December 8, 2011
Practice Groups:
CFTC Adopts Speculative Position Limits
on Physical Commodities
Derivatives and
Structured Products
By Lawrence B. Patent, Charles R. Mills, Gordon F. Peery
Investment
Management
I. Introduction
Hedge Funds and
Venture Funds
Broker-Dealer
Culminating a process that took almost two years to complete, the Commodity Futures Trading
Commission (“CFTC”), by a 3-2 vote on October 18, 2011, adopted regulations under the Dodd-Frank
Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) imposing so-called “hard” position
limits on a wide range of commodity interest contracts based upon underlying agricultural, metal and
energy products.1 On December 2, 2011, the International Swaps and Derivatives Association and the
Securities Industry and Financial Markets Association initiated a legal challenge to the CFTC’s
regulations by both filing a suit in the federal district court in the District of Columbia and filing a
petition for review of the regulations in the U.S. Court of Appeals for the District of Columbia Circuit.
They allege that the CFTC violated the Administrative Procedure Act by (1) concluding that DoddFrank required it to establish position limits without first determining whether they were necessary;
(2) failing to present a reasoned analysis or consider all evidence before adopting the regulations;
(3) failing to conduct an adequate cost-benefit analysis; and (4) conducting a flawed rulemaking
process that prevented commenters from meaningfully participating. They will seek guidance from
the courts regarding which court is the correct forum for their challenge.
The new regulations effectively cap the net speculative position (long or short) that a trader may
hold -- even on an intraday basis -- of each of 28 specified futures contracts, options on those futures
contracts, and economically equivalent swaps.2 The regulations refer to those 28 futures contracts as
“Core Referenced Futures Contracts.”3 Such contracts and their economically equivalent options on
futures and swaps will be referred to collectively as “Referenced Contracts.” Positions in Referenced
Contracts that meet the CFTC’s definition of bona fide hedges are exempt from the limits, provided a
trader files a notice with the CFTC to claim the exemption.
1
Section 737(a)(4) of Dodd-Frank added Sections 4a(a)(2) and (3) to the Commodity Exchange Act (“CEA”) to authorize
the CFTC to adopt position limits on “exempt” commodities (generally, energy and metals) and agricultural commodities.
2
A swap is deemed “economically equivalent” if it is: 1) a “look-alike” contract (i.e., it settles off of the Core Referenced
Futures Contract or contracts that are based on the same commodity for the same delivery location as the Core
Referenced Futures Contract); (2) a contract with a reference price based on only the combination of at least one
Referenced Contract price and one or more prices in the same or substantially the same commodity as that underlying the
relevant Core Referenced Futures Contract, provided that such a contract is not a locational basis swap; (3) an
intercommodity spread contract with two reference price components, one or both of which are based on Referenced
Contracts; or (4) priced at a fixed differential to a Core Referenced Futures Contract. For example, a swap settled to the
price of the New York Mercantile Exchange (“NYMEX”) Heating Oil Calendar Swap Futures Contract would be
economically equivalent because the floating price of the futures contract is equal to the monthly average settlement price
of the first nearby contract month for the NYMEX New York Harbor No. 2 Heating Oil Contract.
3
The CFTC has created a new Part 151 for these regulations. The CFTC selected the 28 futures contracts as Core
Referenced Futures Contracts because they (1) have high levels of open interest and significant notional value, or
(2) serve as a reference price for a significant number of cash market transactions. (See our Appendix, hereto.) Basis
contracts and commodity index contracts are not included in the definition of Referenced Contract, except Regulation
151.1 states in defining “commodity index contract” that “a commodity index contract used to circumvent speculative
position limits shall be considered to be a Referenced Contract for the purpose of applying the position limits.”
The CFTC did not set position limits for contracts on “excluded” commodities, which generally
include contracts on securities and financial instruments, rates and indices. The CFTC position limits
also do not apply to positions in exchange-traded funds on physical commodities.
In addition to the new hard limits, the CFTC also adopted new “visibility levels” for specified metals
and energy contracts. These levels do not trigger position limits, but reaching them will require
traders to report information about their positions to the CFTC.
As expected, the Commission vote split along party lines. Chairman Gensler and the other two
Democratic appointees -- Commissioner Chilton and outgoing Commissioner Dunn -- voted in favor
of the final regulation, while the two Republican appointees -- Commissioners Sommers and
O’Malia -- voted against the final regulations. Commissioner O’Malia had voted to publish the
proposals for comment in January, but at the time he had indicated that he was not necessarily
committed to their adoption.4
II. A Two-Phase Implementation
The position limits will be implemented in two phases. During the first phase, the futures exchanges’
current spot-month position limits will become the hard limits for those months.5 In addition, for each
of those agricultural commodities that are already subject to CFTC limits (so-called “legacy”
agricultural commodities), the final rules impose an identical limit for all months combined (including
the spot month) and for any single month other than the spot month. These “first phase” limits will
become effective sixty days after the CFTC adopts and makes effective its definition of the term
“swap.”6
In the second phase, the CFTC will determine limits for all months combined (including the spot
month) and for any single month (other than the spot month) for all commodities other than the legacy
agricultural commodities. Here again, each commodity’s all-months-combined and single month
limits will be identical. The initial limits will be established within a month after the CFTC obtains or
estimates 12 months of open interest for futures, options on futures and swaps, pursuant to the CFTC’s
recently adopted final regulations governing large trader reporting for physical commodity swaps.7
Following the completion of the second phase, limits will be adjusted biannually on staggered
intervals throughout the year and published on the CFTC’s website. The CFTC’s published limits
generally will adhere to the following formula: (1) for the spot month, 25% of deliverable supply, and
4
76 Fed. Reg. 4751 (January 26, 2011).
5
These limits are set forth in Appendix A to new Part 151 of the CFTC’s regulations.
6
The CFTC and the Securities and Exchange Commission have an ongoing rulemaking to further define the terms “swap”
and “security-based swap,” which also addresses such issues as the treatment of forward contracts and currency
products. 76 Fed. Reg. 29817 (May 23, 2011). The CFTC has recognized that these product definitions will impact the
other regulations related to swaps and thus has generally extended the compliance date for the regulation of swaps until
the end of 2011, and has recently proposed a further extension until July 16, 2012. 76 Fed. Reg. 42508 (July 14, 2011)
and 76 Fed. Reg. 65999 (October 25, 2011), respectively.
7
76 Fed. Reg. 43851 (July 22, 2011). During the second phase, the respective limits for spot-month contracts for both
physically settled and cash-settled contracts will be 25% of deliverable supply. The cash-settled contract limit set forth in
Regulation 151.4(a)(2) has been adopted as an “interim final rule,” with the CFTC accepting comments thereon through
January 17, 2012. The deliverable supply figure will be re-set biannually and will be based upon the greater of the
preceding 12-month or 24-month average, derived from exchange estimates and any CFTC revisions to them. However,
there is one exception to the general rule of parity for physically-settled and cash-settled contracts. The limit for cashsettled contracts on Henry Hub natural gas will be five times greater than the limit for physically-settled contracts, provided
that this higher cash-settled contract limit may not exceed the level of any single-month position limit, which will be set in
accordance with the formula described herein.
2
(2) for all-months-combined/any single month, (a) 10% of open interest up to the first 25,000
contracts, plus (b) 2.5% of the open interest above 25,000 contracts.8
III. The Non-Hedge Positions Subject to the Limits
A. New Definition of Bona Fide Hedging
The new position limits apply only to speculative positions, i.e., positions in futures, options on
futures, and swaps that do not qualify as bona fide hedges under the CEA’s and the CFTC’s
regulations. New CFTC Regulation 151.5 sets forth a new, narrower definition of bona fide hedging
to govern application of the new position limit regulations. Under this definition, bona fide hedging is
limited to (1) positions that represent a substitute for positions taken or to be taken at a later time in a
physical marketing channel, i.e., the cash market, and (2) positions entered into to mitigate the risk of
a swap if the swap was executed opposite a counterparty that itself entered into the swap as a bona
fide hedge. The latter qualification is referred to as a “pass through” swap because the qualification of
one party’s swap for bona fide hedging treatment will “pass through” to the counterparty when the
counterparty enters into another position to offset the risk of the swap.9 Thus, for example, if a swap
dealer enters into a swap with an energy producer and the energy producer’s use of the swap qualifies
as a bona fide hedge, the swap dealer may treat any position it enters into to hedge the risk of the swap
as a bona fide hedge position exempt from the application of the position limits.10
The CFTC’s pre-existing and broader definition of bona fide hedging in Regulation 1.3(z) will
continue to apply only to excluded commodities. Accordingly, that broader hedging definition will
still apply to such products as broad-based stock indices and interest rate instruments when used to
manage the risk of a securities portfolio or to adjust the duration of a fixed-income portfolio.
B. Portfolio Hedging
“Portfolio hedging” will continue to qualify as bona fide hedging under the new CFTC definition
described above. Portfolio hedging refers to positions that hedge the risk associated with several (or a
“portfolio” of) cash market transactions. Traders therefore will not be required to link each
commodity interest position to a discrete cash market transaction or position, as long as the aggregate
positions claimed to be bona fide hedges can be linked to the aggregate portfolio of cash market risks.
C. Exemptions From Position Limits Relating to Agents, Anticipatory Hedging,
Royalties, Service Contracts and Financial Distress
CFTC Regulation 151.5 enumerates certain types of positions that will qualify as bona fide hedges.
Four of these are the traditional hedges set forth in current regulations that involve ownership of
physical commodities, fixed-price commitments on them, unfixed price commitments on them for
8
“Open interest” is the total number of contracts that have been entered into and not yet liquidated by an offsetting
transaction or fulfilled by delivery.
9
The CFTC stated that, for the pass-through to apply, the direct counterparty must be able to claim a hedge exemption.
Therefore, a swap dealer could not claim this exemption by relying upon a series of transactions where the hedger was
not its direct counterparty on the swap, but was only a party to a transaction in the series linked to the swap.
10
In this example, the swap dealer may rely upon this exemption from position limits if the energy producer provides a
written representation that the swap qualifies in good faith as a bona fide hedge when executed. This representation must
be retained by the parties for at least two years following expiration of the swap and furnished to the CFTC upon request.
In addition, the energy producer must keep and make available to the CFTC upon request all relevant books and records
supporting its representation for the same length of time, i.e., at least two years following expiration of the swap.
3
different delivery months, and cross-commodity hedges for commodities closely correlated in terms of
market risk. The CFTC further expanded the list of enumerated transactions that will be deemed bona
fide hedges or otherwise exempt from the application of position limits. They include, subject to
conditions, positions entered into to hedge a merchandising agent’s risks, anticipated merchandising
activity, royalty payments (a type of asset), the hedging of service contracts, and circumstances where
a trader is in financial distress. We discuss each of these in turn below.
Agents
Regulation 151.5(a)(2)(iv) provides that positions entered into by an agent to hedge risks associated
with merchandising its principal’s commodities will qualify as bona fide hedges.
Anticipatory Hedging
The CFTC will recognize an anticipatory merchandising transaction as a bona fide hedge, provided
the following conditions are met: (1) the hedger owns dedicated capacity; (2) the hedge is only to the
extent of unfilled dedicated capacity; (3) the hedge is in the form of a calendar spread (and utilizing a
calendar spread is economically appropriate to manage the risks associated with anticipated
merchandising activity); and (4) no such position is maintained in any physical delivery referenced
contract during the last five days of trading of the Core Referenced Futures Contract for physical
delivery of agricultural or metal contracts or the spot month for other physical delivery contracts. The
anticipatory merchandising hedge exemption may extend for only one year forward for referenced
agricultural contracts.
The CFTC makes clear that an anticipatory hedge qualifies as such only as long as the trader is
reasonably certain that it will engage in the anticipated activity. Further, the CFTC has clarified that
the concept of “unfilled capacity” will include expected unfilled capacity over extended periods of
merchandising, such as the circumstances of a grain elevator being emptied and replenished during
harvest season, and thus this concept is not limited by the physical amount of unfilled storage capacity
at a given point in time.
Royalty Contracts
New Regulation 151.5(a)(2)(vi) treats the positions of owners of royalty rights arising out of the
production, manufacturing, processing, use or transportation of the commodity underlying a
Referenced Contract as bona fide anticipatory hedges to the extent they are “substantially related” to
anticipated royalty revenues. For the purpose of this section, a royalty right would include, among
other things, rights to receive volumetric production payments.
Service Contracts
Regulation 151.5(a)(2)(vii) provides that positions entered into by a party to a service contract will
qualify as a bona fide hedge only if the contract (1) arises out of the production, manufacturing,
processing, consumption or transportation of the commodity underlying the referenced futures or
futures-equivalent contract or “substantially similar commodities,” and (2) the hedge’s value is
“substantially related” to the anticipated payments or revenues from a contract for services. The
preamble to the new regulations notes that crop insurance providers and other agents that provide
services in a physical marketing channel could qualify for a bona fide hedge if their service contracts
arise out of the production of the commodity.
4
Financial Distress Exemption
In response to comments on the proposals, the CFTC has adopted what it refers to as the “financial
distress exemption.” This will be available in circumstances involving the potential default or
bankruptcy of a customer, affiliate or potential acquisition target of the person or persons requesting
the exemption. Such an exemption will become effective only if a person specifically requests it and
the CFTC issues an order granting it.
Obtaining CFTC Guidance on Other Types of Hedge Positions
The CFTC has revoked Regulation 1.47, which provided a means for traders to request bona fide
hedge treatment for specific transactions and positions other than those enumerated in the regulations.
The CFTC indicated, however, that traders seeking guidance regarding whether certain positions
involving agricultural and exempt commodities would qualify as bona fide hedges may (a) approach
the staff for guidance informally, (b) request relief pursuant to Regulation 140.99, or (c) petition the
CFTC for issuance of a specific order or for rulemaking to expand the list of qualifying hedges.
D. Filing Requirements -- Perfecting Hedge Exemptions and Form 404 and 404A
Disclosures
To perfect the enumerated bona fide hedge exemptions, a trader must file a notice with the CFTC
using Form 404 claiming the exemption within three business days after exceeding a position limit.
The exemption will become effective upon mailing. Form 404 must include data on cash market
positions and Referenced Contracts used to hedge those positions. Thereafter, these data must be
reported on Form 404 for each business day, but to lessen the reporting burden, the Form need only be
filed on a monthly basis.
For anticipatory hedges, the notice of a claim of exemption must be filed on Form 404A ten days in
advance of a date the trader expects to exceed the position limit, and the notice will be effective after
that ten-day period unless the CFTC otherwise notifies the trader. This notice must include
information concerning anticipated activities that would be appropriate to justify a bona fide hedge
classification. The CFTC may require the trader to submit such other information, before or after the
effective date of the notice, that the CFTC deems necessary to determine whether the positions fall
within the scope of bona fide hedges.
IV. Aggregation of Positions
A. General Rule
Speculative position limits apply to a single trader and to a group of affiliated traders. Positions held
by two or more traders acting pursuant to an express or implied agreement or understanding are
treated the same as if the positions were held by a single trader. A trader must aggregate all positions
in accounts in which the trader (1) directly or indirectly holds an ownership or equity interest of 10%
or greater, (2) controls trading, by power of attorney or otherwise, or (3) has any interest and such
accounts use “identical trading strategies” to those other owned or controlled accounts. Accordingly,
a trader must aggregate, for example, all of its positions in commodity interests held in any
commodity pools, separately-managed accounts, and passively-managed index funds in which the
trader has any interest (i.e., where the 10% threshold requirement for determining ownership interest
does not apply), to the extent that such pools or accounts use identical trading strategies to the
accounts the trader has a 10% ownership interest in or over which it has trading control.
5
B. Commodity Pools
The CFTC’s new regulations retain the current disaggregation exemption from position limits related
to interests in commodity pools. Accordingly, except for a pool’s commodity pool operator (“CPO”),
a participant in a commodity pool need not aggregate the commodity pool’s positions with the
participant’s own positions held outside the pool, as long as the participant does not control the
commodity pool’s trading decisions and the participant and the pool do not use identical trading
strategies. This is true also for a trader who is a principal or affiliate of a pool’s CPO, provided that
the trader does not control or supervise the commodity pool’s trading and the CPO has proper
informational barriers between the commodity pool’s trading and the trader. In addition, the current
rule that requires aggregation of a pool’s positions with the positions of a pool participant that has a
25% ownership interest in a pool will continue to apply to small pools (as defined in the regulations)
whose operators are exempt from CPO registration requirements.11
C. Independent Account Controllers
The CFTC did not adopt one of its more controversial proposals, which would have eliminated the
existing disaggregation exemption for accounts of the same entity that are independently controlled by
different persons, known as “independent account controllers” (“IACs”). Pursuant to the CFTC’s IAC
exemption provision, as retained, an “eligible entity,” which includes mutual funds, banks, CPOs,
commodity trading advisors (“CTAs”) and insurance companies, may disaggregate from its
proprietary positions those positions that are managed by an IAC if certain conditions are satisfied.
Those conditions are that an IAC must (1) trade independently of the eligible entity and of any other
IAC trading for the eligible entity, (2) have no knowledge of the trading decisions by any other IAC,
and (3) be registered as a futures commission merchant, introducing broker or CTA, or as an
associated person of any of the foregoing registrants, or be a general partner of a commodity pool
whose operator is exempt from CPO registration. Importantly, however, aggregation of the positions
of all IACs is required during the spot month in a physical-delivery Referenced Contract.
In determining whether the IAC “trades independently” of an entity, the CFTC will consider the
degree to which there is a functional separation (a) between the proprietary trading desk of the eligible
entity and the IAC’s trading operations and (b) between the research functions supporting an eligible
entity’s proprietary trading desk and those supporting the IAC’s trading decisions. An eligible entity’s
research information concerning fundamental demand and supply factors and other data may be made
available to an IAC. However, the trader would not retain IAC status if specific trading
recommendations of the eligible entity contained in such research information were substituted for a
trader’s independently-derived trading decisions. If the person who directs trading in an account of an
eligible entity regularly follows the trading suggestions disseminated by the eligible entity, such
trading activity will be evidence that the account is controlled by the eligible entity. A sufficient
informational “firewall” separating the trading and research functions is necessary to qualify for the
IAC exemption.
11
An exempt “small” commodity pool for these purposes is a pool that has (i) no more than 15 participants, and (ii) total
gross capital contributions that do not exceed $400,000. In addition, a CPO need not register as such under the CEA if
(i) it operates only one pool at a time, (ii) it receives no compensation, except reimbursement for ordinary administrative
expenses, (iii) there is no advertising of the pool, and (iv) it is not otherwise required to register, nor is it an affiliate of any
person required to register, under the CEA. CFTC Regulation 4.13 currently provides two additional CPO registration
exemptions not limited by the number of participants, amount of capital contributions or compensation to the CPO
(although subject to investor qualifications and, in one case, limits on the amount of commodity interest trading), so it is
unlikely that a single investor would own 25% of such pools. The CFTC has proposed to revoke these latter two
exemptions.
6
Additional requirements apply if the IAC is affiliated with the eligible entity or another IAC.12 In
these cases, each of the affiliated entities must take the following steps: (i) enforce written procedures
to preclude the affiliated entities from having knowledge of, gaining access to, or receiving data about,
trades of the other -- these procedures must include document routing and other procedures or security
arrangements, including separate physical locations, to maintain independence; (ii) trade such
accounts pursuant to separately developed and independent trading systems; (iii) market such trading
systems separately; and (iv) if CFTC regulations require them to use disclosure documents to solicit
funds for such trading, such solicitations must be made by using separate disclosure documents.
In addition, it is important to recognize that, under the CFTC’s IAC exemption, the IAC must
aggregate, like every other trader, all of the speculative positions in accounts in which it owns at least
10%, for which it controls trading, or in which it has any interest and which uses identical trading
strategies. Thus, when an IAC’s aggregate speculative position for all such accounts approaches or
reaches the limit, its ability to trade on behalf of existing or new clients will be correspondingly
constrained. For example, if a CPO engages an IAC to direct the trading of the pool, positions entered
in other third-party accounts managed by the IAC will be aggregated with those of the pool, and, if
they collectively trigger a position limit, that will restrict the size of any position the IAC might
establish for the CPO’s pool thereafter.
D. Affiliates
The CFTC’s general rule is that all accounts in which a trader directly or indirectly has a 10% or
greater ownership or equity interest must be aggregated. In order to mitigate the impact of the
aggregation requirements that apply to commonly-owned entities or accounts, however, the CFTC has
adopted two new provisions that were not previously proposed. First, Regulation 151.7(g) will allow
a person to disaggregate when ownership above the 10% threshold is associated with the underwriting
of securities. Second, Regulation 151.7(i) will provide for disaggregation relief, subject to notice
filing and an opinion of counsel, in instances where aggregation across commonly-owned affiliates
(above the 10% ownership threshold) would require sharing position information that could result in
the violation of federal law, such as restrictions imposed by bank regulators, the Federal Energy
Regulatory Commission, and the antitrust laws. The CFTC notes, however, when a trader has actual
knowledge of the positions of an affiliate, that trader is required to aggregate all such positions. This
implies that a trader relying on this provision must maintain information barriers between itself and
the affiliate.
E. Filings to Claim Exemption From Aggregation Requirements
To obtain an exemption from aggregation, a trader must file a notice with the CFTC within five
business days of the time the trader claims a disaggregation exemption, which notice is effective upon
submission. This differs from the existing self-effectuating exemption from aggregation requirements
and from the CFTC’s proposal, which would have required that the CFTC approve an application for
exemption and annual renewal. The notice required under the new regulations must include a
description of the relevant circumstances that warrant disaggregation as well as the trader’s
certification that it meets the relevant conditions for the exemption claimed. The CFTC may require a
trader to provide additional information concerning the claim for exemption.
12
The IAC is affiliated with an eligible entity or another IAC where one party directly or indirectly controls, is controlled by
or is under common control with the IAC, which would include parent, subsidiary and sister company relationships.
7
V. Class Limits
The CFTC decided not to adopt class limits (i.e., separate limits for different classes of transactions -swap, futures, options on futures). Accordingly, compliance with non-spot month position limits will
be determined in reference to a trader’s net speculative position with respect to a particular commodity
across its aggregate positions in Core Referenced Futures Contracts and economically equivalent
options on futures and swaps.
VI. Preexisting Positions
A. In General
Regulation 151.9 provides a limited exemption for preexisting positions that are in excess of the
position limits, provided that they were established in good faith prior to the effective date of a
position limit. Therefore, if a trader’s preexisting positions acquired in good faith exceeded the limit,
the trader would not be deemed to be in violation of the limit. Such a trader, however, would not be
allowed to enter into new, additional contracts in the same direction, but could enter into offsetting
positions and thus reduce its net position. If the trader’s preexisting position were below the limit, and
the trader adds contracts in the same direction after the limit becomes effective, the CFTC, for
purposes of determining position limit compliance, will combine the trader’s preexisting Core
Referenced Futures Contracts, and options on such futures, and the trader’s post-effective-date
contracts in such futures and options and economically equivalent swaps. Accordingly, a trader could
not violate position limits based upon preexisting positions alone, but preexisting futures and options
contracts that were below the limit would be included in the computation of the trader’s overall
position after the effective date of the limit.
The CFTC will also permit swap dealers to continue to rely on the exemption recognized in the now
repealed Regulation 1.47 for open swaps, so that swap dealers may continue to manage the risk of
their swap portfolio that exists at the time of implementation of the new limits, but new swaps would
need to comply with the new requirements for exemption to be excluded from the computation of the
swap dealer’s position under the new regulations.
B. Index Funds
For index funds that roll over their existing positions as a new delivery month approaches, any newlyestablished positions as a result of a rollover that occur after the effective date of a new position limit
will not qualify for the preexisting position limit exemption. Further, although several commenters
recommended that commodity index funds be generally exempted from position limits, the CFTC
stated that more analysis is needed before it would create a general exemption or adopt a separate
position limit regime for any group or class of traders such as commodity index funds. The CFTC
release invited the submission of additional studies in this area. As explained above, the CFTC’s
aggregation requirements for positions in managed accounts with identical trading strategies will
include positions in passively-managed index funds.
VII. Foreign Boards of Trade
Regulation 151.8 provides that the position limits also encompass a trader’s positions in referenced
contracts executed on, or pursuant to the rules of, a foreign board of trade (“FBOT”), subject to the
following conditions: (1) the contract, agreement, or transaction must settle against the price of a
contract executed or cleared pursuant to the rules of a U.S. exchange; and (2) the FBOT must make
8
such linked contracts available to its members or other participants located in the United States by
direct access to its electronic trading and order matching system.
VIII. Position Limits Set by Registered Entities
Regulation 151.11 requires each commodity exchange in the United States to establish hard position
limits for Referenced Contracts that are no higher than the CFTC position limits. For non-Referenced
Contracts, exchanges may adopt the CFTC’s general formula referred to above for establishing
position limits. Exchanges are also provided a safe harbor whereby they may adopt non-spot-month
limits of up to 1,000 contracts for tangible commodities other than energy products and up to 5,000
contracts for energy products and non-tangible commodities, including contracts on financial
products, provided that the notional quantity per contract is no larger than a typical cash market
transaction in the underlying commodity. Each exchange must apply the CFTC’s new account
aggregation standards and bona fide hedging definition with respect to exempt and agricultural
commodities.
As alternatives to the above-described limits for non-Referenced Contracts, the exchanges have
discretion to establish position accountability levels. For agricultural or exempt commodities that are
outside of the new Referenced Contract framework, U.S. exchanges have the discretion to establish
position accountability levels in lieu of position limits if: (1) average month-end open interest is
50,000 or more contracts; (2) average daily trading volume is 5,000 or more contracts; and (3) there is
a highly liquid cash market. Position accountability levels also may be established with respect to
excluded commodities if (a) the contract involves a major currency for which there is no legal
impediment to delivery and for which a highly liquid cash market exists, or (b) the excluded
commodity is an index or measure of inflation, or other macroeconomic index or measure, or meets
the definition of excluded commodity under CEA Sections 1a(19) (ii), (iii) or (iv).13 For all other
excluded commodities (interest rates, exchange rates, non-major currencies, broad-based security
indices, credit risks or measures, and debt or equity instruments), an exchange must present either a
position limit or an accountability level to the CFTC, which will determine if it meets the core
principles under the CEA. When position accountability levels are reached, exchange staff typically
contact traders to inquire about their trading and sometimes request that they reduce their positions,
but reaching these levels is not a violation of exchange rules or CFTC regulations.
As noted above, the definition of “bona fide hedging” applicable to positions in excluded commodities
will continue to be the definition in CFTC Regulation 1.3(z), except that exchanges may also continue
to provide exemptions for “risk-reducing” and “risk-management” transactions consistent with
existing CFTC guidance.14 The CFTC will continue to recognize prior exemptions granted by the
CFTC staff for positions that did not meet the definition of bona fide hedging in Regulation 1.3(z). In
addition, U.S. exchanges are authorized to grant exemptions for positions that do not meet the
definition of bona fide hedging exempt transactions, subject to Commission review.
13
These excluded commodities relate to indexes or measures of commodities with no cash market, that are based upon
prices, rates, values or levels beyond the control of any party to the contract, and so-called “event” contracts, respectively.
14
See Clarification of Certain Aspects of Hedging Definition, 52 Fed. Reg. 27195 (July 20, 1987); and Risk Management
Exemptions from Speculative Position Limits Approved under CFTC Regulation 1.61, 52 Fed. Reg. 34633 (September 14,
1987).
9
IX. Position Visibility Levels
The CFTC has established “position visibility levels” for Referenced Contracts on energy and metals,
which are calculated on the basis of a trader’s total position in such contracts in all months combined,
including bona fide hedge positions. Once a trader crosses a position visibility level, the trader must
file quarterly reports with the CFTC that disclose the trader’s physical and derivatives portfolio in that
commodity and substantially the same commodities as the Referenced Contract. The CFTC believes
that the position visibility levels will enhance its surveillance capabilities and permit it to better
understand the positions of the largest traders for referenced energy and metals contracts, as well as
better enable the CFTC to set and adjust subsequent position limits.
The position visibility levels will be approximately 50% of the position limit, with the exception of
crude oil and Henry Hub natural gas, where the levels have been set lower. The CFTC’s final
regulations require reporting of uncleared swaps only if visibility levels are reached in any single
month of those uncleared swaps (rather than requiring all related positions).
X. Conclusion
The CFTC’s new position limit regulations under Dodd-Frank will, when they take effect, impose
hard federal limits for many commodities where such limits have previously not existed, a narrower
definition of bona fide hedging for these limits, and new visibility levels and corresponding reporting
requirements. Some of the CFTC’s original proposals, such as separate specific “class” limits on
futures, options on futures, and swaps were not adopted, and the CFTC elected to retain the current
disaggregation exception for IACs.
The market impact of these new limits remains to be seen and may not be known for some period of
time. The limits on new positions in other than the spot month will not take effect until “Phase II,”
which will not begin before 2013. Traders should therefore utilize this transition period to review
their trading strategies and make any necessary adjustments to minimize the impact of the new
regulations.
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Appendix – Commodities Subject to Position Limits
The commodities subject to the position limit rules include:
 The nine agricultural products with existing limits -- corn, cotton, oats, soybeans, soybean meal,
soybean oil, and three wheat contracts that are traded in Chicago, Kansas City (hard winter wheat)
and Minneapolis (hard red spring wheat) (these are know as the “legacy” agricultural products);
 Ten additional agricultural products -- milk, feeder cattle, live cattle, lean hogs, rough rice, cocoa,
coffee, frozen concentrated orange juice, and two sugar contracts;
 Four energy products -- crude oil, gasoline, heating oil, and Henry Hub natural gas; and
 Five metals -- copper, gold, silver, palladium, and platinum.
The definition of “Referenced Contract” in final Rule 151.1 expressly excludes “commodity index
contracts… [which are indexes] comprised of prices of commodities that are not the same nor
substantially the same.” Thus, diversified commodity index positions are excluded from the position
limit regime. However, single commodity index contracts fall within the scope of the position limit
regime.
Authors:
Lawrence B. Patent
Charles R. Mills
Gordon F. Peery
lawrence.patent@klgates.com
+1.202.778.9219
charles.mills@klgates.com
+1.202.778.9096
gordon.peery@klgates.com
+1.949.623.3535
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