In a split vote along party lines, the three Democratic members voted to impose new limits on speculation in the commodity markets, approving the rule over their two Republican colleagues.
Despite this decision, many industry analysts are still unsure about how it will be assessed through the lens of history. Some believe the question remains as to whether position limits were necessary in the first place, whether they will actually address the problem they are intended to address and whether, now that they are set to be put in place, the details under which they will be implemented, will make them ineffectual.
Industry group spokesman, John Damgard, president of the Futures Industry Association, was quick to put out a statement disagreeing with the decision. CFTC Commission Michael Dunn likened position limits as a cure for a disease that does not exist.
Walter Zimmerman, a market analyst for ICAP-United, told FOW that while he agrees there is no solid evidence that position limits can curb excessive price manipulation or price rises, the industry calling foul on this issue is a lot of hot air.
“In over twenty years of being in the commodities business, I can’t imagine why any trader out there would ever want 25% of deliverable supply of one contract. It seems the limit has been set so high, to be calling it an actual limit, seems ludicrous. While at the same time, they have expanded the definition of a bonafide hedger,” said Zimmerman.
Covered in the ruling are 28 commodities, including nine agricultural commodities which already had position limits in place, plus, added to this list were a further ten agricultural contracts, four energy contracts and five metals contracts. On these commodities, the new rule enforces spot-month and non-spot month position limits on futures and swaps.
In the case of spot month position limits, traders will be prohibited from acquiring more than 25% of derivatives contracts - a ruling not likely to come into play until mid-April 2012 at the earliest.
This is because the CFTC must first finalise the definition of a swap, which is not expected to be completed until at least early 2012, and then wait a further 60-days before implementing spot month position limits.
Non-spot position limits have been set using the 10/2.5% formula, meaning a single trader can hold 10% of a contract’s initial 25,000 of open interest, and 2.5% thereafter. This rule will be made effective for some legacy contracts at the same time as the rule for spot month position limits, however, new contracts covered by position limits will not be impacted for at least another year.
The introduction of position limits has been one of the most contentious rule-makings emanating from the Dodd Frank Act, the CFTC received some 15,000 comments on position limits prior to the vote.
Reacting to the ruling, Scott O’Malia, a Republic commissioner, said he was disappointed by the result: “Unfortunately, in its exuberance and attempt to justify doing so, the commission has overreached.”
Already, rumours are swirling that legal challenges will emerge, particularly in the conservative DC Circuit Court. Challenges are expected to centre around whether the CFTC, and by extension Congress, has the authority to impose position limits without showing hardcore evidence that speculation has been the certain cause of wild fluctuations in commodity prices, thereby inflating prices for consumers.
Talk of a legal challenge has grown louder over summer, due to a separate Dodd-Frank rule that was struck down due to an insufficient cost-benefit analysis. O’Malia has already questioned the cost benefit analysis surrounding position limits, suggesting it is “vulnerable to legal challenge”. CFTC Chairman, Gary Gensler, however, praised the ruling saying it was a good step towards reining in speculative commodities trading.
All of this, however, is a mute point, according to Zimmerman at ICAP-United. “The fact is that the issue of position limits is all smoke and mirrors. The real reason commodity prices are driven higher is because of a weaker US Dollar.
“The real solution is better policies out of Washington DC, but that is a much tougher nut to crack than simply setting position limits,” he says. Policies that lead to higher interest rates, will lead investors back into bond investments and away from playing the markets, Zimmerman believes.