U.S. regulator revives plan to limit excessive commodity bets

Reuters

By Douwe Miedema

WASHINGTON, Nov 5 (Reuters) - The U.S. derivatives regulatoron Tuesday reintroduced a plan to curb commodity marketspeculation, reviving a crucial Wall Street reform after a judgeknocked down an earlier version of its rules on position limits.

The Commodity Futures Trading Commission proposal will setcaps on the number of contracts that a single trader can hold inenergy, metal and agricultural markets, a measure aimed atcapping speculation that some blamed for the spike in rawmaterial and food prices prior to the 2008 financial crisis.

The redrafted rules sought to answer some of the deficitsthat a judge pointed out last year. The agency cited two of thebiggest cases of market manipulation in history - the HuntBrothers' silver corner and hedge fund Amaranth natural gas bet- as evidence of why curbs were necessary.

The new rules will also make it easier for big banks such asGoldman Sachs Group Inc and Barclays PLC toremain in the market by allowing them to exclude positions heldby entities in which the banks own minority stakes - a keytrigger for the banks to sue the agency.

They may now ignore positions held by affiliates in whichthey own up to 50 percent of the shares but do not control - farabove the 10 percent in an earlier rule - or in affiliates inwhich they own more than 50 percent but which are notconsolidated.

"The ... restriction that was in before was very excessiveand that was a sensible adjustment," said Craig Pirrong, afinance professor at the University of Houston who has beencritical of efforts to set limits on positions.

The rules have been one of the most hotly debated aspects ofthe 2010 Dodd-Frank law and is re-emerging as some of thelargest global banks face political pressure to reduce theircontrol over commodities markets.

Still, the plan could prove to be far less rigorous thanfeared by markets, data provided by the world's largest futuresexchange the CME Group Inc showed.

The maximum position traders would be allowed to hold couldin some cases dramatically rise rather than become tighter, thenumbers showed, in one specific contract almost 10 times as muchas is currently the case.

Reuters had first reported the main changes in the CFTC'snewly drafted rule.

Also at the meeting, Democrat Commissioner Bart Chiltonannounced he would soon leave the agency, creating a possiblepower vacuum if no successor is found soon for Chairman GaryGensler, who also leaves this year.

With his shoulder-long peroxide blond hair, and hisubiquitous references to pop culture in speeches, Chilton is astriking figure amongst financial regulators - as well as astrong proponent of position limits.

EXPANDED LIMITS

Position limits have long been used in agricultural marketsto curb speculation, but Congress gave the CFTC far greaterpowers to impose them after the crisis. The agency will nowextend the practice to oil, gas and metals markets.

The calculation method the CFTC uses remains similar:traders may hold futures and swaps amounting to 25 percent ofthe estimated deliverable supply of the underlying commodity inthe spot-month contract.

The estimates will be provided by CME and revised regularly,the CFTC said.

The financial industry's fight to fend off new limits may belosing some of its vigor as large pension funds and otherinstitutional investors - which plowed more than $400 billioninto raw material markets over the past decade - show signs ofcooling interest in the asset class.

The limits were partly a response to the 2008 surge in oiland grain prices, which some blamed on the influx of newcapital. But with investor appetite waning, traders are lesslikely to breach the new limits.

The rule also provides a better legal argument to underscorewhy the CFTC thinks Congress has mandated it to implement theposition limits, something that the U.S. district court had saidwas ambiguous.

On top of that, the agency also provided a finding of whyposition limits were necessary to curb speculation - somethingthe court had not specifically asked for but that it said it wasdoing anyway to be on the safe side.

Staff at the agency had found that they were necessary bylooking at the manipulation of the silver market by the HuntBrothers in 1979 and the cornering of the natural gas market byhedge fund Amaranth in the 2000s.

IRKING MERCHANTS

While the redrafted rule eases a major irritant for bigbanks by lowering the thresholds for aggregating positions, itthreatens to create a new rift with commodity merchants such asCargill Inc looking to hedge certain transactions.

"The CFTC's new proposal will likely be at least ascontroversial as the last. Commercial users will likely havedifficulties with the narrowed definition of hedging," said aformer CFTC staffer who worked on the rule.

The text of the rule proposal changes details of what canlegally be defined as hedging, an activity that is exempted fromposition limits under the Dodd-Frank law. It kept certainexemptions, but removed others.

Commercial commodity traders would no longer be allowed totake derivative positions in anticipation of having to pay rentfor storage facilities that were in fact empty and were notactually needed, CFTC staff said at the meeting.

Staff had found no evidence that rents were related tomarket prices, and had therefore proposed not to exempt thistype of anticipatory hedging. But others forms will still beallowed, the CFTC staffers said.

The new rule also reintroduced so-called conditional limits,which allow traders to hold five times the limit in cash-settledcontracts, provided that they do not hold a single position inphysical-settled contracts.

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