Opening Statement of Commissioner J. Christopher Giancarlo Before the Second Meeting of the CFTC’s Energy and Environmental Markets Advisory Committee
July 29, 2015
I am pleased to convene the second meeting of the CFTC’s reconstituted Energy and Environmental Markets Advisory Committee (EEMAC).
I would like to welcome four new Associate Members to the EEMAC and to today’s meeting: Mr. William B. Jones, CEO of Jones Petroleum and JP Capital & Insurance, Inc. from Jackson, Georgia; Mr. Martin Bates, President, Strategy, Energy & Development, Alcoa Inc., Global Primary Products, Pittsburgh, Pennsylvania; Mr. Joseph W. Allen, Director of Energy Policy for Caterpillar Inc. and Solar Turbines Inc., Washington, D.C.; and Mr. Andrew K. Soto, Vice President for Regulatory Affairs, American Gas Association, Washington, D.C. Thank you to our new Associate Members for agreeing to join the EEMAC to engage in its important work.
In February, the EEMAC focused on the CFTC’s proposed rules to impose for the first time federal position limits on our energy and environmental markets. That meeting identified several areas where the current position limits proposal would be especially harmful: First, the CFTC’s proposed limitation of the bona fide hedging exemption to only a limited number of “enumerated” hedges leaves many other strategies – including “bread and butter” risk management strategies for energy and environmental markets – ineligible for the bona fide hedging exemption.1 Second, there is increasing evidence of a distinct lack of liquidity and widening bid-ask spreads farther out the curve, perhaps resulting from insufficient speculation, which the CFTC’s position limits proposal would exacerbate.2 We must find an approach that would make the more troublesome aspects of the proposed rule actually work for many market participants in order to allow them to manage the risk associated with their market activity.
Along these lines, I would be remiss if I did not briefly make a point about conditions across commodity markets. I had the privilege to spend last week in the Midwest meeting with a variety of market participants, including many agricultural producers, such as dairymen, pork producers and row crop farmers. While CFTC rules were certainly discussed during those meetings, it should come as no surprise that the number one concern of producers of corn, soybeans, pork and dairy is what price they will get paid for their harvest or product. The spot price they are paid for these commodities is what puts food on their tables. It was easy to understand their heighted concern about the steep drop in worldwide commodity prices that have been widely reported.3 These falling prices led me to ask the CFTC Office of the Chief Economist (OCE) for some basic data covering the 28 commodities covered by the CFTC’s proposed position limits regime. The information they provided me was stark: across the 28 commodities that will be covered by the proposed position limits rules, there has been a dramatic decrease in prices since December 2010, the year Dodd-Frank was signed into law.4
It was apparent from my meetings last week that many American agricultural producers have reduced their hedging activity in the past few years, making them more vulnerable to volatile price swings in U.S. commodity markets. If and when the Commission moves forward with a position limits regime, we must be absolutely certain that we do not make it more difficult for American agricultural and energy producers to protect themselves against 40 percent declines in commodity prices because of wooden or inflexible rules. If the current collapse in commodity prices continues and the position limits rules are not made workable, we may be imposing burdens on hedging risk at precisely the wrong time. I trust this Commission has the concern and foresight to avoid such a result.
Panel I: How Can Exchanges Help Implement Federal Position Limits?
Now, let me briefly highlight what the EEMAC will cover at today’s meeting. The first panel will consider a framework for a CFTC authorization of the exchanges to grant bona fide hedging exemptions for legitimate risk reducing strategies. This approach was recently commended by Chairman Massad.5 The major commodities exchanges, some EEMAC members and the CFTC staff have all expressed interest as well.6 The panel will discuss a minimum framework for providing discretion to the exchanges (and SEFs) to review and approve, where appropriate, non-enumerated hedging exemptions from federal position limits. Of course, this authority would remain subject to CFTC oversight. Yet, handled properly, this has the potential to make the current proposal more workable, which many commentators have said is greatly needed.
In addition, the first panel will explore the possibility that exchanges can administer a position accountability regime as a way to soften the impact of declining liquidity outside of the spot period. As we heard in the last EEMAC meeting, position accountability is a process long used by exchanges and approved – not only by the CFTC but also Congress – to obtain more detailed information from market participants upon reaching specified position thresholds.7 The exchange has the authority to order market participants to cap, reduce or liquidate their positions, as it deems appropriate.8 This tool is essential because liquidity and available counterparties both diminish dramatically out the curve. Accountability helps ameliorate this problem by permitting those market participants willing to offer liquidity, which is very important to hedgers, to increase the size of their positions above pre-determined concentration points.9 Position accountability already includes safeguards to avoid harming market integrity, and would of course, include appropriate CFTC supervision.10
Panel II: A Phased Approach to Position Limits
Our second panel will examine the possibility of adopting a phased federal position limits rule that would begin by covering the spot month.11 Many market participants have argued that even if position limits are necessary – and even if there is a congressional mandate to impose them – the CFTC should proceed cautiously.
This approach would avoid exacerbating the present liquidity problems outside of the spot month that were identified in our last EEMAC meeting. In addition, proceeding in a phased approach would give all market participants the opportunity to adjust to the new process of tracking and reporting commodity swaps along with their futures and options. A phased approach would also be useful for the CFTC, which will then have additional time to obtain better data about the OTC market for physical commodities, as well as conduct additional research and analysis to determine whether federal position limits are appropriate and necessary at all outside of the spot month. This is a relatively safe approach because the CFTC has already acknowledged that excessive speculation, if any, is least likely to harm markets outside of the spot month.12 Moreover, the CFTC has experienced great success with phased implementations, most recently with its phased implementation of the swaps clearing mandate. Finally, proceeding incrementally with the expensive project of expanding federal position limits reflects responsible stewardship of the resources provided to the Commission.
Panel III: Trade Options and Forwards with Embedded Volumetric Optionality – Where Do We Stand?
In our third panel, we will explore another important issue of concern: trade options (“TOs”) and forward contracts with embedded volumetric optionality (“EVOs”). As most of you know, the CFTC has started taking action to strike the right balance in its regulation of these very important transactions. We recently finalized a revised interpretation of our 7-part test for EVOs to provide market participants certainty on whether their physically-settled, often long-term, contracts must nonetheless be treated as swaps because they contain embedded volumetric optionality.13 In addition, the CFTC has recently proposed to relieve market participants of some (but not all) of the costly reporting and record-keeping burdens associated with trade options.14
This panel will provide us with an update on the degree to which the CFTC’s recent actions have resulted in the intended regulatory certainty. In addition, we will consider whether there is more the CFTC can do to ensure that these vital transactions are not subject to burdensome regulatory requirements. Maintaining robust liquidity in, and easy availability of, these physically settled energy transactions is especially imperative in light of the substantial liquidity declines in energy derivatives that were highlighted in our last meeting.15 Reliable and cost-effective methods for maintaining energy reliability and managing risk are essential not only for our nation’s energy market participants, but also the economy as a whole.16
Thank you to all of the witnesses who have prepared thoughtful presentations and thank you to the CFTC staff who worked so hard to arrange this meeting. And of course, I would like to thank again all of the Members and Associate Members of the EEMAC for volunteering your time and expertise. We are all grateful for your service.
I am pleased to announce that EEMAC Member Michael Cosgrove has graciously agreed to chair today’s meeting. Thanks, Michael for taking on the job. I would like to recognize Chairman Massad and other commissioners to make their opening remarks.
1 EEMAC Transcript at 157-58, 160-61, 183 (Feb. 26, 2015) (EEMAC Tr.).
2 E.g. id. at 81-83, 91-92, 95-96, 103-04, 174-76.
3 See Ira Iosebashvili and Tatyana Shumsky, Investors Flee Commodities, The Wall Street Journal, Jul. 20, 2015, available at: http://www.wsj.com/articles/investors-flee-commodities-1437434367; Veronica Brown and Pratima Desai, Speculators Show Global Commodities Rout Still Has Legs, Reuters, Jul. 27, 2015, available at: http://www.reuters.com/article/2015/07/27/us-markets-commodities-rout-idUSKCN0Q11TJ20150727
4 Data provided by the CFTC OCE showed a 42.6 percent decline in the 22 commodities covered by the Bloomberg Investible Commodity Index from December 2010 to July 2015. Similarly, information provided by the OCE for all 28 enumerated commodities included in the CFTC’s proposed position limits regime showed an analogous downward price trend from December 2010 to July 2015.
5 Chairman Timothy Massad, “Remarks of Chairman Massad Before Natural Gas Roundtable,” (May 13, 2015) available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-23.
6 See EEMAC Tr. at 213.
7 See 7 U.S.C. § 7(d)(5).
8 E.g. EEMAC Tr. at 106.
9 Id. at 106-07.
10 Id. at 106-08; 139-40; Rule Enforcement Review of the Chicago Mercantile Exchange and the Chicago Board of Trade, 39-50 (Jul. 26, 2013), available at http://www.cftc.gov/idc/groups/public/@iodcms/documents/file/rercmecbot072613.pdf; 7 U.S.C. § 4a(e); see also J. Christopher Giancarlo, “The CFTC’s Proposed Position Limits Regime: Are U.S. Energy Markets at Risk?,” (May 13, 2015), available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlos-6.
11 See, e.g., MFA Comment Letter (Mar. 30, 2015) at 8-9; Joint Natural Gas Supply Association & National Corn Growers’ Association Comment Letter (Mar. 28, 2011) at 2-4.
12 Position Limits for Derivatives, 78 Fed. Reg. 75680, 75766 (Dec. 12 2013).
13 Forward Contracts with Embedded Volumetric Optionality, 80 Fed. Reg. 28239 (May 18, 2015).
14 Trade Options, 80 Fed. Reg. 26200 (May 7, 2015).
15 E.g. EEMAC Tr. at 81-82, 91-92, 95-906, 103-04, 174-76, 220-22.
16 Id. at 196-99.
Last Updated: July 29, 2015