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CFTC Energy and Environmental Markets Advisory Committee Meeting

Commodity Futures Trading Commission

Energy and Environmental Markets Advisory Committee Meeting

Thursday, May 7, 2020

Opening Statements

Chairman Heath P. Tarbert

In his opening statement, Chairman Tarbert noted that he is looking forward to feedback from presenters on a number of areas including how the proposal can be improved to further promote credible, well-functioning derivatives and cash commodity markets as well as allow end users to successfully manage and hedge their risks. Specifically, Tarbert outlined his focus on whether the federal spot month limits are appropriately tailored to each contract, and the list of enumerated, self-effectuating bona fide hedge exemptions and how they can be further clarified or expanded to encompass hedging practices frequently utilized in the energy sector. Overall, he noted that the position limits aren’t a silver bullet and they should strike a balance in helping promote liquidity, while deterring manipulation, corners and squeezes, and ensuring the price discovery function of the underlying cash market is not disrupted.

Commissioner Brian D. Quintenz

In his opening statement, Quintenz noted that he is interested in hearing from market participants on how the position limits rule can be improved, emphasizing that if it is done poorly, it could directly affect the participants in America’s real economy more than any other area of the CFTC’s regulations. Quintenz stated that the position limits proposal is one tool in the toolbox of the agency to monitor markets and ensure they maintain their integrity. Finally, he noted that he is interested in hearing from market participants their thoughts on the list of enumerated hedges, the bona fide hedging definition, and whether these will need to be expanded.

Commissioner Rostin Behnam

In his opening statement, Behnam noted the critical importance of the position limits rule for the CFTC. In addition to expressing his interest in hearing from the panels on the proposal, he lent his support to Commissioner Berkovitz’s comments regarding the EEMAC taking on the issues with recent volatility in the WTI market, and that the CFTC needs to review and educate themselves to learn from these times.

Commissioner Dan M. Berkovitz

Commissioner Berkovitz began his statement with a discussion of the recent volatility in the West Texas Intermediate (WTI) crude oil futures market. He noted that on April 20th the price of the WTI crude oil futures contract for May delivery collapsed from about $18 to -$37 per barrel, a fall of $55 per barrel, in one trading session. During that trading session, he noted, that the price of the May contract diverged from the price of crude oil in the physical market. Berkovitz stated that the CFTC, along with the CME Group, to determine what caused this unprecedented price movement and divergence from the physical market. Further, he called upon the CFTC and CME to work together to ensure that trading in upcoming WTI expirations is orderly, supports convergence, and reflects supply and demand in physical markets while maintaining sufficient liquidity for commercial market participants. With respect to the EEMAC, Commissioner Berkovitz then noted that the EEMAC can play a role in the analysis of the WTI futures disruption, and separately, noted that he is curious of the impact a position limits proposal would have had on the operation of these markets during that time.

Presentations

Panel 1: Proposed Position Limits for Spot Months, Single Month, and All-Months Combined

Staff:

  • Thomas LaSala, CME Group
  • Demetri Karousos, Nodal Exchange, LLC
  • William F. McCoy, Morgan Stanley
  • Sean Cota, NEFI
  • Susan Bergles, Exelon Corporation
  • Daniel Dunleavy, Ingevity Corporation
  • Kaiser Malik, Calpine Corporation
  • Dr. Richard Sandor, Environmental Financial Products, LLC

Thomas LaSala, CME Group, kicked off the panel by outlining CME’s views on the Position Limits Proposal (the “Proposal”). LaSala indicated that CME is supportive of the CFTC’s proposal to establish federal limits for energy and metal markets, as well as certain newly captured soft markets. He continued by stating that CME agrees with the CFTC’s preliminary finding that position limits are necessary for the 25 referenced contracts in the spot month and is consistent with the pattern adopted by DCMs as related to position limits in the physical commodity markets today. CME is also supportive of the deference to the expertise of the DCMs, and are appreciative that their recommendations, which were based on a measured approach to avoid risk of disruption and ensure orderly operation of markets, were in the proposal. LaSala also warned that setting artificially high federal limits can incentivize exchanges to set limits for competitive reasons rather than for regulators purposes which can result in denigrating price discovery in the core physical market. Finally, LaSala noted that CME is encouraged by the Commission’s inclusion of swaps in the rulemaking, particularly in the look alike markets, and suggested that the commission expand its look alike definition.

Demetri Karousos, Nodal Exchange, LLC, presented on the perspective of the power futures and options market. Karousos explained situations where manipulation may appear and the role of mark monitors in the power context. He then discussed the key differences between financially settled power contracts and those for natural gas and oil. Overall, he noted that they have identified areas where he believes the CFTC was applying the “gas model” too generally to the power market. More specifically, he noted issues with some of the exclusions from the referenced contracts definitions. Karousos expressed the concern that the exclusion language used with regard to the reference contracts (based on natural gas contracts) may ultimately be confused in their application to power and electricity contracts. Separately, Karousos noted that he is appreciative of the flexibility and deference provided to the expertise of the exchanges (especially in terms of power and derivatives contracts) and that he is supportive of that aspect of the proposal.

William F. McCoy, Morgan Stanley, presented Morgan Stanley’s position on the Proposal from the perspective a swap dealer. McCoy noted Morgan Stanley’s support for the Proposal, emphasizing that it reflects careful consideration of prior industry comments and is better aligned with current commercial hedging practices. Specifically, Morgan Stanley is supportive of position limits on the 25 core referenced futures contracts based on measurements of deliverable supply, and believe the Proposal strikes an appropriate balance between the federal and exchange position limit regime. McCoy noted that Morgan Stanley believes that there are many reasons not to set hard limits outside of the spot month based on policy concerns, and further explained that the Exchanges’ accountability regime is an effective means of preventing market disruptions. Morgan Stanley also holds that market participants on both sides of the supply and demand chain are heavily dependent on the speed and flexibility of exchanges to accommodate hedging needs. The need for quick and flexible hedging solutions which is accommodated by intermediaries such as futures commissions merchants and swap dealers might not be possible if the market is subject to hard position limits in the non-spot month. McCoy further stated that it is appropriate to limit the new regime, if it is to apply to swaps, to spot month positions and a workable definition of economically equivalent swap.

Sean Cota, NEFI, presented the perspective of a non-profit association for retail and wholesale distributers. Cota noted that his members include main street businesses and that they have long utilized derivatives to hedge market volatility. Overall, Cota expressed that NEFI believes the Proposal has some pros and significant cons. Specifically, he noted that the proposal only covers 25 core referenced contracts and should be expanded to cover all contracts. On the economically equivalent swap definition, NEFI believes it narrower than in previous proposals and therefore would allow for easy avoidance. Additionally, Cota emphasized that the recent WTI market events and COVID-19 upheaval play an important role in evaluating a position limits proposal. He then requested that the CFTC withdraw the Proposal and consider the historically significant WTI market April market disruptions before finalizing any proposal. Related to these issues, Cota requested that the CFTC allow more time to comment on the Proposal.

Susan Bergles, Exelon Corporation, noted that Exelon’s primary focus has been on market liquidity and the ability of commercial end-users to effectively hedge. Bergles noted that the Proposal is a significant improvement from prior proposals. However, Bergles explained that the proposal can be improved by adding more regulatory certainty. Specifically, Bergles stated that there is still some confusion about how to interpret the Proposal to know whether some contracts are included or not. Bergles suggested the Commission consider an all-inclusive list of contracts that are subject to the limits, which could evolve over time. Without regulatory certainty, Bergles noted, the proposed position limits would be a burden on end-users. Furthermore, Bergles stated that should the CFTC move forward with this rule, the Commission should undertake a study for implementation, and measures that should be taken as appropriate.

Daniel Dunleavy, Ingevity corporation, presented the perspective of an industrial end user of a significant amount of natural gas. Ingevity, Dunleavy noted, participates in physical and financial U.S. natural gas markets and relies on high functioning and transparent energy markets. Dunleavy stated that while the proposed limits appear reasonable for the markets the CFTC is targeting, they would recommend the Commission cast a wider net and increase its oversight on natural gas basis markets. Furthermore, Dunleavy recommended that the CFTC take the lead on re-examining the limits to the pool of participants in the commodity markets. As certain regulations since Dodd-Frank have drove banks out of the physical energy markets, allowing the expanded participation of banks may create more efficiency and spread risk around to banks with healthy balance sheets and a diversified risk portfolio.

Kaiser Malik, Calpine Corporation, presented the perspective of some commercial end users of energy and natural gas markets. He began by noting that majority of risk exposures for the end users he represents comes from the operation of power plants, with additional risk coming from other aspects of the business such as transportation. Overall, Malik noted Calpine’s support for the proposed rule, given his belief that it is well aligned with current hedging practices and less burdensome on end users. Moreover, he emphasized that for end-users, primary access to hedging and reliable and accurate price discovery was of particular importance. In addition to supporting the overall framework, Malik noted support of the limits on the 25 core referenced contracts, limits only on spot-month contracts, the proposed definition of reference contracts, and finally the definition of economically equivalent swaps.

Dr. Richard Sandor’s, Environmental Financial Products, LLC (EFP), remarks specifically targeted the proposed position limits on environmental products. He noted that the limits both in spot and futures markets for the California Carbon Allowances, Regional Greenhouse Gas Initiative Allowances, and others, all seem by the exchanges, to perfectly satisfy the needs of the markets. Dr. Sandor further explained that the environmental markets tend to be hedger dominated, could use more speculation rather than less, and currently perform hedging and the price discovery function very well. Overall, he commended the Commission and the exchanges for instituting appropriate position limits and for encouraging these important markets.

Q&A

Matthew Picardi, Commercial Energy Working Group, asked Mr. LaSala (CME) how the current proposal could be expanded to cover more swaps. Mr. LaSala responded that, as he noted in his opening remarks, there is a discord between the swap definition and the workbook. He explained that one way is to expand the swap definition to include “pens”.

James C. Allison, JCA Advisory Services LLC, asked LaSala how the May crude expiry may have been different if the proposed rules were in effect. LaSala responded that it was too premature to be able to answer that question. He noted that CME is conducting a deep dive into that activity to understand the circumstances and that there is still more work to do. Derek Sammann, CME Group, addressed some comments made earlier in the meeting, specifically, that CME has seen significant market disruptions due to COVID-19, and that they are in contact with the CFTC and market participants.

Commissioner Berkovitz then expressed his further thoughts on the recent market developments. Specifically, he noted that he was interested in the role of exchange traded funds that have investments in commodities and how those are managed. He further added that he believes the accountability regime works and that CME took appropriate action. Following his comments, Commissioner Berkovitz asked whether any participants would like to comment on the role of passive investment vehicles and the approach the proposal took on this. Trabue Bland, ICE Futures U.S., responded that with respect to ICE’s markets there isn’t a significant number of ETFs or passive investments, but noted that a risk management exemption is important to the operation of those markets. LaSala responded that ETFs, such as the one Berkovitz was implicitly referring to, are public companies with public positions and the accountability structure did work well with regards to that circumstance. McCoy added that he believes the exchanges accountability regime has been effective.

Panel 2: Proposed Bona Fide Hedge Exemptions from Position Limits and Related Procedures

Staff:

  • Vito Naimoli, ICE Futures U.S.
  • Thomas LaSala, CME Group
  • Demetri Karousos, Nodal Exchange, LLC
  • Tyson T. Slocum, Public Citizen
  • Matthew Picardi, Commercial Energy Working Group
  • Dr. John Parsons, Special Government Employee
  • Jennifer Fordham, Natural Gas Supply Association
  • Matthew Agen, American Gas Association
  • Daniel Dunleavy, Ingevity Corporation
  • Kaiser Malik, Calpine Corporation
  • Lopa Parikh, Edison Electric Institute
  • Jeffrey Walker, ACES
  • William F. McCoy, Morgan Stanley

Vito Naimoli, ICE Futures U.S., provided ICE’s perspective on the proposed bona fide hedge exemptions. Naimoli stated that the current limit regime functions well, and that exchanges are in the best position to process any exemptions. Naimoli then stated that to ensure continued consistency, enumerated exemptions should remain narrow and transparent. On the exchanges’ expertise to handle the exemption process, he noted that the exchanges understand the dynamics of market participants as well as the ongoing communications with market participants due to requests for clarifications on applications for exemptions. Additionally, Naimoli urged the Commission to adopt several hedge modifications such as expanding the list of enumerated hedges even further and expanding cross-commodity hedging. Finally, Naimoli requested a clarification around the 10-day process relating to what a market participant could put on during that process.

Thomas LaSala, CME Group, began by stating that the CME Group broadly supports the expansion of enumerated exemption types and the removal of the 5-day rule. LaSala recommended the Commission clarify and/or review certain processes around the information needed to be provided by the market participants. Specifically, LaSala recommended the removal of the proposed guidance in Paragraph B of Appendix B, the removal of requirements for applicants for retroactive exemptions to include an explanation warranting the sudden increase in hedging needs, the adoption of the current exchange process for retroactive exemptions, and the addition of several other enumerated hedges. LaSala stated that the CME Group supports the exchange management of enumerated exemptions and further supports the proposed 10-day and 2-day review period for non-enumerated hedges. With respect to the proposed compliance date, LaSala stated that it is broadly reasonable, but concerns do exist which should be considered.

Demetri Karousos, Nodal Exchange, LLC, began by highlighting the particular role played by large energy entities. Karousos noted that the exposures of these firms could change drastically as certain deals are negotiated and finalized. With that in mind, Karousos noted that the Commission should consider the power hedging model in mind when developing new procedures. Specifically, he noted that hedging needs for these large energy entities are complex and everchanging. He recommend the Commission establish an application that is flexible and able to accommodate a range of expected outcomes.

Tyson T. Slocum, Public Citizen, presented the perspective of a national consumer advocacy interest group. Slocum emphasized that from his institution’s perspective there were a number of concerns with the Proposal, including that it would grant for-profit exchanges the right to make the determination of granting non-enumerated hedge exemptions. Slocum stated that he believes that this decision should rest with the CFTC and CFTC staff. Further, Slocum stated that the extreme volatility and the role speculation played in the WTI contract disruption should inform the position limits proposal.

Matthew Picardi, Commercial Energy Working Group, began by stating that recent global and economic events impacting energy markets re-affirm the need for an appropriately tailored framework that includes a coherent and coordinated approach to commercial hedging that draws upon the knowledge and expertise of the exchanges and provides commercial firms the discretion to use their business judgment for the purposes of identifying their exposure to price risk and managing that risk as necessary. Picardi noted that the Commercial Energy Working Group is broadly supportive of the proposed. Specifically, he noted support for certain features that will help a commercial entity with their hedging efforts like delegation of responsibility to exchanges, appropriate limitation on new federal regime to spot, and expanding the list of enumerated bona fide hedge exemptions. Picardi stated that the rule should provide regulators a paradigm that avoids harm to commodity markets and leverages the platforms already used by exchanges and market participants to manage their position limits. However, Picardi did note some concerns. Specifically, he noted additional items that should be included in the list of enumerated hedges, requested the Commission clarify and review the guidance set forth in Paragraph A of Appendix B of the proposed Part 150 changes, and some further concerns with the 5-day rule and the definition of reference contract.

Dr. John Parsons, Special Government Employee, emphasized that there is a distinction between speculative trading and hedging. To explain this distinction, he discussed two specific cases (a 1993 case, and a 1995 case, respectively). However, he noted that the distinction is constantly being blurred, whether at the trader level or even at the business unit level. Dr. Parsons stated that exchanges and regulators need to be able to determine the difference, and in the current Proposal, the CFTC is stepping back from its responsibility of determining the difference. He expanded on that thought by stating that when the CFTC is not an active participant in the conversation, the CFTC’s own capacity to know the difference may wither. In sum, he stated the CFTC needs to be involved.

Jennifer Fordham, Natural Gas Supply Association, presented the perspective of a natural gas supply association. Overall, Fordham stated that the proposal put us on a viable path to the finish line but is in need of some modifications. Specifically, she highlighted that the Commission must retain the old definition of risk in the hedge exemption, rather than narrowing the definition of risk to price risk. Additionally, Fordham added that the enumerated hedges must be expanded to include other specific enumerated hedges. Fordham then noted that with a few critical modifications, the regulatory uncertainty currently embodied in the proposal can eliminated.

Matthew Agen, American Gas Association (AGA), presented the perspective of more than 200 local energy companies that deliver natural gas throughout the U.S. AGA believes that any position limits rule should: 1) allow commercial end users to enter into bona fide hedges to manage, hedge and mitigate commercial risks; 2) not be unduly burdensome for end-users; and 3) permit end-users to cost effectively mitigate risks and costs, ultimately benefiting customers. With respect to exemptions for bona fide hedges, AGA noted that any hedge exemption should not be too narrow or restrictive to burden end users, and that market participants should be able to benefit from clear rules and definitions. Moreover, AGA noted that the proposal should include hedges for anticipated merchandising and recognize other certain non-enumerated hedges.

Daniel Dunleavy, Ingevity Corporation, presented an industrial end user’s view of the bona fide hedging exemptions. Specifically, he noted that as an industrial end-user they should be exempt from position limits given the governance structure outside the CFTC that would limit their ability to hold certain contracts. On governance, he explained that they have board approved hedging programs that establish hedge ratios which is ultimately checked by external auditors. Separately, with respect to hedge accounting treatment, Ingevity is subject to strict FASB hedge accounting treatment.

Kaiser Malik, Calpine Corporation, provided a few concerns related to hedging. Specifically, he noted that the economically appropriate test is too narrow and inconsistent with the text of the Commodity Exchange Act. Malik stated that the price qualifier to risk in the bona fide hedging definition should be removed. With respect to the enumerated hedges, he emphasized that the enumerated hedges should be within the definition itself, and not within an appendix, in order to trigger a public notice and comment period each time an enumerated hedge is added.

Lopa Parikh, Edison Electric Institute (EEI), presented the perspective of investor owned electric companies in the U.S. Parikh stated that the CFTC needs to have a workable definition of bona fide hedging that takes into account all of the hedging activity of end-users. Their primary concern, as Parikh noted, is ensuring that the definition is too narrow or inflexible. Parikh noted EEI’s support of the current definition, including their support of the enumerated hedges, and allowing for a flexible list of enumerated hedges that can be updated as necessary. EEI also supports the Commission’s proposal to delegate authority to the exchanges. In addition to this support, Parikh provided a few areas where the Commission may want to provide guidance and clarity. Specifically, if a new enumerated hedge is created by the commission or an exchange, the CFTC may want to provide notice to all market participants. Further, Parikh stated the Commission should provide more clarity on the process for commercial end users seeking to go directly to the Commission for an additional enumerated hedge.

Jeffrey Walker, ACES, make a few recommendations with respect to the bona fide hedging definition and noted some concerns with the burdens of compliance. Walker recommended that the Commission expand the enumerated hedge for Anticipated Requirements to include unfilled or unpriced anticipated requirements. He stated that can be accomplished by either extending the exemption or definition unfilled accordingly. Beyond enumerated hedging, Walker noted that there will be burdensome compliance requirements on end-users whether they are below or are exceeding the position limits. Specifically, he noted that monitoring, recordkeeping, and responses to calls for information may be burdensome on some end-users.

William F. McCoy, Morgan Stanley, began by noting that Morgan Stanley is pleased to support the rule. In addition to expressing support, McCoy noted specific recommendations relating to the pass-through swap provision and the elimination of the risk management exemption. On the pass-through swap provision, McCoy recommended that the provision be clarified to make it more commercially practicable. He continued that the proposal indicates that the counterparties provide a representation that the transaction is a bona fide hedge, which is likely unworkable for practical reasons. Specifically, with respect to setting up a trading relationship, a counterparty may not want to represent that all transactions will be a bona fide hedge. McCoy explained that allowing for greater flexibility of how a dealer could represent a pass through would be helpful. On the elimination of the risk management exemption, McCoy noted that this may result in a decrease in liquidity and it is unclear how the other parts of the proposal will mitigate the elimination of this exemption. Further, McCoy noted that the Commission should preserve the ability to grant exemptions for appropriate risk reducing transactions and should acknowledge the ability of the exchanges to grant risk management exemptions.

Q&A

James Allison, JCA Advisory Services LLC, responded to Slocum’s earlier about the role of exchanges and posed a question for Dr. Parsons. With respect to the role of exchanges, Allison stated that he disagrees with Slocum because the exchanges have the best expertise and data to make decisions, and with respect to any conflict of interest, there is a real and effective separation of duties that leads to best in class risk management.. Allison then asked Dr. Parsons whether he could expand on how he believes the Commission could get more involved in the process for determining speculation versus hedging. Dr. Parsons responded that under the current proposal the CFTC is sort of a backstop and are not regulatory participants in the process. He recommended that the Commission periodically review decisions. Additionally, with respect to the difference between speculation and hedging, Dr. Parsons noted that a simple definition is a reduction of overall risk. LaSala then added to the response to Slocum’s comments by stating that the exchanges’ examination process with respect to exemptions is rigorous and not a blanket “do as you please.”

Paul Cicio, Industrial Energy Consumers of America, echoed his support for Walker’s comments with respect to unfilled prices and asked LaSala if he could further expand on the concern mentioned earlier that there may be a mass of requests for exemptions all at the same time. Separately, he asked LaSala to clarify whether there was still a direct tap to go straight to the Commission for exemptions. LaSala responded that CME has been successful in evenly laying out all exemption applications for effective markets evenly over the course of a 12-month period. However, he noted that the concern he was trying to raise is that an effective date may create a rush all at once. La Sala expanded that he believes the CFTC should be willing to allow a safe harbor period prior to the effective date so that the exchanges could get ahead of the rush.

Commissioner Berkovitz noted that the CFTC has been working for about 10 years to get the definition of bona fide hedge correct. He stated that the feedback received so far is that the Commission has made progress on the definition, but there are some refinements that need to be made based on comments. He continued that we need an appropriate balance between the authority of the exchanges and the authority of the CFTC. Berkovitz emphasized that the CFTC definitely has the expertise and ability to make decisions on exemptions, as they have been successful in the agricultural sector. He further stated that ultimately, the CFTC has to decide what’s hedging and what is speculation. Moreover, he clarified that he is supportive of delegation to the exchanges and the determination of whether somebody is meeting a bona fide hedge exemption.

Commission Stump asked whether LaSala and Bland could describe the engagement that the exchanges have with the CFTC with respect to position limit core principle compliance. Vito Naimoli, ICE Futures U.S., noted that when exchanges file for a new product they have to file with the commission and that there are consistent communications with the CFTC. Further, he noted that there are quarterly meetings with the Commission to discuss how market fundamentals are operating and any concerns about market. LaSala agreed with those comments and noted that even with the Proposal, there was quite extensive conversations between the exchanges and DMO staff about the methodology.

Closing Remarks

Chairman Heath P. Tarbert

Chairman Tarbert closed by noting that many aspects of this rule call for balance. In particular he noted the need to strike a balance between speculation and hedging, and duties between CFTC and exchanges. He stated that in order to achieve the right balance, the CFTC is counting on the input form market participants and other concerned stakeholders. He noted that the CFTC will look to finalize this rule later this year.

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