Commodity Futures Trading Commission Open Meeting

Commodity Futures Trading Commission

Open Meeting

Thursday, January 30, 2020

Key Topics & Takeaways

Position Limits: In a 3-2 vote, the Commission approved a proposed rule concerning position limits for derivatives.

Swap Execution Facility Requirements: The Commission unanimously approved a proposed rule concerning amendments to ceraint swap execution facility requirements and real-time reporting requirements.

Opening Statements

Chairman Heath P. Tarbert

After providing a brief overview of the agenda items, Tarbert noted in his opening statement that the Commodity Futures Trading Commission (CFTC or Commission) has issued four proposed rules since 2010 on position limits. Only one was adopted, but it was struck down by the courts. He continued that the rule they are proposing today exemplifies agency values of teamwork and commitment, and he wants this rule to be a practical solution for the American people. He noted that the limits in the proposed rule are on speculative activity, and limiting speculative positions ensures prices in markets reflect actual price and demand. Tarbert explained that the proposal is meant to be a practical and official way to use the bona fide hedging exemption and that if the hedging need fits within the proposed enumerated list it will automatically be exempt. He noted that if the hedging need is not on the proposed enumerated list, parties can still request exemption from the exchanges. He concluded that the proposed rule is meant to put the burden on the government, rather than the American people.

Commissioner Brian D. Quintenz

Quintenz stated that end users have had to live through iteration after iteration that has affected their ability to risk manage their business. He said the Commission wants to provide them with certainty, flexibility, and market integrity, adding that the Commission will need to listen to the end user community to know what is right.

Commissioner Rostin Behnam

Behnam thanked each department involved, their staff and his own staff for their hard work on this proposal. He also released a statement of dissent.

Commissioner Dawn DeBerry Stump

Stump noted that she struggles with what metric to use to evaluate this proposal: whether it is reasonable, balanced in approach, and workable for users and the Commission. Overall, she said the answer is yes, therefore she supports the proposal. She said that the proposal is not perfect and that the areas for the most improvement are the list of enumerated hedges and the process for reviewing hedges outside of the enumerated list. She said the hedging process has become much more complex since the last time the Commission reviewed position limits and noted that she takes issue with the proposal’s 10-day/two-day approval process, which is both too long and too short. Instead, she said she would like a more formalized process to recognize non-enumerated transactions. Stump encouraged those in the metal space to comment and identify further enumerated trades.

Commissioner Dan M. Berkovitz

Berkovitz stated in his dissent that while the proposal is much improved, there are still fundamental disagreements on the proposal, mainly the opaque process for the approval of non-enumerated bonafide hedges, the lack of a phase in period for the large increase in speculative position limits, the absence of non-spot month limits for certain commodities, and the lack of ability to monitor the effect of increases or decreases. He said market participants need to know their limitations. Berkovitz said he believes the proposal does not meet Congress’s mandate in Dodd-Frank and reverses 84 years of Commodity Exchange Act (CEA) and Commission standards and legal interpretations to prevent speculation. He concluded that this proposal misconstrues the Dodd-Frank Act’s, and Congress’s, directive regarding the Commission’s responsibility to impose position limits.

Presentations

Staff Presentation: Proposed Rule – Position Limits for Derivatives

Staff:

Daniel J. Davis, Office of the General Counsel

Rob Schwartz, Office of the General Counsel

Vincent A. McGonagle, CFTC

Dorothy D. DeWitt, Division of Market Oversight

Aaron Brodsky, Division of Market Oversight

Steven A. Haidar, Division of Market Oversight

Lillian Cardona, Division of Market Oversight

Jeanette Curtis, Division of Market Oversight

Steven Benton, Division of Market Oversight

Scott Mixon, Office of the Chief Economist

Stephen Kane, Office of the Chief Economist

Harold Hild, Division of Market Oversight

Staff explained that the proposal is intended to achieve statutory objectives and goals while minimizing effect on markets. Contracts covered by the proposal include 3 categories of contracts:

Core Referenced Futures Contracts (CRFCs), which are 25 of mostly liquid, physically settled trade futures. This includes 9 agricultures as well as 16 new futures (7 agriculture, 9 metals, 4 energy);

Other futures and options related to CRFCs, including cash futures; and

Economically Equivalent Swaps (EES) – a swap would qualify as an EES as long as it shares identical material contractual specification, terms, and conditions with the referenced contracts. There is also an exemption for natural gas penultimate swaps if the delivery date differs by less than two dates, rather than one.

Staff continued that the proposed federal position limits would be increased, and the proposal would generally increase federal or exchange spot month position limits on all 25 core contracts set at or below 25 percent of deliverable supply. The proposal would substantially increase combined spot and all month limits for the nine legacy CRFCs. Subject to Commission oversight, the proposal removes federal limits outside of the spot month for the other 16 CRFCs, as corners and squeezes cannot occur outside of the federal spot month. Further, staff stated that under this proposal, market participants would generally no longer be allowed to treat positions as a bona fide hedge unless it meets the bona fide hedge definition.

Curtis then outlined the process for distributing exemptions. She noted that this proposal outlines both the various types of exemptions from the different position limits as well as the process for requesting exemptions for bona fide hedges. Of note, Curtis stated that the proposed rulemaking’s approach on this issue is similar to the existing process that has been in place for many years and as such, market participants are already familiar. Further, this proposal also offers a second option for obtaining a non-enumerated bona fide hedging exemption. Under this option, a person can submit one application directly to an exchange to obtain a non-enumerated bona fide hedging exemption and that exemption would be valid for the purposes of both federal and exchange set limits. She continued that if an exchange approves such an exemption, the exchange would then notify the Commission and the applicant simultaneously and the non-enumerated bona fide hedge would be deemed approved for the purposes of exceeding federal position limits so long as the Commission does not intervene within 1.) a limited 10-day review period; or 2.) a two-day review period in cases where applications are filed for the purposes of sudden and unforeseen bona fide hedging needs.

Q&A

Tarbert asked how many futures contracts are covered by these limits. Benton stated that there are currently 428 core reference contracts while noting that CFTC staff is not claiming this as an all-inclusive list and that he expects hundreds of new contracts down the line to be included as well.

Quintenz asked how many new enumerated hedges would be included under this proposal. Staff responded that under the proposal there will be five additional. He then asked what role the CFTC will play regarding self-effectuating enumerated hedges. Staff responded that under the proposal, exchanges would be required to file a monthly report outlining all exemptions they are granting each month, so the Commission will get a month-to-month look at what exchanges are granting.

Quintez asked about the rationale behind removing Form 204. Staff explained that the form was duplicative of data exchanges were already receiving from market participants.

Stump asked about how non-enumerated hedge exemptions would be granted and what happens when a trader exceeds their limit. Staff explained that the trader would have five days to notify the exchange and the Commission, then the exchange can determine if it is a bona fide hedging transaction and notify the participant and the Commission. Staff continued that if it is determined that it is not, the market participant would be required to lower the position and bring it back into compliance and would not be subject to an enforcement action.

Berkovitz opined at length on whether the Commission has a mandate from Congress to impose position limits, noting that is has been subject to many legal challenges. He noted that he would be offering an alternative interpretation, saying that if there is an alternative that meets the Chairman’s criteria and accomplishes the Commission’s stated goals including considering the costs of how position limits are developed, it should be considered. He noted that a necessity finding is difficult to make, saying that there are a number of factors that contribute to why position limits are needed for these commodities and asking whether there are detrimental consequences if there is excessive speculation. Staff said the point is to demonstrate the seriousness of the damage that could be done if these commodities were to experience price disruptions. He concluded that the Commission has the “tools in the toolkit” to act and there is a “clear path forward” to accomplish its objectives.

Tarbert said the Commission would be thinking about these questions over the next several months, saying it needs to be “done right” from a substance perspective.

Berkovitz expressed his agreement with Stump on necessity finding. He noted all the work the Commssion and the private sector have put into position limits and that the Commission has received specific requests on certain hedging practices that market participants are using or would like to use, which may not be included in this proposal. Berkovitz asked a series of questions on whether certain requested hedging practices are in the proposal. Staff responded that most of the individual requests are in the proposal and Berkovitz stated that this is a positive development.

Berkovitz expressed concern over the issues of phase-in and the large increase in limits. He stated that jumps in the past can disrupt pricing relationships and cause volatility in smaller commodity markets. Limits on these contracts are being substantially increased and there is no more risk management exemption. He noted there could be more index fund participants coming in and asked what the view is of phasing in some of the increases or ability to market activity. Division of Market Oversight (DMO) staff stated they ask in the preamble if the increase in limits should be phased-in. Berkovitz followed up by asking that rather than increasing the single month limit all the way to the max, could there a lower number on single month limits in the end as opposed to the number suggested in the proposal. DMO said they would have to look at comments, but that is definitely under consideration. Berkovitz continued by stating that the number could go somewhere in between, if there’s logic for it. He stated that he has seen what happens in markets with large increases in speculative activity. He concluded by suggesting the need to be careful and need for tools to be able to monitor and respond to this.

Final Vote: Proposed Rule – Position Limits for Derivatives

The proposed rule was approved in a 3-2 vote, with Behnam and Berkovitz opposing.

Closing Remarks

Chairman Heath P. Tarbert

Tarbert closed by thanking all the departments involved and stated that a tremendous amount of work has gone into this over the last decade as this is a very complex issue without an easy solution. Tarbert expressed a need for comments on a possible phase-in, adding to enumerated hedges, and the issued of clarity to market participants.

Commissioner Brian D. Quintenz

Quintenz spoke of the scale on the Commission seal, representing symbol of balanced interest and one that is exemplified by this rulemaking and thought process. He continued that the proposal adds new flexibility while creating new regulation. He concluded that the proposal gives exchanges and the Commission more flexibility while broadening and removing exemptions

Commissioner Rostin Behnam

Behnam thanked everyone involved and said that while he wants to be in a position to support this rule, he could not. He said that in tasking the Commission with establishing position limits, Congress was aware of its relationship with the exchanges and tasked the Commission with implementation. He continued that he does not believe the proposal will hold together and that it is flawed. He criticized that the proposal takes a “backseat” regarding oversight by allowing the exchanges to “take the wheel.”

Commissioner Dan M. Berkovitz

Berkovitz stated in his closing remarks that he had three major concerns: 1) Necessity finding; 2) the significant jump in limits that are being proposed and his desire for the limits to be phased in or not increased to full level of what formula suggests; and 3) the hedge exemption process, stating he is favorably inclined to push as much forward as possible and not be in 10 day review. He stated his belief that market participants shouldn’t have to come to the Commission office in D.C. to get their hedge exemptions. He stated that the position after today on necessity finding is the Commission stating “we need a necessity finding for federally imposed numbers and have made necessity findings for those 25 commodities. For every single other commodity under today’s interpretation, we do not need a necessity finding.” He continued that the legal position given today is one that states that the Commission can impose limits and tell exchanges what to do without a necessity finding, giving solid grounds to impose position limits on all commodities, as The Commission determines appropriate. If the Commission doesn’t have the tools to do it directly then we can give it to the exchanges and use their tools to do it.

Staff Presentation: Proposed Rule – Amendments to Codify No-Action Relief in Swap Execution Facility and Real-Time Reporting Requirements

Staff:

Roger Smith, Division of Market Oversight

Dorothy DeWitt, Division of Market Oversight

Vincent McGonagle, CFTC

Before turning to the staff presentation, all five commissioners expressed their support for this proposed rulemaking. Smith then provided a summary of the proposed rule and stated that this proposal is intended to provide long overdue regulatory certainty to both swap execution facilities (SEFs) and market participants. Specifically, this proposed rulemaking would impact processing requirements and exemption determinations related to packaged transactions, blocktrades and error trades while also increasing flexible means of execution for certain categories of these types of transactions. Specifically, this proposal includes an exemption from the trade execution requirement for swap components executed in a packaged transaction with new issuance bonds. Further, this proposed rulemaking would enable SEFs to permit market participants to execute swap transactions to correct operational or clerical errors using execution methods other than those required under 379A. The proposal would also require market participants to provide prompt notice to the SEF of an error trade and as applicable, the corresponding correcting trade and offsetting trade. While the proposal grants SEFs the flexibility in determining the most suitable error trade rules and procedures for their markets and market participants, it also requires that any such error trade rules or procedures be fair, transparent and consistent as well as allow for the timely resolution of an error trade. He concluded by noting that with respect to blocktrades, the proposal would allow enable SEFs to offer non-orderbook methods of execution for market participants to execute swap blocktrades on the SEF.

Q&A

Tarbert voiced his support for the proposal and presented a brief historical overview of SEFs in order to provide context for this proposed rulemaking. He stated that this measure will foster increased trading activity on SEFs, a trend that he views as a positive on

Quintenz voiced his support for the proposal and asked various questions concerning the error trade provisions codified in this proposal. Smith noted that Commission staff expects the SEFs’ error trade policies to be consistent with their other CFTC mandated obligations. Quintenz concluded by encouraging the Commission to codify the remaining no-action letters that are applicable in this space.

Behnam asked whether the existing no-action letters that are being codified in this proposal will remain in effect. Smith stated that the no-action letters will remain in place until there is a permanent and final solution in this area. In response to a question from Behnam regarding the error trade provisions outlined in the proposal, Smith reiterated that the intent of the proposed rulemaking is to give the SEFs the flexibility to determine the error trade policy that is best suited to their market and market participants while reaffirming that if a SEF policy fails to be either fair, transparent or consistent, it would necessitate action by the commission. Behnam concluded by voicing his support.

Stump outlined her support for the proposal and asked about pre-trade credit checks and the related obligations of futures commission merchants (FCM). In response, Smith stated that the genesis of this proposal was the desire to provide a pre-trade credit check function and added that such a function can be provided by using the non-orderbook methods of execution on the SEF. He continued that the proposal makes clear that if the FCM is unaware when it clears a transaction that the transaction had been executed away from the platform without its knowledge, the FCM would not be found to have violated their pre-trade credit check responsibilities. Stump concluded by echoing the comments of Quintenz in encouraging additional codification of no-action letters in this space.

In response to a question from Berkovitz, Smith stated that CFTC staff does not believe that this proposal will deter the SEFs from developing and implementing new execution methods. He continued that SEFs are incentivized to provide the most effective and efficient methods of execution to their markets but noted that the proposal makes clear that the Commission will continue to monitor developments in this space. Smith concluded by stating that the intent of this proposal is not to change, alter or supersede any of the status regarding void ab initio.

In conclusion, Tarbert emphasized that the codification of guidance as it relates to SEFs should be an evolutionary process, not a revolutionary process. He stated that while he is open to codifying additional no-action letters, he would like any measure that is proposed to have a broad-based consensus.

Final Vote: Final Rule – Amendments to Codify No-Action Relief in Swap Execution Facility and Real-Time Reporting Requirements

The final rule was approved unanimously.

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