The effects of speculation on commodities pricing has been hotly debated in recent years. In the aftermath of the 2008 financial crisis there was a sharp increase in raw-materials speculation, leading to record-high prices in some markets and calls from member of Congress to limit the number of options or futures contracts an investor may hold on any one underlying security.
These restrictions, known as position limits, have been used by regulators for decades to prevent abuse and price manipulation.
Position limits for commodity futures, options and swaps were put into the 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act. They were intended to curb the speculation that some people blamed for the high price volatility of certain commodities, primarily crude oil contracts that affected gasoline prices.
Beyond Statutory Authority
The new position rules were intended to go into effect October 12, but a recent court decision has temporarily brought the rules implementation to a halt. The lawsuit was filed in U.S. District Court in the District of Columbia by the International Swaps and Derivatives Association (ISDA) and the Securities Industry and Financial Markets Association (SIFMA), which argued the CFTC had overreached its statutory authority in establishing the position limits. Plaintiff also argued the CFTC had not determined the restrictions were “necessary or appropriate before issuing the rules.
U.S. District Judge Robert Wilkins agreed with the plaintiffs. He 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.
Robert Pickel, Chief Executive Officer of ISDA and T. Timothy Ryan, Jr., President and CEO of SIFMA, voiced their support for Judge Wilkins decision, reiterating their point that the position limits would harm the market.
“The Court’s ruling today vacates the rule and remands it back to the CFTC,” said Pickel and Ryan in a statement. “The position limits rule would adversely impact commodities markets and market participants, including end-users, by reducing liquidity and increasing price volatility.”
In October 2011, the CFTC approved rules designed to limit holdings of futures and options for 28 commodities and their derivatives.
According to Bloomberg News, the rules limit the number of contracts a single firm can hold and “limits traders to 25 percent of deliverable supply in the month nearest to delivery. The spot-month limits apply separately to physically settled and cash-settled contracts. Deliverable supply will be determined by the CFTC in conjunction with the exchanges.”
Defended by Chairman
CFTC Chairman Gary Gensler argued when the rule was approved that position limits are appropriate to manage speculation and have been used successfully before.
“Our duty is to protect both market participants and the American public from fraud, manipulation and other abuses,” said Gensler at the time. “Position limits have served since the Commodity Exchange Act passed in 1936 as a tool to curb or prevent excessive speculation that may burden interstate commerce.”
After the ruling Gensler responded in a statement, “As part of the Dodd-Frank Act, Congress directed the Commission to impose limits on speculative positions in physical commodity futures and options contracts and economically equivalent swaps. The rule addresses Congress’ concern that that no single trader is permitted to obtain too large a share of the market, and that derivatives markets remain fair and competitive. I believe it is critically important that these position limits be established as Congress required. I am disappointed by [the] ruling, and we are considering ways to proceed.”
Hilary Till is a co-founder and principal of Premia Capital Management, LLC, and a Heartland Institute policy advisor. She says the CFTC did fail to include a necessity finding when it implemented the new limits.
No ‘Necessity Findings’
“I read the court’s decision. Essentially, in prior federal agency decisions to impose speculative position limits, dating back to 1938, the relevant agency had made ‘necessity findings in its rulemakings’ of actual or potential harmful excessive speculation.
“The CFTC precisely did not do so during the current iteration of federal position limit rulemakings. And in fact, three Commissioners noted that no such finding had been made. The court essentially found that a plausible ‘plain reading’ of the Dodd-Frank amendments to the Commodity Exchange Act could lead one to conclude that the CFTC still needed to make a finding of necessity before imposing new limits.”
Till says the court acknowledged there is more than one plausible interpretation of the Dodd-Frank amendments regarding whether the imposition of federal position limits is mandatory. But the court ruled the CFTC “would need to specifically address this ambiguity with its expertise rather than asserting that this ambiguity does not exist.”
Even before the recent ruling, there was disagreement over whether imposing position limits would have a positive effect on price volatility. An August 2009 CFTC economist memorandum cast doubt on their effectiveness.
“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,” the memo stated. “Our results are consistent with those found in the existing literature on position limits.”
CFTC Commissioner Michael Dunn voiced similar concerns at a January 2011 hearing: “My fear is that, at best, position limits are a cure for a disease that does not exist. Or at worst, a placebo for one that does.”