rules, unless an
exemption applies, all of the positions held and trading done by the
person must be aggregated with positions for which the person controls
trading or for which the person holds a 10% or greater ownership
interest. DMO has issued time-limited no-action relief through August
12, 2022 (``NAL 19-19'') from some of the aggregation requirements
contained in that rulemaking.\910\
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\909\ See 81 FR at 91454.
\910\ See CFTC Letter No. 19-19 (July 31, 2019), available at
https://www.cftc.gov/csl/19-19/download. NAL 19-19 extends NAL 17-37
and provides an additional three-year period of no-action relief
from compliance with certain position aggregation requirements under
Commission Regulation 150.4 by streamlining the compliance
requirements that must be satisfied for a person or entity to rely
on an exemption from aggregation.
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ii. Summary of the 2020 NPRM--Eligible Affiliates and Position
Aggregation
Proposed Sec. 150.2(k) addressed entities that would qualify as an
``eligible affiliate'' as defined in proposed Sec. 150.1. Under the
proposed definition, an ``eligible affiliate'' would include certain
entities that, among other things, are required to aggregate their
positions under Sec. 150.4 and that do not claim an exemption from
aggregation. There may be certain entities that would be eligible for
an exemption from aggregation, but that prefer to aggregate rather than
disaggregate their positions (such as when aggregation would result in
advantageous netting of positions with affiliated entities). Proposed
Sec. 150.2(k) intended to address such a circumstance by making clear
that an ``eligible affiliate'' may opt to aggregate its positions even
though it is eligible to disaggregate.
iii. Summary of the Commission Determination--Eligible Affiliates and
Position Aggregation
The Commission is adopting Sec. 150.2(k) as proposed.
iv. Comments--Eligible Affiliates and Position Aggregation
Although the Commission did not receive any comments on this
provision, it received a number of comments related to position
aggregation in general. These commenters urged the Commission to amend
the Federal position limits aggregation rules in existing Sec. 150.4
by codifying existing NAL 19-19.\911\ Some commenters further requested
that the Commission revisit certain aspects of NAL 19-19 and the
aggregation rules, such as the threshold ownership percentage set forth
in existing Sec. 150.4 that triggers the requirement to aggregate
positions or rely upon an exemption.\912\ Conversely, IATP argued that
before applying the existing aggregation rules, and accompanying
exemptions, to additional commodities, the Commission should study
whether the existing exemptions from aggregation have resulted in
increased speculation.\913\
---------------------------------------------------------------------------
\911\ FIA at 28; ISDA at 11; PIMCO at 6; CMC at 12-13; and SIFMA
AMG at 2, 9.
\912\ CMC at 12-13; FIA at 28.
\913\ IATP at 18-19.
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v. Discussion of Final Rule--Eligible Affiliates and Position
Aggregation
The Commission declines to codify NAL 19-19 \914\ in this
rulemaking since NAL 19-19's relief from some of the aggregation
requirements contained in 2016 Final Aggregation Rulemaking \915\
continues to apply until August 12, 2022. DMO extended this relief for
three years to provide sufficient time to ``evaluate whether the relief
granted is hindering Commission staff's ability to conduct
surveillance; assess the impact of the relief; and consider long-term
solutions that must, appropriately, be implemented by a notice and
comment rulemaking.'' \916\ Accordingly, the Commission believes it is
appropriate to first monitor the application of the existing position
aggregation requirements before considering amendments to those
aggregation requirements, and the Commission will address the
aggregation rules, including whether to codify NAL 19-19, as needed,
after this Final Rule goes into effect.
---------------------------------------------------------------------------
\914\ See CFTC Letter No. 19-19 (July 31, 2019), available at
https://www.cftc.gov/csl/19-19/download.
\915\ 81 FR 91454 (December 16, 2016).
\916\ See CFTC Letter No. 19-19 at 4.
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C. Sec. 150.3--Exemptions From Federal Position Limits
1. Background--Existing Sec. Sec. 150.3, 1.47, and 1.48--Exemptions
From Federal Position Limits
Existing Sec. 150.3(a), which pre-dates the Dodd-Frank Act, lists
positions that may, under certain circumstances, exceed Federal
position limits, including: (1) Bona fide hedging transactions, as
defined in the current bona fide hedging definition in Sec. 1.3; and
(2) spread or arbitrage positions, subject to certain conditions.\917\
Existing Sec. 150.3(b) provides that the Commission or certain
Commission staff may make a ``call'' to demand certain information from
exemption holders so that the Commission can effectively oversee the
use of such exemption. Section Sec. 150.3(b) also provides that any
such call may request information relating to positions owned or
controlled by that person, trading done pursuant to that exemption, the
futures, options or cash-market positions that support the claimed
exemption, and the relevant business relationships supporting a claim
of exemption.\918\
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\917\ 17 CFR 150.3(a).
\918\ 17 CFR 150.3(b).
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The current bona fide hedge definition in existing Sec. 1.3
requires applicants who wish to receive bona fide hedging recognition
and exceed Federal position limits to apply for non-enumerated bona
fide hedges under Sec. 1.47 and to apply for anticipatory bona fide
hedges under Sec. 1.48 of the Commission's existing regulations. Under
Sec. 1.47, persons seeking recognition by the Commission of a non-
[[Page 3350]]
enumerated bona fide hedging transaction or position must file certain
initial statements with the Commission at least 30 days in advance of
the date that such transaction or position would be in excess of
Federal position limits.\919\ Similarly, persons seeking recognition by
the Commission of certain anticipatory bona fide hedges must submit
their application 10 days in advance of the date that such transactions
or positions would be in excess of Federal position limits.\920\
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\919\ 17 CFR 1.47.
\920\ 17 CFR 1.48.
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With respect to spread exemptions, the Commission's authority and
existing regulation for exempting certain spread positions can be found
in CEA section 4a(a)(1) and existing Sec. 150.3(a)(3) of the
Commission's regulations. In particular, CEA section 4a(a)(1)
authorizes the Commission to exempt from Federal position limits
transactions ``normally known to the trade as 'spreads' or 'straddles'
or 'arbitrage.''' Similarly, in existing Sec. 150.3(a)(3), the
Commission exempts ``spread or arbitrage positions,'' and allows such
exemptions to be self-effectuating for the nine legacy agricultural
contracts currently subject to Federal position limits. The Commission
does not specify a formal process, in Sec. 150.3(a)(3), for granting
spread exemptions.\921\
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\921\ Since 1938, the Commission (then known as the Commodity
Exchange Commission) has recognized the use of spread positions to
facilitate liquidity and hedging. See Notice of Proposed Order in
the Matter of Limits on Position and Daily Trading in Grain for
Future Delivery, 3 FR 1408 (June 14, 1938).
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2. Overview of Proposed Sec. 150.3, Commenters' Views, and the
Commission's Final Rule Determination
This section provides a brief overview of proposed Sec. 150.3,
commenters' general views, and the Commission's determination. The
Commission will summarize and address each sub-section of Sec. 150.3
in greater detail further below. The Commission proposed several
changes to Sec. 150.3. First, the Commission proposed to update Sec.
150.3 to conform to the proposed bona fide hedging definition in Sec.
150.1 (described above) and the new streamlined process in proposed
Sec. 150.9 for recognizing non-enumerated bona fide hedging positions
(described further below). The Commission also proposed to amend Sec.
150.3 to include new exemption types not explicitly listed in existing
Sec. 150.3, including: (i) Exemptions for financial distress
situations; (ii) conditional exemptions for certain spot month
positions in cash-settled natural gas contracts; and (iii) exemptions
for pre-enactment swaps and transition period swaps.\922\ Proposed
Sec. 150.3(b)-(g) respectively addressed: Non-enumerated bona fide
hedge and spread exemption requests submitted directly to the
Commission; previously-granted risk management exemptions to Federal
position limits; exemption-related recordkeeping and reporting
requirements; the aggregation of accounts; and the delegation of
certain authorities to the Director of the Division of Market
Oversight.
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\922\ The Commission revised Sec. 150.3(a) in 2016, relocating
the independent account controller aggregation exemption from Sec.
150.3(a)(4) in order to consolidate it with the Commission's
aggregation requirements in Sec. 150.4(b)(4). See Final Aggregation
Rulemaking, 81 FR at 91489-91490.
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The most substantive comments on proposed Sec. 150.3 relate to the
spread transaction exemption in proposed Sec. 150.3(a)(2) and to the
natural gas conditional position limit exemption in proposed Sec.
150.3(a)(4), as described in detail below and under the discussion of
Sec. 150.2, above.\923\ In addition, one commenter expressed general
support for the Commission's proposed approach to recognizing
exemptions under Sec. 150.3.\924\
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\923\ See supra Section II.B.3.vi.a. (discussing the spot-month
limit for natural gas).
\924\ See CMC at 6.
---------------------------------------------------------------------------
The Commission has determined to adopt Sec. 150.3 largely as
proposed, with certain modifications and clarifications in response to
commenters' views and other considerations, as described in detail
below.
3. Section 150.3(a)(1)--Exemption for Bona Fide Hedging Transaction or
Position
i. Summary of the 2020 NPRM--Exemption for Bona Fide Hedging
Transaction or Position
First, under proposed Sec. 150.3(a)(1)(i), a bona fide hedging
transaction or position that falls within one of the proposed
enumerated hedges set forth in proposed Appendix A to part 150,
discussed above, would be self-effectuating for purposes of Federal
position limits. A market participant thus would not be required to
request Commission approval prior to exceeding Federal position limits
for such transaction or position. However, this does not affect a
market participant's obligations under proposed Sec. 150.5(a) and
under the relevant exchange's rules and thus, the market participant
would be required to request a bona fide hedge exemption from the
relevant exchange for purposes of exchange-set limits established
pursuant to proposed Sec. 150.5(a), and submit required cash-market
information to the exchange as part of that request.\925\ The
Commission also proposed to allow the existing enumerated anticipatory
bona fide hedges (some of which are not currently self-effectuating,
and must be approved by the Commission, under existing Sec. 1.48) to
be self-effectuating for purposes of Federal position limits (and thus
would not require prior Commission approval).
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\925\ See infra Section II.D.3. See also 85 FR at 11644
(proposed Sec. 150.5(a)(2)(ii)(A)).
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Second, under proposed Sec. 150.3(a)(1)(ii), for positions in
referenced contracts that do not satisfy one of the proposed enumerated
hedges in Appendix A, (i.e., non-enumerated bona fide hedges), a market
participant must request approval from the Commission either directly,
or indirectly through an exchange, prior to exceeding Federal position
limits. Such exemptions thus would not be self-effectuating and a
market participant in such cases would have one of the following two
options for requesting such a non-enumerated bona fide hedge
recognition: (1) Apply directly to the Commission in accordance with
Sec. 150.3(b) (described below), and, separately, also apply to an
exchange pursuant to exchange rules established under proposed Sec.
150.5(a); \926\ or (2) apply through an exchange pursuant to proposed
Sec. 150.9 for a non-enumerated bona fide hedge recognition that could
ultimately be valid both for purposes of Federal and exchange-set
position limit requirements, unless the Commission (and not staff,
which would not have delegated authority) denies the application within
a limited period of time.\927\ As discussed in the 2020 NPRM, market
participants relying on enumerated or non-enumerated bona fide hedge
recognitions would no longer have to file the monthly Form 204/304 with
supporting cash-market information.\928\
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\926\ See infra Section II.D.3. (discussion of proposed Sec.
150.5).
\927\ See infra Section II.G. (discussion of proposed Sec.
150.9).
\928\ See infra Section II.H.2. (discussion of the proposed
elimination of Form 204).
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ii. Comments and Discussion of Final Rule--Exemption for Bona Fide
Hedging Transactions or Positions
The Commission did not receive any comments on proposed Sec.
150.3(a)(1). As such, the Commission is finalizing Sec. 150.3(a)(1)
with a few grammatical and organizational changes to improve
readability. The Commission is also finalizing the introductory text in
Sec. 150.3(a) with a clarification that ``each'' of a person's
transactions or positions must satisfy at least one of the
[[Page 3351]]
exemptions in Sec. 150.3(a) in order to exceed Federal limits. None of
the technical revisions are intended to change the substance of
proposed Sec. 150.3(a)(1).
4. Section 150.3(a)(2)--Spread Exemptions
i. Summary of the 2020 NPRM--Spread Exemptions
Under proposed Sec. 150.3(a)(2)(i), a spread position would be
self-effectuating for purposes of Federal position limits, provided
that the position fits within at least one of the types of spread
strategies listed in the ``spread transaction'' definition in proposed
Sec. 150.1,\929\ and provided further that the market participant
separately requests a spread exemption from the relevant exchange's
limits established pursuant to proposed Sec. 150.5(a).
---------------------------------------------------------------------------
\929\ See supra Section II.A.20. (proposed definition of
``spread transaction'' in Sec. 150.1, which would cover: Intra-
market, inter-market, intra-commodity, or inter-commodity spreads,
including calendar spreads, quality differential spreads, processing
spreads (such as energy ``crack'' or soybean ``crush'' spreads),
product or by-product differential spreads, and futures-options
spreads.)
---------------------------------------------------------------------------
Under proposed Sec. 150.3(a)(2)(ii), for a spread strategy that
does not meet the ``spread transaction'' definition in proposed Sec.
150.1, a market participant must apply for a spread exemption directly
from the Commission in accordance with proposed Sec. 150.3(b). The
market participant must also receive a notification of the approved
spread exemption under proposed Sec. 150.3(b)(4) before exceeding the
Federal speculative position limits for that spread position. The
Commission thus did not propose a process akin to Sec. 150.9 for
spreads that do not meet the proposed ``spread transaction''
definition.
ii. Comments--Spread Exemptions
Several commenters advocated for the Commission to expand the
proposed Sec. 150.9 process, which would allow exchanges to process
applications for non-enumerated bona fide hedge exemptions for purposes
of both Federal and exchange limits, to also allow exchanges to grant
``non-enumerated'' spread exemptions for spread positions that do not
meet the ``spread transaction'' definition.\930\ Commenters also
requested that the Commission provide an explanation for why the
Commission would not expand Sec. 150.9 to cover ``non-enumerated''
spread exemptions.\931\ Finally, commenters requested that market
participants be able to apply for spread exemptions on a late or
retroactive basis the same way they would be permitted to apply for
bona fide hedge exemptions within five days of exceeding Federal
position limits under proposed Sec. Sec. 150.3 and 150.9.\932\
---------------------------------------------------------------------------
\930\ See MFA/AIMA at 10; FIA at 21; Citadel at 8-9; ISDA at 9;
ICE at 7-8 (suggesting that if the list of spread positions in the
spread transaction definition is determined to be an exhaustive
list, then the Commission should permit additional flexibility for
an exchange to grant additional spread exemptions--that are not
covered in the spread transaction definition--using the proposed
Sec. 150.9 process).
\931\ See MFA/AIMA at 10.
\932\ See ICE at 8.
---------------------------------------------------------------------------
iii. Discussion of Final Rule--Spread Exemptions
The Commission has determined to adopt Sec. 150.3(a)(2) with non-
substantive revisions to address technical edits or improve
readability. For the reasons discussed immediately below, the
Commission has determined not to expand Sec. 150.3(a)(2) as requested
by commenters to allow market participants to apply to exchanges for
``non-enumerated'' spread exemptions that are not covered in the
``spread transaction'' definition in Sec. 150.1.
First, as discussed above,\933\ the Commission has determined to
expand the ``spread transaction'' definition so that it covers most, if
not all, of the most common spread exemptions used by market
participants. With this expansion, the Commission expects that most
spread exemption requests will fall within the scope of the ``spread
transaction'' definition. Accordingly, the Commission expects that most
spread exemptions will thus be self-effectuating for purposes of
Federal position limits. Also, the Commission expects that any spread
exemption requests falling outside of the ``spread transaction''
definition are likely to be novel exemption requests that the
Commission--and not exchanges--should review, considering certain
statutory considerations in CEA section 4a(a)(3)(B). As explained
immediately below, the Commission cannot authorize exchanges to conduct
this analysis because exchanges would lack clear standards for
assessing whether a particular spread position satisfies the
requirements of the CEA.
---------------------------------------------------------------------------
\933\ See supra Section II.A.20. (discussing changes to expand
the spread transaction definition).
---------------------------------------------------------------------------
Second, bona fide hedge recognitions and spread exemptions are
subject to different legal standards. That is, under CEA section
4a(a)(c)(2), Congress provided clear criteria to the Commission for
determining what constitutes a bona fide hedging transaction or
position. In turn, the Commission has defined in detail the term bona
fide hedging transaction or position in Sec. 150.1. As a result, under
final Sec. 150.9, the Commission is permitting exchanges to evaluate
applications for non-enumerated bona fide hedges for purposes of
exchange-set limits in accordance with the same clear criteria used by
the Commission.
In contrast, the CEA does not include clear criteria for granting
spread exemptions. Instead, CEA section 4a(a)(1) generally permits the
Commission to exempt ``transactions normally known to the trade as
``spreads'' or ``straddles'' or ``arbitrage'' from position limits
\934\ and requires the Commission to administer Federal position limits
in a manner that comports with certain policy considerations in CEA
section 4a(a)(3)(B).\935\ Analyzing novel spread exemption requests in
accordance with these general principles requires the Commission to use
its judgment to conduct a highly fact-specific analysis. And, in the
absence of any detailed statutory or regulatory criteria, the
Commission is not comfortable, at this time, with leveraging an
exchange's analysis and determination with respect to novel spread
exemption requests. As such, the Commission has determined that the
Commission should conduct a direct review of any spread exemptions that
do not meet the ``spread transaction'' definition, and the Commission
thus will not expand Sec. 150.9 to cover spreads because exchanges
would lack clear standards for assessing whether a particular spread
position satisfies the requirements of the CEA. In the future, the
Commission may, however, consider developing regulatory criteria for
spread exemptions such that novel spread exemptions could be considered
through a more streamlined process, such as Sec. 150.9.
---------------------------------------------------------------------------
\934\ 7 U.S.C. 6a(a)(1).
\935\ 7 U.S.C. 6a(a)(3)(b).
---------------------------------------------------------------------------
Finally, unlike for certain bona fide hedge recognitions as
discussed below, the Commission has determined not to permit
retroactive applications for spread exemptions or other exemptions
permitted under this Sec. 150.3(a). The Commission believes that the
Federal position limits framework adopted herein provides sufficient
flexibility through expanded speculative limits, and a clear,
comprehensive set of exemptions, most of which are self-effectuating
and thus do not require prior Commission approval. As such, the
Commission believes that market participants will be able to identify
their exemption needs based on these clear regulatory requirements and
apply for
[[Page 3352]]
all such exemptions ahead of time. In addition, the Commission believes
that allowing retroactive spread exemptions and other types of
retroactive exemptions (such as the financial distress or conditional
natural gas spot month exemption) could potentially be harmful to the
market as these types of strategies may involve non-risk-reducing or
speculative activity that should be evaluated prior to a person
exceeding Federal position limits.
5. Section 150.3(a)(3)--Financial Distress Exemptions
i. Summary of the 2020 NPRM--Financial Distress Exemptions
Proposed Sec. 150.3(a)(3) would allow for a financial distress
exemption in certain situations, including the potential default or
bankruptcy of a customer or a potential acquisition target. For
example, in periods of financial distress, such as a customer default
at an FCM or a potential bankruptcy of a market participant, it may be
beneficial for a financially-sound market participant to take on the
positions and corresponding risk of a less stable market participant,
and in doing so, exceed Federal speculative position limits. Pursuant
to authority delegated under Sec. Sec. 140.97 and 140.99, Commission
staff previously granted exemptions in these types of situations to
avoid sudden liquidations required to comply with a position
limit.\936\ Such sudden liquidations could otherwise potentially hinder
statutory objectives, including by reducing liquidity, disrupting price
discovery, and/or increasing systemic risk.\937\
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\936\ See, e.g., CFTC Press Release No. 5551-08, CFTC Update on
Efforts Underway to Oversee Markets, (Sept. 19, 2008), available at
http://www.cftc.gov/PressRoom/PressReleases/pr5551-08.
\937\ See 7 U.S.C. 6a(a)(3).
---------------------------------------------------------------------------
The proposed exemption would be available for the positions of ``a
person, or related persons,'' meaning that a financial distress
exemption request should be specific to the circumstances of a
particular person, or to persons affiliated with that person, and not a
more general request by a large group of unrelated people whose
financial distress circumstances may differ from one another. The
proposed exemption would be granted on a case-by-case basis in response
to a request submitted to the Commission pursuant to Sec. 140.99, and
would be evaluated based on the specific facts and circumstances of a
particular person or a related person or persons. Any such financial
distress position would not be a bona fide hedging transaction or
position unless it otherwise met the substantive and procedural
requirements set forth in proposed Sec. Sec. 150.1, 150.3, and 150.9,
as applicable.
ii. Comments and Summary of the Commission Determination--Financial
Distress Exemptions
The Commission did not receive any substantive comments on proposed
Sec. 150.3(a)(3), although one commenter expressed general support for
the financial distress exemption.\938\ As such, the Commission has
determined to finalize Sec. 150.3(a)(3) as proposed, for the reasons
discussed above and in the 2020 NPRM.
---------------------------------------------------------------------------
\938\ CCI at 2.
---------------------------------------------------------------------------
6. Section 150.3(a)(4)--Conditional Spot Month Exemption in Natural Gas
i. Summary of the 2020 NPRM--Conditional Spot Month Exemption in
Natural Gas
Certain natural gas contracts are currently subject to exchange-set
position limits, but not Federal position limits.\939\ In the 2020
NPRM, the Commission proposed applying Federal position limits to
certain natural gas contracts for the first time by including the
physically-settled NYMEX Henry Hub Natural Gas (``NYMEX NG'') contract
as a core referenced futures contract listed in proposed Sec.
150.2(d). The Commission also proposed, consistent with existing
exchange practice, establishing a conditional spot month exemption for
Federal position limit purposes that would permit larger positions
during the spot month for cash-settled natural gas referenced contracts
so long as the market participant held no physically-settled NYMEX NG.
---------------------------------------------------------------------------
\939\ Some examples include natural gas contracts that use the
NYMEX NG futures contract as a reference price, such as ICE's Henry
Financial Penultimate Fixed Price Futures (PHH), options on Henry
Penultimate Fixed Price (PHE), Henry Basis Futures (HEN) and Henry
Swing Futures (HHD), NYMEX's E-mini Natural Gas Futures (QG), Henry
Hub Natural Gas Last Day Financial Futures (HH), and Henry Hub
Natural Gas Financial Calendar Spread (3 Month) Option (G3).
---------------------------------------------------------------------------
ii. Summary of the Commission Determination--Conditional Spot Month
Exemption in Natural Gas
For the Final Rule, the Commission is adopting the conditional spot
month exemption in natural gas, as proposed. The Commission discusses
this conditional spot month exemption, as well as other issues in
connection with NYMEX NG, above under the discussion of Sec.
150.2.\940\ The Commission is discussing all the issues related to the
NYMEX NG core referenced futures contract, including this conditional
spot month exemption, together in one place in this release for the
reader's convenience.
---------------------------------------------------------------------------
\940\ See supra Section II.B.3.vi.a. (discussing the Federal
spot-month limit for natural gas).
---------------------------------------------------------------------------
7. Section 150.3(a)(5)--Exemption for Pre-Enactment Swaps and
Transition Period Swaps
i. Background and Summary of the 2020 NPRM--Exemption for Pre-Enactment
Swaps and Transition Period Swaps
Currently, swaps are not subject to the existing Federal position
limits framework, and the Commission is unaware of any exchange-set
limits on swaps with respect to any of the 25 core referenced futures
contracts.
In order to promote a smooth transition to compliance for swaps,
which were not previously subject to Federal speculative position
limits, in the 2020 NPRM, the Commission proposed to exempt pre-
enactment swaps and transition period swaps from Federal position
limits. Proposed Sec. 150.3(a)(5) provided that Federal position
limits would not apply to positions acquired in good faith in any pre-
enactment swaps or in any transition period swaps, in either case as
defined by Sec. 150.1.\941\ Under the 2020 NPRM, any pre-enactment
swap or transition period swap would be exempt from Federal position
limits--even if the swap would qualify as an economically equivalent
swap under the 2020 NPRM. This proposed exemption would be self-
effectuating and would not require a market participant to request
relief from the Commission.
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\941\ ``Pre-enactment swap'' would mean any swap entered into
prior to enactment of the Dodd-Frank Act of 2010 (July 21, 2010),
the terms of which have not expired as of the date of enactment of
that Act.
``Transition period swap'' would mean a swap entered into during
the period commencing after the enactment of the Dodd-Frank Act of
2010 (July 21, 2010), and ending 60 days after the publication in
the Federal Register of final amendments to this part implementing
section 737 of the Dodd-Frank Act of 2010, the terms of which have
not expired as of 60 days after the publication date.
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For purposes of complying with the proposed Federal non-spot month
limits, the 2020 NPRM would also allow both pre-enactment swaps and
transition period swaps (to the extent such swaps qualify as
``economically equivalent swaps'') to be netted with post-Effective
Date commodity derivative contracts. The 2020 NPRM did not permit such
positions to be netted during the spot month so as to avoid rendering
spot month limits ineffective. Specifically, the Commission explained
that it was particularly concerned about protecting the spot month in
physically-delivered futures contracts from price distortions or
manipulation to protect against
[[Page 3353]]
disrupting the hedging and price discovery utility of the futures
contract.
ii. Comments and Summary of the Commission Determination--Exemption for
Pre-Enactment Swaps and Transition Period Swaps
The Commission did not receive any comments specifically addressing
the exemption for pre-enactment swaps and transition period swaps
addressed in proposed Sec. 150.3(a)(5). The Commission is adopting
Sec. 150.3(a)(5) as proposed with certain limited grammatical and
technical changes that are not intended to reflect a change in the
substantive meaning. For comments generally related to the exemption
for pre-enactment swaps and transition period swaps, please refer to
the discussion of pre-existing positions in general and comments
thereto, in Sec. 150.2(g) above,\942\ and Sec. 150.5(a)(3)(ii)
below.\943\
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\942\ See supra Section II.B.7. (discussing Sec. 150.2 Federal
position limits on pre-existing positions).
\943\ See infra Section II.D.3. (discussing Sec. 150.5
requirements for exchange limits on pre-existing positions in a non-
spot month).
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8. Section 150.3(b)--Application for Relief and Removal of Existing
Commission Application Processes
i. Summary of the 2020 NPRM--Application for Relief and Removal of
Existing Commission Application Processes
The Commission proposed two avenues for a market participant to
request a non-enumerated bona fide hedge recognition: Sec. 150.3(b),
described below, which would allow market participants to apply
directly to the Commission; and Sec. 150.9, which, as described in
detail further below, would allow market participants to apply to
exchanges for a non-enumerated bona fide hedge exemption for purposes
of both Federal and exchange limits.\944\ The Commission proposed to
remove its existing processes for applying for such exemptions under
Sec. Sec. 1.47 and 1.48. The Commission also proposed to remove
existing Sec. 140.97, which delegates to the Director of the Division
of Enforcement or his designee authority regarding requests for
classification of positions as bona fide hedges under existing
Sec. Sec. 1.47 and 1.48.\945\
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\944\ See infra Section II.G.
\945\ 17 CFR 140.97.
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In the 2020 NPRM, the Commission explained that it did not intend
the proposed replacement of Sec. Sec. 1.47 and 1.48 to have any
bearing on bona fide hedges previously recognized under those
provisions. With the exception of certain recognitions for risk
management positions discussed below, positions that were previously
recognized as bona fide hedges under Sec. Sec. 1.47 or 1.48 would
continue to be recognized, provided such positions continue to meet the
statutory bona fide hedging definition and all other existing and
proposed requirements.
With respect to a Sec. 150.3(b) application for a bona fide hedge
recognition, the Commission proposed that such application must
include: (i) A description of the position in the commodity derivative
contract for which the application is submitted, including the name of
the underlying commodity and the position size; (ii) information to
demonstrate why the position satisfies CEA section 4a(c)(2) and the
definition of bona fide hedging transaction or position in proposed
Sec. 150.1, including ``factual and legal analysis;'' (iii) a
statement concerning the maximum size of all gross positions in
derivative contracts for which the application is submitted (in order
to provide a view of the true footprint of the position in the market);
(iv) information regarding the applicant's activity in the cash markets
and the swaps markets for the commodity underlying the position for
which the application is submitted; \946\ and (v) any other information
that may help the Commission determine whether the position meets the
requirements of CEA section 4a(c)(2) and the definition of bona fide
hedging transaction or position in Sec. 150.1.\947\
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\946\ The Commission stated that it would expect applicants to
provide cash-market data for at least the prior year.
\947\ For example, the Commission may, in its discretion,
request a description of any positions in other commodity derivative
contracts in the same commodity underlying the commodity derivative
contract for which the application is submitted. Other commodity
derivative contracts could include other futures contracts, option
on futures contracts, and swaps (including OTC swaps) positions held
by the applicant.
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In addition, under the 2020 NPRM, a market participant would be
required to apply to the Commission using the application process in
Sec. 150.3(b) for exemptions for any spread positions that do not meet
the proposed ``spread transaction'' definition. With respect to a Sec.
150.3(b) application for a spread exemption, the Commission proposed
that such application must include: (i) A description of the spread
transaction for which the exemption application is submitted; \948\
(ii) a statement concerning the maximum size of all gross positions in
derivative contracts for which the application is submitted; and (iii)
any other information that may help the Commission determine whether
the position is consistent with CEA section 4a(a)(3)(B).
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\948\ The nature of such description would depend on the facts
and circumstances, and different details may be required depending
on the particular spread.
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Under proposed Sec. 150.3(b)(2), the Commission (or Commission
staff pursuant to delegated authority proposed in Sec. 150.3(g)) could
request additional information from the applicant and would provide the
applicant with ten business days to respond. Under proposed Sec.
150.3(b)(3) and (4), the applicant, however, could not exceed Federal
position limits unless it receives a notice of approval from the
Commission or from Commission staff pursuant to delegated authority
proposed in Sec. 150.3(g)--with one exception. That is, due to
demonstrated sudden or unforeseen increases in a person's bona fide
hedging needs, the person could request a recognition of a bona fide
hedging transaction or position within five business days after the
person established the position that exceeded the Federal speculative
position limit.\949\
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\949\ Where a person requests a bona fide hedge recognition
within five business days after exceeding Federal position limits,
such person would be required to demonstrate that they encountered
sudden or unforeseen circumstances that required them to exceed
Federal position limits before submitting and receiving approval of
their bona fide hedge application. These applications submitted
after a person has exceeded Federal position limits should not be
habitual and would be reviewed closely. If the Commission reviews
such application and finds that the position does not qualify as a
bona fide hedge, then the applicant would be required to bring its
position into compliance within a commercially reasonable time, as
determined by the Commission in consultation with the applicant and
the applicable DCM or SEF. If the applicant brings the position into
compliance within a commercially reasonable time, then the applicant
would not be considered to have violated the position limits rules.
Further, any intentional misstatements to the Commission, including
statements to demonstrate why the bona fide hedging needs were
sudden and unforeseen, would be a violation of sections 6(c)(2) and
9(a)(2) of the Act. 7 U.S.C. 9(2) and 13(a)(2).
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Under this proposed process, market participants would be
encouraged to submit their requests for bona fide hedge recognitions
and spread exemptions as early as possible since proposed Sec.
150.3(b) would not set a specific timeframe within which the Commission
must make a determination for such requests. Further, under the 2020
NPRM, all approved bona fide hedge recognitions and spread exemptions
would need to be renewed if there are any changes to the information
submitted as part of the request, or upon request by the Commission or
Commission staff.\950\
[[Page 3354]]
Finally, under proposed Sec. 150.3(b)(6), the Commission (and not
staff) could revoke or modify any bona fide hedge recognition or spread
exemption at any time if the Commission determines that the bona fide
hedge recognition or spread exemption, or portions thereof, are no
longer consistent with the applicable statutory and regulatory
requirements.\951\
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\950\ See proposed Sec. 150.3(b)(5). Currently, the Commission
does not require automatic updates to bona fide hedge applications,
and does not require applications or updates thereto for spread
exemptions, which are self-effectuating. Consistent with current
practices, under proposed Sec. 150.3(b)(5), the Commission would
not require automatic annual updates to bona fide hedge and spread
exemption applications; rather, updated applications would only be
required if there are changes to information the requestor initially
submitted or upon Commission request. This approach is different
than the proposed streamlined process in Sec. 150.9, which would
require automatic annual updates to such applications, which is more
consistent with current exchange practices. See, e.g., CME Rule 559.
\951\ This proposed authority to revoke or modify a bona fide
hedge recognition or spread exemption would not be delegated to
Commission staff.
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In the 2020 NPRM, the Commission noted that it anticipates that
most market participants would utilize the streamlined process set
forth in proposed Sec. 150.9 rather than the process proposed in Sec.
150.3(b) because: Exchanges would generally be able to make an initial
determination more efficiently than Commission staff; and market
participants are likely already familiar with the proposed processes
set forth in Sec. 150.9 (which are intended to leverage the processes
currently used by exchanges to address requests for exemptions from
exchange-set limits). Nevertheless, proposed Sec. 150.3(a)(1) and (2)
clarify that market participants could request non-enumerated bona fide
hedge recognitions and spread exemptions that do not meet the ``spread
transaction'' definition directly from the Commission. After receiving
any approval of a bona fide hedge recognition or spread exemption from
the Commission under proposed Sec. 150.3(b), the market participant
would still be required to request a bona fide hedge recognition or
spread exemption from the relevant exchange for purposes of exchange-
set limits established pursuant to proposed Sec. 150.5(a).
ii. Comments--Application for Relief and Removal of Existing Commission
Application Processes
The Commission received one comment on proposed Sec. 150.3(b)
requesting that the Commission remove the requirement proposed in Sec.
150.3(b)(1)(i)(B) that an applicant provide a ``factual and legal
analysis'' as part of an exemption application for a non-enumerated
bona fide hedge.\952\
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\952\ CME Group at 10.
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iii. Discussion of Final Rule--Application for Relief and Removal of
Existing Commission Application Processes
The Commission has determined to finalize its proposal to remove
existing Sec. Sec. 1.47, 1.48, and 140.97.\953\ The Commission has
also determined to finalize Sec. 150.3(b) largely as proposed but with
the following modifications in response to commenters and other
considerations.
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\953\ Although Sec. Sec. 1.47 and 1.48 are currently reflected
in the Code of Federal Regulations (``CFR'') as ``[Reserved]'',
Sec. Sec. 1.47 and 1.48 that existed prior to the 2011 Final
Rulemaking are currently in effect. The 2011 Final Rulemaking
removed and reserved Sec. Sec. 1.47 and 1.48. However, the U.S.
District Court for the District of Columbia in ISDA subsequently
vacated the 2011 Final Rulemaking on September 28, 2012. As a
result, Sec. Sec. 1.47 and 1.48 that existed prior to the 2011
Final Rulemaking went back into effect, though they were not
recodified in the CFR. This Final Rule removes Sec. Sec. 1.47 and
1.48 as they are currently in effect (i.e., as they existed prior to
the 2011 Final Rulemaking) and leaves those two sections reserved in
the CFR. As this action does not result in a change to the currently
codified CFR, there is no corresponding amendment in the regulatory
text of this document.
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Generally, the information required to be submitted as part of the
Sec. 150.3(b) application is necessary to allow the Commission to
evaluate whether the applicant's position satisfies the requirements in
Sec. 150.3(b)(1), as applicable. The Commission has determined to
modify the requirement, as it appears in both Sec. 150.3(b) and Sec.
150.9(c), that an applicant provide a ``factual and legal analysis'' as
part of its non-enumerated bona fide hedge exemption application. As
explained further below, in proposing this requirement, the Commission
did not intend to require that applicants engage legal counsel to
complete their applications for non-enumerated bona fide hedge
recognitions. Rather, the purpose of this proposed requirement was to
ensure that applicants explain their hedging strategies and provide
sufficient information to demonstrate why a particular position
satisfies the bona fide hedge definition in proposed Sec. 150.1 and
CEA section 4a(c)(2).\954\ Accordingly, the Commission has revised
Sec. 150.3(b)(1)(i)(B) to replace the requirement to provide ``factual
and legal'' analysis with the requirement that an applicant provide:
(1) An explanation of the hedging strategy, including a statement that
the applicant's position complies with the applicable requirements of
the bona fide hedge definition, and (2) information that demonstrates
why the position satisfies the applicable requirements.
---------------------------------------------------------------------------
\954\ See supra Section II.G.5. (providing a more detailed
discussion of this requirement as it appears in Sec. 150.9(c)).
---------------------------------------------------------------------------
The Commission is also making several other clarifications to Sec.
150.3(b). First, in Sec. 150.3(b)(3)(ii)(C), the Commission proposed
that, for a retroactive application submitted to the Commission after a
person has already exceeded Federal position limits, the Commission
would not hold an applicant accountable for a position limits violation
during the period of the Commission's review, nor once the Commission
has issued its determination. The Commission is revising this provision
to clarify that the Commission ``will not pursue an enforcement
action'' in these circumstances. The Commission is also revising this
provision to clarify that the provision applies so long as the
applicant submitted its application in good faith and, if required, the
applicant brings its position below the Federal position limits. This
revision is simply intended to make explicit an implicit presumption
that the applicant should have a reasonable and good faith basis for
determining that its position meets the requirements of Sec. 150.3(b)
and for submitting the retroactive application. This requirement is
also intended to deter the filing of frivolous retroactive exemption
applications. Finally, the Commission is making a few technical
revisions to clarify that this section is referring to the retroactive
application provisions in Sec. 150.3(b)(3)(ii), and to correct a
cross-reference in this paragraph to correctly reference paragraph
Sec. 150.3(b)(3)(ii)(B).
In addition, the Commission is modifying proposed Sec. 150.3(b)(5)
to clarify that an applicant who received its original approval of a
recognition of a non-enumerated bona fide hedge or spread exemption
through the Commission's Sec. 150.3(b) process is required to submit a
renewal application if there are any ``material'' changes to the
original application, but is not required to submit a renewal
application as a result of circumstances involving any minor or non-
substantive changes to the information underlying the original
application. If a market participant using the Sec. 150.3(b) process
has any questions regarding what qualifies as a material change to the
original application, the Commission encourages the market participant
to contact DMO staff for guidance on a case-by-case basis.
Next, the Commission is revising its revocation authority under
Sec. 150.3(b)(6) to expressly require that the Commission provide a
person with an opportunity to respond after the Commission notifies
such person that
[[Page 3355]]
the Commission believes their transactions or positions no longer
satisfy the bona fide hedge definition or spread exemption
requirements, as applicable. The Commission is also revising Sec.
150.3(b)(6) to clarify that the Commission will discuss with the
applicant and consult with the relevant exchange when determining what
is a commercially reasonable amount of time for the applicant to bring
its position below the Federal position limits. The Commission also
reorganized this section to improve readability.
Finally, the Commission made several grammatical and technical
changes to Sec. 150.3(b) that are not intended to change the substance
of the remaining sections, unless discussed above.
9. Section 150.3(c)--Previously-Granted Risk Management Exemptions
i. Summary of the 2020 NPRM--Previously-Granted Risk Management
Exemptions
As discussed above, the Commission previously recognized, as bona
fide hedges under Sec. 1.47, certain risk-management positions in
physical commodity futures and/or option on futures contracts held
outside of the spot month that were used to offset the risk of
commodity index swaps and other related exposures, but that did not
represent substitutes for transactions or positions to be taken in a
physical marketing channel.\955\ However, the 2020 NPRM interpreted the
Dodd-Frank Act amendments to the CEA as eliminating the Commission's
authority to grant such relief unless the position satisfies the pass-
through provision in CEA section 4a(c)(2)(B).\956\ Accordingly, to
ensure consistency with the Dodd-Frank Act, the Commission proposed
that it would not recognize further risk management positions as bona
fide hedges, unless the position otherwise satisfies the requirements
of the pass-through provisions.\957\
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\955\ See supra Section II.A.1.iii. (discussing the temporary
substitute test and risk management exemption under Sec. 150.1).
\956\ Id.
\957\ 85 FR at 11641.
---------------------------------------------------------------------------
In addition, the Commission proposed in Sec. 150.3(c) that such
previously-granted exemptions shall not apply after the effective date
of a final Federal position limits rulemaking implementing the Dodd-
Frank Act. Proposed Sec. 150.3(c) used the phrase ``positions in
financial instruments'' to refer to such commodity index swaps and
related exposure, and would have the effect of revoking the ability to
use previously-granted risk management exemptions once the limits
proposed in Sec. 150.2 go into effect.
ii. Comments and Discussion of Final Rule--Previously-Granted Risk
Management Exemptions
The Commission has addressed any comments on risk management
exemptions in the discussion of Sec. 150.1 above.\958\ As discussed
above, to ensure consistency with the Dodd-Frank Act, the Commission
will not recognize risk management positions as bona fide hedges under
the Final Rule, unless the position otherwise satisfies the
requirements of the Final Rule's pass-through swap provisions.\959\
Consequently, the Commission is adopting Sec. 150.3(c) largely as
proposed, which provides that such previously-granted risk management
exemptions issued pursuant to Sec. 1.47 shall no longer be
recognized.\960\ However, the Final Rule is also providing for a
compliance date of January 1, 2023 with respect to the elimination of
the risk management exemption by which risk management exemption
holders must reduce their risk management exemption positions to comply
with Federal position limits under the Final Rule.\961\
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\958\ See supra Section II.A.1.iii (discussing risk management
exemptions and comments received in greater detail).
\959\ See supra Section II.A.1.x. (discussing the proposed pass-
through swap provisions).
\960\ Under this Final Rule, however, exchanges may continue to
grant risk management exemptions (that do not otherwise meet the
bona fide hedge definition in Sec. 150.1) up to the applicable
Federal position limit.
\961\ See supra Section I.D. (discussing the effective and
compliance dates).
---------------------------------------------------------------------------
Section 150.3(c) uses the phrase ``positions in financial
instruments'' to refer to such commodity index swaps and related
exposure and would have the effect of revoking the ability to use
previously-granted risk management exemptions once the Final Rule's
Federal position limits in Sec. 150.2 become effective. However, the
Final Rule will also include an extended compliance date until January
1, 2023 with respect to positions entered into upon reliance of an
existing risk management exemption.\962\
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\962\ Id.
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The Final Rule also deletes the sentence in proposed Sec.
150.3(c), which stated that nothing in Sec. 150.3(c) shall preclude
the Commission, a DCM, or SEF from recognizing a bona fide hedging
transaction or position for the former holder of such a risk management
exemption if the position complies with the definition of bona fide
hedging transaction or position under this part, including appendices
hereto. This sentence was intended to clarify what has been explained
above--risk management exemptions that meet the pass-through swap
provisions are permitted under the Final Rule.\963\ The Commission has
determined that this sentence is unnecessary.
---------------------------------------------------------------------------
\963\ See supra Section II.A.1.x. (discussing the proposed pass-
through language).
---------------------------------------------------------------------------
The Commission is making several technical changes to proposed
Sec. 150.3(c), including to clarify that the provision covers risk
management exemptions previously granted by the Commission or by
Commission staff. The Commission also reorganized Sec. 150.3(c) to
improve readability.
10. Section 150.3(d)--Recordkeeping
i. Summary of the 2020 NPRM--Recordkeeping
Proposed Sec. 150.3(d) would establish recordkeeping requirements
for persons who claim any exemption under proposed Sec. 150.3.
Proposed Sec. 150.3(d) is intended to help ensure that any person who
claims any exemption permitted under proposed Sec. 150.3 could
demonstrate compliance with the applicable requirements by providing
all relevant records to support the claim of a particular exemption.
That is, under proposed Sec. 150.3(d)(1), any persons claiming an
exemption would be required to keep and maintain complete books and
records concerning all details of their related cash, forward, futures,
options on futures, and swap positions and transactions, including
anticipated requirements, production and royalties, contracts for
services, cash commodity products and by-products, cross-commodity
hedges, and records of bona fide hedging swap counterparties.
Proposed Sec. 150.3(d)(2) would address recordkeeping requirements
related to the pass-through swap provision in the proposed definition
of bona fide hedging transaction or position in proposed Sec.
150.1.\964\ Under proposed Sec. 150.3(d)(2), a pass-through swap
counterparty, as contemplated by proposed Sec. 150.1, that relies on a
representation received from a bona fide hedging swap counterparty that
a swap qualifies in good faith as a bona fide hedging position or
transaction under proposed Sec. 150.1, would be required to: (i)
Maintain any written representation for at least two years following
the expiration of the swap; and (ii) furnish the representation to the
Commission upon request.
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\964\ See supra Section II.A.1.x. (discussion of proposed pass-
through swap provision).
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ii. Comments--Recordkeeping
Several commenters requested clarification that the recordkeeping
[[Page 3356]]
requirements in proposed Sec. 150.3(d)(1) would not impose an
additional recordkeeping obligation on commercial end-users beyond the
records that are kept in the normal course of business and are typical
for the relevant industry.\965\
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\965\ Cope at 5-6; EEI/EPSA at 7-8.
---------------------------------------------------------------------------
In addition, commenters recommended that the Commission delete the
pass-through swap recordkeeping requirements in proposed Sec.
150.3(d)(2).\966\ Commenters were concerned that the pass-through swap
provision in Sec. 150.1 places all compliance burdens on the pass-
through swap counterparty offering the swap, and not on the bona fide
hedging counterparty using the swap.\967\ Commenters expressed that
this recordkeeping provision would require the pass-through swap
counterparty to maintain records of each representation made by the
bona fide hedging counterparty on a trade-by-trade basis--a practice
commenters view as onerous and unnecessary.\968\ Commenters suggested
that the Commission will have access to records from anyone availing
themselves of any exemption from speculative limits, and thus does not
need the additional recordkeeping requirement in proposed Sec.
150.3(d)(2).\969\ One commenter also requested that the Commission
clarify that the pass-through swap counterparty can rely on the bona
fide hedging counterparty's good faith representation that a record of
an agreement or confirmation of the transaction containing the bona
fide hedge pass-through representation would satisfy the record
retention requirements set forth in proposed Sec. 150.3(d)(2).\970\
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\966\ Cargill at 6; Shell at 6.
\967\ Id.
\968\ Shell at 7; CMC at 5.
\969\ COPE at 5-6.
\970\ Shell at 6.
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iii. Discussion of Final Rule--Recordkeeping
The Commission has determined to finalize Sec. 150.3(d), for the
reasons stated in the 2020 NPRM, with certain clarifications discussed
below.
First, the Commission clarifies that the recordkeeping requirements
in Sec. 150.3(d)(1) are not intended to impose any additional
recordkeeping obligations on market participants beyond the records
they are required to keep in the normal course of business. The
Commission notes, however, that, consistent with the general
recordkeeping obligations in Commission regulation 1.31, and as
explained in the 2020 NPRM, Sec. 150.3(d)(1) is intended to capture
records market participants should be maintaining with respect to each
of their exemptions from Federal position limits. The Commission is
revising Sec. 150.3(d)(1) to clarify that market participants that
avail themselves of exemptions under this section are required to keep
the relevant ``books and records'' of ``each of their exemptions'' and
any related position or transaction information for such applications,
including any books and records market participants create for related
``merchandising activity'' or other relevant aspects of a particular
exemption (including the items listed in Sec. 150.3(d)(1)), as
applicable.
Next, regarding the pass-through swap recordkeeping requirements,
in Sec. 150.2(d)(2), the Commission intended for this requirement to
be an extension of market participants' existing obligations to
maintain swap data records under Part 45 and regulatory records under
Sec. 1.31.\971\ That is, under Sec. 150.1, the Commission has revised
paragraph (2) of the bona fide hedging transaction or position
definition to require that a pass-through swap counterparty receive a
written representation from its bona fide hedging swap counterparty
that the swap ``qualifies as a bona fide hedging transaction or
position'' pursuant to paragraph (1) of the definition of a bona fide
hedging transaction or position in Sec. 150.1 in order for the pass-
through swap to qualify as a bona fide hedge. The pass-through swap
counterparty may rely in good faith on such written representation from
the bona fide hedging swap counterparty, unless the pass-through swap
counterparty has information that would cause a reasonable person to
question the accuracy of the representation. Thus, the recordkeeping
requirements in Sec. 150.3(d)(2) are intended to capture any
``written'' record created for purposes of making such demonstration.
The Commission provides additional explanation above on how a pass-
through swap counterparty can demonstrate good faith reliance.\972\ For
the avoidance of doubt, the Commission is revising Sec. 150.3(d)(2) to
clarify that a person relying on the pass-through swap provision is
required to maintain any records created for purposes of demonstrating
a good faith reliance on that provision in accordance with Sec. 150.1.
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\971\ 17 CFR 1.31(a)-(b).
\972\ See supra Section II.A.1.x. (discussing the pass-through
swap provision in greater detail).
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The Commission also clarifies that, pursuant to the swap
recordkeeping requirements in Sec. 45.2(b) \973\ and the general
recordkeeping requirements in Sec. 1.31,\974\ the bona fide hedging
swap counterparty to the pass-through swap is required to maintain a
record of such pass-through swap. The Commission considers any written
representation the bona fide hedging swap counterparty provides to the
pass-through swap counterparty as being part of the full, complete, and
systematic records that the bona fide hedging swap counterparty is
required to keep pursuant to Sec. 45.2(b), with respect to each pass-
through swap to which it is a counterparty. The bona fide hedging swap
counterparty is required to keep such records according to the form and
duration requirements of Sec. 1.31. Such records are also subject to
the inspection and production requirements of both Sec. 1.31(d) \975\
and Sec. 45.2(h).\976\ As such, the Commission reminds bona fide
hedging swap counterparties to a pass-through swap that they are
responsible for maintaining an accurate and true record of any written
representations they make to the pass-through swap counterparty
regarding the bona fides of the pass-through swap. Further, any such
records and written representations that a bona fide hedging swap
counterparty makes may, upon request, be filed with the Commission as
part of an inspection, pursuant to Sec. Sec. 1.31(d) and 45.2(h), and
would be subject to the Commission's prohibition regarding false
statements in section 6(c)(2) of the Act, as well as any other
applicable provisions regarding false information.\977\
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\973\ 17 CFR 45.2(b) (requiring that all non-swap dealer/non-
major swap participant counterparties keep full, complete, and
systematic records, together with all pertinent data and memoranda,
with respect to each swap in which they are a counterparty).
\974\ 17 CFR 1.31 (regulatory records, retention, and production
requirements).
\975\ 17 CFR 1.31(d) (requirement for a records entity, as
defined in Sec. 1.31(a), to produce or make accessible for
inspection all regulatory records).
\976\ 17 CFR 45.2(h) (swap record inspection requirements).
\977\ 7 U.S.C. 9(2) (prohibition on making a false or misleading
statement of material fact to the Commission); see also 7 U.S.C.
9(4) (general enforcement authority of the Commission).
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11. Section 150.3(e)--Call for Information
i. Summary of the 2020 NPRM--Call for Information
The Commission proposed to move existing Sec. 150.3(b), which
currently allows the Commission or certain Commission staff to make
calls to demand certain information regarding positions or trading, to
proposed
[[Page 3357]]
Sec. 150.3(e), with some technical modifications.
Together with the recordkeeping provision of proposed Sec.
150.3(d), proposed Sec. 150.3(e) should enable the Commission to
monitor the use of exemptions from speculative position limits and help
to ensure that any person who claims any exemption permitted by
proposed Sec. 150.3 can demonstrate compliance with the applicable
requirements.
ii. Comments and Summary of Commission Determination--Call for
Information
The Commission did not receive comments on proposed Sec. 150.3(e).
Accordingly, the Commission is adopting Sec. 150.3(e) with one
grammatical edit that is not intended to reflect a substantive change
to this section.
12. Section 150.3(f)--Aggregation of Accounts
i. Summary of the 2020 NPRM--Aggregation of Accounts
Proposed Sec. 150.3(f) would clarify that entities required to
aggregate under Sec. 150.4 would be considered the same person for
purposes of determining whether they are eligible for a bona fide hedge
recognition under Sec. 150.3(a)(1).\978\
---------------------------------------------------------------------------
\978\ See 17 CFR 150.4 (providing the Commission's existing
aggregation requirements for Federal position limits); See also
supra Section II.B.11. (discussing eligible affiliates and position
aggregation requirements).
---------------------------------------------------------------------------
ii. Comments and Summary of Commission Determination--Aggregation of
Accounts
The Commission did not receive comments on proposed Sec. 150.3(f).
Accordingly, the Commission is adopting Sec. 150.3(f) as
proposed.\979\
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\979\ The Commission did receive general comments on position
aggregation discussing existing no-action relief in connection with
the position aggregation requirement in existing Sec. 150.4. For a
discussion on comments received in connection with existing staff
no-action relief for position aggregation requirements, see supra
Section II.B.11.
---------------------------------------------------------------------------
13. Section Sec. 150.3(g)--Delegation of Authority
i. Summary of the 2020 NPRM--Delegation of Authority
Proposed Sec. 150.3(g) would delegate authority to the Director of
the Division of Market Oversight to: Grant financial distress
exemptions pursuant to proposed Sec. 150.3(a)(3); request additional
information with respect to an exemption request pursuant to proposed
Sec. 150.3(b)(2); determine, in consultation with the exchange and
applicant, a commercially reasonable amount of time for a person to
bring its positions within the Federal position limits pursuant to
proposed Sec. 150.3(b)(3)(ii)(B); make a determination whether to
recognize a position as a bona fide hedging transaction or to grant a
spread exemption pursuant to proposed Sec. 150.3(b)(4); and to request
that a person submit additional application information or updated
materials or renew their request pursuant to proposed Sec. 150.3(b)(2)
or (5). This proposed delegation would enable the Division of Market
Oversight to act quickly in the event of financial distress and in the
other circumstances described above.
ii. Comments and Summary of the Commission Determination--Delegation of
Authority
The Commission did not receive comments on proposed 150.3(g).
Accordingly, the Commission is adopting Sec. 150.3(g) with one
technical edit to correct a punctuation error, which is not intended to
reflect a change in the substance of this section.
14. Request for a New Exemption in Sec. 150.3(a) for Certain Energy
Utility Entities
i. Summary of the 2020 NPRM and Comments--New Exemption for Certain
Energy Utility Entities
Although the 2020 NPRM did not include a new exemption explicitly
applicable to certain energy utility entities, it did include a request
for comment regarding the possibility of such an exemption.\980\ In
response, NRECA (which encompasses several not-for-profit energy
associations) \981\ along with other commenters,\982\ requested that
the Commission use its authority in CEA section 4a(a)(7) to exempt
certain not-for-profit electric and natural gas utility entities (``NFP
Energy Entities'') from position limits.
---------------------------------------------------------------------------
\980\ See 85 FR at 11642.
\981\ NRECA at 3-14.
\982\ See IECA at 5; LIPA at 1; NFPEA at 6.
---------------------------------------------------------------------------
These commenters (in particular, NRECA) argued that Congress did
not intend for the Commission's position limits regime to apply to
commercial market participants engaged in hedging and mitigating
commercial risk, such as the NFP Energy Entities.\983\ The commenters
also provided several reasons why the Commission's position limits
regulatory regime is incongruous with the operations of NFP Energy
Entities, including that NFP Energy Entities: (a) Operate on a not-for-
profit basis; (b) have unique public service obligations to provide
reliable, affordable utility services to residential, commercial, and
industrial customers; (c) have governance structures with oversight by
elected or appointed government officials or cooperative members/
consumers; (d) do not engage in speculative trading in derivatives
markets; and (e) enter into energy commodity swaps and trade options
only to hedge or mitigate commercial risk arising from ongoing business
operations.\984\ NRECA expressed concern that the effort required for
NFP Energy Entities to analyze and identify every transaction as non-
speculative would be purely academic and would unnecessarily increase
the cost of electricity, natural gas and other fuels for generation for
American consumers and businesses served by the NFP Energy
Entities.\985\
---------------------------------------------------------------------------
\983\ NRECA at 19.
\984\ Id.
\985\ Id.
---------------------------------------------------------------------------
ii. Discussion of the Commission Determination--New Exemption for
Certain Energy Utility Entities
The Commission has considered these comments and believes that many
of the concerns raised by NFP Energy Entities are addressed through the
Final Rule's pass-through swap provision and the expanded list of
enumerated bona fide hedge exemptions. That is, the Commission believes
that most, if not all, of the hedging needs of NFP Energy Entities will
be considered enumerated, self-effectuating bona fide hedges that will
not be subject to Federal position limits. Further, NFP Energy Entity
counterparties that are not bona fide hedgers would receive pass-
through bona fide hedging treatment for any swaps with NFP Energy
Entities, or any offsetting positions as a result of such swaps with
NFP Energy Entities. This expanded flexibility should significantly
alleviate the compliance burdens and cost concerns voiced by NFP Energy
Entities.
The Commission recommends that NFP Energy Entities assess the
impact of the Final Rule on their operations, and if needed, pursue the
requested exemption separate from this Final Rule. The Commission also
believes that the extended compliance date for the Final Rule of
January 1, 2022 in connection with the Federal position limits for the
16 non-legacy core referenced futures contracts, and the further
extended compliance date of January 1, 2023 for swaps that are subject
to Federal position limits under the Final Rule, should give commenters
and the Commission sufficient time to
[[Page 3358]]
continue to discuss this request if necessary.
D. Sec. 150.5--Exchange-Set Position Limits and Exemptions Therefrom
For the avoidance of confusion, this discussion of Sec. 150.5
addresses exchange-set limits and exemptions therefrom, not Federal
position limits. For a discussion of the proposed processes by which an
exemption may be recognized for purposes of Federal position limits,
please see the discussion of proposed Sec. 150.3 above and Sec. 150.9
below.\986\
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\986\ See supra Section II.C. (discussing Sec. 150.3 exemptions
from Federal position limits). See also infra Section II.G.
(discussing the Sec. 150.9 streamlined process for recognizing non-
enumerated bona fide hedges for purposes of both exchange and
Federal position limits).
---------------------------------------------------------------------------
1. Background--Existing Requirements for Exchange-Set Position Limits
i. Applicable DCM and SEF Core Principles
Under DCM Core Principle 5, a DCM shall adopt for each contract, as
is necessary and appropriate, position limitations or position
accountability for speculators. In addition, for any contract that is
listed on a DCM and subject to a Federal position limit, the DCM must
establish exchange-set limits for such contract no higher than the
Federal limit level.\987\ Finally, DCMs are required to monitor their
markets and enforce compliance with their rules.\988\
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\987\ See 7 U.S.C. 7(d)(5).
\988\ See 7 U.S.C. 7(d)(2).
---------------------------------------------------------------------------
Similarly, under SEF Core Principle 6, a SEF that is a trading
facility must adopt for each contract, as is necessary and appropriate,
position limitations or position accountability for speculators.\989\
Such SEF must also, for any contract that is listed on the SEF and
subject to a Federal position limit, establish exchange-set limits for
such contract no higher than the Federal limit.\990\ Finally, such SEF
must monitor positions established on or through the SEF for compliance
with the limit set by the Commission and the limit, if any, set by the
SEF.\991\ Beyond these and other statutory and certain specified
Commission requirements, unless otherwise determined by the Commission,
DCM Core Principle 1 and SEF Core Principle 1 afford DCMs and SEFs,
respectively, ``reasonable discretion'' in establishing the manner in
which they comply with the core principles.\992\
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\989\ See 7 U.S.C. 7b-3(f)(6).
\990\ Id.
\991\ Id.
\992\ See 7 U.S.C. 7(d)(1) and 7 U.S.C. 7b-3(f)(1).
---------------------------------------------------------------------------
The current regulatory provisions governing exchange-set position
limits and exemptions therefrom appear in Sec. 150.5.\993\ To align
Sec. 150.5 with statutory changes made by the Dodd-Frank Act,\994\ and
with other changes in the 2020 NPRM,\995\ the Commission proposed a new
version of Sec. 150.5. This new proposed Sec. 150.5 would generally
afford exchanges the discretion to decide how best to set limit levels
and grant exemptions from such limits in a manner that best reflects
their specific markets.
---------------------------------------------------------------------------
\993\ 17 CFR 150.5.
\994\ While existing Sec. 150.5 on its face only applies to
contracts that are not subject to Federal position limits, DCM Core
Principle 5, as amended by the Dodd-Frank Act, and SEF Core
Principle 6, establish requirements both for contracts that are, and
are not, subject to Federal position limits. 7 U.S.C. 7(d)(5) and 7
U.S.C. 7b-3(f)(6).
\995\ Significant changes discussed herein include the process
set forth in proposed Sec. 150.9 and revisions to the bona fide
hedging definition proposed in Sec. 150.1.
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ii. Existing Sec. 150.5
As noted above, existing Sec. 150.5 pre-dates the Dodd-Frank Act
and addresses the establishment of DCM-set position limits for all
contracts not subject to Federal position limits under existing Sec.
150.2 (aside from certain major foreign currencies).\996\ First,
existing Sec. 150.5(a) authorizes DCMs to set different limits for
different contracts and contract months, and permits DCMs to grant
exemptions from DCM-set limits for spreads, straddles, or arbitrage
trades. Existing Sec. 150.5(b) provides a limited set of methodologies
for DCMs to use in establishing initial limit levels, including
separate maximum spot-month limit levels for physical-delivery
contracts and cash-settled contracts,\997\ as well as separate non-spot
month limits for tangible commodities (other than energy),\998\ and for
energy products and non-tangible commodities, including
financials.\999\ Existing Sec. 150.5(c) provides guidelines for how
DCMs may adjust their speculative initial levels.
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\996\ Existing Sec. 150.5(a) states that the requirement to set
position limits shall not apply to futures or option contract
markets on major foreign currencies, for which there is no legal
impediment to delivery and for which there exists a highly liquid
cash market. 17 CFR 150.5(a).
\997\ See 17 CFR 150.5(b)(1) (providing that, for physical
delivery contracts, the spot month limit level must be no greater
than one-quarter of the estimated spot month deliverable supply,
calculated separately for each month to be listed, and for cash
settled contracts, the spot month limit level must be no greater
than necessary to minimize the potential for manipulation or
distortion of the contract's or the underlying commodity's price).
\998\ See 17 CFR 150.5(b)(2) (providing that individual non-spot
or all-months-combined levels must be no greater than 1,000
contracts for tangible commodities other than energy products).
\999\ See 17 CFR 150.5(b)(3) (providing that individual non-spot
or all-months-combined levels must be no greater than 5,000
contracts for energy products and nontangible commodities, including
contracts on financial products).
---------------------------------------------------------------------------
Next, existing Sec. 150.5(d) addresses bona fide hedging
exemptions from DCM-set limits, including an exemption application
process, providing that exchange-set speculative position limits shall
not apply to bona fide hedging positions as defined by a DCM in
accordance with the definition of bona fide hedging transactions and
positions for excluded commodities in Sec. 1.3. Existing Sec.
150.5(d) also addresses factors for DCMs to consider in recognizing
bona fide hedging exemptions (or position accountability), including
whether such positions ``are not in accord with sound commercial
practices or exceed an amount which may be established and liquidated
in an orderly fashion.'' \1000\
---------------------------------------------------------------------------
\1000\ See 17 CFR 150.5(d)(1).
---------------------------------------------------------------------------
As an alternative to exchange-set position limits set in accordance
with the provisions described above, existing Sec. 150.5(e) permits a
DCM, in certain circumstances, to submit for Commission approval a rule
requiring traders ``to be accountable for large positions'' (or
position accountability levels). That is, under certain circumstances,
the DCM would require traders to, upon request, provide information
about their position to the exchange, and/or consent to halt further
increasing a position if so ordered by the exchange.\1001\ Among other
things, this provision includes open interest and volume-based
parameters for determining when DCMs may do so.\1002\
---------------------------------------------------------------------------
\1001\ 17 CFR 150.5(e).
\1002\ 17 CFR 150.5(e)(1)-(4).
---------------------------------------------------------------------------
In addition, existing Sec. 150.5(f) provides that DCM speculative
position limits adopted pursuant to Sec. 150.5 shall not apply to
certain positions acquired in good faith prior to the effective date of
such limits or to a person that is registered as an FCM or as a floor
broker under the CEA except to the extent that transactions made by
such person are made on behalf of, or for the account or benefit of,
such person.\1003\ This provision also provides that in addition to the
express exemptions specified in Sec. 150.5, a DCM may propose such
other exemptions from the requirements of Sec. 150.5 as are consistent
with the purposes of Sec. 150.5, and submit such rules for Commission
review.\1004\ Finally, existing Sec. 150.5(g) addresses aggregation of
positions for which a person directly or indirectly controls trading.
---------------------------------------------------------------------------
\1003\ 17 CFR 150.5(f).
\1004\ Id.
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[[Page 3359]]
2. Overview of the 2020 NPRM, Commenters' Views, and Commission Final
Rule Determination--Exchange-Set Position Limits and Exemptions
Therefrom
This section provides a brief overview of proposed Sec. 150.5,
commenters' general views, and the Commission's determination. The
Commission will summarize and address each sub-section of Sec. 150.5
in greater detail further below.
Pursuant to CEA sections 5(d)(1) and 5h(f)(1), the Commission
proposed a new version of Sec. 150.5.\1005\ Proposed Sec. 150.5 is
intended to allow DCMs and SEFs to set limit levels and grant
exemptions in a manner that best accommodates activity particular to
their markets, while promoting compliance with DCM Core Principle 5 and
SEF Core Principle 6. Proposed Sec. 150.5 is also intended to ensure
consistency with other changes proposed herein, including the process
for exchanges to administer applications for non-enumerated bona fide
hedge exemptions for purposes of Federal position limits proposed in
Sec. 150.9.\1006\
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\1005\ While proposed Sec. 150.5 included references to swaps
and SEFs, the proposed rule would initially only apply to DCMs, as
requirements relating to exchange-set limits on swaps would be
phased in at a later time.
\1006\ To avoid confusion created by the parallel Federal and
exchange-set position limit frameworks, the Commission clarifies
that proposed Sec. 150.5 deals solely with exchange-set position
limits and exemptions therefrom, whereas proposed Sec. 150.9 deals
solely with a streamlined process for the Commission to recognize
non-enumerated bona fide hedges for purposes of Federal position
limits by leveraging exchanges.
---------------------------------------------------------------------------
Proposed Sec. 150.5 contains two main sub-sections, with each sub-
section addressing a different category of contract: (i) Sec. 150.5(a)
proposed rules governing exchange-set limits for referenced contracts
subject to Federal position limits; and (ii) Sec. 150.5(b) proposed
rules governing exchange-set limits for physical commodity derivative
contracts that are not subject to Federal position limits.
Notably, with respect to exchange-set limits on swaps, the
Commission proposed to delay compliance with DCM Core Principle 5 and
SEF Core Principle 6, as compliance would otherwise be impracticable,
and, in some cases, impossible, at this time. In the 2020 NPRM, the
Commission explained that this delay was based largely on the fact that
exchanges cannot view positions in OTC swaps across the various places
they are trading, including on competitor exchanges.
The Commission has determined to finalize Sec. 150.5 largely as
proposed, with certain modifications and clarifications in response to
commenters and other considerations, as discussed below.
The Commission will oversee swaps in connection with compliance
with Federal position limits under the Final Rule. The Commission has
also determined to delay compliance for the requirement for exchanges
to set position limits on swaps at this time. Specifically, with
respect to exchange-set position limits on swaps, the Commission notes
that in two years, the Commission will reevaluate the ability of
exchanges to establish and implement appropriate surveillance
mechanisms with respect to swaps and to implement DCM Core Principle 5
and SEF Core Principle 6, as applicable.
The Commission believes that delayed implementation of exchange-set
position limits on swaps at this time is not inconsistent with the
statutory objectives outlined in section 4a(a)(3) of the CEA for
several reasons. First, as explained above, at this time, it would be
impracticable and, in some cases, impossible for exchanges to comply
with any requirement for establishing exchange-set limits on swaps.
Next, the Commission is adopting in this Final Rule Federal position
limits on economically equivalent swaps, which the Commission will
monitor. These factors, coupled with the Commission's existing ability
to surveil swap exposure across markets in a manner that at this time
would be impracticable for the exchanges, will help ensure that the
Commission meets its statutory obligations. Accordingly, while Sec.
150.5 as finalized herein will apply to DCMs and SEFs, the Final Rule's
requirements associated with exchange oversight of swaps, including
with respect to exchange-set position limits, will be enforced at a
later time. In other words, upon the compliance date, exchanges must
comply with final Sec. 150.5 only with respect to futures and options
on futures traded on DCMs.
3. Section 150.5(a)--Requirements for Exchange-Set Limits on Commodity
Derivative Contracts Subject to Federal Position Limits Set Forth in
Sec. 150.2
The following section discusses the 2020 NPRM, comments received,
and the Commission's final determination with respect to each sub-
section of Sec. 150.5(a), which addresses exchange-set position limits
on contracts that are subject to Federal position limits.
i. Section Sec. 150.5(a)(1)--Requirements for Exchange-Set Limits on
Contracts Subject to Federal Position Limits
a. Summary of the 2020 NPRM--Requirements for Exchange-Set Limits on
Contracts Subject to Federal Position Limits
Proposed Sec. 150.5(a) would apply to all contracts subject to the
Federal position limits proposed in Sec. 150.2 and, among other
things, is intended to help ensure that exchange-set limits do not
undermine the Federal position limits framework. Under proposed Sec.
150.5(a)(1), for any contract subject to a Federal limit, DCMs and,
ultimately, SEFs, would be required to establish exchange-set limits
for such contracts. Consistent with DCM Core Principle 5 and SEF Core
Principle 6, the exchange-set limit levels on such contracts, whether
cash-settled or physically-settled, and whether during or outside the
spot month, would have to be no higher than the level specified for the
applicable referenced contract in proposed Sec. 150.2. An exchange
would be free to set position limits that are lower than the Federal
limit. An exchange would also be permitted to adopt position
accountability levels that are lower than the Federal position limits,
in addition to any exchange-set position limits it adopts that are
equal to or less than the Federal position limits.
b. Comments--Requirements for Exchange-Set Limits on Contracts Subject
to Federal Position Limits
With respect to requirements for exchange-set limits under proposed
Sec. 150.5(a)(1), some commenters expressed concern that if an
exchange determines to set a position limit for a particular contract
significantly below the Federal position limit for that contract, then
market participants could be restricted in their ability to provide
liquidity, hedge activity, and otherwise pursue their trading
objectives.\1007\ ISDA recommended that to the extent that an exchange
determines to set position limits significantly below Federal position
limits, CFTC staff, through its exchange examination process, should
make transparent the exchange's reasoning and analysis underlying any
lower position limits.\1008\ Likewise, SIFMA AMG encouraged the
Commission to require exchanges to explain and justify any exchange-set
limits that are below Federal position limits, and to work
[[Page 3360]]
with exchanges to ensure that exchange limits do not discourage
liquidity.\1009\
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\1007\ ISDA at 11; SIFMA AMG at 4.
\1008\ ISDA at 11.
\1009\ SIFMA AMG at 4.
---------------------------------------------------------------------------
c. Discussion of Final Rule--Requirements for Exchange-Set Limits on
Contracts Subject to Federal Position Limits
The Commission is adopting Sec. 150.5(a)(1) as proposed. In
response to comments on Sec. 150.5(a)(1) requesting that the
Commission require transparency into exchanges' reasoning for when they
set limits well below Federal position limits, the Commission believes
market participants already have sufficient transparency under part 40
of the Commission's regulations. When exchanges seek to implement rules
to establish new or amended exchange-set limits, exchanges are required
to submit those rules through the Commission's part 40 process, and the
rules are made publicly available on the CFTC's website.\1010\
Exchanges are also required to post such submissions on their own
websites.\1011\
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\1010\ See CFTC Industry Filings available at https://www.cftc.gov/IndustryOversight/IndustryFilings/index.htm.
\1011\ See 17 CFR 40.2(a)(3)(vi), 40.3(a)(9), 40.5(a)(6),
40.6(a)(2).
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Further, regarding the request that the Commission work with
exchanges on exchange-set limits that are below Federal position
limits, exchanges are permitted to establish exchange-set limits in a
manner that is most appropriate for their own marketplaces and in a
manner that allows them to comply with the applicable DCM and SEF core
principles. The Commission views this process as a business and
compliance decision that is best left in the discretion of each
exchange. However, pursuant to DCM Core Principle 5 and SEF Core
Principle 6, exchanges must implement exchange-set position limits in a
manner that reduces market manipulation and congestion.
ii. Section 150.5(a)(2)--Exemptions to Exchange-Set Limits for
Contracts Subject to Federal Position Limits
a. Summary of the 2020 NPRM--Exemptions to Exchange-Set Limits for
Contracts Subject to Federal Position Limits
Under the 2020 NPRM, Sec. 150.5(a)(2)(ii) would permit exchanges
to grant exemptions from exchange-set limits according to the
guidelines outlined below.
First, if such exemptions from exchange-set limits conform to the
types of exemptions that may be granted for purposes of Federal
position limits under proposed sections: (1) 150.3(a)(1)(i) (enumerated
bona fide hedge recognitions), (2) 150.3(a)(2)(i) (spread exemptions
that meet the ``spread transaction'' definition in Sec. 150.1), (3)
150.3(a)(4) (exempt conditional spot month positions in natural gas),
or (4) 150.3(a)(5) (pre-enactment and transition period swaps), then
the level of the exemption may exceed the applicable Federal position
limit under proposed Sec. 150.2. Because the proposed exemptions
listed in the four provisions above are self-effectuating for purposes
of Federal position limits, exchanges may grant such exemptions
pursuant to proposed Sec. 150.5(a)(2)(i) without prior Commission
approval.
Second, if such exemptions from exchange-set limits conform to the
exemptions from Federal position limits that may be granted under
proposed Sec. Sec. 150.3(a)(1)(ii) (non-enumerated bona fide hedges)
and 150.3(a)(2)(ii) (spread positions that do not meet the ``spread
transaction'' definition in proposed Sec. 150.1), then the level of
the exemption may exceed the applicable Federal position limit under
proposed Sec. 150.2, provided that the exemption for purposes of
Federal position limits is first approved in accordance with proposed
Sec. 150.3(b) or, in the case of non-enumerated bona fide hedges,
Sec. 150.9, as applicable.
Third, if such exemptions conform to the exemptions from Federal
position limits that may be granted under proposed Sec. 150.3(a)(3)
(financial distress positions), then the level of the exemption may
exceed the applicable Federal position limit under proposed Sec.
150.2, provided that the Commission has first issued a letter or other
notice approving such exemption pursuant to a request submitted under
Sec. 140.99.\1012\
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\1012\ Under the 2020 NPRM, requests for exemptions for
financial distress positions would be submitted directly to the
Commission (or delegated staff) for consideration, and any approval
of such exemption would be issued in the form of an exemption letter
from the Commission (or delegated staff) pursuant to Sec. 140.99.
---------------------------------------------------------------------------
Finally, for purposes of exchange-set limits only, under the 2020
NPRM, exchanges may grant exemption types that are not listed in Sec.
150.3(a). However, in such cases, the exemption level would have to be
capped at the level of the applicable Federal position limit, so as not
to undermine the Federal position limits framework, unless the
Commission has first approved such exemption for purposes of Federal
position limits pursuant to Sec. 140.99 or proposed Sec. 150.3(b).
The 2020 NPRM also explained that exchanges that wish to offer
exemptions from their own limits other than the types listed in
proposed Sec. 150.3(a) could also submit rules for the Commission's
review, pursuant to part 40, allowing for such exemptions. The
Commission would carefully review any such exemption types for
compliance with applicable standards, including any statutory
requirements \1013\ and Commission regulations.\1014\
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\1013\ For example, an exchange would not be permitted to adopt
rules allowing for risk management exemptions for positions in
physical commodities that exceed Federal limits because the
Commission interprets the Dodd-Frank Act amendments to CEA section
4a(c)(2) as prohibiting risk management exemptions in such
commodities (unless such position is considered a pass-through swap
under paragraph (2) of the bona fide hedging definition in Sec.
150.1). See supra Section II.A.1. (discussing of the temporary
substitute test, risk-management exemptions, and the pass-through
swap provision).
\1014\ For example, as discussed below, proposed Sec.
150.5(a)(2)(ii)(C) would require that exchanges consider whether the
requested exemption would result in positions that are not in accord
with sound commercial practices in the relevant commodity derivative
market and/or would not exceed an amount that may be established and
liquidated in an orderly fashion in that market.
---------------------------------------------------------------------------
Under proposed Sec. 150.5(a)(2)(ii)(A)(1), exchanges that wish to
grant exemptions from their own limits would have to require traders to
file an application. The 2020 NPRM explained that, generally, exchanges
would have flexibility to establish the application process as they see
fit, but subject to the requirements discussed below, including the
requirement that the exchange collect cash-market and swaps market
information from the applicant.
For all exemption types, exchanges would have to generally require
that such applications be filed in advance of the date such position
would be in excess of the limits. However, under proposed Sec.
150.5(a)(2)(ii)(B) and (C), exchanges would be given the discretion to
adopt rules allowing traders to file retroactive applications for bona
fide hedges within five business days after a trader established such
position so long as the applicant demonstrates a sudden and unforeseen
increase in its hedging needs. Further, under proposed Sec.
150.5(a)(2)(ii)(D), if the exchange denies a retroactive application,
it would require that the applicant bring its position into compliance
with exchange-set limits within a commercially reasonable amount of
time (as determined by the exchange). Finally, pursuant to proposed
Sec. 150.5(a)(2)(ii)(A)(5), neither the Commission nor the exchange
would enforce a position limits violation for such retroactive
applications.
Proposed Sec. 150.5(a)(2)(ii)(B) provided that an exchange would
require that a trader reapply for the exemption granted
[[Page 3361]]
under proposed Sec. 150.5(a)(2) at least annually so that the exchange
and the Commission can closely monitor exemptions for contracts subject
to Federal position limits, and to help ensure that the exchange and
the Commission remain aware of the trader's activities.
Proposed Sec. 150.5(a)(2)(ii)(C) would authorize an exchange to
deny, limit, condition, or revoke any exemption request in accordance
with exchange rules,\1015\ and would set forth a principles-based
standard for doing so. Specifically, under proposed Sec.
150.5(a)(2)(ii)(C), exchanges would be required to take into account:
(i) Whether granting the exemption request would result in a position
that is ``not in accord with sound commercial practices'' in the market
in which the DCM is granting the exemption; and (ii) whether granting
the exemption request would result in a position that would ``exceed an
amount that may be established or liquidated in an orderly fashion in
that market.'' The 2020 NPRM explained that exchanges' evaluation of
exemption requests against these standards would be a facts and
circumstances determination.
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\1015\ Currently, DCMs review and set exemption levels annually
based on the facts and circumstances of a particular exemption and
the market conditions at that time. As such, a DCM may decide to
deny, limit, condition, or revoke a particular exemption, typically,
if the DCM determines that certain conditions have changed and
warrant such action. This may happen if, for example, there are
droughts, floods, embargoes, trade disputes, or other events that
cause shocks to the supply or demand of a particular commodity and
thus impact the DCM's disposition of a particular exemption.
---------------------------------------------------------------------------
The 2020 NPRM further explained that activity may reflect ``sound
commercial practice'' for a particular market or market participant but
not for another market or market participant. Similarly, activity may
reflect ``sound commercial practice'' outside the spot month, but not
in the spot month. Further, activity with manipulative intent or
effect, or that has the potential or effect of causing price distortion
or disruption, would be inconsistent with ``sound commercial
practice,'' even if it is common practice among market participants.
While an exemption granted to an individual market participant may
reflect ``sound commercial practice'' and may not ``exceed an amount
that may be established or liquidated in an orderly fashion in that
market,'' the 2020 NPRM clarified that the Commission expects exchanges
to also evaluate whether the granting of a particular exemption type to
multiple participants could have a collective impact on the market in a
manner inconsistent with ``sound commercial practice'' or in a manner
that could result in a position that would ``exceed an amount that may
be established or liquidated in an orderly fashion in that market.''
In the 2020 NPRM, the Commission explained that it understands that
the above-described parameters for exemptions from exchange-set limits
are generally consistent with current practice among DCMs. Bearing in
mind that proposed Sec. 150.5(a) would apply to contracts subject to
Federal position limits, the Commission proposed codifying such
parameters, as they would establish important, minimum standards needed
for exchanges to administer, and the Commission to oversee, a robust
program for granting exemptions from exchange-set limits in a manner
that does not undermine the Federal position limits framework. Proposed
Sec. 150.5(a) also would afford exchanges the ability to generally
oversee their programs for granting exemptions from exchange-set limits
as they see fit, including to establish different application processes
and requirements to accommodate the unique characteristics of different
contracts.
Finally, proposed Sec. 150.5(a)(2)(ii)(D) would permit an
exchange, in its discretion, to require a person relying on an
exchange-granted exemption (for contracts subject to Federal position
limits) to exit or limit the size of any position in excess of
exchange-set limits during the lesser of the last five days of trading
or the time period for the spot month in a physical-delivery contract.
The Commission has traditionally referred to such requirements as a
``Five-Day Rule.''
b. Comments--Exemptions to Exchange-Set Limits for Contracts Subject to
Federal Position Limits
With respect to permitted exemptions from exchange-set limits under
proposed Sec. 150.5(a)(2), CMC requested that the Commission clarify
that each exchange has discretion to determine what information is
required of applicants when applying for a spread exemption from
exchange-set limits, and that an exchange is not responsible for
monitoring the use of spread positions for purposes of Federal position
limits.\1016\
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\1016\ CMC at 7.
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In addition, regarding the retroactive application provision in
proposed Sec. 150.5(a)(2)(ii)(A)(5), CME Group recommended that the
Commission should implement a standard that permits exchanges to impose
position limits violations in cases where a person has exceeded Federal
position limits and filed a late or retroactive application that the
exchange then denies.\1017\
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\1017\ See CME Group at 10 (explaining that today at the
exchange level, CME Group considers firms to be in violation of a
position limit if the firms exceed a limit and the exemption
application is denied. CME Group believes the Commission should
implement this standard, rather than permitting the proposed grace
period for denial of an exemption application. CME Group explains
that, otherwise, market participants with excessively large
speculative positions could exploit the grace period accompanying an
application for an exemption and intentionally go over the
applicable limit without consequences--all the while disrupting
orderly market operations. In CME Group's experience, the prospect
of having an application denied and being found in violation of
position limits has worked to deter market participants from
attempting to exploit the retroactive exemption process).
---------------------------------------------------------------------------
The Commission also received several comments regarding the
provision that allows exchanges to impose a Five-Day Rule in proposed
Sec. 150.5(a)(2)(ii)(D). In particular, commenters requested that the
Commission expressly clarify that the Five-Day Rule does not apply to
markets for energy commodity derivatives.\1018\ Commenters also
requested clarification about whether, in cases where an exchange opts
not to apply the Five-Day Rule, the Commission expects the exchange to
follow the waiver guidance in proposed Appendix B, or whether the
exchange can simply take no further action.\1019\
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\1018\ Chevron at 13; Suncor at 12.
\1019\ CCI at 9-10; CEWG at 25-26. See also supra Section
II.A.1.viii. (explaining Appendix B, which provides guidance the
Commission believes exchanges should consider when determining
whether to apply the Five-Day Rule restriction).
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c. Discussion of Final Rule--Exemptions to Exchange-Set Limits for
Contracts Subject to Federal Position Limits
The Commission has determined to finalize Sec. 150.5(a)(2) largely
as proposed and with the clarifications and modifications, described
below, in response to commenters and other considerations.
Regarding comments on application information exchanges are
required to collect under Sec. 150.5(a)(2), as explained in the 2020
NPRM, the Commission is providing exchanges great flexibility to create
an application process for exemptions from exchange-set limits as they
see fit. This means an exchange has discretion to determine what
information is required of applicants applying for a spread exemption,
or any other exemption from exchange-set limits, except for instances
where the exchange is processing a non-enumerated bona fide hedge
application
[[Page 3362]]
in accordance with the application requirements of Sec. 150.9. The
Commission is making one modification to clarify the Commission's
posture when reviewing exchange-granted exemptions. In proposed Sec.
150.5(a)(2)(ii)(A), the Commission proposed to require exchanges to
collect sufficient information for the exchange to determine and the
Commission to ``verify'' that the facts and circumstances demonstrate
that the exchange may grant the exemption. In final Sec.
150.5(a)(2)(ii)(A), the Commission is revising this provision to make
clear that the Commission will conduct an independent evaluation of any
application it reviews to ``determine'' (not verify) whether the facts
and circumstances demonstrate that the exchange may grant the
exemption.
Further, regarding monitoring spread exemptions, exchanges are
required to administer and monitor their position limits and any
exemptions therefrom in accordance with DCM Core Principle 5 and SEF
Core Principle 6, as applicable. To the extent, however, that an
exchange grants an inter-market spread exemption where part of the
spread position is executed on another exchange or OTC, although an
exchange is not responsible for monitoring a trader's position on other
exchanges or OTC, an exchange should request information from the
spread exemption applicant about the entire composition of the spread
position so that the exchange is best informed about whether to grant
the exemption. Ultimately, the person relying on the spread exemption
is responsible for monitoring for compliance with the applicable
Federal position limits. The Commission reminds market participants
that an approved exemption does not preclude the Commission from
finding that a person has otherwise disrupted or manipulated the
market.
Next, regarding comments on the retroactive application provision
in proposed Sec. 150.5(a)(2)(ii)(A)(5), the Commission believes that
exchanges are in the best position to determine whether to pursue
enforcement actions for violations of exchange-set limits. Accordingly,
the Commission has determined to revise this provision so that
exchanges have discretion to determine whether to impose a position
limits violation for any retroactive exemption request for exchange-set
limits that the exchange ultimately denies. The Commission, however,
retains its position that the Commission will not pursue a position
limits violation in those circumstances, provided that the application
was submitted in good faith and the applicant brings its position
within the DCM or SEF's speculative position limits within a
commercially reasonable time, as determined by the DCM or SEF.\1020\
This revision is simply intended to make explicit an implicit
presumption that the applicant should have a reasonable and good faith
basis for determining that its position meets the requirements of Sec.
150.5(a)(2)(ii)(A) and for submitting the retroactive application.
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\1020\ The Commission notes that, under Section 4a(e) of the
Act, the Commission could pursue violations of exchange position
limit rules; however, the Commission, as a matter of policy, will
not pursue such violations so long as the conditions of Sec.
150.5(a)(2)(ii)(E) are met.
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Next, regarding various comments on the provision that allows
exchanges to impose the Five-Day Rule, or a similar requirement, in
proposed Sec. 150.5(a)(2)(ii)(D), for the avoidance of doubt, the
Commission reiterates that exchanges are not required to impose the
Five-Day Rule. Further, the Commission is adopting Appendix B and
Appendix G to provide guidance for exchanges to consider when
determining whether to impose the Five-Day Rule or similar requirements
in the spot period with respect to bona fide hedge exemptions or spread
exemptions, respectively.\1021\ The Final Rule permits exchanges to
determine whether any such restriction on trading in the spot period is
necessary given the facts and circumstances of a particular exemption
request. Further, when an exchange determines not to impose the Five-
Day Rule or similar requirement for an approved exemption, it is not
obligated to take any additional steps. The Commission has revised
Sec. 150.5(a)(2)(ii)(H) to make these points clear.
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\1021\ See supra Sections II.A.1.viii. (discussing Appendix B)
and II.A.20 (discussing Appendix G). See also infra Appendices B and
G.
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Finally, the Commission is making various non-substantive technical
and grammatical changes to Sec. 150.5(a)(2) to improve readability.
The Commission has also updated the outline numbering of Sec.
150.5(a)(2)(ii). These changes are not intended to change the substance
of this section.
iii. Section 150.5(a)(3)--Exchange-Set Limits on Pre-Existing Positions
for Contracts Subject to Federal Position Limits
a. Summary of the 2020 NPRM--Exchange-Set Limits on Pre-Existing
Positions for Contracts Subject to Federal Position Limits
In the 2020 NPRM, the Commission recognized that the proposed
Federal position limits framework may result in certain ``pre-existing
positions'' being subject to speculative position limits, even though
the positions predated the adoption of such limits. So as not to
undermine the Federal position limits framework during the spot month,
and to minimize disruption outside the spot month, proposed Sec.
150.5(a)(3) would require that during the spot month, for contracts
subject to Federal position limits, exchanges impose limits no larger
than Federal levels on ``pre-existing positions,'' other than for pre-
enactment swaps and transition period swaps. However, outside the spot
month, an exchange would not be required to impose limits on any such
position, provided the position is acquired in good faith consistent
with the ``pre-existing position'' definition of proposed Sec. 150.1,
and provided further that if the person's position is increased after
the effective date of the limit, such pre-existing position (other than
pre-enactment swaps and transition period swaps) along with the
position increased after the effective date, would be attributed to the
person. This provision is consistent with the proposed treatment of
pre-existing positions for purposes of Federal position limits set
forth in proposed Sec. 150.2(g), and was intended to prevent spot-
month limits from being rendered ineffective.
That is, not subjecting pre-existing positions to spot-month
position limits could result in a large, pre-existing position either
intentionally or unintentionally causing a disruption as it is rolled
into the spot month, and the Commission was particularly concerned
about protecting the spot month in physical-delivery futures from
corners and squeezes. Outside of the spot month, however, concerns over
corners and squeezes may be less acute.
b. Comments--Exchange-Set Limits on Pre-Existing Positions for
Contracts Subject to Federal Position Limits
The Commission addressed comments on pre-existing positions under
its discussion of Sec. 150.2(g)(2) above.\1022\
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\1022\ See supra Section II.B.7. (further discussing limits on
pre-existing positions).
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[[Page 3363]]
c. Discussion of Final Rule--Exchange-Set Limits on Pre-Existing
Positions for Contracts Subject to Federal Position Limits
The Commission is adopting Sec. 150.5(a)(3) with two modifications
to conform to the changes made to Sec. 150.2(g)(2), described below.
First, the Commission is amending Sec. 150.5(a)(3)(ii) to clarify
that non-spot month limits shall apply to pre-existing positions, other
than pre-enactment swaps and transition period swaps. As discussed
above in Section II.B.7., the Commission did not intend in the 2020
NPRM to exclude existing non-spot month positions in the nine legacy
agricultural contracts that would otherwise qualify as ``pre-existing
positions.'' As discussed, the other 16 non-legacy core referenced
futures contracts that are subject to Federal position limits for the
first time under the Final Rule are not subject to Federal non-spot
month position limits and therefore proposed Sec. 150.5(a)(3)(ii)
would not have applied to these contracts in any event.\1023\
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\1023\ See supra Section II.B.7. (discussing Sec. 150.2 Federal
position limits on pre-existing positions).
---------------------------------------------------------------------------
Second, the Commission is eliminating the language in proposed
Sec. 150.5(a)(3)(ii) that would attribute to a person any increase in
their position after the effective date of the non-spot month limit.
This language is no longer necessary since final Sec. 150.5(a)(3)(ii)
clarifies that pre-existing positions, other than pre-enactment swaps
and transition period swaps, are subject to non-spot month limits.
For further discussion on pre-existing positions in general and
comments thereto, please refer to Sec. Sec. 150.2(g).\1024\
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\1024\ Id.
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iv. Section 150.5(a)(4)--Monthly Report Detailing Exemption
Applications for Contracts Subject to Federal Limits
a. Summary of the 2020 NPRM--Monthly Report Detailing Exemption
Applications for Contracts Subject to Federal Limits
In the 2020 NPRM, the Commission explained that it seeks a balance
between having sufficient information to oversee the exchange-granted
exemptions, and not burdening exchanges with excessive periodic
reporting requirements. The Commission thus proposed under Sec.
150.5(a)(4) to require one monthly report by each exchange providing
certain information about exchange-granted exemptions for contracts
that are subject to Federal position limits. Certain exchanges already
voluntarily file these types of monthly reports with the Commission,
and proposed Sec. 150.5(a)(4) would standardize such reports for all
exchanges that process applications for bona fide hedges, spread
exemptions, and other exemptions from exchange-set limits for contracts
that are subject to Federal position limits. The proposed report would
provide information regarding the disposition of any application to
recognize a position as a bona fide hedge (both enumerated and non-
enumerated) or to grant a spread or other exemption, including any
renewal, revocation of, or modification to the terms and conditions of,
a prior recognition or exemption.\1025\
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\1025\ Under the 2020 NPRM, in the monthly report, exchanges may
elect to list new recognitions or exemptions, and modifications to
or revocations of prior recognitions and exemptions each month.
Alternatively, exchanges may submit cumulative monthly reports
listing all active recognitions and exemptions (i.e., including
exemptions that are not new or have not changed).
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As specified under proposed Sec. 150.5(a)(4), the report would
provide certain details regarding any application to recognize a bona
fide hedging position, or grant a spread exemption or other exemption,
including: The effective date and expiration date of any recognition or
exemption; any unique identifier assigned to track the application or
position; identifying information about the applicant; the derivative
contract or positions to which the application pertains; the maximum
size of the commodity derivative position that is recognized or
exempted by the exchange (including any ``walk-down'' requirements);
\1026\ any size limitations the exchange sets for the position; and a
brief narrative summarizing the applicant's relevant cash-market
activity.
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\1026\ An exchange could determine to recognize as a bona fide
hedge or spread exemption all, or a portion, of the commodity
derivative position for which an application has been submitted,
provided that such determination is made in accordance with the
requirements of proposed Sec. 150.5 and is consistent with the Act
and the Commission's regulations. In addition, an exchange could
require that a bona fide hedging position or spread position be
subject to ``walk-down'' provisions that require the trader to scale
down its positions in the spot month in order to reduce market
congestion as needed based on the facts and circumstances.
---------------------------------------------------------------------------
With respect to any unique identifiers to be included in the
proposed monthly report, the exchange's assignment of a unique
identifier would assist the Commission's tracking process. Accordingly,
the Commission suggested that, as a ``best practice,'' the exchange's
procedures for processing bona fide hedging position and spread
exemption applications contemplate the assignment of such unique
identifiers.\1027\ The proposed report would also be required to
specify the maximum size and/or size limitations by contract month and/
or type of limit (e.g., spot month, single month, or all-months-
combined), as applicable. The proposed monthly report would be a
critical element of the Commission's surveillance program by
facilitating the Commission's ability to track bona fide hedging
positions and spread exemptions approved by exchanges. The proposed
monthly report would also keep the Commission informed as to the manner
in which an exchange is administering its application procedures, the
exchange's rationale for permitting large positions, and relevant cash-
market activity. The Commission expected that exchanges would be able
to leverage their current exemption processes and recordkeeping
procedures to generate such reports.
---------------------------------------------------------------------------
\1027\ The unique identifier could apply to each of the bona
fide hedge or spread exemption applications that the exchange
receives, and, separately, each type of commodity derivative
position that the exchange wishes to recognize as a bona fide hedge
or spread exemption.
---------------------------------------------------------------------------
In certain instances, information included in the proposed monthly
report may prompt the Commission to request records required to be
maintained by an exchange. For example, the Commission proposed that,
for each derivative position that an exchange wishes to recognize as a
bona fide hedge, or any revocation or modification of such recognition,
the report would include a concise summary of the applicant's activity
in the cash markets and swaps markets for the commodity underlying the
position. The Commission explained that it expects that this summary
would focus on the facts and circumstances upon which an exchange based
its determination to recognize a bona fide hedge, to grant a spread
exemption, or to revoke or modify such recognition or exemption. In
light of the information provided in the summary, or any other
information included in the proposed monthly report regarding the
position, the Commission may request the exchange's complete record of
the application. The Commission also explained that it expects that it
would only need to request such complete records in the event that it
noticed an issue that could cause market disruptions.
Proposed Sec. 150.5(a)(4) would require an exchange, unless
instructed otherwise by the Commission, to submit such monthly reports
according to the form and manner requirements the Commission specifies.
In order to facilitate the processing of such reports,
[[Page 3364]]
and the analysis of the information contained therein, the Commission
would establish reporting and transmission standards. The 2020 NPRM
would also require that such reports be submitted to the Commission
using an electronic data format, coding structure, and electronic data
transmission procedures specified on the Commission's Forms and
Submissions page of its website.
b. Comments--Monthly Report Detailing Exemption Applications for
Contracts Subject to Federal Limits
With respect to the monthly reporting requirement in proposed Sec.
150.5(a)(4), ICE requested that the Commission clarify that the monthly
report is only required to capture positions that are subject to
Federal position limits and does not apply to other exchange-set non-
enumerated exemptions.\1028\ ICE also requested that the Commission
codify when the monthly reports are required to be submitted, and that
any regular reports can be made at the discretion of the
exchange.\1029\ Other commenters expressed that they prefer that the
Commission not specify a particular day each month as a deadline for
exchanges to submit their monthly reports pursuant to Sec.
150.5(a)(4).\1030\ Finally, ICE requested that the Commission clarify
how factual and legal justifications for exemptions should be provided
in the monthly report, and the level of granularity required.\1031\
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\1028\ ICE at 14.
\1029\ Id.
\1030\ CME Group at 14; IFUS at 13.
\1031\ ICE at 14.
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c. Discussion of Final Rule--Monthly Report Detailing Exemption
Applications for Contracts Subject to Federal Limits
The Commission is finalizing Sec. 150.5(a)(4) as proposed, with
minor technical revisions. The Commission clarifies, as stated in the
proposed and final regulation text, that the monthly reporting
requirement only applies to exemptions an exchange grants for contracts
that are subject to Federal position limits. Further, in consideration
of comments and the Commission's past with collecting voluntary monthly
reports from exchanges, the Commission has determined not to prescribe
a particular day of the month or monthly deadline for exchanges to
submit the monthly reports. Rather, the Commission defers to exchanges
on the best timing for submitting their reports so long as the reports
are submitted on a monthly basis in accordance with Sec. 150.5(a)(4).
Finally, the Commission clarifies that Sec. 150.5(a)(4) does not
require exchanges to provide factual and legal analysis in the monthly
report. The monthly report is intended to give the Commission a
snapshot of all exemptions the exchange has granted from exchange-set
limits for contracts that are subject to Federal position limits. The
Commission's expectation is that in circumstances when it needs
additional information on the exchange's analysis for a particular
exemption application, it will work with the exchange to obtain such
additional information.
4. Section 150.5(b)--Requirements and Acceptable Practices for
Exchange-Set Limits on Commodity Derivative Contracts in a Physical
Commodity That Are Not Subject to the Limits Set Forth in Sec. 150.2
i. Summary of the 2020 NPRM--Exchange-Set Limits on Commodity
Derivative Contracts in a Physical Commodity Not Subject to the Limits
Set Forth in Sec. 150.2
Under proposed Sec. 150.5(b), for physical commodity derivative
contracts that are not subject to Federal position limits, whether
cash-settled or physically-settled, exchanges would be subject to
flexible standards for setting exchange limits during the contract's
spot month and non-spot month.
During the spot month, under proposed Sec. 150.5(b)(1)(i),
exchanges would be required to establish position limits, and such
limits would have to be set at a level that is no greater than 25
percent of deliverable supply. As described in detail in connection
with the proposed Federal spot-month limits described above, it would
be difficult, in the absence of other factors, for a participant to
corner or squeeze a market if the participant holds less than or equal
to 25 percent of deliverable supply, and the Commission has long used
deliverable supply as the basis for spot month position limits due to
concerns regarding corners, squeezes, and other settlement-period
manipulative activity.\1032\
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\1032\ See supra Section II.B. (discussing proposed Sec.
150.2).
---------------------------------------------------------------------------
In the 2020 NPRM, the Commission recognized, however, that there
may be circumstances where an exchange may not wish to use the 25%
formula, including, for example, if the contract is cash-settled, does
not have a measurable deliverable supply, or if the exchange can
demonstrate that a different parameter is better suited for a
particular contract or market.\1033\ Accordingly, proposed Sec.
150.5(b)(1) would afford exchanges the ability to submit to the
Commission alternative potential methodologies for calculating spot
month limit levels, provided that the limits are set at a level that is
``necessary and appropriate to reduce the potential threat of market
manipulation or price distortion of the contract's or the underlying
commodity's price or index.'' This standard has appeared in existing
Sec. 150.5 since its adoption in connection with spot-month limits on
cash-settled contracts.
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\1033\ Guidance for calculating deliverable supply can be found
in Appendix C to part 38. 17 CFR part 38, Appendix C.
---------------------------------------------------------------------------
As noted above, existing Sec. 150.5 includes separate parameters
for spot-month limits in physical-delivery contracts and for cash-
settled contracts, but does not include flexibility for exchanges to
consider alternative parameters. In an effort to both simplify the
regulation and provide the ability for exchanges to consider multiple
parameters that may be better suited for certain products, the
Commission proposed the above standard as a principles-based
requirement for both cash-settled and physically-settled contracts
subject to proposed Sec. 150.5(b).
Outside of the spot month, where, historically, attempts at certain
types of market manipulation is generally less of a concern, proposed
Sec. 150.5(b)(2)(i) would allow exchanges to choose between position
limits or position accountability for physical commodity contracts that
are not subject to Federal position limits. While exchanges would be
permitted to decide whether to use limit levels or accountability
levels for any such contract, under either approach, the exchange would
have to set a level that is ``necessary and appropriate to reduce the
potential threat of market manipulation or price distortion of the
contract's or the underlying commodity's price or index.''
To help exchanges efficiently demonstrate compliance with this
standard for physical commodity contracts outside of the spot month,
the Commission proposed separate acceptable practices for exchanges
that wish to adopt non-spot month position limits and exchanges that
wish to adopt non-spot month accountability.\1034\ For
[[Page 3365]]
exchanges that choose to adopt non-spot month position limits, rather
than position accountability, proposed paragraph (a)(1) to Appendix F
of part 150 would set forth non-exclusive acceptable practices. Under
that provision, an exchange would be deemed in compliance with proposed
Sec. 150.5(b)(2)(i) if the exchange sets non-spot limit levels for
each contract subject to Sec. 150.5(b) at a level no greater than: (1)
The average of historical position sizes held by speculative traders in
the contract as a percentage of the contract's open interest; \1035\
(2) the spot month limit level for the contract; (3) 5,000 contracts
(scaled up proportionally to the ratio of the notional quantity per
contract to the typical cash-market transaction if the notional
quantity per contract is smaller than the typical cash-market
transaction, or scaled down proportionally if the notional quantity per
contract is larger than the typical cash-market transaction); \1036\ or
(4) 10% of open interest in that contract for the most recent calendar
year up to 50,000 contracts, with a marginal increase of 2.5% of open
interest thereafter.\1037\ When evaluating average position sizes held
by speculative traders, the Commission expected exchanges: (i) To be
cognizant of speculative positions that are extraordinarily large
relative to other speculative positions, and (ii) to not consider any
such outliers in their calculations.
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\1034\ The acceptable practices in Appendix F to part 150 of the
2020 NPRM reflected non-exclusive methods of compliance.
Accordingly, the language of these proposed acceptable practices,
used the word ``shall'' not to indicate that the acceptable practice
is a required method of compliance, but rather to indicate that in
order to satisfy the acceptable practice, a market participant must
(i.e., shall) establish compliance with that particular acceptable
practice.
\1035\ For example, if speculative traders in a particular
contract typically make up 12 percent of open interest in that
contract, the exchange could set limit levels no greater than 12
percent of open interest.
\1036\ Under the 2020 NPRM, for exchanges that choose to adopt a
non-spot month limit level of 5,000 contracts, this level assumes
that the notional quantity per contract is set at a level that
reflects the size of a typical cash-market transaction in the
underlying commodity. However, if the notional quantity of the
contract is larger/smaller than the typical cash-market transaction
in the underlying commodity, then the DCM must reduce/increase the
5,000 contract non-spot month limit until it is proportional to the
notional quantity of the contract relative to the typical cash-
market transaction. These required adjustments to the 5,000-contract
metric are intended to avoid a circumstance where an exchange could
allow excessive speculation by setting excessively large notional
quantities relative to typical cash-market transaction sizes. For
example, if the notional quantity per contract is set at 30,000
units, and the typical observed cash-market transaction is 2,500
units, the notional quantity per contract would be 12 times larger
than the typical cash-market transaction. In that case, the non-spot
month limit would need to be 12 times smaller than 5,000 (i.e., at
417 contracts.). Similarly, if the notional quantity per contract is
1,000 contracts, and the typical observed cash-market transaction is
2,500 units, the notional quantity per contract would be 2.5 times
smaller than the typical cash-market transaction. In that case, the
non-spot month limit would need to be 2.5 times larger than 5,000,
and would need to be set at 12,500 contracts.
\1037\ In connection with the proposed Appendix F to part 150
acceptable practices, open interest should be calculated by
averaging the month-end open positions in a futures contract and its
related option contract, on a delta-adjusted basis, for all months
listed during the most recent calendar year.
---------------------------------------------------------------------------
These proposed parameters have largely appeared in existing Sec.
150.5 for many years in connection with either initial or subsequent
levels.\1038\ The Commission was of the view that these parameters
would be useful, flexible standards to carry forward as acceptable
practices. For example, the Commission expected that the 5,000-contract
acceptable practice would be a useful benchmark for exchanges because
it would allow them to establish limits and demonstrate compliance with
Commission regulations in a relatively efficient manner, particularly
for new contracts that have yet to establish open interest. Similarly,
for purposes of exchange-set limits on physical commodity contracts
that are not subject to Federal position limits, the Commission
proposed to maintain the baseline 10/2.5 percent formula as an
acceptable practice. Because these parameters are simply acceptable
practices, exchanges may, after evaluation, propose higher limits or
accountability levels.
---------------------------------------------------------------------------
\1038\ 17 CFR 150.5(b) and (c). Proposed Sec. 150.5(b) would
address physical commodity contracts that are not subject to Federal
position limits.
---------------------------------------------------------------------------
Along those lines, the Commission recognized that other parameters
may be preferable and/or just as effective, and was open to considering
alternative parameters submitted pursuant to part 40 of the
Commission's regulations, provided, at a minimum, that the parameter
complies with Sec. 150.5(b)(2)(i). The Commission encouraged exchanges
to submit potential new parameters to Commission staff in draft form
prior to submitting them under part 40.
For exchanges that choose to adopt position accountability, rather
than limits, outside of the spot month, proposed paragraph (a)(2) of
Appendix F to part 150 would set forth a non-exclusive acceptable
practice that would permit such exchanges to comply with proposed Sec.
150.5(b)(2)(i) by adopting rules establishing ``position
accountability'' as defined in proposed Sec. 150.1. ``Position
accountability'' would mean rules that the exchange submits to the
Commission pursuant to part 40 that require a trader, upon request by
the exchange, to consent to: (i) Provide information to the exchange
about their position, including, but not limited to, information about
the nature of the positions, trading strategies, and hedging
information; and (ii) halt further increases to their position or to
reduce their position in an orderly manner.\1039\
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\1039\ While existing Sec. 150.5(e) includes open-interest and
volume-based limitations on the use of position accountability, the
Commission opted not to include such limitations in the 2020 NPRM.
Under the 2020 NPRM, if an exchange submitted a part 40 filing
seeking to adopt position accountability, the Commission would
determine on a case-by-case basis whether such rules are consistent
with the Act and the Commission's regulations. The Commission did
not want to use one-size-fits-all volume-based limitations for
making such determinations.
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Proposed Sec. 150.5(b)(3) addressed a circumstance where multiple
exchanges list contracts that are substantially the same, including
physically-settled contracts that have the same underlying physical
commodity and delivery location, or cash-settled contracts that are
directly or indirectly linked to a physically-settled contract. Under
proposed Sec. 150.5(b)(3), exchanges listing contracts that are
substantially the same in this manner must either adopt ``comparable''
limits for such contracts, or demonstrate to the Commission how the
non-comparable levels comply with the standards set forth in proposed
Sec. 150.5(b)(1) and (2). Such a determination also must address how
the levels are necessary and appropriate to reduce the potential threat
of market manipulation or price distortion of the contract's or the
underlying commodity's price or index. Proposed Sec. 150.5(b)(3) would
apply equally to cash-settled and physically-settled contracts, and to
limits during and outside of the spot month, as applicable.\1040\
Proposed Sec. 150.5(b)(3) was intended to help ensure that position
limits established on one exchange would not jeopardize market
integrity or otherwise harm other markets. Further, proposed Sec.
150.5(b)(3) would be consistent with the Commission's proposed approach
to generally apply equivalent Federal position limits to linked
contracts, including linked contracts listed on multiple
exchanges.\1041\
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\1040\ For reasons discussed elsewhere in the 2020 NPRM, this
provision would not apply to natural gas contracts. See supra
Section II.C.6. (discussion of proposed conditional spot month
exemption in natural gas).
\1041\ See supra Section II.A.16. (discussion of the proposed
referenced contract definition and linked contracts).
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Finally, under proposed Sec. 150.5(b)(4), exchanges would be
permitted to grant exemptions from any limits established under
proposed Sec. 150.5(b). As noted, proposed Sec. 150.5(b) would apply
to physical commodity contracts not subject to Federal position limits;
thus, exchanges would be given flexibility to
[[Page 3366]]
grant exemptions in such contracts, including exemptions for both
intra-market and inter-market spread positions,\1042\ as well as other
exemption types (including risk management exemptions) not explicitly
listed in proposed Sec. 150.3.\1043\ However, such exchanges must
require that traders apply for the exemption. In considering any such
application, the exchanges would be required to consider whether the
exemption would result in a position that would not be in accord with
``sound commercial practices'' in the market for which the exchange is
considering the application, and/or would ``exceed an amount that may
be established and liquidated in an orderly fashion in that market.''
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\1042\ See Appendix G (providing additional guidance on spread
exemptions).
\1043\ As noted above, proposed Sec. 150.3 would allow for
several exemption types, including: Bona fide hedging positions;
certain spreads; financial distress positions; and conditional spot
month limit exemption positions in natural gas.
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While exchanges would be subject to the requirements of Sec.
150.5(a) and (b) described above, such proposed requirements are not
intended to limit the discretion of exchanges to utilize other tools to
protect their markets. Among other things, an exchange would have the
discretion to: Impose additional restrictions on a person with a long
position in the spot month of a physical-delivery contract who stands
for delivery, takes that delivery, and then re-establishes a long
position; establish limits on the amount of delivery instruments that a
person may hold in a physical-delivery contract; and impose such other
restrictions as it deems necessary to reduce the potential threat of
market manipulation or congestion, to maintain orderly execution of
transactions, or for such other purposes consistent with its
responsibilities.
ii. Comments--Exchange-Set Limits on Commodity Derivative Contracts in
a Physical Commodity Not Subject to the Limits Set Forth in Sec. 150.2
Better Markets recommended revisions for proposed Sec. 150.5(b)(2)
if the Commission decides to finalize the proposed approach to only
implement spot month limits on contracts that are not subject to
Federal position limits.\1044\ Proposed Sec. 150.5(b)(2) requires
exchanges to have either non-spot month position limits or
accountability levels, as necessary and appropriate, to reduce
manipulation and price distortions for contracts that are not subject
to limits in Sec. 150.2. Better Markets' recommendation goes a step
further and would require exchanges to set position limits and position
accountability levels outside of the spot month to reduce the potential
threat of market manipulation or price distortion and the potential for
sudden or unreasonable fluctuations or unwarranted changes.\1045\
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\1044\ Better Markets at 47-48.
\1045\ Id.
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iii. Discussion of Final Rule--Exchange-Set Limits on Commodity
Derivative Contracts in a Physical Commodity Not Subject to the Limits
Set Forth in Sec. 150.2
The Commission is adopting Sec. 150.5(b), as proposed, with a few
technical or grammatical revisions to improve readability and the
following explanation. Of note, the Commission is revising the
beginning of Sec. 150.5(b)(1) to clarify that this section applies to
exchange-set limits on cash-settled and physically-settled commodity
derivative contracts in a physical commodity that are not subject to
the Federal position limits set forth in Sec. 150.2. Although this
point is made clear in the preamble and the introductory title of Sec.
150.5(b), the Commission has added the additional clarification for the
avoidance of any confusion.
In response to comments from Better Markets, and as explained in
detail earlier in this release, the Commission believes that outside
the spot month, either exchange-set position limits or exchange-set
accountability levels will be sufficient for exchanges to reduce the
potential threat of market manipulation and price distortions and
manage fluctuations and changes in their markets.\1046\ Accordingly,
the Commission has determined to finalize the position limits and
accountability requirements as proposed.
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\1046\ See supra Section II.B.2.iv. (providing a detailed
discussion of the Commission's extensive experience monitoring
position accountability levels, which have been effective at
exchanges).
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5. Section 150.5(c)--Requirements for Security Futures Products
i. Background and Summary of the 2020 NPRM--Requirements for Security
Futures Products
As the Commission has previously noted, security futures products
and security options may serve economically equivalent or similar
functions to one another.\1047\ Therefore, when the Commission
originally adopted position limits regulations for security futures
products in part 41, it set levels that were generally comparable to,
although not identical with, the limits that applied to options on
individual securities.\1048\ The Commission has pointed out that
security futures products may be at a competitive disadvantage if
position limits for security futures products vary too much from those
of security options.\1049\ As a result, the Commission in 2019 adopted
amendments to the position limitations and accountability requirements
for security futures products, noting that one goal was to provide a
level regulatory playing field with security options.\1050\ The
Commission proposed Sec. 150.5(c), therefore, to include a cross-
reference clarifying that for security futures products, position
limitations and accountability requirements for exchanges are specified
in Sec. 41.25.\1051\ This would allow the Commission to take into
account the position limits regime that applies to security options
when considering position limits regulations for security futures
products.
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\1047\ See Position Limits and Position Accountability for
Security Futures Products, 83 FR at 36799, 36802 (July 31, 2018).
\1048\ Id. See also Listing Standards and Conditions for Trading
Security Futures Products, 66 FR at 55078, 55082 (Nov. 1, 2001)
(explaining the Commission's adoption of position limits for
security futures products).
\1049\ See 83 FR at 36802.
\1050\ See Position Limits and Position Accountability for
Security Futures Products, 84 FR at 51005, 51009 (Sept. 27, 2019).
\1051\ See 17 CFR 41.25. Rule Sec. 41.25 establishes conditions
for the trading of security futures products.
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ii. Comments and Summary of the Commission Determination--Requirements
for Security Futures Products
The Commission did not receive comments on Sec. 150.5(c) and is
adopting this section as proposed.
6. Section 150.5(d)--Rules on Aggregation
i. Summary of the 2020 NPRM--Rules on Aggregation
As noted earlier in this release, the Commission adopted in 2016
final aggregation rules under Sec. 150.4 that apply to all contracts
subject to Federal position limits. The Commission recognized that with
respect to contracts not subject to Federal position limits, market
participants may find it burdensome if different exchanges adopt
different aggregation standards. Accordingly, under proposed Sec.
150.5(d), all DCMs, and, ultimately, SEFs, that list any physical
commodity derivatives, regardless of whether the contract is subject to
Federal position limits, would be required to adopt position
aggregation rules for such contracts that
[[Page 3367]]
conform to Sec. 150.4.\1052\ Exchanges that list excluded commodities
would be encouraged to also adopt position aggregation rules that
conform to Sec. 150.4. Aggregation policies that otherwise vary from
exchange to exchange would increase the administrative burden on a
trader active on multiple exchanges, as well as increase the
administrative burden on the Commission in monitoring and enforcing
exchange-set position limits.
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\1052\ Under Sec. 150.4, unless an exemption applies, a
person's positions must be aggregated with positions for which the
person controls trading or for which the person holds a 10% or
greater ownership interest. Commission Regulation Sec. 150.4(b)
sets forth several exemptions from aggregation. See Final
Aggregation Rulemaking, 81 FR at 91454. The Division of Market
Oversight has issued time-limited no-action relief from some of the
aggregation requirements contained in that rulemaking. See CFTC
Letter No. 19-19 (July 31, 2019), available at https://www.cftc.gov/csl/19-19/download.
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ii. Comments and Summary of the Commission Determination--Rules on
Aggregation
The Commission did not receive comments on Sec. 150.5(d) and is
adopting this section as proposed.
7. Section 150.5(e)--Requirements for Submissions to the Commission
i. Summary of the 2020 NPRM--Requirements for Submissions to the
Commission
Proposed Sec. 150.5(e) reflects that, consistent with the
definition of ``rule'' in existing Sec. 40.1, any exchange action
establishing or modifying exchange-set position limits or exemptions
therefrom, or position accountability, in any case pursuant to proposed
Sec. 150.5(a), (b), (c), or Appendix F to part 150, would qualify as a
``rule'' and must be submitted to the Commission as such pursuant to
part 40 of the Commission's regulations. Such rules would also include,
among other things, parameters used for determining position limit
levels, and policies and related processes setting forth parameters
addressing, among other things, which types of exemptions are
permitted, the parameters for the granting of such exemptions, and any
exemption application requirements.
Proposed Sec. 150.5(e) further provides that exchanges would be
required to review regularly\1053\ any position limit levels
established under proposed Sec. 150.5 to ensure the level continues to
comply with the requirements of those sections. For example, in the
case of Sec. 150.5(b), exchanges would be expected to ensure the
limits comply with the requirement that limits be set ``at a level that
is necessary and appropriate to reduce the potential threat of market
manipulation or price distortion of the contract's or the underlying
commodity's price or index.'' Exchanges would also be required to
update such levels as needed, including if the levels no longer comply
with the proposed rules.
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\1053\ Under the 2020 NPRM, an acceptable, regular review regime
would consist of both a periodic review and an event-specific review
(e.g., in the event of supply and demand shocks such as
unanticipated shocks to supply and demand of the underlying
commodity, geo-political shocks, and other events that may result in
congestion and/or other disruptions).
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ii. Comments and Summary of the Commission Determination--Requirements
for Submissions to the Commission
The Commission did not receive comments on Sec. 150.5(e) and is
adopting this section with a few non-substantive revisions to address
grammatical issues and improve the readability and organization of the
section. These revisions are not intended to change the substance of
this section.
8. Section 150.5(f)--Delegation of Authority to the Director of the
Division of Market Oversight
i. Summary of the 2020 NPRM--Delegation of Authority to the Director of
the Division of Market Oversight
The Commission proposed to delegate its authority, pursuant to
proposed Sec. 150.5(a)(4)(ii), to the Director of the Commission's
Division of Market Oversight, or such other employee(s) that the
Director may designate from time to time, to provide instructions
regarding the submission of information required to be reported by
exchanges to the Commission on a monthly basis, and to determine the
manner, format, coding structure, and electronic data transmission
procedures for submitting such information.
ii. Comments and Summary of the Commission Determination--Delegation of
Authority to the Director of the Division of Market Oversight
The Commission did not receive comments on Sec. 150.5(f) and is
adopting this section as proposed.
9. Commission Enforcement of Exchange-Set Limits
As discussed throughout this Final Rule, the framework for
exchange-set limits operates in conjunction with the Federal position
limits framework. The Futures Trading Act of 1982 gave the Commission,
under CEA section 4a(5) (since re-designated as section 4a(e)), the
authority to directly enforce violations of exchange-set, Commission-
approved speculative position limits in addition to position limits
established directly by the Commission.\1054\ Since 2008, it has also
been a violation of the Act for any person to violate an exchange
position limit rule certified to the Commission by such exchange
pursuant to CEA section 5c(c)(1).\1055\ Thus, under CEA section 4a(e),
it is a violation of the Act for any person to violate an exchange
position limit rule certified to or approved by the Commission,
including to violate any subsequent amendments thereto, and the
Commission has the authority to enforce those violations.
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\1054\ See Futures Trading Act of 1982, Public Law 97-444, 96
Stat. 2299-30 (1983).
\1055\ See CFTC Reauthorization Act of 2008, Food, Conservation
and Energy Act of 2008, Public Law 110-246, 122 Stat. 1624 (June 18,
2008) (also known as the ``Farm Bill'') (amending CEA section 4a(e),
among other things, to assure that a violation of exchange-set
position limits, regardless of whether such position limits have
been approved by or certified to the Commission, would constitute a
violation of the Act that the Commission could independently
enforce). See also Federal Speculative Position Limits for
Referenced Energy Contracts and Associated Regulations, 75 FR at
4144, 4145 (Jan. 26, 2010) (summarizing the history of the
Commission's authority to directly enforce violations of exchange-
set speculative position limits).
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The Commission did not receive comments on its authority to enforce
exchange-set position limits.
E. Sec. 150.6--Scope
Existing Sec. 150.6 provides that nothing in this part shall be
construed to affect any provisions of the CEA relating to manipulation
or corners nor to relieve any contract market or its governing board
from responsibility under the CEA to prevent manipulation and
corners.\1056\
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\1056\ 17 CFR 150.6. The Commission notes that while existing
Sec. 150.6 references ``section 5(4) of the [CEA]'' no such CEA
section currently exists. The Final Rule instead references section
5(d)(4) of the CEA.
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1. Summary of the 2020 NPRM--Scope
Proposed Sec. 150.6 was intended to make clear that fulfillment of
specific part 150 requirements alone does not necessarily satisfy other
obligations of an exchange. Proposed Sec. 150.6 provided that part 150
of the Commission's regulations would only be construed as having an
effect on position limits set by the Commission or an exchange
including any associated recordkeeping and reporting requirements.
Proposed Sec. 150.6 provided further that nothing in part 150 would
affect any other provisions of the CEA or Commission regulations
including those relating to actual or attempted manipulation, corners,
squeezes, fraudulent or deceptive conduct, or to prohibited
[[Page 3368]]
transactions. For example, proposed Sec. 150.5 would require DCMs,
and, ultimately, SEFs, to impose and enforce exchange-set speculative
position limits. The fulfillment of the requirements of Sec. 150.5
alone would not satisfy any other legal obligations under the CEA or
Commission regulations applicable to exchanges to prevent manipulation
and corners. Likewise, a market participant's compliance with position
limits or an exemption thereto would not confer any type of safe harbor
or good faith defense to a claim that the participant had engaged in an
attempted or perfected manipulation.
Further, the proposed amendments were intended to help clarify that
Sec. 150.6 would apply to: Regulations related to position limits
found outside of part 150 of the Commission's regulations (e.g.,
relevant sections of part 1 and part 19); and recordkeeping and
reporting regulations associated with speculative position limits.
2. Comments and Discussion of Final Rule--Scope
The Commission received no comments on proposed Sec. 150.6 and is
adopting as proposed.
As the Commission explained in the 2020 NPRM, position limits are
meant to diminish, eliminate, and prevent excessive speculation and to
deter and prevent market manipulation, squeezes, and corners. The
Commission stresses that nothing in the Final Rule's revisions to part
150 would impact the anti-disruptive, anti-cornering, and anti-
manipulation provisions of the CEA and Commission regulations,
including but not limited to CEA sections 6(c) or 9(a)(2) regarding
manipulation, CEA section 4c(a)(5) regarding disruptive practices
including spoofing, or sections 180.1 and 180.2 of the Commission's
regulations regarding manipulative and deceptive practices. It may be
possible for a trader to manipulate or attempt to manipulate the prices
of futures contracts or the underlying commodity with a position that
is within the Federal position limits. It may also be possible for a
trader holding a bona fide hedge, as recognized by the Commission or an
exchange, to manipulate or attempt to manipulate the markets. The
Commission would not consider it a defense to a charge under the anti-
manipulation provisions of the CEA or the regulations that a trader's
position was within position limits.
F. Sec. 150.8--Severability
Final Sec. 150.8 provides that should any provision(s) of part 150
be declared invalid, including the application thereof to any person or
circumstance, all remaining provisions of part 150 shall not be
affected to the extent that such remaining provisions, or the
application thereof, can be given effect without the invalid
provisions.
The Commission did not receive comments on proposed Sec. 150.8,
and is adopting it as proposed.
G. Sec. 150.9--Process for Recognizing Non-Enumerated Bona Fide
Hedging Transactions or Positions With Respect to Federal Speculative
Position Limits
1. Background--Non-Enumerated Bona Fide Hedging Transactions or
Positions
The Commission's authority and existing processes for recognizing
bona fide hedges can be found in CEA section 4a(c), and Sec. Sec. 1.3,
1.47, and 1.48 of the Commission's regulations.\1057\ In particular,
CEA section 4a(c)(1) provides that no CFTC rule issued under CEA
section 4a(a) applies to ``transactions or positions which are shown to
be bona fide hedging transactions or positions.'' \1058\ Under the
existing definition of ``bona fide hedging transactions and positions''
in Sec. 1.3,\1059\ paragraph (1) provides the Commission's general
definition of bona fide hedging transactions or positions; paragraph
(2) provides a list of enumerated bona fide hedging positions that,
generally, are self-effectuating, and must be reported (along with
supporting cash-market information) to the Commission monthly on Form
204 after the positions are taken; \1060\ and paragraph (3) provides a
procedure for market participants to seek recognition from the
Commission for non-enumerated bona fide hedging positions. Under
paragraph (3), any person that seeks a Commission recognition of a
position as a non-enumerated bona fide hedge must apply to the
Commission in advance of taking on the position, and pursuant to the
processes outlined in Sec. 1.47 (30 days in advance for non-enumerated
bona fide hedges) or Sec. 1.48 (10 days in advance for enumerated
anticipatory hedges), as applicable.
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\1057\ 7 U.S.C. 6a(c); 17 CFR 1.3, 1.47, and 1.48.
\1058\ 7 U.S.C. 6a(c)(1).
\1059\ As described above, the Commission is moving an amended
version of the bona fide hedging definition from Sec. 1.3 to Sec.
150.1. See supra Section II.A.1. (discussion of Sec. 150.1).
\1060\ As described below, the Commission is eliminating Form
204 and relying instead on the cash-market information submitted to
exchanges pursuant to Sec. Sec. 150.5 and 150.9. See infra Section
II.H. (discussion of amendments to part 19).
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For the nine legacy agricultural contracts currently subject to
Federal position limits, the Commission's current process for
recognizing non-enumerated bona fide hedge positions exists in parallel
with exchange processes for granting exemptions from exchange-set
limits, as described below. The exchange processes for granting
exemptions vary by exchange, and generally do not mirror the
Commission's processes.\1061\ Thus, when requesting a non-enumerated
bona fide hedging position recognition, currently market participants
must submit two applications--one application submitted to the
Commission in accordance with Sec. 1.47 for purposes of compliance
with Federal position limits, and another application submitted to the
relevant exchange in accordance with the exchange's rules for purposes
of exchange-set position limits.
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\1061\ As discussed in the 2020 NPRM, exchanges typically use
one application process to grant all exemption types, whereas the
Commission has different processes for different bona fide hedge
exemption types. That is, the Commission currently has different
processes for permitting enumerated bona fide hedges and for
recognizing positions as non-enumerated bona fide hedges or
anticipatory bona fide hedges. Generally, for bona fide hedges
enumerated in paragraph (2) of the bona fide hedge definition in
Sec. 1.3, no formal process is required by the Commission. Instead,
such enumerated bona fide hedge recognitions are self-effectuating
and Commission staff reviews monthly reporting of cash-market
positions on existing Form 204 and part 17 position data to monitor
such positions. Requests for recognitions of non-enumerated bona
fide hedging positions and for certain enumerated anticipatory bona
fide hedge positions, as explained above, must be submitted to the
Commission pursuant to the processes in existing Sec. Sec. 1.47 and
1.48 of the regulations, as applicable. Further, exchanges generally
do not require the submission of monthly cash-market information;
instead, they generally require exemption applications to include
cash-market information supporting positions that exceed the limits,
to be filed prior to exceeding a position limit, and to be updated
on an annual basis. On the other hand, the Commission has various
monthly reporting requirements under Form 204 and part 17 of the
Commission's regulations as described above.
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2. Overview of the 2020 NPRM, Comments, and the Commission's
Determination
Generally, the Commission is adopting Sec. 150.9 largely as
proposed, but with certain clarifications and modifications to address
commenters' views and other considerations. This section provides an
overview of, and addresses general comments regarding, proposed Sec.
150.9. Further below, the Commission summarizes each sub-section of
Sec. 150.9 and comments relevant to that sub-section, and provides a
more detailed discussion of the Commission's determination and any
changes to each sub-section of Sec. 150.9.
i. General Overview of the 2020 NPRM
The Commission proposed Sec. 150.9 to establish a new framework
whereby a
[[Page 3369]]
market participant seeking a non-enumerated bona fide hedge recognition
could file one application with an exchange to receive a non-enumerated
bona fide hedge recognition for purposes of both exchange-set limits
and Federal position limits.\1062\ The proposed framework was intended
to be independent of, and serve as an alternative to, the Commission's
process for reviewing exemption requests under proposed Sec. 150.3.
The proposed framework was also intended to help: (1) Streamline the
process by which non-enumerated bona fide hedge applications are
addressed; (2) minimize disruptions by leveraging existing exchange-
level processes with which many market participants are already
familiar; \1063\ and (3) reduce inefficiencies created when market
participants are required to comply with different Federal and
exchange-level processes.
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\1062\ Alternatively, under the proposed framework, a trader
could submit a request directly to the Commission pursuant to
proposed Sec. 150.3(b). A trader that submitted such a request
directly to the Commission for purposes of Federal position limits
would have to separately request an exemption from the applicable
exchange for purposes of exchange-set limits. As discussed earlier
in this release, the Commission proposed to separately allow for
enumerated hedges and spreads that meet the ``spread transaction''
definition to be self-effectuating. See supra Section II.C.
(discussing proposed Sec. 150.3).
\1063\ In particular, the Commission recognizes that, in the
energy and metals spaces, market participants are familiar with
exchange application processes and are not familiar with the
Commission's processes since, currently, there are no Federal
position limits for those commodities.
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In the 2020 NPRM, the Commission emphasized that proposed Sec.
150.9 would serve as a separate, self-contained process that is related
to, but independent of, the proposed regulations governing: (1) The
process in proposed Sec. 150.3 for traders to apply directly to the
Commission for a bona fide hedge recognition; and (2) exchange
processes for establishing exchange-set limits and granting exemptions
therefrom in proposed Sec. 150.5. The Commission also emphasized that
proposed Sec. 150.9 would serve as a voluntary process that exchanges
could implement to provide additional flexibility for their market
participants to file one non-enumerated bona fide hedge application
with an exchange to receive a recognition for purposes of both
exchange-set limits and Federal speculative position limits. Finally,
the 2020 NPRM made clear that an exchange's determination to recognize
a non-enumerated bona fide hedge in accordance with proposed Sec.
150.9 with respect to exchange-set limits would serve to inform the
Commission's own decision as to whether to recognize the exchange's
determination for purposes of Federal speculative position limits set
forth in proposed Sec. 150.2, and would not be a substitute for the
Commission's determination.
Under the proposed procedural framework, an exchange's
determination to recognize a non-enumerated bona fide hedge in
accordance with proposed Sec. 150.9 with respect to exchange-set
limits would serve to inform the Commission's own decision as to
whether to recognize the exchange's determination for purposes of
Federal position limits set forth in proposed Sec. 150.2. Among other
conditions, the exchange would be required to base its determination on
standards that conform to the Commission's own standards for
recognizing bona fide hedges for purposes of Federal position limits.
Further, the exchange's determination with respect to its own
position limits and application process would be subject to Commission
review and oversight. These requirements were proposed to facilitate
the Commission's independent review and determination by ensuring that
any bona fide hedge recognized by an exchange for purposes of exchange-
set limits in accordance with proposed Sec. 150.9 conforms to the
Commission's standards. For a given referenced contract, proposed Sec.
150.9 would allow a person to exceed Federal position limits if the
exchange listing the contract recognized the position as a bona fide
hedge with respect to exchange-set limits, unless the Commission denies
or stays the application within ten business days (or two business days
for applications, including retroactive applications, filed due to
sudden or unforeseen circumstances) (the ``10/2-day review''). Under
the 2020 NPRM, if the Commission does not intervene during that 10/2-
day review period, then the exemption would be deemed approved for
purposes of Federal position limits. The Commission provides a more
detailed discussion of each sub-section of proposed Sec. 150.9 further
below.
ii. General Comments--Non-Enumerated Bona Fide Hedging Transactions or
Positions, Generally
Generally, the majority of commenters supported the Commission's
proposed approach in Sec. 150.9.\1064\ In particular, one commenter
expressed that Sec. 150.9 represents a ``fair and balanced''
approach,\1065\ and another commenter expressed that Sec. 150.9 offers
an ``efficient and timely process for hedgers to obtain permission to
mitigate their risk.'' \1066\ On the other hand, certain commenters
opposed the streamlined process in Sec. 150.9 and requested that the
Commission reduce or eliminate the role of exchanges in processing non-
enumerated bona fide hedge exemptions.\1067\
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\1064\ ICE at 8; CCI at 2; IECA at 1-2; NGFA at 9; MGEX at 4;
AGA at 11; CME Group at 7; FIA at 2; CMC at 10-11; EPSA at 6-7;
Suncor at 2; COPE at 4; Shell at 3-4; and CEWG at 3; See also ASR at
3 (noting that proposed Sec. 150.9 effectively leverages existing
exchange frameworks).
\1065\ Suncor at 2.
\1066\ COPE at 4.
\1067\ Rutkowski at 1; AFR at 2; IECA at 2-3; Public Citizen at
2-3; NEFI at 4; Better Markets at 3, 62; IATP at 13-14; NEFI at 4;
and PMAA at 4 (noting a concern that non-enumerated bona fide hedges
would be granted outside of the notice and comment rulemaking
process).
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In particular, certain commenters expressed concerns regarding the
proposed role of exchanges in Sec. 150.9. That is, certain commenters
were concerned that the streamlined approach in proposed Sec. 150.9
would create conflicts of interest for exchanges (which commenters note
are for-profit entities) where exchanges could benefit from granting
non-compliant non-enumerated bona fide hedge exemptions to boost
trading volume and profits.\1068\ Other commenters expressed concern
that Sec. 150.9 delegates too much discretion to exchanges to
determine what qualifies as a non-enumerated bona fide hedge without
well-defined criteria, and that such discretion could lead to an
unlimited universe of new non-enumerated bona fide hedge exemptions
that could adversely impact
[[Page 3370]]
markets.\1069\ Finally, several commenters shared the view that Sec.
150.9 would erode the Commission's authority over exchange-granted
exemptions, and that the Commission should retain all authority to
grant non-enumerated bona fide hedge exemptions.\1070\
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\1068\ Rutkowski at 1; see also AFR at 2 (stating concerns that
proposed Sec. 150.9 would be ineffective at controlling speculation
due, in part, to the substantially increased flexibility of
exchanges and market participants to determine whether positions
qualify for bona fide hedge exemptions or to propose and institute
new non-enumerated hedge exemptions, despite clear conflicts posed
by exchanges' incentive to directly profit from trading volume);
IECA at 2-3 and NEFI at 4 (stating that proposed Sec. 150.9 would
perpetuate a concern, raised by Congress in the Dodd-Frank Act, that
exchanges may be motivated by profit to allow broad hedge exemptions
that may include non-commercial market participants); Public Citizen
at 2-3 (stating that proposed Sec. 150.9 puts for-profit exchanges
in the driver's seat of making decisions on granting exemptions, and
that customer incentive programs offered by exchanges to increase
trading volumes would undermine the exchanges' efforts to determine
hedge exemptions; arguing that certain exchanges have experienced
difficulty in ``cooperating'' with current laws and regulations,
thus casting doubt on their ability to enforce the proposed rule;
and arguing that no additional authority should be granted to CME
pending resolution of CFTC v. Byrnes, Case. No. 13-cv-01174 (SDNY)
(alleging a violation of internal firewalls and sales of
confidential trading information to an outside broker). Regarding
Public Citizen's comment on CFTC v. Byrnes, the Commission notes
that this case has been resolved and is not a condition precedent to
this Final Rule.
\1069\ PMAA at 4; see also Better Markets at 63 (arguing that
the standards for exchanges to grant non-enumerated bona fide hedge
recognitions are too flexible and lack meaningful constraints).
\1070\ PMAA at 4 (noting a concern that non-enumerated bona fide
hedges would be granted outside of the notice and comment rulemaking
process); IATP at 13-14; NEFI at 4.
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iii. Discussion of Final Rule--Non-Enumerated Bona Fide Hedging
Transactions or Positions, Generally--General Concerns and Comments on
Sec. 150.9
First, the Commission reiterates, as stated in the 2020 NPRM, that
an exchange's determination to recognize a non-enumerated bona fide
hedge in accordance with proposed Sec. 150.9 with respect to exchange-
set limits would serve to inform the Commission's decision whether to
recognize such position as a non-enumerated bona fide hedge for
purposes of Federal position limits set forth in proposed Sec. 150.2.
The Commission is not delegating or ceding its authority to exchanges
to make the determination for purposes of Federal position limits to
recognize a position as a non-enumerated bona fide hedge for
applications submitted under Sec. 150.9. In that regard, the
exchange's determination to recognize a bona fide hedge with respect to
exchange-set limits established under Sec. 150.5 is not a substitute
for the Commission's independent review of, and determination with
respect to, non-enumerated bona fide hedge applications submitted
pursuant to Sec. 150.9.
As described in detail below, under Sec. 150.9 as adopted herein,
exchanges that elect to review non-enumerated bona fide hedge
applications under Sec. 150.9 are required to establish and maintain
standards and processes for such review, approved by the Commission
pursuant to Sec. 40.5. Section 150.9 requires, among other things,
that the exchanges base their determinations on standards that conform
to the Commission's own standards for recognizing bona fide hedges for
purposes of Federal position limits. The Final Rule also requires an
exchange to directly notify the Commission of any determinations to
recognize a non-enumerated bona fide hedge for purposes of exchange-set
limits, and, upon such notification, the Commission will make its
determination as to such applications for purposes of Federal position
limits. The Commission also reserves authority to, at a later date and
after providing an opportunity to respond, revoke a non-enumerated bona
fide hedge recognition that is approved through the Sec. 150.9 process
and require a participant to lower its position below the Federal
position limit level within a commercially reasonable time if the
Commission finds that the position no longer meets the bona fide hedge
definition in Sec. 150.1.
In response to general concerns that Sec. 150.9 would create
conflicts of interest for exchanges, the Commission does not believe
that Sec. 150.9 creates incentives for exchanges to grant non-
enumerated bona fide hedge exemptions in order to boost trading volume
and profits.\1071\ On the contrary, the Commission believes there are
several requirements and obligations that incentivize and require
exchanges to implement Sec. 150.9 in a manner that protects their
markets.
---------------------------------------------------------------------------
\1071\ See generally supra Sections II.B.2.iv.b. and II.G.2.
(discussing studies that indicate that exchanges are incentivized to
maintain market integrity).
---------------------------------------------------------------------------
First, under Sec. 150.9, exchanges may only grant non-enumerated
bona fide hedges that meet the Commission's bona fide hedging
definition, and each non-enumerated bona fide hedge approved by an
exchange for purposes of its own limits is separately and independently
reviewed by the Commission for purposes of Federal position limits.
Next, under Sec. 150.5(a)(2)(ii)(G) finalized herein, exchanges
are required to consider whether approving a particular exemption
request would result in positions that would not be in accord with
sound commercial practices in the relevant commodity derivatives market
and/or whether the position resulting from an approved exemption would
exceed an amount that may be established and liquidated in an orderly
fashion in that market.\1072\
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\1072\ See infra Final Rule Sec. 150.5(a)(2)(ii)(G).
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Finally, under DCM Core Principle 5 and SEF Core Principle 6,
exchanges are accountable for administering position limits in a manner
that reduces the potential threat of market manipulation or
congestion.\1073\ The Commission believes that these requirements,
working in concert, provide sufficient guardrails to mitigate any
potential conflicts of interest for exchanges.
---------------------------------------------------------------------------
\1073\ See 17 CFR 37.600 and 38.300.
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Further, the Commission does not agree that Sec. 150.9 improperly
delegates discretion to exchanges or erodes the Commission's authority
over exchanges and the non-enumerated bona fide hedge recognition
process because, as discussed above, the Commission is not delegating
its decision-making authority with respect to the granting of bona fide
hedge recognitions for purposes of Federal position limits. Rather, the
Commission is allowing exchanges to offer traders the opportunity to
submit their applications for a bona fide hedge recognition pursuant to
a consolidated review process under which the Commission will conduct
its own review and make an independent determination for purposes of
Federal speculative position limits.
The Commission has thus determined to adopt Sec. 150.9 largely as
proposed, but with certain modifications and clarifications, as
described further below, to address commenters' views and other
considerations. The following discussions summarize each sub-section of
proposed Sec. 150.9, as well as comments received and the Commission's
final determination with respect to each sub-section of Sec. 150.9.
3. Section 150.9(a)--Approval of Exchange Rules Related to the
Application Submission Process for Non-Enumerated Bona Fide Hedging
Transactions or Positions
i. Summary of 2020 NPRM--Approval of Rules
Proposed Sec. 150.9(a) would require an exchange to have rules,
adopted pursuant to the existing rule-approval process in Sec. 40.5 of
the Commission's regulations, that establish standards and processes in
accordance with proposed Sec. 150.9 as described below. The Commission
would review such rules to ensure that the exchange's standards and
processes for recognizing bona fide hedges for its own exchange-set
limits conform to the Commission's standards and processes for
recognizing bona fide hedges for Federal position limits.
ii. Comments--Approval of Exchange Rules Related to the Application
Submission Process for Non-Enumerated Bona Fide Hedging Transactions or
Positions
Although the Commission did not receive comments directly about the
requirements under proposed Sec. 150.9(a), the Commission did receive
comments related to when an exchange could start implementing Sec.
150.9, which is contingent on the exchange having approved rules in
place. That is, several commenters recommended a phased implementation
for starting the Sec. 150.9 process to avoid a concentration of non-
enumerated bona fide hedge applications at one time.\1074\
[[Page 3371]]
Commenters suggested starting the process either six months prior to
the effective date or permitting phased compliance for six months after
the effective date of the Final Rule.
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\1074\ See ICE at 9; IFUS at 7; CMC at 12; Shell at 4; FIA at
18; Chevron at 16; and CEWG at 27. See also CME Group at 8
(supporting a 12-month compliance date, but suggesting that the
Commission work with exchanges to implement a rolling process where
market participants are ``grandfathered into current exchange
approved exemptions they hold today, permitting them to file for
those exemptions on the same annual schedule'').
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iii. Discussion of Final Rule--Approval of Exchange Rules Related to
the Application Submission Process for Non-Enumerated Bona Fide Hedging
Transactions or Positions
The Commission is finalizing Sec. 150.9(a) with the clarifications
and rewording changes described below. As explained in the Proposal,
the Commission's pre-approval of an exchange's standards and process
for review of non-enumerated bona fide hedge applications ensures that
the exchange's determination is based on the Commission's applicable
standards and process, allowing the Commission to leverage off exchange
determinations in conducting the Commission's own, independent review.
While the Commission has determined, as described above, to extend
the compliance period with respect to certain obligations under this
Final Rule,\1075\ exchanges may start, but are not required, to
implement and begin processing non-enumerated bona fide hedge
applications under Sec. 150.9 as early as the Effective Date of the
Final Rule.\1076\ The Commission reminds exchanges that, to implement
Sec. 150.9, they will first need to submit new or amended rules to the
Commission, pursuant to the existing rule-approval process in Sec.
40.5 (which could take up to 45-90 days or longer, as agreed to by the
exchange) before they exchanges can begin processing applications under
Sec. 150.9.
---------------------------------------------------------------------------
\1075\ See supra Section I.D. (discussing the effective and
compliance dates for the Final Rule).
\1076\ Id.
---------------------------------------------------------------------------
Finally, the Commission clarifies that market participants with
existing Commission-granted non-enumerated or anticipatory bona fide
hedge recognitions (other than risk management exemptions) are not
required to reapply to the Commission for a new recognition under the
Final Rule. That is, if the Commission previously issued a non-
enumerated or anticipatory bona fide hedge recognition for one of the
nine legacy agricultural contracts pursuant to existing Sec. 1.47 or
Sec. 1.48, as applicable, a market participant is not required, under
the Final Rule, to reapply to the Commission for such recognition
pursuant to final Sec. 150.3 or Sec. 150.9.
In addition, the Commission is making a technical change by
rewording Sec. 150.9(a) to clarify that exchanges must seek approval,
using the Commission's rule approval process in existing Sec. 40.5, to
implement their rules establishing application processes under Sec.
150.9.
4. Section 150.9(b)--Prerequisites for an Exchange To Recognize Non-
Enumerated Bona Fide Hedges in Accordance With This Section
i. Summary of 2020 NPRM--Prerequisites for an Exchange To Recognize
Non-Enumerated Bona Fide Hedges
Proposed Sec. 150.9(b) set forth conditions that would require an
exchange-recognized bona fide hedge to conform to the corresponding
definitions and standards the Commission uses in proposed Sec. Sec.
150.1 and 150.3 for purposes of the Federal position limits regime.
Proposed Sec. 150.9(b) would require the exchange to meet the
following conditions: (i) The exchange lists the applicable referenced
contract for trading; (ii) the position is consistent with both the
definition of bona fide hedging transaction or position in proposed
Sec. 150.1 and existing CEA section 4a(c)(2); and (iii) the exchange
does not recognize as bona fide hedges any positions that include
commodity index contracts and one or more referenced contracts,
including exemptions known as risk management exemptions.\1077\
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\1077\ The Commission finds that financial products are not
substitutes for positions taken or to be taken in a physical
marketing channel. Thus, the offset of financial risks arising from
financial products would be inconsistent with the definition of bona
fide hedging transactions or positions for physical commodities in
proposed Sec. 150.1. See supra Section II.A.1. (discussion of the
temporary substitute test and risk-management exemptions).
---------------------------------------------------------------------------
ii. Comments and Summary of Commission Determination--Prerequisites for
an Exchange To Recognize Non-Enumerated Bona Fide Hedges
The Commission did not receive any comments on proposed Sec.
150.9(b) and is finalizing this section as proposed, for reasons stated
above with respect to Sec. 150.9(b), and with only minor grammatical
edits to change certain words to a singular tense.
5. Section 150.9(c)--Application Process
Proposed Sec. 150.9(c) set forth the information and
representations that the exchange, at a minimum, would be required to
obtain from applicants as part of the Sec. 150.9 application process.
Proposed Sec. 150.9(c) would permit exchanges to rely upon their
existing application forms and processes in making such determinations,
provided that they collect the information outlined below. The
following sections summarize each sub-section of proposed Sec.
150.9(c) as well as comments received and the Commission's
determination on each sub-section.
i. Section 150.9(c)(1)--Required Information for Non-Enumerated Bona
Fide Hedging Positions
a. Summary of 2020 NPRM--Required Information for Non-Enumerated Bona
Fide Hedging Positions
With respect to bona fide hedging positions in referenced
contracts, proposed Sec. 150.9(c)(1) would require that any
application include: (i) A description of the position in the commodity
derivative contract for which the application is submitted (which would
include the name of the underlying commodity and the position size);
(ii) information to demonstrate why the position satisfies CEA section
4a(c)(2) and the definition of bona fide hedging transaction or
position in proposed Sec. 150.1, including ``factual and legal
analysis;'' (iii) a statement concerning the maximum size of all gross
positions in derivative contracts for which the application is
submitted (in order to provide a view of the true footprint of the
position in the market); (iv) information regarding the applicant's
activity in the cash markets for the commodity underlying the position
for which the application is submitted; \1078\ and (v) any other
information the exchange requires, in its discretion, to enable the
exchange and the Commission to determine whether such position should
be recognized as a bona fide hedge.\1079\
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\1078\ The Commission expects that exchanges would require
applicants to provide cash-market data for at least the prior year.
\1079\ Under proposed Sec. 150.9(c)(1)(iv) and (v), exchanges,
in their discretion, could request additional information as
necessary, including information for cash-market data similar to
what is required in the Commission's existing Form 204. See infra
Section II.H.2. (discussion of Form 204 and amendments to part 19).
Exchanges could also request a description of any positions in other
commodity derivative contracts in the same commodity underlying the
commodity derivative contract for which the application is
submitted. Other commodity derivatives contracts could include other
futures contracts, option on futures contracts, and swaps (including
OTC swaps) positions held by the applicant.
---------------------------------------------------------------------------
In the 2020 NPRM, the Commission noted that exchanges would not
need to require the identification of a hedging need against a
particular identified
[[Page 3372]]
category, but that the requesting party must satisfy all applicable
requirements in proposed Sec. 150.9, including demonstrating with a
factual and legal analysis that a position would fit within the bona
fide hedge definition. The 2020 NPRM was not intended to require the
hedging party's books and records to identify the particular type of
hedge being applied.
b. Comments--Required Information for Non-Enumerated Bona Fide Hedging
Positions
The Commission received few comments related to the application
requirements exchanges must implement under proposed Sec. 150.9(c)(1).
Some commenters requested that the Commission remove the requirement
that the exchange applications implemented under proposed Sec.
150.9(c)(1)(ii) require a ``factual and legal analysis'' from
applicants.\1080\ Another commenter requested that the Commission
clarify any additional factors exchanges should consider when granting
non-enumerated bona fide hedge applications pursuant to proposed Sec.
150.9.\1081\
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\1080\ CME Group at 10 (noting its concern that this requirement
could be interpreted as requiring applicants to engage legal counsel
to complete their applications. CME Group stated that by way of
background, CME Group exchanges have never required detailed legal
or economic analysis to demonstrate compliance with regulatory
requirements. Instead, CME Group requires the applicant to explain
its strategy, and CME Group considers and analyzes this explanation
using the exchange's expertise. CME Group recommends that the CFTC
instead require an applicant to ``explain its strategy and state
that it complies with the regulatory requirements for a bona fide
hedge exemption without having to provide a legal analysis.'' The
exchange can solicit additional information from the applicant as
needed.) and CMC at 11 (providing that, in the alternative, the
Commission could clarify that exchanges or the Commission might
request legal analyses at their discretion, which may be in the form
of analysis provided by in-house counsel).
\1081\ See ISDA at 9 (requesting that the final rule include
factors exchanges should consider, such as ``sound commercial
practices'' or ``necessary and appropriate to reduce potential
threat of market manipulation'').
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c. Discussion of Final Rule--Required Information for Non-Enumerated
Bona Fide Hedging Positions
The Commission is adopting Sec. 150.9(c)(1), with certain
revisions and clarifications, explained below. The information required
to be submitted as part of the application is necessary to allow the
exchange and the Commission to evaluate whether the applicant's hedging
position satisfies the bona fide hedge definition in proposed Sec.
150.1 and CEA section 4a(c)(2).
The Commission is making one modification to clarify the
Commission's posture when reviewing non-enumerated bona fide hedge
applications under the Sec. 150.9 process. In proposed Sec.
150.9(c)(1) the Commission proposed to require exchanges to collect
sufficient information for the exchange to determine and the Commission
to ``verify'' that the facts and circumstances demonstrate that the
exchange may recognize a position as a bona fide hedge. In final Sec.
150.9(c)(1), the Commission is revising this provision to make clear
that the Commission will conduct an independent evaluation of any
application it reviews to ``determine'' (not verify) whether the facts
and circumstances demonstrate that the exchange may recognize the
position as a bona fide hedge. Likewise, the Commission is also
revising final Sec. 150.9(c)(1)(v), to require that exchanges collect
any other information they deem necessary to ``determine'' (not
``verify'' as proposed) whether a particular position meets the bona
fide hedge definition. The term ``determine'' more accurately describes
the exchange's responsibility to conduct an independent evaluation of
each application, as opposed to a verification, as proposed.
In final Sec. 150.9(c)(1)(ii), the Commission is modifying the
requirement from proposed Sec. 150.9(c)(1)(ii) that exchanges request
a ``factual and legal'' analysis from applicants for non-enumerated
bona fide hedge recognitions. In proposing this requirement, the
Commission did not intend for exchanges to require that applicants
engage legal counsel to complete their applications for non-enumerated
bona fide hedge recognitions. Rather, the purpose of this proposed
provision was to ensure that applicants provide an explanation and
information that sufficiently demonstrates why a particular position
qualifies as bona fide hedge, as defined in Sec. 150.1 and CEA section
4a(c)(2). Instead of requiring a ``factual and legal analysis,'' the
Commission has revised Sec. 150.9(c)(1)(ii) in the Final Rule
accordingly so that an applicant must provide an explanation of the
hedging strategy, including a statement that the applicant's position
complies with the applicable requirements of the bona fide hedge
definition, and information to demonstrate why the position satisfies
the applicable requirements. This revision is intended to clarify that
the applicant is not required to provide a detailed legal analysis or
engage legal counsel to complete their application. Rather, the
applicant must provide: (1) A simple explanation or description of the
hedging strategy (and include a statement that the strategy complies
with the bona fide hedge definition requirements); and (2) the relevant
information that shows why or how the strategy meets the bona fide
hedge definition requirements. The exchange can then consider this
explanation and information in light of its expertise with the relevant
market in performing its own analysis.
Also, under Sec. 150.9(c)(1), regarding the request that the
Commission provide additional factors that exchanges should consider
when granting non-enumerated bona fide hedge recognitions, the
Commission believes that the requirements under final Sec. 150.9(c)
provide sufficient criteria for exchanges to consider when evaluating
applications. As stated in the 2020 NPRM, the Commission believes the
information an exchange is required to collect under Sec. 150.9(c) is
sufficient for the exchange and the Commission to determine whether a
particular transaction or position satisfies the definition of bona
fide hedging transaction for purposes of Federal position limits. The
Commission further highlights that, under final Sec. 150.9(c)(1)(v),
an exchange has the authority to collect any additional information
that, in its discretion, would help it assess whether to approve a
request for a non-enumerated bona fide hedge recognition. Further, in
response to ISDA's request, an exchange is required by Sec.
150.5(a)(2)(ii)(G) to consider some of the factors ISDA recommended
when determining whether to grant an exemption, including whether the
approval of an exemption would result in positions that are in accord
with sound commercial practices, among other considerations.\1082\ In
summary, the Commission believes that the final regulations strike the
proper balance by providing sufficient guidance to the exchanges for
their review and determination in the context of exchange-set limits,
while preserving the exchanges' discretionary authority to determine
what types of additional information, if any, to collect.
---------------------------------------------------------------------------
\1082\ See supra Section II.D.3. (addressing other factors
exchanges must consider, under Sec. 150.5(a)(2)(ii)(G), when
granting exemptions for contracts that are subject to Federal
position limits).
---------------------------------------------------------------------------
In addition to the revisions and explanations above, the Commission
is adding the word ``needed'' to Sec. 150.9(c)(1) to clarify that
exchanges may collect all information needed to conduct their analysis
of a particular application.
[[Page 3373]]
ii. Section 150.9(c)(2)--Timing of Non-Enumerated Bona Fide Hedge
Application
a. Summary of 2020 NPRM--Timing of Non-Enumerated Bona Fide Hedge
Application
The Commission did not propose to prescribe timelines (e.g., a
specified number of days) for exchanges to review applications because
the Commission believed that exchanges are in the best position to
determine how to best accommodate the needs of their market
participants. Rather, under proposed Sec. 150.9(c)(2), an applicant
must submit its application in advance of exceeding the applicable
Federal position limits for any given referenced contract.
However, the 2020 NPRM would permit a person to submit a bona fide
hedge application within five days after the person has exceeded
Federal speculative limits (commonly referred to as retroactive
applications) if such person exceeds the limits due to ``demonstrated
sudden or unforeseen increases in its bona fide hedging needs.'' Where
an applicant claims a sudden or unforeseen increase in its bona fide
hedging needs, the 2020 NPRM would require exchanges to require that
the person provide materials demonstrating that the person exceeded the
Federal speculative limit due to sudden or unforeseen circumstances.
Further, in the 2020 NPRM, the Commission cautioned exchanges that
applications submitted after a person has exceeded Federal position
limits should not be habitual and would be reviewed closely. Finally,
if the Commission found that the position did not qualify as a bona
fide hedge, then the applicant would be required to bring its position
into compliance, and could face a position limits violation if it did
not reduce the position within a commercially reasonable time.
b. Comments--Timing of Non-Enumerated Bona Fide Hedge Application
The Commission received several comments regarding the retroactive
application provision in proposed Sec. 150.9(c)(2)(ii). CME preferred
allowing retroactive application exemptions that are not limited to
circumstances involving sudden/unforeseen increases in bona fide
hedging needs.\1083\ Instead, CME Group recommended that the Commission
(i) allow retroactive applications regardless of the circumstances, and
(ii) impose a position limits violation upon an applicant if the
exchange denies the retroactive application.\1084\ ICE recommended that
the Commission permit retroactive exemptions for other types of
exemptions (including spread exemptions and pass-through-swap
exemptions) as well as for position limit overages that occur as a
result of operational or incidental issues where the applicant did not
intend to evade position limits.\1085\ Finally, IFUS supported the
retroactive application provision as it was proposed.\1086\ IFUS noted
that it follows a similar approach under its existing rules.\1087\
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\1083\ CME Group at 9-10 (explaining that in its experience,
position limit violations ``often occur unintentionally due to
operational or administrative oversight, not because the market
participant needed to enter into a hedge quickly in response to
changing market conditions'' and that over the past three years, CME
Group has received at least 49 retroactive exemption applications to
address some type of administrative oversight issue); See also CMC
at 11 (agreeing with CME Group), and FIA at 18 (recommending the
Commission allow retroactive exemptions within five business days
for any reason).
\1084\ CME Group at 9-10 (explaining that without the threat of
a potential position limits violation, market participants could
exploit the retroactive provision and intentionally exceed position
limits without consequences--``all while disrupting orderly market
operations.'' According to CME Group, the prospect of having an
application denied and being found in violation of position limits
has worked to deter market participants from attempting to exploit
the retroactive exemption process).
\1085\ ICE at 10.
\1086\ IFUS at 13-14.
\1087\ Id.
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c. Discussion of Final Rule--Timing of Non-Enumerated Bona Fide Hedge
Application
The Commission is adopting Sec. 150.9(c) largely as proposed, with
certain modifications and clarifications to reflect commenters' views
and other considerations. First, the Commission is revising Final Rule
Sec. 150.9(c)(2)(i) so that it is consistent with changes the
Commission is making to Sec. 150.9(e)(3), discussed further
below.\1088\ As explained below, under Final Rule Sec.
150.9(e)(3),\1089\ applicants may elect (at their own risk) \1090\ to
exceed Federal position limits after an exchange notifies the
Commission of the exchange's approval of the application for purposes
of exchange-set limits,\1091\ and during the Commission's 10-day review
period. This is a change from the 2020 NPRM under which a person would
be required to wait until the Commission's 10-day review period expired
before exceeding Federal position limits. Proposed Sec. 150.9(c)(2)(i)
was drafted in a manner that reflects this proposed requirement.
Accordingly, the Commission is revising Sec. 150.9(c)(2)(i) to clarify
that an applicant may exceed Federal position limits after receiving a
notice of approval from the relevant designated contract market or swap
execution facility.
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\1088\ See infra Section II.G.7. (discussing when a person may
exceed Federal position limits).
\1089\ Id.
\1090\ See infra Section II.G.7.ii. (explaining that an
applicant bears the risk that the Commission could deny the
application and require the person to bring their position into
compliance with Federal position limits).
\1091\ The Commission clarifies, for the avoidance of doubt,
that an exchange approval of a non-enumerated bona fide hedge (for
purposes of exchange limits) issued under Sec. 150.9 is not a
Commission approval of the non-enumerated bona fide hedge.
---------------------------------------------------------------------------
Next, the Commission has determined not to expand the retroactive
application provision in Sec. 150.9(c)(2)(ii) to be available in any
circumstances (i.e., not just for sudden or unforeseen hedging needs)
or for other exemption types. The Final Rule provides broad flexibility
to market participants in the form of various exemptions from Federal
position limits. In particular, this Final Rule significantly expands
the list of self-effectuating enumerated bona fide hedges available to
market participants,\1092\ provides an expansive spread transaction
exemption provision,\1093\ and provides new exemptions for relief for
financial distress positions and conditional spot month limits for
certain natural gas positions.\1094\ This Final Rule also grants
additional flexibility for market participants to exceed Federal
position limits during the pendency of the Commission's review of the
application. Given these additional enhancements to the Federal
position limits framework for bona fide hedges and other exemptions,
the Commission expects that there will be a limited number of non-
enumerated bona fide hedge requests submitted through the Sec. 150.9
process and that it is reasonable to expect that market participants
will be able to file any such non-enumerated bona fide hedge requests
ahead of needing to exceed limits.
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\1092\ See supra Section II.A.1. (discussing the expanded list
of enumerated bona fide hedges in Appendix A).
\1093\ See supra Section II.A.20. (discussing the expanded
spread transaction definition in Sec. 150.1).
\1094\ See supra Section II.C.5-6. (discussing the financial
distress exemption and the conditional spot month limit exemption in
natural gas).
---------------------------------------------------------------------------
The Commission is willing to permit the limited exception for
retroactive applications that occur due to sudden or unforeseen bona
fide hedging needs, as described above. Otherwise, market participants
would be penalized and prevented from assuming appropriate hedges even
though their hedging need arises from circumstances beyond their
[[Page 3374]]
control. Beyond that exception, the Commission believes that market
participants are able, and should be required, to file timely
applications. The Commission believes this is particularly true for
trading strategies that are not enumerated bona fide hedges and thus
may involve some element of non-risk reducing activity. Expanding the
exception beyond bona fide hedging needs that arise due to sudden or
unforeseen circumstances may dis-incentivize market participants from
properly monitoring their hedging activities and filing exemption
applications in a timely manner.
iii. Section 150.9(c)(3)--Renewal of Applications for Non-Enumerated
Bona Fide Hedges
a. Summary of 2020 NPRM--Renewal of Applications for Non-Enumerated
Bona Fide Hedges
Proposed Sec. 150.9(c)(3) would require that the exchange require
persons with approved non-enumerated bona fide hedges that were
previously granted pursuant to proposed Sec. 150.9 to reapply to the
exchange at least on an annual basis by updating their original
applications. Proposed Sec. 150.9(c)(3) would also require that the
exchange require applicants to receive a notice of approval of the
renewal from the exchange prior to exceeding the applicable position
limit.
b. Comments--Renewal of Applications for Non-Enumerated Bona Fide
Hedges
Several commenters requested a clarification that an applicant (i)
would only be subject to the Commission's 10/2-day review process in
Sec. 150.9(e) (described below) for initial applications for non-
enumerated bona fide hedge recognitions, and (ii) would not be subject
to such review for annual renewal applications, unless the facts and
circumstances materially change from those presented in the initial
application.\1095\
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\1095\ CEWG at 27; MGEX at 3; CME Group at 8; FIA at 17; ICE at
9; and IFUS at 7 (further requesting that if a non-enumerated bona
fide hedge is granted, a participant should be able to treat similar
positions as bona fide hedges so long as they re-apply to the
exchange through the annual renewal process).
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c. Discussion of Final Rule--Renewal of Applications for Non-Enumerated
Bona Fide Hedges
The Commission is adopting Sec. 150.9(c)(3) with modifications to
clarify that the Commission's review and determination conducted under
final Sec. 150.9(e) is required only for initial applications for non-
enumerated bona fide hedge recognitions. The Commission is also
clarifying that, except as provided below, renewals of previously-
approved non-enumerated bona fide hedge applications are not required
to be submitted to the Commission under Sec. 150.9, and need only be
submitted to and approved by the relevant exchange at least on an
annual basis for the applicant to continue relying on such recognition
for purposes of Federal position limits. Such renewal application
serves the purpose of confirming that the facts and circumstances
underlying the original application approved by the Commission remain
operative. However, if the facts and circumstances underlying a renewal
application are materially different than the initial application, then
such application should be treated as a new request that should be
submitted through the Sec. 150.9 process and subject to the
Commission's 10/2-day review process in Sec. 150.9(e).
iv. Section 150.9(c)(4)--Exchange Revocation Authority
a. Summary of the 2020 NPRM--Exchange Revocation Authority
Proposed Sec. 150.9(c)(4) would require that an exchange retain
its authority to limit, condition, or revoke, at any time, any
recognition previously issued pursuant to proposed Sec. 150.9, for any
reason, including if the exchange determines that the recognition is no
longer consistent with the bona fide hedge definition in proposed Sec.
150.1 or section 4a(c)(2) of the Act.
b. Comments and Summary of the Commission Determination--Exchange
Revocation Authority
The Commission did not receive comments on proposed Sec.
150.9(c)(4) and is finalizing this section as proposed.
6. Section 150.9(d)--Recordkeeping
i. Summary of the 2020 NPRM--Recordkeeping
Proposed Sec. 150.9(d) would require exchanges to maintain
complete books and records of all activities relating to the processing
and disposition of applications in a manner consistent with the
Commission's existing general regulations regarding
recordkeeping.\1096\ Such records would need to include: All
information and documents submitted by an applicant in connection with
its application; records of oral and written communications between the
exchange and the applicant in connection with the application; and
information and documents in connection with the exchange's analysis
of, and action on, such application. Exchanges would also be required
to maintain any documentation submitted by an applicant after the
disposition of an application, including, for example, any reports or
updates the applicant files with the exchange.
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\1096\ Requirements regarding the keeping and inspection of all
books and records required to be kept by the Act or the Commission's
regulations are found at Sec. 1.31. 17 CFR 1.31. DCMs are already
required to maintain records of their business activities in
accordance with the requirements of Sec. 1.31 and Sec. 38.951. 17
CFR 38.951.
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ii. Comments--Recordkeeping
The Commission received one comment regarding exchange
recordkeeping requirements under proposed Sec. 150.9. NGSA requested
that any exchange recordkeeping/reporting requirements that apply to
the proposed Sec. 150.9 process do not require matching applicants'
hedge positions to their underlying cash positions on a one-to-basis,
but should instead allow for recordkeeping/reporting of positions on an
aggregate basis.\1097\
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\1097\ See NGSA at 9 (noting that allowing matching on an
aggregate basis would accommodate the practical needs of many market
participants to hedge their risks on a portfolio basis).
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iii. Discussion of Final Rule--Recordkeeping
The Commission is adopting Sec. 150.9(d) as proposed, and with
only one minor grammatical edit to change the term ``designated
contract market'' to the correct possessive tense. The Commission also
clarifies here, in response to comments, that the Sec. 150.9(d)
recordkeeping requirements do not prescribe the manner in which
exchanges record how they match applicants' bona fide hedge positions
to applicants' underlying cash positions. Rather, final Sec.
150.9(c)(1)(iv) requires that an exchange collect the necessary
information regarding an applicant's cash-market activity and
offsetting cash positions, and final Sec. 150.9(d) simply requires the
exchange to keep a record of such application materials and information
collected. However, an exchange's records should be sufficient to
demonstrate that any approved non-enumerated bona fide hedges meet the
requirements of Sec. 150.9(b). The Commission also reiterates, as
explained in the 2020 NPRM, that exchanges are required to store and
produce records pursuant to existing Sec. 1.31,\1098\ and will
[[Page 3375]]
be subject to requests for information pursuant to other applicable
Commission regulations, including, for example, existing Sec.
38.5.\1099\
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\1098\ Consistent with existing Sec. 1.31, the Commission
expects that these records would be readily available during the
first two years of the required five-year recordkeeping period for
paper records, and readily accessible for the entire five-year
recordkeeping period for electronic records. In addition, the
Commission expects that records required to be maintained by an
exchange pursuant to this section would be readily accessible during
the pendency of any application, and for two years following any
disposition that did not recognize a derivative position as a bona
fide hedge.
\1099\ See 17 CFR 38.5 (requiring, in general, that upon request
by the Commission, a DCM must file responsive information with the
Commission, such as information related to its business, or a
written demonstration of the DCM's compliance with one or more core
principles).
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7. Section 150.9(e)--Process for a Person To Exceed Federal Position
Limits
The following discussion summarizes proposed Sec. 150.9(e),
comments received, and the Commission's determination according to each
sub-section, or a combination of certain subsections, of Sec.
150.9(e).
i. Section 150.9(e)(1)-(2)--Notification to the Commission and
Notification Requirements
a. Summary of the 2020 NPRM--Notification to the Commission and
Notification Requirements
Under proposed Sec. 150.9(e)(1), once an exchange recognizes a
non-enumerated bona fide hedge with respect to its own exchange-set
position limits established pursuant to Sec. 150.5(a), the exchange
would be required to notify the Commission concurrently with the
approval notice it provides to the applicant. Under proposed Sec.
150.9(e)(2), such notification to the Commission would need to include
a copy of the application and any supporting materials, as well as
certain basic information, outlined in Sec. 150.9(e)(2)(i)-(vi), about
the exemption. The exchange would only be required to provide this
notice to the Commission with respect to its initial (and not renewal)
determination for a particular application.
b. Comments--Notification to the Commission and Notification
Requirements
While proposed Sec. 150.9(e)(1) would require an exchange to
notify the Commission upon making an initial determination to recognize
a non-enumerated bona fide hedge, that rule would not require the
exchange to notify the public of any such determination. Commenters
submitted several general requests related to the publication of non-
enumerated bona fide hedges and the future expansion of the list of
enumerated bona fide hedges in Appendix A to the proposed regulatory
text in the 2020 NPRM. Specifically, certain commenters requested that
exchanges be required to publicize approved non-enumerated bona fide
hedge recognitions so that market participants are aware of the types
of recognitions they can receive.\1100\
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\1100\ See COPE at 5 (noting that such notice should provide
market participants the facts upon which the recognition is based,
and would save the Commission from repeatedly processing requests
for the same hedging strategy); FIA at 15, 19 (requesting that
exchanges be required to publish anonymized descriptions of non-
enumerated hedging recognitions granted by the exchange); EPSA at 5-
7.
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c. Discussion of Final Rule--Notification to the Commission and
Notification Requirements
The Commission has determined to finalize Sec. 150.9(e)(1)-(2) as
proposed. While the Final Rule does not require exchanges to publicize
approved non-enumerated bona fide hedge recognitions, an exchange may
elect, in its discretion, to provide such a list. The Commission
understands, however, that in the past, exchanges and market
participants have raised concerns that publicizing information about
approved non-enumerated bona fide hedges could divulge confidential
information (such as trade secrets, intellectual property, the market
participant's identity or position).\1101\
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\1101\ See 81 FR at 96824.
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To the extent that an exchange elects to publicize descriptions of
approved non-enumerated bona fide hedges, the Commission cautions that
any such data published should not disclose the identity of, or
confidential information about, the applicant. Rather, any published
summaries are expected to be general (generic facts and circumstances).
While the decision whether to publicize descriptions of approved non-
enumerated bona fide hedges is at the discretion of the exchange, the
exchange remains subject to all applicable laws and regulations
(including exchange bylaws) governing the protection of confidential
trade and trader information. The Commission also cautions exchanges to
make clear that any descriptions or lists of approved non-enumerated
bona fide hedges they elect to publish are for informational purposes
only and do not bestow any rights upon applicants to a claim that a
particular strategy is a non-enumerated bona fide hedge simply because
it aligns with a published example or description provided by the
exchange.
ii. Section 150.9(e)(3)-(4)--Exceeding Federal Speculative Position
Limits and the Commission's 10/2-Day Review Process
a. Summary of the 2020 NPRM--Exceeding Federal Speculative Position
Limits and the Commission's 10/2-Day Review Process
Under proposed Sec. 150.9(e)(3), a person could exceed Federal
position limits ten business days after the exchange notifies the
Commission in accordance with proposed Sec. 150.9(e)(2) that the
exchange has approved the non-enumerated bona fide hedge application
for purposes of exchange limits, provided that the Commission does not
notify the exchange or applicant that the Commission has determined to
stay or deny the application during its ten-day review.
Under proposed Sec. 150.9(e)(4), if a person exceeds Federal
position limits due to sudden or unforeseen bona fide hedging needs and
then files a retroactive application pursuant to proposed Sec.
150.9(c)(2)(ii), then such application would be deemed approved by the
Commission two business days after the exchange issues the required
notification, provided that the Commission does not notify the exchange
or applicant that the Commission has determined to stay or deny the
application during its two-day review.
Under the 2020 NPRM, once those ten (or two) business days have
passed, the person could rely on the bona fide hedge recognition both
for purposes of exchange-set and Federal position limits, with the
certainty that the Commission (and not Commission staff) would only
revoke that determination in the limited circumstances set forth in
proposed Sec. 150.9(f)(1) and (2) described further below.
b. Comments--Exceeding Federal Speculative Position Limits and the
Commission's 10/2-Day Review Process
The bulk of the comments the Commission received on proposed Sec.
150.9 relate to the Commission's proposed ten-day or two-day period for
reviewing a non-enumerated bona fide hedge application after an
exchange has already approved the application for purposes of the
exchange-set limits (as noted above,\1102\ the 10/2-day review). In
particular, the Commission received several comments on the sufficiency
of the proposed review periods, including that the Commission's
proposed 10/2-
[[Page 3376]]
day review period is: (1) Too long; \1103\ (2) too short; \1104\ and
(3) just right.\1105\
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\1102\ See supra Section II.G.
\1103\ ADM at 6 (suggesting a five/one business day review
period); ICE at 9 (explaining that the 10-day review period would
impose unnecessary burdens and delay and create uncertainty for
market participants); IFUS at 14 (explaining that the 10-day review
period potentially conflicts with the exchange's spot-month
exemption review process, as contracts could expire before the
review period ends, and noting that a two day review, although not
ideal, is preferred); NGFA at 9 (suggesting a two-business-day
review period).
\1104\ IATP at 13-14 (contending that the 10/2-day review period
would burden an under-resourced Commission); Better Markets at 3, 63
(asserting that, under proposed Sec. 150.9, it is impossible for
Commission staff to, within the prescribed amount of time: review
and collect additional information on non-enumerated bona fide hedge
applications; draft orders; receive the Chairman's approval for a
seriatim process; and secure the necessary Commissioner votes).
\1105\ CME Group at 7 (also agreeing that a timeline for
exchanges' review of applications should not be prescribed).
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In addition, several commenters suggested that the Commission
permit applicants to exceed Federal position limits during the
Commission's ten-day review period (which occurs after an exchange
issues its approval with respect to exchange-set limits).\1106\
Commenters also suggested that rather than the CFTC reviewing each non-
enumerated bona fide hedge exemption application after each exchange
determination, the CFTC should monitor exchanges at a higher level
(such as through the rule enforcement review process).\1107\
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\1106\ ADM at 6; ICE at 9; IFUS at 7; CME Group at 7-8
(explaining that exchanges have ``strong incentives to grant
exemptions only after careful review'' because they have statutory
obligations to prevent manipulation); CMC at 12 (noting that it is
currently unclear whether an applicant can enter into a position
during the Commission's 10/2-day review).
\1107\ ICE at 9; IFUS at 7 (questioning whether it is necessary
for the Commission to routinely review each non-enumerated bona fide
hedge application); CEWG at 26-27 (suggesting an annual exchange
rule enforcement review process instead of the 10/2-day review).
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c. Discussion of Final Rule--Exceeding Federal Speculative Position
Limits and the Commission's 10/2-Day Review Process
The Commission is adopting Sec. 150.9(e)(3)-(4) with certain
revisions and clarifications as discussed below.
First, regarding general comments on the length of the Commission's
10/2-day review periods, the Commission acknowledges commenters'
concerns regarding whether the Commission will have enough time to
review and act on non-enumerated bona fide hedge applications. However,
the Commission will continue to develop internal processes and systems
to respond to Sec. 150.9 applications as needed and within those
timeframes. In addition, the Sec. 150.9 process enables the Commission
to leverage the exchange's review and analysis, which would serve to
inform the Commission's own review. The Commission believes that this
streamlined approach will reduce the amount of time required for the
Commission's review each application.
In addition, regarding comments suggesting that the 10/2-day review
periods are too long and will impose unnecessary delays on market
participants, and the request that market participants be able to
exceed Federal position limits during the Commission's 10-day review,
the Commission is revising proposed Sec. 150.9(e)(3) to provided
additional flexibility. Under Sec. 150.9(e)(3), applicants may elect
to exceed Federal position limits once they receive a notice of
approval from the relevant exchange and during the Commission's 10-day
review period, but will do so at their own risk.
That is, if an applicant exceeds Federal position limits before the
Commission's 10-day review period ends, the applicant bears market risk
for that position, in that the Commission could, in accordance with
Sec. 150.9(e)(6) described below, deny the application for purposes of
Federal position limits and require the applicant to bring its position
back into compliance with the Federal position limits within a
commercially reasonable amount of time, as determined by the Commission
in consultation with the relevant exchange and applicant. As discussed
below in connection with Sec. 150.9(e)(6), in these circumstances
where an applicant is required to lower its position, as a matter of
policy, the Commission will not pursue an enforcement action against
the applicant so long as the application was filed in good faith
(meaning the applicant and exchange have a reasonable and good faith
basis for determining that the position meets the requirements of Sec.
150.9(b)) and the applicant brings its position into compliance within
a commercially reasonable amount of time.
Further, regarding general comments that the length of the 10/2-day
review period is too long, the Commission believes allowing applicants
to exceed Federal position limits during the Commission's ten-day
review period addresses many commenter concerns. As described above,
the Final Rule also affords applicants the ability to file retroactive
applications in certain limited circumstances, and to hold positions
above Federal position limits during the Commission's two-day review of
such retroactive application. The Commission believes that these
avenues adequately accommodate market participants' needs to hedge in a
timely manner, and are well-balanced with the Commission's need to
maintain adequate oversight of non-enumerated bona fide hedge
applications through its limited 10/2-day review periods.
Furthermore, the Commission would consider it to be a reasonable
and helpful practice if exchanges elect to provide information to the
Commission on non-enumerated bona fide hedge applications as the
exchange is considering such applications. That is, the Commission
would find it helpful to receive an advance courtesy copy of any Sec.
150.9 applications the exchange receives. The exchange is not, however,
required to provide such advance copies, and would not be required to
obtain an opinion on such applications from the Commission before
making its determination. Rather, providing such application
information as the exchange receives it could facilitate a more rapid
Commission evaluation of Sec. 150.9 applications. This would help
facilitate additional regulatory certainty for market participants and
would aid the Commission in its review of applications processed under
Sec. 150.9.
Also, while commenters requested that the Commission should not
review each non-enumerated bona fide hedge application, the Commission
is of the view that it must review each application in order to conform
to the legal limits on what an agency may delegate to persons outside
the agency.\1108\ Under the new model finalized herein, the Commission
will be informed by the exchanges' determinations to make the
Commission's own determination for purposes of Federal position limits
before the 10/2-day review period expires. Accordingly, the Commission
will retain its decision-making authority with respect to the Federal
position limits and provide legal certainty to market participants of
their determinations.
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\1108\ In U.S. Telecom Ass'n v. FCC, the D.C. Circuit held
``that, while Federal agency officials may sub-delegate their
decision-making authority to subordinates absent evidence of
contrary congressional intent, they may not sub-delegate to outside
entities--private or sovereign--absent affirmative evidence of
authority to do so.'' U.S. Telecom Ass'n v. FCC, 359 F.3d 554, 565-
68 (D.C. Cir. 2004) (citations omitted). Nevertheless, there are
three circumstances that the agency may ``delegate'' its authority
to an outside party because they do not involve sub-delegation of
decision-making authority: (1) Establishing a reasonable condition
for granting Federal approval; (2) fact gathering; and (3) advice
giving. Id. at 568.
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Finally, in Sec. 150.9(e)(3) and (4), the Commission is making one
technical correction to clarify that a person may exceed Federal
position limits or rely on
[[Page 3377]]
an approved retroactive application after the 10/2-day review period,
as applicable, unless the Commission notifies the person and relevant
exchange that it has determined to stay or deny the application,
pursuant to Sec. 150.9(e)(5) or (e)(6). In the 2020 NPRM, the
Commission only referred to its stay authority in Sec. 150.9(e)(5),
discussed in detail below. However, as clarified in the Final Rule, the
Commission could also notify the applicant and exchange of its
determination to deny the application for purposes of Federal position
limits under Sec. 150.9(e)(6), also discussed below. This change is a
technical correction and does not change the substance of Sec.
150.9(e)(3) or (4).
iii. Section 150.9(e)(5)--Commission Stay of Pending Applications and
Requests for Additional Information
a. Summary of the 2020 NPRM--Commission Stay of Pending Applications
and Requests for Additional Information
Under proposed Sec. 150.9(e)(5), the Commission could stay a non-
enumerated bona fide hedge application that an exchange has approved,
pursuant to Sec. 150.9(e)(2), for purposes of exchange-set limits.
Under the 2020 NPRM, if, during the ten (or two) business day timeframe
in Sec. 150.9(e)(3) or (4), the Commission notifies the exchange and
applicant that the Commission (and not staff) has determined to stay
the application, the applicant would not be able to rely on the
exchange's approval of the application for purposes of exceeding
Federal position limits, unless the Commission approves the application
after further review. The proposed stay provision did not include a
time limitation on the duration of a Commission stay.
Separately, under proposed Sec. 150.9(e)(5), the Commission (or
Commission staff) could request additional information from the
exchange or applicant in order to evaluate the application, and the
exchange and applicant would have an opportunity to provide the
Commission with any supplemental information requested to continue the
application process. Any such request for additional information by the
Commission (or staff), however, would not stay or toll the ten (or two)
business day application review period.
b. Comments--Commission Stay of Pending Applications and Requests for
Additional Information
With respect to instances where the Commission has stayed an
exchange-granted non-enumerated bona fide hedge application or elects
to review a previously approved-application, several commenters
requested that the Commission limit the duration of its review period,
which was unlimited in the 2020 NPRM.\1109\
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\1109\ ICE at 9; FIA at 18; CME Group at 7 (suggesting that the
Commission's stay or review of an application should not exceed 30
calendar days); IFUS at 15 (noting that any Commission stay will
almost certainly conflict with IFUS procedures for reviewing
exemptions in the spot month, where certain exemptions may be in
effect for less than 10 days).
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c. Discussion of Final Rule--Commission Stay of Pending Applications
and Requests for Additional Information
The Commission has determined to finalize Sec. 150.9(e)(5) with
certain modifications and clarifications in response to commenters and
other considerations.
In response to commenters' requests, the Commission is modifying
its stay authority under proposed Sec. 150.9(e)(5). Under the Final
Rule, any Commission stay issued pursuant to Sec. 150.9(e)(5) will be
limited to 45 days. The Commission has a long history of conducting
other extensive regulatory reviews within a 45-day period.\1110\ The
Commission has found that this timeframe provides sufficient time for
the Commission to conduct an adequate review while also providing
certainty to market participants that the review will not be
indefinite.
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\1110\ See 17 CFR 40.3 and 40.5 (providing the Commission's 45-
day review period for new product and rule approval applications).
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The Commission is also clarifying in final Sec. 150.9(e)(5) that
if the Commission stays a pending application where the applicant has
not yet exceeded Federal position limits, then the applicant may not
exceed Federal position limits until the Commission issues a final
determination. Further, if the Commission stays a pending application
and the applicant has already exceeded Federal position limits (either
during the Commission's 10-day review period or as part of a
retroactive application), then the applicant may continue to maintain
its position unless the Commission notifies the designated contract
market or swap execution facility and the applicant otherwise, pursuant
to Sec. 150.9(e)(6).
In addition to the changes above, the Commission is making several
technical edits to improve readability, none of which impact the
substance of the section.
iv. Section 150.9(e)(6)--Commission Determination for Applications
During the 10/2-Day Review
The following discussion addresses Sec. 150.9(e)(6), which deals
with any Commission determinations that are issued for pending
applications and during the Commission's 10/2-day review.
a. Summary of the 2020 NPRM--Commission Determination for Applications
During the 10/2-Day Review
Under proposed Sec. 150.9(e)(6), if the Commission determined that
an application does not meet the conditions set forth in proposed Sec.
150.9(b), the Commission would notify the exchange and the applicant
and provide an opportunity for the applicant to respond. After doing
so, the Commission could, in its discretion, deny the application for
purposes of Federal position limits, and require the person to reduce
the position within a commercially reasonable amount of time, as
determined by the Commission in consultation with the applicant and the
exchange.
In such a case, the applicant would not be subject to any finding
of a position limits violation during the Commission's review of a
pending application or after the Commission makes its determination. A
person would also not be subject to a violation if they already
exceeded Federal position limits and filed a retroactive application,
and the Commission then determined that the bona fide hedge is not
approved for purposes of Federal position limits. In either case, the
2020 NPRM provided that the Commission would not find that the person
had committed a position limits violation so long as the person brings
the position into compliance within a commercially reasonable time.
b. Comments--Commission Determination for Applications During the 10/2-
Day Review
Commenters requested that the Commission allow traders sufficient
time to exit a position if the Commission denies an exchange-approved
non-enumerated bona fide hedge application before the end of the 10/2-
day review period.\1111\
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\1111\ CMC at 12 (requesting a commercially reasonably amount of
time to exit positions); ADM at 6 (requesting, in addition, that the
Commission consult exchanges on what is a commercially reasonable
amount of time for an applicant to exit a position); CME Group at 7-
8.
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[[Page 3378]]
c. Discussion of Final Rule--Commission Determination for Applications
During the 10/2-Day Review
The Commission has determined to finalize Sec. 150.9(e)(6) with
certain modifications and clarifications in response to commenters and
other considerations.
First, for the avoidance of doubt and in response to comments, the
Commission clarifies and reiterates how it will handle any
determination to deny an application under final Sec. 150.9(e)(6).
Generally, if the Commission denies an application under Sec.
150.9(e)(6), and the applicant consequently is required to reduce its
position below the applicable Federal position limit, the Commission
will allow the applicant a commercially reasonable amount of time to do
so. The Commission will determine the commercially reasonable amount of
time in consultation with the relevant exchange and the applicant. The
Commission intends for the applicant and the relevant exchange to have
input regarding what amount of time is sufficient.
Further, the Commission is clarifying for final Sec. 150.9(e)(6)
that it expects all applicants to submit their applications in good
faith. As part of that good faith submission, the Commission expects
each applicant will have a reasonable basis for determining that the
purported non-enumerated bona fide hedge meets the requirements of
Sec. 150.9(b). Accordingly, the Commission is revising Sec.
150.9(e)(6) to clarify that the Commission will not pursue an
enforcement action for a position limits violation for the applicant
holding the position if the applicant exceeds Federal position limits
during the 10/2-day review and the Commission subsequently determines
to deny the application, so long as: (1) The application was submitted
to the exchange pursuant to Sec. 150.9 in good faith, and (2) if
required, the applicant reduces its positions within a commercially
reasonable amount of time.
In addition, the Commission is making several non-substantive
clarifications to final Sec. 150.9(e)(6). The Commission is clarifying
that this section deals with any Commission determination issued for
pending applications during the 10/2-day review period (as opposed to
Commission determinations issued under Sec. 150.9(f) after the 10/2-
day review period). The Commission is also adding language to clarify
that the Commission must notify the applicant and relevant exchange of
any determination within the 10/2-day review period. In addition, the
Commission is adding language to clarify that Sec. 150.9(e)(6) is not
limited to Commission denials of applications; rather, the Commission
could also determine to issue an approval with certain conditions or
limitations that may be different from the approval issued by the
exchange for purposes of exchange-set limits. Finally, the Commission
is making various non-substantive technical and organizational changes
to make the section more readable.
v. Section 150.9(e)--Recognition of Additional Enumerated Bona Fide
Hedges
a. Summary of the 2020 NPRM--Recognition of Additional Enumerated Bona
Fide Hedges
Proposed Appendix A to the Final Rule identified each of the
enumerated bona fide hedges, and under the 2020 NPRM, the Commission's
recognition of a non-enumerated bona fide hedge, pursuant to Sec.
150.3 or Sec. 150.9, would not add new bona fide hedges to the list of
enumerated bona fide hedges in Appendix A.
b. Comments--Recognition of Additional Enumerated Bona Fide Hedges
Commenters requested that the Commission codify a path to move
commonly granted non-enumerated bona fide hedge recognitions to the
list of enumerated bona fide hedge recognitions in Appendix A.\1112\
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\1112\ See MGEX at 4; EPSA at 5-7; COPE at 5; FIA at 19 (noting
that the process should be subject to the notice and comment
rulemaking process); ICE at 10; and IFUS at 7 (requesting that such
process also require Commission staff to provide an annual report to
the Commission recommending non-enumerated bona fide hedges that
should be enumerated).
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c. Discussion of Final Rule--Recognition of Additional Enumerated Bona
Fide Hedges
The Commission has determined to finalize the approach as proposed.
Regarding a path forward for the Commission to expand the list of
enumerated bona fide hedges to include certain non-enumerated bona fide
hedges that are commonly granted, the Commission notes that it has an
existing rulemaking process (which requires public notice and comment)
to accomplish this. The Commission also clarifies, for the avoidance of
doubt, that it remains open to expanding the list of enumerated hedges,
as appropriate, but that the Commission would be required to do so
under its existing rulemaking process subject to public notice and
comment. Market participants are welcome to request that the Commission
take up future rulemakings to amend the list of enumerated bona fide
hedges.\1113\
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\1113\ Market participants may petition the Commission to expand
the list of enumerated bona fide hedges under existing Sec. 13.1,
which provides that any ``person may file a petition with . . . the
Commission . . . for the issuance, amendment or repeal of a rule of
general application.''
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8. Section 150.9(f)--Commission Revocation of an Approved Application
i. Summary of 2020 NPRM--Commission Revocation of an Approved
Application
Proposed Sec. 150.9(f) set forth the limited circumstances under
which the Commission would revoke a previously-approved non-enumerated
bona fide hedge recognition granted pursuant to proposed Sec. 150.9.
First, under proposed Sec. 150.9(f)(1), if an exchange limits,
conditions, or revokes its recognition of a non-enumerated bona fide
hedge that was previously approved under Sec. 150.9, then such bona
fide hedge would also be deemed limited, conditioned, or revoked for
purposes of Federal position limits.
Next, under proposed Sec. 150.9(f)(2), if the Commission
determines that an application that has been approved or deemed
approved by the Commission is no longer consistent with the applicable
sections of the Act and the Commission's regulations, the Commission
could revoke the non-enumerated bona fide hedge recognition and/or
require the person to reduce its position within a commercially
reasonable time, or otherwise come into compliance.
Under proposed Sec. 150.9(f)(2), if the Commission makes such
determination, it would need to first notify the person holding the
position and provide them with an opportunity to respond. The
Commission would also provide a notification briefly explaining the
nature of the issues raised and the regulatory provision with which the
position is inconsistent. If the Commission requires the person to
reduce the position, the Commission would allow the person a
commercially reasonable amount of time to do so, as determined by the
Commission in consultation with the applicable exchange and applicant.
Finally, under the 2020 NPRM, the Commission would not find that the
person has committed a position limit violation so long as the person
comes into compliance within the commercially reasonable time.
[[Page 3379]]
ii. Comments--Commission Revocation of an Approved Application
Commenters' views on proposed Sec. 150.9(f) tended to overlap with
their views on the Commission's determination authority under Sec.
150.9(e)(6) (discussed above). In particular, commenters requested that
the Commission allow traders sufficient time to exit a position if the
Commission revokes a previously approved non-enumerated bona fide hedge
recognition.\1114\ Commenters also requested that the Commission
further clarify that an applicant will not be penalized for relying on
an approved non-enumerated bona fide hedge recognition if the
Commission later revokes such approval after the 10/2-day review
period.\1115\
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\1114\ CMC at 12 (requesting a commercially reasonable amount of
time to exit positions); ADM at 6 (requesting, in addition, that the
Commission consult exchanges on what is a commercially reasonably
amount of time for an applicant to exit a position).
\1115\ CMC at 12; ADM at 6.
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iii. Discussion of Final Rule--Commission Revocation of an Approved
Application
The Commission has determined to finalize Sec. 150.9(f) with
certain modifications and clarifications in response to commenters and
other considerations.
First, under the Final Rule, if the Commission limits, conditions,
or revokes a previously approved non-enumerated bona fide hedge
recognition under Sec. 150.9(f)(2), and the applicant consequently is
required to reduce its position below the applicable Federal position
limit, the Commission will allow the applicant a commercially
reasonable amount of time to do so. The Commission will determine the
commercially reasonable amount of time in consultation with the
relevant exchange and the applicant. The Commission intends for the
applicant and the relevant exchange to have input regarding what amount
of time is sufficient.
Further, if the Commission limits, conditions, or revokes a
previously approved non-enumerated bona fide hedge recognition under
Sec. 150.9(f)(2), the Commission will not pursue an enforcement action
for a position limits violation for the person holding the position in
excess of Federal position limits so long as the person: (1) Submitted
its application pursuant to Sec. 150.9 in good faith,\1116\ and (2) if
required, reduces the position within a commercially reasonable amount
of time as determined by the Commission in consultation with the person
and the relevant exchange.
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\1116\ See supra Section II.G.7. (providing additional
discussion of the premise that a person submit their Sec. 150.9
application in good faith).
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The Commission is revising the title of final Sec. 150.9(f) to
clarify that this section is limited to revocations of non-enumerated
bona fide hedges previously approved by the Commission. The Commission
is also adding language to final Sec. 150.9(f)(2)(i) (consistent with
language in Sec. 150.9(f)(1)) to clarify that, in addition to revoking
a previously-granted non-enumerated bona fide hedge recognition, the
Commission could alternatively determine to limit or condition a
previously-granted recognition. The Commission believes that there
could be circumstances where it would not need to completely revoke a
previously-granted recognition, but instead may determine a less
drastic measure is more appropriate to enable a market participant to
achieve compliance with the applicable requirements. Finally, the
Commission is revising Sec. 150.9(f)(2)(iii) to include the same
language that it added to Sec. 150.9(e)(6) to explicitly make clear an
underlying premise that the Commission will not pursue Federal position
limits violations so long as any applications are filed in good faith.
Finally, the Commission is making a number of technical and grammatical
corrections in Sec. 150.9(f) that are not substantive revisions.
In addition to the clarifications and modifications above, the
Commission would like to reiterate the following explanations and
guidance from the 2020 NPRM. The Commission expects for persons to be
able to rely on non-enumerated bona fide hedge recognitions granted
pursuant to Sec. 150.9 with the certainty that the final determination
would only be limited, conditioned, or revoked in very limited
circumstances. The Commission expects that it (and not Commission
staff) would only exercise such authority under rare circumstances
where the disposition of an application has resulted, or is likely to
result, in price anomalies, threatened manipulation, actual
manipulation, market disruptions, or disorderly markets. The Commission
also expects that any action compelling a market participant to reduce
its position pursuant to Sec. 150.9(f)(2) would be a rare Commission
action, and such action is not delegated to Commission staff. In
determining requirements for a person to reduce a position, the
Commission may consult the person and relevant exchange, and may also
consider factors such as current market conditions and the protection
of price discovery in the market. Finally, for the avoidance of doubt,
the Commission expects that its exercise of its authorities under Sec.
150.9(f)(2) would not be subject to the requirements of CEA section
8a(9), that is, the Commission would not be compelled to find that a
CEA section 8a(9) emergency condition exists prior to requiring that a
market participant reduce certain positions.
9. Section 150.9(g)--Delegation of Authority to the Director of the
Division of Market Oversight
i. Summary of the 2020 NPRM--Delegation of Authority to the Director of
the Division of Market Oversight
The Commission proposed to delegate certain of its authorities
under proposed Sec. 150.9 to the Director of the Commission's Division
of Market Oversight, or such other employee(s) that the Director may
designate from time to time. Proposed Sec. 150.9(g)(1) would delegate
the Commission's authority, in Sec. 150.9(e)(5), to request additional
information from the exchange and applicant.
The Commission did not propose, however, to delegate its authority,
in proposed Sec. 150.9(e)(5) and (6) to stay or deny a non-enumerated
bona fide hedge application. The Commission also did not delegate its
authority in proposed Sec. 150.9(f)(2) to revoke a non-enumerated bona
fide hedge recognition granted pursuant to Sec. 150.9, or to require
an applicant to reduce its positions or otherwise come into compliance.
The Commission stated that if an exchange's disposition of an
application raises concerns regarding consistency with the CEA,
presents novel or complex issues, or requires remediation, then the
Commission (and not Commission staff) would make the final
determination, after taking into consideration any supplemental
information provided by the exchange or the applicant.
As with all authorities delegated by the Commission to staff, under
the 2020 NPRM, the Commission would maintain the authority to consider
any matter which has been delegated. The Commission stated in the 2020
NPRM that it intended to closely monitor staff administration of the
proposed processes for granting non-enumerated bona fide hedge
recognitions.
ii. Comments and Summary of the Commission Determination--Delegation of
Authority to the Director of the Division of Market Oversight
The Commission did not receive comments on proposed Sec. 150.9(g).
The Commission is finalizing Sec. 150.9(g) with one revision to
reorganize certain text to improve readability. This update is not
[[Page 3380]]
intended to change the substance of this section.
H. Part 19 and Related Provisions--Reporting of Cash-Market Positions
1. Background
Key reports currently used for purposes of monitoring compliance
with Federal position limits include Form 204 \1117\ and Parts I and II
of Form 304,\1118\ known collectively as the ``series `04'' reports.
Under existing Sec. 19.01, market participants that hold bona fide
hedging positions in excess of limits for the nine legacy agricultural
contracts currently subject to Federal position limits must justify
such overages by filing the applicable report each month: Form 304 for
cotton, and Form 204 for the other commodities.\1119\ These reports
are: Generally filed after exceeding the Federal position limit; show a
snapshot of such trader's cash positions on one given day each month;
and are used by the Commission to determine whether a trader has
sufficient cash positions to justify futures and options on futures
positions above the speculative limits.
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\1117\ CFTC Form 204: Statement of Cash Positions in Grains,
Soybeans, Soybean Oil, and Soybean Meal, available at https://www.cftc.gov/sites/default/files/idc/groups/public/@forms/documents/file/cftcform204.pdf (existing Form 204).
\1118\ CFTC Form 304: Statement of Cash Positions in Cotton,
available at http://www.cftc.gov/ucm/groups/public/@forms/documents/file/cftcform304.pdf (existing Form 304). Parts I and II of Form 304
address fixed-price cash positions used to justify cotton positions
in excess of Federal position limits. As described below, Part III
of Form 304 addresses unfixed-price cotton ``on-call'' information,
which is not used to justify cotton positions in excess of limits,
but rather to allow the Commission to prepare its weekly cotton on-
call report.
\1119\ 17 CFR 19.01.
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The existing series `04 reports are both duplicative of, and
inconsistent with, the processes market participants use to report
cash-market information to the exchanges. When granting exemptions from
their own limits, exchanges do not use a monthly cash-market reporting
framework akin to the `04 reports. Instead, exchanges generally require
market participants who wish to exceed exchange-set limits, including
for bona fide hedging positions, to submit an annual exemption
application form in advance of exceeding the limits.\1120\ Such
applications are typically updated annually and generally include a
month-by-month breakdown of cash-market positions for the previous year
supporting any position-limits overages during that period.\1121\
---------------------------------------------------------------------------
\1120\ See, e.g., ICE Rule 6.29 and CME Rule 559.
\1121\ For certain physically-delivered agricultural contracts,
some exchanges may require that spot month exemption applications be
renewed several times a year for each spot month, rather than
annually.
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2. Elimination of Form 204 and Cash-Reporting Elements of Form 304
i. Summary of the 2020 NPRM--Elimination of Form 204 and Cash-Reporting
Elements of Form 304
The Commission proposed to eliminate existing Form 204. The
Commission also proposed to eliminate Parts I and II of existing Form
304, which request information on cash-market positions for cotton akin
to the information requested in Form 204.\1122\ As discussed in the
2020 NPRM, the Commission believed that eliminating these forms would
reduce duplicative reporting requirements for market participants
without hindering the Commission's ability to access cash-market
information, which the exchanges would be required to collect and
provide to the Commission under proposed Sec. Sec. 150.3, 150.5, and
150.9.\1123\
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\1122\ Part III of Form 304, which addresses cotton-on-call, is
discussed below.
\1123\ 78 FR at 11694, 11655-11656.
---------------------------------------------------------------------------
For a market participant accustomed to filing series `04 reports
the 2020 NPRM would result in a slight change in practice. Under the
2020 NPRM, such participant's bona fide hedge recognitions could still
be self-effectuating for purposes of Federal position limits, provided
that the market participant also separately applies for a bona fide
hedge exemption from exchange-set limits established pursuant to
proposed Sec. 150.5(a), discussed above, and provided further that the
participant submits the requisite cash-market information to the
exchange as required by proposed Sec. 150.5(a)(2)(ii)(A).
ii. Summary of the Commission Determination--Elimination of Form 204
and Cash-Reporting Elements of Form 304
The Commission has carefully considered the comments received and
is eliminating existing Form 204 and Parts I and II of existing Form
304 as proposed.
iii. Comments--Elimination of Form 204 and Cash-Reporting Elements of
Form 304
Numerous commenters supported the elimination of the Form 204 and
Parts I and II of the Form 304.\1124\ In particular, several commenters
supported the proposed streamlined process that eliminates duplicative
reporting requirements to both the Commission and the exchanges.\1125\
ISDA additionally recommended that the Commission rely on its special
call authority and relevant exchange authority to request additional
information on an as-need basis.\1126\
---------------------------------------------------------------------------
\1124\ See, e.g., ACSA at 3; AMCOT at 2-3; ACA at 3; Canale
Cotton at 3; Cargill at 9-10; CCI at 2; CEWG at 4; Chevron at 3; CHS
at 2, 6; CMC at 12; COPE at 3-4; DECA at 2; East Cotton at 3; Ecom
at 1; EEI at 7; EPSA at 7; FIA at 3; IMC at 3; ISDA at 9-10; Jess
Smith at 3; LDC at 2; Mallory Alexander at 2; McMeekin at 2-3;
Memtex at 2-3; Moody Compress at 2; Namoi at 1; NCFC at 2; Olam at
3; Omnicotton at 2-3; Parkdale at 2; SEMI at 3; Shell at 4; SCA at
3; SW Ag at 2-3; Texas Cotton at 2-3; Toyo at 2-3; Walcot at 3; WCSA
at 3; White Gold at 2-3.
\1125\ See, e.g., Cargill at 9-10; CCI at 2; CEWG at 4; COPE at
3-4; ISDA at 10.
\1126\ ISDA at 10.
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Three commenters opposed the elimination of the series `04 reports.
In particular, AFR and Rutkowski expressed concern that eliminating
Form 204 will delegate position limit oversight and enforcement
responsibilities to the exchanges.\1127\ These commenters contended
that the exchanges are financially disincentivized from imposing limits
on speculation because the exchanges profit from trading volume.\1128\
Similarly, Better Markets also opposed the elimination of the series
`04 reports, contending that Federal law provides more substantial
deterrents for misreporting information on a form provided to Federal
agencies such as the Commission.\1129\
---------------------------------------------------------------------------
\1127\ AFR at 2-3; Rutkowski at 2.
\1128\ Id.
\1129\ Better Markets at 59-60.
---------------------------------------------------------------------------
Better Markets also commented that the reporting changes would
increase the industry's overall reporting burdens because market
participants would have to report information to multiple
exchanges.\1130\ Better Markets suggested that the Commission should
instead ``ensure that all cash positions reporting is automated'' and
``amenable to aggregation'' in order to provide such information to the
exchanges.\1131\
---------------------------------------------------------------------------
\1130\ Id. at 59.
\1131\ Id. at 60.
---------------------------------------------------------------------------
iv. Discussion of Final Rule--Elimination of Form 204 and Cash-
Reporting Elements of Form 304
The Commission is eliminating Form 204 and Sections I and II of
existing Form 304, as proposed. For the reasons described below and as
discussed in the 2020 NPRM, the Commission believes that the
elimination of these forms will reduce duplication and inefficiency
resulting from market participants submitting cash-market information
to both the Commission and the exchanges under the existing
framework.\1132\ As described below, under the approach
[[Page 3381]]
adopted herein, the Commission will receive any necessary information
related to market participants' recognized bona fide hedges by
leveraging existing expertise and processes at the exchanges, as well
as information that market participants will be required to submit to
exchanges under the Final Rule.
---------------------------------------------------------------------------
\1132\ 85 FR at 11694.
---------------------------------------------------------------------------
The Commission finds comments that the elimination of the series
`04 reports would require the Commission to delegate authority to the
exchanges to be misplaced for several reasons. First, by eliminating
the series `04 reports, the Commission is not delegating any oversight
or enforcement responsibilities to the exchanges. The CEA establishes
the statutory framework under which the Commission operates.\1133\ Even
without the series `04 reports, the Commission will continue to
administer the CEA to monitor and protect the derivatives markets,
market users, and the public from fraud, manipulation, and other
abusive practices that are prohibited by the CEA and Commission
regulations. The Commission will continue to do so through its market
surveillance program,\1134\ rule enforcement reviews,\1135\ and other
regulatory tools. The Commission will also continue to investigate and
prosecute persons who violate the CEA and Commission regulations in
connection with derivatives trading on exchanges and related conduct in
cash-market commodities.\1136\
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\1133\ See 7 U.S.C. 2(a)(1).
\1134\ CFTC Market Surveillance Program, U.S. Commodity Futures
Trading Commission website, available at https://www.cftc.gov/IndustryOversight/MarketSurveillance/CFTCMarketSurveillanceProgram/index.htm#P5_912. The Commission's Market Surveillance Program is
responsible for collecting market data and position information from
registrants and large traders, and for monitoring the daily
activities of large traders, key price relationships, and relevant
supply and demand factors in a continuous review for potential
market problems. Id.
\1135\ The Commission conducts regular rule enforcement reviews
of each exchange's audit trail, trade practice surveillance,
disciplinary, and dispute resolution programs for ongoing compliance
with the Core Principles. See Rule Enforcement Reviews of Designated
Contract Markets, U.S. Commodity Futures Trading Commission website,
available at https://www.cftc.gov/IndustryOversight/TradingOrganizations/DCMs/dcmruleenf.html.
\1136\ Enforcement, U.S. Commodity Futures Trading Commission
website, available at https://www.cftc.gov/LawRegulation/Enforcement/OfficeofDirectorEnforcement.html.
---------------------------------------------------------------------------
Second, the elimination of Form 204 and the cash-market reporting
portions of Form 304 will not hinder the Commission's access to the
cash-market information needed for the Commission to effectuate its
oversight and enforcement responsibilities. Instead, the Commission is
ensuring that it will continue to have access to sufficient cash-market
information by adopting several reporting and recordkeeping
requirements in final Sec. Sec. 150.3, 150.5, and 150.9.\1137\ In
particular, under Sec. 150.5, an exchange will be required to collect
applications, which must be updated at least on an annual basis, for
purposes of granting bona fide hedge recognitions from exchange-set
limits for contracts subject to Federal position limits,\1138\ and for
recognizing bona fide hedging positions for purposes of Federal
position limits.\1139\ Among other things, each application will be
required to include: (1) Information regarding the applicant's activity
in the cash markets for the underlying commodity; and (2) any other
information to enable the exchange and the Commission to determine
whether the exchange may recognize such position as a bona fide
hedge.\1140\ Additionally, consistent with existing industry practice
for certain exchanges, exchanges will be required to file monthly
reports to the Commission showing, among other things, for all bona
fide hedges (whether enumerated or non-enumerated), a concise summary
of the applicant's activity in the cash markets.\1141\
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\1137\ As discussed earlier in this Final Rule, Final Sec.
150.9 also includes reporting and recordkeeping requirements
pertaining to spread exemptions. Those requirements will not be
discussed again in this Section of the Final Rule, which addresses
cash-market reporting in connection with bona fide hedges.
\1138\ See Final Sec. 150.5(a)(2)(ii)(A).
\1139\ As discussed above in connection with Final Sec. 150.9,
market participants who wish to request a bona fide hedge
recognition under Sec. 150.9 will not be required to file such
applications with both the exchange and the Commission. They will
only file the applications with the exchange, which will then be
subject to recordkeeping requirements in Final Sec. 150.9(d), as
well as Final Sec. Sec. 150.5 and 150.9 requirements to provide
certain information to the Commission on a monthly basis and upon
demand.
\1140\ See Final Sec. 150.5(a)(2)(ii)(G).
\1141\ See Final Sec. 150.5(a)(4).
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Collectively, final Sec. Sec. 150.5 and 150.9 will provide the
Commission with the same substantive information from monthly reports
about all recognitions granted for purposes of contracts subject to
Federal position limits, including cash-market information supporting
the applications, and annual information regarding all month-by-month
cash-market positions used to support a bona fide hedging recognition.
These reports will help the Commission determine whether any person who
claims a bona fide hedging position can demonstrate satisfaction of the
relevant requirements. This information will also help the Commission
perform market surveillance in order to detect and deter manipulation
and abusive trading practices in physical commodity markets.
While the Commission will no longer receive the monthly snapshot
data currently included on the series `04 reports, the Commission will
have broad access, at any time, to the cash-market information
described above, as well as any other data or information exchanges
collect as part of their application processes.\1142\ This will include
any updated application forms and periodic reports that exchanges may
require applicants to file regarding their positions. To the extent
that the Commission observes market activity or positions that warrant
further investigation, Sec. 150.9 will also provide the Commission
with access to any supporting or related records the exchanges will be
required to maintain.\1143\
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\1142\ See, e.g., Final Sec. 150.9(d) (requiring that all such
records, including cash-market information submitted to the
exchange, be kept in accordance with the requirements of Sec.
1.31), and Final Sec. 19.00(b) (requiring, among other things, all
persons exceeding speculative position limits who have received a
special call to file any pertinent information as specified in the
call).
\1143\ See Final Sec. 150.9(d).
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Furthermore, the Final Rule will not impact the Commission's
existing provisions for gathering information through special calls
relating to positions exceeding limits and/or to reportable positions.
As discussed further below, under the Final Rule, all persons exceeding
the Federal position limits set forth in final Sec. 150.2, as well as
all persons holding or controlling reportable positions pursuant to
Sec. 15.00(p)(1), must file any pertinent information as instructed in
a special call.\1144\
---------------------------------------------------------------------------
\1144\ See Final Sec. 19.00(b).
---------------------------------------------------------------------------
In response to commenter concerns that elimination of the series
`04 reports may increase reliance on exchanges which may lack
incentives to impose position limits, the Commission does not view the
question of whether exchanges impose speculative position limits in
this context as a matter of incentives. Even with the elimination of
the series `04 reports, exchanges will be under statutory and
regulatory obligations, as they are today, to establish speculative
position limits for all contracts subject to Federal position
limits.\1145\ Additionally, as discussed above, the Commission does not
believe that exchanges generally lack proper incentives to maintain the
integrity of their markets; to the contrary, they are subject to
various statutory core principles and regulatory obligations
[[Page 3382]]
that require them to maintain integrity in their markets.\1146\
Further, exchanges will remain subject to regulatory oversight and
enforcement responsibilities required for DCMs by CEA section 5(d) and
part 38 of the Commission's regulations and for SEFs by CEA section 5h
and part 37 of the Commission's regulations.\1147\ Specifically,
several existing Commission regulations in parts 38 and 37 require
exchanges to monitor for violations of exchange-set position
limits,\1148\ and detect and prevent manipulation, price distortions
and, where possible, disruptions of the physical-delivery or cash-
settlement process.\1149\
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\1145\ See 7 U.S.C. 7(d)(5) and Sec. 150.5(a).
\1146\ For further discussion, see Section II.B.3.iii.b(3)(iii)
(addressing comments from Better Markets related to conflicts-of-
interest).
\1147\ See 7 U.S.C. 7(d); 17 CFR 38; 7 U.S.C. 7b-3(f); 17 CFR
37.
\1148\ See 17 CFR 38.251(d); 17 CFR 37.205(b).
\1149\ See 17 CFR 38.251(a); 17 CFR 37.205(a).
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In response to Better Markets' concern that eliminating the '04
reports will reduce deterrents for misreporting, the Commission
believes that the false reporting provision in Section 9(a)(4) of the
CEA, which makes it a felony to make any false statements to an
exchange, is sufficient to deter market participants from misreporting
cash-market information to exchanges.\1150\
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\1150\ 7 U.S.C. 13(a)(4). The Commission has not hesitated to
impose severe penalties on market participants that mislead
exchanges about cash positions. See, e.g., In the Matter of EMF
Financial Products LLC, CFTC Docket No. 10-02, U.S. Commodity
Futures Trading Commission website, available at https://www.cftc.gov/PressRoom/PressReleases/5751-09 (imposing a $4,000,000
civil monetary penalty on a firm that misled an exchange about the
firm's cash positions in treasury futures). See also supra Section
II.D.9. (discussing Commission enforcement of exchange-set position
limits).
---------------------------------------------------------------------------
Further, the Commission disagrees with Better Markets' concerns
about increased burdens. Given that market participants are currently
required both to file the series `04 reports with the Commission, and
to submit cash-market information to the exchanges, eliminating the
series `04 reports will reduce burdens on market participants.\1151\ In
fact, the Commission did not receive any comments opposing the
elimination of the series `04 reports from traders who currently have
an obligation to file such forms. While the Commission supports
streamlined and automated reporting requirements whenever possible,
Better Markets has not identified any practicable method or program
that would permit the automated reporting of the kinds of disparate
cash-market information currently reflected in Forms 204 and 304.
---------------------------------------------------------------------------
\1151\ See infra Section IV.A.5.iii. (discussing the benefits of
elimination of Form 204 and amendment of Form 304).
---------------------------------------------------------------------------
In addition to the justifications for eliminating the series `04
reports described above, the Commission has also determined that Form
204, including the timing and procedures for its filing, is inadequate
for the reporting of cash-market positions relating to certain energy
contracts, which will be subject to Federal position limits for the
first time under the Final Rule. For example, when compared to
agricultural contracts, energy contracts generally expire more
frequently, have a shorter delivery cycle, and have significantly more
product grades. The information required by Form 204, as well as the
timing and procedures for its filing, reflects the way agricultural
contracts trade, but is inadequate for purposes of reporting cash-
market information involving energy contracts.
Finally, the Commission understands that the exchanges maintain
regular dialogue with their participants regarding cash-market
positions, and that it is common for exchange surveillance staff to
make informal inquiries of market participants, including if the
exchange has questions about market events or a participant's use of an
exemption or recognition. The Commission encourages exchanges to
continue this practice. Similarly, the Commission anticipates that its
own staff will engage in dialogue with market participants, either
through the use of informal conversations or, in limited circumstances,
via special call authority.
3. Changes to Parts 15 and 19 To Implement the Elimination of Form 204
and Portions of Form 304
i. Background--Changes to Parts 15 and 19 To Implement the Elimination
of Form 204 and Portions of Form 304
The market and large-trader reporting rules are contained in parts
15 through 21 of the Commission's regulations. Collectively, these
reporting rules effectuate the Commission's market and financial
surveillance programs by enabling the Commission to gather information
concerning the size and composition of the commodity derivative markets
and to monitor and enforce any established speculative position limits,
among other regulatory goals.
ii. Summary of the 2020 NPRM--Changes to Parts 15 and 19 To Implement
the Elimination of Form 204 and Portions of Form 304
To effectuate the proposed elimination of Form 204 and the cash-
market reporting components of Form 304, the Commission proposed to
eliminate: (a) Existing Sec. 19.00(a)(1), which requires persons
holding reportable positions which constitute bona fide hedging
positions to file a Form 204; and (b) existing Sec. 19.01, which,
among other things, sets forth the cash-market information required on
Forms 204 and 304.\1152\ Based on the proposed elimination of existing
Sec. Sec. 19.00(a)(1) and 19.01 and Form 204, the Commission proposed
conforming technical changes to remove related reporting provisions
from: (i) The ``reportable position'' definition in Sec. 15.00(p);
(ii) the list of ``persons required to report'' in Sec. 15.01; and
(iii) the list of reporting forms in Sec. 15.02.
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\1152\ 17 CFR 19.01.
---------------------------------------------------------------------------
iii. Comments and Summary of the Commission Determination--Changes to
Parts 15 and 19 To Implement the Elimination of Form 204 and Portions
of Form 304
The Commission did not receive any comments on the conforming
changes to parts 15 and 19 that implement the elimination of Form 204
and Sections I and II of Form 304, and is adopting the changes as
proposed.
4. Special Calls
i. Summary of the 2020 NPRM--Special Calls
Notwithstanding the proposed elimination of the series `04 reports,
the Commission did not propose to make any significant substantive
changes to information requirements relating to positions exceeding
limits and/or to reportable positions. Accordingly, in proposed Sec.
19.00(b), the Commission proposed that all persons exceeding the
proposed limits set forth in Sec. 150.2, as well as all persons
holding or controlling reportable positions pursuant to Sec.
15.00(p)(1), must file any pertinent information as instructed in a
special call. This proposed provision is similar to existing Sec.
19.00(a)(3), but would require any such person to file the information
as instructed in the special call, rather than to file the information
on a series `04 report.\1153\
---------------------------------------------------------------------------
\1153\ 17 CFR 19.00(a)(3).
---------------------------------------------------------------------------
The Commission also proposed to add language to existing Sec.
15.01(d) to clarify that persons who have received a special call are
deemed ``persons required to report'' as defined in Sec. 15.01.\1154\
The Commission proposed this change to clarify an existing requirement
found in Sec. 19.00(a)(3), which requires persons holding or
controlling positions that are reportable
[[Page 3383]]
pursuant to Sec. 15.00(p)(1) who have received a special call to
respond.\1155\ The proposed changes to part 19 operate in tandem with
the proposed additional language for Sec. 15.01(d) to reiterate the
Commission's existing special call authority without creating any new
substantive reporting obligations. Finally, proposed Sec. 19.03
delegated authority to issue such special calls to the Director of the
Division of Enforcement, and proposed Sec. 19.03(b) delegated to the
Director of the Division of Enforcement the authority in proposed Sec.
19.00(b) to provide instructions or to determine the format, coding
structure, and electronic data transmission procedures for submitting
data records and any other information required under part 19.
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\1154\ 17 CFR 15.01.
\1155\ 17 CFR 19.00(a)(3).
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ii. Comments and Summary of the Commission Determination--Special Calls
The Commission did not receive any comments on these changes and is
adopting the changes to Sec. Sec. 15.01(d), Sec. 19.00(b), and
19.03(b) as proposed.
5. Form 304 Cotton On-Call Reporting
i. Summary of the 2020 NPRM--Form 304 Cotton On-Call Reporting
With the proposed elimination of the cash-market reporting portions
of Form 304 as described above, Form 304 would be used exclusively to
collect the information needed to publish the Commission's weekly
cotton on-call report, which shows the quantity of unfixed-price cash
cotton purchases and sales that are outstanding against each cotton
futures month.\1156\ While the Commission did not propose to eliminate
the cotton on-call portions of Form 304, or to stop publishing the
cotton on-call report, the Commission did request comment about the
implications of doing so.\1157\
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\1156\ Cotton On-Call, U.S. Commodity Futures Trading Commission
website, available at https://www.cftc.gov/MarketReports/CottonOnCall/index.htm (weekly report).
\1157\ Specifically, the Commission requested comments on the
following issues: To what extent, and for what purpose, do market
participants and others rely on the information contained in the
Commission's weekly cotton on-call report; Whether publication of
the cotton on-call report creates any informational advantages or
disadvantages, and/or otherwise impact competition in any way;
Whether the Commission should stop publishing the cotton on-call
report, but continue to collect, for internal use only, the
information required in Part III of Form 304 (Unfixed-Price Cotton
``On-Call''); Or alternatively, whether the Commission should stop
publishing the cotton on-call report and also eliminate the Form 304
altogether, including Part III. See 85 FR at 11657.
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In addition to requesting comment regarding continued collection of
the Form 304 and publication of the cotton-on-call report, the
Commission proposed a number of technical changes to the Form 304.
Under the 2020 NPRM, the requirements pertaining to that report would
remain in proposed Sec. Sec. 19.00(a) and 19.02, with minor
modifications to existing provisions. In particular, the Commission
proposed to update cross references (including to renumber Sec.
19.00(a)(2) as Sec. 19.00(a)) and to clarify and update the procedures
and timing for the submission of Form 304. Specifically, proposed Sec.
19.02(b) would require that each Form 304 report be made weekly, dated
as of the close of business on Friday, and filed not later than 9 a.m.
Eastern Time on the third business day following that Friday using the
format, coding structure, and electronic data transmission procedures
approved in writing by the Commission. The Commission also proposed
some modifications to the Form 304 itself, including conforming and
technical changes to the organization, instructions, and required
identifying information.\1158\
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\1158\ Among other things, the proposed changes to the
instructions would clarify that traders must identify themselves on
Form 304 using their Public Trader Identification Number, in lieu of
the CFTC Code Number required on previous versions of Form 304. This
change will help Commission staff to connect the various reports
filed by the same market participants. This release includes a
representation of the final Form 304, which is to be submitted in an
electronic format published pursuant to this Final Rule, either via
the Commission's web portal or via XML-based, secure FTP
transmission.
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ii. Summary of the Commission Determination--Form 304 Cotton On-Call
Reporting
The Commission has determined to maintain the status quo as
proposed by not eliminating the cotton on-call portions (currently Part
III) of the Form 304, and by continuing to publish the cotton on-call
report. The Commission is also adopting the proposed technical changes
described above.
iii. Comments--Form 304 Cotton On-Call Reporting
Commenters were divided on the questions posed by the Commission on
whether to retain Part III of the Form 304 and to continue publishing
the weekly cotton on-call report.
CMC, along with numerous commenters from the cotton industry,
believed the Commission should eliminate Form 304 in its entirety and
stop publishing the cotton on-call report.\1159\ For example, Namoi and
ACSA both argued that the cotton on-call report allows market
participants to see proprietary cash-market information for every other
participant in the cotton market, which among other things, creates an
opportunity for speculators to profit by trading against this publicly
disclosed unfixed-price positions.\1160\ Additionally, Namoi and ACSA
each highlighted that the Commission does not collect or publish
similar information for any other commodities.\1161\ ACSA also argued
that the cotton on-call report causes competitive harm to the U.S.
cotton industry because, according to ACSA, foreign mills believe that
the report imposes risks and costs and are therefore more likely to
purchase cotton from outside of the United States in order to avoid
completing Part III of Form 304.\1162\ The NCTO suggested that textile
mills are particularly harmed when speculators trade against the cash-
market positions disclosed in the cotton on-call report because textile
mills purchase the majority of their cotton on call.\1163\
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\1159\ ACA at 3; ACSA at 3, 9-11; Cargill at 10; CMC at 12; East
Cotton at 3; McMeekin at 2-3; Namoi at 1-2; Omnicotton at 2-3; Texas
Cotton at 2-3; Toyo at 2-3; Walcot at 3; and White Gold at 2.
\1160\ Namoi at 1-2; ACSA at 9-11.
\1161\ Namoi at 1-2.
\1162\ ACSA at 9-11.
\1163\ NCTO at 1-2.
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Conversely, several commenters, including other cotton industry
members, stated that the Commission should continue to collect the
information required by Form 304 and to publish the cotton on-call
report.\1164\ For example, Glencore argued that discontinuing the
report would reduce transparency, open the market to more manipulation,
and harm smaller participants due to asymmetrical information.\1165\
Similarly, AMCOT argued that without the report, large participants,
who account for a significant amount of the cotton bought or sold on
call, would have an informational advantage over small producers who
have less visibility into a large portion of the cotton market.\1166\
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\1164\ VLM Comment Text; Eric Matsen Comment Text; AMCOT at 2-3;
Gerald Marshall at 3; Lawson/O'Neill at 1; Glencore at 2; and
Dunavant at 1.
\1165\ Glencore at 2; Dunavant at 1.
\1166\ AMCOT at 2.
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iv. Discussion of Final Rule--Form 304 Cotton On-Call Reporting
After reviewing the comments discussed above, the Commission has
decided to retain the cotton on-call portions (currently Section III)
of existing Form 304 and to continue publishing its weekly cotton on-
call report. Because the comments from cotton industry firms were
divided, and
[[Page 3384]]
because the cotton on-call report has been a part of the cotton market
for more than 80 years, the Commission believes that it would be
imprudent to eliminate the report based solely on the information
provided in the comment letters, which do not include any concrete
data, studies, or quantifiable financial harms. The Commission further
notes that continued publication of the cotton on-call report will not
change the existing dynamics of the cotton market.
In the future, the Commission may solicit comments to determine
whether the cotton on-call report continues to benefit the market and
whether the report hinders the competitiveness of U.S. firms in the
global cotton market. The Commission may seek input from cotton market
participants in the form of additional comments, data, studies, or
information about specific financial harms that would warrant
discontinuing the report. The Commission emphasizes that it remains
open to continuing to discuss this important issue with market
participants and to receive additional data and information that may
more concretely demonstrate the competitive harms discussed by
commenters above.
6. Proposed Technical Changes to Part 17
i. Summary of the 2020 NPRM--Proposed Technical Changes to Part 17
Part 17 of the Commission's regulations addresses reports by
reporting markets, FCMs, clearing members, and foreign brokers.\1167\
The Commission proposed to amend existing Sec. 17.00(b), which
addresses information to be furnished by FCMs, clearing members, and
foreign brokers, to delete certain provisions related to position
aggregation, because those provisions have become duplicative of
aggregation provisions that were adopted in Sec. 150.4 in the 2016
Final Aggregation Rulemaking.\1168\ The Commission also proposed to add
a new provision, Sec. 17.03(i), which delegates certain authority
under Sec. 17.00(b) to the Director of the Office of Data and
Technology.\1169\
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\1167\ 17 CFR part 17.
\1168\ See Final Aggregation Rulemaking, 81 FR at 91455.
Specifically, the Commission proposes to delete paragraphs (1), (2),
and (3) from Sec. 17.00(b). 17 CFR 17.00(b).
\1169\ Under Sec. 150.4(e)(2), which was adopted in the 2016
Final Aggregation Rulemaking, the Director of the Division of Market
Oversight is delegated authority to, among other things, provide
instructions relating to the format, coding structure, and
electronic data transmission procedures for submitting certain data
records. 17 CFR 150.4(e)(2). A subsequent rulemaking changed this
delegation of authority from the Director of the Division of Market
Oversight to the Director of the Office of Data and Technology, with
the concurrence of the Director of the Division of Enforcement. See
82 FR at 28763 (June 26, 2017). The proposed addition of Sec.
17.03(i) would conform Sec. 17.03 to that change in delegation.
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ii. Comments and Summary of the Commission Determination--Proposed
Technical Changes to Part 17
The Commission did not receive any comments addressing these
changes and is adopting these technical changes as proposed.
I. Removal of Part 151
1. Summary of the 2020 NPRM--Removal of Part 151
Finally, the Commission proposed to remove and reserve part 151 in
response to its vacatur by the U.S. District Court for the District of
Columbia,\1170\ as well as in light of the proposed revisions to part
150 that conform part 150 to the amendments made to CEA section 4a by
the Dodd-Frank Act.
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\1170\ See supra notes 10-11 and accompanying discussion.
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2. Comments and Summary of the Commission Determination--Removal of
Part 151
The Commission did not receive any comments regarding these changes
and is adopting these conforming changes as proposed.
III. Legal Matters
This section of the release sets forth certain legal determinations
by the Commission that underlie the determinations regarding the
specifics of the Final Rule set forth previously in this preamble, as
well as the reasons for those legal determinations and consideration of
relevant comments. Specifically, Part A sets forth the Commission's
determination that, in a rulemaking pursuant to CEA section 4a(a)(2),
the Commission must find position limits to be ``necessary'' within the
meaning of paragraph 4a(a)(1). Part B sets forth the Commission's
interpretation of the criteria for finding position limits to be
necessary within the meaning of the statute. Part C sets forth the
Commission's necessity findings for the 25 core referenced futures
contracts. Part D sets forth the Commission's necessity finding for
futures contracts and options on futures contracts linked to a core
referenced futures contract. Finally, Part E sets forth the
Commission's necessity finding for spot and non-spot months.
A. Interpretation of Statute Regarding Whether Necessity Finding Is
Required for Position Limits Established Pursuant to CEA Section
4a(a)(2)
1. The Commission's Preliminary Interpretation in the 2020 NPRM
In the 2020 NPRM the Commission considered whether CEA section 4a,
as amended, requires the Commission to issue Federal position limits
for all physical commodities other than excluded commodities without
making its own antecedent finding that such position limits are
necessary. This was in response to ISDA, in which the U.S. District
Court for the District of Columbia held that the CEA was ambiguous in
that respect. Specifically, the court held that where CEA section
4a(a)(2) (``paragraph 4a(a)(2)'') states that the Commission shall
issue such position limits ``[i]n accordance with the standards set
forth in paragraph (1),'' \1171\ it is unclear whether the
``standards'' include the requirement in paragraph (1) of CEA section
4a(a) (``paragraph 4a(a)(1)'') that the Commission establish such
limits as it ``finds are necessary to diminish, eliminate, or prevent''
specified burdens on interstate commerce.\1172\ In the 2020 NPRM, the
Commission preliminarily determined that paragraph 4a(a)(2) should be
interpreted as incorporating the necessity requirement of paragraph
4a(a)(1).\1173\ For the Final Rule, the Commission herein adopts that
determination as final, along with the reasoning set forth in the 2020
NPRM.
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\1171\ Paragraph 4a(a)(1) of the CEA states, in relevant part:
``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, or swaps that perform or affect a significant price
discovery function with respect to registered entities 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. For the purpose of
diminishing, eliminating, or preventing such burden, the Commission
shall, from time to time, after due notice and opportunity for
hearing, by rule, regulation, or order, proclaim and fix such limits
on the amounts of trading which may be done or positions which may
be held by any person, including any group or class of traders,
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, or swaps traded on or subject to the
rules of a designated contract market or a swap execution facility,
or swaps not traded on or subject to the rules of a designated
contract market or a swap execution facility that performs a
significant price discovery function with respect to a registered
entity as the Commission finds are necessary to diminish, eliminate,
or prevent such burden.''
\1172\ Paragraphs 4a(a)(1) and 4a(a)(2)(A); ISDA, 887 F. Supp.
2d at 280-81.
\1173\ 85 FR at 11659.
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[[Page 3385]]
The Commission's preliminary determination was based on a number of
considerations, set forth in detail in the 2020 NPRM.\1174\ Consistent
with the district court's instructions,\1175\ the Commission based its
determination both on analysis of the CEA's statutory language and on
application of the Commission's experience and expertise to relevant
facts and policy concerns.\1176\ Among the most important factual and
policy concerns relied upon by the Commission in the 2020 NPRM were:
---------------------------------------------------------------------------
\1174\ Id. at 11659-11661.
\1175\ The court directed the Commission, on remand, to resolve
the ambiguity not by ``rest[ing] simply on its parsing of the
statutory language'' but by ``bring[ing] its experience and
expertise to bear in light of the competing interests at stake.'' 85
FR at 11659, quoting ISDA, 887 F. Supp. 2d at 281.
\1176\ 85 FR at 11659-11661.
---------------------------------------------------------------------------
a. Absent the necessity-finding requirement, the language of
paragraph 4a(a)(2) would evidently require the imposition of some level
of position limits for a physical commodity even if limits at any level
would be likely to do more harm than good, including with respect to
public interests specifically identified in paragraph 4a(a)(1) and
elsewhere in section 4a or the CEA generally.\1177\ In addition to
being inconsistent with the thrust of section 4a taken as a whole, this
approach makes little sense as a matter of policy.\1178\
---------------------------------------------------------------------------
\1177\ Id. at 11659, citing as examples CEA sections 5,
4a(a)(2)(C), and 4a(a)(3)(B).
\1178\ Id. at 11660.
---------------------------------------------------------------------------
b. Subparagraph 4a(a)(2)(A) requires that position limits be set
``as appropriate.'' At a minimum, this language requires the Commission
to use its best judgment in determining the levels at which position
limits are set. In addition, there is authority from case law that the
word ``appropriate'' in a regulatory statute requires agencies to take
into account the costs of regulation, if only in a rough or approximate
way, and that consideration may preclude the considered action if the
costs are highly disproportionate.\1179\ The statute thus allows for
the possibility that, in establishing position limit levels for some
commodities or contracts, the Commission, in its judgment, may
determine that the optimal level is no limit at all. This possibility
does not harmonize with a requirement to impose limits for all physical
commodities, but is consistent with a requirement to impose limits
where they are necessary.
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\1179\ See Michigan v. EPA, 132 S.Ct. 2699, 2707-08, 2711 (2015)
(agency could not disregard major costs under statute requiring that
regulation be ``appropriate,'' but use of this word did not require
formal cost-benefit analysis).
---------------------------------------------------------------------------
c. Requiring position limits without a necessity finding would be a
``sea change'' in derivatives regulation since it would involve a shift
from Federal limits on a small number of agricultural commodities to
limits on all physical commodities.\1180\ The Commission was skeptical
that Congress would have made such a change through ambiguous
language.\1181\ The Commission noted that there are currently over
1,200 listed futures contracts on physical commodities and that there
is no indication that Congress had concerns about, or even considered,
all of them.\1182\ To the contrary, the legislative history suggests
that enactment of paragraph 4a(a)(2) was driven, in part, by studies of
potential excessive speculation in a small number of particularly
important commodities.\1183\ This history is consistent with an
interpretation of the statute as requiring position limits for
commodities where controlling excessive speculation is most important,
absent statutory language that unambiguously requires limits for all
commodities.
---------------------------------------------------------------------------
\1180\ 85 FR at 11660.
\1181\ Id.
\1182\ Id.
\1183\ 85 FR at 1160 (discussing Congressional staff studies of
potential excessive speculation in oil, natural gas, and wheat).
---------------------------------------------------------------------------
d. A necessity finding allows the Commission to apply its
experience and expertise to impose position limits where they are
likely to do the most good, taking into consideration the fact that
even well-crafted position limits create compliance costs and
potentially may have a negative effect on liquidity and forms of
speculation that benefit the market.\1184\
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\1184\ 85 FR at 11660.
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In the 2020 NPRM, the Commission recognized that it was proposing
to change its interpretation regarding whether paragraph 4a(a)(2)
incorporates a requirement to find position limits necessary.\1185\ The
Commission noted that, in the preamble to the 2011 Final Rulemaking as
well as the Commission's subsequent position limits proposals,\1186\
the Commission had interpreted paragraph 4a(a)(2) to mandate the
imposition of position limits without the need for a necessity
finding.\1187\ As part of its preliminary determinations in the 2020
NPRM that the CEA does require a necessity finding, the Commission
explained in detail why the reasons it had previously given for the
``mandate'' approach do not compel that interpretation of the statute.
Taken as a whole, such reasons are insufficiently persuasive to
outweigh the factors that favor a necessity finding.\1188\
---------------------------------------------------------------------------
\1185\ Id. at 11658.
\1186\ See supra Section I.A.
\1187\ 85 FR at 11658.
\1188\ 85 FR at 11661-64. CEA Section 4a(a)(2), which was
enacted as part of the Dodd-Frank Act, directs the Commission to
``establish'' limits on positions. The Commission does not interpret
this directive to apply to the nine legacy agricultural contracts
included in the list of core referenced futures contracts because
they are already subject to Federal position limits that have
existed for decades based on prior necessity findings pursuant to
CEA Section 4a(a)(1). Nevertheless, as discussed infra at Section
III.C, the Commission has determined that such limits are necessary.
---------------------------------------------------------------------------
2. Comments on the Commission's Preliminary Interpretation in the 2020
NPRM and Commission Responses
In response to the Commission's preliminary interpretation provided
in the 2020 NPRM, a number of commenters stated that the Commission
must make a necessity finding before establishing position limits under
paragraph 4a(a)(2).\1189\ These commenters generally asserted that this
result was required by the language of the statute, although they did
not provide a detailed analysis of that language beyond that set forth
in the 2020 NPRM.\1190\ Some commenters also asserted that a necessity
finding is important to avoid imposing unwarranted costs on market
participants, a position consistent with the policy concerns that
entered into the Commission's preliminary determination that paragraph
4a(a)(2) requires a necessity finding.\1191\
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\1189\ E.g., Citadel at 2; EEI at 2-3; ISDA at 3; MFA/AIMA at 1,
14; SIFMA AMG at 1-2.
\1190\ Id.
\1191\ E.g., EEI at 3.
---------------------------------------------------------------------------
A number of other commenters stated that the statute does not
require a necessity finding for the establishment of position limits
pursuant to paragraph 4a(a)(2).\1192\ These commenters made the
following points:
---------------------------------------------------------------------------
\1192\ E.g., AFR at 1; Better Markets at 3-4, 64; IATP at 4;
NEFI at 2-3.
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a. Some commenters asserted that the language of paragraph 4a(a)(2)
requires the Commission to establish position limits for all physical
commodities without first determining that limits are necessary.\1193\
Commenters making this point emphasized the language of subparagraph
4a(a)(2)(A) stating that the Commission ``shall'' impose position
limits on physical commodities and the
[[Page 3386]]
language of subparagraph 4a(a)(2)(B) referring to position limits
``required'' by subparagraph 4a(a)(2)(A).\1194\ However, while these
words are suggestive of a mandatory requirement of some kind, they do
not dictate the conclusion that paragraph 4a(a)(2) requires position
limits across-the-board without a necessity finding, and to conclude
otherwise would contradict the holding in ISDA that the statutory text
is ambiguous.\1195\ The requirements of paragraph 4a(a)(2) are subject
to the condition that position limits be imposed ``[i]n accordance with
the standards set forth in paragraph [4a(a)(1)].'' The meaning of that
text, and specifically the meaning of ``the standards,'' is the primary
issue for the Commission to resolve here. For reasons explained above
and in the 2020 NPRM, these standards are best interpreted as including
the paragraph 4a(a)(1) necessity requirement.\1196\
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\1193\ E.g., Better Markets at 64 (incorporating by reference
amicus brief by Senators Levin et al. in the ISDA litigation). The
statute applies to all physical commodities ``other than excluded
commodities.'' 7 U.S.C. 6a(a)(2). The Commission here refers to
``all physical commodities'' for purposes of brevity only, and does
not mean to imply that the statute covers excluded commodities.
\1194\ E.g., Better Markets at 64; NEFI at 1. Better Markets
stated that the Commission should adopt the legal views set forth in
the amicus brief filed by certain U.S. Senators in the ISDA case.
Better Markets at 64. However, in ISDA, the district court stated
that ``[g]iven the fundamental ambiguities in the statute,'' it was
``not persuaded by their arguments.'' ISDA, 887 F. Supp. 2d at 283.
\1195\ ISDA, 887 F. Supp. 2d at 274.
\1196\ Other arguments against a necessity requirement made by
commenters based on the statutory wording have previously been
addressed in the 2020 NPRM. Compare Better Markets at 64
(incorporating by reference amicus brief by Senators Levin et al. in
the ISDA litigation) with 85 FR at 11661-64.
---------------------------------------------------------------------------
b. Some commenters asserted that the legislative history of
paragraph 4a(a)(2) supports imposing limits on all physical commodities
without requiring a necessity finding.\1197\ Among the points
emphasized by commenters were that (1) certain bill language that
ultimately became paragraph 4a(a)(2) evolved from using the permissive
word ``may'' to the mandatory word ``shall''; and (2) the House
Committee on Agriculture voted out a predecessor bill containing
language similar to that of paragraph 4a(a)(2), and there are
indications that members of the committee viewed this language as
requiring limits for all physical commodities.\1198\ In the view of the
Commission, neither of these points is sufficient to resolve the
ambiguity in the language of paragraph 4a(a)(2) or dictate the
conclusion that the statute mandates position limits without a
necessity finding.
---------------------------------------------------------------------------
\1197\ E.g., Better Markets at 64 (incorporating by reference
amicus brief by Senators Levin et al. in the ISDA litigation).
\1198\ Id.
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With regard to the first point, there is no question that the final
version of paragraph 4a(a)(2) states that the Commission ``shall''
impose position limits. But, as explained above, this mandatory
language is explicitly subject to a requirement that limits be imposed
in accordance with the standards of paragraph 4a(a)(1), and that
condition is ambiguous. The commenters' second point was addressed in
detail in the 2020 NPRM.\1199\ Briefly, the House Committee on
Agriculture bill described by commenters was never approved by the full
House of Representatives.\1200\ Its language on position limits was
included in the Dodd-Frank Act, but discussion of this language in the
floor debate and conference committee report did not characterize it as
requiring limits for all physical commodities.\1201\ And nothing in the
legislative history specifies that the word ``standards'' in paragraph
4a(a)(2) excludes the paragraph 4a(a)(1) necessity requirement. As a
result, the legislative history, taken as a whole, does not resolve the
ambiguity in the statute.
---------------------------------------------------------------------------
\1199\ 85 FR at 11663.
\1200\ Id.
\1201\ Id.
---------------------------------------------------------------------------
c. Some commenters asserted that to require a necessity finding
construes the Dodd-Frank Act's amendment to section 4a as narrowing the
Commission's power to impose position limits, which is implausible as
an interpretation given the overall thrust of the Dodd-Frank Act and
the legislative history of paragraph 4a(a)(2).\1202\ However, the CEA
already required the Commission to find position limits necessary
before the Dodd-Frank Act, so continuing to require such a finding is
not a new constraint on the Commission.\1203\ And, even with a
necessity requirement, paragraph 4a(a)(2) imposes an important new duty
on the Commission: to affirmatively proceed to establish position
limits for physical commodities where limits are necessary, within a
specified period of time, including as to economically equivalent
swaps, and to report to Congress on the effects of those limits, if
any.\1204\ So the Commission's preliminary interpretation of the
statute is consistent with legislative history indicating that Congress
wanted the Commission to take action on the subject of position limits.
---------------------------------------------------------------------------
\1202\ E.g. AFR at 1.
\1203\ See paragraph 4a(a)(1). The House Committee on
Agriculture summarized this provision as giving the government ``the
power, after due notice and opportunity for hearing and a finding of
a burden on interstate commerce caused by such speculation, to fix
and proclaim limits on futures trading . . .'' H.R. Rep. No. 421,
74th Cong., 1st Sess. 5 (1935), stated more specifically in the
statutory text as authority to diminish, eliminate, or prevent
burdens that are ``undue and unnecessary.'' Public Law 74-675
section 5.
\1204\ See paragraphs 4a(a)(2) and 4a(a)(5), 7 U.S.C. 6a(a)(2),
6a(a)(5); Public Law 111-203 Sec. 719(a).
---------------------------------------------------------------------------
d. Some commenters asserted that a necessity finding creates
unnecessary administrative obstacles to establishing position
limits.\1205\ In the view of the Commission, any extra needed
administrative activity is a reasonable tradeoff for the flexibility
and public policy benefits of imposing position limits only where they
are economically justified as an efficient means of addressing the
concerns Congress expressed in section 4a(a)(1). One commenter went
further and suggested that a requirement to find necessity could make
implementation and enforcement of position limits ``nigh to
impossible.'' \1206\ However, that commenter premised this assertion on
a different necessity standard, that the Commission is not adopting in
this rulemaking.\1207\ In the view of the Commission, the necessity
standard it is adopting herein is both consistent with the statute and
workable in practice, as demonstrated by the necessity findings below.
The workability of the Commission's standard is supported by a
commenter who was opposed to a requirement to find necessity but
nevertheless acknowledged that the necessity standard preliminarily
adopted in the 2020 NPRM is ``unlikely to limit the CFTC's practical
ability to impose Federal position limits.'' \1208\
---------------------------------------------------------------------------
\1205\ E.g., Better Markets at 4.
\1206\ IATP at 5.
\1207\ Id. IATP assumed the use of a necessity standard, which
it attributed to an industry group, requiring the Commission to,
among other things, ``determine the likelihood that a specific limit
would curtail excessive speculation in a specific market.'' Id. The
Commission has determined that the statute does not require that. 85
FR at 11664-66 and infra.
\1208\ Better Markets at 4.
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Commenters who opposed a necessity-finding requirement also set
forth a number of justifications for broad use of Federal position
limits without asserting specifically that these concerns require
limits for all physical commodities or justify imposing limits without
finding them to be necessary. For example, commenters pointed out that
unjustified volatility in derivatives markets can have negative
consequences for price discovery and hedging in related non-financial
markets.\1209\ The Commission agrees with this point and agrees that
preventing these consequences is the major reason why the CEA provides
for position limits.\1210\ However, this observation does not justify
limits for all physical commodities since (a) the importance of the
link between derivatives markets and associated cash markets can vary
for
[[Page 3387]]
different commodities; and (b) good policy requires consideration of
the costs and burdens associated with position limits as well as their
potential preventative effects.\1211\ These points are discussed
further in sections of this release dealing with the Commission's legal
standard for necessity, necessity findings, and consideration of costs
and benefits pursuant to CEA section 15(a).
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\1209\ Id. at 25-29.
\1210\ See Congressional finding in first sentence of paragraph
4a(a)(1), 7 U.S.C. 6a(a)(1).
\1211\ In reaching this conclusion, the Commission draws upon
its experience and expertise in considering costs and benefits
before promulgating a rule, pursuant to 7 U.S.C. 19(a). The
Commission believes that such consideration (which need not be
mathematical) leads to better outcomes.
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Commenters opposed to a necessity-finding requirement also asserted
that exchanges cannot always be relied upon to establish optimal
position limits since they may benefit from revenue generated from high
levels of speculation, including, in some instances, high levels of
speculation by individual market participants.\1212\ To the extent that
this is so, it is a reason for Congress to authorize, and the
Commission to implement, position limits where needed. But it is not a
reason to apply them to physical commodities across the board for the
reasons just stated: The importance of unjustified volatility in
derivatives markets for the non-financial economy can vary, and
position limits have associated costs and burdens. Moreover, as
discussed earlier in the preamble, exchanges are subject to statutory
and regulatory obligations to establish position limits or position
accountability and must do so in accordance with standards established
by the Commission. Further, any incentives for exchanges to impose
suboptimal position limits are reduced because an exchange that leaves
itself open to an enhanced risk of excessive speculation, manipulation,
or other forms of unjustified pricing is likely to lose business from
traders seeking a stable market that reflects fundamental
conditions.\1213\
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\1212\ Better Markets at 22-24.
\1213\ See supra Section II.B.2.iv.b., for additional discussion
of exchange incentives and related statutory and regulatory
obligations to maintain market integrity.
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3. Commission Determination
Having reviewed the comments and further considered the issue, the
Commission has determined that the interpretation of paragraph 4a(a)(2)
as incorporating the requirement of paragraph 4a(a)(1) to find position
limits necessary before imposing them is the best interpretation of the
statute, and the Commission adopts this interpretation as its
interpretation under the Final Rule. This determination is based on the
reasons set forth above and in the relevant portion of the 2020
NPRM.\1214\ The Commission further recognizes that this determination
is a change from the Commission's earlier interpretation of paragraph
4a(a)(2) as not requiring a necessity finding. The Commission has
determined that the reasons previously given for such an interpretation
of paragraph 4a(a)(2) are not compelling for the reasons stated above
and in the relevant portion of the 2020 NPRM.\1215\ The specifics of
what the term ``necessary'' means in this context are discussed in the
next section, followed by the Commission's final necessity finding.
---------------------------------------------------------------------------
\1214\ 85 FR at 11658-61.
\1215\ Id. at 11661-64.
---------------------------------------------------------------------------
B. Legal Standard for Necessity Finding
For the reasons discussed above, paragraph 4a(a)(2) requires the
Commission to establish position limits to the extent they are
``necessary'' to ``diminish, eliminate, or prevent'' the burden on
interstate commerce in a commodity from ``sudden or unreasonable
fluctuations or unwarranted changes in the price'' of the commodity
caused by excessive speculation in futures contracts (and options
thereon) or swaps.\1216\ In the 2020 NPRM the Commission preliminarily
interpreted this requirement and preliminarily reached several
conclusions about what sort of necessity finding the statute requires.
This section of the preamble (1) reviews the preliminary conclusions
set forth in the 2020 NPRM with some additional clarification and
elaboration; \1217\ (2) reviews and evaluates important points made in
comments regarding the CEA's statutory standard for finding necessity;
and (3) sets forth the Commission's conclusions for this Final Rule on
the legal standard for finding position limits to be necessary within
the meaning of CEA section 4a.
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\1216\ The first sentence of paragraph 4a(a)(1) is a
Congressional finding that ``excessive speculation in any
commodity'' under futures contracts or certain swaps ``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.'' 7 U.S.C. 6a(a)(1). The
second sentence of paragraph 4a(a)(1), referring back to the burden
on interstate commerce found in the first sentence, states that the
Commission shall establish such position limits ``as the Commission
finds are necessary to diminish, eliminate, or prevent such
burden.'' Id.
\1217\ Certain points relevant to the legal standard for
necessity that were made in a number of different sections of the
NPRM are integrated into the discussion of the legal standard here.
---------------------------------------------------------------------------
1. Preliminary Legal Standard for Necessity in 2020 NPRM
In the 2020 NPRM, the Commission reached a number of conclusions:
First, the CEA does not require the Commission to determine whether
excessive speculation in general may create a risk of sudden or
unreasonable fluctuations or unwarranted changes in the price of a
commodity or whether position limits are an effective tool for
controlling or preventing these potential effects.\1218\ Section
4a(a)(1) of the CEA contains a Congressional finding that ``[e]xcessive
speculation . . . causing sudden or unreasonable fluctuations or
unwarranted changes in . . . price . . . is an undue and unnecessary
burden on interstate commerce in such commodity'' and prescribes
position limits for the purpose of ``diminishing, eliminating, or
preventing'' that burden.\1219\ The analysis in the 2020 NPRM accepted
those premises as established by Congress.
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\1218\ 85 FR at 11664.
\1219\ See Commodity Futures Trading Com'n v. Hunt, 592 F.2d
1211, 1215 (7th Cir. 1979) (``Congress concluded that excessive
speculation in commodity contracts for future delivery can cause
adverse fluctuations in the price of a commodity, and authorized the
Commission to restrict the positions held or trading done by any
individual person or by certain groups of people acting in
concert.'').
---------------------------------------------------------------------------
Second, the word ``necessary'' has a spectrum of legal meanings
from absolute physical necessity to merely useful or convenient.\1220\
The 2020 NPRM explained that it is unlikely Congress intended either
extreme.\1221\ The Commission preliminarily determined in the 2020 NPRM
that the necessity requirement is best interpreted as a directive to
establish position limits where they are economically justified as an
efficient mechanism to advance the Congressional goal of preventing
undue burdens on commerce in an underlying commodity caused by
excessive speculation in the associated futures or swaps markets.\1222\
---------------------------------------------------------------------------
\1220\ 85 FR at 11664.
\1221\ Id.
\1222\ Id. at 11665.
---------------------------------------------------------------------------
Under this approach, the Commission explained, position limits are
necessary where diminishing, eliminating, or preventing burdens on
commerce in a commodity caused by excessive speculation in the
associated derivatives market is likely to offer the greatest benefits
to the cash market for the commodity and the economy, and not where the
benefit of controlling or preventing such burdens is likely to be less
significant or to be accompanied by disproportionate costs or negative
consequences, including negative
[[Page 3388]]
consequences with respect to Congress's stated purpose, to prevent the
burdens of sudden or unreasonable fluctuations or unwarranted changes
in price that burden interstate commerce.\1223\ For example, it may be
that for a given commodity, high levels of sudden or unreasonable
fluctuation or unwarranted changes in the price of a commodity would
have little overall impact on commerce in the cash commodity market or
the national economy. If the burdens or negative economic consequences
associated with position limits for that commodity, as discussed in the
Commission's consideration of costs and benefits, are out of proportion
to the likely economic benefits of position limits, it would be
unwarranted to impose them.\1224\ However, there are markets in which
sudden or unreasonable fluctuations or unwarranted changes in the price
of a commodity caused by excessive speculation would have significantly
negative effects on the cash commodity market or the broader economy.
Even if such disruptions would be unlikely due to the particular
characteristics of the relevant derivatives market, the Commission may
nevertheless determine that position limits are necessary as a
prophylactic measure given the potential magnitude or impact of the
unlikely event.\1225\
---------------------------------------------------------------------------
\1223\ 85 FR at 11665.
\1224\ Id.
\1225\ Id.
---------------------------------------------------------------------------
The Commission's proposed test in the 2020 NPRM thus focused on the
Congressional purpose implicit in the finding in the first sentence of
paragraph 4a(a)(1): Protecting the cash commodity markets from such
sudden or unreasonable fluctuations or unwarranted changes in the
price. The Commission specified that this standard cannot be determined
by a mathematical formula, but requires judgment by the Commission,
taking into account available facts but also based on the Commission's
experience and expertise.\1226\ The Commission further specified that
this standard includes consideration of costs and benefits under CEA
section 15(a), insofar as the Commission is required by that section to
consider the costs and benefits of its discretionary choices.\1227\
---------------------------------------------------------------------------
\1226\ 85 FR at 11665.
\1227\ Id. For further discussion of the cost-benefit
implications of the Commission's necessity finding with respect to
the 25 core referenced futures contracts, see infra Section IV.A.2.
For further discussion of the cost-benefit implications of Federal
position limits in light of existing exchange-set limits, see infra
Section IV.A.6.
---------------------------------------------------------------------------
In applying this necessity standard in the 2020 NPRM, the
Commission identified two primary factors to be used in identifying
commodities where using position limits in derivatives markets to
control or prevent injury to the underlying commodity market would be
most valuable:
The first primary factor is the importance of the derivatives
market for a commodity to the operation of the market for the cash
commodity itself.\1228\ Examples of links between derivatives markets
and cash markets that exemplify this factor include:
---------------------------------------------------------------------------
\1228\ 85 FR at 11665, 11666.
---------------------------------------------------------------------------
a. The extent to which volatility in the derivatives market is
likely to result in sudden or unreasonable fluctuations or unwarranted
changes in the price in the cash commodity market including, in
particular, the extent to which participants in the cash market rely on
the derivatives market as a price discovery mechanism. This includes
the use of futures prices for pricing cash-market transactions and the
use of futures prices for planning purposes, such as when farmers
decide what crops to plant or manufacturers estimate the cost of inputs
to their production processes.\1229\
---------------------------------------------------------------------------
\1229\ 85 FR at 11665, 11666.
---------------------------------------------------------------------------
b. The extent to which participants in the cash market use the
derivatives market for hedging.\1230\ The second primary factor
specified in the 2020 NPRM is the importance of the underlying
commodity to the economy as a whole.\1231\ In the view of the
Commission, evidence demonstrating either one of these primary factors
is sufficient to establish that position limits are necessary. This is
so because each primary factor identifies circumstances that present an
undue risk that disruptions to derivatives markets for a commodity will
have consequences for industries that produce and use the relevant
commodity and, ultimately, the general public that invests in and is
employed by those industries and purchases their end-products.\1232\
Thus, each of the primary factors relates to the statutory objective of
diminishing, eliminating, or preventing undue and unnecessary burdens
on interstate commerce in a commodity arising from excessive
speculation in associated derivatives contracts. Of course, to the
extent that both factors are present, a necessity finding will be
strengthened.
---------------------------------------------------------------------------
\1230\ Id. at 11666.
\1231\ Id. at 11665, 11666.
\1232\ See Id. at 11664, fn. 471, 11666-11670 (giving examples
as part of necessity finding).
---------------------------------------------------------------------------
In the 2020 NPRM, the Commission emphasized that a necessity
determination cannot be reduced to a mathematical formula, though data
may of course be highly relevant. To the extent that the primary
factors identified by the Commission cannot be directly measured, the
Commission, in the exercise of its judgment, may look to market data or
qualitative information that correlates with these factors for guidance
in applying them.\1233\
---------------------------------------------------------------------------
\1233\ See discussion in findings section below.
---------------------------------------------------------------------------
With respect to futures contracts and options contracts linked to
core referenced futures contracts, the Commission determined that
position limits are necessary for linked contracts because such
position limits are likely to make position limits for core referenced
futures contracts more effective in preventing manipulation and other
sources of sudden or unreasonable fluctuations or unwarranted changes
in the price in the underlying commodity.\1234\
---------------------------------------------------------------------------
\1234\ 85 FR at 11619-11620. See also supra at Section
II.A.16.iii.
---------------------------------------------------------------------------
The Commission's preliminary necessity finding in the 2020 NPRM
also took into consideration economic differences between derivatives
positions held during spot months and those held during other months
that affect the extent to which position limits are an efficient
mechanism for controlling or preventing sudden or unreasonable
fluctuations or unwarranted changes in the price in underlying
commodities. Specifically, the Commission stated that corners and
squeezes can occur only during the spot month.\1235\ Thus, certain
important sources of sudden or unreasonable fluctuations or unwarranted
changes in the price are present only during the spot month. While the
fact that certain types of disruptions in a given market may be
unlikely is not dispositive of the necessity question,\1236\ the
Commission judged that the impossibility of corners and squeezes in
non-spot months diminished the likelihood of excessive speculation
causing sudden or unreasonable fluctuations or unwarranted changes in
the price in underlying commodities to such an extent as to reduce the
benefit of position limits for those months below the point where, in
the Commission's judgment, position limits would be justified under the
necessity standard.\1237\ Nevertheless, the Commission did not rescind
existing non-spot month limits for legacy
[[Page 3389]]
agricultural contracts, because it did not observe problems that would
give a reason to eliminate them at this time.\1238\
---------------------------------------------------------------------------
\1235\ 85 FR at 11629.
\1236\ Id. at 11665.
\1237\ 85 FR at 11628. The Commission also believes that the
relevant benefits and burdens indicate that no level of new non-
spot-month limits is ``appropriate'' as that term is used in Section
4a(a)(2)(A). See discussion at Section IV.A.6.iii.b.
\1238\ 85 FR at 11628. Specifics of the Commission's findings
with regard to the need for limits during spot and non-spot months
are in the 2020 NPRM at 85 FR 11596, 11628, and supra at Sections
II.B.3. and II.B.4.
---------------------------------------------------------------------------
2. Comments and Commission Responses
Relatively few commenters addressed the substance of the
Commission's legal interpretation of what CEA section 4a requires in
order for the Commission to determine that position limits are
necessary for a particular commodity or contract. Major points made by
commenters, and the Commission's evaluation of these points include:
a. Several commenters stated that the necessity finding must be
``robust and data-driven.'' \1239\ The Commission agrees that the
agency is required to consider available data, to the extent that it is
relevant, in determining whether to establish position limits. At the
same time, the Commission interprets the statute as requiring it to
exercise judgment regarding the need for position limits where data is
not available. The statute does not specify the use of any particular
methodology, quantitative or otherwise, in determining whether position
limits are necessary.
---------------------------------------------------------------------------
\1239\ E.g. ISDA at 3; SIFMA AMG at 2. See also MFA/AIMA at 4
(advocating for individualized necessity findings based on detailed
analyses for each contract).
---------------------------------------------------------------------------
In addition, the Commission must implement CEA section 4a in a
fashion consistent with the finding regarding excessive speculation and
its effects on commerce in the first sentence of paragraph 4a(a)(1) and
the directive in paragraph 4a(a)(2) that the Commission ``shall''
promptly establish position limits for physical commodities, albeit
subject to the necessity-finding requirement. These provisions imply
that the Commission must act on position limits, even if available data
is imperfect, so long as it has a reasonable basis for determining
limits to be necessary. Other language of CEA section 4a further
supports the conclusion that Congress intended the Commission to
consider available data but also to exercise judgment in establishing
position limits. For example, paragraph 4a(a)(2) requires that limits
be established ``as appropriate,'' which implies consideration of a
broad range of relevant factors, but subject to the reasonable exercise
of subjective judgment.\1240\ Similarly, paragraph 4a(a)(3)(B) lists
policy objectives for position limits that the Commission must achieve
``to the maximum extent possible'' but specifies that the Commission
must do this ``in its discretion.'' The Commission also believes it is
better policy to interpret ``as necessary'' to permit flexibility in
response to imperfect available data, so long as there is a reasonable
basis for its decisions.\1241\ Such flexibility may facilitate
achieving the objectives of the statute, whether by determining that
position limits either are necessary or not necessary in particular
circumstances.
---------------------------------------------------------------------------
\1240\ See Michigan v. EPA, 576 U.S.C. 743, 752 (2015).
\1241\ 7 U.S.C. 6a(a)(3)(B).
---------------------------------------------------------------------------
b. One commenter, MGEX, supported the Commission's general approach
of focusing on the relationship between the derivatives market and the
underlying commodity in making necessity determinations.\1242\ This
commenter stated, ``As the Commission appropriately points out, it is
important to focus on derivatives that are vital to price discovery and
distribution of the underlying commodity so that any excessive
speculation may have a small impact.'' \1243\ The Commission agrees
with that statement.
---------------------------------------------------------------------------
\1242\ MGEX at 1.
\1243\ Id.
---------------------------------------------------------------------------
c. One commenter, Citadel, asserted that the statute required a
different test for a finding of necessity than that used by the
Commission.\1244\ According to this commenter, for each commodity
subject to position limits, the Commission must establish ``when and
how holding a large position in a given commodity could allow a market
participant to exert undue market power or influence.'' \1245\ The
commenter criticized the Commission for relying on the role core
referenced futures contracts play in price discovery and the fact that
they require physical delivery.\1246\ According to the commenter, the
Commission proposed position limits on certain commodities ``based
merely on their size or importance'' and ``did not explain why size or
importance, without more'' justifies position limits.\1247\ The
commenter expressed concern that the Commission's standard could set a
precedent for the establishment of position limits for additional
commodities in the future without adequate justification and therefore
could reduce investor participation in commodity markets in a fashion
that would impair the use of those markets for risk management and
commercial decision making.\1248\
---------------------------------------------------------------------------
\1244\ Citadel at 2-4. Somewhat similar views have been
expressed by other commenters in earlier phases of the Commission's
efforts to promulgate a position limits rule under paragraph
4a(a)(2). See, e.g., IATP at 5 (describing views of ISDA/SIFMA AMG
in connection with ISDA litigation).
\1245\ Citadel at 2.
\1246\ Id.
\1247\ Id.
\1248\ Id.
---------------------------------------------------------------------------
The Commission disagrees with Citadel's interpretation of the CEA
section 4a necessity requirement and criticism of the Commission's
interpretation for several reasons, most of which have been stated
previously.
i. The statutory language does not state a requirement to make the
particular findings Citadel claims are necessary. To the contrary, it
includes a Congressional finding that excessive speculation can cause
sudden or unreasonable fluctuations or unwarranted changes in the price
that are a burden on interstate commerce in commodities. The Commission
is required to establish position limits in light of that finding, and
neither Congress nor the Commission have ever required the sort of
showing Citadel suggests here with respect to individual
commodities.\1249\ It is not reasonable to surmise that Congress
intended Citadel's test to apply without saying so, particularly under
the Dodd-Frank Act's amendments, which reflect a Congressional intent,
or at least expectation, that the position limits regime be expanded.
The Commission also notes that Citadel set forth its proposed standard
for necessity in just a few sentences and did not spell out what sort
of data would be needed to comply with it in practice and how such data
would be used.\1250\ If there were any evidence that Congress intended
Citadel's approach, or if a case could be made that the Commission
should prefer it, such specifics would have been readily available.
---------------------------------------------------------------------------
\1249\ The Commission has made similar determinations in
connection with requirements for DCMs to impose position limits or
position accountability levels by DCM rule. E.g., Establishment of
Speculative Position Limits, 46 FR 50938, 50940 (Oct. 16, 1981)
(``it appears that the capacity of any contract market to absorb the
establishment and liquidation of large speculative positions in an
orderly manner is related to the relative size of such positions,
i.e., the capacity of the market is not unlimited''). See also 2020
NPRM, 85 FR at 11665-11666 (Commission has repeatedly found that all
markets in physical commodities are ``susceptible to the burdens of
excessive speculation'' because they ``have a finite ability to
absorb the establishment and liquidation of large speculative
positions in an orderly manner,'' but this characteristic of these
markets is not sufficient to establish that limits are necessary
within the meaning of paragraph 4a(a)(1) for all physical
commodities).
\1250\ Citadel at 2-3.
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[[Page 3390]]
ii. The Congressional finding at the beginning of paragraph
4a(a)(1) makes clear that Congress's primary concern was the effect of
excessive speculation in derivatives markets on the related cash
markets for the associated commodities. The Commission's focus on the
role the core referenced futures contracts play in price discovery and
hedging and the importance of certain commodities to the economy as a
whole therefore is directly responsive to the statutory purpose of
position limits. The Commission's focus on hedging and price discovery
is further supported by CEA section 3, which sets forth the purpose of
the CEA. Subsection 3(a) contains a Congressional finding that the
transactions subject to the CEA serve a ``national public interest'' by
providing a means for ``managing and assuming price risks'' (i.e.,
hedging and supporting hedging) ``discovering prices'' and
``disseminating pricing information.'' Subsection 3(b) states that the
purpose of the CEA, among other things, is to ``serve the public
interests'' described in subsection 3(a).\1251\ The Commission's focus
is thus consistent with the Congressional intent.
---------------------------------------------------------------------------
\1251\ 7 U.S.C. 5(a), (b).
---------------------------------------------------------------------------
The Commission's consideration of the size of the futures market
for the core referenced futures contracts also is consistent with the
statutory purpose. As explained below,\1252\ contracts with a large
volume of trading, generally speaking, are contracts that are likely to
be heavily used for price discovery and hedging by participants in the
cash market. It is rational to conclude that position limits are
unnecessary for contracts that play little role in price discovery or
for commodities that have a lesser economic footprint. In addition,
imposing position limits based on the size or importance of futures
markets is a rational way to avoid imposing compliance costs related to
position limits on futures contracts and related options contracts that
are relatively inactive or otherwise a minor part of the market.
---------------------------------------------------------------------------
\1252\ See infra Section III. (discussing necessity finding).
---------------------------------------------------------------------------
iii. As for Citadel's claim that the Commission's standard for
necessity will set a precedent for imposing position limits on
additional commodities in the future without adequate justification, if
the Commission were to establish additional position limits in the
future, it would need to justify that decision through reasoned
decision making in a new rulemaking, which would be subject to public
comment and judicial review to the same extent as other rules.
iv. Citadel's concern with adequate investor participation in the
derivatives markets applies to varying degrees with respect to all
position limits. The Commission has considered such effects, including
on liquidity and bona fide hedging, throughout this rulemaking,
including in its consideration of costs and benefits and in connection
with the determination of position limit levels.\1253\
---------------------------------------------------------------------------
\1253\ See 7 U.S.C. 6a(a)(3)(B)(iii) (position limits should be
set at level that ensures sufficient market liquidity for bona fide
hedgers to the maximum extent practicable in the discretion of the
Commission).
---------------------------------------------------------------------------
c. One commenter, IATP, endorsed a dissenting Commissioner's
criticism of the necessity standard set forth in the 2020 NPRM.\1254\
The criticism was to the effect that the standard ``boils down'' to the
assertion that the core referenced futures contracts are large and
critically important to the underlying cash markets.\1255\ However, for
reasons set forth above and in the 2020 NPRM, this is an incomplete
characterization of the Commission's standard. Moreover, as also
explained above and in the 2020 NPRM, importance to the cash market is
a criterion for necessity that flows directly from the statutory
purpose and, for reasons explained in the necessity findings section,
the amount of trading in a contract, generally speaking, is likely to
correlate with factors relevant to the statutory purpose, including use
of the contract for price discovery and hedging.
---------------------------------------------------------------------------
\1254\ IATP at 4 (quoting dissenting statement of Commissioner
Berkovitz).
\1255\ Id.
---------------------------------------------------------------------------
While critical of the Commission's standard, IATP was even more
critical of a standard like that proposed by Citadel that would require
the Commission to ``determine the likelihood that a specific limit
would curtail excessive speculation in a specific market.'' \1256\
According to IATP, such a standard, in combination with a requirement
to avoid undue costs, would make implementation of position limits
``nigh to impossible.'' \1257\ However, whether or not such a standard
is possible to apply, the Commission has determined that the statute
does not require it, and that the Commission's approach to the
necessity finding is the one most consistent with the statutory
language and purpose.
---------------------------------------------------------------------------
\1256\ IATP at 5. IATP did not refer specifically to Citadel's
comment but to similar concepts in connection with the ISDA
litigation.
\1257\ IATP at 5.
---------------------------------------------------------------------------
d. Many commenters asserted that necessity findings needed to be
made for each contract or commodity subject to position limits.\1258\
The Commission agrees with this interpretation of the statute, subject
to a number of clarifications and provisos.
---------------------------------------------------------------------------
\1258\ E.g., ISDA at 3 (necessity determination must be made
``in connection with any specific position limits that are
adopted''); PIMCO at 3 (necessity determination should be made on a
``commodity-by-commodity and product-by-product basis''); MFA/AIMA
at 4 (advocating ``for individualized necessity findings based on
detailed analyses for each contract . . . including a more specific
necessity finding for each contract'').
---------------------------------------------------------------------------
i. While the Commission must find position limits necessary for
each contract, it may do so based on different criteria for different
types of contracts so long as the criteria are reasonable and
consistent with the Commission's overall interpretation of the
necessity provision. For example, as described above, the Commission
has determined that, where limits are necessary for a core referenced
futures contract, position limits for contracts linked to the core
referenced futures contract are also necessary to enable position
limits on the associated core referenced futures contract to function
as intended.\1259\
---------------------------------------------------------------------------
\1259\ For further discussion on contracts linked to core
referenced futures contracts, see Sections II.A.16. and III.D.
---------------------------------------------------------------------------
ii. The statute does not require a necessity finding for
economically equivalent swaps for which position limits are required
pursuant to paragraph 4a(a)(5) of the CEA.\1260\ While a necessity
finding is required for position limits established under paragraph
4a(a)(2) because the Commission must apply ``the standards set forth in
paragraph [4a(a)(1)],'' no similar language appears in paragraph
4a(a)(5). To the contrary, paragraph 4a(a)(5)(A) states that position
limits for economically equivalent swaps must be established
``[n]otwithstanding any other provision of this section.'' Moreover,
the statute requires the Commission to develop position limits for
economically equivalent swaps ``concurrently'' with position limits
established under paragraph 4a(a)(2), and establish those limits
``simultaneously'' with those established under paragraph
4a(a)(2).\1261\ The necessity finding provision of paragraph 4a(a)(1)
therefore does not apply to economically equivalent swaps. Rather, when
position limits are necessary under paragraph 4a(a)(2), the requirement
to establish them for economically equivalent swaps is automatically
triggered under CEA section 4a(a)(5).
---------------------------------------------------------------------------
\1260\ 7 U.S.C. 6a(a)(5).
\1261\ 7 U.S.C. 6a(a)(5)(B).
---------------------------------------------------------------------------
In addition to being compelled by the statutory language, this is a
reasonable
[[Page 3391]]
interpretation of the statute in policy terms because Congress could
reasonably have determined that the necessity finding for position
limits for futures contracts (and options thereon) carries over to
economically equivalent swaps by virtue of the fact that they are
economically equivalent.\1262\ The Commission notes that, while
paragraph 4a(a)(5) does not require the Commission to make a necessity
finding for economically equivalent swaps, it requires the Commission
to make policy judgments with respect to such swaps in connection with
the definition of what swaps are economically equivalent and the
requirement that limit levels be established ``as appropriate.'' \1263\
The relevant discussion with respect to the determination of what swaps
that are deemed to be ``economically equivalent swaps'' is set forth
elsewhere in this preamble.\1264\
---------------------------------------------------------------------------
\1262\ Some commenters stated that the statute requires a
necessity finding for swaps. E.g., ISDA at 4. The Commission
generally agrees with this position for swaps, but not for
economically equivalent swaps for the reasons stated herein.
\1263\ 7 U.S.C. 6a(a)(5)(A), (B).
\1264\ See Section II.A.4.
---------------------------------------------------------------------------
e. Some commenters asked the Commission to clarify that it finds
position limits not to be necessary for futures contracts other than
the referenced contracts specified in the rule.\1265\ The Commission
agrees that, for commodities falling within the scope of this
rulemaking, i.e., ``physical commodities other than excluded
commodities'' for which position limits are required by paragraph
4a(a)(2), the Commission has determined that position limits are
necessary only for the 25 core referenced futures contracts and any
associated referenced contracts on futures contracts or options on
futures contracts, but not for other futures contracts or options on
futures contracts.\1266\ As with any rulemaking, the necessity
determinations made in connection with this rule may change in the
future based on market developments, new information or analysis, or
changes in Commission policy.
---------------------------------------------------------------------------
\1265\ E.g. SIFMA AMG at 5 (``spot month limits should apply
only to physically settled futures contracts (i.e., the core
referenced futures contracts), and the Commission should not make
any determinations on, or adopt final rules applicable to,
financially settled futures at this time.''); ISDA at 4 (stating
that the Commission should start with final rules only for
physically-settled contracts during the spot month.)
\1266\ As discussed above, while economically equivalent swaps
are encompassed within the ``referenced contract'' definition, such
swaps are subject to Federal position limits pursuant to 7 U.S.C.
6a(a)(5) and therefore are not subject to a necessity determination.
---------------------------------------------------------------------------
3. Commission Determination Regarding Necessity Standard
For these reasons and those set forth in the 2020 NPRM, the
Commission adopts the interpretation of ``necessity'' set forth in the
2020 NPRM and clarified and elaborated upon here.
C. Necessity Finding as to the 25 Core Referenced Futures Contracts
1. Introduction
This Final Rule imposes Federal position limits on 25 core
referenced futures contracts, any futures contracts or options on
futures contracts directly or indirectly linked to the core referenced
futures contracts, and any economically equivalent swaps. As discussed
above, the Commission bases its necessity analysis on the following
propositions reflected in the text of CEA section 4a(a)(1). First, that
excessive speculation in derivatives markets can cause sudden or
unreasonable fluctuations or unwarranted changes in the price of an
underlying commodity. Second, that such price fluctuations and changes
are an undue and unnecessary burden on interstate commerce in that
commodity. Third, that position limits can diminish, eliminate, or
prevent that burden. With these propositions established by Congress,
the Commission makes a further determination of whether it is necessary
to use position limits, Congress's prescribed tool to address those
burdens on interstate commerce, in light of the facts and
circumstances.
The Commission finds that position limits on the 25 core referenced
futures contracts identified in the 2020 NPRM are necessary to prevent
the economic burdens on interstate commerce associated with excessive
speculation causing sudden or unreasonable fluctuations or unwarranted
changes in the price of the commodities underlying these
contracts.\1267\ As in the 2020 NPRM, this necessity determination is
based on two interrelated factors: The importance of the 25 core
referenced futures contracts to their respective underlying cash
markets, including that they require physical delivery of the
underlying commodity; and the particular importance to the national
economy of the commodities underlying the 25 core referenced futures
contracts. The Commission analyzes both factors in turn below.
---------------------------------------------------------------------------
\1267\ See supra Section III.B.
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2. Importance of the 25 Core Referenced Futures Contracts to Their
Respective Underlying Cash Markets
a. Link Between the Derivatives Market and Its Underlying Cash-Market
As explained in the 2020 NPRM, the Commission has determined that
position limits are necessary for physical commodities only where there
exists a physically-settled futures contract for two reasons. First,
physical settlement establishes a direct link between the futures
market and the cash market since futures contracts, while normally
closed out by offset, may be settled by delivery of the commodity
itself. This link helps to force convergence between futures contract
settlement prices and cash-market prices by ensuring that futures
prices in the delivery period reflect supply and demand in the cash-
market, whereas cash-settled futures contracts do not provide a direct
link because physical-delivery is not an option.\1268\ As a result, in
many circumstances, commercial participants use physically-settled
futures contracts for price discovery. Illustrative of this point, at
the May 2020 public meeting of the Commission's Energy and
Environmental Markets Advisory Committee, an industry representative
discussing application of position limits to power markets observed,
``In futures markets, where physically-settled contracts are
established, such as natural gas or crude oil, these physical contracts
effectively serve as the most important price discovery tool for the
spot market at baseload supply and demand for the delivery month is
managed with the physical futures or physical deals linked to it.''
\1269\
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\1268\ See 85 FR at 11667. Many participants rely on the
possibility of settlement by physical delivery to foster convergence
at expiration of the futures contract. Id. Because of imperfect
contract design or other factors, the convergence mechanism does not
always work as hoped in practice. Id. at 11676, fn. 575. Such
malfunctions are considered to be a public policy concern because
bona fide hedgers and other participants seek to hedge cash-market
prices with futures contract prices. Id. at 11667.
\1269\ See Transcript of Committee Meeting at 46:19-47:06,
Comment by Nodal Exchange, Inc., U.S. Commodity Futures Trading
Commission Energy and Environmental Markets Advisory Committee
(2020), https://www.cftc.gov/sites/default/files/2020/06/1591218221/eemactranscript050720.pdf.
---------------------------------------------------------------------------
Second, physically-settled contracts may be at risk of corners and
squeezes, because the settlement mechanism of the contract requires
participants with short positions to deliver the underlying commodity
at expiration.\1270\ Physical
[[Page 3392]]
settlement therefore may increase the sources of the risk of sudden or
unreasonable fluctuations or unwarranted changes in the price of the
underlying commodity arising from excessive speculation.\1271\ Applying
position limits to commodities where there is a physically-settled core
referenced futures contract therefore is consistent with the
Commission's interpretation of the paragraph 4a(a)(1) necessity
requirement as directing the Commission to impose limits where they are
most likely to be an efficient mechanism for achieving the statutory
objectives.\1272\
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\1270\ 85 FR at 11672. For example, based on its general
experience, the Commission recognizes that if the underlying
commodity is ``cornered'' and the participant with the short
position does not already have the commodity to deliver, then the
short participant must exit its position through an offsetting long
position. As a consequence, the participant will likely have to bid
up the price of the futures contract to exit the market, thus
``squeezing'' the short to pay a higher price for the offsetting
long position. Conversely, for a cash-settled contract, a market
participant who has cornered the cash market for an underlying
commodity cannot squeeze someone who is short the cash-settled
futures contract because the short does not have to acquire the
underlying commodity to make delivery to the long in a cash-settled
contract.
\1271\ See 7 U.S.C. 6a(a)(3)(B)(ii) (identifying deterrence and
prevention of corners and squeezes as one of the objectives of
position limits required by 7 U.S.C. 6a(a)(2)).
\1272\ See ISDA at 3-4 (suggesting that the Commission
``finalize the proposed Federal position limits rules only for
physically delivered spot month futures contracts, in the first
phase . . . as the Commission finds are necessary to . . . prevent
[e]xcessive speculation . . . .'')
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b. The 25 Core Referenced Futures Contracts Are Used for Hedging and
Price Discovery
In the 2020 NPRM, the Commission presented information supporting
its determination that the proposed 25 core referenced futures
contracts are used extensively for hedging and price discovery, thus
establishing a close link between the markets for these futures
contracts and commerce in the relevant commodities.\1273\ The
Commission's conclusions on this point are further supported by
comments discussing the use of particular core referenced futures
contracts for hedging and price discovery, or discussing more generally
the use of futures contracts for hedging and price discovery in the
context of the Commission's proposed rule.\1274\
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\1273\ 85 FR at 11666-71.
\1274\ See, e.g., ASR at 1 (stating that ICE Sugar No. 11 and
ICE Sugar No. 16 are commonly used by commercial participants for
hedging.); NGSA at 12 (``Physical market participants currently
hedge Henry Hub price risk through both physically settled and
financially-settled futures contracts.''); Cargill at 2
(``Commercial end-users . . . rely on the futures and derivatives
markets to perform vital functions including price discovery and
risk management related to significant physical commodity
origination, production and processing, transportation, purchasing
and sales, among other things.''); EEI/EPSA at 2 (``The Joint
Associations members are not financial entities. Rather, they are
physical commodity market participants that rely on futures and
swaps to hedge and mitigate their commercial risk.''); ADM at 2
(``Many . . . [futures] transactions are critical elements of risk
management, price discovery and hedging while also playing a role in
the acquisition of physical commodities.''); CMC at 1 (noting that
commercial participants ``use futures markets to hedge risk
exposures related to commercial activities in physical
commodities.''); DECA at 2 (``The [Cotton] CT contract plays an
indispensable role in the global cotton ecosystem and it is needed
to provide price discovery for all market participants.''); AFIA at
2 (``As commercial end-users, AFIA's members prioritize the need for
[futures] markets to work well for their primary function of price
discovery and risk management.); NGFA at 2 (``The NGFA's member
firms are bona fide hedgers who hedge physical commodity risk and
depend on futures markets for price discovery and risk
management.''); ACSA at 5 (``. . . the futures delivery process is
essential to maintaining functioning agricultural markets, price
discovery, and convergence.''); PMAA at 1 (``For decades, petroleum
marketers have been utilizing oil and refined product futures
markets for their hedging needs to protect customers from volatility
and price spikes. Well-functioning markets are critical to commodity
price discovery.''); CCI at 3 (``In addition to covering timing
differentials in commodity prices, intra-commodity spreads perform
an important function in energy markets by, among other things,
promoting price discovery and convergence as well as providing
liquidity for priced-linked, physically-settled and cash-settled
Referenced Contracts in the same underlying commodity during the
spot month as market participants manage their risks across
markets.''). See also NFP Electric Associations, Comment Letter on
Proposed Rule on Position Limits for Derivatives and Aggregation of
Positions (July 3, 2014), https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=59934&SearchText= (noting that the ``[energy]
markets . . . provide commercial risk management opportunities and
achieve price convergence between futures and cash-market prices for
the benefit of commercial hedgers and their counterparties.'').
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The 25 core referenced futures contracts also serve as key
benchmarks for use in pricing cash-market and other transactions.\1275\
For example, NYMEX NY Harbor RBOB Gasoline (RB) is the main benchmark
used for pricing gasoline in the U.S. petroleum products market, a huge
physical market with total U.S. refinery capacity of approximately 9.5
million barrels per day of gasoline.\1276\ Similarly, the NYMEX NY
Harbor ULSD Heating Oil (HO) contract is the main benchmark used for
pricing the distillate products market, which includes diesel fuel,
heating oil, and jet fuel.\1277\ The utility of the price discovery
function for these futures contracts is thus impactful for commercial
participants regardless of whether they are actively trading in the
futures market.
---------------------------------------------------------------------------
\1275\ See, e.g., USDA Economic Research Service, Contracts,
Markets, and Prices: Organizing the Production and Use of
Agricultural Commodities, Agricultural Economic Report No. 837, at 6
(Nov. 2004), https://www.ers.usda.gov/webdocs/publications/41702/14700_aer837_1_.pdf?v.=41061 (one-third of all U.S. agricultural
production is produced under contracts using pricing formulas
determined by reference to futures prices); see also Paul Peterson,
Fixing Prices and Fixing Markets, farmdoc daily (4): 118, Department
of Agricultural and Consumer Economics, University of Illinois at
Urbana-Champaign (June 25, 2014), https://farmdocdaily.illinois.edu/2014/06/fixing-prices-and-fixing-markets.html (explaining that
futures markets provide price discovery for cash grain spot markets
and how price discovery through negotiated prices has diminished
over time).
\1276\ See 85 FR at 11669.
\1277\ Id.
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There is also evidence that the 25 core referenced futures
contracts are the physically-settled contracts in physical commodities
traded on U.S. exchanges that, by and large, are most used for hedging
and price discovery by cash-market participants. Unfortunately, the
Commission does not have information that permits a direct comparative
measurement of the extent to which each of the actively traded futures
contracts is used for hedging and price discovery. However, available
statistics from exchanges show that the 25 core referenced futures
contracts, with the partial exception of CBOT Oats (O), a legacy
contract, are the most actively traded physically-settled contracts in
physical commodities, as measured by open interest and trading volume.
As discussed in detail further below, the most actively traded futures
contracts will usually be the contracts that are most used for hedging
and price discovery.
[[Page 3393]]
To follow up on the discussion of trading activity in the 2020
NPRM,\1278\ the Commission analyzed average total open interest \1279\
and average notional open interest \1280\ for all physically-settled
futures contracts for the period between January 2019 and December
2019.\1281\ From that data, the Commission assessed the 30 largest
physically-settled contracts in terms of average total open interest
and average notional open interest for comparison.\1282\ These 30
contracts comprised the 25 core referenced futures contracts, and the
five physically-settled physical commodity contracts with the next-
highest amounts of average total open interest and average notional
open interest. As shown in the tables below, there is a significant
drop in open interest between CBOT Oats (O), which has the lowest open
interest of the core referenced futures contracts, and CME Random
Length Lumber (LBS), which is the 27th largest physically-settled
futures contract and has the second highest open interest of the five
contracts not selected from the group of 30 contracts.\1283\
Specifically, average total open interest in CBOT Oats (O) (5,630 OI)
is almost twice the size of average total open interest in CME Random
Length Lumber (LBS) (3,025 OI).\1284\
---------------------------------------------------------------------------
\1278\ See id. at 11666, 11668-70.
\1279\ Open interest refers to the total number of outstanding
futures contracts that have not been offset at the end of the
trading day.
\1280\ Notional value means the value of average open interest
without adjusting for delta in options.
\1281\ The 25 core referenced futures contract are all long-
standing, established contracts. Generally speaking, for purposes of
this Final Rule, the Commission focused on mature contract markets
with at least five years of reported open interest and volume. For
example, the Commission notes that the ICE Canola Futures (RS) and
NYMEX WTI Houston Crude Oil Futures (HCL) contracts appear to have
characteristics similar to those which the Commission has found
support a necessity finding, but these contracts are both much
newer, and the Commission finds that this militates against finding
a position limit necessary until their respective markets mature
further. The Commission may consider a position limit necessary for
one or both in the future, as it revisits these issues from time to
time as required by statute.
\1282\ As discussed in the 2020 NPRM, the Commission also
analyzed FIA end of month open interest data for December 2019 and
FIA 12-month total trading volume data (January 2019 through
December 2019) and reached the same conclusion as discussed herein.
See 85 FR at 11670.
\1283\ Many commenters suggested that the Commission's final
rule should demonstrate that position limits are necessary on a
``commodity-by-commodity basis'' as supported by empirical evidence
or data. See, e.g. PIMCO at 3; ISDA at 3; SIFMA AMG at 2; MFA/AIMA
at 4. As discussed in Section III.B.2.a., supra, the Commission
agrees that the agency is required to consider relevant data, where
available, in determining whether to establish position limits. The
Commission however notes that the CEA does not specify the use of
any particular methodology, quantitative or otherwise, in
determining whether position limits are necessary.
\1284\ During the period January 1, 2019 through December 31,
2019, the NYMEX Loop Crude Oil Storage (LPS) futures contract had
higher open interest than four of the 25 core referenced futures
contracts and the remaining largest contracts that were not
selected, as shown in the chart below. The Commission, however,
notes that the contract is a capacity allocation contract, which
gives the buyer of the contract the legal right to store crude oil
at a storage facility in Louisiana for a specified calendar month.
The Commission further notes that the contract is a newer one, has
fewer reportable traders, and significantly lower average daily
trading volume (NYMEX Loop Crude Oil Storage (LPS) 131 Vol.) and
average notional value than any of the 25 core referenced futures
contracts during this same period. In addition, open interest in the
contract has dropped precipitously between January 1, 2020 and
September 30, 2020. The Commission finds that all of these reasons
militate against finding a position limit necessary for this
contract until its market matures further. The Commission may
consider a position limit necessary for this contract in the future,
as it revisits these issues from time to time as required by
statute.
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With the exception of CBOT Oats (O),\1285\ as shown in the tables
below, the average notional open interest values for the 25 core
referenced futures contracts are all substantially larger and more
valuable than the five contracts that were not selected. Specifically,
outstanding futures average notional values range from approximately $
33 billion for CBOT Corn (C) to approximately $ 80 million for CBOT
Oats (O), with the other core referenced futures contracts on
agricultural commodities all falling somewhere in between.\1286\
Outstanding futures average notional values of the core referenced
futures contracts on metal commodities range from approximately $ 80
billion in the case of COMEX Gold (GC), to approximately $ 3.6 billion
in the case of NYMEX Platinum (PL), with the other metals core
referenced futures contracts all falling somewhere in between.\1287\
With regard to energy commodities, futures average notional values
range from $ 116.7 billion in the case of NYMEX Light Sweet Crude Oil
(CL) to $ 28.3 billion in the case of NYMEX NY Harbor RBOB Gasoline
(RB).\1288\
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\1285\ See supra Section II.B.1. (discussing CBOT Oats (O)
legacy contract status).
\1286\ Calculations are based on data submitted to the
Commission pursuant to part 16 of the Commission's regulations.
\1287\ Id.
\1288\ Id.
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[[Page 3394]]
[GRAPHIC] [TIFF OMITTED] TR14JA21.013
In addition to open interest and notional value, the Commission
analyzed average daily trading volume \1290\ for the period January 1,
2019 through December 31, 2019 and notes that trading volume on the 25
core referenced futures contracts is also generally larger than trading
volume on the five contracts that were not selected. For example, the
CBOT Corn (C) and CBOT Soybean (S) contracts trade over 409,000 and
211,000 contracts respectively per day.\1291\ The COMEX Gold (GC)
contract trades approximately 343,288 contracts daily.\1292\ The NYMEX
Light Sweet Crude Oil (CL) contract, which is the world's most liquid
and actively traded crude oil contract, trades nearly 1.2 million
contracts a day, and the NYMEX Henry Hub Natural Gas (NG) contract
trades on average approximately 409,480 contracts daily.\1293\ In
contrast, the CME Random Length Lumber (LBS), CBOT Ethanol (EH), COMEX
Aluminum (ALI), and NYMEX Mont Belvieu Spot Ethylene In-Well (MBE)
contracts, which were not selected, trade approximately 645, 315, 123,
and 15.7 contracts respectively per day.\1294\
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\1289\ Id.
\1290\ Daily trading volume represents the total quantity of
futures contracts traded within a day.
\1291\ Calculations are based on data submitted to the
Commission pursuant to part 16 of the Commission's regulations.
\1292\ Id.
\1293\ Id.
\1294\ Id. The average daily trading volume for CBOT Oats (O)
(645.04 Vol) is approximately the same as the average daily trading
volume for CME Random Length Lumber (LBS) (645.56 Vol), which is the
largest contract in terms of volume of the five contracts that were
not selected. While the average daily trading volume for ICE Sugar
No. 16 (SF) (307.32 Vol), which is the smallest of the 25 core
contracts in terms of volume, is less than the average daily trading
volume for both CME Random Length Lumber (LBS) (645.56 Vol) and CBOT
Ethanol (EH) (315.7 Vol), the Commission notes that many commercial
participants frequently use both ICE Sugar No. 16 (SF) and ICE Sugar
No. 11 (SB) together for hedging and price discovery because the
underlying commodity is the same for both contracts. See infra
Section III.C.5. (discussing the ICE Sugar No. 16 (SF) and ICE Sugar
No. 11 (SB) contracts).
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[[Page 3395]]
There are a number of reasons to expect that, generally speaking,
the most actively traded futures contracts will usually be the
contracts that are most used for hedging and price discovery. First, it
is generally accepted that successful futures contracts usually require
active market participation by hedgers as well as speculators.\1295\ It
is therefore reasonable to expect that some significant proportion of
the activity in the most active futures contracts will normally consist
of hedging and not solely consist of purely speculative trading. In
addition, the most active futures contracts are likely to be the most
liquid, at least most of the time. Such contracts are likely to be
heavily relied upon as sources of price information because their
prices reflect the collective opinion of more traders and are therefore
likely to be a more accurate representation of the underlying cash-
market price conditions.\1296\ While the correlation between the
magnitude of trading activity and use of a contract for hedging and
price discovery is likely imperfect, it provides reason to expect that
the 25 core referenced futures contracts are, on the whole, the
physically-settled contracts in physical commodities traded on U.S.
exchanges that are most used for hedging and price discovery. This is
particularly true given the very large gap in activity levels between
most of the 25 core referenced futures contracts and physically-settled
contracts not included as core referenced futures contracts.
---------------------------------------------------------------------------
\1295\ See, e.g., Holbrook Working, Futures Trading and Hedging,
43 a.m. Econ. Rev. 314, 319-320 (June 1953), https://www.jstor.org/stable/1811346. See
also William L. Silber, Innovation, Competition, and New Contract
Design in Futures Markets, 1 J. of Futures Markets 129, 131 (Summer
1981), https://onlinelibrary.wiley.com/doi/abs/10.1002/fut.3990010205.
\1296\ See, e.g., 85 FR at 11669, fn. 522-523. See generally
William L. Silber, The Economic Role of Financial Futures, in
Futures Markets: Their Economic Role 83, 89-90 (A. Peck ed., Am.
Enter. Inst. for Pub. Pol'y Rsch. 1985), https://legacy.farmdoc.illinois.edu/irwin/archive/books/Futures-Economic/Futures-Economic_chapter2.pdf (discussing the price discovery and
hedging functions of futures markets).
---------------------------------------------------------------------------
c. Conclusion Regarding Importance of the 25 Core Referenced Futures
Contracts to Their Respective Underlying Cash Markets
Based on the information set forth in the NPRM and supplemented
here, the Commission concludes that the importance of the 25 core
referenced futures contracts to their respective underlying cash
markets supports the conclusion that position limits are necessary for
these contracts.
3. Importance of the Commodities Underlying the 25 Core Referenced
Futures Contracts to the National Economy
With respect to the second factor, importance of the cash commodity
to the U.S. economy as a whole, the 2020 NPRM set forth information
demonstrating that each of the 25 core referenced futures contracts is
important to the U.S. economy in various ways.\1297\ Many of the 25
core referenced futures contracts involve commodities that are among
the most important physical commodities for the U.S. economy, among
those commodities for which physically-settled contracts are traded on
U.S. exchanges.\1298\
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\1297\ See 85 FR at 11666-11671.
\1298\ See, e.g., 85 FR at 11668 (discussing agricultural
commodities and their downstream uses), id. at 11669-70 (discussing
energy contracts).
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For example, in the agricultural sector, three of the top five
commodities in the United States, as measured by cash receipts,
underlie core referenced futures contracts, including cattle, corn, and
soybeans.\1299\ An additional commodity that underlies several core
referenced contracts, wheat, is in the top ten.\1300\ Primary energy
commodities that underlie core referenced futures contracts,
specifically crude oil and natural gas, account for over half of U.S.
energy production.\1301\ Two additional core referenced futures
contracts in the energy space, NYMEX New York Harbor ULSD Heating Oil
(HO) and NYMEX New York Harbor RBOB Gasoline (RB), relate, in turn, to
commodities that are among the most widely used byproducts of crude
oil.\1302\
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\1299\ USDA Economic Research Service, Cash receipts by State,
commodity ranking and share of U.S. total, 2019 Nominal (current
dollars), https://data.ers.usda.gov/reports.aspx?ID=17843.
\1300\ Id.
\1301\ U.S. Energy Information Administration, Annual Energy
Review, Primary Energy Production by Source, Table 1.2 (last updated
Sept. 2020), https://www.eia.gov/totalenergy/data/monthly/pdf/sec1_5.pdf.
\1302\ See, e.g., U.S. Energy Information Administration, U.S.
petroleum flow, 2018, https://www.eia.gov/totalenergy/data/monthly/pdf/flow/petroleum.pdf.
---------------------------------------------------------------------------
Thus, based on the information set forth in the NPRM and
supplemented here, the importance of the underlying commodity to the
national economy supports the conclusion that position limits are
necessary for the 25 core referenced futures contracts.
4. Commodity Indices
As an independent check on its selection of core referenced futures
contracts, the Commission has compared its list with the lists of
commodities included in several widely-tracked third-party commodity
indices: The Bloomberg Commodity Index, the S&P GSCI index, and the
Rogers International Commodity Index. Based on the criteria used to
create these indices, inclusion of a commodity in the index is an
indication that the commodity is important to the world or U.S.
economy, and that futures prices for the commodity are considered to be
an important source of price information. In particular, Bloomberg
states that it selects commodities for its Bloomberg Commodity Index
that in its view are ``sufficiently significant to the world economy to
merit consideration,'' that are ``tradeable through a qualifying
related futures contract'' and that generally are the ``subject of at
least one futures contract that trades on a U.S. exchange.'' \1303\
Similarly, S&P's GSCI index is, among other things, ``designed to
reflect the relative significance of each of the constituent
commodities to the world economy.'' \1304\ Likewise, the Rogers
International Commodity Index ``represents the value of a basket of
commodities consumed in the global economy'' that are ``tracked via
futures contracts on 38 different exchange-traded physical
commodities'' and that ``aims to be an effective measure of the price
action of raw materials not just in the United States but also around
the world.'' \1305\
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\1303\ The Bloomberg Commodity Index Methodology, Bloomberg, at
16-17 (Jan. 2020), https://data.bloomberglp.com/professional/sites/10/BCOM-Methodology.pdf.
\1304\ S&P GSCI Methodology, S&P Dow Jones Indices, at 8 (May
2020), https://www.spglobal.com/spdji/en/indices/commodities/sp-gsci/#overview.
\1305\ The RICI Handbook, The Guide to the Rogers International
Commodity Index, at 4-5 (Aug. 2020), http://www.rogersrawmaterials.com/documents/RICIHndbk_01.31.19.pdf.
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Applying these criteria, Bloomberg, S&P, and Rogers have all deemed
eligible for inclusion in their indices lists of commodities that
overlap significantly with the Commission's 25 core referenced futures
contracts. In particular, Bloomberg, S&P, and Rogers include 17, 15,
and 22 contracts respectively per index of the 25 contracts selected by
the Commission.\1306\ Independent index
[[Page 3396]]
providers thus appear to have arrived at similar conclusions to the
Commission's necessity finding regarding the relative importance of
certain commodity markets for the economy and price discovery. The
indices, taken individually or as a whole, support the Commission's
conclusion that position limits are necessary for the 25 core
referenced futures contracts.
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\1306\ The 17 Bloomberg contracts are ICE Coffee C (KC), COMEX
Copper (HG), CBOT Corn (and Mini-Corn) (C), ICE Cotton No. 2 (CT),
COMEX Gold (GC), NYMEX New York Harbor ULSD Heating Oil (HO), CME
Live Cattle (LC), NYMEX Henry Hub Natural Gas (NG), NYMEX New York
Harbor RBOB Gasoline (RB), COMEX Silver (SI), CBOT Soybeans (and
Mini-Soybeans) (S), CBOT Soybean Meal (SM), CBOT Soybean Oil (SO),
ICE Sugar No. 11 (SB), CBOT Wheat (and Mini-Wheat) (W), CBOT KC HRW
Wheat (KW), and NYMEX Light Sweet Crude Oil (CL). See https://data.bloomberglp.com/professional/sites/10/BCOM-Methodology.pdf.
The 15 S&P GSCI contracts are ICE Cocoa (CC), ICE Coffee C (KC),
CBOT Corn (and Mini-Corn) (C), ICE Cotton No. 2 (CT), COMEX Gold
(GC), NYMEX New York Harbor ULSD Heating Oil (HO), CME Live Cattle
(LC), NYMEX Henry Hub Natural Gas (NG), NYMEX New York Harbor RBOB
Gasoline (RB), COMEX Silver (SI), CBOT Soybeans (and Mini-Soybeans)
(S), ICE Sugar No. 11 (SB), CBOT Wheat (and Mini-Wheat) (W), CBOT KC
HRW Wheat (KW), and NYMEX Light Sweet Crude Oil (CL). See S&P GSCI
Methodology, S&P Dow Jones Indices, at 26 (May 2020), https://www.spglobal.com/spdji/en/indices/commodities/sp-gsci/#overview. The
22 Rogers contracts are ICE Cocoa (CC), ICE Coffee C (KC), COMEX
Copper (HG), CBOT Corn (and Mini-Corn) (C), ICE Cotton No. 2 (CT),
COMEX Gold (GC), NYMEX New York Harbor ULSD Heating Oil (HO), CME
Live Cattle (LC), NYMEX Henry Hub Natural Gas (NG), CBOT Oats (O),
ICE FCOJ-A (OJ), NYMEX Palladium (PA), NYMEX Platinum (PL), NYMEX
New York Harbor RBOB Gasoline (RB), CBOT Rough Rice (RR), COMEX
Silver (SI), CBOT Soybeans (and Mini-Soybeans) (S), ICE Sugar No. 11
(SB), CBOT Wheat (and Mini-Wheat) (W), CBOT KC HRW Wheat (KW), MGEX
Hard Red Spring Wheat (MWE), and NYMEX Light Sweet Crude Oil (CL).
See http://www.rogersrawmaterials.com/weight.asp.
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5. Comments on Proposed Necessity Finding for Core Referenced Futures
Contracts
While some commenters asserted that position limits are mandatory
for all physical commodities, no commenter argued that the necessity
finding should apply to any particular contract other than the 25 core
referenced futures contracts.\1307\
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\1307\ E.g., NEFI at 2 (supporting Federal position limits for
all 25 core referenced futures contracts, but stating that the list
is too limited because it included only four energy contracts and
that Congress imposed a clear mandate to establish limits on all
commercially-traded energy derivatives); Better Markets at 64.
---------------------------------------------------------------------------
Only one commenter advocated that the Commission remove commodities
from the proposed list of 25 core referenced futures contracts. That
commenter, IFUS, objected to imposing Federal position limits on its
Sugar No. 11 (SB) contract.\1308\ IFUS argued that the Sugar No. 11
(SB) contract does not have ``a major significance to U.S. interstate
commerce'' because the contract prices the physical delivery of raw
cane sugar for more than 30 delivery points around the world and only a
de minimis amount of the raw sugar represented by the contract can be
imported into the U.S. under U.S. sugar tariff-rate quotas.\1309\ In
addition, IFUS stated that the Commission's necessity finding does not
establish that ICE Sugar No. 11 (SB) is used for price discovery for
sugar produced and consumed in the United States.\1310\
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\1308\ IFUS at 3. The ICE Sugar No. 11 (SB) ``contract prices
the physical delivery of raw cane sugar free-on-board the receiver's
vessel to a port within the country of origin of the sugar.'' See
Sugar No. 11 Futures Product Specs, Intercontinental Exchange
website, available at https://www.theice.com/products/23/Sugar-No-11-Futures. The United States is one of the delivery points for the
ICE Sugar No. 11 (SB) contract because U.S. origin raw cane sugar is
one of the 29 deliverable origins under the contract. Id.
\1309\ IFUS at 3-4.
\1310\ IFUS at Exhibit 1, No. 52.
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The Commission has considered the comments and is adopting the list
of the 25 core referenced futures contracts as proposed, including
incorporating the ICE Sugar No. 11 (SB) contract as a core referenced
futures contract. In response to IFUS' comment, the Commission
recognizes that ``Sugar No. 11 (SB) is primarily an international
benchmark.'' \1311\ The Commission, however, disagrees with IFUS'
comment that the Sugar No. 11 (SB) contract does not have a major
significance to U.S. interstate commerce or play a role in price
discovery for sugar produced and consumed in the United States.\1312\
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\1311\ 85 FR at 11668, fn. 507.
\1312\ The Commission notes that IFUS did not object to the
inclusion of ICE Sugar No. 16 (SF) as a core referenced futures
contract in the 2020 NPRM. The ICE Sugar No. 16 (SF) ``contract
prices physical delivery of US-grown (or foreign origin with duty
paid by deliverer) raw cane sugar at one of five U.S. refinery ports
as selected by the receiver.'' See Sugar No. 16 Futures Product
Specs, Intercontinental Exchange website, available at https://www.theice.com/products/914/Sugar-No-16-Futures. The same commodity,
raw centrifugal cane sugar based on 96 degrees average polarization,
underlies both ICE Sugar No. 16 (SF) and ICE Sugar No. 11 (SB)
contracts. Id. See also Sugar No. 11 Futures Product Specs,
Intercontinental Exchange website, available at https://www.theice.com/products/23/Sugar-No-11-Futures. Both contracts also
trade on IFUS in units of 112,000 pounds per contract. Id.
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For several reasons, the Commission finds that the ICE Sugar No. 11
(SB) contract has sufficient connection to the domestic sugar market to
warrant Federal position limits. First, USDA data reflects that roughly
one-quarter of the annual U.S. raw sugar supply is imported.\1313\
While U.S. imports may be a small percentage of the total sugar
represented by open interest in the ICE Sugar No. 11 (SB) contract,
U.S. imports still account for a significant percentage of the total
U.S. raw sugar supply. As described below, Commission data suggests
that the ICE Sugar No. 11 (SB) contract is used for price discovery and
hedging within the United States. Thus, when the contract is being used
by commercial participants for price discovery or hedging in the
domestic raw sugar market, it is therefore reasonable to expect that
any sudden or unreasonable fluctuations or unwarranted changes in the
global price of raw sugar could impose significant disruptions or harms
to the domestic raw sugar markets. Because the ICE Sugar No. 11 (SB)
contract represents a material portion of the U.S. sugar market, the
Commission determines that it is necessary to include it as a core
referenced futures contract to protect against any sudden or
unreasonable fluctuations or unwarranted changes, which could result in
undue burdens on the U.S. economy. Additionally, as further discussed
below, since the ICE Sugar No. 11 (SB) contract represents a material
portion of the U.S. raw sugar supply, the Commission concludes that
disruptions to this contract potentially could harm both the price
discovery process for the domestic sugar markets as well as the
physical delivery of the underlying commodity.
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\1313\ USDA Economic Research Service, Sugar and Sweeteners
Yearbook Tables, World Production, Supply, and Distribution, at
Table 1 (July 19, 2018), https://www.ers.usda.gov/data-products/sugar-and-sweeteners-yearbook-tables. For example, between 2009 and
2019, the United States has imported between 22.7% and 28.6% of its
raw sugar from other countries. Id. In 2019, the United States
imported approximately 3 million metric tons of sugar from other
countries whose sugar is deliverable under the ICE Sugar No. 11 (SB)
contract. See USDA, U.S. Sugar Monthly Import and Re-Exports, Final
Report, Fiscal Year 2019 (Oct. 2019), https://www.fas.usda.gov/sites/default/files/2020-01/fy_2019_final_sugar_report.pdf.
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Second, the ICE Sugar No. 11 (SB) contract is listed on IFUS, a DCM
registered with the Commission that lists derivatives contracts for
trading by U.S. participants in the United States, among others. Data
reported to the Commission through Form 102s reflects that domestic
firms account for approximately 20% of commercial market participants
and 65%-70% of the non-commercial market participants trading in the
ICE Sugar No. 11 (SB) contract.\1314\ This data supports the
Commission's finding that the ICE Sugar No. 11 (SB) contract is ``used
for price discovery and hedging within the United States.'' \1315\
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\1314\ See also ASR at 1 (stating that the ICE Sugar No. 11 (SB)
and ICE Sugar No. 16 (SF) contracts are commonly used by commercial
participants for hedging).
\1315\ 85 FR at 11668, fn. 507.
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Finally, as the Commission noted in the 2020 NPRM, the Commission
believes that the ICE Sugar No. 11 (SB) and ICE Sugar No. 16 (SF)
contracts together ``[a]s a pair'' are ``crucial tools for risk
management and for ensuring reliable pricing.'' \1316\ The Commission's
view is informed by the fact that both ICE Sugar No. 11 (SB) and ICE
Sugar No. 16 (SF) call for delivery of the same size and quality of raw
cane sugar, with the
[[Page 3397]]
former contract calling for delivery from 29 different country origins
of growth, including the United States, and the latter contract calling
for delivery of domestic origin.\1317\ This implies that there is
likely to be a common group of market participants trading in both
contracts. Based on its experience in other markets, the Commission
understands that U.S. firms may utilize both contract markets to hedge
cash positions and offset other related risks even if their inventories
cannot be delivered against both contracts.
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\1316\ Id.
\1317\ See ICE Sugar No. 16 Futures Product Specs,
Intercontinental Exchange website, available at https://www.theice.com/products/914/Sugar-No-16-Futures; see also Sugar No.
11 Futures Product Specs, Intercontinental Exchange website,
available at https://www.theice.com/products/23/Sugar-No-11-Futures.
---------------------------------------------------------------------------
In that regard and as discussed above in Section III.C.2.b, the
Commission analyzed average open interest and average notional values
for ICE Sugar No. 11 (SB) and ICE Sugar No. 16 (SF) for the period
January 1, 2019 through December 31, 2019. Specifically, average open
interest in ICE Sugar No. 11 (SB) (947,198 OI) is more than 100 times
the size of average open interest in ICE Sugar No. 16 (SF) (8,485
OI).\1318\ Similarly, the average notional value for ICE Sugar No. 11
(SB) ($13,535,036,765 Notional OI) is roughly 54 times greater than the
average notional value for ICE Sugar No. 16 (SF) ($250,447,669 Notional
OI).\1319\ In terms of average trading volume for the same time period,
the ICE Sugar No. 11 (SB) contract trades approximately 146,077
contracts per day, whereas the ICE Sugar No. 16 (SF) contract trades
approximately 307 contracts per day.\1320\ Accordingly, the Commission
believes, and the data supports, that U.S. commercial participants use
the more-liquid ICE Sugar No. 11 (SB) contract to hedge domestically
sourced raw sugar or domestic inventories and for price discovery for
sugar produced and consumed in the United States. \1321\
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\1318\ Calculations are based on data submitted to the
Commission pursuant to part 16 of the Commission's regulations and
does not include delta adjusted option on futures contracts.
\1319\ Id.
\1320\ Id.
\1321\ USDA data reflects that each year, U.S. commercial firms
hold over 1 million metric tons of raw sugar as inventory (after
accounting for all imports, production, and use during the year).
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6. Commission Determination
For the reasons stated in the 2020 NPRM and further discussed here,
the Commission finds that position limits are necessary for the 25 core
referenced futures contracts.
D. Necessity Finding as to Linked Contracts
The Commission finds that position limits on futures and options on
futures contracts that are linked to core referenced futures contracts
are necessary to enable position limits to function effectively for
commodities where position limits have been found to be necessary in
connection with the relevant core referenced futures contracts. As
explained in detail above at Section II.A.16, due to the nature of the
linkages specified in the definition of ``referenced contract'' in
Sec. 150.1, and the resulting possibilities for arbitrage, contracts
linked to core referenced futures contracts, including cash-settled
linked contracts, function together with the linked core referenced
futures contract as part of one market.\1322\ As a result, without
position limits on such linked contracts, excessive speculative
positions in these contracts can affect associated core referenced
futures contracts and cash commodity markets in a variety of ways that
undermine the effectiveness of position limits on the core contracts.
---------------------------------------------------------------------------
\1322\ For further discussion of referenced contracts and linked
contracts, see supra Section II.A.16.
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For example, large positions in linked contracts can serve as a
vehicle for profiting from manipulation of the prices of core
referenced futures contracts and cash commodities.\1323\ Conversely,
excessive speculation that artificially affects the price of a linked
contract can distort pricing, liquidity, and delivery in the market for
the core referenced futures contract and cash commodity to which the
contract is linked.\1324\ Finally, physically-settled indirectly linked
contracts, if not subject to position limits, can serve as a vehicle
for evasion through the creation of contracts that are economically
equivalent to core referenced futures contracts.\1325\
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\1323\ Id. (discussing the use of linked contracts to manipulate
prices of physically-settled contracts and the use of cash-market
transactions to affect prices of physically-settled futures
contracts and their linked counterparts).
\1324\ Id.
\1325\ See supra Section II.A.16. (discussing referenced
contracts).
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The Commission therefore finds that position limits for futures
contracts and options on futures contracts that are linked to core
referenced futures contracts are necessary within the meaning of
paragraph 4a(a)(1) where limits are necessary for the associated core
referenced futures contracts.
E. Necessity Finding for Spot/Non-Spot Month Position Limits
As discussed above in Section II.B.2. and in the 2020 NPRM, the
Commission preliminarily determined that Federal position limits should
only apply to spot month positions except with respect to the nine
legacy agricultural contracts, where non-spot month position Federal
position limits have been in place for many years. As discussed above,
the Commission is adopting this aspect of the rule as proposed.
Consistent with this policy determination, the Commission finds that
position limits are necessary during all months for the nine legacy
agricultural contracts. The Commission further finds that position
limits are necessary only during the spot month for the 16 non-legacy
core referenced futures contracts and unnecessary outside of the spot
month.\1326\
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\1326\ At least one commenter asked to Commission to explicitly
clarify this point, see ISDA at 3.
---------------------------------------------------------------------------
The Commission makes this necessity finding for substantially the
reasons set forth above, including in responses to comments on the
spot/non-spot month issue. Briefly, certain potential sources of sudden
or unreasonable fluctuations or unwarranted changes in commodity prices
caused by excessive speculation, particularly corners, squeezes, and
certain convergence problems, are associated primarily with large
positions held during spot months.\1327\ And, to the extent that these
problems may arise in prior months, they are mitigated by exchange
policies including exchange-set position limits and position
accountability.\1328\ As a result, even if position limits may have
benefits outside the spot month, restricting Federal position limits to
spot months for most commodities is consistent with the Commission's
interpretation of the paragraph 4a(a)(1) necessity requirement as
directing the Commission to impose position limits where they are most
economically justified as an efficient mechanism for achieving the
statutory objectives.
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\1327\ See supra Section II.B.2. (discussing Final Rule
provisions).
\1328\ Id.
---------------------------------------------------------------------------
The Commission similarly finds position limits in non-spot months
to be necessary for the legacy agricultural contracts for substantially
the reasons discussed above.\1329\ These limits were put in place
pursuant to past statutory necessity findings and have been in place
for decades without the Commission observing problems that
[[Page 3398]]
would give reasons to remove them.\1330\ And they are generally
supported by many market participants.\1331\ Because no commenters
argued that the Commission should eliminate Federal non-spot month
position limits for the nine legacy agricultural contracts and because
these limits have been in existence for decades, the Commission
believes that it would be imprudent to eliminate them absent any
specific reason in support thereof, particularly insofar as maintaining
them, by definition, will result in no new costs or burdens. The
Commission further notes that maintaining non-spot month limits for the
nine legacy agricultural contracts will not change the existing
dynamics of these markets.
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\1329\ See supra Section II.B.2. (discussing Final Rule
provisions).
\1330\ Id.
\1331\ Id. The Commission notes that while ISDA did not
specifically address the nine legacy agricultural contracts, it
suggested that the Commission ``should finalize the proposed Federal
position limits rules only for physically delivered spot month
futures contracts, in the first phase.'' See ISDA at 3-4.
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The Commission is therefore satisfied that these limits remain an
efficient mechanism for achieving the objectives of CEA section 4a.
IV. Related Matters
A. Cost-Benefit Considerations
1. Introduction
Section 15(a) of the Commodity Exchange Act (``CEA'' or ``Act'')
requires the Commodity Futures Trading Commission (``Commission'') to
consider the costs and benefits of its actions before promulgating a
regulation under the CEA.\1332\ Section 15(a) further specifies that
the costs and benefits 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; (4) sound risk management
practices; and (5) other public interest considerations (collectively,
the ``section 15(a) factors'').\1333\
---------------------------------------------------------------------------
\1332\ 7 U.S.C. 19(a).
\1333\ Id.
---------------------------------------------------------------------------
The Commission interprets section 15(a) to require the Commission
to consider only those costs and benefits of its changes that are
attributable to the Commission's discretionary determinations (i.e.,
changes that are not otherwise required by statute) compared to the
existing status quo baseline requirements. For this purpose, the status
quo requirements, which serve as the baseline for the consideration of
the costs and benefits of the regulations adopted in this final
position limits rulemaking (``Final Rule''), include the CEA's
statutory requirements as well as any applicable existing Commission
regulations.\1334\ As a result, any changes to the Commission's
regulations that are required by the CEA or other applicable statutes
are not deemed to be discretionary changes for purposes of discussing
related costs and benefits of the Final Rule.
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\1334\ This cost-benefit consideration section is divided into
seven parts, including this introductory section, with respect to
any applicable CEA or regulatory provisions.
---------------------------------------------------------------------------
The Commission anticipates that the Final Rule will affect market
participants differently depending on their business models and scale
of participation in the commodity contracts that are covered by the
Final Rule.\1335\ The Commission also anticipates that the Final Rule
may result in ``programmatic'' costs to some market participants.
Generally, affected market participants may incur increased costs
associated with developing or revising, implementing, and maintaining
compliance functions and procedures. Such costs might include those
related to the monitoring of positions in the relevant referenced
contracts; related filing, reporting, and recordkeeping requirements;
and the costs of changes to information technology systems.
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\1335\ For example, the Final Rule could result in increased
costs to market participants who may need to adjust their trading
and hedging strategies to ensure that their aggregate positions do
not exceed Federal position limits, particularly those who will be
subject to Federal position limits for the first time (i.e., those
who may trade contracts for which there are currently no Federal
position limits). On the other hand, existing costs could decrease
for those existing market participants whose positions would fall
below the new Federal position limits and therefore such market
participants would not be required to adjust their trading
strategies and/or apply for exemptions from the limits, particularly
if the Final Rule improves market liquidity or other metrics of
market health. Similarly, for those market participants who would
become subject to the Federal position limits, general costs would
be lower to the extent such market participants can leverage their
existing compliance infrastructure in connection with existing
exchange position limit regimes, relative to those market
participants that do not currently have such systems.
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The Commission has determined that it is not feasible to quantify
the costs or benefits with reasonable precision and instead has
identified and considered the costs and benefits qualitatively.\1336\
The Commission believes that, for many of the costs and benefits,
quantification is not feasible with reasonable precision, because
quantification requires understanding all market participants' business
models, operating models, cost structures, and hedging strategies,
including an evaluation of the potential alternative hedging or
business strategies that could be adopted under the Final Rule.
Further, while Congress has tasked the Commission with establishing
such Federal position limits as the Commission finds are ``necessary,''
some of the benefits, such as mitigating or eliminating manipulation or
excessive speculation, may be very difficult or infeasible to quantify.
These benefits, moreover, will likely manifest over time and be
distributed over the entire market.
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\1336\ With respect to the Commission's analysis under its
discussion of its obligations under the Paperwork Reduction Act
(``PRA''), the Commission has endeavored to quantify certain costs
and other burdens imposed on market participants related to
collections of information as defined by the PRA. See generally
Section IV.B. (discussing the Commission's PRA determinations).
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In light of these limitations, to inform its consideration of costs
and benefits of the Final Rule, the Commission in its discretion relies
on: (1) Its experience and expertise in regulating the derivatives
markets; (2) information gathered through public comment letters \1337\
and meetings with a broad range of market participants; and (3) certain
Commission data, such as the Commission's Large Trader Reporting System
and data reported to swap data repositories.
---------------------------------------------------------------------------
\1337\ While the general themes contained in comments submitted
in response to prior proposals informed this rulemaking, the
Commission withdrew the 2013 Proposal, the 2016 Supplemental
Proposal, and the 2016 Reproposal. See supra Section I.A.
---------------------------------------------------------------------------
The Commission considers the benefits and costs discussed below in
the context of international markets, because market participants and
exchanges subject to the Commission's jurisdiction for purposes of
position limits may be organized outside of the United States; some
industry leaders typically conduct operations both within and outside
the United States; and market participants may follow substantially
similar business practices wherever located. Where the Commission does
not specifically refer to matters of location, the discussion of
benefits and costs below refers to the effects of the Final Rule on all
activity subject to it, whether by virtue of the activity's physical
location in the United States or by virtue of the activity's connection
with, or effect on, U.S. commerce under CEA section 2(i).\1338\
---------------------------------------------------------------------------
\1338\ 7 U.S.C. 2(i).
---------------------------------------------------------------------------
The Commission sought comments on all aspects of the cost and
benefit considerations in the 2020 NPRM, including: (1) Identification
and assessment of any costs and benefits not discussed in the 2020
NPRM; (2) data and any other information to assist or otherwise inform
the Commission's
[[Page 3399]]
ability to quantify or qualify the costs and benefits of the 2020 NPRM;
and (3) substantiating data, statistics, and any other information to
support positions posited by comments with respect to the Commission's
consideration of costs and benefits.\1339\ The Commission also
requested specific comments regarding its considerations of the
benefits and costs of proposed Sec. Sec. 150.3 and 150.9, as well as
comments on whether a Commission-administered exemption process, such
as the process in proposed Sec. 150.3, would promote more consistent
and efficient decision-making or whether an alternative to proposed
Sec. 150.9 would result in a superior cost-benefit profile.\1340\
Last, the Commission requested comment on all aspects of the
Commission's discussion of the 15(a) factors for the 2020 NPRM.\1341\
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\1339\ 85 FR 11671, 11698.
\1340\ 85 FR 11693.
\1341\ 85 FR 11700.
---------------------------------------------------------------------------
The Commission identifies and discusses the costs and benefits of
the Final Rule organized conceptually by topic, and certain topics may
generally correspond with a specific regulatory section. The
Commission's discussion is organized as follows: (1) This introduction
discussion section; (2) a discussion of the Commission's necessity
finding with respect to the 25 core referenced futures contracts that
are subject to the Federal position limits framework; (3) the Federal
position limit levels (final Sec. 150.2), and the definitions of
``referenced contract'' and ``economically equivalent swap''; (4) the
Commission's exemptions from Federal position limits (final Sec.
150.3), including the Federal bona fide hedging definition (final Sec.
150.1); (5) the streamlined process for the Commission to recognize
non-enumerated bona fide hedges (final Sec. 150.9) and to grant other
exemptions for purposes of Federal position limits (final Sec. 150.3)
and related reporting changes to part 19 of the Commission's
regulations; (6) the exchange-set position limits framework and
exchange-granted exemptions thereto (final Sec. 150.5); and (7) the
section 15(a) factors.
2. Costs and Benefits of Commission's Necessity Finding for the 25 Core
Referenced Futures Contracts With Respect to Liquidity and Market
Integrity and Resulting Impact on Market Participants and Exchanges
Rather than discussing the general costs and benefits of the
Federal position limits framework in this section, the Commission will
instead address the potential costs and benefits resulting from the
Commission's necessity finding with respect to the 25 core referenced
futures contracts.\1342\ The discussion in this section begins with an
overview of the Commission's Federal position limits framework in part
one followed by an overview of the Commission's interpretation of the
criteria for finding position limits necessary within the meaning of
CEA section 4a(a)(1) in part two. An overview of the Commission's
necessity finding for the 25 core referenced futures contracts, linked
``referenced contracts,'' and spot/non-spot month position limits is
discussed in part three. Finally, part four includes a discussion of
the potential costs and benefits of the Commission's necessity finding
for the 25 core referenced futures contracts with respect to (a) the
liquidity and integrity of the futures and related options markets; and
(b) market participants and exchanges.
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\1342\ This Section does not address the cost-benefit
implications for imposing position limits on futures contracts and
options thereon that are directly or indirectly linked to a core
referenced futures contract. That discussion is below in Section
IV.A.4. Further, this Section does not address the cost-benefit
implications for maintaining non-spot month position limits on the
nine legacy agricultural contracts. The Commission is of the view
that the Final Rule should not have any cost-benefit consideration
impacts due to the existence of Federal non-spot month position
limits on the nine legacy agricultural commodities since the
Commission is maintaining the status quo with respect to the
existence of such limits for those contracts. As a result, the
Commission does not expect there to be a change with respect to the
costs and benefits of its approach by simply finding that Federal
position limits continue to be necessary during the non-spot months
for the nine legacy agricultural commodities. However, with the
exception of CBOT Oats (O), CBOT KC HRS Wheat (KW), and MGEX HRS
Wheat (MWE), the final rule will result in higher non-spot month
position limit levels for the remaining legacy agricultural
commodities. See infra Section IV.A.4. (addressing the costs and
benefits of generally increased non-spot month position limit levels
for the legacy agricultural contracts).
---------------------------------------------------------------------------
i. Federal Position Limits Framework
The Commission currently enforces and sets Federal spot and non-
spot month position limits only for futures and options on futures
contracts on the nine legacy agricultural commodities.\1343\ The Final
Rule expands the scope of commodity derivative contracts subject to the
Commission's existing Federal position limits framework \1344\ to
include (a) futures contracts and options on futures contracts on 16
additional contracts during the spot month only, for a total of 25 core
referenced futures contracts,\1345\ (b) futures contracts and options
on futures contracts directly or indirectly linked to one of the 25
core referenced futures contracts, and (c) swaps that are
``economically equivalent'' to certain referenced contracts.\1346\
Under this Final Rule, Federal non-spot month position limits will
continue to apply only to futures and options on futures on the nine
legacy agricultural commodities. As discussed above in Section
III.B.2., while economically equivalent swaps are encompassed within
the ``referenced contract'' definition, such swaps are subject to
Federal position limits pursuant to CEA section 4a(a)(5) and therefore
not subject to a necessity determination. The cost-benefit implications
of the Commission's ``economically equivalent swap'' definition are
discussed further below.
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\1343\ The nine legacy agricultural contracts currently subject
to Federal spot and non-spot month limits are: CBOT Corn (C), CBOT
Oats (O), CBOT Soybeans (S), CBOT Wheat (W), CBOT Soybean Oil (SO),
CBOT Soybean Meal (SM), MGEX Hard Red Spring Wheat (MWE), ICE Cotton
No. 2 (CT), and CBOT KC Hard Red Winter Wheat (KW).
\1344\ 17 CFR 150.2. Because the Commission had not yet
implemented the Dodd-Frank Act's amendments to the CEA regarding
position limits, except with respect to aggregation (see generally
Final Aggregation Rulemaking, 81 FR at 91454) and the vacated 2011
Position Limits Rulemaking's amendments to 17 CFR 150.2 (see ISDA,
887 F. Supp. 2d 259 (2012)), the existing baseline or status quo
consisted of the provisions of the CEA relating to position limits
immediately prior to effectiveness of the Dodd-Frank Act amendments
to the CEA and the relevant provisions of existing parts 1, 15, 17,
19, 37, 38, 140, and 150 of the Commission's regulations, subject to
the aforementioned exceptions.
\1345\ The 16 new products that are subject to Federal spot
month position limits for the first time include seven agricultural
(CME Live Cattle (LC), CBOT Rough Rice (RR), ICE Cocoa (CC), ICE
Coffee C (KC), ICE FCOJ-A (OJ), ICE Sugar No. 11 (SB), and ICE Sugar
No. 16 (SF)), four energy (NYMEX Light Sweet Crude Oil (CL), NYMEX
New York Harbor ULSD Heating Oil (HO), NYMEX New York Harbor RBOB
Gasoline (RB), NYMEX Henry Hub Natural Gas (NG)), and five metals
(COMEX Gold (GC), COMEX Silver (SI), COMEX Copper (HG), NYMEX
Palladium (PA), and NYMEX Platinum (PL)) contracts.
\1346\ See supra Section II.A.4. (defining the term
``economically equivalent swap'' for purposes of the Federal
position limits framework under the Final Rule).
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ii. The Commission's Interpretation of Section 4a
As previously discussed, the Commission interprets CEA section 4a
to require that the Commission make an antecedent ``necessity'' finding
that establishing Federal position limits is ``necessary'' to diminish,
eliminate, or prevent certain burdens on interstate commerce with
respect to the physical commodities in question.\1347\ As the statute
does not define the term ``necessary,'' the Commission must apply its
expertise in construing this term, and, as discussed further below,
must do so consistent with the policy
[[Page 3400]]
goals articulated by Congress, including in CEA sections 4a(a)(2)(C)
and 4a(a)(3), as noted throughout this discussion of the Commission's
cost-benefit considerations.\1348\
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\1347\ See supra Section III.B. (discussing legal standard for
necessity finding).
\1348\ In promulgating the position limits framework, Congress
instructed the Commission to consider several factors: First, CEA
section 4a(a)(3) requires the Commission when establishing position
limits, to the maximum extent practicable, in its discretion, to (i)
diminish, eliminate, or prevent excessive speculation; (ii) deter
and prevent market manipulation, squeezes, and corners; (iii) ensure
sufficient market liquidity for bona fide hedgers; and (iv) ensure
that the price discovery function of the underlying market is not
disrupted. Second, CEA section 4a(a)(2)(C) requires the Commission
to strive to ensure that any limits imposed by the Commission will
not cause price discovery in a commodity subject to position limits
to shift to trading on a foreign exchange.
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Under this Final Rule, the Commission is establishing position
limits on 25 core referenced futures contracts \1349\ and any futures
contracts or options on futures contracts directly or indirectly linked
to the core referenced futures contracts,\1350\ on the basis that
position limits on such contracts are ``necessary'' to achieve the
purposes of the CEA. In reaching this conclusion, the Commission
analyzed (1) the importance of these contracts to the operation of the
underlying cash commodity market, including that they require physical
delivery; and (2) the importance of the underlying commodity to the
economy as a whole.\1351\ As discussed above, the Commission is of the
view that evidence demonstrating one or both of these factors is
sufficient to establish that position limits are necessary because each
factor relates to the statutory objective identified in paragraph
4a(a)(1).\1352\ As a result, the Commission has concluded that it must
exercise its judgment in light of facts and circumstances, including
its experience and expertise, in determining whether Federal position
limit levels are economically justified.\1353\
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\1349\ See supra Section III.C. (discussing necessity finding
for the 25 core referenced futures contracts).
\1350\ See supra Section III.D. (discussing necessity finding
for linked contracts).
\1351\ See supra Section III.B. (discussing and adopting legal
standard for necessity finding in 2020 NPRM).
\1352\ Id.
\1353\ Id.
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iii. The Commission's Necessity Finding
With respect to the first factor of the Commission's necessity
analysis, the Commission focused on physically-settled futures
contracts because they perform an important price discovery function
for many cash-market participants and may be affected by corners and
squeezes, which can occur near the expiration of these contracts,
compared to cash-settled contracts.\1354\ Based on the above
discussion, the Commission determined that the 25 core referenced
futures contracts are important to their respective underlying cash
markets because they (1) are the physically-settled contracts in
physical commodities traded on U.S. exchanges that are the most used
for hedging and price discovery by commercial participants, as measured
by open interest, notional value, and trading volume; and (2) serve as
key benchmarks for use in pricing cash-market and other
transactions.\1355\ Upon consideration of the second factor, as
discussed in further detail above, the Commission has determined that
the cash markets underlying the 25 core referenced futures contracts
are all, to varying degrees, vitally important to the U.S. economy
because many of the commodities underlying the 25 contracts are among
the most important physical commodities, as measured by production and
use, for commodities for which physically-settled futures contracts are
traded on U.S. exchanges.\1356\ For these reasons, the Commission finds
that position limits are necessary for the 25 core referenced futures
contracts to achieve the purposes of the CEA.\1357\
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\1354\ See supra Section III.C.2.a. (discussing the link between
the derivatives markets and underlying cash-markets).
\1355\ See supra Section III.C.2.b. (discussing the Commission's
determination that the 25 core referenced futures contracts are used
extensively for hedging and price discovery, thus establishing a
close link between both markets).
\1356\ See supra Section III.C.3. (discussing second factor of
necessity analysis).
\1357\ See supra Section III.C. (discussing necessity finding
for 25 core referenced futures contracts).
---------------------------------------------------------------------------
As noted previously, the Commission has determined that position
limits for futures and options on futures contracts that are linked to
core referenced futures contracts are necessary within the meaning of
paragraph 4a(a)(1) because such position limits are likely to make
position limits for core referenced futures contracts more effective in
preventing manipulation and other sources of sudden or unreasonable
fluctuations or unwarranted changes in the price of the underlying
commodity.\1358\
---------------------------------------------------------------------------
\1358\ See supra Section III.D. (discussing necessity finding
for linked contracts).
---------------------------------------------------------------------------
Further, the Commission has determined that position limits are
necessary during all months for the nine legacy agricultural contracts,
where non-spot month Federal position limits have been in place for
decades, and only necessary during the spot month for the 16 additional
core referenced futures contracts.\1359\ Specifically, the Commission
found that certain potential sources of sudden or unreasonable
fluctuations or unwarranted changes in commodity prices caused by
excessive speculation, particularly corners, squeezes, and certain
convergence problems, are associated primarily with large positions
held during spot months.\1360\ And, to the extent that these problems
may arise in prior months, they are mitigated by exchange policies
including exchange-set position limits and position
accountability.\1361\ As a result, even if position limits may have
benefits outside the spot month, restricting Federal position limits to
spot months for most commodities is consistent with the Commission's
interpretation of the CEA section 4a(a)(1) necessity requirement as
directing the Commission to impose position limits where they are
economically justified as an efficient mechanism for achieving the
statutory objectives.
---------------------------------------------------------------------------
\1359\ See supra Section III.E. (discussing necessity finding
for spot/non-spot month position limits).
\1360\ See supra Section III.C.2.a. (discussing link between
derivatives market and cash markets).
\1361\ See supra Section III.E. (discussing necessity finding
for spot/non-spot month position limits).
---------------------------------------------------------------------------
The Commission similarly found position limits in non-spot months
to be necessary for the nine legacy agricultural contracts for the
reasons previously stated above.\1362\ Briefly, these limits were put
in place pursuant to past statutory necessity findings and have been in
place for decades without the Commission observing problems or concerns
by market participants that would give reasons to remove them.\1363\
For these reasons, the Commission has determined that it would be
imprudent to eliminate them absent any specific reason in support
thereof.
---------------------------------------------------------------------------
\1362\ Id.
\1363\ Id.
---------------------------------------------------------------------------
iv. Potential Costs and Benefits of the Commission's Necessity Finding
for the 25 Core Referenced Futures Contracts
In this section, the Commission will discuss potential costs and
benefits resulting from the Commission's necessity finding with respect
to: (1) The liquidity and integrity of the futures and related options
markets; and (2) market participants and exchanges. The Commission
discusses each factor in turn below.
a. Potential Impact of the Scope of the Commission's Necessity Findings
on Market Liquidity and Integrity
The Commission has determined that the 25 core referenced futures
contracts included in its necessity finding are
[[Page 3401]]
among the most liquid physical commodity contracts, as measured by open
interest and trading volume,\1364\ and, therefore, imposing positions
limits on these contracts may impose costs on market participants by
constraining liquidity because a trader may be prevented from trading
due to a position limit reducing liquidity on the other side of the
contract. However, to the extent that the nine legacy agricultural
contracts already are subject to existing Federal position limits, the
Final Rule does not represent a change to the status quo baseline
(although, as noted below, the applicable Federal position limits will
increase under the Final Rule for most of the nine legacy agricultural
contracts and the associated costs and benefits are discussed
thereunder). Nonetheless, the Commission believes that any potential
harmful effect on liquidity will be muted, as a result of the generally
high levels of open interest and trading volumes of the respective 25
core referenced futures contracts. This is so because, all other things
being equal, large, liquid markets tend to have more participants and
tend to be less concentrated. As a result, in such markets, if position
limits on some occasion restrict trading by one or a small number of
large traders, it is highly likely that other traders will be
participating in the market in sufficient volume for the purpose of
providing liquidity on reasonable terms.
---------------------------------------------------------------------------
\1364\ See supra Section III.C.2.b. (discussing average open
interest and average daily trading volume for the 25 core referenced
futures contracts for the period January 1, 2019 through December
31, 2019).
---------------------------------------------------------------------------
The Commission has determined that, as a general matter, focusing
on the 25 core referenced futures contracts may benefit market
integrity since these contracts generally are amongst the largest
physically-settled contracts with respect to relative levels of open
interest and trading volumes.\1365\ The Commission therefore believes
that excessive speculation or potential market manipulation in such
contracts is more likely to affect additional market participants and
therefore potentially more likely to cause an undue and unnecessary
burden (e.g., potential harm to market integrity or liquidity) on
interstate commerce. Because each core referenced futures contract is
physically-settled, as opposed to cash-settled, the Final Rule focuses
on preventing corners and squeezes in those contracts where such market
manipulation could cause significant harm in the price discovery
process for their respective underlying commodities.\1366\
---------------------------------------------------------------------------
\1365\ Id.
\1366\ The Commission must also make this determination in light
of its limited available resources and responsibility to allocate
taxpayer resources in an efficient manner to meet the goals of CEA
section 4a(a)(1), 7 U.S.C. 6a(a)(1), and the CEA generally.
---------------------------------------------------------------------------
While the Commission recognizes that market participants may engage
in market manipulation through cash-settled futures contracts and
options on futures contracts, the Commission has determined that
focusing on the physically-settled core referenced futures contracts
will benefit market integrity by reducing the risk of corners and
squeezes in particular. In addition, not imposing position limits on
additional commodities may foster non-excessive speculation, leading to
better prices and more efficient resource allocation in these
commodities. This may ultimately benefit commercial end users and
possibly be passed on to the general public in the form of better
pricing. As noted above, the scope of the Commission's necessity
finding with respect to the 25 core referenced futures contracts allows
the Commission to focus on those contracts that, in general, the
Commission recognizes as having particular importance in the price
discovery process for their respective underlying commodities as well
as potentially acute economic burdens that would arise from excessive
speculation causing sudden or unreasonable fluctuations or unwarranted
changes in the commodity prices underlying these contracts.\1367\
---------------------------------------------------------------------------
\1367\ See supra Section III.C.2.b.
---------------------------------------------------------------------------
To the extent the Commission did not include additional commodities
in its necessity finding, those markets will not receive the benefits
intended from the Final Rule's Federal position limits framework. It is
conceivable that this could entice bad actors to turn to those markets
for illegal schemes. On the other hand, markets outside the 25 core
referenced futures contracts are not left totally exposed. Some of the
potential harms to market integrity associated with not including
additional commodities within the Federal position limits framework
could be mitigated to an extent by exchanges, which can use tools other
than position limits, such as margin requirements or position
accountability at lower levels than the Federal position limits adopted
in the Final Rule, to defend against certain market behavior.
Further, burdens related to potential market manipulation for
markets outside the 25 core referenced futures contracts may be
mitigated through exchanges also establishing exchange-set position
limits. Under final Sec. 150.5(a) and (b), exchanges are required to
adopt exchange-set position limits both (i) for contracts subject to
Federal position limits and (ii) during the spot month for physical
commodity contracts not subject to Federal position limits.\1368\ Final
Sec. 150.5(b) also requires exchanges to adopt position limits or
position accountability outside the spot month for those physical
commodity contracts not subject to Federal position limits outside of
the spot month.
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\1368\ As discussed earlier in this release, final Sec.
150.5(a) requires exchange-set limits for contracts subject to
Federal limits to be no higher than the Federal limit. Final Sec.
150.5(b)(1) requires exchanges to establish position limits for
spot-month contracts in physical commodities that are not subject to
Federal position limits at a level that is ``necessary and
appropriate to reduce the potential threat of market manipulation or
price distortion of the contract's or the underlying commodity's
price or index.'' See supra Section II.D. (discussing Final Sec.
150.5).
---------------------------------------------------------------------------
Exchange-set position limits, including amendments to existing
limits, are reviewed by Commission staff via submissions under part 40
of the Commission's regulations, and must meet standards established by
the Commission, including in Sec. Sec. 150.1 and 150.5.\1369\ While
the review of exchange-set limits is focused on the adequacy of the
exchange-set position limit to minimize the potential for manipulation,
it isn't reviewed considering all of the CEA section 4a(a)(3)(B)
factors as Federal position limits require. Thus, exchange-set limits
may be set at a more restrictive level than a Federal speculative
position limit might be set for the same contract if it were subject to
Federal limits and therefore may have higher compliance and liquidity
costs than Federal limits on the same contract for periods of time.
Exchange limits may be updated much faster and more frequently than
Federal limits can be updated.\1370\ Therefore, any added compliance
and liquidity costs may only be realized in the short-term relative to
any compliance and liquidity costs from a Federal limit on the same
contract.
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\1369\ Further, as part of the submission process, exchanges are
encouraged to determine exchange-set limits based on the guidance in
Appendix C to part 38 (``Demonstration of compliance that a contract
is not readily susceptible to manipulation''). See 17 CFR part 38,
Appendix C. Appendix C provides guidance on calculating deliverable
supply for physical commodity contracts based on the terms and
conditions of the futures contract and also refers to part 150 for
specific information regarding the establishment of speculative
position limits including exchange-set speculative position limits.
\1370\ Exchanges can self-certify amendments to exchange-set
limits under Sec. 40.6. Federal position limits are updated only
through the rulemaking process.
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[[Page 3402]]
Although the Commission does not find that exchange-set limits
render Federal position limits unnecessary for the 25 core referenced
futures contracts and associated markets, due to their overall
importance, these tools do diminish the potential costs of refraining
from imposing Federal position limits outside of the 25 core referenced
futures contracts. Bad actors may also be deterred by the Commission's
anti-manipulation authority and the Commission's authority to purse
violations of exchange-set limits.\1371\
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\1371\ See, e.g., In the Matter of Sukarne SA de CV, CFTC No.
20-60, 2020 WL 5701586 (Sept. 18, 2020) (imposing a $35,000 civil
monetary penalty for a one-day violation of exchange-set position
limits in CME live cattle futures).
---------------------------------------------------------------------------
b. Potential Impact of the Scope of the Commission's Necessity Findings
on Market Participants and Exchanges
The Commission acknowledges that the Final Rule's Federal position
limits framework could impose certain administrative, logistical,
technological, and financial burdens on exchanges and market
participants, especially with respect to developing or expanding
compliance systems and the adoption of monitoring policies.\1372\ The
Commission, however, believes that these burdens will be mostly
incremental as many of the fixed costs have already been incurred by
exchanges and market participants. For example, exchanges are currently
required to comply with comparable requirements such as calculating
average daily trading volume. Further, market participants are required
to comply with existing requirements such as existing Federal position
limits and exchange-set limits and accountability levels.\1373\
---------------------------------------------------------------------------
\1372\ See, e.g., ISDA at 4 (``new Federal position limits
rulemaking will involve significant compliance costs and burdens . .
. that the CFTC can mitigate . . . by starting with final rules only
for physically-delivered spot month futures contracts in a first
phase.'').
\1373\ See NFPEA at 6 and 14 (explaining that the Federal
position limits framework would ``place unnecessary regulatory
burdens and costs on the NFP Energy Entities, without providing the
Commission with useful or usable information about speculators,
speculative transactions or speculative positions'' and asserting
that ``[t]here is no regulatory benefit in terms of reducing the
burdens of excessive speculation on CFTC-regulated markets to
balance against the costs and burdens for NFP Energy Entities (on-
speculators) to study, understand and apply the Commission's
Speculative Position Limits rules to their transactions and
positions''). See also supra Section II.C.14.i. (discussing NFPEA's
request for an exemption from the Federal position limits framework
and how the Final Rule addresses many of the concerns raised by
NFPEA).
---------------------------------------------------------------------------
The Commission further believes that these potential burdens are
mitigated by (1) the compliance date of January 1, 2022 in connection
with the Federal position limits for the 16 non-legacy core referenced
futures contracts, and (2) the compliance date of January 1, 2023 for
both (a) economically equivalent swaps that are subject to Federal
position limits under the Final Rule and (b) the elimination of
previously-granted risk management exemptions (i.e., market
participants may continue to rely on their previously-granted risk
management exemptions until January 1, 2023).\1374\ These delayed
compliance deadlines should mitigate compliance costs by permitting the
update and build out of technological and compliance systems more
gradually. They may also reduce the burdens on market participants not
previously subject to position limits, who will have a longer period of
time to determine whether they may qualify for certain bona fide
hedging recognitions or other exemptions, and to possibly alter their
trading or hedging strategies.\1375\ Further, the delayed compliance
dates will reduce the burdens on exchanges, market participants, and
the Commission by providing each with more time to resolve
technological and other challenges for compliance with the new
regulations. In turn, the Commission anticipates that the extra time
provided by the delayed compliance dates will result in more robust
systems for market oversight, which should better facilitate the
implementation of the Final Rule and avoid unnecessary market
disruptions while exchanges and market participants prepare for its
implementation. However, the delayed compliance deadlines will extend
the time it will take to realize the benefits identified above.
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\1374\ See supra Section I.D. (discussing effective date and
compliance date of the Final Rule).
\1375\ Commenters on the Commission's notice of a proposed
rulemaking for a new position limits proposal issued on February 27,
2020 (``2020 NPRM'') and prior proposals have requested a sufficient
phase-in period. See supra Section I.D.iv. (discussing comments
regarding compliance period of Final Rule); see also 81 FR at 96815
(implementation timeline).
---------------------------------------------------------------------------
This January 1, 2022 compliance date also applies to exchange
obligations under final Sec. 150.5, and market participants' related
obligation to temporarily continue providing Forms 204/304 in
connection with bona fide hedges. Furthermore, with respect to
exchanges' implementation of Sec. 150.9, the Commission is clarifying
that exchanges may choose to implement the streamlined process for non-
enumerated bona fide hedge applications as soon as the Final Rule's
effective date,\1376\ or anytime thereafter (or not at all).
---------------------------------------------------------------------------
\1376\ The Final Rule's effective date is March 15, 2021 (the
``Effective Date'').
---------------------------------------------------------------------------
CME expressed concern that it may receive an influx of exemption
applications at the end of the compliance period, and therefore
suggested a rolling process where market participants are grandfathered
into their current exemptions, permitting them to file for those
exemptions on the same annual schedule.\1377\ ISDA urged the Commission
to recognize the burdens associated with implementing a new set of
rules, and adopt a phase-in to minimize market disruptions and
increases in compliance costs.\1378\ As noted above, the Commission
seeks to alleviate the compliance burdens on exchanges associated with
the Final Rule by providing for a compliance date of January 1, 2022
for exchanges with respect to their obligations under Sec. 150.5. The
Commission believes CME's concern is mitigated since exchanges, at
their discretion, may implement final Sec. 150.9 as soon as the
Effective Date, which will allow exchanges to review non-enumerated
bona fide hedges on a rolling basis between the Effective Date and the
end of the compliance period rather than having to process a large
number of applications at once. Furthermore, market participants with
existing Commission-granted non-enumerated or anticipatory bona fide
hedge recognitions are not required to reapply to the Commission for a
new recognition under the Final Rule. The delayed compliance should
better facilitate the implementation of the Final Rule by preventing
unnecessary market disruptions and reducing the burdens on exchanges,
market participants, and the Commission by providing each with more
time to resolve technological and other challenges for compliance with
the new regulations.
---------------------------------------------------------------------------
\1377\ CME Group at 8.
\1378\ ISDA at 2.
---------------------------------------------------------------------------
The 2020 NPRM did not provide a specific date as the compliance
date but rather stated ``365 days after publication . . . in the
Federal Register,'' and did not provide a separate compliance date for
economically equivalent swaps or related to previously-granted risk
management exemptions. In response, several commenters requested the
that Commission further extend the compliance date for swaps to provide
market participants additional time to identify which swaps would be
deemed economically equivalent to a referenced contract, refine their
compliance
[[Page 3403]]
systems, and manage other operational and administrative
challenges.\1379\ These commenters generally stressed that burdens
related to economically equivalent swaps may be greater than related
futures contracts and options thereon.\1380\ The Commission generally
agrees with commenters that additional time would reduce burdens
associated with establishing compliance and monitoring systems, and has
therefore extended the compliance date for economically equivalent
swaps until January 1, 2023. Because the Commission understands that
risk management positions tend to also involve OTC swap positions, the
Commission believes that having the same compliance date as
economically equivalent swaps in connection with the elimination of the
risk management exemption would similarly reduce burdens.
---------------------------------------------------------------------------
\1379\ MFA/AIMA at 8; NCFC at 6; NGSA at 15-16; SIFMA AMG at 9-
10; and Citadel at 9.
\1380\ Id.
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3. Federal Position Limit Levels (Final Sec. 150.2)
i. General Approach
Existing Sec. 150.2 establishes Federal position limit levels that
apply net long or net short to futures and, on a futures-equivalent
basis, to options on futures contracts on nine legacy physically-
settled agricultural contracts.\1381\ The Commission has previously set
separate Federal position limits for: (i) The spot month, and (ii) a
single month and all-months-combined (i.e., ``non-spot months'').\1382\
For the existing spot month Federal position limit levels, the contract
levels are based on, among other things, 25% or lower of the estimated
deliverable supply (``EDS'').\1383\ For the existing non-spot month
position limit levels, the levels are generally set at 10% of open
interest for the first 25,000 contracts of open interest, with a
marginal increase of 2.5% of open interest thereafter (the ``10/2.5%
formula'').
---------------------------------------------------------------------------
\1381\ The nine legacy agricultural contracts subject to
existing Federal spot and non-spot month position limits were: CBOT
Corn (C), CBOT Oats (O), CBOT Soybeans (S), CBOT Wheat (W), CBOT
Soybean Oil (SO), CBOT Soybean Meal (SM), MGEX Hard Red Spring Wheat
(MWE), ICE Cotton No. 2 (CT), and CBOT KC Hard Red Winter Wheat
(KW).
\1382\ For clarity, limits for single and all-months-combined
apply separately. However, the Commission previously has applied the
same limit levels to the single month and all-months-combined.
Accordingly, the Commission will discuss the single and all-months
limits, i.e., the non-spot month limits, together.
\1383\ See supra Section II.B.1--Existing Sec. 150.2
(discussing that establishing spot month levels at 25% or less of
EDS is consistent with past Commission practices).
---------------------------------------------------------------------------
Final Sec. 150.2 revises and expands the existing Federal position
limits framework as follows. First, during the spot month, Sec. 150.2:
(i) Subjects 16 additional core referenced futures contracts and their
associated referenced contracts to Federal spot month position limits,
which are based on, among other things, the Commission's existing
approach of establishing limit levels at 25% or lower of EDS, for a
total of 25 core referenced futures contracts (and their associated
referenced contracts) subject to Federal spot month position limits
(i.e., the nine legacy agricultural contracts plus the 16 additional
contracts); \1384\ and (ii) updates the existing spot month levels for
the nine legacy agricultural contracts based on, among other things,
revised EDS.\1385\
---------------------------------------------------------------------------
\1384\ The 16 new products that are subject to Federal spot
month position limits for the first time include seven agricultural
(CME Live Cattle (LC), CBOT Rough Rice (RR), ICE Cocoa (CC), ICE
Coffee C (KC), ICE FCOJ-A (OJ), ICE Sugar No. 11 (SB), and ICE Sugar
No. 16 (SF)), four energy (NYMEX Light Sweet Crude Oil (CL), NYMEX
NY Harbor ULSD Heating Oil (HO), NYMEX NY Harbor RBOB Gasoline (RB),
and NYMEX Henry Hub Natural Gas (NG)), and five metals (COMEX Gold
(GC), COMEX Silver (SI), COMEX Copper (HG), NYMEX Palladium (PA),
and NYMEX Platinum (PL)) contracts.
\1385\ The Final Rule maintains the current spot month limits on
CBOT Oats (O).
---------------------------------------------------------------------------
Second, for non-spot month position limit levels, final Sec. 150.2
revises the 10/2.5% formula so that: (i) The incremental 2.5% increase
takes effect after the first 50,000 contracts of open interest, rather
than after the first 25,000 contracts under the existing rule (the
``marginal threshold level''); and (ii) the limit levels are calculated
by applying the updated 10/2.5% formula to open interest data for the
two 12-month periods from July 2017 to June 2018 and July 2018 to June
2019 of the applicable futures contracts and delta-adjusted options on
futures contracts.\1386\ The 12-month period yielding the higher limit
is selected as the non-spot month limit for that legacy agricultural
commodity.
---------------------------------------------------------------------------
\1386\ As discussed below, for most of the legacy agricultural
commodities, this results in a higher non-spot month limit. However,
the Commission is not changing the non-spot month limits for either
CBOT Oats (O) or MGEX Hard Red Spring Wheat (MWE) based on the
revised open interest since this would result in a reduction of non-
spot month limits from 2,000 to 700 contracts for CBOT Oats (O) and
12,000 to 5,700 contracts for MGEX HRS Wheat (MWE). Similarly, the
Commission also is maintaining the current non-spot month limit for
CBOT KC Hard Red Winter Wheat (KW). Furthermore, the Commission is
adopting a separate single month position limit level of 5,950
contracts for ICE Cotton No. 2 (CT). The all-months-combined
position limit level for ICE Cotton No. 2 (CT) is set at 11,900
contracts, based on the modified 10/2.5% formula and updated open
interest figures.
---------------------------------------------------------------------------
Third, the final Federal position limits framework expands to cover
(i) any cash-settled futures and related options on futures contracts
directly or indirectly linked to any of the 25 proposed physically-
settled core referenced futures contracts as well as (ii) any
economically equivalent swaps.
For spot month positions, the Federal position limits in final
Sec. 150.2 apply separately, net long or short, to cash-settled
referenced contracts and to physically-settled referenced contracts in
the same commodity. This results in a separate net long/short position
for each category so that cash-settled contracts in a particular
commodity are netted with other cash-settled contracts in that
commodity, and physically-settled contracts in a given commodity are
netted with other physically-settled contracts in that commodity; a
cash-settled contract and a physically-settled contract may not be
netted with one another during the spot month. Outside the spot month,
cash and physically-settled contracts in the same commodity are netted
together to determine a single net long/short position.
Fourth, final Sec. 150.2 subjects pre-existing positions, other
than pre-enactment swaps and transition period swaps, to Federal
position limits during the spot month and non-spot months.
In setting the Federal position limit levels, the Commission seeks
to advance the enumerated statutory objectives with respect to position
limits in CEA section 4a(a)(3)(B).\1387\ The Commission recognizes that
relatively high Federal position limit levels may be more likely to
support some of the statutory goals and less likely to advance others.
For instance, a relatively higher Federal position limit level may be
more likely to benefit market liquidity for hedgers or ensure that the
price discovery of the underlying market is not disrupted, but may be
less likely to benefit market integrity by being less effective at
diminishing, eliminating, or preventing excessive speculation or at
deterring and preventing market manipulation, corners, and squeezes. In
particular, setting relatively high Federal position limit levels may
result in excessively large speculative positions and/or increased
volatility, especially during speculative showdowns (when two market
participants disagree about the proper market price and trade
aggressively in large quantities
[[Page 3404]]
expressing their view causing the market price to be volatile), which
may cause some market participants to retreat from the commodities
markets due to perceived decreases in market integrity. In turn, fewer
market participants may result in lower liquidity levels for hedgers
and harm to the price discovery function in the underlying markets.
---------------------------------------------------------------------------
\1387\ See supra Sections II.B.3.ii.a(1) and II.B.4.iii.a(4)
(further discussing the CEA's statutory objectives for the Federal
position limits framework).
---------------------------------------------------------------------------
Conversely, setting a relatively lower Federal position limit level
may be more likely to diminish, eliminate, or prevent excessive
speculation, but may also limit the availability of certain hedging
strategies, adversely affect levels of liquidity, and increase
transaction costs.\1388\ Additionally, setting Federal position limits
too low may cause non-excessive speculation to exit a market, which
could reduce liquidity, cause ``choppy'' \1389\ prices and reduced
market efficiency, and increase option premia to compensate for the
more volatile prices. The Commission in its discretion has nevertheless
endeavored to set Federal position limit levels, to the maximum extent
practicable, to benefit the statutory goals identified by Congress.
---------------------------------------------------------------------------
\1388\ For example, relatively lower Federal position limits may
adversely affect potential hedgers by reducing liquidity. In the
case of reduced liquidity, a potential hedger may face unfavorable
spreads and prices, in which case the hedger must choose either to
delay implementing its hedging strategy and hope for more favorable
spreads in the near future or to choose immediate execution (to the
extent possible) at a less favorable price.
\1389\ ``Choppy'' prices often refer to illiquidity in a market
where transacted prices bounce between the bid and the ask prices.
Market efficiency may be harmed in the sense that transacted prices
might need to be adjusted for the bid-ask bounce to determine the
fundamental value of the underlying contract.
---------------------------------------------------------------------------
As discussed above, the contracts that are subject to the Federal
position limits adopted in the Final Rule are currently subject to
either Federal or exchange-set position limits (or both). To the extent
that the Federal position limit levels in final Sec. 150.2 are higher
than the existing Federal position limit levels for either the spot or
non-spot month, market participants currently trading these contracts
could engage in additional trading under the Federal position limit
levels in final Sec. 150.2 that otherwise would be prohibited under
existing Sec. 150.2.\1390\ On the other hand, to the extent an
exchange--set position limit level is lower than its corresponding
Federal position limit level in final Sec. 150.2, the Federal position
limit does not affect market participants since market participants are
required to comply with the lower exchange--set position limit level
(to the extent that the exchanges maintain their current levels).\1391\
---------------------------------------------------------------------------
\1390\ For the spot month, all the legacy agricultural contracts
other than CBOT Oats (O) have higher Federal position limit levels.
For the non-spot months, all the legacy agricultural contracts other
than CBOT Oats (O), MGEX HRS Wheat (MWE), and CBOT KC HRW Wheat
(KW), have higher Federal position limit levels.
\1391\ While the Final Rule generally either increases or
maintains the Federal position limits for both the spot months and
non-spot months compared to existing Federal position limits, where
applicable, and exchange limits, the Federal spot month position
limit level for COMEX Copper (HG) is below the existing exchange-set
level. Accordingly, market participants may have to change their
trading behavior with respect to COMEX Copper (HG), which could
impose compliance and transaction costs on these traders, to the
extent their existing trading exceeds the lower Federal spot month
position limit levels.
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ii. Spot Month Levels
The Commission is maintaining 25% of EDS as a ceiling for Federal
spot month position limits, except for cash-settled NYMEX Henry Hub
Natural Gas (``NYMEX NG'') referenced contracts, which is discussed
below. Based on the Commission's experience overseeing Federal position
limits for decades, and overseeing exchange-set position limits
submitted to the Commission pursuant to part 40 of the Commission's
regulations, none of the Federal spot month position limit levels
listed in final Appendix E of part 150 of the Commission's regulations:
(i) Are so low as to reduce liquidity for bona fide hedgers or disrupt
the price discovery function of the underlying market; \1392\ or (ii)
so high as to invite excessive speculation, manipulation, corners, or
squeezes because, among other things, any potential economic gains
resulting from the manipulation may be insufficient to justify the
potential costs, including the costs of acquiring, and ultimately
offloading, the positions used to effect the manipulation.\1393\
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\1392\ The Federal spot month position limit levels adopted in
the Final Rule are set at, or higher than, existing Federal spot
month position limit levels (for the nine legacy agricultural
contracts) or at, or higher than, existing exchange-set spot month
position limit levels (for the 16 non-legacy core referenced futures
contracts). As a result, the Commission does not believe that
liquidity will be reduced with respect to the core referenced
futures contracts and their associated referenced contracts.
Consequently, the Commission also believes that the Federal spot
month position limit levels will be less burdensome on market
participants. See AFIA at 1.
\1393\ This is driven primarily by the Federal spot month
position limit levels being set at or below 25% of EDS.
---------------------------------------------------------------------------
The Commission considered alternative Federal spot month position
limit levels provided by Better Markets, which requested a standard
Federal spot month position limit level of 10% of EDS, which could be
adjusted as needed.\1394\ The Commission believes that this across-the-
board approach fails to take into account the differences between the
core referenced futures contracts and could result in material costs to
certain types of referenced contracts without concomitant benefits. For
example, the Commission has determined to set the Federal spot month
position limit levels for eight core referenced futures contracts below
10% of EDS. Raising the levels to 10% of EDS for some of these
contracts could increase the risk of market manipulation. As an
example, raising the Federal position limit level to 10% of EDS would
result in an increase of approximately 46% over the proposed and final
Federal spot month position limit level for CBOT KC HRS Wheat (KW). The
Commission believes that, despite the increased potential for market
manipulation, this would result in a negligible improvement in
liquidity, because the level for CBOT KC HRS Wheat (KW) is being set as
a ceiling within the Federal position limits framework.
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\1394\ Better Markets at 41. Other commenters, such as PMAA and
AFR, generally suggested lowering Federal spot month position limit
levels. However, neither provided specific levels or a formula for
determining alternative levels. As a result, the Commission is
unable to engage in a cost-benefit analysis with respect to their
suggestions.
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On the other end of the spectrum, for some core referenced futures
contracts with proposed and final Federal position limit levels higher
than 10% of EDS, decreasing the levels to 10% of EDS could have a
material negative impact on liquidity. For example, this would result
in a reduction in the Federal spot month position limit levels by
approximately 60% for the seven core referenced futures contracts for
which the Commission is adopting a Federal spot month position limit
level of 25% of EDS.\1395\ This could cause a significant decrease in
liquidity in those markets, as speculative traders may not be of
sufficient size and quantity to take the other side of bona fide
hedgers' positions. This may impact the price discovery function and
hedging utility of those contracts because hedgers could not transact
at better prices provided by the presence of the speculative traders.
Furthermore, it could severely restrict the breadth of exchange-set
spot month position limit levels that an exchange may set, which would
provide less
[[Page 3405]]
flexibility to the exchanges to respond to rapidly changing market
conditions.
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\1395\ The seven such core referenced futures contracts are: (1)
MGEX HRS Wheat (MWE); (2) ICE Cocoa (CC); (3) ICE Coffee C (KC); (4)
ICE FCOJ-A (OJ); (5) ICE Sugar No. 11 (SB); (6) ICE Sugar No. 16
(SF); and (7) NYMEX Henry Hub Natural Gas (NYMEX NG).
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The Commission also considered PMAA's statement that ``the spot-
month limit of 25 percent of deliverable supply is not sufficiently
aggressive to deter excessive speculation.'' \1396\ However, PMAA
provides no defined alternative for the Commission to consider, which
makes it difficult to compare the costs and benefits of PMAA's
suggested approach. Nonetheless, the Commission acknowledges that, as a
general principle, lowering position limit levels may decrease the
likelihood of excessive speculation.\1397\ However, that may come at
the cost of liquidity for bona fide hedgers. The Commission notes that
PMAA's suggestion would apply to only seven of the 25 core referenced
futures contracts that have Federal spot month position limit levels
set at 25% of EDS in the Final Rule.\1398\ The others are all set well
below 25% of EDS, with the highest being 19.29% of EDS for CBOT Oats
(O). For all core referenced futures contracts, including ones that
have Federal spot month position limit levels set at 25% of EDS, the
Commission reviewed the methodology underlying the EDS figures and the
Federal spot month position limit levels, and determined that they
advance the objectives of CEA section 4a(a)(3), including preventing
excessive speculation and manipulation, while also ensuring sufficient
market liquidity for bona fide hedgers. Finally, the Final Rule's
position limits framework also leverages the exchanges' expertise and
ability to quickly set and adjust their exchange-set spot month
position limits at any level lower than the Federal spot month position
limit levels in response to market conditions, which relieves some of
the potential costs of setting the Federal spot month position limit
levels at 25% of EDS (i.e., a higher likelihood of excessive
speculation compared to lower levels) for the seven core referenced
futures contracts discussed above.
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\1396\ PMAA at 2.
\1397\ However, based on the Commission's past experience in
setting Federal speculative position limits, the Commission notes
that it is very unlikely that there will be excessive speculation if
the Federal spot month position limit level is set at 25% or less of
EDS.
\1398\ The seven such core referenced futures contracts are: (1)
MGEX HRS Wheat (MWE); (2) ICE Cocoa (CC); (3) ICE Coffee C (KC); (4)
ICE FCOJ-A (OJ); (5) ICE Sugar No. 11 (SB); (6) ICE Sugar No. 16
(SF); and (7) NYMEX Henry Hub Natural Gas (NYMEX NG).
---------------------------------------------------------------------------
The Commission also considered CME Group's recommendation with
respect to the non-CME Group-listed core referenced futures contracts
``that the Commission not adopt final spot month position limit levels
at 25% of deliverable supply as a rigid formula and, based on the
factors previously described above, work with the exchange to determine
an appropriate limit based on the market dynamics previously
described.'' \1399\ CME Group commented that, ``[t]aking an across-the-
board approach by setting a Federal limit at the full 25 percent of
deliverable supply could have a significant negative impact on many
markets across all asset classes. . . . For example, setting a uniform
and high Federal limit without regard to the unique characteristics of
a particular contract market can encourage exchanges to set limits for
competitive reasons rather than for regulatory purposes . . . [and]
that perverse incentive structure could lead to a race to the bottom
and undermine the statutory goals of deterring manipulation and
excessive speculation through position limits.'' \1400\ The Commission
agrees that mechanically applying a Federal spot month position limit
level of 25% of EDS can undermine the statutory goals of CEA section
4a(a)(3). However, in proposing the Federal spot month position limit
levels, the Commission did not mechanically apply 25% of EDS as a rigid
formula for the non-CME Group-listed core referenced futures contracts.
Instead, as it did for the CME Group-listed core referenced futures
contracts, the Commission reviewed the methodology underlying the EDS
figures and the Federal spot month position limit levels, and
determined that they advance the objectives of CEA section 4a(a)(3),
including preventing excessive speculation and manipulation, while also
ensuring sufficient market liquidity for bona fide hedgers. The
Commission also considered the Federal spot month position limit levels
in the context of the Final Rule's position limits framework, which
leverages the exchanges' expertise and ability to quickly set and
adjust their exchange-set spot month position limits at any level lower
than the Federal spot month position limit levels in response to market
conditions, which relieves some of the potential costs of setting the
Federal spot month position limit levels at 25% of EDS. Furthermore,
the Commission considered comments received in response to the 2020
NPRM before finalizing the Federal spot month position limit levels.
This is evidenced in the changes to the Federal spot month position
limit levels with respect to NYMEX Henry Hub Natural Gas (NG) and ICE
Cotton No. 2 (CT), the latter of which is set at 12.95% of EDS in the
Final Rule.
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\1399\ CME Group at 5. CME considered the following factors:
contract specifications, market participation, physical market
fundamentals, delivery process, convergence, market liquidity,
volatility, market participant concentration, and market participant
feedback.
\1400\ CME Group at 5.
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The Commission also recognizes comments from Better Markets and
NEFI, which state that exchanges have incentives to maximize
shareholder profits, which could be accomplished by, among other
things, maximizing trading.\1401\ One way exchanges could spur trading
in the context of setting Federal spot month position limit levels in
this rulemaking is by taking steps to ensure that the Federal spot
month position limit levels are set as high as possible by providing
higher EDS figures and recommending higher Federal spot month position
limit levels. A potential cost of extremely high Federal spot month
position limit levels is harm to market integrity through excessive
speculation and manipulation. However, the Commission believes that
these costs are mitigated through a number of mechanisms. First, the
Commission independently assessed and verified the exchanges' EDS
estimates, which included: (1) Working closely with the exchanges to
independently verify that all EDS methodologies and figures are
reasonable; \1402\ and (2) reviewing each exchange-recommended level
for compliance with the requirements established by the Commission and/
or by Congress, including those in CEA section 4a(a)(3)(B).\1403\
Second, the Commission conducted its own analysis of the exchange-
recommended Federal spot month position limit levels and determined
that the levels adopted herein are: (1) Low enough to diminish,
eliminate, or prevent excessive speculation and also protect price
discovery; (2) high enough to ensure that there is sufficient market
liquidity for bona fide hedgers; (3) fall within a range of acceptable
limit levels; and (4) are properly calibrated to account for
differences between markets. Third, the Commission notes that exchanges
have significant incentives and obligations to maintain well-
functioning markets as self-regulatory organizations that are
themselves subject to regulatory requirements. Specifically, the DCM
and
[[Page 3406]]
SEF Core Principles require exchanges to, among other things, list
contracts that are not readily susceptible to manipulation, and surveil
trading on their markets to prevent market manipulation, price
distortion, and disruptions of the delivery or cash-settlement
process.\1404\ Fourth, exchanges also have significant incentives to
maintain well-functioning markets to remain competitive with other
exchanges. Market participants may choose exchanges that are less
susceptible to sudden or unreasonable fluctuations or unwarranted
changes caused by corners, squeezes, and manipulation, which could,
among other things, harm the price discovery function of the commodity
derivative contracts and negatively impact the delivery of the
underlying commodity, bona fide hedging strategies, and market
participants' general risk management.\1405\ In addition, several
academic studies, including one concerning futures exchanges and
another concerning demutualized stock exchanges, support the conclusion
that exchanges are able to both satisfy shareholder interests and meet
their self-regulatory organization responsibilities.\1406\ Finally, the
Commission itself conducts general market oversight through, among
other things, its own surveillance program to ensure well-functioning
markets.
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\1401\ Better Markets at 22-23; NEFI at 3.
\1402\ As discussed in detail in Section II.B.3.iii.b., the
verification involved: confirming that the methodology and data for
the underlying commodity reflected the commodity characteristics
described in the core referenced futures contract's terms and
conditions; replicating exchange EDS figures using the methodology
provided by the exchange; and working with the exchanges to revise
the methodologies as needed.
\1403\ See supra Section II.B.3.ii.a(1).
\1404\ 17 CFR 38.200; 17 CFR 38.250; 17 CFR 37.300; and 17 CFR
37.400.
\1405\ Kane, Stephen, Exploring price impact liquidity for
December 2016 NYMEX energy contracts, n.33, U.S. Commodity Futures
Trading Commission website, available at https://www.cftc.gov/sites/default/files/idc/groups/public/@economicanalysis/documents/file/oce_priceimpact.pdf.
\1406\ See David Reiffen and Michel A. Robe, Demutualization and
Customer Protection at Self-Regulatory Financial Exchanges, Journal
of Futures Markets, Vol. 31, 126-164 (in many circumstances, an
exchange that maximizes shareholder (rather than member) income has
a greater incentive to aggressively enforce regulations that protect
participants from dishonest agents); and Kobana Abukari and Isaac
Otchere, Has Stock Exchange Demutualization Improved Market Quality?
International Evidence, Review of Quantitative Finance and
Accounting, Dec 09, 2019, https://doi.org/10.1007/s11156-019-00863-y
(demutualized exchanges have realized significant reductions in
transaction costs in the post-demutualization period).
---------------------------------------------------------------------------
a. NYMEX Henry Hub Natural Gas (NYMEX NG) Cash-Settled Referenced
Contracts
Based on comments received \1407\ and based on the existing
exchange-set practices with respect to the NYMEX NG core referenced
futures contract and its associated cash-settled referenced contracts,
the Commission is permitting market participants to hold a position in
cash-settled NYMEX NG referenced contracts up to the Federal spot month
position limit level of 2,000 referenced contracts per exchange and
another position in cash-settled economically equivalent NYMEX NG OTC
swaps that has a notional amount of up to 2,000 equivalent-sized
contracts. This is: (i) A modification from the proposed Federal spot
month position limit level for NYMEX NG referenced contracts, in which
market participants would be able to hold only 2,000 cash-settled NYMEX
NG referenced contracts aggregated between all exchanges and the OTC
swaps market; but (ii) a continuation of the existing exchange-set spot
month position limit framework that has been in place for over a
decade. The Commission believes that this modification from the 2020
NPRM will, relative to the proposed approach, help minimize liquidity
costs for market participants trading in both cash and physically-
settled natural gas derivatives markets, in which the markets for cash-
settled NYMEX NG referenced contracts is significantly more liquid than
the market for the physically-settled NYMEX NG core referenced futures
contract during the spot month. This is, in part, because this
modification will continue to allow existing market participants ``to
optimize the proportion of physically-settled and cash-settled natural
gas contracts that they wish to hold.'' \1408\ Finally, although the
Commission acknowledges that market participants may hold an aggregate
position in the cash-settled NYMEX NG referenced contracts that is in
excess of 25% of EDS, the Commission does not believe that this will
lead to excessive speculation and volatility in the natural gas
markets, because of the highly liquid nature of the cash-settled
natural gas markets and the Commission's experience in overseeing the
exchange-set framework with respect to cash-settled natural gas
contracts.
---------------------------------------------------------------------------
\1407\ See MFA/AIMA at 11-12; Citadel at 7-8; and SIFMA AMG at
10-11.
\1408\ MFA/AIMA at 11-12.
---------------------------------------------------------------------------
b. ICE Cotton No. 2 (CT)
The Commission also modified the Federal spot month position limit
level for ICE Cotton No. 2 (CT) by adopting a level of 900 contracts,
instead of 1,800 contracts as proposed. The Commission is adopting the
level of 900 contracts based on its analysis of the alternatives
suggested by bona fide hedgers using the ICE Cotton No. 2 (CT) core
referenced futures contract.\1409\ The Commission received two defined
alternatives to the proposed level of 1,800 contracts--300 contracts
and 900 contracts. Specifically, based on those comments, the
Commission believes that it could further improve protections against
corners and squeezes without materially sacrificing liquidity for bona
fide hedgers by reducing the Federal spot month position limit level
from the proposed 1,800 contracts to 900 contracts. However, the
Commission believes that retaining the existing Federal spot month
limit level of 300 contracts may cause concerns about adequate
liquidity, especially because it would be the lowest Federal spot month
position limit level, by far, in terms of percent of EDS, among all
core referenced futures contracts, and the Commission has observed
illiquidity during the early part of the spot month.\1410\
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\1409\ AMCOT at 1-2; ACSA at 8; Ecom at 1; Southern Cotton at 2;
NCC at 1; Mallory Alexander at 2; Canale Cotton at 2; IMC at 2; Olam
at 3; DECA at 2; Moody Compress at 1; ACA at 2; Choice at 1; East
Cotton at 2; Jess Smith at 2; McMeekin at 2; Memtex at 2; NCC at 2;
Omnicotton at 2; Toyo at 2; Texas Cotton at 2; Walcot at 2; White
Gold at 1; LDC at 1; SW Ag at 2; NCTO at 2; Parkdale at 2; and
IFUS--Estimated Deliverable Supply--Cotton Methodology, August 2020,
IFUS Comment Letter (Aug. 14, 2020).
\1410\ At 300 contracts, the Federal spot month position limit
level for ICE Cotton No. 2 (CT) would be set at 4.32% of EDS. CBOT
KC HRS Wheat (KW) generally has the lowest Federal spot month
position limit level in terms of percentage of EDS at 6.82%, which
is 58% higher than 4.32%. However, following the close of trading on
the business day prior to the last two trading days of the contract
month, CME Live Cattle (LC) has the lowest Federal spot month
position limit level in terms of percentage of EDS at 5.29%, which
is 22% higher than 4.32%.
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iii. Levels Outside of the Spot Month
a. The 10/2.5% Formula
The Commission has determined that the existing 10/2.5% formula
generally has functioned well for the existing nine legacy agricultural
contracts, and has successfully benefited the markets by taking into
account the competing goals of facilitating both liquidity formation
and price discovery, while also protecting the markets from harmful
market manipulation and excessive speculation. However, since the
existing Federal non-spot month position limit levels are based on open
interest levels from 2009 (except for CBOT Oats (O), CBOT Soybeans (S),
and ICE Cotton No. 2 (CT), for which existing levels are based on the
respective open interest from 1999), the Commission is revising the
levels based on the periods from July 2017 to June 2018 and July 2018
to June 2019 to reflect the general increases in open interest \1411\
that have
[[Page 3407]]
occurred over time in the nine legacy agricultural contracts (other
than CBOT Oats (O), MGEX HRS Wheat (MWE), and CBOT KC HRW Wheat
(KW)).\1412\
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\1411\ The Commission notes that NGFA commented ``NGFA still is
not completely convinced that open interest is the best yardstick
for this exercise,'' because ``[a]s volume and open interest grow,
Federal non-spot limits expand correspondingly . . . which leads to
yet higher volume and open interest . . . which again prompts
expanded Federal non-spot limits . . . and so on.'' However, NGFA
did not provide any alternatives to utilizing open interest for
determining Federal non-spot month position limit levels. As
discussed previously in the Final Rule, the Commission believes that
open interest is an appropriate way of measuring market activity for
a particular contract and that a formula based on open interest,
such as the 10/2.5% formula: (1) Helps ensure that positions are not
so large relative to observed market activity that they risk
disrupting the market; (2) allows speculators to hold sufficient
contracts to provide a healthy level of liquidity for hedgers; and
(3) allows for increases in position limits and position sizes as
markets expand and become more active. Furthermore, the Commission
notes that under the Final Rule, Federal non-spot month position
limit levels do not automatically increase with higher open interest
levels. In order to make any amendments to the Federal position
limit levels, the Commission is required to engage in notice-and-
comment rulemaking.
\1412\ For most of the legacy agricultural commodities, this
results in a higher non-spot month limit. However, the Commission is
not changing the non-spot month limits for either CBOT Oats (O) or
MGEX HRS Wheat (MWE) based on the revised open interest since this
would result in a reduction of non-spot month limits from 2,000 to
700 contracts for CBOT Oats (O) and 12,000 to 5,700 contracts for
MGEX HRS Wheat (MWE). Similarly, the Commission also is maintaining
the current non-spot month limit for CBOT KC HRW Wheat (KW). See
supra Section II.B.4.--Federal Non-Spot Month Position Limit Levels
for further discussion.
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Since the increase for most of the Federal non-spot position limits
is predicated on the increase in open interest, as reflected in the
revised data reviewed by the Commission, the Commission believes that
the increases may enhance, or at least should maintain, general
liquidity, which the Commission believes may benefit those with bona
fide hedging positions, and commercial end users in general. On the
other hand, the Commission believes that many market participants,
especially commercial end users, generally accept that the existing
Federal non-spot month position limit levels for the nine legacy
agricultural commodities function well, including promoting liquidity
and facilitating bona fide hedging in the respective markets. As a
result, the Final Rule may in some cases result in higher Federal non-
spot month position limits, which could increase speculation without
achieving any concomitant benefits of increased liquidity for bona fide
hedgers compared to the status quo.
The Commission also recognizes that there could be potential costs
to keeping the existing 10/2.5% formula (even if revised to reflect
current open interest levels) compared to alternative formulae that
would result in even higher Federal position limit levels. First, while
the 10/2.5% formula may have reflected ``normal'' observed market
activity through 1999 when the Commission adopted it, there have been
changes in the markets themselves and the entities that participate in
those markets. When adopting the 10/2.5% formula in 1999, the
Commission's experience in these markets reflected aggregate futures
and options open interest well below 500,000 contracts, which no longer
reflects market reality.\1413\ As the nine legacy agricultural
contracts (with the exception of CBOT Oats (O)) all have open interest
well above 25,000 contracts, and in some cases above 500,000 contracts,
the existing formula may act as a negative constraint on liquidity
formation relative to the higher revised formula. Further, if open
interest continues to increase over time, the Commission anticipates
that the existing 10/2.5% formula could impose even greater marginal
costs on bona fide hedgers by potentially constraining liquidity
formation (i.e., as the open interest of a commodity contract
increases, a greater relative proportion of the commodity's open
interest is subject to the 2.5% limit level rather than the initial 10%
limit). In turn, this may increase costs to commercial firms, which may
be passed to the public in the form of higher prices.
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\1413\ See 64 FR at 24038, 24039 (May 5, 1999). As discussed in
the preamble, the data show that by the 2015-2018 period, five of
the nine legacy agricultural contracts had maximum open interest
greater than 500,000 contracts. The contracts for CBOT Corn (C),
CBOT Soybeans (S), and CBOT KC HRW Wheat (KW) saw increased maximum
open interest by a factor of four to five times the maximum open
interest during the years leading up to the Commission's adoption of
the 10/2.5% formula in 1999. Similarly, the contracts for CBOT
Soybean Meal (SM), CBOT Soybean Oil (SO), CBOT Wheat (W), and MGEX
HRS Wheat (MWE) saw increased maximum open interest by a factor of
three to four times. See supra Section II.B.4., Federal Non-Spot
Month Position Limit Levels, for further discussion.
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Further, to the extent there may be certain liquidity constraints,
the Commission has determined that this potential concern could be
mitigated, at least in part, by the Final Rule's change to increase the
marginal threshold level from 25,000 contracts to 50,000 contracts,
which the Commission believes should provide an appropriate increase in
the Federal non-spot month position limit levels for most contracts to
better reflect the general increase observed in open interest across
futures markets. The Commission acknowledges that, as an alternative,
the Commission could have adopted a marginal threshold level above
50,000 contracts, but notes that each increase of 25,000 contracts in
the marginal threshold level would only increase the permitted non-spot
month level by 1,875 contracts (i.e., (10% of 25,000 contracts)-(2.5%
of 25,000 contracts) = 1,875 contracts). The Commission has observed
based on current data that changing the marginal threshold to 50,000
contracts could benefit several market participants per legacy
agricultural commodity who otherwise would bump up against the non-spot
month position limit levels based on the status quo threshold of 25,000
contracts. As a result, the Commission has determined that changing the
marginal threshold level could result in marginal benefits and costs
for many of the legacy agricultural commodities, but the Commission
acknowledges the change is relatively minor compared to revising the
existing 10/2.5% formula based on updated open interest data.
Second, the Commission recognizes that an alternative formula that
allows for higher Federal non-spot month position limit levels,
compared to the existing 10/2.5% formula, could benefit liquidity and
market efficiency by creating a framework that is more conducive to the
larger liquidity providers that have entered the market over
time.\1414\ Compared to when the Commission first adopted the 10/2.5%
formula, today there are relatively more large non-commercial traders,
such as banks, managed money traders, and swap dealers, which generally
hold long positions and act as aggregators or market makers that
provide liquidity to short positions (e.g., commercial hedgers).\1415\
These dealers also function in the swaps market and use the futures
market to hedge their exposures. Accordingly, to the extent that larger
non-commercial market makers and liquidity providers have entered the
market--particularly to the extent they are able to take offsetting
positions to commercial short interests--a hypothetical alternative
formula that would permit higher Federal non-spot month position limit
levels might provide greater market liquidity, and possibly increased
market efficiency, by allowing for greater market-making
activities.\1416\
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\1414\ See supra Section II.B.4., Federal Non-Spot Month
Position Limit Levels, for further discussion.
\1415\ Id.
\1416\ For example, the Commission is aware of several market
makers that either have left particular commodity markets, or
reduced their market making activities. See, e.g., McFarlane, Sarah,
Major Oil Traders Don't See Banks Returning to the Commodity Markets
They Left, The Wall Street Journal (Mar. 28, 2017), available at
https://www.wsj.com/articles/major-oil-traders-dont-see-banks-returning-to-the-commodity-markets-they-left-1490715761?mg=prod/com-wsj (describing how ``Morgan Stanley sold its oil trading and
storage business . . . and J.P. Morgan unloaded its physical
commodities business . . . .''); Decambre, Mark, Goldman Said to
Plan Cuts to Commodity Trading Desk: WSJ (Feb. 5, 2019), available
at https://www.marketwatch.com/story/goldman-said-to-plan-cuts-to-commodity-trading-desk-wsj-2019-02-05 (describing how Goldman Sachs
``plans on making cuts within its commodity trading platform . . .
.'').
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[[Page 3408]]
However, the Commission believes that any purported benefits
related to a hypothetical alternative formula, or a suggested
alternative such as the one provided by ISDA,\1417\ that would allow
for higher Federal non-spot month position limits would be minimal at
best. Liquidity providers are still able to maintain, and possibly
increase, market making activities under the Final Rule since the
Federal non-spot month position limits are generally still increasing
under the existing 10/2.5% formula to reflect the increase in open
interest. Further, to the extent that the Final Rule's elimination of
the risk management exemption could theoretically force liquidity
providers to reduce their trading activities, the Commission believes
that certain liquidity-providing activity of the existing risk
management exemption holders may still be permitted under the Final
Rule, either as a result of the pass-through swap provision or because
of the general increase in limits based on the revised open interest
levels.\1418\ Furthermore, bona fide hedgers and end-users generally
have not requested a revised formula to allow for significantly higher
Federal non-spot month position limits. The Commission also recognizes
an additional benefit to market integrity of the Final Rule compared to
a hypothetical alternative formula: While the Commission believes that
the pass-through swap provision is narrowly-tailored to enable
liquidity providers to continue providing liquidity to bona fide
hedgers, in contrast, an alternative formula that would allow higher
limit levels for all market participants would potentially permit
increased excessive speculation and increase the probability of market
manipulation or harm the underlying price discovery function.\1419\
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\1417\ ISDA at 7.
\1418\ See supra Sections II.A.1.x. (discussing pass-through
swap provision), II.B.4.iii.a(1)(i) (discussing increases in open
interest); see also NCFC at 7 (stating that NCFC is ``confident that
the substantial increase in the overall speculative position limits
and allowances for pass-through swaps will limit any potential loss
of liquidity'' that might be associated with the elimination of the
risk management exemption).
\1419\ See Section II.B.4.iv.a(2)(iii).
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Additionally, some \1420\ have voiced general concern that
permitting increased Federal non-spot month limits in the nine legacy
agricultural contracts (at any level), especially in connection with
commodity indices, could disrupt price discovery and result in a lack
of convergence between futures and cash prices, resulting in increased
costs to end users, which ultimately could be borne by the public. The
Commission has not seen data demonstrating this causal connection, but
acknowledges arguments to that effect.\1421\
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\1420\ AMCOT at 1-2; Moody Compress at 1; ACA at 2; Jess Smith
at 2; McMeekin at 2; Memtex at 2; Mallory Alexander at 2; Walcot at
2; White Gold at 2; LDC at 2; Southern Cotton at 2-3; and Better
Markets at 44-48.
\1421\ IECA expressed similar concerns with respect to commodity
index funds. IECA at 4 (stating that a June 2009 bipartisan report
of the Senate Permanent Subcommittee for Investigation concluded
that the ``activities of commodity index traders, in the aggregate,
constituted `excessive speculation,' '' and that index funds have
caused an ``unwarranted burden on commerce.''). The Commission notes
that one of the concerns that prompted the 2008 moratorium on
granting risk management exemptions was a lack of convergence
between futures and cash prices in wheat. Some at the time
hypothesized that perhaps commodity index trading was a contributing
factor to the lack of convergence, and, some have argued that this
could harm price discovery since traders holding these positions may
not react to market fundamentals, thereby exacerbating any problems
with convergence. However, the Commission has determined for various
reasons that risk management exemptions did not lead to the lack of
convergence since the Commission understands that many commodity
index traders vacate contracts before the spot month and therefore
would not influence convergence between the spot and futures price
at expiration of the contract. Further, the risk-management
exemptions granted prior to 2008 remain in effect, yet the
Commission is unaware of any significant convergence problems
relating to commodity index traders at this time. Additionally,
there did not appear to be any convergence problems between the
period when Commission staff initially granted risk management
exemptions and 2007. Instead, the Commission believes that the
convergence issues that started to occur around 2007 were due to the
contract specification underpricing the option to store wheat for
the long futures holder making the expiring futures price more
valuable than spot wheat.
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Third, if the Final Rule's Federal non-spot position limits are too
high for a commodity, the Final Rule might be less effective in
deterring excessive speculation and market manipulation for that
commodity's market. Conversely, if the Commission's Federal position
limit levels are too low for a commodity, the Final Rule could unduly
constrain liquidity for bona fide hedgers or result in a diminished
price discovery function for that commodity's underlying market. In
either case, the Commission would view these as costs imposed on market
participants. However, to the extent the Commission's Federal non-spot
month position limit levels could be too high, the Commission believes
these costs could be mitigated because exchanges would potentially be
able to establish lower non-spot month position limit levels.\1422\
Moreover, these concerns may be mitigated further to the extent that
exchanges use other tools for protecting markets aside from position
limits, such as establishing position accountability levels below
Federal position limit levels or imposing liquidity and concentration
surcharges to initial margin if vertically integrated with a
derivatives clearing organization. Further, as discussed below, the
Commission is maintaining current Federal non-spot month position limit
levels for CBOT Oats (O), MGEX HRS Wheat (MWE), and CBOT KC HRW Wheat
(KW), which otherwise would be lower based on current open interest
levels for these contracts.
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\1422\ The Commission notes that several commenters, including
Better Markets, stated that exchanges may have financial incentives
to increase trading volume, which could incentivize exchanges to set
the highest possible exchange-set position limit levels. See, e.g.,
Better Markets at 22-24, 46-47. While the Commission acknowledges
that this is the case, the Commission also believes that such costs
are sufficiently mitigated through exchange statutory and regulatory
obligations, the Commission's oversight of the exchanges, and the
exchanges' own financial incentives to maintain well-functioning
markets. This is discussed more in depth in Sections II.B.2.iv.b and
III.B.3.iii.b(3)(iii).
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b. Setting a Lower Single Month Position Limit Level for ICE Cotton No.
2 (CT)
The Commission is adopting a single month position limit level of
5,950 contracts, which is 50% of the proposed level of 11,900
contracts, which, in turn, was based on the modified 10/2.5% formula.
This was in response to numerous comments from end-users suggesting
that the Commission set the single month position limit level lower
than the all-months-combined position limit level.\1423\
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\1423\ E.g., LDC at 2; Moody Compress at 1; ACA at 2; Jess Smith
at 2; McMeekin at 2; Memtex at 2; Mallory Alexander at 2; Walcot at
2; and White Gold at 1.
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The Commission notes that there could be a benefit to setting the
single month position limit level lower than the all-months-combined
position limit level, because it could help diminish excessive
speculation or prevent price distortions if traders hold unusually
large positions in contracts outside of the spot month and those
traders simultaneously exit those positions immediately before the spot
month.
However, the Commission acknowledges that there could be a cost to
adopting a single month limit that is half of the all-months-combined
position limit levels. Specifically, it
[[Page 3409]]
would restrict a speculative trader's ability to take opposite
positions to bona fide hedgers by, for example, entering into calendar
spread transactions that would normally provide liquidity to bona fide
hedgers. Thus, by adopting the lower single month limit, liquidity in
deferred month contracts would be reduced because the speculative
trader would not be able to hold positions in excess of the single
month limit. Nonetheless, the Commission believes that, based on the
unanimous comments from the end-users of the ICE Cotton No. 2 (CT)
contract requesting a lower single month position limit level, such
costs may not materially negatively impact liquidity for bona fide
hedgers.
c. Exceptions to the 10/2.5% Formula for CBOT Oats (O), MGEX Hard Red
Spring Wheat (MWE), and CBOT Kansas City Hard Red Winter Wheat (KW)
Based on the Commission's experience since 2011 with Federal non-
spot month position limit levels for the MGEX HRS Wheat (``MWE'') and
CBOT KC HRW Wheat (``KW'') core referenced futures contracts, the
Commission is maintaining the Federal non-spot month position limit
levels for MWE and KW at the existing level of 12,000 contracts, rather
than reducing them to the lower level that would result from applying
the proposed updated 10/2.5% formula. Maintaining the status quo for
the MWE and KW Federal non-spot month position limit levels results in
partial wheat parity between those two wheat contracts, but not with
CBOT Wheat (``W''), which increases to 19,300 contracts under the Final
Rule.
The Commission believes that this benefits the MWE and KW markets
since the two species of wheat are similar to one another; accordingly,
decreasing the Federal non-spot month position limit levels for MWE
could impose liquidity costs on the MWE market and harm bona fide
hedgers, which could further harm liquidity for bona fide hedgers in
the KW market. On the other hand, although commenters requested raising
the Federal non-spot month position limit level for KW to match the
level for W,\1424\ the Commission has determined not to raise the
Federal non-spot month position limit levels for KW and for MWE as well
to the Federal non-spot month position limit level for W. This is
because the limit level for W appears to be extraordinarily large in
comparison to open interest in KW and MWE markets, and the limit levels
for both the KW and the MWE contracts are already larger than the limit
levels would be based on the 10/2.5% formula. While W is a potential
substitute for KW and MWE, it is not similar to the same extent that
MWE and KW are to one another, and so the Commission has determined
that partial wheat parity outside of the spot month will maintain
liquidity and price discovery while not unnecessarily inviting
excessive speculation or potential market manipulation in the MWE and
KW markets.
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\1424\ SIFMA AMG at 3-4; ISDA at 12; PIMCO at 4-5; MFA/AIMA at
12; and Citadel at 6-7.
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Likewise, based on the Commission's experience since 2011 with the
Federal non-spot month speculative position limit for CBOT Oats (O),
the Commission is maintaining the limit level at the current 2,000
contracts level, rather than reducing it to the lower level that would
result from applying the updated 10/2.5% formula based on current open
interest. The Commission has determined that there is no evidence of
potential market manipulation or excessive speculation, and so there
would be no perceived benefit to reducing the Federal non-spot month
position limit for the CBOT Oats (O) contract, while reducing the level
could impose liquidity costs.
iv. Subsequent Spot and Non-Spot Month Position Limit Levels
The Commission received several comments concerning updates to the
Federal position limit levels, with commenters requesting that the
Commission periodically review the levels and revise them if
appropriate.\1425\ One commenter was concerned that the Federal
position limit levels could become too high over time,\1426\ while the
rest were concerned that the levels could become too low.\1427\ In
addition, CME Group also suggested that exchanges should update the EDS
figures ``every two years [and] . . . DCMs should be provided the
opportunity to submit data voluntarily to the Commission on a more
frequent basis.'' \1428\
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\1425\ MFA/AIMA at 5 (stating that ``the Commission should
direct exchanges to periodically monitor the proposed new position
limit levels''); PIMCO at 6 (urging the CFTC ``to include . . . a
mandatory requirement to regularly (and at least annually) review
and update limits as markets grow and change''); SIFMA AMG at 10
(suggesting the Final Rule should require ``that the Commission
regularly consult with exchanges and review and adjust position
limits when it is necessary to do so based on relevant market
factors''); ISDA at 10 (stating that ``the Commission must regularly
convene and consult with exchanges on deliverable supply and, if
appropriate, propose notice and comment rulemaking to adjust limit
levels''); and IATP at 16-17 (proposing that the Commission should
engage in ``an annual review of position limit levels to give
[commercial hedgers] legal certainty over that period'' and also
retain ``the authority to revise position limits . . . if data
monitoring and analysis show that those annual limit levels are
failing to prevent excessive speculation and/or various forms of
market manipulation'').
\1426\ IATP at 16-17.
\1427\ MFA/AIMA at 5-6; PIMCO at 6; SIFMA AMG at 10; and ISDA at
10.
\1428\ CME Group at 5.
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The Commission recognizes that there may be costs if Federal
position limit levels become too high or low over time. For example,
levels that become too high may permit excessive speculation; levels
that become too low may negatively impact liquidity. However, the
Commission believes that the Final Rule's position limits framework,
which utilizes Federal position limit levels as ceilings and allows
exchange-set position limits to operate under that ceiling, will
mitigate such potential costs. Specifically, because the Federal
position limits are utilized as ceilings, this framework will enable
exchanges to respond to market conditions through a greater range of
acceptable exchange-set position limit levels than if the Federal
position limit levels did not operate as ceilings. Furthermore, because
such exchange actions can be effectuated significantly faster than
modifying Federal position limits, the Final Rule's position limits
framework is able to quickly respond to rapidly evolving market
conditions through exchange-action as well.\1429\
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\1429\ Furthermore, the Commission notes that updating EDS
figures and Federal position limit levels is a resource-intensive
endeavor for both the Commission and the exchanges. Also, periodic,
predetermined review intervals may not always align with market
changes or other events resulting in material changes to deliverable
supply that would warrant adjusting Federal spot month position
limit levels. As a result, the Commission believes that it would be
more efficient, timely, and effective to review the EDS figure and
the Federal position limit level for a core referenced futures
contract if warranted by market conditions, including changes in the
underlying cash market, which the Commission and exchanges
continually monitor.
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v. Phase-In of Federal Position Limit Levels
The Commission received comments requesting that the Commission
``consider phasing in these adjustments for agricultural commodities to
assess the impacts of increasing limits on contract performance.''
\1430\ CMC also noted that, ``[a] phased approach could provide market
participants, exchanges, and the Commission a way to build in scheduled
pauses to evaluate the effects of increased limits, thereby fostering
confidence and trust in the markets.'' \1431\
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\1430\ AFIA at 2; CMC at 6.
\1431\ CMC at 6. Although commenters did not provide specific
details about what they meant by ``phase-in,'' the Commission
understands these comments to mean that they are requesting a
gradual, step-up increase in Federal spot month and non-spot month
position limit levels over time for agricultural core referenced
futures contracts, instead of having the new Federal position limit
levels apply all at once.
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[[Page 3410]]
The Commission acknowledges that there could be some benefit in
implementing a formal, gradual phase-in for the Federal position limit
levels, because this could allow the Commission to more incrementally
assess whether there are any issues with respect to the referenced
contract markets.\1432\ However, the Commission believes that the
position limits framework that is implemented in the Final Rule
effectively provides a similar, but more flexible result. Specifically,
market participants will still be subject to the exchange-set spot
month position limit levels even after the Final Rule's Federal spot
month position limit levels go into effect. The existing exchange-set
position limit levels are lower than the corresponding Federal levels
as adopted in this Final Rule for most core referenced futures
contracts \1433\ and, unless and until exchanges affirmatively modify
their exchange-set spot month position limit levels pursuant to part 40
of the Commission's regulations,\1434\ the operative spot month
position limit levels for market participants trading exchange-listed
referenced contracts will be the exchange-set ones. So, if an exchange
deems it appropriate to maintain its existing exchange-set position
limit levels and does not choose to adopt the new applicable Federal
speculative position limit level as the new exchange-set speculative
limit for any relevant referenced contract listed on its exchange, then
there will be no practical change from the status quo for market
participants from a position limits perspective. If the exchange
believes that it is appropriate to raise its exchange-set spot month
position limit levels either up to the Federal position limit levels or
lower levels as it deems appropriate, then the exchange may do so in a
way that is tailored for each referenced contract (including through a
phased-in approach) and that is informed by the exchange's knowledge of
each market.
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\1432\ As a preliminary matter, the Commission believes that the
referenced contract markets will be able to function in an orderly
fashion when the final Federal position limit levels go into effect.
This is because, among other things, the final Federal spot month
position limit levels are supported by the updated EDS figures and
are set at or below 25% of EDS, and the final Federal non-spot month
position limit levels are supported by increased open interest and
are generally set pursuant to the modified 10/2.5% formula. The
three core referenced futures contracts that do not strictly follow
the 10/2.5% formula in the non-spot month (i.e., CBOT KC HRW Wheat
(KW), MGEX HRS Wheat (MWE), and CBOT Oats (O)) do not require any
phase-in period, because they remain at existing Federal and
exchange-set non-spot month position limit levels.
\1433\ Nineteen of the core referenced futures contracts will
have Federal spot month position limit levels that are higher than
current exchange-set spot month position limit levels. COMEX Copper
(HG), CBOT Oats (O), NYMEX Platinum (PL), and NYMEX Palladium (PA)
will have Federal spot month position limit levels that are equal to
the current exchange-set spot month position limit levels. The last
two steps of the Federal spot month step-down position limit levels
for CME Live Cattle (LC) are equal to the corresponding last two
steps of exchange-set spot month step-down position limit levels.
Finally, although currently there is technically no exchange-set
spot month position limit for ICE Sugar No. 16, this contract is
subject to a single month position limit level of 1,000 contracts,
which effectively serves as its spot month position limit level. As
a result, the Federal spot month position limit level for ICE Sugar
No. 16 will effectively be higher than its current exchange-set spot
month position limit level.
\1434\ 17 CFR part 40.
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A further benefit to the Final Rule's position limits framework
over a federally-mandated phase-in is that exchanges have greater
flexibility (relative to the Commission) to quickly modify exchange-set
levels, including modifying any phase-in levels, to respond to sudden
and changing market conditions.
vi. Core Referenced Futures Contracts and Linked Referenced Contracts;
Netting
The definitions of the terms ``core referenced futures contract''
and ``referenced contract'' set the scope of contracts to which Federal
position limits apply. As discussed above, by applying the Federal
position limits to ``referenced contracts,'' the Final Rule expands the
Federal position limits beyond the 25 physically-settled ``core
referenced futures contracts'' listed in final Appendix E to part 150
by also including any cash-settled and physically-settled ``referenced
contracts'' linked thereto, as well as swaps that meet the
``economically equivalent swap'' definition in final Sec. 150.1 and
thus qualify as ``referenced contracts.'' \1435\
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\1435\ As discussed in the preamble, the position limits
framework also applies to physically-settled swaps that qualify as
economically equivalent swaps. However, the Commission believes that
physically-settled economically equivalent swaps would be few in
number.
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a. Referenced Contracts
The Commission has determined that including futures contracts and
options thereon that are ``directly'' or ``indirectly linked'' to the
core referenced futures contracts, including cash-settled contracts,
under the definition of ``referenced contract'' in final Sec. 150.1
helps prevent the evasion of Federal position limits--especially during
the spot month--through the creation of a financially equivalent
contract that references the price of a core referenced futures
contract, or of the commodity underlying a core referenced futures
contract. The Commission has determined that this benefits market
integrity and potentially reduces costs to market participants that
otherwise could result from market manipulation.
The Commission also recognizes that including cash-settled
contracts within the final Federal position limits framework may impose
additional compliance costs on market participants and exchanges.
Further, the Federal position limits--especially outside the spot
month--may not provide all of the benefits discussed above with respect
to market integrity and manipulation because there is no physical
delivery outside the spot month and therefore there is reduced concern
for corners and squeezes. However, to the extent that there is
manipulation or price distortion involving such non-spot, cash-settled
contracts, the Commission's authority to regulate and oversee futures
and related options on futures markets (other than through establishing
Federal position limits) may also be effective in uncovering or
preventing manipulation or distortion, especially in the non-spot cash
markets, and may result in relatively lower compliance costs incurred
by market participants. Similarly, the Commission acknowledges that
exchange oversight could provide similar benefits to market oversight
and prevention of market manipulation, but with lower costs imposed on
market participants--given the exchanges' deep familiarity with their
own markets and their ability to tailor a response to a particular
market disruption--compared to Federal position limits.
The ``referenced contract'' definition in final Sec. 150.1 also
includes ``economically equivalent swap,'' and, for the reasons
discussed below, includes a narrower set of swaps compared to the set
of futures contracts and options thereon that would be, under the
``referenced contract'' definition, captured as either ``directly'' or
``indirectly linked'' to a core referenced futures contract.\1436\
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\1436\ See infra Section IV.A.3.vi.e. (discussing economically
equivalent swaps).
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b. List of Referenced Contracts \1437\
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\1437\ Appendix C of the Final Rule provides staff guidance to
assist market participants and exchanges in determining whether a
particular contract qualifies as a referenced contract.
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The Commission's publication of the Staff Workbook is intended to
provide a non-exhaustive list of exchange-traded
[[Page 3411]]
referenced contracts that are subject to Federal position limits.
Although the Commission expects to timely update this list of
contracts, the omission of a contract from the Staff Workbook does not
mean that such contract is outside the definition of a referenced
contract subject to Federal position limits.
Additionally, the Staff Workbook will provide a linkage between
each referenced contract, and either the core referenced futures
contract or referenced contract, as applicable to which it is linked,
to aid in market participants' understanding of the Commission's
determination.
Although some commenters believed that the Commission should
require exchanges to publish and maintain a definitive list of
referenced contracts (other than economically equivalent swaps) \1438\
the Commission believes that the centralized publication of this
Workbook creates efficiency by providing market participants a known
access location, and minimizes costs by not requiring redundant
publication.
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\1438\ MFA/AIMA at 7; Citadel at 4-5; SIFMA AMG at 11-12.
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The Commission's concurrent publication of the Staff Workbook
provides a non-exhaustive list of exchange-traded referenced contracts,
and will help market participants in determining categories of
contracts that fit within the referenced contract definition. This
effort is intended to provide clarity to market participants regarding
which exchange-traded contracts are subject to Federal position limits.
c. Netting and Related Treatment of Cash-Settled Referenced Contracts
Under paragraph (1) of the final ``referenced contract''
definition, referenced contracts include a core referenced futures
contract, and any cash-settled futures contracts and options on futures
contacts that are directly or indirectly linked to a physically-settled
core referenced futures contract.
PIMCO and SIFMA AMG contended that cash-settled referenced
contracts should not be subject to Federal position limits at all
because cash-settled contracts do not introduce the same risk of market
manipulation. They argued that subjecting cash-settled referenced
contracts to Federal position limits would increase transaction costs
and reduce market liquidity and depth in these instruments.\1439\
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\1439\ PIMCO at 3; SIFMA AMG at 4-7. These entities did not
specifically argue that cash-settled contracts should be excluded
from the ``referenced contract'' definition; rather, they contended
that in general such instruments should not be subject to Federal
position limits. The Commission notes that this is technically a
different argument since cash-settled instruments could be exempt
from position limits but still qualify as ``referenced contracts.''
Nevertheless, the practical result is the same.
---------------------------------------------------------------------------
ISDA argued that cash-settled contracts should not be included in
an immediate Federal position limits rulemaking, and should instead be
deferred until the Commission has adopted Federal limits with respect
to physically-delivered spot month futures contracts, and after which
the Commission should revisit Federal limits for cash-settled
contracts.\1440\
---------------------------------------------------------------------------
\1440\ ISDA at 3-5.
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FIA and ICE argued that limits for cash-settled referenced
contracts should be higher relative to Federal position limits for
physically-settled referenced contracts. They similarly argued that
cash-settled referenced contracts are ``not subject to corners and
squeezes'' and will `` `ensure market liquidity for bona fide hedgers.'
'' \1441\
---------------------------------------------------------------------------
\1441\ ICE at 3, 15 (also arguing that cash-settled limits
should apply per exchange, rather than across exchanges); FIA at 7-
8.
---------------------------------------------------------------------------
In contrast, CME supported the Commission's approach for spot-month
parity for physically-settled and cash-settled referenced contracts
across all commodity markets. CME explained that absent such parity,
one side of the market could be vulnerable to artificial distortions
from manipulations on the other side of the market, regulatory
arbitrage, and liquidity drain to the other side of the market.\1442\
---------------------------------------------------------------------------
\1442\ CME Group at 6.
---------------------------------------------------------------------------
The Commission believes that its parity approach, including parity
with respect to the size of the Federal position limits for both cash-
settled and physically-settled contracts, benefits market integrity,
liquidity, and price discovery by not providing skewed incentives to a
market participant to favor one group of contracts over the other, or
providing avenues for manipulation that this rulemaking seeks to avoid.
The Commission is also generally adopting Federal position limits
on an aggregated, instead of on a per-DCM basis.\1443\ FIA and ICE
suggested that Federal position limits for cash-settled referenced
contracts should apply per DCM (rather than in the aggregate across
DCMs).\1444\ The Commission views DCM-based limits as restrictive and
costly for the most innovative DCMs, as DCM-based limits would
necessarily represent a smaller volume of contracts available than
would an aggregated limit. By making the full aggregated Federal
position limit available to the contract that is most responsive to the
needs of the market, the Commission believes that this provides a
market-wide benefit by promoting innovation and competition in the
marketplace.
---------------------------------------------------------------------------
\1443\ The Commission is permitting market participants to hold
a position in cash-settled NYMEX NG referenced contracts up to the
Federal spot month position limit on a per exchange basis. This is
discussed more in depth in Section IV.A.3.ii.a.
\1444\ FIA at 7-8; ICE at 13.
---------------------------------------------------------------------------
The Final Rule permits market participants to net positions outside
the spot month in linked physically-settled and cash-settled referenced
contracts, but during the spot month market participants may not net
their positions in cash-settled referenced contracts against their
positions in physically-settled referenced contracts. The Commission
believes that final Sec. 150.2(a) and (b) benefits liquidity formation
and bona fide hedgers outside the spot months since the netting rules
facilitate the management of risk on a portfolio basis for liquidity
providers and market makers. In turn, improved liquidity may benefit
bona fide hedgers and other end users by facilitating their hedging
strategies and reducing related transaction costs (e.g., improving
execution timing and reducing bid-ask spreads). On the other hand, the
Commission recognizes that allowing such netting could increase
transaction costs and harm market integrity by allowing for a greater
possibility of market manipulation since market participants and
speculators can maintain larger gross positions outside the spot month.
However, the Commission has determined that such potential costs may be
mitigated since concerns about corners and squeezes generally are less
acute outside the spot month given there is no physical delivery
involved, and because there are tools other than Federal position
limits for preventing and deterring other types of manipulation,
including banging the close, such as exchange-set limits and
accountability and surveillance both at the exchange and Federal level.
Moreover, prohibiting the netting of physical and cash positions
during the spot month should benefit bona fide hedgers as well as price
discovery of the underlying markets since market makers and speculators
are not able to maintain a relatively large position in the physical
markets by netting it against its positions in the cash markets.\1445\
While
[[Page 3412]]
this may increase compliance and transaction costs for speculators, it
may benefit some bona fide hedgers and end users. It may also impose
costs on exchanges, including increased surveillance and compliance
costs and lost fees related to the trading that such market makers or
speculators otherwise might engage in absent Federal position limits or
with the ability to net their physical and cash positions.
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\1445\ Otherwise, a market participant could maintain large,
offsetting positions in excess of limits in both the physically-
settled and cash-settled contract, which might harm market integrity
and price discovery and undermine the Federal position limits
framework. For example, absent such a restriction in the spot month,
a trader could stand for over 100% of deliverable supply during the
spot month by holding a large long position in the physical-delivery
contract along with an offsetting short position in a cash-settled
contract, which effectively would corner the market.
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d. Exclusions From the ``Referenced Contract'' Definition
Although the ``referenced contract'' definition in final Sec.
150.1 includes linked contracts, it explicitly excludes location basis
contracts,\1446\ commodity index contracts, swap guarantees, trade
options that satisfy Sec. 32.3 of the Commission's regulations,\1447\
outright price reporting agency index contracts, and monthly average
pricing contracts.
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\1446\ ICE further recommended that additional basis and spread
contracts be excluded from the referenced contract definition. ICE
at 10-11. The Commission has determined not to exclude these
additional contracts from the referenced contract definition, as,
among other reasons discussed further above, the Commission views
the constraints on the liquidity and volatility associated with
other excluded contracts as not present to an equal degree in basis
and spread contracts proposed to be excluded by ICE.
\1447\ 17 CFR 32.3.
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First, the ``referenced contract'' definition explicitly excludes
location basis contracts, which are contracts that reflect the
difference between two delivery locations or quality grades of the same
commodity.\1448\ The Commission believes that excluding location basis
contracts from the ``referenced contract'' definition benefits market
integrity by preventing a trader from obtaining an extraordinarily
large speculative position in the commodity underlying the referenced
contract. Absent this exclusion, a market participant could increase
its exposure in the commodity underlying the referenced contract by
using the location basis contract to net down against its position in a
referenced contract, and then further increase its position in the
referenced contract that would otherwise be restricted by position
limits. Similarly, the Commission believes that the exclusion of
location basis contracts reduces hedging costs for hedgers and
commercial end-users, as they are able to more efficiently hedge the
cost of commodities at their preferred location without the risk of
possibly hitting a position limits ceiling or incurring compliance
costs related to applying for a bona fide hedge recognition related to
such position.\1449\
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\1448\ The term ``location basis contract'' generally means a
derivative that is cash-settled based on the difference in price,
directly or indirectly, of (1) a core referenced futures contract;
and (2) the same commodity underlying a particular core referenced
futures contract at a different delivery location than that of the
core referenced futures contract. See Appendix C to final part 150.
For clarity, a core referenced futures contract may have
specifications that include multiple delivery points or different
grades (i.e., the delivery price may be determined to be at par, a
fixed discount to par, or a premium to par, depending on the grade
or quality). The above discussion regarding location basis contracts
is referring to delivery locations or quality grades other than
those contemplated by the applicable core referenced futures
contract.
\1449\ AGA agrees that the exclusion of location basis contracts
from the ``referenced contract'' definition creates certain netting
benefits and may allow commercial end-users to more efficiently
hedge the cost of commodities at a preferred location. AGA at 9. In
general, AGA supported all of the proposed exclusions from the
``referenced contract'' definition in the 2020 NPRM, as it believes
that market participants benefit from clear rules and definitions
that help prevent ``potential disagreement leading to increased
transaction costs, potential loss of liquidity, and compliance
strategies that generally make the markets less efficient.'' Id.
---------------------------------------------------------------------------
Excluding location basis contracts from the ``referenced contract''
definition also could impose costs for market participants that wish to
trade location basis contracts since, as noted, such contracts are not
subject to Federal position limits and thus could be more easily
subject to manipulation by a market participant that obtained an
excessively large position. However, the Commission believes such costs
are mitigated because location basis contracts generally demonstrate
less volatility and are less liquid than the core referenced futures
contracts, meaning the Commission believes that it would be an
inefficient method of manipulation (i.e., too costly to implement and
therefore, the Commission believes that the probability of manipulation
is low). Further, excluding location basis contracts from the
``referenced contract'' definition is consistent with existing market
practice since the market treats a contract on one grade or delivery
location of a commodity as different from another grade or delivery
location. Accordingly, to the extent that this exclusion is consistent
with current market practice, any benefits or costs already may have
been realized.
Second, the Commission has concluded that excluding commodity index
contracts from the ``referenced contract'' definition benefits market
integrity by preventing speculators from using a commodity index
contract to net down an outright position in a referenced contract that
is a component of the commodity index contract, which would allow the
speculator to take on large outright positions in the referenced
contracts and therefore result in increased speculation, undermining
the Federal position limits framework.\1450\ However, the Commission
believes that this exclusion could impose costs on market participants
that trade commodity index contracts since, as noted, such contracts
are not subject to Federal position limits and thus could be more
easily subject to manipulation by a market participant that obtained an
excessively large position. The Commission believes such costs would be
mitigated because the commodities comprising the index are themselves
subject to limits, and because commodity index contracts generally tend
to exhibit low volatility since they are diversified across many
different commodities. Further, the Commission believes that it is
possible that excluding commodity index contracts from the definition
of ``referenced contract'' could result in some trading shifting to
commodity index contracts, which may reduce liquidity in exchange-
listed core referenced futures contracts, harm pre-trade transparency
and the price discovery process in the futures markets, and depress
open interest (as volumes shift to index positions, which would not
count toward open interest calculations). However, the Commission
believes that the probability of this occurring is low because the
Commission believes that using commodity index contracts is an
[[Page 3413]]
inefficient means of obtaining exposure to a specific commodity.
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\1450\ Further, the Commission believes that prohibiting the
netting of a commodity index position with a referenced contract is
required by its interpretation of the Dodd-Frank Act's amendments to
the CEA's definition of ``bona fide hedging transaction or
position.'' The Commission interprets the amended CEA definition to
eliminate the Commission's ability to recognize risk management
positions as bona fide hedges or transactions. See infra Section
IV.A.4, Exemptions from Federal Position Limits--Bona Fide Hedging
Recognitions, Spread and Other Exemptions (Final Sec. Sec. 150.1
and 150.3), for further discussion. In this regard, the Commission
has observed that it is common for swap dealers to enter into
commodity index contracts with participants for which the contract
would not qualify as a bona fide hedging position (e.g., with a
pension fund). Failing to exclude commodity index contracts from the
``referenced contract'' definition could enable a swap dealer to use
positions in commodity index contracts as a risk management hedge by
netting down its offsetting outright futures positions in the
components of the index. Permitting this type of risk management
hedge would subvert the statutory pass-through swap language in CEA
section 4a(c)(2)(B), which the Commission interprets as prohibiting
the recognition of positions entered into for risk management
purposes as bona fide hedges unless the swap dealer is entering into
positions opposite a counterparty for which the swap position is a
bona fide hedge.
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Third, the Commission's determination to exclude trade options from
the referenced contract definition is consistent with the historical
practice of the Commission, in which it has exempted a number of trade
options from Commission requirements. This exclusion benefits end-users
who hedge their physical risk through these instruments, yet do not
contribute to excessive speculation.
Fourth, the Commission's exclusion of swap guarantees from the
referenced contract definition will help avoid any potential confusion
regarding the application of position limits to guarantees of swaps.
The Commission understands that swap guarantees generally serve as
insurance, and, in many cases, swap guarantors guarantee the
performance of an affiliate in order to entice a counterparty to enter
into a swap with such guarantor's affiliate. As a result, the
Commission believes that swap guarantees do not contribute to excessive
speculation, market manipulation, squeezes, or corners. Furthermore,
the Commission believes that swap guarantees were not contemplated when
Congress articulated its policy goals in CEA section 4a(a).\1451\
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\1451\ To the extent that swap guarantees may lower costs for
uncleared OTC swaps in particular by incentivizing a counterparty to
enter into a swap with the guarantor's affiliate, excluding swap
guarantees may benefit market liquidity, which is consistent with
the CEA's statutory goals in CEA section 4a(a)(3)(B) to ensure
sufficient liquidity for bona fide hedgers when establishing its
position limit framework.
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Fifth, the Final Rule reaffirms the Commission's determination that
an outright price reporting agency index contract does not qualify as a
``referenced contract.'' \1452\ To provide market participants clarity
regarding this determination, the Commission modified the regulatory
text of the ``referenced contract'' definition in final Sec. 150.1 to
explicitly exclude the term ``outright price reporting agency index
contracts.'' \1453\ The exclusion of outright price reporting agency
index contracts from the ``referenced contract'' definition benefits
market participants through clarity and mitigation of costs, such as
costs to monitor positions for aggregation and other compliance
purposes. The Commission believes that this exclusion maintains market
integrity as it would be costly to employ these contracts to circumvent
position limits.
---------------------------------------------------------------------------
\1452\ As explained in the preamble to the Final Rule, the
Commission has concluded that an ``outright price reporting agency
index contract,'' which is based on an index published by a price
reporting agency that surveys cash-market transaction prices (even
if the cash-market practice is to price at a differential to a
futures contract), is not directly or indirectly linked to the
corresponding referenced contract. See supra Section
II.A.16.iii.b(4)(v) (discussing new exclusions from the ``referenced
contract'' definition).
\1453\ The Commission does not believe this technical change to
the regulatory text represents a change in policy. See supra Section
II.A.16.
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Finally, the Commission has concluded that excluding ``monthly
average pricing contracts'' \1454\ from the ``referenced contract''
definition benefits market integrity by ensuring sufficient market
liquidity for bona fide hedgers due to: (1) The difficulty and expense
of any entity artificially moving the price of the monthly average by
manipulating one or more component prices within the contract; and (2)
the widespread use of these contracts by, and their utility to,
commercial entities in hedging their risk. As with the outright price
reporting agency index contracts, this exclusion benefits market
participants to the extent it mitigates costs to monitor positions for
aggregation and other compliance purposes.
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\1454\ The definition of the new term ``monthly average pricing
contracts'' in Appendix C of this Final Rule is intended to cover
the types of contracts generally referred to in the industry as
calendar-month average, trade-month average, and balance-of-the-
month contracts. See supra Section II.A.16.iii.b(4)(v) (discussing
new exclusions from the ``referenced contract'' definition).
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e. Economically Equivalent Swaps
The existing Federal position limits framework does not include
Federal position limit levels on swaps. The Dodd-Frank Act added CEA
section 4a(a)(5), which requires that when the Commission imposes
Federal position limits on futures contracts and options on futures
contracts pursuant to CEA section 4a(a)(2), the Commission also
establish limits simultaneously for ``economically equivalent'' swaps
``as appropriate.'' \1455\ As the statute does not define the term
``economically equivalent,'' the Commission is applying its expertise
in construing such term consistent with the policy goals articulated by
Congress, including in CEA sections 4a(a)(2)(C) and 4a(a)(3) as
discussed below.
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\1455\ CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5). In addition, CEA
section 4a(a)(4) separately authorizes, but does not require, the
Commission to impose Federal position limits on swaps that meet
certain statutory criteria qualifying them as ``significant price
discovery function'' swaps. 7 U.S.C. 6a(a)(4). The Commission
reiterates, for the avoidance of doubt, that the definitions of
``economically equivalent'' in CEA section 4a(a)(5) and
``significant price discovery function'' in CEA section 4a(a)(4) are
separate concepts and that contracts can be economically equivalent
without serving a significant price discovery function.
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Specifically, under the Commission's definition of ``economically
equivalent swap'' set forth in final Sec. 150.1, a swap generally
qualifies as economically equivalent with respect to a particular
referenced contract so long as the swap shares ``identical material''
contract specifications, terms, and conditions with the referenced
contract. Further, any differences between the swap and referenced
contract with respect to the following are disregarded for purposes of
determining whether the swap qualifies as economically equivalent: (i)
Lot size or notional amount; (ii) for a natural gas swap and a
referenced contract that are both physically-settled, delivery dates
diverging by less than two calendar days, and for any other swap and
referenced contract that are both physically-settled, delivery dates
diverging by less than one calendar day; \1456\ and (iii) post-trade
risk-management arrangements.\1457\
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\1456\ As discussed below, the definition of ``economically
equivalent swap'' with respect to natural gas referenced contracts
contains the same terms, except that it includes delivery dates
diverging by less than two calendar days.
\1457\ See supra Section II.A.4. (further discussing the
Commission's definition of ``economically equivalent swap'').
---------------------------------------------------------------------------
As discussed in turn below, the Commission believes that the Final
Rule's definition of ``economically equivalent swaps'' benefits (1)
market integrity by protecting against excessive speculation and
potential manipulation and (2) market liquidity by not favoring OTC or
foreign markets over domestic markets. Additionally, (3) the Commission
will discuss the costs and benefits related to the Final Rule's
economically equivalent swap definition's treatment of natural gas
swaps; and (4) the Commission will address the several proposed
alternative definitions included in commenter letters.
As discussed further below, with respect to exchange-set position
limits on swaps, the Commission proposed to delay compliance with DCM
Core Principle 5 and SEF Core Principle 6, as compliance would
otherwise be impracticable, and, in some cases, impossible, at this
time. In the 2020 NPRM, the Commission explained that this delay was
based largely on the fact that exchanges cannot view positions in OTC
swaps across the various places they are trading, including on
competitor exchanges. The Commission is maintaining this approach to
permit exchanges to delay compliance with respect to exchange-set
position limits on swaps, although the Commission emphasizes, for the
avoidance of doubt, that it will monitor and enforce swaps for
compliance with Federal position limits subject to the compliance dates
[[Page 3414]]
discussed above.\1458\ However, the Commission notes that in two years,
the Commission will reevaluate the ability of exchanges to establish
and implement appropriate surveillance mechanisms to implement DCM Core
Principle 5 and SEF Core Principle 6 with respect to swaps.
---------------------------------------------------------------------------
\1458\ For discussion of the relevant compliance dates for the
Final Rule, see supra Section I.D.
---------------------------------------------------------------------------
(1) Benefits and Costs Related to Market Integrity
The Commission believes that the final economically equivalent swap
definition benefits market integrity in two ways. First, the final
definition protects against excessive speculation and potential market
manipulation by limiting the ability of speculators to obtain excessive
positions through netting. As explained above, under the Final Rule,
market participants may net positions across linked referenced
contracts, including positions across linked referenced contracts in
economically equivalent swaps and futures.\1459\ Accordingly, a more
inclusive ``economically equivalent'' definition that would encompass
additional swaps (e.g., swaps that may differ in their ``material''
terms or physically-settled swaps with delivery dates that diverge by
one day or more) could make it easier for market participants to
inappropriately net down against their referenced futures contracts by
allowing market participants to structure swaps that do not necessarily
offer identical risk or economic exposure or sensitivity as the linked
futures contract, but which could still be netted under the Final
Rules. In such a hypothetical case, a market participant could enter
into an OTC swap with a maturity that differs by days or even weeks in
order to net down a position in a referenced contract, enabling the
market participant to hold an even greater position in the referenced
contract.
---------------------------------------------------------------------------
\1459\ See supra Section II.B.10. (discussing netting).
---------------------------------------------------------------------------
Similarly, applying Federal position limits to swaps that share
identical ``material'' terms with their corresponding referenced
contracts benefits market integrity by preventing market participants
from escaping the position limits framework merely by altering non-
material terms, such as holiday conventions. On the other hand, the
Commission recognizes that such a narrow ``economically equivalent
swap'' definition could impose costs on the marketplace by possibly
permitting excessive speculation since market participants would not be
subject to Federal position limits if they were to enter into swaps
that may have different material terms (e.g., penultimate swaps to the
extent a penultimate futures contract or options contract does not
exist to which a penultimate swap could possibly be deemed to be
``economically equivalent'' and therefore subject to the applicable
Federal position limits) \1460\ but may nonetheless be sufficiently
correlated to their corresponding referenced contract. In this case, it
is possible that there may be potential for excessive speculation,
market manipulation, or it is possible that market participants could
leave the futures markets for the swaps markets, which could introduce
new costs to commercial market participants due to reduced market
liquidity or disruptions to the price discovery function.\1461\
Nonetheless, to the extent that swaps currently are not subject to
Federal position limit levels, such potential costs would remain
unchanged compared to the status quo.
---------------------------------------------------------------------------
\1460\ Or, in the case of natural gas referenced contracts,
which would potentially include penultimate swaps as economically
equivalent swaps, a swap with a maturity of less than one day away
from the penultimate swap. See supra Sections II.A.4.iii.f. and
II.B.3.vi. (discussing natural gas swaps).
\1461\ The Commission acknowledges that liquidity could shift to
penultimate swaps, which would impose costs on price discovery and
market efficiency in the futures markets, in cases where there are
no corresponding penultimate futures contracts or options contracts
(and therefore the swap would not be deemed to be an economically
equivalent swap), but the Commission believes that this concern is
mitigated for two reasons. First, basis risk may exist between the
penultimate swap and the referenced contract, and so the Commission
believes that a market participant is less likely to hold a
penultimate swap the greater the economic difference compared to the
corresponding referenced contract. Second, the absence of
penultimate futures contracts or options contracts may indicate lack
of appropriate penultimate liquidity to hedge or offset one's
penultimate swap position and therefore may militate against
entering into penultimate swaps.
---------------------------------------------------------------------------
Second, the relatively narrow final definition benefits market
integrity, and reduces associated compliance and implementation costs,
by permitting exchanges, market participants, and the Commission to
focus resources on those swaps that pose the greatest threat for
facilitating corners and squeezes--that is, those swaps with
substantially identical delivery dates and identical material economic
terms to futures and options on futures subject to Federal position
limits. While swaps that have different material terms than their
corresponding referenced contracts, including different delivery dates,
may potentially be used for engaging in market manipulation, the final
definition benefits market integrity by allowing exchanges and the
Commission to focus on the most sensitive period of the spot month,
including with respect to the Commission's and exchanges' various
surveillance and enforcement functions. To the extent market
participants would be able to use swaps that fall outside the scope of
the final definition to effect market manipulation, such potential
costs would remain unchanged from the status quo since no swaps are
currently covered by existing Federal position limits. The Commission
however acknowledges that its narrow economically equivalent swap
definition may introduce possible burdens to market integrity--as the
form of an opportunity cost--since fewer swaps are covered under the
Federal position limits compared to the alternative in which the
Commission adopted a broader definition.
Further, the Final Rule's delayed compliance with respect to the
establishment and enforcement of exchange-set limits on swaps benefits
exchanges by facilitating exchanges' ability to establish surveillance
and compliance systems. As noted above, exchanges currently lack
sufficient data regarding individual market participants' open swap
positions since exchanges cannot view positions in OTC swaps across the
various places they are trading, including competitor exchanges, which
means that requiring exchanges to establish oversight over market
participants' positions currently could impose substantial costs and
also may be impractical to achieve.\1462\
---------------------------------------------------------------------------
\1462\ SIFMA AMG agrees with the Commission's assessment,
stating that ``[s]ince the exchanges do not have visibility into OTC
swaps markets, market participants and the CFTC would be responsible
for implementing position limits on swaps without the benefit of the
exchanges' extensive experience in monitoring and applying position
limits for exchange-listed contracts.'' SIFMA AMG at 10.
---------------------------------------------------------------------------
As a result, the Commission has determined that allowing exchanges
delayed compliance with respect to swaps reduces unnecessary costs.
Nonetheless, the Commission's determination to permit exchanges to
delay implementing Federal position limits on swaps could incentivize
market participants to leave the futures markets and instead transact
in economically-equivalent swaps, which could reduce liquidity in the
futures and related options markets. However, the Commission emphasizes
that the Commission will oversee and enforce compliance with Federal
position limits for economically equivalent swaps, which should
mitigate the concern related to incentivizing futures contracts and
related options on futures contracts to move trading and related
liquidity to
[[Page 3415]]
the OTC swaps markets. With respect to exchange-set position limits on
swaps, the Commission notes that in two years, the Commission will
reevaluate the ability of exchanges to establish and implement
appropriate surveillance mechanisms to implement position limits for
economically equivalent swaps at the exchange level.\1463\
---------------------------------------------------------------------------
\1463\ In response to the 2020 NPRM's proposal to permit
exchanges to delay oversight and enforcement of exchanges' position
limit rules on economically equivalent swaps, IATP stated that
``[d]elaying compliance with position limit requirement [sic] to
avoid imposing costs on market participants makes it appear that the
Commission is serving as a swap dealer booster, although swap
dealers are amply resourced to provide the necessary data to the
exchanges and to the Commission. The Commission is bending over
backward to avoid requiring swaps market participants from paying
the costs of exchange trading.'' However, the Commission emphasizes
that the Commission will still implement, oversee, and enforce
Federal position limits on swaps. As a result, the proposed delayed
enforcement of exchange-set position limits is designed to reduce
costs imposed on exchanges rather than swap dealers, which will be
subject to Federal position limits under the Final Rule.
---------------------------------------------------------------------------
Additionally, while futures contracts and options thereon are
subject to clearing and exchange oversight, economically equivalent
swaps may be transacted bilaterally off-exchange (i.e., OTC swaps). As
a result, it is relatively easy to create customized OTC swaps that may
be highly correlated to its corresponding futures (or options)
contract, which would allow the market participant to create an
exposure in the underlying commodity similar to the referenced
contract's exposure. Due to the relatively narrow ``economically
equivalent swap'' definition, the Commission believes that it may be
possible for market participants to attempt to avoid Federal position
limits by entering into such OTC swaps.\1464\ While such swaps may not
be perfectly correlated to their corresponding referenced contracts,
market participants may find this risk acceptable in order to avoid
Federal position limits. An increase in OTC swaps at the expense of
futures contracts and options on futures contracts may impose costs on
market integrity due to lack of exchange oversight. If liquidity were
to move from futures exchanges to the OTC swaps markets, non-dealer
commercial entities may face increased transaction costs and widening
spreads, as swap dealers gain market power in the OTC market relative
to centralized exchange trading. The Commission is unable to quantify
the costs of these potential harms. However, while the Commission
acknowledges these potential costs, such costs to those contracts that
already have limits (including Federal and/or exchange-set position
limits) on them already may have been realized in the marketplace
because swaps are not subject to Federal position limits under the
status quo.
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\1464\ In contrast, since futures contracts and options on
futures contracts are created by exchanges and submitted to the
Commission for either self-certification or approval under part 40
of the Commission's regulations, a market participant would not be
able to customize an exchange-traded futures contract or option on
futures contract.
---------------------------------------------------------------------------
Lastly, under the Final Rule, market participants are able to
determine whether a particular swap satisfies the definition of
``economically equivalent swap,'' as long as market participants make a
reasonable, good faith effort in reaching their determination and are
able to provide sufficient evidence, if requested, to support a
reasonable, good faith effort.\1465\ The Commission anticipates that
this flexibility will benefit market integrity by providing a greater
level of certainty to market participants, in contrast to the
alternative in which market participants would be required to first
submit swaps to the Commission staff and wait for feedback or approval.
On the other hand, the Commission also recognizes that not having the
Commission explicitly opine on whether a swap would qualify as
economically equivalent could cause market participants to avoid
entering into such swaps.\1466\ In turn, this could lead to less
efficient hedging strategies if the market participant is forced to
turn to the futures markets (e.g., a market participant may choose to
transact in the OTC swaps markets for various reasons, including
liquidity, margin requirements, or simply better familiarity with ISDA
and swap processes over exchange-traded futures). However, as noted
below, the Commission reserves the right to declare whether a swap or
class of swaps is or is not economically equivalent, and a market
participant could petition, or request informally, that the Commission
make such a determination, although the Commission acknowledges that
there could be costs associated with this, including delayed timing and
monetary costs.
---------------------------------------------------------------------------
\1465\ See supra Section II.A.4.g (discussing market
participants' discretion in determining whether a swap is
economically equivalent). Regarding the obligations of swap dealers
to monitor position limits, ISDA commented that the requirements
imposed by Sec. 23.601 are burdensome and requested additional
guidance regarding same. ISDA at 10. The Commission believes it is
unnecessary to provide further detail with respect to Sec. 23.601
because, as discussed above and in the preamble, the Commission will
defer to a market participant's determination as long as the market
participant is able to provide sufficient support to show that it
made a reasonable, good faith effort in applying its discretion.
Furthermore, the Commission is not adopting any amendments to Sec.
23.601, so the baseline status quo in connection with Sec. 23.601
is unchanged under the Final Rule. See supra Section II.A.4.g.
\1466\ For example, NRECA believes that a standardized reference
source to confirm whether a particular swap is subject to Federal
position limits would benefit market participants: ``Because the
Commission has determined not to codify its interpretations and
other guidance, or to establish a single reference source for
assistance in confirming `swap/not-a-swap' distinction, the two
counterparties to a bilateral off-facility energy transaction must
make the `swap/not-a-swap' determination without the benefit of
standardized rules or product definitions. Although the terms of
many off-facility, bilateral energy commodity transactions are
highly-customized, other such transactions may be many iterations
closer to futures contract `look-alikes,' that is, to referenced
contracts. If such a transaction is (or may be) a `swap,' such a
swap would then also need to be evaluated to determine whether it
was `economically equivalent' under the Speculative Position Limits
Rules.'' NRECA at 18; see also CEWG at 30-31.
---------------------------------------------------------------------------
Further, the Commission recognizes that requiring market
participants to conduct reasonable due diligence and maintain related
records also could impose new compliance costs. Additionally, the
Commission recognizes that certain market participants could assert
that an OTC swap is (or is not) ``economically equivalent'' depending
upon whether such determination benefits the market participant. In
such a case, market participants could theoretically subvert the intent
of the Federal position limits framework, although the Commission
believes that such potential costs would be mitigated due to the
Commission's surveillance functions and authority to declare that a
particular swap or class of swaps either does or does not qualify as
economically equivalent.
(2) The Final Definition Could Increase Benefits or Costs Related to
Market Liquidity and Price Discovery
First, the final economically equivalent swap definition could
benefit market liquidity by being, in general, less disruptive to the
swaps markets, which in turn may reduce the potential for disruption
for the price discovery function compared to a possible alternative,
broader definition. For example, if the Commission were to adopt an
alternative to its final ``economically equivalent swap'' definition
that encompassed a broader range of swaps by including, for example,
delivery dates that diverge by one or more calendar days--perhaps by
several days or weeks--a market participant (including speculators)
with a large portfolio of swaps could more easily bump up against the
applicable position limits and therefore would have an incentive either
to reduce its
[[Page 3416]]
swaps activity or move its swaps activity to foreign jurisdictions. If
there were many similarly situated market participants, the market for
such swaps could become less liquid, which in turn could harm liquidity
for bona fide hedgers as large liquidity providers could move to other
markets.
Second, the final definition could benefit market liquidity by
being sufficiently narrow to reduce incentives for liquidity providers
to move to foreign jurisdictions, such as the European Union
(``EU'').\1467\ Additionally, the Commission believes that proposing a
definition similar to that used by the EU will benefit international
comity.\1468\ Further, market participants trading in both U.S. and EU
markets would find the final definition to be familiar, which may help
reduce compliance costs for those market participants that already have
systems and personnel in place to identify and monitor such swaps. As
discussed by SIFMA AMG, ``[m]any market participants are active in
markets and products that are regulated by the CFTC and EU authorities.
Having different definitions would be costly for firms, since they
would have to build out different compliance functions, and inefficient
for markets.'' \1469\ As noted above, any differences between the Final
Rule's ``economically equivalent swap'' and the EU's corresponding
definition by the addition of the ``material'' qualifier should lead to
the benefits identified in the above discussion, along with the
corresponding costs.
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\1467\ In this regard, the final definition is similar in
certain ways to the EU definition for OTC contracts that are
``economically equivalent'' to commodity derivatives traded on an EU
trading venue. The applicable European regulations define an OTC
derivative to be ``economically equivalent'' when it has ``identical
contractual specifications, terms and conditions, excluding
different lot size specifications, delivery dates diverging by less
than one calendar day and different post trade risk management
arrangements.'' While the Commission's final definition is similar,
the Commission's final definition requires ``identical material''
terms rather than simply ``identical'' terms. Further, the
Commission's final definition excludes different ``lot size
specifications or notional amounts'' rather than referencing only
``lot size'' since swaps terminology usually refers to ``notional
amounts'' rather than to ``lot sizes.'' See EU Commission Delegated
Regulation (EU) 2017/591, 2017 O.J. (L 87).
\1468\ Both the Commission's definition and the applicable EU
regulation are intended to prevent harmful netting. See European
Securities and Markets Authority, Draft Regulatory Technical
Standards on Methodology for Calculation and the Application of
Position Limits for Commodity Derivatives Traded on Trading Venues
and Economically Equivalent OTC Contracts, ESMA/2016/668 at 10 (May
2, 2016), available at https://www.esma.europa.eu/sites/default/files/library/2016-668_opinion_on_draft_rts_21.pdf (``[D]rafting the
[economically equivalent OTC swap] definition in too wide a fashion
carries an even higher risk of enabling circumvention of position
limits by creating an ability to net off positions taken in on-venue
contracts against only roughly similar OTC positions.'')
The applicable EU regulator, the European Securities and Markets
Authority (``ESMA''), recently released a ``consultation paper''
discussing the status of the existing EU position limits regime and
specific comments received from market participants. According to
ESMA, no commenter, with one exception, supported changing the
definition of an economically equivalent swap (referred to as an
``economically equivalent OTC contract'' or ``EEOTC''). ESMA further
noted that for some respondents, ``the mere fact that very few EEOTC
contracts have been identified is no evidence that the regime is
overly restrictive.'' See European Securities and Markets Authority,
Consultation Paper MiFID Review Report on Position Limits and
Position Management Draft Technical Advice on Weekly Position
Reports, ESMA70-156-1484 at 46, Question 15 (Nov. 5, 2019),
available at https://www.esma.europa.eu/document/consultation-
paper-position-limits.
\1469\ SIFMA AMG at 6-7.
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(3) The Final Definition Could Create Costs or Benefits Related to
Market Liquidity for the Natural Gas Market
SIFMA AMG commented that ``financially-settled penultimate day
expiry products in natural gas should be excluded from limits to the
same extent as penultimate day expiry contracts for each of the other
24 core referenced futures contracts. To introduce a change from
existing exchange practice (under which these financially-settled
penultimate day contracts are out of scope) could introduce an
otherwise avoidable disruption to trading during the closing days of
the natural gas contract month, with no corresponding benefits to
market oversight or integrity.'' \1470\
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\1470\ SIFMA AMG at 11. For the purpose of this comment, even
though SIFMA AMG refers generally to ``financially-settled
penultimate'' contracts in natural gas, the Commission assumes it is
referring to penultimate cash-settled economically equivalent swaps
since penultimate futures contracts and options on futures contracts
are included under the ``referenced contract'' definition.
---------------------------------------------------------------------------
As discussed in greater detail in the preamble, the Commission
recognizes that the market dynamics in natural gas are unique in
several respects, including the fact that unlike with respect to other
core referenced futures contracts, for natural gas, relatively liquid
spot-month and penultimate cash-settled futures exist.\1471\ However,
in contrast to SIFMA AMG's comment, the Commission has determined that
creating an exception to the proposed ``economically equivalent swap''
definition for natural gas benefits market liquidity by not
unnecessarily favoring existing natural gas penultimate contracts over
spot contracts. The Commission is especially sensitive to potential
market manipulation in the natural gas markets since market
participants--to a significantly greater extent compared to the other
core referenced futures contracts that are included in the Final Rule--
regularly trade in both the physically-settled core referenced futures
contract and the cash-settled look-alike referenced contracts that are
penultimate contracts. Accordingly, the Commission has concluded that a
slightly broader definition of ``economically equivalent swap'' to
encompass penultimate natural gas swaps uniquely benefits the natural
gas markets by helping to deter and prevent manipulation of a
physically-settled contract to benefit a related cash-settled contract,
including penultimate positions.
---------------------------------------------------------------------------
\1471\ See supra Section II.A.4.iii.f. (discussing economically
equivalent natural gas swaps).
---------------------------------------------------------------------------
(4) Alternatives to the ``Economically Equivalent Swap'' Definition
Several commenters provided alternative approaches to the 2020
NPRM's proposed ``economically equivalent swap'' definition.
First, SIFMA AMG argued that the Commission should not impose
Federal position limits on swaps at all, and that the proposed Federal
position limits were ``unnecessary and would in fact impose cost
burdens . . . that are not commensurate with any of the suggested
benefits . . . .'' \1472\ Similarly, CHS stated that ``[t]here is
little doubt, from CHS's perspective, that including economically
equivalent swaps as `referenced contracts' for position limit purposes
will result in a material burden for (a) commercial end-users and (b)
small to mid-sized FCMs that focus on the needs of grain and energy
hedgers, which are referred to as `Commodity-Focused FCMs'. The costs
of compliance on such participants will likely be large and time-
consuming, and possibly entail some risk of operational error arising
out of the implementation process.'' \1473\
---------------------------------------------------------------------------
\1472\ SIFMA AMG at 6-7. Additional commenters similarly argued
that subjecting swaps to position limits is unnecessary and would
increase costs without commensurate benefits. E.g., CHS at 5; NCFC
at 5; and ISDA at 5.
\1473\ CHS at 4. See also NCFC at 5 (similarly stating that
``[t]he costs of compliance on such participants will likely be
large and time-consuming, and possibly entail some risk of
operational error arising out of the implementation process.''). CHS
further stated, ``[w]ith respect to commercial end-users, absent
additional Commission guidance CHS believes that the burdens will
take the form of (a) determining which types of swaps will be deemed
to be economically equivalent swaps, (b) making significant and
costly modifications to systems to identify and track transactions
for reporting purposes, (c) developing tools for swaps aggregation
purposes (or manually conducting such tasks if such a tool is not
readily available to be interpolated into existing systems) and (d)
determining intra-day positions when addressing economically
equivalent swaps, which will require real-time system reporting and
real-time exception alerts, among other things . . . . In these
respects, CHS asks the Commission to be mindful and more fully
address the costs and benefits applicable to commercial end-users
and Commodity-Focused FCMs, and to provide more clarity regarding
the scope of referenced contracts. As a guide, CHS urges the
Commission to maintain as narrow a definition of `referenced
contract' as possible. CHS also urges the Commission, both in the
context of market participants generally and commercial end-users
and Commodity-Focused FCMs particularly, to address CHS's
recommendations in the following section.'' Id. at 4-5. NCFC
similarly stated that ``NCFC believes any Federal speculative
position limits rule should not unduly burden commercial end-users
who utilize derivatives markets for economically appropriate risk
management activities.'' NCFC at 7.
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[[Page 3417]]
However, as discussed above, the Dodd-Frank Act added CEA section
4a(a)(5), which explicitly requires that the Commission impose Federal
position limits on swaps that are ``economically equivalent'' to the
futures contracts and options on futures contracts subject to Federal
position limits, and that the Commission establish limits
simultaneously for ``economically equivalent'' swaps. Accordingly, from
the perspective of this cost-benefit discussion, the question is not
whether the Final Rule should encompass swaps at all, but only the
extent to which swaps should be incorporated as ``economically
equivalent'' pursuant to CEA section 4a(a)(5). Nonetheless, the
Commission recognizes that subjecting economically equivalent swaps to
Federal position limits could impose the compliance costs referenced
above by CHS and others. However, to the extent that the Final Rule
adopts a narrow ``economically equivalent swap'' definition, the
Commission anticipates these costs should be mitigated compared to
alternative definitions, while simultaneously satisfying the statutory
requirement under CEA section 4a(a)(5).
Second, CME and Better Markets both suggested that the general
``referenced contract'' definition that applies to futures contracts
and options on futures contracts should also apply to swaps, rather
than the narrower ``economically equivalent swap'' definition.
Similarly, NEFI argued that the narrower ``economically equivalent
swap'' definition could allow for easy avoidance of Federal position
limits.\1474\ The Commission discusses the possible costs and benefits
of the Final Rule's narrow definition versus this proposed alternative
of a broader definition throughout this cost-benefit discussion of
economically equivalent swaps, and the reasons discussed by the
Commission throughout this section similarly apply in response to
CME's, Better Markets', and NEFI's proposed alternative to establish a
broader ``economically equivalent swap'' definition.
---------------------------------------------------------------------------
\1474\ NEFI at 3.
---------------------------------------------------------------------------
Third, SIFMA AMG argued that while it opposed including swaps
within the Final Rule, to the extent the Commission determines to
include swaps within the Final Rule, that, in the alternative, at least
cash-settled swaps should be excluded from the economically equivalent
swap definition since these types of swaps ``have not historically been
the source of manipulative corners, squeezes, or other disruptions
related to physical commodity prices, and SIFMA AMG does not believe
limits on these products would be necessary to further deter and
prevent this type of trading activity.'' \1475\
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\1475\ SIFMA AMG at 7. SIFMA AMG further argued that ``imposing
spot month limits only on physically-settled futures contracts would
avoid such confusion, and more importantly, would adequately address
the products of greatest concern and would serve to reduce
compliance costs and related burdens (i.e., technology builds,
personnel allocation, training, etc.) for the Commission and market
participants by allowing the Commission to observe the impact of
limits for physically-settled futures prior to evaluating whether to
extend limits to a broader scope of derivatives products.'' SIFMA
AMG at 5-6.
PIMCO and ISDA similarly argue that neither cash-settled swaps
nor futures contracts should be subject to position limits. PIMCO at
3; ISDA at 5 (arguing that position limits on cash-settled
referenced contracts, whether futures contracts or swaps, ``impose a
level of cost and complexity in implementation that does not
correspond to any identified regulatory or policy benefit of such
limits.'') AQR similarly argued that the ``opportunity or ability to
use a swap to squeeze or corner an underlying physical commodity is
extremely remote and thus extension of position limits to swaps
would likely not be merited based on an analysis of the costs and
benefits of such action.'' AQR at 10.
---------------------------------------------------------------------------
However, the Commission believes that SIFMA AMG's proposed
alternative to exclude all cash-settled swaps ex ante would impose
liquidity costs for bona fide hedgers since excluding all cash-settled
swaps could incentivize liquidity to move from corresponding cash-
settled referenced contracts to cash-settled OTC swaps, potentially
harming the liquidity in the futures markets, including liquidity for
bona fide hedgers. This could also harm price discovery if significant
liquidity and trading migrates from the exchange-traded futures markets
to the more opaque OTC swaps markets. For example, as noted above, if
liquidity were to move from futures exchanges to the OTC swaps markets,
non-dealer commercial entities may face increased transaction costs and
widening spreads, as swap dealers gain market power in the OTC market
relative to centralized exchange trading. The Commission is unable to
quantify the costs of these potential harms.\1476\
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\1476\ However, while the Commission acknowledges these
potential costs, such costs to the nine legacy agricultural
contracts may already have been realized because their corresponding
swaps are not subject to Federal position limits under the status
quo. Nonetheless, the Commission also recognizes that certain of the
16 non-legacy core referenced futures contracts that would be
subject to Federal position limits for the first time under the
Final Rule may have larger, more liquid swaps markets than the nine
legacy agricultural contracts, and therefore potentially larger
concomitant benefits and/or costs.
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Furthermore, the Commission notes that CEA section 4a(a)(3) does
not merely refer to corners and squeezes, but also refers to
``manipulation'' generally. Accordingly, the Commission believes that
the Final Rule will better benefit market integrity to the extent that
cash-settled swaps would be subject to the Final Rule by helping to
prevent other forms of manipulation, such as ``banging'' or ``marking''
the close.
Fourth, in contrast to the alternative posited by SIFMA AMG
immediately above in which the Commission would exclude all cash-
settled swaps, Better Markets believed that the Final Rule's exclusion
of certain cash-settled swaps could actually impose costs on liquidity
formation. Better Markets thus proposed an alternative where settlement
type (i.e., cash-settled versus physically-settled) was not considered
to be a ``material'' difference and therefore cash-settled swaps could
be deemed to be ``economically equivalent'' to core referenced futures
contracts, which are all physically-settled. Better Markets argued that
the 2020 NPRM's economically equivalent definition ``essentially
excludes'' cash-settled swaps from Federal position limits because
cash-settled swaps would not be able to qualify as economically
equivalent to a physically-settled core referenced futures
contract.\1477\ As Better Markets commented, distinguishing between
cash-settled and physically-settled swaps and futures contracts by
deeming settlement type (i.e., cash-settled vs. physically-settled
settlement) to be a material term would ``incentivize[ ] speculative
liquidity formation away from more liquid, more transparent, and more
restrictive futures exchanges and to the swaps markets.'' \1478\
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\1477\ Better Markets at 32.
\1478\ Id.
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However, the Commission does not believe that the treatment of
cash-settled swaps under the Final Rule imposes such costs, at least to
the extent assumed by Better Markets. The
[[Page 3418]]
Commission believes Better Markets' concern is mitigated since under
the Final Rule cash-settled swaps are subject to Federal position
limits only if there is a corresponding (i.e., ``economically
equivalent'') cash-settled futures contract or option on a futures
contract.\1479\ That is, cash-settled swaps are free from Federal
position limits if there are no corresponding cash-settled futures
contracts or options on futures contracts. In these situations, if no
corresponding futures contract or option thereon exists, then there is
no liquidity formation in cash-settled futures contracts and options on
futures contracts with which a cash-settled swap would be competing for
liquidity in the first place.\1480\
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\1479\ The Commission notes that a swap could be deemed to be
``economically equivalent'' to any referenced contract, including
cash-settled look-alikes, and that the ``economically equivalent
swap'' definition is not limited to core referenced futures
contracts.
\1480\ In contrast to Better Markets, AQR noted that any
``extension of position limits to swaps risks negatively impacting
commercial hedgers by reducing market liquidity, increasing
transaction costs, and increasing commodity market volatility. While
the Commission cannot entirely avoid those risks if compelled to
impose such limits, the proposed approach to economically equivalent
swaps may mitigate them in ways that allow the Commission to fully
discharge its statutory obligation without unnecessarily restricting
market activity.'' AQR at 11.
---------------------------------------------------------------------------
Fifth, FIA proposed an alternative in which cash-settled
economically equivalent swaps would be subject to a separate (higher)
Federal spot-month position limit levels compared to their
corresponding referenced contracts, and FIA argued that its proposed
alternative would benefit innovation and competition between
exchanges.\1481\ However, the Commission believes that establishing
separate (or higher) position limits for economically equivalent swaps
could impose liquidity costs and burden market integrity and price
discovery.
---------------------------------------------------------------------------
\1481\ FIA at 7-8. The Commission generally addresses FIA's
argument about innovation and competition in the preamble above
under Section II.B.10.v.
---------------------------------------------------------------------------
In particular, separate position limits for cash-settled swaps
would make it easier for potential manipulators to engage in market
manipulation, such as ``banging'' or ``marking'' the close, by
effectively permitting higher Federal position limits in cash-settled
referenced contracts. For example, a market participant would be able
to double its cash-settled positions by maintaining positions in both
cash-settled futures and cash-settled economically equivalent swaps
since under FIA's proposed alternative positions in each contract type,
that is futures contracts (including options thereon) and swaps, would
be subject to their own separate position limits for purposes of
Federal position limits.
Furthermore, imposing position limits separately on economically
equivalent swaps and futures contracts (and options thereon) as
requested under FIA's proposed alternative would mean that market
participants would not be able to net their economically equivalent
swaps with their futures positions. In contrast, the absence of
separate Federal position limits for economically equivalent swaps
means that market participants are able to net economically equivalent
swaps with other referenced contracts, i.e., futures contracts against
swaps. The Commission also recognizes that netting could permit larger
speculative positions in futures markets for market participants who
did not previously have bona fide hedge exemptions, but who have
positions in swaps in the same commodity that could be netted against
futures contracts in the same commodity. This observation might seem to
be at cross-purposes with the relatively narrow ``economically
equivalent swap'' definition. However, the Commission is concerned that
separate position limits for swaps could impair liquidity in futures
contracts or swaps, as the case may be. For example, a market
participant (including a market maker or speculator) with a large
portfolio of swaps (or futures contracts) near the applicable position
limit would be assumed to have a strong preference for executing
futures contracts (or swaps) transactions in order to maintain a swaps
(or futures contracts) position below the applicable position limit. If
there were many similarly situated market participants, the market for
such swaps (or futures contracts) could become less liquid, which could
burden market efficiency and impose higher trading costs for bona fide
hedgers. The absence of separate position limits for swaps should
decrease the possibility of illiquid markets for referenced contracts
subject to Federal position limits. Because economically equivalent
swaps and the corresponding futures contracts and options on futures
contracts are close substitutes for each other, the absence of separate
position limits should allow greater integration between the
economically equivalent swaps and corresponding futures and options
markets for referenced contracts, which should benefit price discovery,
and should also provide market participants with more flexibility
whether hedging, providing liquidity or market making, or speculating,
which should benefit market efficiency and price discovery.
Sixth, COPE alternatively requested that the Commission explicitly
exclude physically-settled swaps, or at least provide specific examples
of the contracts intended to be included.\1482\ While the Commission
provides greater clarity in the corresponding preamble discussion
above,\1483\ the Commission has determined that excluding all
physically-settled swaps ex ante is inconsistent with the statutory
goals in CEA section 4a(a)(3)(B), especially the requirements to deter
corners and squeezes and to ensure sufficient market liquidity for bona
fide hedgers enumerated in CEA section 4a(a)(3)(B)(ii) and (iii),
respectively. For example, excluding physically-settled swaps could
potentially incentivize liquidity to move from physically-settled core
referenced futures contracts to physically-settled swaps, which could
impose costs both on market liquidity for bona fide hedgers and also on
market integrity by enabling potential manipulators to accumulate large
directional positions in physically-settled contracts to effect a
corner and squeeze more easily. This could additionally harm price
discovery as liquidity and trading would move from the more transparent
exchange-traded futures contracts and options thereon to the more
opaque OTC swaps markets.
---------------------------------------------------------------------------
\1482\ COPE at 4-5.
\1483\ See Section II.A.4.iii.d(1).
---------------------------------------------------------------------------
Seventh, NCFC stated that it ``appreciate[s] that CFTC proposed a
narrow definition of an economically equivalent swap under a Federal
position limits regime. Likewise, we do not object to an inclusion of
such swaps in theory since our members use them for legitimate hedging
purposes. However, NCFC continues to be concerned with the operational
difficulties, burdens, and costs for commercial end users and small- to
mid-sized FCMs that focus on the needs of agricultural hedgers of
including swaps for position limit purposes. The costs of compliance on
such participants will likely be large and time-consuming, and possibly
entail some risk of operational error arising out of the implementation
process.'' \1484\ As a result, NCFC suggested, as an alternative to the
2020 NPRM's approach, that the Final Rule exclude from a commercial
end-user's Federal position limits those agricultural commodity swaps
that are transacted by invoking the ``End-User Exemption to Mandatory
Clearing'' rule.\1485\
[[Page 3419]]
According to NCFC, those swap contracts already must meet the test ``to
hedge or mitigate commercial risk,'' and are ``not used for a purpose
that is in the nature of speculation, investing, or trading,'' as
outlined in Sec. 50.50 of the Commission's regulations, and therefore,
by definition, these contracts should not be subject to end-user
Federal speculative position limits.\1486\
---------------------------------------------------------------------------
\1484\ NCFC at 5.
\1485\ Id.
\1486\ Id.
---------------------------------------------------------------------------
The Commission understands NCFC's concern, but believes NCFC's
alternative is unnecessary for two reasons. First, to the extent a swap
described by NCFC would ``hedge or mitigate commercial risk,'' the
Commission believes that the costs described by NCFC are mitigated
since such swap likely would qualify for an enumerated bona fide hedge
under the Final Rule and therefore would not contribute to a commercial
end-user's net position for Federal position limits purposes.\1487\
Second, the Commission believes the purported benefits related to
NCFC's alternative are limited since physical commodity swaps are not
required to be cleared under the Commission's existing regulations, so
determining whether the end-user clearing exemption applies is not
necessarily a helpful proxy in determining whether a swap is
``economically equivalent'' or not for purposes of CEA section
4a(a)(5).
---------------------------------------------------------------------------
\1487\ To the extent an FCM would not be able to qualify for a
bona fide hedge, the Commission believes that excepting such swaps
for purely financial firms would functionally have the same effect
as maintaining the risk-management exemption, which Congress,
through the Dodd-Frank Act's amendments to the CEA, has directed the
Commission to eliminate. See Section II.A.4.iii. Nonetheless, to the
extent that NCFC's comment is limited to small- and medium-sized
FCMs, the Commission does not believe that such FCMs generally will
violate the Federal position limit levels based on the Commission's
understanding of existing market dynamics and positions held by
market participants under the status quo, and therefore costs should
be comparatively mitigated for small- and medium-sized FCMs.
---------------------------------------------------------------------------
vii. Pre-Existing Positions
Final Sec. 150.2(g) imposes Federal position limits on ``pre-
existing positions'' \1488\--other than pre-enactment swaps and
transition period swaps--during both the spot month and non-spot month.
---------------------------------------------------------------------------
\1488\ Final Sec. 150.1 defines ``pre-existing position'' to
mean ``any position in a commodity derivative contract acquired in
good faith prior to the effective date'' of any applicable position
limit.
---------------------------------------------------------------------------
The Commission believes that final Sec. 150.2(g) benefits market
integrity since pre-existing positions (other than pre-enactment and
transition period swaps) that exceed spot-month limits could result in
market or price disruptions as positions are rolled into the spot
month.\1489\ The Commission recognizes some costs and benefits
associated with final Sec. 150.2(g)(2) may have already been realized
given that the nine legacy agricultural contracts are already subject
to the Federal non-spot month position limits. Therefore, exchanges and
market participants should not incur any significant new costs to
comply with Sec. 150.2(g)(2), and will likely continue to benefit from
market integrity as a result of the Final Rule.
---------------------------------------------------------------------------
\1489\ The Commission is particularly concerned about protecting
the spot month in physical-delivery futures from corners and
squeezes.
---------------------------------------------------------------------------
In response to the 2020 NPRM, FIA and MGEX suggested that the
Commission alternatively restructure the provision to include just two
categories, ``pre-existing swaps'' and ``pre-existing futures,''
because the variability of exemptive relief could create operational
challenges for market participants.'' \1490\ Although the Commission
did not adopt the terms ``pre-existing swaps'' and ``pre-existing
futures'' for the Final Rule as FIA and MGEX suggested, the practical
effect is that final Sec. 150.2(g) creates two categories--(1) pre-
existing futures contracts (including options thereon), which are
subject to both the spot month and non-spot month Federal position
limits; and (2) pre-existing swaps, which are not subject to such
limits. Furthermore, to offset the operational challenges or other
burdens associated with final Sec. 150.2(g), the Commission is
delaying the compliance date to January 1, 2022 in connection with the
Federal position limits for the 16 non-legacy core referenced futures
contracts, and further delaying the compliance date to January 1, 2023
for swaps that are subject to Federal position limits under the Final
Rule.
---------------------------------------------------------------------------
\1490\ FIA at 8-9; MGEX at 4.
---------------------------------------------------------------------------
viii. Anti-Evasion
Final Sec. 150.2(i) provides that, if used to willfully circumvent
or evade speculative position limits: (1) A commodity index contract,
monthly average pricing contract, outright price reporting contract,
and/or a location basis contract will be considered to be a referenced
contract; (2) a bona fide hedging transaction or position recognition
or spread exemption will no longer apply; and (3) a swap will
considered to be an economically equivalent swap even if it does not
meet the economically equivalent swap definition set forth in Sec.
150.1. This provision serves to deter and prevent a number of potential
methods of evading Federal position limits, the specifics of which the
Commission may not be able to anticipate. Like the Federal position
limits it supports, Sec. 150.2(i) helps to protect market integrity by
preventing excessive speculation and market manipulation. However, the
Commission also recognizes possible costs to market participants due to
uncertainty under the Final Rule's anti-evasion provision since it may
be difficult for market participants to determine, as a bright-line
matter, whether their positions and trading strategies represent
legitimate avoidance of position limits or instead represent malfeasant
evasive practices.\1491\ As a result, the lack of a bright-line
standard could potentially impose liquidity costs as market
participants may instead choose to engage in less efficient trading
strategies in order to err cautiously to avoid engaging in potentially
``evasive'' behavior.
---------------------------------------------------------------------------
\1491\ SIFMA AMG at 7, n.16 (noting that the anti-evasion
provision makes the application of the proposed ``economically
equivalent swap'' definition less clear because it incorporates a
subjective measure of intent); see also FIA at 25 (questioning how a
participant would distinguish a strategy that minimizes position
size with an evasive strategy); Better Markets at 33 (describing the
anti-evasion provision as a ``useful deterrent,'' but noting that
the willful circumvention standard would be difficult to meet and
partially turns on the Commission's consideration of the legitimate
business purpose analysis).
---------------------------------------------------------------------------
As an alternative to the ``willfully'' standard, FIA recommended
that the anti-evasion analysis be based on the presence of ``deceit,
deception, or other unlawful or illegitimate activity.'' \1492\ Because
a position that does not involve fraud or deceit can still involve
other indicia of evasive activity, the proposed alternative would be
less effective in protecting market integrity to the extent it failed
to capture evasive activity. Further, the incorporation of a standard
other than ``willful'' would create confusion to market participants by
resulting in divergent standards among Commission rulemakings
concerning evasion.
---------------------------------------------------------------------------
\1492\ FIA at 25-26.
---------------------------------------------------------------------------
4. Exemptions From Federal Position Limits--Bona Fide Hedging
Recognitions, Spread and Other Exemptions (Final Sec. Sec. 150.1 and
150.3)
i. Background
The Final Rule provides for several exemptions that, subject to
certain conditions, permit a trader to exceed the applicable Federal
position limit set forth in final Sec. 150.2. Specifically, Sec.
150.3 generally maintains but modifies, as discussed below, the two
existing Federal exemptions that include (1) bona fide hedging
positions and (2) spread positions. Final Sec. 150.3 also includes new
Federal exemptions
[[Page 3420]]
for certain conditional spot month positions in natural gas, financial
distress positions, and pre-enactment and transition period swaps.
Final Sec. 150.1 sets forth the definitions for which positions may
qualify as a ``bona fide hedging transaction or position'' and for
``spread transaction.'' \1493\
---------------------------------------------------------------------------
\1493\ The Commission currently defines this term in existing
Sec. 1.3 in the plural as ``bona fide hedging transactions or
positions'' while the Final Rule defines it in the singular ``bona
fide hedging transaction or position.'' See supra Section I.E.
(discussing use of certain terminology). This discussion sometimes
refers to the ``bona fide hedging transaction or position''
definition as ``bona fide hedges,'' ``bona fide hedging,'' or ``bona
fide hedge positions.'' For the purpose of this discussion, the
terms have the same meaning.
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ii. Bona Fide Hedging Definition; Enumerated Bona Fide Hedges; and
Guidance on Spot Month Hedge Exemption Restrictions and Measuring Risk
The Commission is adopting several amendments to the bona fide
hedge definition. First, the Commission is revising some of the general
elements of the ``bona fide hedging transaction or position''
definition in final Sec. 150.1 to conform the Commission's regulatory
definition to the statutory bona fide hedge definition in CEA section
4a(c), as amended by Congress in the Dodd-Frank Act. As discussed in
greater detail in the preamble, the Final Rule (1) revises the
temporary substitute test, consistent with the Commission's
understanding of the Dodd-Frank Act's amendments to section 4a of the
CEA, to no longer recognize as bona fide hedges certain risk management
positions; (2) revises the economically appropriate test to make
explicit that the position must be economically appropriate to the
reduction of ``price risk''; and (3) eliminates the incidental test and
orderly trading requirement, which the Dodd-Frank Act did not include
in section 4a of the CEA. The Commission believes that these amendments
to the existing general elements of the regulatory definition include
non-discretionary changes that are required by Congress's amendments to
section 4a of the CEA, or in the case of the incorporation of ``price
risk,'' do not represent a change from the status quo baseline. The
Commission is also amending the bona fide hedge definition to conform
to the CEA's statutory definition, by adding a provision for positions
that qualify as pass-through swaps and pass-through swap offsets.\1494\
---------------------------------------------------------------------------
\1494\ As discussed in Section II.A.--Sec. 150.1--Definitions
of the preamble, the existing definition of ``bona fide hedging
transactions and positions'' appears in existing Sec. 1.3 of the
Commission's regulations; the revised definition of this term, in
singular form, now appears in Sec. 150.1.
---------------------------------------------------------------------------
Second, the Commission is maintaining the distinction between
enumerated and non-enumerated bona fide hedges but is (1) moving the
location of the enumerated bona fide hedges, which will remain part of
the regulatory text, from the existing definition of ``bona fide
hedging transactions and positions'' currently found in Commission
regulation Sec. 1.3 to final Appendix A in part 150; \1495\ and (2)
expanding the list of enumerated hedges, which will continue to be
self-effectuating for Federal position limit purposes, thereby not
requiring prior Commission approval.
---------------------------------------------------------------------------
\1495\ For the avoidance of doubt, Appendix A will still be
incorporated as part of the Commission's regulations under the Final
Rule. In contrast, the 2020 NPRM had proposed to make Appendix A
Acceptable Practices.
---------------------------------------------------------------------------
Third, the Commission is proposing guidance in Appendix B with
respect to (i) whether an entity may measure risk on a net or gross
basis for purposes of determining its bona fide hedge positions, and
(ii) factors exchanges could consider when applying a restriction on an
exemption against holding a position under a bona fide hedge or spread
transaction exemption in excess of limits during the lesser of the last
five days of trading or the time period for the spot month in a
physically-delivered contract, or otherwise limit the size of such
position.
The Commission expects that these modifications related to bona
fide hedging will primarily benefit physical commodity commercial
market participants, as well as their counterparties. CEA section
4a(c)(1) directs the Commission to exclude bona fide hedge positions
from any Federal position limits framework. Further, the Commission
believes that, generally, recognizing bona fide hedges supports all
section 15(a) factors under this cost-benefit discussion. For example,
recognizing bona fide hedges encourages participation in the futures
markets by commercial market participants.\1496\ Increasing
participation from different types of market participants, including
commercial market participants: (i) protects the legitimate commercial
activity of cash-market participants,\1497\ (ii) increases
competitiveness, and (iii) supports the financial integrity of futures
markets. Further, increased participation and competitiveness will
benefit price discovery. Finally, an expanded list of enumerated bona
fide hedges supports sound risk management practices by commercial
market participants and their counterparties, which may result in
indirect benefits to commodity end users or the public.\1498\
---------------------------------------------------------------------------
\1496\ NFPEA at 6 (stating that ``Congress intended the
Commission to protect end-users' continued access to cost-effective
commercial risk management tools, and did not intend to burden end-
users with unnecessary regulatory compliance obligations'').
\1497\ AGA expressed its support of an expanded list of
enumerated hedges by stating that, ``consistent with the mandate of
the CEA, any speculative position limits regime adopted by the CFTC
must be established in a way that allows commercial end-users, such
as natural gas utilities, to continue to enter into bona fide hedges
to manage, hedge and mitigate the commercial risks of their natural
gas distribution business in a non-burdensome and cost-effective
manner on behalf of customers.'' AGA at 2.
\1498\ In expressing overall support for the proposed definition
of bona fide hedging transaction or position in the 2020 NPRM, CME
Group noted that the Commission's recognition of a wider range of
commercial hedging practices generally reflects Congress's intent
not to unduly burden bona fide hedgers. CME Group at 9.
---------------------------------------------------------------------------
Recognizing an expanded list of enumerated bona fide hedges, which
are self-effectuating and do not require prior approval from the
Commission, will mitigate related compliance costs for those contract
markets that will be newly subject to Federal position limits under the
Final Rule. This is in comparison to an alternative scenario in which a
narrow set of available enumerated hedges would have required market
participants to obtain prior approval before availing themselves of an
exemption for Federal position limit purposes.
The Commission notes that this section will discuss the substantive
exemptions for Federal position limit purposes while the next section
will discuss the process for the Commission or exchanges, as
applicable, to grant exemptions and bona fide hedge recognitions.
a. Bona Fide Hedging Definition
(1) Elimination of Risk Management Exemptions; Addition of the Pass-
Through Swap
Exemption
The Commission is eliminating the word ``normally'' from the bona
fide hedge definition's temporary substitute test and, as a result,
prohibiting recognition, as bona fide hedges, of risk management
positions in physical commodity derivatives subject to Federal
speculative position limits. This amendment conforms the regulatory
bona fide hedging definition with the Commission's interpretation that
the removal of the word ``normally'' from the CEA's section 4a(c)(2)
statutory temporary substitute test by the Dodd-Frank Act signaled
Congressional intent
[[Page 3421]]
to cease recognizing ``risk management'' positions as bona fide hedges
for physical commodities.
Additionally, in accordance with CEA section 4a(c)(2)(B), the
Commission is, however, expanding the bona fide hedging definition to
also include as a bona fide hedge any position that qualifies as a
pass-through swap/swap offset, discussed further below.\1499\ The
Commission believes that including pass-through swaps and pass-through
swap offsets within the definition of a bona fide hedge will mitigate
some of the potential impact resulting from the rescission of the risk
management exemption,\1500\ and the Commission discusses the costs and
benefits related to the pass-through swap provision further below.
---------------------------------------------------------------------------
\1499\ See infra Section IV.A.4.ii.a(2). The existing bona fide
hedging definition in Sec. 1.3 requires that a position must
``normally'' represent a substitute for transactions or positions
made at a later time in a physical marketing channel (i.e., the
``temporary substitute test''). The Dodd-Frank Act amended the
temporary substitute language that previously appeared in the
statute by removing the word ``normally'' from the phrase normally
``represents a substitute for transactions made or to be made or
positions taken or to be taken at a later time in a physical
marketing channel.'' 7 U.S.C. 6a(c)(2)(A)(i). The Commission
interprets this change as reflecting Congressional direction that a
bona fide hedging position in physical commodities must always (and
not just ``normally'') be in connection with the production, sale,
or use of a physical cash-market commodity.
Previously, the Commission stated that, among other things, the
inclusion of the word ``normally'' in connection with the pre-Dodd-
Frank-Act version of the temporary substitute language indicated
that the bona fide hedging definition should not be construed to
apply only to firms using futures to reduce their exposures to risks
in the cash market, and that to qualify as a bona fide hedge, a
transaction in the futures market did not need to be a temporary
substitute for a later transaction in the cash market. See
Clarification of Certain Aspects of the Hedging Definition, 52 FR at
27195, 27196 (Jul. 20, 1987). In other words, that 1987
interpretation took the view that a futures position could still
qualify as a bona fide hedging position even if it was not in
connection with the production, sale, or use of a physical
commodity. Accordingly, based on the Commission's interpretation of
the revised statutory definition of bona fide hedging in CEA section
4a(c)(2), risk-management hedges would not be recognized under the
Commission's bona fide hedging definition in Sec. 150.1.
\1500\ See, e.g., ICE at 5-6 (contending that eliminating risk
management exemptions could make it less efficient and more
expensive for commercial end-users to hedge risks and that pass-
through exemption is an inadequate substitution); ISDA at 6-7
(arguing that the elimination of the risk management exemptions will
result in increased costs for ``tailored over-the-counter financial
products, . . . will cause some dealers to exit the business and
will in any event lead to decreases in liquidity in the underlying
futures markets, with a corresponding increase in volatility.'');
see also supra Section II.A.1.iii.a(4) (discussing elimination of
the risk management exemptions).
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As discussed below, the Final Rule's pass-through provisions should
help address certain of the hedging needs of persons seeking to offset
the risk from swap books, allowing for sufficient liquidity in the
marketplace for both bona fide hedgers and their counterparties.
Accordingly, under the Final Rule, market participants with positions
that do not otherwise satisfy the bona fide hedging definition or
qualify for another exemption are no longer able to rely on recognition
of such risk-reducing techniques as bona fide hedges. Market
participants who provide liquidity to commercial market participants
and have obtained or requested a risk management exemption under the
existing definition, and who do not qualify for a pass-through swap
offset, may resort to other hedging strategies. These other hedging
strategies may result in increased costs for these liquidity providers
for those activities that are not eligible for the bona fide hedge
treatment.
The Commission recognizes the possible liquidity costs as a result
of eliminating risk management exemptions. Specifically, the Commission
considered the risk that dealers who approach or exceed the Federal
position limit may decide to pull back on providing liquidity,
including to bona fide hedgers, due to the exclusion of risk management
positions from the bona fide hedge definition. However, the Commission
considered the risk of possible reduced liquidity against various
factors and believes that the potential cost of reduced liquidity will
be mitigated for several reasons.
First, the Final Rule extends the compliance date by which risk
management exemption holders must reduce their positions to comply with
Federal position limits under the Final Rule to January 1, 2023. This
delay provides sufficient time for existing positions to roll off and/
or be replaced with positions that conform with the Federal position
limits adopted in this Final Rule.
Second, for the nine legacy agricultural contracts, the Final Rule
generally sets Federal non-spot month position limit levels higher than
existing non-spot limits, which may enable additional dealer activity
described above.\1501\ The remaining non-legacy 16 core referenced
futures contracts will not be subject to non-spot month Federal
position limits and will remain subject to existing exchange-set limits
or accountability levels outside of the spot month, which does not
represent a change from the status quo. The generally higher levels
with respect to the nine legacy agricultural contracts, and the
exchanges' flexible accountability regimes with respect to the new 16
core referenced futures contracts, should mitigate at least some
potential costs related to the prohibition on recognizing risk
management positions as bona fide hedges.
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\1501\ See infra Section II.B.4. (discussing non-spot month
limit levels). Final Sec. 150.2 generally increases position limits
for non-spot months for contracts that currently are subject to the
Federal position limits framework other than for CBOT Oats (O), CBOT
KC HRW Wheat (KW), and MGEX HRS Wheat (MWE), for which the
Commission is maintaining existing levels.
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Third, the Final Rule may improve market competitiveness and reduce
transaction costs. As noted above, existing holders of the risk
management exemption, and the levels permitted thereunder, are
currently confidential, and the Commission is no longer granting new
risk management exemptions to potential new liquidity providers.
Accordingly, by eliminating the risk management exemption, the Final
Rule benefits the public and strengthens market integrity by improving
market transparency since certain dealers are no longer able to
maintain the grandfathered risk management exemption while other
dealers lack this ability under the status quo. While the Commission
believes that the risk management exemption may allow dealers to
provide additional market making activities, which benefits market
liquidity and may result in lower prices for end-users, as noted above,
the potential costs resulting from removing the risk management
exemption may be mitigated by the Final Rule's revised position limit
levels that reflect current EDS for spot month levels and current open
interest and trading volume for non-spot month levels. Therefore, the
Commission believes that existing risk management exemption holders
should be able to continue providing liquidity to bona fide hedgers,
but acknowledges that some may not to the same degree as under the
exemption. However, the Commission believes that any potential harm to
liquidity should be mitigated.
Further, the spot month and non-spot month levels, which generally
are higher than the status quo, together with the elimination of the
risk management exemptions that benefit only certain dealers, may
enable new liquidity providers to enter the markets on a level playing
field with the existing risk management exemption holders. With the
possibility of additional liquidity providers, the framework may
strengthen market integrity by decreasing concentration risk
potentially posed by too few market makers. However, the benefits to
market liquidity the Commission described above may be muted since this
analysis is predicated, in part, on the
[[Page 3422]]
understanding that dealers are the predominant large traders. Data in
the Commission's Supplementary COT and its underlying data indicate
that risk-management exemption holders are not the only large
participants in these markets--large commercial firms also hold large
positions in such commodities.
Fourth, although the Commission will no longer recognize risk
management positions as bona fide hedges under this Final Rule, the
Commission maintains other authorities, including the authority under
CEA section 4a(a)(7), to exempt risk management positions from Federal
position limits.
Fifth, consistent with existing industry practice, exchanges may
continue to recognize risk management positions for contracts that are
not subject to Federal position limits, including for excluded
commodities.
Finally, as discussed immediately below, the Commission believes
the recognition of pass-through swaps and pass-through swap offsets
could mitigate, to some extent, the costs to the market in general, or
to specific market participants, resulting from the risk management
exemption's elimination.\1502\
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\1502\ NCFC concurs that ``the substantial increase in the
overall speculative position limits and allowances for pass-through
swaps will limit any potential loss of liquidity'' that may result
from the elimination of the risk management exemption. NCFC at 7.
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(2) Pass-Through Swaps and Pass-Through Swap Offsets
The revised bona fide hedging definition, consistent with the Dodd-
Frank Act's changes to CEA section 4a(c)(2), permits the recognition as
bona fide hedges of futures and options on futures positions that
offset pass-through swaps entered into by dealers and other liquidity
providers (the ``pass-through swap counterparty'') \1503\ opposite bona
fide hedging swap counterparties (the ``bona fide hedge
counterparty''), as long as: (1) The pass-through swap counterparty
receives from the bona fide hedging swap counterparty a written
representation that the pass-through swap qualifies as a bona fide
hedge; and (2) the pass-through swap counterparty enters into a futures
or option on a futures position or a swap position to offset and reduce
the price risk attendant to the pass-through swap.\1504\ Accordingly, a
subset of risk management exemption holders and transactions they enter
into could continue to benefit from an exemption, and potential
counterparties could benefit from the liquidity they provide, as long
as the position being offset qualifies as a bona fide hedge for the
bona fide hedge counterparty.
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\1503\ Such pass-through swap counterparties are typically swap
dealers providing liquidity to bona fide hedgers.
\1504\ See paragraph (2)(i) of the proposed bona fide hedging
definition. Of course, if the pass-through swap qualifies as an
``economically equivalent swap,'' then the pass-through swap
counterparty does not need to rely on the pass-through swap
provision since it may be able to offset its long (or short)
position in the economically equivalent swap with the corresponding
short (or long) position in the futures or option on futures
position or on the opposite side of another economically equivalent
swap.
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The Commission has determined that any resulting costs or benefits
related to the proposed pass-through swap exemption are a result of
Congress's amendments to CEA section 4a(c) rather than the Commission's
discretionary action. On the other hand, the Commission's discretionary
action to require the pass-through swap counterparty to receive and
maintain a written representation from the bona fide hedging swap
counterparty that the pass-through swap qualifies as a bona fide
hedging position causes the swap counterparty to incur marginal
recordkeeping costs.\1505\ The Commission considered comments
requesting the elimination of the pass-through swap provision
recordkeeping requirement in Sec. 150.3(d) based on arguments that
requiring this recordkeeping was not practical.\1506\ The Commission is
not persuaded by those arguments as the recordkeeping requirements
assist the Commission in verifying that the pass-through swap provision
is only being utilized to offset risks arising from bona fide hedges.
Accordingly, the Commission is finalizing the proposed pass-through
swap recordkeeping requirement in Sec. 150.3(d), subject to certain
conforming changes to reflect amendments to the pass-through swap
paragraph of the bona fide hedging definition.
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\1505\ To the extent that the pass-through swap counterparty is
a swap dealer or major swap participant, it already may be subject
to similar recordkeeping requirements under Sec. 1.31 and part 23
of the Commission's regulations. As a result, such costs may already
have been realized.
\1506\ Cargill at 10; EEI/EPSA at 7-8; FIA at 11-12; CMC at 5;
Shell at 6-7; ICE at 6-7; ISDA at 11-12.
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Since not all swaps entered into by a commercial entity may qualify
as a bona fide hedge, the Commission declines commenters' requests that
a pass-through swap counterparty may reasonably rely solely upon the
fact that the counterparty is a commercial end user and, absent an
agreement between the counterparties, that the swap appears to be
consistent with hedges entered into by end users in the same line of
business. The Commission, however, is amending the regulatory text to
provide flexibility and avoid a prescriptive requirement that would
otherwise cause additional costs or burdens.
Instead, the Final Rule provides that the pass-through swap
counterparty (i.e., the swap dealer) may rely in good faith on a
written representation made by its bona fide hedging swap counterparty,
unless the pass-through swap counterparty has information that would
cause a reasonable person to question the accuracy of the
representation. The Commission is adding the written representation
requirement to enable the Commission to verify that only market
participants with bona fide hedge exemptions are able to pass-through
those exemptions to their swap dealer counterparties. To avoid a
prescriptive requirement that would incur additional costs to market
participants, the Final Rule does not prescribe the form or manner by
which the pass-through swap counterparty obtains the written
representation. The Commission recognizes that such flexibility would
allow for the bona fide hedging counterparty to make such
representations on a relationship basis through counterparty
relationship documentation (e.g., through ISDA documentation) or on a
transaction basis (e.g., through trade confirmations or in other forms
as agreed upon by the parties), based on the most cost efficient manner
for the market participants.
The Final Rule's pass-through swap provision, consistent with the
Dodd-Frank Act's changes to CEA section 4a(c)(2), also addresses a
situation where a participant who qualifies as a bona fide hedging swap
counterparty (i.e., a participant with a position in a previously-
entered into swap that qualified, at the time the swap was entered
into, as a bona fide hedging position under the revised definition)
seeks, at some later time, to offset that swap position.\1507\ Such
step might be taken, for example, to respond to a change in the
participant's risk exposure in the underlying commodity. As a result, a
participant could use futures contracts or options on futures contracts
in excess of Federal position limits to offset the price risk of a
previously-entered into swap, which would allow the participant to
exceed Federal position limits using either new futures or options on
futures or swap positions that reduce the risk of the original swap.
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\1507\ See paragraph (2)(ii) of the ``bona fide hedging
transaction or position'' definition in Sec. 150.1.
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The Commission expects the pass-through swap provision to
facilitate
[[Page 3423]]
dynamic hedging by market participants. The Commission recognizes that
a significant number of market participants use dynamic hedging to more
effectively manage their portfolio risks. Therefore, this provision may
increase operational efficiency. In addition, by permitting dynamic
hedging, a greater number of dealers should be better able to provide
liquidity to the market, as these dealers will be able to more
effectively manage their risks by entering into pass-through swaps with
bona fide hedgers as counterparties. Moreover, market participants are
not precluded from using swaps that are not ``economically equivalent
swaps'' for such risk management purposes since swaps that are not
deemed to be ``economically equivalent'' to a referenced contract are
not subject to the Commission's position limits framework.
(3) Limiting ``Risk'' to ``Price'' Risk; Elimination of the Incidental
Test and Orderly Trading Requirement
The bona fide hedging definition's ``economically appropriate
test'' set out in final Sec. 150.1 explicitly provides that only
hedges that offset price risks can be recognized as bona fide hedging
transactions or positions. The Commission does not believe that this
particular change imposes any new costs or benefits, as it is
consistent with both the existing bona fide hedging definition \1508\
as well as the Commission's longstanding policy.\1509\ Nonetheless, the
Commission realizes that hedging occurs for more types of risks than
price (e.g., volumetric hedging) and hedging solely to protect against
changes in value of non-price risks would fall outside the category of
a bona fide hedge, which offsets the ``price risk'' of an underlying
commodity cash position.
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\1508\ The existing bona fide hedging definition in Sec. 1.3
provides that ``no transactions or positions shall be classified as
bona fide hedging unless their purpose is to offset price risks
incidental to commercial cash or spot operations.'' (emphasis
added). Accordingly, the definition in final Sec. 150.1 merely
moves this requirement to the definition's revised ``economically
appropriate test'' requirement.
\1509\ For example, in promulgating existing Sec. 1.3, the
Commission explained that a bona fide hedging position must, among
other things, ``be economically appropriate to risk reduction, such
risks must arise from operation of a commercial enterprise, and the
price fluctuations of the futures contracts used in the transaction
must be substantially related to fluctuations of the cash-market
value of the assets, liabilities or services being hedged.'' Bona
Fide Hedging Transactions or Positions, 42 FR at 14832, 14833 (Mar.
16, 1977). The Dodd-Frank Act added CEA section 4a(c)(2), which
copied the ``economically appropriate test'' from the Commission's
definition in Sec. 1.3. See also 78 FR at 75702, 75703.
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In response to commenters, the Commission clarifies in the preamble
that price risk can be informed and impacted by various other types of
risks.\1510\ The Commission agrees with commenters who stated that
market participants form independent economic assessments of how
different risks (including, but not limited to, geopolitical, turmoil,
weather, or counterparty) might create or impact the price risk of
underlying commodities.\1511\ The Commission recognizes these risks can
create price risks and understands that firms may manage these
potential risks to their businesses differently and in the manner most
suitable for their business. By limiting the economically appropriate
prong to price risk, the Commission is reiterating its historical
practice (which has adequately applied to the legacy agricultural
contracts for decades) to recognize hedges of price risk of an
underlying commodity position as bona fide hedges while acknowledging
that price risk may itself be impacted by non-price risks. Market
participants may continue to manage non-price risks in a variety of
ways, which may include participation in the futures markets or
exposure to other financial products. In fact, market participants may
decide to use futures contracts that are not subject to Federal
position limits, if they determine such contracts will help them manage
non-price risks faced by their businesses.
---------------------------------------------------------------------------
\1510\ See supra Section II.A.1.iii.b (discussing economically
appropriate test); Cargill at 3.
\1511\ See, e.g., CMC at 3.
---------------------------------------------------------------------------
Alternatively, commenters suggested that the Commission permit
market participants to use the non-enumerated hedge process to receive
recognition of hedges of non-price risk on a case-by-case basis.\1512\
The Commission is precluded from adopting this alternative in light of
its view that price risk is required to satisfy the CEA's economically
appropriate test. Further, the Commission is unaware of commercial
market participants historically seeking non-enumerated bona fide hedge
recognition for non-price risk in the spot month.
---------------------------------------------------------------------------
\1512\ MGEX at 2; FIA at 11.
---------------------------------------------------------------------------
The Commission further implements Congress's Dodd-Frank Act
amendments that did not include in the statutory bona fide hedge
definition the incidental test and orderly trading requirement by
eliminating those elements from to the Commission's regulatory
definition. As discussed in the preamble, the Commission believes that
these changes do not represent a change in policy or regulatory
requirement. As a result, the Commission does not identify any costs or
benefits related to these changes.
b. Enumerated Bona Fide Hedges
The Commission maintains, and incorporates in final Sec. 150.3, a
list of enumerated bona fide hedges in Appendix A to part 150 of the
Commission's regulations that includes: (i) All of the existing
enumerated hedges; and (ii) additional enumerated bona fide hedges. The
Commission reinforces that hedging practices not otherwise listed may
still be deemed, on a case-by-case basis, to comply with the proposed
bona fide hedging definition (i.e., non-enumerated bona fide hedges).
As discussed further below, the enumerated bona fide hedges in Appendix
A are ``self-effectuating'' for purposes of Federal position limit
levels. This is expected to help in ensuring timely hedging and
therefore reduce compliance costs associated with seeking an
exemption.\1513\
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\1513\ For example, AGA expressed support for the Commission's
proposal to recognize anticipatory merchandising as an enumerated
hedge because it promotes liquidity. AGA at 8. AGA stated that
``[a]bsent such an enumerated hedge, there would be a piecemeal
approach to permitting such hedges which could reduce liquidity,
raise costs, and create undue risks for gas utilities, without any
regulatory benefits toward the Commission's goal to reduce excessive
speculative activities.'' Id.
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(1) Treatment of Unfixed Price Transactions
As discussed in the preamble, the Commission has long recognized
fixed-price commitments as the basis for a bona fide hedge.\1514\ Under
existing Sec. 1.3, only one enumerated hedge explicitly mentions
``unfixed price,'' and its availability is limited to circumstances
where a market participant has both an unfixed-price purchase and an
unfixed-price sale on hand (precluding a market participant with only
an unfixed-price purchase or an unfixed price sale from qualifying for
this particular enumerated hedge).\1515\ In 2012, Commission staff
issued interpretive letter 12-07 (``Staff Letter 12-07''), which
clarified that a commercial entity may qualify for the existing
enumerated bona fide hedge for unfilled anticipated requirements even
if the commercial entity has entered into long-term, unfixed-price
supply or requirements contracts because, as staff explained, the
unfixed-price purchase
[[Page 3424]]
contract does not ``fill'' the commercial entity's anticipated
requirements.\1516\
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\1514\ See supra Section I.
\1515\ See, e.g., paragraphs (2)(i)(A) and 2(ii)(A) of existing
Sec. 1.3.
\1516\ CFTC Staff Letter 12-07 at 1, issued August 16, 2012,
https://www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm,
title search ``12-07.''
---------------------------------------------------------------------------
The Final Rule affirms and broadens the application of the
interpretation provided in Staff Letter No. 12-07. As a result,
commercial market participants with unfixed price transactions may
qualify for bona fide hedge treatment under the enumerated bona fide
hedges for anticipatory merchandising, anticipated unsold production,
or anticipated unfilled requirements.\1517\ The Commission clarifies
that a commercial market participant that enters into an unfixed-price
transaction will not be precluded from qualifying for one of these
anticipatory enumerated bona fide hedges as long as the commercial
entity otherwise satisfies all requirements for such anticipatory bona
fide hedge, including demonstrating its anticipated need in the
physical marketing channel related to either its unsold production,
unfilled requirements, and/or merchandising, as applicable.\1518\ As
such, merely entering into an unfixed-price transaction is not alone
sufficient to demonstrate compliance with one of the enumerated
anticipatory bona fide hedges.
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\1517\ See supra Section II.A.1.iv (discussing treatment of
unfixed price transactions).
\1518\ The specific requirements associated with each enumerated
bona fide hedge, including each anticipatory bona fide hedge, are
described in detail further below.
---------------------------------------------------------------------------
The same costs and benefits described above with respect to an
expanded list of enumerated bona fide hedge recognitions also apply to
such recognition based on unfixed-price transactions. The Commission's
treatment of unfixed price transactions under the Final Rule will
benefit physical commodity commercial market participants. As discussed
previously, CEA section 4a(c)(1) directs the Commission to exclude bona
fide hedge positions from any Federal position limits framework. In
accordance with CEA section 4a(c)(1), the Commission's treatment of
unfixed price transactions entered into by commercial market
participants protects the legitimate commercial activity of cash-market
participants,\1519\ thereby encouraging participation in the futures
markets by commercial market participants. Additionally, bona hedge
treatment for qualified unfixed price transactions benefits the public
by allowing commercial market participants to more effectively and
predictably hedge their price risks, thus controlling costs that might
be passed on to the public.\1520\ However, to the extent the Commission
currently allows exemptions related to unfixed-price transactions, the
costs and benefits already may be realized by market participants and
may not represent a change from the status quo baseline.
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\1519\ See Cargill at 6 (stating that the Commission should
recognize unfixed price transactions as they are ``fundamental to
price risk management and routinely used by firms to manage risk'').
\1520\ CEWG at 18 (discussing storage hedges, stating that
``(``[n]ot allowing commercial energy firms to utilize these
industry-standard hedges on an enumerated basis because they are
``anticipatory'' in nature or viewed as a form of
``merchandising''--or both--could result in storage assets being
underutilized, which could increase volatility in physical and
financial markets for energy commodities that ultimately could
translate into higher costs for consumers'').
---------------------------------------------------------------------------
Alternatively, several commenters requested that the Commission
create a new enumerated bona fide hedge for unfixed-price transactions
or amend the existing enumerated bona fide hedge for offsetting unfixed
purchase and sales.\1521\ The Commission does not believe that this is
necessary since, as described above, commercial market participants may
continue to both qualify for anticipatory bona fide hedges while also
entering into unfixed-price transactions. Further, the Commission
believes that neither of these alternatives is suitable because there
is an inherent difficulty in evaluating the propriety of a hedge of an
unfixed price obligation with a fixed-price futures contract due to the
basis risk that exists until the unfixed price obligation is fixed.
Given differences among markets, creating a new enumerated bona fide
hedge for any unfixed price transaction could, under certain
circumstances, impose costs on market integrity, including by enabling
potential market manipulation and/or allowing excessive speculation by
potentially affording bona fide hedging treatment for speculative
transactions. To the extent that a market participant does not qualify
for an enumerated bona fide hedge in connection with an unfixed-price
transaction, the Commission believes that any potential harms or costs
to that market participant would be mitigated because the participant
could still avail itself of the process under Sec. Sec. 150.3 and
150.9 for non-enumerated bona fide hedges.\1522\
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\1521\ See, e.g., Ecom at 1; ACA at 2; CEWG at 19-21; Chevron at
11; CME Group at 8-9; DECA at 2; East Cotton at 2; Gerald Marshall
at 2; IFUS at 5-7; IMC at 2; Jess Smith at 2; LDC at 2; Mallory
Alexander at 2; McMeekin at 2; Memtex at 2; Moody Compress 1; NCC at
1; NGFA at 7; Olam at 2; Omnicotton at 2; Canale Cotton at 2; Shell
at 7; Southern Cotton at 2; Suncor at 7; SW Ag at 2; Toyo at 2;
Texas Cotton at 2; Walcot at 2; White Gold at 2.
\1522\ One commenter maintains that reliance on the non-
enumerated bona fide hedge process for management of unpriced
physical purchase or sale commitments ``will impose procedural
hurdles, uncertainty, and additional costs on a critically important
function of the supply chain in the U.S. economy.'' CEWG at 21.
Another commenter stated that imposing a burden on commercial end
users with unpriced physical purchase or sale commitments to rely on
the non-enumerated hedge exemption process is contrary to the intent
and language of the CEA. Cargill at 6. These concerns, however, are
mitigated because, under the Final Rule, commercial market
participants with unfixed price transactions may qualify for bona
fide hedge treatment under the enumerated bona fide hedges for
anticipatory merchandising, anticipated unsold production, or
anticipated unfilled requirements.
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(2) Elimination of the Five-Day Rule
The Final Rule eliminates the existing restriction on holding
certain enumerated bona fide hedges during the last five days of
trading under existing Sec. 1.3. Instead, under final Sec.
150.5(a)(2)(ii)(H), the exchanges have discretion to determine, for
purposes of their own exchange-granted exemptions (for contracts
subject to Federal position limits), whether to apply a restriction
against holding positions in excess of limits during the lesser of the
last five days of trading or the time period for the spot month in such
physical-delivery contract (the ``Five-Day Rule''). Under final Sec.
150.5(a)(2)(ii)(H), exchanges are able to establish their own Five-Day
Rule, or otherwise limit the size of positions. The exchanges would
thus have the ability and discretion, but not an obligation, to apply a
five-day Rule or similar restriction to exemptions on any contracts
subject to Federal position limits, regardless of whether such
contracts have been subject to Federal position limits before.\1523\
The Commission has determined that exchanges are well-informed with
respect to their respective markets, and well-positioned to make a
determination with respect to imposing the Five-Day Rule in connection
with recognizing bona fide hedges for their respective commodity
contracts.
---------------------------------------------------------------------------
\1523\ The Commission is adopting Appendix B and Appendix G of
this Final Rule to provide guidance for exchanges to consider when
determining whether to impose the Five-Day Rule or similar
requirements on bona fide hedge exemptions and spread exemptions,
respectively.
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In general, the Commission believes that, on the one hand, limiting
a trader's ability to establish a position in this manner by requiring
the Five-Day Rule could result in increased costs related to
operational inefficiencies, as a trader may believe that holding a
position late into the spot period is necessary for the bona fide hedge
position. On the other hand, the Commission believes that price
convergence may be particularly sensitive to potential market
manipulation or excessive speculation during the spot period.
Accordingly, the Commission believes that the
[[Page 3425]]
determination to not impose the Five-Day Rule with respect to any of
the enumerated bona fide hedges for Federal purposes, but to instead
rely on exchanges' determinations with respect to exchange-granted
exemptions, helps to better optimize these considerations. The
Commission notes there is a potential cost to market integrity and
price convergence since the Five-Day Rule is being eliminated as a
blanket Federal requirement from some enumerated hedges while the
exchanges will now have guidance from the Commission to consider when
choosing whether to grant a position limits exemption subject to a
five-day rule or similar restriction.\1524\ Under this new framework,
however, the Commission will continue to leverage its own market
surveillance and oversight functions to ensure that exchanges continue
to comply with their legal obligations, including with respect to Core
Principles 2, 3, 4, and 5, among others.\1525\ With an expanded list of
contracts subject to Federal position limits, it is best to provide the
exchanges additional discretion to protect their markets using tools
other than a five-day rule, and to supplement that discretion with
guidance highlighting the importance of the spot month to ensure price
convergence and an orderly delivery process. Finally, the Commission
believes a concern over oversight is also mitigated by the fact that
the exchanges have an economic incentive to ensure that price
convergence occurs with their respective contracts since commercial
end-users would be less willing to use such contracts for hedging
purposes if price convergence failed to occur in such contracts as they
may generally desire to hedge cash-market prices with futures
contracts.
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\1524\ Better Markets at 61 (discussing elimination of the Five-
Day Rule and Appendix B guidance by stating that '' the CFTC
proposes to abolish the rule for enumerated hedges, over-relying
instead--and again--on the judgment of the exchanges to determine
whether to apply the Five-Day Rule, or apply and grant fact specific
waivers'').
\1525\ Core Principle 4, 7 U.S.C. 7b-3(f)(4)(B); 7 U.S.C. 7b-
3(f)(2); 7 U.S.C. 7b-3(f)(3); 7 U.S.C.7b-3(f)(5).
---------------------------------------------------------------------------
The Commission is also adopting guidance in Appendix B to part 150
on factors for the exchanges to consider when granting an exemption
subject to a restriction against holding physically delivered futures
contracts into the spot month. In response to some commenters who
stated that the proposed guidance was too prescriptive and would result
in additional burdens,\1526\ the Commission clarifies and reiterates
the appendix is not intended to be used as a mandatory checklist. The
Commission, however, has determined it is helpful to provide the
exchanges with guidance highlighting the importance of the spot month
to ensure price convergence and an orderly delivery process. Since
price convergence and an orderly trading environment serve as a
deterrent to mitigate certain types of market manipulation schemes such
as corners and squeezes, the guidance is intended to include a non-
exclusive list of considerations the Commission expects the exchanges
to consider when determining whether to allow a position in excess of
limits throughout the spot month. The Commission does not expect the
guidance to impose additional burdens on the exchanges, as the
exchanges currently have in place market surveillance practices or
procedures to review the appropriateness of an exemption during the
relevant referenced contract's spot period. The guidance is intended to
supplement that existing process.
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\1526\ Cargill at 9; CME Group at 9 (stating that the ``CME
Group believes the proposed guidance could be interpreted to cause
unnecessary burden and costs to market participants. The guidance
appears to create a formal process for firms to provide information
outlined in the Appendix as part of their bona fide hedge exemption
applications, but the Proposal does not seem to consider this
additional burden in its cost analysis'').
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As discussed in the preamble, the guidance does not impose any
additional reporting requirements on market participants, and the
factors described in the guidance apply simply to the exchanges'
evaluation of the specific contract market when considering whether an
exemption shall be granted subject to any condition or limitation in
the spot month. Finally, the Commission is making certain amendments to
the guidance to ensure that the factors maintain a flexible approach,
particularly where existing exchange application requirements already
require market participants to provide relevant cash-market
information.
c. Guidance for Measuring Risk
The Commission is issuing guidance in paragraph (a) of final
Appendix B to part 150 on whether positions may be hedged on either a
gross or net basis. Under the guidance, among other things, a trader
may measure risk on a gross basis if that approach is consistent with
the trader's historical practice and is not intended to evade
applicable limits. The key cost associated with allowing gross hedging
is that it may provide opportunity for hidden speculative trading or
for cherry picking of positions in a manner that subverts positions
limits.\1527\
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\1527\ For example, using gross hedging, a market participant
could potentially point to a large long cash position as
justification for a bona fide hedge, even though the participant, or
an entity with which the participant is required to aggregate, has
an equally large short cash position that would result in the
participant having no net price risk to hedge as the participant had
no price risk exposure to the commodity prior to establishing such
derivative position. Instead, the participant created price risk
exposure to the commodity by establishing the derivative position.
---------------------------------------------------------------------------
Such risk is mitigated to a certain extent by the guidance's
provisos that the trader does not switch between net hedging and gross
hedging in order to evade limits and that the trader must demonstrate,
upon request by the Commission or an exchange, the justifications for
measuring risk on a gross basis.\1528\ By focusing on consistency and
historical practice with respect to the manner in which a person
measures risk, the guidance enables market participants to measure risk
on a gross basis when dictated by the nature of the exposure, but not
simply when utilizing gross hedging will yield a larger exposure than
net hedging, or will otherwise subvert Federal position limit or
aggregation requirements. However, the Commission also recognizes that
there are myriad ways in which organizations are structured and engage
in commercial hedging practices, including the use of multi-line
business strategies in certain industries that are subject to Federal
position limits for the first time under this Final Rule and for which
net hedging could impose significant costs or be operationally
unfeasible.\1529\
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\1528\ The proposed guidance on gross hedging positions in the
2020 NPRM provided that an exchange document the justifications for
recognizing a gross position as a non-enumerated bona fide hedge
pursuant to Sec. 150.9. Several commenters alternatively requested
elimination of that requirement as imposing unnecessary burdens
directly on exchanges and indirectly on market participants. See
CEWG at 4; FIA at 14; and MGEX at 3. Because the Commission and
exchanges have other tools for accessing such information, the
Commission eliminated that requirement from the guidance in Appendix
B of this Final Rule. Under final Sec. 150.3(b)(2) and (e) and
final Sec. 150.9(e)(5), and (g), the Commission has access to any
information related to the applicable exemption request, and
therefore concludes that eliminating this requirement does not
result in any related costs and benefits.
\1529\ FIA stated that ``the recommendation to implement
specific policies and procedures governing gross and net hedging has
the potential to create unnecessary, unintended and burdensome
conflicts with other company policies, such as accounting policies,
with little or no measurable benefit.'' FIA at 15. The Final Rule
clarifies that the guidance does not require market participants to
develop written policies or procedures setting forth when gross or
net hedging is appropriate.
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[[Page 3426]]
iii. Spread Exemptions
Under existing Sec. 150.3, certain spread exemptions are self-
effectuating. Specifically, existing Sec. 150.3 allows for ``spread or
arbitrage positions'' that are ``between single months of a futures
contract and/or, on a futures-equivalent basis, options thereon,
outside of the spot month, in the same crop year; provided, however,
that such spread or arbitrage positions, when combined with any other
net positions in the single month, do not exceed the all-months limit
set forth in Sec. 150.2.'' \1530\
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\1530\ 17 CFR 150.3. CEA section 4a(a)(1) provides the
Commission with authority to exempt from position limits
transactions ``normally known to the trade'' as ``spreads'' or
``straddles'' or ``arbitrage'' or to fix limits for such
transactions or positions different from limits fixed for other
transactions or positions.
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Final Sec. Sec. 150.1 and 150.3 amend the existing spread position
exemption for Federal position limits by (i) listing, in the spread
transaction definition, specific types of spread exemptions that are
self-effectuating for purposes of Federal limits and that may be
granted by an exchange; (ii) creating a process that requires a person
to apply for spread exemptions (that are not listed in the spread
transaction definition) directly with the Commission pursuant to final
Sec. 150.3; \1531\ and (iii) providing guidance on the types of spread
positions that meet the spread transaction definition in a new Appendix
G to part 150 under the Final Rule. In addition, final Sec. 150.3
permits spread exemptions outside the same crop year and/or during the
spot month.\1532\
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\1531\ The ``spread transaction'' definition lists the most
common types of spread positions: intra-market spread, inter-market
spread, intra-commodity spread, or inter-commodity spread, including
a calendar spread, quality differential spread, processing spread,
product or by-product differential spread, or futures-option spread.
Final Sec. 150.3(b) also permits market participants to apply to
the Commission for other spread transactions.
\1532\ As discussed under final Sec. 150.3, spread exemptions
identified in the proposed ``spread transaction'' definition in
final Sec. 150.1 are self-effectuating, similar to the status quo,
and do not represent a change to the status quo baseline. The
related costs and benefits, particularly with respect to requesting
exemptions with respect to spreads other than those identified in
the proposed ``spread transaction'' definition, are discussed under
the respective sections below.
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In connection with the spread exemption provisions, the Commission
is relaxing the prohibition for contracts during the same crop year
and/or the spot month so that market participants may receive spread
exemptions outside the same crop year and/or during the spot month.
There may be benefits that result from permitting these types of spread
exemptions. For example, the Commission believes that permitting spread
exemptions in different crop years or during the spot month may
potentially improve price discovery and provide market participants
with the ability to use additional strategies involving spread
positions, which may reduce hedging costs.
As in the inter-market wheat example discussed below, the spread
relief, which is not limited to the same crop year, may better link
prices between two markets (e.g., the price of MGEX wheat futures and
the price of CBOT wheat futures). Put another way, permitting spread
exemptions outside the same crop year may enable pricing in two
different but related markets for substitute goods to be more highly
correlated, which benefits market participants with a price exposure to
the underlying protein content in wheat generally, rather than that of
a particular commodity.
However, the Commission also recognizes certain potential costs to
permitting spread exemptions during the spot month, particularly to
extend into the last five days of trading. This feature could raise the
risk of allowing participants in the market at a time in the contract
where only those interested in making or taking delivery should be
present. When a contract goes into expiration, open interest and
trading volume naturally decrease, as traders not interested in making
or taking delivery roll their positions into deferred calendar months.
The presence of large spread positions, normally tied to large
liquidity providers so close to the expiration of a futures contract,
could lead to disruptions in the price discovery function of the
contract by disrupting the futures/cash price convergence. This could
lead to increased transaction costs and harm the hedging utility for
end-users of the futures contract, which could lead to higher costs
passed on to consumers.
However, the Commission believes that these concerns are mitigated,
as spread exemptions will not be self-effectuating for purposes of
exchange-set position limits. Accordingly, exchanges will continue to
apply their expertise in overseeing and maintaining the integrity of
their markets. For example, an exchange could: Refuse to grant a spread
exemption if the exchange determines that the exemption is inconsistent
with the requirements of Sec. 150.5(a) or harmful to its markets;
require a market participant to reduce its positions; or implement a
five-day rule for spread exemptions, as discussed above.\1533\ The
Commission has also provided guidance to exchanges in a new Appendix G
to support exchange analysis of whether to grant a particular spread
exemption and to remind exchanges of their oversight obligations when
granting spread exemptions.
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\1533\ See supra Section II.A.1.viii. (discussing the Five-Day
Rule).
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Generally, the Commission finds that, by allowing speculators to
execute inter-market and intra-market spreads, speculators are able to
hold a greater amount of open interest in underlying contract(s), and
therefore, bona fide hedgers may benefit from any increase in market
liquidity. Spread exemptions may also lead to better price continuity
and price discovery if market participants who seek to provide
liquidity (for example, through entry of resting orders for spread
trades between different contracts) receive a spread exemption, and
thus would not otherwise be constrained by a position limit.
For clarity, the Commission has identified the following two
examples of spread positions that could benefit from the spread
exemptions permitted by this Final Rule:
Reverse crush spread in soybeans on the CBOT subject to an
inter-market spread exemption. In the case where soybeans are processed
into two different products, soybean meal and soybean oil, the crush
spread is the difference between the combined value of the products and
the value of soybeans. There are two actors in this scenario: The
speculator and the soybean processor. The spread's value approximates
the profit margin from actually crushing (or mashing) soybeans into
meal and oil. The soybean processor may want to lock in the spread
value as part of its hedging strategy, establishing a long position in
soybean futures and short positions in soybean oil futures and soybean
meal futures, as substitutes for the processor's expected cash-market
transactions (the long position hedges the purchase of the anticipated
inputs for processing and the short position hedges the sale of the
anticipated soybean meal and oil products). On the other side of the
processor's crush spread, a speculator takes a short position in
soybean futures against long positions in soybean meal futures and
soybean oil futures. The soybean processor may be able to lock in a
higher crush spread because of liquidity provided by such a speculator
who may need to rely upon a spread exemption. In this example, the
speculator is accepting basis risk represented by the crush spread, and
the speculator is providing liquidity to the soybean processor. The
crush spread positions may result in greater correlation between the
futures prices of
[[Page 3427]]
soybeans on the one hand and those of soybean oil and soybean meal on
the other hand, which means that prices for all three products may move
up or down together in a more correlated manner.
Wheat spread subject to inter-market spread exemptions.
There are two actors in this scenario: The speculator and the wheat
farmer. In this example, a farmer growing hard wheat would like to
reduce the price risk of her crop by shorting a MGEX wheat futures.
There, however, may be no hedger, such as a mill, that is immediately
available to trade at a desirable price for the farmer. There may be a
speculator willing to offer liquidity to the hedger; however, the
speculator may wish to reduce the risk of an outright long position in
MGEX wheat futures through establishing a short position in CBOT wheat
futures (soft wheat). Such a speculator, who otherwise would have been
constrained by a position limit at MGEX and/or CBOT, may seek
exemptions from MGEX and CBOT for an inter-market spread, that is, for
a long position in MGEX wheat futures and a short position in CBOT
wheat futures of the same maturity. As a result of the exchanges
granting an inter-market spread exemption to such a speculator, who
otherwise may be constrained by limits, the farmer might be able to
transact at a higher price for hard wheat than might have existed
absent the inter-market spread exemptions. Under this example, the
speculator is accepting basis risk between hard wheat and soft wheat,
reducing the risk of a position on one exchange by establishing a
position on another exchange, and potentially providing liquidity to a
hedger. Further, spread transactions may aid in price discovery
regarding the relative protein content for each of the hard and soft
wheat contracts.
iv. Conditional Spot Month Exemption Positions in Natural Gas
Final Sec. 150.3(a)(4) provides a new Federal conditional spot
month position limit exemption for cash-settled NYMEX NG referenced
contracts. The conditional exemption permits traders to acquire
positions up to 10,000 cash-settled NYMEX NG referenced contracts (the
Federal spot month limit in final Sec. 150.2 for cash-settled NYMEX NG
is 2,000 cash-settled NYMEX NG referenced contracts per exchange and
another 2,000 cash-settled NYMEX NG referenced contracts in the OTC
swaps market) per exchange that lists a cash-settled NYMEX NG
referenced contract, along with an additional position in cash-settled
economically equivalent NYMEX NG OTC swaps that has a notional amount
of up to 10,000 equivalent-sized contracts, as long as such person does
not also hold positions in the physically-settled NYMEX NG referenced
contract.\1534\
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\1534\ The NYMEX NG contract is the only natural gas contract
included as a core referenced futures contract under the Final Rule.
---------------------------------------------------------------------------
NYMEX, IFUS, and Nodal currently have rules in place establishing a
conditional spot month limit exemption of up to 5,000 equivalent-sized
cash-settled natural gas contracts per exchange, provided that the
market participant does not hold any physically-settled natural gas
contracts. Finalizing the conditional limit exemption for NYMEX NG
enables the NYMEX NG referenced contract market to continue to operate
as it has under the existing exchange-set conditional limit exemption
framework, which the Commission notes has functioned well based on its
observation over the past decade. Removing the conditional limit
exemption will result in reduced liquidity, including for commercial
hedgers seeking to offset price risks but not necessarily looking to
make or take delivery, due to the significantly lower positions a
market participant would be able to hold in the cash-settled NYMEX NG
referenced contracts.
Several commenters suggested removing the NYMEX NG conditional
limit exemption's requirement to divest all holdings in the physically-
settled NYMEX NG referenced contract.\1535\ The Commission believes
that this could result in significant costs to the market by
encouraging manipulation of the physically-settled NYMEX NG referenced
contract to benefit a large position in the cash-settled NYMEX NG
referenced contract available through the conditional limit exemption.
Specifically, without this divestiture requirement, a trader could hold
up to 40,000 cash-settled NYMEX NG referenced contracts and 2,000
physically-settled NYMEX NG referenced contracts. At these levels, it
may not require much movement in the physically-settled markets to
disproportionately benefit the cash-settled holdings. As a result, the
requirement to exit the physically-settled contract is critical for
reducing a market participant's incentive to manipulate the cash
settlement price by, for example, banging-the-close or distorting
physical delivery prices in the physically-settled contract to benefit
leveraged cash-settled positions.
---------------------------------------------------------------------------
\1535\ ISDA at 8; SIFMA AMG at 10-11; FIA at 7-8; NGSA at 12-14;
Citadel at 7; CCI at 4; EEI/EPSA at 4.
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CME commented that the conditional limit exemption for NYMEX NG
could ``incentivize the manipulation of a cash commodity price in order
to benefit a position in a cash-settled contract.'' \1536\ The
Commission notes that the conditional limit exemption does provide for
a substantial increase in a trader's cash-settled position, but the
core requirement that a trader must divest out of the physically-
settled NYMEX NG referenced contract during the spot month period is
intended to address and reduce the incentive for a trader to manipulate
the physically-settled NYMEX NG core referenced futures contract to
benefit a position in the cash-settled NYMEX NG referenced contracts.
Furthermore, based on its experience in monitoring the NYMEX NG market
since the conditional limit exemption was adopted, the Commission has
not observed any market manipulations attributable to a trader
utilizing the conditional limit exemption. That said, the Commission is
aware of instances where traders violated the conditional exemption by
holding or trading in the physically-settled NYMEX NG core referenced
futures contracts. The exchanges also detected and took corrective
action against those traders. The Commission will continue to closely
monitor natural gas trader positions across exchanges and work with the
exchanges to ensure the CME Group's concerns continue to be addressed
to protect the market participants and the public and defend the
financial integrity and price discovery function of the NYMEX NG core
referenced futures contract.\1537\
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\1536\ CME Group at 6.
\1537\ See IFUS Rule 6.20(c) and NYMEX Rule 559.F. See, e.g.,
Nodal Rulebook Appendix C (equivalent rule of Nodal).
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Further, the Commission has heeded natural gas traders' concerns
about disrupting market practices and harming liquidity in the cash-
settled contract, which could increase the cost of hedging and possibly
prevent convergence between the physical delivery futures and cash
markets.\1538\ While a trader with a position in the physically-settled
NYMEX NG referenced contract may incur costs associated with
liquidating that position in order to meet the conditions of the
Federal exemption, such costs are incurred outside of the Final Rule,
as the trader would have to do so as a condition of the exchange-level
[[Page 3428]]
exemption under current exchange rules.\1539\
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\1538\ See 81 FR at 96862, 96863.
\1539\ See IFUS Rule 6.20(c) and NYMEX Rule 559.F. See, e.g.,
Nodal Rulebook Appendix C (equivalent rules of Nodal).
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v. Financial Distress Exemption
Final Sec. 150.3(a)(3) provides an exemption for certain financial
distress circumstances, including the default of a customer, affiliate,
or acquisition target of the requesting entity that may require the
requesting entity to take on, in short order, the positions of another
entity. In codifying the Commission's historical practice, the Final
Rule accommodates transfers of positions from financially distressed
firms to financially secure firms. The disorderly liquidation of a
position threatens price impacts that may harm the efficiency and price
discovery function of markets, and Sec. 150.3(a)(3) makes it less
likely that positions are prematurely or needlessly liquidated. The
Commission has determined that costs related to filing and
recordkeeping are negligible. The Commission cannot accurately estimate
how often this exemption may be invoked because emergency or distressed
market situations are unpredictable and dependent on a variety of firm
and market-specific factors as well as general macroeconomic
indicators.\1540\ The Commission, nevertheless, believes that emergency
or distressed market situations that might trigger the need for this
exemption are infrequent, and that codifying this historical practice
adds transparency to the Commission's oversight responsibilities.
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\1540\ See 81 FR at 96862, 96863.
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vi. Pre-Enactment and Transition Period Swaps Exemption
Final Sec. 150.3(a)(5) provides an exemption from position limits
for positions acquired in good faith in any ``pre-enactment swap,'' or
in any ``transition period swap,'' in either case as defined in final
Sec. 150.1. A person relying on this exemption may net such positions
with post-effective date commodity derivative contracts for the purpose
of complying with any non-spot month speculative positions limits, but
may not net against spot month positions. This exemption is self-
effectuating, and the Commission believes that Sec. 150.3(a)(5)
benefits both individual market participants by lessening the impact of
the Federal position limits in final Sec. 150.2, and market liquidity
in general as liquidity providers initially will not be forced to
reduce or exit their positions.
Final Sec. 150.3(a)(5) benefits price discovery and convergence by
prohibiting large traders seeking to roll their positions into the spot
month from netting down positions in the spot-month against their pre-
enactment swap or transition period swap. The Commission acknowledges
that, on its face, including a ``good-faith'' requirement in final
Sec. 150.3(a)(5) could hypothetically diminish market integrity since
determining whether a trader has acted in ``good faith'' is inherently
subjective and could result in disparate treatment among traders, where
certain traders may assert a more aggressive position in order to seek
a competitive advantage over others. The Commission believes the risk
of any such unscrupulous trader or exchange is mitigated since
exchanges are still subject to Commission oversight and to DCM Core
Principles 4 (``prevention of market disruption'') and 12 (``protection
of markets and market participants''), among others. The Commission has
determined that market participants who voluntarily employ this
exemption also incur negligible recordkeeping costs.
5. Process for the Commission or Exchanges To Grant Exemptions and Bona
Fide Hedge Recognitions for Purposes of Federal Position Limits (Final
Sec. Sec. 150.3 and 150.9) and Related Changes to Part 19 of the
Commission's Regulations
Existing Sec. Sec. 1.47 and 1.48 set forth the process for market
participants to apply to the Commission for recognition of certain bona
fide hedges for purposes of Federal position limits, and existing Sec.
150.3 set forth the types of spread exemptions a person can rely on for
purposes of Federal position limits. Under existing Commission
practices, spread exemptions and certain enumerated bona fide hedges
are generally self-effectuating and do not require market participants
to apply to the Commission for purposes of Federal position limits.
Market participants are currently, however, required to file Form 204
monthly reports \1541\ to justify certain position limit overages.
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\1541\ In the case of cotton, market participants currently file
the relevant portions of Form 304.
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Further, for those bona fide hedges for which market participants
are required to apply to the Commission, existing regulations and
market practice require market participants to apply both to the
Commission for purposes of Federal position limits and also to the
relevant exchanges for purposes of exchange-set limits. The Commission
has determined that this dual application process creates
inefficiencies for market participants.
Final Sec. Sec. 150.3 and 150.9, taken together, make several
changes to the process of acquiring bona fide hedge recognitions and
spread exemptions for Federal position limits purposes. Final
Sec. Sec. 150.3 and 150.9 maintain certain elements of the status quo
while also adopting certain changes to facilitate the exemption
process.\1542\
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\1542\ In this section the Commission discusses the costs and
benefits related to the application process for these exemptions and
bona fide hedge recognitions. For a discussion of the costs and
benefits related to the scope of the exemptions and bona fide hedge
recognitions, see supra Section IV.A.4.
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First, with respect to the proposed enumerated bona fide hedges,
final Sec. 150.3 maintains the status quo by providing that those
enumerated bona fide hedges that currently are self-effectuating for
the nine legacy agricultural contracts will continue to remain self-
effectuating for the nine legacy agricultural contracts for purposes of
Federal position limits.\1543\ Similarly, the enumerated bona fide
hedges for the additional 16 contracts that are newly subject to
Federal position limits (i.e., those contracts other than the nine
legacy agricultural contracts) also are self-effectuating for purposes
of Federal position limits.
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\1543\ Final Sec. 150.3(a)(1)(i). Under the status quo, market
participants must apply to the Commission for recognition of certain
enumerated anticipatory bona fide hedges. The Final Rule also makes
these enumerated anticipatory bona fide hedges self-effectuating for
the nine legacy agricultural contracts.
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Second, for recognition of any non-enumerated bona fide hedge in
connection with any referenced contract, market participants are
required to apply either directly to the Commission under final Sec.
150.3 or through an exchange that adheres to certain requirements under
final Sec. 150.9. The Commission notes that existing regulations
require market participants to apply to the Commission for recognition
of non-enumerated bona fide hedges, and so the Final Rule does not
represent a change to the status quo in this respect for the nine
legacy agricultural contracts.
Third, final Sec. 150.3 maintains the status quo by providing that
the most common spread exemptions for the nine legacy agricultural
contracts remain self-effectuating. Similarly, these common spread
exemptions also are self-effectuating for the additional 16 contracts
that are newly subject to Federal position limits. These common spread
exemptions are listed in the
[[Page 3429]]
``spread transaction'' definition under final Sec. 150.1.\1544\
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\1544\ Final Sec. 150.1 defines ``spread transaction'' to
include an intra-market spread, inter-market spread, intra-commodity
spread, or inter-commodity spread, including a calendar spread,
quality differential spread, processing spread, product or by-
product differential spread, or futures-option spread.
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Fourth, for any spread exemption not listed in the ``spread
transaction'' definition, market participants are required to apply
directly to the Commission under final Sec. 150.3. There is no
exception for the nine legacy agricultural products, nor are market
participants permitted to apply through an exchange under final Sec.
150.9 for these types of spread exemptions.\1545\
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\1545\ As discussed below, the Final Rule also eliminates the
Form 204 and the equivalent portions of the Form 304.
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The Commission anticipates that most--if not all--market
participants will utilize the exchange-centric process set forth in
final Sec. 150.9 with respect to applying for recognition of non-
enumerated bona fide hedges, rather than applying directly to the
Commission under Sec. 150.3. Market participants are likely already
familiar with the processes set forth in Sec. 150.9, which is intended
to leverage the processes currently in place at the exchanges for
addressing requests for bona fide hedge recognitions from exchange-set
limits. In the sections below, the Commission will discuss the costs
and benefits related to both processes.
i. Process for Requesting Exemptions and Bona Fide Hedge Recognitions
Directly From the Commission (Final Sec. 150.3)
Under existing Sec. Sec. 1.47 and 1.48, and existing Sec. 150.3,
the processes for obtaining a recognition of a bona fide hedge or for
relying on a spread exemption, are similar in some respects and
different in other respects than the approach adopted in final Sec.
150.3. Existing Sec. Sec. 1.47 and 1.48 require market participants
seeking recognition of non-enumerated bona fide hedges and enumerated
anticipatory bona fide hedges, respectively, for purposes of Federal
position limits to apply directly to the Commission for prior approval.
In contrast, existing non-anticipatory enumerated bona fide hedges
and spread exemptions are self-effectuating, which means that market
participants are not required to submit any information to the
Commission for prior approval, although such market participants must
subsequently file Form 204 or Form 304 each month in order to describe
their cash-market positions and justify their bona fide hedge position.
There currently is no codified Federal process related to financial
distress exemptions or natural gas conditional spot month exemptions.
Final Sec. 150.3 provides a process for market participants to
apply directly to the Commission for recognition of non-enumerated bona
fide hedges or spread exemptions not included in the ``spread
transaction'' definition in final Sec. 150.1, which in each case would
not be self-effectuating under the Final Rule. Under final Sec. 150.3,
any person seeking Commission recognition of these types of bona fide
hedges or spread exemptions (as opposed to applying for recognition of
non-enumerated bona fide hedges using the exchange-centric process
under proposed Sec. 150.9 described below) are required to submit a
request directly to the Commission and to provide information similar
to what is currently required under existing Sec. Sec. 1.47 and
1.48.\1546\
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\1546\ For bona fide hedges and spread exemptions, this
information includes: (i) A description of the position in the
commodity derivative contract (including the name of the underlying
commodity and the derivative position size) or of the spread
position for which the application is submitted; (ii) an explanation
of the hedging strategy, including a statement that the position
complies with the applicable requirements for, and the definition
of, a bona fide hedging transaction or position, and information to
demonstrate why the position satisfies such requirements and
definition; (iii) a statement concerning the maximum size of all
gross positions in commodity derivative contracts for which the
application is submitted; (iv) for bona fide hedges, a description
of the applicant's activity in the cash markets and swaps markets
for the commodity underlying the position for which the application
is submitted, including information regarding the offsetting cash
positions; and (v) any other information that may help the
Commission determine whether the position meets the applicable
requirements for a bona fide hedge position or spread transaction.
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a. Existing Bona Fide Hedges That Currently Require Prior Submission to
the Commission Under Existing Sec. Sec. 1.47 and 1.48 for the Nine
Legacy Agricultural Contracts
Under the Final Rule, the Commission maintains the distinction
between enumerated bona fide hedges and non-enumerated bona fide hedges
in final Sec. 150.3: (1) Enumerated bona fide hedges continue to be
self-effectuating; (2) enumerated anticipatory bona fide hedges are now
self-effectuating, so market participants no longer need to apply to
the Commission for recognition; and (3) non-enumerated bona fide hedges
still require market participants to apply for recognition. Market
participants that choose to apply directly to the Commission for a bona
fide hedge recognition (i.e., for non-enumerated bona fide hedges) are
subject to an application process that generally is similar to what the
Commission currently administers for the non-enumerated bona fide
hedges and the enumerated anticipatory bona fide hedges.\1547\
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\1547\ As noted above, under the existing framework, market
participants are not required to apply for any type of bona fide
hedge recognition or spread exemption from the Commission for any of
the additional 16 contracts that are newly subject to Federal
position limits (i.e., those contracts other than the nine legacy
agricultural contracts); rather, under the existing framework, such
market participants must apply to the exchanges for bona fide hedge
recognitions or exemptions for purposes of exchange-set position
limits. Accordingly, to the extent that market participants do not
need to apply to the Commission in connection with any of the
additional 16 contracts, the Final Rule does not impose additional
costs or benefits compared to the status quo.
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With respect to enumerated anticipatory bona fide hedges for the
nine legacy agricultural contracts, for which market participants
currently are required to apply to the Commission for recognition for
Federal position limit purposes, the Commission anticipates that the
Final Rule will benefit market participants by making such hedges self-
effectuating.\1548\ As a result, market participants will no longer be
required to spend time and resources applying to the Commission.
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\1548\ As noted above, since market participants do not need to
apply to the Commission for bona fide hedge recognition for any of
the additional 16 contracts that are newly subject to Federal
position limits, the Commission's proposal does not result in any
additional costs or benefits to the extent such bona fide hedge
recognitions are self-effectuating.
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Further, for these enumerated anticipatory hedges, existing Sec.
1.48 requires market participants to submit either an initial or
supplemental application to the Commission 10 days prior to entering
into the bona fide hedge that would cause the hedger to exceed Federal
position limits.\1549\ Under existing Sec. 1.48, a market participant
could proceed with its proposed bona fide hedge if the Commission does
not notify a market participant otherwise within the specific 10-day
period. Under the Final Rule, because bona fide hedgers can implement
enumerated anticipatory bona fide hedges without filing an application
with the Commission for approval and waiting the requisite 10 days,
they may be able to implement their hedging strategy more efficiently
with reduced cost and risk. The
[[Page 3430]]
Commission acknowledges that making such bona fide hedges more
efficient to obtain could increase the possibility of excess
speculation since anticipatory exemptions are theoretically more
difficult to substantiate compared to the other existing enumerated
bona fide hedges.
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\1549\ Under the Commission's existing regulations, non-
anticipatory enumerated bona fide hedges are self-effectuating, and
market participants do not have to file any applications for
recognition under existing Commission regulations. However, existing
Commission regulations require bona fide hedgers to file with the
Commission monthly Form 204 (or Form 304 in connection with ICE
Cotton No. 2 (CT)) reports discussing their underlying cash
positions in order to substantiate their bona fide hedge positions.
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However, the Commission has gained significant experience over the
years with bona fide hedging practices in general, and with enumerated
anticipatory bona fide hedging practices in particular, and the
Commission has determined that making such hedges self-effectuating
should not increase the risk of excessive speculation or market
manipulation compared to the status quo.
For non-enumerated bona fide hedges, existing Sec. 1.47 requires
market participants to submit (i) initial applications to the
Commission 30 days prior to the date the market participant would
exceed the applicable position limits and (ii) supplemental
applications (i.e., applications for a market participant that desires
to exceed the bona fide hedge amount provided in the person's previous
Commission filing) 10 days prior for Commission approval, and market
participants can proceed with their proposed bona fide hedges if the
Commission does not intervene within the specific time (e.g., either 10
days or 30 days).
Final Sec. 150.3 similarly requires market participants that elect
to apply directly to the Commission (as opposed to applying through an
exchange pursuant to final Sec. 150.9) for a recognition of a non-
enumerated bona fide hedge for any of the 25 core referenced futures
contracts to apply to the Commission prior to exceeding Federal
position limits. Final Sec. 150.3 does not, however, prescribe a
certain time period by which a bona fide hedger must apply or by which
the Commission must respond. The Commission anticipates that the Final
Rule benefits bona fide hedgers by enabling them, in many cases, to
generally implement their hedging strategies sooner than the existing
30-day or 10-day waiting period, as applicants will have access to an
expanded list of enumerated hedges (which don't require prior
Commission approval), a new streamlined process for applying through
exchanges for non-enumerated hedges, increased position limits, and, as
discussed here, a more flexible approach for applying directly to the
Commission for a non-enumerated hedge. Considering these factors, the
Commission believes that, ultimately, hedging-related costs would
likely decrease. However, the Commission believes that there could also
be circumstances in which the overall process for applying directly to
the Commission could take longer than the existing timelines under
Sec. 1.47, which could increase hedging-related costs if a bona fide
hedger is compelled to wait longer, compared to existing Commission
practices, before executing its hedging strategy.
On the other hand, the Commission also recognizes that there could
be potential costs to bona fide hedgers if, under the Final Rule, they
are forced either to enter into less effective bona fide hedges, or to
wait to implement their hedging strategy, as a result of the potential
uncertainty that could result from Sec. 150.3 not requiring the
Commission to respond within a certain amount of time. However, the
Commission believes this concern is mitigated since market participants
will likely also have the option to apply for a non-enumerated bona
fide hedge under final Sec. 150.9. As explained further below, final
Sec. 150.9(e)(3) is a streamlined process whereby a market participant
in receipt of a notice of approval from the relevant exchange may
elect, at its own risk, to exceed Federal position limits during the
Commission's review period, which is limited to 10 (or 2) days under
Sec. 150.9.\1550\
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\1550\ See supra Section II.G.7. (discussing when a person may
exceed Federal position limits).
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This concern is also mitigated to the extent market participants
utilize the Sec. 150.3 process that permits a market participant that
demonstrates a ``sudden or unforeseen'' increase in its bona fide
hedging needs to enter into a bona fide hedge without first obtaining
the Commission's prior approval, as long as the market participant
submits a retroactive application to the Commission within five
business days of exceeding the applicable position limit. The
Commission believes this ``five-business day retroactive exemption''
benefits bona fide hedgers compared to existing Sec. Sec. 1.47 and
1.48, which require Commission prior approval, since hedgers that
qualify to exercise the five-business day retroactive exemption are
also likely facing more acute hedging needs--with potentially
commensurate costs if required to wait. This provision also leverages,
for Federal position limit purposes, existing exchange practices for
granting retroactive exemptions from exchange-set limits.
On the other hand, the proposed five-business day retroactive
exemption could harm market liquidity and bona fide hedgers if the
applicable exchange or the Commission were to not approve the
retroactive request, and the Commission subsequently required
liquidation of the position in question. As a result, such possibility
could cause market participants to either enter into smaller bona fide
hedge positions than they otherwise would, or cause the bona fide
hedger to delay entering into its hedge, in either case potentially
causing bona fide hedgers to incur increased hedging costs.
However, the Commission believes this concern is partially
mitigated since proposed Sec. 150.3 requires the purported bona fide
hedger to exit its position in a ``commercially reasonable time,''
which the Commission believes should partially mitigate any costs
incurred by the market participant compared to either an alternative
that would require the bona fide hedger to exit its position
immediately, or the status quo where the market participant either is
unable to enter into a hedge at all without Commission prior approval.
b. Spread Exemptions and Non-Enumerated Bona Fide Hedges
Final Sec. 150.3 imposes a new requirement for Federal position
limit purposes for market participants to (1) apply either directly to
the Commission pursuant to Sec. 150.3 or indirectly through an
exchange pursuant to final Sec. 150.9 for any non-enumerated bona fide
hedge; and (2) to apply directly to the Commission pursuant to Sec.
150.3 for any spread exemptions not identified in the proposed ``spread
transaction'' definition (the Commission notes that a market
participant may not apply indirectly through an exchange for spread
exemptions for Federal position limit purposes).\1551\ As noted above,
common spread exemptions (i.e., those identified in the definition of
``spread transaction'' in final Sec. 150.1) remain self-effectuating
for the nine legacy agricultural products, and also are self-
effectuating for the 16 additional core referenced futures
contracts.\1552\
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\1551\ As discussed below, for spread exemptions not identified
in the proposed ``spread transaction'' definition in Sec. 150.3,
market participants are required to apply directly to the Commission
under Sec. 150.3 and are not able to apply under Sec. 150.9.
\1552\ Existing Sec. 150.3(a)(2) does not specify a formal
process for granting either spread exemptions or non-anticipatory
enumerated bona fide hedges that are consistent with CEA section
4a(a)(1), so, in practice, spread exemptions and non-anticipatory
enumerated bona fide hedges have been self-effectuating.
---------------------------------------------------------------------------
The baseline is the status quo under existing Sec. 150.3(a)(3),
which provides that certain spread exemptions are self-effectuating for
purposes of Federal position limits. As noted above, Sec. 150.3 is
also the baseline for non-enumerated bona fide hedges. The final rule
[[Page 3431]]
maintains the status quo with respect to spread exemptions that meet
the ``spread transaction definition'' for the nine legacy agricultural
contracts as such spread exemptions will continue to be self-
effectuating. The final rule also maintains the status quo for any non-
enumerated bona fide hedge in one of the nine legacy agricultural
contracts by requiring an applicant to receive prior approval, and
similarly requiring prior approval for such non-enumerated bona fide
hedges for the additional 16 contracts that are newly subject to
Federal position limits.\1553\
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\1553\ The Commission discusses the costs and benefits related
to the process for non-enumerated bona fide hedge recognitions with
respect to the nine legacy agricultural products in the above
section.
---------------------------------------------------------------------------
The Commission concludes that there is a change to the status quo
baseline with respect to the 16 non-legacy core referenced futures
contracts to the extent that they will be subject to Federal position
limits for the first time under the Final Rule. However, since the most
common spread exemptions will be ``self-effectuating'' for Federal
purposes, market participants will not need to do anything new,
compared to the status quo, under the Final Rule in connection with
self-effectuating spread exemptions. Accordingly, as a practical
matter, the Commission does not believe that the Final Rule will impose
any new costs or benefits with respect to the 16 non-legacy core
referenced futures products related to the Final Rule's treatment of
these self-effectuating spread exemptions since market participants
will not need to do anything differently compared to the status quo
(i.e., market participants will still need to obtain exchange approval
of any spread exemption for purposes of exchange-set position limits,
but will not be required to do anything for Federal purposes in
connection with self-effectuating spread exemptions).
Alternatively, several commenters advocated for the Commission to
expand the proposed Sec. 150.9 process to also allow exchanges to
grant ``non-enumerated'' spread exemptions for spread positions that do
not meet the ``spread transaction'' definition.\1554\ As more fully
explained in the preamble, the Commission determined not to expand
Sec. 150.9 for two primary reasons.\1555\ First, most of the more
common spread exemptions used by market participants fall within the
scope of the Final Rule's expanded ``spread transaction'' definition
and are self-effectuating for purposes of Federal position limits.
Spread exemption requests that fall outside of the ``spread
transaction'' definition are likely to be novel exemption requests that
require Commission review.
---------------------------------------------------------------------------
\1554\ See MFA/AIMA at 10; FIA at 21; Citadel at 8-9; ISDA at 9;
ICE at 7-8.
\1555\ See supra Sections II.G.4., II.G.5.
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Second, bona fide hedge recognitions and spread transactions are
subject to different legal standards under CEA section 4a(a). Because
CEA section 4a(a)(c)(2) provides clear criteria to the Commission for
determining what constitutes a bona fide hedging transaction or
position, the Commission has defined in detail the term ``bona fide
hedging transaction or position'' in Sec. 150.1. As a result, the
Commission is permitting exchanges to evaluate applications for non-
enumerated bona fide hedges for purposes of exchange-set limits in
accordance with the same clear criteria used by the Commission. In
contrast, CEA section 4(a)(a)(1) does not include clear criteria to the
Commission for the granting of spread exemptions and requires the
Commission to use its judgment to conduct a fact-specific analysis of
novel spread exemption requests. Because exchanges would lack clear
standards for assessing whether a particular spread position satisfies
the requirements of the CEA, the Commission currently is uncomfortable
with leveraging an exchange's analysis and determination with respect
to novel spread exemption requests and believes that such an
alternative could impose costs on risk management practices due to
possible inconsistent treatment of such exemption requests across
exchanges as well as potential uncertainty due to lack of a clear
statutory standard.
To the extent market participants are required to obtain prior
approval for a non-enumerated bona fide hedge or spread exemption for
any of the additional 16 contracts that are newly subject to Federal
position limits, the Commission recognizes that Sec. 150.3 imposes
costs on market participants who are now required to spend time and
resources submitting applications to the Commission or an exchange, or
both, as applicable, for prior approval of exemptions for Federal
position limit purposes.\1556\ Further, compared to the status quo in
which the proposed new 16 contracts are not subject to Federal position
limits, the process in Sec. 150.3 could increase uncertainty since
market participants are required to seek prior approval and wait for an
undetermined amount of time for a Commission response. As a result,
such uncertainty could cause market participants to either enter into
smaller spread or bona fide hedging positions or do so at a later time.
In either case, this could cause market participants to incur
additional costs and/or implement less efficient hedging strategies.
---------------------------------------------------------------------------
\1556\ The Commission's Paperwork Reduction Act analysis
identifies some of these information collection burdens in greater
specificity. See infra Section IV.B.3.ii.c. (discussing in greater
detail the cost and benefits related to spread exemptions).
---------------------------------------------------------------------------
However, the Commission believes that final Sec. 150.3's framework
is familiar to market participants that currently apply to the
Commission for bona fide exemptions for the nine legacy agricultural
products, which should serve to reduce costs for some market
participants associated with obtaining recognition of a bona fide hedge
or spread exemption from the Commission for Federal position limits for
those market participants.\1557\
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\1557\ The Commission anticipates that the application process
in Sec. 150.3(b) could slightly reduce compliance-related costs,
compared to the status quo application process to the Commission
under existing Sec. Sec. 1.47 and 1.48, because Sec. 150.3
provides a single, standardized process for all bona fide hedge and
spread exemption requests that is slightly less complex--and more
clearly laid out in the proposed regulations--than the Commission's
existing application processes. Nonetheless, since the Commission
anticipates that most market participants would apply directly to
exchanges for bona fide hedges when provided the option under Sec.
150.9, the Commission believes that most market participants would
incur the costs and benefits discussed thereunder.
---------------------------------------------------------------------------
The Commission believes that this analysis also applies to the nine
legacy agricultural contracts for spread exemptions that are not listed
in the proposed ``spread transaction'' definition and therefore also
requires market participants to apply to the Commission for these types
of spread exemptions for the first time for the nine legacy
agricultural products. However, because the Commission has determined
that most spread transactions are self-effectuating (especially for the
nine legacy agricultural contracts based on the Commission's
experience), the Commission believes that Sec. 150.3 imposes only
small costs with respect to spread exemptions for both the nine legacy
agricultural contracts as well as the additional 16 contracts that are
newly subject to Federal position limits.\1558\
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\1558\ ICE requested that market participants be able to apply
for spread exemptions on a late or retroactive basis the same way
they would be permitted to apply for bona fide hedge exemptions
within five days of exceeding Federal position limits under proposed
Sec. Sec. 150.3 and 150.9. ICE at 8. The Commission has determined
not to permit late retroactive applications for spread exemptions
under Sec. 150.3(a) because the Commission believes that the Final
Rule provides sufficient flexibility to allow market participants to
identify their exemption needs and submit timely applications. See
supra Section II.C.4.iii. The Commission further believes that
allowing retroactive spread exemptions (and other types of
retroactive exemptions) could potentially be harmful to the market,
as these types of strategies may involve non-risk-reducing or
speculative activity that should be evaluated prior to a person
exceeding Federal position limits. Id.
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[[Page 3432]]
While the Commission has years of experience granting and
monitoring spread exemptions and enumerated and non-enumerated bona
fide hedges for the nine legacy agricultural contracts, as well as
overseeing exchange processes for administering exemptions from
exchange-set limits on such commodities, the Commission does not have
the same level of experience or comfort administering bona fide hedge
recognitions and spread exemptions for the additional 16 contracts that
are subject to the Federal position limits and the new exemption
processes for the first time. Accordingly, the Commission recognizes
that permitting enumerated bona fide hedges and spread exemptions
identified in the ``spread transaction'' definition for these
additional 16 contracts might not provide the purported benefits, or
could result in increased costs, compared to the nine legacy
agricultural products.
The Commission also believes that Sec. 150.3 benefits market
participants by providing them the option to choose the process for
applying for a non-enumerated bona fide hedge (i.e., either directly
with the Commission or, alternatively, through the exchange-centric
process discussed under Sec. 150.9 below) for the additional 16
contracts that are newly subject to Federal position limits that are
more efficient given the market participants' unique facts,
circumstances, and experience.\1559\ If a market participant chooses to
apply through an exchange for Federal position limits pursuant to final
Sec. 150.9, the market participant receives the added benefit of not
being required to also submit another application directly to the
Commission. The Commission anticipates that most market participants
would apply directly to exchanges for non-enumerated bona fide hedges,
pursuant to the streamlined process Sec. 150.9, as explained below, in
which case the Commission believes that most market participants would
incur the costs and benefits discussed thereunder. The Commission also
believes that this analysis applies with respect to non-enumerated bona
fide hedges for the nine legacy agricultural contracts.
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\1559\ As noted above, market participants seeking spread
exemptions not listed in the proposed ``spread transaction''
definition in Sec. 150.1 are required to apply directly with the
Commission under Sec. 150.3 and are not permitted to apply under
Sec. 150.9. The Commission recognizes that these types of spread
exemptions are difficult to analyze compared to either the spread
exemptions identified in Sec. 150.1 or bona fide hedges in general.
Accordingly, the Commission has determined to require market
participants to apply directly to the Commission. Further, compared
to the spread exemptions identified in final Sec. 150.1, the
Commission anticipates relatively few requests, and so does not
believe the application requirement will impose a large aggregate
burden across market participants.
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c. Exemption-Related Recordkeeping
Final Sec. 150.3(d) requires persons who avail themselves of any
of the foregoing exemptions to maintain complete books and records
concerning all details of each of their exemptions and any related
position, and to make such records available to the Commission upon
request under Sec. 150.3(e).
Several commenters recommended that the Commission delete the pass-
through swap recordkeeping requirements in proposed Sec. 150.3(d)(2)
based on concerns it would place all compliance burdens on the pass-
through swap counterparty offering the swap rather than the bona fide
hedging counterparty.\1560\ Commenters further expressed concerns the
proposed provision would be burdensome to the extent it would require
the pass-through swap counterparty to maintain records of each
representation made by the bona fide hedging counterparty on a trade-
by-trade basis.\1561\
---------------------------------------------------------------------------
\1560\ Cargill at 6; Shell at 6.
\1561\ Id.
---------------------------------------------------------------------------
The Commission intended Sec. 150.3(d)(2) to be an extension of
market participants' existing obligations to maintain regulatory
records under part 45 and Sec. 1.31. As discussed above, the revised
``bona fide hedging transaction or position'' definition in final Sec.
150.1 requires that a pass-through swap counterparty receive a written
representation from its bona fide hedging swap counterparty in order
for the pass-through swap to qualify as a bona fide hedge.\1562\ In
light of that, final Sec. 150.3(d)(2) requires a person relying on the
pass-through swap provision to maintain any records created for
purposes of demonstrating a good faith reliance on that provision in
accordance with Sec. 150.1.
---------------------------------------------------------------------------
\1562\ See supra at Section II.A.1.x.
---------------------------------------------------------------------------
These recordkeeping requirements benefit market integrity by
providing the Commission with the necessary information to monitor the
use of exemptions from speculative position limits and help to ensure
that any person who claims any exemption permitted by Sec. 150.3 can
demonstrate compliance with the applicable requirements. The Commission
does not expect these requirements to impose significant new costs on
market participants, as these requirements are in line with existing
Commission and exchange-level recordkeeping obligations.
d. Exemption Renewals
Consistent with existing Sec. Sec. 1.47 and 1.48, with respect to
any Commission-recognized bona fide hedge or Commission-granted spread
exemption pursuant to final Sec. 150.3, the Commission does not
require a market participant to reapply annually to the
Commission.\1563\ The Commission believes that this reduces burdens on
market participants but also recognizes that not requiring market
participants to annually reapply to the Commission ostensibly could
harm market integrity since the Commission will not directly receive
updated information with respect to particular bona fide hedgers or
exemption holders prior to the trader exceeding the applicable Federal
position limits.
---------------------------------------------------------------------------
\1563\ As discussed below, with respect to exchange-set limits
under Sec. 150.5 or the exchange process for Federal position
limits under Sec. 150.9, market participants are required to
annually reapply to exchanges.
---------------------------------------------------------------------------
However, the Commission believes that any potential harm is
mitigated since the Commission, unlike exchanges, has access to
aggregate market data, including positions held by individual market
participants. Further, Sec. 150.3 requires a market participant to
submit a new application if any material information changes, or upon
the Commission's request. In addition, the Commission will receive
information about any annual renewals of such requests made to an
exchange (for purposes of exchange-set limits) through the monthly
exchange reports required under Sec. 150.5(a)(4). On the other hand,
market participants benefit by not being required to annually submit
new applications, which the Commission believes reduces compliance
costs.
e. Exemptions for Financial Distress and Conditional Natural Gas
Positions
Final Sec. 150.3 codifies the Commission's existing informal
practice with respect to exemptions for financial distress and existing
industry practice with respect to the conditional spot month limit
exemption positions in natural gas. The same costs and benefits
described above with respect to applications for bona fide hedge
recognitions and spread exemptions also apply to these exemptions.
However, to the extent the Commission currently allows exemptions
related to financial distress, the Commission has determined that the
costs and benefits with respect to the related application
[[Page 3433]]
process already may be recognized by market participants.
ii. Process for Market Participants To Apply to an Exchange for Non-
Enumerated Bona Fide Hedge Recognitions for Purposes of Federal
Position Limits (Final Sec. 150.9) and Related Changes to Part 19 of
the Commission's Regulations
Final Sec. 150.9 provides a framework whereby a market participant
could avoid the existing dual application process described above and,
instead, file one application with an exchange to receive a non-
enumerated bona fide hedging recognition, which as discussed previously
is not self-effectuating for purposes of Federal position limits. Under
this process, a person is allowed to exceed the Federal position limit
levels following an exchange's review and approval of an application
for a bona fide hedge recognition, provided that the Commission during
its review does not notify the exchange otherwise within a certain
period of time thereafter. Market participants who do not elect to use
the process in final Sec. 150.9 for purposes of Federal position
limits are required to request relief both directly from the Commission
under Sec. 150.3, as discussed above, and also apply to the relevant
exchange, consistent with existing practices.\1564\
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\1564\ As noted above, the Commission anticipates that most, if
not all, market participants will use Sec. 150.9, rather than Sec.
150.3, where permitted.
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a. Final Sec. 150.9--Establishment of General Exchange Process
Pursuant to final Sec. 150.9, exchanges that elect to process
these applications are required to file new rules or rule amendments
with the Commission under Sec. 40.5 of the Commission's regulations
and obtain from applicants all information to enable the exchange and
the Commission to determine that the facts and circumstances support a
non-enumerated bona fide hedge recognition. Also, final Sec.
150.9(e)(1) requires exchanges to provide real-time notification to the
Commission of each initial determination to recognize a non-enumerated
bona fide hedging transaction or position. The Commission believes that
exchanges' existing practices generally are consistent with the
requirements of Sec. 150.9, and, therefore, exchanges will only incur
marginal costs, if any, to modify their existing practices to comply.
Similarly, the Commission anticipates that establishing uniform,
standardized exemption processes across exchanges benefits market
participants by reducing compliance costs. On the other hand, the
Commission recognizes that exchanges that wish to participate in the
processing of applications with the Commission under Sec. 150.9 are
required to expend resources to establish a process consistent with the
Final Rule. However, to the extent exchanges have similar procedures,
such benefits and costs may already have been realized by market
participants and exchanges.
The Commission believes that there are significant benefits to the
Sec. 150.9 process that will be largely realized by market
participants. The Commission has determined that the use of a single
application to process both exchange and Federal position limits
exemptions benefits market participants and exchanges by simplifying
and streamlining the process. For applicants seeking recognition of a
non-enumerated bona fide hedge, Sec. 150.9 should reduce duplicative
efforts, because applicants are saved the expense of applying in
parallel to both an exchange and the Commission for relief from
exchange-set position limits and Federal position limits, respectively.
Because many exchanges already possess similar application processes
with which market participants are likely accustomed, compliance costs
should be decreased in the form of reduced application-production time
by market participants and reduced response time by exchanges.\1565\
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\1565\ The Commission has previously estimated the combined
annual burden hours for submitting applications under both
Sec. Sec. 1.47 and 1.48 to be 42 hours. See infra Section IV.B.
(Paperwork Reduction Act) and 85 FR 11596, 11700 (Feb. 27, 2020).
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As discussed above, in connection with the recognition of bona fide
hedges for Federal position limit purposes, current practices set forth
in existing Sec. Sec. 1.47 and 1.48 require market participants to
differentiate between (i) enumerated non-anticipatory bona fide hedges
that are self-effectuating, and (ii) enumerated anticipatory bona fide
hedges and non-enumerated bona fide hedges for which market
participants must apply to the Commission for prior approval. Under the
Final Rule, the Commission's application processes no longer
distinguish among different types of enumerated bona fide hedges (e.g.,
anticipatory versus non-anticipatory enumerated bona fide hedges), and
therefore, do not require exchanges to have separate processes for
enumerated anticipatory positions under Sec. 150.9. The Final Rule
also eliminates the requirement for bona fide hedgers to file Form 204
or the relevant portions of Form 304, as applicable, with respect to
any bona fide hedge, whether enumerated or non-enumerated.\1566\ The
Commission expects this to benefit market participants by providing a
more efficient and less complex process that is consistent with
existing practices at the exchange-level.\1567\
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\1566\ See supra Section II.H.2. (discussing changes to part 19
eliminating Form 204 and portions of Form 304).
\1567\ See infra Section IV.A.5.iii. for discussion related to
changes to part 19 regarding the provision of information by market
participants, noting that the elimination of Form 204 by the Final
Rule reduces the burden hours estimates by 300 annual aggregate
burden hours.
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On the other hand, the Commission recognizes that Sec. 150.9
imposes new costs related to non-enumerated bona fide hedges for the
additional 16 contracts that are newly subject to Federal position
limits. Under final Sec. 150.9(c), market participants are now
required to submit applications, including information to demonstrate
why a particular position qualifies as bona fide hedge, as defined in
Sec. 150.1 and CEA section 4a(c)(2), to receive prior approval for
Federal position limits purposes.\1568\ However, since the Commission
understands that exchanges already require market participants to
submit applications and receive prior approval under exchange-set
limits for all types of bona fide hedges, the Commission does not
believe Sec. 150.9 imposes any additional incremental costs on market
participants beyond those already incurred under exchanges' existing
processes.\1569\ Accordingly, the
[[Page 3434]]
Commission believes that any costs already may have been realized by
market participants.
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\1568\ One commenter requested that the Commission provide
additional factors that exchanges should consider when granting non-
enumerated bona fide hedge recognitions. ISDA at 9. As discussed
more fully in the preamble, the Commission believes that the final
regulations strike a reasonable tradeoff by providing sufficient
guidance to the exchanges for their review and determination in the
context of exchange limits, while preserving the exchanges'
discretionary authority to determine what types of additional
information, if any, to collect. See supra Section II.G.5.
(discussing final Sec. 150.9(c)).
\1569\ Under the 2020 NPRM, proposed Sec. 150.9(c)(1)(ii) would
have required exchanges to request a ``factual and legal'' analysis
from applicants for non-enumerated bona fide hedge recognitions. 85
FR 11638. Two commenters expressed concern that the proposed
requirement could be interpreted as requiring applications to engage
legal counsel to complete their applications, which would result in
additional costs to market participants. See CME Group at 10 and CMC
at 11. The Commission did not intend for exchanges to require that
applicants engage legal counsel to complete their applications for
non-enumerated bona fide hedge recognitions. Final Sec.
150.9(c)(1)(ii), instead of requiring a ``factual and legal
analysis,'' requires an applicant to provide ``an explanation of the
hedging strategy,'' including a statement that the position complies
with the applicable requirements of the bona fide hedge definition,
and information to demonstrate why the position satisfies the
applicable requirements. See supra Section II.G.5. (discussing final
Sec. 150.9(c)).
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Further, the Commission believes that employing a concurrent
process with exchanges that are self-regulatory organizations
responsible for overseeing non-enumerated bona fide hedges executed on
their platforms and that are not self-effectuating for Federal position
limits purposes benefits market integrity by ensuring that market
participants are appropriately relying on such bona fide hedges and not
entering into such positions in order to attempt to manipulate the
market or evade position limits. However, to the extent that exchange
oversight, consistent with Commission standards and DCM core
principles, already exists, such benefits may already be realized.
b. Final Sec. 150.9--Exchange Expertise, Market Integrity, and
Commission Oversight
For non-enumerated bona fide hedge recognitions that require the
Commission's prior approval, the Final Rule provides a framework that
utilizes existing exchange resources and expertise so that fair access
and liquidity are promoted at the same time market manipulations,
squeezes, corners, and other conduct that would disrupt markets are
deterred and prevented.\1570\ Final Sec. 150.9 builds on existing
exchange processes, which the Commission believes strengthens the
ability of the Commission and exchanges to monitor markets and trading
strategies while reducing burdens on both the exchanges, which
administer the process, and market participants, who utilize the
process. For example, exchanges are familiar with their market
participants' commercial needs, practices, and trading strategies, and
already evaluate hedging strategies in connection with setting and
enforcing exchange-set position limits.\1571\ Accordingly, exchanges
should be able to readily identify bona fide hedges.
---------------------------------------------------------------------------
\1570\ See CME Group at 7 (stating that the Sec. 150.9
streamlined process would wisely leverage exchanges' long history of
reviewing hedging approaches and applying those approaches to
specific facts and circumstances, and would thereby advance the
statutory goal of allowing commercial parties to ``hedge their
legitimate anticipated business needs'' without imposing any undue
burden in doing so).
\1571\ For a discussion on the history of exemptions, see 78 FR
at 75703-75706.
---------------------------------------------------------------------------
For these reasons, the Commission has determined that allowing
market participants to apply through an exchange under Sec. 150.9,
rather than directly to the Commission as required under existing Sec.
1.47, is likely to be more efficient than if the Commission itself
initially had to review and approve all applications. The Commission
considers the increased efficiency in processing applications under
Sec. 150.9 as a benefit to bona fide hedgers and liquidity providers.
By having the availability of the exchange's analysis and view of the
markets, the Commission is better informed in its review of the market
participant and its application, which in turn may further benefit
market participants in the form of administrative efficiency and
regulatory consistency. However, the Commission recognizes additional
costs for exchanges required to create and submit real-time notices
under final Sec. 150.9(e). In particular, commenters voiced concerns
that the Commission's review of each non-enumerated bona fide hedge
application could impose significant burdens on exchanges, market
participants, and the Commission.\1572\ To the extent exchanges already
provide similar notice to the Commission or to market participants, or
otherwise are required to notify the Commission under certain
circumstances, such benefits and costs already may have been realized.
In addition, the Commission expects that, due to the expanded list of
enumerated hedges and other exemptions available to market participants
as well as the higher Federal limits in the Final Rule, there will be a
manageable amount of non-enumerated bona fide hedges that exchanges and
the Commission will review through the new streamlined process. The
Commission also reiterates that Sec. 150.9 is an optional process that
exchanges and market participants may elect to use in lieu of utilizing
the traditional process of requesting non-enumerated bona fide hedges
directly from the Commission under Sec. 150.3.
---------------------------------------------------------------------------
\1572\ IFUS at 52 (stating that the ``exemption-by-exemption
review of exchange decisions is a novel and significant departure
from the longstanding process for the implementation of the position
limits regime, imposes substantial burdens on the Commission and the
exchanges, and decreases regulatory certainty for market
participants regarding the status of an exemption''). See also ICE
at 9 (questioning ``whether it is necessary for the Commission to
routinely review each non-enumerated determination by the exchange''
and asserting that the Sec. 150.9 10-day review process ``imposes
unnecessary burdens and delays on market participants'').
---------------------------------------------------------------------------
On the other hand, to the extent exchanges become more involved
with respect to review and oversight of market participants' bona fide
hedges and spread exemptions, exchanges could incur additional costs.
However, as noted, the Commission believes most of the costs have been
realized by exchanges under current market practice.
At the same time, the Commission also recognizes that this aspect
of the Final Rule could hypothetically harm market integrity. Absent
other provisions, since exchanges profit from increased activity, an
exchange could hypothetically seek a competitive advantage by offering
excessively permissive exemptions, which could allow certain market
participants to utilize non-enumerated bona fide hedge recognitions to
engage in excessive speculation or to manipulate market prices. If an
exchange engaged in such activity, other market participants would
likely face greater costs through increased transaction fees, including
forgoing trading opportunities resulting from market prices moving
against market participants and/or preventing the market participant
from executing at its desired prices, which may also further lead to
inefficient hedging.
However, the Commission believes that these hypothetical costs are
unfounded since under final Sec. 150.9 the Commission reviews the
applications submitted by market participants for bona fide hedge
recognitions and spread exemptions for Federal position limits. The
Commission emphasizes that Sec. 150.9 is not providing exchanges with
an ability to recognize a bona fide hedge or grant an exemption for
Federal position limit purposes in lieu of a Commission review.\1573\
Rather, Sec. 150.9(e) and (f) require an exchange to provide the
Commission with notice of the disposition of any application for
purposes of exchange limits concurrently with the notice the exchange
provides to the applicant, and the Commission will have 10 business
days to make its determination for Federal position limits purposes
(although, in connection with ``sudden or unforeseen increases'' in
bona fide hedging needs, as discussed in connection with final Sec.
150.3, Sec. 150.9 requires the Commission to make its determination
within two business days). Each non-enumerated bona fide hedge approved
by an exchange for purposes of its own limits is separately and
independently reviewed by the Commission for purposes of Federal
position limits. Finally, under DCM Core Principle 5 and SEF Core
Principle 6, exchanges are accountable for administering position
limits in a manner that reduces the potential threat of market
manipulation or congestion. The Commission believes that these
[[Page 3435]]
requirements, working in concert, provide sufficient protection against
any potential harm to market integrity.
---------------------------------------------------------------------------
\1573\ See supra Section II.G. (discussing Commission
determination of non-enumerated bona fide hedge applications
submitted under Sec. 150.9).
---------------------------------------------------------------------------
On the other hand, the Commission also recognizes that there could
be potential costs to bona fide hedgers if, under the Final Rule, they
wait up to 10 business days for the Commission to complete its review
after the exchange's initial review--especially compared to the status
quo for the 16 commodities that are subject to Federal position limits
for the first time under the Final Rule and currently are not required
to receive the Commission's prior approval. As a result, the Commission
recognizes that a market participant could incur costs by waiting
during the 10 business day period, or be required to enter into a less
efficient hedge, which would harm liquidity.\1574\ However, the
Commission believes this concern is mitigated since, under final Sec.
150.9(e)(3), a market participant in receipt of a notice of approval
from the relevant exchange may elect, at its own risk, to exceed
Federal position limits during the Commission's 10-day review
period.\1575\
---------------------------------------------------------------------------
\1574\ See ICE at 9 (requesting that the Commission permit a
``market participant to engage in hedging up to the requested
exemption limit while waiting for approval'').
\1575\ See supra Sections II.G.7. (discussing when a person may
exceed Federal position limits).
---------------------------------------------------------------------------
Further, final Sec. 150.9(c)(2)(i), similar to final Sec. 150.3,
permits a market participant that demonstrates a ``sudden or
unforeseen'' increase in its bona fide hedging needs to enter into a
bona fide hedge without first obtaining the Commission's prior
approval, as long as the market participant submits a retroactive
application to the Commission within five business days of exceeding
the applicable position limit.\1576\ In turn, the Commission only has
two business days (as opposed to the default 10 business days) to
complete its review for Federal purposes. The Commission believes this
retroactive application exemption benefits bona fide hedgers compared
to existing Sec. 1.47, which requires Commission prior approval, since
hedgers that qualify to exercise the retroactive exemption are also
likely facing more acute hedging needs--with potentially commensurate
costs if required to wait. Absent the retroactive application
exemption, market participants would be penalized and prevented from
assuming appropriate hedges even though their hedging need arises from
circumstances beyond their control. This provision also leverages, for
Federal position limit purposes, existing exchange practices for
granting retroactive exemptions from exchange-set limits.
---------------------------------------------------------------------------
\1576\ Id.
---------------------------------------------------------------------------
On the other hand, the retroactive application exemption could harm
market liquidity and bona fide hedgers since the Commission is able to
require a market participant to exit its position if the exchange or
the Commission does not approve of the retroactive request. Such
uncertainty could cause market participants to either enter into
smaller bona fide hedge positions than it otherwise would, or could
cause the bona fide hedger to delay entering into its hedge, in either
case potentially causing bona fide hedgers to incur increased hedging
costs. However, the Commission believes this concern is partially
mitigated since Sec. 150.9 requires the purported bona fide hedger to
exit its position in a ``commercially reasonable time,'' which the
Commission believes should partially mitigate any costs incurred by the
market participant compared to either an alternative that would require
the bona fide hedger to exit its position immediately, or the status
quo where the market participant is unable to enter into a hedge at all
without Commission approval.
As discussed in the preamble, the Commission received and
considered two comments recommending a broader retroactive application
exemption: (1) CME recommended that the Commission allow retroactive
applications regardless of the circumstances and impose a position
limits violation on an applicant in the event the exchange denies its
application; and (2) ICE recommended that the Commission permit
retroactive exemptions for other types of exemptions, as well as for
position limit overages that occur as a result of operational or
incidental issues where the applicant did not intend to evade position
limits.\1577\ An expansion of this exception beyond bona fide hedge
needs that arise due to sudden or unforeseen circumstances could
disincentivize market participants from properly monitoring their
hedging activities and filing applications in a timely manner. Because
the Final Rule provides broad flexibility to market participants in the
form of various exemptions, among other enhancements to the Federal
position limits framework for bona fide hedges and other exemptions,
the Commission determined not to expand the retroactive application
provision in Sec. 150.9(c)(2)(ii).\1578\
---------------------------------------------------------------------------
\1577\ See supra Section II.G.5.iii.b. (citing CME Group at 9-10
and ICE at 10).
\1578\ See supra Section II.G.5.ii. (discussing final Sec.
150.9(c)(2)(i)).
---------------------------------------------------------------------------
While existing Sec. 1.47 does not require market participants to
annually reapply for certain bona fide hedges, final Sec. 150.9(c)(3)
requires market participants to reapply at least annually with
exchanges to maintain previously-approved non-enumerated bona fide
hedge recognition for purposes of Federal position limits. Several
commenters requested the Commission to clarify that an applicant is
subject to the Commission's 10/2-day review process in Sec. 150.9(e)
only for initial applications for non-enumerated bona fide hedges, and
is not subject to such review for annual renewal applications unless
the facts and circumstances materially change from those presented in
the initial application. As discussed in the preamble, market
participants are only subject to the Commission's 10/2-day review
process for their initial applications for non-enumerated bona fide
hedges unless there are material changes to their initial application.
The Commission recognizes that requiring market participants to
reapply annually could impose additional costs on those that are not
currently required to do so. However, the Commission believes that this
is consistent with industry practice with respect to exchange-set
limits and that market participants are familiar with exchanges'
exemption processes, which should reduce related costs.\1579\ Further,
the Commission believes that market integrity is strengthened by
ensuring that exchanges receive updated trader information that may be
relevant to the exchange's oversight.\1580\ However, to the extent any
of these benefits and costs reflects current market practice, they
already may have been realized by exchanges and market participants.
---------------------------------------------------------------------------
\1579\ See infra Section IV.A.6. (discussing final Sec. 150.5).
\1580\ In contrast, the Commission, unlike exchanges, has access
to aggregate market data, including positions held by individual
market participants, and so the Commission has determined that
requiring market participants to apply annually under final Sec.
150.3, absent any changes to their application, does not benefit
market integrity to the same extent.
---------------------------------------------------------------------------
The Commission anticipates additional costs for exchanges required
to create and submit certain notifications and monthly reports. Final
Sec. 150.9(e)(1) requires exchanges to provide real-time notification
to the Commission of each initial determination to recognize a bona
fide hedging transaction or position.\1581\
[[Page 3436]]
Final Sec. 150.5(a)(4) requires exchanges to provide monthly reports
with necessary information in the form and manner required by the
Commission. The exchange-to-Commission monthly report for contracts
subject to Federal speculative position limits in final Sec.
150.5(a)(4) further details the exchange's disposition of a market
participant's application for recognition of a bona fide hedge position
or spread exemption as well as the related position(s) in the
underlying cash markets and swaps markets.\1582\ The Commission
believes that such reports provide greater transparency by facilitating
the tracking of these positions by the Commission and further assist
the Commission in ensuring that a market participant's activities
conform to the exchange's rules and to the CEA. The combination of the
``real-time'' exchange notification and exchanges' provision of monthly
reports to the Commission under final Sec. Sec. 150.9(e)(1) and
150.5(a)(4), respectively, provides the Commission with enhanced
surveillance tools on both a ``real-time'' and a monthly basis to
ensure compliance with the requirements of the Final Rule. However, to
the extent exchanges already provide similar notice to the Commission,
or otherwise are required to notify the Commission under certain
circumstances, such benefits and costs already may have been realized.
---------------------------------------------------------------------------
\1581\ In addition to submitting a copy of any exchange-approved
non-enumerated bona fide hedge application to the Commission under
Sec. 150.9(e), an exchange may, on a voluntary basis, send the
Commission an advance courtesy copy of the non-enumerated bona fide
hedge application when the exchange first receives it from the
applicant. For purposes of the cost-benefit considerations, we
expect this to be a de minimis burden on an exchange that elects to
provide the courtesy copy to the Commission. In addition, we expect
that providing the courtesy copy could facilitate a more rapid
Commission evaluation of applications submitted under Sec. 150.9,
help facilitate additional regulatory certainty for market
participants, and aid the Commission in its review of applications
processed under Sec. 150.9.
\1582\ In response to concerns from ICE that proposed Sec.
150.5(a)(4) may be overly burdensome and redundant, the Commission
clarified that the monthly report is required to capture only
positions that are subject to Federal position limits (as opposed to
other exchange-set non-enumerated exemptions), exchanges have
discretion as to the best timing for submitting their reports so
long as they are submitted on a monthly basis, and exchanges need
not include factual and legal analysis in the monthly report. See
supra Section II.D.3.iv. (discussing Sec. 150.5(a)(4)).
---------------------------------------------------------------------------
c. Final Sec. 150.9(d)--Recordkeeping
Final Sec. 150.9(d) requires exchanges to maintain complete books
and records of all activities relating to the processing and
disposition of any applications, including applicants' submission
materials,\1583\ and determination documents.\1584\ The Commission
believes that this benefits market integrity and Commission oversight
by ensuring that pertinent records are readily accessible, as needed by
the Commission. However, the Commission acknowledges that such
requirements impose costs on exchanges. Nonetheless, to the extent that
exchanges are already required to maintain similar records, such costs
and benefits already may be realized.\1585\
---------------------------------------------------------------------------
\1583\ One commenter requested that Sec. 150.9 allow exchanges
to maintain records of applicants' positions on an aggregate basis,
as opposed to requiring an exchange to match applicants' bona fide
hedge positions to their underlying cash positions on a one-to-one
basis. NGSA at 9. In the preamble, the Commission noted that final
Sec. 150.9(d) does not prescribe the manner in which exchanges
record application materials and information--it simply requires
exchanges to keep a record of application materials and information
collected. See supra Section II.G.6.iii.
\1584\ Moreover, consistent with existing Sec. 1.31, the
Commission expects that these records will be readily accessible
until the termination, maturity, or expiration date of the bona fide
hedge recognition or exempt spread position and during the first two
years of the subsequent five-year retention period.
\1585\ The Commission believes that exchanges that process
applications for recognition of bona fide hedging transactions or
positions and/or spread exemptions currently maintain records of
such applications as required pursuant to other existing Commission
regulations, including existing Sec. 1.31. The Commission, however,
also believes that final Sec. 150.9(d) may impose additional
recordkeeping obligations on such exchanges. The Commission
estimates that each exchange electing to administer the processes
will likely spend five (5) hours annually to comply with the
recordkeeping requirement of final Sec. 150.9(d) and thus will
incur minimal costs compared to the status quo. See generally
Section IV.B. (discussing the Commission's PRA determinations).
---------------------------------------------------------------------------
d. Final Sec. 150.9(f)--Commission Revocation of Previously Approved
Applications
The Commission acknowledges that there may be costs to market
participants if the Commission revokes a previously-approved non-
enumerated hedge recognition for Federal purposes under final Sec.
150.9(f). Specifically, market participants could incur costs to unwind
trades or reduce positions if the Commission required the market
participant to do so under final Sec. 150.9(f)(2).
However, the potential cost to market participants is mitigated
under final Sec. 150.9(f) since the Commission provides a commercially
reasonable time for a person to come back into compliance with the
Federal position limits, which the Commission believes should mitigate
transaction costs to exit the position and allow a market participant
the opportunity to potentially execute other hedging strategies.
e. Final Sec. 150.9--Commodity Indexes and Risk Management Exemptions
Final Sec. 150.9(b) prohibits exchanges from recognizing as a bona
fide hedge any positions that include commodity index contracts and one
or more referenced contracts, including exemptions known as risk
management exemptions. The Commission recognizes that this prohibition
could alter trading strategies that currently use commodity index
contracts as part of an entity's risk management program. Although
there likely is a cost to change risk management strategies for
entities that currently rely on a bona fide hedge recognition for
positions in commodity index contracts, as discussed above, the
Commission believes that such financial products are not substitutes
for positions in a physical market and therefore do not satisfy the
statutory requirement for a bona fide hedge under section 4a(c)(2) of
the Act.\1586\ In addition, the Commission further posits that this
cost may be reduced or mitigated by the proposed increase in Federal
position limit levels set forth in final Sec. 150.2, or by the
implementation of the pass-through swap provision of the bona fide
hedge definition in final Sec. 150.1.\1587\
---------------------------------------------------------------------------
\1586\ See supra Section III.C.4. (discussing commodity
indices); see supra Section IV.A.4.ii.a(1) (discussing elimination
of the risk management exemption).
\1587\ See supra Section IV.A.4.b.i(1) (discussing the pass-
through swap exemption).
---------------------------------------------------------------------------
iii. Related Changes to Part 19 of the Commission's Regulations
Regarding the Provision of Information by Market Participants
Under existing regulations, the Commission relies on Form 204
\1588\ and Form 304,\1589\ known collectively as the ``series `04''
reports, to monitor for compliance with Federal position limits. Prior
to the amendments to part 19 in the Final Rule, market participants
that held bona fide hedging positions in excess of Federal position
limits for the nine legacy agricultural contracts had to justify such
overages by filing the applicable report (Form 304 for cotton and Form
204 for the other eight legacy commodities) each month.\1590\ The
[[Page 3437]]
Commission has used these reports to determine whether a trader had
sufficient cash positions to justify purported bona fide hedges
positions using futures and options on futures positions above the
applicable Federal position limits.
---------------------------------------------------------------------------
\1588\ CFTC Form 204: Statement of Cash Positions in Grains,
Soybeans, Soybean Oil, and Soybean Meal, available at https://www.cftc.gov/sites/default/files/idc/groups/public/@forms/documents/file/cftcform204.pdf (existing Form 204).
\1589\ CFTC Form 304: Statement of Cash Positions in Cotton,
U.S. Commodity Futures Trading Commission website, available at
http://www.cftc.gov/ucm/groups/public/@forms/documents/file/cftcform304.pdf (existing Form 204). Parts I and II of Form 304
address fixed-price cash positions used to justify cotton positions
in excess of Federal position limits. As described below, Part III
of Form 304 addresses unfixed price cotton ``on-call'' information,
which is not used to justify cotton positions in excess of limits,
but rather to allow the Commission to prepare its weekly cotton on-
call report.
\1590\ 17 CFR 19.01.
---------------------------------------------------------------------------
As discussed above, with respect to bona fide hedging positions,
the Commission is adopting a streamlined approach, under final
Sec. Sec. 150.5 and 150.9, to cash-market reporting that reduces
duplication between the Commission and the exchanges. Generally, the
Commission is adopting amendments to part 19 and related provisions in
part 15 that: (i) Eliminate Form 204; and (ii) amend the Form 304, in
each case to remove any cash-market reporting requirements. Under the
Final Rule, the Commission instead relies on cash-market reporting
submitted directly to the exchanges, pursuant to final Sec. Sec. 150.5
and 150.9,\1591\ or requests cash-market information through a special
call.\1592\
---------------------------------------------------------------------------
\1591\ See supra Section II.G.ii.3. (discussing final Sec.
150.9). As discussed above, leveraging existing exchange application
processes should avoid duplicative Commission and exchange
procedures and increase the speed by which position limit exemption
applications are addressed. For purposes of Federal position limits,
the cash-market reporting regime discussed in this section of the
release only pertains to bona fide hedges, not to spread exemptions,
because the Commission has not traditionally relied on cash-market
information when reviewing requests for spread exemptions.
\1592\ See final Sec. 19.00(b).
---------------------------------------------------------------------------
The cash-market and swap-market reporting elements of Sec. Sec.
150.5 and 150.9 discussed above are largely consistent with current
market practices with respect to exchange-set limits and thus should
not result in any new costs.\1593\ The Final Rule's elimination of Form
204 and the cash-market reporting segments of the Form 304 eliminate
the reporting burden and associated costs.\1594\ Market participants
should realize significant benefits by being able to submit cash-market
reporting to one entity--the exchanges--instead of having to comply
with duplicative reporting requirements between the Commission and
applicable exchange, or implement new Commission processes for
reporting cash-market data for market participants who will be newly
subject to position limits.\1595\ Further, market participants are
generally already familiar with exchange processes for reporting and
recognizing bona fide hedging exemptions, which is an added benefit,
especially for market participants that are newly subject to Federal
position limits.
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\1593\ See, e.g., CME Rule 559 and ICE Rule 6.29.
\1594\ Based on revised estimates of the current collections of
information under existing part 19, the Commission estimates that
the Final Rule reduces the collections of information in part 19 by
600 reports and by 300 annual aggregate burden hours since the Final
Rule eliminates Form 204. See infra Section IV.B. (Paperwork
Reduction Act) and 85 FR 11596, 11700 (Feb. 27, 2020).
\1595\ The Commission has noted that certain commodity markets
are subject to Federal position limits for the first time. In
addition, the existing Form 204 would be inadequate for reporting of
cash-market positions relating to certain energy contracts that are
subject to Federal position limits for the first time under the
Final Rule.
---------------------------------------------------------------------------
Further, these changes do not impact the Commission's existing
provisions for gathering information through special calls relating to
positions exceeding limits and/or to reportable positions. Accordingly,
as discussed above, the Commission requires that all persons exceeding
the Federal position limits set forth in final Sec. 150.2, as well as
all persons holding or controlling reportable positions pursuant to
existing Sec. 15.00(p)(1), must file any pertinent information as
instructed in a special call.\1596\ The Commission acknowledges that,
on its face, not obtaining the cash-market position information in the
form of a series `04 report could hypothetically result in some
increase in speculation; however, as set out above, this risk is
mitigated by the Commission's special call authority and by the
requirements that the exchanges receive this information under
Sec. Sec. 150.5 and 150.9, as applicable. The Commission in turn would
be able to receive this information from the applicable exchange. Final
Sec. 19.00(a)(3) is similar to existing Sec. 19.00(a)(3), but
requires any such person to file the information as instructed in the
special call, rather than to file a series `04 report.\1597\ The
Commission believes that relying on its special call authority is less
burdensome for market participants than the existing Forms 204 and 304
reporting costs, as special calls are discretionary requests for
information whereas the series `04 reporting requirements are a
monthly, recurring reporting burden for market participants. While
collecting this data monthly would permit the Commission to analyze the
bona fide hedges in a time series, which may be helpful in
understanding trends in hedging techniques, the Commission will have
access to this same data from the exchanges and could do the same
analysis if required.
---------------------------------------------------------------------------
\1596\ See final Sec. 19.00(b).
\1597\ 17 CFR 19.00(a)(3).
---------------------------------------------------------------------------
The Commission received one comment addressing the purported
burdens that would accompany elimination of the cash-market reporting
forms. Better Markets, for example, argued that eliminating these
series `04 forms would impose additional reporting burdens on market
participants by requiring participants to report cash-market
information to multiple exchanges, and suggested that the Commission
should instead ``ensure that all cash positions reporting is
automated'' and ``amenable to aggregation'' in order to provide such
information to the exchanges.\1598\ The Commission disagrees with
Better Markets' concerns about increased reporting burdens and
criticism of the existing reporting infrastructure for the reasons
discussed above.\1599\ However, as noted above, eliminating the `04
forms will reduce burdens on market participants.\1600\
---------------------------------------------------------------------------
\1598\ Better Markets at 59-60.
\1599\ See supra Section H.2.iii.-iv. (discussing Better
Markets' comments and the Commission's responses thereto).
\1600\ Id.
---------------------------------------------------------------------------
Separately, ACSA argued for the elimination of Form 304 in its
entirety.\1601\ ACSA asserted that Part III of Form 304, which is used
to prepare the Commission's cotton on-call report, causes competitive
harm to the U.S. cotton industry because the report divulges one market
participant's proprietary information to another market participant
and, according to ACSA, foreign mills believe that the report imposes
risks and costs and are therefore more likely to purchase cotton from
outside of the United States in order to avoid completing Part III of
Form 304.\1602\
---------------------------------------------------------------------------
\1601\ ACSA at 9-11.
\1602\ See id.; see also NCTO at 1-2 (arguing against
publication of the cotton-on-call report and that textile mills are
particularly harmed when speculators trade against the cash-market
positions disclosed in the cotton on-call report because textile
mills purchase the majority of their cotton on call).
---------------------------------------------------------------------------
As discussed in detail above at Section II.H.5.iv, the Commission
believes that the cotton on-call report contributes to efficient price
discovery,\1603\ and that continued publication of the cotton on-call
report will not change the existing dynamics of the cotton market.
---------------------------------------------------------------------------
\1603\ See, e.g., Glencore at 2. One commenter stated that it is
difficult to see the benefit in limiting transparency in the cotton
market and that cotton on-call report is useful and necessary
because it allows market participants to identify market
composition. Dunavant at 1. Similarly, another commenter stated that
discontinuation of the cotton on-call report would widen the
informational divide between large and small market participants
while providing no benefits to the public or price discovery. Gerald
Marshall at 3.
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6. Exchange-Set Position Limits (Final Sec. 150.5)
i. Introduction
Existing Sec. 150.5 addresses exchange-set position limits on
contracts not
[[Page 3438]]
subject to Federal position limits under existing Sec. 150.2, and sets
forth different standards for DCMs to apply in setting limit levels
depending on whether the DCM is establishing limit levels: (1) On an
initial or subsequent basis; (2) for cash-settled or physically-settled
contracts; and (3) during or outside the spot month.
In contrast, for physical commodity derivatives, final Sec.
150.5(a) and (b): (1) Expands existing Sec. 150.5's framework to also
cover contracts subject to Federal position limits under final Sec.
150.2; (2) simplifies the existing standards that DCMs apply when
establishing exchange-set position limits; and (3) provides non-
exclusive acceptable practices for compliance with those
standards.\1604\ Additionally, final Sec. 150.5(d) requires DCMs to
adopt aggregation rules that conform to existing Sec. 150.4.\1605\
---------------------------------------------------------------------------
\1604\ See 17 CFR 150.2. Existing Sec. 150.5 addresses only
contracts not subject to Federal position limits under existing
Sec. 150.2 (aside from certain major foreign currency contracts).
To avoid confusion created by the parallel Federal and exchange-set
position limit frameworks, the Commission clarifies that final Sec.
150.5 deals solely with exchange-set position limits and exemptions
therefrom, whereas final Sec. 150.9 deals solely with the process
for purposes of Federal position limits.
\1605\ See 17 CFR 150.4.
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As a general matter, one factor (in addition to more specific
factors discussed throughout this Final Rule's cost-benefit
considerations) affecting the costs and benefits of the Federal
position limits established by this Final Rule is the fact that
exchanges, for many years, have had in place spot month position limits
for all of the core referenced contracts and non-spot month limits for
all of the nine legacy agricultural contracts.\1606\ Under final Sec.
150.5(a) and (b), exchanges will be required to adopt exchange-set
position limits both (i) for contracts subject to Federal position
limits and (ii) during the spot month for physical commodity contracts
not subject to Federal position limits. Exchanges also will be required
to adopt position limits or position accountability outside the spot
month for those physical commodity contracts not subject to non-spot
month Federal position limits, although the specifics may change with
evolving market conditions and regulatory requirements.\1607\ Exchange-
set position limits, broadly speaking, have much the same effect as
Federal position limits since both restrict the size of speculative
positions market participants may hold.\1608\ Moreover, there is
significant interaction between Federal position limits and exchange-
set position limits. In particular, CEA section 5(d)(5)(B) provides
that, for contracts where the Commission has established a position
limit, exchange-set position limits must be set at a level no higher
than the Federal limit.\1609\ In addition, where both the Commission
and an exchange have position limits in place for a contract, final
Sec. 150.5(a)(2) puts constraints on exemptions from the exchange-set
limit that are tied to the Commission's position limits in ways
described in detail in Section II.D.3, above. As a result, the costs
and benefits considered by the Commission, to a considerable extent,
are jointly attributable to Federal and exchange-set position limits.
The Commission does not have information that would permit a
quantitative evaluation of the extent to which this is true.
Qualitatively, where position limits overlap, a greater attribution of
costs and benefits to the Federal limits appears appropriate to the
extent that Federal limits trigger exchange-set limits pursuant to CEA
section 5(d)(5)(B). However, this is less true if an exchange elects to
impose position limits that are more stringent than the Federal limits
for particular contracts.\1610\
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\1606\ See Section II.D, supra, CME Group, Position Limits,
https://www.cmegroup.com/market-regulation/position-limits.html;
IFUS, Market Resources, Position Limits & Reporting, https://www.theice.com/futures-us/market-resources; CEA section 5(d)(5)(A)
(requiring position limits or accountability); existing Sec. 150.5;
final Sec. 150.5(a). This is generally true with the exception of
ICE Sugar No. 16, which is only subject to exchange-set single month
and all-months-combined position limits. However, the single month
position limit effectively acts as the spot month position limits
for this contract.
\1607\ See supra Section II.D; see also CEA section 5(d)(5);
final Sec. 150.5(a).
\1608\ See ICE Futures U.S. at 3 (``There is no apparent benefit
provided by adding a Federal position limit and guidance'' to ICE's
procedures for position limits and exemptions to such limits.)
\1609\ See also final Sec. 150.5(a)(1).
\1610\ For example, exchanges sometimes reduce position limit
levels in response to particular market conditions. See, e.g., ICE
Futures U.S. at 3, n.3 (describing a reduction in spot month
position limit for cocoa in March of 2020 in response to potential
impact of disruptions to normal business conditions on ability of
market participants to submit cocoa for grading). In addition, an
exchange could routinely set a lower position limit based on its
judgment of what is necessary to prevent manipulation or other
problems or based on the preferences of important participants in
its market.
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Despite the overlap in the effects of Federal and exchange-set
position limits, there are a number of distinctive features of Federal
position limits. Most importantly, as noted above, for contracts where
Federal position limits are established, they establish a ceiling on
positions that can be held, both as a matter of law under CEA section
5(d)(5)(B) and as a matter of practicality since market participants
must comply with Federal limits no matter what the level of exchange-
set limits. In addition, while exchanges can share information to some
extent, the Commission regulates trading on all exchanges and therefore
is generally in a position to better monitor and enforce compliance
with position limits across more than one exchange, for example in
connection with positions in a core referenced futures contract in one
exchange and a linked cash-settled look-alike referenced contract on
another exchange.
There are other differences as well. Even where the Commission and
an exchange set the same numerical position limit for a contract, final
Sec. 150.5(a)(2) allows for the possibility that there may be some
differences in the exemptions allowed.\1611\ And Federal position
limits established pursuant to paragraph CEA section 4a(a)(2) are
subject to a statutory requirement to achieve, to the maximum extent
practicable, the multiple policy objectives set forth in subparagraph
4a(a)(3)(B) of the CEA. By contrast, exchanges have a narrower
statutory mandate to adopt position limits or position accountability
to ``reduce the potential threat of market manipulation or
congestion.'' \1612\ Finally, Federal position limits create compliance
costs beyond those attributable to exchange-set position limits since
market participants will need to establish systems to ensure compliance
with Federal requirements. However, some compliance costs, for example
keeping track of position levels, may be common to both forms of
position limits.\1613\
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\1611\ See supra Section II.D.
\1612\ CEA section 5(d)(5)(A), 7 U.S.C. 7(d)(5)(A). However, the
statutory policy objectives for Federal position limits may
indirectly affect exchange-set limits where Federal limits set a
ceiling for exchange-set limits pursuant to CEA section 5(d)(5)(B),
7 U.S.C. 7(d)(5)(B).
\1613\ See supra Section III.B.2.c.ii; see also COPE at 3 (rule
does not require market participants to create recordkeeping system
to track data solely for purpose of filing forms with the Commission
although some additions to existing tracking effort will be
required).
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Exchange-set position limits for contracts and commodities not
subject to Federal position limits also affect the costs and benefits
of Federal position limits, and, in particular, of the Commission's
finding that position limits are necessary only for the 25 CRFCs and
contracts linked to them.\1614\
[[Page 3439]]
The Commission also has concluded that the existence of exchange-set
limits and position accountability (discussed further below) mitigates
the effects of not establishing Federal position limits for other
commodity derivatives contracts.\1615\
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\1614\ For information on exchange-set position limits and
position accountability for contracts and commodities not subject to
Federal position limits, see, e.g., CME Group, Position Limits,
https://www.cmegroup.com/market-regulation/position-limits.html;
IFUS, Market Resources, Position Limits & Reporting, https://www.theice.com/futures-us/market-resources; CEA section 5(d)(5)(A)
(requiring position limits or accountability); existing Sec. 150.5;
final Sec. 150.5(b).
\1615\ See infra Section IV.A.6.
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ii. Physical Commodity Derivative Contracts Subject to Federal Position
Limits Under the Final Rule (Final Sec. 150.5(a))
a. Exchange-Set Position Limits and Related Exemption Process
For contracts subject to Federal position limits under the Final
Rule, final Sec. 150.5(a)(1) requires DCMs to establish exchange-set
limits no higher than the level set by the Commission. This is not a
new requirement, and merely restates the applicable requirement in DCM
Core Principle 5.\1616\
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\1616\ See Commission regulation Sec. 38.300 (restating DCMs'
statutory obligations under the CEA 5(d)(5), 7 U.S.C. 7(d)(5)).
Accordingly, the Commission will not discuss any costs or benefits
related to this proposed change since it merely reflects an existing
regulatory and statutory obligation.
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Final Sec. 150.5(a)(2) authorizes DCMs to grant exemptions from
such limits and is generally consistent with current industry practice.
The Commission has determined that codifying such practice establishes
important, minimum standards needed for DCMs to administer--and the
Commission to oversee--an effective and efficient program for granting
exemptions to exchange-set limits in a manner that does not undermine
the Federal position limits framework.\1617\
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\1617\ This standard is substantively consistent with current
market practice. See, e.g., CME Rule 559 (providing that CME will
consider, among other things, the ``applicant's business needs and
financial status, as well as whether the positions can be
established and liquidated in an orderly manner . . .'') and ICE
Rule 6.29 (requiring a statement that the applicant's ``positions
will be initiated and liquidated in an orderly manner . . .''). This
standard is also substantively similar to existing Sec. 150.5's
standard and is not intended to be materially different. See
existing Sec. 150.5(d)(1) (an exemption may be limited if it would
not be ``in accord with sound commercial practices or exceed an
amount which may be established and liquidated in orderly
fashion.'') 17 CFR 150.5(d)(1).
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In particular, Sec. 150.5(a)(2) protects market integrity and
prevents exchange-granted exemptions from undermining the Federal
position limits framework by requiring DCMs to either conform their
exemptions to the type the Commission would grant under final
Sec. Sec. 150.3 or 150.9, or to cap the exemption at the applicable
Federal position limit level and to assess whether an exemption request
would result in a position that is ``not in accord with sound
commercial practices'' or would ``exceed an amount that may be
established or liquidated in an orderly fashion in that market.''
Absent other factors, this element of the Final Rule could
potentially increase compliance costs for traders since each DCM could
establish different exemption-related rules and practices. However, to
the extent that rules and procedures currently differ across exchanges,
any compliance-related costs and benefits for traders may already be
realized. Similarly, absent other provisions, a DCM could
hypothetically seek a competitive advantage by offering excessively
permissive exemptions, which could allow certain market participants to
utilize exemptions in establishing sufficiently large positions to
engage in excessive speculation and to manipulate market prices.
However, final Sec. 150.5(a)(2) mitigates these risks by requiring
that exemptions that do not conform to the types the Commission may
grant under final Sec. 150.3 cannot exceed final Sec. 150.2's
applicable Federal position limit unless the Commission has first
approved such exemption. Moreover, before a DCM could permit a new
exemption category, final Sec. 150.5(e) requires a DCM to submit rules
to the Commission allowing for such exemptions, allowing the Commission
to ensure that the proposed exemption type would be consistent with
applicable requirements, including with the requirement that any
resulting positions would be ``in accord with sound commercial
practices'' and may be ``established and liquidated in an orderly
fashion.''
Final Sec. 150.5(a)(2) additionally requires traders to re-apply
to the exchange at least annually for the exchange-level exemption. The
Commission recognizes that requiring traders to re-apply annually could
impose additional costs on traders that are not currently required to
do so. However, the Commission believes this is industry practice among
existing market participants, who are likely already familiar with
DCMs' exemption processes.\1618\ This familiarity should reduce related
costs, and the Final Rule should strengthen market integrity by
ensuring that DCMs receive updated information related to a particular
exemption.
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\1618\ As noted above, the Commission believes this requirement
is consistent with current market practice. See, e.g., CME Rule 559
and ICE Rule 6.29. While ICE Rule 6.29 merely requires a trader to
``submit to [ICE Exchange] a written request'' without specifying
how often a trader must reapply, the Commission understands from
informal discussions between Commission staff and ICE that traders
must generally submit annual updates.
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The Commission received various comments pertaining to Sec.
150.5(a)(2). CMC requested that the Commission clarify that each
exchange has discretion to determine what information is required of
applicants when applying for a spread exemption from exchange-set
limits.\1619\ As noted in the 2020 NRPM, exchanges have discretion to
determine what information is required of applicants applying for a
spread exemption, or any other exemption from exchange-set limits,
except for instances where the exchange is processing a non-enumerated
bona fide hedge applications in accordance with the applications
requirements of Sec. 150.9.\1620\ This flexibility permits exchanges
to further mitigate costs and/or burdens associated with the exemption
process by adopting protocols that leverage existing processes with
which their participants are already familiar.
---------------------------------------------------------------------------
\1619\ CMC at 7.
\1620\ 85 FR 11644 (explaining that exchanges have flexibility
to establish the application process as they see fit).
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CMC also requested that the Commission clarify that an exchange is
not responsible for monitoring the use of spread positions for purposes
of Federal position limits.\1621\ Exchanges are required to administer
and monitor their position limits and any exemptions therefrom in
accordance with DCM Core Principle 5 and SEF Core Principle 6, as
applicable.\1622\ For an inter-market spread exemption where part of
the spread position is executed on another exchange or over the
counter, exchanges are encouraged to request information from the
spread exemption applicant about the entire composition of the spread
position.\1623\ Even though an exchange is not responsible for
monitoring a trader's position on other exchanges, it is beneficial to
the exchange to obtain this information so it is best informed about
whether to grant the exemption. The Commission notes while an exchange
may incur costs through requesting information from (or providing
information to) another exchange, these costs already may have been
realized by exchanges to the extent they reflect existing market
practice. Similarly, such information sharing benefits market
integrity, but such benefits likewise already may have been realized.
---------------------------------------------------------------------------
\1621\ CMC at 7.
\1622\ See supra Section II.D.3.ii.c.
\1623\ See id.
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Final Sec. 150.5(a)(4) requires a DCM to provide the Commission
with certain monthly reports regarding the disposition of any exemption
[[Page 3440]]
application, including the recognition of any position as a bona fide
hedge, the exemption of any spread transaction or other position, the
revocation or modification or previously granted recognitions or
exemptions, or the rejection of any application, as well as certain
related information similar to the information that applicants must
provide the Commission under final Sec. 150.3 or an exchange under
final Sec. 150.9, including underlying cash-market and swap-market
information related to bona fide hedge positions. The Commission
generally recognizes that this monthly reporting requirement could
impose additional costs on exchanges, although the Commission also has
determined that this requirement would assist with the Commission's
oversight functions and therefore benefit market integrity. The
Commission discusses this proposed requirement in greater detail in its
discussion of final Sec. 150.9.\1624\
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\1624\ See supra Section IV.A.5.b.ii. (discussing monthly
exchange-to-Commission report in final Sec. 150.5(a)).
---------------------------------------------------------------------------
Further, while existing Sec. 150.5(d) does not explicitly address
whether traders should request an exemption prior to taking on its
position, final Sec. 150.5(a)(2), in contrast, explicitly authorizes
(but does not require) DCMs to permit traders to file a retroactive
exemption request due to ``demonstrated sudden or unforeseen increases
in its bona fide hedging needs,'' but only within five business days
after the trade and as long as the trader provides a supporting
explanation.\1625\ As noted above, these provisions are largely
consistent with existing market practice, and to this extent, the
benefits and costs already may have been realized by DCMs and market
participants.
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\1625\ Certain exchanges currently allow for the submission of
exemption requests up to five business days after the trader
established the position that exceeded a limit in certain
circumstances. See, e.g., CME Rule 559 and ICE's ``Guidance on
Position Limits'' (Mar. 2018).
---------------------------------------------------------------------------
b. Pre-Existing Positions
Final Sec. 150.5(a)(3) requires DCMs to impose exchange-set
position limits on ``pre-existing positions,'' other than pre-enactment
swaps and transition period swaps.\1626\ The Commission believes that
this approach benefits market integrity since pre-existing positions
that exceed spot-month limits could result in market or price
disruptions as positions are rolled into the spot month.\1627\
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\1626\ Final Sec. 150.1 defines ``pre-existing position'' to
mean ``any position in a commodity derivative contract acquired in
good faith prior to the effective date'' of any applicable position
limit.
\1627\ The Commission is particularly concerned about protecting
the spot month in physical-delivery futures from corners and
squeezes.
---------------------------------------------------------------------------
The Commission is alleviating the burden associated with final
150.5(a)(3) by delaying the compliance date to allow exchanges
sufficient time to implement the Final Rule.
iii. Physical Commodity Derivative Contracts Not Subject to Federal
Position Limits Under the Final Rule (Final Sec. 150.5(b))
a. Spot Month Limits and Related Acceptable Practices
For cash-settled contracts during the spot month, existing Sec.
150.5 sets forth the following qualitative standard: exchange-set
limits should be ``no greater than necessary to minimize the potential
for market manipulation or distortion of the contract's or underling
commodity's price.'' However, for physically-settled contracts,
existing Sec. 150.5 provides a one-size-fits-all parameter that
exchange limits must be no greater than 25% of EDS.
In contrast, the standard for setting spot month limit levels for
physical commodity derivative contracts not subject to Federal position
limits set forth in final Sec. 150.5(b)(1) does not distinguish
between cash-settled and physically-settled contracts, and instead
requires DCMs to apply the existing Sec. 150.5 qualitative standard to
both.\1628\ The Commission also provides a related, non-exclusive
acceptable practice that deems exchange-set position limits for both
cash-settled and physically-settled contracts subject to Sec. 150.5(b)
to be in compliance if the limits are no higher than 25% of the spot-
month EDS.
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\1628\ Final Sec. 150.5(b)(1) requires DCMs to establish
position limits for spot-month contracts at a level that is
``necessary and appropriate to reduce the potential threat of market
manipulation or price distortion of the contract's or the underlying
commodity's price or index.'' Existing Sec. 150.5 also
distinguishes between ``levels at designation'' and ``adjustments to
levels,'' although each category similarly incorporates the
qualitative standard for cash-settled contracts and the 25% metric
for physically-settled contracts. Final Sec. 150.5(b) eliminates
this distinction. The Commission intends the final Sec. 150.5(b)(1)
standard to be substantively the same as the existing Sec. 150.5
standard for cash-settled contracts, except that under final Sec.
150.5(b)(1), the standard applies to physically-settled contracts.
---------------------------------------------------------------------------
Applying the existing Sec. 150.5 qualitative standard and non-
exclusive acceptable practice in final 150.5(b)(1), rather than a one-
size-fits-all regulation, to both cash-settled and physically-settled
contracts during the spot month is expected to enhance market integrity
by permitting a DCM to establish a more tailored, product-specific
approach by applying other parameters that may take into account the
unique liquidity and other characteristics of the particular market and
contract, which is not possible under the one-size-fits-all 25% of EDS
parameter set forth in existing Sec. 150.5. While the Commission
recognizes that the existing 25% of EDS parameter has generally worked
well, the Commission also recognizes that there may be circumstances
where other parameters may be preferable and just as effective, if not
more, including, for example, if the contract is cash-settled or does
not have a reasonably accurate measurable deliverable supply, or if the
DCM can demonstrate that a different parameter would better promote
market integrity or efficiency for a particular contract or market.
On the other hand, the Commission recognizes that final Sec.
150.5(b)(1) could adversely affect market integrity by theoretically
allowing DCMs to establish excessively high position limits in order to
gain a competitive advantage, which also could harm the integrity of
other markets that offer similar products.\1629\ However, the
Commission believes these potential risks are mitigated since (i) final
Sec. 150.5(e) requires DCMs to submit proposed position limits to the
Commission, which will review those rules for compliance with Sec.
150.5(b), including to ensure that the proposed limits are ``in accord
with sound commercial practices'' and that they may be ``established
and liquidated in an orderly fashion''; and (ii) final Sec.
150.5(b)(3) requires DCMs to adopt position limits for any new contract
at a ``comparable'' level to existing contracts that are substantially
similar (i.e., ``look-alike contracts'') on other exchanges unless the
exchange listing the new contracts demonstrates to the satisfaction of
Commission staff, in their product filing with the Commission, how its
levels comply with the requirements of Sec. 150.5(b)(1) and (2).
Moreover, this latter requirement also may reduce the amount of time
and effort needed for the DCM and Commission staff to assess proposed
limits for any new contract that competes with another DCM's existing
contract.
---------------------------------------------------------------------------
\1629\ Since the existing Sec. 150.5 framework already applies
the proposed qualitative standard to cash-settled spot-month
contracts, any new risks resulting from the proposed standard would
occur only with respect to physically-settled contracts, which are
currently subject to the one-size-fits-all 25% EDS parameter under
the existing framework.
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[[Page 3441]]
b. Non-Spot Month Limits/Accountability Levels and Related Acceptable
Practices
Existing Sec. 150.5 provides one-size-fits-all levels for non-spot
month contracts and allows for position accountability after a
contract's initial listing only for those contracts that satisfy
certain trading thresholds.\1630\ In contrast, for contracts outside
the spot-month, final Sec. 150.5(b)(2) requires DCMs to establish
either position limits or position accountability levels that satisfy
the same proposed qualitative standard discussed above for spot-month
contracts.\1631\ For DCMs that establish position limits, final
Appendix F to part 150 sets forth related acceptable practices that
provide non-exclusive parameters that are generally consistent with
existing Sec. 150.5's parameters for non-spot month contracts.\1632\
For DCMs that establish position accountability, Sec. 150.1's
definition of ``position accountability'' provides that a trader must
reduce its position upon a DCM's request, which is generally consistent
with existing Sec. 150.5's framework, but does not distinguish between
trading volume or contract type, like existing Sec. 150.5. While DCMs
are provided the ability to decide whether to use limit levels or
accountability levels for any such contract, under either approach, the
DCM has to set a level that is ``necessary and appropriate to reduce
the potential threat of market manipulation or price distortion of the
contract's or the underlying commodity's price or index.''
---------------------------------------------------------------------------
\1630\ As noted above, in establishing the specific metric,
existing Sec. 150.5 distinguishes between ``levels at designation''
and ``adjustments to [subsequent] levels.'' Final Sec. 150.5(b)(2)
eliminates this distinction and applies the qualitative standard for
all non-spot month position limit and accountability levels.
\1631\ DCM Core Principle 5 requires DCMs to establish either
position limits or accountability for speculators. See Commission
regulation Sec. 38.300 (restating DCMs' statutory obligations under
the CEA 5(d)(5)). Accordingly, inasmuch as final Sec. 150.5(b)(2)
requires DCMs to establish position limits or accountability, the
Final Rule does not represent a change to the status quo baseline
requirements.
\1632\ Specifically, the acceptable practices in final Appendix
F to part 150 provides that DCMs are deemed to comply with final
Sec. 150.5(b)(2)(i) qualitative standard if they establish non-spot
limit levels no greater than any one of the following: (1) Based on
the average of historical positions sizes held by speculative
traders in the contract as a percentage of open interest in that
contract; (2) the spot month limit level for that contract; (3)
5,000 contracts (scaled up proportionally to the ratio of the
notional quantity per contract to the typical cash-market
transaction if the notional quantity per contract is smaller than
the typical cash-market transaction, or scaled down proportionally
if the notional quantity per contract is larger than the typical
cash-market transaction); or (4) 10% of open interest in that
contract for the most recent calendar year up to 50,000 contracts,
with a marginal increase of 2.5% of open interest thereafter.
These parameters have largely appeared in existing Sec. 150.5
for many years in connection with non-spot month limits, either for
levels at designation, or for subsequent levels, with certain
revisions. For example, while existing Sec. 150.5(b)(3) has
provided a limit of 5,000 contracts for energy products, existing
Sec. 150.5(b)(2) provides a limit of 1,000 contracts for physical
commodities other than energy products. The acceptable practice
parameters in final Appendix F create a uniform standard of 5,000
contracts for all physical commodities. The Commission expects that
the 5,000 contract acceptable practice, for example, is a useful
rule of thumb for exchanges because it allows them to establish
limits and demonstrate compliance with Commission regulations in a
relatively efficient manner, particularly for new contracts that
have yet to establish open interest. The spot month limit level
under item (2) above is a new parameter for non-spot month
contracts.
---------------------------------------------------------------------------
One commenter alternatively recommended that Sec. 150.5(b)(2)
should require exchanges to set position limits and position
accountability levels outside of the spot month at levels that reduce
the potential threat of market manipulation or price distortion and the
potential for sudden or unreasonable fluctuations or unwarranted
changes.\1633\ For the reasons more fully discussed below, the
Commission believes that outside the spot-month, either exchange-set
position limits or exchange-set accountability levels are sufficient
for exchanges to reduce these potential threats.
---------------------------------------------------------------------------
\1633\ Better Markets at 47-48.
---------------------------------------------------------------------------
Proposed Sec. 150.5(b)(2) benefits market efficiency by
authorizing DCMs to determine whether position limits or accountability
is best-suited outside of the spot month based on the DCM's knowledge
of its markets. For example, position accountability could improve
liquidity compared to position limits since liquidity providers may be
more willing or able to participate in markets that do not have hard
limits. As discussed above, DCMs are well-positioned to understand
their respective markets, and best practices in one market may differ
in another market, including due to different market participants or
liquidity characteristics of the underlying commodities. For DCMs that
choose to establish position limits, the Commission believes that
applying the final Sec. 150.5 qualitative standard to contracts
outside the spot-month benefits market integrity by permitting a DCM to
establish a more tailored, product-specific approach by applying other
tools that may take into account the unique liquidity and other
characteristics of the particular market and contract, which is not
possible under the existing Sec. 150.5 specific parameters for non-
spot month contracts. While the Commission recognizes that the existing
parameters may have been well-suited to market dynamics when initially
promulgated, the Commission also recognizes that open interest may have
changed for certain contracts subject to final Sec. 150.5(b), and open
interest will likely continue to change in the future (e.g., as new
contracts may be introduced and as supply and/or demand may change for
underlying commodities). In cases where open interest has not
increased, the exchange may not need to change existing limit levels.
But, for contracts where open interest has increased, the exchange is
able to raise its limits to facilitate liquidity consistent with an
orderly market. However, the Commission reiterates that the specific
parameters in the acceptable practices set forth in final Appendix F to
part 150 are merely non-exclusive examples, and an exchange is be able
to establish higher (or lower) limits, provided the exchange submits
its proposed limits to the Commission under final Sec. 150.5(e) and
explains how its proposed limits satisfy the qualitative standard and
are otherwise consistent with all applicable requirements.
The Commission, however, recognizes that final Sec. 150.5(b)(2)
could adversely affect market integrity by potentially allowing DCMs to
establish position accountability levels rather than position limits,
regardless of whether the contract exceeds the volume-based thresholds
provided in existing Sec. 150.5. However, final Sec. 150.5(e)
requires DCMs to submit any proposed position accountability rules to
the Commission for review, and the Commission will determine on a case-
by-case basis whether such rules satisfy regulatory requirements,
including the proposed qualitative standard. Similarly, in order to
gain a competitive advantage, DCMs could theoretically set excessively
high accountability (or position limit) levels, which also could
potentially adversely affect markets with similar products. However,
the Commission believes these risks are mitigated since (i) final Sec.
150.5(e) requires DCMs to submit proposed position accountability (or
limits) to the Commission, which will review those rules for compliance
with Sec. 150.5(b), including to ensure that the exchange's proposed
accountability levels (or limits) are ``necessary and appropriate to
reduce the potential threat of market manipulation or price
distortion'' of the contract or underlying commodity; and (ii) final
Sec. 150.5(b)(3) requires DCMs to adopt position limits for any new
contract at a ``comparable'' level to existing contracts that are
substantially similar on other exchanges unless the exchange listing
the new
[[Page 3442]]
contracts demonstrates to the satisfaction of Commission staff, in
their product filing with the Commission, how its levels comply with
the requirements of Sec. 150.5(b)(1) and (2).
c. Exchange-Set Limits on Economically Equivalent Swaps
As discussed above, swaps that qualify as ``economically equivalent
swaps'' are subject to the Federal position limits framework. However,
the Commission has determined to permit exchanges to delay enforcing
their respective exchange-set position limits on economically
equivalent swaps at this time. Specifically, with respect to exchange-
set position limits on swaps, the Commission notes that in two years
(which generally coincides with the compliance date for economically
equivalent swaps), the Commission will reevaluate the ability of
exchanges to establish and implement appropriate surveillance
mechanisms to implement DCM Core Principle 5 and SEF Core Principle 6.
However, after the swap compliance period (January 1, 2023), the
Commission underscores that it will enforce Federal position limits in
connection with OTC swaps.
Nonetheless, the Commission's determination to permit exchanges to
delay implementing exchange-set position limits on swaps could
incentivize market participants to leave the futures markets and
instead transact in economically equivalent swaps, which could reduce
liquidity in the futures and related options markets, which could also
increase transaction and hedging costs. Delaying position limits on
swaps therefore could harm market participants, especially end-users
that do not transact in swaps, if many participants were to shift
trading from the futures to the swaps markets. In turn, end-users could
pass on some of these increased costs to the public at large.\1634\
However, the Commission believes that these concerns are mitigated to
the extent the Commission still oversees and enforces Federal position
limits even if the exchanges are not be required to do so.
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\1634\ On the other hand, the Commission has not seen any
shifting of liquidity to the swaps markets--or general attempts at
market manipulation or evasion of Federal position limits--with
respect to the nine legacy core referenced futures contracts, even
though swaps currently are not subject to Federal or exchange
position limits.
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iv. Position Aggregation
Final Sec. 150.5(d) requires all DCMs that list physical commodity
derivative contracts to apply aggregation rules that conform to
existing Sec. 150.4, regardless of whether the contract is subject to
Federal position limits under Sec. 150.2.\1635\ The Commission
believes final Sec. 150.5(d) benefits market integrity in several
ways. First, a harmonized approach to aggregation across exchanges that
list physical commodity derivative contracts prevents confusion that
could result from divergent standards between Federal position limits
under Sec. 150.2 and exchange-set limits under Sec. 150.5(b). As a
result, final Sec. 150.5(d) provides uniformity, consistency, and
reduced administrative burdens for traders who are active on multiple
trading venues and/or trade similar physical contracts, regardless of
whether the contracts are subject to Sec. 150.2's Federal position
limits. Second, a harmonized aggregation policy eliminates the
potential for DCMs to use excessively permissive aggregation policies
as a competitive advantage, which would impair the effectiveness of the
Commission's aggregation policy and position limits framework. Third,
since, for contracts subject to Federal position limits, final Sec.
150.5(a) requires DCMs to set position limits at a level not higher
than that set by the Commission under final Sec. 150.2, differing
aggregation standards could effectively lead to an exchange-set limit
that is higher than that set by the Commission. Accordingly,
harmonizing aggregation standards reinforces the efficacy and intended
purpose of final Sec. Sec. 150.2 and 150.5 and existing Sec. 150.4 by
eliminating DCMs' ability to circumvent the applicable Federal
aggregation and position limits rules.
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\1635\ The Commission adopted final aggregation rules in 2016
under existing Sec. 150.4, which applies to contracts subject to
Federal position limits under Sec. 150.2. See Final Aggregation
Rulemaking, 81 FR at 91454. Under the Final Aggregation Rulemaking,
unless an exemption applies, a person's positions must be aggregated
with positions for which the person controls trading or for which
the person holds a 10% or greater ownership interest. The Division
of Market Oversight has issued time-limited no-action relief from
some of the aggregation requirements contained in that rulemaking.
See CFTC Letter No. 19-19 (July 31, 2019), available at https://www.cftc.gov/csl/19-19/download. Commission regulation Sec.
150.4(b) sets forth several permissible exemptions from aggregation.
The Commission, outside the Final Rule, will separately consider
comments related to the Final Aggregation Rulemaking and
codification of NAL 19-19.
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To the extent a DCM currently is not applying the Federal
aggregation rules in existing Sec. 150.4, or similar exchange-based
rules, final Sec. 150.5(d) could impose costs with respect to market
participants trading referenced contracts for the 16 new commodities
that are subject to Federal position limits for the first time. Market
participants are required to update their trading and compliance
systems to ensure they comply with the new aggregation rules.
7. Section 15(a) Factors \1636\
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\1636\ The discussion here covers the Final Rule amendments that
the Commission has identified as being relevant to the areas set out
in section 15(a) of the CEA: (i) Protection of market participants
and the public; (ii) efficiency, competitiveness, and financial
integrity of futures markets; (iii) price discovery; (iv) sound risk
management practices; and (v) other public interest considerations.
For amendments that are not specifically addressed, the Commission
has not identified any effects.
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i. Protection of Market Participants and the Public
A chief purpose of speculative position limits is to preserve the
integrity of derivatives markets for the benefit of commercial
interests, producers, and other end- users that use these markets to
hedge risk and of consumers that consume the underlying commodities. As
discussed above, the Commission believes that the final position limits
regime operates to deter excessive speculation and manipulation, such
as corners and squeezes, which might impair the contract's price
discovery function and liquidity for bona fide hedgers--and ultimately,
protects the integrity and utility of the commodity markets for the
benefit of both producers and consumers.
The Commission is including 25 core referenced futures contracts,
as well as any referenced contracts directly or indirectly linked
thereto, within the final Federal position limits framework. In
selecting the 25 core referenced futures contracts, the Commission
analyzed (1) the importance of these contracts to the operation of the
underlying cash commodity market, including that they require physical
delivery; and (2) the importance of the underlying commodity to the
economy as a whole. As discussed above, the Commission is of the view
that evidence demonstrating one or both of these factors is sufficient
to establish that position limits are necessary because each factor
relates to the statutory objective identified in CEA section
4a(a)(1).\1637\
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\1637\ See supra Section III.C. (discussing the necessity
findings as to the 25 core referenced futures contacts).
---------------------------------------------------------------------------
Of particular importance in the Commission's position limit regime
are the limits on the spot month, because the Commission believes that
deterring and preventing manipulative behaviors, such as corners and
squeezes, is more urgent during this period. The spot month position
limits are designed, among other things, to deter and prevent corners
and squeezes, as spot months are more susceptible to such activities
[[Page 3443]]
than non-spot months, as well as promote a more orderly liquidation
process at expiration.\1638\ By restricting derivatives positions to a
proportion of the deliverable supply of the commodity, the spot month
position limits reduce the possibility that a market participant can
use derivatives to affect the price of the cash commodity (and vice
versa).\1639\ Limiting a speculative position based on a percentage of
deliverable supply also restricts a speculative trader's ability to
establish a leveraged position in cash-settled derivative contracts,
diminishing that trader's incentive to manipulate the cash settlement
price. As the Commission has determined in the preamble, excessive
speculation or manipulation during the spot month may cause sudden or
unreasonable fluctuations or unwarranted changes in the price of the
commodities underlying these contracts.\1640\ In this way, the
Commission believes that the limits in the Final Rule benefit market
participants that seek to hedge the spot price of a commodity at
expiration, and benefit consumers who are able to purchase underlying
commodities for which prices are determined by fundamentals of supply
and demand, rather than influenced by excessive speculation,
manipulation, or other undue and unnecessary burdens on interstate
commerce.
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\1638\ See supra Sections II.A.19 and II.B.3.iii.
\1639\ See supra Section II.B.3.iii.
\1640\ See supra Section III.C. (discussing the necessity
finding).
---------------------------------------------------------------------------
The Commission believes that the Final Rule's Commission and
exchange-centric processes for granting exemptions from Federal
position limits, including non-enumerated bona fide hedging
recognitions, help ensure the hedging utility of the derivatives
markets for commercial end-users.
First, the Final Rule allows exchanges to leverage existing
processes and their knowledge of their own markets, including
participant positions and activities, along with their knowledge of the
underlying commodity cash market, which should allow for more timely
review of exemption applications than if the Commission were to conduct
such initial application reviews. This benefits the public by allowing
producers and end-users of a commodity to more efficiently and
predictably hedge their price risks, thus controlling costs that might
be passed on to the public.
Second, exchanges may be better-suited than the Commission to
leverage their knowledge of their own markets, including participant
positions and activities, along with their knowledge of the underlying
commodity cash market, in order to recognize whether an applicant
qualifies for an exemption and what the level for that exemption should
be. This benefits market participants and the public by helping assure
that exemption levels are set in a manner that meets the risk
management needs of the applicant without negatively impacting the
derivative and cash market for that commodity.
Third, allowing for self-effectuating spread exemptions for
purposes of Federal position limits could improve liquidity in all
months for a listed contract or across commodities, benefitting hedgers
by providing tighter bid-ask spreads for out-right trades. Furthermore,
traders using spreads can arbitrage price discrepancies between
calendar months within the same commodity contract or price
discrepancies between commodities, helping ensure that futures prices
more accurately reflect the underlying market fundamentals for a
commodity.
Lastly, the Commission will review each application for bona fide
hedge recognitions (other than those bona fide hedges that would be
self-effectuating under the Final Rule), but the Final Rule allows the
Commission to also leverage the exchange's knowledge and experience of
its own markets and market participants discussed above for market
participants that applies to the Commission by first submitting the
application for a non-enumerated bona fide hedge exemption to the
exchange for purposed of exchange-set limits under final Sec. 150.9.
Similarly, the Commission will review each application for a spread
exemption that is not covered by the spread transaction definition and
therefore is not self-effectuating for purposes of Federal position
limits.
The Commission also understands that there are costs to market
participants and the public to setting position limit levels that are
too high or too low. If the levels are set too high, there's greater
risk of excessive speculation, which may harm market participants and
the public. Further, to the extent that the limits are set at such a
level that even without these proposed exemptions, the probability of
nearing or breaching such levels may be negligible for most market
participants, benefits associated with such exemptions may be reduced.
Conversely, if the limits are set too low, transaction costs for
market participants who are near or above the limit will rise as they
transact in other instruments with higher transaction costs to obtain
their desired level of speculative positions. Additionally, limits that
are too low could incentivize speculators to leave the market and be
unavailable to provide liquidity for hedgers, resulting in ``choppy''
prices. It is also possible for limits that are set too low to harm
market efficiency because the views of some speculators might not be
reflected fully in the price formation process.
In setting the final Federal position limit levels, the Commission
considered these factors in order to implement to the maximum extent
practicable, as it finds necessary in its discretion, to apply the
position limits framework articulated in CEA section 4a(a) to set
Federal position limits to protect market integrity and price
discovery, thereby benefiting market participants and the public.
ii. Efficiency, Competitiveness, and Financial Integrity of Futures
Markets
Position limits help to prevent market manipulation or excessive
speculation that may unduly influence prices at the expense of the
efficiency and integrity of markets. The Final Rule's expansion of the
Federal position limits regime to 25 core referenced futures contracts
(e.g., the existing nine legacy agricultural contracts and the 16 new
contracts) enhances the buffer against excessive speculation
historically afforded exclusively to the nine legacy agricultural
contracts, improving the financial integrity of those markets.
Moreover, the limits in final Sec. 150.2 may promote market
competitiveness by preventing a trader from gaining too much market
power in the respective markets.
Also, in the absence of position limits, market participants may be
deterred from participating in a particular market if the market
participants perceive that there is a participant with an unusually
large speculative position exerting what they believe is unreasonable
market power. A lack of participation may harm liquidity, and
consequently, may harm market efficiency.
On the other hand, traders who find position limits overly
constraining may seek to trade in substitute instruments in order to
meet their demand for speculative instruments. The substitute
instruments could be futures contracts or swaps that are similar to or
highly correlated with their corresponding core referenced futures
contracts (but not otherwise deemed to be referenced contracts). They
could also be trade options or other forward contracts. These traders
may also decide to not trade beyond the Federal speculative position
limit.
[[Page 3444]]
Trading in substitute instruments may be less effective than
trading in referenced contracts. For example, the trading of futures
contracts has strong safeguards since futures contracts are by
definition exchange-traded, which includes (1) the posting of initial
and variation margin and (2) credit reviews and guarantees by futures
commission merchants. These safeguards protect the integrity of futures
markets but are generally not required for forward transactions, which
are generally not traded on exchanges or centrally cleared. Forward
contract nonperformance may result in dislocations in the physical
marketing channel, which may lead to higher prices for consumers and
end users and otherwise impose burdens on commerce. Further, with the
use of substitute instruments, futures prices might not fully reflect
all the speculative demand to hold the futures contract, because
substitute instruments may not fully influence prices the same way that
trading directly in the futures contract does. Thus, market efficiency
and price discovery might be harmed, too.
The Commission believes that focusing on the 25 core referenced
futures contracts (included any referenced contracts linked thereto),
which generally have high levels of open interest and trading volume
and/or have been subject to existing Federal position limits for many
years, should, in general, be less disruptive for the respective
derivatives markets, which in turn may reduce the potential for
disruption for the price discovery function of the underlying commodity
markets as compared to including less liquid contracts (only to the
extent that the Commission is able to make the requisite necessity
finding for such contracts).
Finally, the Commission believes that eliminating certain risk
management positions as bona fide hedges, coupled with the increased
non-spot month limit levels for most of the nine legacy agricultural
contracts, will foster competition among swap dealers by subjecting all
market participants, including all swap dealers, to the same non-spot
month limit rather than limited staff-granted risk management
exemptions. Accommodating risk management activity by additional
entities with higher position limit levels may also help lessen the
concentration risk potentially posed by a few commodity index traders
holding exemptions that are not available to competing market
participants.
iii. Price Discovery
As discussed above, market manipulation may result in artificial or
distorted prices.\1641\ Similarly, excessive speculation may result in
``sudden or unreasonable fluctuations or unwarranted changes in the
price of such commodity.'' \1642\ Position limits may help to prevent
the price discovery function of the underlying commodity markets from
being disrupted.\1643\ Also, in the absence of position limits, market
participants might elect to trade less as a result of a perception that
the market pricing does not reflect market forces, as a consequence of
what they perceive is the exercise of too much market power by a
concentration of several or one larger speculator. This reduced trading
may result in a reduction in liquidity, which may have a negative
impact on price discovery.
---------------------------------------------------------------------------
\1641\ See supra Section II.A.16. (discussing the referenced
contract definition).
\1642\ See supra Section III.A. (discussing the necessity
finding).
\1643\ Id.
---------------------------------------------------------------------------
On the other hand, imposing position limits raises the concerns
that liquidity and price discovery may be diminished, because certain
market segments, i.e., speculative traders, are restricted. For certain
commodities, the Final Rule sets the levels of position limits at
increased levels, to avoid harming liquidity that may be provided by
speculators that would establish large positions, while restricting
speculators from establishing extraordinarily large positions. The
Commission further believes that the bona fide hedging recognition and
exemption processes will foster liquidity and potentially improve price
discovery by making it more efficient for market participants to apply
for bona fide hedging recognitions and spread exemptions.
In addition, position limits may serve as a prophylactic measure
that reduces market volatility due to a participant otherwise engaging
in large quantity trades in a short time interval that induce price
impacts that interfere with price discovery. In particular, spot month
position limits make it more difficult to mark the close of a futures
contract to possibly benefit other contracts that settle on the closing
futures price. Marking the close harms markets by spoiling convergence
between futures prices and spot prices at expiration and by damaging
price discovery.
iv. Sound Risk Management Practices
The Final Rule promotes sound risk management practices by
providing exemptions for bona fide hedgers to hedge their corresponding
risk. In addition, the Commission crafted the Final Rule to ensure
sufficient market liquidity for bona fide hedgers to the maximum extent
practicable, e.g., by: (1) Creating a bona fide hedging definition that
is broad enough to accommodate common commercial hedging practices,
including anticipatory hedging, for a variety of commodity types; (2)
maintaining the status quo with respect to existing bona fide hedge
recognitions and spread exemptions that will remain self-effectuating
and make additional bona fide hedges and spreads self-effectuating
(i.e., certain anticipatory hedging); (3) providing additional ability
for a streamlined process where market participants can make a single
submission to an exchange in which the exchange and Commission will
each review applications for non-enumerated bona fide hedge
recognitions for purposes of Federal and exchange-set limits that are
in line with commercial hedging practices; and (4) allowing for a
conditional spot month limit exemption in natural gas.
To the extent that monitoring for position limits requires market
participants to create internal risk limits and evaluate position size
in relation to the market, position limits may also provide an
incentive for market participants to engage in sound risk management
practices. Further, sound risk management practices will be promoted by
the Final Rule to allow for market participants to measure risk in the
manner most suitable for their business (i.e., net versus gross hedging
practices), rather than having to conform their hedging programs to a
one-size-fits-all standard that may not be suitable for their risk
management needs. Finally, generally increasing non-spot month limit
levels for the nine legacy agricultural contracts to levels that
reflect observed levels of trading activity, based on recent data
reviewed by the Commission, should allow swap dealers, liquidity
providers, market makers, and others who have risk management needs,
but who are not hedging a physical commercial, to soundly manage their
risks.
v. Other Public Interest
The Commission has not identified any additional public interest
considerations related to the costs and benefits of this Final Rule.
B. Paperwork Reduction Act
1. Overview
Certain provisions of the Final Rule amend or impose new
``collection of information'' requirements as that term
[[Page 3445]]
is defined under the Paperwork Reduction Act (``PRA'').\1644\ An agency
may not conduct or sponsor, and a person is not required to respond to,
a collection of information unless it displays a valid control number
from the Office of Management and Budget (``OMB''). The Final Rule
modifies the following existing collections of information previously
approved by OMB and for which the Commodity Futures Trading Commission
(``Commission'') has received control numbers: (i) OMB control number
3038-0009 (Large Trader Reports), which generally covers Commission
regulations in parts 15 through 21; (ii) OMB control number 3038-0013
(Aggregation of Positions), which covers Commission regulations in part
150; \1645\ and (iii) OMB control number 3038-0093 (Provisions Common
to Registered Entities), which covers Commission regulations in part
40.
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\1644\ 44 U.S.C. 3501 et seq.
\1645\ Currently, OMB control number 3038-0013 is titled
``Aggregation of Positions.'' The Commission is renaming the OMB
control number ``Position Limits'' to better reflect the nature of
the information collections covered by that OMB control number.
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The Commission requested that OMB approve and revise OMB control
numbers 3038-0009, 3038-0013, and 3038-0093 in accordance with 44
U.S.C. 3507(d) and 5 CFR 1320.11.
2. Commission Reorganization of OMB Control Numbers 3038-0009 and 3038-
0013
The Commission requested two non-substantive changes so that all
collections of information related solely to the Commission's position
limit requirements are consolidated under one OMB control number.\1646\
First, the Commission is transferring collections of information under
part 19 (Reports by Persons Holding Bona Fide Hedge Positions and By
Merchants and Dealers in Cotton) related to position limit requirements
from OMB control number 3038-0009 to OMB control number 3038-0013.
Second, the modified OMB control number 3038-0013 is renamed as
``Position Limits.'' This renaming change is non-substantive and allows
for all collections of information related to the Federal position
limits requirements, including exemptions from speculative position
limits and related large trader reporting, to be housed in one
collection.
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\1646\ The Commission notes that certain collections of
information under OMB control number 3038-0093 relate to several
Commission regulations in addition to the Commission's final
position limits framework. As a result, the collections of
information discussed herein under this OMB control number 3038-0093
are not being consolidated under OMB control number 3038-0013.
---------------------------------------------------------------------------
A single collection makes it easier for market participants to know
where to find the relevant position limits PRA burdens. The remaining
collections of information under OMB control number 3038-0009 cover
reports by various entities under parts 15, 17, and 21 \1647\ of the
Commission's regulations, while OMB control number 3038-0013 holds
collections of information arising from parts 19 and 150.
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\1647\ As noted above, OMB control number 3038-0009 generally
covers Commission regulations in parts 15 through 21. However, it
does not cover Sec. Sec. 16.02, 17.01, 18.04, or 18.05, which are
under OMB control number 3038-0103. 78 FR at 69200 (transferring
Sec. Sec. 16.02, 17.01, 18.04, and 18.05 to OMB Control Number
3038-0103).
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As discussed in Section 3 below, this non-substantive
reorganization results in: (i) A decreased burden estimate under
control number 3038-0009 due to the transfer of the collection of
information arising from obligations in part 19; and (ii) a
corresponding increase of the amended part 19 burdens under control
number 3038-0013. However, as discussed further below, the collection
of information and burden hours arising from revised part 19 that is
transferred to OMB control number 3038-0013 is less than the existing
burden estimate under OMB control number 3038-0009 since the Final Rule
amends existing part 19 by eliminating existing Form 204 and certain
parts of Form 304 and the reporting burdens related thereto. As a
result, market participants will see a net reduction of collections of
information and burden hours under revised part 19.
3. Collections of Information
The Final Rule amends existing regulations, and creates new
regulations, concerning speculative position limits. Among other
amendments, the Final Rule includes: (1) New and amended Federal spot-
month limits for the 25 core referenced futures contracts; (2) amended
Federal non-spot limits for the nine legacy agricultural contracts
subject to existing Federal position limits; (3) amended rules
governing exchange-set limit levels and grants of exemptions therefrom;
(4) an amended process for requesting certain spread exemptions and
non-enumerated bona fide hedge recognitions for purposes of Federal
position limits directly from the Commission; (5) a new streamlined
process for recognizing non-enumerated bona fide hedge positions from
Federal limit requirements; and (6) amendments to part 19 and related
provisions that eliminate certain reporting obligations that require
traders to submit a Form 204 and Parts I and II of Form 304.
Specifically, the Final Rule amends parts 15, 17, 19, 40, and 150
of the Commission's regulations to implement the revised Federal
position limits framework. The Final Rule also transfers an amended
version of the ``bona fide hedging transactions or positions''
definition from existing Sec. 1.3 to final Sec. 150.1, and removes
Sec. Sec. 1.47, 1.48, and 140.97. The Final Rule revises existing
collections of information covered by OMB control number 3038-0009 by
amending part 19,\1648\ along with conforming changes to part 15, in
order to narrow the scope of who is required to report under part
19.\1649\
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\1648\ See supra Section IV.B.2 (discussing the transfer of
information collection under part 19 from OMB control number 3038-
0009 to 3038-0013).
\1649\ As noted above, the Commission accomplishes this by
eliminating existing Form 204 and Parts I and II of Form 304.
Additionally, changes to part 17, covered by OMB control number
3038-0009, make conforming amendments to remove certain duplicative
provisions and associated information collections related to
aggregation of positions, which are in existing Sec. 150.4. These
conforming changes do not impact the burden estimates of OMB control
number 3038-0009.
---------------------------------------------------------------------------
Furthermore, the Final Rule's amendments to part 150 revise
existing collections of information covered by OMB control number 3038-
0013, including new reporting and recordkeeping requirements related to
the application and request for relief from Federal position limit
requirements submitted to exchanges. Finally, the Final Rule amends
part 40 to incorporate a new reporting obligation into the definition
of ``terms and conditions'' in Sec. 40.1(j) and results in a revised
existing collection of information covered by OMB control number 3038-
0093.
i. OMB Control Number 3038-0009--Large Trader Reports; Part 19--Reports
by Persons Holding Bona Fide Hedge Positions and by Merchants and
Dealers in Cotton
Under OMB control number 3038-0009, the Commission currently
estimates that the collections of information related to existing part
19, including Form 204 and Form 304, collectively known as the ``series
`04'' reports, have a combined annual burden hours of 1,553 hours.
Under existing part 19, market participants that hold bona fide hedging
positions in excess of position limits for the nine legacy agricultural
contracts subject to existing Federal position limits must file a
monthly report on Form 204 (or Parts I and II of Form 304 for cotton).
These reports show a snapshot of traders' cash
[[Page 3446]]
positions on one given day each month, and are used by the Commission
to determine whether a trader has sufficient cash positions to justify
futures and options on futures positions above the applicable Federal
position limits in existing Sec. 150.2.
The Final Rule amends part 19 to remove these reporting obligations
associated with Form 204 and Parts I and II of Form 304. As discussed
under final Sec. 150.9 below, the Commission has determined to
eliminate these forms because the Commission will still receive
adequate information to carry out its market and financial surveillance
programs since its amendments to Sec. Sec. 150.5 and 150.9 enable the
Commission to obtain the necessary information from the exchanges. To
effect these changes to traders' reporting obligations, the Commission
is eliminating (i) existing Sec. 19.00(a)(1), which requires the
applicable persons to file a Form 204; and (ii) existing Sec. 19.01,
which among other things, sets forth the cash-market information
required to be submitted on Forms 204 and 304.\1650\ The Commission is
maintaining Part III of Form 304, which requests information on
unfixed-price ``on call'' purchases and sales of cotton and which the
Commission utilizes to prepare its weekly cotton on-call report.\1651\
The Commission is also maintaining its existing special call authority
under part 19.
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\1650\ As noted above, the amendments to part 19 affect certain
provisions of part 15 and Sec. 17.00. Based on the elimination of
Form 204 and Parts I and II of Form 304, as discussed above, the
Commission is adopting conforming technical changes to remove
related reporting provisions from (i) the ``reportable position''
definition in Sec. 15.00(p); (ii) the list of ``persons required to
report'' in Sec. 15.01; and (iii) the list of reporting forms in
Sec. 15.02. These conforming amendments to part 15 do not impact
the existing burden estimates.
\1651\ The Commission is adopting a conforming technical change
to Part III of Form 304 to require traders to identify themselves on
the Form 304 using their Public Trader Identification Number, in
lieu of the CFTC Code Number required on previous versions of the
Form 304. However, the Commission has determined that this does not
result in any change to its existing PRA estimates with respect to
the collections of information related to Part III of Form 304.
---------------------------------------------------------------------------
The supporting statement for the current active information
collection request for part 19 under OMB control number 3038-0009
\1652\ states that in 2014: (i) 135 reportable traders filed the series
`04 reports (i.e., Form 204 and Form 304 in the aggregate), (ii)
totaling 3,105 series `04 reports, for a total of (iii) 1,553 burden
hours.\1653\ However, based on more current and recent 2019 submission
data, the Commission has revised its existing estimates slightly higher
for the series `04 reports under part 19:
---------------------------------------------------------------------------
\1652\ See ICR Reference No: 201906-3038-008.
\1653\ 3,105 Series '04 submissions x 0.5 hours per submission =
1,553 aggregate burden hours for all submissions. The Commission
notes that it has estimated that it takes approximately 20 minutes
to complete a Form 204 or 304. However, in order to err
conservatively, the Commission now uses a figure of 30 minutes.
[GRAPHIC] [TIFF OMITTED] TR14JA21.014
Accordingly, based on the above revised estimates, the Commission
is revising its estimate of the current collections of information
under existing part 19 to reflect that approximately 105 reportable
traders \1654\ file a total of 3,460 responses annually \1655\
resulting in an aggregate annual burden of 1,730
hours.1656 1657 The Final Rule reduces the current OMB
control number 3038-0009 by these revised burden estimates under part
19 as they will be transferred to OMB control number 3038-0013.
---------------------------------------------------------------------------
\1654\ 55 Form 304 reports + 50 Form 204 reports = 105
reportable traders.
\1655\ 2,860 Form 304s + 600 Form 204s = 3,460 total annual
series '04 reports.
\1656\ 3,460 series `04 reports x 0.5 hours per report = 1,730
annual aggregate burden hours.
\1657\ These revised estimates result in an increased estimate
under existing part 19 of 355 series '04 reports submitted by
traders (3,460 estimated series '04 reports-3,105 submissions from
the Commission's previous estimate = an increase of 355 response
difference); an increase of 177 aggregate burden hours across all
respondents (1,730 aggregate burden hours-1,553 aggregate burden
hours from the Commission's previous estimate = an increase of 177
aggregate burden hours); and a decrease of 30 respondent traders
(105 respondents-135 respondents from the Commission's previous
estimate = a decrease of 30 respondents).
---------------------------------------------------------------------------
With respect to the overall collections of information transferred
to OMB control number 3038-0013 based on the Commission's revised part
19 estimate, the Commission estimates that the Final Rule reduces the
collections of information in part 19 by 600 reports \1658\ and by 300
annual aggregate burden hours since the Final Rule eliminates Form 204,
as discussed above.\1659\ The Commission does not expect a change in
the number of reportable traders that are required to file Part III of
Form 304.\1660\ Thus, the Commission continues to expect approximately
55 weekly Form 304 reports, for an annual total of 2,860 reports \1661\
for an aggregate total of 1,430 burden hours, which information
collection burdens will be transferred to OMB control number 3038-
0013.\1662\
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\1658\ 50 monthly Form 204 reports x 12 months = 600 total
annual reports.
\1659\ 600 Form 204 reports x 0.5 burden hours per report = 300
aggregate annual burden hours.
\1660\ Since the Final Rule eliminates Parts I and II of Form
304, amended Form 304 only refers to existing Part III of that form.
\1661\ 55 weekly Form 304 reports x 52 weeks = 2,860 total
annual Form 304 reports.
\1662\ 2,860 Form 304 reports x 0.5 burden hours per report =
1,430 aggregate annual burden hours.
---------------------------------------------------------------------------
In addition, the Commission is maintaining its authority to issue
special calls for information to any person claiming an exemption from
speculative Federal position limits. While the position limits
framework expands to traders in the 25 core referenced futures contacts
(an increase from the existing nine legacy agricultural products), the
position limit levels themselves are also generally higher. The higher
position limit levels result in a smaller universe of traders who may
exceed the position limits and thus be subject to a special call for
information on their large position(s). Taking into account the higher
limits
[[Page 3447]]
and smaller universe of traders who will likely exceed the position
limits, the Commission estimates that it is likely to issue a special
call for information to four reportable traders. The Commission
estimates that it will take approximately five hours to respond to a
special call. The Commission therefore estimates that industry will
incur a total of 20 aggregate annual burden hours.\1663\
---------------------------------------------------------------------------
\1663\ Four possible reportable traders x 5 hours each = 20
aggregate annual burden hours.
---------------------------------------------------------------------------
ii. OMB Control Number 3038-0013--Aggregation of Positions (Renaming
``Position Limits'')
a. Introduction; Bona Fide Hedge Recognition and Exemption Process
The Final Rule amends the existing process for market participants
to apply to obtain an exemption or recognition of a bona fide hedge
position. Currently, the ``bona fide hedging transaction or position''
definition appears in existing Sec. 1.3. Under existing Sec. Sec.
1.47 and 1.48, a market participant must apply directly to the
Commission to obtain a bona fide hedge recognition in accordance with
Sec. 1.3 for Federal position limit purposes.
Final Sec. Sec. 150.3 and 150.9 establish an amended process for
obtaining a bona fide hedge exemption or recognition, which includes:
(i) A new bona fide hedging definition in Sec. 150.1, (ii) a new
process administered by the exchanges in final Sec. 150.9 for
recognizing non-enumerated bona fide hedging positions for Federal
limit requirements, and (iii) an amended process to apply directly to
the Commission for certain spread exemptions or for recognition of non-
enumerated bona fide hedging positions in final Sec. 150.3. Final
Sec. 150.3 also includes new exemption types not explicitly listed in
existing Sec. 150.3.
The Commission has previously estimated the combined annual burden
hours for submitting applications under both Sec. Sec. 1.47 and 1.48
to be 42 hours.\1664\ The Final Rule largely maintains the existing
process where market participants may apply directly to the Commission,
although the Commission expects market participants to predominantly
rely on the streamlined process to obtain recognition of their non-
enumerated bona fide hedging positions for purposes of Federal position
limit requirements. Enumerated bona fide hedge positions remain self-
effectuating, which means that market participants do not need to apply
to the Commission for purposes of Federal position limits, although
market participants still need to apply to an exchange for recognition
of bona fide hedge positions for purposes of exchange-set position
limits. The Commission expects market participants to rely on the
streamlined exchange process because all the contracts that are now
subject to Federal position limits are already subject to exchange-set
limits. Thus, most market participants are likely to already be
familiar with an exchange-administered process, as adopted under Sec.
150.9. Familiarity with an exchange-administered process will result in
operational efficiencies, such as completing one application for non-
enumerated bona fide hedge requests for both Federal and exchange-set
limits and thus a reduced burden on market participants.
---------------------------------------------------------------------------
\1664\ The supporting statement for a previous information
collection request, ICR Reference No: 201808-3038-003, for OMB
control number 3038-0013, estimated that seven respondents would
file the Sec. Sec. 1.47 and 1.48 submissions, and that each
respondent would file two submissions for a total of 14 annual
submissions, requiring 3 hours per response, for a total of 42
burden hours for all respondents.
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As previously discussed, the Final Rule moves the ``bona fide hedge
transaction or position'' definition to final Sec. 150.1. The Final
Rule maintains the distinction between enumerated and non-enumerated
bona fide hedges, and market participants are required to apply for
recognition of non-enumerated bona fide hedge positions either directly
from the Commission pursuant to Sec. 150.3 or through an exchange-
centric process under Sec. 150.9.\1665\ The Commission does not
believe that this amendment has any PRA impacts since it is maintaining
the status quo in which enumerated bona fide hedges are self-
effectuating while requiring traders to apply to the Commission or an
exchange for recognition of non-enumerated bona fide hedge positions.
---------------------------------------------------------------------------
\1665\ Currently, in order to determine whether a futures or an
option on futures as a bona fide hedge, either (1) the position in
question must qualify as an enumerated bona fide hedge, as defined
in existing Sec. 1.3, or (2) the trader must file a statement with
the Commission, pursuant to existing Sec. 1.47 (for non-enumerated
bona fide hedges) and/or existing Sec. 1.48 (for enumerated
anticipatory bona fide hedges). The Commission does not expect this
change to have any PRA impacts.
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b. Sec. 150.2 Speculative Limits
Under final Sec. 150.2(f), upon request from the Commission, DCMs
listing a core referenced futures contract are required to supply to
the Commission deliverable supply estimates for each core referenced
futures contract listed at that DCM. DCMs are only required to submit
estimates if requested to do so by the Commission on an as-needed
basis. When submitting estimates, DCMs are required to provide a
description of the methodology used to derive the estimate, as well as
any statistical data supporting the estimate. Appendix C to part 38
sets forth guidance regarding estimating deliverable supply.
Submitting deliverable supply estimates upon demand from the
Commission for contracts subject to Federal position limits is a new
reporting obligation for DCMs. The Commission estimates that six DCMs
will be required to submit initial deliverable supply estimates. The
Commission estimates that it will request each DCM that lists a core
referenced futures contract to file one initial report for each core
reference futures contract it lists on its market. Such requests from
the Commission will result in one initial submission for each of the 25
core referenced futures contracts. The Commission further estimates
that it will take 20 hours to complete and file each report for a total
annual burden of 500 hours for all respondents.\1666\ Accordingly, the
changes to Sec. 150.2(f) result in an initial, one-time increase to
the current burden estimates of OMB control number 3038-0013 of 25
submissions across six respondent DCMs for the initial number of
submissions for the 25 core referenced futures contracts and an
initial, one-time burden of 500 hours.
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\1666\ 20 initial hours x 25 core referenced futures contracts =
500 one-time, aggregate burden hours. While there is an initial
annual submission, the Commission does not expect to require the
exchanges to resubmit the supply estimates on an annual basis.
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c. Sec. 150.3 Exemptions From Federal Position Limit Requirements
Market participants may currently apply directly to the Commission
for recognition of certain bona fide hedges under the process set forth
in existing Sec. Sec. 1.47 and 1.48. There is no existing process that
is codified under the Commission's regulations for spread exemptions or
other exemptions included under final Sec. 150.3.
Final Sec. 150.3(a) specifies the circumstances in which a trader
could exceed Federal position limits.\1667\ With respect to non-
enumerated bona fide hedge recognitions and spread exemptions not
identified in the proposed ``spread transaction'' definition in Sec.
150.1, final Sec. 150.3(b) provides a process for market participants
to request such non-
[[Page 3448]]
enumerated bona fide hedge recognitions or spread exemptions directly
from the Commission (as previously noted, both enumerated bona fide
hedges and spread exemptions identified in the proposed ``spread
transaction'' definition are self-effectuating and do not require a
market participant to submit an exemption request to the Commission).
Final Sec. 150.3(b), (d), and (e) sets forth exemption-related
reporting and recordkeeping requirements that impact the current burden
estimates in OMB control number 3038-0013.\1668\ The collection of
information under final Sec. 150.3(b), (d) and (e) is necessary for
the Commission to determine whether to recognize a trader's position
qualifies for one of the exemptions from Federal position limit
requirements listed in Sec. 150.3(a).
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\1667\ Final Sec. 150.3(b) includes (1) recognitions of bona
fide hedges under Sec. 150.3(b); (2) spread exemptions under Sec.
150.3(b); (3) financial distress positions a person could request
from the Commission under Sec. 140.99(a)(1); and (4) exemptions for
certain natural gas positions held during the spot month. Final
Sec. 150.3(b) also exempts pre-enactment and transition period
swaps. The enumerated bona fide hedge recognitions and spread
exemptions identified in the proposed ``spread transaction''
definition in Sec. 150.1 are self-effectuating.
\1668\ Final Sec. 150.3(f) clarifies the implications on
entities required to aggregate accounts under Sec. 150.4, and Sec.
150.3(g) provides for delegation of certain authorities to the
Director of the Division of Market Oversight. The changes to
Sec. Sec. 150.3(f) and 150.3(g) do not impact the current estimates
for these OMB control numbers. Also, the Final Rule reminds persons
of the relief provisions in Sec. 140.99, covered by OMB control
number 3038-0049, which does not impact the burden estimates.
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Final Sec. 150.3(b) establishes application filing requirements
and recordkeeping and reporting requirements that are similar to
existing requirements for bona fide hedge recognitions under existing
Sec. Sec. 1.47 and 1.48. Although these requirements in final Sec.
150.3 are new for market participants seeking spread exemptions (which
are currently self-effectuating), the filing, recordkeeping, and
reporting requirements in Sec. 150.3(b) are otherwise familiar to
market participants that have requested certain bona fide hedging
recognitions from the Commission under existing regulations.
The Commission estimates that very few or no traders will request
recognition of a non-enumerated bona fide hedge, and any traders that
do would likely prefer the streamlined process in final Sec. 150.9
(discussed further below) rather than applying directly to the
Commission under final Sec. 150.3(b). Similarly, the Commission
estimates that very few or no traders will submit a request for a
spread exemption since the Commission has determined that the most
common spread exemptions are included in the ``spread transaction''
definition and therefore are self-effectuating and do not need
Commission approval for purposes of Federal position limits. The
Commission expects that traders are likely to rely on the Sec.
150.3(b) process when dealing with a spread transaction or non-
enumerated bona fide hedge position that poses a novel or complex
question under the Commission's rules. Particularly when the exchanges
have not recognized a particular hedging strategy as a non-enumerated
bona fide hedge previously, the Commission expects market participants
to seek more regulatory clarity under Sec. 150.3(b). In the event a
trader submits such request under Sec. 150.3, the Commission estimates
that traders would file one request per year for a total of one annual
request for all respondents. The Commission further estimates that in
such situation, it would take 20 hours to complete and file each
report, for a total of 20 aggregate annual burden hours for all
traders.
Final Sec. 150.3(d) establishes recordkeeping requirements for
persons who claim any exemptions or relief under Sec. 150.3. Section
150.3(d) should help to ensure that if any person claims any exemption
permitted under Sec. 150.3 such exemption holder can demonstrate
compliance with the applicable requirements as follows:
First, under Sec. 150.3(d)(1), any person claiming an exemption is
required to keep and maintain complete books and records concerning
certain details.\1669\ Section 150.3(d)(1) establishes recordkeeping
requirements for any person relying on an exemption permitted under
final Sec. 150.3(a). Under Sec. 150.3(d), the Commission estimates
that 425 traders will create five records each, per year, for a total
of 2,125 annual records for respondents. The Commission further
estimates that it will take one hour to comply with the recordkeeping
requirement of Sec. 150.3(d)(1) for a total of five aggregate annual
burden hours for each trader.
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\1669\ The requirement includes all details of related cash,
forward, futures, options on futures, and swap positions and
transactions (including anticipated requirements, production,
merchandising activities, royalties, contracts for services, cash
commodity products and by-products, cross-commodity hedges, and
records of bona fide hedging swap counterparties).
---------------------------------------------------------------------------
Second, under Sec. 150.3(d)(2), a pass-through swap counterparty,
as defined by Sec. 150.1, that relies on a written representation
received from a bona fide hedging swap counterparty that the swap
qualifies in good faith as a ``bona fide hedging position or
transaction,'' as defined under Sec. 150.1, is required to: (i)
Maintain the relevant books and records of any such written
representation for at least two years following the expiration of the
swap; and (ii) furnish any books and records of such written
representation to the Commission upon request. Section 150.3(d)(2)
creates a new recordkeeping obligation for certain persons relying on
the pass-through swap representations, and the Commission estimates
that 425 traders will be requested to maintain the required records.
The Commission estimates that each trader will maintain at least five
records per year for a total of 2,125 aggregate annual records for all
respondents. The Commission further estimates that it will take one
hour to comply with the recordkeeping requirement of Sec. 150.3(d) for
a total of five annual burden hours for each trader and 2,125 aggregate
annual burden hours for all traders.
The Commission is moving existing Sec. 150.3(b), which currently
allows the Commission or certain Commission staff to make special calls
to demand certain information regarding persons claiming exemptions, to
final Sec. 150.3(e), with some modifications to include swaps.\1670\
Together with the recordkeeping provision of Sec. 150.3(d), Sec.
150.3(e) should enable the Commission to monitor the use of exemptions
from speculative position limits and help to ensure that any person who
claims any exemption permitted by Sec. 150.3 can demonstrate
compliance with the applicable requirements. The Commission's existing
collection under existing Sec. 150.3 estimated that the Commission
issues two special calls per year for information related to
exemptions, and that each response to a special call for information
takes 3 burden hours to complete. This includes two burden hours to
fulfill reporting requirements and one burden hour related to
recordkeeping for an aggregate total for all respondents of six annual
burden hours, broken down into four aggregate annual burden hours for
reporting and two aggregate annual burden hours for
recordkeeping.\1671\
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\1670\ Final Sec. 150.3(e) refers to commodity derivative
contracts, whereas existing Sec. 150.3(b) refers to futures and
options on futures. The change results in the inclusion of swaps.
\1671\ The special call authority under part 19 and the special
call authority discussed under Sec. 150.3 are similar in nature;
however, part 19 applies to special calls regarding bona fide hedge
recognitions and related underlying cash-market positions while the
special calls under Sec. 150.3 applies to the other exemptions
under Sec. 150.3.
---------------------------------------------------------------------------
The Commission estimates that Sec. 150.3(e) imposes information
collection burdens related to special calls by the Commission on
approximately 18 additional respondents, for an estimated 20 special
calls per year.\1672\ The Commission
[[Page 3449]]
estimates that these 20 market participants will provide one submission
per year to respond to the special call for a total of 20 annual
submissions for all respondents. The Commission estimates it will take
a market participant approximately 10 hours to complete a response to a
special call. Therefore, the Commission estimates responses to special
calls for information will take an aggregate total of 200 burden hours
for all traders.\1673\ The Commission notes that it is also maintaining
its special call authority for reporting requirements under part 19
discussed above.
---------------------------------------------------------------------------
\1672\ 2 respondents subject to special calls under existing
Sec. 150.3 + 18 additional respondents under final Sec. 150.3 = 20
total respondents. The Commission estimates, at least during the
initial implementation period, that it is likely to issue more
special calls for information to monitor compliance with position
limits, particularly in the commodity markets that will now be
subject to Federal position limits for the first time.
\1673\ 20 special calls x 10 burden hours per call = 200 total
burden hours.
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d. Sec. 150.5 Exchange-Set Limits and Exemptions
Amendments to Sec. 150.5 refine the process, and establish non-
exclusive methodologies, by which exchanges may set exchange-level
limits and grant exemptions therefrom, including separate methodologies
for setting limit levels for contracts subject to Federal position
limits (Sec. 150.5(a)) and physical commodity derivatives not subject
to Federal position limits (Sec. 150.5(b)).\1674\ In compliance with
part 40 of the Commission's regulations, exchanges currently have
policies and procedures in place to address exemptions from exchange-
set limits through their rulebooks. The Commission expects that the
exchanges will accordingly update their rulebooks, both to conform to
new requirements and to incorporate the additional contracts that are
subject to Federal position limits for the first time into their
process for setting exchange-level limits and exemptions therefrom.
---------------------------------------------------------------------------
\1674\ Final Sec. 150.5 addresses exchange-set position limits
and exemptions therefrom, whereas final Sec. 150.9 addresses
Federal position limits and a streamlined process for purposes of
Federal position limits where an applicant may apply through an
exchange to the Commission for recognition of an non-enumerated bona
fide hedge for purposes of Federal position limits.
---------------------------------------------------------------------------
The collections of information related to amended rulebooks under
part 40 are covered by OMB control number 3038-0093. Separately, the
collections of information related to applications for exemptions from
exchange-set limits are covered by OMB control number 3038-0013.
Under final Sec. 150.5(a)(1), for any contract subject to a
Federal position limit, DCMs and, ultimately, SEFs, will be required to
establish exchange-set position limits for such contracts. Under final
Sec. 150.5(a)(2), exchanges that wish to grant exemptions from
exchange-set limits on commodity derivative contracts subject to
Federal position limits must require traders to file an application
that shows a request for a bona fide hedge recognition or exemption
conforms to a type that may be granted under final Sec. 150.3(a)(1)-
(4). Exchanges must require that such exchange-set limit exemption
applications be filed in advance of the date such position would be in
excess of the limits, but exchanges have the discretion to adopt rules
allowing traders to file bona fide hedging applications within five
business days after a trader took on such position due to sudden or
unforeseen increases in the trader's bona fide hedging needs. Final
Sec. 150.5(a)(2) also provides that exchanges must require that the
trader reapply for the exemption at least annually. Final Sec.
150.5(a)(4) requires each exchange to provide a monthly report showing
the disposition of any exemption application, including the recognition
of any position as a bona fide hedge, the exemption of any spread
transaction, the renewal, revocation, or modification of a previously
granted recognition or exemption, or the rejection of any
application.\1675\
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\1675\ Additionally, each report should include the following
details: (A) The date of disposition; (B) The effective date of the
disposition; (C) The expiration date of any recognition or
exemption; (D) Any unique identifier(s) the designated contract
market or swap execution facility may assign to track the
application, or the specific type of recognition or exemption; (E)
If the application is for an enumerated bona fide hedging
transaction or position, the name of the enumerated bona fide
hedging transaction or position listed in Appendix A to this part;
(F) If the application is for a spread transaction listed in the
spread transaction definition in Sec. 150.1, the name of the spread
transaction as it is listed in Sec. 150.1; (G) The identity of the
applicant; (H) The listed commodity derivative contract or
position(s) to which the application pertains; (I) The underlying
cash commodity; (J) The maximum size of the commodity derivative
position that is recognized by the designated contract market or
swap execution facility as a bona fide hedging transaction or
position, specified by contract month and by the type of limit as
spot month, single month, or all-months-combined, as applicable; (K)
Any size limitations or conditions established for a spread
exemption or other exemption; and (L) For a bona fide hedging
transaction or position, a concise summary of the applicant's
activity in the cash markets and swaps markets for the commodity
underlying the commodity derivative position for which the
application was submitted.
---------------------------------------------------------------------------
These collections of information related to exemptions from
exchange-set limits are necessary to ensure that such exchange-set
limits comply with Commission regulations, including that exchange
limits are no higher than the applicable Federal level; to establish
minimum standards needed for exchanges to administer the exchange's
position limits framework; and to enable the Commission to oversee an
exchange's exemptions process to ensure it does not undermine the
Federal position limits framework. In addition, the Commission will use
the information to confirm that exemptions are granted and renewed in
accordance with the types of exemptions that may be granted under final
Sec. 150.3(a)(1)-(4).
The Commission estimates under final Sec. 150.5(a) that 425
traders will submit applications to claim spread exemptions and bona
fide hedge recognitions from exchange-set position limits on commodity
derivatives contracts subject to Federal position limits set forth in
Sec. 150.2. The Commission estimates that each trader on average will
submit five applications to an exchange each year for a total of 2,125
applications for all respondents. The Commission further estimates that
it will take two hours to complete and file each application for a
total of 10 annual burden hours for each trader and 4,250 aggregate
burden hours for all traders.\1676\
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\1676\ To increase efficiency and reduce duplicative efforts,
the Final Rule permits an exchange to have a single process in place
that allows market participants to request non-enumerated bona fide
hedge recognitions from both Federal and exchange-set position
limits at the same time. The Commission believes that under a single
process, the estimated burdens under final Sec. 150.5(a) discussed
in this section for exemptions from exchange-set limits includes the
burdens under the Federal limit exemption process for non-enumerated
bona fide hedges under final Sec. 150.9 discussed below.
---------------------------------------------------------------------------
The Commission estimates under final Sec. 150.5(a)(4) that six
exchanges will provide monthly reports for an annual total of 72
monthly reports for all exchanges.\1677\ The Commission further
estimates that it will take five hours to complete and file each
monthly report for a total of 60 annual burden hours for each exchange
and 360 annual burden hours for all exchanges.\1678\
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\1677\ 6 exchanges x 12 months = 72 total monthly reports per
year.
\1678\ 5 hours per monthly report x 12 months = 60 hours per
year for each exchange. 60 annual hours x 6 exchanges = 360
aggregate annual hours for all exchanges.
---------------------------------------------------------------------------
Final Sec. 150.5(b) requires exchanges, for physical commodity
derivatives that are not subject to Federal position limits, to set
limits during the spot month and to set either limits or accountability
outside of the spot month. Under Sec. 150.5(b)(3), where multiple
exchanges list contracts that are substantially the same, including
physically-settled contracts that have the same underlying commodity
and delivery location, or cash-settled contracts that are directly or
indirectly linked to a physically-settled contract, the exchange must
either adopt ``comparable'' limits for such contracts, or demonstrate
to the Commission how
[[Page 3450]]
the non-comparable levels comply with the standards set forth in Sec.
150.5(b)(1) and (2). Such a determination also must address how the
levels are necessary and appropriate to reduce the potential threat of
market manipulation or price distortion of the contract's or the
underlying commodity's price or index. Final Sec. 150.5(b)(3) is
intended to help ensure that position limits established on one
exchange do not jeopardize market integrity or otherwise harm other
markets. This provision may also improve the efficiency with which
exchanges adopt limits on newly-listed contracts that compete with an
existing contract listed on another exchange and help reduce the amount
of time and effort needed for Commission staff to assess the new limit
levels. Further, Sec. 150.5(b)(3) is consistent with the Commission's
determination to generally apply equivalent Federal position limits to
linked contracts, including linked contracts listed on multiple
exchanges.
The Commission estimates that under Sec. 150.5(b)(3), six
exchanges will make submissions to demonstrate to the Commission how
the non-comparable levels comply with the standards set forth in Sec.
150.5(b)(1) and (2). The Commission estimates that each exchange on
average will make three submissions each year for a total of 18
submissions for all exchanges. The Commission further estimates that it
will take 10 hours to complete and file each submission for a total of
18 annual burden hours for each exchange and 180 burden hours for all
exchanges.\1679\
---------------------------------------------------------------------------
\1679\ 18 estimated annual submissions x 10 burden hours per
submission = 180 aggregate annual burden hours.
---------------------------------------------------------------------------
Final Sec. 150.5(b)(4) permits exchanges to grant exemptions from
any exchange limit established for physical commodity contracts not
subject to Federal position limits. To grant such exemptions, exchanges
must require traders to file an application to show whether the
requested exemption from exchange-set limits is in accord with sound
commercial practices in the relevant commodity derivative market and/or
that may be established and liquidated in an orderly fashion in that
market. This collection of information is necessary to confirm that any
exemptions granted from exchange limits on physical commodity contracts
not subject to Federal position limits do not pose a threat of market
manipulation or congestion, and maintains orderly execution of
transactions. The Commission estimates that 200 traders will submit one
application each year and that each application will take approximately
two hours to complete, for an aggregate total of 400 burden hours per
year for all traders.
Final Sec. 150.5(e) reflects that, consistent with the definition
of ``rule'' in existing Sec. 40.1, any exchange action establishing or
modifying position limits or exemptions therefrom, or position
accountability, in any case pursuant to Sec. 150.5(a), (b), or (c),
including related guidance in Appendices F or G, to part 150, qualifies
as a ``rule'' and must be submitted to the Commission pursuant to part
40 of the Commission's regulations. Final Sec. 150.5(e) further
provides that exchanges are required to review regularly any position
limit levels established under Sec. 150.5 to ensure the level
continues to comply with the requirements of those sections. The
Commission estimates under Sec. 150.5(e) that six exchanges will
submit revised rulebooks to satisfy their compliance obligations under
part 40. The Commission estimates that each exchange on average will
make one initial revision of its rulebook to reflect the new position
limit framework for a total of six applications for all exchanges. The
Commission further estimates that it will take 30 hours to revise a
rulebook for a total of 30 annual burden hours for each exchange and
180 burden hours for all exchanges.\1680\
---------------------------------------------------------------------------
\1680\ 6 initial applications x 30 burden hours = 180 initial
aggregate burden hours.
---------------------------------------------------------------------------
This collection of information is necessary to ensure that the
exchanges' rulebooks reflect the most up-to-date rules and requirements
in compliance with the position limits framework. The information is
used to confirm that exchanges are complying with their requirements to
regularly review any position limit levels established under Sec.
150.5.
e. Sec. 150.9 Exchange Process for Bona Fide Hedge Recognitions From
Federal Position Limits
Final Sec. 150.9 establishes a new streamlined process in which a
trader could apply through an exchange to request a non-enumerated bona
fide hedging recognition for purposes of Federal position limits. As
part of the process, final Sec. 150.9 creates certain recordkeeping
and reporting obligations on the market participant and the exchange,
including: (i) An application to request non-enumerated bona fide hedge
recognitions, which the trader submits to the exchange and which the
exchange subsequently provides to the Commission if the exchange
approves the application for purposes of exchange-set limits; (ii) a
notification to the Commission and the applicant of the exchange's
determination for purposes of exchange limits regarding the trader's
request for recognition of a bona fide hedge or spread exemption; (iii)
and a requirement to maintain full, complete and systematic records for
Commission review of the exchange's decisions. The Commission believes
that the exchanges that will elect to process applications for non-
enumerated bona fide hedging exemptions under Sec. 150.9(a) already
have similar processes for the review and disposition of such exemption
applications in place through their rulebooks for purposes of exchange-
set position limits.
Accordingly, the estimated burden on an exchange to comply with
final Sec. 150.9 will be less burdensome because the exchanges may
leverage their existing policies and procedures to comply with the
Final Rule. The Commission estimates that six exchanges will elect to
process applications for non-enumerated bona fide hedge recognitions
that satisfy the Federal position limit requirements under final Sec.
150.9, and will be required to file amended rulebooks pursuant to part
40 of the Commission's regulations. The Commission bases its estimate
on the number of exchanges that have submitted similar rules to the
Commission in the past.
Final Sec. 150.9(c) requires a trader to submit an application
with certain information to enable the exchange to determine whether it
should recognize a position as a bona fide hedge for purposes of
exchange-set position limits. Each applicant will need to reapply to
the exchange for its non-enumerated bona fide hedge recognition at
least on an annual basis by updating its original application. The
Commission expects that traders will benefit from the streamlined
framework established under final Sec. 150.9 because traders may
submit one application to obtain a non-enumerated bona fide hedge
recognition for purposes of both exchange-set and Federal position
limits, as opposed to submitting separate applications to the
Commission for Federal position limit purposes and separate
applications to an exchange for exchange limit purposes.\1681\
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\1681\ The Commission believes the collections of information
set forth above are necessary for the exchange to process requests
for recognition of non-enumerated bona fide hedges for purposes of
exchange-set position limits, and separately, if applicable, for the
Commission to make its determination for purposes of Federal
position limits. The information is used by the exchange to
determine, and the Commission to review and determine, whether the
facts and circumstances demonstrate it is appropriate to recognize a
position as a non-enumerated bona fide hedging transaction or
position.
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[[Page 3451]]
Accordingly, the estimated burden for traders requesting non-
enumerated bona fide hedge recognitions from exchange-set limits under
Sec. 150.5(a) will subsume the burden estimates in connection with
final Sec. 150.9 for requesting non-enumerated bona fide hedge
recognition's from Federal position limits since the Commission
believes exchanges will combine the two processes (i.e., any trader who
applies through an exchange under final Sec. 150.9 for a non-
enumerated bona fide hedge for Federal position limits purposes also
will be deemed to be applying at the same time under final Sec.
150.5(a) for exchange position limits purposes and thus it would not be
appropriate to distinguish between the two for PRA purposes).
Accordingly, the Commission anticipates that six exchanges each will
receive only one application for a non-enumerated bona fide hedge
recognition under final Sec. 150.9 for a total of six aggregate annual
applications for all exchanges; however, as noted above, this amount is
included in the Commission's estimate in connection with final Sec.
150.5(a).\1682\ Specifically, as discussed above in connection with
final Sec. 150.5(a), the Commission estimates under final Sec. Sec.
150.5(a) and 150.9(a) that 425 traders will submit applications to
claim exemptions and/or bona fide hedge recognitions for contracts
subject to Federal position limits as set forth in Sec. 150.2.\1683\
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\1682\ As discussed above, the process and estimated burdens
under final Sec. 150.9 do not apply to Sec. 150.5(b) because final
Sec. 150.5(b) applies to those physical commodity contracts that
are not subject to Federal position limits (as opposed to final
Sec. 150.5(a), which applies to those contracts subject to Federal
position limits). As a result, a trader that would use the process
established under Sec. 150.5(b) for exchange-set limits will not
need to apply under final Sec. 150.9 since the traders would not
need a bona fide hedge recognition or an exemption from Federal
position limits.
\1683\ As discussed in connection with final Sec. 150.5(a)
above, the Commission estimates that each trader on average will
make five applications each year for a total of 2,125 applications
across all exchanges. The Commission further estimates that, for
final Sec. Sec. 150.5(a) and 150.9(a), taken together, it will take
two hours to complete and file each application for a total of 10
annual burden hours for each trader and 4,250 aggregate annual
burden hours for all traders (2,125 total annual applications x two
burden hours per application = 4,250 aggregate annual burden hours).
The Commission anticipates that compared to final Sec. 150.5(a),
fewer traders will apply under final Sec. 150.9 since final Sec.
150.9 applies only to non-enumerated bona fide hedge recognitions
for Federal purposes. In comparison, while final Sec. 150.5
encompasses these same applications for non-enumerated bona fide
hedge recognitions (but for the purpose of exchange-set limits),
final Sec. 150.5(a) also includes enumerated bona fide hedge
applications along with spread exemption requests. The Commission's
estimate of 4,250 aggregate annual burden hours encompasses all such
requests from all traders. However, for the sake of clarity, the
Commission anticipates that six exchanges each will receive one
application per year for a non-enumerated bona fide hedge under
final Sec. 150.9 (for a total of six applications across all
exchanges); as noted, this burden is included in the Commission's
estimate of 425 respondents in connection with its estimate under
final Sec. 150.5(a).
---------------------------------------------------------------------------
Final Sec. 150.9(d) requires exchanges to keep full, complete, and
systematic records, including all pertinent data and memoranda, of all
activities relating to the processing of such applications and the
disposition thereof. In addition, as provided for in final Sec.
150.9(g) and existing Sec. 1.31, the Commission may, in its
discretion, at any time, review the exchange's records retained
pursuant to final Sec. 150.9(d) or request additional information
pursuant to Sec. 150.9(e)(5). The recordkeeping requirement is
necessary for the Commission to review the exchanges' processes,
retention of records, and compliance with requirements established and
implemented under this section.
Final Sec. 150.9(d) creates a new recordkeeping obligation
consistent with the standards in existing Sec. 1.31.\1684\ The
Commission estimates that six exchanges will each create one record in
connection with final Sec. 150.9 each year for a total of six annual
records for all respondents. The Commission further estimates that it
will take five hours to comply with the recordkeeping requirement of
Sec. 150.9(d) for a total of five annual burden hours for each
exchange and 30 aggregate annual burden hours across all exchanges.
---------------------------------------------------------------------------
\1684\ Consistent with existing Sec. 1.31, the Commission
expects that these records will be readily available during the
first two years of the required five-year recordkeeping period for
paper records, and readily accessible for the entire five-year
recordkeeping period for electronic records. In addition, the
Commission expects that records required to be maintained by an
exchange pursuant to this section will be readily accessible during
the pendency of any application, and for two years following any
disposition that did not recognize a derivative position as a bona
fide hedge.
---------------------------------------------------------------------------
Final Sec. 150.9(d) allows the Commission to inspect such books
and records.\1685\ In the event the Commission exercises its authority
to inspect such books and records, it estimates that the Commission
will conduct an inspection of two exchanges per year and each exchange
will incur four hours to make its books and records available to the
Commission for review for a total of eight aggregate annual burden
hours for the two estimated respondent exchanges.\1686\
---------------------------------------------------------------------------
\1685\ Final Sec. 150.9(d)(1) requires the exchange to keep
full, complete, and systematic records, which include all pertinent
data and memoranda, of all activities relating to the processing of
such applications and the disposition thereof. This requirement
working in concert with Sec. 1.31 allows the Commission to inspect
any such records. Separately, under Sec. 150.9(e)(5), if the
Commission determines additional information is required to conduct
its review, then it would notify the exchange and the relevant
market participant of any issues identified and provide them with an
opportunity to provide supplemental information.
\1686\ 2 exchanges per year subject to a Commission inspection x
4 hours per inspection request = 8 aggregate annual burden hours for
all exchanges.
---------------------------------------------------------------------------
Under final Sec. 150.9(e), an exchange needs to provide an
applicant and the Commission with notice of any approved application of
an exchange's determination to recognize bona fide hedges with respect
to its own position limits for purposes of exceeding the Federal
position limits. The notification requirement is necessary to inform
the Commission of the details of the type of bona fide hedge
recognitions being granted. The information is used to keep the
Commission informed as to the manner in which an exchange administers
its application procedures, and the exchange's rationale for permitting
large positions.
The Commission estimates that under final Sec. 150.9(e), six
exchanges will submit notifications of approved application of an
exchange's determination to recognize non-enumerated bona fide hedges
for purposes of exceeding the Federal position limits. The Commission
estimates that each exchange on average will make two notifications:
One notification each to the applicant trader and to the Commission
each year for a total of 12 notices for all exchanges. The Commission
further estimates that it will take 0.5 hours to complete and file each
notification for a total of one annual burden hour for each exchange
and six burden hours for all exchanges.\1687\
---------------------------------------------------------------------------
\1687\ Twelve notices for all exchanges x 0.5 hours per notice =
six total burden hours across all exchanges.
---------------------------------------------------------------------------
In addition to submitting a copy of any exchange-approved non-
enumerated bona fide hedge application to the Commission under Sec.
150.9(e), the preamble clarifies that an exchange may, on a voluntary
basis, send the Commission an advance courtesy copy of the non-
enumerated bona fide hedge application when the exchange first receives
it from the applicant. Although this advance courtesy copy would be a
voluntary submission, it is still considered a new information
collection under the PRA. However, the Commission believes there is no
corresponding burden for this filing because the Commission considers
this practice to be in the ordinary course of business as it is usual
and customary for exchanges to provide the Commission with advance
copies of various filings under other Commission
[[Page 3452]]
regulations.\1688\ In the event that this practice is not considered
usual and customary, the Commission estimates that the burden of such
filing will be de minimis and take less than five minutes for an
exchange to send an application to the Commission, if the exchange
elects to do so (less than 30 total minutes in the aggregate across all
exchanges: 6 exchanges x 1 advance copy x less than 5 minutes = less
than 30 minutes).
---------------------------------------------------------------------------
\1688\ For example, exchanges have frequently submitted advance
courtesy copies of new rule filings and product filings to the
Commission under the part 40 regulations.
---------------------------------------------------------------------------
iii. OMB Control Number 3038-0093--Provisions Common to Registered
Entities
a. Sec. 150.9(a)
Under final Sec. 150.9(a), exchanges that would like for their
market participants to be able to exceed Federal position limits based
on a non-enumerated bona fide hedge recognition granted by the exchange
with respect to its own limits must maintain rules that establish
processes consistent with the provisions of final Sec. 150.9 and must
seek approval of such rules from the Commission pursuant to Sec. 40.5
of the Commission's regulations. The collection of information is
necessary to capture the new non-enumerated bona fide hedge process in
the exchanges' rulebook, which is subject to Commission approval. The
information is used to assess the process put in place by each exchange
submitting amended rulebooks.
The Commission has previously estimated the combined annual burden
hours for both Sec. Sec. 40.5 and 40.6 to be 7,000 hours.\1689\ Upon
implementation of final Sec. 150.9, the Commission estimates that six
exchanges will each make one initial Sec. 40.5 rule filing per year
for a total of six one-time initial submissions for all exchanges. The
Commission further estimates that the exchanges will employ a
combination of in-house and outside legal and compliance counsel to
update existing rulebooks and it will take 25 hours to complete and
file each rule for a total 25 one-time burden hours for each exchange
and 150 one-time burden hours for all exchanges.
---------------------------------------------------------------------------
\1689\ The supporting statement for the current active
information collection request, ICR Reference No: 201503-3038-002,
for OMB control number 3038-0013, estimated that seven respondents
would file the Sec. Sec. 1.47 and 1.48 reports, and that each
respondent would file two reports for a total of 14 annual
responses, requiring three hours per response, for a total of 42
burden hours for all respondents.
---------------------------------------------------------------------------
C. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires that agencies
consider whether the rules they propose will have a significant
economic impact on a substantial number of small entities and, if so,
provide a regulatory flexibility analysis respecting the impact.\1690\
A regulatory flexibility analysis or certification typically is
required for ``any rule for which the agency publishes a general notice
of proposed rulemaking pursuant to'' the notice-and-comment provisions
of the Administrative Procedure Act, 5 U.S.C. 553(b).\1691\ The
requirements related to the Final Rule fall mainly on registered
entities, exchanges, FCMs, swap dealers, clearing members, foreign
brokers, and large traders. The Commission has previously determined
that registered DCMs, FCMs, swap dealers, major swap participants,
eligible contract participants, SEFs, clearing members, foreign brokers
and large traders are not small entities for purposes of the RFA.\1692\
---------------------------------------------------------------------------
\1690\ 44 U.S.C. 601 et seq.
\1684\ 5 U.S.C. 601(2), 603-05.
\1692\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618-19, (Apr. 30, 1982) (DCMs, FCMs, and large traders)
(``RFA Small Entities Definitions''); Opting Out of Segregation, 66
FR 20740-20743, (Apr. 25, 2001) (eligible contract participants);
Position Limits for Futures and Swaps; Final Rule and Interim Final
Rule, 76 FR 71626, 71680, (Nov. 18, 2011) (clearing members); Core
Principles and Other Requirements for Swap Execution Facilities, 78
FR 33476, 33548, (Jun. 4, 2013) (SEFs); A New Regulatory Framework
for Clearing Organizations, 66 FR 45604, 45609, (Aug. 29, 2001)
(DCOs); Registration of Swap Dealers and Major Swap Participants, 77
FR 2613, Jan. 19, 2012, (swap dealers and major swap participants);
and Special Calls, 72 FR 50209, (Aug. 31, 2007) (foreign brokers).
---------------------------------------------------------------------------
Further, while the requirements under this rulemaking may impact
nonfinancial end users, the Commission notes that position limits
levels apply only to large traders. Accordingly, the Chairman, on
behalf of the Commission, hereby certifies, on behalf of the
Commission, pursuant to 5 U.S.C. 605(b), that the actions taken herein
will not have a significant economic impact on a substantial number of
small entities. The Chairman made the same certification in the 2013
Proposal,\1693\ the 2016 Supplemental Proposal,\1694\ the 2016
Reproposal,\1695\ and the 2020 NPRM.\1696\
---------------------------------------------------------------------------
\1693\ See 2013 Proposal, 78 FR at 75784.
\1694\ See 2016 Supplemental Proposal, 81 FR at 38499.
\1695\ See 2016 Reproposal, 81 FR at 96894.
\1696\ See 2020 NPRM, 85 FR at 11708.
---------------------------------------------------------------------------
D. Antitrust Considerations
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA, in issuing any order or adopting any Commission
rule or regulation.\1697\ The Commission believes that the public
interest to be protected by the antitrust laws is generally to protect
competition. In the Proposal, the Commission requested comments on
whether: (1) The proposed rules could be anticompetitive; (2) there are
other less anticompetitive means of deterring and preventing price
manipulation or any other disruptions to market integrity; and (3)
requiring DCOs to impose initial margin surcharges in lieu of imposing
position limits is feasible.
---------------------------------------------------------------------------
\1697\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The Commission does not anticipate that the position limits regime
that it is adopting today will result in anticompetitive behavior. To
the contrary, the Commission believes that the relatively high position
limit levels (coupled with the numerous exemptions from position limits
adopted as part of this rulemaking) do not establish any barriers to
entry or competitive restraints. As noted above, the Commission
encouraged comments from the public on any aspect of the rulemaking
that may have the potential to be inconsistent with the antitrust laws
or be anticompetitive in nature. The Commission received two (2)
comments asserting that the proposed rule may be anticompetitive.
ICE commented that it has concerns regarding the potential
anticompetitive aspects of the Commission's approach to aggregation of
contracts across all exchanges rather than on a per exchange
basis.\1698\ In particular, ICE asserted that the aggregation of
referenced contracts across all exchanges by the Commission fails to
comply with the requirements of Section 15(b) of the CEA that requires
the Commission take into consideration the public interest to be
protected by the antitrust laws and endeavor to take the least
anticompetitive means of achieving the purposes of the CEA.\1699\ ICE
noted that an aggregated Federal position limit, across all exchanges,
may make it very difficult for an exchange to launch a new contract or
that would be aggregated with an existing contract for position limit
purposes. In addition, ICE also indicated that launching a new exchange
may even be more difficult given the aggregate approach to position
limits across exchanges. The underlying
[[Page 3453]]
basis for ICE's assertion is that aggregation may potentially reduce
the ability of a new exchange or new contract to attract enough
liquidity to become sustainable. ICE argued that a more flexible
approach to aggregation of positions that allows each exchange to
develop its own liquidity (and establish its own limits), even for
similar or look-alike contracts, would better advance the goals of
developing robust and liquid markets while providing adequate means to
protect against excessive speculation.
---------------------------------------------------------------------------
\1698\ ICE at 12.
\1699\ ICE believes that this is particularly true for cash-
settled contracts and for other contracts outside of the delivery
month.
---------------------------------------------------------------------------
Similarly, FIA commented that the Commission's aggregation of
position limits across exchanges in connection with financially-settled
reference contracts ``will reduce innovation and competition between
exchanges because any new proposed financially-settled referenced
futures contracts will have to share the same liquidity pool with
existing financially-settled referenced futures contracts, including
economically-equivalent swaps.'' \1700\ Instead, FIA argued that
position limits should be established per designated contract spot
month limits for financially-settled referenced contracts and a
separate spot month limit should be established for economically-
equivalent swaps in order to enhance competition, innovation and
liquidity for bona fide hedgers.
---------------------------------------------------------------------------
\1700\ FIA at p. 8.
---------------------------------------------------------------------------
As an initial legal matter, the Commission interprets CEA section
4a(a)(6) to generally require aggregated Federal position limits across
exchanges. CEA section 4a(a)(6) requires the Commission to ``establish
limits . . . on the aggregate number or amount of positions . . .
across--(A) contracts listed by designated contract markets . . . .''
Accordingly, even if the Commission were to grant ICE's claim in
arguendo of possible anti-competitive affects, the requirement in CEA
section 4a(a)(6) that Federal position limits should apply in the
aggregate across exchanges is dispositive for the Commission's approach
under the Final Rule.\1701\
---------------------------------------------------------------------------
\1701\ As discussed in the preamble to this release, however,
the Commission is making an exception under its exemptive authority
for position limits in CEA section 4a(a)(7) for the NYMEX NG
referenced contracts, which will be subject to a per-exchange
position limit level, based on the unique liquidity characteristics
of the natural gas markets.
---------------------------------------------------------------------------
As stated above in Section II.B.10 of the preamble, the Commission
disagrees with comments by ICE and FIA asserting that generally the
aggregation of cash-settled positions across exchanges would impair
competition and provide a barrier to financial innovation. Both
commenters essentially advocate for a disaggregated Federal position
limit that applies on a per-exchange basis based on the notion that
this will promote and attract greater liquidity to the markets
regardless of the potential for manipulation and/or market disruption.
In contrast to these commenters' concerns, the Commission submits that
in general an aggregate position limit framework across exchanges
should promote, not prohibit, competition and therefore enhance
liquidity formation.\1702\ The ability to apply the Federal position
limits framework on a disaggregated basis would also significantly
increase position limits so that the potential risk of excessive
speculation and manipulation would become a much greater concern to the
Commission based on the ability of market participants to hold larger
positions in the aggregate across exchanges. Therefore, under the
approach supported by ICE and FIA, the Commission would be required to
re-adjust Federal position limits to a much lower level, potentially
impacting liquidity and future financial innovation. The Commission
also asserts that the application of the Federal position limit levels
across exchanges promotes innovation and competition in the marketplace
because the full aggregate position limit level is available for market
participants regardless of the particular trading venue/exchange,
which, by definition, promotes greater competition and significant
price discovery.
---------------------------------------------------------------------------
\1702\ The Commission believes that permitting Federal position
limits to apply on a disaggregated, per-exchange basis also has the
potential to further divide liquidity among several liquidity pools,
which could make accessing liquidity for bona fide hedgers more
difficult and reduce price discovery.
---------------------------------------------------------------------------
As noted in the 2020 NPRM and the preamble of this adopting
release,\1703\ the Commission is aware that exchanges may also have
conflicting and competing interests in connection with the adoption of
exchange position limits and accountability levels. Additionally, the
final rules with respect to exchange-set position limits require any
new commodity derivative contract to establish limits at a
``comparable'' level to existing contracts that are substantially
similar (i.e., ``look-alike contracts'') on other exchanges unless the
exchange listing the new contract demonstrates to the satisfaction of
Commission staff, in its product filing with the Commission, how its
levels comply with the requirements of Sec. 150.5(b)(1) and (2). This
requirement could potentially provide competitive advantages to the
``first mover'' exchange since such exchange could effectively
establish the position limit for all other exchanges that seek to list
and trade substantially similar contracts.
---------------------------------------------------------------------------
\1703\ See 85 FR 11596, 11677 at fn. 576; see also Section II.G.
(discussing the Sec. 150.9 process and the role of the exchanges)
and Section II.B.2 (discussing the role of exchanges in connection
with non-spot month limits under Sec. 150.2).
---------------------------------------------------------------------------
Although the Commission acknowledges these competitive concerns,
the Commission believes that these concerns are mitigated because (i)
an exchange is required to submit any proposed position limits to the
Commission under part 40 of the Commission's regulations and (ii) an
exchange is required pursuant to Sec. 150.5(b) to set limits that are
necessary and appropriate to reduce the potential threat of market
manipulation or price distortion of the contract's or the underlying
commodity's price or index. In addition, for those commodity derivative
contracts that are subject to a Federal speculative position limit
under Sec. 150.2, the limit set by the exchange can be no higher than
Federal speculative position limit specified in Sec. 150.2. The
Commission believes that exchanges have significant incentives to
maintain well-functioning markets to remain competitive with other
exchanges. Market participants may choose exchanges that are less
susceptible to sudden or unreasonable fluctuations or unwarranted
changes caused by excessive speculation or corners, squeezes, and
manipulation, which could, among other things, harm the price discovery
function of the commodity derivative contracts and negatively impact
the delivery of the underlying commodity, bona fide hedging strategies,
and market participants' general risk management.\1704\ Furthermore,
several academic studies, including one concerning futures exchanges
and another concerning demutualized stock exchanges, support the
conclusion that exchanges are able to both satisfy shareholder
interests and meet their self-regulatory organization
responsibilities.\1705\
---------------------------------------------------------------------------
\1704\ Kane, Stephen, Exploring price impact liquidity for
December 2016 NYMEX energy contracts, n.33, available at https://www.cftc.gov/sites/default/files/idc/groups/public/@economicanalysis/documents/file/oce_priceimpact.pdf.
\1705\ See David Reiffen and Michel A. Robe, Demutualization and
Customer Protection at Self-Regulatory Financial Exchanges, Journal
of Futures Markets, Vol. 31, 126-164, Feb. 2011 (in many
circumstances, an exchange that maximizes shareholder (rather than
member) income has a greater incentive to aggressively enforce
regulations that protect participants from dishonest agents); and
Kobana Abukari and Isaac Otchere, Has Stock Exchange Demutualization
Improved Market Quality? International Evidence, Review of
Quantitative Finance and Accounting, Dec 09, 2019, https://doi.org/10.1007/s11156-019-00863-y (demutualized exchanges have realized
significant reductions in transaction costs in the post-
demutualization period).
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[[Page 3454]]
The Commission has determined that the position limit rules adopted
today serve the regulatory purpose of the CEA ``to deter and prevent
price manipulation or any other disruptions to market integrity.''
\1706\ In addition, the Commission notes that the adopted position
limit rules implement additional purposes and policies set forth in
section 4a(a) of the CEA.\1707\ The Commission has considered the
rulemaking and related comments to determine whether it is
anticompetitive, and continues to believe that the position limits
rulemaking will not result in any unreasonable restraint of trade or
impose any material anticompetitive burden on trading in the markets.
---------------------------------------------------------------------------
\1706\ Section 3(b) of the CEA, 7 U.S.C. 5(b).
\1707\ 7 U.S.C. 7a(a) (burdens on interstate commerce; trading
or position limits).
---------------------------------------------------------------------------
Final Regulatory Text and Related Appendices
List of Subjects
17 CFR Part 1
Agricultural commodity, Agriculture, Brokers, Committees, Commodity
futures, Conflicts of interest, Consumer protection, Definitions,
Designated contract markets, Directors, Major swap participants,
Minimum financial requirements for intermediaries, Reporting and
recordkeeping requirements, Swap dealers, Swaps.
17 CFR Part 15
Brokers, Commodity futures, Reporting and recordkeeping
requirements, Swaps.
17 CFR Part 17
Brokers, Commodity futures, Reporting and recordkeeping
requirements, Swaps.
17 CFR Part 19
Commodity futures, Cottons, Grains, Reporting and recordkeeping
requirements, Swaps.
17 CFR Part 40
Commodity futures, Procedural rules, Reporting and recordkeeping
requirements.
17 CFR Part 140
Authority delegations (Government agencies), Conflict of interests,
Organizations and functions (Government agencies).
17 CFR Part 150
Bona fide hedging, Commodity futures, Cotton, Grains, Position
limits, Referenced Contracts, Swaps.
17 CFR Part 151
Bona fide hedging, Commodity futures, Cotton, Grains, Position
limits, Referenced Contracts, Swaps.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission amends 17 CFR chapter I as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
0
1. The authority citation for part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g,
6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8,
9, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24
(2012).
Sec. 1.3 [Amended]
0
2. In Sec. 1.3, remove the definition of the term ``bona fide hedging
transactions and positions for excluded commodities''.
PART 15--REPORTS--GENERAL PROVISIONS
0
3. The authority citation for part 15 continues to read as follows:
Authority: 7 U.S.C. 2, 5, 6a, 6c, 6f, 6g, 6i, 6k, 6m, 6n, 7,
7a, 9, 12a, 19, and 21, as amended by Title VII of the Dodd-Frank
Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124
Stat. 1376 (2010).
0
4. In Sec. 15.00, revise paragraph (p)(1) to read as follows:
Sec. 15.00 Definitions of terms used in parts 15 to 19, and 21 of
this chapter.
* * * * *
(p) * * *
(1) For reports specified in parts 17 and 18 and in Sec. 19.00(a)
and (b) of this chapter, any open contract position that at the close
of the market on any business day equals or exceeds the quantity
specified in Sec. 15.03 in either:
(i) Any one futures of any commodity on any one reporting market,
excluding futures contracts against which notices of delivery have been
stopped by a trader or issued by the clearing organization of the
reporting market; or
(ii) Long or short put or call options that exercise into the same
futures contract of any commodity, or other long or short put or call
commodity options that have identical expirations and exercise into the
same commodity, on any one reporting market.
* * * * *
0
5. In Sec. 15.01, revise paragraph (d) to read as follows:
Sec. 15.01 Persons required to report.
* * * * *
(d) Persons, as specified in part 19 of this chapter, who:
(1) Are merchants or dealers of cotton holding or controlling
positions for future delivery in cotton that equal or exceed the amount
set forth in Sec. 15.03; or
(2) Are persons who have received a special call from the
Commission or its designee under Sec. 19.00(b) of this chapter.
* * * * *
0
6. Revise Sec. 15.02 to read as follows:
Sec. 15.02 Reporting forms.
Forms on which to report may be obtained from any office of the
Commission or via https://www.cftc.gov. Listed below are the forms to
be used for the filing of reports. To determine who shall file these
forms, refer to the Commission rule listed in the column opposite the
form number.
[[Page 3455]]
[GRAPHIC] [TIFF OMITTED] TR14JA21.015
PART 17--REPORTS BY REPORTING MARKETS, FUTURES COMMISSION
MERCHANTS, CLEARING MEMBERS, AND FOREIGN BROKERS
0
7. The authority citation for part 17 continues to read as follows:
Authority: 7 U.S.C. 2, 6a, 6c, 6d, 6f, 6g, 6i, 6t, 7, 7a, and
12a.
0
8. In Sec. 17.00, revise paragraph (b) introductory text to read as
follows:
Sec. 17.00 Information to be furnished by futures commission
merchants, clearing members and foreign brokers.
* * * * *
(b) Interest in or control of several accounts. Except as otherwise
instructed by the Commission or its designee and as specifically
provided in Sec. 150.4 of this chapter, if any person holds or has a
financial interest in or controls more than one account, all such
accounts shall be considered by the futures commission merchant,
clearing member, or foreign broker as a single account for the purpose
of determining special account status and for reporting purposes.
* * * * *
0
9. In Sec. 17.03, add paragraph (i) to read as follows:
Sec. 17.03 Delegation of authority to the Director of the Office of
Data and Technology or the Director of the Division of Market
Oversight.
* * * * *
(i) Pursuant to Sec. 17.00(b), and as specifically provided in
Sec. 150.4 of this chapter, the authority shall be designated to the
Director of the Office of Data and Technology to instruct a futures
commission merchant, clearing member, or foreign broker to consider
otherwise than as a single account for the purpose of determining
special account status and for reporting purposes all accounts one
person holds or controls, or in which the person has a financial
interest.
0
10. Revise part 19 to read as follows:
PART 19--REPORTS BY PERSONS HOLDING REPORTABLE POSITIONS IN EXCESS
OF POSITION LIMITS, AND BY MERCHANTS AND DEALERS IN COTTON
Sec.
19.00 Who shall furnish information.
19.01 [Reserved]
19.02 Reports pertaining to cotton on call purchases and sales.
19.03 Delegation of authority to the Director of the Division of
Enforcement.
19.04-19.10 [Reserved]
Appendix A to Part 19--Form 304
Authority: 7 U.S.C. 6g, 6c(b), 6i, and 12a(5).
Sec. 19.00 Who shall furnish information.
(a) Persons filing cotton-on-call reports. Merchants and dealers of
cotton holding or controlling positions for future delivery in cotton
that are reportable pursuant to Sec. 15.00(p)(1)(i) of this chapter
shall file CFTC Form 304.
(b) Persons responding to a special call. All persons: Exceeding
speculative position limits under Sec. 150.2 of this chapter; or
holding or controlling positions for future delivery that are
reportable pursuant to Sec. 15.00(p)(1) of this chapter and who have
received a special call from the Commission or its designee shall file
any pertinent information as instructed in the special call. Filings in
response to a special call shall be made within one business day of
receipt of the special call unless otherwise specified in the call.
Such filing shall be transmitted using the format, coding structure,
and electronic data submission procedures approved in writing by the
Commission.
Sec. 19.01 [Reserved]
Sec. 19.02 Reports pertaining to cotton on call purchases and sales.
(a) Information required. Persons required to file CFTC Form 304
reports under Sec. 19.00(a) shall file CFTC Form 304 reports showing
the quantity of call cotton bought or sold on which the price has not
been fixed, together with the respective futures on which the purchase
or sale is based. As used herein, call cotton refers to spot cotton
bought or sold, or contracted for purchase or sale at a price to be
fixed later based upon a specified future.
(b) Time and place of filing reports. Each CFTC Form 304 report
shall be made weekly, dated as of the close of business on Friday, and
filed not later than 9 a.m. Eastern Time on the third business day
following that Friday using the format, coding structure, and
electronic data transmission procedures approved in writing by the
Commission.
[[Page 3456]]
Sec. 19.03 Delegation of authority to the Director of the Division
of Enforcement.
(a) The Commission hereby delegates, until it orders otherwise, the
authority in Sec. 19.00(b) to issue special calls to the Director of
the Division of Enforcement, or such other employee or employees as the
Director may designate from time to time.
(b) The Commission hereby delegates, until it orders otherwise, to
the Director of the Division of Enforcement, or such other employee or
employees as the Director may designate from time to time, the
authority in Sec. 19.00(b) to provide instructions or to determine the
format, coding structure, and electronic data transmission procedures
for submitting data records and any other information required under
this part.
(c) The Director of the Division of Enforcement may submit to the
Commission for its consideration any matter which has been delegated in
this section.
(d) Nothing in this section prohibits the Commission, at its
election, from exercising the authority delegated in this section.
Sec. Sec. 19.04--19.10 [Reserved]
Appendix A to Part 19--Form 304
BILLING CODE 6351-01-P
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PART 40--PROVISIONS COMMON TO REGISTERED ENTITIES
0
11. The authority citation for part 40 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 7, 7a, 8 and 12, as amended by
Titles VII and VIII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Public Pub. L. 111-203, 124 Stat. 1376
(2010).
0
12. In Sec. 40.1, revise paragraphs (j)(1)(vii) and (j)(2)(vii) to
read as follows:
Sec. 40.1 Definitions.
* * * * *
(j) * * *
(1) * * *
(vii) Speculative position limits, position accountability
standards, and position reporting requirements, including an indication
as to whether the contract meets the definition of a referenced
contract as defined in Sec. 150.1 of this chapter, and, if so, the
name of either the core referenced futures contract or other referenced
contract upon which the new referenced contract submitted under this
part 40 is based.
* * * * *
(2) * * *
(vii) Speculative position limits, position accountability
standards, and position reporting requirements, including an indication
as to whether the contract meets the definition of economically
equivalent swap as defined in Sec. 150.1 of this chapter, and, if so,
the name of either the core referenced futures contract or referenced
contract, as applicable, to which the swap submitted under this part 40
is economically equivalent.
* * * * *
PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION
0
13. The authority citation for part 140 continues to read as follows:
Authority: 7 U.S.C. 2(a) (12), 12a, 13(c), 13(d), 13(e), and
16(b).
Sec. 140.97 [Removed and Reserved]
0
14. Remove and reserve Sec. 140.97.
PART 150--LIMITS ON POSITIONS
0
15. The authority citation for part 150 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6c, 6f, 6g, 6t, 12a, and
19, as amended by Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
0
16. Revise Sec. 150.1 to read as follows:
Sec. 150.1 Definitions.
As used in this part--
Bona fide hedging transaction or position means a transaction or
position in commodity derivative contracts in a physical commodity,
where:
(1) Such transaction or position:
(i) Represents a substitute for transactions made or to be made, or
positions taken or to be taken, at a later time in a physical marketing
channel;
(ii) Is economically appropriate to the reduction of price risks in
the conduct and management of a commercial enterprise; and
(iii) Arises from the potential change in the value of--
(A) Assets which a person owns, produces, manufactures, processes,
or merchandises or anticipates owning, producing, manufacturing,
processing, or merchandising;
(B) Liabilities which a person owes or anticipates incurring; or
(C) Services that a person provides or purchases, or anticipates
providing or purchasing; or
(2) Such transaction or position qualifies as a:
(i) Pass-through swap and pass-through swap offset pair. Paired
positions of a pass-through swap and a pass-through swap offset, where:
(A) The pass-through swap is a swap position entered into by one
person for which the swap would qualify as a bona fide hedging
transaction or position pursuant to paragraph (1) of this definition
(the bona fide hedging swap counterparty) that is opposite another
person (the pass-through swap counterparty);
(B) The pass-through swap offset:
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(1) Is a futures contract position, option on a futures contract
position, or swap position entered into by the pass-through swap
counterparty; and
(2) Reduces the pass-through swap counterparty's price risks
attendant to the pass-through swap; and
(C) With respect to the pass-through swap offset, the pass-through
swap counterparty receives from the bona fide hedging swap counterparty
a written representation that the pass-through swap qualifies as a bona
fide hedging transaction or position pursuant to paragraph (1) of this
definition, and the pass-through swap counterparty may rely in good
faith on such written representation, unless the pass-through swap
counterparty has information that would cause a reasonable person to
question the accuracy of the representation; or
(ii) Offset of a bona fide hedger's qualifying swap position. A
futures contract position, option on a futures contract position, or
swap position entered into by a bona fide hedging swap counterparty
that reduces price risks attendant to a previously-entered-into swap
position that qualified as a bona fide hedging transaction or position
at the time it was entered into for that counterparty pursuant to
paragraph (1) of this definition.
Commodity derivative contract means any futures contract, option on
a futures contract, or swap in a commodity (other than a security
futures product as defined in section 1a(45) of the Act).
Core referenced futures contract means a futures contract that is
listed in Sec. 150.2(d).
Economically equivalent swap means, with respect to a particular
referenced contract, any swap that has identical material contractual
specifications, terms, and conditions to such referenced contract.
(1) Other than as provided in paragraph (2) of this definition, for
the purpose of determining whether a swap is an economically equivalent
swap with respect to a particular referenced contract, the swap shall
not be deemed to lack identical material contractual specifications,
terms, and conditions due to different lot size specifications or
notional amounts, delivery dates diverging by less than one calendar
day, or different post-trade risk management arrangements.
(2) With respect to any natural gas referenced contract, for the
purpose of determining whether a swap is an economically equivalent
swap to such referenced contract, the swap shall not be deemed to lack
identical material contractual specifications, terms, and conditions
due to different lot size specifications or notional amounts, delivery
dates diverging by less than two calendar days, or different post-trade
risk management arrangements.
(3) With respect to any referenced contract or class of referenced
contracts, the Commission may make a determination that any swap or
class of swaps satisfies, or does not satisfy, this economically
equivalent swap definition.
Eligible affiliate means an entity with respect to which another
person:
(1) Directly or indirectly holds either:
(i) A majority of the equity securities of such entity, or
(ii) The right to receive upon dissolution of, or the contribution
of, a majority of the capital of such entity;
(2) Reports its financial statements on a consolidated basis under
Generally Accepted Accounting Principles or International Financial
Reporting Standards, and such consolidated financial statements include
the financial results of such entity; and
(3) Is required to aggregate the positions of such entity under
Sec. 150.4 and does not claim an exemption from aggregation for such
entity.
Eligible entity means a commodity pool operator; the operator of a
trading vehicle which is excluded, or which itself has qualified for
exclusion from the definition of the term ``pool'' or ``commodity pool
operator,'' respectively, under Sec. 4.5 of this chapter; the limited
partner, limited member or shareholder in a commodity pool the operator
of which is exempt from registration under Sec. 4.13 of this chapter;
a commodity trading advisor; a bank or trust company; a savings
association; an insurance company; or the separately organized
affiliates of any of the above entities:
(1) Which authorizes an independent account controller
independently to control all trading decisions with respect to the
eligible entity's client positions and accounts that the independent
account controller holds directly or indirectly, or on the eligible
entity's behalf, but without the eligible entity's day-to-day
direction; and
(2) Which maintains:
(i) Only such minimum control over the independent account
controller as is consistent with its fiduciary responsibilities to the
managed positions and accounts, and necessary to fulfill its duty to
supervise diligently the trading done on its behalf; or
(ii) If a limited partner, limited member or shareholder of a
commodity pool the operator of which is exempt from registration under
Sec. 4.13 of this chapter, only such limited control as is consistent
with its status.
Entity means a ``person'' as defined in section 1a of the Act.
Excluded commodity means an ``excluded commodity'' as defined in
section 1a of the Act.
Futures-equivalent means:
(1)(i) An option contract, whether an option on a futures contract
or an option that is a swap, which has been:
(A) Adjusted by an economically reasonable and analytically
supported exposure to price changes of the underlying referenced
contract that has been computed for that option contract as of the
previous day's close or the current day's close or computed
contemporaneously during the trading day, and
(B) Converted to an economically equivalent amount of an open
position in the underlying referenced contract.
(ii) An entity is allowed one business day to liquidate an amount
of the position that is in excess of speculative position limits
without being considered in violation of the speculative position
limits if such excess position results from:
(A) A position that exceeds speculative position limits as a result
of an option contract assignment; or
(B) A position that includes an option contract that exceeds
speculative position limits when the applicable option contract is
adjusted by an economically reasonable and analytically supported
exposure to price changes of the underlying referenced contract as of
that business day's close of trading, as long as the applicable option
contract does not exceed such speculative position limits when
evaluated using the previous business day's exposure to the underlying
referenced contract. This paragraph (B) shall not apply if such day
would be the last trading day of the spot month for the corresponding
core referenced futures contract.
(2) A futures contract which has been converted to an economically
equivalent amount of an open position in a core referenced futures
contract; and
(3) A swap which has been converted to an economically equivalent
amount of an open position in a core referenced futures contract.
Independent account controller means a person:
(1) Who specifically is authorized by an eligible entity, as
defined in this section, independently to control trading decisions on
behalf of, but without the day-to-day direction of, the eligible
entity;
(2) Over whose trading the eligible entity maintains only such
minimum control as is consistent with its fiduciary responsibilities
for managed
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positions and accounts to fulfill its duty to supervise diligently the
trading done on its behalf or as is consistent with such other legal
rights or obligations which may be incumbent upon the eligible entity
to fulfill;
(3) Who trades independently of the eligible entity and of any
other independent account controller trading for the eligible entity;
(4) Who has no knowledge of trading decisions by any other
independent account controller; and
(5) Who is:
(i) Registered as a futures commission merchant, an introducing
broker, a commodity trading advisor, or an associated person of any
such registrant, or
(ii) A general partner, managing member or manager of a commodity
pool the operator of which is excluded from registration under Sec.
4.5(a)(4) of this chapter or Sec. 4.13 of this chapter, provided that
such general partner, managing member or manager complies with the
requirements of Sec. 150.4(c).
Long position means, on a futures-equivalent basis, a long call
option, a short put option, a long underlying futures contract, or a
swap position that is equivalent to a long futures contract.
Physical commodity means any agricultural commodity as that term is
defined in Sec. 1.3 of this chapter or any exempt commodity as that
term is defined in section 1a of the Act.
Position accountability means any bylaw, rule, regulation, or
resolution that:
(1) Is submitted to the Commission pursuant to part 40 of this
chapter in lieu of, or along with, a speculative position limit, and
(2) Requires an entity whose position exceeds the accountability
level to consent to:
(i) Provide information about its position to the designated
contract market or swap execution facility; and
(ii) Halt increasing further its position or reduce its position in
an orderly manner, in each case as requested by the designated contract
market or swap execution facility.
Pre-enactment swap means any swap entered into prior to enactment
of the Dodd-Frank Act of 2010 (July 21, 2010), the terms of which have
not expired as of the date of enactment of that Act.
Pre-existing position means any position in a commodity derivative
contract acquired in good faith prior to the effective date of any
bylaw, rule, regulation, or resolution that specifies a speculative
position limit level or a subsequent change to that level.
Referenced contract means:
(1) A core referenced futures contract listed in Sec. 150.2(d) or,
on a futures-equivalent basis with respect to a particular core
referenced futures contract, a futures contract or an option on a
futures contract, including a spread, that is either:
(i) Directly or indirectly linked, including being partially or
fully settled on, or priced at a fixed differential to, the price of
that particular core referenced futures contract; or
(ii) Directly or indirectly linked, including being partially or
fully settled on, or priced at a fixed differential to, the price of
the same commodity underlying that particular core referenced futures
contract for delivery at the same location or locations as specified in
that particular core referenced futures contract; or
(2) On a futures-equivalent basis, an economically equivalent swap.
(3) The definition of referenced contract does not include a
location basis contract, a commodity index contract, any guarantee of a
swap, a trade option that meets the requirements of Sec. 32.3 of this
chapter, any outright price reporting agency index contract, or any
monthly average pricing contract.
Short position means, on a futures-equivalent basis, a short call
option, a long put option, a short underlying futures contract, or a
swap position that is equivalent to a short futures contract.
Speculative position limit means the maximum position, either net
long or net short, in a commodity derivative contract that may be held
or controlled by one person absent an exemption, whether such limits
are adopted for:
(1) Combined positions in all commodity derivative contracts in a
particular commodity, including the spot month futures contract and all
single month futures contracts (the spot month and all single month
futures contracts, cumulatively, ``all-months-combined'');
(2) Positions in a single month of commodity derivative contracts
in a particular commodity other than the spot month futures contract
(``single month''); or
(3) Positions in the spot month of commodity derivative contacts in
a particular commodity. Such a limit may be established under Federal
regulations or rules of a designated contract market or swap execution
facility. For referenced contracts other than core referenced futures
contracts, single month means the same period as that of the relevant
core referenced futures contract.
Spot month means:
(1) For physical-delivery core referenced futures contracts, the
period of time beginning at the earlier of:
(i) The close of business on the trading day preceding the first
day on which delivery notices can be issued by the clearing
organization of a contract market or
(ii) The close of business on the trading day preceding the third-
to-last trading day and ending when the contract expires, except as
follows:
(A) For the ICE Futures U.S. Sugar No. 11 (SB) core referenced
futures contract, the spot month means the period of time beginning at
the opening of trading on the second business day following the
expiration of the regular option contract traded on the expiring
futures contract and ending when the contract expires;
(B) For the ICE Futures U.S. Sugar No. 16 (SF) core referenced
futures contract, the spot month means the period of time beginning on
the third-to-last trading day of the contract month and ending when the
contract expires; and
(C) For the Chicago Mercantile Exchange Live Cattle (LC) core
referenced futures contract, the spot month means the period of time
beginning at the close of trading on the first business day following
the first Friday of the contract month and ending when the contract
expires; and
(2) For referenced contracts other than core referenced futures
contracts, the spot month means the same period as that of the relevant
core referenced futures contract.
Spread transaction means an intra-market spread, inter-market
spread, intra-commodity spread, or inter-commodity spread, including a
calendar spread, quality differential spread, processing spread,
product or by-product differential spread, or futures-option spread.
Swap means ``swap'' as that term is defined in section 1a of the
Act and as further defined in Sec. 1.3 of this chapter.
Swap dealer means ``swap dealer'' as that term is defined in
section 1a of the Act and as further defined in Sec. 1.3 of this
chapter.
Transition period swap means a swap entered into during the period
commencing on the day of the enactment of the Dodd-Frank Act of 2010
(July 21, 2010), and ending 60 days after the publication in the
Federal Register of final amendments to this part implementing section
737 of the Dodd-Frank Act of 2010, the terms of which have not expired
as of 60 days after the publication date.
0
17. Revise Sec. 150.2 to read as follows:
Sec. 150.2 Federal speculative position limits.
(a) Spot month speculative position limits. For physical-delivery
referenced contracts and, separately, for cash-settled referenced
contracts, no person
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may hold or control positions in the spot month, net long or net short,
in excess of the levels specified by the Commission.
(b) Single month and all-months-combined speculative position
limits. For any referenced contract, no person may hold or control
positions in a single month or in all-months-combined (including the
spot month), net long or net short, in excess of the levels specified
by the Commission.
(c) Relevant contract month. For purposes of this part, for
referenced contracts other than core referenced futures contracts, the
spot month and any single month shall be the same as those of the
relevant core referenced futures contract.
(d) Core referenced futures contracts. Federal speculative position
limits apply to referenced contracts based on the following core
referenced futures contracts:
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(e) Establishment of speculative position limit levels. The levels
of Federal speculative position limits are fixed by the Commission at
the levels listed in appendix E to this part.
(f) Designated contract market estimates of deliverable supply.
Each designated contract market listing a core referenced futures
contract shall supply to the Commission an estimated spot month
deliverable supply upon request by the Commission, and may supply such
estimates to the Commission at any other time. Each estimate shall be
accompanied by a description of the methodology used to derive the
estimate and any statistical data supporting the estimate, and shall be
submitted using the format and procedures approved in writing by the
Commission. A designated contract market should use the guidance
regarding deliverable supply in appendix C to part 38 of this chapter.
(g) Pre-existing positions--(1) Pre-existing positions in a spot
month. A spot month speculative position limit established under this
section shall apply to pre-existing positions, other than pre-enactment
swaps and transition period swaps.
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(2) Pre-existing positions in a non-spot month. A single month or
all-months-combined speculative position limit established under this
section shall apply to pre-existing positions, other than pre-enactment
swaps and transition period swaps.
(h) Positions on foreign boards of trade. The speculative position
limits established under this section shall apply to a person's
combined positions in referenced contracts, including positions
executed on, or pursuant to the rules of, a foreign board of trade,
pursuant to section 4a(a)(6) of the Act, provided that:
(1) Such referenced contracts settle against any price (including
the daily or final settlement price) of one or more contracts listed
for trading on a designated contract market or swap execution facility
that is a trading facility; and
(2) The foreign board of trade makes available such referenced
contracts to its members or other participants located in the United
States through direct access to its electronic trading and order
matching system.
(i) Anti-evasion provision. For the purposes of applying the
speculative position limits in this section, if used to willfully
circumvent or evade speculative position limits:
(1) A commodity index contract, monthly average pricing contract,
outright price reporting agency index contract, and/or a location basis
contract shall be considered to be a referenced contract;
(2) A bona fide hedging transaction or position recognition or
spread exemption shall no longer apply; and
(3) A swap shall be considered to be an economically equivalent
swap.
(j) Delegation of authority to the Director of the Division of
Market Oversight. (1) The Commission hereby delegates, until it orders
otherwise, to the Director of the Division of Market Oversight or such
other employee or employees as the Director may designate from time to
time, the authority in paragraph (f) of this section to request
estimated spot month deliverable supply from a designated contract
market and to provide the format and procedures for submitting such
estimates.
(2) The Director of the Division of Market Oversight may submit to
the Commission for its consideration any matter which has been
delegated in this section.
(3) Nothing in this section prohibits the Commission, at its
election, from exercising the authority delegated in this section.
(k) Eligible affiliates and aggregation. For purposes of this part,
if an eligible affiliate meets the conditions for any exemption from
aggregation under Sec. 150.4, the eligible affiliate may choose to
utilize that exemption, or it may opt to be aggregated with its
affiliated entities.
0
18. Revise Sec. 150.3 to read as follows:
Sec. 150.3 Exemptions.
(a) Positions which may exceed limits. A person may exceed the
speculative position limits set forth in Sec. 150.2 to the extent that
all applicable requirements in this part are met, provided that such
person's transactions or positions each satisfy one of the following:
(1) Bona fide hedging transactions or positions. Positions that
comply with the bona fide hedging transaction or position definition in
Sec. 150.1, and are:
(i) Enumerated in appendix A to this part; or
(ii) Approved as non-enumerated bona fide hedging transactions or
positions in accordance with paragraph (b)(4) of this section or Sec.
150.9.
(2) Spread transactions. Transactions that:
(i) Meet the spread transaction definition in Sec. 150.1; or
(ii) Do not meet the spread transaction definition in Sec. 150.1,
but have been approved by the Commission pursuant to paragraph (b)(4)
of this section.
(3) Financial distress positions. Positions of a person, or a
related person or persons, under financial distress circumstances, when
exempted by the Commission from any of the requirements of this part in
response to a specific request made pursuant to Sec. 140.99(a)(1) of
this chapter, where financial distress circumstances include, but are
not limited to, situations involving the potential default or
bankruptcy of a customer of the requesting person or persons, an
affiliate of the requesting person or persons, or a potential
acquisition target of the requesting person or persons.
(4) Conditional spot month limit exemption positions in natural
gas. Spot month positions in natural gas cash-settled referenced
contracts that exceed the spot month speculative position limit set
forth in Sec. 150.2, provided that:
(i) Such positions do not exceed the futures-equivalent of 10,000
NYMEX Henry Hub Natural Gas core referenced futures contracts per
designated contract market that lists a cash-settled referenced
contract in natural gas;
(ii) Such positions do not exceed the futures-equivalent of 10,000
NYMEX Henry Hub Natural Gas core referenced futures contracts in
economically equivalent swaps in natural gas; and
(iii) The person holding or controlling such positions does not
hold or control positions in spot month physical-delivery referenced
contracts in natural gas.
(5) Pre-enactment and transition period swaps exemption. The
speculative position limits set forth in Sec. 150.2 shall not apply to
positions acquired in good faith in any pre-enactment swap or any
transition period swap, provided however that a person may net such
positions with post-effective date commodity derivative contracts for
the purpose of complying with any non-spot month speculative position
limit.
(b) Application for relief. Any person with a position in a
referenced contract seeking recognition of such position as a bona fide
hedging transaction or position in accordance with paragraph (a)(1)(ii)
of this section, or seeking an exemption for a spread position in
accordance with paragraphs (a)(2)(ii) of this section, in each case for
purposes of Federal speculative position limits set forth in Sec.
150.2, may apply to the Commission in accordance with this section.
(1) Required information. The application shall include the
following information:
(i) With respect to an application for recognition of a bona fide
hedging transaction or position:
(A) A description of the position in the commodity derivative
contract for which the application is submitted, including but not
necessarily limited to, the name of the underlying commodity and the
derivative position size;
(B) An explanation of the hedging strategy, including a statement
that the position complies with the requirements of section 4a(c)(2) of
the Act and the definition of bona fide hedging transaction or position
in Sec. 150.1, and information to demonstrate why the position
satisfies such requirements and definition;
(C) A statement concerning the maximum size of all gross positions
in commodity derivative contracts for which the application is
submitted;
(D) A description of the applicant's activity in the cash markets
and swaps markets for the commodity underlying the position for which
the application is submitted, including, but not necessarily limited
to, information regarding the offsetting cash positions; and
(E) Any other information that may help the Commission determine
whether the position satisfies the requirements of section 4a(c)(2) of
the Act and the definition of bona fide
[[Page 3469]]
hedging transaction or position in Sec. 150.1.
(ii) With respect to an application for a spread exemption:
(A) A description of the spread position for which the application
is submitted;
(B) A statement concerning the maximum size of all gross positions
in commodity derivative contracts for which the application is
submitted; and
(C) Any other information that may help the Commission determine
whether the position is consistent with section 4a(a)(3)(B) of the Act.
(2) Additional information. If the Commission determines that it
requires additional information in order to determine whether to
recognize a position as a bona fide hedging transaction or position or
to grant a spread exemption, the Commission shall:
(i) Notify the applicant of any supplemental information required;
and
(ii) Provide the applicant with ten business days in which to
provide the Commission with any supplemental information.
(3) Timing of application. (i) Except as provided in paragraph
(b)(3)(ii) of this section, a person seeking relief in accordance with
this section must apply to the Commission and receive a notice of
approval of such application prior to the date that the position for
which the application was submitted would be in excess of the
applicable Federal speculative position limit set forth in Sec. 150.2;
(ii) Due to demonstrated sudden or unforeseen increases in its bona
fide hedging needs, a person may apply for recognition of a bona fide
hedging transaction or position within five business days after the
person established the position that exceeded the applicable Federal
speculative position limit.
(A) Any application filed pursuant to paragraph (b)(3)(ii) of this
section must include an explanation of the circumstances warranting the
sudden or unforeseen increases in bona fide hedging needs.
(B) If an application filed pursuant to paragraph (b)(3)(ii) of
this section is denied, the person must bring its position within the
Federal speculative position limits within a commercially reasonable
time, as determined by the Commission in consultation with the
applicant and the applicable designated contract market or swap
execution facility.
(C) If an application filed pursuant to paragraph (b)(3)(ii) of
this section is denied, the Commission will not pursue an enforcement
action for a position limits violation for the person holding the
position during the period of the Commission's review nor once the
Commission has issued its determination so long as the application was
submitted in good faith and the person brings its position within the
Federal speculative position limits within a commercially reasonable
time in accordance with paragraph (b)(3)(ii)(B) of this section.
(4) Commission determination. After a review of any application
submitted under paragraph (b) of this section and any supplemental
information provided by the applicant, the Commission will determine,
with respect to the transaction or position for which the application
is submitted, whether to recognize all or a specified portion of such
transaction or position as a bona fide hedging transaction or position
or whether to exempt all or a specified portion of such spread
transaction, as applicable. The Commission shall notify the applicant
of its determination, and an applicant may exceed Federal speculative
position limits set forth in Sec. 150.2, or in the case of
applications filed pursuant to paragraph (b)(3)(ii) of this section,
the applicant may rely upon the Commission's determination, upon
receiving a notice of approval.
(5) Renewal of application. With respect to any application
approved by the Commission pursuant to this section, a person shall
renew such application if there are any material changes to the
information provided in the original application pursuant to paragraph
(b)(1) of this section or upon request by the Commission.
(6) Commission revocation or modification. If the Commission
determines, at any time, that a recognized bona fide hedging
transaction or position is no longer consistent with section 4a(c)(2)
of the Act or the definition of bona fide hedging transaction or
position in Sec. 150.1, or that a spread exemption is no longer
consistent with section 4a(a)(3)(B) of the Act, the Commission shall:
(i) Notify the person holding such position;
(ii) Provide an opportunity for the applicant to respond to such
notification; and
(iii) Issue a determination to revoke or modify the bona fide hedge
recognition or spread exemption for purposes of Federal speculative
position limits and, as applicable, require the person to reduce the
derivative position within a commercially reasonable time, as
determined by the Commission in consultation with the applicant and the
applicable designated contract market or swap execution facility, or
otherwise come into compliance. This notification shall briefly specify
the nature of the issues raised and the specific provisions of the Act
or the Commission's regulations with which the position or application
is, or appears to be, inconsistent.
(c) Previously-granted risk management exemptions. To the extent
that exemptions previously granted under Sec. 1.47 of this chapter or
by a designated contract market or a swap execution facility are for
the risk management of positions in financial instruments, including
but not limited to index funds, such exemptions shall no longer apply
as of January 1, 2023.
(d) Recordkeeping. (1) Persons who avail themselves of exemptions
under this section shall keep and maintain complete books and records
concerning all details of each of their exemptions, including relevant
information about related cash, forward, futures contracts, option on
futures contracts, and swap positions and transactions (including
anticipated requirements, production, merchandising activities,
royalties, contracts for services, cash commodity products and by-
products, cross-commodity hedges, and records of bona fide hedging swap
counterparties) as applicable, and shall make such books and records
available to the Commission upon request under paragraph (e) of this
section.
(2) Any person that relies on a written representation received
from another person that a swap qualifies as a pass-through swap under
paragraph (2) of the definition of bona fide hedging transaction or
position in Sec. 150.1 shall keep and make available to the Commission
upon request the relevant books and records of such written
representation, including any books and records that the person intends
to use to demonstrate that the pass-through swap is a bona fide hedging
transaction or position, for a period of at least two years following
the expiration of the swap.
(3) All books and records required to be kept pursuant to this
section shall be kept in accordance with the requirements of Sec. 1.31
of this chapter.
(e) Call for information. Upon call by the Commission, the Director
of the Division of Enforcement, or the Director's delegate, any person
claiming an exemption from speculative position limits under this
section shall provide to the Commission such information as specified
in the call relating to: the positions owned or controlled by that
person; trading done pursuant to the claimed exemption; the commodity
derivative contracts or cash-market
[[Page 3470]]
positions which support the claimed exemption; and the relevant
business relationships supporting a claimed exemption.
(f) Aggregation of accounts. Entities required to aggregate
accounts or positions under Sec. 150.4 shall be considered the same
person for the purpose of determining whether they are eligible for an
exemption under paragraphs (a)(1) through (4) of this section with
respect to such aggregated account or position.
(g) Delegation of authority to the Director of the Division of
Market Oversight. (1) The Commission hereby delegates, until it orders
otherwise, to the Director of the Division of Market Oversight, or such
other employee or employees as the Director may designate from time to
time:
(i) The authority in paragraph (a)(3) of this section to provide
exemptions in circumstances of financial distress;
(ii) The authority in paragraph (b)(2) of this section to request
additional information with respect to a request for a bona fide
hedging transaction or position recognition or spread exemption;
(iii) The authority in paragraph (b)(3)(ii)(B) of this section to,
if applicable, determine a commercially reasonable amount of time
required for a person to bring its position within the Federal
speculative position limits;
(iv) The authority in paragraph (b)(4) of this section to determine
whether to recognize a position as a bona fide hedging transaction or
position or to grant a spread exemption; and
(v) The authority in paragraph (b)(2) or (5) of this section to
request that a person submit updated materials or renew their request
with the Commission.
(2) The Director of the Division of Market Oversight may submit to
the Commission for its consideration any matter which has been
delegated in this section.
(3) Nothing in this section prohibits the Commission, at its
election, from exercising the authority delegated in this section.
0
19. Revise Sec. 150.5 to read as follows:
Sec. 150.5 Exchange-set speculative position limits and exemptions
therefrom.
(a) Requirements for exchange-set limits on commodity derivative
contracts subject to Federal speculative position limits set forth in
Sec. 150.2--(1) Exchange-set limits. For any commodity derivative
contract that is subject to a Federal speculative position limit under
Sec. 150.2, a designated contract market or swap execution facility
that is a trading facility shall set a speculative position limit no
higher than the level specified in Sec. 150.2.
(2) Exemptions to exchange-set limits. A designated contract market
or swap execution facility that is a trading facility may grant
exemptions from any speculative position limits it sets under paragraph
(a)(1) of this section in accordance with the following:
(i) Exemption levels. An exemption that conforms to an exemption
the Commission identified in:
(A) Sections 150.3(a)(1)(i), (a)(2)(i), (a)(4) and (a)(5) may be
granted at a level that exceeds the level of the applicable Federal
limit in Sec. 150.2;
(B) Sections 150.3(a)(1)(ii) and (a)(2)(ii) may be granted at a
level that exceeds the level of the applicable Federal limit in Sec.
150.2, provided the exemption is first approved in accordance with
Sec. 150.3(b) or 150.9, as applicable;
(C) Section 150.3(a)(3) may be granted at a level that exceeds the
level of the applicable Federal limit in Sec. 150.2, provided that, a
division of the Commission has first approved such exemption pursuant
to a request submitted under Sec. 140.99(a)(1) of this chapter; and
(D) An exemption of the type that does not conform to any of the
exemptions identified in Sec. 150.3(a) must be granted at a level that
does not exceed the applicable Federal limit in Sec. 150.2 and that
complies with paragraph (a)(2)(ii)(G) of this section, unless the
Commission has first approved such exemption pursuant to Sec. 150.3(b)
or pursuant to a request submitted under Sec. 140.99(a)(1).
(ii) Application for exemption from exchange-set limits. With
respect to a designated contract market or swap execution facility that
is a trading facility that elects to grant exemptions under paragraph
(a)(2)(i) of this section:
(A) Except as provided in paragraph (a)(2)(ii)(B) of this section,
the designated contract market or swap execution facility shall require
an entity to file an application requesting such exemption in advance
of the date that such position would be in excess of the limits then in
effect. Such application shall include any information needed to enable
the designated contract market or swap execution facility and the
Commission to determine whether the facts and circumstances demonstrate
that the designated contract market or swap execution facility may
grant an exemption. Any application for a bona fide hedging transaction
or position shall include a description of the applicant's activity in
the cash markets and swaps markets for the commodity underlying the
position for which the application is submitted, including, but not
limited to, information regarding the offsetting cash positions.
(B) The designated contract market or swap execution facility may
adopt rules that allow a person, due to demonstrated sudden or
unforeseen increases in its bona fide hedging needs, to file an
application to request a recognition of a bona fide hedging transaction
or position within five business days after the person established the
position that exceeded the applicable exchange-set speculative position
limit.
(C) The designated contract market or swap execution facility must
require that any application filed pursuant to paragraph (a)(2)(ii)(B)
of this section include an explanation of the circumstances warranting
the sudden or unforeseen increases in bona fide hedging needs.
(D) If an application filed pursuant to paragraph (a)(2)(ii)(B) of
this section is denied, the applicant must bring its position within
the designated contract market or swap execution facility's speculative
position limits within a commercially reasonable time as determined by
the designated contract market or swap execution facility.
(E) The Commission will not pursue an enforcement action for a
position limits violation for the person holding the position during
the period of the designated contract market or swap execution
facility's review nor once the designated contract market or swap
execution facility has issued its determination, so long as the
application was submitted in good faith and the applicant brings its
position within the designated contract market or swap execution
facility's speculative position limits within a commercially reasonable
time as determined by the designated contract market or swap execution
facility.
(F) The designated contract market or swap execution facility shall
require, for any such exemption granted, that the entity re-apply for
the exemption at least annually;
(G) The designated contract market or swap execution facility:
(1) May, in accordance with the designated contract market or swap
execution facility's rules, deny any such application, or limit,
condition, or revoke any such exemption, at any time after providing
notice to the applicant, and
(2) Shall consider whether the requested exemption would result in
positions that would not be in accord with sound commercial practices
in the relevant commodity derivative market and/or that would exceed an
amount
[[Page 3471]]
that may be established and liquidated in an orderly fashion in that
market; and
(H) Notwithstanding paragraph (a)(2)(ii)(G) of this section, the
designated contract market or swap execution facility may grant
exemptions, subject to terms, conditions, or limitations, that require
a person to exit any referenced contract positions in excess of
position limits during the lesser of the last five days of trading or
the time period for the spot month in such physical-delivery contract,
or to otherwise limit the size of such position during that time
period. Designated contract markets and swap execution facilities may
refer to paragraph (b) of appendix B or appendix G to part 150, for
guidance regarding the foregoing, as applicable.
(3) Exchange-set limits on pre-existing positions--(i) Pre-existing
positions in a spot month. A designated contract market or swap
execution facility that is a trading facility shall require compliance
with spot month exchange-set speculative position limits for pre-
existing positions in commodity derivative contracts other than pre-
enactment swaps and transition period swaps.
(ii) Pre-existing positions in a non-spot month. A single month or
all-months-combined speculative position limit established under
paragraph (a)(1) of this section shall apply to any pre-existing
positions in commodity derivative contracts, other than pre-enactment
swaps and transition period swaps.
(4) Monthly reports detailing the disposition of each exemption
application. (i) For commodity derivative contracts subject to Federal
speculative position limits, the designated contract market or swap
execution facility shall submit to the Commission a report each month
showing the disposition of any exemption application, including the
recognition of any position as a bona fide hedging transaction or
position, the exemption of any spread transaction or other position,
the renewal, revocation, or modification of a previously granted
recognition or exemption, and the rejection of any application, as well
as the following details for each application:
(A) The date of disposition;
(B) The effective date of the disposition;
(C) The expiration date of any recognition or exemption;
(D) Any unique identifier(s) the designated contract market or swap
execution facility may assign to track the application, or the specific
type of recognition or exemption;
(E) If the application is for an enumerated bona fide hedging
transaction or position, the name of the enumerated bona fide hedging
transaction or position listed in appendix A to this part;
(F) If the application is for a spread transaction listed in the
spread transaction definition in Sec. 150.1, the name of the spread
transaction as it is listed in Sec. 150.1;
(G) The identity of the applicant;
(H) The listed commodity derivative contract or position(s) to
which the application pertains;
(I) The underlying cash commodity;
(J) The maximum size of the commodity derivative position that is
recognized by the designated contract market or swap execution facility
as a bona fide hedging transaction or position, specified by contract
month and by the type of limit as spot month, single month, or all-
months-combined, as applicable;
(K) Any size limitations or conditions established for a spread
exemption or other exemption; and
(L) For a bona fide hedging transaction or position, a concise
summary of the applicant's activity in the cash markets and swaps
markets for the commodity underlying the commodity derivative position
for which the application was submitted.
(ii) The designated contract market or swap execution facility
shall submit to the Commission the information required by paragraph
(a)(4)(i) of this section:
(A) As specified by the Commission on the Forms and Submissions
page at www.cftc.gov; and
(B) Using the format, coding structure, and electronic data
transmission procedures approved in writing by the Commission.
(b) Requirements for exchange-set limits on commodity derivative
contracts in a physical commodity that are not subject to the limits
set forth in Sec. 150.2--(1) Exchange-set spot-month limits. For any
physical commodity derivative contract that is not subject to a Federal
speculative position limit under Sec. 150.2, a designated contract
market or swap execution facility that is a trading facility shall set
a speculative position limit as follows:
(i) Spot month speculative position limit levels. For any commodity
derivative contract subject to paragraph (b) of this section, a
designated contract market or swap execution facility that is a trading
facility shall establish speculative position limits for the spot month
no greater than 25 percent of the estimated spot month deliverable
supply, calculated separately for each month to be listed.
(ii) Additional sources for compliance. Alternatively, a designated
contract market or swap execution facility that is a trading facility
may submit rules to the Commission establishing spot month speculative
position limits other than as provided in paragraph (b)(1)(i) of this
section, provided that each limit is set at a level that is necessary
and appropriate to reduce the potential threat of market manipulation
or price distortion of the contract's or the underlying commodity's
price or index.
(2) Exchange-set limits or accountability outside of the spot
month--(i) Non-spot month speculative position limit or accountability
levels. For any commodity derivative contract subject to paragraph (b)
of this section, a designated contract market or swap execution
facility that is a trading facility shall adopt either speculative
position limits or position accountability outside of the spot month at
a level that is necessary and appropriate to reduce the potential
threat of market manipulation or price distortion of the contract's or
the underlying commodity's price or index.
(ii) Additional sources for compliance. A designated contract
market or swap execution facility that is a trading facility may refer
to the non-exclusive acceptable practices in paragraph (b) of appendix
F of this part to demonstrate to the Commission compliance with the
requirements of paragraph (b)(2)(i) of this section.
(3) Look-alike contracts. For any newly listed commodity derivative
contract subject to paragraph (b) of this section that is substantially
the same as an existing contract listed on a designated contract market
or swap execution facility that is a trading facility, the designated
contract market or swap execution facility that is a trading facility
listing such newly listed contract shall adopt spot month, individual
month, and all-months-combined speculative position limits comparable
to those of the existing contract. Alternatively, if such designated
contract market or swap execution facility seeks to adopt speculative
position limits that are not comparable to those of the existing
contract, such designated contract market or swap execution facility
shall demonstrate to the Commission how the levels comply with
paragraphs (b)(1) and/or (b)(2) of this section.
(4) Exemptions to exchange-set limits. A designated contract market
or swap execution facility that is a trading facility may grant
exemptions from any
[[Page 3472]]
speculative position limits it sets under paragraph (b)(1) or (2) of
this section in accordance with the following:
(i) An entity seeking an exemption shall be required to apply to
the designated contract market or swap execution facility for any such
exemption from its speculative position limit rules; and
(ii) A designated contract market or swap execution facility that
is a trading facility may deny any such application, or limit,
condition, or revoke any such exemption, at any time after providing
notice to the applicant. Such designated contract market or swap
execution facility shall consider whether the requested exemption would
result in positions that would not be in accord with sound commercial
practices in the relevant commodity derivative market and/or would
exceed an amount that may be established and liquidated in an orderly
fashion in that market.
(c) Requirements for security futures products. For security
futures products, speculative position limits and position
accountability requirements are specified in Sec. 41.25 of this
chapter.
(d) Rules on aggregation. For commodity derivative contracts in a
physical commodity, a designated contract market or swap execution
facility that is a trading facility shall have aggregation rules that
conform to Sec. 150.4.
(e) Requirements for submissions to the Commission. In order for a
designated contract market or swap execution facility that is a trading
facility to adopt speculative position limits and/or position
accountability pursuant to paragraph (a) or (b) of this section and/or
to elect to offer exemptions from any such levels pursuant to such
paragraphs, the designated contract market or swap execution facility
shall submit to the Commission pursuant to part 40 of this chapter
rules establishing such levels and/or exemptions. To the extent that a
designated contract market or swap execution facility adopts
speculative position limit levels, such part 40 submission shall also
include the methodology by which such levels are calculated. The
designated contract market or swap execution facility shall review such
speculative position limit levels regularly for compliance with this
section and update such speculative position limit levels as needed.
(f) Delegation of authority to the Director of the Division of
Market Oversight--(1) Commission delegations. The Commission hereby
delegates, until it orders otherwise, to the Director of the Division
of Market Oversight, or such other employee or employees as the
Director may designate from time to time, the authority in paragraph
(a)(4)(ii) of this section to provide instructions regarding the
submission to the Commission of information required to be reported,
pursuant to paragraph (a)(4)(i) of this section, by a designated
contract market or swap execution facility, to specify the manner for
submitting such information on the Forms and Submissions page at
www.cftc.gov, and to determine the format, coding structure, and
electronic data transmission procedures for submitting such
information.
(2) Commission consideration of delegated matter. The Director of
the Division of Market Oversight may submit to the Commission for its
consideration any matter which has been delegated in this section.
(3) Commission authority. Nothing in this section prohibits the
Commission, at its election, from exercising the authority delegated in
this section.
0
20. Revise Sec. 150.6 to read as follows:
Sec. 150.6 Scope.
This part shall only be construed as having an effect on
speculative position limits set by the Commission or by a designated
contract market or swap execution facility, including any associated
recordkeeping and reporting regulations in this chapter. Nothing in
this part shall be construed to relieve any designated contract market,
swap execution facility, or its governing board from responsibility
under section 5(d)(4) of the Act to prevent manipulation and corners.
Further, nothing in this part shall be construed to affect any other
provisions of the Act or Commission regulations, including, but not
limited to, those relating to actual or attempted manipulation,
corners, squeezes, fraudulent or deceptive conduct, or to prohibited
transactions.
Sec. 150.7 [Reserved]
0
21. Add reserved Sec. 150.7.
0
22. Add Sec. 150.8 to read as follows:
Sec. 150.8 Severability.
If any provision of this part, or the application thereof to any
person or circumstances, is held invalid, such invalidity shall not
affect the validity of other provisions or the application of such
provision to other persons or circumstances that can be given effect
without the invalid provision or application.
0
23. Add Sec. 150.9 to read as follows:
Sec. 150.9 Process for recognizing non-enumerated bona fide hedging
transactions or positions with respect to Federal speculative position
limits.
For purposes of Federal speculative position limits, a person with
a position in a referenced contract seeking recognition of such
position as a non-enumerated bona fide hedging transaction or position,
in accordance with Sec. 150.3(a)(1)(ii), shall apply to the
Commission, pursuant to Sec. 150.3(b), or apply to a designated
contract market or swap execution facility in accordance with this
section. If such person submits an application to a designated contract
market or swap execution facility in accordance with this section, and
the designated contract market or swap execution facility, with respect
to its own speculative position limits established pursuant to Sec.
150.5(a), recognizes the person's position as a non-enumerated bona
fide hedging transaction or position, then the person may also exceed
the applicable Federal speculative position limit for such position in
accordance with paragraph (e) of this section. The designated contract
market or swap execution facility may approve such applications only if
the designated contract market or swap execution facility complies with
the conditions set forth in paragraphs (a) through (e) of this section.
(a) Approval of rules. The designated contract market or swap
execution facility must maintain rules that establish application
processes and conditions for recognizing bona fide hedging transactions
or positions consistent with the requirements of this section, and must
seek approval of such rules from the Commission pursuant to Sec. 40.5
of this chapter.
(b) Prerequisites for a designated contract market or swap
execution facility to recognize a bona fide hedging transaction or
position in accordance with this section. (1) The designated contract
market or swap execution facility lists the applicable referenced
contract for trading;
(2) The position meets the definition of bona fide hedging
transaction or position in section 4a(c)(2) of the Act and the
definition of bona fide hedging transaction or position in Sec. 150.1;
and
(3) The designated contract market or swap execution facility does
not recognize as a bona fide hedging transaction or position any
position involving a commodity index contract and one or more
referenced contracts, including exemptions known as risk management
exemptions.
(c) Application process. The designated contract market or swap
[[Page 3473]]
execution facility's application process meets the following
conditions:
(1) Required application information. The designated contract
market or swap execution facility requires the applicant to provide,
and can obtain from the applicant, all information needed to enable the
designated contract market or swap execution facility and the
Commission to determine whether the facts and circumstances demonstrate
that the designated contract market or swap execution facility may
recognize a position as a bona fide hedging transaction or position,
including the following:
(i) A description of the position in the commodity derivative
contract for which the application is submitted, including but not
limited to, the name of the underlying commodity and the derivative
position size;
(ii) An explanation of the hedging strategy, including a statement
that the position complies with the requirements of section 4a(c)(2) of
the Act and the definition of bona fide hedging transaction or position
in Sec. 150.1, and information to demonstrate why the position
satisfies such requirements and definition;
(iii) A statement concerning the maximum size of all gross
positions in commodity derivative contracts for which the application
is submitted;
(iv) A description of the applicant's activity in the cash markets
and the swaps markets for the commodity underlying the position for
which the application is submitted, including, but not limited to,
information regarding the offsetting cash positions; and
(v) Any other information the designated contract market or swap
execution facility requires, in its discretion, to determine that the
position complies with paragraph (b)(2) of this section, as applicable.
(2) Timing of application. (i) Except as provided in paragraph
(c)(2)(ii) of this section, the designated contract market or swap
execution facility requires the applicant to submit an application and
receive a notice of approval of such application from the designated
contract market or swap execution facility prior to the date that the
position for which such application was submitted would be in excess of
the applicable Federal speculative position limits.
(ii) A designated contract market or swap execution facility may
adopt rules that allow a person, due to demonstrated sudden or
unforeseen increases in its bona fide hedging needs, to file an
application with the designated contract market or swap execution
facility to request a recognition of a bona fide hedging transaction or
position within five business days after the person established the
position that exceeded the applicable Federal speculative position
limit.
(A) The designated contract market or swap execution facility must
require that any application filed pursuant to paragraph (c)(2)(ii) of
this section include an explanation of the circumstances warranting the
sudden or unforeseen increases in bona fide hedging needs.
(B) If an application filed pursuant to paragraph (c)(2)(ii) of
this section is denied by the designated contract market, swap
execution facility, or Commission, the applicant must bring its
position within the applicable Federal speculative position limits
within a commercially reasonable time as determined by the Commission
in consultation with the applicant and the applicable designated
contract market or swap execution facility.
(C) The Commission will not pursue an enforcement action for a
position limits violation for the person holding the position during
the period of the designated contract market, swap execution facility,
or Commission's review nor once a determination has been issued, so
long as the application was submitted in good faith and the person
complies with paragraph (c)(2)(ii)(B) of this section.
(3) Renewal of applications. The designated contract market or swap
execution facility requires each applicant to reapply with the
designated contract market or swap execution facility to maintain such
recognition at least on an annual basis by updating the initial
application, and to receive a notice of extension of the original
approval from the designated contract market or swap execution facility
to continue relying on such recognition for purposes of Federal
speculative position limits. If the facts and circumstances underlying
a renewal application are materially different than the initial
application, the designated contract market or swap execution facility
is required to treat such application as a new request submitted
through the Sec. 150.9 process and subject to the Commission's 10/2-
day review process in paragraph (e) of this section.
(4) Exchange revocation authority. The designated contract market
or swap execution facility retains its authority to limit, condition,
or revoke, at any time after providing notice to the applicant, any
bona fide hedging transaction or position recognition for purposes of
the designated contract market or swap execution facility's speculative
position limits established under Sec. 150.5(a), for any reason as
determined in the discretion of the designated contract market or swap
execution facility, including if the designated contract market or swap
execution facility determines that the position no longer meets the
conditions set forth in paragraph (b) of this section, as applicable.
(d) Recordkeeping. (1) The designated contract market or swap
execution facility keeps full, complete, and systematic records, which
include all pertinent data and memoranda, of all activities relating to
the processing of such applications and the disposition thereof. Such
records include:
(i) Records of the designated contract market's or swap execution
facility's recognition of any derivative position as a bona fide
hedging transaction or position, revocation or modification of any such
recognition, or the rejection of an application;
(ii) All information and documents submitted by an applicant in
connection with its application, including documentation and
information that is submitted after the disposition of the application,
and any withdrawal, supplementation, or update of any application;
(iii) Records of oral and written communications between the
designated contract market or swap execution facility and the applicant
in connection with such application; and
(iv) All information and documents in connection with the
designated contract market or swap execution facility's analysis of,
and action(s) taken with respect to, such application.
(2) All books and records required to be kept pursuant to this
section shall be kept in accordance with the requirements of Sec. 1.31
of this chapter.
(e) Process for a person to exceed Federal speculative position
limits on a referenced contract--(1) Notification to the Commission.
The designated contract market or swap execution facility must submit
to the Commission a notification of each initial determination to
recognize a bona fide hedging transaction or position in accordance
with this section, concurrently with the notice of such determination
the designated contract market or swap execution facility provides to
the applicant.
(2) Notification requirements. The notification in paragraph (e)(1)
of this section shall include, at a minimum, the following information:
(i) Name of the applicant;
(ii) Brief description of the bona fide hedging transaction or
position being recognized;
[[Page 3474]]
(iii) Name of the contract(s) relevant to the recognition;
(iv) The maximum size of the position that may exceed Federal
speculative position limits;
(v) The effective date and expiration date of the recognition;
(vi) An indication regarding whether the position may be maintained
during the last five days of trading during the spot month, or the time
period for the spot month; and
(vii) A copy of the application and any supporting materials.
(3) Exceeding Federal speculative position limits on referenced
contracts. A person may exceed Federal speculative position limits on a
referenced contract after the designated contract market or swap
execution facility issues the notification required pursuant to
paragraph (e)(1) of this section, unless the Commission notifies the
designated contract market or swap execution facility and the applicant
otherwise, pursuant to paragraph (e)(5) or (6) of this section, before
the ten business day period expires.
(4) Exceeding Federal speculative position limits on referenced
contracts due to sudden or unforeseen circumstances. If a person files
an application for a recognition of a bona fide hedging transaction or
position in accordance with paragraph (c)(2)(ii) of this section, then
such person may rely on the designated contract market or swap
execution facility's determination to grant such recognition for
purposes of Federal speculative position limits two business days after
the designated contract market or swap execution facility issues the
notification required pursuant to paragraph (e)(1) of this section,
unless the Commission notifies the designated contract market or swap
execution facility and the applicant otherwise, pursuant to paragraph
(e)(5) or (6) of this section, before the two business day period
expires.
(5) Commission stay of pending applications and requests for
additional information. The Commission may stay an application that
requires additional time to analyze, and/or may request additional
information to determine whether the position for which the application
is submitted meets the conditions set forth in paragraph (b) of this
section. The Commission shall notify the applicable designated contract
market or swap execution facility and the applicant of a Commission
determination to stay the application and/or request any supplemental
information, and shall provide an opportunity for the applicant to
respond. The Commission will have an additional 45 days from the date
of the stay notification to conduct the review and issue a
determination with respect to the application. If the Commission stays
an application and the applicant has not yet exceeded Federal
speculative position limits, then the applicant may not exceed Federal
speculative position limits unless the Commission approves the
application. If the Commission stays an application and the applicant
has already exceeded Federal speculative position limits, then the
applicant may continue to maintain the position unless the Commission
notifies the designated contract market or swap execution facility and
the applicant otherwise, pursuant to paragraph (e)(6) of this section.
(6) Commission determination for pending applications. If, during
the Commission's ten or two business day review period in paragraphs
(e)(3) and (4) of this section, the Commission determines that a
position for which the application is submitted does not meet the
conditions set forth in paragraph (b) of this section, the Commission
shall:
(i) Notify the designated contract market or swap execution
facility and the applicant within ten or two business days, as
applicable, after the designated contract market or swap execution
facility issues the notification required pursuant to paragraph (e)(1)
of this section;
(ii) Provide an opportunity for the applicant to respond to such
notification;
(iii) Issue a determination to deny the application, or limit or
condition the application approval for purposes of Federal speculative
position limits and, as applicable, require the person to reduce the
derivatives position within a commercially reasonable time, as
determined by the Commission in consultation with the applicant and the
applicable designated contract market or swap execution facility, or
otherwise come into compliance; and
(iv) The Commission will not pursue an enforcement action for a
position limits violation for the person holding the position during
the period of the Commission's review nor once the Commission has
issued its determination, so long as the application was submitted in
good faith and the person complies with any requirement to reduce the
position pursuant to paragraph (e)(6)(iii) of this section, as
applicable.
(f) Commission revocation of applications previously approved. (1)
If a designated contract market or a swap execution facility limits,
conditions, or revokes any recognition of a bona fide hedging
transaction or position for purposes of the respective designated
contract market's or swap execution facility's speculative position
limits established under Sec. 150.5(a), then such recognition will
also be deemed limited, conditioned, or revoked for purposes of Federal
speculative position limits.
(2) If the Commission determines, at any time, that a position that
has been recognized as a bona fide hedging transaction or position for
purposes of Federal speculative position limits is no longer consistent
with section 4a(c)(2) of the Act or the definition of bona fide hedging
transaction or position in Sec. 150.1, the following applies:
(i) The Commission shall notify the person holding the position and
the relevant designated contract market or swap execution facility.
After providing such person and such designated contract market or swap
execution facility an opportunity to respond, the Commission may, in
its discretion, limit, condition, or revoke its determination for
purposes of Federal speculative position limits and require the person
to reduce the derivatives position within a commercially reasonable
time as determined by the Commission in consultation with such person
and such designated contract market or swap execution facility, or
otherwise come into compliance;
(ii) The Commission shall include in its notification a brief
explanation of the nature of the issues raised and the specific
provisions of the Act or the Commission's regulations with which the
position or application is, or appears to be, inconsistent; and
(iii) The Commission will not pursue an enforcement action for a
position limits violation for the person holding the position during
the period of the Commission's review, nor once the Commission has
issued its determination, provided the person submitted the application
in good faith and reduces the position within a commercially reasonable
time, as determined by the Commission in consultation with such person
and the relevant designated contract market or swap execution facility,
or otherwise comes into compliance.
(g) Delegation of authority to the Director of the Division of
Market Oversight--(1) Commission delegations. The Commission hereby
delegates, until it orders otherwise, to the Director of the Division
of Market Oversight, or such other employee or employees as the
Director may designate from time to time, the authority to request
additional information, pursuant to paragraph (e)(5) of this section,
from the applicable designated contract market or swap execution
facility and applicant.
[[Page 3475]]
(2) Commission consideration of delegated matter. The Director of
the Division of Market Oversight may submit to the Commission for its
consideration any matter which has been delegated in this section.
(3) Commission authority. Nothing in this section prohibits the
Commission, at its election, from exercising the authority delegated in
this section.
0
24. Add appendices A through G to read as follows:
Appendix A to Part 150--List of Enumerated Bona Fide Hedges
Pursuant to Sec. 150.3(a)(1)(i), positions that comply with the
bona fide hedging transaction or position definition in Sec. 150.1
and that are enumerated in this appendix A may exceed Federal
speculative position limits to the extent that all applicable
requirements in this part are met. A person holding such positions
enumerated in this appendix A may exceed Federal speculative
position limits for such positions without requesting prior approval
under Sec. 150.3 or Sec. 150.9. A person holding such positions
that are not enumerated in this appendix A must request and obtain
approval pursuant to Sec. 150.3 or Sec. 150.9 prior to exceeding
the applicable Federal speculative position limits--unless such
positions qualify for the retroactive approval process, and the
person seeks retroactive approval in accordance with Sec. 150.3 or
Sec. 150.9.
The enumerated bona fide hedges do not state the exclusive means
for establishing compliance with the bona fide hedging transaction
or position definition in Sec. 150.1 or with the requirements of
Sec. 150.3(a)(1).
(a) Enumerated hedges--(1) Hedges of inventory and cash
commodity fixed-price purchase contracts. Short positions in
commodity derivative contracts that do not exceed in quantity the
sum of the person's ownership of inventory and fixed-price purchase
contracts in the commodity derivative contracts' underlying cash
commodity.
(2) Hedges of cash commodity fixed-price sales contracts. Long
positions in commodity derivative contracts that do not exceed in
quantity the sum of the person's fixed-price sales contracts in the
commodity derivative contracts' underlying cash commodity and the
quantity equivalent of fixed-price sales contracts of the cash
products and by-products of such commodity.
(3) Hedges of offsetting unfixed-price cash commodity sales and
purchases. Both short and long positions in commodity derivative
contracts that do not exceed in quantity the amount of the commodity
derivative contracts' underlying cash commodity that has been both
bought and sold by the same person at unfixed prices:
(i) Basis different delivery months in the same commodity
derivative contract; or
(ii) Basis different commodity derivative contracts in the same
commodity, regardless of whether the commodity derivative contracts
are in the same calendar month.
(4) Hedges of unsold anticipated production. Short positions in
commodity derivative contracts that do not exceed in quantity the
person's unsold anticipated production of the commodity derivative
contracts' underlying cash commodity.
(5) Hedges of unfilled anticipated requirements. Long positions
in commodity derivative contracts that do not exceed in quantity the
person's unfilled anticipated requirements for the commodity
derivative contracts' underlying cash commodity, for processing,
manufacturing, or use by that person, or for resale by a utility as
it pertains to the utility's obligations to meet the unfilled
anticipated demand of its customers for the customer's use.
(6) Hedges of anticipated merchandising. Long or short positions
in commodity derivative contracts that offset the anticipated change
in value of the underlying commodity that a person anticipates
purchasing or selling, provided that:
(i) The positions in the commodity derivative contracts do not
exceed in quantity twelve months' of current or anticipated purchase
or sale requirements of the same cash commodity that is anticipated
to be purchased or sold; and
(ii) The person is a merchant handling the underlying commodity
that is subject to the anticipatory merchandising hedge, and that
such merchant is entering into the position solely for purposes
related to its merchandising business and has a demonstrated history
of buying and selling the underlying commodity for its merchandising
business.
(7) Hedges by agents. Long or short positions in commodity
derivative contracts by an agent who does not own or has not
contracted to sell or purchase the commodity derivative contracts'
underlying cash commodity at a fixed price, provided that the agent
is responsible for merchandising the cash positions that are being
offset in commodity derivative contracts and the agent has a
contractual arrangement with the person who owns the commodity or
holds the cash-market commitment being offset.
(8) Hedges of anticipated mineral royalties. Short positions in
a person's commodity derivative contracts offset by the anticipated
change in value of mineral royalty rights that are owned by that
person, provided that the royalty rights arise out of the production
of the commodity underlying the commodity derivative contracts.
(9) Hedges of anticipated services. Short or long positions in a
person's commodity derivative contracts offset by the anticipated
change in value of receipts or payments due or expected to be due
under an executed contract for services held by that person,
provided that the contract for services arises out of the
production, manufacturing, processing, use, or transportation of the
commodity underlying the commodity derivative contracts.
(10) Offsets of commodity trade options. Long or short positions
in commodity derivative contracts that do not exceed in quantity, on
a futures-equivalent basis, a position in a commodity trade option
that meets the requirements of Sec. 32.3 of this chapter. Such
commodity trade option transaction, if it meets the requirements of
Sec. 32.3 of this chapter, may be deemed, for purposes of complying
with this paragraph (a)(10) of this appendix A, as either a cash
commodity purchase or sales contract as set forth in paragraph
(a)(1) or (2) of this appendix A, as applicable.
(11) Cross-commodity hedges. Positions in commodity derivative
contracts described in paragraph (2) of the bona fide hedging
transaction or position definition in Sec. 150.1 or in paragraphs
(a)(1) through (10) of this appendix A may also be used to offset
the risks arising from a commodity other than the cash commodity
underlying the commodity derivative contracts, provided that the
fluctuations in value of the cash commodity underlying the commodity
derivative contracts, shall be substantially related to the
fluctuations in value of the actual or anticipated cash commodity
position or a pass-through swap.
(b) [Reserved]
Appendix B to Part 150--Guidance on Gross Hedging Positions and
Positions Held During the Spot Period
(a) Guidance on gross hedging positions. (1) A person's gross
hedging positions may be deemed in compliance with the bona fide
hedging transaction or position definition in Sec. 150.1, whether
enumerated or non-enumerated, provided that all applicable
regulatory requirements are met, including that the position is
economically appropriate to the reduction of risks in the conduct
and management of a commercial enterprise and otherwise satisfies
the bona fide hedging definition in Sec. 150.1, and provided
further that:
(i) The manner in which the person measures risk is consistent
and follows historical practice for that person;
(ii) The person is not measuring risk on a gross basis to evade
the speculative position limits in Sec. 150.2 or the aggregation
rules in Sec. 150.4; and
(iii) The person is able to demonstrate compliance with
paragraphs (a)(1)(i) and (ii) of this appendix, including by
providing justifications for measuring risk on a gross basis, upon
the request of the Commission and/or of a designated contract
market, including by providing information regarding the entities
with which the person aggregates positions.
(b) Guidance regarding positions held during the spot period.
The regulations governing exchange-set speculative position limits
and exemptions therefrom under Sec. 150.5(a)(2)(ii)(D) provide that
designated contract markets and swap execution facilities
(``exchanges'') may impose restrictions on bona fide hedging
transaction or position exemptions to require the person to exit any
such positions in excess of limits during the lesser of the last
five days of trading or the time period for the spot month in such
physical-delivery contract, or otherwise limit the size of such
position. This guidance is intended to provide factors the
Commission believes exchanges should consider when determining
whether to impose a five-day rule or similar restriction but is not
intended to be used as a mandatory checklist. The exchanges may
consider whether:
[[Page 3476]]
(1) The position complies with the bona fide hedging transaction
or position definition in Sec. 150.1, whether enumerated or non-
enumerated;
(2) There is an economically appropriate need to maintain such
position in excess of Federal speculative position limits during the
spot period for such contract, and such need relates to the purchase
or sale of a cash commodity; and
(3) The person wishing to exceed Federal position limits during
the spot period:
(i) Intends to make or take delivery during that time period;
(ii) Has the ability to take delivery for any long position at
levels that are economically appropriate (i.e., the delivery
comports with the person's demonstrated need for the commodity and
the contract is the most economical source for that commodity);
(iii) Has the ability to deliver against any short position
(i.e., has inventory on hand in a deliverable location and in a
condition in which the commodity can be used upon delivery and that
delivery against futures contracts is economically appropriate, as
it is the best sales option for that inventory).
Appendix C to Part 150--Guidance Regarding the Definition of Referenced
Contract
This appendix C provides guidance regarding the ``referenced
contract'' definition in Sec. 150.1, which provides in paragraph
(3) of the definition of referenced contract that the term
referenced contract does not include a location basis contract, a
commodity index contract, a swap guarantee, a trade option that
meets the requirements of Sec. 32.3 of this chapter, a monthly
average pricing contract, or an outright price reporting agency
index contract. The term ``referenced contract'' is used throughout
part 150 of the Commission's regulations to refer to contracts that
are subject to Federal position limits. A position in a contract
that is not a referenced contract is not subject to Federal position
limits, and, as a consequence, cannot be netted with positions in
referenced contracts for purposes of Federal position limits. This
guidance is intended to clarify the types of contracts that would
qualify as a location basis contract, commodity index contract,
monthly average pricing contract, or outright price reporting agency
index contract.
Compliance with this guidance does not diminish or replace, in
any event, the obligations and requirements of any person to comply
with the regulations provided under this part, or any other part of
the Commission's regulations. The guidance is for illustrative
purposes only and does not state the exclusive means for a contract
to qualify, or not qualify, as a referenced contract as defined in
Sec. 150.1, or to comply with any other provision in this part.
(a) Guidance. (1) As provided in paragraph (3) of the
``referenced contract'' definition in Sec. 150.1, the following
types of contracts are not deemed referenced contracts, meaning such
contracts are not subject to Federal position limits and cannot be
netted with positions in referenced contracts for purposes of
Federal position limits: location basis contracts; commodity index
contracts; swap guarantees; trade options that meet the requirements
of Sec. 32.3 of this chapter; monthly average pricing contracts;
and outright price reporting agency index contracts.
(2) Location basis contract. For purposes of the referenced
contract definition in Sec. 150.1, a location basis contract means
a commodity derivative contract that is cash-settled based on the
difference in:
(i) The price, directly or indirectly, of:
(A) A particular core referenced futures contract; or
(B) A commodity deliverable on a particular core referenced
futures contract, whether at par, a fixed discount to par, or a
premium to par; and
(ii) The price, at a different delivery location or pricing
point than that of the same particular core referenced futures
contract, directly or indirectly, of:
(A) A commodity deliverable on the same particular core
referenced futures contract, whether at par, a fixed discount to
par, or a premium to par; or
(B) A commodity that is listed in appendix D to this part as
substantially the same as a commodity underlying the same core
referenced futures contract.
(3) Commodity index contract. For purposes of the referenced
contract definition in Sec. 150.1, a commodity index contract means
an agreement, contract, or transaction that is based on an index
comprised of prices of commodities that are not the same or
substantially the same, and that is not a location basis contract, a
calendar spread contract, or an intercommodity spread contract as
such terms are defined in this guidance, where:
(i) A calendar spread contract means a cash-settled agreement,
contract, or transaction that represents the difference between the
settlement price in one or a series of contract months of an
agreement, contract, or transaction and the settlement price of
another contract month or another series of contract months'
settlement prices for the same agreement, contract, or transaction;
and
(ii) An intercommodity spread contract means a cash-settled
agreement, contract, or transaction that represents the difference
between the settlement price of a referenced contract and the
settlement price of another contract, agreement, or transaction that
is based on a different commodity.
(4) Monthly average pricing contract means a contract that
satisfies one of the following:
(i) The contract's price is calculated based on the equally-
weighted arithmetic average of the daily prices of the underlying
referenced contract for the entire corresponding calendar month or
trade month, as applicable; or
(ii) In determining the price of such contract, the component
daily prices, in the aggregate, during the spot month of the
underlying referenced contract comprise no more than 40 percent of
such contract's weighting.
(5) Outright price reporting agency index contract means any
outright commodity derivative contract whose settlement price is
based solely on an index published by a price reporting agency that
surveys cash-market transaction prices, provided, however, that this
term does not include any commodity derivative contract that settles
at a basis, or differential, between a referenced contract and a
price reporting agency index.
(b) [Reserved]
Appendix D to Part 150--Commodities Listed as Substantially the Same
for Purposes of the Term ``Location Basis Contract'' as Used in the
Referenced Contract Definition
The following table lists each relevant core referenced futures
contract and associated commodities that are treated as
substantially the same as a commodity underlying a core referenced
futures contract for purposes of the term ``location basis
contract'' as such term is used in the referenced contract
definition under Sec. 150.1, and as such term is discussed in
appendix C to this part.
BILLING CODE 6351-01-P
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Appendix E to Part 150--Speculative Position Limit Levels
---------------------------------------------------------------------------
\1\ Step-down spot month limits apply to positions net long or
net short as follows: 600 contracts at the close of trading on the
first business day following the first Friday of the contract month;
300 contracts at the close of trading on the business day prior to
the last five trading days of the contract month; and 200 contracts
at the close of trading on the business day prior to the last two
trading days of the contract month.
\2\ For persons that are not availing themselves of the Sec.
150.3(a)(4) conditional spot month limit exemption in natural gas,
the 2,000 contract spot month speculative position limit level
applies to: (1) the physically-settled NYMEX Henry Hub Natural Gas
(NG) core referenced futures contract and any other physically-
settled contract that qualifies as a referenced contract to NYMEX
Henry Hub Natural Gas (NG) under the definition of ``referenced
contract'' under Sec. 150.1, in the aggregate across all exchanges
listing a physically-settled NYMEX Henry Hub Natural Gas (NG)
referenced contract and the OTC swaps market, net long or net short;
and (2) the cash-settled NYMEX Henry Hub Natural Gas (NG) referenced
contracts, net long or net short, on a per-exchange basis for each
exchange that lists one or more cash-settled NYMEX Henry Hub Natural
Gas (NG) referenced contract(s) rather than aggregated across such
exchanges. Further, an additional 2,000 contract limit, net long or
net short, applies across all cash-settled economically equivalent
NYMEX Henry Hub Natural Gas (NG) OTC swaps.
\3\ Step-down spot month limits apply to positions net long or
net short as follows: 6,000 contracts at the close of trading three
business days prior to the last trading day of the contract; 5,000
contracts at the close of trading two business days prior to the
last trading day of the contract; and 4,000 contracts at the close
of trading one business day prior to the last trading day of the
contract.
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BILLING CODE 6351-01-C
Appendix F to Part 150--Guidance on, and Acceptable Practices in,
Compliance With the Requirements for Exchange-Set Limits and Position
Accountability on Commodity Derivative Contracts
The following are guidance and acceptable practices for
compliance with Sec. 150.5. Compliance with the acceptable
practices and guidance does not diminish or replace, in any event,
the obligations and requirements of the person to comply with the
other regulations provided under this part. The acceptable practices
and guidance are for illustrative purposes only and do not state the
exclusive means for establishing compliance with Sec. 150.5.
(a) Acceptable practices for compliance with Sec.
150.5(b)(2)(i) regarding exchange-set limits or accountability
outside of the spot month. A designated contract market or swap
execution facility that is a trading facility may satisfy Sec.
150.5(b)(2)(i) by complying with either of the following acceptable
practices:
(1) Non-spot month speculative position limits. For any
commodity derivative contract subject to Sec. 150.5(b), a
designated contract market or swap execution facility that is a
trading facility sets individual single month or all-months-combined
levels no greater than any one of the following:
(i) The average of historical position sizes held by speculative
traders in the contract as a percentage of the average combined
futures and delta-adjusted option month-end open interest for that
contract for the most recent calendar year;
(ii) The level of the spot month limit for the contract;
(iii) 5,000 contracts (scaled-down proportionally to the
notional quantity per contract relative to the typical cash-market
transaction if the notional quantity per contract is larger than the
typical cash-market transaction, and scaled up proportionally to the
notional quantity per contract relative to the typical cash-market
transaction if the notional quantity per contract is smaller than
the typical cash-market transaction); or
(iv) 10 percent of the average combined futures and delta-
adjusted option month-end open interest in the contract for the most
recent calendar year up to 50,000 contracts, with a marginal
increase of 2.5 percent of open interest thereafter.
(2) Non-spot month position accountability. For any commodity
derivative contract subject to Sec. 150.5(b), a designated contract
market or swap execution facility that is a trading facility adopts
position accountability, as defined in Sec. 150.1.
(b) [Reserved]
[[Page 3482]]
Appendix G to Part 150--Guidance on Spread Transaction Exemptions
Granted for Contracts that are Subject to Federal Speculative Position
Limits
Positions that comply with Sec. 150.3(a)(2)(i) or (ii) may
exceed Federal speculative position limits, provided that the entity
separately requests a spread transaction exemption from the relevant
exchange's position limits established pursuant to proposed Sec.
150.5(a). The following provides guidance to exchanges and market
participants on the use of spread transaction exemptions granted
pursuant to Sec. 150.5(a). Exchanges and market participants may
also consider this guidance for purposes of spread transaction
exemptions granted pursuant to Sec. 150.5(b). The following
guidance includes recommendations for exchanges and market
participants to consider when granting or relying on spread
transaction exemptions for positions that include referenced
contracts that are subject to Federal speculative position limits.
(a) General guidance on spread transaction exemptions for
referenced contracts. (1) When granting spread transaction
exemptions pursuant to Sec. 150.5(a), an exchange should:
(i) Collect sufficient information from the market participant
to be able to:
(A) Understand the spread strategy, consistent with Sec.
150.5(a)(2)(ii)(A); and
(B) Verify that there is a material economic relationship
between the legs of the spread transaction, consistent with the
requirement in Sec. 150.5(a)(2)(ii)(G) to grant exemptions in
accordance with sound commercial practices;
(ii) Consider whether granting the spread transaction exemption
would, to the maximum extent practicable:
(A) Ensure sufficient market liquidity for bona fide hedgers;
and
(B) Not unduly reduce the effectiveness of Federal speculative
position limits to:
(1) Diminish, eliminate, or prevent excessive speculation;
(2) Deter and prevent market manipulations, squeezes, and
corners; and
(3) Ensure that the price discovery function of the underlying
market is not disrupted;
(iii) Consider implementing safeguards to ensure that when
granting spread transaction exemptions, especially during the spot
period, the exchange is able to comply with all statutory and
regulatory obligations, including the requirements of:
(A) DCM Core Principle 2 and SEF Core Principle 2, as
applicable, to, among other things, prohibit abusive trading
practices on its markets by members and market participants, and
prohibit any other manipulative or disruptive trading practices
prohibited by the Act or Commission regulations;
(B) DCM Core Principle 4 and SEF Core Principle 4, as
applicable, to prevent manipulation, price distortion, and
disruptions of the delivery or cash-settlement process through
market surveillance, compliance, and enforcement practices and
procedures;
(C) DCM Core Principle 5 and SEF Core Principle 6, as
applicable, to implement exchange-set position limits in a manner
that reduces the potential threat of market manipulation or
congestion; and
(D) DCM Core Principle 12, as applicable, to protect markets and
market participants from abusive practices committed by any party,
including abusive practices committed by a party acting as an agent
for a participant; and to promote fair and equitable trading on the
contract market;
(iv) Ensure that any spread exemption transaction does not
impede convergence or facilitate the formation of artificial prices;
and
(v) Provide a cap or limit on the maximum size of all gross
positions permitted under the spread transaction exemption.
(2) The Commission reminds market participants that when
utilizing a spread transaction exemption, compliance with Federal
speculative position limits or an exemption thereto does not confer
any type of safe harbor or good faith defense to a claim that the
participant has engaged in an attempted or perfected manipulation or
willfully circumvented or evaded speculative position limits,
consistent with the Commission's anti-evasion provision in Sec.
150.2(i).
(b) Guidance on transactions permitted under the spread
transaction definition. (1) The Commission understands that market
participants are generally familiar with the meaning of intra-market
spreads, inter-market spreads, intra-commodity spreads, and inter-
commodity spreads, as those terms are used in the spread transaction
definition in Sec. 150.1. However, for the avoidance of confusion,
the Commission provides the following descriptions of such spread
strategies to assist exchanges in their analysis of whether a spread
position complies with the spread transaction definition. The
Commission generally understands that the following spread
strategies are typically defined as follows:
(i) Intra-market spread means a long (short) position in one or
more commodity derivative contracts in a particular commodity, or
its products or by-products, and a short (long) position in one or
more commodity derivative contracts in the same, or similar,
commodity, or its products or by-products, on the same designated
contract market or swap execution facility.
(ii) Inter-market spread means a long (short) position in one or
more commodity derivative contracts in a particular commodity, or
its products or by-products, at a particular designated contract
market or swap execution facility and a short (long) position in one
or more commodity derivative contracts in that same, or similar,
commodity, or its products or by-products, away from that particular
designated contract market or swap execution facility.
(iii) Intra-commodity spread means a long (short) position in
one or more commodity derivatives contracts in a particular
commodity, or its product or by-products, and a short (long)
position in one or more commodity derivative contracts in the same,
or similar, commodity, or its products or by-products.
(iv) Inter-commodity spread means a long (short) position in one
or more commodity derivatives contracts in a particular commodity,
or its product or by-products, and a short (long) position in one or
more commodity derivative contracts in a different commodity or its
products or by-products.
(2) The following is a non-exhaustive list of spread strategies
that comply with the spread transaction definition in Sec. 150.1:
(i) An inter-market spread transaction in which the legs of the
transaction are futures contracts in the same, or similar commodity,
or its products or its by-products, and same calendar month or
expiration;
(ii) A spread transaction in which one leg is a referenced
contract, as defined in Sec. 150.1, and the other leg is a
commodity derivative contract, as defined in Sec. 150.1, that is
not a referenced contract (including over-the-counter commodity
derivative contracts);
(iii) A spread transaction between a physically-settled contract
and a cash-settled contract;
(iv) A spread transaction between two cash-settled contracts;
and
(v) Spread transactions that are ``legged in,'' that is, carried
out in two steps, or alternatively are ``combination trades,'' that
is, all components of the spread are executed simultaneously or
contemporaneously.
(3) A spread transaction exemption cannot be used to exceed the
conditional spot month limit exemption, in Sec. 150.3(a)(4), for
positions in natural gas.
(4) The spread transaction definition does not include a single
cash-settled agreement, contract or transaction that, by its terms
and conditions:
(i) Simply represents the difference (or basis) between the
settlement price of a referenced contract and the settlement price
of another contract, agreement, or transaction (whether or not a
referenced contract), and
(ii) Does not comprise separate long and short positions.
(5) The spread transaction definition does not include a spread
position involving a commodity index contract and one or more
referenced contracts.
(c) Guidance on cash-and-carry exemptions. The spread
transaction definition in Sec. 150.1 would permit transactions
commonly known as ``cash-and-carry'' trades whereby a market
participant enters a long futures position in the spot month and an
equivalent short futures position in the following month, in order
to guarantee a return that, at minimum, covers the costs of its
carrying charges, such as the cost of financing, insuring, and
storing the physical inventory until the next expiration (including
insurance, storage fees, and financing costs, as well as other costs
such as aging discounts that are specific to individual
commodities). With this exemption, the market participant is able to
take physical delivery of the product in the nearby month and may
redeliver the same product in a deferred month. When determining
whether to grant, and when monitoring, cash-and-carry spread
transaction exemptions, the exchange should consider:
(1) Implementing safeguards to require a market participant
relying on such an exemption to reduce its position below the
speculative Federal position limit within a timely manner once
market prices no longer permit entry into a full carry transaction;
[[Page 3483]]
(2) Implementing safeguards that require market participants to
liquidate all long positions in the nearby contract month before the
price of the nearby contract month rises to a premium to the second
(2nd) contract month; and
(3) Requiring market participants that seek to rely on such
exemption to:
(i) Provide information about their expected cost of carrying
the physical commodity, and the quantity of stocks currently owned
in exchange-licensed warehouses or tank facilities; and
(ii) Agree that before the price of the nearby contract month
rises to a premium to the second (2nd) contract month, the market
participant will liquidate all long positions in the nearby contract
month.
PART 151 [REMOVED AND RESERVED]
0
27. Under the authority of section 8a(5) of the Commodity Exchange Act,
7 U.S.C. 12a(5), remove and reserve part 151.
Issued in Washington, DC, on November 12, 2020, by the
Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Position Limits for Derivatives--Commission Voting
Summary, Chairman's Statement, and Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz and
Stump voted in the affirmative. Commissioners Behnam and Berkovitz
voted in the negative.
Appendix 2--Statement of Support of Chairman Heath P. Tarbert
I am very proud to bring to a final vote the Commission's rule
on speculative position limits. Like my fellow Commissioners and so
many who have held these seats before us, I promised during my
confirmation hearing that I would work to finalize this rule. So to
the Senate Committee on Agriculture, Nutrition, and Forestry, to the
market participants who rely on futures markets, and to the American
people, I am pleased to say--promise made, promise kept.
Today, we are removing a cloud that has hung over both the CFTC
and the derivatives markets for a decade. Market participants,
particularly Americans who need these markets to hedge the risks
inherent in their businesses, will finally have regulatory
certainty.
Long Journey of Position Limits
Ralph Waldo Emerson is quoted as saying ``Life is a journey, not
a destination.'' Lucky for him, his journey did not involve position
limits. This rule has been one of the most difficult undertakings in
CFTC history.
The Commission has issued five position limits proposals over
the past 10 years. The first was adopted in 2011, but vacated by the
U.S. District Court for the District of Columbia before it took
effect. One proposal issued in 2013, and two more in 2016, were
never finalized. All told, those four proposals received thousands
of comments from the public--the vast majority of which objected to
the proposals for good reason. Much ink was spilled, and many trees
were felled over those proposals.
Finally, the Commission issued its fifth position limits
proposal in January of this year. Today we will finalize that rule.
But it is important to note we are not completely rejecting prior
attempts. Instead, we build on the good from previous proposals
while recognizing and fixing their shortcomings.
Any position limits rule involves a balancing act. To paraphrase
a famous saying--You can please some of the people all the time, and
all the people some of the time, but--as is certainly the case with
position limits--you can't please all the people all the time.
That is especially true given the three things the Commission is
tasked with balancing for position limits:
1. Whether position limits on a particular contract are more
helpful than harmful;
2. which positions should be subject to the limits and which
should not; and
3. at what levels position limits should be set to allow for
liquid markets but not excessive speculation.
Recognizing Dead Ends
Prior position limits proposals ultimately failed because they
were unable to strike the correct balance on these three points.
First, prior proposals were based on a plausible, but ultimately
unsupportable, interpretation--``the mandate.'' The mandate would
mean there is no balancing test; instead, all futures would be
subject to Federal limits. Given the wide range of futures in our
markets, this approach would require the CFTC to evaluate thousands
of contracts. It also would necessitate limits on everything--
regardless of the benefits those limits would bring or the burdens
they would impose.
Second, prior proposals failed to recognize all the ways that
participants use futures markets to hedge price risks. Agricultural,
energy, and metal futures markets are a vital to American
businesses, which is why Congress explicitly excluded bona fide
hedging positions from position limits. Reading the term bona fide
hedging too broadly risks inviting the wolf of speculative activity
into the market wearing sheep's clothing. Reading it too narrowly
creates the possibility of locking out the businesses that need
these markets to manage their risks. And taking away that ability to
manage risk jeopardizes economic growth.
As a result, the Commission's prior proposals were too
restrictive on what constitutes bona fide hedging. They threw up too
many roadblocks for businesses to access futures markets.
Ultimately, an overly rigid interpretation of bona fide hedging
stood in the way of finalizing a position limits rule.
Finally, prior proposals set limits that were both too low and
too rigid. Those limits did not balance the need for liquidity and
price discovery against the risks of excessive speculation, which is
the real mandate of Congress. The proposed limits were frozen in
time, not budging from limits last updated as far back as 1999.
Getting Back on the Right Path
Recognizing the missteps of the past yields a path to success.
Unlike prior position limits proposals that garnered a library of
negative comment letters, this proposal is overwhelmingly supported
by businesses and trade groups across many facets of our real
economy.
There are several differences that will let today's rule succeed
where others failed.
First, the rule recognizes the limits of limits. Position limits
are one method to combat corners and squeezes, but that does not
mean they are the singular tool that should always be deployed.
Position limits are like a medicine that can help cure a disease,
but also carries potential side effects. That is why Congress told
us to use them only when ``necessary.'' The necessity finding is
like a doctor's prescription--someone needs to evaluate the risks of
the disease against the side effects.
In addition, the rule takes into account market participants'
needs. As I have always said, position limits is the rare case where
the exception is as important as the rule. Today's rule lays out a
robust set of enumerated bona fide hedge exemptions to ensure that
participants in the physical commodity markets can access the
futures markets. Building on the proposal, we have added clarity
around unfixed price transactions and storage.
The rule also acknowledges the different ways people access the
markets. We have streamlined the process for pass-through swap
exemptions, making it easier for dealers to provide liquidity to
commercial users in the swaps market. And the rule clarifies that
someone can take a position during the Commission's 10-day review
period of an exchange-granted, non-enumerated exemption. In short,
we have built a robust set of enumerated exemptions and a workable
non-enumerated exemption process.
The rule also strikes a balance with respect to the limits
themselves. The January proposal included significant increases to
spot and non-spot limits for the legacy agricultural products. Many
commenters were concerned about these increases, particularly for
non-spot limits.
The level of the non-spot limits in the final rule are a
function of the significant growth in the market and the long delay
in making adjustments. Open interest in many of the legacy grains
contracts has doubled or tripled since we last updated position
limits, reflecting the usefulness of these contracts as a benchmark
for cash market transactions and faith in CFTC-regulated markets.
The non-spot limits we are adopting are the same percentage of
today's open interest as the 2011 limits were compared to open
interest back then. Our markets have grown tremendously, and we
cannot expect them to be subject to the same limits they were 10
years ago.
It is important to remember that Federal position limits are a
ceiling, not a floor.
[[Page 3484]]
Exchanges have their own limits, which can be no higher than what we
specify. And exchanges can calibrate those limits quickly to account
for issues with deliverable supply or other cash market issues. As
we have seen play out over the past decade, the CFTC has a difficult
time adjusting position limits. Therefore, exchange-set limits are a
way to fine tune position limits on a particular market within the
outer bounds of the Federal limits. Similar to the process for
granting non-enumerated exemptions, we are leveraging the knowledge
of the exchanges as well as their ability to act more nimbly to
respond to market needs.
Arriving at the Destination
Some of my colleagues may see these features of the final rule
as a flaw. While there are significant departures from prior
proposals, after four failed attempts, that departure is exactly
what we need. The flexibility in the necessity finding, the
exemption process, and the adjusted limits are what make this rule
workable. Otherwise, we are just repeating past mistakes and hoping
for a different result--the very definition of insanity.
So let me conclude by saying that we have come a long way. Today
we have reached the end of an arduous journey. We have learned from
our mistakes and adjusted our approach. We have balanced the
interests of all the participants in these markets--some of which
are in diametric opposition to one another. Most importantly, we
have crafted a workable and flexible system. The rule sets hard
limits, but leverages the flexibility of exchanges to adjust for a
particular market. The rule recognizes the variety of ways that
businesses use these markets to hedge their risks, while recognizing
how vital it is to have a method to address the unknown unknowns.
And the rule acknowledges that position limits are not always
necessary and sets out a solid methodology for determining when they
are.
I again want to thank the CFTC staff and my fellow Commissioners
for their tireless commitment to finishing this journey. I look
forward to voting in favor of this final rule.
Appendix 3--Supporting Statement of Commissioner Brian Quintenz
I am pleased to support the agency's revitalized approach to
position limits. The rulemaking finalized today follows four
proposals since the passage of the Dodd-Frank Act \1\ and is, by
far, the strongest of them all. I commend Chairman Tarbert for his
leadership in completing this rulemaking. I am very pleased that
today's final rule echoes the key policy points I outlined in my
remarks before the 2018 Commodity Markets Council State of the
Industry Conference.\2\ The new position limits regime will provide
commercial market participants with sufficient flexibility to hedge
their risks efficiently and will promote liquidity and price
discovery.
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\1\ 76 FR 4752 (Jan. 26, 2011); 78 FR 75680 (Dec. 12, 2013); 81
FR 38458 (June 13, 2016) (``supplemental proposal''); and 81 FR
96704 (Dec. 30, 2016). The Commodity Exchange Act (CEA) addresses
position limits in Section (Sec.) 4a (7 U.S.C. 6a).
\2\ Remarks of Commissioner Brian Quintenz before the CMC State
of the Industry 2018 Conference, https://www.cftc.gov/PressRoom/SpeechesTestimony/opaquintenz5.
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Today's rule promotes flexibility, certainty, and market
integrity for end-users--farmers, ranchers, energy producers,
transporters, processors, manufacturers, merchandisers, and all who
use physically-settled derivatives to risk manage their exposure to
physical goods. The rule includes an expansive list of enumerated
and self-effectuating bona fide hedge exemptions and spread
exemptions, and a streamlined, exchange-centered process to
adjudicate non-enumerated bona fide hedge exemption requests. I am
pleased that the rule seriously considered the usability of hedging
exemptions, and I thank Commissioner Stump for her leadership on
that point.
In contrast to the Commission's failed proposed rulemakings in
2011, 2013, and 2016, this rule is the most true to the CEA in many
significant respects. It requires, as has long been the Commission's
practice, a necessity finding before imposing limits. It includes
economically equivalent swaps. And, perhaps most importantly, it
balances the interests among promoting liquidity, deterring
manipulation, and ensuring the price discovery function of the
underlying market is not disrupted.\3\ The confluence of these
factors occurs most acutely in the spot month for physically-settled
contracts. In the spot month, price convergence is exceptionally
vulnerable to potential manipulation or disruption due to outsized
positions. By establishing position limits for non-legacy contracts
only in the spot month, the rule elegantly balances the
countervailing policy interests enumerated in the statute.
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\3\ Sec. 4a(a)(3).
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Responding to the Public's Concerns
Through staff's serious consideration of over 70 public
comments, the final rule significantly improves on what appears in
the proposal. Examples of modifications based on public comment
include considerations of gross hedging, price risk, the pass-
through swap exemption, spot month limits for natural gas and
cotton, a special non-spot single-month limit for cotton, spread
exemptions, and the Commission's review of exchange-granted non-
enumerated hedge exemptions.
With regard to enumerated bona fide hedges, the final rule took
into account several suggestions from commenters. The proposed
enumerated hedges were already a significant improvement upon
previously proposed hedge exemptions (for example, eliminating a
mandatory ``five-day rule'' \4\ and no longer conditioning cross-
commodity hedging on a needlessly rigid quantitative test). Now,
under the final rule, the enumerated hedges will be even more
practical. For example, the final rule makes clear that a hedger
with only an unfixed-price cash commodity sale or purchase, but not
an offsetting pair, may rely on one of the three anticipatory
hedges, provided that the other elements of such hedge are also met,
even though the hedger is ineligible to elect the hedge for a pair
of unfixed-price sale and purchase transactions.\5\ The final rule
also makes clear that the new anticipatory merchandising hedge can
be used both by integrated energy firms and by firms that limit
their business to merchandising. Furthermore, the final rule permits
the anticipatory merchandising hedge to now be used in connection
with storage hedges.
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\4\ Previous versions of enumerated hedges had required a hedger
to eliminate positions in excess of position limits during the last
five days of the spot month.
\5\ Preamble discussion of Exemptions from Federal Position
Limits. The hedge for a pair of offsetting unfixed-price
transactions is described in Appendix B, paragraph (a)(3), and the
anticipatory hedges are described in Appendix B, paragraphs (a)(4)-
(6).
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I support the final rule's determination to delay by two years
two important elements that will require significant changes in the
marketplace: The imposition of position limits on swaps economically
equivalent to the referenced futures contracts and the required
unwinding of previously elected risk management exemptions.\6\ It is
prudent to allow for additional time for financial entities to
adjust to these significant new policies.
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\6\ Whereas the general compliance date for the final rule is
January 1, 2022, the compliance date for these two items is January
1, 2023.
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Necessity Finding
Today's rule correctly premises new limits on a finding that
they are necessary to diminish, eliminate, or prevent the burden on
interstate commerce from extraordinary price movements caused by
excessive speculation (``necessity finding'') in specific contracts,
as Congress has long required in the CEA and its legislative
precursors since 1936.\7\ I am pleased that the rule complies with
the District Court's ruling in the ISDA-position limits litigation:
That the Commission must decide whether Section 4a of the CEA
mandates the CFTC set new limits or only permits the CFTC to set
such limits pursuant to a necessity finding.\8\ As the District
Court noted, ``the Dodd-Frank amendments do not constitute a clear
and unambiguous mandate to set position limits.'' \9\ I agree with
the rule's determination that, when read together, paragraphs (1)
and (2) of Section 4a demand a necessity finding.
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\7\ Sec. 4a(1).
\8\ ISDA et al. v. CFTC, 887 F. Supp. 2d 259, 278 and 283-84
(D.D.C. Sept. 28, 2012).
\9\ Id. at 280.
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Section 4a(a)(2)(A) states that the Commission shall establish
limits ``in accordance with the standards set forth in paragraph (1)
of this subsection.'' \10\ Paragraph (1) establishes the
Commission's
[[Page 3485]]
authority to, ``proclaim and fix such limits on the amounts of
trading . . . as the Commission finds are necessary to diminish,
eliminate or prevent [the] burden'' on interstate commerce caused by
unreasonable or unwarranted price moves associated with excessive
speculation. This language dates back almost verbatim to legislation
passed in 1936, in which Congress directed the CFTC's precursor to
make a necessity finding before imposing position limits. The
Congressional report accompanying the CEA from the 74th Congress
includes the following directive, ``[Section 4a of the CEA] gives
the Commodity Exchange Commission the power, after due notice and
opportunity for hearing and a finding of a burden on interstate
commerce caused by such speculation, to fix and proclaim limits on
futures trading . . .'' \11\ In its ISDA opinion, the District Court
noted the following: ``This text clearly indicated that Congress
intended for the CFTC to make a `finding of a burden on interstate
commerce caused by such speculation' prior to enacting position
limits.'' \12\
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\10\ Sec. 4a(a)(2)(A) (``In accordance with the standards set
forth in paragraph (1) of this subsection and consistent with the
good faith exception cited in subsection (b)(2), with respect to
physical commodities other than excluded commodities as defined by
the Commission, 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.'')
\11\ H.R. Rep. 74-421, at 5 (1935).
\12\ 887 F. Supp. 2d 259, 269 (fn 4).
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I support the rule's view that the most natural reading of
Section 4a(a)(2)(A)'s reference to paragraph (1)'s ``standards'' is
that it logically includes the ``necessity'' standard. Paragraph
(1)'s requirement to make a necessity finding, along with the
aggregation requirement, provide substantive guidance to the
Commission about when and how position limits should be implemented.
If Congress intended to mandate that the Commission impose
position limits on all physical commodity derivatives, there is
little reason it would have referred to paragraph (1) and the
Commission's long established practice of necessity findings.
Instead, Congress intended to focus the Commission's attention on
whether position limits should be considered for a broader set of
contracts than the legacy agricultural contracts, but did not
mandate those limits be imposed.
Setting New Limits ``As Appropriate''
The rule determines that position limits are necessary to
diminish, eliminate, or prevent the burden on interstate commerce
posed by unreasonable or unwarranted prices moves that are
attributable to excessive speculation in 25 referenced commodity
markets that each play a crucial role in the U.S. economy.
Conversely, the rule also finds that the contracts on which the
referenced limits are placed are the only contracts which met the
necessity finding. The rule explicitly states that no other
contracts met this test.
I am aware that there is significant skepticism in the
marketplace and among academics as to whether position limits are an
appropriate tool to guard against extraordinary price movements
caused by extraordinarily large position size. Some argue there is
no evidence that excessive speculation currently exists in U.S.
derivatives markets.\13\ Others believe that large and sudden price
fluctuations are not caused by hyper-speculation, but rather by
market participants' interpretations of basic supply and demand
fundamentals.\14\ In contrast, still others believe that outsized
speculative positions, however defined, may aggravate price
volatility, leading to price run-ups or declines that are not fully
supported by market fundamentals.\15\
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\13\ Testimony of Erik Haas (Director, Market Regulation, ICE
Futures U.S.) before the CFTC at 70 (Feb. 26, 2015) (``We point out
the makeup of these markets, primarily to show that any regulations
aimed at excessive speculation is a solution to a nonexistent
problem in these contracts.''), available at: https://www.cftc.gov/idc/groups/public/@aboutcftc/documents/file/emactranscript022615.pdf.
\14\ BAHATTIN B[Uuml]Y[Uuml]K[Scedil]AHIN & JEFFREY HARRIS,
CFTC, THE ROLE OF SPECULATORS IN THE CRUDE OIL FUTURES MARKET 1, 16-
19 (2009) (``Our results suggest that price changes leads the net
position and net position changes of speculators and commodity swap
dealers, with little or no feedback in the reverse direction. This
uni-directional causality suggests that traditional speculators as
well as commodity swap dealers are generally trend followers.''),
available at http://www.cftc.gov/idc/groups/public/@swaps/documents/file/plstudy_19_cftc.pdf; Testimony of Philip K. Verleger, Jr.
before the CFTC, Aug. 5, 2009 (``The increase in crude prices
between 2007 and 2008 was caused by the incompatibility of
environmental regulations with the then-current global crude supply.
Speculation had nothing to do with the price rise.''), available at:
https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/hearing080509_verleger.pdf.
\15\ For a discussion of studies discussing supply and demand
fundamentals and the role of speculation, see 81 FR 96704, 96727
(Dec. 30, 2016). See, e.g., Hamilton, Causes and Consequences of the
Oil Shock of 2007-2008, Brookings Paper on Economic Activity (2009);
Chevallier, Price Relationships in Crude oil Futures: New Evidence
from CFTC Disaggregated Data, Environmental Economics and Policy
Studies (2012).
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In my opinion, one thing is predominately clear: position limits
should not be viewed as a means to counteract long-term directional
price moves. The CFTC is not a price setting agency and we should
not impede the market from reflecting long term supply and demand
fundamentals. A case in point is palladium, the physically-settled
contract which has seen the largest sustained price increase
recently,\16\ and which has also seen its exchange-set position
limit decline four times since 2014 to what is now the smallest
limit of any contract in the referenced contract set.\17\
Nevertheless, between the start of 2018 and the end of 2019,
palladium futures prices rose 76%.\18\ Taking these conflicting
views and facts into account, it is clear the Commission correctly
stated in its 2013 proposal, ``there is a demonstrable lack of
consensus in the [academic] studies'' as to the effectiveness of
position limits.\19\
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\16\ Platinum, gold slide as dollar soars; palladium eases off
record, Reuters (Sept. 30, 2019), available at: https://www.reuters.com/article/global-precious/precious-platinum-gold-slide-as-dollar-soars-palladium-eases-off-record-idUSL3N26L3UV.
\17\ Between 2014 and 2017, the CME Group lowered the spot month
position limit in the contract four times, from 650, to 500, to 400,
to 100, to the current limit of 50 (NYMEX regulation 40.6(a)
certifications, filed with the CFTC, 14-463 (Oct. 31, 2014), 15-145
(Apr. 14, 2015), 15-377 (Aug. 27, 2015), and 17-227 (June 6, 2017)),
available at: https://sirt.cftc.gov/sirt/sirt.aspx?Topic=ProductTermsandConditions.
\18\ Palladium futures were at $1,087.35 on Jan. 2, 2018 and at
$1,909.30 on Dec. 31, 2019. Historical prices available at: https://futures.tradingcharts.com/historical/PA_/2009/0/continuous.html.
\19\ 78 FR 75694 (Dec. 12, 2013).
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With that healthy dose of skepticism, and in strict accordance
with the balance of factors which Dodd Frank added to the CEA for
the Commission to consider, I think the rule appropriately focuses
on the time period and contract type where position limits can have
the most positive, and the least negative, impact--the spot month of
physically settled contracts--while also calibrating those limits to
function as just one of many tools in the Commission's regulatory
toolbox that can be used to promote credible, well-functioning
derivatives and cash commodity markets.
Because of the significance of these 25 core referenced futures
contracts to the underlying cash markets, the level of liquidity in
the contracts, as well as the importance of these cash markets to
the national economy, I think it is appropriate for the Commission
to protect the physical delivery process and promote convergence in
these critical commodity markets. Further, the limits issued today
are higher than in the past, notably because the rule utilizes
current estimates of deliverable supply--numbers which haven't been
updated since 1999.\20\
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\20\ 64 FR 24038 (May 5, 1999).
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Taking End-Users Into Account
Perhaps more than any other area of the CFTC's regulations,
position limits directly affect the participants in America's real
economy: Farmers, ranchers, energy producers, manufacturers,
merchandisers, transporters, and other commercial end-users that use
the derivatives market as a risk management tool to support their
businesses. I am pleased that today's rule takes into account many
of the serious concerns that end-users voiced in response to this
rulemaking's proposal, and in response to the CFTC's previous four
unsuccessful position limits proposals.
Importantly, and in response to many comments, this rule, for
the first time, expands the possibility for enterprise-wide
hedging,\21\ (including additional clarification provided in the
proposal in response to comments), establishes an enumerated
anticipated merchandising exemption,\22\ eliminates the ``five-day
rule'' for enumerated hedges,\23\ and no longer requires the filing
of certain cash market information with the Commission that the CFTC
can obtain from exchanges.\24\ Regarding enterprise-wide hedging--
otherwise known as ``gross hedging''--the rule will provide an
energy company, for example, with increased flexibility to hedge
different units of its business separately if those units face
different economic realities. The final rule eliminates the
requirement that exchanges document their justifications when
allowing
[[Page 3486]]
gross hedging; clarifies that market participants are not required
to develop written policies or procedures that set forth when gross
versus net hedging is appropriate; and clarifies that gross hedging
is permissible for both enumerated and non-enumerated hedges.\25\
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\21\ Appendix B, paragraph (a).
\22\ Appendix A, paragraph (a)(6).
\23\ Preamble discussion of Exemptions from Federal Position
Limits.
\24\ Elimination of CFTC Form 204.
\25\ Preamble discussion, Execution Summary, section 6. Legal
Standards for Exemptions from Position Limits.
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With respect to cross-commodity hedging, today's rule completely
rejects the arbitrary, unworkable, ill-informed, and frankly,
ludicrous ``quantitative test'' from the 2013 proposal.\26\ That
test would have required a correlation of at least 0.80 or greater
in the spot markets prices of the two commodities for a time period
of at least 36 months in order to qualify as a cross-hedge.\27\
Under this test, longstanding hedging practices in the electric
power generation and transmission markets would have been
prohibited. Today's rule not only shuns this Government-Knows-Best
approach, it also establishes new flexibility for the cross-
commodity hedging exemption, allowing it to be used in conjunction
with other enumerated hedges, such as hedges of anticipated
merchandising transactions.\28\ For example, an energy marketer
anticipating buying and selling jet fuel to supply airports will be
eligible for a hedge exemption in connection with trading heating
oil futures, a commonly-used cross-commodity hedge for jet fuel.
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\26\ 78 FR 75717 (Dec. 12, 2013).
\27\ Id.
\28\ Appendix A, paragraph (a)(11).
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Bona Fide Hedges and Coordination With Exchanges
For those market participants who employ non-enumerated bona
fide hedging practices in the marketplace, the final rule creates a
streamlined, exchange-focused process to approve those requests for
purposes of both exchange-set and Federal limits. I am pleased that
commenters were generally supportive of the proposed process. As the
marketplaces for the core referenced futures contracts addressed by
the proposal, the DCMs have significant experience in, and
responsibility towards, a workable position limits regime. CEA core
principles require DCMs and swap execution facilities to set
position limits, or position accountability levels, for the
contracts that they list in order to reduce the threat of market
manipulation.\29\ DCMs have long administered position limits in
futures contracts for which the CFTC has not set limits, including
in certain agricultural, energy, and metals markets. In addition,
the exchanges have been strong enforcers of their own rules: During
2018 and 2019, CME Group and ICE Futures US concluded 32 enforcement
matters regarding position limits.
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\29\ DCM Core Principle 5 (sec. 5 of the CEA, 7 U.S.C. 7)
(implemented by CFTC regulation 38.300) and SEF Core Principle 6
(sec. 5h of the CEA, 7 U.S.C. 7b-3) (implemented by CFTC regulation
37.600).
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As part of their stewardship of their own position limits
regimes, DCMs have long granted bona fide hedging exemptions in
those markets where there are no Federal limits. Today's final rule
provides what I believe is a workable framework to utilize
exchanges' long standing expertise in granting exemptions that are
not enumerated by CFTC rules.\30\ This rule also recognizes that the
CEA does not provide the Commission with free rein to delegate all
of the authorities granted to it under the statute.\31\ The
Commission itself, through a majority vote of the five
Commissioners, retains the ability to reject an exchange-granted
non-enumerated hedge request within 10 days of the exchange's
approval.\32\ The Commission has successfully and responsibly used a
similar process for both new contract listings as well as exchange
rule filings, and I am pleased to see the final rule expand that
approach to non-enumerated hedge exemption requests that will limit
the uncertainty for bone fide commercial market participants.
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\30\ Regulation 150.9.
\31\ Preamble discussion of regulation 150.9, including
references to cases pointing out the extent to which an agency can
delegate to persons outside of the agency.
\32\ Regulation 150.9(e)(6).
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Limits on Swaps
The CEA requires the Commission to consider limits not only on
exchange-traded futures and options, but also on ``economically
equivalent'' swaps.\33\ Today's final rule provides the market with
far greater certainty on the universe of such swaps than the
previous proposed rulemakings. Prior proposals failed to
sufficiently explain what constituted an ``economically equivalent
swap,'' thereby ensuring that compliance with position limits was
essentially unworkable, given real-time aggregation requirements and
ambiguity over in-scope contracts. In stark contrast, today's rule
narrows the scope of ``economically equivalent'' swaps to those with
material contractual specifications, terms, and conditions that are
identical to exchange-traded contracts.\34\ For example, in order
for a swap to be considered ``economically equivalent'' to a
physically-settled core referenced futures contract, that swap would
also have to be physically-settled, because settlement type is
considered a material contractual term. I believe the narrowly-
tailored definition included in today's rule will provide market
participants with clarity over those contracts subject to position
limits. I think it is prudent that the final rule took commenters'
concerns about updating compliance systems into account by delaying
for an additional year, beyond the general compliance date of
January 1, 2022, that is until January 1, 2023, the imposition of
position limits on economically equivalent swaps.
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\33\ Sec. 4a(5).
\34\ Regulation 150.1.
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Conclusion
During my confirmation hearing in front of the Senate Committee
on Agriculture, Forestry and Nutrition on July 27, 2017, I was asked
to directly commit to finalizing a position limits rule. My response
was brief, but unquestionable: ``Yes, I commit to support finalizing
a position limits rule.'' Making such a commitment to a committee of
the U.S. Congress in sworn testimony is something I take very
seriously, second only to taking my oath to defend the Constitution
of the United States. With today's vote, I am very pleased to have
made good on that commitment three years in the making and am even
more proud of the product with which I was able to fulfill it.
Appendix 4--Dissenting Statement of Commissioner Rostin Behnam
Introduction
The last time we gathered as a Commission to discuss position
limits I used some of my time to speak a bit about the award winning
movie, Ford v. Ferrari.\1\ At that point, we were nearing the airing
of the 92nd Academy Awards and this action-packed drama had earned
four nominations--not to mention the distinction of being one of the
few films I actually saw in a theater. For those of you who have not
found it in one of your quarantine movie queues, Ford v. Ferrari
tells the true story of American car designer Carroll Shelby and
British-born driver Ken Miles who built a race car for Ford Motor
Company--the GT40--and competed with Enzo Ferrari's dominating,
iconic red racing cars at the 1966 24 Hours of Le Mans.\2\ I used
the film and racing metaphors throughout my speaking and written
statements to highlight serious concerns that the proposed
amendments to the CFTC rules addressing position limits (the
``Proposal'') signified yet one more instance where the Commission
seemed to be comfortable with deferring core, congressionally
mandated duties to others and calling it a victory.\3\
---------------------------------------------------------------------------
\1\ Statement of Dissent by Commissioner Rostin Behnam Regarding
Position Limits for Derivatives; Proposed Rule, https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement013020 (the
``Dissent'').
\2\ Ford v Ferrari, Fox Movies, https://www.foxmovies.com/movies/ford-v-ferrari (Last visited Oct. 13, 2020).
\3\ Dissent.
---------------------------------------------------------------------------
We are here today to finalize the Proposal.\4\ In just short of
nine months, we have come to terms with life during a global
pandemic complete with economic turmoil and pockets of historic
market volatility. Amid the mere 60-day open comment period
following the Proposal's publication in the Federal Register
(graciously extended by 16 days to May 15th in light of the pandemic
\5\), on April 20th, the price of the West Texas Intermediate crude
oil futures contract (``WTI contract''), a key benchmark in the
energy and financial markets, experienced an unprecedented collapse
one day prior to the last day of trading and expiration for May
delivery.\6\ Defying market mechanics, the
[[Page 3487]]
price of the contract fell from $17.73 per barrel at market open, to
a closing settlement price of negative $37.63--with the price
dropping approximately $40 in the last 20 minutes of trading.\7\
And, while we are still in recovery, with great fanfare after almost
10 years, the Commission is going to establish the position limits
regime required under the Dodd-Frank Act. I am reminded again of Ken
who, at the 1966 24 Hours of Le Mans, went against his gut, giving
way and leaving behind a milestone in car racing that to this day
remains elusive.
---------------------------------------------------------------------------
\4\ See Position Limits for Derivatives, 85 FR 11596 (Feb. 27,
2020).
\5\ See Press Release Number 8146-20, CFTC, CFTC Extends Certain
Comment Periods in Response to COVID-19 (Apr. 10, 2020), https://www.cftc.gov/PressRoom/PressReleases/8146-20; Extension of Currently
Open Comment Periods for Rulemakings in Response to the COVID-19
Pandemic, 85 FR 22690, 22691 (Apr. 23, 2020).
\6\ See Statement of Commissioner Dan M. Berkovitz on Recent
Trading in the WTI Futures Contract before the Energy and
Environmental Markets Advisory Committee Meeting (May 7, 2020),
https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement050720.
\7\ See Bloomberg News, The 20 Minutes that Broke the U.S. Oil
Market, Bloomberg (Apr. 25, 2020), https://www.bloomberg.com/news/articles/2020-04-25/the-20-minutes-that-broke-the-u-s-oil-market?sref=DzeLiNol.
---------------------------------------------------------------------------
If you have not seen the movie, this is a spoiler alert: Ken did
not win Le Mans in '66. While he was one and a half laps ahead of
two other GT40s, he was given orders to slow down so that the three
Fords in the lead would cross the finish line in a dead heat
formation. Ken lost his well-deserved win because the 24 Hours of Le
Mans awards the victory to the car that covers the greatest distance
in 24 hours. In the event of a tie, the rules provided that the car
that had started farther down the grid had traveled the greater
distance. Ken's GT 40 had started in the grid roughly 60 feet ahead
of the GT40 driven by Bruce McLaren and Chris Amon, who were the
declared winners.\8\
---------------------------------------------------------------------------
\8\ Press Release, Ford Division News Bureau, For Immediate
Release at 8 (July 5, 1966), made available in PDF at Wikipedia, the
Free Encyclopedia, 1966 24 Hours of Le Mans, at https://en.wikipedia.org/wiki/1966_24_Hours_of_Le_Mans.
---------------------------------------------------------------------------
In the film, Ken seems to accept his loss with quiet dignity.
However, in reality he was fully aware that in many respects, he had
been robbed. From what I've read, Ken likely articulated his
feelings a bit more colorfully.\9\
---------------------------------------------------------------------------
\9\ Matthew Phelan, What's Fact and What's Fiction in Ford v.
Ferrari, Slate (Nov. 18, 2019), https://slate.com/culture/2019/11/ford-v-ferrari-fact-vs-fiction-le-mans-ken-miles.html.
---------------------------------------------------------------------------
The point is that bringing something across the finish line
doesn't always equate to a success. As detailed in my questions
today, I believe that by going against our Congressional mandate and
clear statutory intent by overly deferring to the exchanges, we have
relinquished a claim to victory in this final position limits rule
which in many ways has itself felt like the CFTC's version of the 24
hours of Le Mans. Therefore, I will go with my gut and not be part
of the formation in supporting this final rule.
A Long Road, But a Fast Finish
It has been nine years since the Commission first set out to
establish the position limits regime required by amendments to
section 4a of the Commodity Exchange Act (the ``Act'' or ``CEA'')
\10\ under the Dodd-Frank Wall Street Reform and Consumer Protection
Act of 2010.\11\ While today's final rule purports to respect
Congressional intent and the purpose and language of CEA section 4a,
in reality, it pushes the bounds of reasonable interpretation by
overly deferring to the exchanges \12\ and allowing them to take the
lead in administering a position limits regime.
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\10\ See Position Limits for Derivatives, 76 FR 4752 (proposed
Jan. 26, 2011) (the ``2011 Proposal'').
\11\ The Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203 sec. 737, 124 Stat. 1376, 1722-25 (2010)
(the ``Dodd-Frank Act'').
\12\ Unless otherwise indicated, the use of the term
``exchanges'' throughout this statement refers to designated
contract markets (``DCMs'') and swap execution facilities
(``SEFs'').
---------------------------------------------------------------------------
In passing the Dodd-Frank Act, Congress understood that for the
derivatives markets in physical commodities to perform optimally,
there needed to be limits on the amount of control exerted by a
single person (or persons acting in agreement). In fact, Congress
has understood this need since at least 1936, when it first
authorized the Commission's predecessor to impose limits on
speculative positions in order to prevent the harms caused by
excessive speculation. In tasking the Commission with establishing
limits and the framework around their operation, Congress was aware
of our relationship with the exchanges, but nevertheless opted for
our experience and our expertise to meet the policy objectives of
the Act.
Last January, as the Commission voted on the Proposal that is
being finalized today, I warned that we seemed to be pushing to go
faster and just get to the finish line, making real-time adjustments
without regard to even trying for that ``perfect lap.'' \13\ Just
nine months later, nothing has changed. If anything, we seem to be
further prioritizing just crossing the finish line over achieving a
rule that actually follows Congressional intent and its first order
priority: Protecting market participants from excessive speculation.
---------------------------------------------------------------------------
\13\ Dissent.
---------------------------------------------------------------------------
Letting the Exchanges Make the Call
As I argued in regard to the proposal, my principal disagreement
is with the Commission's determination to in effect disregard the
tenets supporting the statutorily created parallel Federal and
exchange-set position limit regime, and take a back seat when it
comes to administration and oversight.\14\ Like Ken Miles, the
Commission is relinquishing a rightful lead in an act of deference.
In doing so, the Commission claims victory for recognizing that the
exchanges are better positioned in terms of resources, information,
knowledge, and agility, and therefore ought to take the wheel. While
this may seem like the logical move, it ignores that even if we
operate as a team, our incentives and interests are not fully
aligned. Based on consideration of the Commission's mission, and
Congressional intent as evinced in the Dodd-Frank Act amendments to
CEA section 4a and elsewhere in the Act, I continue to believe that
(1) the Commission is required to establish position limits based on
its reasoned and expert judgment within the parameters of the Act;
(2) the Commission has not provided a rational basis for its
determination not to establish Federal limits outside of the spot
month for referenced contracts based on commodities other than the
nine legacy agricultural commodities; and (3) the Commission's
seemingly unlimited flexibility in deciding to (a) significantly
broaden the bona fide hedging definition, (b) codify an expanded
list of self-effectuating enumerated bona fide hedges, and (c)
provide for exchange recognition of non-enumerated bona fide hedge
exemptions with respect to Federal limits, is both inexplicably
complicated to parse and inconsistent with Congressional intent.
---------------------------------------------------------------------------
\14\ Id.
---------------------------------------------------------------------------
Not only does the final version of the rule fail to address
these deficiencies in the proposal, it actually goes and makes many
of these issues worse.
Ignoring a Mandate
Like the proposal, this final rule goes to great lengths to
reconcile whether CEA section 4a(a)(2)(A) requires the Commission to
make an antecedent necessity finding before establishing any
position limit,\15\ with the implication that if a necessity finding
is required, then the Commission could rationalize imposing no
limits at all. Looking back at the record, what is necessary is that
the Commission complies with the mandate in the Dodd-Frank Act.\16\
In the 2011 Proposal, the Commission provided a review of CEA
section 4a(a)--interpreting the various provisions, giving effect to
each paragraph, acknowledging the Commission's own informational and
experiential limitations regarding the swaps markets at that time,
and focusing on the Commission's primary mission of fostering fair,
open and efficient functioning of the commodity derivatives
markets.\17\ Of note, ``Critical to fulfilling this statutory
mandate,'' the Commission pronounced, ``is protecting market users
and the public from undue burdens that may result from `excessive
speculation.' '' \18\ Federal position limits, as predetermined by
Congress, are most certainly the only means towards addressing the
burdens of excessive speculation when such limits must address a
``proliferation of economically equivalent instruments trading in
multiple trading venues.'' \19\ Exchange-set position limits or
accountability levels simply cannot meet the mandate.
---------------------------------------------------------------------------
\15\ See Final Rule at III.
\16\ The Commission's analysis in support of its denial of a
mandate misconstrues form over substance and assumes the answer it
is looking for. The Commission seems to suggest that it is free to
ignore a Congressional mandate if it determines that Congress is
wrong about the underlying policy. See Final Rule at III.A.
\17\ 76 FR at 4752-4754.
\18\ Id. at 4753.
\19\ Id. at 4754-4755.
---------------------------------------------------------------------------
In exercising its authority, the Commission may evaluate whether
exchange-set position limits, accountability provisions, or other
tools for contracts listed on such exchanges are currently in place
to protect against manipulation, congestion, and price
distortions.\20\ Such an evaluation--while permissible--is just one
factor for consideration. The existence of exchange-set limits or
accountability levels, on their own, can neither predetermine
deference nor be justified absent substantial consideration. As I
argued in my dissenting statement regarding
[[Page 3488]]
the Proposal, the authority and jurisdiction of individual exchanges
are necessarily different than that of the Commission. They do not
always have congruent interests to the Commission in monitoring
instruments that do not trade on or subject to the rules of their
particular platform or the market participants that trade them. They
do not have the attendant authority to determine key issues such as
whether a swap performs or affects a significant price discovery
function, or what instruments fit into the universe of economically
equivalent swaps. They are not permitted to define bona fide hedging
transactions or grant exemptions for purposes of Federal position
limits. It is therefore clear that CEA section 4a, as amended by the
Dodd-Frank Act ``warrants extension of Commission-set position
limits beyond agricultural products to metals and energy
commodities.'' \21\
---------------------------------------------------------------------------
\20\ See 76 FR at 4755.
\21\ Id.
---------------------------------------------------------------------------
``If it ain't broke, don't fix it''
In spite of all of this--the foregoing mandate; the clear
Congressional intent in CEA section 4a(a)(3)(A); and the
Commission's real experience and expertise (including its unique
data repository)--the Commission's final rule only maintains Federal
non-spot month limits for the nine legacy agricultural contracts
(with questionably appropriate modifications), ``because the
Commission has observed no reason to eliminate them.'' \22\
Essentially, the Commission concludes: ``if it ain't broke, don't
fix it.'' In keeping with this relatively riskless course of action,
the Commission similarly concludes that Federal non-spot month
limits are not necessary for the remaining 16 proposed core
referenced futures contracts identified in the Final Rule.
---------------------------------------------------------------------------
\22\ Final Rule at II.B.2.i.
---------------------------------------------------------------------------
In so doing, the Commission ignores Congressional intent. The
Commission never considers that Congress directed the Commission to
establish limits--not accountability levels. The Commission's
observation that exchange-set accountability levels have
``functioned as-intended'' until this point in time ignores the
wider purpose and function of aggregate position limits established
by the Commission, and is shortsighted given the ever expanding
universe of economically equivalent instruments trading across
multiple trading venues. As I pointed out in my dissenting statement
regarding the Proposal, it seems odd to conclude that Congress
envisioned that its painstaking amendments to CEA section 4a were a
directive for the Commission to check the box that the current
system is working perfectly.
Hedging on Bona Fide Hedging
Today's Final Rule provides for significantly broader bona fide
hedging opportunities that will be largely self-effectuating, and
the Commission defers to the exchanges in recognizing non-enumerated
bona fide hedging. While I support enhancing the cooperation between
the Commission and the exchanges, the Commission here is cooperating
by dropping back. The Commission's decision to essentially give up
primary authority to recognize non-enumerated bona fide hedges seems
both careless and inconsistent with Congressional intent.
I raised these concerns last January when we voted on the
Position Limits Proposal. Unfortunately, rather than retaking the
lead, the Commission further cedes authority to the exchanges. The
Proposal provided the Commission with the authority to reject an
exchange's grant of non-enumerated bona fide hedge recognition, and
provided a window of ten business days (or two in the case of sudden
or unforeseen circumstances) for the Commission to make this
determination. I pointed out in my dissent that this did not give
the Commission nearly enough time or guidance to properly make a
determination. In today's Final Rule, the Commission actually
further reduces its ability to make an independent determination.
Now, market participants will be able to establish positions based
upon an exchange's non-enumerated bona fide hedge recognition during
the Commission's 10-day review period, and the Commission cannot
determine that the person holding the position has committed a
position limits violation during the Commission's ongoing review or
upon issuing its determination. This reduces the Commission's review
to an ineffectual afterthought.
Trust the Process
A clear theme in my statements regarding our many rules over the
last few years is this: Process matters. Sharing our viewpoints with
the public matters. Following the Administrative Procedure Act,\23\
and giving the public an opportunity for meaningful comment on our
proposals, matters. We are at our best when we involve all five
Commissioners and our many stakeholders in the process.
---------------------------------------------------------------------------
\23\ 5 U.S.C. 553(b).
---------------------------------------------------------------------------
I want to thank the Chairman for consistently providing the
Commissioners with drafts of proposed and final rules 30 days in
advance of an open meeting. I believe there have only been two major
exceptions over the course of our many laps in the last year: The
position limits proposal, and the position limits final rule. In the
case of the final rule, we did not receive a full draft until last
Friday--six days before the open meeting. This simply is not enough
time for the Commission to engage in a fulsome discussion of the
merits of the rule, and makes the final rule more or less a fait
accompli. Perhaps most perplexing is that we did not receive a draft
of the cost benefit considerations until two weeks ago. This is
literally a rule where a prior iteration resulted in a court
challenge--one that the Commission lost.\24\ If ever a rule required
more consideration by the Commission itself, this would seem to be
it. Instead, the Commissioners actually had less time to review and
consider the rule than we normally do.
---------------------------------------------------------------------------
\24\ Int'l Swaps & Derivatives Ass'n v. U.S. Commodity Futures
Trading Comm'n, 887 F. Supp. 2d 259 (D.D.C. 2012).
---------------------------------------------------------------------------
When we focus on just getting to the finish line, and do not
take the time for meaningful consideration and dialogue, we risk
failing to take into account everything that we should in our
rulemakings. Subsequent to the issuance of the Position Limits
Proposal, there was a major market event resulting from the ongoing
pandemic that may have important implications for our position
limits regime. As the NYMEX Light Sweet Crude Oil (CL) contract,
also known as the WTI contract, neared expiration in April 2020, the
contract experienced extreme volatility, with the market trading
below zero for the first time. The Commission received at least
eight comments that addressed this event; a number of commenters
noted that the extreme volatility was driven by speculators. The
speculators, unable to physically deliver upon expiration for
various reasons, had no choice but to exit the contract at whatever
price was available. Commission staff continues to review and
analyze this event, and the rule today recognizes that the analysis
may impact the rule itself. Today's preamble states: ``The
Commission will continue to analyze the events of April 20 to
evaluate whether any changes to the position limits regulations may
be warranted in light of the circumstances surrounding the
volatility in the WTI contract.''\25\ This begs the question--if the
Commission is currently in the midst of this analysis, why not wait
to finalize position limits until the analysis is complete?
---------------------------------------------------------------------------
\25\ Final Rule at I.G.
---------------------------------------------------------------------------
Conclusion
Before concluding, I want to acknowledge and thank the
Commission staff who worked on the Proposal, today's final rule, and
every related study, matter, and undertaking to support it for the
better part of 10 years. You were the design team, the engineers,
the production team and the pit crew. You kept us on course at a
pace set by our Chairman, and you have performed at the top of your
field.
Back in '66, by holding back, Ken Miles lost the win at Le Mans,
which denied him the ``Triple Crown'' of endurance racing: The 24
Hours of Daytona, the 12 Hours of Sebring, and the 24 Hours of Le
Mans. No driver has won all three races in the same year,\26\ and
Ken missed out because he was part of a team and Ford had been good
to him.\27\ He committed and moved forward without the victory that
should have been his because he was the best driver that day. I am
committed to vote and move forward, even if it means giving up the
triple crown of the day. But I will not go against my gut.
---------------------------------------------------------------------------
\26\ Martin Raffauf, Porsche and the Triple Crown of endurance
racing, Porsche Road & Race (Dec. 7, 2018), https://www.porscheroadandrace.com/porsche-and-the-triple-crown-of-endurance-racing/.
\27\ Phelan, supra note 9.
---------------------------------------------------------------------------
Appendix 5--Statement of Commissioner Dawn D. Stump Overview
With all that has transpired in our country and in our lives
this year, it feels like ages ago that we gathered together in
person to consider proposing amendments to update the Commission's
rules regarding position limits back at the end of January. At the
time,
[[Page 3489]]
I said that there were three guideposts by which I would evaluate
that proposal: First, is it reasonable in design? Second, is it
balanced in approach? And third, is it workable in practice for both
market participants and for the Commission?
Since I believed the answer to each of these questions was yes,
I supported issuing the proposal. And by and large, my belief has
been confirmed by the comments we received from those who trade in
this country's derivatives markets. In the months since January, we
have heard from all corners of the marketplace--agricultural
interests, energy interests, managed fund advisors, and dealers that
provide liquidity, to name a few--that have voiced support for the
fundamental architecture of the position limits framework that we
proposed. Their support stands in stark contrast to the serious
concerns they had expressed about the several previous position
limit proposals put forward by the Commission during the past
decade.
Of course, each interest had its issues with one aspect or
another in the proposal. That is to be expected, given the varied
and sometimes divergent objectives for our position limit rules set
out in the Commodity Exchange Act (``CEA'').\1\ Congress has tasked
us with adopting position limits that: (1) On the one hand,
diminish, eliminate or prevent excessive speculation in derivatives
and deter and prevent market manipulation, squeezes, and corners;
while on the other hand, and simultaneously (2) ensuring sufficient
market liquidity for bona fide hedgers and ensuring that the price
discovery function of the underlying market is not disrupted and
does not shift to foreign competitors.
---------------------------------------------------------------------------
\1\ CEA Section 4a(a), 7 U.S.C. 6a(a).
---------------------------------------------------------------------------
Reasonable minds will always differ as to exactly where to draw
the line among these statutory objectives. But while we must always
strive for perfection, we cannot permit that aspiration to paralyze
us from acting to improve our rule sets. The final position limit
rules before us smooth some of the rough edges in the proposal, and
they address the areas in which I expressed some misgivings at the
time. They incorporate valuable input we have received from the
exchanges that operate the markets and the businesses that trade in
those markets.
And above all, the final rulemaking is reasonable in design,
balanced in approach, and workable in practice. For these reasons, I
am pleased to support it.
Bona Fide Hedging and Spread Transactions: Policy and Process
In commenting on the proposal in January, I noted two areas that
I felt could be improved: (1) The list of enumerated bona fide
hedging transactions and positions; and (2) the process for
reviewing hedging transactions outside of that list. I want to
briefly address each of these concerns, in turn.
Enumerated Bona Fide Hedges
The CEA prohibits the Commission from adopting position limit
rules that apply to bona fide hedging transactions or positions, as
such terms are defined by the Commission. It gives the Commission
the authority to define the term ``bona fide hedging transactions
and positions'' to ``permit producers, purchasers, sellers,
middlemen, and users of a commodity or a product derived therefrom
to hedge their legitimate anticipated business needs . . .'' \2\
Congress thereby recognized the critical function of our derivatives
markets in enabling those whom we all depend upon to deliver goods
and services to hedge their risks--both risks they currently bear as
well as those they reasonably anticipate.\3\
---------------------------------------------------------------------------
\2\ CEA Section 4a(c)(1), 7 U.S.C. 6a(c)(1).
\3\ The CEA provides that a bona fide hedging transaction or
position is one that, among other things, ``is economically
appropriate to the reduction of risks in the conduct and management
of a commercial enterprise.'' CEA Section 4a(c)(2)(A)(ii), 7 U.S.C.
6a(c)(2)(A)(ii). The Commission's policy in administering Federal
position limits in the agricultural sector over the years has been
to limit this economically appropriate test to the hedging of price
risk. However, as set forth in the final rulemaking release, the
Commission acknowledges, consistent with that historical policy,
that price risk can be impacted by various non-price risks.
---------------------------------------------------------------------------
The Commission's proposal recognized this as well, as it
expanded the list of ``enumerated'' bona fide hedging transactions
that are identified in our current rules. Positions taken as a
result of these enumerated hedging transactions constitute bona fide
hedging, and therefore are not subject to Federal speculative
position limits. This expansion of the list of enumerated bona fide
hedges is entirely appropriate (indeed, it is long overdue). Hedging
practices at companies that produce, process, trade, and use
agricultural, energy, and metals commodities have become far more
sophisticated, complex, and global over time, and the Commission's
list of enumerated hedging practices to which its position limit
rules do not apply has failed to keep pace with these realities.
And given Congress' recognition of the appropriateness of
hedging legitimate anticipated business needs,\4\ the proposal also
added, at my request, anticipatory merchandising as an enumerated
bona fide hedge. There is no policy basis for distinguishing hedging
risks of anticipated merchandising from hedging risks of other
activities in the physical supply chain.
---------------------------------------------------------------------------
\4\ CEA Section 4a(c)(1), 7 U.S.C. 6a(c)(1). See also CEA
Section 4a(c)(2)(A)(iii)(I), 7 U.S.C. 6a(c)(2)(A)(iii)(I) (bona fide
hedging transaction or position is a transaction or position that,
among other things, ``arises from the potential change in the value
of . . . assets that a person owns, produces, manufactures,
processes, or merchandises or anticipates owning, producing,
manufacturing, processing, or merchandising . . .'' (emphasis
added)).
---------------------------------------------------------------------------
Yet, I was concerned in January that our proposed list of
enumerated bona fide hedges still might not be as robust as it
should be. We needed input on this question from market
participants--especially those in the energy and metals sectors
where we are applying Federal position limits for the first time.
And that input was nearly unanimous in recommending that hedging the
risk of unfixed-price forward transactions be added to the list of
enumerated bona fide hedges.
Hedges of offsetting unfixed-price cash commodity sales and
purchases have historically been recognized as an enumerated bona
fide hedge under our rules, and that was carried over in the
proposal, too. These are hedges of risk incurred where a market
participant has both bought and sold the underlying cash commodity
at unfixed prices. We received many comments, though, urging us to
include as an enumerated bona fide hedge those situations in which
the purchase or sale, but not both, is an unfixed-price forward
transaction. Some commenters asked that the historical enumerated
hedge for offsetting unfixed-price cash commodity sales and
purchases be expanded to cover unfixed-price cash commodity sales or
purchases; others asked the Commission to create a new, stand-alone
enumerated bona fide hedge category for these unfixed-price
transactions. The final rulemaking concludes that neither step is
necessary because, as suggested by still other commenters,
commercial market participants may qualify for one of the enumerated
anticipatory bona fide hedges that will be available, to the extent
of their demonstrated anticipated need.\5\
---------------------------------------------------------------------------
\5\ These enumerated anticipatory bona fide hedges include: (1)
The existing enumerated bona fide hedge for unsold anticipated
production; (2) the existing enumerated bona fide hedge for
anticipated requirements; and (3) the new enumerated bona fide hedge
established in this rulemaking for anticipated merchandising.
---------------------------------------------------------------------------
Spread Transactions
Although the treatment of spread transactions for purposes of
Federal position limits is distinct from the treatment of bona fide
hedging transactions, I would like to take a short detour to note an
important similarity between the two. That is, we also received
numerous comments suggesting that the proposed definition of a
spread transaction, which would be exempt from Federal position
limits, was too narrow.
At the suggestion of commenters, the final rulemaking adds the
well-established categories of intra-market, inter-market, and
intra-commodity spreads to the list of defined spreads that fall
outside the Federal position limits regime. The release notes that
as a result, the spread transaction definition captures most, if not
all, spread exemptions currently granted by exchanges and used by
market participants. The rulemaking appropriately recognizes that
these spread positions simply do not raise the type of concerns that
position limits are intended to address.
The Non-Enumerated Bona Fide Hedge Recognition Process
Getting the list of enumerated bona fide hedges right is
important because they are ``self-effectuating'' for purposes of
Federal position limits. In other words, a trader need not count
positions that result from enumerated bona fide hedging transactions
towards the Federal position limits, and does not need to apply to
the Commission for approval (although the trader still must receive
approval from the relevant exchange to exceed exchange-set limits).
Other hedging practices, generally referred to as ``non-
enumerated'' hedges, can still be
[[Page 3490]]
recognized as bona fide hedging, but only after a review process. A
trader can either ask the exchange and the Commission to separately
review and approve the proposed non-enumerated hedging activity for
purposes of exchange and Federal limits, respectively, or it can
follow what the rulemaking calls a ``streamlined'' process. Under
that process, if an exchange recognizes a non-enumerated transaction
as a bona fide hedge for purposes of the exchange's position limits,
the Commission would then review the exchange's bona fide hedge
recognition for application to Federal limits as well. The
Commission must notify the exchange and market participant of any
denial within 10 business days, or 2 business days in the case of an
application based on a sudden or unforeseen increase in the trader's
bona fide hedging needs (although that timeline can be extended if
the Commission issues a stay or requests additional information).
In January, I expressed reservations about whether this 10/2-day
process would be workable in practice for either market participants
or the Commission because it appeared to be both too long and too
short: (1) Too long to be workable for market participants that may
need to take a hedge position quickly; and (2) too short for the
Commission to meaningfully review the relevant circumstances related
to the exchange's recognition of the hedge as bona fide. But while
some commenters took the ``too long'' view and others took the ``too
short'' view, the majority of commenters were generally supportive
of this process.
The final rulemaking adopts the 10/2-day process, with an
adjustment recommended by several commenters as well as participants
in a meeting of the Commission's Energy and Environmental Markets
Advisory Committee (``EEMAC'') \6\ that discussed the position
limits proposal. That is, the final rulemaking now provides that a
trader can exceed Federal limits based on the exchange's approval of
the non-enumerated hedge while the Commission is conducting its
assessment. This is not a delegation of authority to the exchange,
since the Commission will still make the final determination whether
positions resulting from the non-enumerated hedging transaction
should count towards Federal position limits. Thus, a trader that
exceeds Federal limits in reliance on the initial exchange
determination runs the risk that the Commission will later deny the
requested non-enumerated hedge. In that event, the trader will have
to reduce the position to come into compliance with limits within a
commercially reasonable period of time.
---------------------------------------------------------------------------
\6\ See, e.g., Transcript of CFTC Energy and Environmental
Markets Advisory Committee Meeting at 103:14-17, Comment by Thomas
LaSala, CME Group (May 7, 2020) (``the Commission should permit a
participant to exceed Federal position limits during the 10-day/2-
day Commission review period of an exchange-granted exemption''),
available at https://www.cftc.gov/sites/default/files/2020/06/1591218221/eemactranscript050720.pdf.
---------------------------------------------------------------------------
Is it a perfect process? It is not. My preference would have
been that recognition of non-enumerated hedges be the responsibility
of the exchanges, which are most familiar with both their own
markets and the hedging practices of participants in those markets.
The Commission, in turn, has the tools it needs to monitor this
process through its routine, ongoing review of the exchanges. But
those who participate in the markets have generally expressed the
view that this is a reasonable, balanced, and workable process. And
so, I support it.
Response to Commenter Objections
Before concluding, I would like to briefly respond to a couple
of points raised by commenters that were critical of the proposed
position limit rules. Some commenters argued that: (1) The
amendments to the CEA's position limit provisions that were enacted
as part of the Dodd-Frank Act \7\ constitute a mandate for the
Commission to establish Federal position limits without having to
make an antecedent finding that such limits are necessary to achieve
the CEA's objectives; and (2) the rules we are adopting improperly
abdicate Commission responsibilities with respect to Federal
position limits to the exchanges.
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\7\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203 (2010) (``Dodd-Frank Act'').
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The Commission's Mandate To Impose Position Limits it Finds Are
Necessary
As I read the statute, the CEA's position limit provisions, as
amended by the Dodd-Frank Act, mandate the Commission to impose
position limits that it finds are necessary. The basis for my view
is set out in detail in my Statement in support of the proposal last
January, which included an explanatory graphic. Both of these
documents are available on the Commission's website for those who
are interested,\8\ and so I will not repeat that analysis here.
Suffice it to say, though, that I have not seen anything in the
comment letters we received that changes my view.
---------------------------------------------------------------------------
\8\ See Statement of Commissioner Dawn D. Stump Regarding
Proposed Rule: Position Limits for Derivatives (January 30, 2020),
and Commodity Exchange Act Sec. 4a(a): Finding Position Limits
Necessary is a Prerequisite to the Mandate for Establishing Such
(January 30, 2020), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement013020.
---------------------------------------------------------------------------
The Role of the Exchanges
I fundamentally disagree with the suggestion that the amended
position limit rules that we are adopting in any way reflect an
inappropriate reliance by the Commission on the exchanges. My
disagreement is rooted in several considerations.
First, the CEA itself states without limitation that it is the
purpose of the CEA to serve the public interests described in the
statute ``through a system of effective self-regulation of trading
facilities, clearing systems, market participants and market
professionals under the oversight of the Commission.'' \9\ This is
an overarching statement of purpose by Congress, and is the lens
through which all other provisions of the CEA--including its
position limit provisions--must be interpreted. And nothing in the
amendments to those position limit provisions enacted as part of the
Dodd-Frank Act indicate otherwise.
---------------------------------------------------------------------------
\9\ CEA Section 3(b), 7 U.S.C. 5(b).
---------------------------------------------------------------------------
Second, the rules we are adopting do not delegate any authority
of the Commission to the exchanges. With respect to applications for
non-enumerated bona fide hedges in particular, the Commission will
be informed by an exchange's determination whether to recognize the
hedge for purposes of exchange-set limits. But the determination
whether to do so with respect to Federal limits is the Commission's
alone to make, and a trader who trades in reliance on an exchange
determination risks having to reduce the position if the Commission
subsequently disagrees with the exchange's determination.
Third, the exchanges know their markets.\10\ They have a
comprehensive understanding of the traders that participate in those
markets as well as current hedging practices in agricultural,
energy, and metals commodities. Indeed, the expertise of the
exchanges makes them uniquely well-suited to make the initial
determination on requests for non-enumerated bona fide hedges in
real-time.
---------------------------------------------------------------------------
\10\ It is notable that, due to certain trading dynamics unique
to natural gas contracts, including the existence of liquid cash-
settled contracts trading on three different exchanges, the final
rulemaking for the Federal conditional spot-month limit is derived
from the existing exchange framework that has been in place for
approximately a decade.
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Finally, I return once again to my foundational principles:
Reasonable, balanced, and workable. A system in which a business
must put its economic needs and risk management efforts on hold
while the Commission undertakes to learn about its operations and
hedging activities in order to pass upon a request for a non-
enumerated bona fide hedge violates all three principles.
Conclusion
After nearly a decade of trying, we stand on the cusp of
amending the Commission's position limit rules, which are sorely in
need of updating. Before us is a thorough and well-reasoned final
rulemaking release that considers the extensive comments we
received, and clearly presents the Commission's rationale in
addressing those comments and adopting the rules in the form that we
are adopting them. The fact that this release is before us less than
nine months after we issued the proposal--in the midst of a
pandemic, no less--is a tribute to the dedication, perseverance, and
analytical capabilities of the professionals in the Commission's
Division of Market Oversight, Office of General Counsel, and Chief
Economist's Office. Their work on this rulemaking has been nothing
short of amazing.
My fellow Commissioners and I have each publicly committed that
we would work to finish a position limits rulemaking. The time has
come to fulfill that commitment. The release that staff has
presented is reasonable in design, balanced in approach, and
workable for both market participants and the Commission. I am
pleased to support it.
[[Page 3491]]
Appendix 6--Dissenting Statement of Commissioner Dan M. Berkovitz
I. Introduction
I dissent from today's position limits final rule (``Final
Rule''). The Final Rule fails to achieve the most fundamental
objective of position limits: To prevent the harms arising from
excessive speculation. It is another disappointing chapter in the
Commission's 10-year saga to implement Congress's mandate in the
Dodd-Frank Act to impose speculative position limits in the energy,
metals, and agricultural markets. In a number of instances, the
Final Rule appears more intent on limiting the actions and
discretion of the Commission than it does on actually limiting such
speculation.
As I previously observed, the proposed rule demoted the
Commission from head coach to Monday-morning quarterback. The Final
Rule declares that the players on the field are the referees. In
this arena, the public interest loses.
I support effective position limits to restrain excessive
speculation in physical commodity markets, coupled with legitimate
bona fide hedge exemptions for commercial market participants. The
Final Rule, however, fails to address excessive speculation in
several key respects:
First, the Final Rule impermissibly permits private entities to
devise new bona fide hedge exemptions, while simultaneously
constricting the Commission's review and enforcement of such
privately-created exemptions.
Second, the Final Rule fails to address trading at settlement
(``TAS'') transactions. The potential for market manipulation
through the use of TAS is well documented. The Final Rule was a
valuable but wasted opportunity to address an important type of
transaction in many commodity markets that, if abused, can present
risks to orderly trading and price discovery.
Third, while the Final Rule eliminates the risk management
exemptions that had been granted to a limited number of index funds,
it also increases the non-spot month limits to accommodate the
speculative positions of these funds in the futures markets.
Cumulatively, index funds can have a substantial price impact and
exacerbate volatility. Their monthly position rolls can also distort
inter-month spreads. Yet the Commission performed no assessment of
the impact of potential increases in this type of speculation that
these higher limits would permit.\1\
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\1\ For detailed comments on the effects of large speculative
positions of index funds, see Better Markets Comments Letter, at 8-
12 (May 15, 2020).
---------------------------------------------------------------------------
Fourth, the Final Rule misinterprets the Dodd-Frank Act and
reverses decades of precedent by declaring, for the first time, that
the Commission must make antecedent necessity findings on a
commodity-by-commodity basis prior to imposing Federal speculative
position limits.
II. Physical Commodity Markets Benefit From Position Limits and
Appropriate Bona Fide Hedge Exemptions
Position limits help prevent market manipulation and price
distortion arising from excessively large speculative positions in
futures, options, and swaps tied to physical commodities. Section 4a
of the CEA reflects Congress's long-standing determination that
excessive speculation in a commodity can cause ``sudden,''
``unreasonable,'' or ``unwarranted'' fluctuations and changes in
commodity prices.\2\ Section 4a directs the Commission to establish
speculative position limits to address these harms, while also
providing that such limits shall not apply to ``transactions or
positions which are shown to be bona fide hedging transactions or
positions, as those terms are defined by the Commission . . . .''
\3\
---------------------------------------------------------------------------
\2\ 7 U.S.C. 6a.
\3\ 7 U.S.C. 6a(c)(1) (emphasis added).
---------------------------------------------------------------------------
Experience from decades of limits in agricultural commodities
teaches that a properly crafted position limits regime is an
``effective prophylactic measure'' to protect American businesses,
consumers, and market participants that rely on physical commodity
derivatives markets.\4\ The parameters of an effective position
limits regime are well established. They include: (1) Meaningful
limits on excessive speculation to help prevent market manipulation
and price distortion; (2) recognition of bona fide hedging
activities and exemptions to permit producers, end-users, merchants,
and others to manage their commercial risks; and (3) clear divisions
of responsibility, consistent with the CEA, that recognize the
complimentary but distinct roles of exchanges, the Commission, and
market participants in administering a position limits regime.
---------------------------------------------------------------------------
\4\ Establishment of Speculative Position Limits, 46 FR 50938
(Oct. 16, 1981).
---------------------------------------------------------------------------
Federal speculative position limits have been in place to
protect derivatives markets since the 1930s. The Commission or its
predecessors adopted position limits for grains in 1938, cotton in
1940, and soybeans in 1951. In 1981, the Commission adopted rules
requiring exchange limits for all commodities for which there were
no Federal limits--a rule which notably did not require an
antecedent, commodity-by-commodity necessity finding. The Commission
has also consistently relied on exchanges to help administer the
position limits regime, including position accountability and
enumerated bona fide hedge exemptions.
These efforts, spanning over 80 years, have helped prevent
manipulation and price distortion through a complementary system
that relies on the respective expertise of Commission, exchange, and
market participant stakeholders. The Final Rule discards this
balance. The Final Rule relies excessively on exchanges and market
participants to permit positions as bona fide hedges, and in so
doing impermissibly delegates the Commission's statutory
responsibility to determine what constitutes a bona fide hedge.\5\
---------------------------------------------------------------------------
\5\ ``[W]hile Federal agency officials may sub-delegate their
decision-making authority to subordinates absent evidence of
contrary congressional intent, they may not sub-delegate to outside
entities--private or sovereign--absent affirmative evidence of
authority to do so.'' U.S. Telecom Ass'n v. FCC, 359 F.3d 554, 565-
68 (D.C. Cir. 2004) (citations omitted).
---------------------------------------------------------------------------
III. Significant Flaws in the Final Rule
A. The Final Rule Permits Market Participants To Violate Federal
Speculative Position Limits With No Prior Commission Recognition of
a Bona Fide Hedge Exemption
The Final Rule explicitly permits market participants to violate
Federal speculative position limits with no bona fide hedge
exemption from the Commission. It impermissibly delegates the
Commission's statutory responsibility to define bona fide hedging to
the very market participants with large speculative positions that
section 4a is intended to restrain, as well as to the exchanges, who
have no authority to determine what is a hedge under Federal law.
First, the Final Rule authorizes market participants to create
their own bona fide hedge exemptions and exceed speculative position
limits for ``sudden or unforeseen increases in their bona fide
hedging needs.'' No prior approval from the Commission or an
exchange is required to exceed the limits established by the
Commission, and market participants may file their hedge
applications up to five days after violating the applicable position
limit. The Final Rule offers no guardrails on what can be considered
a ``sudden or unforeseen'' circumstance. In an efficient market, all
future price movements are inherently unforeseeable; that is the
reason for hedging to begin with.\6\ Further, in today's
interconnected markets, where the speed of light is the limiting
factor on the transmission of information, sudden and unforeseen
circumstances arise virtually every millisecond. This provision may
swallow the Final Rule.
---------------------------------------------------------------------------
\6\ ``The basic efficient market hypothesis positions that the
market cannot be beaten because it incorporates all important
determining information into current share prices. Therefore, stocks
trade at the fairest value, meaning that they can't be purchased
undervalued or sold overvalued. The theory determines that the only
opportunity investors have to gain higher returns on their
investments is through purely speculative investments that pose a
substantial risk.'' J. B. Maverick, The Weak, Strong, and Semi-
Strong Efficient Market Hypotheses, Investopedia, available at
https://www.investopedia.com/ask/answers/032615/what-are-differences-between-weak-strong-and-semistrong-versions-efficient-market-hypothesis.asp (updated Sept. 30, 2020). The unpredictability
of the market has long been recognized. ``If you can look into the
seeds of time, and say which grain will grow and which will not,
speak then unto me.'' William Shakespeare, Macbeth, Act 1, Scene 3
(1623).
---------------------------------------------------------------------------
Second, the Final Rule authorizes a market participant to exceed
Federal speculative positon limits if an exchange permits it to
exceed the exchange's position limits. In other words, an exchange
determination can enable a market participant to violate Federal
limits even in the absence of a Commission determination. Here
again, the Final Rule ignores the Commission's statutory
responsibility to define bona fide hedging. Exchanges have a
critical role in any properly balanced position limits regime, but
they are not authorized by the CEA to define Federal hedge
exemptions, nor are they authorized to green-light violations of
Federal position limits.
This process for market participants to ``self-recognize'' non-
enumerated hedges that
[[Page 3492]]
they wish had been enumerated under Federal law undoes the existing,
Commission-led procedures that have worked well for decades.
The Final Rule reflects a multi-year, iterative process of
notice and comment rulemaking to comprehensively determine which
practices should constitute bona fide hedging. Members of the public
and industry participants have enjoyed multiple opportunities to
inform the Commission on this topic, including through additional
proposed position limits rules in 2013 and twice in 2016. The Final
Rule's enumerated hedges reflect the Commission's extensive dialogue
and reasoned deliberations, and they recognize a wide array of
hedging practices identified by commenters. To my knowledge, the
Commission is not aware of any novel hedging practices that were not
addressed during this rulemaking process.
Commission regulations currently allow for the recognition of
non-enumerated bona fide hedges through a 30-day, Commission-led
review process. The Commission must recognize the requested hedge as
bona fide before a market participant can put the hedge on the
exchange and exceed position limits. This process has worked well
for decades. The Final Rule replaces it with a new system that
allows market participants to make their own bona fide hedge
determinations and exceed Federal position limits in advance of any
reasoned, considered evaluation by the Commission.
1. The 10 and 2 Day Review Periods Are Inadequate for the Commission To
Consider Applications for Exemptions After an Exchange Determination
The Final Rule attempts to cure the impermissible statutory
delegation described above through crammed, after-the-fact reviews
of market participants' hedge applications and violations of
position limits rules.
Market participants who request prospective non-enumerated bona
fide hedge exemptions from an exchange may violate Federal
speculative position limits upon being granted the exemption. The
exchange must then forward the application and other materials to
the Commission for the beginning of a constricted 10-day review
period.
The Commission, for its part, must complete the difficult task
of evaluating the law, facts, and circumstances with respect to cash
market risks that have already been incurred and commodity positions
that have already been posted on an exchange. Commission
determinations regarding the validity of positions that have already
been entered into will be complicated by the commercial implications
involved in unwinding such positions. Further, in the event that the
Commission determines to deny the application, the Commission must
provide the applicant with notice and opportunity to respond. In the
case of positions established due to ``sudden or unforeseen''
events, the Final Rule calls for a two-day review. This is an
unrealistic and unworkable timeframe. This fig leaf of a ``review''
cannot provide legal cover for the impermissible delegation.
2. The Final Rule Adopts a Policy of Non-Enforcement for Position Limit
Violations
Both the rule text and the preamble to the Final Rule leave no
doubt that any person who puts on a position in excess of a position
limit prior to receiving Commission approval of the exemption is in
violation of the speculative position limits. However, where an
application for a non-enumerated bona fide hedge is submitted
retroactively to either an exchange or the Commission due to
``sudden or unforeseen circumstances,'' or where an exchange has
approved an application for an exemption from the exchange limit,
the Commission limits its ability to prosecute such violations by
declaring that, ``as a matter of policy,'' it will not pursue an
enforcement action as long as the application was submitted in
``good faith.''
The Final Rule does not define ``good faith.'' Perhaps this is
because the concept of good faith traditionally is used as a safe
harbor to protect persons who reasonably believe they are acting in
compliance with the law. For example, when exercising its
prosecutorial discretion for violations of the swap dealer business
conduct standards, the Commission considers whether the swap dealer
attempted in ``good faith'' to follow policies and procedures
reasonably designed to comply with the CEA and Commission
Regulations.\7\ This application of the good faith doctrine is
consistent with the long-established understanding of the term.\8\
In the Final Rule, however, the Commission turns this doctrine on
its head and mandates prosecutorial discretion where a market
participant knowingly acts in violation of the law by putting on a
position in excess of the legal limit.
---------------------------------------------------------------------------
\7\ See Business Conduct Standards for Swap Dealers and Major
Swap Participants With Counterparties, 77 FR 9734, 9744, 9746, 9750
(Feb. 17, 2012).
\8\ See, e.g., CFTC v. Monex Credit Co., No. SACV-171868, 2020
WL 1625808, at *4-5 (C.D. Cal. Feb. 12, 2020) (finding that
controlling persons did not establish good faith defense to
liability under 7 U.S.C. 13b where they knowingly or recklessly
violated the CEA or were aware or should have been aware that
employees were violating the CEA, or did not reasonably enforce
system designed to promote legal compliance) (citing Monieson v.
CFTC, 996 F.2d 852, 860-861 (7th Cir. 1993)); U.S. v. Leon, 468 U.S.
897 (1984) and Massachusetts v. Sheppard, 468 U.S. 981 (1984)
(establishing good faith doctrine as exemption to Fourth Amendment
exclusionary rule when police officer reasonably believed conduct to
be legal).
---------------------------------------------------------------------------
Notably, the Commission describes its position not to enforce
these violations as ``a matter of policy.'' So although this non-
enforcement policy is adopted as part of this rulemaking, it is
nonetheless just that--a statement of policy. As the Supreme Court
has recognized, ``general statements of policy,'' or ``statements
issued by an agency to advise the public prospectively of the manner
in which the agency proposes to exercise a discretionary power,''
are not subject to the notice-and-comment procedures of the
Administrative Procedure Act.\9\ Accordingly, the Commission may
change this enforcement policy at any time without engaging in a
notice-and-comment rulemaking.
---------------------------------------------------------------------------
\9\ Nor are blanket statements of policy that abandon an
agency's responsibility to enforce the law constitutionally
permissible. Crowley Caribbean Transp., Inc. v. Pe[ntilde]a, 37 F.3d
671, 677 (DC Cir. 1994) (``[A]n agency's pronouncement of a broad
policy against enforcement poses special risks that it `has
consciously and expressly adopted a general policy that is so
extreme as to amount to an abdication of its statutory
responsibilities.''') (citing Heckler v. Chaney, 470 U.S. 821, 833
n.4 (1985)).
---------------------------------------------------------------------------
Significantly, in its comment letter, the entity with the most
experience in retroactive applications for hedge exemptions, the CME
Group, pointed out to the Commission the importance of being able to
take enforcement action for position limit violations that have
occurred when retroactive applications are denied. It stated:
Today at the exchange level, CME Group considers firms to be in
violation of a position limit if they exceed a limit and the
exemption application is denied. We believe the Commission should
implement this standard rather than permitting the proposed grace
period for denial of an exemption application. Otherwise, market
participants with excessively large speculative positions could
exploit the grace period accompanying an application for an
exemption and intentionally go over the applicable limit without
consequences--all the while disrupting orderly market operations. In
our experience, the prospect of having an application denied and
being found in violation of position limits has worked to deter
market participants from attempting to exploit the retroactive
exemption process.\10\
---------------------------------------------------------------------------
\10\ CME Comment Letter (May 14, 2020).
Although the Final Rule is replete with deference to the
experience of the exchanges in implementing the position limits
regime, and creates a process specifically reliant upon the
exchange's expertise in granting hedge exemptions, here in the
context of enforcing violations and deterring abuse, the Commission
oddly rejects that expertise.
B. The Final Rule Fails To Address TAS Transactions or the Historic
Collapse of WTI Crude Oil Futures
On April 20, 2020, the price of the May futures contract for
West Texas Intermediate (``WTI'') crude oil traded on the New York
Mercantile Exchange collapsed from $17.73 per barrel at the market
open to a closing price of negative $37.63. This single-day fall in
prices of approximately $55 per barrel is unprecedented, and was
accompanied by a massive disconnect between May crude oil futures
and the price of crude oil in the physical market.
WTI crude oil futures are a key benchmark in global energy
markets and can impact the overall U.S. economy. Following the WTI
event, I called upon the Commission to determine the causes of this
unprecedented price movement and divergence from physical markets,
and to work with CME to ``take whatever measures may be appropriate
to ensure that trading in the WTI futures contract is orderly and
supports convergence of the futures and physical markets.'' \11\
[[Page 3493]]
Almost six months later, the Commission has yet to complete its
investigation or issue even preliminary results. It should not take
this long for the world's leading derivatives regulator to
understand the historic collapse of a benchmark contract that it has
overseen for decades.
---------------------------------------------------------------------------
\11\ Statement of Commissioner Dan M. Berkovitz on Recent
Trading in the WTI Futures Contract before the Energy and
Environmental Markets Advisory Committee Meeting (May 7, 2020),
available at https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement050720.
---------------------------------------------------------------------------
Independently of the Commission's investigation, public
commentary following the WTI event focused on TAS transactions and
the well-known integrity concerns regarding TAS under certain market
conditions.\12\ TAS transactions represent the purchase or sale of
an underlying exchange commodity at the closing price for that
commodity or at a specified differential. Notably, exchange rules
may permit TAS transactions to be netted intraday against futures
positions in that commodity established via outright purchases and
sales. Such netting could permit a trader to establish very large
long or short positions in the outright futures contracts, while
remaining below speculative position limits on a net basis.
---------------------------------------------------------------------------
\12\ See, e.g., Matt Levine, It's a Good Time to Cut Dividends,
Money Stuff (Apr. 29, 2020), available at https://www.bloomberg.com/news/articles/2020-08-04/oil-s-plunge-below-zero-was-500-million-jackpot-for-a-few-london-traders?sref=DzeLiNol (``If you combine
these two facts--a lot of TAS contracts and not much volume around
the settlement time--you get a well-known theoretical problem. . . .
The basic pattern--agree in advance to buy (sell) stuff at the
official settlement price at some fixed future time, and then sell
(buy) a bunch of that stuff in the minutes leading up to the
official settlement time with the effect of pushing down (up) the
price at which you are buying (selling)--is incredibly common . . .
.''); Craig Pirrong, Streetwise Professor Blog, WTI-WTF? Part 3: Did
CLK20 Get TAS-ed? (Apr. 30, 2020), available at https://streetwiseprofessor.com/2020/04/.
---------------------------------------------------------------------------
The Final Rule recognizes the importance of netting practices
and rules in several regards. For example, it prohibits the spot-
month netting of physically settled contracts with linked cash
settled contracts. The Final Rule explains that allowing such
netting during the spot month ``could lead to disruptions in the
price discovery function of the core referenced futures contract or
allow a market participant to manipulate the price of the core
referenced futures contract.'' The Final Rule is silent, however,
with respect to any limitations on the netting of TAS with outright
futures.
One commenter on the Final Rule reminded the Commission in
significant detail of the market integrity issues associated with
TAS orders.\13\ But even apart from the comment letters on the
proposed rule, and apart from the WTI event, the potential for
manipulation through the use of offsetting TAS contracts has been
well-known.\14\ Further, the CFTC has direct experience with this
issue: it has brought two manipulation cases where WTI TAS orders
were an integral part of the manipulative scheme.\15\ Given the
Commission's familiarity with the potential for manipulation and
disruption of the price discovery process arising from an abuse of
the TAS order type, the failure of the Final Rule to address in any
manner these well-known dangers to market integrity is inexcusable.
---------------------------------------------------------------------------
\13\ Better Markets Comment Letter, at 13-14 (May 15, 2020).
\14\ See, e.g., Craig Pirrong, Derived Pricing: Fragmentation,
Efficiency, and Manipulation, Bauer College of Business, University
of Houston, at 10 (Jan. 14, 2019), available at https://streetwiseprofessor.com/2020/04/ (``The analysis in Section 2
demonstrates that TAS contracts create trading opportunities with
asymmetric price impacts. This suggests that TAS may therefore also
create opportunities for profitable trade-based manipulation, and
this is indeed the case.''); see also Paul Peterson, Trading at
Settlement for Agricultural Futures: Results from the First Month,
farmdoc daily (July 29, 2015), available at https://farmdocdaily.illinois.edu/2015/07/trading-at-settlement-for-agricultural-futures.html (``Over the years TAS has been associated
with several efforts to artificially influence the daily settlement
price through `banging the close' and other forms of manipulation
[citations omitted].'').
\15\ See In re Optiver US LLC, CFTC No. 08 Civ 6560, 2012 WL
1632613 (Apr. 19, 2012); In re Shak, CFTC No. 14-03, 2013 WL
11069360 (Nov. 25, 2013) (consent order).
---------------------------------------------------------------------------
C. The Final Rule Misconstrues the CEA by Requiring Antecedent,
Commodity-by-Commodity Necessity Findings Prior to Imposing Federal
Position Limits
The Final Rule misinterprets the Dodd-Frank Act and reverses
decades of Commission interpretation and finds that an antecedent,
commodity-by-commodity necessity finding is required prior to
imposing Federal speculative position limits. The Final Rule further
states that this ``is the best interpretation'' of CEA section
4a(a)(2), and that the Commission's prior interpretations are ``not
compelling.''
I addressed this issue extensively in my dissenting opinion on
the proposed position limits rule, and I reiterate those views
now.\16\ Neither the statutory language of CEA section 4a(a)(2), nor
the district court's decision in ISDA v. CFTC, require an antecedent
necessity finding prior to imposing position limits. The Final
Rule's new interpretation, which the Commission concedes is a
``change'' from prior interpretations, is mistaken.\17\
---------------------------------------------------------------------------
\16\ See Dissenting Statement of Commissioner Dan M. Berkovitz
Regarding Proposed Rule on Position Limits for Derivatives (Jan. 30,
2020), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement013020.
\17\ Significantly, however, at the Commission's meeting on the
proposal rule, the Commission's Office of General Counsel clarified
that a necessity finding is required only with respect to the
Commission's establishment of Federal position limits. The Office of
General Counsel stated that a necessity finding was neither a
prerequisite for a Commission directive to the exchanges to
establish limits, nor prior to establishing the standards for such
limits. The Commission's legal interpretation in the Final Rule is
identical to the interpretation in the proposed rule in this regard
as well.
---------------------------------------------------------------------------
As articulated in my prior dissent, the Final Rule's
interpretation of CEA section 4a(a)(2) ``defies history and common
sense.'' \18\ Following hard on the heels of the 2008 financial
crisis and the collapse of the Amaranth hedge fund in 2006, it is
implausible that the drafters of the Dodd-Frank Act intended what
the Commission has now adopted. The Final Rule requires the
Commission to believe that a Congress in the midst of the financial
crisis, aware the CEA had never been interpreted to require
predicate necessity findings for position limits, and engaged in a
historic effort to regulate financial markets, would nonetheless
make it harder for the Commission to impose Federal speculative
position limits. The Commission's revisionist legislative history is
neither accurate nor credible.
---------------------------------------------------------------------------
\18\ For a detailed discussion of how the Commission's necessity
finding misconstrues the CEA as amended by the Dodd-Frank Act, see
Dissenting Statement of Commissioner Dan M. Berkovitz Regarding
Proposed Rule on Position Limits for Derivatives (Jan. 30, 2020),
available at https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement013020b.
---------------------------------------------------------------------------
IV. Conclusion
The Final Rule departs from both legal interpretations and
policy frameworks that have served commodity markets well for
decades.
Most significantly, the Final Rule impermissibly delegates the
authority to recognize non-enumerated hedge exemptions; provides
farcically short review periods for private-entity hedge
determinations; attempts to enshrine a policy of non-enforcement for
position limits violations; fails to address the well-known risks of
TAS transactions; and reinterprets the CEA to require antecedent
necessity findings prior to imposing Federal position limits.
I cannot support such a flawed rule.
[FR Doc. 2020-25332 Filed 1-5-21; 11:15 am]
BILLING CODE 6351-01-P