On October 15, the Commodity Futures Trading Commission (CFTC or the Commission) adopted final rules imposing speculative position limits in derivative contracts referencing 25 agricultural, metals and energy commodities (the Final Rules). These limits are the culmination of almost a decade of work from the Commission and its staff, including revising the rules after a federal court vacated its last attempt to expand speculative position limits in 2012.
The Final Rules are intended to "prevent excessive speculation" and broadly apply to positions in futures, options and economically equivalent swaps referencing the covered commodities (Covered Contracts). The Final Rules approach the exemption for bona fide hedges flexibly, to "accommodate potential future, unpredictable developments in commercial hedging practices." This is in contrast to previous rule proposals, which were both more prescriptive and restrictive. The Final Rules also exempt certain recognized spread transactions.
Although the Final Rules have a relatively distant compliance date (January 1, 2022, for futures contracts in the 16 commodities not subject currently to federal limits and January 1, 2023, for economically equivalent swaps), market participants should familiarize themselves with the Final Rules and their exemptions because many participants and intermediaries will likely find it necessary to establish internal control procedures, which may require systems development in advance of the Final Rules' compliance date. The Commission has long prioritized enforcement actions based on violations of existing federal and exchange-set position limits, and we expect this focus to continue with the adoption of this broadened speculative position limits regime.
I. Relevant Background
Since its adoption in 1936, Section 4a of the of the Commodity Exchange Act has authorized the Commission to impose speculative position limits.1 Section 737 of the 2008 Dodd-Frank Wall Street Reform and Consumer Protection Act amended Section 4a to expand the Commission's authority to impose speculative positions limits "as necessary." The CFTC first attempted to adopt rules under this new authority in 2011.2 However, these rules were largely vacated by a federal court in 2012, after the court found the Commission had not appropriately determined that the position limits adopted were necessary to advance the statute's goals.3
In the eight years following this setback, the CFTC proposed several iterations of revised speculative position limit rules that were designed to address the issues in the original 2011 rules. The first of the revised rules were noticed for comment in December 2013. In response to comments from market participants and other commenters, the Commission issued a supplemental proposal in June 2016, followed by a complete re-proposal in December of that year. In February 2020, the Commission issued a further revised proposal, which specifically found that the proposed position limits were necessary to prevent excessive speculation. The Final Rules adopt the February 2020 proposal with few material changes.
II. Summary of the Rulemaking
The Final Rules become effective upon publication in the Federal Register. Market participants must comply with applicable position limits for futures and options contracts not currently subject to federal limits by January 1, 2022, and for economically equivalent swaps by January 1, 2023.
- Overall Structure of Speculative Position Limits
The Final Rules amend the overall framework for speculative position limits by building on the current structure that applies to the agricultural contracts currently subject to federal limits (the Legacy Contracts). These nine agricultural commodities4 will continue to be subject to spot-month and combined single-month and all-month limits, using a formula based on 25 percent of the current estimated deliverable supply. The spot-month limits for most of these commodities have been increased from their existing levels, reflecting increases in the deliverable supply.
Amended Regulation 150.2 also continues to impose non-spot-month limits for these contracts. The formula is 10 percent of open interest for the first 50,000 contracts, with an incremental increase of 2.5 percent of open interest thereafter adjusted by the size of the unit of trading. Most of these levels have also been adjusted upward to reflect increased open interest in these contracts.
The remaining Covered Contracts are subject only to spot-month limits at the federal level. Specifically, the Final Rules amend Regulation 150.2 to establish federal spot-month position limits for derivative contracts referencing 16 agricultural, metals and energy commodities not covered by the Commission's existing position limits. As with the Legacy Contracts, these limits are based on 25 percent of the current estimated deliverable supply for the relevant commodity, as reported by the designated contract market listing the core referenced futures contract.5
For all Covered Contracts, these limits apply separately to positions in physically and cash-settled products. Market participants must aggregate, and net, positions in contracts within each delivery type.6 These limits also apply to cash-settled futures and options contracts that are either "directly or indirectly" linked to the price of a "core referenced futures contract" or the same commodity, "for delivery at the same location as specified in that core referenced futures contract," but exclude certain index and average-price contracts, including location basis contracts, commodity index contracts and calendar month average contracts.
In addition, these limits apply to "economically equivalent swaps" entered after the effective date of the Final Rules that "have identical material specifications, terms, and conditions" to a "core referenced futures contract" or covered cash-settled contract, even if the swap provides a different lot size or notional value, post-trade risk management arrangement, or, for physically settled swaps, delivery dates that diverge by less than one calendar day from the equivalent futures contract.7
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Footnotes
1. 7 U.S.C. § 6a.
2. See Position Limits for Futures and Swaps, 76 Fed. Reg., 71,626 (Nov. 18, 2011).
3. See ISDA v. CFTC, 887 F. Supp. 2d 259 (D.D.C. 2012).
4. They are CBOT Corn, CBOT Oats, CBOT Soybeans, CBOT Wheat, CBOT Soybean Oil, CBOT Soybean Meal, MGEX Hard Red Spring Wheat, ICE Cotton No. 2 and CBOT KC Hard Red Winter Wheat.
5. While these limits do not automatically adjust, we expect that the Commission will take action to increase or decrease these limits if the deliverable supply of a covered commodity changes materially.
6. For the NYMEX Henry Hub Natural Gas (NYMEX NG) physically delivered core referenced futures contract and its associated cash-settled referenced contracts, federal position limits apply to NYMEX NG cash-settled referenced contracts and are not aggregated across different exchanges.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
