Reining In Market Speculation

A rule limiting speculation on commodities exchanges ‘ a most important market reform in the eyes of fuel oil dealers ‘ was stopped by a legal challenge late last year, but a revised version of the rule is likely to be implemented this summer, said a commissioner on the U.S. Commodity Futures Trading Commission (CFTC).

‘We will have position limits in place,” Commissioner Bart Chilton told Fuel Oil News in an interview. ‘I am one hundred percent confident.”

The Commission is charged with writing and implementing some 60 rules under the Dodd-Frank Wall Street Reform & Consumer Protection Act of 2010. The Commission had completed about 40 of those rules by mid January, Chilton said.

But the Speculative Position Limits rule, important to the fuel oil industry because it would, for the first time, limit on- and off-exchange energy trades, isn’t one of those that have been implemented. The rule was written and finalized, but was challenged 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) days before it was to go into effect last October. A ruling in favor of the plaintiffs, by Judge Robert Wilkins, vacated the rule and remanded it to the CFTC for reconsideration.

The CFTC filed an appeal, and at the same time is writing a revised version of the rule, Chilton said.

‘If the appeal is granted then we win,” Chilton said. ‘We’ll be able to implement [the original version of] the rule.” But the appeal process may take many months, Chilton said, noting that as of mid January the court had yet to ask the commission for its arguments on the appeal. So, Chilton came up with a ‘Plan B.”

‘I suggested that we should re-issue yet another rule ‘ try to overcome any of the objections that were made in the plaintiff’s case ‘ and have it implemented sooner than an appeal could potentially be determined,” Chilton said. A staff-written revision, addressing issues raised in the plaintiffs’ filing, should be ready for commissioners’ consideration sometime in February, Chilton said.

The new proposed rule would then be put out for comment, Chilton said, ‘but we certainly do not need a long comment period because we know what everybody thinks about position limits.” The revised rule would ‘not be significantly altered” from the first version, Chilton added, so a public comment period of fifteen days or thirty days should be sufficient. ‘We’d have the rule in place by the beginning of summer” ‘ before the appeal of the originally proposed rule is completed, Chilton said. ‘That would be my hope. That’s what I’ve suggested to my colleagues.”

Asked whether his colleagues on the five-member commission seemed receptive to his proposal, Chilton, a Democrat appointee, said, ‘Well, two of them seem generally receptive and we only need three votes.” The commission consists of three Democrat appointees and two Republican appointees. ‘I’m optimistic that there will be three of the five votes to move forward” on a new version of the rule, which would differ in two key ways from the original, Chilton said.

‘The judge said we have authority to set position limits, but we need to say why we’re doing it,” Chilton said. The revised rule can cite Dodd-Frank and another authority, the Commodity Exchange Act of 1936, ‘and we’ll explain why we’re using both of them,” Chilton said. ‘We’ll essentially make that part of the rule bulletproof to litigation,” he said.

The other change will have to do with a cost/benefit analysis. ‘The government is required to do a cost/benefit analysis before finishing a rule,” Chilton said, ‘and we did one, but [the plaintiffs] claim that we didn’t do an adequate job.”

The key question ‘ How much will this cost you as a firm? ‘ was posed in the rulemaking, Chilton said. It was known that affected firms, including fuel oil dealers, would have to implement computer programs to help them monitor their positions in the commodity markets, and that this would be a cost.

The commission received almost 13,000 comments on the position limits rule, Chilton said, but only 50 to 60 contained comments regarding cost, and of those only a dozen provided numbers indicating the actual cost of compliance.

‘When we promulgated the final rule,” Chilton said, ‘we based the cost/benefit analysis on the information that we had, which was only the information from these twelve different firms,” The plaintiffs argued that wasn’t good enough, and the judge agreed, Chilton noted.

For this second try, more information on the cost of compliance is available, Chilton said, because traders in the market had readied themselves in anticipation of the implementation of the original rule on Oct. 12, 2012. Implementation never happened because on Sept. 28 the court kicked the rule back to the CFTC.

‘Everybody was ready to go,” Chilton said, ‘and therefore they know what it costs.” This time around, the request for public comment will again include a call for cost estimates, which should garner many more meaningful responses, Chilton said. ‘We will have a much better sense of the actual costs and the benefits of a position limits rule,” he said.

Reforming the markets isn’t exclusively a matter of promulgating and enforcing rules under Dodd-Frank. How U.S. regulations match up, or don’t, with those in other nations ‘ referred to as ‘extra-territoriality” ‘ is a concern as well, Chilton said. If rules are seen as overly strict in one nation, the result could be ‘market migration to other countries ‘ the countries with thinner rule books,” Chilton said.

‘These are global markets now,” he said. ‘What you do in energy in New York is impacted by, and impacts, what goes on in London, in Shanghai, in Singapore. They’re really interrelated and interconnected. That means that other regulators around the globe should have comparable regulations.”


International coordination is the way to thwart market migration, Chilton said. In that spirit, he said, ‘We’ve delayed some of our rules for six months in order to accommodate the European Union, which should be coming online this year with fairly comparable regulations.”

Much of the rest of the world is preparing market reforms as well, Chilton said, ‘some sooner than this summer, some later.”

With the U.S. and the European Union taking action, Chilton said, ‘it’s sort of like the movie ‘Field of Dreams’ ‘ ‘If you build it they will come.’ If the E.U. and the U.S. do this, the rest of the world will come online.”

Chilton said, ‘I’m really optimistic that we’re going to have globally harmonized rules and regulations in financial markets. That will make these markets globally more efficient and effective.”

High-frequency trading is another concern that needs addressing, Chilton said. He has coined the term ‘cheetah” for traders who are operating 24 hours, 365 days a year, around-the-globe, ‘trying to scoop up micro-dollars in milliseconds.”

Chilton said, ‘I’m concerned they are impacting markets in a way that is not helpful and that needs to be regulated.” Such traders constitute the majority of trading volume on the exchanges, but they are not mentioned specifically in Dodd-Frank because they were not a contributing factor in the 2008 financial collapse, Chilton said. They came into the public spotlight later. ‘There was a problem with them with regard to the ‘flash crash’ of May 2010,” Chilton said. (‘Flash crash” became the popular way to refer to a quick drop and recovery in securities prices that occurred one afternoon in that month of 2010.)

‘No place in [Dodd-Frank] are they mentioned, yet these traders are constituting the majority of the trading volume,” Chilton said. ‘They’re not even required to be registered with us, which means that we can’t request their books and records. They should be registered.”

Further, Chilton said, high-speed traders should be required to test their programs before putting them into operation; their programs should be required to have ‘kill switches”; and they should not be permitted to engage in ‘wash trades” or cross-trading ‘ trading with themselves.

‘These are basic pedestrian steps that should be taken to ensure that markets are better protected, and customers are better protected,” Chilton said.




Industry groups eager to see position limits for traders

Transparency is the goal of market reforms, and though the Dodd-Frank Wall Street Reform & Consumer Protection Act of 2010 is still in the process of being implemented, some enhanced clarity is already apparent, said representatives of the Petroleum Marketers Association of America (PMAA) and the New England Fuel Institute (NEFI).

‘That’s as important as anything else,” Jim Collura, NEFI vice president for government affairs, said of transparency, ‘because when regulators and the public and other market participants can see what’s going on ‘ what size position speculators hold, how much banks are charging their customers for derivatives contracts ‘ numbers can be put to paper. That’s a huge deal.”

Collura said that investment firm Goldman Sachs Group, and other firms and pension funds, had begun scaling back commodities investments ‘largely due to Dodd-Frank” and the increased transparency it is bringing about. ‘It’s going to make it less lucrative for them to play around in this sandbox,” Collura said.

‘We wanted these regulations implemented right away and we needed them implemented right away,” said Sherri Stone, vice president of PMAA, ‘but it’s really no surprise to anyone that the banks and Wall Street are fighting this with tremendous amounts of money and resources.”

The Speculative Position Limits rule, which would limit on- and off-exchange energy trades, is one rule that NEFI and PMAA especially hope to see implemented soon. ‘We’re going to continue to push for positions limits,” said Rob Underwood, PMAA’s manager of congressional relations.

Commissioner Bart Chilton of the Commodity Futures Trading Commission (CFTC) told Fuel Oil News that he expected such a rule to be in place by this summer (see accompanying article). ‘Transparency is the best disinfectant for potentially dirty markets,” Chilton said, ‘and I think Dodd Frank is cleaning the markets up slowly, but surely.”

About the Speculative Position Limits rule being formulated by CFTC staff, NEFI’s Collura said, ‘We’re hoping for the strongest possible reforms there.” An initial version of the rule ran up against a legal challenge and is wending its way through an appeals process that is expected to go on for months; the CFTC is writing a second version, designed to be implemented without raising objections while the first is still being contended in court.

‘Hopefully, it will be better,” Collura said of the second version. Though they support a limit on speculative positions, NEFI and PMAA had objections to the first version. ‘It allowed an individual trader to have contracts up to 25 percent of deliverable supply for, say, heating oil,” Collura said, ‘and we were very opposed to that. It was too high. We wanted a much lower limit.”



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