Statement of Commissioner Brian D. Quintenz in Support of Proposed Rule on Position Limits before the Commission Open Meeting

January 30, 2020

I am pleased to support the agency’s revitalized approach to position limits. Today’s iteration marks the CFTC’s fifth proposed position limits rule since the Dodd-Frank Act[1] amended the Commodity Exchange Act’s (CEA) section on position limits. This proposal is, by far, the strongest of them all.

Today’s proposed 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 proposal includes an expansive list of enumerated and self-effectuating bona fide hedge exemptions, and a streamlined, exchange-centered process to adjudicate non-enumerated bona fide hedge exemption requests.  

Of the five proposed rules, this proposal is the most true to the CEA in many significant respects: by requiring, as has long been the Commission’s practice, a necessity finding before imposing limits, by including economically equivalent swaps, and, perhaps most importantly, by following Congress’ instruction that, “to the maximum extent practicable,” any limits set by the Commission balance the interests among promoting liquidity, deterring manipulation, squeezes, and corners, and ensuring the price discovery function of the underlying market is not disrupted.[2] The confluence of these factors occurs most acutely in the spot month for physically-settled contracts where the delivery process and price convergence is most vulnerable to potential manipulation or disruption due to outsized positions. By focusing exclusively on spot month position limits in the new set of physically-settled (and closely related cash-settled) contracts, the proposal elegantly balances the countervailing policy interests enumerated in the statute.  

Necessity Finding

Today’s proposal, unlike the recent prior proposals, 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.[3] I am pleased that the proposal 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.[4]  As the District Court noted, “the Dodd-Frank amendments do not constitute a clear and unambiguous mandate to set position limits.”[5] I agree with the proposal’s determination that, when read together, paragraphs (1) and (2) of Section 4a demand a necessity finding. 

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.”[6] Paragraph (1) establishes the Commission’s 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 74^th 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 ...”[7] 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.”[8]

I support the proposal’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 proposal preliminarily 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. 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.[9] 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.[10] 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.[11]

In my opinion, 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. It is worth noting that the physically-settled contract which has seen the largest sustained price increase recently is palladium,[12] 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.[13]  Nevertheless, between the start of 2018 and the end of 2019, palladium futures prices rose 76%.[14] 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.[15] 

With that healthy dose of skepticism, I think the proposal 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 proposed today are higher than in the past, notably because the proposal utilizes current estimates of deliverable supply - numbers which haven’t been updated since 1999.[16]  I am interested to hear feedback from commenters about whether the estimates of deliverable supply, and the calibrated limits based off of them, are sufficiently tailored for the individual contracts.

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 proposal takes into account many of the serious concerns that end-users voiced in response to the CFTC’s previous five unsuccessful position limits  proposals. 

Importantly, and in response to many comments, this proposal, for the first time, expands the possibility for enterprise-wide hedging,[17] proposes an enumerated anticipated merchandising exemption,[18] eliminates the “five-day rule” for enumerated hedges,[19] and no longer requires the filing of certain cash market information with the Commission that the CFTC can obtain from exchanges.[20] Regarding enterprise-wide hedging – otherwise known as “gross hedging” – the proposal would provide an energy company, for example, with increased flexibility to hedge different units of its business separately if those units face different economic realities. 

With respect to cross-commodity hedging, today’s proposal completely rejects the arbitrary, unworkable, ill-informed, and frankly, ludicrous “quantitative test” from the 2013 proposal.[21] 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.[22] Under this test, longstanding hedging practices in the electric power generation and transmission markets would have been prohibited. Today’s proposal not only shuns this Government-Knows-Best approach, it also proposes new flexibility for the cross-commodity hedging exemption, allowing it to be used in conjunction with other enumerated hedges.[23] For example, a commodity merchant could rely on the enumerated hedge for unsold anticipated production to exceed limits in a futures contract subject to the CFTC’s limits in order to hedge exposure in a commodity for which there is no futures contract, provided that the two commodities share substantially related fluctuations in value.

Bona Fide Hedges and Coordination with Exchanges

For those market participants who employ non-enumerated bona fide hedging practices in the marketplace, this proposal creates a streamlined, exchange-focused process to approve those requests for purposes of both exchange-set and federal limits. 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.[24] 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.

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 proposal provides what I believe is a workable framework to utilize exchanges’ long standing expertise in granting exemptions that are not enumerated by CFTC rules.[25] This proposed 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.[26] 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.  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 proposal expand that approach to non-enumerated hedge exemption requests that will limit the uncertainty for bone fide commercial market participants.

I look forward to hearing from end-users about whether this proposal provides them the flexibility and certainty they need to manage their exposures in a way that reflects the complexities and realities of their physical businesses. In particular, I am interested to hear if the list of enumerated bona fide hedging exemptions should be broadened to recognize other types of common, legitimate commercial hedging activity.

Proposed 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.[27] Today’s proposal provides the market with far greater certainty on the universe of such swaps than the previous proposals.  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 proposed rule narrows the scope of “economically equivalent” swaps to those with material contractual specifications, terms, and conditions that are identical to exchange-traded contracts.[28] 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 proposed narrowly-tailored definition will provide market participants with clarity over those contracts subject to position limits.  I also welcome suggestions from commenters regarding ways in which the definition can be further refined to complement limits on exchange-traded contracts. 

Conclusion

Section 2a(10) of the CEA is not an often cited passage of text.  It describes the Seal of the United States Commodity Futures Trading Commission, and in particular, lists a number of symbols on the seal which represent the mission and legacy of our agency: the plough showing the agricultural origin of futures markets; the wheel of commerce illuminating the importance of hedging markets to the broader economy; and, the scale of balanced interests, proposing a fair weighing of competing or contradicting forces.

As I think about the proposal in front of us today, I believe it speaks to all of those elements enshrined in our agency’s legacy, but the scale of balanced interests comes most to mind with this rule: new flexibility combined with new regulation, the removal of a few exemptions with the expansion or addition of others, the reliance on exchange expertise but with Commission review and oversight, and the balance of liquidity and price discovery against the threat of corners and squeezes. I am very pleased to support today’s revitalized, confined, and tempered approach to position limits and look forward to comment letters, particularly from the end-user community.