Policy Documents

Research & Commentary: Commodities Position Limits

November 9, 2012

Since the 2008 financial crisis, the effect of speculation on commodities pricing has been hotly debated. Although speculation in commodities may play a role in determining prices, price fluctuations are largely a response to the fundamental forces of supply and demand. 

Nonetheless, in the 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act, “position limits” on the number of options or futures contracts an investor may hold on any one underlying security were placed on all commodity futures, options, and swaps, to curb speculation that some people blamed for the high price volatility of certain commodities, primarily crude oil contracts that affected gasoline prices. 

In October 2011 the Commodity Futures Trading Commission (CFTC) approved rules to limit holdings of futures and options for 28 commodities and their derivatives. A recent court decision has temporarily halted implementation; U.S. District Judge Robert Wilkins ruled the Dodd-Frank Act did not give the CFTC a “clear and unambiguous mandate” to set limits without identifying where they were needed and why. 

Even before the recent ruling, there was disagreement over whether position limits would reduce price volatility. An August 2009 CFTC economist memorandum stated, “In our analysis of the impact of position limits, we find little evidence to suggest that changes from a position limit regime to an accountability level regime or changes in the levels of position limits impact price volatility in either energy or agricultural markets. Our results are consistent with those found in the existing literature on position limits.” 

An editorial from the Economist warns, “There is good reason to worry that position limits will harm markets more than help them. Producers of commodities enter into futures contracts to hedge their risk, but need a party to take the other side. Investors will become pickier about the contracts they enter into as a result of the limits, which may cause markets to become less liquid, worsening volatility rather than reducing it.” 

In sum, position limits add an unnecessary layer of regulation on financial markets that ends up hurting the economy further. 

The following articles examine commodities position limits from multiple perspectives.

CFTC Adopts Final Position Limit Rules for Futures, Options and Swaps on 28 Physical Commodities
http://heartland.org/policy-documents/cftc-adopts-final-position-limit-rules-futures-options-and-swaps-28-physical-commod
Skadden, Arps, Slate, Meagher & Flom LLP summarize key aspects of the CFTC’s final position limits rulemaking and the main features of its new position limit regime. 

The Role of Financial Speculation in Driving the Price of Crude Oil
http://heartland.org/policy-documents/role-financial-speculation-driving-price-crude-oil
Ron Alquist and Olivier Gervais of the Bank of Canada examine the claim that financial speculation caused the run-up in oil prices. The authors outline several arguments that cast doubt on this claim. 

The Impact of Index and Swap Funds on Commodity Futures Markets
http://heartland.org/policy-documents/impact-index-and-swap-funds-commodity-futures-markets
This report for the OECD by professors Scott Irwin and Dwight Sanders represents a preliminary study intended to clarify the role of index and swap funds in agricultural and energy commodity futures markets. 

Q&A – Position Limits for Derivatives
http://heartland.org/policy-documents/q-position-limits-derivatives
The Commodity Futures Trading Commission explains how the position limits will work, how they will be enforced, and who is expected to follow them.

CFTC Approves Final Position Limits for Physical Commodity Futures and Swaps under Dodd-Frank
http://us.practicallaw.com/6-515-4428?q=&qp=&qo=&qe=#null
In a Legal Update, the Practical Law Company examines the CFTC’s approved final rules under the Dodd-Frank Act setting position limits for physical commodity futures contracts and economically equivalent futures, options, and swaps. 

Judge Throws Commodity Position Limit Rules Back to CFTC
http://www.complianceweek.com/judge-throws-commodity-position-limit-rules-back-to-cftc/article/261617/
Joe Mont of Compliance Week reports on the federal court decision to stop the position limits the Commodity Futures Trading Commission was set to impose on firms trading in certain commodity contracts in an effort to prevent price manipulation by speculators. Mont quotes reactions of legislators and the CFTC chairman. 

Top U.S. Regulator Approves New Limit on Commodity Speculation in 3-2 Vote
http://www.bloomberg.com/news/2011-10-18/cftc-votes-3-2-to-approve-new-limits-on-commodity-speculation.html
Asjylyn Loder and Silla Brush of Bloomberg examine the CFTC’s approval of the new limits on commodities’ positions, describe how the limits will affect the market, and report reactions from regulators and the financial industry. 

Back to the Futures: Regulators are Homing in on New Rules to Rein in Speculators
http://www.economist.com/node/21529073
The Economist reports on the CFTC’s proposed position limits and examines some of the expected consequences of the new regime. The authors warn of negative economic effects and stress that the details of the new rules will be critically important. 

U.S. CFTC Boss Supports Appealing Position-Limits Ruling
http://www.reuters.com/article/2012/10/10/us-financial-regulation-appeal-idUSBRE8991RS20121010
Emily Stephenson and Tom Polansek of Reuters speak with Gary Gensler, chairman of the U.S. Commodity Futures Trading Commission about his reaction to the court’s ruling on position limits. Gensler voices his support for the limits and for an appeal. 

Memorandum: Impact of Position Limits on Volatility in Energy Futures Markets
http://heartland.org/policy-documents/memorandum-impact-position-limits-volatility-energy-futures-markets
This CFTC memorandum analyzes the expected impact of position limits on price volatility of energy commodities and finds “little evidence to suggest that changes from a position limit regime to an accountability level regime or changes in the levels of position limits impact price volatility in either energy or agricultural markets.” 

Price Surges in Food Markets: How Should Organized Futures Markets Be Regulated?
http://heartland.org/policy-documents/price-surges-food-markets-how-should-organized-futures-markets-be-regulated
The Food and Agriculture Organization of the United Nations examines the effect of speculation on food prices, finding that the worldwide rise in food prices two years ago “might have been amplified by speculators in organized futures markets. However, limiting or banning speculative trading might do more harm than good.” The authors argue some regulation of commodities futures markets is desirable, but any intervention should be cautious and stop short of imposing tight limits or an outright ban on such trading. 

Summary of the Dodd-Frank Act: Swaps and Derivatives
http://us.practicallaw.com/3-502-8950#a565026
Practical Law Company provides a comprehensive summary of the provisions of Title VII of the Dodd-Frank Act and related rulemaking over swaps and derivatives covering both security-based swaps and non-security-based swaps. 

CFTC Position Limits Rule Divides Agency, Angers Market Participants
http://www.forbes.com/sites/kitconews/2011/10/19/cftc-position-limits-rule-divides-agency-angers-market-participants/
Forbes reports on market participants’ reaction to the CFTC’s position limits rule, noting, “Market participants said the rules target a concern that has never been proven and don’t address the heart of the problems of the financial crisis, which was the purpose of the Dodd-Frank act.”

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit The Heartlander’s Finance and Insurance News Web site at http://news.heartland.org/insurance-and-finance, The Heartland Institute’s Web site at www.heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org

If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or mglans@heartland.org.