More Thoughts on Proposed Position Limits and Aggregation Rules

The CFTC proposed two rules intended to impose speculative position limits. The first proposed rule would impose position limits on 28 futures contracts and economically equivalent futures and swaps, and the second proposed rule would add amendments to the aggregation standards applicable to position limits. Both proposed rules provide for a 60-day comment period starting from the date of publication in the Federal Register.

Lofchie Comment: As we commented in yesterday’s news, the discussions at the CFTC’s open hearing on the position limits rules made clear that the CFTC has a very shaky basis on which to justify the imposition of the rules. CFTC Chairman Gensler, whom one would expect to be a vigorous advocate for position limits, conceded that only a third of the academic studies available to the CFTC seemed to support such limits (with another third being neutral and the last third concluding that such limits were affirmatively harmful). As we further noted, the CFTC failed to mention one of the most, if not the most, significant studies done by the CFTC on position limits. See Interim Report on Crude Oil of the Interagency Task Force on Commodity Markets. Here is the key language from the CFTC’s own report:

“The Task Force’s preliminary analysis also suggests that changes in the positions of swap dealers and noncommercial traders most often followed price changes. This result does not [emphasis supplied] support the hypothesis that the activity of these groups is driving prices higher. The Task Force has found that the activity of market participants often described as ‘speculators’ has not resulted in systematic changes in price over the last five and a half years. On the contrary, most speculative traders typically alter their positions following price changes, suggesting that they are responding to new information – just as one would expect in an efficiently operating market. In particular, the positions of hedge funds appear to have moved inversely with the preceding price changes, suggesting instead that their positions might have provided a buffer against volatility-inducing shocks.”

In short, the CFTC’s own study indicates that the imposition of limits on speculative traders will result in more volatile markets and, ultimately, be a negative for the economy.

The likely result of this is that the CFTC’s outgoing Commissioners may have left the incoming Chairperson and new Commissioners (whoever they might prove to be) in a difficult situation. Given the very ambivalent (at best) cost-benefit justification that the outgoing Commissioners are providing for the proposed rule (see the discussion at pages 51-56 of the attached “Position Limits for Derivatives” release linked below), it seems inevitable that any final rule based on this proposal will be challenged in court as having been inadequately justified. The new Chairman will then have a difficult decision to make: whether to (i) fight it out in court on the basis of the academic foundation summarized on pages 51-56 of the release or (ii) restart the process, this time, perhaps, with a more academic approach that can produce an analysis (whether in favor of position limits or opposed) that is sufficient to withstand at least “deferential” judicial scrutiny.

CFTC Proposed Rules: Aggregation of Positions; Position Limits for Derivatives.