I.  Introduction

The Commission’s final rules on Position Limits for Derivatives (Position Limits Final Rules) become effective today, March 15, 2021.[1]  In anticipation of this effective date, the New York Mercantile Exchange (NYMEX), a CFTC-registered designated contract market, “self-certified”[2] amended product terms and conditions to raise the speculative position limits for its West Texas Intermediate (WTI) crude oil futures, including in the spot month.[3]  NYMEX and other CME Group contract markets also requested and received Commission approval of new or amended rules relevant to their position limits.   These exchange regulatory filings implementing the Position Limits Final Rules miss an opportunity to remediate a well-known vulnerability in these contract markets’ Trading at Settlement (TAS) rules, namely the absence of any numerical limits on the speculative use of TAS contracts during the spot month of the contract.  Last year, the Commission failed to address this issue in its report on the April 20 collapse of WTI crude oil futures prices,[4] as well as in the Position Limits Final Rules.[5]  Today, the contract markets also do not address this issue. 

TAS contracts have been and can be used to manipulate the price of WTI, and were traded in extraordinary amounts during the historic collapse of WTI futures on April 20, 2020.  NYMEX must not continue to sidestep reforms to TAS, including exchange rules governing the netting of TAS positions against other open positions in the same commodity.  Absent appropriate exchange action, the Commission must address this structural issue in the WTI contract and impose appropriate limits on the netting of TAS by speculators.        

At a meeting of the CFTC’s Energy and Environmental Markets Advisory Committee held shortly after the April 20 WTI price collapse, I called upon the CFTC and the CME to analyze the event and “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.”[6]   Today I am renewing this call for action.  Fixing TAS is critical to the protection of consumers, end-users, and all market participants. 

II.  The Trading at Settlement Order Type

TAS is an order type that allows market participants to execute orders at any time during the trading day, and to have such orders filled at a differential to the settlement price.[7]  For market participants whose primary concern is exposure to the settlement price, TAS is an efficient means of execution with no obligation to actually be in the market during the close.  TAS also offers market participants the opportunity to net their TAS positions against other long or short positions in the same commodity contract.  Netting of long and short positions in a commodity contract is a normal practice under exchange and federal position limits rules, subject to limitations.  However, as discussed below, netting in the context of TAS presents unique challenges to market integrity.    

Positions established via TAS can be netted without limit against other long or short positions in the same commodity contract to remain under exchange and federal position limits.  This unlimited ability to net TAS positions with outright positions presents opportunities for malfeasance or price distortions because it allows a market participant to establish a large open position, the value of which will not be determined until the contract’s settlement price is determined.  The ability to net TAS and outright positions without limit permits a market participant to establish a large TAS position at the yet-to-be determined settlement price and then trade outright contracts aggressively as an offset to affect the TAS settlement price in the trader’s favor.[8] 

The Commission has brought two enforcement actions arising from the use of TAS to manipulate prices in the WTI crude oil futures contract.[9]  Academic research has also found that TAS may “create opportunities for profitable trade-based manipulation . . . .”[10]  The CME Group contract markets have recognized the potential for market abuse and distortion through the use of TAS, warning market participants that “any trading activity that is intended to disrupt orderly trading or to manipulate or attempt to manipulate a settlement price to benefit a TAS position will subject the member and/or the market participant to disciplinary action.”[11]  Further, “[t]o prevent these abuses . . . the CME/CBOT has limited TAS trading in agricultural commodities to only the most liquid commodities, and only in the most liquid contract months.”[12]   

Although the CFTC and exchanges may bring post-event enforcement or disciplinary actions for trading abuses, speculative position limits are a well-established prophylactic measure that complement other measures to deter or prevent price manipulations and distortions, particularly in the spot month.  “An ounce of prevention is worth a pound of cure.”[13]  The CFTC’s position limits regime both limits the market power or ability of traders to manipulate prices and also reduces the financial incentive to do so by limiting the size of gains that could result from a manipulative scheme.[14]   No satisfactory rationale has been presented why there should not be limits on the netting of TAS with outright WTI contracts for speculative positions during the spot month to prevent market abuse or price distortion.    

III.  The Collapse of WTI Crude Oil Futures on April 20, 2020

On April 20, 2020, the WTI crude oil futures contract fell by $55 dollars per barrel in a single trading session, reaching a closing price of negative $37 per barrel.  It was an unprecedented collapse, during which the price of the May WTI futures contract diverged from the price of crude oil in the physical market.  Divergence between futures and physical prices is the opposite of what happens in a properly functioning futures market, and renders the market unusable as a means of discovering prices or managing price risks for a physical commodity.

The WTI crude oil futures contract is a global benchmark for both energy and financial markets.  It is used by businesses to manage the risks arising from energy prices and by financial market participants to manage inflationary and other risks correlated to energy prices.  The WTI contract may take on even greater importance based on the growth of U.S. oil exports since 2015.[15]   The importance of WTI futures contracts to our energy markets, and of the NYMEX WTI crude oil futures contract in particular, requires urgent steps to ensure that the contract functions properly for all market participants—particularly in times of market stress.     

In November of last year, Commission staff published an “Interim Report on NYMEX WTI Crude Contract Trading on and around April 20, 2020” (Interim Report).[16]  As I stated previously, the Interim Report was incomplete, inadequate, and failed to determine the cause of the unprecedented plunge on April 20 of the price of the WTI futures contract and its resulting divergence from physical markets.[17]  Among other shortcomings, the Interim Report failed to analyze the role and price effect of the very large number of TAS contracts traded on that day.  For example, the Interim Report found that TAS was the single largest source of trading volume on April 20 (almost 21 percent), and that during the April 20 trading session, “the number of outright TAS contracts traded at the maximum limit was more than 70 times higher than in all of 2019.”[18]  However, the materiality of, and any impact from, this TAS trading on the collapse of WTI crude oil futures was left unaddressed and unanswered.      

The Interim Report also did not consider exchange practices around the netting of TAS positions against other long and short positions in the same commodity contract.  I raised this concern and others during the Commission’s open meeting to consider the Position Limits Final Rules in November 2020.  The then-chairman responded that the TAS issue was an “interpretive” or “technical” issue that could be resolved during the implementation of the position limits regime and “wouldn’t necessitate another rulemaking.”[19]  The exchanges’ implementation of the position limits regime is now proceeding without any resolution to this issue.  This is unfortunate to say the least. 

IV.  Conclusion

As the Position Limits Final Rules become effective, contract markets and the Commission should continue to work together to ensure a successful implementation.  I encourage all contract markets that permit TAS to impose limits on the netting of TAS by speculators, while continuing to permit these instruments to be properly used for legitimate hedging purposes.  Historically, the exchanges and the Commission have worked well together to develop and implement meaningful speculative position limits, but the Commission must be prepared to impose such limits unilaterally when an exchange does not act in a timely manner.  We must not ignore the lessons of prior market manipulations and failures and allow known vulnerabilities in the crude oil futures market to fester.