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CFTC Agricultural Advisory Committee Discusses Position Limits

Commodity Futures Trading Commission

Agricultural Advisory Committee Meeting on Position Limits

Tuesday, September 22, 2015  

Key Topics & Takeaways:

  • Position Limits Implications: CFTC Chair   Massad said the Commission is committed to taking the time to consider the implications of the position limits rule proposal and noted that the ability for exchanges to grant non-enumerated hedge exemptions would require a change to the proposed rules. 
  • Position Limits Harm: Commissioner Giancarlo expressed concern that the CFTC’s position limits rulemaking would harm the ability of farmers to make a living. 
  • Aggregation Proposal: CFTC’s Fajfar said a new proposal from the CFTC would revise the position limits aggregation process so that “owners of a greater than 50 percent interest would follow the same procedure that would apply for owners of an interest between 10 and 50 percent” and be able to disaggregate with the filing of a notice to the CFTC stating that specified standards have been met. 
  • Enumerated Hedges:CME’s Hawrysz highlighted that the list of enumerated hedges has not changed in almost 30 years, and asked that the CFTC consider adding hedges which are routinely the subject of an exemption request. 

Meeting Participants:

Opening Statements

In his opening remarks, Tim Massad, Chairman of the Commodity Futures Trading Commission (CFTC), noted that there has been a decline in the number of futures commission merchants (FCMs) in the marketplace “as a result of many factors,” but that overall trading volumes have increased. On the position limits rulemaking, Massad explained that the possibility of for exchanges to grant non-enumerated hedge exemptions would require a change to the proposed rules and noted that the CFTC released a supplement to the proposal regarding aggregation provisions, which will be open for public comment.  

Massad said the CFTC is committed to taking the time to consider the implications of the position limits rule proposal. He also noted the Commission is taking a closer look at automated trading and will be proposing additional rules in this space. 

Commissioner Sharon Bowen, in her remarks, said the CFTC “at this point” has “probably heard all possible comments regarding the rule” and that if the Commission “needs to do a supplemental proposal to improve the rule, let’s do it.” She added that she believes there “are ways to move forward on issues such as anticipatory hedging that fit within the rule’s existing framework” and hopes the CFTC can “move forward soon.” 

Commissioner Christopher Giancarlo, in his remarks, said net farm income will decline by 36 percent from last year and expressed concern that the CFTC’s position limits rulemaking would harm the ability of farmers to make a living. He stressed that the CFTC should not displace “the everyday commercial judgment of farmers and business people with a small set of allowable hedging options pre-selected by a Washington Commission with limited experience in commercial risk management.” 

Agriculture Market Update

Tim Andriesen, CME Group, gave a presentation explained that the CME takes a proactive approach to reviewing contracts and possible changes and that all contracts are reviewed over a two- to three-year cycle. He noted that the process includes internal reviews at the CME, focus group feedback, request for comments, and submission to the CFTC for approval. 

Tim Barry, ICE Futures U.S., gave a presentation explaining ICE’s new World Cotton Contract, which he said was been in the works for nearly two years and will be filed with the CFTC later this week.  Barry said this contract will trade alongside CME’s other cotton contract and be a new price discovery tool for the market. He said the product will launch November 2, with a first delivery month of May 2016. 

Layne Carlson, Minneapolis Grain Exchange, gave a presentation explaining that trading volume at the grain exchange has been growing “dramatically” and that liquidity is an essential element to allow market participants to enter or exit contracts at their desired price. He said the exchange would prefer for grain to not be subject to position limits and that he realized that setting the limits themselves is “a lot to ask” but stressed that “position limit parity” among wheat contracts is important. He also expressed concern that narrowing the definition of bona fide hedge will not be helpful. 

Question and Answer

Randall Fortenbery, Chairperson of the Agricultural Advisory Committee, asked if there is latent demand for activity in the new cotton contract. Barry said he has heard there is latent demand in non-U.S. producing areas and that there will be pick-up from current cotton contract users, as well as arbitrage opportunities with the new contracts. 

Edward Gallagher, National Milk Producers Federation, asked if the industry comes to the CME to suggest contract review or if the CME suggests changes itself.  Andriesen said it is “a bit of both” and that the CME is “engaged with the industry on a consistent basis.” 

Gallagher then said exchanges should be able to make bona fide hedge determinations because there are new ways that swaps are being used in the marketplace and market participants will want to know in advance if a certain swap is a bona fide hedge.  Neil Dierks, National Pork Producers Council, agreed that exchanges are better positioned to make real time determinations of bona fide hedges. 

Massad asked if there is any other significant competition for the new world cotton contract. Barry said there is no other direct competitor, adding that the closest one is a contract used only in China that is often referenced as a benchmark. 

FCM Market Trends

Kevin Piccoli, Division of Swap Dealer & Intermediary Oversight, gave a presentation noting that the number of FCMs declined from 180 in 2005 to 76 in 2014 and explained that the biggest decrease was in the number of FCMs that do not hold customer assets. He said FCMs have exited due to reasons such as bankruptcy, consolidation, higher costs of compliance with new regulations, and changing of registrations status. He specifically noted that the National Futures Association (NFA) insisted that many FCMs change their registration status to commodity pool operators over the years. 

Piccoli cited that there has been a 53 percent increase in customer assets held at FCMs and said that the majority of this increase has been captured by the ten largest firms. He further noted that in 2005 the top ten firms held 67 percent of customer assets and in 2014 held 77 percent. 

Question and Answer

Giancarlo said he is concerned about recent reports of acquired FCMs letting go of smaller customers and asked where these smaller customers go. Piccoli said smaller customers may follow the trading desks of firms when the FCM is acquired and stressed that the portability of customers is an important focus of the CFTC when it goes through the process of overseeing an FCM acquisition. 

Giancarlo then asked if it is good policy for trading houses to have access to more than one FCM. Piccoli said larger institutions and professional traders usually have access to two or sometimes three FCMs. 

Tom Kadlec, Futures Industry Association, said FCMs need to perform due diligence on potential new customers to determine their needs and service requirements. He said the ability to say “no” to bringing on a new customer can sometimes “be the best decision we make,” because some customers are not willing to pay a fair rate for the service they are given. Kadlec also stressed the increased costs that FCMs face due to regulations resulting from the Dodd-Frank Act and Basel Accords, which he said must be passed down to customers in a “rational and well-defined way.” 

Kadlec also added that the market should embrace the exchanges and the CFTC making determinations of hedgers but said it is the responsibility of the customer to “prove they fit into one of those buckets.” 

Scott Cordes, National Council of Farmer Cooperatives, asked how many FCMs operated in the agriculture space, to which Piccoli replied that about 12 FCMs are agriculture-oriented. 

Eileen Flaherty, CFTC Director of the Division of Swap Dealer and Intermediary Oversight, noted that being an FCM is a very expensive business with very low margins. While regulations are not entirely to blame, she said, customer protection requirements and the “extra layer” of Dodd-Frank regulations “squeeze FCMs.” She also noted that infrastructure costs are high and that FCMs basically act as guarantors for their customers to clearing houses. 

Bowen asked what happens to customer funds in an FCM bankruptcy. Flaherty said that “finding a home” for customers in an FCM bankruptcy is difficult, noting that firms have risk management policies that require them to review every new customer. She noted it is difficult to port customers to a new FCM, but said she does not know if there is a better way. 

Kadlec said the customer segregation rules were “done quite well” and that it is important for the CFTC to model additional rulemakings on this process. 

Sayee Srinivasan, CFTC Chief Economist, said the FCM industry is in transition and that the cost structure has changed for customers. He then said the CFTC would like to hear comments on what barriers to entry exist for new entrant FCMs and what the CFTC can do to support innovation and new pricing models. 

Massad agreed that CFTC examination of these issues is important. He said he is curious about pricing differences between market participants who trade long-term positions and those who “are flat at the end of the day.” Kadlec said there are many subjective factors that go into how a product is priced, including capital allocation, risk assessment, and required service level. 

Bryan Dierlam, International Swaps and Derivatives Association, Inc., asked Piccoli if FCMs that provide retail services for agriculture customers are impacted by new regulations as much as other FCMs. Piccoli said the top ten FCMs are banks or are owned by banks and have a more diversified revenue model, and thus are not as impacted by regulatory hurdles as smaller FCMs. He also noted that returns are dependent on the level of trading that an FCMs’ customers are engaged in. 

Gallagher noted that customers must perform due diligence when selecting an FCM to do business with, saying that his firm looks for a well-capitalized FCM. Kaldec noted that his FCM’s data is publically available online so that customers can judge them on a daily basis. 

Position Limits

Mark Fajfar, CFTC Office of the General Counsel

Mark Fajfar, CFTC Office of the General Counsel, opened the panel discussion with a brief summary of the Commission’s proposed rulemaking to modify aggregation provisions of its position limits rulemaking.  Fajfar explained that, in accordance with the Commodity Exchange Act, CFTC regulations require that a person aggregate all positions in which it holds a 10 percent or greater ownership interest, applicable for all federal position limits, subject to certain exemptions.  Fajfar then detailed how the Commission is seeking to address situations when aggregation is required on the basis of ownership of a greater than 50 percent interest in another entity, in its new proposal.  He explained that under  the CFTC’s previous November 2013 Aggregation Proposal, owners with less than 50 percent ownership interest would be able to file a notice to the CFTC stating that specified standards had been met (i.e., appropriate firewalls and lack of control), and subsequently would be able to disaggregate the owned entity’s positions.  Conversely, the 2013 proposal would require owners with greater than 50 percent interest to provide specific information and certifications in an application to the Commission and subsequently wait for the Commission’s approval before being able to disaggregate. 

Fajfar noted that commenters on the 2013 proposal indicated that the “greater than 50 percent ownership” exemption as proposed was to narrow and difficult to qualify for.  In light of these concerns, the new proposal would revise the process so that “owners of a greater than 50 percent interest would follow the same procedure that would apply for owners of an interest between 10 and 50 percent” and be able to disaggregate with the filing of a notice to the CFTC stating that specified standards have been met.  Fajfar went on to clarify that “all other aspects of the November 2013 proposal remain the same and the commission continues to consider that proposal and the comments submitted during the earlier comment period”. 

Joe Hawrysz, CME Group

Joe Hawrysz, CME Group, spoke next, providing background on the role of exchanges and how they may be able to assist the Commission in the processing, analysis and approval of exemptions.  Hawrysz walked through the expertise CME has in processing exemptions for products with and without federal limits via its regulatory/market surveillance department.  He highlighted that the department’s primary responsibility “is to deter and detect manipulation,” and that individuals there are given a core product to monitor, which they “live and breathe” in order to detect price anomalies.  

He went on to explain that the exemption process requires review and approvals from several levels of employees and that the final recommendation could be for a lower exposure than requested, depending on several factors.  He explained, however, that CME continues surveillance following approval and that the limit may be increased or decreased depending on circumstances.  Hawrysz also highlighted that list of enumerated hedges has not changed in almost 30 years, and asked that the CFTC consider adding hedges which are routinely the subject of an exemption request. 

Erik Hass, ICE Futures U.S.

Erik Hass, ICE Futures U.S., then detailed a joint proposal from ICE and CME which would allow exchanges to leverage their existing surveillance and procedures to provide non-enumerated hedge exemptions.  Under the proposal, Haas explained that participants seeking an exemption for a non-enumerated hedge would be required to fill out an application detailing their strategy, exposure, and requested exemption level.  The exchanges would then review the strategy (to ensure it meets hedging criteria), review whether there is “justifiable exposure,” and determine what the appropriate exemption level should be, based on participant exposure and market conditions.  Haas noted that exemptions provided could be less than requested. 

Haas further explained that under the proposal, where an exchange provides an exemption for a non-enumerated hedge subject to CFTC rulemaking, the participant would be allowed to rely on the exchange’s non-enumerated hedging exemption for its over-the-counter (OTC) hedging transactions.  Additionally, Haas stated that in order to facilitate this process, the exchanges would plan to submit to the CFTC all approvals and determinations for non-enumerated hedging strategies on a timely basis, and further provide notice on their website of the “general nature of strategies granted exemption,” without any identifying specifics. 

Haas then emphasized concerns regarding a “one-size-fits-all” approach to position limits.  Haas explained that “all-month accountability levels allow the market surveillance departments and processes to really manage and review large positions” and that “accountability rules can be more effective at times than limits.”  He provided several examples detailing the fact that there is little to distinguish the prices and settlement of products without single or all months limits, managed with only accountability levels, as opposed to those managed with limits.  He then expressed concern that implementing single and all-month limits may force out market participants providing stability and liquidity. 

Question and Answer

Lance Kotschwar, Commodity Markets Council, expressed support for the exchanges’ proposal, noting their holistic view on markets which provided the necessary context to make proper determinations. 

Gallagher sought insight on how quickly the exchanges would be able to work through the decision making process for a non-enumerated hedge request.  Hawrysz responded that the exchanges would seek to engage in dialogue and work with the requestor, stating a decision might be able to be made “within a couple of days … assuming there’s no miscommunication” and that the exchanges have the information needed to make such a determination.  Hawrysz caveated, however, that it is not an easy process and that the timing may be impacted by other factors, such as the number of requests and bandwidth issues at any given time. 

Bill May, American Cotton Shippers Association, expressed concern that provisions within the Commission’s proposals would restrict hedging for commercial end-users, requesting that the CFTC continue to modify proposals to prevent problems. 

Gallagher next asked whether the CFTC would monitor OTC positions, as opposed to exchanges.  Hawrysz confirmed that the CFTC would monitor OTC positions, as they have insight into the market via swap execution facilities (SEFs), which the exchanges would not have.  When asked whether the CFTC is able to monitor OTC positions, Massad explained that the CFTC’s data reporting regime is still a work in progress and noted that the CFTC needed time to think about how to integrate the monitoring of SEFs and exchanges. 

In response to a question of how detailed the information published on the exchanges’ websites would be in the event of an approval, it was confirmed that the details would be generic.  It was explained that under the CME/ICE proposal, the website publications would only be meant to provide an example of the types of hedges that were approved and that participants would still need to submit their own requests. 

John Owen, USA Rice Federation, cautioned the Commission regarding the “unintended consequences of overregulation,” explaining that if it becomes “more difficult to obtain hedging exemptions, I’m afraid that you are going to slow things down,” and said that the CFTC should be careful not to negatively impact liquidity.  Owen noted that if basis becomes way out of line with the futures market, then participants will lose confidence in futures contract and move towards the cash markets. Owen then expressed confidence in the ability of the exchanges to grant hedging exemptions. 

For more information on this meeting, please click here.