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Proposed Rule

Position Limits for Derivatives

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Start Preamble Start Printed Page 96704

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Reproposal.

SUMMARY:

The Commodity Futures Trading Commission (“Commission” or “CFTC”) is reproposing rules to amend part 150 of the Commission's regulations concerning speculative position limits to conform to the Wall Street Transparency and Accountability Act of 2010 (“Dodd-Frank Act”) amendments to the Commodity Exchange Act (“CEA” or “Act”). The reproposal would establish speculative position limits for 25 exempt and agricultural commodity futures and option contracts, and physical commodity swaps that are “economically equivalent” to such contracts (as such term is used in section 4a(a)(5) of the CEA). In connection with establishing these limits, the Commission is reproposing to update some relevant definitions; revise the exemptions from speculative position limits, including for bona fide hedging; and extend and update reporting requirements for persons claiming exemption from these limits. The Commission is also reproposing appendices to part 150 that would provide guidance on risk management exemptions for commodity derivative contracts in excluded commodities permitted under the revised definition of bona fide hedging position; list core referenced futures contracts and commodities that would be substantially the same as a commodity underlying a core referenced futures contract for purposes of the definition of location basis contract; describe and analyze fourteen fact patterns that would satisfy the reproposed definition of bona fide hedging position; and present the reproposed speculative position limit levels in tabular form. In addition, the Commission proposes to update certain of its rules, guidance and acceptable practices for compliance with Designated Contract Market (“DCM”) core principle 5 and Swap Execution Facility (“SEF”) core principle 6 in respect of exchange-set speculative position limits and position accountability levels. Furthermore, the Commission is reproposing processes for DCMs and SEFs to recognize certain positions in commodity derivative contracts as non-enumerated bona fide hedges or enumerated anticipatory bona fide hedges, as well as to exempt from position limits certain spread positions, in each case subject to Commission review. Separately, the Commission is reproposing to delay for DCMs and SEFs that lack access to sufficient swap position information the requirement to establish and monitor position limits on swaps.

DATES:

Comments must be received on or before February 28, 2017.

ADDRESSES:

You may submit comments, identified by RIN number 3038-AD99, by any of the following methods:

  • CFTC Web site: http://comments.cftc.gov;
  • Mail: Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581;
  • Hand delivery/courier: Same as Mail, above.
  • Federal eRulemaking Portal: http://www.regulations.gov. Follow instructions for submitting comments.

All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be posted as received to http://www.cftc.gov. You should submit only information that you wish to make available publicly. If you wish the Commission to consider information that may be exempt from disclosure under the Freedom of Information Act, a petition for confidential treatment of the exempt information may be submitted according to the procedures established in CFTC regulations at 17 CFR part 145.

The Commission reserves the right, but shall have no obligation, to review, pre-screen, filter, redact, refuse or remove any or all of your submission from http://www.cftc.gov that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the rulemaking will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under the Freedom of Information Act.

Start Further Info

FOR FURTHER INFORMATION CONTACT:

Stephen Sherrod, Senior Economist, (202) 418-5452, ssherrod@cftc.gov, Riva Spear Adriance, Senior Special Counsel, (202) 418-5494, radriance@cftc.gov, Hannah Ropp, Surveillance Analyst, 202-418-5228, hropp@cftc.gov, or Steven Benton, Industry Economist, (202) 418-5617, sbenton@cftc.gov, Division of Market Oversight; or Lee Ann Duffy, Assistant General Counsel, 202-418-6763, lduffy@cftc.gov, Office of General Counsel, in each case at the Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.

End Further Info End Preamble Start Supplemental Information

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. Introduction

B. The Commission Construes CEA Section 4a(a) To Mandate That the Commission Impose Position Limits

C. Necessity Finding

II. Proposed Compliance Date

III. Reproposed Rules

A. § 150.1—Definitions

B. § 150.2—Position limits

C. § 150.3—Exemptions

D. § 150.5—Exchange-set speculative position limits and Parts 37 and 38

E. Part 19—Reports by persons holding bona fide hedging positions pursuant to § 150.1 of this chapter and by merchants and dealers in cotton

F. § 150.7—Reporting requirements for anticipatory hedging positions

G. § 150.9—Process for recognition of positions as non-enumerated bona fide hedging positions

H. § 150.10—Process for designated contract market or swap execution facility exemption from position limits for certain spread positions

I. § 150.11—Process for recognition of positions as bona fide hedging positions for unfilled anticipated requirements, unsold anticipated production, anticipated royalties, anticipated services contract payments or receipts, or anticipatory cross-commodity hedge positions

J. Miscellaneous regulatory amendments

1. Proposed § 150.6—Ongoing responsibility of DCMs and SEFs

2. Proposed § 150.8—Severability

3. Part 15—Reports—General provisions

4. Part 17—Reports by reporting markets, futures commission merchants, clearing members, and foreign brokers

5. Part 151—Position limits for futures and swaps, Commission Regulation 1.47 and Commission Regulation 1.48—Removal

IV. Related Matters

A. Cost-Benefit Considerations

B. Paperwork Reduction Act

C. Regulatory Flexibility Act

V. Appendices

A. Appendix A—Review of Economic Studies

B. Appendix B—List of Comment Letters Cited in this Rulemaking

I. Background

A. Introduction

The Commission has long established and enforced speculative position limits for futures and options contracts on various agricultural commodities as authorized by the Commodity Exchange Start Printed Page 96705Act (“CEA”).[1] The part 150 position limits regime [2] generally includes three components: (1) The level of the limits, which set a threshold that restricts the number of speculative positions that a person may hold in the spot-month, individual month, and all months combined,[3] (2) exemptions for positions that constitute bona fide hedging transactions and certain other types of transactions,[4] and (3) rules to determine which accounts and positions a person must aggregate for the purpose of determining compliance with the position limit levels.[5]

In late 2013, the CFTC proposed to amend its part 150 regulations governing speculative position limits.[6] These proposed amendments were intended to conform the requirements of part 150 to particular changes to the CEA introduced by the Wall Street Transparency and Accountability Act of 2010 (”Dodd-Frank Act”).[7] The proposed amendments included the adoption of federal position limits for 28 exempt and agricultural commodity futures and option contracts and swaps that are “economically equivalent” to such contracts.[8] In addition, the Commission proposed to require that DCMs and SEFs that are trading facilities (collectively, “exchanges”) establish exchange-set limits on such futures, options and swaps contracts.[9] Further, the Commission proposed to (i) revise the definition of bona fide hedging position (which includes a general definition with requirements applicable to all hedges, as well as an enumerated list of bona fide hedges),[10] (ii) revise the process for market participants to request recognition of certain types of positions as bona fide hedges, including anticipatory hedges and hedges not specifically enumerated in the proposed bona fide hedging definition; [11] and (iii) revise the exemptions from position limits for transactions normally known to the trade as spreads.[12]

On June 13, 2016, the Commission published a supplemental proposal to its December 2013 Position Limits rulemaking.[13] The supplemental proposal included revisions and additions to regulations and guidance proposed in 2013 concerning speculative position limits in response to comments received on that proposal, and alternative processes for DCMs and SEFs to recognize certain positions in commodity derivative contracts as non-enumerated bona fide hedges or enumerated anticipatory bona fide hedges, as well as to exempt from federal position limits certain spread positions, in each case subject to Commission review. In this regard, under the 2016 Supplemental Position Limits Proposal, certain of the regulations proposed in 2013 regarding exemptions from federal position limits and exchange-set position limits would be amended to take into account the alternative processes. In connection with those proposed changes, the Commission proposed to further amend certain relevant definitions, including to clearly define the general definition of bona fide hedging for physical commodities under the standards in CEA section 4a(c). Separately, the Commission proposed to delay for DCMs and SEFs that lack access to sufficient swap position information the requirement to establish and monitor position limits on swaps at this time.

After review of the comments responding to both the December 2013 Position Limits Proposal and the 2016 Supplemental Position Limits Proposal, the Commission, in consideration of those comments, is now issuing a reproposal (“Reproposal”). The Commission invites comments on all aspects of this Reproposal.

B. The Commission Preliminarily Construes CEA Section 4a(a) To Mandate That the Commission Impose Position Limits

1. Introduction

a. The History of Position Limits and the 2011 Position Limits Rule

As part of the Dodd-Frank Act, Congress amended the CEA's position limits provision, which since 1936 has authorized the Commission (and its predecessor) to impose limits on speculative positions to prevent the harms caused by excessive speculation. Prior to the Dodd-Frank Act, CEA section 4a(a) stated that for the purpose of diminishing, eliminating or preventing specified burdens on interstate commerce, the Commission shall, from time to time, after due notice and an opportunity for hearing, by rule, regulation, or order, proclaim and fix such limits on the amounts of trading which may be done or positions which may be held by any person under contracts of sale of such commodity for future delivery on or subject to the rules of any contract market as the Commission finds are necessary to Start Printed Page 96706diminish, eliminate, or prevent such burden.[14]

In the Dodd-Frank Act, Congress renumbered a modified version of CEA section 4a(a) as section 4a(a)(1) and added, among other provisions, CEA section 4a(a)(2), captioned “Establishment of Limitations,” which provides that in accordance with the standards set forth in CEA section 4a(a)(1), the Commission shall establish limits on the amount of positions, as appropriate, other than bona fide hedge positions, that may be held by any person. CEA section 4a(a)(2) further provides that for exempt commodities (energy and metals), the limits required under CEA section 4a(a)(2) shall be established within 180 days after the date of the enactment of CEA section 4a(a)(2); for agricultural commodities, the limits required under CEA section 4a(a)(2) shall be established within 270 days after the date of the enactment of CEA section 4a(a)(2).[15]

These and other changes to CEA section 4a(a) are described in more detail below.

Pursuant to these amendments, the Commission adopted a position limits rule in 2011 (“2011 Position Limits Rule”) in a new part 151.[16] In the 2011 Position Limits Rule, the Commission imposed, in new part 151, speculative limits in the spot-month and non-spot-months on 28 physical commodity derivatives “of particular significance to interstate commerce.” [17] Under the 2011 Position Limits Rule, part 151 used formulas for calculating limit levels that are similar to the formulas used to calculate previous Commission- and exchange-set position limits.[18] The 2011 Position Limits Rule contained provisions in part 151 that implemented the statutory exemption for bona fide hedging.[19] It also provided account aggregation standards to determine which positions to attribute to a particular market participant.[20] Because it interpreted the Dodd-Frank Act as mandating position limits, the Commission did not make an independent threshold determination that position limits are necessary to accomplish the purposes set forth in the statute. The Commission explained:

Congress directed the Commission to impose position limits and to do so expeditiously. Section 4a(a)(2)(B) states that the limits for physical commodity futures and options contracts “shall” be established within the specified timeframes, and section 4a(a)(2)(5) states that the limits for economically equivalent swaps “shall” be established concurrently with the limits required by section 4a(a)(2). The congressional directive that the Commission set position limits is further reflected in the repeated references to the limits “required” under section 4a(a)(2)(A).[21]

ISDA and SIFMA sued the Commission to vacate part 151 on the basis (among others) that, in their view, CEA section 4a(a) clearly required the Commission to make an antecedent necessity finding.

b. The District Court Opinion

As set forth in the Commission's December 2013 Position Limits Proposal,[22] the district court in ISDA v. CFTC found that, on one hand, CEA section 4a(a)(1) “unambiguously requires that, prior to imposing position limits, the Commission find that position limits are necessary to `diminish, eliminate, or prevent' the burden described in [CEA section 4a(a)(1)].” [23] On the other hand, the court found that the Dodd-Frank Act amendments to CEA section 4a(a) rendered section 4a(a)(1) ambiguous with respect to whether such findings are required for the position limits described in CEA section 4a(a)(2)—futures contracts, options, and certain swaps on agricultural and exempt commodities.[24]

The court's determination in ISDA v. CFTC that CEA sections 4a(a)(1) and (2), read together, are ambiguous focused on the opening phrase of subsection (A)—“[i]n accordance with the standards set forth in [CEA section 4a(a)(1)].” The court held that the term “standards” in CEA section 4a(a)(2) was ambiguous as to whether it referred to the requirement in CEA section 4a(a)(1) that the Commission impose position limits only “as [it] finds are necessary to diminish, eliminate, or prevent” an unnecessary burden on interstate commerce.[25] If not, “standards” would refer to the aggregation and flexibility standards stated in CEA section 4a(a)(1) by which position limits are to be implemented. Accordingly, the court rejected both (1) the Commission's contention that CEA section 4a(a) as a whole unambiguously mandated the imposition of position limits without the Commission finding independently that they are necessary; and (2) the plaintiffs' contention that CEA section 4a(a) unambiguously required the Commission to make such findings before the imposition of position limits.[26] The court stated that because the Commission had incorrectly found CEA section 4a(a) unambiguous, it could not defer to any interpretation by the Commission to resolve the section's ambiguity. As the court observed, the D.C. Circuit has held that “ ‘deference to an agency's interpretation of a statute is not appropriate when the agency wrongly believes that interpretation is compelled by Congress.’ ” [27] The court further held that, pursuant to the law of the D.C. Circuit, it was required to remand the matter to the Commission so that it could “fill in the gaps and resolve the ambiguities.” [28] The court instructed that the Commission must apply its experience and expertise and cautioned that, in resolving the ambiguity in CEA section 4a(a), “ ‘it is incumbent upon the agency not to rest simply on its parsing of the statutory language.’ ” [29] The Commission does not rest simply on parsing the statutory language, but any interpretation necessarily begins with the text, which is described in the next section.

2. The Statutory Framework for Position Limits

Before the Dodd-Frank Act, what was then CEA section 4a(a) authorized the Start Printed Page 96707Commission to set limits on futures for any exchange-traded contract for future delivery of any commodity “as the Commission finds are necessary to diminish, eliminate, or prevent [the] burden” of “[e]xcessive speculation” “causing sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity.” 7 U.S.C. 6a(a) (2009 Supp.).[30] CEA section 4a(a) also required the Commission to follow certain criteria for aggregating limits once it made that determination. And the Commission was authorized to impose limits flexibly, depending on the commodity, delivery month, and other factors.[31]

The 2010 Dodd-Frank Act amendments to CEA section 4a(a) significantly expanded and altered it. The entirety of pre-Dodd-Frank CEA section 4a(a) became CEA section 4a(a)(1). Congress added six new subsections to CEA section 4a(a)—sections 4a(a)(2) through (7). And, outside of section 4a(a), Congress imposed a requirement that the Commission study the new limits it imposed and provide Congress with a report on their effects within one year of their imposition.[32]

The primary change at issue here was the addition of new CEA section 4a(a)(2), which addresses position limits on a specific class of commodity contracts, “physical commodities other than excluded commodities”:

CEA section 4a(a)(2)(A) provides that in accordance with the standards set forth in CEA section 4a(a)(1), with respect to physical commodities other than excluded commodities, the Commission shall establish limits on the amount of positions, as appropriate, other than bona fide hedge positions, that may be held by any person with respect to contracts of sale for future delivery or with respect to options on the contracts.

CEA section 4a(a)(2)(B), in turn, provides that the limits “required” under CEA section 4a(a)(2)(A) “shall be established within 180 days after the date of enactment of this paragraph” for “agricultural commodities” (such as wheat or corn) and “within 270 days after the date of the enactment of this paragraph” for “exempt commodities” (which include energy-related commodities like oil, as well as metals).[33]

The other new subsections of CEA section 4a(a) delineate the types of physical commodity derivatives to which the new limits apply, set forth criteria for the Commission to consider in determining the levels of the required limits, require the Commission to aggregate the limits across exchanges for equivalent derivatives, require the Commission to impose limits on swaps that are economically equivalent to the physical commodity futures and options subject to CEA section 4a(a)(2), and permit the Commission to grant exemptions from the position limits it must impose under the provision:

  • Section 4a(a)(3) guides the Commission in setting appropriate limit levels by providing that the Commission shall consider whether the limit levels: (i) Diminish, eliminate, or prevent excessive speculation; (ii) deter and prevent market manipulation, squeezes, and corners; (iii) ensure sufficient market liquidity for bona fide hedgers; and (iv) ensure that the price discovery function of the underlying market is not disrupted;
  • Section 4a(a)(4) sets forth criteria for determining which swaps perform a significant price discovery function for purposes of the position limits provisions;
  • Section 4a(a)(5) requires the Commission to concurrently impose appropriate limit levels on physical commodity swaps that are economically equivalent to the futures and options for which limits are required;
  • Section 4a(a)(6) requires the Commission to apply the required position limits on an aggregate basis to contracts based on the same underlying commodity across all exchanges; and
  • Section a(a)(7) authorizes the Commission to grant exemptions from the position limits it imposes.[34]

In a separate Dodd-Frank Act provision, Congress required that the Commission, in consultation with exchanges, “shall conduct a study of the effects (if any) of the position limits imposed” under CEA section 4a(a)(2), that “[w]ithin twelve months after the imposition of position limits” the Commission “shall” submit a report of the results of the study to Congress, and that Congress “shall” hold hearings within 30 days of receipt of the report regarding its findings.[35]

3. The Commission's Experience With Position Limits

As explained in the December 2013 Position Limits Proposal, position limits have a long history as a tool to prevent unwarranted price movement and volatility, including but not limited to price swings caused by market manipulation.[36] Physical commodities underlying futures contracts are, by definition, in finite supply, and so it is Start Printed Page 96708possible to amass or dissipate an extremely large position in such a way as to interfere with the normal forces of supply and demand. Speculators (who have no commercial use for the underlying commodity) are considered differently from hedgers (who use commodity derivatives to hedge commercial risk). Speculators have been considered a greater source of risk because their trading is unconnected with underlying commercial activity, whereas a hedger's trading is calibrated to other business needs. In various statutory enactments, Congress has recognized both the utility of position limits and the need to treat speculators differently from hedgers.

Congress began regulating commodity derivatives in 1917, when Congress enacted emergency legislation to stabilize the U.S. grain markets during the First World War by suspending wheat futures and securing “a voluntary limitation” of 500,000 bushels on trading in corn futures.[37] In 1922 Congress enacted the Grain Futures Act, in which it noted that “sudden or unreasonable fluctuations in the prices of commodity futures . . . frequently occur as a result of speculation, manipulation, or control . . . .” [38] In 1936, Congress strengthened the government's authority by providing for limits on speculative trading in commodity derivatives when it enacted the CEA. The CEA authorized the CFTC's predecessor, the Commodity Exchange Commission (CEC), to establish limits on speculative trading. Since that time, the Commission has been establishing or authorizing position limits for the past 80 years. As discussed in the December 2013 Position Limits Proposal and prior rulemakings, this history includes setting position limits beginning in 1938; overseeing exchange-set limits beginning in the 1960s; promulgating a rule in 1981, later directly ratified by Congress, mandating that exchanges set limits for all commodity futures for which there were no limits; allowing exchanges, in the 1990s, to set position accountability levels for certain financial contracts, such as futures and options on foreign currencies and other financial instruments with high degrees of stability; [39] and later expanding exchange limits or accountability requirements to significant price discovery contracts traded on exempt commercial markets.[40]

As addressed in the December 2013 Position Limits Proposal, two aspects of the Commission's experience are particularly important to the Commission's interpretation of the Dodd-Frank Act amendments to CEA section 4a. The first is the Commission's experience with the time required to make necessity findings before setting limits, which relates to the time limits contained in CEA section 4a(a)(2)(B). The second is the Commission's experience in rulemaking requiring exchanges to set limits in accordance with certain “standards,” the term the district court found ambiguous.

a. Time to Establish Position Limits

Based on its experience administering position limits, the Commission preliminarily concludes (as stated preliminarily in the December 2013 Position Limits Proposal) that Congress could not have contemplated that, as a prerequisite to imposing limits, the Commission would first make antecedent commodity-by-commodity necessity determinations in the 180-270 day time frame within which CEA section 4a(a)(2)(B) states that limits “required under subparagraph [4a(a)(2(A)] shall be established.” [41] As described in the December 2013 Position Limits Proposal, for 45 years after passage of the CEA, the Commission's predecessor agency made findings of necessity in its rulemakings establishing position limits.[42] During that period, the Commission had jurisdiction over only a limited number of agricultural commodities. In orders issued by the Commodity Exchange Commission between 1940 and 1956 establishing position limits, the CEC stated that the limits it was imposing in each were necessary. Each of those orders involved no more than a small number of commodities. But it took the CEC many months to make those findings. For example, in 1938, the CEC imposed position limits on six grain products.[43] Proceedings leading up to the establishment of the limits commenced more than 13 months earlier, when the CEC issued a notice of hearing regarding the limits.[44] Similarly, in September 1939, the CEC issued a Notice of Hearing with respect to position limits for cotton, but it was not until August 1940 that the CEC finally promulgated such limits.[45] And the CEC began the process of imposing limits on soybeans and eggs in January 1951, but did not complete the process until more than seven months later.[46]

In the Commission's experience (including the experience of its predecessor agency), it generally took many months to make a necessity finding with respect to one commodity. The process of making the sort of necessity findings that plaintiffs in ISDA v. SIFMA urged with respect to all agricultural commodities and all exempt commodities (and that some commenters urge) would be far more lengthy than the time allowed by CEA section 4a(a)(3), i.e., 180 or 270 days from enactment of the Dodd-Frank Act.[47] Because of the stringent time limits in CEA section 4a(a)(2)(B), the Commission concludes that Congress did not intend for the Commission to delay the imposition of limits until it first made antecedent, contract-by-contract necessity findings.

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b. Prior Rulemaking Requiring Exchanges to Set Limits

The CFTC's preliminary interpretation of the statute is also based in part on its promulgation of a rule in 1981 requiring exchanges to impose limits on all contracts that did not already have limits. In that rulemaking, the Commission, acting expressly pursuant to, inter alia, what was then CEA section 4a(1) (predecessor to CEA section 4a(a)(1)), adopted what was then 17 CFR 1.61.[48] This rule required exchanges to set speculative position limits “for each separate type of contract for which delivery months are listed to trade” on any DCM, including “contracts for future delivery of any commodity subject to the rules of such contract market.” [49] The Commission explained that this action would “close the existing regulatory gap whereby some but not all contract markets [we]re subject to a specified speculative position limit.” [50]

Like the Dodd-Frank Act, the 1981 final rule established (and the rule release described) that such limits “shall” be established according to what the Commission termed “standards.” [51] As used in the 1981 final rule and release, “standards” meant the criteria for determining how the required limits would be set.[52] “Standards” did not include the antecedent “necessity” determination of whether to order limits at all. The Commission had already made the antecedent judgment in the rule that “speculative limits are appropriate for all contract markets irrespective of the characteristics of the underlying market.” [53] The Commission further concluded that, with respect to any particular market, the “existence of historical trading data” showing excessive speculation or other burdens on that market is not “an essential prerequisite to the establishment of a speculative limit.” [54]

The Commission thus directed the exchanges to set limits for all futures contracts “pursuant to the . . . standards of rule 1.61,” without requiring that the exchanges first make a finding of necessity.[55] And rule 1.61 incorporated the “standards” from then-CEA-section 4a(1)—an “Aggregation Standard” (46 FR at 50943) for applying the limits to positions both held and controlled by a trader, and a flexibility standard allowing the exchanges to set “different and separate position limits for different types of futures contracts, or for different delivery months, or from exempting positions which are normally known in the trade as `spreads, straddles or arbitrage' or from fixing limits which apply to such positions which are different from limits fixed for other positions.” [56] Because the Commission had already made the antecedent necessity findings, it imposed tight deadlines for the exchanges to establish the limits. It is, accordingly, reasonable to believe that Congress would have structured CEA section 4a(a) similarly, by first making the antecedent necessity determination on its own,[57] then directing the Commission to impose the limits without making an independent determination of necessity, and then using the term “standards” just as the Commission did in 1981 to refer to aggregation and flexibility rather than necessity for the required limits.

Indeed, legislative history shows reason to believe that Congress' choice of the word “standards” to refer to aggregation and flexibility alone was purposeful and intended it to mean the same thing it did in the Commission's 1981 rule.[58] The language that ultimately became section 737 of the Dodd-Frank Act, amending CEA section 4a(a), originated in substantially final form in H.R. 977, introduced by Representative Peterson, who was then Chairman of the House Agriculture Committee and who would ultimately be a member of the Dodd-Frank Act conference committee.[59] In important respects, the language of H.R. 977 resembles the language the Commission used in 1981, suggesting that the regulation's text may have influenced the statutory text. Like the Commission's 1981 rule, H.R. 977 states that there “shall” be position limits in accordance with the “standards” identified in CEA section 4a(a).[60] This language was included in CEA section 4a(a)(2) as adopted. Also like the 1981 rule, H.R. 977 established (and the Dodd-Frank Act ultimately adopted) a “good faith” exception for positions acquired prior to the effective date of the mandated limits.[61] The committee report accompanying H.R. 977 described it as “Mandat[ing] the CFTC to set speculative position limits” and the section-by-section analysis stated that the legislation “requires the CFTC to set appropriate position limits for all physical commodities other than excluded commodities.” [62] This closely resembles the omnibus prophylactic approach the Commission took in 1981, when the Commission required the establishment of position limits on all futures contracts according to “standards” it borrowed from CEA section 4a(1). The Commission views the history and interplay of the 1981 rule and Dodd-Frank Act section 737 as further evidence that Congress intended to follow much the same approach as the Commission did in 1981, mandating position limits as to all physical commodities.[63]

There is further evidence based on the 1981 rulemaking that Congress would have found the across-the-board prophylactic approach attractive. In 1983, when enacting the Futures Trading Act of 19982, Public Law 97-444, 96 Stat. 2294 (1983), Congress was aware that the Commission had “promulgated a final rule requiring exchanges to submit speculative position limit proposals for Commission approval for all futures contracts traded as of that date.” [64] Presented with competing industry and Commission proposals to amend the position limits statute, Congress elected to amend the Start Printed Page 96710CEA “to clarify and strengthen the Commission's authority in this area,” including authorizing the Commission to prosecute violations of exchange-set limits as if they were violations of the CEA.[65] Thus, by granting the Commission explicit authority to enforce the Commission-mandated exchange-set limits, Congress in effect ratified the 1981 rule, finding it reasonable to impose position limits on an across-the board basis, rather than following a commodity-by-commodity determination. This contributes to the Commission's judgment that Congress reasonably could have followed a similar approach here and, for the reasons given elsewhere, likely did.

c. Comments [66]

i. Commission's Experience: No commenter disputed the depth or breadth of the Commission's experience and expertise with position limits.[67] Most, if not all, commenters, many of them exchanges, traders, and other market participants who have been subject to a long-standing federal and exchange-set limit regime, implicitly or explicitly agreed that at least spot-month position limits continue to be essential to prevent manipulation and excessive volatility and thus serve the public interest.[68] One commenter acknowledged that only the Commission can impose and monitor limits across exchanges.[69] Another opined that only the Commission could impose limits without any conflicts of interest due to the exchanges' imperative to maximize trading volume in order to maximize profit.[70]

ii. Time to Establish Limits: No commenters disputed the fact that it took many months for the Commission to make a necessity determination before establishing limits. Some commenters agreed with the determinations the Commission preliminarily drew from its experience.[71]

Several commenters asserted that the Commission's reliance on the timelines to support its view ignores other qualifying language in the statute, such as the terms “necessary” and “appropriate.” [72] The Commission disagrees, because its interpretation of the statute considers the relevant provisions as an integrated whole, which is required in interpreting any statute. Under this approach, it is appropriate to give consideration to the import of the tight statutory deadlines in light of the Commission's experience that it could not possibly comply with if it had to make necessity findings as it has in the past. These comments fail to take these considerations into account. The Commission addresses the language relied upon by these commenters, infra, in its discussion of the text of the statute.

CME also contended that the 180- and 270-day time limits were a difficulty manufactured by the December 2013 Position Limits Proposal itself. According to CME, the Commission could instead expedite the process for setting limits by utilizing its exchanges and others to determine whether position limits are necessary and appropriate for a particular commodity and, if so, the appropriate types and levels of limits and related exemptions.[73] While this is a plausible approach to generating necessity findings, the Commission views it unlikely that Congress had this approach in mind. The provisions at issue make no mention of exchange-set limits or necessity findings. CME also gave no reason to believe that commodity-by-commodity necessity findings could be made by the exchanges within the prescribed 180/270 day limits.

iii. 1981 Rulemaking: Some commenters disagreed with the Commission's consideration of the 1981 Rule. CME commented that the 1981 Rule is inapposite because there the Commission was requiring DCMs to impose position limits based on an “antecedent judgment” that limits were necessary and appropriate; a necessity finding was not required there.[74] The Commission believes that CME's observation is consistent with its interpretation. In the 1981 rule, the Commission made an antecedent judgment on an across-the-board basis that position limits were necessary, and the exchanges then set them according to specific standards. Here, Congress has made the antecedent judgment on an across-the-board basis that position limits are necessary for physical commodities (i.e., commodities other than excluded commodities), and ordered the Commission to set them according to the same types of standards referenced in the 1981 rule. This supports, rather than undermines, the Commission's interpretation that the “standards” in CEA section 4a(a)(1), referred to in CEA section 4a(a)(2) as added by the Dodd-Frank Act, are the flexibility and aggregation standards, much as they were in the 1981 rulemaking interpreting CEA section 4a(a)(1).

Several commenters contended that the Commission's reliance on the 1981 rulemaking ignores that the CFTC then imposed limits only after a fact-intensive inquiry into the characteristics of individual contracts markets to determine the limits most appropriate for individual contract markets.[75] However, the Commission has taken those inquiries into account. The Commission believes these inquiries are significant because while the Commission performed such investigation for some markets, it did not do so for all markets ultimately within the scope of the rule. The 1981 Rule directed exchanges to impose limits on all futures contracts for which exchanges had not already imposed limits. For example, citing a then-recent disruption in the silver market, the Commission directed that position limits be imposed prophylactically for all futures and options contracts.[76] It further directed the exchanges to consider the characteristics of particular contracts and markets in determining how to set limits (the standards, limit Start Printed Page 96711levels and so on) but not whether to do so.[77] It specifically rejected commenters' concerns that position limits would not be beneficial for all contracts, finding, after “considerable years of Federal and contract market regulatory experience,” that “the capacity of any contract market . . . is not unlimited,” and there was no need to evaluate the particulars of whether any contract would benefit from position limits.[78] The Dodd-Frank Act amendments unfolded in an analogous fashion. Prior to the Dodd-Frank Act, Congress conducted studies of some, but not all, markets in physical commodities. This history suggests that Congress extrapolated from the conclusions reached in those studies to determine that position limits were necessary for all physical commodities other than excluded commodities.

ISDA and SIFMA asserted that the Commission's reliance on the 1981 rulemaking is unavailing because (1) it cannot alter the Commission's statutory burdens with respect to imposing position limits; and (2) it was never adopted by Congress.[79] The first of these comments begs the question, i.e., what is “the statutory burden” intended in the text of CEA sections 4a(a)(1) and (2), read as a whole and considered in context to resolve the ambiguity found by the district court. As to the second comment, the Commission does not contend that Congress adopted the 1981 rule. Rather, it is relevant because the language the district court found ambiguous in the Dodd-Frank Act amendments to CEA section 4a(a) resembles the language of the 1981 rule, and some of the context is parallel. The relevance of this rulemaking is supported by the fact that Congress did ratify it the following year, when it amended the CEA by granting the Commission the authority to enforce the position limits set by the exchanges, reinforcing that as a historical matter Congress had approved an omnibus prophylactic approach as reasonable. That Congress had approved of such an approach before and then used language in the Dodd-Frank Act that closely resembles the very language the Commission used when it mandated that omnibus approach is another factor that weighs on the side of interpreting the statutory ambiguity to find a mandate to impose physical commodity positon limits.[80]

Finally, several commenters asserted that the Commission cannot consider the 1981 rulemaking because the Commission later allowed exchanges to set position accountability levels in lieu of limits for some commodities and contracts.[81] Those later exemptions do not, however, alter the language or import of the 1981 rule, which directed the exchanges to impose limits in accordance with “standards” that did not include a necessity finding. The 1981 rulemaking is the last time the Commission definitively addressed and identified the “standards” in CEA section 4a(a)(1) for imposing across-the-board, prophylactic position limits in a manner akin to the Dodd-Frank Act amendments. That other approaches intervened is not inconsistent with the inference that Congress was influenced by the 1981 rulemaking in the Dodd-Frank Act amendments.

4. Legislative History of the Dodd-Frank Act Amendments to Position Limits Statute

As discussed in the 2016 Supplemental Position Limits Proposal, the Commission has also considered the legislative history of the Dodd-Frank Act amendments.[82] That history contains further indication that Congress intended to mandate the imposition of limits for physical commodity derivatives without requiring the Commission to make antecedent necessity findings, and did not intend the term “standards” to include such a finding.[83]

The Commission's preliminary interpretation of CEA section 4a(a)(2) is based in part on congressional concerns that arose, and congressional actions taken, before the passage of the Dodd-Frank Act amendments.[84] During the 1990s, the Commission began permitting exchanges to experiment with an alternative to position limits—position accountability, which allowed a trader to hold large positions subject to reporting requirements and gave the exchange the right to order the trader to hold or reduce its position.[85] Then, in the Commodity Futures Modernization Act of 2000 (“CFMA”),[86] Congress expressly authorized the use of position accountability as an alternative means to limit speculative positions.[87]

Following this experiment with position accountability, Congress became concerned about fluctuations in commodity prices. In the late 1990s and 2000s, Congress conducted several investigations that concluded that excessive speculation accounted for significant volatility and price increases in physical commodity markets. For example, a congressional investigation determined that prices of crude oil had risen precipitously and that “[t]he traditional forces of supply and demand cannot fully account for these increases.” [88] The investigation found evidence suggesting that speculation was responsible for an increase of as much as $20-25 per barrel of crude oil, which was then at $70.[89] Subsequently, Congress found similar price volatility stemming from excessive speculation in the natural gas market.[90]

These investigations appear to have informed the drafting of the Dodd-Frank Act. During hearings prior to the passage of the Dodd-Frank Act, Senator Carl Levin, then-Chair of the Senate Permanent Subcommittee on Investigations that had conducted them, urged passage to ensure “a cop on the beat in all commodity markets where U.S. commodities are traded . . . that can enforce the law to prevent excessive speculation and market manipulation.” [91] In addition, Congress viewed the nearly $600 trillion little-regulated swaps market as a “major contributor to the financial crisis” because excessive risk taking, hidden leverage, and under collateralization in that market created a systemic risk of harm to the entire financial system.[92] As Senator Cantwell and others explained, it was imperative that the CFTC have the ability to regulate swaps through Start Printed Page 96712“position limits,” “exchange trading,” and “public transparency” to avoid a recurrence of the instability that rippled through the entire financial system in 2008.[93] And in the House of Representatives, Representative Collin Peterson, then-Chairman of the House Committee on Agriculture and author of an amendment strengthening the position limits provision as discussed below, reminded his colleagues that his committee's own “in-depth review of derivative markets began when we experienced significant price volatility in energy futures markets due to excessive speculation—first with natural gas and then with crude oil. We all remember when we had $147 oil. . . . This conference report [now] includes the tools we authorized and the direction to the CFTC to mitigate outrageous price spikes we saw 2 years ago.” [94] Congress's focus in its investigations on excessive speculation involving physical commodities is reflected in the scope of the Dodd-Frank Act's position limits amendment: It applies only to physical commodities.

The evolution of the position limits provision in the bills before Congress from permissive to mandatory supports a preliminary determination that Congress intended to do something more than continue the long-standing statutory regime giving the Commission discretionary authority to impose limits.[95] As initially introduced, the House bill that became the Dodd-Frank Act provided the Commission with discretionary authority to issue position limits, stating that the Commission “may” impose them.[96] However, the House replaced the word “may” with the word “shall,” suggesting a specific judgment that the limits should be mandatory, not discretionary. The House also added other language militating in favor of interpreting CEA section 4a(a)(2) as a mandate. In two new subsections, it set the tight deadlines described above.[97] After changing “may” to “shall,” the House further amended the bill to refer in one instance to the limits for agricultural and exempt commodities as “required.” [98] And only after the language had changed from permissive to mandatory, the House added the requirement that the Commission conduct studies on the “effects (if any) of position limits imposed” [99] to determine if the required position limits were harming U.S. markets.[100] Underscoring its intent to amend the bill to include a mandate, the House Report accompanying the House Bill stated that it “required” the Commission to impose limits.[101] The Conference Committee adopted the House bill's amended provisions on position limits and then strengthened them even further by referring to the position limits as “required” an additional three times, bringing the total to four times in the final legislation the number of references in statutory text to position limits as “required.” [102]

a. Comments

A number of commenters generally supported or opposed the Commission's consideration of Congressional investigations and the textual strengthening of the Dodd-Frank bill. The Commission addresses specific comments below.

i. Congressional Investigations: Several commenters agreed that the Congressional investigations, hearings and reports support the view that Congress decided to mandate position limits.[103] They pointed out that Congress's investigations followed amendments in 2000 to the CEA as part of the CFMA that exempted swaps and energy derivatives from position limits and expressly authorized exchanges to impose position accountability levels in lieu of limits.[104] According to the Commodity Markets Oversight Coalition (“CMOC”), “witnesses confirmed [at those hearings] that the erosion of the position limits regime was a leading cause in market instability and wild price swings.” [105] Senator Levin, who presided over the investigations, commented that those investigations, conducted from 2002 onwards, “into how our commodity markets function, focusing in particular on the role of excessive speculation on commodity prices” “have demonstrated that the failure to impose and enforce effective position limits have led to greater speculation and increased price volatility in U.S. commodity markets.” [106] According to Senator Levin, the investigations “provide[d] strong support for the Dodd-Frank decision to require the Commission to impose position limits on all types of commodity futures, swaps, and options.” [107] Senator Levin also stated that the harms of excessive speculation continue to be felt in the absence of the mandated limits. He cited recent actions by federal regulators to stop manipulation in energy markets, and opined that the continuing problems in the absence of the mandated limits only reinforce the reasonableness of the Commission's view that Congress intended to mandate position limits as a prophylactic measure.[108] Senator Levin's point was echoed by Public Citizen, a consumer advocacy organization, and Airlines for America, a trade association for the U.S. scheduled airline industry.[109]

Other commenters disagreed with the Commission's preliminary determination that the Congressional investigations indicate that Congress intended to mandate limits. CME asserted that the investigations do not in themselves demonstrate that Congress required the CFTC to impose position limits as recommended even if those investigations suggest that excessive speculation poses a burden on interstate commerce in certain physical commodity markets.[110] Citadel questioned whether the cited reports could be “broadly indicative of Congressional intent,” or could “redefine statutory language that has existed for nearly eight decades.” [111]

But the Commission is not relying solely on these reports. The question, rather, is whether these Congressional Start Printed Page 96713investigations and findings of excessive speculation and price volatility in energy markets, conducted and issued when the Commission was authorized but not required by law to impose limits, may be one indication, among others, that Congress sought to do something more with the Dodd-Frank Act amendments than to maintain the statutory status quo for futures on physical commodities. In the Commission's preliminary view, it is more plausible, based on these investigations, that Congress sought to do something more—to require that the Commission impose limits for the covered commodities without having to first find that they are necessary to prevent excessive speculation. Contrary to Citadel's comment, the Commission is not relying on the investigations and reports to redefine statutory language that has existed for nearly eight decades. Rather, the Commission believes that the investigations favor the conclusion that Congress added CEA section 4a(a)(2) to the pre-existing language in order to strengthen the long-standing position limits regime for a category of commodity derivatives—physical commodities—that Congress's investigations revealed to be vulnerable to substantial price fluctuations.

ii. Evolution of the Dodd-Frank Bill: Several commenters agreed with the Commission's preliminary determination that the strengthening of the position limits language in the Dodd-Frank bill evinces Congress' intent to mandate limits.[112]

CME and MFA disagreed; while they do not directly address this point, they believed that the strengthening of the language in the Dodd-Frank bills does not indicate that Congress intended to de-couple the enacted directive to impose position limits from the necessity finding of CEA section 4a(a)(1).[113] The Commission, however, preliminarily considers this the most plausible interpretation. The evolution of the bill from one stating the Commission “may” impose position limits to include statements that the Commission “shall” impose them, that they are “required,” and that the Commission shall study their effects indicates intentional progressive refinement from a bill that would continue the status quo for futures to one that added special nondiscretionary requirements for a category of commodities. This legislative evolution also supports the conclusion “standards” does not include an antecedent necessity finding.

5. The Commission Preliminarily Interprets the Text of CEA Section 4a(a) as an Integrated Whole, In Light of Its Experience and Expertise.

In the December 2013 Position Limits Proposal, the Commission discussed how its interpretation of the text of CEA section 4a(a), considered as an integrated whole, is consistent with and supports its conclusions based on experience and expertise. As discussed, the ambiguity is the meaning of CEA section 4a(a)(2)'s statement that the Commission “shall” establish limits on physical commodities other than excluded commodities “[i]n accordance with the standards” set forth in CEA section 4a(a)(1). If “standards” includes a necessity finding, then a necessity finding is required before limits can be imposed on agricultural and exempt commodities. If not, the Commission must impose limits for that subset of commodity derivatives. In the December 2013 Position Limits Proposal, the Commission resolved the ambiguity by preliminarily determining that the reference in CEA section 4a(a)(2) to the “standards” in pre-Dodd-Frank section 4a(a)(1) refers to the criteria in CEA section 4a(a)(1) for how the required limits are to be set and not the antecedent finding whether limits are even necessary. The Commission explained that, in its preliminary view, “standards” refers to, in CEA section 4a(a)(1), only the following two provisions. First, the limits must account for situations in which one person controls another or two persons act in concert, by aggregating those positions as if the trading were done by one person acting alone (aggregation). The second “standard” in CEA section 4a(a)(1) states that the limits may be different for different commodities, markets, delivery months, etc. (flexibility).

The Commission reasoned that this construction of “standards” seemed most consistent with the Commission's experience and history administering position limits. It also seemed most consistent with the text of CEA section 4a(a)(2), the rest of CEA section 4a(a), and the Act as a whole. The Dodd-Frank Act amendments to CEA section 4a(a) largely re-shape CEA section 4a(a) by adding a new, detailed, and comprehensive section 4a(a)(2) that applies only to a subset of the derivatives regulated by the Commission—physical commodities like wheat, oil, and gold—and not intangible commodities like interest rates. Amended CEA section 4a(a) repeatedly uses the word “shall” and refers to the new limits as “required,” differentiating it from the text that existed before the Dodd-Frank Act.[114] Never before in the Commission's experience had Congress set deadlines on action for position limits by a date certain, much less the short time provided in CEA section 4a(a)(2)(B).[115] Nor, in the Commission's experience, had Congress required a report by a given date or committed itself to hold hearings on the report within 30 days thereafter.[116] The Commission preliminarily concluded that, considered as a whole in light of this experience, these provisions evince a Congressional mandate that the Commission impose limits on physical commodities, that it do so quickly, that it impose limit levels in accordance with certain requirements, and that it study the effectiveness of the limits after imposing them and then report to Congress.

By the same token, the Commission preliminarily determined that interpreting CEA section 4a(a)(2) as it proposed to do would not render superfluous the necessity finding requirement in CEA section 4a(a) because that section still applies to the non-physical (excluded) commodity derivatives that are not subject to CEA section 4a(a)(2). Nor would it nullify other parts of CEA section 4a(a), as those are unaffected by this reading.

The Commission received a number of comments on its discussion of the interplay between the statute's text and the Commission's experience and expertise. The Commission has considered them carefully, but is not thus far persuaded. The Commission preliminarily believes that it is a reasonable interpretation of the text of the statute considered as an integrated whole and viewed through the lens of the Commission's experience and expertise, that Congress mandated that the Commission establish position limits for physical commodities. It is also reasonable to construe the reference to “standards” as an instruction to the Commission to apply the flexibility and aggregation standards set forth in CEA section 4a(a)(1), just as the Commission instructed the exchanges to impose Start Printed Page 96714omnibus limits in 1981. And it is at least reasonable to conclude that Congress, in directing the Commission to impose the “required” limits on extremely tight deadlines, did not intend the Commission to independently make an antecedent finding that any given position limit for physical commodities is “necessary”—a finding that would take many months for each individual physical commodity contract.

a. Comments

Several commenters disputed the Commission's interpretation, based on its experience and expertise, that CEA section 4a(a)(2) is a mandate for prophylactic limits based on their view that the statute unambiguously requires the Commission to promulgate position limits only after making a necessity finding, and only “as appropriate.” [117] But in ISDA v. SIFMA, the district court held that the statute was ambiguous in this respect, and the Commission here is following the court's direction to apply its experience and expertise to resolve the ambiguity. This is consistent with a commenter's statement that “the meshing of the Dodd-Frank Act into the CEA may have created some ambiguity from a technical drafting/wording standpoint.” [118] Nevertheless, the Commission addresses these textual arguments to show that its preliminary interpretation is, at a minimum, a permissible one.

The commenters that disagreed with the Commission's preliminary conclusion argued that the Commission: (i) Erred in determining that the reference to “standards” in CEA section 4a(a)(2) does not include the necessity finding in CEA section 4a(a)(1); (ii) failed to consider other provisions that show Congress intended to require the Commission to make antecedent findings; and (iii) incorrectly determined that its interpretation is the only way to give effect to CEA section 4a(a)(2).

i. Meaning of Standards: Several commenters asserted that the language: “[in] accordance with the standards set forth in paragraph (1)” in section 4a(a)(2) must include the phrase “as the Commission finds are necessary to diminish, eliminate, or prevent [the burden on interstate commerce]” in CEA section 4a(a)(1).[119] They believed that the Commission's contrary interpretation constitutes an implied repeal of the necessity finding language.[120]

The Commission disagrees that this constitutes an implied repeal. First, CEA section 4a(a)(2) applies only to physical commodities, not other commodities. Accordingly, the requirement of a necessity finding in section 4a(a)(1) still applies to a broad swath of commodity derivatives. Second, there is no implied repeal even in part, because the Commission is interpreting express language—the term “standards.” The Commission must bring its experience to bear when interpreting the ambiguity in the new provision, and the Commission preliminarily believes that the statute, read in light of the Commission's experience administering position limits and making necessity findings, is more reasonably read as an express limited exception, for physical commodities futures and economically equivalent swaps, to the preexisting authorization in CEA section 4a(a)(1) for the Commission to impose limits when it finds them necessary.

ii. Other Limiting Language: Some commenters pointed to a number of terms and provisions that they say support the notion that the Commission must make antecedent findings before imposing any limits under new CEA section 4a(a)(2).

First, some commenters asserted that the term “as appropriate” in CEA sections 4a(a)(3) (factors that the “Commission, “as appropriate” must consider when it “shall set limits”) and 4a(a)(5)(A) (providing that Commission “shall” “as appropriate” establish limits on swaps that are economically equivalent to physical commodity futures and options) require the Commission to make antecedent findings that the limits required under CEA section 4a(a)(2) are appropriate before it may impose them.[121] The district court found these words to be ambiguous. In the court's view, they could refer to the Commission's obligation to impose limits (i.e., the Commission shall, “as appropriate,” impose limits), or to the level of the limits the Commission is to impose.[122]

The Commission preliminarily believes that when these words are considered in the context of CEA section 4a(a)(2)-(7) as a whole, including the multiple uses of the new terms “shall” and “required” and the historically unique stringent time limits for imposing the covered limits and post-imposition study requirement, it is more reasonable to interpret these words as referring to the level of limits, i.e., the Commission must set physical commodity limits at an appropriate level, and not to require the Commission to first determine whether the required limits are appropriate before it may even impose them.[123] In other words, while Congress made the threshold decision to impose position limits on physical commodity futures and options and economically equivalent swaps, Congress at the same time delegated to the Commission the task of setting the limits at levels that would maximize Congress' objectives.

Some commenters claimed that other parts of CEA section 4a(a)(2) undermine the Commission's determination. First, CEA section 4a(2)(C) states that the “[g]oal . . . [i]n establishing the limits required” is to “strive to ensure” that trading on foreign boards of trade (“FBOTs”) for commodities that have limits will be subject to “comparable limits.” It goes on to state that for “any limits to be imposed” the Commission will strive to ensure that they not shift trading overseas. Commenters argue that “any limits to be imposed” under CEA section 4a(a)(2)(A) implies that limits might not be imposed under that section. However, in the context discussed and in view of the reference in that section to position limits Start Printed Page 96715“required,” the reference to “any limits to be imposed” refers again to the levels or other standards applied. That is, whatever the contours the Commission chooses for the required limits, they must meet the goal set forth in that section.

Second, CEA section 4a(a)(3)(B) states certain factors that the Commission must consider in setting limits under CEA section 4a(a)(2).[124] The Commission sees no inconsistency with mandatory position limits—the Commission must consider these factors in setting the appropriate levels and other contours. Indeed, CEA section 4a(a)(3)(B) applies by its own terms to “establishing the limits required in paragraph (2).” Moreover, consideration of these factors under CEA section 4a(a)(3) is not mandatory, as some commenters suggest,[125] but rather to be made “in [the Commission's] discretion.” [126] In the Commission's preliminary view, there is thus nothing in these provisions at odds with the Commission's interpretation that it is required by CEA section 4a(a)(2)(A) to impose limits on a subset of commodities without making antecedent findings whether they should be imposed, particularly when the language at issue is construed, as it should be, with other terms in CEA section 4a(a)(2)-(7), discussed above, that use mandatory language and impose time limits.

Some commenters stated that two pre-Dodd Frank Act provisions in CEA section 4a undermine the Commission's interpretation. The first is CEA section 4a(e),which states, “if the Commission shall have fixed limits . . . for any contract . . . , then the limits” imposed by DCMs, SEFs or other trading facilities “shall not be higher than the limits fixed by Commission.” [127] According to a commenter, the “if/then” formulation suggests position limits should not be presupposed for any contract.[128] The Commission sees the provision differently. CEA section 4a(a)(2) applies only to a subset of futures contracts—contracts in physical commodities. For other commodities, position limits remain subject to the Commission's determination of necessity, and the “if/then” formulation applies and remains logical. There is, accordingly, no inconsistency.

The second pre-Dodd Frank Act provision the commenters mentioned is CEA section 5(d)(5); [129] it gives the exchanges discretionary authority to impose position limits on all commodity derivatives “as is necessary and appropriate.” [130] There is, however, no inconsistency. Exchanges retain the discretionary authority to set position limits for the many commodities not covered by CEA section 4a(a)(2), and they retain the discretion to impose position limits for physical commodities, so long as the limits are no higher than federal position limits.

Some commenters cited other language in CEA section 5(d)(5) to support their assertion that, notwithstanding the Dodd-Frank Act amendments discussed above requiring the Commission to impose limits, the Commission retains and should exercise its discretion to impose position accountability levels in lieu of limits or delegate that authority exchanges to do so. CEA section 5(d)(5) authorizes exchanges to adopt “position limitations or position accountability” levels in order to reduce the threat of manipulation and congestion. These commenters also pointed out that the Commission has previously endorsed accountability levels for exchanges in lieu of limits.[131] Other commenters disagree. They asserted that, given what they interpret as a mandate in CEA section 4a(a)(2) for the Commission to impose position limits for physical commodities, it would be inappropriate for the Commission to consider imposing position accountability levels instead for those commodities, or to allow exchanges to do so.[132]

The Commission agrees with the latter group of commenters and finds the former reading strained. CEA section 4a(a)(2) makes no mention of position accountability levels. Regardless whether pre-Dodd Frank section 5(d)(5) allows exchanges to set accountability levels in lieu of limits where the Commission has not set limits, and regardless whether the Commission has in the past endorsed exchange-set position accountability levels in lieu of limits, CEA section 4a(a)(2) does not mention that tool. If anything, reference to accountability levels elsewhere in the CEA shows that Congress understands that exchanges have used position accountability, but made no reference to it in amended CEA section 4a(a).

iii. Avoiding Surplusage or Nullity: Several commenters took issue with the Commission's preliminary determination that its interpretation is necessary in order to avoid rendering CEA section 4a(a)(2)(A) surplusage. These commenters suggested that reading the term “standards” in CEA section 4a(a)(2)(A) to include the antecedent necessity finding in CEA section 4a(a)(1) will not render CEA section 4a(a)(2) surplusage because if the Commission finds a position limit is “necessary” and “appropriate,” it now must impose one (as opposed to pre-Dodd-Frank, when the Commission had authority but not a mandate under CEA section 4a(a) to impose limits).[133] The Commission finds this reading highly unlikely. There is no history of the Commission determining that limits are necessary and appropriate, but then declining to impose them. Nor is it reasonable to expect that the Commission might do so. Indeed, historically necessity findings were made only in connection with establishing limits.

Furthermore, if Congress had still wanted to leave it to the Commission to ultimately decide whether a limit was necessary, there is no reason for it to have also set tight deadlines, repeat multiple times that the limits are “required,” and direct the agency to conduct a study after the limits were imposed. In other words, requiring the Commission to make an antecedent necessity finding would render many of the Dodd-Frank Act amendments superfluous. For example, if the Commission determined limits were not necessary then, contrary to CEA section 4a(a)(2), no limits were in fact “required,” no limits needed to be imposed by the deadlines, and no study Start Printed Page 96716needed to be conducted. But none of these provisions were phrased in conditional terms (e.g., if the Commission finds a limit necessary, then it shall . . . ). Had Congress wanted the Commission to continue to be the decisionmaker regarding the need for limits, it could have expressed that view in countless ways that would not strain the statutory language in this way.

CME contended that the Commission's position—that requiring a necessity finding would essentially give the Commission the same permissive authority it had before the Dodd-Frank Act amendments—is “short-sighted” because other provisions of CEA section 4a(a) “would still have practical significance.” In support of this view, CME stated that new CEA sections 4a(a)(2)(C) and 4(a)(3)(B) have significance even if the Commission is required to make a necessity finding because they “set forth safeguards that the CFTC must balance when it establishes limits” after “the CFTC finds that such limits are necessary.” The Commission preliminarily believes it unlikely that Congress would have intended that. On CME's reading, the statute would place additional requirements to constrain the Commission's preexisting authority. Given the background for the amendments, particularly the studies that preceded the Dodd-Frank Act, the Commission sees no reason why Congress would have placed additional constraints, nor any reason it would have placed them with respect to physical commodities but not excluded commodities or others. This comment also does not address the thrust of the Commission's interpretation, which is that finding a mandate is the only way to read the entirety of the statute harmoniously, including the timing requirements of CEA section 4a(a)(2)(B) and the reporting requirements of Section 719 of the Dodd-Frank Act, account for the historical context, and, at the same time, avoid reading CEA section 4a(a)(2)(A) as the functional equivalent of CEA section 4a(a)(1).[134] CME also cited CEA section 4a(a)(5), which requires position limits for economically equivalent swaps, to make the same point that there are still meaningful provisions in CEA section 4a(a), even with a necessity finding. But CEA section 4a(a)(1) already authorizes the Commission to establish limits on swaps as necessary, and so the authority, which would be discretionary under CME's reading, to impose limits on economically equivalent swaps would add nothing to the statute and the amendment would be wholly superfluous.

6. Conclusion

Having carefully considered the text, purpose and legislative history of CEA section 4a(a) as a whole, along with its own experience and expertise and the comments on its proposed interpretation, the Commission preliminarily believes for the reasons above that Congress—while not expressing itself with ideal clarity—decided that position limits were necessary for a subset of commodities, physical commodities, mandated the Commission to impose them on those commodities in accordance with certain criteria, and required that the Commission do so expeditiously, without first making antecedent findings that they are necessary to prevent excessive speculation. Consistent with this interpretation, Congress also directed the agency to report back to Congress on their effectiveness within one year. In the Commission's preliminary view, this interpretation, even if not the only possible interpretation, best gives effect to the text and purpose of the Dodd-Frank Act amendments in the context of the pre-existing position limits provision, while ensuring that neither the amendments nor the pre-existing language is rendered superfluous.

C. Necessity Finding

1. Necessity

The Commission reiterates its preliminary alternative necessity finding as articulated in the December 2013 Position Limits Proposal: [135] Out of an abundance of caution in light of the district court decision in ISDA v. CFTC,[136] and without prejudice to any argument the Commission may advance in any forum, the Commission reproposes, as a separate and independent basis for the Rule, a preliminary finding herein that the speculative position limits in this reproposed Rule are necessary to achieve their statutory purposes.

As described in the Proposal, the policy basis and reasoning for the Commission's necessity finding is illustrated by two major incidents in which market participants amassed massive futures positions in silver and natural gas, respectively, which enabled them to cause sudden and unreasonable fluctuations and unwarranted changes in the prices of those commodities. CEA section 4a(a)(1) calls for position limits for the purpose of diminishing, eliminating, or preventing the burden of excessive speculation.[137] Although both episodes involved manipulative intent, the Commission believes that such intent is not necessary for an excessively large position to give rise to sudden and unreasonable fluctuations or unwarranted changes in the price of an underlying commodity. This is illustrated, for example, by the fact that when the perpetrators of the silver manipulation lost the ability to control their scheme, i.e., to manipulate the market at will, they were forced to liquidate quickly, which, given the amount of contracts sold in a very short time, caused silver prices to plummet. Any trader who was forced by conditions in the market or their own financial condition to liquidate a very large position could predictably have similar effects on prices, regardless of their motivation for amassing the position in the first place. Moreover, although these two episodes unfolded in contract markets for silver and natural gas, and unfolded at two different times in the past, there is nothing unique about either market at either relevant time that causes the Commission to restrict its preliminary finding of necessity to those markets or to reach a different conclusion based on market conditions today. Put another way, any contract market has a limited ability, closely linked to the market's size, to absorb the establishment and liquidation of large speculative positions in an orderly manner.[138] The silver and natural gas examples illustrate these issues, but the reasoning applies beyond their specific facts. Accordingly, the Commission preliminarily finds it necessary to implement position limits as a prophylactic measure for the 25 core referenced futures contracts.[139]

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The Commission received many comments on its preliminary alternative necessity finding; the Commission summarizes and responds to significant comments below.

a. Studies' Lack of Consensus.[140] The Commission stated in the December 2013 Position Limits Proposal that the lack of consensus in the studies reviewed at that time warrants acting on the side of caution and implementing position limits as a prophylactic measure, “to protect against undue price fluctuations and other burdens on commerce that in some cases have been at least in part attributable to excessive speculation.” [141] Some commenters suggested that a lack of consensus means instead that the Commission should not implement position limits,[142] that the issue merits further study,[143] that it would be arbitrary and capricious to implement position limits,[144] and that the desire to err on the side of caution should be irrelevant to an assessment of whether position limits are necessary.[145] In short, these comments contend that the lack of consensus means position limits cannot be necessary.[146] The Commission disagrees. The lack of consensus does not provide “objective evidence that position limits are not necessary;” [147] rather, it suggests that they remain controversial.[148] In response to these comments, the Commission believes that Congress could not have intended by using the word “necessary” to restrict the Commission from determining to implement position limits unless experts unanimously agree or form a consensus they would be beneficial. Otherwise a necessity finding would be virtually impossible and, in fact, the Commission could plausibly be stymied by interested persons publishing self-interested studies. The Commission's view in this respect is supported by the text of CEA section 4a(a)(1), which states that there shall be such limits as “the Commission finds” are necessary.[149] Thus, while the Commission finds the studies useful, it does not cede the necessity finding to the authors.

b. Reliance on Silver and Natural Gas Studies.[150] The Commission stated in the December 2013 Position Limits Proposal that it “found two studies of actual market events to be helpful and persuasive in making its preliminary alternative necessity finding,” [151] namely, the Interagency Silver Study [152] and the PSI Report on Excessive Speculation in the Natural Gas Market.[153] Some commenters criticized the Commission's reliance on these two studies.[154] These commenters dismissed the two studies, variously, as limited, outdated,[155] dubious,[156] unpersuasive, anecdotal, and irrelevant.[157] Other commenters characterized the episodes as extreme or unique.[158] Some commenters observed that neither study recommended position limits.[159] One noted that, “Each study focuses on activities in a single market during a limited timeframe that occurred years ago.”[160] Others noted that the Commission has undertaken no independent analysis of each market, commodity, or contract affected by this rulemaking.[161] They then claim that because particular markets or commodities have unique characteristics, one cannot extrapolate from these two specific episodes to other commodities or other markets.[162] Several commenters describe the Hunt brothers silver crisis and the collapse of the natural gas speculator Amaranth as instances of market manipulation rather than excessive speculation.[163]

As discussed above, the presence of manipulative intent or activity does not preclude the existence of excessive speculation, and traders do not need manipulative intent for the accumulation of very large positions to cause the negative consequences observed in the Hunt and Amaranth incidents. These are some reasons position limits are valuable as a prophylactic measure for, in the language of CEA section 4a(a)(1), “preventing” burdens on interstate commerce. The Hunt brothers, who distorted the price of silver, and Amaranth, who distorted the price of natural gas, are examples that illustrate the burdens on interstate commerce of excessive speculation that occurred in the absence of position limits, and position limits would have restricted those traders' ability to cause unwarranted price movement and market volatility, and this would be so even had their motivations been innocent. Both episodes involved extraordinarily large speculative positions, which the Commission has historically associated with excessive speculation.[164] We are also given no persuasive reason to change our conclusion that extraordinarily large speculative positions could result in sudden or unreasonable fluctuations or unwarranted price changes in other physical commodity markets, just as they did in silver and natural case in the Hunt Brothers and Amaranth episodes. Although commenters describe changes in these markets over time, the characteristics that we find salient have Start Printed Page 96718not changed materially.[165] Thus, these two examples remain relevant and compelling.

CME makes a textual argument in support of the position that CEA section 4a(a)(2) requires a commodity-by-commodity determination that position limits are necessary. It cites several places in CEA section 4a(a)(1) that refer to limits as necessary to eliminate “such burden” on “such commodity” or “any commodity.” [166] However, the prophylactic measures described herein address vulnerabilities characteristic of each market.[167] Accordingly, the Commission believes the statute's use of the singular is immaterial.[168]

The Commission's analysis applies to all physical commodities, and it would account for differences among markets by setting the limits at levels based on updated data regarding estimated deliverable supply in each of the given underlying commodities in the case of spot-month limits or based on exchange recommendation, if an exchange recommended a spot-month limit level of less than 25 percent of estimated deliverable supply, and open interest in the case of single-month and all-months-combined limits, for each separate commodity. The Commission's Reproposal regarding whether to adopt conditional spot-month limits is also based on updated data.[169] The Commission also does not find it relevant that the Interagency Silver Study and the PSI Report, each of which was published before the Dodd-Frank Act became law, do not recommend the imposition of position limits. Based on the facts described in those reports, along with the Commission's understanding of the policies underlying CEA section 4a(a)(1) in light of the Commission's own experience with legacy limits, the Commission preliminarily finds that position limits are necessary within the meaning of that section.

c. Commission research. One commenter asserted that the Commission failed “to conduct proper economic analysis to determine, if in fact, the position limits as proposed were likely to have any positive impact in promoting fair and orderly commodity markets.” [170] While acknowledging the Commission's resource constraints, this commenter remarked on “the paucity of the published record by the CFTC's s own staff” [171] and suggests that outside authors be given “controlled access to all of the CFTC's data regarding investor and hedger trading records.” [172] This commenter then proceeds to accuse the Commission of failing to “conduct such research because they felt the data would not in fact support the proposed position limit regulations.” [173]

The Commission disagrees that it has failed to conduct proper economic analysis to determine the likely benefits of position limits. CEA section 15(a) requires that before promulgating a regulation under the Act, the Commission consider the costs and benefits of the action according to five statutory factors. The Commission does so below in robust fashion with respect to the Reproposal in its entirety, including the alternative necessity finding. Neither section 15(a) of the CEA nor the Administrative Procedure Act requires the Commission to conduct a study in any particular form so long as it considers the costs and benefits and the entire administrative record. Section 719(a) of the Dodd-Frank Act, on the other hand, provides that the Commission “shall conduct a study of the effects (if any) of the position limits imposed pursuant to the . . . [CEA] on excessive speculation” and report to Congress on such matters after the imposition of position limits.[174] The Commission will do so as required by Section 719(a), thereby fully discharging its duty. At all stages, the Commission has relied on and will continue to rely on the input of staff economists in the Division of Market Oversight (“DMO”) and the Office of the Chief Economist (“OCE”).

d. Excessive Speculation

One commenter opined that, “in discussing only the Hunt Brothers and Amaranth case studies the Commission has not given adequate weight to the benefits that speculators provide to the market.” [175] To the contrary, the Commission recognizes that speculation is part of a well-functioning market, particularly insofar as speculators contribute valuable liquidity. The focus of this reproposed rulemaking is not speculation per se; Congress identified excessive speculation as an undue Start Printed Page 96719burden on interstate commerce in CEA section 4a(a)(1).[176]

One commenter asserted that the Commission must provide a definition of excessive speculation before making any necessity finding.[177] The Commission disagrees that the rule must include such a definition. The statute contains no such requirement, and did not contain such a requirement prior to the Dodd-Frank Act. The Commission has never based necessity findings on a rigid definition. The Commission's position on this issue has been clear over time: “The CEA does not define excessive speculation. But the Commission historically has associated it with extraordinarily large speculative positions . . . .” [178] CEA section 4a(a)(1) states that position limits should diminish, eliminate, or prevent burdens on interstate commerce associated with sudden or unreasonable fluctuations or unwarranted changes in the price of commodities.[179] It stands to reason that excessive speculation involves positions large enough to risk such unreasonable fluctuations or unwarranted changes. This commenter also urges the Commission to “demonstrate and determine that . . . harmful excessive speculation exists or is reasonably likely to occur with respect to particular commodities” [180] before implementing any position limits.[181] As stated in the December 2013 Position Limits Proposal, the Commission referenced its prior determination in 1981 “that, with respect to any particular market, the `existence of historical trading data' showing excessive speculation or other burdens on that market is not `an essential prerequisite to the establishment of a speculative limit.' ” [182] The Commission reiterates this statement and underscores that these risks are characteristic of contract markets generally. Differences among markets can be addressed, as the Commission reproposes to do here, by setting the limit levels to account for individual market characteristics. Attempting to demonstrate and determine that excessive speculation is reasonably likely to occur with respect to particular commodities before implementing position limits is impractical because historical trading data in a particular commodity is not necessarily indicative of future events in that commodity. Further, it would require the Commission to determine what may happen in a forecasted future state of the market in a particular commodity. As the Commission has often repeated, position limits are a prophylactic measure. Inherently, then, position limits are designed to address the burdens of excessive speculation well before they occur, not when the Commission somehow determines that such speculation is imminent, which the Commission (or any market actor for that matter) cannot reliably do.

e. Volatility

Commenters assert, variously, that “the volatility of commodity markets has decreased steadily over the past decade,” [183] that “research found that there was a negative correlation between speculative positions and market volatility,” [184] research shows that factors other than excessive speculation were primarily responsible for specific instances of price volatility,[185] that futures markets are associated with lower price volatility,[186] that particular types of speculators provide liquidity rather than causing price volatility,[187] that position limits will increase volatility,[188] etc. It would follow, then, according to these commenters, that because they believe there is little or no volatility (no sudden or unreasonable fluctuations or unwarranted price changes), or no volatility caused by excessive speculation, position limits cannot be necessary.

As stated above, the Commission recognizes that speculation is part of a Start Printed Page 96720well-functioning market particularly, as noted in comments, as a source of liquidity. Position limits address excessive speculation, not speculation per se. Position limits neither exclude particular types of speculators nor prohibit speculative transactions; they constrain only speculators with excessively large positions in order to diminish, eliminate, or prevent an undue and unnecessary burden on interstate commerce in a commodity.[189] The Commission agrees that futures markets are associated with, and may indeed contribute to, lower volatility in underlying commodity prices. However, as Congress observed, in CEA section 4a(a)(1), excessive speculation in a commodity contract that causes sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity, is an undue and unnecessary burden on interstate commerce in such commodity.[190] In promulgating CEA section 4a(a)(1), Congress adopted position limits as a useful tool to diminish, eliminate, or prevent those problems. The Commission believes that position limits are a necessary prophylactic measure to guard against disruptions arising from excessive speculation, and the Commission has endeavored to repropose limit levels that are not so low as to hamper healthy speculation as a source of liquidity.[191]

f. Basis for Determination

One commenter states, “The necessity finding . . . proffered by the Commission—which consists of a discussion of two historical events and a cursory review of existing studies and reports on position limits related issues—falls short of a comprehensive analysis and justification for the proposed position limits.[192] We disagree with the commenter's opinion that the Commission's analysis is not comprehensive or falls short of justifying the reproposed rule.[193]

Another commenter states that the December 2013 Position Limits Proposal “does not provide any quantitative analysis of how the outcome of these [two historical] events might have differed if the proposed position limits had been in place.” [194] The Commission disagrees. The Commission stated in the December 2013 Position Limits Proposal that, “The Commission believes that if Federal speculative position limits had been in effect that correspond to the . . . . [proposed] limits . . . , across markets now subject to Commission jurisdiction, such limits would have prevented the Hunt brothers and their cohorts from accumulating such large futures positions.” [195] This statement was based on calculations using a methodology similar to [196] that proposed in the December 2013 Position Limits Proposal applied to quantitative data included and as described therein.[197] The Commission's stated belief is unchanged at the higher single-month and all-months-combined limit levels of 7,600 contracts that the Commission adopts today for silver.[198] Nevertheless, historical data regarding absolute position size from the period of the late-1970's to 1980 may not be readily comparable to the numerical limits adopted in the current market environment. Accordingly, the Commission is reproposing establishing levels using the methodology based on the size of the current market as described elsewhere in this release.

With respect to Amaranth, the Commission stated, “Based on certain assumptions . . . , the Commission believes that if Federal speculative position limits had been in effect that correspond to the limits that the Commission . . . [proposed in the December 2013 Position Limits Proposal], across markets now subject to Commission jurisdiction, such limits would have prevented Amaranth from accumulating such large futures positions and thereby restrict its ability to cause unwarranted price effects.” [199] This statement of belief about Amaranth was also based on calculations using the methodology applied to quantitative data as described and included in the December 2013 Position Limits Proposal preamble.[200] The historical size of Amaranth positions would no longer breach the higher single-month and all-months-combined limit levels of 200,900 contracts that the Commission adopts today for natural gas.[201] However, the Commission is reproposing setting a level using a methodology that adapts to changes in the market for natural gas, i.e., the fact that it has grown larger and more liquid since the collapse of Amaranth. Thus, it stands to reason that a speculator might now have to accumulate a larger position than Amaranth's historical position to present a similar risk of disruption to the natural gas market. In fact, the Commission has long recognized “that the capacity of any contract market to absorb the establishment and liquidation of large speculative positions in an orderly manner is related to the relative size of such positions, i.e., the capacity of the market is not unlimited.” [202] A larger market should have larger capacity, other things being equal; [203] hence, the Commission is adopting higher levels of limits. Moreover, costly disruptions like those associated with Amaranth remain entirely possible. Because the costs of these disruptions can be great, and borne by members of the public Start Printed Page 96721unconnected with trading markets, the Commission preliminarily finds it necessary to impose speculative position limits as a preventative measure. As markets differ in size, the limit levels differ accordingly, each designed to prevent the accumulation of positions that are extraordinary in size in the context of each market.

Several commenters opined that the Commission, in reaching its preliminary alternative necessity finding, ignores current market developments and does not employ the “new tools” other than position limits available to it to prevent excessive speculation or manipulative or potentially manipulative behavior.[204] Specifically, some commenters suggested that position limits are not necessary because position accountability rules and exchange-set limits are adequate.[205] The Commission agrees that the Dodd-Frank Act gave the Commission new tools with which to protect and oversee the commodity markets, and agrees that these along with older tools may be useful in addressing market volatility. However, the Commission disagrees that the availability of other tools means that position limits are not necessary.[206] Rather the statute, at a minimum, reflects Congress' judgment that position limits may be found by the Commission to be necessary. The Commission notes that although CEA section 4a(a) position limits provisions have existed for many years, the Dodd-Frank Act not only retained CEA section 4a(a), but added, rather than deleted, several sections. This leads to the conclusion that Congress appears to share the Commission's view that the other tools provided by Congress were not sufficient.

Position accountability, for example, is an older tool, from the era of the CFMA. As the Commission explained in the December 2013 Position Limits Proposal, the CFMA “provided a statutory basis for exchanges to use pre-existing position accountability levels as an alternative means to limit the burdens of excessive speculative positions. Nevertheless, the CFMA did not weaken the Commission's authority in CEA section 4a to establish position limits as an alternative means to prevent such undue burdens on interstate commerce. More recently, in the CFTC Reauthorization Act of 2008, Congress gave the Commission expanded authority to set position limits for significant price discovery contracts on exempt commercial markets,” [207] and it expanded the Commission's authority again in the Dodd-Frank Act.[208] While position accountability is useful in providing exchanges with information about specific trading activity so that exchanges can act if prudent to require a trader to reduce a position after the position has already been amassed, position limits operate prophylactically without requiring case-by-case, ex post determinations about large positions. As to exchange-set accountability levels or position limits set at levels below those of federal position limits, those remain useful as well and should be used, at the exchanges' discretion, in conjunction with federal position limits. They may be most useful, for example, with respect to contracts that are not core-referenced futures contracts or if an exchange determines that federal limits are too high to address adequately the conditions in the markets it administers. In the regulations that the Commission reproposes today, the Commission would update (rather than eliminate) the acceptable practices for exchange-set speculative position limits and position accountability rules to conform to the Dodd-Frank Act changes [as described in the December 2013 Position Limits Proposal].[209] Generally, for contracts subject to speculative limits, exchanges may set limits no higher than the federal limits,[210] and may impose “restrictions . . . to reduce the threat of market manipulation or congestion, to maintain orderly execution of transactions, or for such other purposes consistent with its responsibilities.” [211] And § 150.5(b)(3) sets forth the requirements for position accountability in lieu of exchange-set limits in the case of contracts not subject to federal limits. The exchanges are also still authorized to react to instances of greater price volatility by exercising emergency authority as they did during the silver crisis.[212] In addition, the Commission has striven to take current market developments into account by considering the market data to which the Commission has access as described herein and by considering the description of current market developments to the extent included in the comments the Commission has received in connection with the December 2013 Position Limits Proposal. Some commenters suggest that the Commission, in reaching its preliminary alternative necessity finding, has not undertaken any empirical analysis of available data.[213] As discussed above, the Commission carefully reviewed the Interagency Silver Study and the PSI Report on Excessive Speculation in the Natural Gas Market.[214] The Commission also carefully considered the studies submitted during the various comment periods regarding the December 2013 Position Limits Proposal and the 2016 Supplemental Position Limits Proposal. Other commenters suggest that the Commission relies on incomplete, unreliable, or out of date data, and that the Commission should collect more and/or better data before determining that position limits are necessary or implementing position limits.[215] The Commission disagrees. The Commission has considered the recent data presented by the exchanges in support of their estimates of deliverable supply. The Commission is expending significant, agency-wide efforts to improve data collection and to analyze the data it receives. The quality of the data on which the Commission relies has improved since the December 2013 Position Limits Proposal. The Commission is satisfied with the quality of the data on which it bases its Reproposal.

One commenter opines that, “The Proposal's `necessary' finding offers no reasoned basis for adopting its framework and the shift in regulatory policy it embodies.” [216] To the contrary, Start Printed Page 96722the necessity finding, including the Commission's responses to comments, is the Commission's explanation of why position limits are necessary.[217]

g. Non-Spot-Month Limits

Some commenters opine that “the Commission's proposed non-spot-month position limits do not increase the likelihood of preventing the excessive speculation or manipulative trading exemplified by Amaranth or the Hunt brothers relative to the status quo.” [218] The Commission disagrees; as repeated above, “the capacity of the market is not unlimited.” [219] This includes markets in non-spot month contracts. Thus, as with spot-month contracts, extraordinarily large positions in non-spot month contracts may still be capable of distorting prices.[220] If prices are distorted, the utility of hedging may decline.[221] One commenter argues for non-spot month position accountability rules; [222] the Commission discusses position accountability above.[223] Another argues that Amaranth was really just “another case of spot-month misconduct.” [224] The Commission disagrees that this limits the relevance of Amaranth; a speculator like Amaranth may attempt to distort the perception of supply and demand in order to benefit, for instance, calendar spread positions by, for instance, creating the perception of a nearby shortage of the commodity which a speculator could do by accumulating extraordinarily large long positions in the nearby month.[225] One commenter states that “improperly calibrated non-spot month limits would also deter speculative activity that triggers no risk of manipulation or `causing sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity,' the hallmarks of `excessive speculation.' ” [226] The Commission sees little merit in this objection because the Reproposal would calibrate the levels of the non-spot month limits to accommodate speculative activity that provides liquidity for hedgers.

h. Meaning of Necessity

One commenter suggests that position limits could only be necessary if they were the only means of preventing the Hunt brothers and Amaranth crises.[227] First, while the Commission relies on these incidents to explain its reasoning, the risks they illustrate apply to all markets in physical commodities, and so the efficacy of the limits the Commission adopts today, and the extent to which other tools are sufficient, cannot be judged solely by whether they might have prevented those specific incidents. Second, in any event, the Commission rejects such an overly restrictive reading, which lacks a basis in both common usage and statutory construction. The Commission preliminarily finds that limits are necessary as a prophylactic tool to strengthen the regulatory framework to prevent excessive speculation ex ante to diminish the risk of the economic harm it may cause further than it would reliably be from the other tools alone. Other commenters question why the Commission proposed limits at levels they contend are too high to be effective, undercutting the Commission's alternative necessity finding.[228] One commenter points out that the limit levels as proposed would not have prevented the misconduct alleged by the Commission in a particular enforcement action filed in 2011.[229] As repeated elsewhere in this Notice [230] and in the December 2013 Position Limits Proposal,[231] in establishing limits, the Commission must, “to the maximum extent practicable, in its discretion . . . ensure sufficient market liquidity for bona fide hedgers.[232] The Commission realizes that the reproposed initial limit levels may prevent or deter some, but fail to eliminate all, excessive speculation in the markets for the 25 commodities covered by this first phase of implementation. But the Commission is concerned that initial limit levels set lower than those reproposed today, and in particular low enough to prevent market manipulation or excessive speculation in specific, less egregious cases than the Hunt brothers or Amaranth, could impair liquidity for hedges.[233]

The Commission requests comment on all aspects of this section.

2. Studies and Reports

The Commission has reviewed and evaluated studies and reports received as comments on the December 2013 Position Limits Proposal, in addition to the studies and reports reviewed in connection with the December 2013 Position Limits Proposal [234] (such Start Printed Page 96723studies and reports, collectively, “studies”). Appendix A to this preamble is a summary of the various studies reviewed and evaluated by the Commission.

The Commission observed in the December 2013 Position Limits Proposal, “There is a demonstrable lack of consensus in the studies.” [235] Neither the passage of time nor the additional studies have changed the Commission's view: As a group, these studies do not show a consensus in favor of or against position limits.[236] In addition to arriving at disparate conclusions, the quality of the studies varies. Nevertheless, the Commission believes that some well-executed studies suggest that excessive speculation cannot be excluded as a possible cause of undue price fluctuations and other burdens on commerce in certain circumstances. All of these factors persuade the Commission to act on the side of caution in preliminarily finding limits necessary, consistent with their prophylactic purpose. For these reasons, explained in more detail below, the Commission preliminarily concludes that the studies, individually or taken as a whole, do not persuade the Commission to reverse course [237] or to change its necessity finding.[238]

The Commission's deliberations are informed by its consideration of the studies. The Commission recognizes that speculation and volatility are not per se unusual or exceptional occurrences in commodity markets. Some economic studies attempt to distinguish normal, helpful speculative activity in commodity markets from excessive speculation, and normal volatility from unreasonable price fluctuations. It has proven difficult in some studies to discriminate between the proper workings of a well-functioning market and unwanted phenomena. That some studies have as yet failed to do so with precision or certainty does not, in light of the full record, persuade the Commission to reverse course or to change its necessity finding.

In general, many studies focused on subsidiary questions and did not directly address the desirability or utility of position limits. Their proffered interpretations may not be the only plausible explanation for statistical results. There is no broad academic consensus on the formal, testable economic definition of “excessive speculation” in commodity futures markets or other relevant terms such as “price bubble.” There is also no broad academic consensus on the best statistical model to test for the existence of excessive speculation. There are not many papers that quantify the impact and effectiveness of position limits in commodity futures markets. The Commission has identified some reasons why there are not many compelling, peer-reviewed economic studies engaging in quantitative, empirical analysis of the impact of position limits on prices or price volatility: Limitations on publicly available data, including detailed information on specific trades and traders; pre-existing position limits in some commodity markets, making it difficult to determine how those markets would operate in the absence of position limits; and the difficulties inherent in modelling complex economic phenomena.

The studies that the Commission considered can be grouped into seven categories.239

Granger Causality Analyses 240

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Some economic studies considered by the Commission employ the Granger method of statistical analysis. The Granger method seeks to assess whether there is a strong linear correlation between two sets of data that are arranged chronologically forming a “time series.” While the Granger test is referred to as the “Granger causality test,” it is important to understand that, notwithstanding this shorthand, “Granger causality” does not necessarily establish an actual cause and effect relationship. The result of the Granger method is evidence, or the lack of evidence, of the existence of a linear correlation between the two time series. The absence of Granger causality does not necessarily imply the absence of actual causation.

Comovement or Cointegration Analyses 241

The comovement method looks for whether there is correlation that is contemporaneous and not lagged. A subset of these comovement studies use a technique called cointegration for testing correlation between two sets of data.

Models of Fundamental Supply and Demand 242

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Some economists have developed economic models for the supply and demand of a commodity. These models often include theories of how storage capacity and use affect supply and demand, which may influence the price of a physical commodity over time. An economist looks at where the model is in equilibrium with respect to quantities of a commodity supplied and demanded to arrive at a “fundamental” price or price return. The economist then looks for deviations between the fundamental price (based on the model) and the actual price of a commodity. When there is a statistically significant deviation between the fundamental price and the actual price, the economist generally infers that the price is not driven by market fundamentals of supply and demand.

Switching Regressions or Similar Analyses 243

In the context of studies relating to position limits, economists employing switching regression analysis generally posit a model with two states: A normal state, where prices reflect market fundamentals, and a second state, often interpreted as a “bubble.” [244] Using price data, authors of these studies calculate the probability of a transition between the two states. The point of transition is called a structural “breakpoint.” Examination of these breakpoints permits the researcher to identify the duration of a particular “bubble.”

Eigenvalue Stability Analysis 245

Some economists have run regression analyses [246] on price and time-lagged values of price. They estimate an equation that relates current to past time values over short time intervals and solve for the roots of that equation, called the eigenvalues (latent values), in order to detect unusual price changes. If they find an eigenvalue [247] with an absolute value of greater than one, they infer that the price of the commodity is in a “bubble.”

Theoretical Models 248

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Some studies perform little or no empirical analysis and instead present a general theoretical model that may bear, directly or indirectly, on the effect of excessive speculation in the commodities markets. Because these papers do not include empirical analysis, they contain many untested assumptions and conclusory statements, limiting their usefulness to the Commission.

Surveys of Economic Literature and Opinion Pieces 249

The Commission considered more than seventy studies that are survey or opinion pieces. Some of these studies provide useful background material but, on the whole, they offer mere opinion unsupported by rigorous empirical analysis. While they may be useful for developing hypotheses or informing policymakers, these secondary sources often exhibit policy bias and are not neutral, reliable bases for scientific inquiry the way that primary economic studies are.[250]

More Persuasive Academic Studies

While the economic literature is inconclusive, the Commission can Start Printed Page 96727identify a few of the well-executed studies that do not militate against and, to some degree, support the Commission's reproposal to follow, out of due caution, a prophylactic approach.[251] Hamilton and Wu, in Risk Premia in Crude Oil Futures Prices, Journal of International Money and Finance (2013), using models of fundamental supply and demand, find evidence that changes in non-commercial positions can affect the risk premium in crude oil futures prices; that is, Hamilton and Wu found that, for a limited period around the time of the 2008 financial crisis that gave rise to the Dodd-Frank Act, increases in speculative positions reduced the risk premiums [252] in crude oil futures prices.[253] This is important because, all else being equal, one would expect the risk premium to be the component of price that would be affected by traders accumulating large positions.[254] Hamilton, in Causes of the Oil Shock of 2007-2008, Brookings Paper on Economic Activity (2009), also concludes that the oil price run-up was caused by strong demand confronting stagnating world production, but that something other than fundamental factors of supply and demand (as modeled) may have aggravated the speed and magnitude of the ensuing oil price collapse. Singleton, in Investor Flows and the 2008 Boom/Bust in Oil Prices (working paper 2011), employs a technique that is similar to Granger causality and finds a negative correlation between speculative positions and risk premiums.[255] Chevallier, in Price Relationships in Crude Oil Futures: New Evidence from CFTC Disaggregated Data, Environmental Economics and Policy Studies (2012), applies switching regression analysis to position data and concludes that one cannot eliminate the possibility of speculation as one of the main factors contributing to oil price volatility in 2008. This study also suggests that when supply and demand are highly inelastic, i.e., relatively unresponsive to price changes, financial investors may have contributed to oil price volatility by taking large positions in energy sector commodity index funds.[256] As one may infer from this small sample, some of the more compelling studies that support the proposition that large positions may move prices involve empirical studies of the oil market. The Commission acknowledges that not all commodity markets exhibit the same price behavior at the same times. Even so, that the findings of a particular study of the market experience of a particular commodity over a particular time period may not be extensible to other commodity markets or over other time periods does not mean that the Commission should disregard that study. This is because, as explained elsewhere, these markets are over time all susceptible to similar risks from excessive speculation. Again, this supports a prophylactic approach to limits and a determination that limits are necessary to effectuate their statutory purposes.

The Commission in the December 2013 Position Limits Proposal identified two studies of actual market events to be helpful and persuasive in making its alternative necessity finding: [257] The inter-agency report on the silver crisis [258] and the PSI Report on Excessive Speculation in the Natural Gas Market.[259] These two studies and some of the other reports included in the survey category [260] do not use statistical or theoretical models to reach economically rigorous conclusions. Some of the evidence cited in these studies is anecdotal. Still, these two studies are in-depth examinations of actual market events and the Commission continues to find them to be helpful and persuasive in making its preliminary alternative necessity finding. The Commission reiterates that the PSI Report (because it closely preceded Congress' amendments to CEA section 4a(a) in the Dodd-Frank Act) indicates how Congress views limits as necessary as a prophylactic measure to prevent the adverse effects of excessively large speculative positions. The studies, individually or taken as a whole, do not dissuade the Commission from its consistent view that large speculative positions and outsized market power pose risks to well-functioning commodities markets, nor from its preliminary finding that speculative position limits are necessary to achieve their statutory purposes.

The Commission requests comment on its discussion of studies and reports. It also invites commenters to advise the Commission of any additional studies that the Commission should consider, and why.

II. Compliance Date for the Reproposed Rules

Commenters requested that the Commission delay the compliance date, generally for at least nine months, to provide adequate time for market participants to come into compliance with a final rule.[261] In addition, a commenter requested the Commission delay the compliance date until no earlier than January 3, 2018, to coordinate with the expected implementation date for position limits in Europe.[262]

In response to commenters, in this reproposal, the Commission proposes to delay the compliance date of any final rule until, at earliest, January 3, 2018, as provided under reproposed § 150.2(e). The Commission is of the opinion that a delay would provide market participants with sufficient time to come into compliance with a final rule, particularly in light of grandfathering provisions, discussed below.

The Commission believes that a delay until January 3, 2018, would provide time for market participants to gain Start Printed Page 96728access to adequate systems to compute futures-equivalent positions. The Commission bases this opinion on its experience, including with swap dealers and clearing members of derivative clearing organizations, who, as reporting entities under part 20 (swaps large trader reporting), have been required to prepare reports of swaps on a futures-equivalent basis for years. As discussed above, futures-equivalent reporting of swaps under part 20 generally has improved. This means many reporting entities already have implemented acceptable systems to compute futures-equivalent positions. The systems developed for that purpose also should be acceptable for monitoring compliance with position limits. The Commission believes it is reasonable to expect some reporting entities to offer futures-equivalent computation services to market participants. In this regard, such reporting entities already compute and report, under part 20, futures-equivalent positions for swap counterparties with reportable positions, including spot-month positions and non-spot-month positions.

The Commission notes that market participants who expect to be over the limits would need to assess whether exemptions are available (including requesting non-enumerated bona fide hedging positon exemptions or spread exemptions from exchanges, as discussed below under reproposed §§ 150.9 and 150.10). In the absence of exemptions, such market participants would need to develop plans for coming into compliance.

The Commission notes the request for a further delay in a compliance date may be mitigated by the grandfathering provisions in the Reproposal. First, the reproposed rules would exclude from position limits “pre-enactment swaps” and “transition period swaps,” as discussed below. Second, the rules would exempt certain pre-existing positions from position limits under reproposed § 150.2(f). Essentially, this means only futures contracts initially would be subject to non-spot-month position limits, as well as swaps entered after the compliance date. The Commission notes that a pre-existing position in a futures contract also would not be a violation of a non-spot-month limit, but, rather, would be grandfathered, as discussed under reproposed § 150.2(f)(2), below. Nevertheless, the Commission intends to provide a substantial implementation period to ease the compliance burden.

The Commission requests comment on its discussion of the proposed compliance date.

III. Reproposed Rules

The Commission is not addressing comments that are beyond the scope of this reproposed rulemaking.

A. § 150.1—Definitions

1. Various Definitions Found in § 150.1

Among other elements, the December 2013 Position Limits Proposal included amendments to the definitions of “futures-equivalent,” “long position,” “short position,” and “spot-month” found in § 150.1 of the Commission's regulations, to conform them to the concepts and terminology of the CEA, as amended by the Dodd-Frank Act. The Commission also proposed to add to § 150.1, definitions for “basis contract,” “calendar spread contract,” “commodity derivative contract,” “commodity index contract,” “core referenced futures contract,” “eligible affiliate,” “entity,” “excluded commodity,” “intercommodity spread contract,” “intermarket spread positions,” “intramarket spread positions,” “physical commodity,” “pre-enactment swap,” “pre-existing position,” “referenced contract,” “spread contract,” “speculative position limit,” “swap,” “swap dealer” and “transition period swap.” In addition, the Commission proposed to move the definition of bona fide hedging from § 1.3(z) into part 150, and to amend and update it. Moreover, the Commission proposed to delete the definition for “the first delivery month of the `crop year.' ” [263] Separately, the Commission proposed making a non-substantive change to list the definitions in alphabetical order rather than by use of assigned letters.[264] According to the December 2013 Position Limits Proposal, this last change would be helpful when looking for a particular definition, both in the near future, in light of the additional definitions proposed to be adopted, and in the expectation that future rulemakings may adopt additional definitions.

Finally, in connection with the 2016 Supplemental Position Limits Proposal, which provided new alternative processes for DCMs and SEFs to recognize certain positions in commodity derivative contracts as non-enumerated bona fide hedges or enumerated anticipatory bona fide hedges, and to exempt from federal position limits certain spread positions, the Commission proposed to further amend certain relevant definitions, including changes to the definitions of “futures-equivalent,” “intermarket spread position,” and “intramarket spread position.”

Separately, as noted in the December 2013 Position Limits Proposal, amendments to two definitions were proposed in the November 2013 Aggregation Proposal,[265] which was approved by the Commission on the same date as the December 2013 Position Limits Proposal. The November 2013 Aggregation Proposal, a companion to the December 2013 Position Limits Proposal, included amendments to the definitions of “eligible entity” and “independent account controller.” [266] The Commission notes that since the amendments were part of the separate Aggregation proposal, the proposed amendments to those definitions, and comments thereon, are addressed in the final Aggregation rulemaking (the “2016 Final Aggregation Rule”); [267] therefore, the Commission is not addressing the definitions of “eligible entity” and “independent account controller” herein.

The Commission is reproposing the amendments to the definitions in § 150.1, as set forth in the December 2013 Position Limits Proposal and as amended in the 2016 Supplemental Position Limits Proposal, with modifications made in response to public comments. The Reproposal also includes non-substantive changes to certain definitions to enhance readability and clarity for market participants and the public, including the extraction of definitions that were contained in the definition of “referenced contract” to stand on their own. The amendments and the public Start Printed Page 96729comments relevant to each amendment are discussed below.

a. Basis Contract

Proposed Rule: In the December 2013 Position Limits Proposal, the Commission proposed to exclude “basis contracts” from the definition of “referenced contracts.” [268] While the term “basis contract” is not defined in current § 150.1, the Commission proposed a definition for basis contract in the December 2013 Position Limits Proposal. Proposed § 150.1 defined basis contract to mean “a commodity derivative contract that is cash-settled based on the difference in: (1) The price, directly or indirectly, of: (a) A particular core referenced futures contract; or (b) a commodity deliverable on a particular core referenced futures contract, whether at par, a fixed discount to par, or a premium to par; and (2) the price, at a different delivery location or pricing point than that of the same particular core referenced futures contract, directly or indirectly, of: (a) A commodity deliverable on the same particular core referenced futures contract, whether at par, a fixed discount to par, or a premium to par; or (b) a commodity that is listed in appendix B to this part as substantially the same as a commodity underlying the same core referenced futures contract.”

The Commission also proposed Appendix B to part 150, Commodities Listed as Substantially the Same for Purposes of the Definition of Basis Contract. As proposed, the definition of basis contract would include contracts cash-settled on the difference in prices of two different, but economically closely related commodities, for example, certain quality differentials (e.g., RBOB gasoline vs. 87 unleaded).[269] As explained when it was proposed, the intent of the proposed definition was to reduce the potential for excessive speculation in referenced contracts where, for example, a speculator establishes a large outright directional position in referenced contracts and nets down that directional position with a contract based on the difference in price of the commodity underlying the referenced contracts and a close economic substitute that was not deliverable on the core referenced futures contract.[270] In the absence of this provision, the speculator could then increase further the large position in the referenced contracts. By way of comparison, the Commission noted in the December 2013 Position Limits Proposal that there is greater concern (i) that someone may manipulate the markets by disguise of a directional exposure through netting down the directional exposure using one of the legs of a quality differential (if that quality differential contract were not exempted), than (ii) that someone may use certain quality differential contracts that were exempted from position limits to manipulate the outright price of a referenced contract.[271]

Comments Received: The Commission received a number of comment letters regarding the proposed definition of basis contract. One commenter supported the proposed definition of basis contract and stated that it appreciates the Commission's inclusion of Appendix B listing the commodities it believes are substantially the same as a core referenced futures contract for purposes of identifying contracts that meet the basis contract definition.[272] Other comment letters requested that the Commission broaden the definition to include contracts that settle to other types of differentials, such as processing differentials (e.g., crack or crush spreads) or quality differentials (e.g., sweet vs. sour crude oil). One commenter recommended a definition of basis contract that includes crack spreads, by-products priced at a differential to other by-products (e.g., jet fuel vs. heating oil, both of which are crude oil by-products), and a commodity that includes similar commodities such as a contract based on the difference in prices between light sweet crude and a sour crude that is not deliverable against the NYMEX Light Sweet Crude Oil core referenced futures contract. This commenter suggested that if these types of contracts are included as basis contracts, market participants should be able to net certain contracts where a commodity is priced at a differential to a product or by-product, subject to prior approval according to a process created by the Commission.[273]

Two commenters specifically requested that the list in Appendix B include Jet fuel (54 grade) as substantially the same as heating oil (67 grade). They also requested that WTI Midland (Argus) vs. WTI Financial Futures should be listed as basis contracts for Light Louisiana Sweet (LLS) Crude Oil.[274]

Noting that basis contracts are excluded from the definition of referenced contract and thus not subject to speculative position limits, two commenters requested CFTC expand the list in Appendix B to part 150 of commodities considered substantially the same as a core referenced futures contract, and the corresponding list of basis contracts, to reflect the commercial practices of market participants.[275] One of these commenters recommended that the Commission adopt a flexible process for identifying any additional commodities that are substantially the same as a commodity underlying a core referenced futures contract for inclusion in Appendix B, and allow market participants to request a timely interpretation regarding whether a particular commodity is substantially the same as a core referenced futures contract or that a particular contract qualifies as a basis contract.[276]

Commission Reproposal: The Commission has determined to repropose the definition of basis contract as originally proposed, but to change the defined term from “basis contract” to “location basis contract.” The Commission intended the “basis contract” definition to encompass contracts that settle to the difference between prices in separate delivery locations of the same (or substantially the same) commodity, while the industry seems to use the term “basis” more broadly to include other price differentials, including, among other things, processing differentials and quality differentials. Thus, under the Reproposal, the term is changing from “basis contract” to “location basis contract” in order to reduce any confusion stemming from the more encompassing use of the word “basis” in industry parlance.[277]

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The Commission is reproposing Appendix B as originally proposed. The Commission is not persuaded by commenters' suggestions for expanding the current list of commodities considered “substantially the same” in Appendix B. While a commenter requested the Commission expand the list to address all “commercial practices” used by market participants, the Commission believes this request is too vague and too broad to be workable. In addition, although a commenter recommended that the Commission adopt a flexible process for identifying any additional commodities that are substantially the same as a commodity underlying a core referenced futures contract for inclusion in Appendix B,[278] the Commission observes that market participants are already provided the flexibility of two processes: (i) To request an exemptive, no-action or interpretative letter under § 140.99; and/or (ii) to petition for changes to Appendix B under § 13.2. Under either process, the Commission would need to carefully consider whether it would be beneficial and consistent with the policies underlying CEA section 4a to list additional commodities as substantially the same as a commodity underlying a core referenced futures contract, especially since various market participants might have conflicting views on such a determination in certain cases.

Finally, the Commission notes that comments regarding other types of differentials were addressed in the Commission's 2016 Supplemental Position Limits Proposal, which would allow exchanges to grant spread exemptions, including calendar spreads, quality differential spreads, processing spreads, and product or by-product differential spreads.[279] Comments responding to that 2016 Supplemental Position Limits Proposal and the Commission's Reproposal are discussed below.

b. Commodity Derivative Contract

Proposed Rule: The December 2013 Position Limits Proposal would define in § 150.1 the term “commodity derivative contract” for position limits purposes as shorthand for any futures, option, or swap contract in a commodity (other than a security futures product as defined in CEA section 1a(45)). The proposed use of such a generic term would be a convenient way to streamline and simplify references in part 150 to the various kinds of contracts to which the position limits regime applies. As such, this new definition can be found frequently throughout the Commission's proposed amendments to part 150.[280]

Comments Received: The Commission received no comments on the proposed definition.

Commission Reproposal: The Commission has determined to repropose the definition as proposed for the reasons given above.

c. Commodity Index Contract, Spread Contract, Calendar Spread Contract, and Intercommodity Spread Contract

Proposed Rule: The December 2013 Position Limits Proposal excluded commodity index contracts from the definition of referenced contracts; thus, commodity index contracts would not be subject to position limits. The Commission also proposed to define the term commodity index contract, which is not in current § 150.1, to mean “an agreement, contract, or transaction that is not a basis contract or any type of spread contract, based on an index comprised of prices of commodities that are not the same or substantially the same.”

Further, the Commission proposed to add a definition of basis contract, as discussed above, and spread contract to clarify which types of contracts would not be considered a commodity index contract and thus would be subject to position limits. Under the proposal, a spread contract was defined as “a calendar spread contract or an intercommodity spread contract.” [281] Finally, the Commission proposed the addition of definitions for a calendar spread contract, and an intercommodity spread contract to clarify the meanings of those terms. In particular, under the proposal, a calendar spread contract would mean “a cash-settled agreement, contract, or transaction that represents the difference between the settlement price in one or a series of contract months of an agreement, contract or transaction and the settlement price of another contract month or another series of contract months' settlement prices for the same agreement, contract or transaction.” An intercommodity spread contract would mean “a cash-settled agreement, contract or transaction that represents the difference between the settlement price of a referenced contract and the settlement price of another contract, agreement, or transaction that is based on a different commodity.” [282]

The December 2013 Position Limits Proposal further noted that part 20 of the Commission's regulations requires reporting entities to report commodity reference price data sufficient to distinguish between commodity index contract and non-commodity index contract positions in covered contracts.[283] Therefore, for commodity index contracts, the Commission stated its intention to rely on the data elements in § 20.4(b) to distinguish data records subject to § 150.2 position limits from those contracts that are excluded from § 150.2. The Commission explained that this would enable the Commission to set position limits using the narrower data set (i.e., referenced contracts subject to § 150.2 position limits) as well as conduct surveillance using the broader data set.[284]

Comments Received: The Commission received no comments on the proposed definitions for commodity index contract, spread contract, calendar spread contract, and intercommodity spread contract.[285]

Start Printed Page 96731

Commission Reproposal: The Commission has determined to repropose the definitions as originally proposed for the reasons provided above, with the exception that, under the Reproposal, the term “basis contract” will be replaced with the term “location basis contract,” in the reproposed definition of commodity index contract, to conform to the name change discussed above. In addition, the Commission notes that while it had proposed to subsume the definitions of commodity index contract, spread contract, calendar spread contract, and intercommodity spread contract under the definition of referenced contract, in the Reproposal it is enumerating each as a separate definition for ease of reference.

d. Core referenced Futures Contract

Proposed Rule: The December 2013 Position Limits Proposal provided a list of futures contracts in § 150.2(d) to which proposed position limit rules would apply. The Commission proposed the term “core referenced futures contract” as a short-hand phrase to denote such contracts.[286] Accordingly, the Commission proposed to include in § 150.1 a definition of core referenced futures contract to mean “a futures contract that is listed in § 150.2(d).” In its proposal, the Commission also clarified that core referenced futures contracts include options that expire into outright positions in such contracts.[287]

Comments Received: The Commission received no comments on the proposed definition.

Commission Reproposal: The Commission has determined to repropose the definition as originally proposed.

e. Eligible Affiliate

Proposed Rule: The term “eligible affiliate,” used in proposed § 150.2(c)(2), is not defined in current § 150.1. The Commission proposed to amend § 150.1 to define an “eligible affiliate” as an entity with respect to which another person: (1) Directly or indirectly holds either: (i) A majority of the equity securities of such entity, or (ii) the right to receive upon dissolution of, or the contribution of, a majority of the capital of such entity; (2) reports its financial statements on a consolidated basis under Generally Accepted Accounting Principles or International Financial Reporting Standards, and such consolidated financial statements include the financial results of such entity; and (3) is required to aggregate the positions of such entity under § 150.4 and does not claim an exemption from aggregation for such entity.[288]

The definition of “eligible affiliate” proposed in the December 2013 Position Limits Proposal qualified persons as eligible affiliates based on requirements similar to those adopted by the Commission in a separate rulemaking.[289] On April 1, 2013, the Commission provided relief from the mandatory clearing requirement of CEA section 2(h)(1)(A) of the Act for certain affiliated persons if the affiliated persons (“eligible affiliate counterparties”) meet requirements contained in § 50.52.[290] Under both § 50.52 and the definition proposed in the December 2013 Position Limits Proposal, a person is an eligible affiliate if another person (e.g. a parent company), directly or indirectly, holds a majority ownership interest in such affiliates, reports its financial statements on a consolidated basis under Generally Accepted Accounting Principles or International Financial Reporting Standards, and such consolidated financial statements include the financial results of such affiliates. In addition, for purposes of the position limits regime, that other person (e.g., a parent company) must be required to aggregate the positions of such affiliates under § 150.4 and not claim an exemption from aggregation for such affiliates.[291]

Comments Received: The Commission received few comments on the proposed definition of “eligible affiliate.” Commenters requested that the Commission harmonize the definition of “eligible affiliate” with the definition of “eligible affiliate counterparty” under § 50.52 in order to include “sister affiliates” within the definition.[292]

Commission Reproposal: The Commission notes that under § 150.4, aggregation is required by a person that holds an ownership or equity interest of 10 percent or greater in another person, unless an exemption applies. Under reproposed § 150.2(c)(2), sister affiliates would not be required to comply separately with position limits, provided such entities are eligible affiliates.[293]

As such, the Commission does not believe a there is a need to conform the “eligible affiliate” definition in reproposed § 150.1 to the definition of “eligible affiliate counterparty” in § 50.52 in order to accommodate sister affiliates. The Commission notes that a third person that holds an ownership or equity interest in each of the sister affiliates—e.g., the parent company—would be required to aggregate positions of such eligible affiliates. Thus, the Commission is reproposing the definition without changes.

f. Entity

Proposed Rule: The December 2013 Position Limits Proposal defined “entity” to mean “a `person' as defined in section 1a of the Act.” [294] The term, not defined in current § 150.1, is used in a number of contexts, and in various definitions in the proposed amendments to part 150. Thus, the definition originally proposed would provide a clear and unambiguous meaning for the term, and prevent confusion.

Comments Received: The Commission received no comments on the proposed definition.

Commission Reproposal: The Commission has determined to repropose the definition as originally proposed, for the reasons provided above.

g. Excluded Commodity

Proposed Rule: The phrase “excluded commodity” was added into the CEA in the CFMA, and is defined in CEA Start Printed Page 96732section 1a(19), but is not defined or used in current part 150.[295] CEA section 4a(a)(2)(A), as amended by the Dodd-Frank Act, utilizes the phrase “excluded commodity” when it provides a timeline under which the Commission is charged with setting limits for futures and option contracts other than on excluded commodities.[296]

The December 2013 Position Limits Proposal included in § 150.1, a definition of excluded commodity that simply incorporates the statutory meaning, as a useful term for purposes of a number of the proposed changes to part 150. For example, the phrase was used in the proposed amendments to § 150.5, in its provision of requirements and acceptable practices for DCMs and SEFs in their adoption of rules and procedures for monitoring and enforcing position limits and accountability provisions; the phrase was also used in the definition of bona fide hedging position.

Comments Received: The Commission received no comments on the proposed definition.

Commission Reproposal: The Commission has determined to repropose the definition as previously proposed, for the reasons provided above.

h. First Delivery Month of the Crop Year

Proposed Rule: The term “first delivery month of the crop year” is currently defined in § 150.1(c), with a table of the first delivery month of the crop year for the commodities for which position limits are currently provided in § 150.2. The crop year definition had been pertinent for purposes of the spread exemption to the individual month limit in current § 150.3(a)(3), which limits spreads to those between individual months in the same crop year and to a level no more than that of the all-months limit.[297] Under the December 2013 Position Limits Proposal, the definition of “crop year” would be deleted from § 150.1. The proposed elimination of the definition conformed with level of individual month limits set at the level of the all-months limits, thus negating the purpose of the existing spread exemption in current § 150.3(a)(3), which the December 2013 Position Limits Proposal also eliminated.

The Commission notes that in its 2016 Supplemental Position Limits Proposal, the Commission proposed to retain a spread exemption in § 150.3 and not, as proposed in the December 2013 Position Limits Proposal, to eliminate it altogether.[298]

Comments Received: The Commission received no comments on the proposed deletion of the crop year definition.

Commission Reproposal: The Commission has determined to repropose the deletion of the definition of the term “first delivery month of the crop year” as originally proposed. The Commission notes that, although in its 2016 Supplemental Position Limits Proposal, the Commission proposed to retain a spread exemption in § 150.3 and, in fact, provides for the approval by exchanges of exemptions to spread positions beyond the limited exemption for spread positions in current § 150.3(a)(3), the crop year definition remains unnecessary since the level of individual month limits has been set at the level of the all-months limits.

i. Futures Equivalent

Proposed Rule: In the December 2013 Position Limits Proposal, the Commission proposed to broaden the definition of the term “futures-equivalent” found in current § 150.1(f) of the Commission's regulations,[299] and to expand upon clarifications included in the current definition relating to adjustments and computation times.[300] The Dodd-Frank Act amendments to CEA section 4a,[301] in part, direct the Commission to apply aggregate federal position limits to physical commodity futures contracts and to swaps contracts that are economically equivalent to such physical commodity futures contracts on which the Commission has established limits. In order to aggregate positions in futures, options and swaps contracts, it is necessary to adjust the position sizes, since such contracts may have varying units of trading (e.g., the amount of a commodity underlying a particular swap contract could be larger than the amount of a commodity underlying a core referenced futures contract). The Commission proposed to adjust position sizes to an equivalent position based on the size of the unit of trading of the core referenced futures contract. Under the December 2013 Position Limits Proposal, the definition of “futures equivalent” in current § 150.1(f), which is applicable only to an option contract, would be extended to both options and swaps.

In the 2016 Supplemental Position Limits Proposal, the Commission proposed two further clarifications to the definition of the term “futures-equivalent.” First, the Commission proposed to address circumstances in which a referenced contract for which futures equivalents must be calculated is itself a futures contract. The Commission noted that this may occur, for example, when the referenced contract is a futures contract that is a mini-sized version of the core referenced futures contract (e.g., the mini-corn and the corn futures contracts).[302] The Commission proposed to clarify in proposed § 150.1 that the term “futures-equivalent” includes a futures contract which has been converted to an economically equivalent amount of an open position in a core Start Printed Page 96733referenced futures contract. This clarification would mirror the expanded definition of “futures-equivalent” in the December 2013 Position Limits Proposal, as it would pertain to swaps.

Second, the Commission proposed in the 2016 Supplemental Position Limits Proposal to clarify the definition of the term “futures-equivalent” to provide that, for purposes of calculating futures equivalents, an option contract must also be converted to an economically equivalent amount of an open position in a core referenced futures contract. This clarification would address situations, for example, where the unit of trading underlying an option contract (that is, the notional quantity underlying an option contract) may differ from the unit of trading underlying a core referenced futures contract.[303]

The Commission expressed the view in the 2016 Supplemental Position Limits Proposal that these clarifications would be consistent with the methodology the Commission used to provide its analysis of unique persons over percentages of the proposed position limit levels in the December 2013 Position Limits Proposal.[304]

Comments Received: The Commission received two comments on the proposed definition of “futures-equivalent” in the December 2013 Position Limits Proposal.[305] Each comment was generally supportive of the proposed definition. Although one commenter commended the flexibility granted to market participants to use different option valuation models, it recommended that the Commission provide guidance on when it would consider an option valuation model unsatisfactory and what the factors the Commission would consider in arriving at such an opinion.[306] According to the commenter, the Commission should utilize a “reasonableness approach” by explicitly providing a “safe harbor” for models that produce results within 10 percent of an exchange or Commission model, and should permit market participants to demonstrate the reasonableness under prevailing market conditions of any model that falls outside this safe harbor.[307] It was also recommended that the Commission consider the exchanges' approach to option valuation where appropriate because these approaches are already in use and familiar to market participants.[308]

Both MFA and FIA supported the optional use of the prior day's delta to calculate a futures-equivalent position for purposes of speculative position limit compliance.[309] In addition, each requested that the Commission confirm or adopt a provision similar to CME Rule 562. That exchange rule provides, among other things, that if a participant's position exceeds position limits as a result of an option assignment, that participant is allowed one business day to liquidate the excess position without being considered in violation of the limits. FIA urged the Commission to provide market participants with a reasonable period of time to reduce its position below the speculative position limit.[310]

Commission Reproposal: The Commission has determined to repropose the definition of “futures-equivalent” as proposed in the 2016 Supplemental Position Limits proposal, with the exception that it now proposes adopting the current exchange practice with regard to option assignments, as discussed below.

Regarding risk (delta) models, the Reproposal does not provide a “safe harbor” as requested since risk models, generally, should produce similar results. The Commission believes a difference of 10 percent above or below the delta resulting from an exchange's model generally would be too great to be economically reasonable. However, the Commission notes that, under the Reproposal, should a market participant believe its model produces an economically reasonable and analytically supported risk factor for a particular trading session that differs significantly from a result published by an exchange for that same time,[311] it may describe the circumstances that result in a significant difference and request that staff review that model for reasonableness.[312]

Regarding the time period for a participant to come into compliance because of option assignment, the Commission agrees that a participant in compliance only because of a previous day's delta, and no longer, after option assignment, in compliance on a subsequent day, should have one business day to liquidate the excess position resulting from option assignment without being considered in violation of the limits.[313] Exchanges currently provide the same amount of time to come into compliance.

j. Intermarket Spread Position and Intramarket Spread Position

Proposed Rule: In the December 2013 Position Limits Proposal, the Commission proposed to add to current § 150.1 new definitions of the terms “intermarket spread position” and “intramarket spread position.” [314] These terms were defined in the December 2013 Position Limits Proposal within the definition of “referenced contract.” In connection with its 2016 Supplemental Position Limits Proposal to permit exchanges to process applications for exemptions from federal position limits for certain spread positions, the Commission proposed to expand the definitions of these terms as proposed in the December 2013 Position Limits Proposal.

In particular, in the 2016 Supplemental Position Limits Proposal, Start Printed Page 96734the Commission proposed to define an “intermarket spread position” to mean “a long (short) position in one or more commodity derivative contracts in a particular commodity, or its products or its by-products, at a particular designated contract market, and a short (long) position in one or more commodity derivative contracts in that same, or similar, commodity, or its products or its by-products, away from that particular designated contract market.” Similarly, the Commission proposed in the 2016 Supplemental Position Limits Proposal to define an “intramarket spread position” to mean “a long position in one or more commodity derivative contracts in a particular commodity, or its products or its by-products, and a short position in one or more commodity derivative contracts in the same, or similar, commodity, or its products or its by-products, on the same designated contract market.”

The Commission expressed the view that the expanded definitions proposed in the 2016 Supplemental Position Limits Proposal would take into account that a market participant may take positions in multiple commodity derivative contracts to establish an intermarket spread position or an intramarket spread position. The expanded definitions would also take into account that such spread positions may be established by taking positions in derivative contracts in the same commodity, in similar commodities, or in the products or by-products of the same or similar commodities. By way of example, the Commission noted that the expanded definitions would include a short position in a crude oil derivative contract and long positions in a gasoline derivative contract and a diesel fuel derivative contract (collectively, a reverse crack spread).

Comments Received: The Commission did not receive any comments in response to the definitions of “intermarket spread position” and “intramarket spread position” proposed in the December 2013 Position Limits Proposal [315] or in response to the 2016 Supplemental Position Limits Proposal.

Commission Reproposal: The Commission has determined to repropose the definitions of the terms “intermarket spread position” and “intramarket spread position” as proposed in the 2016 Supplemental Position Limits Proposal.

k. Long Position

Proposed Rule: The term “long position” is currently defined in § 150.1(g) to mean “a long call option, a short put option or a long underlying futures contract.” The Commission proposed to update the definition to make it also applicable to swaps such that a long position would include a long futures-equivalent swap.

Commission Reproposal: Though no commenters suggested changes to the definition of “long position,” the Commission is concerned that the proposed definition does not clearly articulate that futures and options contracts are subject to position limits on a futures-equivalent basis in terms of the core referenced futures contract. Longstanding market practice has applied position limits on futures and options on a futures-equivalent basis, and the Commission believes that practice ought to be made explicit in the definition in order to prevent confusion. Thus, the Commission is reproposing an amended definition to clarify that a long position is “on a futures-equivalent basis, a long call option, a short put option, a long underlying futures contract, or a swap position that is equivalent to a long futures contract.” This clarification is consistent with the clarification to the definition of futures-equivalent basis proposed in the 2016 Supplemental Position Limits Proposal. Though the substance of the definition is fundamentally unchanged, the revised language should prevent unnecessary confusion over the application of futures-equivalency to different kinds of commodity derivative contracts.

l. Physical Commodity

Proposed Rule: The December 2013 Position Limits Proposal would amend § 150.1 by adding in a definition of the term “physical commodity” for position limit purposes. Congress used the term “physical commodity” in CEA sections 4a(a)(2)(A) and 4a(a)(2)(B) to mean commodities “other than excluded commodities as defined by the Commission.” Therefore, the Commission interprets “physical commodities” to include both exempt and agricultural commodities, but not excluded commodities, and proposes to define the term as such.[316]

Comments Received: The Commission received no comments on the proposed definition.

Commission Reproposal: The Commission has determined to repropose the definition as originally proposed.

m. Pre-enactment Swap and Pre-Existing Position

Proposed Rule: The December 2013 Position Limits Proposal would amend § 150.1 by adding in new definitions of the terms “pre-enactment swap” and “pre-existing position” for position limit purposes. Under the definitions proposed in the December 2013 Position Limits Proposal, “pre-enactment swap” means any swap entered into prior to enactment of the Dodd-Frank Act of 2010 (July 21, 2010), the terms of which have not expired as of the date of enactment of that Act, while “pre-existing position” means any position in a commodity derivative contract acquired in good faith prior to the effective date of any bylaw, rule, regulation or resolution that specifies an initial speculative position limit level or a subsequent change to that level.

Comments Received: The Commission received no comments on the proposed definitions either of the terms “pre-enactment swap” or “pre-existing position.”

Commission Reproposal: The Commission has determined to repropose both definitions as previously proposed.

n. Referenced Contract

Proposed Rule: Part 150 currently does not include a definition of the phrase “referenced contract,” which was introduced and adopted in vacated part 151.[317] As was noted when part 151 was adopted, the Commission identified 28 core referenced futures contracts and proposed to apply aggregate limits on a futures equivalent basis across all derivatives that met the definition of referenced contracts.[318] The definition of referenced contract proposed in the December 2013 Position Limits Proposal was similar to that of vacated part 151, Start Printed Page 96735but there were certain differences, including an exclusion of guarantees of swaps and the incorporation of other terms into the definition of referenced contract.

In the December 2013 Position Limits Proposal, the term “referenced contract” was proposed to be defined in § 150.1 to mean, on a futures-equivalent basis with respect to a particular core referenced futures contract, a core referenced futures contract listed in § 150.2(d) of this part, or a futures contract, options contract, or swap, other than a guarantee of a swap, a basis contract, or a commodity index contract: (1) That is: (a) Directly or indirectly linked, including being partially or fully settled on, or priced at a fixed differential to, the price of that particular core referenced futures contract; or (b) directly or indirectly linked, including being partially or fully settled on, or priced at a fixed differential to, the price of the same commodity underlying that particular core referenced futures contract for delivery at the same location or locations as specified in that particular core referenced futures contract; and (2) where: (a) Calendar spread contract means a cash-settled agreement, contract, or transaction that represents the difference between the settlement price in one or a series of contract months of an agreement, contract or transaction and the settlement price of another contract month or another series of contract months' settlement prices for the same agreement, contract or transaction; (b) commodity index contract means an agreement, contract, or transaction that is not a basis or any type of spread contract, based on an index comprised of prices of commodities that are not the same or substantially the same; (c) spread contract means either a calendar spread contract or an intercommodity spread contract; and (d) intercommodity spread contract means a cash-settled agreement, contract or transaction that represents the difference between the settlement price of a referenced contract and the settlement price of another contract, agreement, or transaction that is based on a different commodity.

Comments Received: The Commission received numerous comments [319] regarding various aspects of the definition of “referenced contract.” Some were generally supportive of the proposed definition while others suggested changes. One commenter expressly stated its support for speculative limits on futures, options, and swaps because each financial instrument “can be used to develop market power and increase volatility.” [320] Another commenter expressed its support for the exclusion of guarantees of swaps from the definition of referenced contract.[321] These comments and the Commission's response are detailed below.

Commission Reproposal: The Commission is reproposing the definition of referenced contract with two substantive modifications from the original proposal, both of which are discussed further below. First, the Commission is now proposing to amend the definition of “referenced contract” to expressly exclude trade options. Second, the Reproposal would clarify the meaning of “indirectly linked.” The Reproposal also moves four definitions that were embedded in the proposed definition of referenced contract, specifically “calendar spread contract,” “commodity index contract,” “spread contract,” and “intercommodity spread contract,” to their own definitions in § 150.1, while otherwise retaining those definitions as proposed. In addition, the Reproposal makes non-substantive modifications to the definition of referenced contract to make it easier to read.

Comments Received: In response to a specific request for comment in the December 2013 Position Limits Proposal, many commenters recommended excluding trade options from the definition of referenced contract.[322]

Commission Reproposal: In response to numerous comments, the reproposed definition of “referenced contract” expressly excludes trade options that meet the requirements of § 32.3. The Commission notes that in its trade options final rule,[323] the cross-reference to vacated part 151 position limits was deleted from § 32.3(c). At that time, the Commission stated its belief that federal speculative position limits should not apply to trade options, as well as its intention to address trade options in the context of the any final rulemaking on position limits.[324] Therefore, the Commission is reproposing the definition of “referenced contract” to expressly exclude trade options that meet the requirements of § 32.3 of this chapter.

Comments Received: Commenters asserted that certain aspects of the definition of referenced contract are unclear and/or unworkable. For example, commenters suggested that the concept of “indirectly linked” is unclear and so market participants may not know whether a particular contract is subject to limits.[325] Some commenters believe that the definition is overbroad and captures products that they state do not affect price discovery or impair hedging and are not truly economically-equivalent.[326] Commenters request that the Commission support its determination regarding which contracts are economically equivalent by providing a description of the methodology used to determine the contracts considered to be economically-equivalent, including examples of over-the-counter (“OTC”) and FBOT contracts.[327] One commenter stated that support is necessary because “mechanically assign[ing]” the label of economically-equivalent to any contract that references a core referenced futures contract does not make it equivalent.[328]

Commission Reproposal: The Commission agrees with commenters that there is a need to clarify the meaning of “indirectly linked.” The Commission notes that including contracts that are “indirectly linked” to the core referenced futures contract under the definition of referenced contract is intended to prevent the evasion of position limits through the creation of an economically equivalent contract that does not directly reference the core referenced futures contract price. Under the reproposed definition, “indirectly linked” means a contract that settles to a price based on another derivative contract that, either directly or through linkage to another derivative contract, has a settlement price based on Start Printed Page 96736the price of a core referenced futures contract or based on the price of the same commodity underlying that particular core referenced futures contract for delivery at the same location specified in that particular core referenced futures contract. Therefore, contracts that settle to the price of a referenced contract, for example, would be indirectly linked to the core referenced futures contract (e.g., a swap that prices to the ICE Futures US Henry LD1 Fixed Price Futures (H) contract, which is a referenced contract that settles directly to the price of the NYMEX Henry Hub Natural Gas (NG) core referenced futures contract).

On the other hand, an outright derivative contract whose settlement price is based on an index published by a price reporting agency (“PRA”) that surveys cash market transaction prices (even if the cash market practice is to price at a differential to a futures contract) would not be directly or indirectly linked to the core referenced futures contract.[329] Similarly, a derivative contract whose settlement price was based on the same underlying commodity at a different delivery location (e.g., ultra-low sulfur diesel delivered at L.A. Harbor) would not be linked, directly or indirectly, to the core referenced futures contract. The Commission is publishing an updated CFTC Staff Workbook of Commodity Derivative Contracts Under the Regulations Regarding Position Limits for Derivatives along with this release, which provides a non-exhaustive list of referenced contracts and may be helpful to market participants in determining categories of contracts that fit within the definition. Under the Reproposal, as always, market participants may request clarification from the Commission when necessary.

Regarding comments that the definition is overbroad and captures products that commenters state do not affect price discovery or are not truly economically-equivalent, the Commission notes that commenters seem to be confusing the statutory definitions of “significant price discovery function” (in CEA section 4a(a)(4)) and “economically equivalent” (in CEA section 4a(a)(5)). As a matter of course, contracts can be economically equivalent without serving a significant price discovery function. The Commission notes that there is no unpublished methodology used to determine which contracts are referenced contracts. Instead, the Commission proposed, and, following notice and comment, is now reproposing a definition for referenced contracts, and contracts that fit under that definition will be subject to federal speculative position limits.

Comments Received: Several commenters suggested that cash-settled contracts should not be subject to position limits.[330] One commenter asserted that non-deliverable cash-settled contracts are “fundamentally different” from deliverable commodity contracts and should not be subject to position limits.[331] The commenter also asserted that subjecting penultimate-day contracts such as options to a limit structure would make managing an option portfolio “virtually impossible” and would result in confusion and uncertainty.[332]

Commission Reproposal: The Commission has determined not to make any changes in the Reproposal that would broadly exempt cash-settled contracts from position limits. Cash-settled contracts are economically equivalent to deliverable contracts, and Congress has required that the Commission impose limits on economically equivalent swaps. The Commission notes that Congress took action twice to address this issue. In CEA section 4a(a)(5)(A), Congress required the Commission to adopt position limits for swaps that are economically equivalent to futures or options on futures or commodities traded on a futures exchange, for which the Commission has adopted position limits. Previously, in the CFTC Reauthorization Act of 2008,[333] Congress imposed a core principle for position limitations on swaps that are significant price discovery contracts.[334] In addition, because cash-settled referenced contracts are economically equivalent to the physical delivery contract in the same commodity, a trader has an incentive to manipulate one contract in order to benefit the other.[335] The Commission notes that a trader with positions in both the physically delivered and cash-settled referenced contracts would have, in the absence of position limits, increased ability to manipulate one contract to benefit positions in the other.

Moreover, if speculators were incentivized to abandon physical delivery contracts for cash-settled contracts so as to avoid position limits, it could result in degradation of the physical delivery contract markets that position limits are intended and designed to protect.

Comments Received: One commenter asked the Commission to confirm that a non-transferable repurchase right granted in connection with a hedged commodity transaction does not count towards position limits, citing CME Group and ICE Futures rules to that effect. The commenter is concerned that such a transaction could be deemed a commodity option and therefore legally a swap, but that it believed the transaction satisfies the criteria for exemption from definition as a swap.[336]

Commission Reproposal: As the commenter notes, whether the contract is subject to position limits depends on whether it is a swap. The Commission points out that the release adopting the definition of swap noted the Commission's belief that its forward contract interpretation “provides sufficient clarity with respect to the forward contract exclusion from the swap and future delivery definitions.” [337] Also in that release, the Commission noted that commodity options are swaps.[338] Separately, the Commission adopted Commission § 32.3, providing an exemption from the commodity option definition for trade options; the exemption was recently further amended.[339] The commenter should apply these rules to determine whether a given contract is a swap. In addition, the Commission notes that under Commission § 140.99, the commenter may request clarification or exemptive relief regarding whether a non-transferable repurchase right falls under the definition of a “swap.” To the extent the commenter seeks a clarification or change to the definition of a swap, the current rulemaking has not been expanded to revisit that definition.

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Comments Received: One commenter [340] requested clarification that a bid, offer, or indication of interest for an OTC swap that does not constitute a binding transaction will not count towards position limits, noting that current CME Rule 562 provides that such bids or offers would be in violation of the limit.

Commission Reproposal: The Reproposal does not change the definition originally proposed in response to the comment requesting clarification that a bid, offer, or indication of interest for an OTC swap that does not constitute a binding transaction will not count towards position limits. Nevertheless, the Commission clarifies that under the Reproposal, such bids, offers, or indications of interest do not count toward position limits.[341]

Comments Received: One commenter requested that the Commission exclude from the definition of referenced contract any agreement, contract, and transaction exempted from swap regulations by virtue of an exemption order, interpretation, no-action letter, or other guidance; the commenter stated that it believes the Commission can use its surveillance capacity and anti-manipulation authority, along with its MOU with FERC, to monitor these nonfinancial commodity transactions as well as the market participants relying on the exemptive relief.[342]

Commission Reproposal: The Reproposal does not change the proposed definition in response to the comment requesting that the Commission exclude from the definition of referenced contract any agreement, contract, and transaction exempted from swap regulations by virtue of an exemption order, interpretation, no-action letter, or other guidance. The Commission notes that any contract that is not a commodity derivative contract, including one that has been excluded from the definition of swap, is not subject to position limits. The commenter is requesting a broad exclusion from the definition of referenced contract, based on other regulatory relief which may have been adopted for a variety of policy reasons unrelated to position limits. Consequently, in light of the many and varied policy reasons for issuing an exemption order, interpretation, no-action letter or other guidance from swap regulation, each such action would need to be considered in the context of the goals of the Commission's position limits regime. Rather than issuing a blanket exemption from the definition of referenced contract for any agreement, contract, and transaction exempted from swap regulations, therefore, the Commission believes it would be better to consider each such action on its own merits prior to issuing an exemption from position limits. Under the Reproposal, if a market participant desires to extend a previously taken exemptive action by exempting certain agreements, contracts, and transactions from the definition of referenced contract, the market participant can request that the particular exemption order, interpretation, no-action letter, or other guidance be so extended. This would allow the Commission to consider the particular action taken and the merits of that particular exemption in the context of the position limits regime.

The Commission notes that in the particular exemptive order cited by the commenter,[343] certain delineated non-financial energy transactions between certain specifically defined entities were exempted, pursuant to CEA sections 4(c)(1) and 4(c)(6), from all requirements of the CEA and Commission regulations issued thereunder, subject to certain anti-fraud, anti-manipulation, and record inspection conditions. All entities that meet the requirements for the exemption provided by the Federal Power Act 201(f) Order are, therefore, already exempt from position limits compliance for all transactions that meet the Order's conditions.

Comments Received: Commenters were divided with respect to the exclusion of “commodity index contracts” from the definition of referenced contract. As a result of the exclusion, the position of a market participant who enters into a commodity index contract with a dealer will not be subject to position limits. One commenter supported the exclusion of commodity index contracts from the definition of referenced contracts.[344] The commenter was concerned, however, that a dealer who offsets his or her exposure in such contracts by purchasing futures contracts on the constituent components of the commodity index will be subject to position limits in the referenced contracts. The commenter urged the Commission to recognize as a bona fide hedge “the offsetting nature of the dealer's position by exempting the futures contracts that a dealer acquires to hedge its commitments under commodity index contracts.” [345] Alternatively, the Commission should “modify the definition of `referenced contract' and the definition of `commodity derivative contract' by excluding core referenced futures contracts and related futures contracts, options contracts or swaps that are offset on an economically equivalent basis by the constituent portions of commodity index contracts.” [346] Another commenter supported the Commission's proposal to exclude swaps that reference indices such as the Goldman Sachs Commodity Index (GSCI) from the definition of a referenced contract.[347]

One commenter asked that the Commission reconsider excluding commodity index contracts from the definition of referenced contract.[348] Another commenter urged that commodity index contracts should be included in the definition of referenced contract in conjunction with (1) a class limit (as was proposed for vacated part 151, but not included in final part 151); and (2) a lower position limit set at a level “aimed to maintain no more than” 30 percent speculation in each commodity (based on COT report classifications) that is reset every 6 months.[349] The same commenter noted that trading by passive, long only Start Printed Page 96738commodity index fund speculators does not provide liquidity, but rather takes net liquidity, dilutes the pool of market information to be less reflective of fundamental forces, causes volatility, and causes an increased frequency of contango attributed to frequent rolls from selling a nearby contract and buying a deferred (second month) contract. The commenter noted that, broadly, speculators in commodity futures historically constituted between 15 and 30 percent of open interest without meaningfully disrupting the market and providing beneficial intermediation between hedging producers and hedging consumers.[350]

Commission Reproposal: The Commission is reproposing the provision excluding commodity index contracts from the definition of referenced contract as previously proposed.

Regarding commenters who requested that the Commission alter the proposed definition to include commodity index derivative contracts, the Commission notes that if it were to include such contracts, the Commission's rules would allow netting of such positions in commodity index contracts with other offsetting referenced contracts. The ability to net such commodity index derivative contracts positions with other offsetting referenced contracts would eliminate the need for a bona fide hedging exemption for such contracts. Thus, the Commission believes such netting would contravene Congressional intent, as expressed in CEA section 4a(c)(B)(i) in its requirement to permit a pass-thru swap offset only if the counterparty's position would qualify as a bona fide hedge.

Another commenter suggested including commodity index contracts under the definition of referenced contract in conjunction with a class limit (e.g., a separate limit for commodity index contracts compared to all other categories of derivative contracts). The commenter suggested that the limit be set at a level aimed at maintaining a particular ratio of speculative trading in the market. In response to this commenter, the Commission declines in this Reproposal to propose class limits because it believes any adoption of a class limit would require a rationing scheme wherein unrelated legal entities would be limited by the positions of other unrelated legal entities. Further, the Commission is concerned that class limits (including the one proposed by the commenter) could impair liquidity in the relevant markets.[351] The Commission also notes that it currently does not collect information to effectively enforce any ratio of speculative trading, and has not done so since the Commission eliminated Series '03 reporting in 1981.[352] The Reproposal does not make any changes to the definition of referenced contract pursuant to this comment.

Finally, in response to the commenter who suggested that, in addition to excluding commodity index contracts as proposed, the Commission should recognize as bona fide hedge positions those positions that offset a position in a commodity index derivative contract by using the component futures contracts, the Commission observes that it still believes, as discussed in the December 2013 Position Limits Proposal, that financial products do not meet the temporary substitute test. As such, the offset of financial risks arising from financial products is inconsistent with the statutory definition of a bona fide hedging position. The Commission also declines in this Reproposal to accept the commenter's request to exempt these offsetting positions using its authority under CEA section 4a(a)(7) because it does not believe that permitting the offset of financial risks furthers the purposes of the Commission's position limits regime as described in CEA section 4a(a)(3)(B). Finally, the commenter suggested as an alternative that the Commission modify the definition of referenced contract to broadly exclude any derivative contracts that are used to offset commodity index exposure. However, the Commission believes such a broad exclusion would, at best, be too difficult to administer and, at worst, provide an easy vehicle for entities to evade position limits regulations.

Comments Received: One commenter suggested that the Commission unnecessarily limited the scope of permissible netting by not recognizing cross-commodity netting, recommending either a threshold correlation factor of 60 percent or an approach that would permit pro rata netting to the extent of demonstrated correlation.[353]

Commission Reproposal: The Commission believes that recognizing cross-commodity netting as requested by the commenter would substantially expand the definition of referenced contract and, thus, may weaken: (1) The protection of the price discovery function in the core referenced futures contract; (2) the prevention of excessive speculation; and (3) the prevention of market manipulation. Therefore, this Reproposal does not change the definition of referenced contract to accommodate cross-commodity netting.

Comments Received: One commenter requested that all “nonfinancial commodity derivatives” used by commercial end-users for hedging purposes be expressly excluded from the definition of referenced contract (and so excluded from position limits). The commenter also suggested that the Commission allow an end-user to identify a swap as being used to “hedge or mitigate commercial risks” at the time the swap is executed and noted that such trades are highly-customized bilateral agreements that are difficult to convert into futures equivalents.[354] The commenter also requested that “customary commercial agreements” be excluded from referenced contract definition. The commenter stated that these contracts may reference a core referenced futures contract or may be misinterpreted as directly or indirectly linking to a core referenced futures contract, but that the Commission has already determined that Congress did not intend to regulate such agreements as swaps.[355]

Commission Reproposal: This Reproposal does not amend the definition of referenced contract in response to the request that “nonfinancial commodity derivatives” used by commercial end-users for hedging purposes be expressly excluded from the definition of referenced contract. The Commission understands the comment to mean that when a particular transaction qualifies for the end-user exemption, it should also be exempt from position limits by excluding such transactions from the definition of “referenced contract.” The commenter quotes language from the end-user exemption definition, which was issued to provide relief from the clearing and trade execution mandates. The Commission notes that under the CEA's statutory language, the commercial end user exemption Start Printed Page 96739definition is broader than the bona fide hedging definition. Under the canons of statutory construction, when Congress writes one section differently than another, the differences should be assumed to have different meaning. Thus, the Commission believes that the more restrictive language in the bona fide hedging definition should be applied here. The definition of bona fide hedging position, as proposed in the December 2013 Position Limits Proposal, as amended by the 2016 Supplemental Position Limits Proposal, and as reproposed here, would be consistent with the differences in the two definitions, as adopted by Congress. The Commission notes that under this Reproposal, commercial end-users may rely on any applicable bona fide hedge exemption.

In response to the commenter's concern regarding “customary commercial agreements,” the Commission reiterates its belief that contracts that are exempted or excluded from the definition of “swap” are not considered referenced contracts and so are not subject to position limits.

o. Short Position

Proposed Rule: The term “short position” is currently defined in § 150.1(c) to mean a short call option, a long put option, or a short underlying futures contract. In the December 2013 Position Limits Proposal, the Commission proposed to amend the definition to state that a short position means a short call option, a long put option or a short underlying futures contract, or a short futures-equivalent swap. This proposed revision reflects the fact that under the Dodd-Frank Act, the Commission is charged with applying the position limits regime to swaps.

Comments Received: The Commission received no comments regarding the proposed amendment to the definition of “short position.”

Commission Reproposal: Though no commenters suggested changes to the definition of “short position,” the Commission is concerned that the proposed definition, like the proposed definition of “long position” described supra, does not clearly articulate that futures and options contracts are subject to position limits on a futures-equivalent basis in terms of the core referenced futures contract. Longstanding market practice has applied position limits to futures and options on a futures-equivalent basis, and the Commission believes that practice ought to be made explicit in the definition in order to prevent confusion. Thus, in this Reproposal, the Commission is proposing to amend the definition to clarify that a short position is on a futures-equivalent basis, a short call option, a long put option, a short underlying futures contract, or a swap position that is equivalent to a short futures contract. Though the substance of the definition is fundamentally unchanged, the revised language should prevent unnecessary confusion over the application of futures-equivalency to different kinds of commodity derivative contracts.

p. Speculative Position Limit

The term “speculative position limit” is currently not defined in § 150.1. In the December 2013 Position Limits Proposal, the Commission proposed to define the term “speculative position limit” to mean “the maximum position, either net long or net short, in a commodity derivatives contract that may be held or controlled by one person, absent an exemption, such as an exemption for a bona fide hedging position. This limit may apply to a person's combined position in all commodity derivative contracts in a particular commodity (all-months-combined), a person's position in a single month of commodity derivative contracts in a particular commodity, or a person's position in the spot-month of commodity derivative contacts in a particular commodity. Such a limit may be established under federal regulations or rules of a designated contract market or swap execution facility. An exchange may also apply other limits, such as a limit on gross long or gross short positions, or a limit on holding or controlling delivery instruments.” [356]

As explained in the December 2013 Position Limits Proposal, the proposed definition is similar to definitions for position limits used by the Commission for many years,[357] as well as glossaries published by the Commission for many years.[358] For example, the December 2013 Position Limits Proposal noted that the version of the staff glossary currently posted on the CFTC Web site defines speculative position limit as “[t]he maximum position, either net long or net short, in one commodity future (or option) or in all futures (or options) of one commodity combined that may be held or controlled by one person (other than a person eligible for a hedge exemption) as prescribed by an exchange and/or by the CFTC.”

The Commission received no comments on the proposed definition, and is reproposing the definition without amendment.

q. Spot-Month

Proposed Rule: In the December 2013 Position Limits Proposal, the Commission proposed to adopt a definition of “spot-month” that expands upon the current § 150.1 definition.[359] The definition, as proposed, specifically addressed both physical-delivery contracts and cash-settled contracts, and clarified the duration of “spot-month.” Under the proposed definition, the “spot-month” for physical-delivery commodity derivatives contracts would be the period of time beginning at of the close of trading on the trading day preceding the first day on which delivery notices could be issued or the close of trading on the trading day preceding the third-to-last trading day, until the contract was no longer listed for trading (or available for transfer, such as through exchange for physical transactions). The proposed definition included similar, but slightly different language for cash-settled contracts, providing that the spot month would begin at the earlier of the start of the period in which the underlying cash-settlement price was calculated or the close of trading on the trading day preceding the third-to-last trading day and would continue until the contract Start Printed Page 96740cash-settlement price was determined. In addition, the proposed definition included a proviso that, if the cash-settlement price was determined based on prices of a core referenced futures contract during the spot month period for that core referenced futures contract, then the spot month for that cash-settled contract would be the same as the spot month for that core referenced futures contract.[360]

Comments Received: The Commission received several comments regarding the definition of spot month.[361] One commenter noted that the definition of the spot month for federal limits does not always coincide with the definition of spot month for purposes of any exchange limits and assumes that the Commission did not intend for this to happen. For example, the commenter noted the proposed definition of spot month would commence at the close of trading on the trading day preceding the first notice day, while the ICE Futures US definition commences as of the opening of trading on the second business day following the expiration of regular option trading on the expiring futures contract. Regarding the COMEX contracts, the commenter stated that the exchange spot month commences at the close of business, rather than at the close of trading, which would allow market participants to incorporate exchange of futures for related position transactions (EFRPs) that occur after the close of trading, but before the close of business.[362] Finally, the commenter requested the Commission ensure the definition of spot month for federal limits is the same as the definition of spot month for exchange limits for all referenced contracts.[363]

Two commenters urged the Commission to reconsider its proposed definition of spot month for cash-settled contracts that encompasses the entire period for calculation of the settlement price, preferring the current exchange practice which is to apply the spot month limit during the last three days before final settlement.[364] One commenter noted its concern that the proposed definition would discourage use of calendar month average price contracts.[365]

Another commenter recommended that the Commission define “spot month” in relation to each core referenced futures contract and all related physically-settled and cash-settled referenced contracts, to assure that the definition works appropriately in terms of how each underlying nonfinancial commodity market operates, and to ensure that commercial end-users of such nonfinancial commodities can effectively use such referenced contracts to hedge or mitigate commercial risks.[366]

The Commission also received the recommendation from one commenter that the Commission should publish a calendar listing the spot month for each Core Referenced Futures Contract to provide clarity to market participants and reduce the cost of identifying and tracking the spot month.[367]

Commission Reproposal: For core referenced futures contracts, the Commission agrees with the commenter that the definition of spot month for federal limits should be the same as the definition of spot month for exchange limits. The Commission is therefore the definition of spot month in this Reproposal generally follows exchange practices. In the reproposed version, spot month means the period of time beginning at the earlier of the close of business on the trading day preceding the first day on which delivery notices can be issued by the clearing organization of a contract market, or the close of business on the trading day preceding the third-to-last trading day, until the contract expires for physical delivery core referenced futures contracts,[368] except for the following: (a) ICE Futures U.S. Sugar No. 11 (SB) referenced contract for which the spot month means the period of time beginning at the opening of trading on the second business day following the expiration of the regular option contract traded on the expiring futures contract; (b) ICE Futures U.S. Sugar No. 16 (SF) referenced contract,[369] for which the spot month means the period of time beginning on the third-to-last trading day of the contract month until the contract expires [370] and (c) Chicago Mercantile Exchange Live Cattle (LC) referenced contract, for which the spot month means the period of time beginning at the close trading on the fifth business day of the contract month.[371]

As noted above, in the December 2013 Position Limits Proposal, spot month was proposed to be defined to begin at the earlier of: (1) “the close of trading on the trading day preceding the first day on which delivery notices can be issued to the clearing organization”; or (2) “the close of trading on the trading day preceding the third-to-last trading day”—based on the comment letters received, the proposed definition resulted in some confusion.[372] The Commission observes that the current definition also seems to be a source of some confusion when it defines “spot month,” in current CFTC Regulation 150.1(a), to begin “at the close of trading on the trading day preceding the first day on which delivery notices can be issued to the clearing organization.”

The Commission understands current DCM practice for physical-delivery contracts permitting delivery before the close of trading generally is that the spot month begins at the start of the first business day on which the clearing house can issue “stop” notices to a clearing member carrying a long position, or, at the close of business on the day preceding the first business day on which the clearing house can issue “stop” notices to a clearing member carrying a long position, but current DCM rules vary somewhat. For some ICE contracts,[373] the spot month includes “any month for which delivery notices have been or may be issued,” [374] and begins at the open of trading; [375] the Start Printed Page 96741CME spot month, as noted above, begins at the close of trading. However, the Commission understands that the amended “spot month” definition, as reproposed herein, would be consistent with the existing spot month practices of exchanges when enforcing the start of the spot month limits in any of the 25 core referenced futures contracts, based on the timing of futures large trader reports, discussed below.

Furthermore, based on Commission staff discussions with staff from several DCMs regarding exchange current practices, the Commission believes that the spot month should begin at the same time as futures large trader reports are submitted—that is, under the definition of reportable position, the spot month should begin “at the close of the market.” [376] The Commission views the “close of the market” as consistent with “the close of business.”

In consideration of the practicality of this approach, and in light of the definition of “reportable position,” the Commission believes that it would be more practical, clear, and consistent with existing exchange practices, for the spot month to begin “at the close of business.” In addition, as noted by one commenter,[377] when the exchange spot month commences at the close of business, rather than at the close of trading, it would allow market participants to incorporate exchange of futures for related position transactions (“EFRPs”) [378] that occur after the close of trading, but before the close of business.

The Commission points out an additional correction made to the reproposed definition, changing it from “preceding the first day on which delivery notices can be issued to the clearing organization of a contract market” to “preceding the first day on which delivery notices can be issued by the clearing organization of a contract market” [emphasis added]. The Commission understands that the spot periods on the exchanges commence the day preceding the first day on which delivery notices can be issued by the clearing organization of a contract market, not the first day on which notices can be issued to the clearing organization. The “spot month” definition in this Reproposal, therefore, has been changed to correct this error.

The revisions included in the reproposed definition addresses the concerns of the commenter who suggested the Commission define the spot month according to each core referenced futures contract and for cash-settled and physical delivery referenced contracts that are not core referenced futures contracts, although for clarity and brevity the Commission has chosen to highlight contracts that are the exception to the general definition rather than list each of the 25 core referenced futures contracts and multitude of referenced contracts separately.

In response to the commenters' concern regarding cash-settled referenced contracts, the Reproposal changes the definition of spot month to agree with the limits proposed in § 150.2. In the December 2013 Position Limits Proposal, the Commission defined the spot month for certain cash-settled referenced contracts, including calendar month averaging contracts, to be a longer period than the spot month period for the related core referenced futures contract. However, the Commission did not propose a limit for such contracts in proposed § 150.2, rendering superfluous that aspect of the proposed definition of spot month, at this time. The Commission is reproposing the definition of spot month without this provision, thereby addressing the concerns of the commenters regarding the impact of the definition on calendar month averaging contracts outside of the spot month for the relevant core referenced futures contract. In order to make clearer the relevant spot month periods for referenced contracts other than core referenced futures contracts, the Commission has included subsection (3) of the definition that states that the spot month for such referenced contracts is the same period as that of the relevant core referenced futures contract.

The Commission believes that the revised definition reproposed here sufficiently clarifies the applicable spot month periods, which can also be determined via exchange rulebooks and defined contract specifications, such that a defined calendar of spot months is not necessary. Further, a published calendar would need to be revised every year to update spot month periods for each contract and each expiration. The Commission believes this constant revision may lead to more confusion than it is meant to correct.

r. Spot-Month, Single-Month, and All-Months-Combined Position Limits

Proposed Rule: In addition to a definition for “spot month,” current part 150 includes definitions for “single month,” and for “all-months” where “single month” is defined as “each separate futures trading month, other than the spot month future,” and “all-months” is defined as “the sum of all futures trading months including the spot month future.”

As noted in the December 2013 Position Limits proposal, vacated part 151 retained only the definition for spot month, and, instead, adopted a definition for “spot-month, single-month, and all-months-combined position limits.” The definition specified that, for Referenced Contracts based on a commodity identified in § 151.2, the maximum number of contracts a trader could hold was as provided in § 151.4.

In the December 2013 Position Limits Proposal, as noted above, the Commission proposed to amend § 150.1 by deleting the definitions for “single month,” and for “all-months,” but, unlike the vacated part 151, the proposal did not include a definition for “spot-month, single-month, and all-months-combined position limits.” Instead, it proposed to adopt a definition for “speculative position limits” that should obviate the need for these definitions.[379]

Comments Received: The Commission received no comments regarding the deletion of these definitions.

Commission Reproposal: This Reproposal, consistent with the December 2013 Position Limits Proposal, eliminates the definitions for “single month,” and for “all-months,” for the reasons provided above.

s. Swap and Swap Dealer

Proposed Rule: While the terms “swap” and “swap dealer” are not currently defined in § 150.1, the December 2013 Position Limits Proposal amended § 150.1 to define these terms as they are defined in section 1a of the Act and as further defined in section 1.3 of this chapter.” [380]

Comments Received: The Commission received no comments on these definitions.Start Printed Page 96742

Commission Reproposal: The Commission has determined to repropose these definitions as originally proposed, for the reasons provided above.

2. Bona Fide Hedging Definition

a. Bona Fide Hedging Position (BFH) Definition—Background

Prior to the 1974 amendments to the CEA, the definition of a bona fide hedging position was found in the statute. The 1974 amendments authorized the newly formed Commission to define a bona fide hedging position.[381] The Commission published a final rule in 1977, providing a general definition of a bona fide hedging position in § 1.3(z)(1).[382] The Commission listed certain positions, meeting the requirements of the general definition of a bona fide hedging position, in § 1.3(z)(2) (i.e., enumerated bona fide hedging positions). The Commission provided an application process for market participants to seek recognition of non-enumerated bona fide hedging positions in §§ 1.3(z)(3) and 1.48.

During the 1980's, exchanges were required to incorporate the Commission's general definition of bona fide hedging position into their exchange-set position limit regulations.[383] While the Commission had established position limits on only a few commodity futures contracts in § 150.2, Commission rule § 1.61 (subsequently incorporated into § 150.5) required DCMs to establish limits on commodities futures not subject to federal limits. The Commission directed in § 1.61(a)(3) (subsequently incorporated into § 150.5(d)(1)) that no DCM regulation regarding position limits would apply to bona fide hedging positions as defined by a DCM in accordance with § 1.3(z)(1).

In 1987, the Commission provided interpretive guidance regarding the bona fide hedging definition and risk management exemptions for futures in financial instruments (now termed excluded commodities).[384] This guidance permitted exchanges, for purposes of exchange-set limits on excluded commodities, to recognize risk management exemptions.[385]

In the 1990's, the Commission allowed exchanges to experiment with substituting position accountability levels for position limits.[386] The CFMA, in 2000, codified, in DCM Core Principle 5, position accountability as an acceptable practice.[387] The CFMA, however, did not address the definition of a bona fide hedging position.

With the passing of the CFMA in 2000, the Commission's requirements for exchanges to adopt position limits and associated bona fide hedging exemptions, in § 150.5, were rendered mere guidance. That is, exchanges were no longer required to establish limits and no longer required to use the Commission's general definition of a bona fide hedging position. Nonetheless, the Commission continued to guide exchanges to adopt position limits, particularly for the spot month in physical-delivery physical commodity derivatives, and to provide for exemptions.

The Farm Bill of 2008 authorized the Commission to regulate swaps traded on exempt commercial markets (ECM) that the Commission determined to be a significant price discovery contract (SPDC).[388] The Commission implemented these provisions in part 36 of its rules.[389] The Commission provided guidance to ECMs in complying with Core Principle IV regarding position limitations or accountability.[390] That guidance provided, as an acceptable practice for cleared trades, that the ECM's position limit rules may exempt bona fide hedging positions.

In 2010, the Dodd-Frank Act added a directive, for purposes of implementation of CEA section 4a(a)(2), for the Commission to define a bona fide hedging position for physical commodity derivatives consistent with, in the Commission's opinion, the reasonably certain statutory standards in CEA section 4a(c)(2). Those statutory standards build on, but differ slightly from, the Commission's general definition in rule 1.3(z)(1).[391] The Commission interprets those statutory standards as directing the Commission to narrow the bona fide hedging position definition for physical commodities.[392] The Commission discusses those differences, below.

b. BFH Definition Summary

Under the December 2013 Position Limits Proposal, the Commission proposed a new definition of bona fide hedging position, to replace the current definition in § 1.3(z), that would be applicable to positions in excluded commodities and in physical commodities.[393] The proposed definition was organized into an opening paragraph and five numbered paragraphs. In the opening paragraph, for positions in either excluded commodities or physical commodities, the proposed definition would have applied two general requirements: The incidental test; and the orderly trading requirement. For excluded commodities, the Commission proposed in paragraph (1) a definition that conformed to the Commission's 1987 Start Printed Page 96743interpretations permitting risk management exemptions in excluded commodity contracts. For physical commodities, the Commission proposed in paragraph (2) to amend the current general definition to conform to CEA section 4a(c) and to remove the application process in §§ 1.3(z)(3) and 1.48, that permits market participants to seek recognition of non-enumerated bona fide hedging positions. Rather, the Commission proposed that a market participant may request either a staff interpretative letter under § 140.99 [394] or seek CEA section 4a(a)(7) exemptive relief.[395] Paragraphs (3) and (4) listed enumerated exemptions. Paragraph (5) listed the requirements for cross-commodity hedges of enumerated exemptions.

In response to comments on the December 2013 Position Limits Proposal, in the 2016 Supplemental Proposal, the Commission amended the proposed definition of bona fide hedging position.[396] The amended definition proposed in the 2016 Supplemental Proposal would no longer apply the two general requirements (the incidental test and the orderly trading requirement). For excluded commodities, the Commission again proposed paragraph (1) of the definition, substantially as in 2013. For physical commodities, the Commission again proposed to conform paragraph (2) more closely to CEA section 4a(c), but also proposed an application process for market participants to seek recognition of non-enumerated bona fide hedging positions, without the need to petition the Commission. The Commission again proposed paragraphs (3) through (5).

In response to comments on both the December 2013 Position Limits Proposal and the 2016 Supplemental Proposal, the Commission is now reproposing the definition of bona fide hedging position, generally as proposed in the 2016 Supplemental Proposal, but with a few further amendments. First, for excluded commodities, the Commission clarifies further the discretion of exchanges in recognizing risk management exemptions. Second, for physical commodities, the Commission: (a) Clarifies the scope of the general definition of a bona fide hedging position; (b) conforms that general definition more closely to CEA section 4a(c) by including recognition of positions that reduce risks attendant to a swap that was used as a hedge; and, (c) re-organizes additional requirements for enumerated hedges and requirements for other recognition as a non-enumerated bona fide hedging position, apart from the general definition.

c. BFH Definition Discussion—Remove Incidental Test and Orderly Trading Requirement

Proposed Rule: As noted above, the Commission proposed to retain, in its December 2013 Position Limits Proposal,[397] then proposed to remove, in its 2016 Supplemental Position Limits Proposal,[398] two general requirements contained in the § 1.3(z)(1) definition of bona fide hedging position: the incidental test; and the orderly trading requirement. The incidental test requires, for a position to be recognized as a bona fide hedging position, that the “purpose is to offset price risks incidental to commercial cash, spot, or forward operations.” The orderly trading requirement mandates that “such position is established and liquidated in an orderly manner in accordance with sound commercial practices.”

Comments Received: Commenters generally objected to retaining the incidental test and the orderly trading requirement in the definition of bona fide hedging position, as proposed in 2013.[399] A number of commenters supported the Commission's 2016 Supplemental Proposal to remove the incidental test and the orderly trading requirement.[400]

Incidental Test: Commenters objected to the incidental test, because that test is not included in the standards in CEA section 4a(c) for the Commission to define a bona fide hedging position for physical commodities.[401]

However, other commenters noted their belief that eliminating the incidental test would permit swap dealers or purely financial entities to avail themselves of bona fide hedging exemptions, to the detriment of commercial hedgers.[402]

Orderly trading requirement: One commenter urged the Commission to eliminate the orderly trading requirement, because this requirement does not apply to over-the-counter markets, the Commission does not define orderly trading in a bi-lateral market, and this requirement imposes a duty on end users to monitor market activities to ensure they do not cause a significant market impact; additionally, the commenter noted the anti-disruptive trading prohibitions and polices apply regardless of whether the orderly trading requirement is imposed.[403] Similarly, another commenter urged the Commission to exempt commercial end-users from the orderly trading requirement, arguing that an orderly trading requirement unreasonably requires commercial end-users to monitor markets to measure the impact of their activities without clear guidance from the Commission on what would constitute significant market impact.[404]

Other commenters to the 2013 Proposal requested the Commission interpret the orderly trading requirement consistently with the Commission's disruptive trading practices interpretation (i.e., a standard of intentional or reckless conduct) and not to apply a negligence standard.[405] Yet another commenter requested clarification on the process the Commission would use to determine whether a position has been established and liquidated in an orderly manner, whether any defenses may be available, and what would be the consequences of failing the requirement.[406]

However, one commenter is concerned that eliminating the orderly trading requirement for bona fide hedging for swaps positions would discriminate against market participants in the futures and options markets. The commenter noted that, if the Commission eliminates this requirement, the Commission could not use its authority effectively to review exchange-granted exemptions for swaps from position limits to prevent or diminish excessive speculation.[407]

Commission Reproposal: In the reproposed definition of bona fide hedging position, the Commission is eliminating the incidental test and the orderly trading requirement.

Incidental Test: Under the Reproposal, the incidental test has been eliminated, because the Commission views the economically appropriate test (discussed below) as including the concept of the offset of price risks Start Printed Page 96744incidental to commercial cash, spot, or forward operations. It was noted in the 2013 Position Limits Proposal that, “The Commission believes the concept of commercial cash market activities is also embodied in the economically appropriate test for physical commodities in [CEA section 4a(c)(2)].” [408] It should be noted the incidental test has been part of the regulatory definition of bona fide hedging since 1975,[409] but that the requirement was not explained in the 1974 proposing notice (“proposed definition otherwise deviates in only minor ways from the hedging definition presently contained in [CEA section 4a(3)]”).[410]

The Commission is not persuaded by the commenters who believe eliminating the incidental test would permit financial entities to avail themselves of a bona fide hedging exemption, because the incidental test is essentially embedded in the economically appropriate test. In addition, for a physical-commodity derivative, the reproposed definition, in mirroring the statutory standards of CEA section 4a(c), requires a bona fide hedging position to be a substitute for a transaction taken or to be taken in the cash market (either for the market participant itself or for the market participant's pass-through swap counterparty), which generally would preclude financial entities from availing themselves of a bona fide hedging exemption (in the absence of qualifying for a pass-through swap offset exemption, discussed below).

Orderly Trading Requirement: The Reproposal also eliminates the orderly trading requirement. That provision has been a part of the regulatory definition of bona fide hedging since March 12, 1975 [411] and previously was found in the statutory definition of bona fide hedging position prior to the 1974 amendment removing the statutory definition from CEA section 4a(3). However, the Commission is not aware of a denial of recognition of a position as a bona fide hedging position, as a result of a lack of orderly trading. Further, the Commission notes that the meaning of the orderly trading requirement is unclear in the context of the over-the-counter (OTC) swap market or in the context of permitted off-exchange transactions (e.g., exchange of futures for physicals).

In regard to the anti-disruptive trading prohibitions of CEA section 4c(a)(5), those prohibitions apply to trading on registered entities, but not to OTC transactions. It should be noted that the anti-disruptive trading prohibitions in CEA section 4c(a)(5) make it unlawful to engage in trading on a registered entity that “demonstrates intentional or reckless disregard for orderly execution of trading during the closing period” (emphasis added); however, the Commission has not, under the authority of CEA section 4c(a)(6), prohibited the intentional or reckless disregard for the orderly execution of transactions on a registered entity outside of the closing period.

The Commission notes that an exchange may impose a general orderly trading on all market participants. Market participants may request clarification from exchanges on their trading rules. The Commission does not believe that the absence of an orderly trading requirement in the definition of bona fide hedging position would discriminate against any particular trading venue for commodity derivative contracts.

d. BFH Definition Discussion— Excluded Commodities

Proposed Rule: In both the 2013 Position Limits Proposal and the 2016 Supplement Proposal, the proposed definition of bona fide hedging position for contracts in an excluded commodity included a standard that the position is economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise (the economically appropriate test) and also specified that such position should be either (i) specifically enumerated in paragraphs (3) through (5) of the definition of bona fide hedging position; or (ii) recognized as a bona fide hedging position by a DCM or SEF consistent with the guidance on risk management exemptions in proposed Appendix A to part 150.[412] As noted above, the 2016 Supplemental Proposal would eliminate the two additional general requirements (the incidental test and the orderly trading requirement).

Comments Received: One commenter believed that, to avoid an overly restrictive definition due to the limited set of examples provided by the Commission, only the general definition of a bona fide hedging position should be applicable to hedges of an excluded commodity.[413]

Commission Reproposal: After consideration of comments and review of the record, the Commission has determined in the Reproposal to apply the economically appropriate test to enumerated exemptions, as proposed.[414] However, the Reproposal amends the proposed definition of a bona fide hedging position for an excluded commodity, to clarify that an exchange may otherwise recognize risk management exemptions in an excluded commodity, without regard to the economically appropriate test. Regarding risk management exemptions, the Commission notes that Appendix A (which codifies the Commission's two 1987 interpretations of the bona fide hedging definition in the context of excluded commodities) includes examples of risk altering transactions, such as a temporary increase in equity exposure relative to cash bond holdings. Such risk altering transactions appear inconsistent with the Commission's interpretation of the economically appropriate test. Accordingly, the Reproposal removes the economically appropriate test from the guidance for exchange-recognized risk management exemptions in excluded commodities.

Regarding an exchange's obligation to comply with core principles pertaining to position limits on excluded commodities, as discussed further in § 150.5, the Commission clarifies that under the Reproposal, exchanges have reasonable discretion as to whether to adopt the Commission's definition of a bona fide hedging position, including whether to grant risk management exemptions, such as those that would be consistent with, but not limited to, the examples in Appendix A to part 150. That is, the set of examples in Appendix A to part 150 is non-restrictive, as it is guidance. The Reproposal also makes minor wording changes in Appendix A to part 150, including to clarify an exchange's reasonable discretion in granting risk management exemptions and to eliminate a reference to the orderly trading requirement which has been deleted, as discussed above, but otherwise is adopting Appendix A as proposed.

e. BFH Definition Discussion—Physical Commodities General Definition

As noted in its proposal, the core of the Commission's approach to defining bona fide hedging over the years has focused on transactions that offset a Start Printed Page 96745recognized price risk.[415] Once a bona fide hedge is implemented, the hedged entity should be price insensitive because any change in the value of the underlying physical commodity is offset by the change in value of the entity's physical commodity derivative position.

Because a firm that has hedged its price exposure is price neutral in its overall physical commodity position, the hedged entity should have little incentive to manipulate or engage in other abusive market practices to affect prices. By contrast, a party that maintains a derivative position that leaves it with exposure to price changes is not neutral as to price and, therefore, may have an incentive to affect prices. Further, the intention of a hedge exemption is to enable a commercial entity to offset its price risk; it was never intended to facilitate taking on additional price risk.

The Commission recognizes there are complexities to analyzing the various commercial price risks applicable to particular commercial circumstances in order to determine whether a hedge exemption is warranted. These complexities have led the Commission, from time to time, to issue rule changes, interpretations, and exemptions. Congress, too, has periodically revised the Federal statutes applicable to bona fide hedging, most recently in the Dodd-Frank Act.

CEA section 4a(c)(1),[416] as re-designated by the Dodd-Frank Act, authorizes the Commission to define bona fide hedging positions “consistent with the purposes of this Act.” CEA section 4a(c)(2), as added by the Dodd-Frank Act, provides new requirements for the Commission to define bona fide hedging positions in physical commodity derivatives “[f]or the purposes of implementation of [CEA section 4a(a)(2)] for contracts of sale for future delivery or options on the contracts of commodities [traded on DCMs].” [417]

General Definition: The Commission's proposed general definition for physical commodity derivative contracts, mirroring CEA section 4a(c)(2)(a), specifies a bona fide hedging position is one that:

(a) Temporary substitute test: represents a substitute for transactions made or to be made or positions taken or to be taken at a later time in the physical marketing channel;

(b) Economically appropriate test: is economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise; and

(c) Change in value requirement: arises from the potential change in the value of assets, liabilities, or services, whether current or anticipated.

In addition to the above, the Commission's proposed general definition, mirroring CEA section 4a(c)(2)(B)(i), also recognizes a bona fide hedging position that:

(d) Pass-through swap offset: reduces risks attendant to a position resulting from a swap that was executed opposite a counterparty for which the transaction would qualify as a bona fide hedging transaction under the general definition above.

The Commission proposed another provision, based on the statutory standards, to recognize as a bona fide a position that:

(e) Pass-through swap: is itself the swap executed opposite a pass-through swap counterparty, provided that the risk of that swap has been offset.

The Commission received a number of comments on the December 2013 Position Limits Proposal and the 2016 Supplemental Proposal. Those concerning the incidental test and the orderly trading requirement are discussed above. Others are discussed below.

i. Temporary Substitute Test and Risk Management Exemptions

Proposed Rule: The temporary substitute test is discussed in the 2013 Position Limits Proposal at 75708-9. As the Commission noted in the proposal, it believes that the temporary substitute test is a necessary condition for classification of positions in physical commodities as bona fide hedging positions. The proposed test mirrors the statutory test in CEA section 4a(c)(2)(a)(i). The statutory test does not include the adverb “normally” to modify the verb “represents” in the phrase “represents a substitute for transactions taken or to be taken at a later time in a physical marketing channel.” Because the definition in § 1.3(z)(1) includes the adverb “normally,” the Commission interpreted that provision to be merely a temporary substitute criterion, rather than a test. Accordingly, the Commission previously granted risk management exemptions for persons to offset the risk of swaps and other financial instruments that did not represent substitutes for transactions or positions to be taken in a physical marketing channel. However, given the statutory change in direction, positions that reduce the risk of such speculative swaps and financial instruments would no longer meet the requirements for a bona fide hedging position under the proposed definition in § 150.1.

Comments Received: A number of commenters urged the Commission not to deny risk-management exemptions for financial intermediaries who utilize referenced contracts to offset the risks arising from the provision of diversified, commodity-based returns to the intermediaries' clients.[418]

However, other commenters noted the “proposed rules properly refrain from providing a general exemption to financial firms seeking to hedge their financial risks from the sale of commodity-related instruments such as index swaps, Exchange Traded Funds (ETFs), and Exchange Traded Notes (ETNs),” because such instruments are inherently speculative and may overwhelm the price discovery function of the derivative market.[419]

Commission Reproposal: The Reproposal would retain the temporary substitute test, as proposed. The Commission interprets the statutory temporary substitute test as more stringent than the temporary substitute criterion in § 1.3(z)(1); [420] that is, the Commission views the statutory test as narrowing the standards for a bona fide hedging position. Further, the Commission believes that retaining a risk management exemption for swap intermediaries, without regard to the purpose of the counterparty's swap, would fly in the face of the statutory restrictions on pass-through swap offsets (requiring the position of the pass-through swap counterparty to Start Printed Page 96746qualify as a bona fide hedging transaction).[421]

Proposed Rule on risk management exemption grandfather provisions: The Commission proposed in § 150.2(f) and § 150.3(f) to grandfather previously granted risk-management exemptions, as applied to pre-existing positions.[422]

Comments Received: Commenters requested that the Commission extend the grandfather relief to permit pre-existing risk management positions to be increased after the effective date of a limit.[423] Commenters also requested that the Commission permit the risk associated with a pre-existing position to be offset by a futures position in a deferred contract month, after the liquidation of an offsetting position in a nearby futures contract month.[424]

Some commenters urged the Commission not to deny risk-management exemptions for financial intermediaries who utilize referenced contracts to offset the risks arising from the provision of diversified commodity-based returns to the intermediaries' clients.[425]

In contrast, other commenters noted that the proposed rules “properly refrain” from providing a general exemption to financial firms seeking to hedge their financial risks from the sale of commodity-related instruments such as index swaps, ETFs, and ETNs because such instruments are “inherently speculative” and may overwhelm the price discovery function of the derivative market.[426] Another commenter noted, because commodity index contracts are speculative, the Commission should not provide a regulatory exemption for such contracts.[427]

Commission Reproposal: The Reproposal clarifies and expands the relief in § 150.3(f) (previously granted exemptions) by: (1) Clarifying that such previously granted exemptions may apply to pre-existing financial instruments that are within the scope of existing § 1.47 exemptions, rather than only to pre-existing swaps; and (2) recognizing exchange-granted non-enumerated exemptions in non-legacy commodity derivatives outside of the spot month (consistent with the Commission's recognition of risk management exemptions outside of the spot month), and provided such exemptions are granted prior to the compliance date of the final rule, once adopted, and apply only to pre-existing financial instruments as of the effective date of that final rule. These two changes are intended to reduce the potential for market disruption by forced liquidations, since a market intermediary would continue to be able to offset risks of pre-effective-date financial instruments, pursuant to previously-granted federal or exchange risk management exemptions.

The Reproposal clarifies that the Commission will continue to recognize the offset of the risk of a pre-existing financial instrument as bona fide using a derivative position, including a deferred derivative contract month entered after the effective date of a final rule, provided a nearby derivative contract month is liquidated. However, under the Reproposal, such relief will not be extended to an increase in positions after the effective date of a limit, because that appears contrary to Congressional intent to narrow the definition of a bona fide hedging position, as discussed above.

ii. Economically Appropriate Test

Commission proposal: The economically appropriate test is discussed in the 2013 Position Limits Proposal at 75709-10. The proposed economically appropriate test mirrors the statutory test, which, in turn, mirrors the test in current § 1.3(z)(1).

Comments received: Several commenters requested that the Commission broadly interpret the phrase “economically appropriate” to include more than just price risk, stating that there are other types of risk that are economically appropriate to address in the management of a commercial enterprise including operational risk, liquidity risk, credit risk, locational risk, and seasonal risk.[428]

Commenters suggested that if the Commission objected to expanding its interpretation of “economically appropriate” risks, then the Commission should allow the exchanges to utilize discretion in their interpretations of the economically appropriate test.[429] Another commenter believed that the Commission should provide “greater flexibility” in the various bona fide hedging tests, because hedging that reduces all the various types of risk should be deemed “economically appropriate.” [430] Commenters suggested that a broader view of the types of risks considered to be “economically appropriate” should not be perceived as being at odds with the Commission's view of “price risk” because all of these risks can inform and determine price, noting that firms evaluate different risks and determine a price impact based on a combination of their likelihood of occurrence and the price impact in the event of occurrence.[431]

Commission Reproposal: The Reproposal does not broaden the interpretation of the phrase “economically appropriate.” The Commission notes that it has provided interpretations and guidance over the years as to the meaning of “economically appropriate.” [432] The Commission reiterates its view that, to satisfy the economically appropriate test and the change in value requirement of CEA section 4a(c)(2)(A)(iii), the purpose of a bona fide hedging position must be to offset price risks incidental to a commercial enterprise's cash operations.[433]

The Commission notes that an exchange is permitted to recognize non-enumerated bona fide hedging positions under the process of § 150.9, discussed below, subject to assessment of the particular facts and circumstances, where price risk arises from other types of risk. The Reproposal does not, however, allow the exchanges to utilize unbounded discretion in interpreting “economically appropriate” in such recognitions. The Commission believes that such a broad delegation is not authorized by the CEA and, in the Commission's view, would be contrary to the reasonably certain statutory standard of the economically appropriate test. Further, as explained in the discussion of § 150.9, exchange determinations will be subject to the Commission's de novo review.

Comments on gross vs. net hedging: A number of commenters requested that the Commission recognize as bona fide both “gross hedging” and “net hedging,” without regard to overall risk.[434] Commenters generally requested, as “gross hedging,” that an enterprise should be permitted the flexibility to use either a long or short derivative to offset the risk of any cash position, identified at the discretion of Start Printed Page 96747the commercial enterprise, irrespective of the commercial enterprise's net cash market position.[435] For example, a commenter contended that a commercial enterprise should be able to hedge fixed-price purchase contracts (e.g., with a short futures position), without regard to the enterprise's fixed-price sales contracts, even if such a short derivative position may increase the enterprise's risk.[436] One commenter stated that the “new proposed interpretation” of the “economically appropriate” test requires a commercial enterprise to include, and consider for purposes of bona fide hedging, portions of its portfolio it would not otherwise consider in managing risk.[437] Another commenter did not agree that market participants should be required to calculate risk on a consolidated basis, because this approach would require commercial entities to build out new systems. As an alternative, that commenter requests the Commission recognize current risk management tools.[438]

Commission Reproposal: The Reproposal retains the Commission's interpretation, as proposed, of economically appropriate gross hedging: that in circumstances where net hedging does not measure all risk exposures, an enterprise may appropriately enter into, for example, a calendar month spread position as a gross hedge. A number of comments misconstrued the Commission's historical interpretation of gross and net hedging. The Commission has not recognized selective identification of cash positions to justify a position as bona fide; rather, the Commission has permitted a regular practice of excluding certain commodities, products, or by-products, in determining an enterprise's risk position.[439] As proposed, the Reproposal requires such excluded commodities to be de minimis or difficult to measure, because a market participant should not be permitted to ignore material cash market positions and enter into derivative positions that increase risk while avoiding a position limit restriction; rather, such a market participant's speculative activity must remain below the level of the speculative position limit.

Note, however, under a partial reading of a preamble to a 1977 proposal, the Commission has appeared to recognize gross hedging, without regard to net risk, as bona fide; the Commission noted in 1977 that: “The previous statutory definition of bona fide hedging transactions or positions contained in section 4a of the Act before amendment by the CFTC Act and the present definition permit persons to classify as hedging any purchase or sale for future delivery which is offset by their gross cash position irrespective of their net cash position.” [440] However, under a full reading of that 1977 proposal, the Commission made clear that gross hedging was appropriate in circumstances where “net cash positions do not necessarily measure total risk exposure due to differences in the timing of cash commitments, the location of stocks, and differences in grades or types of the cash commodity.” [441] Thus, the 1977 proposal noted the Commission “does not intend at this time to alter the provisions of the present definition with respect to the hedging of gross cash position.” [442] At the time of the 1977 proposal, the “present definition” had been promulgated in 1975 by the Administrator of the Commodity Exchange Authority based on the statutory definition; and the Administrator had interpreted the statutory definition to recognize gross hedging as bona fide in the context of a merchant who “may hedge his fixed-price purchase commitments by selling futures and at the same time hedge his fixed-price sale commitments by buying futures,” rather than hedging only his net position.[443]

Comments on specific, identifiable risk: Commenters requested the Commission consider as economically appropriate any derivative position that a business can reasonably demonstrate reduces or mitigates one or more specific, identifiable risks related to individual or aggregated positions or transactions, based on its own business judgment and risk management policies, whether risk is managed enterprise-wide or by legal entity, line of business, or profit center.[444] One commenter disagreed with what it called a “one-size-fits-all” risk management paradigm that requires market participants to calculate risk on a consolidated basis because this approach would require commercial entities to build out new systems in order to manage risk this way. The commenter requests that the Commission instead recognize that current risk management tools are used effectively for positions that are below current limits and those tools remain effective above position limit levels as well.[445]

Commission Reproposal: The Reproposal declines to assess the bona fides of a position based solely on whether a commercial enterprise can identify any particular cash position within an aggregated person, the risks of which such derivative position offsets. The Commission believes that such an approach would run counter to the aggregation rules in § 150.4 and would permit an enterprise to cherry pick cash market exposures to justify exceeding position limits, with either a long or short derivative position, even though such derivative position increases the enterprise's risk.

The Commission views a derivative position that increases an enterprise's risk as contrary to the plain language of CEA section 4a(c) and the Commission's bona fide hedging definition, which requires that a bona fide hedging position “is economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise.” [446]

If a transaction that increases a commercial enterprise's overall risk should be considered a bona fide hedging position, this would result in position limits not applying to certain positions that should be considered speculative. For example, assume an enterprise has entered into only two cash forward transactions and has no inventory. The first cash forward transaction is a purchase contract (for a particular commodity for delivery at a particular later date). The second cash forward transaction is a sales contract (for the same commodity for delivery on the same date as the purchase contract). Under the terms of the cash forward contracts, the enterprise may take delivery on the purchase contract and re-deliver the commodity on the sales contract. Such an enterprise does not have a net cash market position that exposes it to price risk, because it has both purchased and sold the same commodity for delivery on the same date (such as cash forward contracts for the same cargo of Brent crude oil). The enterprise could establish a short derivative position that would offset the risk of the purchase contract; however, that would increase the enterprise's price risk. Alternatively, the enterprise Start Printed Page 96748could establish a long derivative position that would offset the risk of the sales contract; however, that would increase the enterprise's price risk. If price risk reduction at the level of the aggregate person is not a requirement of a bona fide hedging position, such an enterprise could establish either a long or short derivative position, at its election, and claim an exemption from position limits for either derivative position, ostensibly as a bona fide hedging position. If either such position could be recognized as bona fide, position limits would simply not apply to such an enterprise's derivative position, even though the enterprise had no price risk exposure to the commodity prior to establishing such derivative position and created price risk exposure to the commodity by establishing the derivative position. Based on the Commission's experience and expertise, it believes that such a result (entering either a long or short derivative position, whichever the market participant elects) simply cannot be recognized as a legitimate risk reduction that should be exempt from position limits; rather, such a position should be considered speculative for purposes of position limits.

The Commission notes that a commercial enterprise that wishes to separately manage its operations, in separate legal entities, may, under the aggregation requirements of § 150.4, establish appropriate firewalls and file a notice for an aggregation exemption, because separate legal entities with appropriate firewalls are treated as separate persons for purposes of position limits. The Commission explained that an aggregation exemption was appropriate in circumstances where the risk of coordinated activity is mitigated by firewalls.[447]

Comments on processing hedge: A commenter requested the Commission recognize, as bona fide, a long or short derivative position that offsets either inputs or outputs in a processing operation, based on the business judgment of the commercial enterprise that it might not be an appropriate time to hedge both inputs and outputs, and requested the Commission withdraw the processing hedge example on pages 75836-7 of the 2013 Position Limits Proposal (proposed example 5 in Appendix C to part 150).[448]

Commission Reproposal: For the reasons discussed above regarding gross hedging and specific, identifiable risks, the Reproposal does not recognize as a bona fide hedging position a derivative position that offsets either inputs or outputs in a processing operation, absent additional facts and circumstances. The Commission reiterates its view that, as explained in the Commission's 2013 Position Limits Proposal, by way of example, processing by a soybean crush operation or a fuel blending operation may add relatively little value to the price of the input commodity. In such circumstances, it would be economically appropriate for the processor or blender to offset the price risks of both the unfilled anticipated requirement for the input commodity and the unsold anticipated production; such a hedge would, for example, fully lock in the value of soybean crush processing.[449] However, under such circumstances, merely entering an outright derivative position (i.e., either a long position or a short position, at the processor's election) appears to be risk increasing, since the price risk of such outright position appears greater than, and not offsetting of, the price risk of anticipated processing and, thus, such outright position would not be economically appropriate to the reduction of risks.

Comments on economically appropriate anticipatory hedges: Commenters requested the Commission recognize derivative positions as economically appropriate to the reduction of certain anticipatory risks, such as irrevocable bids or offers.[450]

Commission Reproposal: The Commission has a long history of providing for the recognition, in § 1.3(z)(2), as enumerated bona fide hedging positions, of anticipatory hedges for unfilled anticipated requirements and unsold anticipated production, under the process of § 1.48.[451] The Reproposal continues to enumerate those two anticipatory hedges, along with two new anticipatory hedges for anticipated royalties and contracts for services, as discussed below.

The Commission did not propose an enumerated exemption for binding, irrevocable bids or offers as the Commission believes that an analysis of the facts and circumstances would be necessary prior to recognizing such an exemption. Consequently, the Reproposal does not provide for such an enumerated exemption. However, the Commission withdraws the view that a binding, irrevocable bid or offer fails to meet the economically appropriate test.[452] Rather, the Commission will permit exchanges, under § 150.9, to make a facts-and-circumstances determination as to whether to recognize such and other anticipatory hedges as non-enumerated bona fide hedges, consistent with the Commission's recognition “that there can be a gradation of probabilities that an anticipated transaction will occur.” [453]

iii. Change in Value Requirement

Commission proposal: To satisfy the change in value requirement, the hedging position must arise from the potential change in the value of: (I) Assets that a person owns, produces, manufactures, processes, or merchandises or anticipates owning, producing, manufacturing, processing, or merchandising; (II) liabilities that a person owes or anticipates incurring; or (III) services that a person provides, purchases, or anticipates providing or purchasing.[454] The proposed definition incorporated the potential change in value requirement in current § 1.3(z)(1).[455] This provision largely mirrors the provision of CEA section 4a(c)(2)(A)(iii).[456]

Comments on change in value: One commenter urged a more narrow definition of bona fide hedging that restricts exemptions to “commercial entities that deal exclusively in the production, processing, refining, storage, transportation, wholesale or retail distribution, or consumption of physical commodities.” [457] However, numerous commenters urged the Commission to enumerate new exemptions consistent with the change in value requirement, such as for merchandising, as discussed below.

Commission Reproposal: The Reproposal retains the change in value requirement as proposed, which mirrors CEA section 4a(c)(2)(A)(iii). Rather than further restrict the types of commercial entities who may avail themselves of a Start Printed Page 96749bona fide hedging exemption under the change in value requirement, the Commission notes that the reproposed definition also reflects the statutory requirement under the temporary substitute test, that the hedging position be a substitute for a position taken or to be taken in a physical marketing channel, either by the market participant or the market participant's pass-through swap counterparty.

Comments on anticipatory merchandising or storage: Numerous commenters asserted the Commission should recognize anticipatory merchandising as a bona fide hedge, as included in CEA section 4a(c)(A)(iii), such as (1) a merchant desiring to lock in the price differential between an unfixed price forward commitment and an anticipated offsetting unfixed price forward commitment, where there is a reasonable basis to infer that an offsetting transaction was likely to occur (such as in anticipation of shipping), (2) a bid or offer, where there is a reasonably anticipated risk that such bid or offer will be accepted, or (3) an anticipated purchase and/or anticipated storage of a commodity, prior to anticipated merchandising (or usage).[458]

Commenters recommended the Commission recognize unfilled storage capacity as the basis of a bona fide hedge of, either (1) anticipated rents (e.g., a type of anticipated asset or liability), (2) anticipated merchandising, or (3) anticipated purchase and storage prior to usage.[459] By way of example, one commenter contended anticipated rent on a storage asset is like an option and the appropriate hedge position should be dynamically adjusted.[460] Also by way of example, another commenter suggested enumerated hedges should include (1) offsetting long and short positions in commodity derivative contracts as hedges of storage or transportation of the commodity underlying such contracts; and (2) positions that hedge the value of assets owned, or anticipated to be owned, used to produce, process, store or transport the commodity underlying the derivative.[461]

Commission Reproposal: The Commission notes that an exchange, under reproposed § 150.9, as discussed below, is permitted to recognize anticipated merchandising or anticipated purchase and storage, as potential non-enumerated bona fide hedging positions, subject to assessment of the particular facts and circumstances, including such information as the market participant's activities (taken or to be taken) in the physical marketing channel and arrangements for storage facilities. While the Commission previously discussed its doubt that storage hedges generally will meet the economically appropriate test, because the value fluctuations in a calendar month spread in a commodity derivative contract will likely have at best a low correlation with value fluctuations in expected returns (e.g., rents) on unfilled storage capacity,[462] the Commission now withdraws that discussion of doubt and, as reproposed, would review exchange-granted non-enumerated bona fide hedging exemptions for storage with an open mind.

The Commission does not express a view as this time on one commenter's assertion that the anticipated rent on a storage asset is like an option; the commenter did not provide data regarding the relationship between calendar spreads and the “profitability of filling storage.” The Commission notes that, under the Reproposal, an exchange could evaluate the particulars of such a situation in an application for a non-enumerated hedging position.

Similarly, as reproposed, an exchange could evaluate the particulars of other situations, such as a commenter's example of storage or transportation hedges. The Commission notes that it is not clear from the comments how the value fluctuations of calendar month or location differentials are related to the fluctuations in value of storage or transportation. Regarding a commenter's examples of assets owned or anticipated to be owned, it is not clear how the value fluctuations of whatever would be the relevant hedging position (e.g., long, short, or calendar month spread) are related to the fluctuations in value of whatever would be the particular assets (e.g., tractors, combines, silos, semi-trucks, rail cars, pipelines) to be used to produce, process, store or transport the commodity underlying the derivative.

Comments on unfixed price commitments: Commenters recommended the Commission recognize, as a bona fide hedge, the fixing of the price of an unfixed price commitment, for example, to reduce the merchant's operational risk and potentially to acquire a commodity through the delivery process on a physical-delivery futures contract.[463] Another commenter provided an example of a preference to shift unfixed-price exposure on cash commitments from daily index prices to the first-of-month price under the NYMEX Henry Hub Natural Gas core referenced futures contract.[464] A commenter suggested that the interpretation of a fixed price contract should include “basis priced contracts which are purchases or sales with the basis value fixed between the buyer and the seller against a prevailing futures” contract; the commenter noted such basis risk could be hedged with a calendar month spread to lock in their purchase and sale margins.[465] Another commenter requested the Commission explicitly recognize index price transactions as appropriate for a bona fide hedging exemption, citing concerns that the price of an unfixed price forward sales contract may fall below the cost of production.[466]

Commission Reproposal: The Commission affirms its belief that a reduction in a price risk is required under the economically appropriate test of CEA section 4a(c)(2)(A)(ii); consistent with the economically appropriate test, a potential change in value (i.e., a price risk) is required under CEA section 4a(c)(2)(A)(iii). In both the reproposed and proposed definitions of bona fide hedging position, the incidental test would require a reduction in price risk. Although the Reproposal deletes the incidental test from the first paragraph of the bona fide hedging position definition (as discussed above), the Commission notes that it interprets risk in the economically appropriate test as price risk, and does not interpret risk to include operational risk. Interpreting risk to include operational risk would broaden the scope of a bona fide hedging position beyond the Commission's historical interpretation Start Printed Page 96750and may have adverse impacts that are inconsistent with the policy objectives of limits in CEA section 4a(a)(3)(B).

The Commission has consistently required a bona fide hedging position to be a position that is shown to reduce price risk in the conduct and management of a commercial enterprise.[467] By way of background, the Commission notes, in promulgating the definition of bona fide hedging position in § 1.3(z), it explained that a bona fide hedging position “must be economically appropriate to risk reduction, such risks must arise from operation of a commercial enterprise, and the price fluctuations of the futures contracts used in the transaction must be substantially related to fluctuations of the cash market value of the assets, liabilities or services being hedged.” [468] As noted above, the Dodd-Frank Act added CEA section 4a(c)(2), which copied the economically appropriate test from the Commission's definition in § 1.3(z)(1). Thus, the Commission believes it is reasonable to interpret that statutory standard in the context of the Commission's historical interpretation of § 1.3(z).

While the Commission has enumerated a calendar month spread as a bona fide hedge of offsetting unfixed-price cash commodity sales and purchases, the Reproposal will permit an exchange, under reproposed § 150.9, to conduct a facts-and-circumstances, case-by-case review to determine whether a calendar month spread is appropriately recognized as a bona fide hedging position for only a cash commodity purchase or sales contract. For example, assume a merchant enters into an unfixed-price sales contract (e.g., priced at a fixed differential to a deferred month futures contract), and immediately enters into a calendar month spread to reduce the risk of the fixed basis moving adversely. It may not be economically appropriate to recognize as bona fide a long futures position in the spot (or nearby) month and a short futures position in a deferred calendar month matching the merchant's cash delivery obligation, in the event the spot (or nearby) month price is higher than the deferred contract month price (referred to as backwardation, and characteristic of a spot cash market with supply shortages), because such a calendar month futures spread would lock in a loss and may be indicative of an attempt to manipulate the spot (or nearby) futures price.

Regarding the risk of an unfixed price forward sales contract falling below the cost of production, the Reproposal enumerates a bona fide hedging exemption for unsold anticipated production; the Commission clarifies, as discussed below, that such an enumerated hedge is available regardless of whether production has been sold forward at an unfixed (that is, index) price.

Comments on cash and carry: Commenters requested the Commission enumerate, as a bona fide hedging position, a “cash and carry” trade, where a market participant enters a nearby long futures position and a deferred short futures position, with the intention to take delivery and carry the commodity for re-delivery.[469]

Commission Reproposal: The Reproposal does not propose to enumerate a cash and carry trade as a bona fide hedging position. A cash and carry trade appears to fail the temporary substitute test, since such market participant is not using the derivative contract as a substitute for a position taken or to be taken in the physical marketing channel. The long futures position in the cash and carry trade is in lieu of a purchase in the cash market. In the 2016 Supplemental Proposal, the Commission asked whether, and subject to what conditions (e.g., potential facilitation of liquidity for a bona fide hedger of inventory), a cash and carry position might be recognized by an exchange as a spread exemption under § 150.10, subject to the Commission's de novo review.[470] This issue is discussed under § 150.10, regarding exchange recognition of spread exemptions.

iv. Pass-Through Swap Offsets and Offsets of Hedging Swaps

Commission proposal: The Commission proposed to recognize as bona fide a commodity derivative contract that reduces the risk of a position resulting from a swap executed opposite a counterparty for which the position at the time of the transaction would qualify as a bona fide hedging position.[471] This proposal mirrors the requirements in CEA section 4a(c)(B)(i). The proposal also clarified that the swap itself is a bona fide hedging position to the extent it is offset. However, the Commission proposed that it would not recognize as bona fide hedges an offset in physical-delivery contracts during the shorter of the last five days of trading or the time period for the spot month in such physical-delivery commodity derivative contract (the “five-day” rule, discussed further below).

Comments received: As noted above, commenters recommended that the Commission's bona fide hedging definition should reflect the standards in CEA section 4a(c). One commenter suggested that the Commission broaden the pass-through swap offset provisions to accommodate secondary pass-through transactions among affiliates within a corporate organization to make “the most efficient and effective use of their existing corporate structures.” [472]

Commission Reproposal: The Commission agrees that the bona fide hedging definition, in general, and the pass-through swap provision, in particular, should more closely reflect the statutory standards in CEA section 4a(c). Under the proposed definition, a market participant who reduced the risk of a swap, where such swap was a bona fide hedging position for that market participant, would not have received recognition for the swap offset as a bona fide hedging position, as this provision in CEA section 4a(c)(2)(B)(ii) was not mirrored in the proposed definition.[473] To adhere more closely to the statutory standards, the Reproposal recognizes such offset as a bona fide hedging position. Consistent with the proposal for offset of a pass-through swap, the Reproposal imposes a five-day rule restriction on the offset in a physical-delivery contract of a swap used as a bona fide hedge; however, as reproposed, an exchange listing a physical-delivery contract may recognize, on a case-by-case basis, such offset as a non-enumerated bona fide hedging position pursuant to the process in reproposed § 150.9.

The Reproposal retains and clarifies in subparagraph (ii)(A) that the bona fides of a pass-through swap may be Start Printed Page 96751determined at the time of the transaction by the intermediary. The clarification is intended to reduce the burden on such intermediary of otherwise needing to confirm the continued bona fides of its counterparty over the life of the pass-through swap.

In addition, the Reproposal retains, as proposed, application of the five-day rule to pass-through swap offsets in a physical-delivery contract. However, the Commission notes that under the Reproposal, an exchange listing a physical-delivery contract may recognize, on a case-by-case basis, a pass-through swap offset (in addition to the offset of a swap used as a bona fide hedge), during the last five days of trading in a spot month, as a non-enumerated bona fide hedge pursuant to the process in reproposed § 150.9.

Further, the Reproposal retains the recognition of a pass-through swap itself that is offset, not just the offsetting position (and, thus, permitting the intermediary to exclude such pass-through swap from position limits, in addition to excluding the offsetting position).

Regarding the request to broaden the pass-through swap offset provisions to accommodate secondary pass-through transactions among affiliates, the Commission declines in this Reproposal to broaden the pass-through swap offset exemption beyond the provisions in CEA section 4a(c)(2)(B)(i). However, the Commission notes that a group of affiliates under common ownership is required to aggregate positions under the Commission's requirements in § 150.4, absent an applicable aggregation exemption. In the circumstance of aggregation of positions, recognition of a secondary pass-through swap transaction would not be necessary among such an aggregated group, because the group is treated as one person for purposes of position limits.

v. Additional Requirements for Enumeration or Other Recognition

Commission proposal: In 2013, the Commission proposed in subparagraph (2)(i)(D) of the definition of a bona fide hedging position, that, in addition to satisfying the general definition of a bona fide hedging position, a position would not be recognized as bona fide unless it was enumerated in paragraph (3), (4), or (5)(discussed below), or recognized as a pass-through swap offset or pass-through swap.[474] In 2016, in response to comments on the 2013 proposed definition, the Commission proposed, in subparagraph (2)(i)(D)(2) of the definition, to also recognize as bona fide any position that has been otherwise recognized as a non-enumerated bona fide hedging position by either a designated contract market or a swap execution facility, each in accordance with § 150.9(a), or by the Commission.[475]

Comments received: Commenters objected to the requirement for a position to be specifically enumerated in order to be recognized as bona fide, noting that the enumerated requirement is not supported by the legislative history of the Dodd-Frank Act, conflicts with longstanding Commission practice and precedent, and may be overly restrictive due to the limited set of specific enumerated hedges.[476] Other commenters recommended that the Commission expand the list of enumerated bona fide hedge positions, to encompass all transactions that reduce risks in the conduct and management of a commercial enterprise, such as anticipatory merchandising hedges and other general examples.[477]

Commission Reproposal: In response to comments, the Reproposal retains, as proposed in 2016, a proposed definition that recognizes as bona fide, in addition to enumerated positions, any position that has been otherwise recognized as a non-enumerated bona fide hedging position by either a designated contract market or a swap execution facility, each in accordance with reproposed § 150.9(a), or by the Commission. These provisions for recognition of non-enumerated positions are included in re-designated subparagraph (2)(iii)(C) of the reproposed definition of a bona fide hedging position.

The Commission notes that it is not possible to list all positions that would meet the general definition of a bona fide hedging position. However, the Commission observes that the commenters' many general examples, which they recommended be included in the list of enumerated bona fide hedging positions, generally did not provide sufficient context or facts and circumstances to permit the Commission to evaluate whether recognition as a non-enumerated bona fide hedging position would be warranted. Context would be supplied, for instance, by the provision of the particular market participant's historical activities in the physical marketing channel and such participant's estimate, in good faith, of its reasonably expected activities to be taken in the physical marketing channel.

In a clarifying change, the Commission notes that the Reproposal has re-designated the provisions proposed in subparagraph (2)(i)(D), in new subparagraph 2(iii), regarding the additional requirements for recognition of a position in a physical commodity contract as a bona fide hedging position. Concurrent with this re-designation, the Commission notes the Reproposal re-organizes, also for clarity, the application of the five-day rule to pass-through swaps and hedging swaps in subparagraph (2)(iii)(B), as discussed above.[478]

3. Enumerated Hedging Positions

a. Proposed Enumerated Hedges

In paragraph (3) of the proposed definition of a bona fide hedging position, the Commission proposed four enumerated hedging positions: (i) Hedges of inventory and cash commodity purchase contracts; (ii) hedges of cash commodity sales contracts; (iii) hedges of unfilled anticipated requirements; and (iv) hedges by agents.[479]

Comments received: Numerous commenters objected to the provision in proposed subparagraph (3)(iii)(A) that would have limited recognition of a hedge for unfilled anticipated requirements to one year for agricultural commodities. For example, commenters noted a need to hedge unfilled anticipated requirements for sugar for a time period longer than twelve months.[480] Similarly, other commenters noted there may be a need to offset risks arising from investments in processing capacity in agricultural commodities for a period in excess of twelve months.[481]

Other commenters recommended the Commission (1) remove the restriction that unfilled anticipated requirement hedges by a utility be “required or encouraged to hedge by its public utility commission” because most public utility commissions do not require or encourage such hedging, (2) expand the reach beyond utilities, by including Start Printed Page 96752entities designated as providers of last resort who serve the same role as utilities, and (3) clarify the meaning of unfilled anticipated requirements, consistent with CFTC Staff Letter No. 12-07.[482]

Commission Reproposal: The Reproposal retains the enumerated exemptions as proposed, with two amendments. First, the Commission agrees with the commenters' request to remove the twelve month constraint on hedging unfilled anticipated requirements for agricultural commodities, as that provision appears no longer to be a necessary prudential constraint. Second, the Commission agrees with the commenters' request to remove the condition that a utility be “required or encouraged to hedge by its public utility commission.” Accordingly, the condition that a utility be “required or encouraged to hedge by its public utility commission” is omitted from the reproposed definition. The Commission notes that under the Reproposal, a market participant, who is not a utility, may request that an exchange consider recognizing a non-enumerated exemption, as it is not clear who would be appropriately identified as a “provider of last resort” and under what circumstance such person would reasonably estimate its unfilled requirements.

Consistent with CFTC Staff Letter No. 12-07, the Commission affirms its belief that unfilled anticipated requirements are those anticipated inputs that are estimated in good faith and that have not been filled. Under the Reproposal, an anticipated requirement may be filled, for example, by fixed-price purchase commitments, holdings of commodity inventory by the market participant, or unsold anticipated production of the market participant. However, an unfixed-price purchase commitment does not fill an anticipated requirement, in that the market participant's price risk to the input has not been fixed.

b. Proposed Other Enumerated Hedges Subject to the Five-Day Rule

In paragraph (4) of the proposed definition of a bona fide hedging position, the Commission proposed four other enumerated hedging positions: (i) Hedges of unsold anticipated production; (ii) hedges of offsetting unfixed-price cash commodity sales and purchases; (iii) hedges of anticipated royalties; and (iv) hedges of services.[483] The Commission proposed to apply the five-day rule to all such positions.

Comments received on the five-day rule: Numerous commenters requested that the five-day rule be removed from the Commission's other enumerated bona fide hedging positions, as that condition is not included in CEA section 4a(c).

Commission Reproposal on the five-day rule: The Commission is retaining the prudential condition of the five-day rule in the other enumerated hedging positions. The Commission has a long history of applying the five-day rule, in its legacy agricultural federal position limits, to hedges of unsold anticipated production and hedges of offsetting unfixed-price cash commodity sales and purchases. However, as discussed in relation to reproposed § 150.9, the Commission will permit an exchange, in effect, to remove the five-day rule on a case-by-case basis in physical-delivery contracts, as a non-enumerated bona fide hedging position, by applying the exchange's experience and expertise in protecting its own physical-delivery market.

Comments on other enumerated exemptions: As noted above, commenters recommended removing the twelve-month limitation on agricultural production, as unnecessarily short in comparison to the expected life of investment in production facilities.[484]

Commission Reproposal on other enumerated exemptions: The Reproposal removes the twelve-month limitations on unsold anticipated agricultural production and hedges of services for agricultural commodities. As noted above, that provision appears no longer to be a necessary prudential constraint. Otherwise, the Reproposal retains the other enumerated exemptions, as proposed.

c. Proposed Cross-Commodity Hedges

In paragraph (5) of the proposed definition of a bona fide hedging position, the Commission proposed to recognize as bona fide cross-commodity hedges.[485] Cross-commodity hedging would be conditioned on: (i) The fluctuations in value of the position in the commodity derivate contract (or the commodity underlying the commodity derivative contract) being substantially related to the fluctuations in value of the actual or anticipated cash position or pass-through swap (the substantially related test); and (ii) the five-day rule being applied to positions in any physical-delivery commodity derivative contract. The Commission proposed a non-exclusive safe harbor for cross-commodity hedges that would have two factors: A qualitative factor; and a quantitative factor.

Comments on cross-commodity hedges: Numerous commenters requested the Commission withdraw the safe harbor quantitative “test,” and noted such test is impracticable where there is no relevant cash market price series for the commodity being hedged.[486] Some commenters requested the Commission retain a qualitative approach to assessing whether the fluctuations in value of the position in the commodity derivate contract are substantially related to the fluctuations in value of the actual or anticipated cash position.

One commenter urged the Commission to clarify that market participants need not treat as enumerated cross-commodity hedges strategies where the cash position being hedged is the same cash commodity as the commodity underlying the futures contract even if the cash commodity is not deliverable against the contract. The commenter believes that this clarification would verify that non-deliverable grades of certain commodities could be deemed as the same cash commodity and thus not be deemed a cross-commodity hedge subject to the five-day rule.[487]

Commenters requested the Commission not apply a five-day rule to cross-commodity hedges or, alternatively, permit exchanges to determine the appropriate facts and circumstances where a market participant may be permitted to hold such positions into the spot month, Start Printed Page 96753noting that a cross-commodity hedge in a physical-delivery contract may be the best hedge of its commercial exposure.[488]

Commission Reproposal: The Reproposal retains the cross-commodity hedge provision in paragraph (5) of the definition of a bona fide hedging position as proposed. However, for the reasons requested by commenters and because of confusion regarding application of a safe harbor, the Reproposal does not include the safe harbor quantitative test. If questions arise regarding the bona fides of a particular cross-commodity hedge, it would, as reproposed, be reviewed based on facts and circumstances, including a market participant's qualitative review of a particular cross-commodity hedge.

The Reproposal retains the five-day rule, because a market participant who is hedging the price risk of a non-deliverable cash commodity has no need to make or take delivery on a physical-delivery contract. However, the Commission notes that an exchange may consider, on a case-by-case basis in physical-delivery contracts, whether to recognize such cross-commodity positions as non-enumerated bona fide hedges during the shorter of the last five days of trading or the time period for the spot month, by applying the exchange's experience and expertise in protecting its own physical-delivery market, under the process of § 150.9.

4. Commodity Trade Options Deemed Cash Equivalents

Commission proposal: The Commission requested comment as to whether the Commission should use its exemptive authority under CEA section 4a(a)(7) to provide that the offeree of a commodity option would be presumed to be a pass-through swap counterparty for purposes of the offeror of the trade option qualifying for the pass-through swap offset exemption.[489] Alternatively, the Commission, noting that forward contracts may serve as the basis of a bona fide hedging position exemption, proposed that it may similarly include trade options as one of the enumerated bona fide hedging exemptions. The Commission noted, for example, such an exemption could be similar to the enumerated exemption for the offset of the risk of a fixed-price forward contract with a short futures position.

Comments on trade option exemptions: Commenters requested that the Commission clarify that hedges of commodity trade options be recognized as bona fide hedges, as would be available for other cash positions.[490]

Commission Reproposal: The Commission agrees with the commenters and has determined to address the request that commodity trade options should be recognized as the basis for a bona fide hedging position, as would be available for other cash positions. The reproposed definition of a bona fide hedging position adds new paragraph (6), specifying that a commodity trade option meeting the requirements of § 32.3 may be deemed a cash commodity purchase or sales contract, as the case may be, provided that such option is adjusted on a futures-equivalent basis. The reproposed definition also provides non-exclusive guidance on making futures-equivalent adjustments to a commodity trade option. For example, the guidance provides that the holder of a trade option, who has the right, but not the obligation, to call the commodity at a fixed price, may deem that trade option, converted on a futures-equivalent basis, to be a position in a cash commodity purchase contract, for purposes of showing that the offset of such cash commodity purchase contract is a bona fide hedging position.

Because the price risk of an option, including a trade option with a fixed strike price, should be measured on a futures-equivalent basis,[491] the Commission has determined that under the reproposed definition, a trade option should be deemed equivalent to a cash commodity purchase or sales contract only if adjusted on a futures-equivalent basis. The Commission notes that it may not be possible to compute a futures-equivalent basis for a trade option that does not have a fixed strike price. Thus, under the reproposed definition, a market participant may not use a trade option as a basis for a bona fide hedging position until a fixed strike price reasonably may be determined.

5. App. C to Part 150—Examples of Bona Fide Hedging Positions for Physical Commodities

Commission proposal: The Commission proposed a non-exhaustive list of examples meeting the requirements of the proposed definition of a bona fide hedging position, noting that market participants could see whether their practices fall within the list.[492]

Comments on examples: Comments regarding the processing hedge example number 5 of proposed Appendix C to part 150 are discussed above. Another commenter requested the Commission affirm that aggregation is required pursuant to an express or implied agreement when that agreement is to trade referenced contracts, and that aggregation is not triggered by the condition in example number 7 of proposed Appendix C to part 150, where a Sovereign grants an option to a farmer at no cost, conditioned on the farmer entering into a fixed-price forward sale.[493]

Commission Reproposal: The Commission agrees with the commenter that aggregation is required pursuant to an express or implied agreement when that agreement is to trade referenced contracts. Proposed example number 7 was focused on recognizing the legitimate public policy objectives of a sovereign furthering the development of a cash spot and forward market in agricultural commodities. To avoid confusion regarding the aggregation policy under rule 150.4, in the Reproposal, the Commission has revised example number 7, and has provided an interpretation that a farmer's synthetic position of a long put option may be deemed a pass-through swap, for purposes of a sovereign who has granted a cash-settled call option at no cost to such farmer in furtherance of a public policy objective to induce such farmer to sell production in the cash market. The Commission notes the combination of a farmer's forward sale agreement and a granted call option is approximately equivalent to a purchased put option. A farmer anticipating production or holding inventory may use such a long position in a put option as a bona fide hedging position.

The Reproposal also includes a number of conforming amendments and corrections of typographical errors. Specifically, it conforms example number 4 regarding a utility to the Start Printed Page 96754changes to paragraph (3)(iii)(B) of the bona fide hedging position definition, as discussed above. The references in the examples to a 12-month restriction on hedges of agricultural commodities have also been removed because the Reproposal eliminates those proposed restrictions from the reproposed enumerated bona fide hedging positions, as discussed above. In addition, based on discussions with cotton merchants, example number 6, regarding agent hedging, has been amended from a generic example to a specific illustration of the hedge of cotton equities purchased by a cotton merchant from a producer, under the USDA loan program. Finally, the Reproposal corrects typographical errors in example number 12, regarding the hedge of copper inventory and the cross-hedge of copper wire inventory, to correctly reflect the 25,000 pound unit of trading in the Copper core referenced futures contract, and deletes the unnecessary reference to the price relationship between the nearby and deferred Copper futures contracts.

B. § 150.2—Position Limits

1. Setting Levels of Spot Month Limits

In the December 2013 Position Limits Proposal, the Commission proposed to establish speculative position limits on 28 core referenced futures contracts in physical commodities.[494]

As stated in the December 2013 Position Limits Proposal, the Commission proposed to set the initial spot month position limit levels for referenced contracts at the existing DCM-set levels for the core referenced futures contracts because the Commission believed this approach to be consistent with the regulatory objectives of the Dodd-Frank Act amendments to the CEA and many market participants are already used to those levels.[495] The Commission also stated that it was considering setting initial spot month limits based on estimated deliverable supplies submitted by CME Group Inc. (“CME”) in 2013.[496] The Commission suggested that it might use the exchange's estimated deliverable supplies if it could verify that they are reasonable.[497] The Commission further stated that it was considering another alternative of using, in the Commission's discretion, the recommended level, if any, of the spot month limit as submitted by each DCM listing a core referenced futures contract (if lower than 25 percent of estimated deliverable supply).[498]

2. Verification of Estimated Deliverable Supply

The Commission received comment letters from CME, Intercontinental Exchange (“ICE”) and Minneapolis Grain Exchange, Inc. (“MGEX”) containing estimates of deliverable supply. CME submitted updated estimates of deliverable supply for CBOT Corn (C), Oats (O), Rough Rice (RR), Soybeans (S), Soybean Meal (SM), Soybean Oil (SO), Wheat (W), and KC HRW Wheat (KW); COMEX Gold (GC), Silver (SI), Platinum (PL), Palladium (PA), and Copper (HG); NYMEX Natural Gas (NG), Light Sweet Crude Oil (CL), NY Harbor ULSD (HO), and RBOB Gasoline (RB).[499] ICE submitted estimates of deliverable supply for Cocoa (CC), Coffee C (KC), Cotton No. 2 (CT), FCOJ-A (OJ), Sugar No. 11 (SB), and Sugar No. 16 (SF).[500] MGEX submitted an estimate of deliverable supply for Hard Red Spring Wheat (MWE).[501]

The Commission is verifying that the estimates for C, O, RR, S, SM, SO, W, and KW submitted by CME are reasonable. The Commission is verifying that the estimate for MWE submitted by MGEX is reasonable. The Commission is verifying that the estimates for CC, KC, CT, OJ, SB, and SF submitted by ICE are reasonable. The Commission is verifying that the estimates for GC, SI, PL, PA, and HG submitted by CME are reasonable. Finally, the Commission is verifying that the estimates for NG, CL, HO, and RB submitted by CME are reasonable. In verifying that all of these estimates of deliverable supply are reasonable, Commission staff reviewed the exchange submissions and conducted its own research. Commission staff reviewed the data submitted, confirmed that the data submitted accurately reflected the source data, and considered whether the data sources were authoritative. Commission staff considered whether the assumptions made by the exchanges in the submissions were acceptable, or whether alternative assumptions would lead to similar results. In response to Commission staff questions about the exchange submissions, the Commission received revised estimates from exchanges. In some cases, Commission staff conducted trade source interviews. Commission staff replicated the calculations included in the submissions.Start Printed Page 96755

In verifying the exchange estimates of deliverable supply, the Commission is not endorsing any particular methodology for estimating deliverable supply beyond what is already set forth in Appendix C to part 38 of the Commission's regulations.[502] As circumstances change over time, exchanges may need to adjust the methodology, assumptions and allowances that they use to estimate deliverable supply to reflect then current market conditions and other relevant factors. The Commission anticipates that it will base initial spot-month position limits on the current verified exchange estimates as and to the extent described below, unless an exchange provides additional updates during the Reproposal comment period that the Commission can verify as reasonable.

3. Single-Month and All-Months-Combined Limits

Commission Proposal: In the December 2013 Position Limits Proposal, the Commission proposed to set the level of single-month and all-months-combined limits (collectively, non-spot month limits) based on total open interest for all referenced contracts in a commodity.[503] The Commission also proposed to estimate average open interest based on the largest annual average open interest computed for each of the past two calendar years, using either month-end open contracts or open contracts for each business day in the time period, as the Commission finds in its discretion to be reliable.[504] For setting the levels of initial non-spot month limits, the Commission proposed to use open interest for calendar years 2011 and 2012 in futures contracts, options thereon, and in swaps that are significant price discovery contracts that are traded on exempt commercial markets.[505] The Commission explained that it had reviewed preliminary data submitted to it under part 20, but preliminarily decided not to use it for purposes of setting the initial levels of single-month and all-months-combined position limits because the data prior to January 2013 was less reliable than data submitted later.[506] The Commission noted that it was considering using part 20 data, should it determine such data to be reliable, in order to establish higher initial levels in a final rule.[507]

In the June 2016 Supplemental Proposal, the Commission noted that, since the December 2013 Position Limits Proposal, the Commission worked with industry to improve the quality of swap position data reported to the Commission under part 20.[508] The Commission also noted that, in light of the improved quality of such swap position data reporting, the Commission intended to rely on part 20 swap position data, given adjustments for obvious errors (e.g., data reported based on a unit of measure, such as an ounce, rather than a futures-equivalent number of contracts), to establish initial levels of federal non-spot month limits on futures and swaps in a final rule.

Comments Received: Commenters requested that the Commission delay the imposition of hard non-spot month limits until it has collected and evaluated complete open interest data.[509]

Commission Reproposal: The Commission has determined that certain part 20 large trader position data, after processing and editing by Commission staff as described below,[510] is reliable. The Commission has determined to repropose the initial non-spot month position limit levels based on the combination of such adjusted part 20 swaps data and data on open interest in physical commodity futures and options from the relevant exchanges, as described below. The Commission is using two 12-month periods of data, covering a total of 24 months, rather than two calendar years of data, as is practicable, in reproposing the initial non-spot month position limit levels.

Data Editing

Commission staff analyzed and evaluated the quality of part 20 data for the period from July 1, 2014 through June 30, 2015 (“Year 1”), and the period from July 1, 2015 through June 30, 2016 (“Year 2”).[511] The Commission used open contracts as reported for each business day in the time periods, rather than month-end open contracts, primarily because it lessens the impact of missing data. Averaging generally also smooths over errors in reporting when there is both under- and over-reporting, both of which the Commission observed in the part 20 data. By calculating a daily average for each month for each reporting entity,[512] one calculates a reporting entity's open contracts on a “representative day” for each month. The Commission then summed the open contracts for each reporting entity on this representative day, to determine the average open interest for a particular month.[513]

First, for each of Year 1 and Year 2, Commission staff identified all reported positions in swaps that do not satisfy the definition of referenced contract as proposed in the December 2013 Position Limits Proposal [514] and removed those positions from the data set. For example, swaps settled using the price of the LME Gold PM Fix contract do not meet the definition of referenced contract for the gold core referenced futures contract (GC) but positions reported based on these types of swaps represented 14% of records submitted Start Printed Page 96756under part 20 by reporting entities for gold swaps. The percentage of average daily open interest excluded from the adjusted part 20 swaps data resulting from this deletion are set forth in Table 1 below. Other adjustments to the data are described below. Because not all commodities required exclusion of non-referenced contracts, the Commission reports only the 11 commodities that required this type of exclusion.

Table III-B-1—Percent of Adjusted Average Daily Open Interest Excluded as Not Meeting the Definition of Referenced Contract

Core referenced futures contractYear 1 percent of excluded adjusted open interest (%)Year 2 percent of excluded adjusted open interest (%)
Cotton No. 2 (CT)0.220.00
Sugar No. 11 (SB)0.050.00
Gold (GC)42.590.00
Silver (SI)48.100.00
Platinum (PL)9.125.36
Palladium (PA)56.876.87
Copper (HG)37.580.25
Natural Gas (NG)12.4912.52
Light Sweet Crude (CL)3.600.83
New York Harbor ULSD (HO)0.961.74
RBOB Gasoline (RB)1.341.30

Second, Commission staff checked and edited the remaining data to mitigate certain types of errors. Commission staff identified three general types of reporting errors and made edits to adjust the data for:

(i) Positions that were clearly reported in units of a commodity when they should have been reported in the number of gross futures-equivalent contracts. For example, a position in gold (GC) with a futures contract unit of trading of 100 ounces might be reported as 480,000 contracts, when other available information, reasonable assumptions, consultation with reporting entities and/or Commission expertise indicate that the position should have been reported as 4,800 contracts (that is, 480,000 ounces divided by 100 ounces per contract). Commission staff corrected such reported swaps position data and included the corrected data in the data set.

(ii) Positions that are not obviously reported in units of a commodity but appear to be off by one or more decimal places (e.g., a position is overstated, but not by a multiple of the contract's unit of trading). For example, a position in COMEX gold is reported as 100,000 and the notional value might be reported as $13,000,000, when the price of gold is $1300 and the COMEX gold contract is for 100 ounces, indicating that the position should have been reported as 100 futures-equivalent contracts. Staff corrected such reported swaps position data and included the corrected data in the data set.

(iii) Positions reported multiple times per day or otherwise extremely different from surrounding days' reported open interest. In some cases, reporting entities submitted the same report using different reporting identifiers, for the same day. In other cases, a position would inexplicably spike for one day, to a multiple of other days' reported open interest. When Commission staff checked with the reporting entity, the reporting entity confirmed that the reports were, indeed, erroneous. Commission staff did not include such incorrectly reported duplicative swaps position data in its analysis. In other cases, positions that were clearly reported incorrectly, but for which Commission staff could discern neither a reason nor a reasonable adjustment, were not included. For example, Commission staff deleted all swap position data reports submitted by one swap dealer from its analysis because the reports were inexplicably anomalous in light of other available information, reasonable assumptions and Commission expertise. As another example, one reporting entity reported extremely large values for only certain types of positions. After speaking with the reporting entity, Commission staff determined that there was no systematic adjustment to be made, but that the actual positions were, in fact, small. Hence, Commission staff did not include such reported swaps position data in its analysis.

The number of principal records edited, resulting from the edits relating to the three types of edits to erroneous position reports noted above, is set forth in Table 2 below. A principal record is a report of a swaps open position where the reporting entity is a principal to the swap, as opposed to a counterparty record.

Table III-B-2—Percentage of Principal Records Adjusted by Edit Type and Underlying Commodity, Referenced Contracts Only

Edit typeNumber of records adjusted year 1 (%)Number of records adjusted year 2 (%)
Corn (C)(i)0.000.0001
(iii)0.000.66
Oats (O)(iii)0.000.20
Rough Rice (RR)(iii)0.380.00
Start Printed Page 96757
Soybeans (S)(i)0.000.03
(iii)2.381.46
Soybean Meal (SM)(iii)0.000.41
Soybean Oil (SO)(iii)9.154.93
Wheat (W)(i)0.000.01
(iii)1.770.71
Wheat (MWE)(iii)0.0430.002
Wheat (KW)(iii)1.340.68
Cocoa (CC)(i)0.0010.0005
(iii)1.790.25
Coffee C (KC)(i)0.000.01
(iii)5.330.60
Cotton No. 2 (CT)(iii)16.765.59
FCOJ-A (OJ)(iii)13.3017.43
Sugar No. 11 (SB)(i)0.000.0009
(iii)1.210.54
Live Cattle (LC)(i)0.0020.00
(iii)45.6515.50
Gold (GC)(i)1.990.02
(ii)0.320.00
(iii)91.4589.04
Silver (SI)(i)3.010.19
(iii)93.0889.52
Platinum (PL)(i)2.750.01
(ii)0.330.01
(iii)23.5121.11
Palladium (PA)(i)0.620.00
(ii)0.300.00
(iii)32.9722.29
Copper (HG)(i)4.940.48
(iii)20.8016.82
Natural Gas (NG)(i)0.011.03
(iii)7.683.80
Light Sweet Crude (CL)(i)0.0010.003
(iii)9.538.43
New York Harbor ULSD (HO)(i)0.010.0006
(iii)29.584.33
RBOB Gasoline (RB)(i)0.220.60
(iii)30.4624.62

Some records also appeared to contain errors attributable to other factors that Commission staff could detect and for which Commission staff can correct. For example, there were instances where the reporting entity misreported the ownership of the position, i.e., principal vs. counterparty. Commission staff corrected the misreported ownership data and included the corrected data in the data set. Such corrections are important to ensure that data is not double counted. In Year 1, eight reporting entities required an adjustment to the reported position ownership information. In Year 2, five reporting entities required an adjustment to the reported position ownership information.

Third, in the part 20 large trader swap data, staff checked and adjusted the average daily open interest for positions resulting from inter-affiliate transactions and duplicative reporting of positions due to transactions between reporting entities. For an example of duplicative reporting by reporting entities (which is reporting in terms of futures-equivalent contracts), assume Swap Dealer A and Swap Dealer B have an open swap equivalent to 50 futures contracts, Swap Dealer A also has a swap equivalent to 25 futures contracts with End User X, and Swap Dealer B has a swap equivalent to 200 futures contracts with End User Y. The total open swaps in this scenario is equivalent to 275 futures contracts. However, Swap Dealer A will report a gross position of 75 contracts and Swap Dealer B will report a gross position of 250 contracts. Simply summing these two gross positions would overestimate the open swaps as 325 contracts—50 contracts more than there actually should be. For this reason, Commission staff used the counterparty accounts of each reporting entity to flag counterparty accounts of other reporting entities. Commission staff then used the daily average of the gross positions for these accounts to reduce the amount of average daily open swaps. Similarly, Commission staff flagged the counterparty accounts for entities that are affiliates of each reporting entity in order to adjust the amount of average daily open swaps. These adjustments to the Year 1 data are reflected in Table 3 below, and the corresponding adjustments to the Year 2 data are reflected in Table 4 below.Start Printed Page 96758

Table III-B-3—Average Daily Open Interest in Year 1 Adjusted for Duplicate and Affiliate Reporting by Underlying Commodity

Paired swaps forAverage adjusted daily open interestAverage adjusted daily open interest reporting entity duplication removedAverage adjusted daily open interest reporting entity duplication & affiliates removed
Corn (C)655,492522,566359,715
Oats (O)684667646
Rough Rice (RR)916640362
Soybeans (S)157,017139,608109,858
Soybean Meal (SM)125,44499,79571,887
Soybean Oil (SO)74,83164,85455,265
Wheat (W)272,839229,453162,999
Wheat (MGE)3,4303,0211,944
Wheat (KW)14,91814,2139,436
Cocoa (CC)15,20713,79211,257
Coffee C (KC)31,54028,53924,164
Cotton No. 2 (CT)51,44242,80635,102
FCOG-A (OJ)160142121
Sugar No. 11 (SB)279,355256,887211,994
Live Cattle (LC)46,36136,99923,626
Gold (GC)79,77864,36347,727
Silver (SI)19,37314,6789,867
Platinum (PL)25,14524,53021,566
Palladium (PA)2,0441,9391,929
Copper (HG)31,14328,71822,859
Natural Gas (NG)4,100,4193,603,3682,866,128
Light Sweet Crude (CL)2,039,9631,875,6601,587,450
NY Harbor ULSD (HO)178,978161,617138,360
RBOB Gasoline (RB)103,586100,02181,822

Table III-B-4—Average Daily Open Interest in Year 2 Adjusted for Duplicate and Affiliate Reporting by Underlying Commodity

Paired swaps forAverage adjusted daily open interestAverage adjusted daily open interest reporting entity duplication removedAverage adjusted daily open interest reporting entity duplication & affiliates removed
Corn (C)1,265,639960,088641,014
Oats (O)1,029858480
Rough Rice (RR)3962504
Soybeans (S)453,419351,279235,679
Soybean Meal (SM)282,123209,023134,399
Soybean Oil (SO)282,207198,744125,106
Wheat (W)437,711334,136222,420
Wheat (MWE)15,1679,5113,079
Wheat (KW)65,53347,72229,563
Cocoa (CC)141,526100,56456,853
Coffee C (KC)97,12874,73951,846
Cotton No. 2 (CT)137,29599,49660,477
FCOJ-A (OJ)1,1376405
Sugar No. 11 (SB)717,967558,423382,816
Live Cattle (LC)102,13177,78352,330
Gold (GC)62,80450,05436,029
Silver (SI)9,3066,2073,510
Platinum (PL)2,5752,5072,285
Palladium (PA)889857823
Copper (HG)82,47965,18747,365
Natural Gas (NG)4,239,5813,828,7393,331,141
Light Sweet Crude (CL)2,318,0742,050,2701,744,137
NY Harbor ULSD (HO)170,316117,00465,721
RBOB Gasoline (RB)102,09466,56030,477

Staff made numerous significant adjustments to the part 20 data for natural gas, due to numerous reports in units rather than the number of gross futures-equivalent contracts and the large number of reports of swaps that did not meet the definition of referenced contract.Start Printed Page 96759

The Commission continues to be concerned about the quality of data submitted in large trader reports pursuant to part 20 of the Commission's regulations. Commissioners and staff have expressed concerns about data reporting publicly on a variety of occasions.[515] Nevertheless, the Commission anticipates that over time part 20 submissions will become more reliable and intensive efforts by Commission staff to process and edit raw data will become less necessary. As stated in the December 2013 Position Limits Proposal, for setting subsequent levels of non-spot month limits, the Commission proposes to estimate average open interest in referenced contracts using data reported pursuant to parts 16, 20, and/or 45.[516] It is crucial, therefore, that market participants make sure they submit accurate data to the Commission, and resubmit data discovered to be erroneous, because subsequent limit levels will be based on that data. Reporting is at the heart of the Commission's market and financial surveillance programs, which are critical to the Commission's mission to protect market participants and promote market integrity. Failure to meet reporting obligations to the Commission by submitting reports and data that contain errors and omissions in violation of the part 20 regulations may subject reporting entities to enforcement actions and remedial sanctions.[517]

4. Setting Levels of Spot-Month Limits

In the December 2013 Position Limits Proposal, the Commission proposed to set the initial spot month speculative position limit levels for referenced contracts at the existing DCM-set levels for the core referenced futures contracts.[518] As an alternative, the Commission stated that it was considering using 25 percent of an exchange's estimate of deliverable supply if the Commission verified the estimate as reasonable.[519] As a further alternative, the Commission stated that it was considering setting initial spot month position limit levels at a recommended level, if any, submitted by a DCM (if lower than 25 percent of estimated deliverable supply).[520]

In determining the levels at which to repropose the initial speculative position limits, the Commission considered, without limitation, the recommendations of the exchanges as well as data to which the exchanges do not have access. In considering these and other factors, the Commission became very concerned about the effect of alternative limit levels on traders in the cash-settled referenced contracts. A DCM has reasonable discretion in establishing the manner in which it complies with core principle 5 regarding position limits.[521] As the Commission observed in the December 2013 Position Limits Proposal, “there may be a range of spot month limits, including limits set below 25 percent of deliverable supply, which may serve as practicable to maximize . . . [the] policy objectives [set forth in section 4a(a)(3)(B) of the CEA].” [522] The Commission must also consider the competitiveness of futures markets.[523] Thus, the Commission accepts the recommendations of the exchanges and has determined to repropose federal limits below 25 percent of deliverable supply, where setting a limit level at less than 25 percent of deliverable supply does not appear to restrict unduly positions in the cash-settled referenced contracts. The exchanges retain the ability to adopt lower exchange-set limit levels than the initial Start Printed Page 96760speculative position limit levels that the Commission reproposes today.

a. CME and MGEX Agricultural Contracts

As explained above, the Commission has verified that the estimates of deliverable supply for each of the CBOT Corn (C), Oats (O), Rough Rice (RR), Soybeans (S), Soybean Meal (SM), Soybean Oil (SO), Wheat (W) core referenced futures contract, the Hard Red Winter Wheat (KW) core referenced futures contract submitted by CME, and the Hard Red Spring Wheat (MWE) core referenced futures contract submitted by MGEX are reasonable.

Nevertheless, the Commission has determined to repropose the initial speculative spot month position limit levels for C, O, RR, S, SM, SO, W and KW at the recommended levels submitted by CME,[524] all of which are lower than 25 percent of estimated deliverable supply.[525] As is evident from the table set forth below, this also means that the Commission is reproposing the initial speculative position limit levels for these eight contracts as proposed in the December 2013 Position Limits Proposal. These initial levels track the existing DCM-set levels for the core referenced futures contracts; [526] therefore, as noted in the December 2013 Position Limits Proposal, many market participants are already used to these levels.[527] The Commission continues to believe this approach is consistent with the regulatory objectives of the Dodd-Frank Act amendments to the CEA.

Table III-B-5—CME Agricultural Contracts—Spot Month Limit Levels

ContractPreviously proposed limit level 52825% of estimated deliverable supply 529Reproposed speculative limit level
C600900600
O600900600
RR6002,300600
S6001,200600
SM7202,000720
SO5403,400540
W 5306001,000600
KW6003,000600

The Commission has also determined to repropose the initial speculative spot month position limit level for MWE at 1,000 contracts, which is the level requested by MGEX [531] and just slightly lower than 25 percent of estimated deliverable supply.[532] This is an increase from the previously proposed level of 600 contracts and is greater than the reproposed speculative spot month position limit levels for W and KW.[533] Upon deliberation, the Commission accepts the recommendation of MGEX.[534]

Table III-B-6—CME and MGEX Agricultural Contracts—Spot Month

Core referenced futures contractBasis of spot-month levelLimit levelUnique persons over spot month limitReportable persons spot month only
Cash settled contractsPhysical delivery contracts
Corn (C)CME recommendation† 6000361,050
25% DS900020
Oats (O)CME recommendation† 6000033
25% DS90000
Soybeans (S)CME recommendation† 600022929
25% DS1,200014
Soybean Meal (SM)CME recommendation† 720014381
25% DS2,0000*
Start Printed Page 96761
Soybean Oil (SO)CME recommendation† 540021397
25% DS3,40000
Wheat (W)CME recommendation† 600011444
25% DS1,00006
Wheat (MWE)Parity w/CME recommendation† 6000*102
25% DS†† 1,0000*
Wheat (KW)CME recommendation† 60004250
25% DS (MW)1,0000*
25% DS (KW)3,0000*
Rough Rice (RR)CME recommendation† 6000091
25% DS2,30000
Reproposed speculative position limit levels are shown in bold.
“25% DS” means 25 percent of the deliverable supply as estimated by the exchange listing the core referenced futures contract.
† Denotes existing limit level.
†† Limit level requested by MGEX.
* Denotes fewer than 4 persons.

The Commission's impact analysis reveals no traders in cash settled contracts in any of C, O, S, SM, SO, W, MWE, KW, or RR, and no traders in physical delivery contracts for O and RR, above the initial speculative limit levels for those contracts. The Commission found varying numbers of traders in the C, S, SM, SO, W, MWE, KW physical delivery contracts over the initial levels, but the numbers were very small for MWE and KW.[535] Because the levels that the Commission reproposes today for C, O, S, SM, SO, W, KW, and RR maintain the status quo for those contracts, the Commission assumes that some or possibly all of such traders over the initial levels are hedgers. Hedgers may have to file for an applicable exemption, but hedgers with bona fide hedging positions should not have to reduce their positions as a result of speculative position limits per se. Thus, the number of traders in the C, S, SM, SO, W and KW physical delivery contracts who would need to reduce speculative positions below the initial limit levels should be lower than the numbers indicated by the impact analysis. The Commission believes that setting initial speculative levels at 25 percent of deliverable supply would, based upon logic and the Commission's impact analysis, affect fewer traders in the C, S, SM, SO, W and KW physical delivery contracts. Consistent with its statement in the December 2013 Position Limits Proposal, the Commission believes that accepting the recommendation of the DCM to set these lower levels of initial spot month limits will serve the objectives of preventing excessive speculation, manipulation, squeezes and corners,[536] while ensuring sufficient market liquidity for bona fide hedgers in the view of the listing DCM and ensuring that the price discovery function of the market is not disrupted.[537]

b. Softs

As explained above, the Commission has verified that the estimates of deliverable supply for each of the IFUS Cocoa (CC), Coffee “C” (KC), Cotton No. 2 (CT), FCOJ-A (OJ), Sugar No. 11 (SB), and Sugar No. 16 (SF) core referenced futures contracts submitted by ICE are reasonable.

The Commission has determined to repropose the initial speculative spot month position limit levels for the CC, KC, CT, OJ, SB, and SF [538] core referenced futures contracts at 25 percent of estimated deliverable supply, based on the estimates of deliverable supply submitted by ICE.[539] As is evident from the table set forth below, this also means that the Commission is reproposing initial speculative position limit levels that are significantly higher than the levels for these six contracts as previously proposed. As stated in the December 2013 Position Limits Proposal, the 25 percent formula “is consistent with the longstanding acceptable practices for DCM core principle 5 which provides that, for physical-delivery contracts, the spot-month limit should not exceed 25 percent of the estimated deliverable supply.” [540] The Commission continues to believe, based on its experience and expertise, that the 25 percent formula is an “effective prophylactic tool to reduce the threat of corners and squeezes, and promote convergence without compromising market liquidity.” [541]

Table III-B-7—IFUS Soft Agricultural Contracts—Spot Month Limit Levels

ContractPreviously proposed limit level 54225% of estimated deliverable supply 543Reproposed speculative limit level
CC1,0005,5005,500
Start Printed Page 96762
KC5002,4002,400
CT3001,6001,600
OJ3002,8002,800
SB5,00023,30023,300
SF1,0007,0007,000

The Commission did not receive any estimate of deliverable supply for the CME Live Cattle (LC) core referenced futures contract from CME, nor did CME recommend any change in the limit level for LC. In the absence of any such update, the Commission is reproposing the initial speculative position limit level of 450 contracts. Of 616 reportable persons, the Commission's impact analysis did not reveal any unique person trading cash settled or physical delivery spot month contracts who would have held positions above this level for LC.

With respect to the IFUS CC, KC, CT, OJ, SB, and SF core referenced futures contracts, the Commission's impact analysis did not reveal any unique person trading cash settled spot month contracts who would have held positions above the initial levels that the Commission adopts today; as illustrated below, lower levels would mostly have affected small numbers of traders in physical delivery contracts.

Table III-B-8—IFUS Soft Agricultural Contracts—Spot Month

Core referenced futures contractBasis of spot-month levelLimit levelUnique persons over spot month limitReportable persons spot month only
Cash settled contractsPhysical delivery contracts
Cocoa (CC)15% DS3,30000164
25% DS†† 5,50000
Coffee “C” (KC)15% DS1,4400*336
25% DS†† 2,4000*
Cotton No. 2 (CT)15% DS9600*122
25% DS†† 1,60000
FCOJ-A (OJ)15% DS1,6800038
25% DS†† 2,80000
Sugar No. 11 (SB)15% DS13,980*10443
25% DS†† 23,3000*
Sugar No. 16 (SF)15% DS4,2000012
†† 25% DS†† 7,00000
Reproposed speculative position limit levels are shown in bold.
“15% DS” means 15 percent of the deliverable supply as estimated by the exchange listing the core referenced futures contract and is included to provide information regarding the distribution of reportable traders.
“25% DS” means 25 percent of the deliverable supply as estimated by the exchange listing the core referenced futures contract.
†† Limit level requested by ICE.
* Denotes fewer than 4 persons.

c. Metals

As explained above, the Commission has verified that the estimates of deliverable supply for each of the COMEX Gold (GC), COMEX Silver (SI), NYMEX Platinum (PL), NYMEX Palladium (PA), and COMEX Copper (HG) core referenced futures contracts submitted by CME are reasonable.

Nevertheless, the Commission has determined to repropose the initial speculative spot month position limit levels for GC, SI, and HG at the recommended levels submitted by CME,[544] all of which are lower than 25 percent of estimated deliverable supply.[545] In the case of GC and SI, this is a doubling of the current exchange-set limit levels.[546] In the case of HG, the initial level is the same as the existing DCM-set level for the core referenced futures contract and lower than the level previously proposed.

Table III-B-9—CME Metals Contracts—Spot Month Limit Levels

ContractPreviously proposed limit level 54725% of estimated deliverable supply 548Reproposed speculative limit level
GC3,00011,2006,000
Start Printed Page 96763
SI1,5005,6003,000
PL500900100
PA650900−500
HG1,2001,1001,000

The Commission has also determined to repropose the initial speculative spot month position limit level for PL at 100 contracts and PA at 500 contracts, which are the levels recommended by CME. In the case of PL and PA, the reproposed level is the same as the existing DCM-set level for the core referenced futures contract, and a decrease from the previously proposed levels of 500 and 650 contracts, respectively.

The Commission found varying numbers of traders in the GC, SI, PL, PA, and HG physical delivery contracts over the initial levels, but the numbers were very small except for PA.[549] Because the levels that the Commission reproposes today for PL, PA, and HG maintain the status quo for those contracts, the Commission assumes that some or possibly all of such traders over the reproposed levels are hedgers. The Commission reiterates the discussion above regarding agricultural contracts: hedgers may have to file for an applicable exemption, but hedgers with bona fide hedging positions should not have to reduce their positions as a result of speculative position limits per se. Thus, the number of traders in the metals physical delivery contracts who would need to reduce speculative positions below the reproposed limit levels should be lower than the numbers indicated by the impact analysis. And, while setting initial speculative levels at 25 percent of deliverable supply would, based upon logic and the Commission's impact analysis, affect fewer traders in the metals physical delivery contracts, consistent with its statement in the December 2013 Position Limits Proposal, the Commission believes that setting these lower levels of initial spot month limits will serve the objectives of preventing excessive speculation, manipulation, squeezes and corners,[550] while ensuring sufficient market liquidity for bona fide hedgers in the view of the listing DCM and ensuring that the price discovery function of the market is not disrupted.

Table III-B-10—CME Metal Contracts—Spot Month

Core referenced futures contractBasis of spot-month levelLimit levelUnique persons over spot month limitReportable persons spot month only
Cash settled contractsPhysical delivery contracts
Gold (GC)CME recommendation6,000**518
25% DS11,20000
Silver (SI)CME recommendation3,00000311
25% DS5,60000
Platinum (PL)CME recommendation† 50013*235
25% DS90010*
50% DS1,800*0
Palladium (PA)CME recommendation† 100614164
25% DS90000
Copper (HG)CME recommendation† 1,0000*493
25% DS1,1000*
Reproposed speculative position limit levels are shown in bold.
“25% DS” means 25 percent of the deliverable supply as estimated by the exchange listing the core referenced futures contract.
“50% DS” means 50 percent of the deliverable supply as estimated by the exchange listing the core referenced futures contract and is included to provide information regarding the distribution of reportable traders.
† Denotes existing exchange-set limit level.
* Denotes fewer than 4 persons.

The Commission's impact analysis reveals no unique persons in the SI and HG cash settled referenced contracts, and very few unique persons in the cash settled GC referenced contract, whose positions would have exceeded the initial limit levels for those contracts. Based on the Commission's impact analysis, setting the initial federal spot month limit levels for PL and PA at the lower levels recommended by CME would impact a few traders in PL and PA cash settled contracts.

The Commission has carefully considered the numbers of unique persons that would be impacted by each of the cash-settled and physical-delivery spot month limits in the PL and PA referenced contracts. The Commission notes those limits would appear to impact more traders in the physical-delivery PA contract than in the cash-settled PA contract, while fewer traders would be impacted in the physical-delivery PL contract than in the cash-settled PL contract (in any event, few traders would appear to be affected).[551]

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The Commission also observed the distribution of those cash-settled traders over time; as reflected in the open interest table discussed below regarding setting non-spot month limits, it can be readily observed that open interest in each of the cash-settled PL and PA referenced contracts was markedly lower in the second 12-month period (year 2) than in the prior 12-month period (year 1). Accordingly, the Commission accepts the CME recommended levels in PL and PA referenced contracts.

d. Energy

As explained above, the Commission has verified that the estimates of deliverable supply for each of the NYMEX Natural Gas (NG), Light Sweet Crude (CL), NY Harbor ULSD (HO), and RBOB Gasoline (RB) core referenced futures contracts submitted by CME are reasonable.

The Commission has determined to repropose the initial speculative spot month position limit levels for the NG, CL, HO, and RB core referenced futures contracts at 25 percent of estimated deliverable supply which, in the case of CL, HO, and RB is higher than the levels recommended by CME.[552] As is evident from the table set forth below, this also means that the Commission is reproposing speculative position limit levels that are significantly higher than the levels for these four contracts as previously proposed. As stated in the December 2013 Position Limits Proposal, the 25 percent formula “is consistent with the longstanding acceptable practices for DCM core principle 5 which provides that, for physical-delivery contracts, the spot-month limit should not exceed 25 percent of the estimated deliverable supply.” [553] The Commission continues to believe, based on its experience and expertise, that the 25 percent formula is an “effective prophylactic tool to reduce the threat of corners and squeezes, and promote convergence without compromising market liquidity.” [554]

Table III-B-11—CME Energy Contracts—Spot Month Limit Levels

ContractPreviously proposed limit level 55525% of estimated deliverable supply 556Reproposed speculative limit level
NG1,0002,0002,000
CL3,00010,40010,400
HO1,0002,9002,900
RB1,0006,8006,800

The levels that CME recommended for NG, CL, HO, and RB are twice the existing exchange-set spot month limit levels. Nevertheless, the Commission is reproposing speculative spot month limit levels at 25 percent of deliverable supply for CL, HO, and RB because the Commission believes that higher levels will lessen the impact on a number of traders in both cash settled and physical delivery contracts. For NG, the Commission is reproposing the physical delivery limit at 25% of deliverable supply, as recommended by CME; [557] the Commission is also reproposing a conditional spot month limit exemption of 10,000 for cash-settled contracts in natural gas only.[558] This exemption would to some degree maintain the status quo in natural gas because each of the NYMEX and ICE cash-settled natural gas contracts, which settle to the final settlement price of the physical delivery contract, include a conditional spot month limit exemption of 5,000 contracts (for a total of 10,000 contracts).[559] However, neither the Start Printed Page 96765NYMEX and ICE penultimate contracts, which settle to the daily settlement price on the next to last trading day of the physical delivery contract, nor OTC swaps, are currently subject to any spot month position limit. In addition, the Commission's impact analysis suggests that a conditional spot month limit exemption greater than 25% of deliverable supply for cash settled contracts in natural gas would potentially benefit many traders.

Table III-B-12—Energy Contracts—Spot Month

Core referenced futures contractBasis of spot-month levelLimit levelUnique persons over spot month limitReportable persons spot month only
Cash settled contractsPhysical delivery contracts
Natural Gas (NG)CME recommendation2,000131161,400
50% DS4,00077*
Conditional Exemption10,000200
Light Sweet Crude (CL)CME recommendation†† 6,0001981,733
25% DS10,40016*
50% DS20,800*0
NY Harbor ULSD (HO)CME recommendation2,0002411470
25% DS2,900155
50% DS5,80050
RBOB Gasoline (RB)CME recommendation2,0002314463
25% DS6,800*0
50% DS13,60000
Reproposed speculative position limit levels are shown in bold.
“25% DS” means 25 percent of the deliverable supply as estimated by the exchange listing the core referenced futures contract.
“50% DS” means 50 percent of the deliverable supply as estimated by the exchange listing the core referenced futures contract and is included to provide information regarding the distribution of reportable traders.
†† CME recommended a step-down spot month limit of 6,000/5,000/4,000 contracts in the last three days of trading.
* Denotes fewer than 4 persons.

5. Setting Levels of Single-Month and All-Months-Combined Limits

The Commission has determined to use the futures position limits formula, 10 percent of the open interest for the first 25,000 contracts and 2.5 percent of the open interest thereafter, to repropose the non-spot month speculative position limits for referenced contracts, subject to the details and qualifications set forth in this Notice.[560] The Commission continues to believe that “the non-spot month position limits would restrict the market power of a speculator that could otherwise be used to cause unwarranted price movements.” [561]

a. CME and MGEX Agricultural Contracts

The Commission is reproposing the non-spot month speculative position limit levels for the Corn (C), Oats (O), Rough Rice (RR), Soybeans (S), Soybean Meal (SM), Soybean Oil (SO), and Wheat (W) core referenced futures contracts based on the 10, 2.5 percent open interest formula.[562] Based on the Commission's experience since 2011 with non-spot month speculative position limit levels for the Hard Red Winter Wheat (KW) and Hard Red Spring Wheat (MWE) core referenced futures contracts, the Commission is reproposing the limit levels for those two commodities at the current level of 12,000 contracts rather than reducing them to the lower levels that would result from applying the 10, 2.5 percent formula.[563]

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Table III-B-13—CME and MGEX Agricultural Contracts—Non-Spot Month Limit Levels

ContractCurrent limit levelPreviously proposed limit levelReproposed speculative limit level
C33,00053,50062,400
O2,0001,6005,000
RR1,8002,2005,000
S15,00026,90031,900
SM6,5009,00016,900
SO8,00011,90016,700
W 56412,00016,20032,800
KW12,0006,50012,000
MWE12,0003,30012,000

Maintaining the status quo for the non-spot month limit levels for the KW and MWE core referenced futures contracts means there will be partial wheat parity.[565] The Commission has determined not to raise the reproposed limit levels for KW and MWE to the limit level for W, as 32,800 contracts appears to be extraordinarily large in comparison to open interest in the KW and MWE markets, and the limit levels for KW and MWE are already larger than a limit level based on the 10, 2.5 percent formula. Even when relying on a single criterion, such as percentage of open interest, the Commission has historically recognized that there can “result . . . a range of acceptable position limit levels.” [566]

Table III-B-14—CME and MGEX Agricultural Contracts—Non-Spot Months

Core-referenced futures contractOpen interestInitial limit levelUnique persons above limit levelReportable persons in market— all months
YearFuturesSwapsTotalAll monthsSingle month
Corn (C)11,829,359359,7152,189,07462,400**2,606
21,779,977641,0142,420,991
Oats (O)110,09764610,7435,00000173
211,22348011,703
Rough Rice (RR)110,58536210,9485,00000281
212,769412,773
Soybeans (S)1973,037109,8581,082,89531,900642,503
2962,636235,6791,198,315
Soybean Meal (SM)1422,61171,887494,49816,90054978
2463,549134,399597,948
Soybean Oil (SO)1421,11455,265476,37916,700541,034
2464,373125,106589,478
Wheat (W)11,072,107162,9991,235,10532,800**1,867
21,010,342222,4201,232,762
Wheat (MWE)167,6531,94469,596† 5,000107342
266,6083,07969,68712,00000
Wheat (KW)1169,0599,436178,495† 8,10098718
2216,23629,563245,79912,000**
Year 1 = July 1, 2014 to June 30, 2015
Year 2 = July 1, 2015 to June 30, 2016
Reproposed speculative position limit levels are shown in bold.
† Application of the 10, 2.5 percent formula would result in a level lower than the level adopted by the Commission in 2011.
* Denotes fewer than 4 persons.

b. Softs

The Commission is reproposing non-spot month speculative position limit levels for the CC, KC, CT, OJ, SB, SF and LC [567] core referenced futures contracts based on the 10, 2.5 percent open interest formula.

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Table III-B-15—Softs and Other Agricultural Contracts—Non-Spot Month Limit Levels

ContractPreviously proposed limit level 568Reproposed speculative limit level
CC7,10010,200
KC7,1008,800
CT8,8009,400
OJ2,9005,000
SB23,50038,400
SF1,2007,000
LC12,90012,200

Set forth below is a summary of the impact analysis for softs and live cattle.

Table III-B-16—Softs and Other Agricultural Contracts—Non-Spot Months

Core-referenced futures contractOpen interestInitial limit levelUnique persons above limit levelReportable persons in market— all months
YearFuturesSwapsTotalAll monthsSingle month
Cocoa (CC)1240,98411,257252,24010,200127682
2273,13456,853329,987
Coffee C (KC)1211,05124,164235,2158,8006*1,175
2223,88551,846275,731
Cotton No. 2 (CT)1238,58035,102273,6829,4001381,000
2239,32160,477299,798
FCOJ-A (OJ)116,88312117,0045,000
**242
216,336516,341
Sugar No. 11 (SB)11,016,271211,9941,228,26538,400149874
21,077,452382,8161,460,268
Sugar No. 16 (SF)18,38508,3857,000*022
29,60809,608
Live Cattle (LC)1387,89623,626411,52212,2009*1,436
2350,14752,330402,478
Year 1 = July 1, 2014 to June 30, 2015. Year 2 = July 1, 2015 to June 30, 2016. Reproposed speculative position limit levels are shown in bold.
* Denotes fewer than 4 persons.

c. Metals

The Commission is reproposing non-spot month speculative position limit levels for the GC, SI, PL, PA, and HG core referenced futures contracts based on the 10, 2.5 percent open interest formula.[569]

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Table III-B-17—CME Metals Contracts—Non-Spot Month Limit Levels

ContractPreviously proposed limit levelReproposed speculative limit level
GC21,50019,500
SI6,4007,600
PL50005,000
PA50005,000
HG5,6007,800

Set forth below is a summary of the impact analysis for metals.[570]

Table III-B-18—CME Metals Contracts—Non-Spot Months

Core-referenced futures contractOpen interestInitial limit levelUnique persons above limit levelReportable persons in market—all months
YearFuturesSwapsTotalAll monthsSingle month
Gold (GC)1618,73847,727666,46519,50019171,557
2667,49536,029703,525
Silver (SI)1218,0289,867227,8957,60015181,023
2203,6453,510207,155
Platinum (PL)170,15121,56691,7175,0002626842
270,7132,28572,997
Palladium (PA)137,4881,92939,4175,000**580
228,27682329,099
Copper (HG)1170,78422,859193,6437,80019121,457
2186,52547,365233,890
Year 1 = July 1, 2014 to June 30, 2015
Year 2 = July 1, 2015 to June 30, 2016
Reproposed speculative position limit levels are shown in bold.
* Denotes fewer than 4 persons.

d. Energy

The Commission is reproposing non-spot month speculative position limit levels for the NG, CL, HO, and RB core referenced futures contracts based on the 10, 2.5 percent open interest formula.[571]

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Table III-B-19—CME Energy Contracts—Non-Spot Month Limit Levels

ContractPreviously proposed limit levelReproposed speculative limit level
NG149,600200,900
CL109,200148,800
HO16,10021,300
RB11,80015,300

Set forth below is a summary of the impact analysis for energy contracts.

Table III-B-20—CME Energy Contracts—Non-Spot Months

Core-referenced futures contractOpen interestInitial limit levelUnique persons above limit levelReportable persons in market—all months
YearFuturesSwapsTotalAll monthsSingle month
Natural Gas (NG)14,919,8412,866,1287,785,969200,900*01,846
24,628,4713,331,1417,959,612
Light Sweet Crude (CL)14,071,6811,587,4505,659,130148,800002,673
24,130,1311,744,1375,874,268
NY Harbor ULSD (HO)1638,040138,360776,40021,3006*760
2587,79665,721653,518
RBOB Gasoline (RB)1448,59881,822530,42015,30087837
2505,84930,477536,327
Year 1 = July 1, 2014 to June 30, 2015.
Year 2 = July 1, 2015 to June 30, 2016.
Reproposed speculative position limit levels are shown in bold.
* Denotes fewer than 4 persons.

6. Subsequent Levels of Limits

The Commission notes that many of the comments referenced above, regarding setting initial position limits, are also discussed below, regarding re-setting levels of limits.

a. General Procedure for Re-Setting Levels of Limits

Commission Proposal: The Commission proposed in § 150.2(e)(2) that it would fix subsequent levels of speculative position limits no less frequently than every two calendar years, in accordance with the procedures in § 150.2(e)(3) for spot-month limits and § 150.2(e)(3) for non-spot-month limits, discussed below.[572] The Commission proposed it would publish such subsequent levels on its Web site.

Comments Received: Regarding § 150.2(e)(2), commenters requested the Commission review the level of limits more frequently than every two years to address changes that may occur within the commodities markets.[573]

Commission Reproposal: The Commission has determined to repropose this provision as previously proposed in the December 2013 Position Limits Proposal, and reiterates that it will fix subsequent levels no less frequently than every two calendar years. The Commission is not proposing to establish a procedural requirement to reset limit levels more frequently than every two years, because as the frequency of reset increases, the burdens on market participants to update compliance systems and strategies, and on exchanges to submit deliverable supply estimates and reset exchange limit levels, also increase. The Commission believes that a two year timetable should reduce burdens on market participants while still maintaining limits based on recent market data. Should higher limit levels be desired, exchanges or market participants may petition the Commission to change limit levels within the two year period.

b. Re-setting Levels of Spot-Month Limits

Commission Proposal: The Commission proposed in § 150.2(e)(3) to reset each spot month limit at a level no greater than one-quarter of the estimated spot-month deliverable supply, based on the estimate of deliverable supply provided by the exchange listing the core referenced futures contract. The Commission proposed that it could, in its discretion, rely on its own estimate of deliverable supply. The Commission further proposed that, alternatively, it could set spot-month limits based on the recommended level of the exchange listing the core referenced futures contract, if lower than 25 percent of estimated deliverable supply.[574]

Comments Received: Commenters generally recommended the Commission enhance predictability and reduce uncertainty for market participants, by either restricting how much adjustment would be made to the position limit level, or having the discretion to not alter position limit Start Printed Page 96770levels, for example, if there have not been problems with convergence.[575]

Commenters were divided regarding the proposed methodology for computing spot month position limit levels (which is calculated by determining a figure that is no more than 25 percent of estimated deliverable supply).[576] Several commenters stated that the proposed formula for setting spot month limits based on 25 percent of deliverable supply results in spot month position limits that would be too high and may result in contract performance issues.[577] Other commenters thought the formula results in spot-month position limits that would be too low and hinder market liquidity.[578] Yet another requested that the Commission do further research to determine whether deliverable supply or open interest was a better means of setting spot month position limits, and apply the same metric (deliverable supply or open interest) to spot month limits and to non-spot month limits.[579] Several commenters recommended that the Commission consider an alternative means of limiting excessive speculation, that is, by setting position limits at a level low enough to restore a hedger majority in open interest in each core referenced futures contract.[580]

In estimating deliverable supply, some commenters recommended that the Commission include supply that is subject to long-term supply contracts, arguing that such supply can be readily made available for futures delivery.[581] One commenter recommended that the Commission permit the inclusion in the deliverable supply calculation of supplies that can be readily transported to the futures delivery location.[582] Another commenter recommended that the deliverable supply estimate should include related commodities that a DCM allows to be used to liquidate a futures position through an EFP transaction.[583] One commenter recommended that the deliverable supply estimate for natural gas should include supplies that are available at other major locations in addition to the specific futures delivery location of Erath, Louisiana, because commercials at these locations use the futures contract for hedging and price basing and basing spot month limits on a more limited delivery area would be too restrictive.[584] In estimating deliverable supply, one commenter recommended that the Commission not include supplies that do not meet delivery specifications.[585] The same commenter said that DCMs should provide documentation if including long term supply agreements in deliverable supply estimates to enable the Commission to verify the information. The commenter expressed concern about financial holding companies' ability to own, warehouse and trade physical commodities and urged the Commission to assess how such firms might affect deliverable supply.[586]

Commission Reproposal: The Commission is reproposing to reset each spot-month limit, in its discretion, either: Based on 25 percent of deliverable supply as estimated by an exchange listing the core referenced futures contract; to the existing spot-month position limit level (that is, not changing such level); or to the recommended level of the exchange listing the core referenced futures contract, but not greater than 25 percent of estimated deliverable supply. In the alternative, if the Commission elects to rely on its own estimate of deliverable supply, it will first publish that estimate for comment in the Federal Register.

Thus, the Commission accepts the commenter's recommendation that the Commission have discretion to retain current spot-month position limit levels. In this regard, the Commission provides, in reproposed § 150.2(e)(3)(ii)(B), that an exchange need not submit an estimate of deliverable supply, if the exchange provides notice to the Commission, not less than two calendar months before the due date for its submission of an estimate, that it is recommending the Commission not change the spot-month limit, and the Commission accepts such recommendation.

The Commission notes that it has long used deliverable supply as the basis for spot month position limits due to concerns regarding corners, squeezes, and other settlement-period manipulative activity. By restricting derivative positions to a proportion of the deliverable supply of the commodity, spot month position limits reduce the possibility that a market participant can use derivatives, including referenced contracts, to affect the price of the cash commodity (and vice versa). Limiting a speculative position based on a percentage of deliverable supply also restricts a speculative trader's ability to establish a leveraged position in cash-settled derivative contracts, diminishing that trader's incentive to manipulate the cash settlement price. Commenters did not provide evidence that would suggest that the open interest formula would respond more effectively to these concerns, and the Commission does not believe that using open interest would be preferable for calculating spot-month position limit levels.

In addition, setting the limit levels at no greater than 25 percent of deliverable supply has historically been effective on both the federal and exchange level to combat corners and squeezes. In the preamble to the final rules for vacated Part 151, the Commission noted that the 25 percent of deliverable supply formula appears to “work effectively as a prophylactic tool to reduce the threat of corners and squeezes and promote convergence without compromising market liquidity.” Commenters did not provide evidence to support claims that this historical formula is no longer effective.

In response to concerns that 25 percent of deliverable supply may result in a limit level that is too high, the Commission notes that exchanges can and often do—and are permitted under reproposed § 150.5(a) to—set limits at a level lower than 25 percent of estimated deliverable supply, which allows the exchanges to alter exchange-set limits easily based on changing market conditions.

In response to commenters' suggestion to restore a hedger majority, the Commission notes such an alternative may fail the requirements of CEA section 4a(a)(3)(B)(iv) to ensure sufficient liquidity for bona fide hedgers. Hedgers may not be transacting on opposite sides of the market simultaneously and, thus, need speculators to provide liquidity. Simply changing the proportion of hedgers in the market does not mean that the markets would operate more efficiently for bona fide hedgers. In addition, in order to adopt the commenter's suggestion, the Commission would need to reintroduce the withdrawn '03 series forms which required traders to identify which positions were speculative and which were hedging, since any entity, Start Printed Page 96771even a commercial end-user, can establish speculative positions.

In response to commenters' suggestions regarding methods for estimating deliverable supply, the Commission notes that deliverable supply estimates are calculated and submitted by DCMs. Guidance for calculating deliverable supply can be found in Appendix C to part 38. Amendments to part 38 are beyond the scope of this rulemaking. However, such guidance already provides that deliverable supply calculations are estimates based on what “reasonably can be expected to be readily available” (including estimates of long-term supply that can be shown to be regularly made available for futures delivery).

c. Re-Setting Levels of Non-Spot-Month Limits

Commission Proposal—General Procedure: For setting subsequent levels of non-spot month limits no less frequently than every two calendar years, the Commission proposed in § 150.3(e)(4) to use the open interest formula: 10 percent of the first 25,000 contracts and 2.5 percent of the open interest thereafter (10, 2.5 percent formula).[587]

Comments Received and Commission Response: “In order to enhance the predictability and reduce uncertainty in business planning,” one commenter recommended that the Commission “adjust limits gradually and by no more than a minimum percentage in one biennial cycle.” [588] The Commission declines this suggestion because, as explained below, the Commission is reproposing a minimum non-spot month limit level of 5,000 contracts; market participants would be certain that in no circumstance would the limit level fall below that figure. Also, because exchanges can set limits at levels below the federal limit level, a change in the federal limit may not have an effect on exchange limit levels.

Several commenters recommended that the Commission review the levels of position limits more frequently than once every two years to address changes that may occur within the commodities markets.[589] In response these concerns, the Commission notes that exchanges may set limits at a level lower than the federal limits in order to more readily adapt to changing market conditions. Should higher limit levels be desired, exchanges may petition the Commission or the Commission may determine to change limit levels within the two year period. Thus, the flexibility to change limit levels more frequently than every two years is already permitted by the reproposed rules and the Commission is not changing the timeline.

One commenter recommended that the Commission “adopt final rules that give the Commission the flexibility to increase position limits immediately or with little delay so that the market can accurately respond to external forces without violating position limits” or, in the alternative, “include peak open interest levels beyond the most recent two years when it determines the level of open interest on which to base position limits.[590] In response, the Commission notes that using peak open interest figures, as opposed to an average, as reproposed, may not necessarily represent an accurate portrait of current market conditions. Using the most recent two years of data is designed to ensure that the non-spot-month limit levels are set relative to the current size of the market.

Several commenters expressed the view that the proposed limits based on the open interest formula would result in limit levels that are too high and would not accomplish the goal of reducing excessive speculation.[591] In response, the Commission believes the open interest formula provides a level that is low enough to reduce the potential for excessive speculation and market manipulation without unduly impairing liquidity for bona fide hedgers. Under the rules reproposed today, both the Commission and the exchanges would have flexibility to impose non-spot month limit levels at the greater of the open interest formula, the spot month limit level, or 5,000 contracts.

Several commenters expressed the view that the proposed limits based on the open interest formula would result in limit levels for dairy contracts that are too low and would restrict hedging use by limiting liquidity.[592] The Commission responds that it is deferring the imposition of position limits on the Class III Milk contract, as discussed below.[593] The Commission also observes that reproposed § 150.9 permits market participants to apply directly to the exchanges to obtain an exemption to exceed speculative position limits.

Several commenters recommended that the Commission consider an alternative means of limiting speculative traders, by setting position limits at a level low enough to restore a hedger majority in open interest in each core referenced futures contract.[594] As discussed above, the Commission is concerned that “restoring” a hedger majority may not ensure sufficient liquidity for bona fide hedgers. Hedgers may not be transacting on opposite sides of the market simultaneously and, thus, need speculators to provide liquidity. Simply changing the proportion of hedgers in the market does not mean that the markets would operate more efficiently for bona fide hedgers. In addition, in order to implement this suggestion, the Commission would need to reintroduce the long defunct '03 series forms which required traders to identify which positions were speculative and which were hedging, because any entity, even a commercial end-user, can establish speculative positions.

One commenter noted that the open interest formula permits a speculator to hold a larger percentage of open interest in a smaller commodity market and thus the formula's entire rationale seems “arbitrary . . . and . . . capricious.” [595] The Commission acknowledges that, because of the way the 10, 2.5 percent formula works, a speculator in a market with open interest of fewer than 25,000 contracts may have a larger share of the open interest than a speculator in a market with an open interest of greater Start Printed Page 96772than 25,000 contracts. The Commission responds that it is by design that the 10, 2.5 percent open interest formula provides that a speculator may hold a larger percentage of total open interest in a smaller market, potentially providing liquidity for bona fide hedgers in such a smaller market. As open interest increases, the 2.5% marginal increase results in limit levels that become a progressively smaller percentage of total open interest, essentially placing a greater emphasis on deterring market manipulation and protecting the price discovery process in a larger market.

Another commenter suggested that the Commission use a 10, 5 percent open interest formula rather than a 10, 2.5 percent formula as proposed, arguing that the 10, 5 percent formula has worked well for certain agricultural futures markets and should be applied more broadly. Alternatively, this commenter said that Commission should use the 10, 5 percent formula for at least spread positions.[596] The Commission notes the 10, 2.5 percent formula has produced limit levels that should sufficiently maximize the CEA section 4a(a)(3)(B) criteria, and the Commission does not believe increasing the marginal percentage is necessary. A larger limit such as would be produced from a 10, 5 percent formula may not adequately prevent excessive speculation. In the preamble to the proposed rules, the Commission noted that the 10, 2.5 percent formula was first proposed in 1992, and the commenter has not provided sufficient justification for moving away from this established standard.

One commenter recommended that the Commission consider commodity-related ratios in establishing limits, such as the ratio between crude oil and its products, diesel (30 percent) and gasoline (50 percent), rather than on separate open interest formulas applied to each.[597] In response, the Commission notes setting limit levels based on the open interest of a related commodity may result in limit levels that are too large to be effective in the smaller commodity markets. For example, based on the levels proposed in this release in Appendix D, implementing a limit for NYMEX RBOB Gasoline equal to 50 percent of the crude oil limit, as suggested by the commenter, would result in a limit almost 10 times the size otherwise indicated by the open interest formula, and would equal almost 28 percent of total average open interest in the RBOB referenced contract. Further, hedgers with positions in multiple contracts could establish positions in various ratios without violating a position limit, provided they comply with the bona fide hedging position definition and any applicable requirements. The Commission also notes that the process in reproposed § 150.10 exempting certain spread positions may allow speculators some flexibility in inter- and intra-commodity spreads for the purpose of providing liquidity to bona fide hedgers.

One commenter suggested the Commission consider setting position limits on “customary position size” which had been used for setting non-spot month limits by the Commission in the past and which the commenter argues is a more effective means of curtailing large speculative positions.[598] In response, the Commission believes the 10, 2.5 percent formula has been effective in preventing excessive speculation without unduly limiting liquidity for bona fide hedgers. The Commission notes when the “customary position size” methodology was used to set non-spot-month limit levels, such levels were below the levels established using 10, 2.5 percent formula.

Commission Reproposal Regarding General Procedure for Re-Setting Levels of Non-Spot Month Limits: The Commission has determined to repropose the 10, 2.5 percent formula, generally as proposed in the December 2013 Position Limits Proposal, for the reasons discussed above. However, the Commission has determined, in response to requests by commenters requesting wheat parity, as discussed above, to provide that it may determine not to change the level of a non-spot month limit. This would permit, for example, the Commission to continue to retain a level of 12,000 contracts for the non-spot month limits in the KW and MWE contracts, even if average open interest did not exceed 405,000 contracts (which is the level that, when applying the 10, 2.5 percent formula, would result in a limit of 12,000 contracts).

Commission Proposal for Time Periods, Data Sources, Publication and Minimum Levels for Re-Setting Levels of Non-Spot Month Limits: Under proposed in § 150.2(e)(4)(i) and (ii), the Commission would estimate average open interest in referenced contracts using data reported for each of the last two calendar years pursuant to parts 16, 20, and/or 45.[599] The Commission also proposed under § 150.2(e)(4)(iii) to publish on the Commission's Web page estimates of average open interest in referenced contracts on a monthly basis to make it easier for market participants to estimate changes in levels of position limits.[600] Finally, the Commission proposed under § 150.2(e)(4)(iv) to establish minimum non-spot month levels of 1,000 contracts for agricultural commodity contracts and 5,000 contracts for exempt commodity contracts.

Comments Received and Commission Response: Regarding the time period for average open interest, as noted above, one commenter recommended that the Commission, as an alternative, “include peak open interest levels beyond the most recent two years when it determines the level of open interest on which to base position limits.” [601] In response, the Commission notes that using peak open interest figures, as opposed to an average, as reproposed, may not necessarily represent an accurate portrait of current market conditions.

Regarding data sources for average open interest, several commenters noted that the open interest data used by the Commission in determining the non-spot month limits was not complete since it did not include all OTC swaps data and that the Commission should correct this deficiency before it sets the limits using the open interest formula.[602] In response, the Commission notes it used futures-equivalent open interest for swaps reported under part 20, in determining the initial non-spot month limits, as discussed above, and believes this data also is acceptable for re-setting limit levels, as reproposed.

The Commission received no comments regarding publication of average open interest.

Regarding minimum levels for non-spot month limits, some commenters urged the Commission to afford itself the flexibility to set non-spot month limits at least as high as the spot-month position limit, rather than base the non-spot month limit strictly on the open interest formula in cases where the latter would result in a relatively small limit that would hinder liquidity.[603] The Commission accepts these Start Printed Page 96773commenters' recommendation. Upon consideration of proposing minimum initial non-spot month limits, as discussed above, the Commission is removing the distinction between agricultural and exempt commodities. This change would establish a minimum non-spot month limit level of 5,000 contracts in either agricultural or exempt commodities.

Commission Reproposal: The Commission has determined to repropose these provisions generally as proposed in the December 2013 Position Limits Proposal, but with the changes described above to provide flexibility for a higher minimum level of non-spot month limits.

7. Deferral of Limits on Cash-Settled Core Referenced Futures Contracts

Commission Proposal:

The Commission proposed, but is not reproposing, positon limits on three cash-settled core referenced futures contracts: CME Class III Milk; CME Feeder Cattle; and CME Lean Hogs.[604]

Comments Received: Commenters raised concerns with these cash-settled contracts and how they fit within the federal position limits regime. While many of these concerns were raised in the context of the dairy industry, they apply to all three cash-settled core referenced futures contracts. Concerns raised include: (1) How to apply spot month limits in a contract that is cash-settled; [605] (2) the “five-day rule” for bona fide hedging; [606] and (3) the length of the spot month period.[607] Commenters contended that the Commission's rationale in the December 2013 Position Limits Proposal focused on concerns with physical-delivery contracts, which the commenters believe do not apply to cash-settled core referenced futures contracts because there is no physical delivery process and because the contracts settle to government-regulated price series (through the USDA).[608] Commenters were concerned that the Commission's “one-size-fits-all” approach discriminates against participants in dairy and livestock because the spot-month limit is effectively smaller compared to the separate spot-month limits for physical-delivery and cash-settled contracts in other commodities.[609] Several commenters suggested limit levels that do not follow the proposed formulae for determining limit levels for both spot and non-spot-month limits due to the unique aspects of cash-settled core referenced futures contracts, including the relatively large cash market and trading strategies not found in other core referenced futures markets.[610]

Commission Determination: The Commission, as part of the phased approach to implementing position limits on all physical commodity derivative contracts, is deferring action so that it may, at a later date: (1) Clarify the application of limits to cash-settled core referenced futures contracts; and (2) consider further which method to use to determine a level for a spot-month limit for a cash-settled core referenced futures contract. The Commission notes that the December 2013 Position Limits Proposal discussed spot-month limits primarily in the context of protecting the price discovery process by preventing corners and squeezes.[611] There was limited discussion of cash-settled core referenced futures contracts.[612] The Commission did not propose alternate means of calculating limit levels for cash-settled core referenced futures contracts in the December 2013 Position Limits Proposal.

C. § 150.3—Exemptions

1. Current § 150.3

Statutory authority: CEA section 4a(c)(1) exempts positions that are shown to be bona fide hedging positions, as defined by the Commission, from any Commission rule establishing speculative position limits under CEA section 4a(a).[613] In addition, CEA section 4a(a)(1) authorizes the Commission to exempt transactions normally know to the trade as “spreads.” [614] Further, CEA section 4a(a)(7) authorizes the Commission to exempt any person, contract, or transaction from any position limit requirement the Commission establishes.[615]

Current exemptions: The three existing exemptions in current § 150.3(a), promulgated prior to the enactment of the Dodd-Frank Act, are part of the Commission's regulatory framework for speculative position limits.[616] First, current § 150.3(a)(1) exempts positions shown to be bona fide hedging positions from federal position limits.[617] Second, current § 150.3(a)(3) exempts spread positions between single months of a futures contract (and/or, on a futures-equivalent basis, options) outside of the spot month, provided a trader's spread position in any single month does not exceed the all-months limit.[618] Third, under current § 150.3(a)(4), positions carried for an eligible entity [619] in the separate account of an independent account controller (“IAC”) [620] that manages customer positions need not be aggregated with the other positions owned or controlled by that eligible entity (the “IAC exemption”).[621]

Start Printed Page 96774

2. Proposed § 150.3

In the December 2013 Position Limits Proposal, the Commission proposed a number of organizational and substantive amendments to § 150.3, generally resulting in an increase in the number of exemptions to speculative position limits. First, the Commission proposed to amend the three exemptions from federal speculative limits contained in current § 150.3. These previously proposed amendments would update cross references, relocate the IAC exemption and consolidate it with the Commission's separate proposal to amend the aggregation requirements of § 150.4,[622] and delete the calendar month spread provision which is unnecessary under changes to § 150.2 that would set the level of each single month position limit to that of the all-months position limit. Second, the Commission proposed to add exemptions from the federal speculative position limits for financial distress situations, certain spot-month positions in cash-settled referenced contracts, and grandfathered pre-Dodd-Frank and transition period swaps. Third, the Commission proposed to revise recordkeeping and reporting requirements for traders claiming any exemption from the federal speculative position limits.

a. Proposed Amendments to Existing Exemptions

Proposed Rule: In the December 2013 Position Limits Proposal, the Commission proposed to update cross-references within § 150.3 to reflect other changes in part 150. Specifically, the Commission proposed: To update references to the bona fide hedging definition to § 150.1 from § 1.3(z); to require that those filing for exemptive relief must meet the reporting requirements in part 19; and to add a cross-reference to aggregation provisions in proposed § 150.4.

The Commission also proposed to move the existing IAC exemption to § 150.4, thereby deleting the current exemption in § 150.3(a)(4). The Commission also proposed to delete the spread exemption in current § 150.3, because it noted that the proposed non-spot month limits rendered such an exemption unnecessary.[623]

In the 2016 Supplemental Position Limits Proposal, the Commission proposed to conform § 150.3(a) to accommodate processes proposed in other sections of part 150. Specifically, the Commission proposed under § 150.3(a)(1)(i) exemptions for those bona fide hedging positions that have been recognized by a DCM or SEF in accordance with proposed §§ 150.9 and 150.11. The Commission also proposed under § 150.3(a)(1)(iv) exemptions for those spread positions that have been recognized by a DCM or SEF in accordance with proposed § 150.10. Recognition of other positions exempted under proposed § 150.3(e) was re-numbered as subsection (v) from subsection (iv) of § 150.3(a)(1) of the 2013 Position Limits Proposal.

Comments Received: The Commission received no comments on the proposed conforming changes to § 150.3.[624] The Commission addresses comments on the IAC exemption in its final rule amending the aggregation policy under § 150.4, published separately.

Commission Reproposal: The Commission is reproposing these amendments as previously proposed in the December 2013 Position Limits Proposal.

b. Positions Which May Exceed Limits—§ 150.3(a)

Proposed Rule: In the December 2013 Position Limits Proposal, the Commission listed positions which may exceed limits in proposed § 150.3(a). Such positions included: (i) Bona fide hedging positions as defined in § 150.1; (ii) financial distress positions exempted under § 150.3(b); (iii) conditional spot month limit positions exempted under § 150.3(c); and (iv) other positions exempted under § 150.3(e). Proposed § 150.3(a) also provided that all such positions may exceed limits only if recordkeeping requirements in § 150.3(g) are met and any applicable reporting requirements in part 19 are met.

In the 2016 Supplemental Position Limits Proposal, the Commission proposed to revise § 150.3(a) to include, in addition to bona fide hedging positions as defined in § 150.1, positions that are recognized by a DCM or SEF in accordance with § 150.9 or § 150.11 as well as spread positions recognized by a DCM or SEF in accordance with § 150.10.

Comments Received: The Commission received many comments on the definition of bona fide hedging in § 150.1, as well as on the processes proposed in §§ 150.9-11.[625] The Commission addresses those comments in the discussion of the definition of bona fide hedging position in § 150.1, above, and in the discussion of the processes proposed in §§ 150.9-11, below. The Commission did not receive comments specific to the conforming revisions to § 150.3(a).

Commission Reproposal: The Commission is reproposing § 150.3(a) as previously proposed in the December 2013 Position Limits Proposal, with conforming changes consistent with the reproposed definition of a bona fide hedging position in § 150.1, which includes positions that are recognized by a DCM or SEF in accordance with reproposed § 150.9 or § 150.11, or by the Commission, and conforming changes consistent with the process for spread positions recognized by a DCM or SEF in accordance with reproposed § 150.10, or by the Commission.

c. Proposed Additional Exemptions From Position Limits

i. Financial Distress Exemption—§ 150.3(b)

Proposed Rule: The Commission proposed to add in § 150.3(b) an exemption from position limits for market participants in financial distress circumstances, upon the Commission's approval of a specific request.[626] For example, the Commission recognized that, in periods of financial distress, it may be beneficial for a financially sound market participant to take on the positions (and corresponding risk) of a less stable market participant. The Commission explained that it has historically provided an exemption from position limits in these types of situations in order to avoid sudden liquidations that could potentially reduce liquidity, disrupt price discovery, and/or increase systemic risk. The Commission therefore proposed to codify this historical practice.

Comments Received: One commenter requested the non-exclusive circumstances for the financial distress exemption be clarified by adding “bud not limited to” after the word “include” to permit other situations not listed.[627]

Commission Reproposal: In response to the commenter, the Commission clarifies that the circumstances under which a financial distress exemption may be claimed include, but are not limited to, the specific scenarios in the definition. However, the Commission believes that the proposed definition Start Printed Page 96775sufficiently articulates that the list of potential circumstances for claiming the financial distress exemption is non-exclusive, and, therefore, is reproposing the definition as previously proposed.

ii. Pre-Enactment and Transition Period Swaps Exemption—§ 150.3(d)

Proposed Rule: In the December 2013 Position Limits Proposal, the Commission proposed to provide an exemption from federal position limits for (1) pre-enactment swaps, defined as swaps entered into prior to July 21, 2010 (the date of the enactment of the Dodd-Frank Act of 2010), so long as the terms of which have not expired as of that date, and (2) transition period swaps, defined as swaps entered into during the period commencing July 22, 2010 and ending 60 days after the publication of the final position limit rules in the Federal Register, the terms of which have not expired as of that date. The Commission also proposed to allow both pre-enactment and transition period swaps to be netted with commodity derivative contracts acquired more than 60 days after publication of the final rules in the Federal Register for purposes of complying with non-spot-month position limits.[628]

Comments Received: One commenter suggested that “grandfathering” relief should be extended to pre-existing positions, and should also permit the pre-existing positions to be increased after the effective date of the limit. The commenter also suggested that the Commission should permit the risk associated with a pre-existing position to be offset through roll of a position from a prompt month into a deferred contract month.[629]

Commission Reproposal: The Commission declines to accept the commenter's recommendation regarding increasing positions, because allowing pre-existing positions to be increased after the effective date of the limits effectively would create a loophole for exceeding position limits. Further, the Commission declines the commenter's recommendation to permit a roll of a pre-existing position, because that would permit a market participant to extend indefinitely the holding of a speculative economic exposure in commodity derivative contracts exempt from position limits, frustrating the intent of speculative position limits. The Commission notes, however, that reproposed § 150.3(d), like the previous proposal, allows for netting of pre- and post-effective date positions, allowing a market participant to offset the risk of the position provided the offsetting position is not held into a spot month. The Commission is reproposing § 150.3(d) as proposed in the December 2013 Position Limits Proposal.

iii. Previously Granted Exemptions—§ 150.3(f)

Proposed Rule: The Commission proposed in the December 2013 Position Limits Proposal that exemptions previously granted by the Commission under § 1.47 for swap risk management would not apply to new swap positions entered into after the effective date of the final rule. The Commission noted that the proposed rules revoke the previously granted exemptions for risk management positions for such new swaps. Therefore, risk management positions that offset such new swaps would be subject to federal position limits, unless another exemption applied. The Commission explained that these risk management positions are inconsistent with the revised definition of bona fide hedging contained in the December 2013 Position Limits Proposal and the purposes of the Dodd-Frank Act amendments to the CEA.[630]

Comments Received: A number of commenters urged the Commission not to deny risk-management exemptions for financial intermediaries who utilize referenced contracts to offset the risks arising from the provision of diversified commodity-based returns to the intermediaries' clients.[631]

In contrast, other commenters noted that the proposed rules “properly refrain” from providing a general exemption to financial firms seeking to hedge their financial risks from the sale of commodity-related instruments such as index swaps, ETFs, and ETNs because such instruments are “inherently speculative” and may overwhelm the price discovery function of the derivative market.[632]

Commission Reproposal: As discussed above in the clarifications to the bona fide hedging position definition, the Commission now proposes to expand the relief in § 150.3(f) by: (1) Clarifying that such previously granted exemptions may apply to pre-existing financial instruments that are within the scope of existing § 1.47 exemptions, rather than only to pre-existing swaps; and (2) recognizing exchange-granted non-enumerated exemptions in non-legacy commodity derivatives outside of the spot month (consistent with the Commission's recognition of risk management exemptions outside of the spot month), and provided such exemptions are granted prior to the compliance date of the final rule, and apply only to pre-existing financial instruments as of the effective date of the final rule. These two changes are intended to reduce the potential for market disruption by forced liquidations, since a market intermediary would continue to be able to offset risks of pre-effective-date financial instruments, pursuant to previously-granted federal or exchange risk management exemptions.

iv. Non-Enumerated Hedging Positions—§ 150.3(e)

Proposed Rule: In the December 2013 Position Limits Proposal, the Commission noted that it previously permitted a person to file an application seeking approval for a non-enumerated position to be recognized as a bona fide hedging position under § 1.47. The Commission proposed to delete § 1.47 for several reasons described in the December 2013 Position Limits Proposal.[633]

Proposed § 150.3 provided that a person that engages in risk-reducing practices commonly used in the market, that the person believes may not be included in the list of enumerated bona fide hedging positions, may apply to the Commission for an exemption from position limits. As previously proposed, market participants would be guided in § 150.3(e) first to consult proposed Appendix C to part 150 to see whether their practices fell within a non-exhaustive list of examples of bona fide hedging positions as defined under proposed § 150.1.

A person engaged in risk-reducing practices that are not enumerated in the revised definition of bona fide hedging position in previously proposed § 150.1 may use two different avenues to apply to the Commission for relief from federal position limits: The person may request an interpretative letter from Commission staff pursuant to § 140.99 [634] concerning the applicability Start Printed Page 96776of the bona fide hedging position exemption, or the person may seek exemptive relief from the Commission under CEA section 4a(a)(7).[635]

In the 2016 Supplemental Position Limits Proposal, the Commission proposed §§ 150.9, 150.10, and 150.11 which provided alternative processes that would permit eligible DCMs and SEFs to provide relief for non-enumerated bona fide hedging positions, certain spread positions, and anticipatory bona fide hedging positions, respectively.[636] However, the Commission did not propose to alter or delete § 150.3 because the Commission determined to provide multiple avenues for persons seeking exemptive relief.

Comments Received: One commenter requested that the Commission provide a spread exemption from federal position limits for certain soft commodities, reasoning that there was a “lack of fungibility of certain soft commodities . . . [because] inventories of various categories vary widely in terms of marketability over time.” The commenter also stated that such a spread exemption would allow for effective competition for the ownership of certified inventories that in turn helps to maintain a close relationship between the cash and futures markets.[637] Another commenter recommended the Commission recognize calendar spread netting, and not place any limits on the same, because speculators provide liquidity in deferred months to hedgers and offset, in part, that exposure with shorter dated contracts.[638]

Commission Reproposal: Both of these comments were submitted in response to the December 2013 Position Limits Proposal, well in advance of the 2016 Supplemental Position Limits Proposal. Spread exemptions such as those described by the commenters are addressed in § 150.10, discussed below. The Commission is reproposing § 150.3(e) as previously proposed in the December 2013 Position Limits Proposal.

d. Proposed Conditional Spot Month Limit Exemption—§ 150.3(c)

Conditional spot month limit exemptions to exchange-set spot-month position limits for natural gas contracts were adopted in 2009, after the ICE submitted such an exemption as part of its certification of compliance with core principles required of exempt commercial markets (“ECMs”) on which significant price discovery contracts (“SPDCs”) were traded.[639]

As ICE developed its rules in order to comply with the ECM SPDC requirements,[640] ICE expressed concerns regarding the impact of position limits on the open interest in its LD1 contract. ICE demonstrated that as the open interest declines in the physical-delivery New York Mercantile Exchange Inc. (“NYMEX”) Henry Hub Natural Gas Futures (“NYMEX NG”) contract approaching expiration, open interest increases rapidly in the cash-settled ICE NG LD1 contract, and suggested that the ICE NG LD1 contract served an important function for hedgers and speculators who wished to recreate or hedge the NYMEX NG contract price without being required to make or take delivery. ICE stated that it believed there are “significant and material distinctions between the design and use of” the NYMEX NG contract and the ICE NG LD1 contract, and those distinctions were most pronounced at expiration. Further, ICE stated that, due to the size of some positions in the cash-settled ICE NG LD1 contract, the impact to the market of an equivalent limit could impair the ability for market participants to adjust their positions in an orderly fashion to come into compliance. For these reasons, ICE requested that the Commission consider an alternative to the Commission's acceptable practice that spot month position limits for the NG LD1 contract should be equivalent to the spot month position limits in the NYMEX NG contract.[641]

After discussion with both the Commission's Division of Market Oversight and NYMEX, ICE submitted and certified rule amendments implementing position limits and position accountability rules for the ICE NG LD1 contract. Specifically, ICE imposed a spot-month position limit and non-spot-month position accountability levels equal to those of the economically equivalent NYMEX NG contract. ICE also adopted a rule for a larger conditional position limit for traders who: (1) Agreed not to maintain a position in the NYMEX NG futures contract during the last three trading days, and (2) agreed to show ICE their complete book of Henry Hub related positions.[642]

In June 2009, the Commission also received self-certified rule amendments from CME Group, Inc. (“CME”) regarding position limits and position accountability levels for the cash-settled NYMEX Henry Hub Financial Last Day Futures (HH) contract and related cash-settled contracts.[643] The rules, as amended, established spot month position limits for the NYMEX HH contract as well as certain related cash-settled contracts so as to be consistent with the requirements for the SPDC contract on ICE. In the rule certification documents, CME stated that it was amending its position limits rules for the HH contract in anticipation of ICE's new rules. In February 2010, the conditional spot month limit exemptions on NYMEX and ICE went into effect.

Proposed Rules: In the December 2013 Position Limits Proposal, the Start Printed Page 96777Commission proposed a conditional spot month limit exemption for all commodities subject to federal limits under proposed § 150.2. That proposed rule was identical to the rule proposed in the Part 151 Proposal, with the exception that the December 2013 Position Limits Proposal did not include any restriction on trading in the cash market.[644] In proposing the conditional spot month limit exemption in proposed § 150.3(c), the Commission stated its preliminary belief that the current exemption in natural gas markets has served “to further the purposes Congress articulated for position limits” and that the exemption “would not encourage price discovery to migrate to the cash-settled contracts in a way that would make the physical-delivery contract more susceptible to sudden price movements near expiration.” [645] In addition, the Commission noted that it has observed repeatedly that open interest levels in physical-delivery contracts “naturally decline leading up to and during the spot month, as the contract approaches expiration” because “both hedgers and speculators exit the physical-delivery contract in order to, for example, roll their positions to the next contract month or avoid delivery obligations.” [646] The Commission also stated its preliminary belief that “it is unlikely that the factors keeping traders in the spot month physical-delivery contract will change due solely to the introduction of a higher cash-settled limit,” as traders participating in the physical-delivery contract in the spot month are “understood to have a commercial reason or need to stay in the spot month.” [647]

Comments Received: The Commission received many comments regarding the conditional spot month limit exemption. These comments revealed little to no consensus among market participants, exchanges, and industry groups regarding spot-month position limits in cash-settled contracts.

Several commenters supported the higher spot-month limit (or no limit at all) for cash-settled contracts, but opposed the restriction on holding a position in the physical-delivery referenced contract to obtain the higher limit for various reasons, including: The view that there is no discernible reason for the restriction in the first place; the belief that it provides a negative impact on liquidity in the physical delivery contract; and the view that it prevents commercials from taking advantage of the higher limit given their need to have some exposure in a physical delivery referenced contract during the spot month.[648]

One commenter said that the conditional spot month position limit exemption for gold is not supported by sufficient research, could decouple the cash-settled contract from the physical-delivery contract, and could lead to lower liquidity in the physical-delivery contract and higher price volatility.[649] Several commenters opposed a spot-month position limit for cash-settled contracts that is higher than the limit for physical-delivery contracts for various reasons including: The higher limit does not address the problem of excessive speculation; the higher limit would reduce liquidity in the physical-delivery contract; and the conditional limit is not restrictive enough and should include a restriction on holdings of the physical commodity as had been proposed in vacated part 151.[650]

Several commenters expressed the view that a market participant holding a trade option position, which presumably would be considered a physical delivery referenced contract, should not be precluded from using the conditional spot-month limit exemption because trade options are functionally equivalent to a forward contract and the conditional exemption does not restrict holding forwards.[651]

One commenter supported the conditional spot month limit exemption provided that the Commission modifies its proposal to allow independently-operated subsidiaries to hold positions in physical-delivery contracts if the subsidiary engages in separate and independent trading activities, shares no employees, and is not jointly directed in its trading activity with other subsidiaries by the parent company.[652]

Some commenters supported the continuation of the practice of DCMs separately establishing and maintaining their own conditional spot month limits and not aggregating cash-settled limits across exchanges and the OTC market, arguing that the resultant aggregated limit will be unnecessarily restrictive and result in lower liquidity and increased volatility.[653]

Some commenters expressed the view that the filing of daily Form 504 reports to satisfy the conditional spot month limit exemption was burdensome, and recommended less frequent reporting such as monthly reports [654] or no reporting at all.[655]

Two exchanges which currently permit a conditional spot month limit exemption, CME and ICE, have each submitted several comments regarding the exemption, some in direct response to the other exchange's comments. This back-and-forth nature of the disagreement surrounding the conditional spot month limit exemption has been significant and, on many aspects of the previously proposed exemption, the comments have been in direct opposition to each other. CME submitted a comment letter in response to the 2016 Supplemental Position Limits Proposal that reiterated its belief that the conditional limit would drain liquidity from the physical-delivery contract; [656] ICE responded that nothing in the natural gas market has suggested that the physical-delivery contract has been harmed.[657] ICE noted that CME's current conditional limit benefits CME's own cash-settled natural gas contracts; [658] CME responded that it opposes any conditional limit framework even though such opposition could work “to the detriment of CME Group's commercial interests in certain of its cash-settled markets.” [659] CME stated its belief that the CEA necessitates “one-to-one limit treatment and similar exemptions” for both physical-delivery and cash-settled contracts within a particular commodity; [660] ICE suggested that removing or reducing the conditional limit would “disrupt present market practice.” [661]

ICE also submitted a series of charts, using CFTC Commitment of Traders Start Printed Page 96778Report data, illustrating the opposite: That spot-month open interest and volume in the physical-delivery contract (the NYMEX NG) have actually increased since the introduction of the conditional spot month limit.[662]

CME stated its opposition to the conditional limits “as a matter of statutory law,” opining that CEA section 4(b) does not allow the imposition of the conditional limit.[663] CME believes that the conditional limit contained in the December 2013 Position Limits Proposal “contravenes Congress's intent behind the statutory `comparability' requirement” in multiple ways, and that neither ICE nor the Commission has “addressed these aspects of [CEA section 4(b)].” [664]

ICE replied that the Commission “has no basis to modify the current conditional limit level” because the markets “have functioned efficiently and effectively” and the Commission should not “change the status quo.” [665] ICE continued that the conditional limit of five times the physical-delivery contract's spot-month limit “appears to be arbitrary and likely insufficient” and opined that the Commission has not indicated how it arrived at that figure or how such a level “strikes the right balance between supporting liquidity and diminishing undue burdens.” [666] ICE concluded that the conditional exemption “must be maintained at no less than the current levels.” [667]

Commission Reproposal: After taking into consideration all the comments it received regarding the conditional spot-month limit exemption, the Commission is reproposing the conditional spot-month limit exemption in natural gas markets only. The Commission believes the volume of comments regarding the conditional spot-month limit exemption indicates the importance of careful and thoughtful analysis prior to finalizing policy with respect to conditional spot-month limit exemptions in other cash-settled referenced contracts. In particular, the considerations may vary, and should be considered in relation to the particular commodity at issue. As such, the Commission believes it is prudent to proceed cautiously in expanding the conditional spot-month limit exemption beyond the natural gas markets where it is currently employed. The Commission encourages exchanges and/or market participants who believe that the Commission should extend the conditional spot-month limit exemption to additional commodities to petition the Commission to issue a rule pursuant to § 13.2 of the Commission's regulations.[668]

With respect to natural gas cash-settled referenced contracts, the reproposed rules allow market participants to exceed the position limit provided that such positions do not exceed 10,000 contracts and the person holding or controlling such positions does not hold or control positions in the spot-month natural gas physical-delivery referenced contract (NYMEX NG). Persons relying upon this exemption must file Form 504 during the spot month.[669]

The Commission observes that the conditional exemption level of 10,000 contracts is equal to five times the federal natural gas spot-month position limit level of 2,000 contracts. The conditional exemption level is also equal to the sum of the current conditional exemption levels for each of the NYMEX HH contract and the ICE NG LD1 contract. The Commission believes the level of 10,000 contracts provides relief for market participants who currently may hold or control 5,000 contracts in each of these two cash-settled natural gas futures contracts and an unlimited number of cash-settled swaps, while still furthering the purposes of the Dodd-Frank Act's amendments to CEA section 4a.

The Commission is proposing the fixed figure of 10,000 contracts, rather than the variable figure of five times the spot-month position limit level, in order to avoid confusion in the event NYMEX were to set its spot-month limit in the physical-delivery NYMEX NG contract at a level below 2,000 contracts.

The Commission provides, for informational purposes, summary statistical information that it considered in declining to extend the conditional spot-month limit exemption beyond the natural gas referenced contract. The four tables below present the number of unique persons that held positions in commodity derivative contracts greater than or equal to the specified levels, as reported to the Commission under the large trader reporting systems for futures and swaps, for the period July 1, 2014 to June 30, 2016. The table also presents counts of unique reportable persons, whether reportable under part 17 (futures and future option contracts) or under part 20 (swap contracts). The method the Commission used to analyze this large trader data is discussed above, under § 150.2.

The four tables group commodities only for convenience of presentation. In each table, the term “25% DS” means 25 percent of the deliverable supply as estimated by the exchange listing the core referenced futures contract and verified as reasonable by the Commission. Similarly, “15% DS” means 15 percent of estimated deliverable supply. An asterisk (“*”) means that fewer than four unique persons were reported. “CME proposal” means the level recommended by the CME Group for the spot-month limit. MGEX submitted a recommended spot-month limit level that is slightly less than 25 percent of estimated deliverable supply but did not affect the reported number of unique persons; no other exchange recommended a spot-month level of less than 25 percent of estimated deliverable supply.

For the first group of commodities, there was no unique person in the cash-settled referenced contracts whose position would have exceeded 25 percent of the exchange's estimated deliverable supply. Moreover, no unique person held a position in the cash-settled referenced contracts that would have exceeded the reproposed spot-month limits discussed under § 150.2, above, that are lower than 25 percent of the exchange's estimated deliverable supply.Start Printed Page 96779

Table III-B-21—CME Group and MGEX Agricultural Contracts

Core-referenced futures contractBasis of spot-month levelPosition limit levelNumber of unique persons >= levelNumber of reportable persons in market
Spot month cash settledSpot month physical deliverySpot month onlyAll months
CornCME proposal6000361,0502,606
(CBOT current limit 600)25% DS900020
OatsCME proposal6000033173
(CBOT current limit 600)25% DS90000
SoybeansCME proposal6000229292,503
(CBOT current limit 600)25% DS1,200014
Soybean MealCME proposal720014381978
(CBOT current limit 720)25% DS2,0000(*)
Soybean OilCME proposal5400213971,034
(CBOT current limit 540)25% DS3,40000
Wheat (CBOT)CME proposal6000114441,867
(CBOT current limit 600)25% DS1,00006
Wheat (MGEX)Parity w/CME proposal6000(*)102342
(MGEX current limit 600)Approx. 25% DS1,0000(*)
Wheat (KCBT)CME proposal60004250718
(KCBT current limit 600)25% CBOT DS1,0000(*)
25% DS3,0000(*)
Rough RiceCME proposal6000091281
(CBOT current limit 600)25% DS2,30000

For the second group of commodities, there was no unique person in the cash-settled referenced contracts whose position would have exceeded 25 percent of the exchange's estimated deliverable supply or, in the case of Live Cattle, the current exchange limit level of 450 contracts. Moreover, other than in the Sugar No. 11 contract, no unique person held a position in the cash-settled referenced contracts that would have exceeded 15 percent of the exchange's estimated deliverable supply. For informational purposes, the table also shows for Live Cattle that no unique person held a position in the cash-settled referenced contracts that would have exceeded 60 percent of the exchange's current spot-month limit of 450 contracts.[670]

Table III-B-22—Other Agricultural Contracts and ICE Futures U.S. Softs

Core-referenced futures contractBasis of spot-month levelPosition limit levelNumber of unique persons >= levelNumber of unique persons in market
Spot month cash settledSpot month physical deliverySpot month onlyAll months
Cotton No. 215% DS9600(*)1221,000
(ICE current limit 300)25% DS1,60000
Cocoa15% DS3,30000164682
(ICE current limit 1,000)25% DS5,50000
Coffee15% DS1,4400(*)3361,175
(ICE current limit 500)25% DS2,4000(*)
Orange Juice15% DS1,6800038242
(ICE current limit 300)25% DS2,80000
Live Cattle60% Current Limit2250336161,436
(CME current limit 450)Current limit *45000
Sugar No. 1115% DS13,980(*)10443874
(ICE current limit 5,000)25% DS23,3000(*)
Sugar No. 1615% DS4,200001222
(ICE current limit 1,000)25% DS7,00000

For the third group of energy commodities, there were a number of unique persons in the cash-settled referenced contracts whose position would have exceeded 25 percent of the exchange's estimated deliverable supply. For energy commodities other than natural gas, there were fewer than 20 unique persons that had cash-settled positions in excess of the reproposed spot-month limit levels, each based on 25 percent of deliverable supply, as discussed above under § 150.2. However, for natural gas referenced contracts, 131 unique persons had cash-settled positions in excess of the reproposed spot-month limit level of 2,000 contracts. As can be observed in the table below, only 20 unique persons had cash-settled referenced contract positions that would have exceeded the Start Printed Page 96780reproposed natural gas conditional spot-month limit level of 10,000 contracts. Thus, a conditional spot-month limit exemption in natural gas referenced contracts potentially would provide relief to a substantial number of market participants, each of whom did not have a position that was extraordinarily large in relation to other traders' positions in cash-settled referenced contracts.

Table III-B-23—Energy Contracts

Core-referenced futures contractBasis of spot-month levelPosition limit levelNunber of unique persons >= levelNumber of unique persons in market
Spot month cash settledSpot month physical deliverySpot month onlyAll months
Crude Oil, Light Sweet (WTI)CME proposal *6,0001981,7732,673
(NYMEX current limit25% DS10,40016(*)
3,000 contracts)50% DS20,800(*)0
Gasoline Blendstock (RBOB)CME proposal2,0002314463837
(NYMEX current limit25% DS6,800(*)0
1,000 contracts)50% DS13,60000
Natural Gas25% DS2,000131161,4001,846
(NYMEX current limit50% DS4,00077(*)
1,000 contracts)Current single exchange conditional spot-month limit exemption5,00065(*)
Conditional spot-month limit exemption10,000200
ULSD (HO)CME proposal2,0002411470760
(NYMEX current limit25% DS2,900155
1,000 contracts)50% DS5,80050
* For WTI, CME Group recommended a step-down spot-month limit of 6,000/5,000/4,000 contracts in the last three days of trading.

For the fourth group of metal commodities, there were a few unique persons in the cash-settled referenced contracts whose position would have exceeded the reproposed levels of the spot-month limits, based on the CME Group's recommended levels, as discussed above under § 150.2. However, there were fewer than 20 unique persons that had cash-settled positions in excess of the reproposed spot-month limit levels for metal commodities; this is in marked contrast to the 131 unique persons who had cash-settled positions in excess of the reproposed spot-month limit for natural gas contracts. The Commission, in consideration of the distribution of unique persons holding positions in cash-settled metal commodity contracts across the 24 calendar months of its analysis, particularly in platinum,[671] is of the view that the spot-month limit level, as discussed above under § 150.2, and without a conditional spot-month limit exemption, is within the range of acceptable limit levels that, to the maximum extent practicable, may achieve the statutory policy objectives in CEA section 4a(a)(3)(B).

Table III-B-24—Metal Contracts (COMEX Division of NYMEX)

Core-referenced futures contractBasis of spot-month levelPosition limit levelNumber of unique persons >= levelNumber of unique persons in market
Spot month cash settledSpot month physical deliverySpot month onlyAll months
CopperCME proposal1,0000(*)4931,457
(current limit 1,000)25% DS1,1000(*)
GoldCME proposal6,000(*)(*)5181,557
(current limit 3,000)25% DS11,20000
PalladiumCME proposal100614164580
(current limit 100)25% DS90000
PlatinumCME proposal50013(*)235842
(current limit 500)25% DS90010(*)
50% DS1,800(*)0
SilverCME proposal3,000003111,023
(current limit 1,500)25% DS5,60000
Start Printed Page 96781

e. Proposed Recordkeeping and Special Call Requirements—§ 150.3(g) and § 150.3(h)

Proposed Rules: As proposed in the December 2013 Position Limits Proposal, § 150.3(g) specifies recordkeeping requirements for persons who claim any exemption set forth in § 150.3. Persons claiming exemptions under previously proposed § 150.3 must maintain complete books and records concerning all details of their related cash, forward, futures, options and swap positions and transactions. Furthermore, such persons must make such books and records available to the Commission upon request under previously proposed § 150.3(h), which would preserve the “special call” rule set forth in current § 150.3(b). This “special call” rule would have required that any person claiming an exemption under § 150.3 must, upon request, provide to the Commission such information as specified in the call relating to the positions owned or controlled by that person; trading done pursuant to the claimed exemption; the commodity derivative contracts or cash market positions which support the claim of exemption; and the relevant business relationships supporting a claim of exemption.

The Commission noted that the previously proposed rules concerning detailed recordkeeping and special calls are designed to help ensure that any person who claims any exemption set forth in § 150.3 can demonstrate a legitimate purpose for doing so.[672]

Comments Received: The Commission did not receive any comments on the recordkeeping provisions in § 150.3(g) as proposed in the December 2013 Position Limits Proposal. With respect to previously proposed § 150.3(h), one commenter opposed the “special call” provision because, in the commenter's opinion, it is “too passive.” The commenter advocated, instead, a revision requiring persons claiming an exemption to maintain books and records on an ongoing basis and provide information to the Commission on a periodic and automatic basis, because even if the Commission lacked staff and resources to review the submitted material in real-time, Commission staff would have detailed historical data for use in compliance audits. This commenter stated that since required records are likely to be kept in an electronic format, the more frequent reporting requirement would not be considered burdensome.[673]

Commission Reproposal: The Commission believes the previously proposed recordkeeping and “special call” provisions in § 150.3(g) and § 150.3(h), respectively, are sufficient to limit abuse of exemptions without causing undue burdens on market participants. The Commission is reproposing these sections generally as proposed in the December 2013 Position Limits Proposal. The Commission is clarifying, in reproposed § 150.3(g)(2), that the bona fides of the pass-through swap counterparty may be determined at the time of the transaction or, alternatively, at such later time that the counterparty can show the swap position to be a bona fide hedging position. As previously proposed, such bona fides could only be determined at the time of the transaction, as opposed to at a later time.

D. § 150.5—Exchange-Set Speculative Position Limits and Parts 37 and 38

1. Background

As discussed above, the Commission currently sets and enforces position limits pursuant to its broad authority under CEA section 4a,[674] and does so only with respect to certain enumerated agricultural products.[675] As the Commission explained above and in the December 2013 Position Limits Proposal,[676] section 735 of the Dodd-Frank Act amended section 5(d)(1) of the CEA to explicitly provide that the Commission may mandate the manner in which DCMs must comply with the core principles.[677] However, Congress limited the exercise of reasonable discretion by DCMs only where the Commission has acted by regulation.[678]

The Dodd-Frank Act also amended DCM core principle 5. As amended, DCM core principle 5 requires that, for any contract that is subject to a position limitation established by the Commission pursuant to CEA section 4a(a), the DCM “shall set the position limitation of the board of trade at a level not higher than the position limitation established by the Commission.” [679] Moreover, the Dodd-Frank Act added CEA section 5h to provide a regulatory framework for Commission oversight of SEFs.[680] Under SEF core principle 6, which parallels DCM core principle 5, Congress required that SEFs that are trading facilities adopt for each swap, as is necessary and appropriate, position limits or position accountability.[681] Furthermore, Congress required that, for any contract that is subject to a Federal position limit under CEA section 4a(a), the SEF shall set its position limits at a level no higher than the position limitation established by the Commission.[682]

2. Summary

As explained in the December 2013 Position Limits Proposal,[683] to implement the authority provided by section 735 of the Dodd-Frank Act amendments to CEA sections 5(d)(1) and 5h(f)(1), the Commission evaluated its pre-Dodd-Frank Act regulations and approach to oversight of DCMs, which had consisted largely of published guidance and acceptable practices, with the aim of updating them to conform to the new Dodd-Frank Act regulatory framework. Based on that review, and pursuant to the authority given to the Commission in amended sections 5(d)(1) and 5h(f)(1) of the CEA, which permit the Commission to determine, by rule or regulation, the manner in which boards of trade and SEFs, respectively, must comply with the core principles,[684] the Commission in its December 2013 Position Limit Proposal, proposed several updates to § 150.5 to promote compliance with DCM core principle 5 and SEF core principle 6 governing position limitations or accountability.[685]

First, the Commission proposed amendments to the provisions of § 150.5 to include SEFs and swaps. Second, the Commission proposed to codify rules and revise acceptable practices for Start Printed Page 96782compliance with DCM core principle 5 and SEF core principle 6 within amended § 150.5(a) for contracts subject to the federal position limits set forth in § 150.2. Third, the Commission proposed to codify rules and revise guidance and acceptable practices for compliance with DCM core principle 5 and SEF core principle 6 within amended § 150.5(b) for contracts not subject to the federal position limits set forth in § 150.2. Fourth, the Commission proposed to amend § 150.5 to implement uniform requirements for DCMs and SEFs that are trading facilities relating to hedging exemptions across all types of contracts, including those that are subject to federal limits. Fifth, the Commission proposed to require DCMs and SEFs that are trading facilities to have aggregation policies that mirror the federal aggregation provisions.[686]

In addition to the changes to the provisions of § 150.5 proposed in the December 2013 Position Limits Proposal, the Commission also noted that it had, in response to the Dodd-Frank Act, previously published several earlier rulemakings that pertained to position limits, including in a notice of proposed rulemaking to amend part 38 to establish regulatory obligations that each DCM must meet in order to comply with section 5 of the CEA, as amended by the Dodd-Frank Act.[687] In addition, as noted above, the Commission had published a proposal to replace part 150 with a proposed part 151, which was later finalized before being vacated.[688] In the December 2013 Position Limits Proposal, the Commission pointed out that as it was originally proposed, § 38.301 would require each DCM to comply with the requirements of part 151 as a condition of its compliance with DCM core principle 5.[689] When the Commission finalized Dodd-Frank updates to part 38 in 2012, it adopted a revised version of § 38.301 with an additional clause that requires DCMs to continue to meet the requirements of part 150 of the Commission's regulations—the current position limit regulations—until such time that compliance would be required under part 151.[690] At that time, the Commission explained that this clarification would ensure that DCMs were in compliance with the Commission's regulations under part 150 during the interim period until the compliance date for the new position limits regulations of part 151 would take effect.[691] The Commission further explained that its new regulation, § 38.301, was based on the Dodd-Frank amendments to the DCM core principles regime, which collectively would provide that DCM discretion in setting position limits or position accountability levels was limited by Commission regulations setting position limits.[692]

Similarly, as the Commission noted in the December 2013 Position Limits Proposal,[693] when in 2010 the Commission proposed to adopt a regulatory scheme applicable to SEFs, it proposed to require that SEFs establish position limits in accordance with the requirements set forth in part 151 of the Commission's regulations under proposed § 37.601.[694] The Commission pointed out that it had revised § 37.601 in the SEF final rulemaking, to state that until such time that compliance was required under part 151, a SEF may refer to the guidance and/or acceptable practices in Appendix B of part 37 to demonstrate to the Commission compliance with the requirements of SEF core principle 6.[695]

In the December 2013 Position Limits Proposal, the Commission noted that in light of the District Court vacatur of part 151, the Commission proposed to amend § 37.601 to delete the reference to vacated part 151. The amendment would have instead required that SEFs that are trading facilities meet the requirements of part 150, which would be comparable to the DCM requirement, since, as proposed in the December 2013 Position Limits Proposal, § 150.5 would apply to commodity derivative contracts, whether listed on a DCM or on a SEF that is a trading facility. At the same time, the Commission would have amended Appendix B to part 37, which provides guidance on complying with core principles, both initially and on an ongoing basis, to maintain SEF registration.[696] Since the December 2013 Position Limits Proposal required that SEFs that are trading facilities meet the requirements of part 150, the proposed amendments to the guidance regarding SEF core principle 6 reiterated that requirement. The Commission noted that for SEFs that are not trading facilities, to whom core principle 6 would not be applicable under the statutory language, part 150 should have been considered as guidance.[697]

More recently, the Commission issued the 2016 Supplemental Position Limits Proposal to revise and amend certain parts of the December 2013 Position Limits Proposal based on comments received on the December 2013 Position Limits Proposal,[698] viewpoints expressed during a Roundtable on Position Limits,[699] several Commission advisory committee meetings that each provided a focused forum for participants to discuss some aspects of the December 2013 Position Limits Proposal,[700] and information obtained in the course of ongoing Commission Start Printed Page 96783review of SEF registration applications.[701]

In the 2016 Supplemental Position Limits Proposal, the Commission proposed to delay for exchanges that lack access to sufficient swap position information the requirement to establish and monitor position limits on swaps at this time by: (i) Adding Appendix E to part 150 to provide guidance regarding § 150.5; and (ii) revising guidance on DCM Core Principle 5 and SEF Core Principle 6 that corresponds to that proposed guidance regarding § 150.5.[702] In addition, the Commission in the 2016 Supplemental Position Limits Proposal proposed new alternative processes for DCMs and SEFs to recognize certain positions in commodity derivative contracts as non-enumerated bona fide hedges or enumerated anticipatory bona fide hedges, as well as to exempt from federal position limits certain spread positions, in each case subject to Commission review.[703] Moreover, the Commission proposed that DCMs and SEFs could recognize and exempt from exchange position limits certain non-enumerated bona fide hedging positions, enumerated anticipatory bona fide hedges, and certain spread positions.[704] To effectuate the latter proposals, the Commission proposed amendments to § 150.3 and new § 150.9, 150.10, and 150.11, as well as corresponding amendments to § 150.5(a)(2) and 150.5(b)(5).[705]

3. Discussion

As discussed in greater detail below, the Commission has determined to repropose § 150.5 largely as proposed in the December 2013 Position Limit Proposal and as revised in the 2016 Supplemental Position Limits Proposal. In addition, the Commission has determined to repropose the previously proposed amendments to § 37.601 and § 38.301.[706]

Some changes were made to § 150.5 in response to concerns raised by commenters; other changes to the reproposed regulation are to conform to changes made in other sections. For example, in reproposing § 150.5(b)(1) and (2), the Commission has determined to make certain changes to the acceptable practices for establishing the levels of individual non-spot or all-months combined position limits for futures and future option contracts that are not subject to federal limits. The changes to reproposed § 150.5(b)(1) and (2) correspond to changes to reproposed § 150.2(e)(4)(iv) discussed above, for establishing the levels of individual non-spot or all-months combined positions limits for futures and future option contracts that are subject to federal limits. Moreover, several non-substantive changes were made in response to commenter requests to provide greater clarity.[707]

The essential features of the changes to reproposed § 150.5 are discussed below.

a. Treatment of Swaps on SEFs and DCMs

i. December 2013 Position Limits Proposal. As explained above, CEA section 4a(a)(5), as amended by the Dodd-Frank Act, requires federal position limits for swaps that are “economically equivalent” to futures and options that are subject to mandatory position limits under CEA section 4a(a)(2).[708] The CEA also requires in SEF Core Principle 6 that a SEF that is a trading facility: (i) Set its exchange-set limit on swaps at a level no higher than that of the federal position limit; and (ii) monitor positions established on or through the SEF for compliance with the federal position limit and any exchange-set limit.[709] Similarly, for all contracts subject to a federal position limit, including swaps, DCMs, under DCM Core Principle 5, must set a position limit no higher than the federal limit.[710]

The December 2013 Position Limits Proposal specified that federal position limits would apply to referenced contracts,[711] whether futures or swaps, regardless of where the futures or swaps positions are established.[712] Consistent with DCM Core Principle 5 and SEF Core Principle 6, the Commission at § 150.5(a)(1) previously proposed that for any commodity derivative contract that is subject to a speculative position limit under § 150.2, a DCM or SEF that is a trading facility shall set a speculative position limit no higher than the level specified in § 150.2.” [713]

ii. Comments Received to December 2013 Position Limits Proposal

Several comment letters on previously proposed § 150.5 recommended that the Commission not require SEFs to establish position limits.[714] Two noted that because SEF participants may use more than one derivatives clearing organization (“DCO”), a SEF may not know when a position has been offset.[715] Further, during the ongoing SEF registration process,[716] a number of Start Printed Page 96784persons applying to become registered as SEFs told the Commission that they lack access to information that would enable them to knowledgeably establish position limits or monitor positions.[717] As the Commission observed in the 2016 Supplemental Position Limits Proposal, this information gap would also be a concern for DCMs in respect of swaps.[718]

iii. 2016 Supplemental Position Limits Proposal

As explained above, in the 2016 Supplemental Position Limits Proposal, the Commission proposed to temporarily delay for DCMs and SEFs that are trading facilities, which lack access to sufficient swap position information, the requirement to establish and monitor position limits on swaps by: (i) Adding Appendix E to part 150 to provide guidance regarding § 150.5; and (ii) revising guidance on DCM Core Principle 5 and SEF Core Principle 6 that corresponds to that guidance regarding § 150.5.[719] At that time, the Commission acknowledged that, if an exchange does not have access to sufficient data regarding individual market participants' open swap positions, then it cannot effectively monitor swap position limits, and expressed its belief that most exchanges do not have access to sufficient swap position information to effectively monitor swap position limits.[720]

In this regard, the Commission expressed its belief that an exchange would have or could have access to sufficient swap position information to effectively monitor swap position limits if, for example: (1) It had access to daily information about its market participants' open swap positions; or (2) it knows that its market participants regularly engage in large volumes of speculative trading activity, including through knowledge gained in surveillance of heavy trading activity, that would cause reasonable surveillance personnel at an exchange to inquire further about a market participant's intentions [721] or total open swap positions.[722]

The Commission noted that it is possible that an exchange could obtain an indication of whether a swap position established on or through a particular exchange is increasing a market participant's swap position beyond a federal or exchange-set limit, if that exchange has data about some or all of a market participant's open swap position from the prior day and combines it with the transaction data from the current day, to obtain an indication of the market participant's current open swap position.[723] The indication would alert the exchange to contact the market participant to inquire about that participant's total open swap position.

The Commission expressed its belief that although this indication would not include the market participant's activity transacted away from that particular exchange, such monitoring would comply with CEA section 5h(f)(6)(B)(ii). However, the Commission observed that exchanges generally do not currently have access to a data source that identifies a market participant's reported open swap positions from the prior trading day. With only the transaction data from a particular exchange, it would be impracticable, if not impossible, for that exchange to monitor and enforce position limits for swaps.[724]

The Commission also acknowledged in the 2016 Supplemental Position Limits Proposal that it has neither Start Printed Page 96785required any DCO [725] or SDR [726] to provide such swap data to exchanges,[727] nor provided any exchange with access to swaps data collected under part 20 of the Commission's regulations.[728]

The Commission stated that in light of the foregoing, it was proposing a delay in implementation of exchange-set limits for swaps only, and only for exchanges without sufficient swap position information.[729] After consideration of the circumstances described above, and in an effort to accomplish the policy objectives of the Dodd-Frank Act regulatory regime, including to facilitate trade processing of any swap and to promote the trading of swaps on SEFs,[730] the 2016 Supplemental Position Limits Proposal amended the guidance in the appendices to parts 37 and 38 of the Commission's regulations regarding SEF core principle 6 and DCM core principle 5, respectively. According to the 2016 Supplemental Position Limits Proposal, the revised guidance clarified that an exchange need not demonstrate compliance with SEF core principle 6 or DCM core principle 5 as applicable to swaps until it has access to sufficient swap position information, after which the guidance would no longer be applicable.[731] For clarity, the 2016 Supplemental Position Limits Proposal included the same guidance in a new Appendix E to proposed part 150 in the context of the Commission's proposed regulations regarding exchange-set position limits.

Although the Commission proposed to temporarily relieve exchanges that do not now have access to sufficient swap position information from having to set position limits on swaps, it also noted that nothing in the 2016 Supplemental Position Limits Proposal would prevent an exchange from nevertheless establishing position limits on swaps, while stating that it does seem unlikely that an exchange would implement position limits before acquiring sufficient swap position information because of the ensuing difficulty of enforcing such a limit. The Commission expressed its belief that providing delay for those exchanges that need it both preserved flexibility for subsequent Commission rulemaking and allowed for phased implementation of limitations on swaps by exchanges, as practicable.[732]

Additionally, the Commission observed that courts have authorized relieving regulated entities of their statutory obligations where compliance is impossible or impracticable,[733] and noted its view that it would be impracticable, if not impossible, for an exchange to monitor and enforce position limits for swaps with only the transaction data from that particular exchange.[734] The Commission expressed its belief that, accordingly, it was reasonable to delay implementation of this discrete aspect of position limits, only with respect to swaps position limits, and only for exchanges that lacked access to sufficient swap position information. This approach, the Commission believed, would further the policy objectives of the Dodd-Frank Act regulatory regime, including the facilitation of trade processing of swaps Start Printed Page 96786and the promotion of trading swaps on SEFs. Finally, the Commission noted that while this approach would delay the requirement for certain exchanges to establish and monitor exchange-set limits on swaps, under the December 2013 Position Limits Proposal, federal position limits would apply to swaps that are economically equivalent to futures contracts subject to federal position limits.[735]

iv. Comments Received to 2016 Supplemental Position Limits Proposal

Several commenters addressed the Commission's proposed guidance on exchange-set limits on swaps.[736]

Regarding insufficient swap data, four commenters agreed that SEFs and DCMs lack access to sufficient swap position data to set exchange limits on swaps, and as such, the commenters support the Commission's decision to delay the position limit monitoring requirements for SEFs that are trading facilities and DCMs.[737] In addition, one commenter recommended that the Commission provide notice for public comments prior to implementing any determination that a DCM or SEF has access to sufficient swap position data to set exchange limits on swaps.[738] Further, two commenters recommended that the Commission identify a plan, to address the insufficient data issues, that goes beyond “simply exempting affected exchanges.” [739]

On the other hand, one commenter asserted that there should be no delay in implementing position limits for swaps because, according to the commenter, the Commission has access to sufficient swap data it needs to implement position limits.[740]

v. Commission Determination

The Commission has determined to repropose the treatment of swaps and SEFs as previously proposed in the 2016 Supplemental Position Limits Proposal for the reasons given above.[741]

Regarding the comments recommending that the Commission identify a plan to address the insufficient data issues that goes beyond “simply exempting affected exchanges,” the Commission may consider granting DCMs and SEFs, as self-regulatory organizations, access to part 20 data or SDR data at a later time.

In addition, regarding the comment that the Commission already has access to sufficient swap data in order to implement position limits, the Commission points out that it proposes to adopt a phased approach to updating its position limits regime.[742] In conjunction with this phased approach, the Commission believes that at this time it should limit its implementation of position limits for swaps to those that are referenced contracts.

b. § 150.5(a)—Requirements and Acceptable Practices for Commodity Derivative Contracts That Are Subject to Federal Position Limits

i. December 2013 Position Limits Proposal

Several requirements were added to § 150.5(a) in the December 2013 Position Limits Proposal to which a DCM or SEF that is a trading facility must adhere when setting position limits for contracts that are subject to the federal position limits listed in § 150.2.[743] Previously proposed § 150.5(a)(1) specified that a DCM or SEF that lists a contract on a commodity that is subject to federal position limits must adopt position limits for that contract at a level that is no higher than the federal position limit.[744] Exchanges with cash-settled contracts price-linked to contracts subject to federal limits would also be required to adopt those limit levels.

Previously proposed § 150.5(a)(3) would have required a DCM or SEF that is a trading facility to exempt from speculative position limits established under § 150.2 a swap position acquired in good faith in any pre-enactment and transition period swaps, in either case as defined in § 150.1.[745] However, previously proposed § 150.5(a)(3) would allow a person to net such a pre-existing swap with post-effective date commodity derivative contracts for the purpose of complying with any non-spot-month speculative position limit. Under previously proposed § 150.5(a)(4)(i), a DCM or SEF that is a trading facility must require compliance with spot month speculative position limits for pre-existing positions in commodity derivatives contracts other than pre-enactment or transition period swaps, while previously proposed § 150.5(a)(4)(ii) provides that a non-spot-month speculative position limit established under § 150.2 would not apply to any commodity derivative contract acquired in good faith prior to the effective date of such limit.[746] As proposed in the December 2013 Position Limits Proposal, however, such a pre-existing commodity derivative contract position must be attributed to the person if the person's position is increased after the effective date of such limit.[747]

Under the December 2013 Position Limits Proposal, the Commission had proposed to require DCMs and SEFs that are trading facilities to have aggregation polices that mirror the federal aggregation provisions.[748] Therefore, Start Printed Page 96787previously proposed § 150.5(a)(5) required DCMs and SEFs that are trading facilities to have aggregation rules that conformed to the uniform standards listed in § 150.4.[749] As noted in the December 2013 Position Limits Proposal, aggregation policies that vary from exchange to exchange would increase the administrative burden on a trader active on multiple exchanges, as well as increase the administrative burden on the Commission in monitoring and enforcing exchange-set position limits.[750]

A DCM or SEF that is a trading facility would have continued to be free to enforce position limits that are more stringent that the federal limits. The Commission clarified in the December 2013 Position Limits Proposal that federal spot month position limits do not to apply to physical-delivery contracts after delivery obligations are established.[751] Exchanges generally prohibit transfer or offset of positions once long and short position holders have been assigned delivery obligations. Previously proposed § 150.5(a)(6) clarified acceptable practices for a DCM or SEF that is a trading facility to enforce spot month limits against the combination of, for example, long positions that have not been stopped, stopped positions, and deliveries taken in the current spot month.[752]

ii. Comments Received to December 2013 Position Limits Proposal Regarding Proposed § 150.5(a)

One commenter recommended that exchanges be required to withdraw their position accountability and position limit regimes in deference to any federal limits and to conform their position limits to the federal limits so that a single regime will apply across exchanges.[753]

Two commenters recommended that the Commission clarify that basis contracts would be excluded from exchange-set limits in order to provide consistency since such contracts are excluded from the Commission's definition of referenced contract and thus are not subject to Federal limits.[754]

One commenter recommended that DCMs and SEFs that are trading facilities be given more discretion, particularly with respect to non-referenced contracts, over aggregation requirements.[755]

iii. 2016 Supplemental Position Limits Proposal

In the 2016 Supplemental Position Limits Proposal, the Commission proposed to amend § 150.5(a)(2) as it was proposed in the December 2013 Position Limits Proposal.[756] The amendments would permit exchanges to recognize non-enumerated bona fide hedging positions under § 150.9, to grant spread exemptions from federal limits under § 150.10, and to recognize certain enumerated anticipatory bona fide hedging positions under § 150.11, each as contained in the 2016 Supplemental Position Limits Proposal. In conjunction with those amendments, the Commission proposed corresponding changes to § 150.3 and § 150.5(a)(2).

For example, § 150.5(a)(2)(i), as proposed in the December 2013 Position Limits Proposal, required that any exchange rules providing for hedge exemptions for commodity derivatives contracts subject to federal position limits conform to the definition of bona fide hedging position as defined in the amendments to § 150.1 contained in the December 2013 Position Limits Proposal. But because the 2016 Supplemental Position Limits Proposal incorporated the bona fide hedging position definition and provided for spread exemptions in 150.3(a)(1)(i), the 2016 Supplemental Position Limits Proposal proposed instead to cite to § 150.3 in § 150.5(a)(2).[757] Similarly, the application process provided for in § 150.5(a)(2) was amended to conform to the requirement in proposed § 150.10 and § 150.11 that exchange rules providing for exemptions for commodity derivatives contracts subject to federal position limits require that traders reapply on at least an annual basis. In addition, the changes to § 150.5(a)(2) clarified that exchanges may deny an application, or limit, condition, or revoke any exemption granted at any time.

Similarly, the 2016 Supplemental Position Limits Proposal amended previously proposed § 150.5(b) to require that exchange rules provide for recognition of a non-enumerated bona fide hedge “in a manner consistent with the process described in § 150.9(a).” Addressing the granting of spread exemptions for contracts not subject to federal position limits, the 2016 Supplemental Position Limits Proposal integrates in the standards of CEA section 4a(a)(3), providing that exchanges should take into account those standards when considering whether to grant spread exemptions. Finally, the 2016 Supplemental Position Limits Proposal clarified that for excluded commodities, the exchange can grant certain exemptions provided under paragraphs § 150.5(b)(5)(i) and (b)(5)(ii) in addition to the risk management exemption previously proposed in the December 2013 Position Limits Proposal.[758]

Start Printed Page 96788

iv. Comments Received on the 2016 Supplemental Position Limits Proposal Regarding § 150.5(a)

While comments were submitted on the 2016 Supplemental Position Limits Proposal that addressed the proposed changes to the definitions under § 150.1, as well as to the proposed exchange processes for recognition of non-enumerated bona fide hedges and anticipatory hedges, and for granting spreads exemptions under proposed §§ 150.9, 150.11, and 150.10, respectively, all of which indirectly affect § 150.5(a), very few comments specifically addressed § 150.5(a). Comments received on the 2016 Supplemental Position Limits Proposal regarding the other sections are addressed in the discussions of those sections.[759]

One commenter urged the Commission to allow exchanges to maintain their current authority to set speculative limits for both spot month and all-months combined limits below federal limits to ensure that convergence continues to occur.[760]

While the Commission's retention of what is often referred to as the five-day rule [761] was included only in the revised definition of bona fide hedging position under § 150.1,[762] several commenters addressed the five-day rule in the context of § 150.5 as proposed in the 2016 Supplemental Position Limits Proposal.[763] According to the commenters, the decision of whether to apply the five-day rule to a particular contract should be delegated to the exchanges because the exchanges are in the best position to evaluate facts and circumstances, and different markets have different dynamics and needs.[764] In addition, one commenter requested that the Commission specifically authorize exchanges to grant bona fide hedging position and spread exemptions during the last five days of trading or less.[765] Two commenters suggested, as an alternative approach if the five-day rule remains, that the Commission instead rely on tools available to exchanges to address concerns, such as exchanges requiring gradual reduction of the position (“step down” requirements) or revoking exemptions to protect the price discovery process in core referenced futures contracts approaching expiration.[766] Another commenter argued that in spite of any five-day rule that is adopted, exchanges should be allowed to recognize non-enumerated bona fide hedging exemptions during the last five trading days for enumerated strategies that are otherwise subject to the five-day rule and the discretion to grant exemptions for hedging strategies that would otherwise be subject to the five-day rule.[767]

One issue raised by several commenters [768] that did not directly address § 150.5 concerns the application procedures in §§ 150.9(a)(4), 150.10(a)(4), and 150.11(a)(3), which require market participants to apply for recognition or an exemption in advance of exceeding the limit.[769] For example, one commenter requested the insertion of a provision permitting exchanges to recognize exemptions retroactively due to “unforeseen hedging needs”; this commenter also stated that certain exchanges currently utilize a similar rule and it is “critical in reflecting commercial hedging needs that cannot always be predicted in advance.” [770] Another commenter requested that the Commission allow exchanges to recognize a bona fide hedge exemption for up to a five-day retroactive period in circumstances where market participants need to exceed limits to address a sudden and unforeseen hedging need.[771] That commenter stated that CME and ICE currently provide mechanisms for such recognition, which are used infrequently but are nonetheless important. According to that commenter, “[t]o ensure that such allowances will not diminish the overall integrity of the process, two effective safeguards under the current exchange-administered processes could continue to be required. First, the exchange rules could continue to require market participants making use of the retroactive application to demonstrate that the applied-for hedge was required to address a sudden and unforeseen hedging need. . . . Second, if the emergency hedge recognition is not granted, the exchange rules could continue to require the applicant to immediately unwind its position and also deem the applicant to have been in violation for any period in which its position exceeded the applicable limits.[772] While these comments address other sections, the Commission will respond to these comments in explaining its reproposal of § 150.5.

v. Commission Determination Regarding § 150.5(a)

The Commission has determined to repropose § 150.5(a) as proposed in the 2016 Supplemental Position Limits Proposal for the reasons provided above with some changes, as detailed below.[773]

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Although the Commission is reproposing § 150.5(a)(1), in response to the comment that the exchanges should conform their position limits to the federal limits so that a single position limit and accountability regime apply across exchanges,[774] the Commission believes that exchanges may find it prudent in the course of monitoring position limits to impose lower (that is, more restrictive) limit levels. The flexibility for exchanges to set more restrictive limits is granted in CEA section 4a(e), which provides that if an exchange establishes limits on a contract, those limits shall be set at a level no higher than the level of any limits set by the Commission. This expressly permits an exchange to set lower limit levels than federal limit levels. The reproposed rules track this statutory provision.

For purposes of clarification in response to comments on the treatment of basis contracts, the reproposed rules provide a singular definition of “referenced contract” which, as stated by the commenters, excludes “basis contracts.” For commodities subject to federal limits under reproposed § 150.2, the definition of referenced contract remains the same for federal and exchange-set limits and may not be amended by exchanges. An exchange could, but is not required to, impose limits on any basis contract independently of the federal limit for the commodity in question, but a position in a basis contract with an independent, exchange-set limit would not count for the purposes of the federal limit.[775]

After consideration of comments regarding § 150.5(a)(2)(i) (Grant of exemption),[776] as proposed in the 2016 Supplemental Position Limits Proposal, the Commission is reproposing it with modifications. Reproposed § 150.5(a)(2)(i) provides that any exchange may grant exemptions from any speculative position limits it sets under paragraph § 150.5(a)(1), provided that such exemptions conform to the requirements specified in § 150.3, and provided further that any exemptions to exchange-set limits not conforming to § 150.3 are capped at the level of the applicable federal limit in § 150.2.

The Commission notes that under the 2013 Position Limits Proposal, exchanges could adopt position accountability at a level lower than the federal limit (along with a position limit at the same level as the federal limit); in such cases, the exchange would not need to grant exemptions for positions no greater than the level of the federal limit. Under the Reproposal, exchanges could choose, instead, to adopt a limit lower than the federal limit; in such a case, the Commission would permit the exchange to grant an exemption to the exchange's lower limit, where such exemption does not conform to § 150.3, provided that such exemption to an exchange-set limit is capped at the level of the federal limit. Such a capped exemption would basically have the same effect as if the exchange set its speculative position limit at the level of the federal limit, as required under DCM core principle 5(B) and SEF core principle 6(B)(1).[777]

In regards to the five-day rule, the Commission notes that the reproposed rule does not apply the prudential condition of the five-day rule to non-enumerated hedging positions. The Commission considered the recommendations that the Commission: Allow exchanges to recognize a bona fide hedge exemption for up to a five-day retroactive period in circumstances where market participants need to exceed limits to address a sudden and unforeseen hedging need; specifically authorize exchanges to grant bona fide hedge and spread exemptions during the last five days of trading or less, and/or delegate to the exchanges for their consideration the decision of whether to apply the five-day rule to a particular contract after their evaluation of the particular facts and circumstances. As reproposed, and as discussed in connection with the definition of bona fide hedging position,[778] the five-day rule would only apply to certain positions (pass-through swap offsets, anticipatory and cross-commodity hedges).[779] However, in regards to exchange processes under § 150.9, § 150.10, and § 150.11, the Commission would allow exchanges to waive the five-day rule on a case-by-case basis.

In addition, the Commission proposes to amend § 150.5(a)(2)(ii) (Application for exemption). The reproposed rule would permit exchanges to adopt rules that allow a trader to file an application for an enumerated bona fide hedging exemption within five business days after the trader assumed the position that exceeded a position limit.[780] The Commission expects that exchanges will carefully consider whether allowing such retroactive recognition of an enumerated bona fide hedging exemption would, as noted by one commenter, diminish the overall integrity of the process.[781] In addition, the Commission cautions exchanges to carefully consider whether to adopt in those rules the two safeguards recommended by that commenter: (i) Requiring market participants making use of the retroactive application to demonstrate that the applied-for hedge was required to address a sudden and unforeseen hedging need; and (ii) providing that if the emergency hedge recognition was not granted, exchange rules would continue to require the applicant to unwind its position in an orderly manner and also would deem the applicant to have been in violation for any period in which its position exceeded the applicable limits.[782]

Concerning the comment recommending greater discretion be given DCMs and SEFs that are trading facilities with respect to aggregation requirements, the Commission reiterates its belief in the benefits of requiring exchanges to conform to the federal standards on aggregation, including lower burden and less confusion for traders active on multiple exchanges,[783] efficiencies in administration for both exchanges and the Commission, and the prevention of a “race-to-the-bottom” wherein exchanges compete over lower standards. The Commission notes that the provision regarding aggregation in reproposed § 150.5(a)(5) incorporates by reference § 150.4 and thus would, on a continuing basis, reflect any changes made to the aggregation standard provided in the section.

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c. § 150.5(b)—Requirements and Acceptable Practices for Commodity Derivative Contracts That Are Not Subject to Federal Position Limits

i. December 2013 Position Limits Proposal

The Commission set forth in § 150.5(b), as proposed in the December 2013 Position Limits Proposal, requirements and acceptable practices that would generally update and reorganize the set of acceptable practices listed in current § 150.5 as they relate to contracts that are not subject to the federal position limits, including physical and excluded commodities.[784] As discussed above, the Commission also proposed to revise § 150.5 to implement uniform requirements for DCMs and SEFs that are trading facilities relating to hedging exemptions across all types of commodity derivative contracts, including those that are not subject to federal position limits. The Commission further proposed to require DCMs and SEFs that are trading facilities to have uniform aggregation polices that mirrored the federal aggregation provisions for all types of commodity derivative contracts, including for contracts that were not subject to federal position limits.[785]

The previously proposed revisions to DCM and SEF acceptable practices generally concerned how to: (1) Set spot-month position limits; (2) set individual non-spot month and all-months-combined position limits; (3) set position limits for cash-settled contracts that use a referenced contract as a price source; (4) adjust position limit levels after a contract has been listed for trading; and (5) adopt position accountability in lieu of speculative position limits.[786]

For spot months under the December 2013 Position Limits Proposal, for a derivative contract that was based on a commodity with a measurable deliverable supply, previously proposed § 150.5(b)(1)(i)(A) updated the acceptable practice in current § 150.5(b)(1) whereby spot month position limits should be set at a level no greater than one-quarter of the estimated deliverable supply of the underlying commodity.[787] Previously proposed § 150.5(b)(1)(i)(A) clarified that this acceptable practice for setting spot month position limits would apply to any commodity derivative contract, whether physical-delivery or cash-settled, that has a measurable deliverable supply.[788]

For a derivative contract that was based on a commodity without a measurable deliverable supply, the December 2013 Position Limits Proposal proposed for spot months, in § 150.5(b)(1)(i)(B), to codify as guidance that the spot month limit level should be no greater than necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract's or the underlying commodity's price.[789]

Under previously proposed § 150.5(b)(1)(ii)(A), the December 2013 Position Limits Proposal preserved the existing acceptable practice in current § 150.5(b)(2) whereby individual non-spot or all-months-combined levels for agricultural commodity derivative contracts that are not subject to the federal limits should be no greater than 1,000 contracts at initial listing. As then proposed, the rule would also codify as guidance that the 1,000 contract limit should be taken into account when the notional quantity per contract is no larger than a typical cash market transaction in the underlying commodity, or reduced if the notional quantity per contract is larger than a typical cash market transaction. Additionally, the December 2013 Position Limits Proposal proposed in § 150.5(b)(1)(ii)(A), to codify for individual non-spot or all-months-combined, that if the commodity derivative contract was substantially the same as a pre-existing DCM or SEF commodity derivative contract, then it would be an acceptable practice for the DCM or SEF that is a trading facility to adopt the same limit as applies to that pre-existing commodity derivative contract.[790]

In § 150.5(b)(1)(ii)(B), the December 2013 Position Limits Proposal preserved the existing acceptable practice for individual non-spot or all-months-combined in exempt and excluded commodity derivative contracts, set forth in current § 150.5(b)(3), for DCMs to set individual non-spot or all-months-combined limits at levels no greater than 5,000 contracts at initial listing.[791] Previously proposed § 150.5(b)(1)(ii)(B) would codify as guidance for exempt and excluded commodity derivative contracts that the 5,000 contract limit should be applicable when the notional quantity per contract was no larger than a typical cash market transaction in the underlying commodity, or should be reduced if the notional quantity per contract was larger than a typical cash market transaction. Additionally, previously proposed § 150.5(b)(1)(ii)(B) would codify a new acceptable practice for a DCM or SEF that is a trading facility to adopt the same limit as applied to the pre-existing contract if the new commodity contract was substantially the same as an existing contract.[792]

The December 2013 Position Limits Proposal provided in § 150.5(b)(1)(iii) Start Printed Page 96791that if a commodity derivative contract was cash-settled by referencing a daily settlement price of an existing contract listed on a DCM or SEF, then it would be an acceptable practice for a DCM or SEF to adopt the same position limits as the original referenced contract, assuming the contract sizes are the same. Based on its enforcement experience, the Commission expressed the belief that limiting a trader's position in cash-settled contracts in this way would diminish the incentive to exert market power to manipulate the cash-settlement price or index to advantage a trader's position in the cash-settled contract.[793]

In previously proposed § 150.5(b)(2)(i)(A), the Commission was updating the acceptable practices in current § 150.5(c) for adjusting limit levels for the spot month.[794] For a derivative contract that was based on a commodity with a measurable deliverable supply, previously proposed § 150.5(b)(2)(i)(A) maintained the acceptable practice in current § 150.5(c) to adjust spot month position limits to a level no greater than one-quarter of the estimated deliverable supply of the underlying commodity, but would apply this acceptable practice to any commodity derivative contract, whether physical-delivery or cash-settled, that has a measurable deliverable supply. For a derivative contract that was based on a commodity without a measurable deliverable supply, previously proposed § 150.5(b)(2)(i)(B) would codify as guidance that the spot month limit level should not be adjusted to levels greater than necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract's or the underlying commodity's price. In addition, the December 2013 Position Limit Proposal would have codified in § 150.5(b)(2)(i)(A) a new acceptable practice that spot month limit levels be reviewed no less than once every two years.[795]

The December 2013 Position Limits Proposal explained that then proposed § 150.5(b)(2)(ii) maintained as an acceptable practice the basic formula set forth in current § 150.5(c)(2) for adjusting non-spot-month limits at levels of no more than 10% of the average combined futures and delta-adjusted option month-end open interest for the most recent calendar year up to 25,000 contracts, with a marginal increase of 2.5% of the remaining open interest thereafter.[796] Previously proposed § 150.5(b)(2)(ii) would also maintain as an alternative acceptable practice the adjustment of non-spot-month limits to levels based on position sizes customarily held by speculative traders in the contract.[797] Previously proposed § 150.5(b)(3) generally updated and reorganized the existing acceptable practices in current § 150.5(e) for a DCM or SEF that is a trading facility to adopt position accountability rules in lieu of position limits, under certain circumstances, for contracts that are not subject to federal position limits. As noted in the December 2013 Position Limits Proposal, this section would reiterate the DCM's authority, with conforming changes for SEFs, to require traders to provide information regarding their position when requested by the exchange.[798] In addition, previously proposed § 150.5(b)(3) would codify a new acceptable practice for a DCM or SEF to require traders to consent to not increase their position in a contract if so ordered, as well as a new acceptable practice for a DCM or SEF to require traders to reduce their position in an orderly manner.[799]

The December 2013 Position Limits Proposal would maintain under § 150.5(b)(3)(i) the acceptable practice for a DCM or SEF to adopt position accountability rules outside the spot month, in lieu of position limits, for an agricultural or exempt commodity derivative contract that: (1) Had an average month-end open interest of 50,000 or more contracts and an average daily volume of 5,000 or more contracts during the most recent calendar year; (2) had a liquid cash market; and (3) was not subject to federal limits in § 150.2—provided, however, that such DCM or SEF that is a trading facility should adopt a spot month speculative position limit with a level no greater than one-quarter of the estimated spot month deliverable supply.[800]

The December 2013 Position Limits Proposal would maintain in § 150.5(b)(3)(ii)(A) the acceptable practice for a DCM or SEF to adopt position accountability rules in the spot month in lieu of position limits for an excluded commodity derivative contract that had a highly liquid cash market and no legal impediment to delivery.[801] For an excluded commodity derivative contract without a measurable deliverable supply, previously proposed § 150.5(b)(3)(ii)(A) would codify an acceptable practice for a DCM or SEF to adopt position accountability rules in the spot month in lieu of position limits because there was not a deliverable supply that was subject to manipulation. However, for an excluded commodity derivative contract that had a measurable deliverable supply, but that may not be highly liquid and/or was subject to some legal impediment to delivery, previously proposed § 150.5(b)(3)(ii)(A) set forth an acceptable practice for a DCM or SEF to adopt a spot-month position limit equal to no more than one-quarter of the estimated deliverable supply for that commodity, because the estimated deliverable supply may be susceptible to manipulation.[802] Furthermore, the December 2013 Position Limits Proposal in § 150.5(b)(3)(ii) would remove the “minimum open interest and volume” test for excluded commodity derivative contracts generally.[803] Finally, the December 2013 Position Limits Proposal would codify in § 150.5(b)(3)(ii)(B) an acceptable practice for a DCM or SEF to adopt position accountability levels for an excluded commodity derivative contract in lieu of position limits in the individual non-spot month or all-months-combined.

The December 2013 Position Limits Proposal added in § 150.5(b)(3)(iii) a new acceptable practice for an exchange to list a new contract with position accountability levels in lieu of position limits if that new contract was substantially the same as an existing contract that was currently listed for trading on an exchange that had already Start Printed Page 96792adopted position accountability levels in lieu of position limits.[804]

As previously proposed, § 150.5(b)(4) would maintain the acceptable practice that for contracts not subject to federal position limits, DCMs and SEFs should calculate trading volume and open interest in the manner established in current § 150.5(e)(4).[805] The Commission stated in the December 2013 Position Limits Proposal that then proposed § 150.5(b)(4) would build upon these standards by accounting for swaps in referenced contracts on a futures-equivalent basis.[806]

As noted above, under the December 2013 Position Limits proposal, the Commission proposed to require DCMs and SEFs to have uniform hedging exemptions and aggregation polices that mirror the federal aggregation provisions for all types of commodity derivative contracts, including for contracts that are not subject to federal position limits. The Commission explained that hedging exemptions and aggregation policies that vary from exchange to exchange would increase the administrative burden on a trader active on multiple exchanges, as well as increase the administrative burden on the Commission in monitoring and enforcing exchange-set position limits.[807] Therefore, the December 2013 Position Limits Proposal in § 150.5(b)(5)(i) would require any hedge exemption rules adopted by a designated contract market or a swap execution facility that is a trading facility to conform to the definition of bona fide hedging position in previously proposed § 150.1.[808]

The December 2013 Position Limits Proposal also set forth in § 150.5(b)(5)(ii) acceptable practices for DCMs and SEFs to grant exemptions from position limits for positions, other than bona fide hedging positions, in contracts not subject to federal limits. The exemptions in § 150.5(b)(5)(ii) under the December 2013 Position Limits Proposal generally tracked the exemptions then proposed in § 150.3; acceptable practices were suggested based on the same logic that underpinned those exemptions.[809] The acceptable practices contemplated that a DCM or SEF might grant exemptions under certain circumstances for financial distress, intramarket and intermarket spread positions (discussed above), and qualifying cash-settled contract positions in the spot month.[810] Previously proposed § 150.5(b)(5)(ii)(E) also set forth an acceptable practice for a DCM or SEF to grant for contracts on excluded commodities, a limited risk management exemption pursuant to rules submitted to the Commission, and consistent with the guidance in new Appendix A to part 150.[811]

The December 2013 Position Limits Proposal provided in § 150.5(b)(6)-(7) acceptable practices relating to pre-enactment and transition period swap positions (as those terms were defined in previously proposed § 150.1),[812] as well as to commodity derivative contract positions acquired in good faith prior to the effective date of mandatory federal speculative position limits.[813]

Additionally, for any contract that is not subject to federal position limits, previously proposed § 150.5(b)(8) required the DCM or SEF that is a trading facility to conform to the uniform federal aggregation provisions.[814] As noted above, aggregation policies that vary from exchange to exchange would increase the administrative burden on a trader active on multiple exchanges, as well as increase the administrative burden on the Commission in monitoring and enforcing exchange-set position limits. The requirement generally mirrored the requirement in § 150.5(a)(5) for contracts that are subject to federal position limits by requiring the DCM or SEF that is a trading facility to have aggregation rules that conform to previously proposed § 150.4.[815]

ii. Comments Received to December 2013 Position Limits Proposal Regarding § 150.5(b)

Three commenters on previously proposed regulation § 150.5 recommended that the Commission not require SEFs to establish position limits.[816] Two noted that because SEF participants may use more than one derivatives clearing organization (“DCO”), a SEF may not know when a position has been offset.[817] Further, during the ongoing SEF registration process,[818] a number of entities applying to become registered as SEFs told the Commission that they lacked access to information that would enable them to knowledgeably establish position limits or monitor positions.[819] The Commission observes that this Start Printed Page 96793information gap would also be a concern for DCMs in respect of swaps.

One commenter expressed the view that deliverable supply calculations used to establish spot month limits should be based on commodity specific actual physical transport/transmission, generation and production.[820]

One commenter urged the Commission to allow the listing exchange to set non-spot month limits at least as high as the spot-month position limit, rather than base the non-spot month limit strictly on the open interest formula.[821] Another commenter recommended that the Commission remove from § 150.5(b)(1)(ii)(B) the provision setting a 5,000 contract limit for non-spot-month or all-months-combined accountability levels for exempt commodities, because that level may not be appropriate for all markets; instead, the Commission should rely on the exchanges to set accountability levels for exempt commodity markets.[822]

One commenter recommended that DCMs be permitted to establish position accountability levels in lieu of position limits outside of the spot month.[823] The commenter recommended that the administration of position accountability should be coordinated with the Commission and other DCMs to the extent that a market participant holds positions on more than one DCM.[824]

iii. 2016 Supplemental Position Limits Proposal

In the 2016 Supplemental Position Limits Proposal, the Commission proposed to revise § 150.5(b)(5) from what was proposed in the December 2013 Position Limits Proposal; proposed § 150.5(b) establishes requirements and acceptable practices that pertain to commodity derivative contracts not subject to federal position limits.[825] The proposed revisions to § 150.5(b)(5) would, under the 2016 Supplemental Position Limits Proposal, permit exchanges, in regards to commodity derivative contracts not subject to federal position limits, to recognize non-enumerated bona fide hedging positions, as well as spreads. Moreover, the exchanges would no longer be prohibited from recognizing spreads during the spot month.[826] Instead, as the Commission noted in the 2016 Supplemental Position Limits Proposal, what it was proposing would, in part, maintain the status quo: Exchanges that currently recognize spreads in the spot month under current § 150.5(a) would be able to continue to do so. Rather than a prohibition, the exchanges would be responsible for determining whether recognizing spreads, including spreads in the spot month, would further the policy objectives in section 4a(a)(3) of the Act.[827]

iv. Comments Received to 2016 Supplemental Position Limits Proposal Regarding § 150.5(b)

Exchange-Administered Exemptions Under § 150.5(b)

Several commenters requested clarification as to the application of exchange-administered exemption requests to non-referenced contracts generally under § 150.5(b).[828] In addition, several commenters raised concerns with the requirement in § 150.5(b)(5)(i) that the exchanges provide exemptions “in a manner consistent with the process described in § 150.9(a).” [829] Similarly, according to one commenter, the exchanges should not be bound to the same exemption process provided under proposed CFTC Regulation 150.9 when administering exemptions from exchange-set limits. Rather, the commenter recommended that the Commission: “(i) not adopt proposed CFTC Regulation 150.5(b)(5)(i) in any final rule issued in this proceeding or (ii) clarify that the phrase `in a manner consistent with the process described in [proposed CFTC Regulation] 150.5(b)(5)(i)' does not mean that the Exchanges must apply the virtually identical process for recognizing non-enumerated bona fide hedging positions under proposed CFTC Regulation 150.9(a) to their exemption process for exchange-set speculative position limits.” [830]

Another commenter stated that the Commission should remove the requirements of § 150.5(b) that apply the exemption procedures of § 150.9 to exemptions granted for contracts in excluded commodities and physical commodities that are not subject to federal position limits. In support of this request, the commenter maintained that exchange exemption programs have been operating successfully without the need for such rules, and exchanges do not require additional guidance from the Commission on how to assess recognitions under the 2016 Supplemental Position Limits Proposal and that rule enforcement reviews are adequate.[831]

Treatment of Spread and Anticipatory Hedge Exemptions Under § 150.5(b)

Several commenters requested that the Commission clarify that spread and anticipatory hedge exemptions are unnecessary for excluded commodities and other products not subject to federal limits. For example, one commenter seeks clarity regarding the application of § 150.5(b) to spread exemption and anticipatory hedge exemption requests, stating that “[p]roposed section 150.5(b) is silent with respect to anticipatory hedges contemplated under the process in proposed section 150.11, and makes no reference in proposed section 150.5(b)(5)(ii)(C) to the process in proposed section 150.10 when describing spread exemptions an exchange may recognize. The Commission must clarify whether it intends that market participants and exchanges may avail themselves of such processes in applying for and recognizing exemptions from exchange limits for non-referenced contracts.” [832] On the other hand, in the associated footnote, the same commenter observes “[h]owever, in its cost-benefit analysis, the Commission notes that proposed section 150.11 `works in concert with' `proposed § 150.5(b)(5), with the effect that recognized anticipatory enumerated Start Printed Page 96794bona fide hedging positions may exceed exchange-set position limits for contracts not subject to federal position limits.' ” [833]

Another commenter urges the Commission to clarify that spread and anticipatory hedge exemptions are unnecessary for excluded commodities and other products not subject to federal limits. In this regard, the commenter seeks the removal of requirements found in § 150.5(b).[834] A third commenter states that extending the requirements for exchange hedge exemption rules to contracts on excluded commodities is “clearly an error” that needs to be rectified, stating that there was no discussion of this expansion in the preamble to the Supplemental. According to the commenter, “there is no basis in the Dodd-Frank amendments to the CEA for this extension of the Commission's authority over exchange position limits on excluded commodities. To the contrary, that authority is clearly limited to position limits on contracts on physical commodities.” [835]

Reporting Requirements Under § 150.5(b)

According to one commenter, the 2016 Supplemental Position Limits Proposal does not provide any explanation regarding the Commission's need to receive from the exchanges the same exemption reports for non-referenced contracts that it would receive for referenced contracts. The commenter states that the 2016 Supplemental Position Limits Proposal characterizes exchange submissions of exemption recipient reports to the CFTC as “support[ing] the Commission's surveillance program, by facilitating the tracking of non-enumerated bona fide hedging positions recognized by the exchange, and helping the Commission to ensure that an applicant's activities conform to the terms of recognition that the exchange has established.” [836] While acknowledging that the Commission has a surveillance obligation with respect to federal limits, the commenter maintains that, “the same obligation has never before existed with respect to exchange-set limits for non-referenced contracts, and does not exist today.” [837] The commenter also states that the Commission has misinterpreted its mandate and therefore should drop this unnecessary reporting requirement and related procedures with respect to non-referenced contracts.”

Five-Day Rule Under § 150.5(b)

As noted above, several commenters [838] addressed the five-day rule, suggesting that the decision whether to apply the five-day rule to a particular contract should be delegated to the exchanges as the exchanges are in the best position to evaluate facts and circumstances, and different markets have different dynamics and needs.[839] And, specifically in connection with non-referenced contracts under § 150.5(b), one commenter states that, as it believes that the scope of exchange discretion under proposed section 150.9(a) is unclear, “exchanges could be bound by the five-day rule in recognizing as non-enumerated bona fide hedging positions certain enumerated hedge strategies for non-referenced contracts, despite the same five-day rule limitation not applying in similar scenarios today.” [840]

Comment Letter Received After the Close of the Comment Period for the 2016 Supplemental Position Limits Proposal Regarding Limit Levels Under § 150.5(b)

One commenter noted that when the CEA addresses “linked contracts” in CEA section 4(b)(1)(B)(ii)(I), in relation to FBOTS, it provides that the Commission may not permit an FBOT to provide direct access to participants located in the United States unless the Commission determines that the FBOT (or the foreign authority overseeing the FBOT) adopts position limits that are comparable to the position limits adopted by the registered entity for the contract(s) against which the FBOT contract settles.[841] According to the commenter, CEA section 4(b), which was added by the Dodd-Frank Act, “contains an explicit Congressional endorsement of `comparable' ” limits for cash-settled contracts in relation to the physically-delivered contracts to which they are linked.[842] The statutory definition of “linked contract,” the commenter stated, “mirrors the definition of `referenced contract' in the Commission's 2013 position limits proposal: Both definitions capture cash-settled contracts that are `linked' to the price of a physically-delivered contract traded on a DCM (referred to as a `core referenced futures contract' in the proposal).” [843] That commenter stated that the only place in the CEA which addresses how to treat a cash-settled contract and its physically-delivered benchmark contract for position limit purposes is in CEA section 4(b), claiming that “Congress unmistakably wanted the two trading instruments to be treated `comparably.' ” [844]

In addition, according to the commenter, when the Commission, in response to the Dodd-Frank Act provisions regarding FBOTs in amended CEA section 4(b), adopted final § 48.8(c)(1)(ii)(A), “it acknowledged that a linked contract and its physically-delivered benchmark contract `create a single market' capable of being affected through trading in either of the linked or physically-delivered markets,” and further noted that the Commission “observed that the price discovery process would be protected by `ensuring that [ ] linked contracts have position limits and accountability provisions that are comparable to the corresponding [DCM] contracts [to which they are linked].' ” [845]

iv. Commission Determination Regarding § 150.5(b)

The Commission has determined to repropose § 150.5(b) generally as proposed in the the 2016 Supplemental Position Limits Proposal, for the reasons stated above, with specific exceptions discussed below.[846] An overall non-substantive change has been made in reproposing § 150.5 pertaining to excluded commodities. To provide Start Printed Page 96795greater clarity regarding which provisions concern excluded commodities, the Commission proposes to move all provisions applying to excluded commodities from § 150.5(b) into § 150.5(c). As the Commission observed in the December 2013 Position Limits Proposal, “CEA section 4a(a) only mandates position limits with respect to physical commodity derivatives (i.e., agricultural commodities and exempt commodities).

Additionally, the Commission proposes to make some substantive revisions specific to excluded commodities in what was previously § 150.5 (b), addressed in the discussion of § 150.5(c).

Limit Levels for Commodity Derivative Contracts in a Physical Commodity Not Subject to Federal Limits

In response to the comment regarding the method for calculating deliverable supply, the Commission notes that guidance for calculating deliverable supply can be found in Appendix C to part 38. Amendments to part 38 are beyond the scope of this rulemaking. However, that guidance already provides that deliverable supply calculations are estimates based on what “reasonably can be expected to be readily available” on a monthly basis based on a number of types of data from the physical marketing channels, as suggested by the commenter, and these calculations are done for each month and each commodity separately. Furthermore, much of § 150.5(b) reiterates longstanding guidance and acceptable practices for DCMs, rather than proposing new concepts for administering limits on contracts that are not subject to federal limits under § 150.2.

The Commission agrees with the commenter urging the Commission to allow exchanges to set non-spot month limits at least as high as the spot-month position limit, in the event the open interest formula would result in a limit level lower than the spot month. Accordingly, consistent with the recommended revisions to the initial limit level listings for contracts subject to federal limits found in § 150.2(e)(4)(iv), the Commission proposes to revise § 150.5(b)(2)(ii) to allow exchanges to set non-spot month limit levels at the maximum of the spot month limit level, the level derived from the 10/2.5% formula, or 5,000 contracts. To conform with those revisions, the Commission also proposes to revise § 150.5(b)(1)(ii)(A)-(B) to remove the distinction between agricultural and exempt commodities.

Regarding the commenter who expressed concern regarding requirements for accountability levels for exempt commodities, the Commission notes that the provisions set forth guidance and acceptable practices for exchanges in setting position limit levels and accountability levels and, as guidance and acceptable practices, are not binding regulations. Under the Commission's guidance, an initial non-spot month limit level of no more than 5,000 is viewed as suitable.

Similarly, in response to the commenter who recommended that DCMs be permitted to establish position accountability levels in lieu of position limits outside the spot month and coordinate the administration of such levels with the Commission and other DCMs, the Commission agrees that position accountability may be permitted for certain physical commodity derivative contracts. Reproposed § 150.5(b)(3), therefore, provides guidance and acceptable practices concerning exchange adoption of position accountability outside the spot month for contracts having an average month-end open interest of 50,000 contracts and an average daily volume of 5,000 or more contracts during the most recent calendar year and a liquid cash market. The Commission again notes that guidance and acceptable practices do not establish mandatory means of compliance. As such, in regards to meeting the specified volume and open interest thresholds in § 150.5(b)(3), the Commission notes that the guidance in § 150.5(b)(3)(i) may not be the only circumstances under which sufficiently high liquidity may be shown to exist for the establishment of position accountability levels in lieu of position limits.

The December 2013 Position Limits Proposal provided in § 150.5(b)(1)(iii) that if a commodity derivative contract was cash-settled by referencing a daily settlement price of an existing contract listed on a DCM or SEF, then it would be an acceptable practice for a DCM or SEF to adopt the same position limits as the original referenced contract, assuming the contract sizes are the same.[847] However, the Commission is reproposing § 150.5(b)(1)(iii) with a modification: While the previously proposed guidance in § 150.5(b)(1)(iii) provided that the exchange should adopt the “same” spot-month, individual non-spot month, and all-months combined limit levels as the original price referenced contract, the Commission is reproposing § 150.5(c)(1)(iii) to provide that the limit levels should, instead, be “comparable.”

As pointed out by one commenter,[848] the CEA establishes a comparability standard for linked FBOT contracts in CEA section 4(b)(1)(B)(ii)(I), when it provides that the Commission may not permit an FBOT to provide direct access to participants located in the United States unless the Commission determines that the FBOT (or the foreign authority overseeing the FBOT) adopts position limits that are “comparable to” the position limits adopted by the registered entity for the contract(s) against which the FBOT contract settles.[849] In addition, as noted by the commenter, the Commission, in adopting § 48.8(c)(2), recognized that the comparability standard and its associated requirements would protect the price discovery process by ensuring that the linked contracts and the U.S. contracts to which they are linked “have position limits and accountability provisions that are comparable to the corresponding [DCM] contracts [to which they are linked].' ” [850] The Commission notes that this change will better align § 150.5(b)(1)(iii) with the statute and with the standard provided in § 48.8(c).[851] Moreover, use of Start Printed Page 96796“comparable” rather than “same” limit levels provides exchanges with a more flexible standard based on statutory language.[852] This change also provides a standard that is consistent with existing practice for domestic contracts that are linked to the price of a physical-delivery contract.[853]

The Commission proposes to revise § 150.5(b)(4)(B) regarding the calculation of open interest for use in setting exchange-set speculative position limits to provide that a DCM or SEF that is a trading facility would include swaps in their open interest calculation only if such entities are required to administer position limits on swap contracts of their facilities. This revision clarifies and harmonizes § 150.5(b)(4)(B) with the relief in Appendix E to part 150, as well as in appendices to parts 37 and 38, which delays for DCMs and SEFs that are trading facilities and lack access to sufficient swap position information the requirement to establish and monitor position limits on swaps at this time. This approach conforms § 150.5(b) with other proposed changes regarding the treatment of swaps.[854]

Exchange—Administered Exemptions for Commodity Derivative Contracts in a Physical Commodity Not Subject to Federal Limits

The Commission is reproposing § 150.5(b)(5)(i) with modifications to clarify that it is guidance rather than a regulatory requirement. In addition, as modified, it provides that under exchange rules allowing a trader to file an application for an enumerated bona fide hedging exemption, the application should be filed no later than five business days after the trader assumed the position that exceeded a position limit.[855] As noted above, the Commission expects that exchanges will carefully consider whether allowing retroactive recognition of an enumerated bona fide hedging exemption would, as noted by one commenter, diminish the overall integrity of the process, and should carefully consider whether to adopt in those rules the two safeguards noted: (i) To continue to require market participants making use of the retroactive application to demonstrate that the applied-for hedge was required to address a sudden and unforeseen hedging need; and (ii) providing that if the emergency hedge recognition was not granted, exchange rules would continue to require the applicant to promptly unwind its position and also would deem the applicant to have been in violation for any period in which its position exceeded the applicable limits.

Additionally, the Commission is reproposing § 150.5(b)(5)(i) with modifications to clarify, as requested by commenters,[856] that the exchanges have reasonable discretion as to whether they apply to their exemption process from exchange-set speculative position limits, a virtually identical process as provided for recognizing non-enumerated bona fide hedging positions under CFTC Regulation 150.9(a). As explained in the discussion regarding the changes to the bona fide hedging definition under § 150.1, the Commission is proposes a phased approach with respect to the definition of a bona fide hedging position applicable to physical commodities.[857] The Commission recognizes that exchanges, under § 150.9, may need to adapt their current process to recognize non-enumerated bona fide hedging positions for commodity derivative contracts that are subject to a federal position limit under § 150.2, or adopt a new one. In turn, market participants will need to seek recognition of a non-enumerated bona fide hedge from an exchange under that new process. In light of this implementation issue, the Commission proposes to limit the mandatory scope of the new definition of bona fide hedging position to contracts that are subject to a federal position limit.[858] This means that the Commission would permit exchanges to maintain both their current bona fide hedging position definition and their existing processes for recognizing non-enumerated bona fide hedging positions for physical commodity contracts not subject to federal limits under § 150.2. The Commission notes an exchange may, but need not, adopt for physical commodities not subject to federal limits the new bona fide hedging position definition and the new process to recognize non-enumerated bona fide hedging positions.

In addition, the Commission is proposing that, for enumerated bona fide hedging positions, exchange rules may allow traders to file an application for an enumerated bona fide hedging exemption within five business days after the trader assumed the position that exceeded a position limit.

Finally, as to § 150.5(b)(5)(ii) (Other exemptions), the Commission did not receive any comments regarding § 150.5(b)(5)(ii)(A) (Financial distress), and is reproposing this exemption without change.

Conditional Spot Month Limit Exemption for Commodity Derivative Contracts in a Physical Commodity Not Subject to Federal Limits

While the conditional spot month limit exemption is addressed in more detail under § 150.3, after consideration of comments, the Commission is reproposing § 150.5(b)(5)(ii)(B) with a modification.[859] The December 2013 Start Printed Page 96797Position Limits Proposal proposed guidance that an exchange may adopt a conditional spot month position limit exemption for cash-settled contracts, with one of two provisos being that such positions should not exceed five times the level of the spot-month limit specified by the exchange that lists the physical-delivery contract to which the cash-settled contracts were directly or indirectly linked.[860] As reproposed, the guidance recommends that such conditional exemptions should not exceed two times the level of the spot-month limit specified by the exchange that lists the applicable physical-delivery contract.

After review of comments and an impact analysis regarding the federal limits, the Commission believes that a five-times conditional exemption is too large, other than in natural gas because, in the markets that the Commission proposes to subject to federal limits, the Commission observed few or no market participants with positions in cash-settled contracts in the aggregate that exceed 25 percent of deliverable supply in the spot month. This is so even though cash-settled contracts that are swaps are not currently subject to position limits. A five-times conditional exemption would not ensure liquidity for bona fide hedgers in the spot month for cash-settled contracts because there appear to be few or no positions that large (other than in natural gas). Consequently, and in light of the other three policy objectives of CEA section 4a(a)(3)(B), the Commission reproposes a more cautious approach.[861]

Since transactions of large speculative traders may tend to cause unwarranted price changes, exchanges should exercise caution in determining whether such conditional exemptions are warranted; for example, an exchange may determine that a conditional exemption is warranted because such a speculative trader is demonstrably providing liquidity for bona fide hedgers. Where an exchange may not have access to data regarding a market participant's cash-settled positions away from a particular exchange, such exchange should require, for any conditional spot-month limit exemption it grants, that a trader report promptly to such exchange the trader's aggregate positions in cash-settled contracts, physical-delivery contracts, and cash market positions.

As noted above, under reproposed § 150.5(b)(5)(ii)(B), an exchange has the choice of whether or not to adopt a conditional spot month position limit exemption for cash-settled contracts that are not subject to federal limits. As also discussed above regarding reproposed § 150.3(c), the Commission is not proposing a conditional spot-month limit for agricultural contracts subject to federal limits under reproposed § 150.2. Further, the Commission notes that the current cash-settled natural gas spot month limit rules of two commenters, CME Group (which operates NYMEX) and ICE, both include the same spot-month limit level and the same conditional spot-month limit exemption. In each case the current cash-settled conditional exemption is five times the limit for the physical-delivery contract. Such natural gas contracts would be subject to federal limits under reproposed § 150.2, so the guidance in reproposed § 150.5(b) would not be applicable to those contracts.[862]

Treatment of Spread and Anticipatory Hedge Exemptions for Commodity Derivative Contracts in a Physical Commodity Not Subject to Federal Limits

In regards to the exemption for intramarket and intermarket spread positions under § 150.5(b)(5)(ii)(C), the comments received concerned the exchange process for providing spread exemptions under § 150.10. The Commission addresses those comments below in its discussion of § 150.10, and is reproposing § 150.5(b)(5)(ii)(C) as proposed in the 2016 Supplemental Position Limits Proposal.

The Commission points out, however, that reproposed § 150.5(b)(5)(ii)(C) would apply only to physical commodity derivative contracts, and would not apply to any derivative contract in an excluded commodity. Furthermore, as noted above, reproposed § 150.5(b)(5)(ii)(C) provides guidance rather than rigid requirements. Instead, under § 150.5(b)(5)(ii)(C), exchanges should take into account whether granting a spread exemption in a physical commodity derivative would, to the maximum extent practicable, ensure sufficient market liquidity for bona fide hedgers, and not unduly reduce the effectiveness of position limits to diminish, eliminate, or prevent excessive speculation; deter and prevent market manipulation, squeezes, and corners; and ensure that the price discovery function of the underlying market is not disrupted.[863]

Five-Day Rule for Commodity Derivative Contracts in a Physical Commodity Not Subject to Federal Limits

While the Commission's determination regarding the five-day rule is addressed elsewhere,[864] the Commission points out that, as discussed in connection with the definition of bona fide hedging position and in relation to exchange processes under § 150.9, § 150.10, and § 150.11, and as noted above in connection with § 150.5(a), the five-day rule would only apply to certain enumerated positions (pass-through swap offsets, anticipatory, and cross-commodity hedges),[865] rather than when determining whether to recognize as non-enumerated bona fide hedging positions certain non-enumerated hedge strategies for non-referenced contracts. As reproposed, therefore, § 150.5(b) would apply the five-day rule only to pass-through swap offsets, anticipatory, and cross-commodity hedges. However, in regards to exchange processes under § 150.9, § 150.10, and § 150.11, the Commission Start Printed Page 96798proposes to allow exchanges to waive the five-day rule on a case-by-case basis.

As the Commission cautioned above, exchanges should carefully consider whether to recognize a position as a bona fide hedge or to exempt a spread position held during the last few days of trading in physical-delivery contracts. The Commission points to the tools that exchanges currently use to address concerns during the spot month; as two commenters observed, current tools include requiring gradual reduction of the position (“step down” requirements) or revoking exemptions to protect the price discovery process in core referenced futures contracts approaching expiration. Consequently, under the reproposed rule, exchanges may recognize positions, on a case-by-case basis in physical-delivery contracts that would otherwise be subject to the five-day rule, as non-enumerated bona fide hedging positions, by applying the exchanges experience and expertise in protecting its own physical-delivery market.

Reporting Requirements for Commodity Derivative Contracts in a Physical Commodity Not Subject to Federal Limits

In response to the comment questioning the proposed reporting requirements by a claim that, “while the Commission has a surveillance obligation with respect to federal limits, the same obligation has never before existed with respect to exchange-set limits for non-referenced contracts, and does not exist today,” [866] the Commission points out, as it did in the 2016 Supplemental Position Limits Proposal, that the Futures Trading Act of 1982 “gave the Commission, under section 4a(5) [since redesignated as section 4a(e)] of the Act, the authority to directly enforce violations of exchange-set, Commission-approved speculative position limits in addition to position limits established directly by the Commission through orders or regulations.” [867] And, since 2008, it has also been a violation of the Act for any person to violate an exchange position limit rule certified by the exchange.[868] To address any confusion that might have led to such a comment, the Commission reiterates, under CEA section 4a(e), its authority to enforce violations of exchange-set speculative position limits, whether certified or Commission-approved. As the Commission explained in the 2016 Supplemental Position Limits Proposal, exchanges, as SROs, do not act only as independent, private actors.[869] In fact, to repeat the explanation provided by the Commission in 1981, when the Act is read as a whole, “it is apparent that Congress envisioned cooperative efforts between the self-regulatory organizations and the Commission. Thus, the exchanges, as well as the Commission, have a continuing responsibility in this matter under the Act.” [870] The 2016 Supplemental Position Limits Proposal pointed out that the “Commission's approach to its oversight of its SROs was subsequently ratified by Congress in 1982, when it gave the CFTC authority to enforce exchange set limits.” [871] In addition, as the Commission observed in 2010, and reiterated in the 2016 Supplemental Position Limits Proposal, “since 1982, the Act's framework explicitly anticipates the concurrent application of Commission and exchange-set speculative position limits.” [872] The Commission further noted that the “concurrent application of limits is particularly consistent with an exchange's close knowledge of trading activity on that facility and the Commission's greater capacity for monitoring trading and implementing remedial measures across interconnected commodity futures and option markets.” [873]

The Commission retains the power to approve or disapprove the rules of exchanges, under standards set out pursuant to the CEA, and to review an exchange's compliance with the exchange's rules, by way of additional examples of the Commission's continuing responsibility in this matter under the Act.

v. Commission Determination Regarding § 150.5(c)

As noted above, in an overall non-substantive change made in reproposing § 150.5, the Commission moved all provisions applying to excluded commodities from § 150.5(b) into reproposed § 150.5(c) to provide greater clarity regarding which provisions concern excluded commodities. The Commission has determined to repropose the rule largely as proposed for excluded commodities (previously under § 150.5(b)), for the reasons noted above, with certain changes discussed below.[874]

Limit Levels for Excluded Commodities

The Commission is reproposing the provisions under § 150.5(c)(1) regarding levels of limits for excluded commodities as modified and reproposed under § 150.5(b)(1),[875] to reference excluded commodities and to remove provisions that were solely addressed to agricultural commodities.[876] These provisions generally provide guidance rather than rigid requirements; the guidance for levels of limits remains the same for Start Printed Page 96799excluded commodities as for all other commodity derivative contracts that are not subject to the limits set forth in reproposed § 150.2, including derivative contracts in a physical commodity as defined in reproposed § 150.1.

Similarly, as to adjustment of limit levels for excluded commodity derivative contracts under § 150.5(c)(2), the reproposed provisions are modified to reference only excluded commodities and to remove provisions that were solely addressed to agricultural commodities. As reproposed, § 150.5(c)(2)(i) provides guidance that the spot month position limits for excluded commodity derivative contracts “should be maintained at a level that is necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract's or the underlying commodity's price or index.”

The Commission did not receive comments regarding § 150.5(c)(3). The guidance in § 150.5(c)(3), on exchange adoption of position accountability levels in lieu of speculative position limits, has been reproposed as was previously proposed in § 150.5(b)(3), modified to remove provisions under § 150.5(b)(3)(i), which were solely addressed to physical commodity derivative contracts, and to reference excluded commodities.

As to the calculation of open interest for use in setting exchange-set speculative position limits for excluded commodities, the Commission is reproposing, in § 150.5(c)(4), the same guidance for excluded commodities that is being reproposed under § 150.5(b)(4) as for all other commodity derivative contracts that are not subject to the limits set forth in § 150.2, including the modification to provide that a DCM or SEF that is a trading facility would include swaps in its open interest calculation only if such entity is required to administer position limits on swap contracts of its facility.

Exchange—Administered Exemptions for Excluded Commodities

In regards to hedge exemptions, the Commission is reproposing in new § 150.5(c)(5)(i) for contracts in excluded commodities a modification of what was previously proposed in § 150.5(b)(5)(i) that eliminates the guidance that exchanges “may provide for recognition of a non-enumerated bona fide hedge in a manner consistent with the process described in § 150.9(a).” That provision was intended to apply only to physical commodity contracts and not to exemptions granted by exchanges for contracts in excluded commodities.[877]

As noted above, in reproposing the definition of bona fide hedging position, the Commission is clarifying that an exchange may otherwise recognize as bona fide any position in a commodity derivative contract in an excluded commodity, so long as such recognition is pursuant to such exchange's rules. Although the Commission's standards in the December 2013 Position Limits Proposal applied the incidental test and the orderly trading requirements to all commodities, the Commission, as previously described, proposed in the 2016 Supplemental Position Limits Proposal to remove both those standards from the definition of bona fide hedging position.[878] Moreover, the reproposed definition of bona fide hedging position would provide only that the position is either: (i) Enumerated in the definition (in paragraphs (3), (4), or (5)) and meets the economically appropriate test; or (ii) recognized by an exchange under rules previously submitted to the Commission.[879] The Commission's standards for recognizing a position as a bona fide hedge in an excluded commodity, therefore, would not include the additional requirements applicable to physical commodities subject to federal limits. Consequently, as reproposed, the exchanges would have reasonable discretion to comply with core principles regarding position limits on excluded commodities so long as the exchange does so pursuant to exchange rules previously submitted to the Commission under Part 40.

In addition, in conjunction with the amendments to the definition of bona fide hedging positions in regards to excluded commodities,[880] the Commission is reproposing § 150.5(c)(5)(ii), proposed as § 150.5(b)(5)(ii)(D) in the 2016 Supplemental Position Limits Proposal, with no further modification, to afford greater flexibility for exchanges when granting exemptions for excluded commodities. The 2016 Supplemental Position Limits Proposal provided, in addition to granting exemptions under paragraphs (b)(5)(ii)(A), (b)(5)(ii)(B), and (b)(5)(ii)(C) of § 150.5, that exchanges may grant a “limited” risk management exemptions pursuant to rules consistent with the guidance in Appendix A of part 150. As reproposed, § 150.5(c)(5)(ii) eliminates the modifier “limited” from the risk management exemptions, and provides merely that exchanges may grant, in addition to the exemptions under paragraphs (b)(5)(ii)(A), (b)(5)(ii)(B), and (b)(5)(ii)(C), risk management exemptions pursuant to rules submitted to the Commission, “including” for a position that is consistent with the guidance in Appendix A of part 150.

In regards to the provisions addressing applications for exemptions for positions in excluded commodities, the Commission is modifying what was copied from § 150.5(b)(5)(iii) to provide, under § 150.5(c)(5)(iii), simply that an exchange may allow a person to file an exemption application for excluded commodities after the person assumes the position that exceeded a position limit.

Finally, in reproposing the aggregation provision for excluded commodities under § 150.5(c)(8), the Commission is not merely mirroring the aggregation provision as previously proposed in § 150.5(b)(8). As noted above, the reproposed aggregation provisions for physical commodity derivatives contracts, whether under § 150.5(a)(8) or § 150.5(b)(8), provide that exchanges must have aggregation provisions that conform to § 150.4. Reproposed § 150.5(c)(8), consistent with the rest of reproposed § 150.5(c), would instead provide guidance, that exchanges “should” have aggregation rules for excluded commodity derivative contracts that conform to § 150.4.

E. Part 19—Reports by Persons Holding Bona Fide Hedge Positions Pursuant to § 150.1 of This Chapter and by Merchants and Dealers in Cotton

1. Current Part 19

The market and large trader reporting rules are contained in parts 15 through 21 of the Commission's regulations.[881] Collectively, these reporting rules effectuate the Commission's market and financial surveillance programs by enabling the Commission to gather information concerning the size and composition of the commodity futures, options, and swaps markets, thereby permitting the Commission to monitor and enforce the speculative position Start Printed Page 96800limits that have been established, among other regulatory goals. The Commission's reporting rules are implemented pursuant to the authority of CEA sections 4g and 4i, among other CEA sections. Section 4g of the Act imposes reporting and recordkeeping obligations on registered entities, and obligates FCMs, introducing brokers, floor brokers, and floor traders to file such reports as the Commission may require on proprietary and customer positions executed on any board of trade.[882] Section 4i of the Act requires the filing of such reports as the Commission may require when positions equal or exceed Commission-set levels.[883]

Current part 19 of the Commission's regulations sets forth reporting requirements for persons holding or controlling reportable futures and option positions “which constitute bona fide hedging positions as defined in [§ ] 1.3(z)” and for merchants and dealers in cotton holding or controlling reportable positions for future delivery in cotton.[884] In the several markets with federal speculative position limits—namely those for grains, the soy complex, and cotton—hedgers that hold positions in excess of those limits must file a monthly report pursuant to part 19 on CFTC Form 204: Statement of Cash Positions in Grains,[885] which includes the soy complex, and CFTC Form 304 Report: Statement of Cash Positions in Cotton.[886] These monthly reports, collectively referred to as the Commission's “series '04 reports,” must show the trader's positions in the cash market and are used by the Commission to determine whether a trader has sufficient cash positions that justify futures and option positions above the speculative limits.[887]

2. Amendments to Part 19

In the December 2013 Position Limits Proposal, the Commission proposed to amend part 19 so that it would conform to the Commission's proposed changes to part 150.[888] First, the Commission proposed to amend part 19 by adding new and modified cross-references to proposed part 150, including the new definition of bona fide hedging position in proposed § 150.1. Second, the Commission proposed to amend § 19.00(a) by extending reporting requirements to any person claiming any exemption from federal position limits pursuant to proposed § 150.3. The Commission proposed to add new series '04 reporting forms to effectuate these additional reporting requirements. Third, the Commission proposed to update the manner of part 19 reporting. Lastly, the Commission proposed to update both the type of data that would be required in series '04 reports as well as the timeframe for filing such reports.

Comments Received: One commenter acknowledges concerns presented by Commission staff at the Staff Roundtable that exemptions from position limits be limited to prevent abuse, but does not believe that the adoption of additional recordkeeping or reporting rules or the development of costly infrastructure is required because statutory and regulatory safeguards already exist or are already proposed in the December 2013 Position Limits Proposal, noting that: (i) The series '04 forms as well as DCM exemption documents will be required of market participants, who face significant penalties for false reporting, and the Commission may request additional information if the information provided is unsatisfactory; and (ii) market participants claiming a bona fide hedging exemption are still subject to anti-disruptive trading prohibitions in CEA section 4c(a)(5), anti-manipulation prohibitions in CEA sections 6(c) and 9(c), the orderly trading requirement in proposed § 150.1, and DCM oversight. The commenter stated that these requirements comprise a “thorough and robust regulatory structure” that does not need to be augmented with new recordkeeping, reporting, or other obligations to prevent misuse of hedging exemptions.[889] A second commenter echoed that additional recordkeeping or reporting obligations are unnecessary and would create unnecessary regulatory burdens.[890]

Another commenter stated that the various forms required by the regime, while not lengthy, represent significant data collection and categorization that will require a non-trivial amount of work to accurately prepare and file. The commenter claimed that a comprehensive position limits regime could be implemented with a “far less burdensome” set of filings and requested that the Commission review the proposed forms and ensure they are “as clear, limited, and workable” as possible to reduce burden. The commenter stated that it is not aware of any software vendors that currently provide solutions that can support a commercial firm's ability to file the proposed forms.[891]

One commenter recommended that the Commission eliminate the series '04 reports in light of the application and reporting requirements laid out in the 2016 Supplemental Position Limits Proposal. The commenter asserted that the application requirements are in addition to the series '04 forms, which the commenter claims “only provide the Commission with a limited surveillance benefit.” [892] Another commenter raised concerns regarding forms filed under part 19 and the data required to be filed with exchanges under §§ 150.9-11. The commenter stated that the 2016 Supplemental Position Limits Proposal requires that “those exceeding the federal limits file the proposed forms including Form 204” but lacks “meaningful guidance” regarding the data that must be maintained “effectively in real-time” to populate the forms.[893]

Several commenters requested that the Commission create user-friendly guidebooks for the forms so that all entities can clearly understand any required forms and build the systems to file such forms, including providing workshops and/or hot lines to improve the forms.[894]

One commenter expressed concern for reporting requirements in conflict with other regulatory requirements (such as FASB ASC 815).[895]

Finally, two commenters recommended modifying or removing the requirement to certify series '04 reports as “true and correct”. One commenter suggested that the requirement be removed due to the difficulty of making such a certification Start Printed Page 96801and the fact that CEA section 6(c)(2) already prohibits the submission of false or misleading information.[896] Another noted that the requirement to report very specific information relating to hedges and cash market activity involves data that may change over time. The commenter suggested the Commission adopt a good-faith standard regarding “best effort” estimates of the data when verifying the accuracy of Form 204 submissions and, assuming the estimate of physical activity does not otherwise impact the bona fide hedge exemption (e.g. cause the firm to lose the exemption), not penalize entities for providing the closest approximation of the position possible.[897]

Commission Reproposal: The Commission responds to specific comments regarding the content and timing of the series '04 forms and other concerns below. The Commission agrees with the commenters that the forms should be clear and workable, and offers several clarifications and amendments below in response to comments about particular aspects of the series '04 reports.

The Commission notes that the information required on the series '04 reports represents a trader's most basic position data, including the number of units of the cash commodity that the firm has purchased or sold, or the size of a swap position that is being offset in the futures market. The Commission believes this information is readily available to traders, who routinely make trading decisions based on the same data that is required on the series '04 reports. The Commission is proposing to move to an entirely electronic filing system, allowing for efficiencies in populating and submitting forms that require the same information every month. Most traders who are required to file the series '04 reports must do so for only one day out of the month, further lowering the burden for filers. In short, the Commission believes potential burdens under the Reproposal have been reduced wherever possible while still providing adequate information for the Commission's Surveillance program. For market participants who may require assistance in monitoring for speculative position limits and gathering the information required for the series '04 reports, the Commission is aware of several software companies who, prior to the vacation of the Part 151 Rulemaking, produced tools that could be useful to market participants in fulfilling their compliance obligations under the new position limits regime.

The Commission notes that the reporting obligations proposed in the 2016 Supplemental Position Limits Proposal are intended to be complimentary to, not duplicative of, the series '04 reporting forms. In particular, the Commission notes the distinction between Form 204 enumerated hedging reporting and exchange-based non-enumerated hedging reporting. The 2016 Supplemental Position Limits Proposal provides exchanges with the authority to require reporting from market participants. That is, regarding an exchange's process for non-enumerated bona fide hedging position recognition, the exchange has discretion to implement any additional reporting that it may require. The Commission declines to eliminate series '04 reporting in response to the commenters because, as noted throughout this section, the data provided on the forms is critical to the mission of the Commission's Surveillance program to detect and deter manipulation and abusive trading practices in physical commodity markets.

In response to the commenters that requested guidebooks for the series '04 reporting forms, the Commission believes that it is less confusing to ensure that form instructions are clear and detailed than it is to provide generalized guidebooks that may not respond to specific issues. The Commission has clarified the sample series `04 forms found in Appendix A to part 19, including instructions to such forms, and invites comments in order to avoid future confusion. Specifically, the Commission has added instructions regarding how to fill out the trader identification section of each form; reorganized instructions relating to individual fields on each form; edited the examples of each form to reduce confusion and match changes to information required as described in this section; and clarified the authority for the certifications made on the signature/authorization page of each form.

The Commission's longstanding experience with collecting and reviewing Form 204 and Form 304 has shown that many questions about the series '04 reports are specific to the circumstances and trading strategies of an individual market participant, and do not lend themselves to generalization that would be helpful to many market participants.

The Commission also notes, in response to the commenter expressing concerns about other regulatory requirements, the policy objectives and standards for hedging under financial accounting standards differ from the statutory policy objectives and standards for hedging under the Act. Because of this, reporting requirements, and the associated burdens, would also differ between the series '04 reports and accounting statements.

Finally, the Commission is proposing to amend the certification language found at the end of each form to clarify that the certification requires nothing more than is already required of market participants in section 6(c)(2) of the Act. In response to the commenters' request for a “best effort” standard, the Commission added the phrase “to the best of my knowledge” preceding the certification from the authorized representative of the reporting trader that the information on the form is true and correct. The Commission has also added instructions to each form clarifying what is required on the signature/authorization page of each form. The Commission notes that, in the recent past, the Division of Market Oversight has issued advisories and guidance on proper filing of series '04 reports, and the Division of Enforcement has settled several cases regarding lack of accuracy and/or timeliness in filing series '04 forms.[898] The Commission believes the certification language is an important reminder to reporting traders of their responsibilities to file accurate information under several sections of the Act, including but not limited to CEA section 6(c)(2).

a. Amended cross references

Proposed Rule: As discussed above, in the December 2013 Position Limits Proposal, the Commission proposed to replace the definition of bona fide hedging transaction found in § 1.3(z) with a new proposed definition of bona fide hedging position in proposed § 150.1. As a result, proposed part 19 would replace cross-references to § 1.3(z) with cross-references to the new definition of bona fide hedging positions in proposed § 150.1.

The Commission also proposed expanding Part 19 to include reporting requirements for positions in swaps, in addition to futures and options positions, for any part of which a person relies on an exemption. To accomplish this, “positions in commodity derivative contracts,” as defined in proposed § 150.1, would replace “futures and option positions” throughout amended Start Printed Page 96802part 19 as shorthand for any futures, option, or swap contract in a commodity (other than a security futures product as defined in CEA section 1a(45)).[899] This amendment was intended to harmonize the reporting requirements of part 19 with proposed amendments to part 150 that encompass swap transactions.

Proposed § 19.00(a) would eliminate the cross-reference to the definition of reportable position in § 15.00(p)(2). The Commission noted that the current reportable position definition essentially identifies futures and option positions in excess of speculative position limits. Proposed § 19.00(a) would simply make clear that the reporting requirement applies to commodity derivative contract positions (including swaps) that exceed speculative position limits, as discussed below.

Comments Received: The Commission received no comments on the proposed cross-referencing amendments.

Commission Reproposal: The Commission is repurposing the amended cross-references in part 19, as originally proposed.

b. Persons required to report—§ 19.00(a)

Proposed Rule: Because the reporting requirements of current part 19 apply only to persons holding bona fide hedge positions and merchants and dealers in cotton holding or controlling reportable positions for future delivery in cotton, the Commission proposed to extend the reach of part 19 by requiring all persons who wish to avail themselves of any exemption from federal position limits under proposed § 150.3 to file applicable series '04 reports.[900] The Commission also proposed to require that anyone exceeding a federal limit who has received a special call related to part 150 must file a series '04 form. Collection of this information would facilitate the Commission's surveillance program with respect to detecting and deterring trading activity that may tend to cause sudden or unreasonable fluctuations or unwarranted changes in the prices of the referenced contracts and their underlying commodities. By broadening the scope of persons who must file series '04 reports, the Commission seeks to ensure that any person who claims any exemption from federal speculative position limits can demonstrate a legitimate purpose for doing so.

Series '04 reports currently refers to Form 204 and Form 304, which are listed in current § 15.02.[901] The Commission proposed to add three new series '04 reporting forms to effectuate the expanded reporting requirements of part 19.[902] Proposed Form 504 would be added for use by persons claiming the conditional spot-month limit exemption pursuant to proposed § 150.3(c).[903] Proposed Form 604 would be added for use by persons claiming a bona fide hedge exemption for either of two specific pass-through swap position types, as discussed further below.[904] Proposed Form 704 would be added for use by persons claiming a bona fide hedge exemption for certain anticipatory bona fide hedging positions.[905]

Comments Received: The Commission received no comments on proposed § 19.00(a) regarding who must file series '04 reports.

Commission Reproposal: The Commission is reproposing the expansion of § 19.00(a), as originally proposed.

c. Manner of reporting—§ 19.00(b)

i. Excluding certain source commodities, products or byproducts of the cash commodity hedged—§ 19.00(b)(1)

Proposed Rule: For purposes of reporting cash market positions under current part 19, the Commission historically has allowed a reporting trader to “exclude certain products or byproducts in determining his cash positions for bona fide hedging” if it is “the regular business practice of the reporting trader” to do so.[906] The Commission has proposed to clarify the meaning of “economically appropriate” in light of this reporting exclusion of certain cash positions.[907] Therefore, in the December 2013 Position Limits Proposal, the Commission proposed in § 19.00(b)(1) that a source commodity itself can only be excluded from a calculation of a cash position if the amount is de minimis, impractical to account for, and/or on the opposite side of the market from the market participant's hedging position.[908]

The Commission explained in the December 2013 Position Limits Proposal that the original part 19 reporting exclusion was intended to cover only cash positions that were not capable of being delivered under the terms of any derivative contract, an intention that ultimately evolved to allow cross-commodity hedging of products and byproducts of a commodity that were not necessarily deliverable under the terms of any derivative contract. The Commission also noted that the instructions on current Form 204 go further than current § 19.00(b)(1) by allowing the exclusion of certain source commodities in addition to products and byproducts, when it is the firm's normal business practice to do so.

Comments Received: One commenter suggested the Commission expand the provision in proposed § 19.00(b)(1) that allows a reporting person to exclude source commodities, products or byproducts in determining its cash position for bona fide hedging to allow a person to also exclude inventory and contracts of the actual commodity in the course of his or her regular business practice. The commenter also noted that proposed § 19.00(b)(1) only permits this exclusion if the amount is de minimis, despite there being “many circumstances” that make the inclusion of such source commodities irrelevant for reporting purposes. The commenter requested that the Commission only require a reporting person to calculate its cash positions in accordance with its regular business practice and report the Start Printed Page 96803cash positions that it considered in making its bona fide hedging determinations.[909]

Commission Reproposal: The Commission is reproposing § 19.00(b)(1), as originally proposed, because the Commission is concerned that adopting the commenter's request could lead to “cherry-picking” a cash market position in an attempt to justify a speculative position as a hedge. As noted in the December 2013 Position Limits Proposal, the Commission's clarification of the § 19.00(b)(1) reporting exclusion was proposed to prevent the definition of bona fide hedging positions in proposed § 150.1 from being swallowed by this reporting rule. The Commission stated “. . . it would not be economically appropriate behavior for a person who is, for example, long derivative contracts to exclude inventory when calculating unfilled anticipated requirements. Such behavior would call into question whether an offset to unfilled anticipated requirements is, in fact, a bona fide hedging position, since such inventory would fill the requirement. As such, a trader can only underreport cash market activities on the opposite side of the market from her hedging position as a regular business practice, unless the unreported inventory position is de minimis or impractical to account for.” [910] If a person were only required to report cash positions that are offset by parti