From inception to today: the development of commodity position limits in the United States Deanna R. Reitman and Sarah Nabors Contents Introduction ___________________________________________________________________ 1 Legislative History of Commodity Position Limits ______________________________________ 1 Introduction ______________________________________________________________________ 1 Food Control Act of 1917 ____________________________________________________________ 2 Future Trading Act of 1921___________________________________________________________ 2 Grain Futures Act of 1922 ___________________________________________________________ 3 Congressional Debates and Studies, 1920s and 1930s _____________________________________ 3 Commodity Exchange Act of 1936 _____________________________________________________ 4 Implementation of CEA _____________________________________________________________ 6 1968 Amendments _________________________________________________________________ 7 1974 Amendments _________________________________________________________________ 7 Exchange-Set Limits _______________________________________________________________ 8 Position Accountability ______________________________________________________________ 9 Commodity Futures Modernization Act of 2000 (CFMA) ___________________________________ 10 CFTC Reauthorization Act of 2008 ___________________________________________________ 11 Legislative History of the Bona Fide Hedge Exemption ____________________________________ 11 Introduction _________________________________________________________________ 11 Legislative and Regulatory Developments: 1956-1974 ________________________________ 11 Futures Trading Act of 1986 ____________________________________________________ 12 Application of Bona Fide Hedge Exemption to Risk Management Activities ________________ 13 Dodd-Frank __________________________________________________________________ 14 CFTC Proposed Amendments to Speculative Position Limits – January 2011 __________________ 15 Introduction _________________________________________________________________ 15 Definitions __________________________________________________________________ 15 Position Limits _______________________________________________________________ 16 Aggregation of Accounts _______________________________________________________ 17 Recordkeeping and Reporting ___________________________________________________ 18 CFTC Proposed Amendments to Bona Fide Hedging Exemption – January 2011 _______________ 18 CFTC Final Position Limit Rules – October 2011 _________________________________________ 19 Referenced Contracts Under the Final Rule ________________________________________ 19 Spot Month Limits Under the Final Rule ___________________________________________ 20 Non-Spot Month Limits Under the Final Rule _______________________________________ 21 CFTC Final Bona Fide Hedging Rules – October 2011 ____________________________________ 22 Anticipatory Hedges ___________________________________________________________ 22 Form 404, Form 404A and Form 404S ____________________________________________ 23 Aggregation _________________________________________________________________ 24 CFTC Position Limit Rules Vacated by DC District Court _______________________________ 25 Introduction _____________________________________________________________________ 25 Factual Basis for the Claim _________________________________________________________ 25 The Claims ______________________________________________________________________ 27 Court Analysis ___________________________________________________________________ 28 Court Findings ___________________________________________________________________ 29 Vacated Final Rule ________________________________________________________________ 32 CFTC Second Proposed Position Limit Rules – December 2013 _________________________ 32 Introduction _____________________________________________________________________ 32 Necessity _______________________________________________________________________ 32 Definitions ______________________________________________________________________ 33 Position Limits ___________________________________________________________________ 35 CFTC Proposed Amendments to Bona Fide Hedging Exemption – December 2013 _________ 37 CFTC Third Proposed Position Limit Rules – December 2016 ___________________________ 39 From inception to today: the development of commodity position limits in the United States DLA Piper 2016 Supplemental Position Limit Proposal _____________________________________________ 39 Compliance Date _________________________________________________________________ 40 Definitions ______________________________________________________________________ 40 Position Limits ___________________________________________________________________ 41 CFTC Proposed Amendments to Bona Fide Hedging Exemption – December 2016 _________ 43 Current State of the Position Limit Rules ___________________________________________ 46 About Us ____________________________________________________________________ 48 From inception to today: the development of commodity position limits in the United States DLA Piper Introduction In general, a commodity position limit is the limit placed upon the number of commodity future contracts, swap positions and their equivalents that can be held by one market participant at a particular period of time. In the first part of this paper, we explore the legislative history of the commodity position limit rules and the bona fide hedge exemption. In the second part, we explore the Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank)1 proposals and re-proposals of commodity position limit rules, concluding with an outline of the current commodity position limit rules and including the current bona fide hedging exemption. In the last part, we explore the current state of the position limit rules, including the bona fide hedge exemption, and its impact on market participants. Legislative History of Commodity Position Limits Introduction Since 1936, the Commodity Exchange Act (CEA) provides that “excessive speculation” in any commodity traded on a futures exchange “causing sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity is an undue and unnecessary burden on interstate commerce” and, therefore, the Commodity Futures Trading Commission (CFTC) is empowered to establish such limits on trading “as the [CFTC] finds are necessary to diminish, eliminate, or prevent such burden.”2 This basic concept of the necessity for a federal agency to set position limits ultimately has remained unchanged since the 1936 enactment of the CEA. However, due to the increase in the number of commodities traded on regulated futures exchanges and other changes in the commodity markets, the manner in which position limits are implemented has varied.3 Additionally, since 1936, the CEA has also exempted “bona fide hedging transactions” from any position limits established under the CEA.4 Initially, the CEA defined a “bona fide hedging transaction” as a transaction related to a transaction in the cash market for the commodity.5Since 1974, however, the CEA has provided the CFTC with discretion to define the term, provided that the CFTC’s definition enables producers, middlemen, and users of a commodity to hedge their legitimate anticipated business needs.6 1 Pub. L. 111-203, 124 Stat. 1376 (2010). 2 7 U.S.C § 6(a) (2010). 3 See 17 C.F.R. §150.5 (2009) by which the CFTC directly fixes the position limits for certain commodities; specifies acceptable practices for the exchanges to establish position limits for other commodities; and also allows the exchanges to use “position accountability levels” rather than fixed position limits in months other than the spot month for commodities that meet certain liquidity requirements. 4 CFTC Regulation 1.3(z), 17 C.F.R. § 1.3(z) (2018). 5 Dan M. Berkovitz, General Counsel of the Commodity Futures Trading Comm’n, Testimony: Position Limits and the Hedge Exemption, Brief Legislative History (Jul. 28, 2009) (transcript available at www.cftc.gov). 6 Id. From inception to today: the development of commodity position limits in the United States DLA Piper 1 Ever since the collapse of grain prices following the end of the First Word War, the US government has discussed the need for commodity position limits. To truly understand the 1936 CEA imposition of commodity position limits, it is important to understand this discussion.7 Food Control Act of 1917 The first exercise of US federal authority to limit trading in the commodity futures markets occurred when the Congress enacted emergency legislation to stabilize the US grain markets during the First World War. Under the Food Control Act of 1917 the trading of wheat futures was suspended and the US Food Administration8 “secur[ed] a voluntary limitation” of 500,000 bushels on the trading of futures contracts for corn.9 Future Trading Act of 1921 After the First World War, many farmers blamed speculators for the continued depression in grain prices. Many of these farmers sought the re-imposition of limits on futures trading. On the contrary, grain merchants, grain exchanges and others in the grain industry believe that any regulation of the futures markets, including the setting of position limits, would unnecessarily harm the market. A number of bills were introduced in the Congress to regulate the grain markets,