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Wall Street Set for New Restrictions On Oil & Metals Trading

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EDITOR NOTE: Remember when oil did the unthinkable last year--go to negative prices, where it cost traders to sell their oil? Well, the CFTC is now imposing caps on how much traders and large funds can buy or sell at any given time. If the cap is too strict, the market can get illiquid; if too loose, the market can get severely volatile (as what happened in the oil market). The caps might also help prevent certain markets, like precious metals, from being too-easily manipulated. That’s the risk of paper markets. You can’t easily do this with physical assets.

Traders are about to be hit with new U.S. rules they’ve long resisted: the first-ever federal restrictions on how much hedge funds and other firms can speculate on key commodities such as oil and metals.

Yet there is a silver lining in having the regulations finished while appointees of President Donald Trump are running government agencies. The measures are softer than what was put forth when Barack Obama was president or what might be on the table should Joe Biden capture the White House next month.

The Commodity Futures Trading Commission will approve what are known as position limits at a Thursday meeting. Major aspects are little changed from what the CFTC -- led by Republican Chairman Heath Tarbert -- proposed in January, agency officials said during a Wednesday call with reporters. However, they said some adjustments were made to make it easier for businesses to use futures to hedge against commodity price fluctuations.

“Our position-limits rule has been a decade in the making,” Tarbert said during the call. He added that the new regulations would provide “clarity” for businesses and are meant to limit excessive speculation.

The rules will impose caps on the number of futures that traders can amass for more than a dozen highly-traded contracts. Still, in many cases the new limits are likely to be looser than the ones exchanges already have in place. Critics say that means some market participants may actually be permitted to expand their holdings.

Vexing Issue

At issue is a vexing and politically fraught question that has confounded derivatives regulators for a decade: how much speculation should be permitted in futures that energy companies, manufacturers and other businesses use to hedge against price changes in raw materials?

Read More: New Derivatives Position Limits Won’t Dampen Trading or Hedging

Allowing substantial bets by hedge funds and other traders can bring needed liquidity to the contracts. But too much speculation can cause spikes in volatility. CFTC officials have also said the rules are intended to crack down on manipulative strategies, such as instances of firms cornering the market or so-called squeezes in which a trader buys an abundance of contracts to try to burn those betting on price declines.

During the Obama era, a Democratic-led CFTC tried several times to strike a balance -- failing to finalize multiple plans and once having a rule blocked by a federal judge after two trade groups representing financial companies sued the regulator.

Compared with those earlier efforts, the agency’s new rules are more deferential to Wall Street and businesses that widely use commodities. Their approval will mark a major policy achievement for Tarbert, who has made it a priority to finish the regulations since he took over in July 2019.

The agency’s January proposal focused on 25 reference futures, including 16 new ones in energy, metals and agricultural products. The other nine contracts, which are tied to agriculture, already face federal restrictions.

Read More: Traders Win as U.S. Issues Softer Plan to Curb Oil Speculation

Under the final rules, traders in newly included energy and metals futures would only face limits on the soonest expiring contracts, which are known as spot months. The CFTC had proposed tying those restrictions to calculations based on 25% of the estimated physically deliverable supply for various commodities.

Deliverable Supply

Speaking Wednesday during a Webinar hosted by the Commodity Markets Council, Tarbert said the rules would use 25% of deliverable supply as “the rule of thumb” for limits on positions in the spot month.

However, Tarbert said the agency had worked with exchanges to settle on thresholds for most agriculture contracts that were well below that level -- ultimately setting them at between 6% and 16%. Non-spot limits for agricultural contracts will be based on open interest instead of deliverable supply, he said.

In the call with reporters, the CFTC said that the rules would also allow natural gas futures positions on different exchanges to be counted separately toward the limits. The agency added that caps for spot-month cotton contracts would be lower than proposed.

Non-financial firms will be eligible for an expanded list exemptions from the trading limits if they are using derivatives to hedge legitimate business risks, officials said. The rules will also set up a process for futures exchanges to approve additional exemptions without prior CFTC sign-off.

The CFTC’s approach has won the backing of key players in industry. The Managed Funds Association and the Alternative Investment Management Association, trade groups representing hedge funds, said in comment letters that focusing on spot months and deferring to exchanges at other times reflected a “thoughtful approach.” Agricultural giant Cargill Inc., Ken Griffin’s Citadel and units of Royal Dutch Shell Plc were also generally supportive.

Oil Crash

A topic that the rules won’t specifically address is oil’s unprecedented April 20 crash that led to contracts trading at negative prices. The CFTC is among regulators investigating whether a small group of London market participants may have contributed to the tumble by breaching rules on trading around settlement periods, Bloomberg News has reported.

When asked why the oil plunge wasn’t dealt with, CFTC officials said Wednesday that the agency is still working on its analysis of trading that day.

Tarbert said the CFTC plans to release those findings in the next few months and that he didn’t want to hold up the new rules. He said the agency would be open to making additional regulatory changes if warranted.

Originally posted on Bloomberg

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