Comments on Position Limits in Commodity Markets

Comments on Position Limits in Commodity Markets

quoted in Federal Registry

...and that allowing owners of more than 10 percent of another entity not to

aggregate could ‘‘potentially spark additional ‘herd-like’ behavior, thus

causing another commodities futures boom-bust cycle.’’

-  International Association of Machinists and Aerospace Workers on June 29, 2012 (‘‘CL– IAMAW’’).

Summary

COMMODITY FUTURES TRADING COMMISSION 17 CFR Part 151 ruN: 3038-AD82 AGGREGATION UNDER PART 151, POSITION LIMITS FOR FUTURES AND SWAPS.

The proposed rule would amend the rules establishing speculative position limits for physical commodity futures and option contracts traded on a designated contract market and economically equivalent swaps, which were published in the Federal Register on November 18, 2011.

 The proposed rules would permit any market participant with an ownership interest of 10% up to 50% in a separately organized entity (an "owned entity") to make a notice filing of exemption from aggregation by demonstrating independence in decision making. The owned entity could be a financial or a nonfinancial entity that has passive ownership interests.

By loosening the ownership of interest up to 50%, the proposed rule can potentially spark additional “herd-like” behavior, thus causing another commodities futures boom-bust cycle. We believe that without strong regulations including position limits established by the Dodd Frank Act, excessive speculation in the futures markets will continue.  Therefore, we recommend that Commodities Futures Trading Commission (CFTC) adhere to its existing formula of setting position limits such that no single investor can constitute more than 10 percent of a market, as measured by open interest, up to 25,000 contracts of open interest, and 2.5 percent thereafter.  However, if CFTC’s existing position limit formula is considered not to be feasible, then we suggest CFTC give Pollin and Heintz (2011) and CME group (2011) position limits proposals serious consideration.[1]

Our views are based on the analysis of the empirical literature on position limits, excessive speculation, price volatility and the financialization of commodities.[2] The literature reviewed shows that institutional investors in its attempts find “safe havens” and increase their profits entered into the commodity markets en masse.  As a result, prices became inflated beyond the fundamentals of supply and demand (boom) and subsequent drop in prices when many institutional investors exited the commodities market (bust).

With the increasing presence of institutional investors in the commodities market, it appears that index traders (institutional investors) primarily hold long positions (buyers).   Several economists show that from a sheer size perspective the number of index traders tend to be small, however, “their average long positions is very large…sometimes more than 10 times the size of an average long positions held by either commercial or non-commercial traders. A direct consequence is that index traders can have strong financial power to influence prices. As a result, speculative bubbles may form and price changes can no longer be interpreted as reflecting fundamental supply and demand signals” (Mayer 2009).

A policy response to guard against excessive speculation is for the CFTC “to exercise its authority to ensure that the policy tools provided by Dodd-Frank are implemented in ways that protect the interests of ordinary people and small businesses throughout the United States (Pollin and Heintz 2011:5). Specifically, Section 737 of the Dodd Frank Act mandates that CFTC  institute position limits in order to “diminish, eliminate, or prevent excessive speculation.”  Thus, from the existing studies, reports and articles cited, it is clear that position limits are needed in the commodities market.[3]

As mentioned previously, we believe that the existing rules are reasonable and sound.  The proposed rule as written deviates from the intended purpose as instructed in the Dodd Frank Act. Although not a panacea to end all excessive speculation, position limits can be another tool in the tool box.

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[1] Pollin and Heintz (2011) and CME Group (2011)

[2] See our analyses in Appendix A.

[3] See Appendix B.