Commodity traders will face a broader, more complex set of position limits when U.S. regulators draw up new speculative curbs in coming weeks -- but the limits are unlikely to be tougher than a plan pitched for energy markets earlier this year.
The new Wall Street reform law directs the Commodity Futures Trading Commission to set up limits on the positions traders can hold across futures and over-the-counter swaps markets. The limits are expected to follow the template used for the CFTC's now-shelved January proposal for energy markets.
"I think there's a certain amount of anxiousness. There's a certain amount of resignation, too," said Michael Philipp, partner with Winston & Strawn in Chicago.
Preparing for the worst, some large commodity funds have already begun restructuring, and there could be more movement of trade to markets outside the United States, where the new rules don't apply -- something which Congress has ordered the CFTC to bear in mind.
Within a year of imposing the limits, the law requires the CFTC to report to Congress on the effect the rule has had on speculation, and on regulatory arbitrage -- an obligation that will likely keep in check any temptation for the regulator to radically limit speculative trading.
"That sets the tone of everything they do: they're going to have to work to create a construct that doesn't force things offshore," said Michael Sweeney, a partner with Hunton & Williams in Washington.
"I imagine that they will move somewhat cautiously and set the limits initially at a relatively high level," he said.
The CFTC began eyeing limits after oil and other commodity prices soared to record highs in 2008, on concerns some trading entities were dominating trade with excessive market positions. Consumers and energy users demanded the government crack down on speculators they perceived as driving up prices.
Delta Air Lines and manufacturing and shipping groups weren't completely happy with the CFTC's January proposal, which set curbs at very high levels.
But banks such as Morgan Stanley and Deutsche Bank and energy companies Royal Dutch Shell and Vitol complained the plan would force massive restructuring for large, diverse trading houses, which could reduce money flows and hurt markets.
The CFTC has said it will build on comments received on its energy plan as it races to meet Congressionally set deadlines for energy and metals markets within 180 days, and agricultural markets in 270 days.
"It wouldn't shock me to see them try to use the same framework," said Philipp of Winston & Strawn. "What was a very complicated and difficult rule to follow will even be more complicated now," he said.
The CFTC now can limit positions in futures, over-the-counter lookalike contracts, swaps that either perform a price discovery function or that affect price discovery. It can also tally up investment positions across all those points and impose limits on trading entities.
"That's a broadening of the universe of contracts that the CFTC can reach," said Tony Mansfield, a partner with McDermott Will & Emery in Washington.
WHERE TO DRAW NEW LINES?
Some derivatives lawyers expect the new rule will include a long list of OTC swaps that will have limits. But David McIndoe of Hunton & Williams said he thinks the CFTC's rule may instead set out its process for determining whether OTC contracts fit the bill, saving that challenging evaluation for a later date.
"You're going to be dealing with contracts that are different by degree, and where are they going to draw that line?" McIndoe said.
The early deadlines for position limits -- only one of 30 rule-making topics that the CFTC must tackle this year -- will come before related rules for collecting data on OTC swaps.
CFTC Commissioner Jill Sommers argues the deadline puts the cart before the horse, making it hard for the CFTC to get an accurate read on OTC markets before it sets its limit formula.
"From my perspective, I am not supportive of moving forward with limits until we're able to see the whole market," said Sommers, one of five commissioners who ultimately will vote on whether the rule hits the mark.
HOW MUCH WILL BE SALVAGED?
The new law leaves most details up to the CFTC, but spells out who can obtain a hedge exemption. If the CFTC takes a literal interpretation of the definition, it could be harder to get an exemption, said Mansfield of McDermott Will & Emery.
Sommers said she thinks the law might limit the CFTC to "looking through" swap dealers' positions to see if their customers are abiding by curbs, something which she believes is logistically impractical.
Traders' anxiety about limits could be eased if the CFTC tweaks its original exemption structure, which would have prevented large hedgers or swap dealers from also trading speculatively.
Traders are also hoping the CFTC drops a plan to limit positions by account ownership, something they argued was unfair and impractical in comments on the energy plan, given that many large firms have stakes in trading units under independent control.
"I think a lot of people would not be all that troubled ... if some of the points that were addressed in the comments were addressed in a different way," said David Perlman, partner with Bracewell & Guiliani's energy practice.
© 2017 Thomson/Reuters. All rights reserved.