June 3, 2016 CFTC Supplements Position Limits Proposal The CFTC Supplements Its Position Limits Proposal by Revising the Proposed Definition of Bona Fide Hedging and Including a Provision that Would Permit Exchanges to Recognize Non-Enumerated Bona Fide Hedges and Other Exemptions SUMMARY On May 26, 2016, the U.S. Commodity Futures Trading Commission (the “CFTC”) released a supplemental notice of proposed rulemaking along with a proposed rule (the “Supplemental Proposal”) that would supplement and amend the proposed rule originally released by the CFTC in December 2013 (the “2013 Proposed Rule”) that would impose speculative position limits on positions held by traders in 28 physical commodity futures contracts, options and “economically equivalent” futures and swaps contracts. The Supplemental Proposal includes three key changes as compared to the 2013 Proposed Rule, each largely aimed at addressing concerns raised by commercial entities. First, the Supplemental Proposal would provide a new process allowing trading facilities, including designated contract markets (“DCMs”) and swap execution facilities (“SEFs”), to recognize certain positions in commodity derivative contracts as non-enumerated bona fide hedges or enumerated anticipatory bona fide hedges, as well as to exempt from federal position limits certain spread positions, in each case subject to CFTC review. Second, the Supplemental Proposal would amend certain definitions originally proposed in the 2013 Proposed Rule, notably including the definition of “bona fide hedging” for physical commodities. Lastly, the Supplemental Proposal would delay the requirement that DCMs and SEFs establish and monitor position limits on swaps where the DCM or SEF lacks access to sufficient swap position information. Comments on the Supplemental Proposal will be due 30 days after the Supplemental Proposal is published in the Federal Register. New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com BACKGROUND The CFTC’s proposed position limit rules generally include three components: (1) the level of the limits, which sets a threshold that restricts the number of speculative positions that a person may hold in the spot month, an individual month and all months combined, (2) exemptions from the limits for positions that constitute bona fide hedging positions and certain other types of transactions or positions, and (3) rules to determine which accounts and positions a person must aggregate for the purpose of determining compliance with the position limit levels.1 CEA section 4a(c) provides generally that federal position limits do not apply to positions that are shown to be “bona fide hedging positions.” CEA section 4a(c)(2), added to the CEA by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), directs the CFTC to narrow the scope of what constitutes a bona fide hedging position from the previous definition promulgated by the CFTC for the purposes of implementing the federal position limits on certain categories of physical commodity derivatives. The 2013 Proposed Rule2 sought to amend the CFTC’s existing pre-Dodd-Frank position limit rules (which only apply federal limits to certain futures and options contracts on nine enumerated agricultural commodities) by, among other things, adopting federal position limits applicable to positions in 28 exempt and agricultural commodity futures and option contracts and swaps that are “economically equivalent” to such contracts.3 Additionally, the 2013 Proposed Rule would require that DCMs and SEFs that are trading facilities (collectively, “Exchanges”) establish Exchange-set limits on such futures, options and swaps contracts. The 2013 Proposed Rule also would (i) revise the definition of bona fide hedging positions (including a general definition with requirements applicable to all hedges, as well as an enumerated list of bona fide hedges for which an exemption from position limits may be available), (ii) revise the process for market participants to request CFTC recognition of certain types of positions as bona fide hedges, including anticipatory hedges and hedges not specifically enumerated in the proposed bona fide hedging definition, and (iii) revise the exemptions from position limits for transactions normally known to the trade as spreads. 1 See generally 17 C.F.R. part 150, as proposed to be expanded and revised under the 2013 Proposed Rule and the Supplemental Proposal. 2 Recall that the 2013 Proposed Rule represented the CFTC’s second post-Dodd-Frank attempt at position limits rules following a successful court challenge to position limits rules that the CFTC had originally finalized in 2011. See Sullivan & Cromwell LLP, Court Vacates Position Limit Rules, October 1, 2012, https://www.sullcrom.com/siteFiles/Publications/SC-Publication-Court-Vacates- Position-Limit-Rules.pdf. 3 See Sullivan & Cromwell LLP, CFTC Proposes New Position Limits, November 18, 2013, https://www.sullcrom.com/siteFiles/Publications/SC_Publication_CFTC_Proposes_New_Position_Lim its.pdf. -2- CFTC Supplements Position Limits Proposal June 3, 2016 As noted above, the Supplemental Proposal would supplement and modify the 2013 Proposed Rule by delegating to DCMs and SEFs the authority to recognize certain exemptions from position limits, revising the proposed definition of bona fide hedging (and certain other definitions related to spread positons), and delaying the requirement that DCMs and SEFs establish and monitor position limits on swaps until such time as DCMs and SEFs have access to sufficient swap position information. THE SUPPLEMENTAL PROPOSAL A. DELEGATION TO EXCHANGES TO RECOGNIZE CERTAIN POSITIONS AS NON-ENUMERATED BONA FIDE HEDGES OR ENUMERATED ANTICIPATORY BONA FIDE HEDGES AND TO EXEMPT FROM FEDERAL POSITION LIMITS CERTAIN SPREAD POSITIONS The Supplemental Proposal proposes three sets of rules that would enable an Exchange to submit to the CFTC rules under which the Exchange could take action to (i) recognize certain non-enumerated bona fide hedging positions (“NEBFHs”);4 (ii) grant exemptions to position limits for certain spread positions;5 and (iii) recognize certain enumerated anticipatory bona fide hedging positions.6 Each of the proposed rules would establish a formal CFTC review process that would provide the CFTC with the ongoing authority to review all such actions by the Exchange. Notably, the Supplemental Proposal would therefore permit commercial end users to avail themselves of an Exchange’s NEBFH application process in lieu of requesting CFTC approval of an NEBFH, which would have required seeking a staff interpretive letter under section 140.99 of the CFTC’s regulations or seeking CEA section 4a(a)(7) exemptive relief. The proposed delegations to the Exchanges would be subject to significant CFTC oversight. Each of the three proposed processes requires that (i) an Exchange submit implementing rules subject to CFTC review, (ii) the Exchange’s standards for receiving the recognition of a bona fide hedge position or other exemption conform to the requirements under the statute,7 (iii) each Exchange’s actions under these processes be reviewed under the CFTC’s rule enforcement review program, and (iv) all Exchange actions under such implementing rules (including the recognition of any exemption) be subject to CFTC review. 4 See Supplemental Proposal at proposed section 150.9. 5 See Supplemental Proposal at proposed section 150.10. 6 See Supplemental Proposal at proposed section 150.11. 7 By way of example, the Notice of Supplemental Rulemaking notes that proposed section 150.9(a)(3) requires Exchanges that elect to process NEBFH applications to solicit information to allow it to determine why a derivative position satisfies the requirements of section 4a(c) of the CEA; proposed section 150.9(a)(4) requires Exchanges that elect to process NEBFH applications to determine whether a derivative position for which a complete application has been submitted satisfies the requirements of section 4a(c) of the CEA; and proposed section 150.10(a)(4)(vi) requires Exchanges that elect to process spread exemption applications to determine that exempting a spread position would further the purposes of CEA section 4a(a)(3)(B). -3- CFTC Supplements Position Limits Proposal June 3, 2016 1. Recognition of Certain Non-Enumerated Bona Fide Hedging Positions (“NEBFHs”) The Supplemental Proposal would permit Exchanges to recognize NEBFHs with respect to the proposed federal speculative position limits (see below for a summary of the proposed definition of “bona fide hedging definition,” as revised by the Supplemental Proposal, including the proposed list of enumerated “bona fide hedging positons”). Exchange recognition of a position as an NEBFH would allow the market participant to exceed the federal position limit, up to approved levels, to the extent that it relied upon the Exchange’s recognition unless and until such time that the CFTC notified the market participant to the contrary. The Supplemental Proposal would require market participants to report certain facts and circumstances attendant to a position to verify whether the position satisfies the requirements of the definition of a “bona fide hedging transaction or position” in the CEA.8 The Supplemental Proposal also proposes to require that all applicants submit detailed information to demonstrate why the position satisfies the requirements of the definition of bona fide hedging in the CEA and any other