Whether or not you favor the financial-reform legislation signed into law last summer, keep in mind it instructs the Commodity Futures Trading Commission (CFTC) to set position limits on physical and agricultural commodities. The proposed rule from CFTC is due out in January.
Judging by a speech CFTC Chairman Bart Chilton made recently to the National Supply Summit in Las Vegas, CFTC is aware of the potential unintended consequences that go with such limits, as well as the need for common sense enabling end users to retain a viable risk management tool.
As for the need, Chilton explains, “Despite what some people say, the U.S. futures markets aren’t gambling marts—they are intended to be used for risk management and price discovery. Yes, speculators play an important part in these markets—they provide necessary liquidity. But when they begin to 'play with the house’s money'—that is, when they are more than just liquidity providers, when they are a new, large, potent force in the markets, making money from the markets without providing inputs that go to the core functions of the markets—then that raises some serious red flags.
“That’s what we saw in 2008. When supplies of crude were at record highs, and demand was at a record low, prices skyrocketed. I asked myself, what’s going on? Part of the answer was the increase in 'massive passives,' new speculators who were playing with the house’s money, getting in the markets and staying there, rolling from one delivery month to the next, insensitive to price. And they had an effect on prices. To what degree we can’t say, but—in hindsight—we can surely say they had an effect.”
Chilton explains that when the commodities laws were written decades ago, “they didn’t contemplate this kind of tectonic plate shift—mammoth changes in asset class participants and strategies—in the use of the futures markets. They didn’t contemplate computers talking to computers, and sweeping up thousands of micro dollar profits in nanosecond trades. They didn’t contemplate the incredibly innovative and creative ways these markets would develop and flourish, and the accompanying challenges we face to ensure that the fundamental purposes of the markets—risk management and price discovery—remain paramount.”
Likewise, Chilton explains financial reform legislation requires an end-user exemption so that risk management via futures markets does not cost more to commercial traders.
“Congress did not have the intent of punishing end users when they passed the bill. And, if there was any question, it was answered by Senators Dodd and Lincoln in a letter they sent to colleagues while the bill was in conference,” Chilton says. “They also instructed us at CFTC and the Securities Exchange Commission not to impose rules that would make hedging costlier. Our goal is not to impose margin on hedgers or to regulate end users as swap dealers or major swap participants. They can take advantage of the end-user exemption from the Act’s mandatory clearing requirement. Whether swaps are used by Nebraska farmers or by major airlines trying to protect themselves from potentially higher fuel costs, they will not face higher costs for their legitimate hedge activities.”
To learn more, see www.cftc.gov/PressRoom/