Futures specialists in the US have cast doubt on the Commodity Futures’ Trading Commission’s ability to enforce position limits on speculative commodity traders – even if the regulator succeeds in its rulemaking quest to create hard and fast position-based limits.

“It doesn’t look like [the Republican-controlled] Congress will approve their budget,” said one analyst in New York. “That’s going to hit enforcement. You can impose the limits, but if you haven’t got the budget to put people on the ground, how are you going to enforce them?”

The position limit proposals are still in the comment phase, with one senior energy player saying he had prepared 30 separate comment pieces for regulators. “I’d expect some more comeback,” said one market commentator. “Typically these guys leave it till the last minute.”

Michael Cosgrove, head of strategic projects in energy and commodities at interdealer broker GFI in New York, said it was essential to distinguish between physically delivered and cash-settled derivatives when setting limits.

“I think the proposed regime is potentially very damaging,” he told FOi. “We have to start with the realisation that physical and cash trading are very different. Until we realise that, we can’t properly regulate either. If you try to impose the same limits on cash trading, that could lead to increased volatility.”

Points not limits

Although the position limit proposal from the CFTC has now gone out for public comment, its path through the agency has been slow and tortuous. The misgivings of the two Republican commissioners, Jill Sommers and Scott O’Malia, and even of some of the Democrats, means that the five-member commission might fail to reach agreement on a workable policy.

At the beginning of January, CFTC commissioner Bart Chilton argued that, in the absence of a consensus among the commissioners, the CFTC should temporarily implement a system of position “points”. These would not be limits but position size thresholds that triggered closer scrutiny or requests for more data.

Chilton said the points would serve as warning signals, allowing for “a determination of the size of a trader’s net position. If a trader’s net position is in excess of a speculative position point, we could use that information to make a determination as to what, if any, course of action to take, just as we do now with market surveillance information. We could do nothing, or we could urge the trader to reduce trading positions.” Staff would brief the commissioners monthly on which firms were exceeding position points.

Cosgrove backed the idea, arguing that it showed faith in the Commission’s role as a market watchdog. “[Position limits are] like mandatory sentencing,” he argued, “rather than allowing your judges to come to a conclusion based on evidence. Do you have confidence in your judges? I have confidence in the CFTC. I trust them to impose the right thing.”

All eyes on Dunn

CME Group made its feelings pretty clear in a blog posting by Thomas LaSala, its chief regulatory officer.

Entitled ‘CFTC position limit proposal sends us in the wrong direction’, the posting argued: “The end result of the CFTC’s proposed rules would have the unfortunate unintended consequence of pushing participants out of the best-regulated and most transparent markets, into less-regulated, more opaque markets that carry greater risk, or preventing participants from efficiently hedging their risks in the first place.” LaSala added: “Rather than hard limits, we believe exchange position accountability rules are the most effective and appropriate tool for addressing any concerns with respect to large positions in a contract prior to the expiration period. We can, and do, utilise position limits and appropriate hedge exemptions during the expiration period for our energy and metals contracts.

“Put in more general terms, if hedging becomes too onerous or too expensive because of position limits and overly restrictive hedge exemptions, participants may choose not to, or be unable to, hedge their risk at all, and that not only increases costs to consumers, but adds risk to our financial system,” LaSala concluded.

The Commission needs three votes out of five to pass a rule. With Sommers and O’Malia unlikely to support the proposal in its present form, chairman Gary Gensler and Chilton will have to rely on the support of Michael Dunn if a rule is to be made.

“The big question now is Dunn,” said Cosgrove. “I think Gensler and Chilton would like [position limits], but Dunn has expressed reservations.”