On October 18 the Commodity Futures Trading Commission (CFTC) will vote on a proposed rule to limit the percentage of contracts in a given commodity that any individual trader can own. The rule, mandated by the Dodd-Frank financial reform bill, could potentially be very important: If a trader or bank is allowed to own too high a share of any given market, financial reform advocates argue, that entity can control the price of the market for its own purposes; or, even if there is no manipulation, market prices may simply rocket higher, untethered to any real-world conception of supply and demand. Indeed, in the past few years, allegations of speculation and market manipulation have been thrown at grain markets, oil markets, and even commodities like silver and cocoa.
But if the logic behind regulating the size of traders’ positions in a given market is sound, the process of bringing the necessary rules into existence has proven difficult, to say the least. The partisan nature of the CFTC and the active lobbying campaigns to influence the rule-making process are making it uncertain if the rule will pass the committee and, if so, whether the final version will be strong enough to live up to Dodd-Frank’s original intent.
Proponents of tight position limits argue that excessive speculation in a market means prices will generally be both higher and more volatile. The consequences of higher prices are easy to understand—for example, a Goldman Sachs report in April estimated that the speculative premium on a barrel of oil was then between $21.40 and $26.75 a barrel, roughly a sixth of the total price at that time. As Marcus Stanley of Americans for Financial Reform told me, all sorts of people rely on predictable commodity markets for their business: gas stations, businesses that supply heating oil, enterprises that order food in bulk such as confectioners, and so on. Higher volatility often ends up being passed on to businesses as a higher cost on their balance sheet, with predictable consequences.
The rule has no chance of going into effect, however, unless it garners enough votes. At present, the CFTC is divided along partisan lines, with two presumed votes for the rule (Chairman Gary Gensler, appointed by Obama, and Bart Chilton, appointed by Bush and reappointed by Obama) and two votes against (Jill Sommers and Scott O’Malia, both former Republican Congressional aides). Meanwhile, Commissioner Michael Dunn, the swing vote who was appointed and re-appointed by Bush, appears to be leaning towards voting no, arguing the CFTC hasn’t performed the proper cost-benefit analysis to back up the rule. An appeals court recently struck down an SEC rule on the basis that it lacked a cost-benefit analysis, which has led the opposed commissioners to argue that all of Dodd-Frank’s proposed rules need such an analysis to be legally valid.
Such sentiments from the commissioners are causing financial reform advocates to fear that the situation is grim. “I am absolutely worried,” Michael Greenberger, professor of law at the University of Maryland and formerly of the CFTC, said in a phone interview about the rule’s prospects. Privately, an aide to Senator Bernie Sanders told me that he shares Greenberger’s worries.
Moreover, even if the rule passes, it faces serious questions about whether a very active lobbying process will have rendered it effectively meaningless. The position-limits rule, in particular, has been subjected to a fierce lobbying effort, especially by big financial institutions. The Sunlight Foundation, a nonprofit organization that advocates for transparency in government, counted over 13,000 comment letters to the CFTC concerning the rule, with groups from airlines to investors pressing their case. Gary Gensler, the chair of the CFTC, has stated that “large institutions” have an “outsized interest” in the rules and that there’s a “little imbalance” in how much access they’ve gotten to the commission. Gensler has estimated the CFTC has held 1,000 meetings to hear comments relating to the rule, and that the “vast majority are from large financial institutions.”
Given all this interest, it’s no surprise that advocates for strong position limits are worried about whether the resulting rule will be tight enough to weed out the kinds of abuse it was intended to curb. The first worry is that the position limits the commissioners have set are simply too high to curb speculation. In its current form, the rule distinguishes between two types of contract ownership—“spot-month” (the number of contracts an entity can own in any given month), which has a limit of 25 percent of the market, and “all months combined” (the number of contracts an entity can own over all months in a single year), which limits investors to 10 percent of the first 25,000 contracts and then 2.5 percent of the remainder. Silver analyst Ted Butler told me by e-mail that the “all months combined limit” allows an interested investor in the silver market to acquire a total number of contracts that exceeds the total yearly amount of silver consumption. In oil markets, the same aide to Sanders described the proposed limits to me as too high.
Then there’s the worry that the rule might not apply to the types of investors it is trying to regulate. Professor Greenberger told me—and also wrote in a comment letter to the CFTC—that the rule has a number of loopholes that will exempt a large portion of speculative trading. Greenberger wrote that “the Commission has adopted some of the biggest swap dealers’ and future exchanges’ arguments” by allowing hedging exemptions to cover all sorts of trades. In other words, there is a good chance the CFTC will allow overly broad exemptions for what is called “netting,” which would allow traders to claim that speculative trades are in fact simply intended to hedge and reduce risk for a client.
It’s not at all clear, therefore, that the position limits rule will have much of an effect. No wonder Brian Hurst, a principal of the hedge fund AQR Capital Management, told The Economist, “My guess is that when the actual rules are in place, it’s going to be underwhelming.” In addition, a report from Keefe, Bruyette & Woods, a small investment bank, estimated a decline in total trading volume in commodity markets of somewhere between 5 percent and 12 percent, and that’s before any exemptions are counted. After exemptions, they predict a decline in trades of less than 5 percent. Perhaps the lobbyists have won this round.
Darius Tahir is an intern at The New Republic.