Position Limits for Derivatives, 11596-11744 [2020-02320]

Download as PDF 11596 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules COMMODITY FUTURES TRADING COMMISSION 17 CFR Parts 1, 15, 17, 19, 40, 140, 150, and 151 RIN 3038–AD99 Position Limits for Derivatives Commodity Futures Trading Commission. ACTION: Proposed rule. AGENCY: The Commodity Futures Trading Commission (‘‘Commission’’ or ‘‘CFTC’’) is proposing amendments to regulations concerning speculative position limits to conform to the Wall Street Transparency and Accountability Act of 2010 (‘‘Dodd-Frank Act’’) amendments to the Commodity Exchange Act (‘‘CEA’’ or ‘‘Act’’). Among other amendments, the Commission proposes new and amended federal spot month limits for 25 physical commodity derivatives; amended single month and all-months-combined limits for most of the agricultural contracts currently subject to federal limits; new and amended definitions for use throughout the position limits regulations, including a revised definition of ‘‘bona fide hedging transactions or positions’’ and a new definition of ‘‘economically equivalent swaps’’; amended rules governing exchange-set limit levels and grants of exemptions therefrom; a new streamlined process for bona fide hedging recognitions for purposes of federal limits; new enumerated hedges; and amendments to certain regulatory provisions that would eliminate Form 204, enabling the Commission to leverage cash-market reporting submitted directly to the exchanges. DATES: Comments must be received on or before April 29, 2020. ADDRESSES: You may submit comments, identified by ‘‘Position Limits for Derivatives’’ and RIN 3038–AD99, by any of the following methods: • CFTC Comments Portal: https:// comments.cftc.gov. Select the ‘‘Submit Comments’’ link for this rulemaking and follow the instructions on the Public Comment Form. • Mail: Send to Christopher Kirkpatrick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581. • Hand Delivery/Courier: Follow the same instructions as for Mail, above. Please submit your comments using only one of these methods. To avoid possible delays with mail or in-person deliveries, submissions through the CFTC Comments Portal are encouraged. lotter on DSKBCFDHB2PROD with PROPOSALS3 SUMMARY: VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 All comments must be submitted in English, or if not, be accompanied by an English translation. Comments will be posted as received to https:// comments.cftc.gov. You should submit only information that you wish to make available publicly. If you wish the Commission to consider information that you believe is exempt from disclosure under the Freedom of Information Act (‘‘FOIA’’), a petition for confidential treatment of the exempt information may be submitted according to the procedures established in § 145.9 of the Commission’s regulations.1 The Commission reserves the right, but shall have no obligation, to review, pre-screen, filter, redact, refuse, or remove any or all submissions from https://www.comments.cftc.gov that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the rulemaking will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under FOIA. FOR FURTHER INFORMATION CONTACT: Aaron Brodsky, Senior Special Counsel, (202) 418–5349, abrodsky@cftc.gov; Steven Benton, Industry Economist, (202) 418–5617, sbenton@cftc.gov; Jeanette Curtis, Special Counsel, (202) 418–5669, jcurtis@cftc.gov; Steven Haidar, Special Counsel, (202) 418– 5611, shaidar@cftc.gov; Harold Hild, Policy Advisor, 202–418–5376, hhild@ cftc.gov; or Lillian Cardona, Special Counsel, (202) 418–5012, lcardona@ cftc.gov; Division of Market Oversight, in each case at the Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581. SUPPLEMENTARY INFORMATION: Table of Contents PO 00000 CFR 145.9. Frm 00002 Fmt 4701 I. Background A. Introduction The Commission has long established and enforced speculative position limits for futures and options on futures contracts on various agricultural commodities as authorized by the CEA.2 The existing part 150 position limits regulations 3 include three components: (1) The level of the limits, which currently apply to nine agricultural commodity derivatives contracts and set a maximum that restricts the number of speculative positions that a person may hold in the spot month, individual month, and all-months-combined; 4 (2) exemptions for positions that constitute bona fide hedges and for certain other types of transactions; 5 and (3) regulations to determine which accounts and positions a person must aggregate for the purpose of determining compliance with the position limit levels.6 The existing federal speculative position limits function in parallel to exchange-set limits required by 27 I. Background A. Introduction B. Executive Summary C. Summary of Proposed Amendments D. The Commission Preliminarily Construes CEA Section 4a(a) To Require the Commission To Make a Necessity Finding Before Establishing Position Limits for Physical Commodities Other Than Excluded Commodities II. Proposed Rules A. § 150.1—Definitions B. § 150.2—Federal Limit Levels C. § 150.3—Exemptions From Federal Position Limits D. § 150.5—Exchange-Set Position Limits and Exemptions Therefrom E. § 150.6—Scope 1 17 F. § 150.8—Severability G. § 150.9—Process for Recognizing NonEnumerated Bona Fide Hedging Transactions or Positions With Respect to Federal Speculative Position Limits H. Part 19 and Related Provisions— Reporting of Cash-Market Positions I. Removal of Part 151 III. Legal Matters A. Introduction B. Key Statutory Provisions C. Ambiguity of Section 4a With Respect to Necessity Finding D. Resolution of Ambiguity E. Evaluation of Considerations Relied Upon by the Commission in Previous Interpretation of Paragraph 4a(a)(2) F. Necessity Finding G. Request for Comment IV. Related Matters A. Cost-Benefit Considerations B. Paperwork Reduction Act C. Regulatory Flexibility Act D. Antitrust Considerations Sfmt 4702 U.S.C. 1 et seq. CFR part 150. Part 150 of the Commission’s regulations establishes federal position limits (that is, position limits established by the Commission, as opposed to exchange-set limits) on nine agricultural contracts. Agricultural contracts refers to the list of commodities contained in the definition of ‘‘commodity’’ in CEA section 1a; 7 U.S.C. 1a. This list of agricultural contracts currently includes nine contracts: CBOT Corn (and Mini-Corn) (C), CBOT Oats (O), CBOT Soybeans (and Mini-Soybeans) (S), CBOT Wheat (and MiniWheat) (W), CBOT Soybean Oil (SO), CBOT Soybean Meal (SM), MGEX Hard Red Spring Wheat (MWE), CBOT KC Hard Red Winter Wheat (KW), and ICE Cotton No. 2 (CT). See 17 CFR 150.2. The position limits on these agricultural contracts are referred to as ‘‘legacy’’ limits because these contracts have been subject to federal position limits for decades. 4 See 17 CFR 150.2. 5 See 17 CFR 150.3. 6 See 17 CFR 150.4. 3 17 E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules designated contract market (‘‘DCM’’) Core Principle 5.7 Certain contracts are thus subject to both federal and DCMset limits, whereas others are subject only to DCM-set limits and/or position accountability. As part of the Dodd-Frank Act, Congress amended the CEA’s position limits provisions, which, since 1936, have authorized the Commission (and its predecessor) to impose limits on speculative positions to prevent the harms caused by excessive speculation. As discussed below, the Commission interprets these amendments as, among other things, tasking the Commission with establishing such position limits as it finds are ‘‘necessary’’ for the purpose of ‘‘diminishing, eliminating, or preventing’’ ‘‘[e]xcessive speculation . . . causing sudden or unreasonable fluctuations or unwarranted changes in . . . price . . .’’ 8 The Commission also interprets these amendments as tasking the Commission with establishing position limits on any ‘‘economically equivalent’’ swaps.9 The Commission previously issued proposed and final rules in 2011 to implement the provisions of the DoddFrank Act regarding position limits and the bona fide hedge definition.10 A September 28, 2012 order of the U.S. District Court for the District of Columbia vacated the 2011 Final Rulemaking, with the exception of the rule’s amendments to 17 CFR 150.2.11 Subsequently, the Commission proposed position limits regulations in 2013 (‘‘2013 Proposal’’), June of 2016 (‘‘2016 Supplemental Proposal’’), and again in December of 2016 (‘‘2016 Reproposal’’).12 The 2016 Reproposal would have amended part 150 to, among other things: establish federal position limits for 25 physical commodity futures contracts and for ‘‘economically equivalent’’ futures, options on futures, and swaps; revise the existing exemptions from such limits, including for bona fide hedges; and establish a framework for 77 U.S.C. 7(d)(5); 17 CFR 38.300. U.S.C. 6a(a)(1); see infra Section III.F. (discussion of the necessity finding). 9 7 U.S.C. 6a(a)(5). 10 Position Limits for Derivatives, 76 FR 4752 (Jan. 26, 2011); Position Limits for Futures and Swaps, 76 FR 71626 (Nov. 18, 2011) (‘‘2011 Final Rulemaking’’). 11 Int’l Swaps & Derivatives Ass’n v. U.S. Commodity Futures Trading Comm’n, 887 F. Supp. 2d 259 (D.D.C. 2012) (‘‘ISDA’’). 12 Position Limits for Derivatives, 78 FR 75680 (Dec. 12, 2013) (2013 Proposal); Position Limits for Derivatives: Certain Exemptions and Guidance, 81 FR 38458 (June 13, 2016) (2016 Supplemental Proposal); and Position Limits for Derivatives, 81 FR 96704 (Dec. 30, 2016) (2016 Reproposal). lotter on DSKBCFDHB2PROD with PROPOSALS3 87 VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 exchanges 13 to recognize certain positions as bona fide hedges, and thus exempt from position limits. To date, the Commission has not issued any final rulemaking based on the 2013 Proposal, 2016 Supplemental Proposal, or 2016 Reproposal. The 2016 Reproposal generally addressed comments received in response to those prior rulemakings. In a companion proposed rulemaking, the CFTC also proposed, and later adopted in 2016, amendments to rules governing aggregation of positions for purposes of compliance with federal position limits.14 These aggregation rules currently apply only to the nine agricultural contracts subject to existing federal limits, and going forward would apply to the commodities that would be subject to federal limits under this release. After reconsidering the prior proposals, including reviewing the comments responding thereto, the Commission is withdrawing from further consideration the 2013 Proposal, the 2016 Supplemental Proposal, and the 2016 Reproposal.15 Instead, the Commission is now issuing a new proposal (‘‘2020 Proposal’’). The 2020 Proposal is intended to (1) recognize differences across commodities and contracts, including differences in commercial hedging and cash-market reporting practices; (2) focus on derivatives contracts that are critical to price discovery and distribution of the underlying commodity such that the burden of excessive speculation in the derivatives contract may have a particularly acute impact on interstate commerce for that commodity; and (3) reduce duplication and inefficiency by leveraging existing expertise and processes at DCMs. For these general reasons, discussed in turn below, the 13 Unless indicated otherwise, the use of the term ‘‘exchanges’’ throughout this proposal refers to DCMs and Swap Execution Facilities. 14 Aggregation of Positions, 81 FR 91454 (Dec. 16, 2016) (‘‘Final Aggregation Rulemaking’’); see 17 CFR 150.4. Under the Final Aggregation Rulemaking, unless an exemption applies, a person’s positions must be aggregated with positions for which the person controls trading or for which the person holds a 10 percent or greater ownership interest. The Division of Market Oversight has issued time-limited no-action relief from some of the aggregation requirements contained in that rulemaking. See CFTC Letter No. 19–19 (July 31, 2019), available at https:// www.cftc.gov/csl/19-19/download. 15 Because the earlier proposals are withdrawn, comments on them will not be part of the administrative record with respect to the current proposal, except where expressly referenced herein. Commenters should resubmit comments relevant to the subject proposal; commenters who wish to reference prior comment letters should cite those prior comment letters as specifically as possible. PO 00000 Frm 00003 Fmt 4701 Sfmt 4702 11597 Commission proposes new regulations, rather than finalizing the 2016 Reproposal.16 First, the Commission preliminarily believes that any position limits regime must take into account differences across commodity and contract types. The existing federal position limits regulations apply only to nine contracts, all of which are physically-settled futures on agricultural commodities. Limits on these commodities have been in place for decades, as have the federal program for exemptions from these limits and the federal rules governing DCM-set limits on such commodities. The existing framework is largely a historical remnant of an approach that predates cash-settled futures contracts, let alone swaps, institutional-investor interest in commodity indexes, and highly liquid energy markets. Congress has tasked the Commission with: Establishing such limits as it finds are ‘‘necessary’’ for the purpose of preventing the burdens associated with excessive speculation causing sudden or unreasonable fluctuations or unwarranted changes in price; and establishing limits on swaps that are ‘‘economically equivalent’’ to certain futures contracts. The Commission has preliminarily determined that an approach that is flexible enough to accommodate potential future, unpredictable developments in commercial hedging practices would be well-suited for the current derivatives markets by accommodating differences in commodity types, contract specifications, hedging practices, cashmarket trading practices, organizational structures of hedging participants, and liquidity profiles of individual markets. The Commission proposes to build this flexibility into several parts of the proposed regulations, including: Exchange-set limits and/or accountability, rather than federal limits, outside of the spot month for referenced contracts based on commodities other than the nine legacy agricultural commodities; the ability for exchanges to use more than one formula when setting their own limit levels; an updated formula for federal non-spot month levels on the nine legacy agricultural contracts that is calibrated to recently observed trading activity; a bona fide hedging definition that is broad enough to accommodate common commercial hedging practices, including anticipatory hedging practices such as anticipatory merchandising; a broader range of exchange-granted recognitions for purposes of federal and 16 The specific proposed new regulations are discussed in detail later in this release. E:\FR\FM\27FEP3.SGM 27FEP3 11598 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules exchange-set limits that are in line with common commercial hedging practices; the elimination of a restriction for purposes of federal limits on holding positions during the last trading days of the spot month; and broader discretion for market participants to measure risk in the manner most suitable for their business. Second, the proposal establishes limits on a limited set of commodities for which the Commission preliminarily finds that speculative position limits are necessary.17 As described below, this necessity finding is based on a combination of factors including: The particular importance of these contracts in the price discovery process for their respective underlying commodities, the fact that they require physical delivery of the underlying commodity, and, in some cases, the commodities’ particular importance to the national economy and especially acute economic burdens on interstate commerce that would arise from excessive speculation causing sudden or unreasonable fluctuations or unwarranted changes in the price of the commodities underlying these contracts.18 Third, the Commission preliminarily believes that there is an opportunity for greater collaboration between the Commission and the exchanges within the statutorily created parallel federal and exchange-set position limit regimes. Given the exchanges’ self-regulatory Legacy agricultural (federal limits during and outside the spot month) CBOT CBOT CBOT CBOT CBOT Non-legacy agricultural (federal limits only during the spot month) 19 Commission invites comments on all aspects of this rulemaking. B. Executive Summary This executive summary provides an overview of the key components of this proposal. The summary only highlights certain aspects of the proposed regulations and generally uses shorthand to summarize complex topics. The executive summary is neither intended to be a comprehensive recitation of the proposal nor intended to supplement, modify, or replace any interpretive or other language contained herein. Section II of this release includes a more detailed and comprehensive discussion of all of the proposed regulations, and Section V includes the actual regulations. 1. Contracts Subject to Federal Speculative Position Limits Federal speculative position limits would apply to ‘‘referenced contracts,’’ which include: (a) 25 ‘‘core referenced futures contracts;’’ (b) futures and options directly or indirectly linked to a core referenced futures contract; and (c) ‘‘economically equivalent swaps.’’ a. Core Referenced Futures Contracts Federal speculative position limits would apply to the following 25 physically-settled core referenced futures contracts: Metals (federal limits only during the spot month) Corn (C) ................................................... Oats (O) .................................................. Soybeans (S) .......................................... Wheat (W) ............................................... Soybean Oil (SO) .................................... CBOT Rough Rice (RR) .................................. ICE Cocoa (CC) ............................................... ICE Coffee C (KC) ........................................... ICE FCOJ–A (OJ) ............................................ ICE U.S. Sugar No. 11 (SB) ............................ COMEX Gold (GC). COMEX Silver (SI) COMEX Copper (HG). NYMEX Platinum (PL). NYMEX Palladium (PA). CBOT Soybean Meal (SM) ................................ ICE U.S. Sugar No. 16 (SF) ............................ Energy (federal limits only during the spot month) MGEX Hard Red Spring Wheat (MWE) ............. ICE Cotton No. 2 (CT) ........................................ CBOT KC Hard Red Winter Wheat (KW) .......... CME Live Cattle (LC) ....................................... NYMEX NYMEX NYMEX (HO). NYMEX (RB). b. Futures and Options on Futures Linked to a Core Referenced Futures Contract lotter on DSKBCFDHB2PROD with PROPOSALS3 responsibilities, resources, deep knowledge of their markets and trading practices, close interactions with market participants, existing programs for addressing exemption requests, and ability to generally act more quickly than the Commission, the Commission preliminarily believes that cooperation between the Commission and the exchanges on position limits should not only be continued, but enhanced. For example, exchanges are particularly well-positioned to provide the Commission with estimates of deliverable supply, to recommend limit levels for the Commission’s consideration, and to help administer the program for recognizing bona fide hedges. Further, given that the Commission is proposing to require exchanges to collect, and provide to the Commission upon request, cash-market information from market participants requesting bona fide hedges, the Commission also proposes to eliminate Form 204, which market participants with bona fide hedging positions in excess of limits currently file each month with the Commission to demonstrate cash-market positions justifying such overages. The Commission preliminarily believes that enhanced collaboration will maintain the Commission’s access to information and result in a more efficient administrative process, in part by reducing duplication of efforts. The Referenced contracts would also include futures and options on futures that are directly or indirectly linked to 17 See infra Section III.F. infra Section III.F.1. 19 While the Commission is proposing federal non-spot month limits only for the nine legacy 18 See VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Henry Hub Natural Gas (NG). Light Sweet Crude Oil (CL). New York Harbor ULSD Heating Oil New York Harbor RBOB Gasoline the price of a core referenced futures contract or to the same commodity underlying the applicable core referenced futures contract for delivery at the same location as specified in that core referenced futures contract. Referenced contracts, however, would not include location basis contracts, commodity index contracts, swap guarantees, and trade options that meet certain requirements. agricultural core referenced futures contracts, exchanges would be required to establish, consistent with Commission standards set forth in this proposal, exchange-set position limits and/or position accountability levels in the non-spot months for the non-legacy agricultural, metals, and energy core referenced futures contracts. PO 00000 Frm 00004 Fmt 4701 Sfmt 4702 E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules c. Economically Equivalent Swaps Referenced contracts would also include economically equivalent swaps, which would be defined as swaps with ‘‘identical material’’ contractual specifications, terms, and conditions to a referenced contract. Swaps in commodities other than natural gas that have identical material specifications, terms, and conditions to a referenced contract, but differences in lot size specifications, notional amounts, or delivery dates diverging by less than one calendar day, would still be deemed economically equivalent swaps. Natural gas swaps that have identical material specifications, terms, and conditions to a referenced contract, but differences in lot size specifications, notional amounts, or delivery dates diverging by less than two calendar days, would still be deemed economically equivalent swaps. 2. Federal Limit Levels During the Spot Month Federal spot month limits would apply to referenced contracts on all 25 core referenced futures contracts. The following proposed spot month limit levels, summarized in the table below, are set at or below 25 percent of deliverable supply, as estimated using recent data provided by the DCM listing 2020 Proposed spot month limit Core referenced futures contract 11599 the core referenced futures contract, and verified by the Commission. The proposed spot month limits would apply on a futures-equivalent basis based on the size of the unit of trading of the relevant core referenced futures contract, and would apply ‘‘separately’’ to physically-settled and cash-settled referenced contracts. Therefore, a market participant could net positions across physically-settled referenced contracts, and separately could net positions across cash-settled referenced contracts, but would not be permitted to net cash-settled referenced contracts with physically-settled referenced contracts. Existing federal spot month limit Existing exchange-set spot month limit Legacy Agricultural Contracts CBOT Corn (C) .............................................................................................. CBOT Oats (O) .............................................................................................. CBOT Soybeans (S) ...................................................................................... CBOT Soybean Meal (SM) ............................................................................ CBOT Soybean Oil (SO) ............................................................................... CBOT Wheat (W) .......................................................................................... CBOT KC Hard Red Winter Wheat (KW) ..................................................... MGEX Hard Red Spring Wheat (MWE) ........................................................ ICE Cotton No. 2 (CT) ................................................................................... 1,200 600 1,200 1,500 1,100 1,200 1,200 1,200 1,800 600 600 600 720 540 600 600 600 300 600 600 600 720 540 600/500/400/300/220 600 600 300 20 600/300/200 800 4,900 1,700 2,200 25,800 6,400 n/a n/a n/a n/a n/a n/a n/a 450/300/200 600/200/250 1,000 500 300 5,000 n/a 6,000 3,000 1,000 500 50 n/a n/a n/a n/a n/a 3,000 1,500 1,500 500 50 2,000 n/a n/a n/a n/a 1,000 3,000 1,000 1,000 Other Agricultural Contracts CME Live Cattle (LC) .................................................................................... CBOT Rough Rice (RR) ................................................................................ ICE Cocoa (CC) ............................................................................................. ICE Coffee C (KC) ......................................................................................... ICE FCOJ–A (OJ) .......................................................................................... ICE U.S. Sugar No. 11 (SB) .......................................................................... ICE U.S. Sugar No. 16 (SF) .......................................................................... Metals Contracts COMEX Gold (GC) ........................................................................................ COMEX Silver (SI) ......................................................................................... COMEX Copper (HG) .................................................................................... NYMEX Platinum (PL) ................................................................................... NYMEX Palladium (PA) ................................................................................. Energy Contracts NYMEX NYMEX NYMEX NYMEX Henry Hub Natural Gas (NG) .......................................................... Light Sweet Crude Oil (CL) ............................................................. New York Harbor ULSD Heating Oil (HO) ...................................... New York Harbor RBOB Gasoline (RB) .......................................... lotter on DSKBCFDHB2PROD with PROPOSALS3 3. Federal Limit Levels Outside of the Spot Month Federal limits outside of the spot month would apply only to referenced contracts based on the nine legacy 20 The proposed federal spot month limit for Live Cattle would feature a step-down limit similar to the CME’s existing Live Cattle step-down exchange set limit. The proposed federal spot month stepdown limit is: (1) 600 at the close of trading on the first business day following the first Friday of the contract month; (2) 300 at the close of trading on VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 21 6,000/5,000/4,000 2,000 2,000 agricultural commodities subject to existing federal limits. All other referenced contracts subject to federal limits would be subject to federal limits only during the spot month, as specified above, and otherwise would only be subject to exchange-set limits and/or position accountability levels outside of the spot month. the business day prior to the last five trading days of the contract month; and (3) 200 at the close of trading on the business day prior to the last two trading days of the contract month. 21 The proposed federal spot month limit for Light Sweet Crude Oil would feature the following stepdown limit: (1) 6,000 contracts as of the close of trading three business days prior to the last trading day of the contract; (2) 5,000 contracts as of the close of trading two business days prior to the last trading day of the contract; and (3) 4,000 contracts as of the close of trading one business day prior to the last trading day of the contract. PO 00000 Frm 00005 Fmt 4701 Sfmt 4702 E:\FR\FM\27FEP3.SGM 27FEP3 11600 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules The following proposed non-spot month limit levels, summarized in the table below, are set at 10 percent of open interest for the first 50,000 contracts, with an incremental increase of 2.5 percent of open interest thereafter, and would apply on a futuresequivalent basis based on the size of the 2020 Proposed single month and all-months combined limit Core referenced futures contract CBOT Corn (C) .......................................................................................................... CBOT Oats (O) .......................................................................................................... CBOT Soybean (S) .................................................................................................... CBOT Soybean Meal (SM) ........................................................................................ CBOT Soybean Oil (SO) ........................................................................................... CBOT Wheat (W) ...................................................................................................... CBOT KC HRW Wheat (KW) .................................................................................... MGEX HRS Wheat (MWE) ........................................................................................ ICE Cotton No. 2 (CT) ............................................................................................... 4. Exchange-Set Limits and Exemptions Therefrom a. Contracts Subject to Federal Limits An exchange that lists a contract subject to federal limits, as specified above, would be required to set its own limits for such contracts at a level that is no higher than the federal level. Exchanges would be allowed to grant exemptions from their own limits, provided the exemption does not subvert the federal limits framework.22 lotter on DSKBCFDHB2PROD with PROPOSALS3 b. Physical Commodity Contracts Not Subject to Federal Limits For physical commodity contracts not subject to federal limits, an exchange would generally be required to set spot month limits no greater than 25 percent of deliverable supply, but would have flexibility to submit other approaches for review by the Commission, provided the approach results in spot month levels that are ‘‘necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract’s or the underlying commodity’s price or index’’ and complies with all other applicable regulations. Outside of the spot month, such an exchange would have additional flexibility to set either position limits or position accountability levels, provided the levels are ‘‘necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract’s or the underlying commodity’s price or index.’’ Non-exclusive Acceptable Practices would provide several examples of formulas that the 22 In addition, as explained further below, exchanges may choose to participate in the Commission’s new proposed streamlined process for reviewing bona fide hedge exemption applications for purposes of federal limits. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 5. Limits on ‘‘Pre-Existing Positions’’ Certain ‘‘Pre-Existing Positions’’ that were entered into prior to the effective date of final position limits rules would not be subject to federal limits. Both ‘‘Pre-Enactment Swaps,’’ which are swaps entered into prior to the DoddFrank Act whose terms have not expired, and ‘‘Transition Period Swaps,’’ which are swaps entered into between July 22, 2010 and 60 days after the publication of final position limits rules, would not be subject to federal limits. All other ‘‘Pre-Existing Positions’’ that are acquired in good faith prior to the effective date of final position limits rules would be subject to federal limits during, but not outside, the spot month. 6. Substantive Standards for Exemptions From Federal Limits a. Bona Fide Hedge Recognition Hedging transactions or positions may continue to exceed federal limits if they satisfy all three elements of the ‘‘general’’ bona fide hedging definition: (1) The hedge represents a substitute for transactions or positions made at a later time in a physical marketing channel (‘‘temporary substitute test’’); (2) the Frm 00006 Fmt 4701 Sfmt 4702 Existing federal single month and all-monthscombined limit 57,800 2,000 27,300 16,900 17,400 19,300 12,000 12,000 11,900 Commission has determined would meet this standard, but an exchange would have the flexibility to develop other approaches. Exchanges would be provided flexibility to grant a variety of exemption types, provided that the exchange must take into account whether the exemption would result in a position that would not be in accord with ‘‘sound commercial practices’’ in the market for which the exchange is considering the application, and/or would ‘‘exceed an amount that may be established and liquidated in an orderly fashion in that market.’’ PO 00000 unit of trading of the relevant core referenced futures contract: 33,000 2,000 15,000 6,500 8,000 12,000 12,000 12,000 5,000 Existing exchange-set single month and all-monthscombined limit 33,000 2,000 15,000 6,500 8,000 12,000 12,000 12,000 5,000 hedge is economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise (‘‘economically appropriate test’’); and (3) the hedge arises from the potential change in value of actual or anticipated assets, liabilities, or services (‘‘change in value requirement’’). The Commission proposes several changes to the existing bona fide hedging definition, including those described immediately below, and also proposes a streamlined process for granting bona fide hedge recognitions, described further below. First, for referenced contracts based on the 25 core referenced futures contracts listed in § 150.2(d), the Commission would expand the current list of enumerated bona fide hedges to cover additional hedging practices included in the 2016 Reproposal, as well as hedges of anticipated merchandising.23 Persons who hold a bona fide hedging transaction or position in accordance with § 150.1 in referenced contracts based on one of the 25 core referenced futures contracts and whose hedging practice is included in the list of enumerated hedges in Appendix A of part 150 would not be required to request prior approval from 23 The existing definition of ‘‘bona fide hedging transactions and positions’’ enumerates the following hedging transactions: (1) Hedges of inventory and cash commodity fixed-price purchase contracts under 1.3(z)(2)(i)(A); (2) hedges of unsold anticipated production under 1.3(z)(2)(i)(B); (3) hedges of cash commodity fixed-price sales contracts under 1.3(z)(2)(ii)(A); (4) certain crosscommodity hedges under 1.3(z)(2)(ii)(B); (5) hedges of unfilled anticipated requirements under 1.3(z)(2)(ii)(C) and (6) hedges of offsetting unfixed price cash commodity sales and purchases under 1.3(z)(2)(iii). The following additional hedging practices are not enumerated in the existing regulation, but are included as enumerated hedges in the 2020 Proposal: (1) Hedges by agents; (2) hedges of anticipated royalties; (3) hedges of services; (4) offsets of commodity trade options; and (5) hedges of anticipated merchandising. E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules the Commission to hold such bona fide hedge position. That is, such exemptions would be self-effectuating for purposes of federal speculative position limits, so a person would only be required to request the bona fide hedge exemption from the relevant exchange for purposes of exchange-set limits. Transactions or positions that do not fit within one of the enumerated hedges could still be recognized as a bona fide hedge, provided the Commission, or an exchange subject to Commission oversight, recognizes the position as such using one of the processes described below. The Commission would be open to adopting additional enumerated hedges as it becomes more comfortable with evolving hedging practices, particularly in the energy space, and provided the practices comply with the general bona fide hedging definition. Second, the Commission is clarifying its position on whether and when market participants may measure risk on a gross basis rather than on a net basis in order to provide market participants with greater flexibility. Instead of only being permitted to hedge on a ‘‘net basis’’ except in a narrow set of circumstances, market participants would also now be able to hedge positions on a ‘‘gross basis’’ in certain circumstances, provided that the participant has done so over time in a consistent manner and is not doing so to evade the federal limits. Third, market participants would have additional leeway to hold bona fide hedging positions in excess of limits during the last five days of the spot period (or during the time period for the spot month if less than five days). The proposal would not include such a restriction for purposes of federal limits, and would make clear that exchanges continue to have the discretion to adopt such restrictions for purposes of exchange-set limits. The proposal would also include flexible guidance on the circumstances under which exchanges may waive any such limitation for purposes of their own limits. Finally, the proposal would modify the ‘‘temporary substitute test’’ to require that a bona fide hedging transaction or position in a physical commodity must always, and not just normally, be connected to the production, sale, or use of a physical cash-market commodity. Therefore, a market participant would generally no longer be allowed to treat positions entered into for ‘‘risk management VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 purposes’’ 24 as a bona fide hedge, unless the position qualifies as either (i) an offset of a pass-through swap, where the offset reduces price risk attendant to a pass-through swap executed opposite a counterparty for whom the swap qualifies as a bona fide hedge; or (ii) a ‘‘swap offset,’’ where the offset is used by a counterparty to reduce price risk attendant to a swap that qualifies as a bona fide hedge and that was previously entered into by that counterparty. b. Spread Exemption Transactions or positions may also continue to exceed federal limits if they qualify as a ‘‘spread transaction,’’ which includes the following common types of spreads: Calendar spreads, intercommodity spreads, quality differential spreads, processing spreads (such as energy ‘‘crack’’ or soybean ‘‘crush’’ spreads), product or by-product differential spreads, or futures-option spreads. Spread exemptions may be granted using the process described below. c. Financial Distress Exemption This exemption would allow a market participant to exceed federal limits if necessary to take on the positions and associated risk of another market participant during a potential default or bankruptcy situation. This exemption would be available on a case-by-case basis, depending on the facts and circumstances involved. d. Conditional Spot Month Limit Exemption in Natural Gas The rules would allow market participants with cash-settled positions in natural gas to exceed the proposed 2,000 contract spot month limit, provided that the participant exits its spot month positions in the New York Mercantile Exchange (‘‘NYMEX’’) Henry Hub (NG) physically-settled natural gas contracts, and provided further that the participant’s position in cash-settled natural gas contracts does not exceed 10,000 NYMEX Henry Hub Natural Gas (NG) equivalent-size natural gas contracts per DCM that lists a natural gas referenced contract. Such market participants would be permitted to hold an additional 10,000 contracts in cashsettled natural gas economically equivalent swaps. 24 The phrase ‘‘risk management’’ as used in this instance refers to derivatives positions, typically held by a swap dealer, used to offset a swap position, such as a commodity index swap, with another entity for which that swap is not a bona fide hedge. PO 00000 Frm 00007 Fmt 4701 Sfmt 4702 11601 7. Process for Requesting Bona Fide Hedge Recognitions and Spread Exemptions a. Self-Effectuating Enumerated Bona Fide Hedges For referenced contracts based on any core referenced futures contract listed in § 150.2(d), bona fide hedge recognitions for positions that fall within one of the proposed enumerated hedges, including the proposed anticipatory enumerated hedges, would be self-effectuating for purposes of federal limits, provided the market participant separately applies to the relevant exchange for an exemption from exchange-set limits. Such market participants would no longer be required to file Form 204/304 with the Commission on a monthly basis to demonstrate cash-market positions justifying position limit overages. Instead, the Commission would have access to cash-market information such market participants submit as part of their application to an exchange for an exemption from exchanges-set limits, typically filed on an annual basis. b. Bona Fide Hedges That Are Not SelfEffectuating The Commission will consider adding to the proposed list of enumerated hedges at a later time once the Commission becomes more familiar with common commercial hedging practices for referenced contracts subject to federal position limits. Until that time, all bona fide hedging recognitions that are not enumerated in Appendix A of part 150 would be granted pursuant to one of the proposed processes for requesting a nonenumerated bona fide hedge recognition, as explained below. A market participant seeking to exceed federal limits for a nonenumerated bona fide hedging transaction or position would be able to choose whether to apply directly to the Commission or, alternatively, apply to the applicable exchange using a new proposed streamlined process. If applying directly to the Commission, the market participant would also have to separately apply to the relevant exchange for relief from exchange-set position limits. If applying to an exchange using the new proposed streamlined process, a market participant would be able to file an application with an exchange, generally at least annually, which would be valid both for purposes of federal and exchange-set limits. Under this streamlined process, if the exchange determines to grant a non-enumerated bona fide hedge recognition for purposes of its exchange-set limits, the E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 11602 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules exchange must notify the Commission and the applicant simultaneously. Then, 10 business days (or two business days in the case of sudden or unforeseen bona fide hedging needs) after the exchange issues such a determination, the market participant could rely on the exchange’s determination for purposes of federal limits unless the Commission (and not staff) notifies the market participant otherwise. After the 10 business days expire, the bona fide hedge exemption would be valid both for purposes of federal and exchange position limits and the market participant would be able to take on a position that exceeds federal position limits. Under this streamlined process, during the 10 business day review period, any rejection of an exchange determination would require Commission action. Further, if, for purposes of federal position limits, the Commission determines to reject an application for exemption, the applicant would not be subject to any position limits violation during the period of the Commission’s review nor once the Commission has issued its rejection, provided the person reduces the position within a commercially reasonable amount of time, as applicable. Under the proposal, positions that do not fall within one of the enumerated hedges could thus still be recognized as bona fide hedges, provided the exchange deems the position to comply with the general bona fide hedging definition, and provided that the Commission does not object to such a hedge within the ten-day (or two-day, as appropriate) window. Requests and approvals to exceed limits would generally have to be obtained in advance of taking on the position, but the proposed rule would allow market participants with sudden or unforeseen hedging needs to file a request for a bona fide hedge exemption within five business days of exceeding the limit. If the Commission rejects the application, the market participant would not be subject to a position limit violation, provided the participant reduces its position within a commercially reasonable amount of time. Among other changes, market participants would also no longer be required to file Form 204/304 with the Commission on a monthly basis to demonstrate cash-market positions justifying position limit overages. c. Spread Exemptions For referenced contracts on any commodity, spread exemptions would be self-effectuating for purposes of VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 federal limits, provided that the position: Falls within one of the categories set forth in the proposed ‘‘spread transaction’’ definition,25 and provided further that the market participant separately applies to the applicable exchange for an exemption from exchange-set limits. Market participants with a spread position that does not fit within the ‘‘spread transaction’’ definition with respect to any of the commodities subject to the proposed federal limits may apply directly to the Commission, and must also separately apply to the applicable exchange. 8. Comment Period and Compliance Date The public may comment on these rules during a 90-day period that starts after this proposal has been approved by the Commission. Market participants and exchanges would be required to comply with any position limit rules finalized from herein no later than 365 days after publication in the Federal Register. C. Summary of Proposed Amendments The Commission is proposing revisions to §§ 150.1, 150.2, 150.3, 150.5, and 150.6 and to parts 1, 15, 17, 19, 40, and 140, as well as the addition of §§ 150.8, 150.9, and Appendices A– F to part 150.26 Most noteworthy, the Commission proposes the following amendments to the foregoing rule sections, each of which, along with all other proposed changes, is discussed in greater detail in Section II of this release. The following summary is not intended to provide a substantive overview of this proposal, but rather is intended to provide a guide to the rule sections that address each topic. Please see the executive summary above for an overview of this proposal organized by topic, rather than by section number. • The Commission preliminarily finds that federal speculative position limits are necessary for 25 core referenced futures contracts and proposes federal limits on physicallysettled and linked cash-settled futures, options on futures, and ‘‘economically equivalent’’ swaps for such commodities. The 25 core referenced futures contracts would include the 25 The categories are: Calendar spreads, intercommodity spreads, quality differential spreads, processing spreads (such as energy ‘‘crack’’ or soybean ‘‘crush’’ spreads), product or by-product differential spreads, and futures-option spreads. 26 This 2020 Proposal does not propose to amend current § 150.4 dealing with aggregation of positions for purposes of compliance with federal position limits. Section 150.4 was amended in 2016 in a prior rulemaking. See Final Aggregation Rulemaking, 81 FR at 91454. PO 00000 Frm 00008 Fmt 4701 Sfmt 4702 nine ‘‘legacy’’ agricultural contracts currently subject to federal limits and 16 additional non-legacy contracts, which would include: seven additional agricultural contracts, four energy contracts, and five metals contracts.27 Federal spot and non-spot month limits would apply to the nine ‘‘legacy’’ agricultural contracts currently subject to federal limits,28 and only federal spot month limits would apply to the additional 16 non-legacy contracts. Outside of the spot month, these 16 non-legacy contracts would be subject to exchange-set limits and/or accountability levels if listed on an exchange. • Amendments to § 150.1 would add or revise several definitions for use throughout part 150, including: new definitions of the terms ‘‘core referenced futures contract’’ (pertaining to the 25 physically-settled futures contracts explicitly listed in the regulations) and ‘‘referenced contract’’ (pertaining to contracts that have certain direct and/or indirect linkages to the core referenced futures contracts, and to ‘‘economically equivalent swaps’’) to be used as shorthand to refer to contracts subject to federal limits; a ‘‘spread transaction’’ definition; and a definition of ‘‘bona fide hedging transactions or positions’’ that is broad enough to accommodate hedging practices in a variety of contract types, including hedging practices that may develop over time. • Amendments to § 150.2 would list the 25 core referenced futures contracts which, along with any associated referenced contracts, would be subject 27 The seven additional agricultural contracts that would be subject to federal spot month limits are CME Live Cattle (LC), CBOT Rough Rice (RR), ICE Cocoa (CC), ICE Coffee C (KC), ICE FCOJ–A (OJ), ICE U.S. Sugar No. 11 (SB), and ICE U.S. Sugar No. 16 (SF). The four energy contracts that would be subject to federal spot month limits are: NYMEX Light Sweet Crude Oil (CL), NYMEX New York Harbor ULSD Heating Oil (HO), NYMEX New York Harbor RBOB Gasoline (RB), and NYMEX Henry Hub Natural Gas (NG). The five metals contracts that would be subject to federal spot month limits are: COMEX Gold (GC), COMEX Silver (SI), COMEX Copper (HG), NYMEX Palladium (PA), and NYMEX Platinum (PL). As discussed below, any contracts for which the Commission is proposing federal limits only during the spot month would be subject to exchange-set limits and/or accountability outside of the spot month. 28 The Commission currently sets and enforces speculative position limits with respect to certain enumerated agricultural products. The ‘‘enumerated’’ agricultural products refer to the list of commodities contained in the definition of ‘‘commodity’’ in CEA section 1a; 7 U.S.C. 1a. These agricultural products consist of the following nine currently traded contracts: CBOT Corn (and MiniCorn) (C), CBOT Oats (O), CBOT Soybeans (and Mini-Soybeans) (S), CBOT Wheat (and Mini-Wheat) (W), CBOT Soybean Oil (SO), CBOT Soybean Meal (SM), MGEX HRS Wheat (MWE), CBOT KC HRW Wheat (KW), and ICE Cotton No. 2 (CT). See 17 CFR 150.2. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 to federal limits; and specify the proposed federal spot and non-spot month limit levels. Federal spot month limit levels would be set at or below 25 percent of deliverable supply, whereas federal non-spot month limit levels would be set at 10 percent of open interest for the first 50,000 contracts of open interest, with an incremental increase of 2.5 percent of open interest thereafter. • Amendments to § 150.3 would specify the types of positions for which exemptions from federal position limit requirements may be granted, and would set forth and/or reference the processes for requesting such exemptions, including recognitions of bona fide hedges and exemptions for spread positions, financial distress positions, certain natural gas positions held during the spot month, and preenactment and transition period swaps. For all contracts subject to federal limits, bona fide hedge exemptions listed in Appendix A to part 150 as an enumerated bona fide hedge would be self-effectuating for purposes of federal limits. For non-enumerated hedges, market participants must request approval in advance of taking a position that exceeds the federal position limit, except in the case of sudden or unforeseen hedging needs. • Amendments to § 150.5 would refine the process, and establish nonexclusive methodologies, by which exchanges may set exchange-level limits and grant exemptions therefrom with respect to futures and options on futures, including separate methodologies for contracts subject to federal limits and physical commodity derivatives not subject to federal limits.29 While the Commission will oversee compliance with federal position limits on swaps, amended § 150.5 would not apply to exchanges with respect to swaps until a later time once exchanges have access to sufficient data to monitor compliance with limits on swaps across exchanges. • New § 150.9 would establish a streamlined process for addressing requests for bona fide hedging recognitions for purposes of federal limits, leveraging off exchange expertise and resources while affording the 29 Proposed § 150.5 addresses exchange-set position limits and exemptions therefrom, whereas proposed § 150.3 addresses exemptions from federal limits, and proposed § 150.9 addresses federal limits and acceptance of exchange-granted bona fide hedging recognitions for purposes of federal limits. Exchange rules typically refer to ‘‘exemptions’’ in connection with bona fide hedging and spread positions, whereas the Commission uses the nomenclature ‘‘recognition’’ with respect to bona fide hedges, and ‘‘exemption’’ with respect to spreads. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Commission an opportunity to intervene as-needed. This process would be used by market participants with nonenumerated positions. Under the proposed rule, market participants could provide one application for a bona fide hedge to a designated contract market or swap execution facility, as applicable, and receive approval of such request for purposes of both exchangeset limits and federal limits. • New Appendix A to part 150 would contain enumerated hedges, some of which appear in the definition of bona fide hedging transactions and positions in current § 1.3, which would be examples of positions that would comply with the proposed bona fide hedging definition. As the enumerated hedges would be examples of bona fide hedging positions, positions that do not fall within any of the enumerated hedges could still potentially be recognized as bona fide hedging positions, provided the position otherwise complies with the proposed bona fide hedging definition and all other applicable requirements. • Amendments to part 19 and related provisions would eliminate Form 204, enabling the Commission to leverage cash-market reporting submitted directly to the exchanges under §§ 150.5 and 150.9. D. The Commission Preliminarily Construes CEA Section 4a(a) To Require the Commission To Make a Necessity Finding Before Establishing Position Limits for Physical Commodities Other Than Excluded Commodities The Commission is required by ISDA to determine whether CEA section 4a(a)(2)(A) requires the Commission to find, before establishing a position limit, that such limit is ‘‘necessary.’’ 30 The provision states in relevant part that ‘‘the Commission shall’’ establish position limits ‘‘as appropriate’’ for contracts in physical commodities other than excluded commodities ‘‘[i]n accordance with the standards set forth in’’ the preexisting section 4a(a)(1).31 That preexisting provision requires the Commission to establish position limits as it ‘‘finds are necessary to diminish, eliminate, or prevent’’ certain enumerated burdens on interstate commerce.32 In the 2011 Final Rulemaking, the Commission interpreted this language as an unambiguous mandate to establish position limits without first finding that such limits are necessary, but with discretion to determine the 30 ISDA, 887 F.Supp.2d at 259, 281. U.S.C. 6a(a)(2)(A). 32 7 U.S.C. 6a(a)(1). 31 7 PO 00000 Frm 00009 Fmt 4701 Sfmt 4702 11603 ‘‘appropriate’’ levels for each.33 In ISDA, the U.S. District Court for the District of Columbia disagreed and held that section 4a(a)(2)(A) is ambiguous as to whether the ‘‘standards set forth in paragraph (1)’’ include the requirement of an antecedent finding that a position limit is necessary.34 The court vacated the 2011 Final Rulemaking and directed the Commission to apply its experience and expertise to resolve that ambiguity.35 The Commission has done so and preliminarily determines that section 4a(a)(2)(A) should be interpreted to require that before establishing position limits, the Commission must determine that limits are necessary.36 A full legal analysis is set forth infra at Section III.F. The Commission preliminarily finds that position limits are necessary for the 25 core referenced futures contracts, and any associated referenced contracts. This preliminary finding is based on a combination of factors including: The particular importance of these contracts in the price discovery process for their respective underlying commodities, the fact that they require physical delivery of the underlying commodity, and, in some cases, the commodities’ particular importance to the national economy and especially acute economic burdens that would arise from excessive speculation causing sudden or unreasonable fluctuations or unwarranted changes in the price of the commodities underlying these contracts. II. Proposed Rules A. § 150.1—Definitions Definitions relevant to the existing position limits regime currently appear in both §§ 1.3 and 150.1 of the Commission’s regulations.37 The Commission proposes to update and supplement the definitions in § 150.1, including by moving a revised definition of ‘‘bona fide hedging transactions and positions’’ from § 1.3 into § 150.1. The proposed changes are intended, among other things, to conform the definitions to the DoddFrank Act amendments to the CEA.38 33 2011 Final Rulemaking, 76 FR at 71626, 71627. 887 F.Supp.2d at 279–280. 35 Id. at 281. 36 See infra Section III.F. 37 17 CFR 1.3 and 150.1, respectively. 38 In addition to the amendments described below, the Commission proposes to re-order the defined terms so that they appear in alphabetical order, rather than in a lettered list, so that terms can be more quickly located. Moving forward, any new defined terms would be inserted in alphabetical order, as recommended by the Office of the Federal Register. See Document Drafting Handbook, Office of the Federal Register, National Archives and Records Administration, 2–31 (Revision 5, Oct. 2, 34 ISDA, Continued E:\FR\FM\27FEP3.SGM 27FEP3 11604 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Each proposed defined term is discussed in alphabetical order below. 1. ‘‘Bona Fide Hedging Transactions or Positions’’ lotter on DSKBCFDHB2PROD with PROPOSALS3 a. Background Under CEA section 4a(c)(1), position limits shall not apply to transactions or positions that are ‘‘shown to be bona fide hedging transactions or positions, as such terms shall be defined by the Commission . . . .’’ 39 The Dodd-Frank Act directed the Commission, for purposes of implementing CEA section 4a(a)(2), to adopt a definition consistent with CEA section 4a(c)(2).40 The current definition of ‘‘bona fide hedging transactions and positions,’’ which first appeared in § 1.3 of the Commission’s regulations in the 1970s,41 is inconsistent, in certain ways described below, with the revised statutory definition in CEA section 4a(c)(2). Accordingly, and for the reasons outlined below, the Commission proposes to remove the current bona fide hedging definition from § 1.3 and replace it with an updated bona fide hedging definition that would appear alongside all of the other position limits related definitions in proposed § 150.1.42 This definition would be 2017) (stating, ‘‘[i]n sections or paragraphs containing only definitions, we recommend that you do not use paragraph designations if you list the terms in alphabetical order. Begin the definition paragraph with the term that you are defining.’’). 39 7 U.S.C. 6a(c)(1). While portions of the CEA and proposed § 150.1 respectively refer, and would refer, to the phrase ‘‘bona fide hedging transactions or positions,’’ the Commission may use the phrases ‘‘bona fide hedging position,’’ ‘‘bona fide hedging definition,’’ and ‘‘bona fide hedge’’ throughout this section of the release as shorthand to refer to the same. 40 7 U.S.C. 6a(c)(2). 41 See, e.g., Definition of Bona Fide Hedging and Related Reporting Requirements, 42 FR 42748 (Aug. 24, 1977). Previously, the Secretary of Agriculture, pursuant to section 404 of the Commodity Futures Trading Commission Act of 1974 (Pub. L. 93–463), promulgated a definition of bona fide hedging transactions and positions. Hedging Definition, Reports, and Conforming Amendments, 40 FR 11560 (Mar. 12, 1975). That definition, largely reflecting the statutory definition previously in effect, remained in effect until the newlyestablished Commission defined that term. Id. 42 In a 2018 rulemaking, the Commission amended § 1.3 to replace the sub-paragraphs that had for years been identified with an alphabetic designation for each defined term with an alphabetized list. See Definitions, 83 FR 7979 (Feb. 23, 2018). The bona fide hedging definition, therefore, is now a paragraph, located in alphabetical order, in § 1.3, rather than in § 1.3(z). Accordingly, for purposes of clarity and ease of discussion, when discussing the Commission’s current version of the bona fide hedging definition, this release will refer to the bona fide hedging definition in § 1.3. Further, the version of § 1.3 that appears in the Code of Federal Regulations applies only to excluded commodities and is not the version of the bona fide hedging definition currently in effect. The VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 applied in determining whether a position is a bona fide hedge that may exceed the proposed federal limits set forth in § 150.2. The Commission’s current bona fide hedging definition is described immediately below, followed by a discussion of the proposed new definition. This section of the release describes the substantive standards for bona fide hedges. The process for granting bona fide hedge recognitions is discussed later in this release in connection with proposed §§ 150.3 and 150.9.43 b. The Commission’s Existing Bona Fide Hedging Definition in § 1.3 Paragraph (1) of the current bona fide hedging definition in § 1.3 contains what is currently labeled the ‘‘general’’ bona fide hedging definition, which has five key elements and requires that the position must: (1) ‘‘normally’’ represent a substitute for transactions or positions made at a later time in a physical marketing channel (‘‘temporary substitute test’’); (2) be economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise (‘‘economically appropriate test’’); (3) arise from the potential change in value of actual or anticipated assets, liabilities, or services (‘‘change in value requirement’’); (4) have a purpose to offset price risks incidental to commercial cash or spot operations (‘‘incidental test’’); and (5) be established and liquidated in an orderly manner (‘‘orderly trading requirement’’).44 Additionally, paragraph (2) currently sets forth a non-exclusive list of four categories of ‘‘enumerated’’ hedging version currently in effect, the substance of which remains as it was amended in 1987, applies to all commodities, not just to excluded commodities. See Revision of Federal Speculative Position Limits, 52 FR 38914 (Oct. 20, 1987). While the 2011 Final Rulemaking amended the § 1.3 bona fide hedging definition to apply only to excluded commodities, that rulemaking was vacated, as noted previously, by a September 28, 2012 order of the U.S. District Court for the District of Columbia, with the exception of the rule’s amendments to 17 CFR 150.2. Although the 2011 Final Rulemaking was vacated, the 2011 version of the bona fide hedging definition in § 1.3, which applied only to excluded commodities, has not yet been formally removed from the Code of Federal Regulations. The currently-in-effect version of the Commission’s bona fide hedging definition thus does not currently appear in the Code of Federal Regulations. The closest to a ‘‘current’’ version of the definition is the 2010 version of § 1.3, which, while substantively current, still includes the ‘‘(z)’’ denomination that was removed in 2018. The Commission proposes to address the need to formally remove the incorrect version of the bona fide hedging definition as part of this rulemaking. 43 See infra Section II.C.2. (discussion of proposed § 150.3) and Section II.G.3. (discussion of proposed § 150.9). 44 17 CFR 1.3. PO 00000 Frm 00010 Fmt 4701 Sfmt 4702 transactions that are included in the general bona fide hedging definition in paragraph (1). Market participants thus need not seek recognition from the Commission of such positions as bona fide hedges prior to exceeding limits for such positions; rather, market participants must simply report any such positions on the monthly Form 204, as required by part 19 of the Commission’s regulations.45 The four existing categories of enumerated hedges are: (1) Hedges of ownership or fixed-price cash commodity purchases and hedges of unsold anticipated production; (2) hedges of fixed-price cash commodity sales and hedges of unfilled anticipated requirements; (3) hedges of offsetting unfixed-price cash commodity sales and purchases; and (4) cross-commodity hedges.46 Paragraph (3) of the current bona fide hedging definition states that the Commission may recognize nonenumerated bona fide hedging transactions and positions pursuant to a specific request by a market participant using the process described in § 1.47 of the Commission’s regulations.47 c. Proposed Replacement of the Bona Fide Hedging Definition in § 1.3 With a New Bona Fide Hedging Definition in § 150.1 i. Background The list of enumerated hedges found in paragraph (2) of the current bona fide hedging definition in § 1.3 was developed at a time when only agricultural commodities were subject to federal limits, has not been updated since 1987,48 and is likely too narrow to reflect common commercial hedging practices, including for metal and energy contracts. Numerous market and regulatory developments have taken place since then, including, among other things, increased futures trading in the metals and energy markets, the development of the swaps markets, and the shift in trading from pits to electronic platforms. In addition, the CFMA 49 and Dodd-Frank Act introduced various regulatory reforms, including the enactment of position limits core principles.50 The Commission is thus proposing to update its bona fide hedging definition to better conform to the current state of the law 45 17 46 17 CFR part 19. CFR 1.3. 47 Id. 48 See Revision of Federal Speculative Position Limits, 52 FR 38914 (Oct. 20, 1987). 49 Commodity Futures Modernization Act of 2000, Public Law 106–554, 114 Stat. 2763 (Dec. 21, 2000). 50 See 7 U.S.C. 7(d)(5) and 7 U.S.C. 7b–3(f)(6). E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules and to better reflect market developments over time. While one option for doing so could be to expand the list of enumerated hedges to encompass a larger array of hedging strategies, the Commission does not view this alone to be a practical solution. It would be difficult to maintain a list that captures all hedging activity across commodity types, and any list would inherently fail to take into account future changes in industry practices and other developments. The Commission proposes to create a new bona fide hedging definition in proposed § 150.1 that would work in connection with limits on a variety of commodity types and accommodate changing hedging practices over time. The Commission proposes to couple this updated definition with an expanded list of enumerated hedges. While positions that fall within the proposed enumerated hedges, discussed below, would be examples of positions that comply with the bona fide hedging definition, they would certainly not be the only types of positions that could be bona fide hedges. The proposed enumerated hedges are intended to ensure that the framework proposed herein does not reduce any clarity inherent in the existing framework; the proposed enumerated hedges are in no way intended to limit the universe of hedging practices that could otherwise be recognized as bona fide. The Commission anticipates these proposed modifications would provide a significant degree of flexibility to market participants in terms of how they hedge, and to exchanges in terms of how they evaluate transactions and positions for purposes of their position limit programs, without sacrificing any of the clarity provided by the existing bona fide hedging definition. Further, as described in detail in connection with the discussion of proposed § 150.9 later in this release, the Commission anticipates that allowing the exchanges to process applications for bona fide hedges for purposes of federal limits would be significantly more efficient than the existing processes for exchanges and the Commission.51 The Commission discusses each element of the proposed bona fide hedging definition below, followed by a discussion of the proposed enumerated hedges. The Commission’s intent with this proposal is to acknowledge to the greatest extent possible, consistent with the statutory language, existing bona 51 In this rulemaking, the Commission proposes to allow qualifying exchanges to process requests for non-enumerated bona fide hedge recognitions for purposes of federal limits. See infra Section II.G.3. (discussion of proposed § 150.9). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 fide hedging exemptions provided by exchanges. ii. Proposed Bona Fide Hedging Definition for Physical Commodities The Commission proposes to maintain the general elements currently found in the bona fide hedging definition in § 1.3 that conform to the revised statutory bona fide hedging definition in CEA section 4a(c)(2), and proposes to eliminate the elements that do not. In particular, the Commission proposes to include the updated versions of the temporary substitute test, economically appropriate test, and change in value requirements that are described below, and eliminate the incidental test and orderly trading requirement, which are not included in the revised statutory text. Each of these proposed changes is described below.52 (1) Temporary Substitute Test The language of the temporary substitute test that appears in the Commission’s existing bona fide hedging definition is inconsistent in some ways with the language of the temporary substitute test that currently appears in the statute. In particular, the bona fide hedging definition in section 4a(c)(2)(A)(i) of the CEA currently provides, among other things, that a bona fide hedging position ‘‘represents a substitute for transactions made or to be made or positions taken or to be taken at a later time in a physical marketing channel.’’ 53 The Commission’s definition currently provides that a bona fide hedging position ‘‘normally represent[s] a substitute for transactions to be made or positions to be taken at a later time in a physical marketing channel’’ (emphasis added).54 The Dodd-Frank Act amended the temporary substitute language that previously appeared in the statute by removing the word ‘‘normally’’ from the phrase ‘‘normally represents a substitute for transactions made or to be made or positions taken or to be taken at a later time in a physical marketing channel. . . .’’ 55 The Commission preliminarily interprets this change as reflecting 52 Bona fide hedge recognition is determined based on the particular circumstances of a position or transaction and is not conferred on the basis of the involved market participant alone. Accordingly, while a particular position may qualify as a bona fide hedge for a given market participant, another position held by that same participant may not. Similarly, if a participant holds positions that are recognized as bona fide hedges, and holds other positions that are speculative, only the speculative positions would be subject to position limits. 53 7 U.S.C. 6a(c)(2)(A)(i). 54 17 CFR 1.3. 55 7 U.S.C. 6a(c)(2)(A)(i). PO 00000 Frm 00011 Fmt 4701 Sfmt 4702 11605 Congressional direction that a bona fide hedging position in physical commodities must always (and not just ‘‘normally’’) be in connection with the production, sale, or use of a physical cash-market commodity.56 Accordingly, the Commission preliminarily interprets this change to signal that the Commission should cease to recognize ‘‘risk management’’ positions as bona fide hedges for physical commodities, unless the position satisfies the pass-through swap/swap offset requirements in section 4a(c)(2)(B) of the CEA, discussed further below.57 In order to implement that statutory change, the Commission proposes a narrower bona fide hedging definition for physical commodities in proposed § 150.1 that does not include the word ‘‘normally’’ currently found in the temporary substitute language in paragraph (1) of the existing § 1.3 bona fide hedging definition. The practical effect of conforming the temporary substitute test in the regulation to the amended statutory provision would be to prevent market participants from treating positions entered into for risk management purposes as bona fide hedges for contracts subject to federal limits, unless the position qualifies under the pass-through swap provision in CEA section 4a(c)(2)(B).58 As noted above, 56 Previously, the Commission stated that, among other things, the inclusion of the word ‘‘normally’’ in connection with the pre-Dodd-Frank Act version of the temporary substitute language indicated that the bona fide hedging definition should not be construed to apply only to firms using futures to reduce their exposures to risks in the cash market, and that to qualify as a bona fide hedge, a transaction in the futures market did not necessarily need to be a temporary substitute for a later transaction in the cash market. See Clarification of Certain Aspects of the Hedging Definition, 52 FR 27195, 27196 (July 20, 1987). In other words, that 1987 interpretation took the view that a futures position could still qualify as a bona fide hedging position even if it was not in connection with the production, sale, or use of a physical commodity. 57 7 U.S.C. 6a(c)(2)(B). In connection with physical commodities, the phrase ‘‘risk management exemption’’ has historically been used by Commission staff to refer to non-enumerated bona fide hedge recognitions granted under § 1.47 to allow swap dealers and others to hold agricultural futures positions outside of the spot month in excess of federal limits in order to offset commodity index swap or related exposure, typically opposite an institutional investor for which the swap was not a bona fide hedge. As described below, due to differences in statutory language, the phrase ‘‘risk management exemption’’ often has a broader meaning in connection with excluded commodities than with physical commodities. See infra Section II.A.1.c.v. (discussion of proposed pass-through language). 58 7 U.S.C. 6a(c)(2)(B). See infra Section II.A.1.c.v. (discussion of proposed pass-through language). Excluded commodities, as described in further detail below, are not subject to the statutory bona fide hedging definition. Accordingly, the statutory E:\FR\FM\27FEP3.SGM Continued 27FEP3 11606 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 the Commission previously viewed positions in physical commodities, entered into for risk management purposes to offset the risk of swaps and other financial instruments and not as substitutes for transactions or positions to be taken in a physical marketing channel, as bona fide hedges. However, given the statutory change, positions that reduce the risk of such swaps and financial instruments would no longer meet the requirements for a bona fide hedging position under CEA section 4a(c)(2) and under proposed § 150.1. As discussed below, any such previouslygranted risk management exemptions would generally no longer apply after the effective date of the speculative position limits proposed herein.59 Further, retaining such exemptions for swap intermediaries, without regard to the purpose of their counterparty’s swap, would be inconsistent with the statutory restrictions on pass-through swap offsets, which require that the swap position being offset qualify as a bona fide hedging position.60 Aside from this change, the Commission is not proposing any other modifications to its existing temporary substitute test. While the Commission preliminarily interprets the Dodd-Frank amendments to the CEA as constraining the Commission from recognizing as bona fide hedges risk management positions involving physical commodities, the Commission has in part addressed the hedging needs of persons seeking to offset the risk from swap books by proposing the pass-through swap and pass-through swap offset provisions discussed below. The Commission observes that while ‘‘risk management’’ positions would not qualify as bona fide hedges, some other provisions in this proposal may provide flexibility for existing and prospective risk management exemption holders in a manner that comports with the statute. In particular, the Commission anticipates that the proposal to limit the applicability of federal non-spot month limits to the nine legacy agricultural contracts,61 coupled with the proposed adjustment to non-spot limit levels based on updated open interest numbers for the nine legacy agricultural contracts restrictions on risk management exemptions that apply to physical commodities subject to federal limits do not apply to excluded commodities. 59 See infra Section II.C.2.g. (discussion of revoking existing risk management exemptions). 60 See 7 U.S.C. 6a(c)(2)(B)(i). The pass-through swap offset language in the proposed bona fide hedging definition is discussed in greater detail below. 61 See infra Section II.B.2.d. (discussion of nonspot month limit levels). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 currently subject to federal limits,62 may accommodate risk management activity that remains below the proposed levels in a manner that comports with the CEA. Further, to the extent that such activity would be opposite a counterparty for whom the swap is a bona fide hedge, the Commission would encourage intermediaries to consider whether they would qualify under the bona fide hedging position definition for the proposed pass-through swap treatment, which is explicitly authorized by the CEA and discussed in greater detail below.63 Moreover, while positions entered into for risk management purposes may no longer qualify as bona fide hedges, some may satisfy the proposed requirements for spread exemptions. Finally, consistent with existing industry practice, exchanges may continue to recognize risk management positions for contracts that are not subject to federal limits, including for excluded commodities. (2) Economically Appropriate Test The bona fide hedging definitions in section 4a(c)(2)(A)(ii) of the CEA and in existing § 1.3 of the Commission’s regulations both provide that a bona fide hedging position must be ‘‘economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise.’’ 64 The Commission proposes to replicate this standard in the new definition in § 150.1, with one clarification: Consistent with the Commission’s longstanding practice regarding what types of risk may be offset by bona fide hedging positions in excess of federal limits,65 the Commission proposes to make explicit that the word ‘‘risks’’ refers to, and is limited to, ‘‘price risk.’’ This proposed clarification does not reflect any change in policy, as the Commission has, when defining bona fide hedging, historically focused on transactions that offset price risk.66 62 The proposed non-spot month levels for the nine legacy agricultural contracts were calculated using a methodology that, with the exception of CBOT Oats (O), CBOT KC HRW Wheat (KW), and MGEX HRS Wheat (MWE), would result in higher levels than under existing rules and prior proposals. See infra Section II.B.2.d (discussion of proposed non-spot month limit levels). 63 See infra Section II.A.1.c.v. (discussion of proposed pass-through language). 64 7 U.S.C. 6a(c)(2)(A)(ii) and 17 CFR 1.3. 65 See, e.g., 2013 Proposal, 78 FR at 75709, 75710. 66 For example, in promulgating existing § 1.3, the Commission explained that a bona fide hedging position must, among other things, ‘‘be economically appropriate to risk reduction, such risks must arise from operation of a commercial enterprise, and the price fluctuations of the futures contracts used in the transaction must be substantially related to fluctuations of the cash market value of the assets, liabilities or services PO 00000 Frm 00012 Fmt 4701 Sfmt 4702 Commenters have previously requested flexibility for hedges of nonprice risk.67 However, re-interpreting ‘‘risk’’ to mean something other than ‘‘price risk’’ would make determining whether a particular position is economically appropriate to the reduction of risk too subjective to effectively evaluate. While the Commission or an exchange’s staff can objectively evaluate whether a particular derivatives position is an economically appropriate hedge of a price risk arising from an underlying cash-market transaction, including by assessing the correlations between the risk and the derivatives position, it would be more difficult, if not impossible, to objectively determine whether an offset of non-price risk is economically appropriate for the underlying risk. For example, for any given non-price risk, such as political risk, there could be multiple commodities, directions, and contract months which a particular market participant may view as an economically appropriate offset for that risk, and multiple market participants might take different views on which offset is the most effective. Reinterpreting ‘‘risk’’ to mean something other than ‘‘price risk’’ would introduce an element of subjectivity that would make a federal position limit framework difficult, if not impossible, to administer. The Commission remains open to receiving new product submissions, and should those submissions include contracts or strategies that are used to hedge something other than price risk, the Commission could at that point evaluate whether to propose regulations that would recognize hedges of risks other than price risk as bona fide hedges. (3) Change in Value Requirement The Commission proposes to retain the substance of the change in value requirement in existing § 1.3, with some non-substantive technical modifications, including modifications to correct a typographical error.68 Aside being hedged.’’ Bona Fide Hedging Transactions or Positions, 42 FR 14832, 14833 (Mar. 16, 1977). ‘‘Value’’ is generally understood to mean price times quantity. Dodd-Frank added CEA section 4a(c)(2), which copied the economically appropriate test from the Commission’s definition in § 1.3. See also 2013 Proposal, 78 FR at 75702, 75703 (stating that the ‘‘core of the Commission’s approach to defining bona fide hedging over the years has focused on transactions that offset a recognized physical price risk’’). 67 See, e.g., 2016 Reproposal, 81 FR at 96847. 68 The Commission proposes to replace the phrase ‘‘liabilities which a person owns,’’ which appears in the statute erroneously, with ‘‘liabilities which E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules from the typographical error, the proposed § 150.1 change in value requirement mirrors the Dodd-Frank Act’s change in value requirement in CEA section 4a(c)(2)(A)(iii).69 lotter on DSKBCFDHB2PROD with PROPOSALS3 (4) Incidental Test and Orderly Trading Requirement While the Commission proposes to maintain the substance of the three core elements of the existing bona fide hedging definition described above, with some modifications, the Commission also proposes to eliminate two elements contained in the existing § 1.3 definition: The incidental test and orderly trading requirement that currently appear in paragraph (1)(iii) of the § 1.3 bona fide hedging definition.70 Notably, Congress eliminated the incidental test from the statutory bona fide hedging definition in CEA section 4a(c)(2).71 Further, the Commission views the incidental test as redundant because the Commission is proposing to maintain the change in value requirement (value is generally understood to mean price per unit times quantity of units), and the economically appropriate test, which includes the concept of the offset of price risks in the conduct and management of (i.e., incidental to) a commercial enterprise. The Commission does not view the proposed elimination of the incidental test in the definition that appears in the regulations as a change in policy. The proposed elimination would not result in any changes to the Commission’s interpretation of the bona fide hedging definition for physical commodities. The Commission also preliminarily believes that the orderly trading requirement should be deleted from the definition in the Commission’s regulations because the statutory bona fide hedging definition does not include an orderly trading requirement,72 and a person owes,’’ which the Commission believes was the intended wording. The Commission interprets the word ‘‘owns’’ to be a typographical error. A person may owe on a liability, and may anticipate incurring a liability. If a person ‘‘owns’’ a liability, such as a debt instrument issued by another, then such person owns an asset. The fact that assets are included in CEA section 4a(c)(2)(A)(iii)(I) further reinforces the Commission’s interpretation that the reference to ‘‘owns’’ means ‘‘owes.’’ The Commission also proposes several other non-substantive modifications in sentence structure to improve clarity. 69 7 U.S.C. 6a(c)(2)(A)(iii). 70 17 CFR 1.3. 71 7 U.S.C. 6a(c)(2). 72 The orderly trading requirement has been a part of the regulatory definition of bona fide hedging since 1975; see Hedging Definition, Reports, and Conforming Amendments, 40 FR 11560 (Mar. 12, 1975). Prior to 1974, the orderly trading requirement was found in the statutory definition of bona fide hedging position; changes to the CEA VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 because the meaning of ‘‘orderly trading’’ is unclear in the context of the over-the counter (‘‘OTC’’) swap market and in the context of permitted offexchange transactions, such as exchange for physicals. The proposed elimination of the orderly trading requirement would also have no bearing on an exchange’s ability to impose its own orderly trading requirement. Further, in proposing to eliminate the orderly trading requirement from the definition in the regulations, the Commission is not proposing any amendments or modified interpretations to any other related requirements, including to any of the anti-disruptive trading prohibitions in CEA section 4c(a)(5),73 or to any other statutory or regulatory provisions. Taken together, the proposed retention of the updated temporary substitute test, economically appropriate test, and change in value requirement, coupled with the proposed elimination of the incidental test and orderly trading requirement, should reduce uncertainty by eliminating provisions that do not appear in the statute, and by clarifying the language of the remaining provisions. By reducing uncertainty surrounding some parts of the bona fide hedging definition for physical commodities, the Commission anticipates that, as described in greater detail elsewhere in this release, it would be easier going forward for the Commission, exchanges, and market participants to address whether novel trading practices or strategies may qualify as bona fide hedges. iii. Proposed Enumerated Bona Fide Hedges for Physical Commodities Federal position limits currently only apply to referenced contracts based on nine legacy agricultural commodities, and, as mentioned above, the bona fide hedging definition in existing § 1.3 includes a list of four categories of enumerated hedges that may be exempt from federal position limits.74 So as not to reduce any of the clarity provided by the current list of enumerated hedges, the Commission proposes to maintain the existing enumerated hedges, some with modification, and, for the reasons described below, to expand this list. Such enumerated bona fide hedges would be self-effectuating for purposes of federal limits.75 The Commission also proposes to move the expanded list to in 1974 removed the statutory definition from CEA section 4a(3). 73 7 U.S.C. 6c(a)(5). 74 17 CFR 1.3. 75 See infra Section II.C.2. (discussion of proposed § 150.3) and Section II.G.3. (discussion of proposed § 150.9). PO 00000 Frm 00013 Fmt 4701 Sfmt 4702 11607 proposed Appendix A to part 150 of the Commission’s regulations. The Commission preliminarily believes that the list of enumerated hedges should appear in an appendix, rather than be included in the definition, because each enumerated hedge represents just one way, but not the only way, to satisfy the proposed bona fide hedging definition and § 150.3(a)(1).76 In some places, as described below, the Commission proposes to modify and/or re-organize the language of the current enumerated hedges; such proposed changes are intended only to provide clarifications, and, unless indicated otherwise, are not intended to substantively modify the types of practices currently listed as enumerated hedges. In other places, however, the Commission proposes substantive changes to the existing enumerated hedges, including the elimination of the five-day rule for purposes of federal limits, while allowing exchanges to impose a five-day rule, or similar restrictions, for purposes of exchange-set limits. With the exception of risk management positions previously recognized as bona fide hedges, and assuming all regulatory requirements continue to be satisfied, bona fide hedging recognitions that are currently in effect under the Commission’s existing rules, either by virtue of § 1.47 or one of the enumerated hedges currently listed in § 1.3, would be grandfathered once the rules proposed herein are adopted. When first proposed, the Commission viewed the enumerated bona fide hedges as conforming to the general definition of bona fide hedging ‘‘without further consideration as to the particulars of the case.’’ 77 Similarly, the proposed enumerated hedges would reflect fact patterns for which the Commission has preliminarily determined, based on experience over time, that no case-by-case determination, or review of additional details, by the Commission is needed to determine that the position or transaction is a bona fide hedge. This proposal would in no way foreclose the recognition of other hedging practices as bona fide hedges. The Commission would be open, on a case-by-case basis, to recognizing as bona fide hedges positions or transactions that may fall outside the bounds of these enumerated hedges, but that nevertheless satisfy the proposed 76 As discussed below, proposed § 150.3(a)(1) would allow a person to exceed position limits for bona fide hedging transactions or positions, as defined in proposed § 150.1. 77 Bona Fide Hedging Transactions or Positions, 42 FR 14832 (Mar. 16, 1977). E:\FR\FM\27FEP3.SGM 27FEP3 11608 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules bona fide hedging definition and section 4a(c)(2) of the CEA.78 The Commission does not anticipate that moving the list of enumerated hedges from the bona fide hedging definition to an appendix per se would have a substantial impact on market participants who seek clarity regarding bona fide hedges. However, the Commission is open to feedback on this point. Positions in referenced contracts subject to position limits that meet any of the proposed enumerated hedges would, for purposes of federal limits, meet the bona fide hedging definition in CEA section 4a(c)(2)(A), as well as the Commission’s proposed bona fide hedging definition in § 150.1. Any such recognitions would be self-effectuating for purposes of federal limits, provided the market participant separately requests an exemption from the applicable exchange-set limit established pursuant to proposed § 150.5(a). The proposed enumerated hedges are each described below, followed by a discussion of the proposal’s treatment of the five-day rule. lotter on DSKBCFDHB2PROD with PROPOSALS3 (1) Hedges of Unsold Anticipated Production This hedge is currently enumerated in paragraph (2)(i)(B) of the bona fide hedging definition in § 1.3, and is subject to the five-day rule. The Commission proposes to maintain it as an enumerated hedge, with the modification described below. This enumerated hedge would allow a market participant who anticipates production, but who has not yet produced anything, to enter into a short derivatives position in excess of limits to hedge the anticipated production. While existing paragraph (2)(i)(B) limits this enumerated hedge to twelvemonths’ unsold anticipated production, the Commission proposes to remove the twelve-month limitation. The twelvemonth limitation may be unsuitable in connection with additional contracts based on agricultural and energy commodities covered by this release, which may have longer growth and/or production cycles than the nine legacy agricultural commodities. Commenters have also previously recommended removing the twelve-month limitation on agricultural production, stating that it is unnecessarily short in comparison to the expected life of investment in production facilities.79 The Commission preliminarily agrees. 78 See infra Section II.G.3. (discussion of proposed § 150.9). 79 See, e.g., 2016 Reproposal, 81 FR at 96752. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 (2) Hedges of Offsetting Unfixed Price Cash Commodity Sales and Purchases This hedge is currently enumerated in paragraph (2)(iii) of the bona fide hedging definition in § 1.3 and is subject to the five-day rule. The Commission proposes to maintain it as an enumerated hedge, with one proposed modification described below. This enumerated hedge allows a market participant to use commodity derivatives in excess of limits to offset an unfixed price cash commodity purchase coupled with an unfixed price cash commodity sale. Currently, under paragraph (2)(iii), the cash commodity must be bought and sold at unfixed prices at a basis to different delivery months, meaning the offsetting derivatives transaction would be used to reduce the risk arising from a time differential in the unfixed-price purchase and sale contracts.80 The Commission proposes to expand this provision to also permit the cash commodity to be bought and sold at unfixed prices at a basis to different commodity derivative contracts in the same commodity, even if the commodity derivative contracts are in the same calendar month. The Commission is proposing this change to allow a commercial enterprise to enter into the described derivatives transactions to reduce the risk arising from either (or both) a location differential 81 or a time differential in unfixed-price purchase and sale contracts in the same cash commodity. Both an unfixed-price cash commodity purchase and an offsetting unfixed-price cash commodity sale must be in hand in order to be eligible for this enumerated hedge, because having both the unfixed-price sale and purchase in hand would allow for an objective evaluation of the hedge.82 Absent either 80 The Commission stated when it proposed this enumerated hedge, ‘‘[i]n particular, a cotton merchant may contract to purchase and sell cotton in the cash market in relation to the futures price in different delivery months for cotton, i.e., a basis purchase and a basis sale. Prior to the time when the price is fixed for each leg of such a cash position, the merchant is subject to a variation in the two futures contracts utilized for price basing. This variation can be offset by purchasing the future on which the sales were based [and] selling the future on which [the] purchases were based.’’ Revision of Federal Speculative Position Limits, 51 FR 31648, 31650 (Sept. 4, 1986). 81 In the case of reducing the risk of a location differential, and where each of the underlying transactions in separate derivative contracts may be in the same contract month, a position in a basis contract would not be subject to position limits, as discussed in connection with paragraph (3) of the proposed definition of ‘‘referenced contract.’’ 82 For example, in the case of a calendar spread, having both the unfixed-price sale and purchase in hand would set the timeframe for the calendar month spread being used as the hedge. PO 00000 Frm 00014 Fmt 4701 Sfmt 4702 the unfixed-price purchase or the unfixed-price sale (or absent both), it would be less clear how the transaction could be classified as a bona fide hedge, that is, a transaction that reduces price risk.83 This is not to say that an unfixedprice cash commodity purchase alone, or an unfixed-price cash commodity sale alone, could never be recognized as a bona fide hedge. Rather, an additional facts and circumstances analysis would be warranted in such cases. Further, upon fixing the price of, or taking delivery on, the purchase contract, the owner of the cash commodity may hold the short derivative leg of the spread as a hedge against a fixed-price purchase or inventory. However, the long derivative leg of the spread would no longer qualify as a bona fide hedging position, since the commercial entity has fixed the price or taken delivery on the purchase contract. Similarly, if the commercial entity first fixed the price of the sales contract, the long derivative leg of the spread may be held as a hedge against a fixed-price sale, but the short derivative leg of the spread would no longer qualify as a bona fide hedging position. Commercial entities in these circumstances thus may have to consider reducing certain positions in order to comply with the regulations proposed herein. (3) Short Hedges of Anticipated Mineral Royalties The Commission is proposing a new acceptable practice that is not currently enumerated in § 1.3 for short hedges of anticipated mineral royalties. The Commission previously adopted a similar provision as an enumerated hedge in part 151 in response to a request from commenters.84 The proposed provision would permit an owner of rights to a future royalty to lock in the price of anticipated mineral production by entering into a short position in excess of limits in a commodity derivative contract to offset the anticipated change in value of mineral royalty rights that are owned by that person and arise out of the production of a mineral commodity 83 In 2013, the Commission provided an example regarding this enumerated hedge: ‘‘The contemplated derivative positions will offset the risk that the difference in the expected delivery prices of the two unfixed-price cash contracts in the same commodity will change between the time the hedging transaction is entered and the time of fixing of the prices on the purchase and sales cash contracts. Therefore, the contemplated derivative positions are economically appropriate to the reduction of risk.’’ 2013 Proposal, 78 FR at 75715. 84 See 2011 Final Rulemaking, 76 FR at 71646. As noted above, part 151 was subsequently vacated. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules (e.g., oil and gas).85 The Commission preliminarily believes that this remains a common hedging practice, and that positions that satisfy the requirements of this acceptable practice would conform to the general definition of bona fide hedging without further consideration as to the particulars of the case. The Commission proposes to limit this acceptable practice to mineral royalties; the Commission preliminarily believes that while royalties have been paid for use of land in agricultural production, the Commission has not received any evidence of a need for a bona fide hedge recognition from owners of agricultural production royalties. The Commission requests comment on whether and why such an exemption might be needed for owners of agricultural production or other royalties. lotter on DSKBCFDHB2PROD with PROPOSALS3 (4) Hedges of Anticipated Services The Commission is proposing a new enumerated hedge that is not currently enumerated in the § 1.3 bona fide hedging definition for hedges of anticipated services. The Commission previously adopted a similar provision as an enumerated hedge in part 151 in response to a request from commenters.86 This enumerated hedge would recognize as a bona fide hedge a long or short derivatives position used to hedge the anticipated change in value of receipts or payments due or expected to be due under an executed contract for services arising out of the production, manufacturing, processing, use, or transportation of the commodity underlying the commodity derivative contract.87 The Commission preliminarily believes that this remains a common hedging practice, and that positions that satisfy the requirements of this acceptable practice would conform to the general definition of 85 A short position fixes the price of the anticipated receipts, removing exposure to change in value of the person’s share of the production revenue. A person who has issued a royalty, in contrast, has, by definition, agreed to make a payment in exchange for value received or to be received (e.g., the right to extract a mineral). Upon extraction of a mineral and sale at the prevailing cash market price, the issuer of a royalty remits part of the proceeds in satisfaction of the royalty agreement. The issuer of a royalty, therefore, does not have price risk arising from that royalty agreement. 86 See 2011 Final Rulemaking, 76 FR at 71646. As noted above, part 151 was subsequently vacated. 87 As the Commission previously stated, regarding a proposed hedge for services, ‘‘crop insurance providers and other agents that provide services in the physical marketing channel could qualify for a bona fide hedge of their contracts for services arising out of the production of the commodity underlying a [commodity derivative contract].’’ 2013 Proposal, 78 FR at 75716. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 bona fide hedging without further consideration as to the particulars of the case. (5) Cross-Commodity Hedges Paragraph (2)(iv) of the existing § 1.3 bona fide hedge definition enumerates the offset of cash purchases, sales, or purchases and sales with a commodity derivative other than the commodity that comprised the cash position(s).88 The Commission proposes to include this hedge in the enumerated hedges and expand its application such that cross-commodity hedges could be used to establish compliance with: Each of the proposed enumerated hedges listed in Appendix A to part 150; 89 and hedges in the proposed pass-through provisions under paragraph (2) of the proposed bona fide hedging definition discussed further below; provided, in each case, that the position satisfies each element of the relevant acceptable practice.90 This enumerated hedge is conditioned on the fluctuations in value of the position in the commodity derivative contract or of the underlying cash commodity being ‘‘substantially related’’ 91 to the fluctuations in value of the actual or anticipated cash position or pass-through swap. To be ‘‘substantially related,’’ the derivative and cash market position, which may be in different commodities, should have a 88 For example, existing paragraph (2)(iv) of the bona fide hedging definition recognizes as an enumerated hedge the offset of a cash-market position in one commodity, such as soybeans, through a derivatives position in a different commodity, such as soybean oil or soybean meal. 89 Specifically, for: (i) Hedges of unsold anticipated production, (ii) hedges of offsetting unfixed-price cash commodity sales and purchases, (iii) hedges of anticipated mineral royalties, (iv) hedges of anticipated services, (v) hedges of inventory and cash commodity fixed-price purchase contracts, (vi) hedges of cash commodity fixed-price sales contracts, (vii) hedges by agents, and (viii) offsets of commodity trade options, a crosscommodity hedge could be used to offset risks arising from a commodity other than the cash commodity underlying the commodity derivatives contract. 90 For example, an airline that wishes to hedge the price of jet fuel may enter into a swap with a swap dealer. In order to remain flat, the swap dealer may offset that swap with a futures position, for example, in ULSD. Subsequently, the airline may also offset the swap exposure using ULSD futures. In this example, under the pass-through swap language of proposed § 150.1, the airline would be acting as a bona fide hedging swap counterparty and the swap dealer would be acting as a passthrough swap counterparty. In this example, provided each element of the enumerated hedge in paragraph (a)(5) of Appendix A, the pass-through swap provision in § 150.1, and all other regulatory requirements are satisfied, the airline and swap dealer could each exceed limits in ULSD futures to offset their respective swap exposures to jet fuel. See infra Section II.A.1.c.v. (discussion of proposed pass-through language). 91 See proposed Appendix A to part 150. PO 00000 Frm 00015 Fmt 4701 Sfmt 4702 11609 reasonable commercial relationship.92 For example, there is a reasonable commercial relationship between grain sorghum, used as a food grain for humans or as animal feedstock, with corn underlying a derivative. There currently is not a futures contract for grain sorghum grown in the United States listed on a U.S. DCM, so corn represents a substantially related commodity to grain sorghum in the United States.93 In contrast, there does not appear to be a reasonable commercial relationship between a physical commodity, say copper, and a broad-based stock price index, such as the S&P 500 Index, because these commodities are not reasonable substitutes for each other in that they have very different pricing drivers. That is, the price of a physical commodity is based on supply and demand, whereas the stock price index is based on various individual stock prices for different companies. (6) Hedges of Inventory and Cash Commodity Fixed-Price Purchase Contracts Hedges of inventory and cashcommodity fixed-price purchase contracts are included in paragraph (2)(i)(A) of the existing § 1.3 bona fide hedge definition, and the Commission proposes to include them as an enumerated hedge with minor modifications. This proposed enumerated hedge acknowledges that a commercial enterprise is exposed to price risk (e.g., that the market price of the inventory could decrease) if it has obtained inventory in the normal course of business or has entered into a fixedprice spot or forward purchase contract calling for delivery in the physical marketing channel of a cash-market commodity (or a combination of the two), and has not offset that price risk. Any such inventory, or a fixed-price purchase contract, must be on hand, as opposed to a non-fixed purchase contract or an anticipated purchase. To satisfy the requirements of this particular enumerated hedge, a bona fide hedge would be to establish a short position in a commodity derivative contract to offset such price risk. An exchange may require such short position holders to demonstrate the ability to deliver against the short 92 Id. 93 Grain sorghum was previously listed for trading on the Kansas City Board of Trade and Chicago Mercantile Exchange, but because of liquidity issues, grain buyers continued to use the more liquid corn futures contract, which suggests that the basis risk between corn futures and cash sorghum could be successfully managed with the corn futures contract. E:\FR\FM\27FEP3.SGM 27FEP3 11610 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules position in order to demonstrate a legitimate purpose for holding a position deep into the spot month.94 (7) Hedges of Cash Commodity FixedPrice Sales Contracts This hedge is enumerated in paragraphs (2)(ii)(A) and (B) of the existing § 1.3 bona fide hedge definition, and the Commission proposes to maintain it as an enumerated hedge. This enumerated hedge acknowledges that a commercial enterprise is exposed to price risk (i.e., that the market price of a commodity might be higher than the price of a fixed-price sales contract for that commodity) if it has entered into a spot or forward fixed-price sales contract calling for delivery in the physical marketing channel of a cashmarket commodity, and has not offset that price risk. To satisfy the requirements of this particular enumerated hedge, a bona fide hedge would be to establish a long position in a commodity derivative contract to offset such price risk. (8) Hedges by Agents lotter on DSKBCFDHB2PROD with PROPOSALS3 This proposed enumerated hedge is included in paragraph (3) of the existing § 1.3 bona fide hedge definition as an example of a potential non-enumerated bona fide hedge. The Commission proposes to include this example as an enumerated hedge, with nonsubstantive modifications,95 because the Commission preliminarily believes that this is a common hedging practice, and that positions which satisfy the requirements of this enumerated hedge would conform to the general definition of bona fide hedging without further consideration as to the particulars of the case. This proposed provision would allow an agent who has the responsibility to trade cash commodities on behalf of another entity for which such positions would qualify as bona fide hedging positions to hedge those cash positions on a long or short basis. For example, an agent may trade on behalf of a farmer or a producer, or a government may wish to contract with a commercial firm to manage the government’s cash wheat inventory; in 94 For example, it would not appear to be economically appropriate to hold a short position in the spot month of a commodity derivative contract against fixed-price purchase contracts that provide for deferred delivery in comparison to the delivery period for the spot month commodity derivative contract. This is because the commodity under the cash contract would not be available for delivery on the commodity derivative contract. 95 For example, the Commission proposes to replace the phrase ‘‘offsetting cash commodity’’ with ‘‘contract’s underlying cash commodity’’ to use language that is consistent with the other proposed enumerated hedges. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 such circumstances, the agent or the commercial firm would not take ownership of the commodity it trades on behalf of the farmer, producer, or government, but would be an agent eligible for an exemption to hedge the risks associated with such cash positions. (9) Offsets of Commodity Trade Options The Commission is proposing a new enumerated hedge to recognize certain offsets of commodity trade options as a bona fide hedge. Under this proposed enumerated hedge, a commodity trade option meeting the requirements of § 32.3 96 of the Commission’s regulations 97 may be deemed a cash commodity fixed-price purchase or cash commodity fixed-price sales contract, as the case may be, provided that such option is adjusted on a futuresequivalent basis.98 Because the Commission proposes to include hedges of cash commodity fixed-price purchase contracts and hedges of cash commodity fixed-price sales contracts as enumerated hedges, the Commission also proposes to include hedges of commodity trade options as an enumerated hedge. (10) Hedges of Unfilled Anticipated Requirements This proposed enumerated hedge appears in paragraph (2)(ii)(C) of the existing § 1.3 bona fide hedge definition. The Commission proposes to include it as an enumerated hedge, with modification. To satisfy the requirements of this particular enumerated hedge, a bona fide hedge would be to establish a long position in a commodity derivative contract to 96 17 CFR 32.3. In order to qualify for the trade option exemption, § 32.3 requires, among other things, that: (1) The offeror is either (i) an eligible contract participant, as defined in section 1a(18) of the Act, or (ii) offering or entering into the commodity trade option solely for purposes related to its business as a ‘‘producer, processor, or commercial user of, or a merchant handling the commodity that is the subject of the’’ trade option; and (2) the offeree is offered or entering into the commodity trade option solely for purposes related to its business as ‘‘a producer, processor, or commercial user of, or a merchant handling the commodity that is the subject’’ of the commodity trade option. 97 17 CFR 32.3. 98 It may not be possible to compute a futuresequivalent basis for a trade option that does not have a fixed strike price. Thus, under this enumerated hedge, a market participant may not use a trade option as a basis for a bona fide hedging position until a fixed strike price reasonably may be determined. For example, a commodity trade option with a fixed strike price may be converted to a futures-equivalent basis, and, on that futuresequivalent basis, deemed a cash commodity sale contract, in the case of a short call option or long put option, or a cash commodity purchase contract, in the case of a long call option or short put option. PO 00000 Frm 00016 Fmt 4701 Sfmt 4702 offset the expected price risks associated with the anticipated future purchase of the cash-market commodity underlying the commodity derivative contract. Such unfilled anticipated requirements could include requirements for processing, manufacturing, use by that person, or resale by a utility to its customers.99 Consistent with the existing provision, for purposes of exchange-set limits, exchanges may wish to consider adopting rules providing that during the lesser of the last five days of trading (or such time period for the spot month), such positions must not exceed the person’s unfilled anticipated requirements of the underlying cash commodity for that month and for the next succeeding month.100 Any such quantity limitation may help prevent the use of long futures to source large quantities of the underlying cash commodity. The Commission preliminarily believes that the two-month limitation would allow for an amount of activity that is in line with common commercial hedging practices, without jeopardizing any statutory objectives. Although existing paragraph (2)(ii)(C) limits this enumerated hedge to twelvemonths’ unfilled anticipated requirements outside of the spot period, the Commission proposes to remove the twelve-month limitation because commenters have previously stated, and the Commission preliminarily believes, that there is a commercial need to hedge unfilled anticipated requirements for a time period longer than twelve months.101 (11) Hedges of Anticipated Merchandising The Commission is proposing a new enumerated hedge to recognize certain offsets of anticipated purchases or sales as a bona fide hedge. Under this proposed enumerated hedge, a merchant may establish a long or short position in 99 The proposed inclusion of unfilled anticipated requirements for resale by a utility to its customers does not appear in the existing § 1.3 bona fide hedging definition. This provision is analogous to the unfilled anticipated requirements provision of existing paragraph (2)(ii)(C) of the existing bona fide hedging definition, except the commodity is not for use by the same person (that is, the utility), but rather for anticipated use by the utility’s customers. This would recognize a bona fide hedging position where a utility is required or encouraged by its public utility commission to hedge. 100 This is essentially a less-restrictive version of the five-day rule, allowing a participant to hold a position during the end of the spot period if economically appropriate, but only up to two months’ worth of anticipated requirements. The two-month quantity limitation has long-appeared in existing § 1.3 as a measure to prevent the sourcing of massive quantities of the underlying in a short time period. 17 CFR 1.3. 101 See, e.g., 2016 Reproposal, 81 FR at 96751. E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules a commodity derivative contract to offset the anticipated change in value of the underlying commodity that the merchant anticipates purchasing or selling in the future. To safeguard against misuse, the enumerated hedge would be subject to certain conditions. First, the commodity derivative position must not exceed in quantity twelve months’ of purchase or sale requirements of the same commodity that is anticipated to be merchandised. This requirement is intended to ensure that merchants are hedging their anticipated merchandising exposure to the value change of the underlying commodity, while calibrating the anticipated need within a reasonable timeframe and the limitations in physical commodity markets, such as annual production or processing capacity. Unlike in the enumerated hedge for unsold anticipated production, where the Commission is proposing to eliminate the twelvemonth limitation, the Commission has preliminarily determined that a twelvemonth limitation for anticipatory merchandising is suitable in connection with contracts that are based on anticipated activity on yet-to-be established cash positions due to the uncertainty of forecasting such activity and, all else being equal, the increased risk of excessive speculation on the price of a commodity the longer the time period before the actual need arises. Second, the Commission is proposing to limit this enumerated hedge to merchants who are in the business of purchasing and selling the underlying commodity that is anticipated to be merchandised, and who can demonstrate that it is their historical practice to do so. Such demonstrated history should include a history of making and taking delivery of the underlying commodity, and a demonstration of an ability to store and move the underlying commodity. The Commission has a longstanding practice of providing exemptive relief to commercial market participants to enable physical commodity markets to continue to be well-functioning markets. The proposed anticipatory merchandising hedge requires that the person be a merchant handling the underlying commodity that is subject to the anticipatory merchandising hedge and that such merchant is entering into the anticipatory merchandising hedge solely for purposes related to its merchandising business. A merchandiser that lacks the requisite history of anticipatory merchandising activity could still potentially receive VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 bona fide hedge recognition under the proposed non-enumerated process, so long as the merchandiser can otherwise show activities in the physical marketing channel, including, for example, arrangements to take or make delivery of the underlying commodity. The Commission preliminarily believes that anticipated merchandising is a hedging practice commonly used by some commodity market participants, and that merchandisers play an important role in the physical supply chain. Positions which satisfy the requirements of this acceptable practice would thus conform to the general definition of bona fide hedging. While each of the proposed enumerated hedges described above would be self-effectuating for purposes of federal limits, the Commission and the exchanges would continue to exercise close oversight over such positions to confirm that market participants’ claimed exemptions are consistent with their cash-market activity. In particular, because all contracts subject to federal limits would also be subject to exchange-set limits, all traders seeking to exceed federal position limits would have to request an exemption from the relevant exchange for purposes of the exchange limit, regardless of whether the position falls within one of the enumerated hedges. In other words, enumerated bona fide hedge recognitions that are selfeffectuating for purposes of federal limits would not be self-effectuating for purposes of exchange limits. Exchanges have well-established programs for granting exemptions, including, in some cases, experience granting exemptions for anticipatory merchandising for certain traders in markets not currently subject to federal limits. As discussed in greater detail below, proposed § 150.5 102 would ensure that such programs require, among other things, that: Exemption applications filed with an exchange include sufficient information to enable the exchange to determine, and the Commission to verify, whether the exchange may grant the exemption, including an indication of whether the position qualifies as an enumerated hedge for purposes of federal limits and a description of the applicant’s activity in the underlying cash markets; and that the exchange provides the Commission with a monthly report showing the disposition of all exemption applications, including cash market information justifying the exemption. The Commission expects exchanges will 102 See infra Section II.D.4. (discussion of proposed § 150.5). PO 00000 Frm 00017 Fmt 4701 Sfmt 4702 11611 be thoughtful and deliberate in granting exemptions, including anticipatory exemptions. The Commission and the exchanges also have a variety of other tools designed to help prevent misuse of selfeffectuating exemptions. For example, market participants who submit an application to an exchange as required under § 150.5 would be subject to the Commission’s false statements authority that carries with it substantial penalties under both the CEA and federal criminal statutes.103 Similarly, the Commission can use surveillance tools, special call authority, rule enforcement reviews, and other formal and informal avenues for obtaining additional information from exchanges and market participants in order to distinguish between true hedging needs and speculative trading masquerading as a bona fide hedge. In the 2013 Proposal, the Commission previously addressed a petition for exemptive relief for 10 transactions described as bona fide hedging transactions by the Working Group of Commercial Energy Firms (which has since reconstituted itself as the ‘‘Commercial Energy Working Group’’) (‘‘BFH Petition’’).104 In the 2013 Proposal, the Commission included examples Nos. 1, 2, 6, 7 (scenario 1), and 8 as being permitted under the proposed definition of bona fide hedging. With respect to the rules proposed herein, the Commission has preliminarily determined that example #4 (binding, irrevocable bids or offers) and #5 (timing of hedging physical transactions) from the BFH Petition potentially fit within the proposed Appendix A paragraph (a)(11) enumerated hedge of anticipatory merchandising, so long as the transaction complies with each condition of that proposed enumerated hedge. In addition, as discussed further below, because the Commission is also proposing to eliminate the five-day rule from the enumerated hedges to which the five-day rule currently applies, the Commission has preliminarily determined that example #9 (holding a cross-commodity hedge using a physical delivery contract into the spot month) and #10 (holding a cross-commodity hedge using a physical delivery contract to meet unfilled anticipated 103 CEA section 6(c)(2), 7 U.S.C. 9(2); CEA section 9(a)(3), 7 U.S.C. 13(a)(3); CEA section 9(a)(4), 7 U.S.C. 13(a)(4); 18 U.S.C. 1001. 104 The Working Group BFH Petition is available at https://www.cftc.gov/stellent/groups/public/@ rulesandproducts/documents/ifdocs/wgbfhpetition 012012.pdf. E:\FR\FM\27FEP3.SGM 27FEP3 11612 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules requirements) from the BFH Petition potentially fit within the proposed Appendix A paragraph (a)(5) enumerated hedge, so long as the transaction otherwise complies with the additional conditions of all applicable enumerated hedges and other requirements. Regarding examples #3 (unpriced physical purchase or sale commitments) and #7 (scenario 2) (use of physical delivery referenced contracts to hedge physical transactions using calendar month average pricing), while the Commission has preliminarily determined that the positions described within those examples do not fit within any of the proposed enumerated hedges, market participants seeking bona fide hedge recognition for such positions may apply for a non-enumerated recognition under proposed §§ 150.3 or 150.9, and a facts and circumstances decision would be made.105 As included in the request for comment on this section, the Commission requests additional information on the scenarios listed above, particularly for the positions that the Commission preliminarily views as falling outside the proposed list of enumerated hedges. lotter on DSKBCFDHB2PROD with PROPOSALS3 iv. Elimination of a Federal Five Day Rule Under the existing bona fide hedging definition in § 1.3, to help protect orderly trading and the integrity of the physical-delivery process, certain enumerated hedging positions in physical-delivery contracts are not recognized as bona fide hedges that may exceed limits when the position is held during the last five days of trading during the spot month. The goal of the five-day rule is to help ensure that only those participants who actually intend to make or take delivery maintain positions toward the end of the spot period.106 When the Commission adopted the five-day rule, it believed that, as a general matter, there is little commercial need to maintain such positions in the last five days.107 However, persons wishing to exceed position limits during the five last 105 Similarly, other examples of anticipatory merchandising that have been described to the Commission in response to request for comment on proposed rulemakings on position limits (i.e., the storage hedge and hedges of assets owned or anticipated to be owned) would be the type of transactions that market participants may seek through one of the proposed processes for requesting a non-enumerated bona fide hedge recognition. 106 Paragraphs (2)(i)(B), (ii)(C), (iii), and (iv) of the existing § 1.3 bona fide hedging definition are subject to some form of the five-day rule. 107 Definition of Bona Fide Hedging and Related Reporting Requirements, 42 FR 42748, 42750 (Aug. 24, 1977). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 trading days could submit materials supporting a classification of the position as a bona fide hedge, based on the particular facts and circumstances.108 The Commission has viewed the fiveday rule as an important way to help ensure that futures and cash-market prices converge and to prevent excessive speculation as a physicaldelivery contract nears expiration, thereby protecting the integrity of the delivery process and the price discovery function of the market, and deterring or preventing types of market manipulations such as corners and squeezes. The enumerated hedges currently subject to the five-day rule are either: (i) Anticipatory in nature; or (ii) involve a situation where there is no need to make or take delivery. The Commission has historically questioned the need for such positions in excess of limits to be held into the spot period if the participant has no immediate plans and/or need to make or take delivery in the few remaining days of the spot period.109 While the Commission continues to believe that the justifications described above for the existing five-day rule remain valid, the Commission has preliminarily determined that for contracts subject to federal limits, the exchanges, subject to Commission oversight, are better positioned to decide whether to apply the five-day rule in connection with their own exchange-set limits, or whether to apply other tools that may be equally effective. Accordingly, consistent with this proposal’s focus on leveraging existing exchange practices and expertise when appropriate, the Commission proposes to eliminate the five-day rule from the enumerated hedges to which the fiveday rule currently applies, and instead to afford exchanges with the discretion to apply, and when appropriate, waive the five-day rule (or similar restrictions) for purposes of their own limits. Allowing for such discretion will afford exchanges flexibility to quickly impose, modify, or waive any such limitation as circumstances dictate. While a strict five day rule may be inappropriate in certain circumstances, including when applied to energy contracts that typically have a shorter spot period than agricultural contracts,110 the flexible approach allowed for herein may allow for the development and implementation of 108 Id. 109 See, e.g., 42 FR at 42749. contracts typically have a three-day spot period, whereas the spot period for agricultural contracts is typically two weeks. 110 Energy PO 00000 Frm 00018 Fmt 4701 Sfmt 4702 additional solutions other than a fiveday rule that protect convergence while minimizing the impact on market participants. The proposed approach would allow exchanges to design and tailor a variety of limitations to protect convergence during the spot period. For example, in certain circumstances, a smaller quantity restriction, rather than a complete restriction on holding positions in excess of limits during the spot period, may be effective at protecting convergence. Similarly, exchanges currently utilize other tools to achieve similar policy goals, such as by requiring market participants to ‘‘step down’’ the levels of their exemptions as they approach the spot period, or by establishing exchange-set speculative position limits that include a similar step down feature. As proposed § 150.5(a) would require that any exchange-set limits for contracts subject to federal limits must be less than or equal to the federal limit, any exchange application of the five day rule, or a similar restriction, would have the same effect as if administered by the Commission for purposes of federal speculative position limits. The Commission expects that exchanges would closely scrutinize any participant who requests a recognition during the last five days of the spot period or in the time period for the spot month. To assist exchanges that wish to establish a five-day rule, or a similar provision, the Commission proposes guidance in paragraph (b) of Appendix B that would set forth circumstances when a position held during the spot period may still qualify as a bona fide hedge. The guidance would provide that a position held during the spot period may still qualify as a bona fide hedging position, provided that, among other things: (1) The position complies with the bona fide hedging definition; and (2) there is an economically appropriate need to maintain such position in excess of federal speculative position limits during the spot period, and that need relates to the purchase or sale of a cash commodity.111 In addition, the guidance would provide that the person wishing to exceed federal position limits during the spot period: (1) Intends to make or take delivery during that period; (2) provides materials to the exchange supporting the waiver of the five-day rule; (3) 111 For example, an economically appropriate need for soybeans would mean obtaining soybeans from a reasonable source (considering the marketplace) that is the least expensive, at or near the location required for the purchaser, and that such sourcing does not cause market disruptions or prices to spike. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules demonstrates supporting cash-market exposure in-hand that is verified by the exchange; (4) demonstrates that, for short positions, the delivery is feasible, meaning that the person has the ability to deliver against the short position; 112 and (5) demonstrates that, for long positions, the delivery is feasible, meaning that the person has the ability to take delivery at levels that are economically appropriate.113 This proposed guidance is intended to include a non-exclusive list of considerations for determining whether to waive a five-day rule established at the discretion of an exchange. v. Guidance on Measuring Risk lotter on DSKBCFDHB2PROD with PROPOSALS3 In prior proposals involving position limits, the Commission discussed the issue of whether the Commission may recognize as bona fide both ‘‘gross hedging’’ and ‘‘net hedging.’’ 114 Such attempts reflected the Commission’s longstanding preference for net hedging, which, although not stated explicitly in prior releases, has been underpinned by a concern that unfettered recognition of gross hedging could potentially allow for the cherry picking of positions in a manner that subverts the position limits rules.115 In an effort to clarify its current view on this issue, the Commission proposes guidance in paragraph (a) to Appendix B. The Commission is of the preliminary view that there are myriad ways in which organizations are structured and engage in commercial hedging practices, including the use of multi-line business strategies in certain industries that would be subject to federal limits for the first time under this proposal. Accordingly, the Commission does not propose a one-size-fits-all approach to the manner in which risk is measured across an organization. The proposed guidance reflects the Commission’s historical practice of recognizing positions hedged on a net 112 That is, the person has inventory on-hand in a deliverable location and in a condition in which the commodity can be used upon delivery. 113 That is, the delivery comports with the person’s demonstrated need for the commodity, and the contract is the cheapest source for that commodity. 114 Id. at 96747. 115 For example, using gross hedging, a market participant could potentially point to a large long cash position as justification for a bona fide hedge, even though the participant, or an entity with which the participant is required to aggregate, has an equally large short cash position that would result in the participant having no net price risk to hedge as the participant had no price risk exposure to the commodity prior to establishing such derivative position. Instead, the participant created price risk exposure to the commodity by establishing the derivative position. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 basis as bona fide; 116 however, as the Commission has also previously allowed, the proposed guidance also may in certain circumstances allow for the recognition of gross hedging as bona fide, provided that: (1) The manner in which the person measures risk is consistent over time and follows a person’s regular, historical practice 117 (meaning the person is not switching between net hedging and gross hedging on a selective basis simply to justify an increase in the size of his/her derivatives positions); (2) the person is not measuring risk on a gross basis to evade the limits set forth in proposed § 150.2 and/or the aggregation rules currently set forth in § 150.4; (3) the person is able to demonstrate (1) and (2) to the Commission and/or an exchange upon request; and (4) an exchange that recognizes a particular gross hedging position as a bona fide hedge pursuant to proposed § 150.9 documents the justifications for doing so and maintains records of such justifications in accordance with proposed § 150.9(d). The Commission continues to believe that a gross hedge may be a bona fide hedge in circumstances where net cash positions do not necessarily measure total risk exposure due to differences in the timing of cash commitments, the location of stocks, and differences in grades or types of the cash commodity.118 However, the Commission clarifies that these may not be the only circumstances in which gross hedging may be recognized as 116 See 2016 Reproposal, 81 FR at 96747 (stating that gross hedging was economically appropriate in circumstances where ‘‘net cash positions do not necessarily measure total risk exposure due to differences in the timing of cash commitments, the location of stocks, and differences in grades or the types of cash commodity.’’) See also Bona Fide Hedging Transactions or Positions, 42 FR at 14832, 14834 (Mar. 16, 1977) and Definition of Bona Fide Hedging and Related Reporting Requirements, 42 FR 42748, 42750 (Aug. 24, 1977). 117 This proposed guidance on measuring risk is consistent in many ways with the manner in which the exchanges require their participants to measure and report risk, which is consistent with the Commission’s requirements with respect to the reporting of risk. For example, under § 17.00(d), futures commission merchants (‘‘FCMs’’), clearing members, and foreign brokers are required to report certain reportable net positions, while under § 17.00(e), such entities may report gross positions in certain circumstances, including if the positions are reported to an exchange or the clearinghouse on a gross basis. 17 CFR 17.00. The Commission’s understanding is that certain exchanges generally prefer, but do not require, their participants to report positions on a net basis. For those participants that elect to report positions on a gross basis, such exchanges require such participants to continue reporting that way, particularly through the spot period. The Commission preliminarily believes that such consistency is a strong indicator that the participant is not measuring risk on a gross basis simply to evade regulatory requirements. 118 See, e.g., Bona Fide Hedging Transactions or Positions, 42 FR at 14834. PO 00000 Frm 00019 Fmt 4701 Sfmt 4702 11613 bona fide. Like the analysis of whether a particular position satisfies the proposed bona fide hedge definition, the analysis of whether gross hedging may be utilized would involve a case-by-case determination made by the Commission and/or by an exchange using its expertise and knowledge of its participants as it considers applications under § 150.9, subject to Commission review and oversight. The Commission believes that permitting market participants with bona fide hedges to use either or both gross or net hedging will help ensure that market participants are able to hedge efficiently. Large, complex entities may have hedging needs that cannot be efficiently and effectively met with either gross or net hedging. For instance, some firms may hedge on a global basis while others may hedge by trading desk or business line. Some risks that appear offsetting may in fact need to be treated separately where a difference in delivery location or date makes net hedging of those positions inappropriate. To prevent ‘‘cherry-picking’’ when determining whether to gross or net hedge certain risks, hedging entities should have policies and procedures setting out when gross and net hedging is appropriate. Consistent usage of appropriate gross and/or net hedging in line with such policies and procedures can demonstrate compliance with the Commission’s regulations. On the other hand, usage of gross or net hedging that is inconsistent with an entity’s policies or a change from gross to net hedging (or vice versa) could be an indication that an entity is seeking to evade position limits regulations. vi. Pass-Through Provisions As the Commission has noted above, CEA section 4a(c)(2)(B) 119 further contemplates bona fide hedges that by themselves do not meet the criteria of CEA section 4a(c)(2)(A), but that are executed by a pass-through swap counterparty opposite a bona fide hedging swap counterparty, or used by a bona fide hedging swap counterparty to offset its swap exposure that does satisfy CEA section 4a(c)(2)(A).120 The 119 7 U.S.C. 6a(c)(2)(B). section 4a(c)(2)(B)(i) recognizes as a bona fide hedging position a position that reduces risk attendant to a position resulting from a swap that was executed opposite a counterparty for which the transaction would qualify as a bona fide hedging transaction pursuant to 4a(c)(2)(A). 7 U.S.C. 6a(c)(2)(B)(i). CEA section 4a(c)(2)(B)(ii) further recognizes as bona fide positions that reduce risks attendant to a position resulting from a swap that meets the requirements of 4a(c)(2)(A). 7 U.S.C. 6a(c)(2)(B)(ii). 120 CEA E:\FR\FM\27FEP3.SGM 27FEP3 11614 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 Commission preliminarily believes that, in affording bona fide hedging recognition to positions used to offset exposure opposite a bona fide hedging swap counterparty, Congress in CEA section 4a(c)(2)(B) intended: (1) To encourage the provision of liquidity to commercial entities that are hedging physical commodity price risk in a manner consistent with the bona fide hedging definition; but also (2) to prohibit risk management positions that are not opposite a bona fide hedging swap counterparty from being recognized as bona fide hedges.121 The Commission proposes to implement this pass-through swap language in paragraph (2) of the bona fide hedging definition for physical commodities in proposed § 150.1. Each component of the proposed passthrough swap provision is described in turn below. Proposed paragraph (2)(i) of the bona fide hedging definition would address a situation where a particular swap qualifies as a bona fide hedge by satisfying the temporary substitute test, economically appropriate test, and change in value requirement under proposed paragraph (1) for one of the counterparties (the ‘‘bona fide hedging swap counterparty’’), but not for the other counterparty, and where those bona fides ‘‘pass through’’ from the bona fide hedging swap counterparty to the other counterparty (the ‘‘pass-through swap counterparty’’). The pass-through swap counterparty could be an entity such as a swap dealer, for example, that provides liquidity to the bona fide hedging swap counterparty. Under the proposed rule, the passthrough of the bona fides from the bona fide hedging swap counterparty to the pass-through swap counterparty would be contingent on: (1) The pass-through swap counterparty’s ability to demonstrate that the pass-through swap is a bona fide hedge upon request from the Commission and/or from an exchange; 122 and (2) the pass-through 121 As described above, the Commission has preliminarily interpreted the revised statutory temporary substitute test as limiting its authority to recognize risk management positions as bona fide hedges unless the position is used to offset exposure opposite a bona fide hedging swap counterparty. 122 While proposed paragraph (2)(i) of the bona fide hedging definition in § 150.1 would require the pass-through swap counterparty to be able to demonstrate the bona fides of the pass-through swap upon request, the proposed rule would not prescribe the manner by which the pass-through swap counterparty obtains the information needed to support such a demonstration. The pass-through swap counterparty could base such a demonstration on a representation made by the bona fide hedging swap counterparty, and such determination may be made at the time when the parties enter into the VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 swap counterparty entering into a futures, option on a futures, or swap position in the same physical commodity as the pass-through swap to offset and reduce the price risk attendant to the pass-through swap. If the two conditions above are satisfied, then the bona fides of the bona fide hedging swap counterparty ‘‘pass through’’ to the pass-through swap counterparty for purposes of recognizing as a bona fide hedge any futures, options on futures, or swap position entered into by the pass-through swap counterparty to offset the pass-through swap (i.e. to offset the swap opposite the bona fide hedging swap counterparty). The pass-through swap counterparty could thus exceed federal limits for the bona fide hedge swap opposite the bona fide hedging swap counterparty and for any offsetting futures, options on futures, or swap position in the same physical commodity, even though any such position on its own would not qualify as a bona fide hedge for the passthrough swap counterparty under proposed paragraph (1). Proposed paragraph (2)(ii) of the bona fide hedging definition would address a situation where a participant who qualifies as a bona fide hedging swap counterparty (i.e., a counterparty with a position in a previously-entered into swap that qualified, at the time the swap was entered into, as a bona fide hedge under paragraph (1)) seeks, at some later time, to offset that bona fide hedge swap position using futures, options on futures, or swaps in excess of limits. Such step might be taken, for example, to respond to a change in the bona fide hedging swap counterparty’s risk exposure in the underlying commodity.123 Proposed paragraph (2)(ii) would allow such a bona fide hedging swap counterparty to use futures, options on futures, or swaps in excess of federal limits to offset the price risk of the previously-entered into swap, even though the offsetting position itself does not qualify for that participant as a bona fide hedge under paragraph (1). The proposed pass-through exemption under paragraph (2) would only apply to the pass-through swap counterparty’s offset of the bona fide hedging swap, and/or to the bona fide swap, or at some later point. For the bona fides to pass-through as described above, the swap position need only qualify as a bona fide hedging position at the time the swap was entered into. 123 Examples of a change in the bona fide hedging swap counterparty’s cash market price risk could include a change in the amount of the commodity that the hedger will be able to deliver due to drought, or conversely, higher than expected yield due to growing conditions. PO 00000 Frm 00020 Fmt 4701 Sfmt 4702 hedging swap counterparty’s offset of its bona fide hedging swap. Any further offsets would not be eligible for a passthrough exemption under (2) unless the offsets themselves meet the bona fide hedging definition. For instance, if Producer A enters into an OTC swap with Swap Dealer B, and the OTC swap qualifies as a bona fide hedge for Producer A, then Swap Dealer B could be eligible for a pass-through exemption to offset that swap in the futures market. However, if Swap Dealer B offsets its swap opposite Producer A using an OTC swap with Swap Dealer C, Swap Dealer C would not be eligible for a passthrough exemption. As discussed more fully above, the pass-through swap provision may help mitigate some of the potential impact resulting from the removal of the ‘‘risk management’’ exemptions that are currently in effect.124 2. ‘‘Commodity Derivative Contract’’ The Commission proposes to create the defined term ‘‘commodity derivative contract’’ for use throughout part 150 of the Commission’s regulations as shorthand for any futures contract, option on a futures contract, or swap in a commodity (other than a security futures product as defined in CEA section 1a(45)). 3. ‘‘Core Referenced Futures Contract’’ The Commission proposes to provide a list of 25 futures contracts in proposed § 150.2(d) to which proposed position limit rules would apply. The Commission proposes the term ‘‘core referenced futures contract’’ as a shorthand phrase to denote such contracts.125 As per the ‘‘referenced contract’’ definition described below, position limits would also apply to any contract that is directly/indirectly linked to, or that has certain pricing relationships with, a core referenced futures contract. 4. ‘‘Economically Equivalent Swap’’ CEA section 4a(a)(5) requires that when the Commission imposes limits on futures and options on futures pursuant to CEA section 4a(a)(2), the Commission also establish limits simultaneously for ‘‘economically equivalent’’ swaps ‘‘as appropriate.’’ 126 124 See supra Section II.A.1.c.ii.(1) (discussion of the temporary substitute test). 125 The selection of the proposed core referenced futures contracts is explained below in the discussion of proposed § 150.2. 126 CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5). In addition, CEA section 4a(a)(4) separately authorizes, but does not require, the Commission to impose federal limits on swaps that meet certain statutory criteria qualifying them as ‘‘significant price discovery function’’ swaps. 7 U.S.C. 6a(a)(4). The Commission reiterates, for the avoidance of E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 As the statute does not define the term ‘‘economically equivalent,’’ the Commission must apply its expertise in construing such term, and, as discussed further below, must do so consistent with the policy goals articulated by Congress, including in CEA sections 4a(a)(2)(C) and 4a(a)(3). Under the Commission’s proposed definition of an ‘‘economically equivalent swap,’’ a swap on any referenced contract (including core referenced futures contracts), except for natural gas referenced contracts, would qualify as ‘‘economically equivalent’’ with respect to that referenced contract so long as the swap shares identical ‘‘material’’ contractual specifications, terms, and conditions with the referenced contract, disregarding any differences with respect to: (i) Lot size or notional amount, (ii) delivery dates diverging by less than one calendar day (if the swap and referenced contract are physically-settled), or (iii) post-trade risk management arrangements.127 For reasons described further below, natural gas swaps would qualify as economically equivalent with respect to a particular referenced contract under the same circumstances, except that physically-settled swaps with delivery dates diverging by less than two calendar days, rather than one calendar day, could qualify as economically equivalent. In promulgating the position limits framework, Congress instructed the Commission to consider several factors: First, CEA section 4a(a)(3) requires the Commission when establishing federal limits, to the maximum extent practicable, in its discretion, to (i) diminish, eliminate, or prevent excessive speculation; (ii) deter and prevent market manipulation, squeezes, and corners; (iii) ensure sufficient market liquidity for bona fide hedgers; and (iv) ensure that the price discovery function of the underlying market is not disrupted. Second, CEA section doubt, that the definitions of ‘‘economically equivalent’’ in CEA section 4a(a)(5) and ‘‘significant price discovery function’’ in CEA section 4a(a)(4) are separate concepts and that contracts can be economically equivalent without serving a significant price discovery function. See 2016 Reproposal, 81 FR at 96736 (the Commission noting that certain commenters may have been confusing the two definitions). 127 The proposed ‘‘economically equivalent’’ language is distinct from the terms ‘‘futures equivalent,’’ ‘‘economically appropriate,’’ and other similar terms used in the Commission’s regulations. For the avoidance of doubt, the Commission’s proposed definition of ‘‘economically equivalent swap’’ for the purposes of CEA section 4a(a)(5) does not impact the application of any such other terms as they appear in part 20 of the Commission’s regulations, in the Commission’s proposed bona fide hedge definition, or elsewhere. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 4a(a)(2)(C) requires the Commission to strive to ensure that any limits imposed by the Commission will not cause price discovery in a commodity subject to federal limits to shift to trading on a foreign exchange. Accordingly, any definition of ‘‘economically equivalent swap’’ must consider these statutory objectives. The Commission also recognizes that physical commodity swaps are largely bilaterally negotiated, traded offexchange (i.e., OTC), and potentially include customized (i.e., ‘‘bespoke’’) terms, while futures contracts are exchange traded with standardized terms. As explained further below, due to these differences between swaps and exchange-traded futures and options, the Commission has preliminarily determined that Congress’s underlying policy goals in CEA section 4a(a)(2)(C) and (3) are best achieved by proposing a narrow definition of ‘‘economically equivalent swaps,’’ compared to the broader definition of ‘‘referenced contract’’ the Commission is proposing to apply to look-alike futures and related options.128 The Commission’s proposed ‘‘referenced contract’’ definition in § 150.1 would include ‘‘economically equivalent swaps,’’ meaning any economically equivalent swap would be subject to federal limits, and thus would be required to be added to, and could be netted against, as applicable, other referenced contracts in the same commodity for the purpose of determining one’s aggregate positions for federal position limit levels.129 Any swap that is not deemed economically equivalent would not be a referenced contract, and thus could not be netted with referenced contracts nor would be required to be aggregated with any referenced contract for federal position limits purposes. The proposed 128 The proposed definition of ‘‘referenced contract’’ would incorporate cash-settled look-alike futures contracts and related options that are either (i) directly or indirectly linked, including being partially or fully settled on, or priced at a fixed differential to, the price of that particular core referenced futures contract; or (ii) directly or indirectly linked, including being partially or fully settled on, or priced at a fixed differential to, the price of the same commodity underlying that particular core referenced futures contract for delivery at the same location or locations as specified in that particular core referenced futures contract. See infra Section II.A.16. (definition of ‘‘referenced contract’’). The proposed definition of ‘‘economically equivalent swap’’ would be included as a type of ‘‘referenced contract,’’ but, as discussed herein, would include a relatively narrower class of swaps compared to look-alike futures and options contracts, for the reasons discussed below. 129 See infra Section II.B.2.k. (discussion of netting). PO 00000 Frm 00021 Fmt 4701 Sfmt 4702 11615 definition is based on a number of considerations. First, the proposed definition would support the statutory objectives in CEA section 4a(a)(3)(i) and (ii) by helping to prevent excessive speculation and market manipulation, including corners and squeezes, by: (1) Focusing on swaps that are the most economically equivalent in every significant way to futures or options on futures for which the Commission deems position limits to be necessary; 130 and (2) simultaneously limiting the ability of speculators to obtain excessive positions through netting. Any swap that meets the proposed definition would offer identical risk sensitivity to its associated referenced futures or options on futures contract with respect to the underlying commodity, and thus could be used to effect a manipulation, benefit from a manipulation, or otherwise potentially distort prices in the same or similar manner as the associated futures or options on futures contract. Because OTC swaps are bilaterally negotiated and customizable, the Commission has preliminarily determined not to propose a more inclusive ‘‘economically equivalent swap’’ definition that would encompass additional swaps because such definition could make it easier for market participants to inappropriately net down against their core referenced futures contracts by allowing market participants to structure swaps that do not necessarily offer identical risk or economic exposure or sensitivity. In contrast, the Commission preliminarily believes that this is less of a concern with exchange-traded futures and related options since these instruments have standardized terms and are subject to exchange rules and oversight. As a result, the proposal would generally allow market participants to net certain positions in referenced contracts in the same commodity across economically equivalent swaps, futures, and options on futures, but the proposed economically equivalent swap definition would focus on swaps with identical material terms and conditions in order to reduce the ability of market participants to accumulate large, speculative positions in excess of federal limits by using tangentiallyrelated (i.e., non-identical) swaps to net down such positions. Second, the proposed definition would address statutory objectives by focusing federal limits on those swaps that pose the greatest threat for facilitating corners and squeezes—that is, those swaps with similar delivery 130 See E:\FR\FM\27FEP3.SGM infra Section III.F. (necessity finding). 27FEP3 11616 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 dates and identical material economic terms to futures and options on futures subject to federal limits—while also minimizing market impact and liquidity for bona fide hedgers by not unnecessarily subjecting other swaps to the new federal framework. For example, if the Commission were to adopt an alternative definition of economically equivalent swap that encompassed a broader range of swaps by including delivery dates that diverge by one or more calendar days—perhaps by several days or weeks—a speculator with a large portfolio of swaps may be more likely to be constrained by the applicable position limits and therefore may have an incentive either to minimize its swaps activity, or move its swaps activity to foreign jurisdictions. If there were many similarly situated speculators, the market for such swaps could become less liquid, which in turn could harm liquidity for bona fide hedgers. As a result, the Commission has preliminarily determined that the proposed definition’s relatively narrow scope of swaps reasonably balances the factors in CEA section 4a(a)(3)(B)(ii) and (iii) by decreasing the possibility of illiquid markets for bona fide hedgers on the one hand while, on the other hand, focusing on the prevention of market manipulation during the most sensitive period of the spot month as discussed above. Third, the proposed definition would help prevent regulatory arbitrage and would strengthen international comity. If the Commission proposed a definition that captured a broader range of swaps, U.S.-based swaps activity could potentially migrate to other jurisdictions with a narrower definition, such as the European Union (‘‘EU’’). In this regard, the proposed definition is similar in certain ways to the EU definition for OTC contracts that are ‘‘economically equivalent’’ to commodity derivatives traded on an EU trading venue.131 The 131 See EU Commission Delegated Regulation (EU) 2017/591, 2017 O.J. (L 87). The applicable European regulations define an OTC derivative to be ‘‘economically equivalent’’ when it has ‘‘identical contractual specifications, terms and conditions, excluding different lot size specifications, delivery dates diverging by less than one calendar day and different post trade risk management arrangements.’’ While the Commission’s proposed definition is similar, the Commission’s proposed definition requires ‘‘identical material’’ terms rather than ‘‘identical’’ terms. Further, the Commission’s proposed definition excludes different ‘‘lot size specifications or notional amounts’’ rather than referencing only ‘‘lot size’’ since swaps terminology usually refers to ‘‘notional amounts’’ rather than to ‘‘lot sizes.’’ Both the Commission’s definition and the applicable EU regulation are intended to prevent harmful netting. See European Securities and Markets Authority, Draft Regulatory Technical Standards on Methodology for Calculation and the VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 proposed definition of economically equivalent swaps thus furthers statutory goals, including those set forth in CEA section 4a(a)(2)(C), which requires the Commission to strive to ensure that any federal position limits are ‘‘comparable’’ to foreign exchanges and will not cause ‘‘price discovery . . . to shift to trading’’ on foreign exchanges.132 Further, market participants trading in both U.S. and EU markets should find the proposed definition to be familiar, which may help reduce compliance costs for those market participants that already have systems and personnel in place to identify and monitor such swaps. Each element of the proposed definition, as well as the proposed exclusions from the definition, is described below. a. Scope of Identical Material Terms Only ‘‘material’’ contractual specifications, terms, and conditions would be relevant to the analysis of whether a particular swap would qualify as an economically equivalent swap. The proposed definition would thus not require that a swap be identical in all respects to a referenced contract in order to be deemed ‘‘economically equivalent.’’ ‘‘Material’’ specifications, terms, and conditions would be limited to those provisions that drive the economic value of a swap, including with respect to pricing and risk. Examples of ‘‘material’’ provisions would include, for example: The underlying commodity, including commodity reference price and grade differentials; maturity or termination Application of Position Limits for Commodity Derivatives Traded on Trading Venues and Economically Equivalent OTC Contracts, ESMA/ 2016/668 at 10 (May 2, 2016), available at https:// www.esma.europa.eu/sites/default/files/library/ 2016–668_opinion_on_draft_rts_21.pdf (‘‘[D]rafting the [economically equivalent OTC swap] definition in too wide a fashion carries an even higher risk of enabling circumvention of position limits by creating an ability to net off positions taken in onvenue contracts against only roughly similar OTC positions.’’). The applicable EU regulator, the European Securities and Markets Authority (‘‘ESMA’’), recently released a ‘‘consultation paper’’ discussing the status of the existing EU position limits regime and specific comments received from market participants. According to ESMA, no commenter, with one exception, supported changing the definition of an economically equivalent swap (referred to as an ‘‘economically equivalent OTC contract’’ or ‘‘EEOTC’’). ESMA further noted that for some respondents, ‘‘the mere fact that very few EEOTC contracts have been identified is no evidence that the regime is overly restrictive.’’ See European Securities and Markets Authority, Consultation Paper MiFID Review Report on Position Limits and Position Management Draft Technical Advice on Weekly Position Reports, ESMA70–156–1484 at 46, Question 15 (Nov. 5, 2019), available at https://www.esma.europa.eu/ document/consultation-paper-position-limits. 132 7 U.S.C. 6a(a)(2)(C). PO 00000 Frm 00022 Fmt 4701 Sfmt 4702 dates; settlement type (e.g., cash- versus physically-settled); and, as applicable for physically-delivered swaps, delivery specifications, including commodity quality standards or delivery locations.133 Because settlement type would be considered to be a material ‘‘contractual specification, term, or condition,’’ a cash-settled swap could only be deemed economically equivalent to a cash-settled referenced contract, and a physically-settled swap could only be deemed economically equivalent to a physically-settled referenced contract; however, a cashsettled swap that initially did not qualify as ‘‘economically equivalent’’ due to no corresponding cash-settled referenced contract (i.e., no cash-settled look-alike futures contract), could subsequently become an ‘‘economically equivalent swap’’ if a cash-settled futures contract market were to develop. In addition, a swap that either references another referenced contract, or incorporates its terms by reference, would be deemed to share identical terms with the referenced contract and therefore would qualify as an economically equivalent swap.134 Any change in the material terms of such a swap, however, would render the swap no longer economically equivalent for position limits purposes.135 In contrast, the Commission generally would consider those swap contractual terms, provisions, or terminology (e.g., ISDA terms and definitions) that are unique to swaps (whether standardized 133 When developing its definition of an ‘‘economically equivalent swap,’’ the Commission, based on its experience, preliminarily has determined that for a swap to be ‘‘economically equivalent’’ to a futures contract, the material contractual specifications, terms, and conditions would need to be identical. In making this determination, the Commission took into account, in regards to the economics of swaps, how a swap and a corresponding futures contract or option on a futures contract react to certain market factors and movements, the pricing variables used in calculating each instrument, the sensitivities of those variables, the ability of a market participant to gain the same type of exposures, and how the exposures move to changes in market conditions. 134 For example, a cash-settled swap that either settles to the pricing of a corresponding cash-settled referenced contract, or incorporates by reference the terms of such referenced contract, could be deemed to be economically equivalent to the referenced contract. 135 The Commission preliminarily recognizes that the material swap terms noted above are essential to determining the pricing and risk profile for swaps. However, there may be other contractual terms that also may be important for the counterparties but not necessarily ‘‘material’’ for purposes of position limits. For example, as discussed below, certain other terms, such as clearing arrangements or governing law, may not be material for the purpose of determining economic equivalence for federal position limits, but may nonetheless affect pricing and risk or otherwise be important to the counterparties. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 or bespoke) not to be material for purposes of determining whether a swap is economically equivalent to a particular referenced contract. For example, swap provisions or terms designating business day or holiday conventions, day count (e.g., 360 or actual), calculation agent, dispute resolution mechanisms, choice of law, or representations and warranties are generally unique to swaps and/or otherwise not material, and therefore would not be dispositive for determining whether a swap is economically equivalent.136 The Commission is unable to publish a list of swaps it would deem to be economically equivalent swaps because any such determination would involve a facts and circumstances analysis, and because most commodity swaps are created bilaterally between counterparties and traded OTC. Absent a requirement that market participants identify their economically equivalent swaps to the Commission on a regular basis, the Commission preliminarily believes that market participants are best positioned to determine whether particular swaps share identical material terms with referenced contracts and would therefore qualify as ‘‘economically equivalent’’ for purposes of federal position limits. However, the Commission understands that for certain bespoke swaps it may be unclear whether the facts and circumstances would demonstrate whether the swap qualifies as ‘‘economically equivalent’’ with respect to a referenced contract. The Commission emphasizes that under this proposal, market participants would have the discretion to make such determination as long as they make a 136 Commodity swaps, which generally are traded OTC, are less standardized compared to exchangetraded futures and therefore must include these provisions in an ISDA master agreement between counterparties. While certain provisions, for example choice of law, dispute resolution mechanisms, or the general representations made in an ISDA master agreement, may be important considerations for the counterparties, the Commission would not deem such provisions material for purposes of determining economic equivalence under the federal position limits framework for the same reason the Commission would not deem a core referenced futures contract and a look-alike referenced contract to be economically different, even though the look-alike contract may be traded on a different exchange with different contractual representations, governing law, holidays, dispute resolution processes, or other provisions unique to the exchanges. Similarly, with respect to day counts, a swap could designate a day count that is different than the day count used in a referenced contract but adjust relevant swap economic terms (e.g., relevant rates or payments, fees, basis, etc.) to achieve the same economic exposure as the referenced contract. In such a case, the Commission may not find such differences to be material for purposes of determining the swap to be economically equivalent for federal position limits purposes. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 reasonable, good faith effort in reaching their determination, and that the Commission would not bring any enforcement action for violating the Commission’s speculative position limits against such market participants as long as the market participant performed the necessary due diligence and is able to provide sufficient evidence, if requested, to support its reasonable, good faith effort.137 Because market participants would be provided with discretion in making any ‘‘economically equivalent’’ swap determination, the Commission preliminarily anticipates that this flexibility should provide a greater level of certainty to market participants in contrast to the alternative in which market participants would be required to first submit swaps to the Commission staff and wait for feedback.138 b. Exclusions From the Definition of ‘‘Economically Equivalent Swap’’ As noted above, the Commission’s proposed definition would expressly provide that differences in lot size or notional amount, delivery dates diverging by less than one calendar day (or less than two calendar days for natural gas), or post-trade risk management arrangements would not disqualify a swap from being deemed to be ‘‘economically equivalent’’ to a particular referenced contract. i. Delivery Dates Diverging by Less Than One Calendar Day The proposed definition as it applies to commodities other than natural gas would encompass swaps with delivery dates that diverge by less than one calendar day from that of a referenced contract.139 As a result, a swap with a delivery date that differs from that of a referenced contract by one calendar day 137 As noted below, the Commission reserves the authority under this proposal to determine that a particular swap or class of swaps either is or is not ‘‘economically equivalent’’ regardless of a market participant’s determination. See infra Section II.A.4.d. (discussion of commission determination of economic equivalence). As long as the market participant made its determination, prior to such Commission determination, using reasonable, good faith efforts, the Commission would not take any enforcement action for violating the Commission’s position limits regulations if the Commission’s determination differs from the market participant’s. 138 As discussed under Section II.A.16. (definition of ‘‘referenced contract’’), the Commission proposes to include a list of futures and related options that qualify as referenced contracts because such contracts are standardized and published by exchanges. In contrast, since swaps are largely bilaterally negotiated and OTC traded, a swap could have multiple permutations and any published list of economically equivalent swaps would be unhelpful or incomplete. 139 This aspect of the proposed definition would be irrelevant for cash-settled swaps since ‘‘delivery date’’ applies only to physically-settled swaps. PO 00000 Frm 00023 Fmt 4701 Sfmt 4702 11617 or more would not be deemed to be economically equivalent under the Commission proposal, and such swaps would not be required to be added to, nor permitted to be netted against, any referenced contract when calculating one’s compliance with federal position limit levels.140 The Commission recognizes that while a penultimate contract may be significantly correlated to its corresponding spot-month contract, it does not necessarily offer identical economic or risk exposure to the spot-month contract, and depending on the underlying commodity and market conditions, a market participant may open itself up to material basis risk by moving from the spot-month contract to a penultimate contract. Accordingly, the Commission has preliminarily determined that it would not be appropriate to permit market participants to net such penultimate positions against their core referenced futures contract positions since such positions do not necessarily reflect equivalent economic or risk exposure. ii. Post-Trade Risk Management The Commission is specifically excluding differences in post-trade risk management arrangements, such as clearing or margin, in determining whether a swap is economically equivalent. As noted above, many commodity swaps are traded OTC and may be uncleared or cleared at a different clearing house than the corresponding referenced contract.141 Moreover, since the core referenced futures contracts, along with futures contracts and options on futures in general, are traded on DCMs with vertically integrated clearing houses, as a practical matter, it is impossible for OTC commodity swaps, which historically have been uncleared, to share identical post-trade clearing house or other post-trade risk management arrangements with their associated core referenced futures contracts. Therefore, if differences in post-trade risk management arrangements were sufficient to exclude a swap from economic equivalence to a core 140 A swap as so described that is not ‘‘economically equivalent’’ would not be subject to a federal speculative position limit under this proposal. 141 Similar to the Commission’s understanding of ‘‘material’’ terms, the Commission construes ‘‘posttrade risk management arrangements’’ to include various provisions included in standard swap agreements, including, for example: Margin or collateral requirements, including with respect to initial or variation margin; whether a swap is cleared, uncleared, or cleared at a different clearing house than the applicable referenced contract; close-out, netting, and related provisions; and different default or termination events and conditions. E:\FR\FM\27FEP3.SGM 27FEP3 11618 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules referenced futures contract, then such an exclusion could otherwise render ineffective the Commission’s statutory directive under CEA section 4a(a)(5) to include economically equivalent swaps within the federal position limits framework. Accordingly, the Commission has preliminarily determined that differences in posttrade risk management arrangements should not prevent a swap from qualifying as economically equivalent with an otherwise materially identical referenced contract. iii. Lot Size or Notional Amount The last exclusion would clarify that differences in lot size or notional amount would not prevent a swap from being deemed to be economically equivalent to its corresponding referenced contract. The Commission’s use of ‘‘lot size’’ and ‘‘notional amount’’ refer to the same general concept— while futures terminology usually employs ‘‘lot size,’’ swap terminology usually employs ‘‘notional amount.’’ Accordingly, the Commission proposes to use both terms to convey the same general meaning, and in this context does not mean to suggest a substantive difference between the two terms. c. Economically Equivalent Natural Gas Swaps lotter on DSKBCFDHB2PROD with PROPOSALS3 Market dynamics in natural gas are unique in several respects including, among other things, that ICE and NYMEX both list high volume contracts, whereas liquidity in other commodities tends to pool at a single DCM. As expiration approaches for natural gas contracts, volume tends to shift from the NYMEX core referenced futures contract (‘‘NG’’), which is physically settled, to an ICE contract, which is cash settled. This trend reflects certain market participants’ desire for exposure to natural gas prices without having to make or take delivery.142 NYMEX and ICE also list several ‘‘penultimate’’ cashsettled referenced contracts that use the price of the physically-settled NYMEX contract as a reference price for cash settlement on the day before trading in the physically-settled NYMEX contract 142 In part to address historical concerns over the potential for manipulation of physically-settled natural gas contracts during the spot month in order to benefit positions in cash-settled natural gas contracts, the Commission proposes later in this release to allow for a higher ‘‘conditional’’ spot month limit in cash-settled natural gas referenced contracts under the condition that market participants seeking to utilize such conditional limit exit any positions in physically-settled natural gas referenced contracts. See infra Section II.C.2.e. (proposed conditional spot month limit exemption for natural gas). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 terminates.143 In order to recognize the existing natural gas markets, which include active and vibrant markets in penultimate natural gas contracts, the Commission thus proposes a slightly broader economically equivalent swap definition for natural gas so that swaps with delivery dates that diverge by less than two calendar days from an associated referenced contract could still be deemed economically equivalent and would be subject to federal limits. The Commission intends for this change to prevent and disincentivize manipulation and regulatory arbitrage and to prevent volume from shifting away from NG to penultimate natural gas contract futures and/or penultimate swap markets in order to avoid federal position limits.144 d. Commission Determination of Economic Equivalence While the Commission would primarily rely on market participants to determine whether their swaps meet the proposed ‘‘economically equivalent swap’’ definition, the Commission is proposing paragraph (3) to the definition to clarify that the Commission may determine on its own initiative that any swap or class of swaps satisfies, or does not satisfy, the economically equivalent definition with respect to any referenced contract or class of referenced contracts. The Commission believes that this provision may provide the ability to offer clarity to the marketplace in cases where uncertainty exists as to whether certain swaps would qualify (or would not qualify) as ‘‘economically equivalent,’’ and therefore would be (or would not be) subject to the proposed federal 143 Such penultimate contracts include: ICE’s Henry Financial Penultimate Fixed Price Futures (PHH) and options on Henry Penultimate Fixed Price (PHE), and NYMEX’s Henry Hub Natural Gas Penultimate Financial Futures (NPG). 144 As noted above, the Commission is proposing a relatively narrow ‘‘economically equivalent swap’’ definition in order to prevent market participants from inappropriately netting positions in core referenced futures contracts against swap positions further out on the curve. The Commission preliminarily acknowledges that liquidity could shift to penultimate swaps as a result but believes that, with the exception of natural gas, this concern is mitigated since certain constraints exist that militate against this occurring. First, there may be basis risk between the penultimate swap and the core referenced futures contract. Second, compared to most other contracts, the Commission believes that natural gas has a relatively liquid penultimate futures market that enables a market participant to hedge or set-off its penultimate swap position. Since the constraints described above do not necessarily apply to the natural gas futures markets, the Commission preliminarily believes that liquidity may be incentivized to shift from NG to penultimate natural gas swaps in order to avoid federal position limits in the absence of the Commission’s proposed exception for natural gas in the ‘‘economically equivalent swap’’ definition. PO 00000 Frm 00024 Fmt 4701 Sfmt 4702 position limits framework. Similarly, where market participants hold divergent views as to whether certain swaps qualify as ‘‘economically equivalent,’’ the Commission can ensure that all market participants treat OTC swaps with identical material terms similarly, and also would be able to serve as a backstop in case market participants fail to properly treat economically equivalent swaps as such. As noted above, the Commission would not take any enforcement action with respect to violating the Commission’s position limits regulations if the Commission disagrees with a market participant’s determination as long as the market participant is able to provide sufficient support to show that it made a reasonable, good faith effort in applying its discretion.145 5. ‘‘Eligible Affiliate’’ The Commission proposes to create the new defined term ‘‘eligible affiliate,’’ which would be used in proposed § 150.2(k), discussed in connection with proposed § 150.2 below. As discussed further in that section of the release, an entity that qualifies as an ‘‘eligible affiliate’’ would be permitted to voluntarily aggregate its positions, even though it is eligible for an exemption from aggregation under § 150.4(b). 6. ‘‘Eligible Entity’’ The Commission adopted a revised ‘‘eligible entity’’ definition in the 2016 Final Aggregation Rulemaking.146 The Commission is not proposing any further amendments to this definition, but is including that revised definition in this document so that all defined terms are included. As noted above, the Commission is also proposing a nonsubstantive change to remove the lettering from this and other definitions that appear lettered in existing § 150.1, and to list the definitions in alphabetical order. 7. ‘‘Entity’’ The Commission proposes defining ‘‘entity’’ to mean ‘‘a ‘person’ as defined in section 1a of the Act.’’ 147 The term, not defined in existing § 150.1, is used throughout proposed part 150 of the Commission’s regulations. 8. ‘‘Excluded Commodity’’ The phrase ‘‘excluded commodity’’ is defined in CEA section 1a(19), but is not defined or used in existing part 150 of the Commission’s regulations. The 145 See supra II.A.4.a. (discussing market participants’ discretion in determining whether a swap is economically equivalent). 146 See 17 CFR 150.1(d). 147 7 U.S.C. 1a(38). E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Commission proposes including a definition of ‘‘excluded commodity’’ in part 150 that references that term as defined in CEA section 1a(19).148 9. ‘‘Futures-Equivalent’’ This phrase is currently defined in existing § 150.1(f) and is used throughout existing part 150 of the Commission’s regulations to describe the method for converting a position in an option on a futures contract to an economically equivalent amount in a futures contract. The Dodd-Frank Act amendments to CEA section 4a,149 in part, direct the Commission to apply aggregate federal position limits to physical commodity futures contracts and to swap contracts that are economically equivalent to such physical commodity futures on which the Commission has established limits. In order to aggregate positions in futures, options on futures, and swaps, it is necessary to adjust the position sizes, since such contracts may have varying units of trading (e.g., the amount of a commodity underlying a particular swap contract could be larger than the amount of a commodity underlying a core referenced futures contract). The Commission thus proposes to adjust position sizes to an equivalent position based on the size of the unit of trading of the core referenced futures contract. The phrase ‘‘futuresequivalent’’ is used for that purpose throughout the proposed rules, including in connection with the ‘‘referenced contract’’ definition in proposed § 150.1. The Commission also proposes broadening this definition to include references to the proposed term ‘‘core referenced futures contracts.’’ lotter on DSKBCFDHB2PROD with PROPOSALS3 10. ‘‘Independent Account Controller’’ The Commission adopted a revised ‘‘independent account controller’’ definition in the 2016 Final Aggregation Rule.150 The Commission is not proposing any further amendments to this definition, but is including that revised definition in this document so that all defined terms appear together. 11. ‘‘Long Position’’ The phrase ‘‘long position’’ is currently defined in § 150.1(g) to mean ‘‘a long call option, a short put option or a long underlying futures contract.’’ The Commission proposes to update this definition to apply to swaps and to 148 7 U.S.C. 1a(19). CEA sections 4a(a)(2) and 4a(a)(5), speculative position limits apply to agricultural and exempt commodity swaps that are ‘‘economically equivalent’’ to DCM futures and options on futures contracts. 7 U.S.C. 6a(a)(2) and (5). 150 See 17 CFR 150.1(e). 149 Under VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 clarify that such positions would be on a futures-equivalent basis. This provision would thus be applicable to options on futures and swaps such that a long position would also include a long futures-equivalent option on futures and a long futures-equivalent swap. 12. ‘‘Physical Commodity’’ The Commission proposes to define the term ‘‘physical commodity’’ for position limits purposes. Congress used the term ‘‘physical commodity’’ in CEA sections 4a(a)(2)(A) and 4a(a)(2)(B) to mean commodities ‘‘other than excluded commodities as defined by the Commission.’’ 151 The proposed definition of ‘‘physical commodity’’ thus would include both exempt and agricultural commodities, but not excluded commodities. 13. ‘‘Position Accountability’’ Existing § 150.5 permits position accountability in lieu of position limits in certain cases, but does not define the term ‘‘position accountability.’’ The proposed amendments to § 150.5 would allow exchanges, in some cases, to adopt position accountability levels in lieu of, or in addition to, position limits. The Commission proposes a definition of ‘‘position accountability’’ for use throughout proposed § 150.5 as discussed in greater detail in connection with proposed § 150.5 below. 14. ‘‘Pre-Enactment Swap’’ The Commission proposes to create the defined term ‘‘pre-enactment swap’’ to mean any swap entered into prior to enactment of the Dodd-Frank Act of 2010 (July 21, 2010), the terms of which have not expired as of the date of enactment of that Act. As discussed in connection with proposed § 150.3 later in this release, if acquired in good faith, such swaps would be exempt from federal speculative position limits, although such swaps could not be netted with post-effective date swaps for purposes of complying with spot month speculative position limits. 15. ‘‘Pre-Existing Position’’ The Commission proposes to create the defined term ‘‘pre-existing position’’ to reference any position in a commodity derivative contract acquired in good faith prior to the effective date of a final federal position limit rulemaking. Proposed § 150.2(g) would set forth the circumstances under which position limits would apply to such positions. 151 7 PO 00000 16. ‘‘Referenced Contract’’ The nine contracts currently subject to federal limits, which are all physically-settled futures, are all listed in existing § 150.2.152 As the Commission is proposing to expand the position limits framework to cover certain cash-settled futures and options on futures contracts and certain economically equivalent swaps, the Commission proposes a new defined term, ‘‘referenced contract,’’ for use throughout proposed part 150 to refer to contracts that would be subject to federal limits. The referenced contract definition would thus include: (1) Any core referenced futures contract listed in proposed § 150.2(d); (2) any other contract (futures or option on futures), on a futures-equivalent basis with respect to a particular core referenced futures contract, that is directly or indirectly linked to the price of a core referenced futures contract, or that is directly or indirectly linked to the price of the same commodity underlying a core referenced futures contract (for delivery at the same location(s)); and (3) any economically equivalent swap, on a futures-equivalent basis. The proposed referenced contract definition would include look-alike futures and options on futures contracts (as well as options or economically equivalent swaps with respect to such look-alike contracts) and contracts of the same commodity but different sizes (e.g., mini contracts). Positions in referenced contracts may in certain circumstances be netted with positions in other referenced contracts. However, to avoid evasion and undermining of the position limits framework, nonreferenced contracts on the same commodity could not be used to net down positions in referenced contracts.153 a. Cash-Settled Referenced Contracts Under these proposed provisions, federal limits would apply to all cashsettled futures and options on futures contracts on physical commodities that are linked in some manner, whether directly or indirectly, to physicallysettled contracts subject to federal limits, and to any cash settled swaps that are deemed ‘‘economically equivalent swaps’’ with respect to a particular cash-settled referenced contract.154 While the Commission 152 17 CFR 150.2. more detailed discussion of when netting is permitted appears below. See infra Section II.B.2.k. (discussion of netting). 154 For example, ICE’s Henry Penultimate Fixed Price Future, which cash-settles directly to 153 A U.S.C. 6a(a)(2)(A) and (B). Frm 00025 Fmt 4701 Sfmt 4702 11619 Continued E:\FR\FM\27FEP3.SGM 27FEP3 11620 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 acknowledges previous comments to the effect that cash-settled contracts are less susceptible to manipulation and thus should not be subject to federal limits, the Commission is of the view that generally speaking, linked cash-settled and physically-settled contracts form one market, and thus should be subject to federal limits. This view is informed by the Commission’s experience overseeing derivatives markets, where it has observed that it is common for the same market participant to arbitrage linked cash- and physically-settled contracts, and where it has also observed instances where linked cashsettled and physically-settled contracts have been used together as part of a manipulation.155 In the Commission’s view, cash-settled contracts are generally economically equivalent to physical-delivery contracts in the same commodity. In the absence of position limits, a trader with positions in both the physically-delivered and cashsettled contracts may have increased ability and incentive to manipulate one contract to benefit positions in the other. The proposal to include futures contracts and options on futures that are ‘‘indirectly linked’’ to the core referenced futures contract under the definition of ‘‘referenced contract’’ is intended to prevent the evasion of position limits through the creation of an economically equivalent futures contract or option on a future, as applicable, that does not directly reference the price of the core referenced futures contract. Such contracts that settle to the price of a referenced contract but not to the price of a core referenced futures contract, for example, would be indirectly linked to the core referenced futures contract.156 On the other hand, an outright derivative contract whose settlement price is based on an index published by a price reporting agency that surveys cash market transaction prices (even if the cash market practice is to price at a differential to a futures contract) would NYMEX’s Henry Hub Natural Gas core referenced futures contract, would be considered a referenced contract under the rules proposed herein. 155 The Commission has previously found that traders with positions in look-alike cash-settled contracts may have an incentive to manipulate and undermine price discovery in the physical-delivery contracts to which the cash-settled contract is linked. The practice known as ‘‘banging the close’’ or ‘‘marking the close’’ is one such manipulative practice that the Commission prosecutes and that this proposal seeks to prevent. 156 As discussed above, the Commission is proposing a definition of ‘‘economically equivalent swap’’ that is narrower than the class of futures and options on futures that would be included as referenced contracts. See supra Section II.A.4. (discussion of economically equivalent swaps). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 not be directly or indirectly linked to the core referenced futures contract. Similarly, a physical-delivery derivative contract whose settlement price was based on the same underlying commodity at a different delivery location (e.g., a hypothetical physicaldelivery futures contract on ultra-low sulfur diesel delivered at L.A. Harbor instead of the NYMEX ultra-low sulfur diesel futures contract delivered in New York Harbor core referenced futures contract) would not be linked, directly or indirectly, to the core referenced futures contract because the price of the physically-delivered L.A. Harbor contract would reflect the L.A. Harbor market price for ultra-low sulfur diesel. b. Exclusions From the Referenced Contract Definition While the proposed referenced contract definition would include linked contracts, it would also explicitly exclude certain other types of contracts. Paragraph (3) of the proposed referenced contract definition would explicitly exclude from that definition a location basis contract, a commodity index contract, a swap guarantee, or a trade option that meets the requirements of § 32.3 of this chapter. First, failing to exclude location basis contracts from the referenced contract definition could enable speculators to net portions of the location basis contract with outright positions in one of the locations comprising the basis contract, which would permit extraordinarily large speculative positions in the outright contract.157 For example, under the proposed rules, a large outright position in Henry Hub Natural Gas futures could not be netted down against a location basis contract that cash-settles to the difference in price between Gulf Coast Natural Gas and Henry Hub Natural Gas. Absent the proposed exclusion, a market participant could otherwise increase its exposure in the outright contract by using the location basis contract to net down, and then increase further, an outright contract position that would otherwise be restricted by position limits.158 Further, excluding location basis contracts from the referenced 157 See infra Section II.B.2.k. (discussion of netting). 158 While excluding location basis contracts from the referenced contract definition would prevent the circumstance described above, it would also mean that location basis contracts would not be subject to federal limits. The Commission would be comfortable with this outcome because location basis contracts generally demonstrate minimal volatility and are typically significantly less liquid than the core referenced futures contracts, meaning they would be more costly to try to use in a manipulation. PO 00000 Frm 00026 Fmt 4701 Sfmt 4702 contract definition may allow commercial end-users to more efficiently hedge the cost of commodities at their preferred location. Similarly, the proposed exclusion of commodity index contracts from the referenced contract definition would help ensure that market participants could not use a position in a commodity index contract to net down an outright position that was a component of the commodity index contract. If the Commission did not exclude commodity index contracts, then speculators would be allowed to take on massive outright positions in referenced contracts, which could lead to excessive speculation. As noted above, it is common for swap dealers to enter into commodity index contracts with participants for which the contract would not qualify as a bona fide hedging position (e.g., with a pension fund). Failing to exclude commodity index contracts from the referenced contract definition could enable a swap dealer to use positions in commodity index contracts to net down offsetting outright futures positions in the components of the index. This would have the effect of subverting the statutory pass-through swap language in CEA section 4a(c)(2)(B), which is intended to foreclose the recognition of positions entered into for risk management purposes as bona fide hedges unless the swap dealer is entering into positions opposite a counterparty for which the swap position is a bona fide hedge.159 In order to clarify the types of contracts that would qualify as location basis contracts and commodity index contracts, and thus would be excluded from the referenced contract definition, the Commission proposes guidance in Appendix C to part 150 of the Commission’s regulations. The proposed guidance would include information which would help define the parameters of the terms ‘‘location basis contract’’ and ‘‘commodity index contract.’’ To the extent a particular contract fits within the proposed guidance, such contract would not be a referenced contract, would not be subject to federal limits, and could not 159 7 U.S.C. 6a(c)(2)(B). While excluding commodity index contracts from the referenced contract definition would prevent the potentially risky netting circumstance described above, it would also mean that commodity index contracts would not be subject to federal limits. The Commission would be comfortable with this outcome because the commodities comprising the index would themselves be subject to limits, and because commodity index contracts generally tend to exhibit low volatility since they are diversified across many different commodities. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 be used to net down positions in referenced contracts.160 Second, swap guarantees are explicitly excluded from the proposed referenced contract definition. In connection with further defining the term ‘‘swap’’ jointly with the Securities and Exchange Commission in connection with the ‘‘Product Definition Adopting Release,’’ 161 the Commission interpreted the term ‘‘swap’’ (that is not a ‘‘security-based swap’’ or ‘‘mixed swap’’) to include a guarantee of such swap, to the extent that a counterparty to a swap position would have recourse to the guarantor in connection with the position.162 Excluding guarantees of swaps from the definition of referenced contract should help avoid any potential confusion regarding the application of position limits to guarantees of swaps. The Commission understands that swap guarantees generally serve as insurance, and in many cases swap guarantors guarantee the performance of an affiliate in order to entice a counterparty to enter into a swap with such guarantor’s affiliate. As a result, the Commission preliminarily believes that swap guarantees neither contribute to excessive speculation, market manipulation, squeezes, or corners nor were contemplated by Congress when Congress articulated its policy goals in CEA sections 4a(a)(1)–(3).163 Third, trade options that meet the requirements of § 32.3 would also be excluded from the proposed referenced contract definition. The Commission has traditionally exempted trade options from a number of Commission requirements because they are typically used by end-users to hedge physical risk and thus do not contribute to excessive speculation. Trade options are not subject to position limits under current regulations, and the proposed exclusion of trade options from the referenced contract definition would simply codify existing practice.164 160 See infra Section II.B.2.k. (discussion of netting). 161 See generally Further Definition of ‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 FR 48207 (Aug. 13, 2012) (‘‘Product Definitions Adopting Release’’). 162 See id. at 48226. 163 To the extent that swap guarantees may lower costs for uncleared OTC swaps in particular by incentivizing counterparties to agree to the swap, excluding swap guarantees arguably may improve market liquidity, which is consistent with the CEA’s statutory goals in CEA section 4a(a)(3)(B) to ensure sufficient liquidity for bona fide hedgers when establishing its position limit framework. 164 In the trade options final rule, the Commission stated its belief that federal limits should not apply to trade options, and expressed an intention to address trade options in the context of any final rulemaking on position limits. See Trade Options, 81 FR at 14966, 14971 (Mar. 21, 2016). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 c. List of Referenced Contracts In an effort to provide clarity to market participants regarding which exchange-traded contracts are subject to federal limits, the Commission anticipates publishing, and regularly updating, a list of such contracts on its website.165 The Commission thus proposes to publish a CFTC Staff Workbook of Commodity Derivative Contracts under the Regulations Regarding Position Limits for Derivatives along with this release, which would provide a non-exhaustive list of referenced contracts and may be helpful to market participants in determining categories of contracts that would fit within the referenced contract definition. As always, market participants may request clarification from the Commission. In order to ensure that the list remains up-to-date and accurate, the Commission is proposing changes to certain provisions of part 40 of its regulations which pertain to the collection of position limits information through the filing of product terms and conditions submissions. In particular, under existing rules, including §§ 40.2, 40.3, and 40.4, DCMs and SEFs are required to comply with certain submission requirements related to the listing of certain products. Many of the required submissions must include the product’s ‘‘terms and conditions,’’ which is defined in § 40.1(j) and which includes, under § 40.1(j)(1)(vii), ‘‘Position limits, position accountability standards, and position reporting requirements.’’ The Commission proposes to expand § 40.1(j)(1)(vii), which addresses futures and options on futures, to also include an indication as to whether the contract meets the definition of a referenced contract as defined in § 150.1, and, if so, the name of the core referenced futures contract on which the referenced contract is based. The Commission proposes to also expand § 40.1(j)(2)(vii), which addresses swaps, to include an indication as to whether the contract meets the definition of economically equivalent swap as defined in § 150.1 of this chapter, and, if so, the name of the referenced contract to which the swap is economically equivalent. This information would enable the Commission to maintain on its website, www.cftc.gov, an up-to-date list of DCM 165 As discussed above, the Commission will provide market participants with reasonable, goodfaith discretion to determine whether a swap would qualify as economically equivalent for federal position limit purposes. See supra Section II.A.4. (discussion of economically equivalent swaps). PO 00000 Frm 00027 Fmt 4701 Sfmt 4702 11621 and SEF contracts subject to federal limits. 17. ‘‘Short Position’’ The Commission proposes to expand the existing definition of ‘‘short position,’’ currently defined in § 150.1(h), to include swaps and to clarify that any such positions would be measured on a futures-equivalent basis. 18. ‘‘Speculative Position Limit’’ The Commission proposes to define the term ‘‘speculative position limit’’ for use throughout part 150 of the Commission’s regulations to refer to federal or exchange-set limits, net long or net short, including single month, spot month, and all-months-combined limits. This proposed definition is not intended to limit the authority of exchanges to adopt other types of limits that do not meet the ‘‘speculative position limit definition,’’ such as a limit on gross long or gross short positions, or a limit on holding or controlling delivery instruments. 19. ‘‘Spot Month,’’ ‘‘Single Month,’’ and ‘‘All-Months’’ The Commission proposes to expand the existing definition of ‘‘spot month’’ to account for the fact that the proposed limits would apply to both physicallysettled and certain cash-settled contracts, to clarify that the spot month for referenced contracts would be the same period as that of the relevant core referenced futures contract, and to account for variations in spot month conventions that differ by commodity. In particular, for the ICE U.S. Sugar No. 11 (SB) core referenced futures contract, the spot month would mean the period of time beginning at the opening of trading on the second business day following the expiration of the regular option contract traded on the expiring futures contract until the contract expires. For the ICE U.S. Sugar No. 16 (SF) core referenced futures contract, the spot month would mean the period of time beginning on the third-to-last trading day of the contract month until the contract expires. For the CME Live Cattle (LC) core referenced futures contract, the spot month would mean the period of time beginning at the close of trading on the fifth business day of the contract month until the contract expires. The Commission also proposes to eliminate the existing definitions of ‘‘single month’’ and ‘‘all-months’’ because the definitions for those terms would be built into the proposed definition of ‘‘speculative position limits’’ described above. E:\FR\FM\27FEP3.SGM 27FEP3 11622 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules 20. ‘‘Spread Transaction’’ The Commission proposes to incorporate a definition for transactions normally known to the trade as ‘‘spreads,’’ which would list the types of transactions that could qualify for spread exemptions for purposes of federal position limits. The proposed list would cover common types of intercommodity and intra-commodity spreads such as: Calendar spreads; quality differential spreads; processing spreads (such as energy ‘‘crack’’ or soybean ‘‘crush’’ spreads); product or by-product differential spreads; and futures-options spreads.166 Separately, under proposed § 150.3(a)(2)(ii), the Commission could determine to exempt any other spread transaction that is not included in the spread transaction definition, but that the Commission has determined is consistent with CEA section 4a(a)(3)(B),167 and exempted, pursuant to proposed § 150.3(b). 21. ‘‘Swap’’ and ‘‘Swap Dealer’’ The Commission proposes to incorporate the definitions of ‘‘swap’’ and ‘‘swap dealer’’ as they are defined in section 1a of the Act and § 1.3 of this chapter.168 lotter on DSKBCFDHB2PROD with PROPOSALS3 22. ‘‘Transition Period Swap’’ The Commission proposes to create the defined term ‘‘transition period swap’’ to mean any swap entered into during the period commencing July 22, 2010 and ending 60 days after the publication of a final federal position limits rulemaking in the Federal 166 For example, trading activity in many commodity derivative markets is concentrated in the nearby contract month, but a hedger may need to offset risk in deferred months where derivative trading activity may be less active. A calendar spread trader could provide liquidity without exposing himself or herself to the price risk inherent in an outright position in a deferred month. Processing spreads can serve a similar function. For example, a soybean processor may seek to hedge his or her processing costs by entering into a ‘‘crush’’ spread, i.e., going long soybeans and short soybean meal and oil. A speculator could facilitate the hedger’s ability to do such a transaction by entering into a ‘‘reverse crush’’ spread (i.e., going short soybeans and long soybean meal and oil). Quality differential spreads, and product or by-product differential spreads, may serve similar liquidity-enhancing functions when spreading a position in an actively traded commodity derivatives market such as CBOT Wheat (W) against a position in another actively traded market, such as MGEX Wheat. 167 As noted above, CEA section 4a(a)(3)(B) provides that the Commission shall set limits ‘‘to the maximum extent practicable, in its discretion— (i) to diminish, eliminate, or prevent excessive speculation as described under this section; (ii) to deter and prevent market manipulation, squeezes, and corners; (iii) to ensure sufficient market liquidity for bona fide hedgers; and (iv) to ensure that the price discovery function of the underlying market is not disrupted.’’ 168 7 U.S.C. 1a(47) and 1a(49); 17 CFR 1.3. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Register, the terms of which have not expired as of that date. As discussed in connection with proposed § 150.3 later in this release, if acquired in good faith, such swaps would be exempt from federal speculative position limits, although such swaps could not be netted with post-effective date swaps for purposes of complying with spot month speculative position limits. Finally, the Commission proposes to eliminate existing § 150.1(i), which includes a chart specifying the ‘‘first delivery month of the crop year’’ for certain commodities. The crop year definition had been pertinent for purposes of the spread exemption to the individual month limit in current § 150.3(a)(3), which limits spreads to those between individual months in the same crop year and to a level no more than that of the all-months limit. This provision was pertinent at a time when the single month and all months combined limits were different. Now that the current and proposed single month and all months combined limits are the same, and now that the Commission is proposing a new process for granting spread exemptions in § 150.3, this provision is no longer needed. 23. Request for Comment The Commission requests comment on all aspects of the proposed amendments and additions to the definitions in § 150.1. The Commission also invites comments on the following: (1) Should the Commission include the enumerated hedges in regulations, rather than in an appendix of acceptable practices? Why or why not? (2) Should the Commission list any additional common commercial hedging practices as enumerated hedges? (3) The Commission proposes to eliminate the five day rule on federal position limits, instead allowing exchanges discretion on whether to apply or waive any five day rule or equivalent on their exchange position limits. The Commission believes that the five day rule can be an important way to help ensure that futures and cash market prices converge. As such, should the Commission require that exchanges apply the five day rule to some or all bona fide hedging positions and/or spread exemptions? If so, to which bona fide hedging positions? Should the exchanges retain the ability to waive such five day rule? (4) The Commission requests comment on the nature of anticipated merchandising exemptions that have been granted by DCMs in connection with the 16 non-legacy commodities or in connection with exemptions from PO 00000 Frm 00028 Fmt 4701 Sfmt 4702 exchange limits in 9 legacy commodities. (5) To what extent do the enumerated hedges proposed in this release encompass the types of positions discussed in the BFH Petition? Should additional types of positions identified in the BFH Petition, including examples nos. 3 (unpriced physical purchase and sale commitments) and 7 (scenario 2) (use of physical delivery referenced contracts to hedge physical transactions using calendar month averaging pricing), be enumerated as bona fide hedges, after notice and comment? (6) The Commission requests comment as to whether price risk is attributable to a variety of factors, including political and weather risk, and could therefore allow hedging political, weather, or other risks, or whether price risk is something narrower in the application of bona fide hedging. (7) While an ‘‘economically equivalent swap’’ qualifies as a referenced contract under paragraph (2) of the ‘‘referenced contract’’ definition, paragraph (1) of the ‘‘referenced contract’’ definition applies a broader test to determine whether futures contracts or options on a futures contract would qualify as a referenced contract. Instead of a separate definition for ‘‘economically equivalent swaps,’’ should the same test (e.g., paragraph (1) of the ‘‘referenced contract’’ definition) that applies to futures and options on futures for determining status as ‘‘referenced contracts’’ also apply to determine whether a swap is an ‘‘economically equivalent swap,’’ and therefore a ‘‘referenced contract’’? Why or why not? (8) The Commission is proposing to define ‘‘economically equivalent swap’’ in a manner that is generally consistent with the EU’s definition, with the exception that a swap must have ‘‘identical material’’ terms, disregarding differences in lot size or notional amount, delivery dates diverging by less than one calendar day (or for natural gas, by less than two calendar days), or post-trade risk management arrangements. Is this approach either too narrow or too broad? Why or why not? (9) The Commission requests comment how a market participant subject to both the CFTC’s and EU’s position limits regimes expects to comply with both regimes for contracts subject to both regimes. (10) With respect to economically equivalent swaps, the Commission proposes an exception that would capture penultimate swaps only for natural gas contracts, including E:\FR\FM\27FEP3.SGM 27FEP3 11623 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules penultimate swaps on the NYMEX NG core referenced futures contract. Is this exception for such penultimate natural gas swaps appropriate, or should economically equivalent natural gas swaps be treated the same as other economically equivalent swaps? Why or why not? (11) Should the Commission broaden the definition of ‘‘economically equivalent swap’’ to include penultimate referenced contracts for all (or at least a subset of) commodities subject to federal position limits? Why or why not? (12) The Commission is proposing that a physically-settled swap may qualify as economically equivalent even if its delivery date diverges by less than one calendar day from its corresponding physically-settled referenced contract. Should the Commission include a similar provision for cash-settled swaps where cash-settled swaps could qualify as economically equivalent if their cash settlement price determination diverged from their corresponding cash-settled referenced contract by less than one calendar day? (13) Under the proposed definition of ‘‘economically equivalent swaps,’’ a cash-settled swap that otherwise shares identical material terms with a physically-settled referenced contract (and vice-versa) would not be deemed to be economically equivalent due to the difference in settlement type. Should the Commission consider treating swaps that share identical material terms, other than settlement type (i.e., cash-settled versus physically-settled swaps), to be economically equivalent? Why or why not? (14) Consistent with the 2016 Reproposal, the Commission is proposing to explicitly exclude swap guarantees from the referenced contract definition.169 Should the Commission again propose to exclude swap guarantees from the referenced contract definition? Why or why not? If the Commission does exclude swap guarantees, should such exclusion be limited to guarantees for affiliated entities only? Why or why not? (15) Please indicate if any updates or other modifications are needed to: (1) The proposed list of referenced contracts that would appear in the CFTC Staff Workbook of Commodity Derivative Contracts Under the Regulations Regarding Position Limits for Derivatives posted on the Commission’s website; 170 or (2) the proposed Appendix D to part 150 list of commodities deemed ‘‘substantially the same’’ for purposes of the term ‘‘location basis contract’’ as used in the proposed ‘‘referenced contract’’ definition. (16) Should the Commission require exchanges to maintain a list of referenced contracts and location basis contracts listed on their platforms? (17) The Commission has previously requested, and commenters have previously provided, a list of risks other than price risk for which commercial enterprises commonly need to hedge.171 Please explain which hedges of nonprice risks could be objectively and systematically verified as bona fide hedges by the Commission, and how the Commission would verify that such positions are bona fide hedges, including how the Commission would consistently and definitively quantify and assess whether any such hedges of non-price risks are bona fide hedges that comply with the proposed bona fide hedging definition. (18) The Commission proposes to define spread transactions to include: Either a calendar spread, intercommodity spread, quality differential spread, processing spread (such as energy ‘‘crack’’ or soybean ‘‘crush’’ spreads), product or by-product differential spread, or futures-option spread. Are there other types of transactions commonly known to the trade as ‘‘spreads’’ that the Commission should include in its spread transaction definition? Please provide any examples or descriptions that will help the Commission determine whether such transactions would be consistent with CEA section 4a(a)(3)(B) and should be included in the definition of spread transaction. (19) Should the Commission require market participants that trade economically equivalent swaps OTC, rather than on a SEF or DCM, to selfidentify and report to the Commission that in their view, such swaps meet the Commission’s proposed economically equivalent swap definition? B. § 150.2—Federal Limit Levels 1. Existing § 150.2 Federal spot month, single month, and all-months-combined position limits currently apply to nine physically-settled futures contracts on agricultural commodities listed in existing § 150.2, and, on a futuresequivalent basis, to options contracts thereon. Existing federal limit levels set forth in § 150.2 172 apply net long or net short and are as follows: EXISTING LEGACY AGRICULTURAL CONTRACT FEDERAL SPOT MONTH, SINGLE MONTH, AND ALL-MONTHS-COMBINED LIMIT LEVELS Contract Spot month limit lotter on DSKBCFDHB2PROD with PROPOSALS3 Chicago Board of Trade (‘‘CBOT’’) Corn (C) .............................................................................................. CBOT Oats (O) ............................................................................................................................................ CBOT Soybeans (S) .................................................................................................................................... CBOT Soybean Meal (SM) .......................................................................................................................... CBOT Soybean Oil (SO) ............................................................................................................................. CBOT Kansas City Hard Red Winter Wheat (KW) ..................................................................................... CBOT Wheat (W) ........................................................................................................................................ ICE Futures U.S. (‘‘ICE’’) Cotton No. 2 (CT) .............................................................................................. Minneapolis Grain Exchange (‘‘MGEX’’) Hard Red Spring Wheat (MWE) ................................................. 169 See 2016 Reproposal, 81 FR at 96966. Limits for Derivatives, U.S. Commodity Futures Trading Commission website, available at https://www.cftc.gov/LawRegulation/ 170 Position VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 DoddFrankAct/Rulemakings/PositionLimitsfor Derivatives/index.htm. 171 See, e.g., National Gas Supply Association Comment Letter at 4 (Feb. 28, 2017) in response to PO 00000 Frm 00029 Fmt 4701 Sfmt 4702 600 600 600 720 540 600 600 300 600 Single month and all-monthscombined limit 33,000 2,000 15,000 6,500 8,000 12,000 12,000 5,000 12,000 2016 Reproposal (listing operational risk, liquidity risk, credit risk, locational risk, and seasonal risk). 172 17 CFR 150.2. E:\FR\FM\27FEP3.SGM 27FEP3 11624 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules While not explicit in § 150.2, the Commission’s practice has been to set spot month limit levels at or below 25 percent of deliverable supply based on DCM estimates of deliverable supply verified by the Commission, and to set limit levels outside of the spot month at 10 percent of open interest for the first 25,000 contracts of open interest, with a marginal increase of 2.5 percent of open interest thereafter. 2. Proposed § 150.2 173 a. Contracts Subject to Federal Limits The Commission proposes to establish federal limits on the 25 core referenced futures contracts listed in proposed § 150.2(d),174 and on their associated referenced contracts, which would include swaps that qualify as ‘‘economically equivalent swaps.’’ 175 The Commission proposes to establish position limits on futures and options on these 25 commodities on the basis that position limits on such contracts are ‘‘necessary.’’ A discussion of the necessity finding and the characteristics of the 25 core referenced futures contracts is in Section III.F. In order to comply with CEA section 4a(a)(5), the Commission also proposes to establish limits on swaps that are ‘‘economically equivalent’’ to the above.176 As discussed above, under the Commission’s proposed definition of ‘‘economically equivalent swap’’ set forth in § 150.1, a swap would generally qualify as economically equivalent with respect to a particular referenced contract so long as the swap shares identical material contract specifications, terms, and conditions with the referenced contract, disregarding any differences with respect to lot size or notional amount, delivery dates diverging by less than one calendar day, (or for natural gas, by less than two calendar days) or posttrade risk-management arrangements.177 As described in greater detail below, the proposed federal limits would apply during all contract months for the nine legacy agricultural commodity contracts 2020 Proposed spot month limit Core referenced futures contract and only during the spot month for the 16 other commodity contracts. Proposed § 150.2(e) would provide that the levels set forth below for the 25 contracts are listed in Appendix E to part 150 of the Commission’s regulations and would set the compliance date for such levels at 365 days after publication of final position limits regulations in the Federal Register. b. Proposed Federal Spot Month Limit Levels Under the rules proposed herein, federal spot month limit levels would apply to all 25 core referenced futures contracts, and any associated referenced contracts.178 Federal spot month limits for referenced contracts on all 25 commodities are essential for deterring and preventing excessive speculation, manipulation, corners and squeezes.179 Proposed § 150.2(e) provides that federal spot month levels are set forth in proposed Appendix E to part 150 and are as follows: Existing federal spot month limit Existing exchange-set spot month limit Legacy Agricultural Contracts lotter on DSKBCFDHB2PROD with PROPOSALS3 CBOT CBOT CBOT CBOT CBOT CBOT CBOT Corn (C) ............................................................................ Oats (O) ............................................................................ Soybeans (S) .................................................................... Soybean Meal (SM) .......................................................... Soybean Oil (SO) ............................................................. Wheat (W) ........................................................................ KC HRW Wheat (KW) ...................................................... 173 This portion of the release is organized by subject matter, rather than by lettered provision, and will proceed in the following order: (1) Contracts subject to federal limits; (2) proposed spot month limit levels; (3) proposed methodology for setting spot month limit levels; (4) proposed nonspot month limit levels; (5) proposed methodology for setting non-spot month limit levels; (6) subsequent levels; (7) relevant contract month for purposes of referenced contracts; (8) limits on preexisting positions; (9) limits for positions on foreign boards of trade; (10) anti-evasion provision; (11) netting of positions; (12) eligible affiliates and aggregation; and (13) request for comment. 174 Proposed § 150.2(d) provides that each core referenced futures contract includes any ‘‘successor’’ contracts. An example of a successor contract would be the RBOB Gasoline contract that was listed due to a change in gasoline specifications and that ultimately replaced the Unleaded Gasoline contract. For some time, both contracts were listed for trading to allow open interest to migrate to the new RBOB contract; once trading migrated, the Unleaded Gasoline contract was delisted. 175 As described above, the proposed term ‘‘referenced contract’’ includes: (1) Futures and options on futures contracts that, with respect to a particular core referenced futures contract, are directly or indirectly linked to the price of that core referenced futures contract, or directly or indirectly linked to the price of the same commodity underlying the core referenced futures contract for delivery at the same location; and (2) ‘‘economically equivalent swaps.’’ See proposed ‘‘referenced contract’’ and ‘‘economically equivalent swap’’ definitions in 150.1. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 1,200 600 1,200 1,500 1,100 1,200 1,200 176 CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5). infra Section II.A.4. (definition of ‘‘economically equivalent swap’’). 178 As described below, federal non-spot month limit levels would only apply to the nine legacy agricultural commodities. The 16 non-legacy commodities would be subject to federal limits during the spot month, and exchange-set limits and/or accountability outside of the spot month. See infra Section II.B.2.d. (discussion of proposed non-spot month limit levels). 179 See infra Section III. (Legal Matters). 180 CBOT’s existing exchange-set limit for Wheat (W) is 600 contracts. However, for its May contract month, CBOT has a variable spot limit that is dependent upon the deliverable supply that it publishes from the CBOT’s Stocks and Grain report on the Friday preceding the first notice day for the May contract month. In the last five trading days of the expiring futures month in May, the speculative position limit is: (1) 600 contracts if deliverable supplies are at or above 2,400 contracts; (2) 500 contracts if deliverable supplies are between 2,000 and 2,399 contracts; (3) 400 contracts if deliverable supplies are between 1,600 and 1,999 contracts; (4) 300 contracts if deliverable supplies are between 1,200 and 1,599 contracts; and (5) 220 contracts if deliverable supplies are below 1,200 contracts. 181 The proposed federal spot month limit for CME Live Cattle (LC) would feature a step-down limit similar to the CME’s existing Live Cattle (LC) step-down exchange set limit. The proposed federal spot month step down limit is: (1) 600 at the close of trading on the first business day following the 177 See PO 00000 Frm 00030 Fmt 4701 Sfmt 4702 600 600 600 720 540 600 600 600 600 600 720 540 180 600/500/400/300/220 600 first Friday of the contract month; (2) 300 at the close of trading on the business day prior to the last five trading days of the contract month; and (3) 200 at the close of trading on the business day prior to the last two trading days of the contract month. 182 CME’s existing exchange-set limit for Live Cattle (LC) has a step-down spot month limit: (1) 450 at the close of trading on the first business day following the first Friday of the contract month; (2) 300 at the close of trading on the business day prior to the last five trading days of the contract month; and (3) 200 at the close of trading on the business day prior to the last two trading days of the contract month. 183 CBOT’s existing exchange-set spot month limit for Rough Rice (RR) is 600 contracts for all contract months. However, for July and September, there is a step-down limit from 600 contracts. In the last five trading days of the expiring futures month, the speculative position limit for the July futures month steps down to 200 contracts from 600 contracts and the speculative position limit for the September futures month steps down to 250 contracts from 600 contracts. 184 NYMEX recommends implementing a stepdown federal spot position limit for its Light Sweet Crude Oil (CL) futures contract: (1) 6,000 contracts as of the close of trading three business days prior to the last trading day of the contract; (2) 5,000 contracts as of the close of trading two business days prior to the last trading day of the contract; and (3) 4,000 contracts as of the close of trading one business day prior to the last trading day of the contract. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules 2020 Proposed spot month limit Core referenced futures contract MGEX HRS Wheat (MWE) .......................................................... ICE Cotton No. 2 (CT) ................................................................. Existing federal spot month limit 1,200 1,800 600 300 11625 Existing exchange-set spot month limit 600 300 Other Agricultural Contracts 181 600/300/200 CME Live Cattle (LC) .................................................................. CBOT Rough Rice (RR) .............................................................. ICE Cocoa (CC) ........................................................................... ICE Coffee C (KC) ....................................................................... ICE FCOJ–A (OJ) ........................................................................ ICE U.S. Sugar No. 11 (SB) ........................................................ ICE U.S. Sugar No. 16 (SF) ........................................................ 182 450/300/200 800 4,900 1,700 2,200 25,800 6,400 n/a n/a n/a n/a n/a n/a n/a 6,000 3,000 1,000 500 50 n/a n/a n/a n/a n/a 3,000 1,500 1,500 500 50 184 6,000/5,000/4,000 n/a n/a n/a n/a 3,000 1,000 1,000 1,000 183 600/200/250 1,000 500 300 5,000 n/a Metals Contracts COMEX Gold (GC) ...................................................................... COMEX Silver (SI) ....................................................................... COMEX Copper (HG) .................................................................. NYMEX Platinum (PL) ................................................................. NYMEX Palladium (PA) ............................................................... Energy Contracts NYMEX NYMEX NYMEX NYMEX Light Sweet Crude Oil (CL) ........................................... NYH ULSD Heating Oil (HO) ........................................ NYH RBOB Gasoline (RB) ............................................ Henry Hub Natural Gas (NG) ........................................ Limits for any contract with a proposed limit above 100 contracts would be rounded up to the nearest 100 contracts from the exchangerecommended level and/or from 25 percent of deliverable supply. lotter on DSKBCFDHB2PROD with PROPOSALS3 c. Process for Calculating Federal Spot Month Limit Levels The existing federal spot month limit levels on the nine legacy agricultural contracts have remained constant for decades, yet the markets have changed significantly during that time period, including the advent of electronic trading and the implementation of extended trading hours. Further, open interest and trading volume have since reached record levels, and some of the deliverable supply estimates on which the existing federal spot month limits were originally based are now decades out of date. In light of these and other factors, CME Group, ICE, and MGEX recommended federal spot month limit levels for each of their respective core referenced futures contracts, including contracts that would be subject to federal limits for the first time under this proposal.185 Commission staff reviewed these recommendations and conducted its own analysis of them, including by requesting additional 185 See ICE Comment Letter at 8 (May 14, 2019); MGEX Comment Letter at 2, 4–8 (Aug. 31, 2018); and Summary DSE Proposed Limits, CME Group Comment Letter (Nov. 26, 2019), available at https://comments.cftc.gov (comment file for RIN 3038–AD99). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 2,000 2,000 2,000 information and by independently assessing the recommended levels using its own experience, observations, and knowledge. The Commission proposes to adopt each of the exchangerecommended levels as federal spot month limit levels. In setting federal limits, the Commission considers the four policy objectives in CEA section 4a(a)(3)(B). That is, to set limits, to the maximum extent practicable, in its discretion, to: (1) Diminish, eliminate, or prevent excessive speculation; (2) deter and prevent market manipulation, squeezes, and corners; (3) ensure sufficient market liquidity for bona fide hedgers; and (4) ensure that the price discovery function of the underlying market is not disrupted.186 In setting federal position limit levels, the Commission endeavors to maximize these objectives by setting limits that are low enough to prevent excessive speculation, manipulation, squeezes, and corners that could disrupt price discovery, but high enough so as not to restrict liquidity for bona fide hedgers. Based on the Commission’s experience overseeing federal position limits for decades, and overseeing exchange-set position limits submitted to the Commission pursuant to part 40 of its regulations, the Commission has analyzed and evaluated the information provided by CME Group, ICE, and MGEX, and preliminarily finds that 186 7 PO 00000 U.S.C. 6a(a)(3)(B). Frm 00031 Fmt 4701 Sfmt 4702 none of the recommended levels considered in preparing this release appear improperly calibrated such that they might hinder liquidity for bona fide hedgers, or invite excessive speculation, manipulation, corners, or squeezes, including activity that could impact price discovery. For these reasons, discussed in turn below, the Commission preliminarily believes that the DCMs’ recommended spot month limit levels all further the statutory objectives set forth in CEA section 4a(a)(3)(B).187 i. The Proposed Spot Month Limit Levels Are Low Enough To Prevent Excessive Speculation and Protect Price Discovery All 25 of the exchange-recommended levels are at or below 25 percent of deliverable supply.188 The Commission has long used deliverable supply as the basis for spot month position limits due to concerns regarding corners, squeezes, and other settlement-period manipulative activity.189 It would be difficult, in the absence of other factors, for a participant to corner or squeeze a market if the participant holds less than or equal to 25 percent of deliverable supply because, among other things, any 187 7 U.S.C. 6a(a)(3)(B). recommended levels range from approximately 7 percent of deliverable supply to 25 percent of deliverable supply. 189 See, e.g., Revision of Federal Speculative Position Limits and Associated Rules, 64 FR 24038 (May 5, 1999). 188 The E:\FR\FM\27FEP3.SGM 27FEP3 11626 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules potential economic gains resulting from the manipulation may be insufficient to justify the potential costs, including the costs of acquiring, and ultimately offloading, the positions used to effectuate the manipulation. By restricting positions to a proportion of the deliverable supply of the commodity, the spot month position limits require that no one speculator can hold a position larger than 25 percent of deliverable supply, reducing the possibility that a market participant can use derivatives, including referenced contracts, to affect the price of the cash commodity (and vice versa). Limiting a speculative position based on a percentage of deliverable supply also restricts a speculative trader’s ability to establish a leveraged position in cashsettled derivative contracts, reducing that trader’s incentive to manipulate the cash settlement price.190 Further, by proposing levels that are sufficiently low to prevent market manipulation, including corners and squeezes, the proposed levels also help ensure that the price discovery function of the underlying market is not disrupted because markets that are free from corners, squeezes, and other manipulative activity reflect fundamentals of supply and demand rather than artificial pressures. Each of the exchange-recommended levels is based on a percentage of deliverable supply estimated by the relevant exchange and submitted to the Commission for review.191 The lotter on DSKBCFDHB2PROD with PROPOSALS3 190 Id. 191 See ICE Comment Letter at 8 (May 14, 2019); MGEX Comment Letter at 2, 4–8 (Aug. 31, 2018); and Summary DSE Proposed Limits, CME Group Comment Letter (Nov. 26, 2019), available at https://comments.cftc.gov (comment file for RIN 3038–AD99).CME Group submitted updated estimates of deliverable supply and recommended federal spot month limit levels for CBOT Corn (C), CBOT Oats (O), CBOT Rough Rice (RR), CBOT Soybeans (S), CBOT Soybean Meal (SM), CBOT Soybean Oil (SO), CBOT Wheat (W), and CBOT KC HRW Wheat (KW); COMEX Gold (GC), COMEX Silver (SI), NYMEX Platinum (PL), NYMEX Palladium (PA), and COMEX Copper (HG); and NYMEX Henry Hub Natural Gas (NG), NYMEX Light Sweet Crude Oil (CL), NYMEX NY Harbor ULSD Heating Oil (HO), and NYMEX NY Harbor RBOB Gasoline (RB). ICE submitted updated estimates of deliverable supply and recommended federal spot month limit levels for ICE Cocoa (CC), ICE Coffee C (KC), ICE Cotton No. 2 (CT), ICE FCOJ– A (OJ), ICE U.S. Sugar No. 11 (SB), and ICE U.S. Sugar No. 16 (SF). MGEX submitted an updated deliverable supply estimate and indicated that if the Commission adopted a specific spot month position limit, MGEX believes the federal spot month limit level for MGEX Hard Red Spring Wheat (MWE) should be no less than 1,000 contracts. Commission staff reviewed the exchange submissions and conducted its own research. Commission staff reviewed the data submitted, confirmed that the data submitted accurately reflected the source data, and considered whether the data sources were authoritative. Commission staff considered whether VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Commission has closely assessed the estimates, which CME Group, ICE, and MGEX updated with recent data using the methodologies they used during the 2016 Reproposal.192 The Commission hereby verifies that the estimates submitted by the exchanges are reasonable. In verifying the DCMs’ estimates of deliverable supply, the Commission is not endorsing any particular methodology for estimating deliverable supply beyond what is already set forth in Appendix C to part 38 of the Commission’s regulations.193 As circumstances change over time, such DCMs may need to adjust the methodology, assumptions, and allowances that they use to estimate deliverable supply to reflect then current market conditions and other relevant factors. ii. The Proposed Spot Month Limit Levels are High Enough To Ensure Sufficient Market Liquidity for Bona Fide Hedgers Section 4a(a)(1) of the CEA addresses ‘‘excessive speculation. . .causing sudden or unreasonable fluctuations or unwarranted [price] changes . . .’’ 194 Speculative activity that is not ‘‘excessive’’ in this manner is not a focus of section 4a(a)(1). Rather, speculative activity may generate liquidity by enabling market participants with bona fide hedging positions to trade more efficiently. Setting position limits too low could result in reduced liquidity, including for bona fide hedgers. The Commission has not observed, or received any complaints about, a lack of liquidity for bona fide hedgers in the markets for the 25 core referenced futures contracts. In fact, as described later in this release, the 25 core referenced futures contracts represent some of the most liquid the assumptions made by the exchanges in the submissions were acceptable, or whether alternative assumptions would lead to similar results. In some cases, Commission staff conducted trade source interviews. Commission staff replicated the calculations included in the submissions. 192 See CME Group Comment Letter (Apr. 15, 2016); CME Group Comment Letter (addressing natural gas) (Sept. 15, 2016); CME Group Comment Letter (addressing ULSD) (Sept. 15, 2016); ICE Comment Letter (Apr. 20, 2016); and MGEX Comment Letter (Jul. 13, 2016), available at https:// comments.cftc.gov/PublicComments/ CommentList.aspx?id=1772&ctl00_ctl00_ cphContentMain_MainContent_ gvCommentListChangePage=8_50. At that time, the Commission reviewed the methodologies that the DCMs used to prepare the estimates, among other things, and verified the deliverable supply estimates as reasonable. See 2016 Reproposal, 81 FR at 96754. 193 17 CFR part 38, Appendix C. 194 CEA section 4a(a)(1); 7 U.S.C. 6a(a)(1). PO 00000 Frm 00032 Fmt 4701 Sfmt 4702 markets overseen by the Commission.195 Market developments that have taken place since federal spot month limits were last amended decades ago, such as electronic trading and expanded trading hours, have likely only contributed to these already liquid markets.196 Market participants have more opportunities than ever to enter, trade, or exit a position. By proposing to generally increase the existing federal spot month limit levels, and by proposing federal spot month limit levels that are generally equal to or higher than existing exchange-set levels,197 yet in all cases still low enough to prevent excessive speculation, manipulation, corners and squeezes, the Commission does not expect the proposed limits to result in a reduction in liquidity for bona fide hedgers. iii. The Proposed Spot Month Limit Levels Fall Within a Range of Acceptable Levels ICE and MGEX recommended federal spot month limit levels at 25 percent of deliverable supply, while CME Group generally recommended levels below 25 percent of deliverable supply.198 These 195 See infra Section III.F. the exception of CBOT Oats (O), open interest for the legacy agricultural commodities has increased dramatically over the past several decades, some by a factor of four. 197 While the proposed spot month limit levels are generally higher than the existing federal or exchange-set levels, the proposed federal level for COMEX Copper (HG) is below the existing exchange-set level, the proposed federal level for CBOT Oats (O) is the same as the existing federal and exchange-set level, and the proposed federal levels for NYMEX Platinum (PL) and NYMEX Palladium (PA) are the same as the existing exchange-set levels. 198 For the following core referenced futures contracts, CME Group recommended spot month levels below 25 percent of deliverable supply: CBOT Corn (C) (9.22% of deliverable supply), CBOT Oats (O) (19.29%), CBOT Soybeans (S) (15.86%), CBOT Soybean Meal (SM) (16.77%), Soybean Oil (SO) (8.31%), CBOT Wheat (W) (9.24%), CBOT KC HRW Wheat (KW) (9.24%), CME Live Cattle (LC) (step-down limits 15.86%–7.93%– 5.29%), CBOT Rough Rice (RR) (8.94%), COMEX Gold (GC) (12.72%), COMEX Silver (SI) (12.62%), COMEX Copper (HG) (9.66%), NYMEX Platinum (PL) (13.60%), NYMEX Palladium (PA) (17.18%), NYMEX Light Sweet Crude Oil (CL) (step-down limits 11.16%–9.30%–7.44%), NYMEX NYH ULSD Heating Oil (HO) (10.85%), and NYMEX NYH RBOB Gasoline (RB) (7.41%). CME Group recommended spot month levels at 25 percent of estimated deliverable supply for NYMEX Henry Hub Natural Gas (NG). ICE and MGEX recommended limit levels at 25 percent of estimated deliverable supply for each of their core referenced futures contracts: Cocoa (CC), Coffee C (KC), FCOJ–A (OJ), Cotton No. 2 (CT), U.S. Sugar No. 11 (SB), and U.S. Sugar No. 16 (SF) on ICE, and Hard Red Spring Wheat (MWE) on MGEX. See ICE Comment Letter at 1–7 (May 14, 2019); MGEX Comment Letter at 2, 4–8 (Aug. 31, 2018); and Summary DSE Proposed Limits, CME Group Comment Letter (Nov. 26, 2019), available at https://comments.cftc.gov (comment file for RIN 3038–AD99). 196 With E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules distinctions reflect philosophical and other differences among the exchanges and differences between the core referenced futures contracts and their underlying commodities, including a preference on the part of CME Group not to increase existing limit levels applicable to its core referenced futures contracts too drastically.199 The Commission has previously stated that ‘‘there is a range of acceptable limit levels,’’ 200 and continues to believe this is true, both for spot and non-spot month limits. There is no single ‘‘correct’’ spot month limit level for a given contract, and it is likely that a number of limit levels within a certain range could effectively address the 4a(a)(3) factors. While the CME Group, ICE, and MGEX recommended levels all fall at different ends of the deliverable supply range, the levels all fall at or below 25 percent of deliverable supply, which is critical for protecting the spot month from excessive speculation, manipulation, corners and squeezes. lotter on DSKBCFDHB2PROD with PROPOSALS3 iv. The Proposed Spot Month Limit Levels Account for Differences Between Markets In addition to being high enough to ensure sufficient liquidity, and low enough to prevent excessive speculation and manipulation, the proposed spot month limit levels are also calibrated to further address CEA section 4a(a)(3) by accounting for differences between markets for the core referenced futures contracts and for their underlying commodities.201 199 CME Group has indicated that for its own exchange-set limits, it historically has not typically set the limit at the full 25 percent of deliverable supply when launching a new product, regardless of asset class or commodity. CME Group’s recommended spot month limit levels are based on observations regarding the orderliness of liquidations and monitoring for appropriate price convergence. CME Group indicated that the recommended levels reflect a measured approach calibrated to avoid the risk of disruption to its markets, and stated that upon analyzing a reasonable body of data relating to the expirations with the recommended spot month limit levels, CME Group would consider in the future making any recommendations for increases in limits if any additional increases were appropriate. Summary DSE Proposed Limits, CME Group Comment Letter (Nov. 26, 2019), available at https:// comments.cftc.gov (comment file for RIN 3038– AD99). 200 See, e.g., Revision of Federal Speculative Position Limits, 57 FR at 12766, 12770 (Apr. 13, 1992). 201 Commenters, including those responding to the 2016 Reproposal, have previously requested that limit levels should be set on a commodity-bycommodity basis to recognize differences among commodities, including differences in liquidity, seasonality, and other economic factors. See, e.g., AQR Capital Management Comment Letter at 12 (Feb. 28, 2017); Copperwood Asset Management Comment Letter at 3 (Feb. 28, 2017); Managed Funds Association, Asset Management Group of the VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 For the agricultural commodities, the Commission considered a variety of factors in evaluating the exchangerecommended spot month levels, including concentration and composition of market participants, the historical price volatility of the commodity, convergence between the futures and cash market prices at the expiration of the contract, and the Commission’s experience observing how the supplies of agricultural commodities are affected by weather (drought, flooding, or optimal growing conditions), storage costs, and delivery mechanisms. In the Commission’s view, the exchanges’ recommended spot month levels for each of the agricultural contracts would allow for speculators to be present in the market while preventing speculative positions from being so large as to harm convergence and otherwise hinder statutory objectives. The Commission also considered the delivery mechanisms for the agricultural commodities in assessing the exchangerecommended spot month levels. For example, for the CME Live Cattle (LC) contract, the Commission considered the physical limitation that exists on how many cattle can be processed (inspected, graded, and weighed) at the delivery facilities. CME Group currently has an exchange-set step-down spot month limit, and recommended a federal step-down limit for CME Live Cattle (LC) of 600/300/200 contracts in order to avoid congestion and to foster convergence by gradually reducing the limit levels in a manner that meets the processing capacity of the delivery facilities. The Commission proposes to adopt this step-down limit due to the unique attributes of the CME Live Cattle (LC) contract. For the metals contracts, which are all listed on NYMEX, the Commission took delivery mechanisms, among other factors, into account in assessing the recommended spot month limit levels. Upon expiration, the long for each metals contract receives the ownership certificate (warrant) for the metal already in the warehouse/depository and can continue to store the metal where it is, load-out the metal, or short a futures contract to sell the ownership certificate. This delivery mechanism, which allows for the resale of the warrant while the metal remains in the warehouse, provides for relatively inexpensive and simple delivery when compared to the delivery mechanisms Securities Industry and Financial Markets Association, and the Alternative Investment Management Association Comment Letter at 9–12 (Feb. 28, 2017); and National Grain and Feed Association Comment Letter at 2 (Feb. 28, 2017). PO 00000 Frm 00033 Fmt 4701 Sfmt 4702 11627 for other commodity types. Further, metals tend not to spoil and are cheap to store on a per dollar basis compared to other commodities. As metals are generally easier to obtain, store, and sell than other commodity types, it is also potentially cheaper to accomplish a corner or squeeze in metals than in other commodity types. The Commission has previously observed manipulative activity in metals as evidenced by the Hunt Brother silver and Sumitomo copper events. The Commission kept this history in mind in accepting CME Group’s recommendation to take a fairly cautious approach with respect to the recommended levels for each metal contract, which are each well below 25 percent of deliverable supply.202 Commission staff has, however, reviewed each of the metals contracts previously and confirms that these contracts satisfy all regulatory requirements, including the DCM Core Principle 3 requirement that the contracts are not readily susceptible to manipulation. Additionally, the Commission considered the volatility in the estimated deliverable supply for metals. For the COMEX Copper (HG) contract, the estimated deliverable supply for copper (measured by copper stocks in COMEX-approved warehouses) has experienced considerable volatility during the past decade, resulting in COMEX amending its exchange-set spot month position limit multiple times, decreasing or increasing the limit level to reflect the amount of copper in its approved warehouses.203 Similarly, volatility in deliverable supplies has been observed for the NYMEX Palladium (PA) contract, where production of palladium from major producers has been declining while demand for palladium by the auto 202 As noted above, CME Group’s recommended federal level of 1,000 for COMEX Copper (HG) is below the existing exchange-set level of 1,500, and CME Group’s recommended federal levels for NYMEX Platinum (PL) and NYMEX Palladium (PA) are equal to the existing exchange-set levels of 500 and 50, respectively. CME Group recommended federal levels of 6,000 for COMEX Gold (GC) and 3,000 for COMEX Silver (SI), which would represent an increase over the existing exchange-set levels of 3,000 and 1,500, respectively. While CME Group’s recommended federal COMEX Gold (GC) and COMEX Silver (SI) levels are higher than the existing exchange-set levels, the recommended levels still represent only approximately 13 percent of deliverable supply each. Summary DSE Proposed Limits, CME Group Comment Letter (Nov. 26, 2019), available at https://comments.cftc.gov (comment file for RIN 3038–AD99). 203 The volatility was based on factors such as the bust in the housing market in 2008, the severe recession in the United States in 2009, and high demand for copper exports to China, which has grown continually over the past 20 years. E:\FR\FM\27FEP3.SGM 27FEP3 11628 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules industry for catalytic converters has increased. This trend in palladium stocks in exchange-approved depositories has been observed since 2014. In a series of amendments, NYMEX reduced its exchange-set spot month limit from 650 contracts to below 200 contracts over time.204 The Commission has not observed similar volatility in the deliverable supply estimates for agricultural or energy commodities. Given this history of volatility in deliverable supply estimates for metals, if the Commission were to set limit levels at, rather than below, 25 percent of deliverable supply, and if deliverable supply were to subsequently change drastically, the spot month limit level could end up being well above (or below) 25 percent of deliverable supply, and thus potentially too high (or too low) to further statutory objectives. For the energy complex, the Commission considered factors such as the underlying infrastructure and connectivity. For example, as of 2017, generally, out of commodities underlying the core referenced futures contracts in energy, natural gas had the most robust infrastructure for moving the commodity, with over 1,600,000 miles of pipeline (including distribution mains, transmission pipelines, and gathering lines) in the United States, compared to only 215,000 miles of pipeline for oil (including crude and product lines).205 The robust infrastructure for moving natural gas supports CME Group’s recommended spot month limit level at 25 percent of estimated deliverable supply for the NYMEX Henry Hub Natural Gas (NG) contract, while comparatively smaller crude oil and crude product pipeline infrastructure support CME Group’s recommended spot month limit levels below 25 percent of estimated deliverable supply for the NYMEX Light lotter on DSKBCFDHB2PROD with PROPOSALS3 204 See, e.g., NYMEX Submissions Nos. 14–463 (Oct. 31, 2014), 15–145 (Apr. 14, 2015), and 15–377 (Aug. 27, 2015). 205 See U.S. Oil and Gas Pipeline Mileage, Bureau of Transportation Statistics website, available at www.bts.gov/content/us-oil-and-gas-pipelinemileage. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Sweet Crude Oil (CL) and NYMEX NYH RBOB Gasoline (RB) contracts. The Commission also considered factors such as the large amounts of liquidity in the cash-settled natural gas referenced contracts relative to the physically settled NYMEX Henry Hub Natural Gas (NG) core referenced futures contract. For that contract, CME Group recommended setting the spot month limit at 25 percent of estimated deliverable supply (2,000 contract spot month limit) with a conditional limit exemption of 10,000 contracts net long or net short conditioned on the participant not holding or controlling any positions during the spot month in the physically-settled NYMEX Henry Hub Natural Gas (NG) core referenced futures contract. Speculators who desire price exposure to natural gas will likely trade in the cash-settled contracts because, generally, they do not have the ability to make or take delivery; trading in the cash-settled contract removes the chance that they may be unable to exit the physically-settled NYMEX Henry Hub Natural Gas (NG) contract and be selected to make or take delivery of natural gas. Thus, speculators are likely to remain out of the NYMEX Henry Hub Natural Gas (NG) contract during the spot month. Since corners and squeezes cannot be effected using cash settled contracts, the Commission proposes a spot month limit set at 25 percent of deliverable supply for the NYMEX Henry Hub Natural Gas (NG) core referenced futures contract. Further, for certain energy commodities, CME Group recommended step-down limits, including for commodities where delivery constraints could hinder convergence or where market participants otherwise provided feedback that such limits would help maintain orderly markets. In the case of NYMEX Light Sweet Crude Oil (CL), CME Group currently has a single spotmonth limit of 3,000 contracts, but is recommending a step down limit that would end at 4,000 contracts (stepdown limits of 6,000/5,000/4,000). Historically, as liquidity decreases in the contract, the exchange would have PO 00000 Frm 00034 Fmt 4701 Sfmt 4702 a step down mechanism in its exemptions that it had granted to force market participants to lower their positions to the current 3,000 contract spot month limit. Given the recommended increase to a final stepdown limit of 4,000 contracts, the exchange, through feedback from market participants, recommended a step-down spot month limit that would in effect provide the same diminishing effect on positions. d. Proposed Federal Single Month and All-Months Combined (‘‘Non-Spot Month’’) Limit Levels Under the rules proposed herein, federal non-spot month limits would only apply to the nine agricultural commodities currently subject to federal limits. The 16 additional contracts covered by this proposal would be subject to federal limits only during the spot month, and exchange-set limits and/or accountability requirements outside of the spot month.206 The Commission proposes to maintain federal non-spot month limits for the nine legacy agricultural contracts, with the modifications set forth below, because the Commission has observed no reason to eliminate them. These non-spot month limits have been in place for decades, and while the Commission is proposing to modify the limit levels,207 removing the levels entirely could potentially result in market disruption. In fact, commercial market participants trading the nine legacy agricultural contracts have requested that the Commission maintain federal limits outside the spot month in order to promote market integrity. For the following reasons, however, the Commission is not proposing limits outside the spot month for the other 16 contracts. 206 Market Resources, ICE Futures website, available at https://www.theice.com/futures-us/ market-resources (ICE exchange-set position limits); Position Limits, CME Group website, available at https://www.cmegroup.com/market-regulation/ position-limits.html; Rules and Regulations of the Minneapolis Grain Exchange, Inc., MGEX, available at https://www.mgex.com/documents/Rulebook_ 051.pdf (MGEX exchange-set position limits). 207 See infra Section II.B.2.e. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules First, corners and squeezes cannot occur outside the spot month when there is no threat of delivery, and there are tools other than federal position limits for deterring and preventing manipulation outside of the spot month.208 Surveillance at both the exchange and federal level, coupled with exchange-set limits and/or accountability, would continue to offer strong deterrence and protection against manipulation outside of the spot month. In particular, under this proposal, for the 16 contracts that would be subject to federal limits only during the spot month, exchanges would be required to establish either position limit levels or position accountability levels outside of the spot month.209 Any such accountability and limit levels would be subject to standards established by the Commission including, among other things, that any such levels be ‘‘necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract’s or the underlying commodity’s price or index.’’ 210 Exchanges would also be required to submit any rules adopting or modifying such position limit and/or accountability levels to the Commission pursuant to part 40 of the Commission’s regulations.211 Exchange position accountability establishes a level at which an exchange will ask traders additional questions, including regarding the trader’s purpose for the position, and will evaluate existing market conditions. If the position does not raise any concerns, the exchange will allow the trader to exceed the accountability level. If the position raises concerns, the exchange has the authority to instruct the trader not to increase the position further, or to reduce the position. Accountability is a particularly flexible and effective tool because it provides the exchanges with an opportunity to intervene once a position hits a relatively low level, while still affording market participants with the flexibility to establish a large position when warranted by the nature of the position and the condition of the market. The Commission has decades of experience overseeing accountability levels implemented by exchanges,212 including for all 16 contracts that would not be subject to federal limits outside of the spot month under this proposal. Such accountability levels apply to all participants on the exchange, whether commercial or non-commercial, and regardless of whether the participant would qualify for an exemption. In the Commission’s experience, these levels have functioned as-intended, and the Commission views exchange accountability outside of the spot month as an equally robust, yet more flexible, alternative to federal non-spot month speculative position limits. Second, applying federal limits during the spot month to referenced Core referenced futures contract contracts based on all 25 core referenced futures contracts, and outside of the spot month only to referenced contracts based on the nine legacy agricultural commodities, furthers statutory goals while minimizing the impact on existing industry practice and leveraging existing exchange-set limits and accountability levels that appear to have functioned well. The Commission thus endeavors to minimize market disruption that could result from eliminating existing federal non-spot month limits on certain agricultural commodities and from adding new nonspot limits on certain metals and energy commodities that have never been subject to federal limits. Layering federal non-spot month limits for the 16 additional contracts on top of existing exchange-set limit/accountability levels may only provide minimal benefits, if any, and would forego the benefits associated with flexible accountability levels, which provide many of the same protections as hard limits but with significantly more flexibility for market participants to exceed the accountability level in cases where the position would not harm the market. As set forth in proposed § 150.2(e), proposed federal non-spot month levels applicable to referenced contracts based on the nine legacy agricultural contracts are listed in proposed Appendix E and are as follows: 2020 Proposed single month and all-months combined limit based on new 10/2.5 formula for first 50,000 OI Existing federal single month and all-monthscombined limit Existing exchange-set single month and all-monthscombined limit 57,800 2,000 27,300 16,900 17,400 19,300 12,000 12,000 11,900 33,000 2,000 15,000 6,500 8,000 12,000 12,000 12,000 5,000 33,000 2,000 15,000 6,500 8,000 12,000 12,000 12,000 5,000 lotter on DSKBCFDHB2PROD with PROPOSALS3 CBOT Corn (C) ............................................................................................................................ CBOT Oats (O) ............................................................................................................................ CBOT Soybeans (S) .................................................................................................................... CBOT Soybean Meal (SM) .......................................................................................................... CBOT Soybean Oil (SO) ............................................................................................................. CBOT Wheat (W) ........................................................................................................................ KC HRW Wheat (KW) ................................................................................................................. MGEX HRS Wheat (MWE) .......................................................................................................... ICE Cotton No. 2 (CT) ................................................................................................................. 208 In the case of certain commodities where open interest in the deferred month contracts may be much larger, it may become difficult to exert market power via concentrated futures positions. For example, a participant with a large cash-market position and a large deferred futures position may attempt to move cash markets in order to benefit that deferred futures position. Any attempt to do so could become muted due to general futures market resistance from multiple vested interests present in that deferred futures month (i.e., the overall size of the deferred contracts may be too large for one individual to influence via cash market activity). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 However, if a large position accumulated over time in a particular deferred month is held into the spot month, it is possible that such positions could form the groundwork for an attempted corner or squeeze in the spot month. 209 See infra Section II.D.4. (discussion of proposed § 150.5). 210 Id. 211 Under the proposed ‘‘position accountability’’ definition in § 150.1, DCM accountability rules would have to require a trader whose position exceeds the accountability level to consent to: (1) Provide information about its position to the DCM; PO 00000 Frm 00035 Fmt 4701 Sfmt 4702 11629 and (2) halt increasing further its position or reduce its position in an orderly manner, in each case as requested by the DCM. 212 See, e.g., 56 FR 51687 (Oct. 15, 1991) (permitting CME to establish position accountability for certain financial contracts traded on CME), Speculative Position Limits—Exemptions from Commission Rule 1.61, 57 FR 29064 (June 30, 1992) (permitting the use of accountability for trading in energy commodity contracts), and 17 CFR 150.5(e) (2009) (formally recognizing the practice of accountability for contracts that met specified standards). E:\FR\FM\27FEP3.SGM 27FEP3 11630 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules e. Methodology for Setting Proposed Non-Spot Month Limit Levels The Commission’s practice has been to set non-spot month limit levels for the nine legacy agricultural contracts at 10 percent of the open interest for the first 25,000 contracts and 2.5 percent of the open interest thereafter (the ‘‘10, 2.5 percent formula’’).213 The existing nonspot month limit levels have not been updated to reflect changes in open interest data in over a decade, and the 10, 2.5 percent formula has been used since the 1990s, and was based on the Commission’s experience up until that time.214 The Commission’s adoption of the 10, 2.5 percent formula was based on two primary factors: growth in open interest and the size of large traders’ positions.215 The Commission proposes to maintain the 10, 2.5 percent formula for non-spot limits, with the limited change that the 2.5 percent calculation will be applied to open interest above 50,000 contracts rather than to the current level of 25,000 contracts. The Commission believes that this change is warranted due to the significant overall increase in open interest in these markets, which has roughly doubled since federal limits were set on these markets. The Commission would apply the modified formula to recent open interest data for the periods from July 2017–June 2018 and July 2018–June 2019 of the applicable futures and delta adjusted futures options. The resulting proposed limit levels, set forth in the second column in the table above, would generally be higher than existing limit levels, with the exception of CBOT Oats (O), CBOT KC HRW Wheat (KW), and MGEX HRS Wheat (MWE), where proposed levels would remain at the existing levels. The Commission continues to believe that a formula based on a percentage of open interest is an appropriate tool for establishing limits outside the spot month. As the Commission stated when it initially proposed to use an open interest formula, taking open interest into account ‘‘will permit speculative position limits to reflect better the changing needs and composition of the futures markets . . .’’ 216 Open interest is a measure of market activity that reflects the number of contracts that are ‘‘open’’ or live, where each contract of open interest represents both a long and a short position. Relative to contracts with smaller open interest, contracts with larger open interest may be better able to mitigate the disruptive impact of excessive speculation because there may be more activity to oppose, diffuse, or otherwise counter a potential pricing disruption. Limiting positions to a percentage of open interest: (1) Helps ensure that positions are not so large relative to observed market activity that they risk disrupting the market; (2) allows speculators to hold sufficient contracts to provide a healthy level of liquidity for hedgers; and (3) allows for increases in position limits and position sizes as markets expand and become more active. While the Commission continues to prefer a formula based on a percentage of open interest, market and potential regulatory changes counsel in favor of proposing a slight modification to the existing formula. In particular, as discussed in detail below, open interest has grown, and market composition has changed, significantly since the 1990s. The proposed increase in the open interest portion of the non-spot month limit formula from 25,000 to 50,000 contracts would provide a modest increase in the non-spot month limit of 1,875 contracts (over what the limit would be if the 10, 2.5 percent formula were applied at 25,000 contracts), assuming the underlying commodity futures market has open interest of at least 50,000 contracts. The Commission believes that the amended non-spot month formula would provide a conservative increase in the non-spot month limits for most contracts to better reflect the general increase observed in open interest across futures markets since the late 1990s, as discussed below. i. Increases in Open Interest The table below provides data that describes the market environment during the period prior to, and subsequent to, the adoption of the 10, 2.5 percent formula by the Commission in 1999. The data includes futures contracts and the delta-adjusted options on futures open interest.217 The first column of the table provides the maximum open interest in the nine legacy agricultural contracts over the five year period ending in 1999. The CBOT Corn (C) contract had maximum open interest of approximately 463,000 contracts, and the CBOT Soybeans (S) contract had maximum open interest of approximately 227,000 contracts. The other seven contracts had maximum open interest figures that ranged from less than 20,000 contracts for CBOT Oats (O) to approximately 172,000 for CBOT Soybean Oil (SO). Hence, when adopting the 10, 2.5 percent formula in 1999, the Commission’s experience in these markets was of aggregate futures and options on futures open interest well below 500,000 contracts. TABLE—MAXIMUM FUTURES AND OPTIONS ON FUTURES OPEN INTEREST, 1994–2018 1994–1999 lotter on DSKBCFDHB2PROD with PROPOSALS3 CBOT Corn (C) .................................................................... ICE Cotton No. 2 (CT) ......................................................... 213 For example, assume a commodity contract has an aggregate open interest of 200,000 contracts over the past 12 month period. Applying the 10, 2.5 percent formula to an aggregate open interest of 200,000 contracts would yield a non-spot month limit of 6,875 contracts. That is, 10 percent of the first 25,000 contracts would equal 2,500 contracts (25,000 contracts × 0.10 = 2,500 contracts). Then add 2.5 percent of the remaining 175,000 of aggregate open interest or 4,375 contracts (175,000 contracts × 0.025 = 4,375 contracts) for a total nonspot month limit of 6,875 contracts (2,500 contracts + 4,375 contracts = 6,875 contracts). 214 See, e.g., Revision of Federal Speculative Position Limits and Associated Rules, 64 FR at 24038 (May 5, 1999) (increasing deferred-month limit levels based on 10 percent of open interest up to an open interest of 25,000 contracts, with a marginal increase of 2.5 percent thereafter). Prior to VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 2000–2004 463,386 122,989 828,176 140,240 1999, the Commission had given little weight to the size of open interest in the contract in determining the position limit level—instead, the Commission’s traditional standard was to set limit levels based on the distribution of speculative traders in the market. See, e.g., 64 FR at 24039; Revision of Federal Speculative Position Limits and Associated Rules, 63 FR at 38525, 38527 (July 17, 1998). 215 See 64 FR at 24038. See also 63 FR at 38525, 38527 (The 1998 proposed revisions to non-spot month levels, which were eventually adopted in 1999, were based upon two criteria: ‘‘(1) the distribution of speculative traders in the markets; and (2) the size of open interest.’’). 216 Revision of Federal Speculative Position Limits, 57 FR 12766, 12770 (Apr. 13, 1992). The Commission also stated that providing for a marginal increase was ‘‘based upon the universal observation that the size of the largest individual PO 00000 Frm 00036 Fmt 4701 Sfmt 4702 2005–2009 1,897,484 388,336 2010–2014 2,052,678 296,596 2015–2018 2,201,990 344,302 positions in a market do not continue to grow in proportion with increases in the overall open interest of the market.’’ Id. 217 Delta is a ratio comparing the change in the price of an asset (a futures contract) to the corresponding change in the price of its derivative (an option on that futures contract) and has a value that ranges between zero and one. In-the-money call options get closer to 1 as their expiration approaches. At-the-money call options typically have a delta of 0.5, and the delta of out-of-themoney call options approaches 0 as expiration nears. The deeper in-the-money the call option, the closer the delta will be to 1, and the more the option will behave like the underlying asset. Thus, deltaadjusted options on futures will represent the total position of those options as if they were converted to futures. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules 11631 TABLE—MAXIMUM FUTURES AND OPTIONS ON FUTURES OPEN INTEREST, 1994–2018—Continued 1994–1999 CBOT Oats (O) .................................................................... CBOT Soybeans (S) ............................................................ CBOT Soybean Meal (SM) .................................................. CBOT Soybean Oil (SO) ..................................................... CBOT Wheat (W) ................................................................. CBOT Wheat: Kansas City Hard Red Winter (KW) ............ MGEX Wheat: Minneapolis Hard Red Spring (MWE) ......... The table also displays the maximum open interest figures for subsequent periods up to, and including, 2018. The maximum open interest for all of these contracts, except for oats, generally increased over the period.218 By the 2015–2018 period covered in the last column of the table, five of the contracts had maximum open interest greater than 500,000 contracts. The contracts for CBOT Corn (C), CBOT Soybeans (S), and CBOT Hard Red Winter Wheat (KW) saw maximum open interest increase by a factor of four to five times the maximum open interest during the 1994–1999 period leading up to the Commission’s adoption of the 10, 2.5 percent formula in 1999. ii. Changes in Market Composition As open interest has increased, the current non-spot limits have become significantly more restrictive over time. In particular, because the 2.5 percent incremental increase applies after the first 25,000 contracts of open interest, limits on commodities with open interest above 25,000 contracts (i.e., all commodities other than oats) continue to increase at a much slower rate of 2.5 percent rather than 10 percent, as for the first 25,000 contracts. This gradual increase was less of a problem in the latter part of the 1990s, for example, when open interest in each of the nine legacy agricultural contracts was below 500,000, and in many cases below 2000–2004 18,879 227,379 155,658 172,424 163,193 76,435 24,999 17,939 327,276 183,255 191,337 187,181 87,611 36,155 200,000. More recently, however, open interest has grown above 500,000 for a majority of the legacy contracts. The 10, 2.5 percent formula has thus become more restrictive for market participants, including those entities with positions that may not be eligible for a bona fide hedging exemption, but who might otherwise provide valuable liquidity to commercial firms. This problem has become worse over time because dealers play a much more significant role in the market today than at the time the Commission adopted the 10, 2.5 percent formula. Prior to 1999, the Commission regulated physical commodity markets where the largest participants were often large commercial interests who held short positions. The offsetting positions were often held by small, individual traders, who tended to be long.219 Several years after the Commission adopted the 10, 2.5 percent formula, the composition of futures market participants changed, as dealers began to enter the physical commodity futures market in larger size. The table below presents data from the Commission’s publicly available ‘‘Bank Participation Report’’ (‘‘BPR’’), as of the December report for 2002–2018.220 The table displays the number of banks holding reportable positions for the seven futures contracts for which federal limits apply and that were reported in the BPR.221 The report presents data for every market where 2005–2009 16,860 672,061 241,917 328,050 507,401 159,332 57,765 2010–2014 15,375 991,258 392,265 395,743 576,333 189,972 68,409 2015–2018 11,313 997,881 544,363 547,784 621,750 311,592 80,635 five or more banks hold reportable positions. The BPR is based on the same large-trader reporting system database used to generate the Commission’s Commitments of Traders (‘‘COT’’) report.222 No data was reported for the seven futures contracts in December 2002, indicating that fewer than five banks held reportable positions at the time of the report. The December 2003 report shows that five or more banks held reportable positions in four of the commodity futures. The number of banks with reportable positions generally increased in the early to mid2000s. As described in the Commission’s 2008 Staff Report on Commodity Swap Dealers & Index Traders, major changes in the composition of futures markets developed over the 20 years prior to 2008, including an influx of swap dealers (‘‘SDs’’), affiliated with banks or other large financial institutions, acting as aggregators or market makers and providing swaps to commercial hedgers and to other market participants.223 The dealers functioned in the swaps market and also used the futures markets to hedge their exposures. When the Commission adopted the 10, 2.5 percent formula in 1999, it had limited experience with physical commodity derivatives markets in which such banks were significant participants. TABLE—NUMBER OF REPORTING COMMERCIAL BANKS WITH LONG FUTURES POSITIONS Year lotter on DSKBCFDHB2PROD with PROPOSALS3 2002 2003 2004 2005 2006 2007 2008 Corn ............................. ............................. ............................. ............................. ............................. ............................. ............................. Cotton NR 5 5 10 11 13 17 NR 6 10 8 11 8 13 218 See infra Section II.B.2.e.iii. (discussion of proposed non-spot month limit level for CBOT Oats (O)). 219 Stewart, Blair, An Analysis of Speculative Trading in Grain Futures, Technical Bulletin No. 1001, U.S. Department of Agriculture (Oct. 1949). 220 Bank Participation Reports, U.S. Commodity Futures Trading Commission website, available at VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Soybeans Soybean meal NR 7 7 6 9 12 16 NR NR NR NR NR NR NR https://www.cftc.gov/MarketReports/ BankParticipationReports/index.htm . 221 The term ‘‘reportable position’’ is defined in § 15.00(p) of the Commission’s regulations. 17 CFR 15.00(p). 222 Commitments of Traders, U.S. Commodity Futures Trading Commission website, available at www.cftc.gov/MarketReports/ CommitmentsofTraders/index.htm. There are PO 00000 Frm 00037 Fmt 4701 Sfmt 4702 Soybean oil NR NR NR 5 7 6 6 Wheat Wheat KCBT NR 5 7 9 14 14 14 NR NR NR 9 7 6 9 generally still as many large commercial traders in the markets today as there were in the 1990s. 223 Staff Report on Commodity Swap Dealers & Index Traders with Commission Recommendations, U.S. Commodity Futures Trading Commission (Sept. 2008), available at https://www.cftc.gov/sites/ default/files/idc/groups/public/@newsroom/ documents/file/cftcstaffreportonswapdealers09.pdf. E:\FR\FM\27FEP3.SGM 27FEP3 11632 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules TABLE—NUMBER OF REPORTING COMMERCIAL BANKS WITH LONG FUTURES POSITIONS—Continued Year 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Corn ............................. ............................. ............................. ............................. ............................. ............................. ............................. ............................. ............................. ............................. Cotton 8 7 10 8 11 15 12 15 16 16 Soybeans 8 7 11 10 11 12 13 14 13 15 Soybean meal 8 7 9 11 13 15 13 15 12 18 Soybean oil NR NR 5 6 10 10 12 12 11 15 Wheat NR NR 5 6 6 9 9 10 9 13 Wheat KCBT 13 11 10 13 11 15 16 15 16 18 NR NR NR 5 5 6 9 6 8 12 NR = ‘‘Not Reported’’. For 2003, the first year in the report with reported data on the futures for these physical commodities, the BPR showed, as displayed in the table below, that the reporting banks held modest positions, totaling 3.4 percent of futures long open interest for wheat and smaller positions in other futures. The positions displayed in the table below increased over the next several years, generally peaking around 2005/2006 as a fraction of the long open interest. TABLE—PERCENT OF FUTURES LONG OPEN INTEREST HELD BY COMMERCIAL BANKS Year (Dec.) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. Corn Cotton NR 1.5% 7.0 12.5 9.4 9.2 8.9 4.3 3.7 4.1 4.7 5.3 9.7 8.1 8.1 5.5 5.8 Soybeans NR 1.4% 6.5 13.8 14.2 9.7 18.2 6.5 2.5 3.3 9.9 9.1 10.0 10.1 8.5 9.5 8.3 Soybean meal NR 0.8% 3.6 8.3 7.7 6.7 10.0 3.6 4.7 4.9 3.7 4.4 6.3 5.0 7.1 4.3 5.9 Soybean oil NR NR NR NR NR NR NR NR NR 1.9 5.8 7.0 6.7 5.9 10.7 9.1 9.2 Wheat NR NR NR 6.8 6.7 6.5 6.4 NR NR 4.4 5.5 4.1 6.5 6.4 6.6 7.3 7.6 Wheat KCBT NR 3.4% 14.5 20.2 17.0 13.5 18.7 9.3 6.9 7.7 7.4 6.2 7.7 7.8 7.3 7.7 10.2 NR NR NR 5.2 6.9 5.5 7.1 NR NR NR 3.5 6.4 10.1 4.3 5.2 4.8 7.0 NR = ‘‘Not Reported’’. lotter on DSKBCFDHB2PROD with PROPOSALS3 iii. Proposed Non-Spot Month Limits for Hard Red Wheat and Oats The Commission proposes partial wheat parity outside of the spot month: limits for CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) would be set at 12,000 contracts, while limits for CBOT Wheat (W) would be set at 19,300 contracts. Based on the Commission’s experience since 2011 with non-spot month speculative position limit levels at 12,000 for the CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) core referenced futures contracts, the Commission is proposing to maintain the current non-spot month limit levels for those two contracts, rather than reducing the existing levels to the lower levels that would result from applying the proposed modified 10, 2.5 percent formula.224 The current 12,000 contract 224 Applying the proposed modified 10, 2.5 percent formula to recent open interest data for VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 level appears to have functioned well for these contracts, and the Commission sees no market-based reason to reduce the levels. CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) are both hard red wheats representing about 60 percent of the wheat grown in the United States 225 and about 80 percent of the wheat grown in Canada.226 Although the CBOT Wheat (W) contract allows for delivery of hard red wheat, it typically sees deliveries of soft white these two contracts would result in limit levels of 11,900 and 5,700, respectively. 225 Wheat Sector at a Glance, USDA Economic Research Service, available at https:// www.ers.usda.gov/topics/crops/wheat/wheat-sectorat-a-glance. 226 Estimated Areas, Yield, Production, Average Farm Price and Total Farm Value of Principal Field Crops, In Metric and Imperial Units, Statistics Canada website, available at https:// www150.statcan.gc.ca/t1/tbl1/en/tv.action? pid=3210035901. PO 00000 Frm 00038 Fmt 4701 Sfmt 4702 wheat varieties, which comprises a smaller percentage of the wheat grown in North America. Even though the CBOT Wheat (W) contract has the majority of liquidity among the three wheat contracts as measured by open interest and trading volume, it is the hard red wheats that make up the bulk of wheat crops in North America. Thus, the Commission proposes to maintain the non-spot month limit for the CBOT KC HRW Wheat (KW) contract and MGEX HRS Wheat (MWE) contract at the 12,000 contract level even though both contracts would have a lower nonspot month limit based solely on the open interest formula. The Commission preliminarily believes that maintaining partial parity and the existing non-spot month limits in this manner will benefit the MWE and KW markets since the two species of wheat are similar (i.e., hard red wheat) to one another relative to CBOT Wheat (W), which is soft white E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules wheat; and as a result, the Commission has preliminarily determined that decreasing the non-spot month levels for MWE could impose liquidity costs on the MWE market and harm bona fide hedgers, which could further harm liquidity for bona fide hedgers in the related KW market. However, the Commission has determined not to raise the proposed limit levels for CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) to the proposed 19,300 contract limit level for CBOT Wheat (W) because 19,300 contracts appears to be extraordinarily large in comparison to open interest in the CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) markets, and the limit levels for both contracts are already larger than a limit level based on the 10, 2.5 percent formula. The Commission is concerned that substantially raising non-spot limits on the KW or MWE contracts could create a greater likelihood of excessive speculation given their smaller overall trading relative to the CBOT Wheat (W) contract. In response to prior proposals, which would have resulted in lower non-spot limits for MWE, MGEX had requested parity among all wheat contracts. In part, MGEX reasoned that intermarket spread trading among the three contracts is vital to their price discovery function.227 The Commission notes that intermarket spreading is permitted under this proposal.228 The intermarket spread exemption should address any concerns over the loss of liquidity in spread trades among the three wheat contracts. Likewise, based on the Commission’s experience since 2011 with the current non-spot month speculative position limit of 2,000 contracts for CBOT Oats (O), the Commission is proposing to maintain the current 2,000 contract level rather than reducing it to the lower levels that would result from applying the updated 10, 2.5 formula.229 The existing 2,000 contract limit for CBOT Oats (O) appears to have functioned well, and the Commission sees no reason to reduce it. While retaining the existing non-spot month limits for the MWE and KW contracts and for CBOT Oats (O) does break with the proposed non-spot month formula, the Commission has confidence that the existing contract limits should continue to be appropriate for these contracts. Furthermore, even when relying on a single criterion, such as percentage of open interest, the Commission has historically recognized that there can ‘‘result . . . a range of acceptable position limit levels.’’ 230 For all of the core referenced contracts, based on decades of experience overseeing exchange-set position limits and administering its own federal position limits regime, the Commission is of the view that the proposed non-spot month limit levels are also low enough to diminish, eliminate, or prevent excessive speculation, and to deter and prevent market manipulation, squeezes, and corners. The Commission has previously studied prior increases in federal non-spot month limits and concluded that the overall impact was modest, and that any changes in market performance were most likely attributable to factors other than changes in the federal position limit rules.231 The Commission has since gained further experience which supports that conclusion, including by monitoring amendments to position limit levels by exchanges. Further, given the significant increases in open interest and changes in market composition that have occurred since the 1990s, the Commission is comfortable that the proposal to amend the 10, 2.5 percent formula will adequately address each of the policy objectives set forth in CEA section 4a(a)(3).232 227 See Statement of Layne Carlson, CFTC Agricultural Advisory Committee meeting, Sept. 22, 2015, at 38–44. 228 See supra Section II.A.20. (definition of spread transaction). 229 Applying the proposed modified 10, 2.5 percent formula to recent open interest data for oats would result in a 700 contract limit level. 230 Revision of Speculative Position Limits, 57 FR 12770, 12766 (Apr. 13, 1992). See also Revision of Speculative Position Limits and Associated Rules, 63 FR at 38525, 38527 (July 17, 1998). Cf. 2013 Proposal, 78 FR at 75729 (there may be range of spot month limits that maximize policy objectives). 231 64 FR 24038, 24039 (May 5, 1999). 232 7 U.S.C. 6a(a)(3)(B). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 iv. Conclusion With the exception of the CBOT KC HRW Wheat (KW), MGEX HRS Wheat (MWE), and CBOT Oats (O) contracts, as noted above, the proposed formula would result in higher non-spot month limit levels than those currently in place. Furthermore, as noted above, under the rules proposed herein, the nine legacy agricultural contracts would be the only contracts subject to limits outside of the spot month. Aside from the CBOT Oats (O) contract, these contracts all have high open interest, and thus their pricing may be less likely to be affected by the trading of large position holders in non-spot months. Further, consistent with the approach proposed herein to leverage existing exchange-level programs and expertise, the proposed federal non-spot month limit levels would serve simply as PO 00000 Frm 00039 Fmt 4701 Sfmt 4702 11633 ceilings—exchanges would remain free to set exchange levels below the federal limit. The exchanges currently have systems and processes in place to monitor and surveil their markets in real time, and have the ability, and regulatory responsibility, to act quickly in the event of a disturbance.233 Additionally, exchanges have tools other than position limits for protecting markets. For instance, exchanges can establish position accountability levels well below a position limit level, and can impose liquidity and concentration surcharges to initial margin if they are vertically integrated with a derivatives clearing organization. One reason that the Commission is proposing to update the formula for calculating non-spot month limit levels is that the exchanges may be able in certain circumstances to act much more quickly than the Commission, including quickly altering their own limits and accountability levels based on changing market conditions. Any decrease in an exchange-set limit would effectively lower the federal limit for that contract, as market participants would be required to comply with both federal and exchange-set limits, and as the Commission has the authority to enforce violations of both federal and exchangeset limits.234 f. Subsequent Spot and Non-Spot Month Limit Levels Prior to amending any of the proposed spot or non-spot month levels, if adopted, the Commission would provide for public notice and comment by publishing the proposed levels in the Federal Register. Under proposed § 150.2(f), should the Commission wish to rely on exchange estimates of deliverable supply to update spot month speculative limit levels, DCMs would be required to supply to the Commission deliverable supply estimates upon request. Proposed § 150.2(j) would delegate the authority to make such requests to the Director of the Division of Market Oversight. Recognizing that estimating deliverable supply can be a time and resource consuming process for DCMs and for the Commission, the Commission is not proposing to require 233 For example, under DCM Core Principle 4, DCMs are required to ‘‘have the capacity and responsibility to prevent manipulation, price distortion, and disruptions of the delivery or cashsettlement process through market surveillance, compliance, and enforcement practices and procedures,’’ including ‘‘methods for conducting real-time monitoring of trading’’ and ‘‘comprehensive and accurate trade reconstructions.’’ 7 U.S.C. 7(d)(4). 234 See infra Section II.D.4.g. (discussion of Commission enforcement of exchange-set limits). E:\FR\FM\27FEP3.SGM 27FEP3 11634 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules DCMs to submit such estimates on a regular basis; instead, DCMs would be required to submit estimates of deliverable supply if requested by the Commission.235 DCMs would also have the option of submitting estimates of deliverable supply and/or recommended speculative position limit levels if they wanted the Commission to consider them when setting/adjusting federal limit levels. Any such information would be included in a Commission action proposing changes to the levels. The Commission encourages exchanges to submit such estimates and recommendations voluntarily, as the exchanges are uniquely situated to recommend updated levels due to their knowledge of individual contract markets. When submitting estimates, DCMs would be required under proposed § 150.2(f) to provide a description of the methodology used to derive the estimate, as well as any statistical data supporting the estimate, so that the Commission can verify that the estimate is reasonable. DCMs should consult the guidance regarding estimating deliverable supply set forth in Appendix C to part 38.236 lotter on DSKBCFDHB2PROD with PROPOSALS3 g. Relevant Contract Month Proposed § 150.2(c) clarifies that the spot month and single month for any given referenced contract is determined by the spot month and single month of the core referenced futures contract to which that referenced contract is linked. This requires that referenced contracts be linked to the core referenced futures contract in order to be netted for position limit purposes. For example, for the NYMEX NY Harbor ULSD Heating Oil (HO) futures core referenced futures contract, the spot month period starts at the close of trading three business days prior to the last trading day of the contract. The spot month period for the NYMEX NY Harbor ULSD Financial (MPX) futures referenced contract would thus start at the same time—the close of trading three business days prior to the last trading day of the core referenced futures contract. h. Limits on ‘‘Pre-Existing Positions’’ Under proposed § 150.2(g)(1), other than pre-enactment swaps and transition period swaps as defined in proposed § 150.1, ‘‘pre-existing 235 For example, if a contract has problems with pricing convergence between the futures and the cash market, it could be a symptom of a deliverable supply issue in the market. In such a situation, the Commission may request an updated deliverable supply estimate from the relevant DCM to help identify the possible cause of the pricing anomaly. 236 17 CFR part 38, Appendix C. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 positions,’’ defined in proposed § 150.1 as positions established in good faith prior to the effective date of a final federal position limits rulemaking, would be subject to federal spot month limit levels. This clarification is intended to avoid rendering spot month limits ineffective—failing to apply spot month limits to such pre-existing positions could result in a large, preexisting position either intentionally or unintentionally causing a disruption to the price discovery function of the core referenced futures contract as positions are rolled into the spot month. The Commission is particularly concerned about protecting the spot month in physical-delivery futures from price distortions or manipulation that would disrupt the hedging and price discovery utility of the futures contract. Proposed § 150.2(g)(2) would provide that the proposed non-spot month limit levels would not apply to positions acquired in good faith prior to the effective date of such limit, recognizing that pre-existing large positions may have a relatively less disruptive effect outside of the spot month than during the spot month given that physical delivery occurs only during the spot month. However, other than preenactment swaps and transition period swaps, any pre-existing positions held outside the spot month would be attributed to such person if the person’s position is increased after the effective date of a final federal position limits rulemaking. i. Positions on Foreign Boards of Trade CEA section 4a(a)(6) directs the Commission to, among other things, establish limits on the aggregate number of positions in contracts based upon the same underlying commodity that may be held by any person across contracts listed by DCMs, certain contracts traded on a foreign board of trade (‘‘FBOT’’) with linkages to a contract traded on a registered entity, and swap contracts that perform or affect a significant price discovery function with respect to regulated entities.237 Pursuant to that directive, proposed § 150.2(h) would apply the proposed limits to a market participant’s aggregate positions in referenced contracts executed on a DCM and on, or pursuant to the rules of, an FBOT, provided that the referenced contracts settle against a price of a contract listed for trading on a DCM or SEF, and that the FBOT makes such contract available in the United States through ‘‘direct access.’’ 238 In other 237 7 U.S.C. 6a(a)(6). regulation § 48.2(c) defines ‘‘direct access’’ to mean an explicit grant of 238 Commission PO 00000 Frm 00040 Fmt 4701 Sfmt 4702 words, a market participant’s positions in referenced contracts listed on a DCM and on an FBOT registered to provide direct access would collectively have to stay below the federal limit level for the relevant core referenced futures contract. The Commission preliminarily believes that, as proposed, § 150.2(h) would lessen regulatory arbitrage by eliminating a potential loophole whereby a market participant could accumulate positions on certain FBOTs in excess of limits in referenced contracts.239 j. Anti-Evasion Pursuant to the Commission’s rulemaking authority in section 8a(5) of the CEA,240 the Commission proposes § 150.2(i), which is intended to deter and prevent a number of potential methods of evading the position limits proposed herein. The proposed antievasion provision is not intended to capture a trading strategy merely because it may result in smaller position size for purposes of position limits, but rather is intended to deter and prevent cases of willful evasion of federal position limits, the specifics of which the Commission may be unable to anticipate. The proposed federal position limit requirements would apply during the spot month for all referenced contracts subject to federal limits and non-spot position limit requirements would only apply for the nine legacy agricultural contracts. authority by a foreign board of trade to an identified member or other participant located in the United States to enter trades directly into the trade matching system of the foreign board of trade. 17 CFR 48.2(c). 239 In addition, CEA section 4(b)(1)(B) prohibits the Commission from permitting an FBOT to provide direct access to its trading system to its participants located in the United States unless the Commission determines, in regards to any FBOT contract that settles against any price of one or more contracts listed for trading on a registered entity, that the FBOT (or its foreign futures authority) adopts position limits that are comparable to the position limits adopted by the registered entity. 7 U.S.C. 6(b)(1)(B). CEA section 4(b)(1)(B) provides that the Commission may not permit a foreign board of trade to provide to the members of the foreign board of trade or other participants located in the United States direct access to the electronic trading and order-matching system of the foreign board of trade with respect to an agreement, contract, or transaction that settles against any price (including the daily or final settlement price) of 1 or more contracts listed for trading on a registered entity, unless the Commission determines that the foreign board of trade (or the foreign futures authority that oversees the foreign board of trade) adopts position limits (including related hedge exemption provisions) for the agreement, contract, or transaction that are comparable to the position limits (including related hedge exemption provisions) adopted by the registered entity for the 1 or more contracts against which the agreement, contract, or transaction traded on the foreign board of trade settles. 240 7 U.S.C. 12a(5). E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Under this proposed framework, and because the threat of corners and squeezes is the greatest in the spot month, the Commission preliminarily anticipates that it may focus its attention on anti-evasion activity during the spot month. First, the proposed rule would consider a commodity index contract and/or location basis contract used to willfully circumvent position limits to be a referenced contract subject to federal limits. Because commodity index contracts and location basis contracts are excluded from the proposed ‘‘referenced contract’’ definition and thus not subject to federal limits,241 the Commission intends that proposed § 150.2(i) would close a potential loophole whereby a market participant who has reached its limits could purchase a commodity index contract in a manner that allowed the participant to exceed limits when taking into account the weighting in the component commodities of the index contract. The proposed rule would close a similar potential loophole with respect to location basis contracts. Second, proposed § 150.2(i) would provide that a bona fide hedge recognition or spread exemption would no longer apply if used to willfully circumvent speculative position limits. This provision is intended to help ensure that bona fide hedge recognitions and spread exemptions are granted and utilized in a manner that comports with the CEA and Commission regulations, and that the ability to obtain a bona fide hedge recognition or spread exemption does not become an avenue for market participants to inappropriately exceed speculative position limits. Third, a swap contract used to willfully circumvent speculative position limits would be deemed an economically equivalent swap, and thus a referenced contract, even if the swap does not meet the economically equivalent swap definition set forth in proposed § 150.1. This provision is intended to deter and prevent the structuring of a swap in order to willfully evade speculative position limits. The determination of whether particular conduct is intended to circumvent or evade requires a facts and circumstances analysis. In preliminarily interpreting these anti-evasion rules, the Commission is guided by its interpretations of anti-evasion provisions appearing elsewhere in the Commission’s regulations, including the 241 See supra Section II.A.16.b. (explanation of proposed exclusions from the ‘‘referenced contract’’ definition). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 interpretation of the anti-evasion rules that the Commission adopted in its rulemakings to further define the term ‘‘swap’’ and to establish a clearing requirement under section 2(h)(1)(A) of the CEA.242 Generally, consistent with those interpretations, in evaluating whether conduct constitutes evasion, the Commission would consider, among other things, the extent to which the person lacked a legitimate business purpose for structuring the transaction in that particular manner. For example, an analysis of how a swap was structured could reveal that persons crafted derivatives transactions, structured entities, or conducted themselves in a manner without a legitimate business purpose and with the intent to willfully evade position limits by structuring a swap such that it would not meet the proposed ‘‘economically equivalent swap’’ definition. As stated in a prior rulemaking, a person’s specific consideration of, for example, costs or regulatory burdens, including the avoidance thereof, is not, in and of itself, dispositive that the person is acting without a legitimate business purpose in a particular case.243 The Commission will view legitimate business purpose considerations on a case-by-case basis in conjunction with all other relevant facts and circumstances. Further, as part of its facts and circumstances analysis, the Commission would look at factors such as the historical practices behind the market participant and transaction in question. For example, with respect to § 150.2(i)(3), the Commission would consider whether a market participant has a history of structuring its swaps one way, but then starts structuring its swaps a different way around the time the participant risked exceeding a speculative position limit as a result of its swap position, such as by modifying the delivery date or other material terms and conditions such that the swap no longer meets the definition of an ‘‘economically equivalent swap.’’ Consistent with interpretive language in prior rulemakings addressing evasion,244 when determining whether a 242 See Further Definition of ‘‘Swap,’’ ‘‘SecurityBased Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 FR 48207, 48297– 48303 (Aug. 13, 2012); Clearing Requirement Determination Under Section 2(h) of the CEA, 77 FR 74284, 74317–74319 (Dec. 13, 2012). 243 See Clearing Requirements Determination Under Section 2(h) of the CEA, 77 FR at 74319. 244 See Further Definition of ‘‘Swap,’’ ‘‘SecurityBased Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap PO 00000 Frm 00041 Fmt 4701 Sfmt 4702 11635 particular activity constitutes willful evasion, the Commission will consider the extent to which the activity involves deceit, deception, or other unlawful or illegitimate activity. Although it is likely that fraud, deceit, or unlawful activity will be present where willful evasion has occurred, the Commission does not believe that these factors are a prerequisite to an evasion finding because a position that does not involve fraud, deceit, or unlawful activity could still lack a legitimate business purpose or involve other indicia of evasive activity. The presence or absence of fraud, deceit, or unlawful activity is one fact the Commission will consider when evaluating a person’s activity. That said, the proposed anti-evasion provision does require willfulness, i.e. ‘‘scienter.’’ The Commission will interpret ‘‘willful’’ consistent with how the Commission has in the past, that acting either intentionally or with reckless disregard constitutes acting ‘‘willfully.’’ 245 In determining whether a transaction has been entered into or structured willfully to evade position limits, the Commission will not consider the form, label, or written documentation as dispositive. The Commission also is not requiring a pattern of evasive transactions as a prerequisite to prove evasion, although such a pattern may be one factor in analyzing whether evasion has occurred. In instances where one party willfully structures a transaction to evade but the other counterparty does not, proposed § 150.2(i) would apply to the party who willfully structured the transaction to evade. Finally, entering into transactions that qualify for the forward exclusion from the swap definition shall not be considered evasive. However, in circumstances where a transaction does not, in fact, qualify for the forward exclusion, the transaction may or may not be evasive depending on an analysis of all relevant facts and circumstances. k. Netting For the reasons discussed above, the referenced contract definition in proposed § 150.1 includes, among other things, cash-settled contracts that are linked, either directly or indirectly, to a core referenced futures contract; and any ‘‘economically equivalent Agreement Recordkeeping, 77 FR 48207, 48297– 48303 and Clearing Requirement Determination Under Section 2(h) of the CEA, 77 FR 74284, 74317–74319. 245 See In re Squadrito, [1990–1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,262 (CFTC Mar. 27, 1992) (adopting definition of ‘‘willful’’ in McLaughlin v. Richland Shoe Co., 486 U.S. 128 (1987)). E:\FR\FM\27FEP3.SGM 27FEP3 11636 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 swaps.’’ 246 Under proposed § 150.2(a), federal spot month limits would apply to physical-delivery referenced contracts separately from federal spot month limits applied to cash-settled referenced contracts, meaning that during the spot month, positions in physically-settled contracts may not be netted with positions in linked cashsettled contracts. Specifically, all of a trader’s positions (long or short) in a given physically-settled referenced contract (across all exchanges and OTC as applicable) 247 are netted and subject to the spot month limit for the relevant commodity, and all of such trader’s positions in any cash-settled referenced contracts (across all exchanges and OTC as applicable) linked to such physicallysettled core referenced futures contract are netted and independently (rather than collectively along with the physically-settled positions) subject to the federal spot month limit for that commodity.248 A position in a commodity contract that is not a referenced contract is therefore not subject to federal limits, and, as a consequence, cannot be netted with positions in referenced contracts for purposes of federal limits.249 For example, a swap that is not a referenced contract because it does not meet the economically equivalent swap definition could not be netted with positions in a referenced contract. Allowing the netting of linked physically-settled and cash-settled contracts during the spot month could lead to disruptions in the price discovery function of the core referenced futures contract or allow a market participant to manipulate the price of the core referenced futures contract. Absent separate spot month limits for physically-settled and cashsettled contracts, the spot month limit would be rendered ineffective, as a participant could maintain large positions in excess of limits in both the 246 See supra Section II.A.16. (discussion of the proposed referenced contract definition). 247 In practice, the only physically-settled referenced contracts under this proposal would be the 25 core referenced futures contracts, none of which are listed on multiple DCMs, although there could potentially be physically-settled OTC swaps that would satisfy the ‘‘economically equivalent swap’’ definition and therefore would also qualify as referenced contracts. 248 Consistent with CEA section 4a(a)(6), this would include positions across exchanges. 249 Proposed Appendix C to part 150 provides guidance regarding the referenced contract definition, including that the following types of contracts are not deemed referenced contracts, meaning such contracts are not subject to federal limits and cannot be netted with positions in referenced contracts for purposes of federal limits: Location basis contracts; commodity index contracts; and trade options that meet the requirements of 17 CFR 32.3. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 physically-settled contract and the linked cash-settled contract, enabling the participant to disrupt the price discovery function as the contracts go to expiration by taking large opposite positions in the physically-settled core referenced futures and cash-settled referenced contracts, or potentially allowing a participant to effect a corner or squeeze.250 Proposed § 150.2(b), which would establish limits outside the spot month, does not use the ‘‘separately’’ language. Accordingly, outside of the spot month, participants may net positions in linked physically-settled and cash-settled referenced contracts, because there is no immediate threat of delivery. Finally, proposed § 150.2(a) and (b) also provide that spot and non-spot limits apply ‘‘net long or net short.’’ Consistent with existing § 150.2, this language requires that, both during and outside the spot month, and subject to the provisions governing netting described above, a given participant’s long positions in a particular contract be aggregated (including across exchanges and OTC as applicable), and a participant’s short positions be aggregated (including across exchanges and OTC as applicable), and those aggregate long and short positons be netted—in other words, it is the net value that is subject to federal limits. Consistent with current and historical practice, the speculative position limits proposed herein would apply to positions throughout each trading session, including as of the close of each trading session.251 l. ‘‘Eligible Affiliates’’ and Aggregation Proposed § 150.2(k) addresses entities that qualify as an ‘‘eligible affiliate’’ as defined in proposed § 150.1. Under the proposed definition, an ‘‘eligible affiliate’’ includes certain entities that, among other things, are required to aggregate their positions under § 150.4 and that do not claim an exemption from aggregation. There may be certain entities that are eligible for an exemption from aggregation but that prefer to aggregate rather than disaggregate their positions; for example, when aggregation would result in advantageous netting of positions with affiliated entities. Proposed § 150.2(k) is intended to address such a 250 For example, absent such a restriction in the spot month, a trader could stand for 100 percent of deliverable supply during the spot month by holding a large long position in the physicaldelivery contract along with an offsetting short position in a cash-settled contract, which effectively would corner the market. 251 See, e.g., Elimination of Daily Speculative Trading Limits, 44 FR 7124, 7125 (Feb. 6, 1979). PO 00000 Frm 00042 Fmt 4701 Sfmt 4702 circumstance by making clear that an ‘‘eligible affiliate’’ may opt to aggregate its positions even though it is eligible to disaggregate. m. Request for Comment The Commission requests comment on all aspects of proposed § 150.2. The Commission also invites comments on the following: (20) Are there legitimate strategies on which the Commission should offer guidance with respect to the antievasion provision? (21) Should the Commission list by regulation specific factors/ circumstances in which it may set spot month limits with other than the at or below 25 percent of deliverable supply formula, and non-spot month limits with other than the modified 10, 2.5 percent formula proposed herein? If so, please provide examples of any such factors, including an explanation of whether and why different formulas make sense for different commodities. (22) Is the proposed compliance date of twelve months after publication of a final federal position limits rulemaking in the Federal Register an appropriate amount of time for compliance? If not, please provide reasons supporting a different timeline. Do market participants support delaying compliance until one year after a DCM has had its new § 150.9 rules approved by the Commission under § 40.5? (23) The Commission understands that it may be possible for a market participant trading options to start a trading day below the delta-adjusted federal speculative position limit for that option, but end up above such limit as the option becomes in-the-money during the spot month. Should the Commission allow for a one-day grace period with respect to federal position limits for market participants who have exercised options that were out-of-the money on the previous trading day but that become in-the-money during the trading day in the spot month? (24) Given that the contracts in corn and soybean complex are more liquid than CBOT Oats (O) and the MGEX HRS (MWE) wheat contract, should the Commission employ a higher open interest formula for corn and the soybean complex? (25) Should the Commission phase-in the proposed increased federal non-spot month limits incrementally over a period of time, rather than implementing the entire increase upon the effective date? Please explain why or why not. If so, please comment on an appropriate phase-in schedule, including whether different E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules commodities should be subject to different schedules. (26) The Commission is aware that the non-spot month open interest is skewed to the first new crop (usually December or November) for the nine legacy agricultural contracts. The Commission understands that cotton may be unique because it has an extended harvest period starting in July in the south and working its way north until November. There may be some concern with positions being rolled from the prompt month into deferred contract months causing disruption to the price discovery function of the Cotton futures. Should the Commission consider lowering the single month limit to a percentage of the all months limits for Cotton? If so, what percentage of the all month limit should be used for the single month limit? Please provide a rationale for your percentage. (27) Should the Commission allow market participants who qualify for the conditional spot month limit in natural gas to net cash-settled natural gas referenced contracts across DCMs? Why or why not? lotter on DSKBCFDHB2PROD with PROPOSALS3 C. § 150.3—Exemptions From Federal Position Limits 1. Existing §§ 150.3, 1.47, and 1.48 Existing § 150.3(a), which pre-dates the Dodd-Frank Act, lists positions that may, under certain circumstances, exceed federal limits: (1) Bona fide hedging transactions, as defined in the current bona fide hedging definition in § 1.3; and (2) certain spread or arbitrage positions.252 So that the Commission can effectively oversee the use of such exemptions, existing § 150.3(b) provides that the Commission or certain Commission staff may make special calls to demand certain information from exemption holders, including information regarding positions owned or controlled by that person, trading done pursuant to that exemption, and positions that support the claimed exemption.253 Existing § 150.3(a) allows for bona fide hedging transactions to exceed federal limits, and the current process for a person to request such recognitions for non-enumerated hedges appears in § 1.47.254 Under that provision, persons seeking recognition by the Commission of a non-enumerated bona fide hedging transaction or position must file statements with the Commission.255 Initial statements must be filed with the Commission at least 30 days in advance of exceeding the 252 17 CFR 150.3(a). CFR 150.3(b). 254 17 CFR 1.47. 255 17 CFR 1.47(a). 253 17 VerDate Sep<11>2014 19:37 Feb 26, 2020 Jkt 250001 limit. 256 Similarly, existing § 1.48 sets forth the process for market participants to file an application with the Commission to recognize certain enumerated anticipatory positions as bona fide hedging positions.257 Under that provision, such recognitions must be requested 10 days in advance of exceeding the limit.258 Further, the Commission provides self-effectuating spread exemptions for the nine legacy agricultural contracts currently subject to federal limits, but does not specify a formal process for granting such spread exemptions.259 The Commission’s authority and existing regulation for exempting certain spread positions can be found in section 4a(a)(1) of the Act and existing § 150.3(a)(3) of the Commission’s regulations, respectively.260 In particular, CEA section 4a(a)(1) provides the Commission with authority to exempt from position limits transactions ‘‘normally known to the trade as ‘spreads’ or ‘straddles’ or ‘arbitrage.’ ’’ 2. Proposed § 150.3 As described elsewhere in this release, the Commission is proposing a new bona fide hedging definition in § 150.1 (described above) and a new streamlined process in proposed § 150.9 for recognizing non-enumerated bona fide hedging positions (described further below). The Commission thus proposes to update § 150.3 to conform to those new proposed provisions. Proposed § 150.3 also includes new exemption types not explicitly listed in existing § 150.3, including: (i) Exemptions for financial distress situations; (ii) conditional exemptions for certain spot month positions in cashsettled natural gas contracts; and (iii) exemptions for pre-enactment swaps 256 17 257 17 CFR 1.47(b). CFR 1.48. 258 Id. 259 Since 1938, the Commission (known as the Commodity Exchange Commission in 1938) has recognized the use of spread positions to facilitate liquidity and hedging. Notice of Proposed Order in the Matter of Limits on Position and Daily Trading in Grain for Future Delivery, 3 FR 1408 (June 14, 1938). 260 See 7 U.S.C. 6a(a)(1) and 17 CFR 150.3(a)(3) (providing that the position limits set in § 150.2 may be exceeded to the extent such positions are: Spread or arbitrage positions between single months of a futures contract and/or, on a futuresequivalent basis, options thereon, outside of the spot month, in the same crop year; provided, however, that such spread or arbitrage positions, when combined with any other net positions in the single month, do not exceed the all-months limit set forth in § 150.2.). Although existing § 150.3(a)(3) does not specify a formal process for granting spread exemptions, the Commission is able to monitor traders’ gross and net positions using part 17 data, the monthly Form 204, and information from the applicable DCMs to identify any such spread positions. PO 00000 Frm 00043 Fmt 4701 Sfmt 4702 11637 and transition period swaps.261 Proposed § 150.3(b)–(g) respectively address: Requests for relief from position limits submitted directly to the Commission or Commission staff (rather than to an exchange under proposed § 150.9, as discussed further below); previously-granted risk management exemptions to position limits; exemption-related recordkeeping and special-call requirements; the aggregation of accounts; and the delegation of certain authorities to the Director of the Division of Market Oversight. a. Bona Fide Hedging Positions and Spread Exemptions The Commission has years of experience granting and monitoring spread exemptions, and enumerated and non-enumerated bona fide hedges, as well as overseeing exchange processes for administering exemptions from exchange-set limits on such contracts. As a result of this experience, the Commission has determined to continue to allow self-effectuating enumerated bona fide hedges and certain spread exemptions for all contracts that would be subject to federal position limits, as explained further below. i. Bona Fide Hedging Positions First, under proposed § 150.3(a)(1)(i), bona fide hedge recognitions for positions in referenced contracts that fall within one of the proposed enumerated hedges set forth in proposed Appendix A to part 150, discussed above, would be selfeffectuating for purposes of federal position limits. Market participants would thus not be required to request Commission approval prior to exceeding federal position limits in such cases, but would be required to request a bona fide hedge exemption from the relevant exchange for purposes of exchange-set limits established pursuant to proposed § 150.5(a), and submit required cashmarket information to the exchange as part of such request.262 The Commission has also determined to allow the proposed enumerated anticipatory bona fide hedges (some of which are not currently self-effectuating and thus are required to be approved by the Commission under existing § 1.48) to be self-effectuating for purposes of federal limits (and thus would not require prior 261 The Commission revised § 150.3(a) in 2016, relocating the independent account controller aggregation exemption from § 150.3(a)(4) in order to consolidate it with the Commission’s aggregation requirements in § 150.4(b)(4). See Final Aggregation Rulemaking, 81 FR at 91489–90. 262 See infra Section II.D.4.a. See also proposed § 150.5(a)(2)(ii)(A)(1). E:\FR\FM\27FEP3.SGM 27FEP3 11638 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Commission approval for such enumerated anticipatory hedges). The Commission may consider expanding the proposed list of enumerated hedges at a later time, after notice and comment, as it gains experience with the new federal position limits framework proposed herein. Second, under proposed § 150.3(a)(1)(ii), for positions in referenced contracts that do not fit within one of the proposed enumerated hedges in Appendix A, (i.e., nonenumerated bona fide hedges), market participants must request approval from the Commission, or from an exchange, prior to exceeding federal limits. Such exemptions thus would not be selfeffectuating and market participants in such cases would have two options for requesting such a non-enumerated bona fide hedge recognition: (1) Apply directly to the Commission in accordance with proposed § 150.3(b) (described below), and separately also apply to an exchange pursuant to exchange rules established under proposed § 150.5(a); 263 or, alternatively (2) apply to an exchange pursuant to proposed § 150.9 for a non-enumerated bona fide hedge recognition that could be valid both for purposes of federal and exchange-set position limit requirements, unless the Commission (and not staff) objects to the exchange’s determination within a limited period of time.264 As discussed elsewhere in this release, market participants relying on enumerated or non-enumerated bona fide hedge recognitions would no longer have to file the monthly Form 204/304 with supporting cash market information.265 ii. Spread Exemptions lotter on DSKBCFDHB2PROD with PROPOSALS3 Under proposed § 150.3(a)(2)(i), spread exemptions for positions in referenced contracts would be selfeffectuating, provided that the position fits within one of the types of spreads listed in the spread transaction definition in proposed § 150.1,266 and provided further that the market participant separately requests a spread exemption from the relevant exchange’s limits established pursuant to proposed § 150.5(a). 263 See infra Section II.D.4. (discussion of proposed § 150.5). 264 See infra Section II.G.3. (discussion of proposed § 150.9). 265 See infra Section II.H.2. (discussion of the proposed elimination of Form 204). 266 See supra Section II.A.20. (proposed definition of ‘‘spread transaction’’ in § 150.1, which would cover: Calendar spreads; quality differential spreads; processing spreads (such as energy ‘‘crack’’ or soybean ‘‘crush’’ spreads); product or by-product differential spreads; and futures-options spreads.) VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 The Commission anticipates that such spread exemptions might include spreads that are ‘‘legged in,’’ that is, carried out in two steps, or alternatively are ‘‘combination trades,’’ that is, all components of the spread are executed simultaneously or near simultaneously. The list of spread transactions in proposed § 150.1 reflects the most common types of spread strategies for which the Commission and/or exchanges have previously granted spread exemptions. Under proposed § 150.3(a)(2)(ii), for all contracts subject to federal limits, if the spread position does not fit within one of the spreads listed in the spread transaction definition in proposed § 150.1, market participants must apply for the spread exemption relief directly from the Commission in accordance with proposed § 150.3(b). The market participant must receive notification of the approved spread exemption under proposed § 150.3(b)(4) before exceeding the federal speculative position limits for that spread position. The Commission may consider expanding the proposed spread transactions definition at a later time, after notice and comment, as it gains experience with the new federal position limits framework proposed herein. iii. Removal of Existing §§ 1.47, 1.48, and 140.97 Given the proposal set forth in § 150.9, as described in detail below, to allow for a streamlined process for recognizing bona fide hedges for purposes of federal limits,267 the Commission also proposes to delete existing §§ 1.47 and 1.48. The Commission preliminarily believes that overall, the proposed approach would lead to a more efficient bona fide hedge recognition process. As the Commission proposes to delete §§ 1.47 and 1.48, the Commission also proposes to delete existing § 140.97, which delegates to the Director of the Division of Enforcement or his designee authority regarding requests for classification of positions as bona fide hedges under existing §§ 1.47 and 1.48.268 The Commission does not intend the proposed replacement of §§ 1.47 and 1.48 to have any bearing on bona fide hedges previously recognized under those provisions. With the exception of certain recognitions for risk management positions discussed below, positions that were previously recognized as bona fide hedges under §§ 1.47 or 1.48 would continue to be recognized, provided they continue to 267 Id. 268 17 PO 00000 CFR 140.97. Frm 00044 Fmt 4701 Sfmt 4702 meet the statutory bona fide hedging definition and all other existing and proposed requirements. b. Process for Requesting CommissionProvided Relief for Non-Enumerated Bona Fide Hedges and Spread Exemptions Under the proposed rules, nonenumerated bona fide hedging recognitions may only be granted by the Commission as proposed in § 150.3(b), or under the streamlined process proposed in § 150.9. Further, spread exemptions that do not meet the proposed spread transaction definition may only be granted by the Commission as proposed in § 150.3(b). Under the Commission process in § 150.3(b), a person seeking a bona fide hedge recognition or spread exemption may submit a request to the Commission. With respect to bona fide hedge recognitions, such request must include: (i) A description of the position in the commodity derivative contract for which the application is submitted, including the name of the underlying commodity and the position size; (ii) information to demonstrate why the position satisfies section 4a(c)(2) of the Act and the definition of bona fide hedging transaction or position in proposed § 150.1, including factual and legal analysis; (iii) a statement concerning the maximum size of all gross positions in derivative contracts for which the application is submitted (in order to provide a view of the true footprint of the position in the market); (iv) information regarding the applicant’s activity in the cash markets and the swaps markets for the commodity underlying the position for which the application is submitted; 269 and (v) any other information that may help the Commission determine whether the position meets the requirements of section 4a(c)(2) of the Act and the definition of bona fide hedging transaction or position in § 150.1.270 With respect to spread exemptions, such request must include: (i) A description of the spread transaction for which the exemption application is 269 The Commission would expect that applicants would provide cash market data for at least the prior year. 270 For example, the Commission may, in its discretion, request a description of any positions in other commodity derivative contracts in the same commodity underlying the commodity derivative contract for which the application is submitted. Other commodity derivatives contracts could include other futures, options, and swaps (including over-the-counter swaps) positions held by the applicant. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 submitted; 271 (ii) a statement concerning the maximum size of all gross positions in derivative contracts for which the application is submitted; and (iii) any other information that may help the Commission determine whether the position is consistent with section 4a(a)(3)(B) of the Act. Under proposed § 150.3(b)(2), the Commission, or Commission staff pursuant to delegated authority proposed in § 150.3(g), may request additional information from the requestor and must provide the requestor with ten business days to respond. Under proposed § 150.3(b)(3) and (4), the requestor, however, may not exceed federal position limits unless it receives a notice of approval from the Commission or from Commission staff pursuant to delegated authority proposed in § 150.3(g); provided however, that, due to demonstrated sudden or unforeseen increases in its bona fide hedging needs, a person may request a recognition of a bona fide hedging transaction or position within five business days after the person established the position that exceeded the federal speculative position limit.272 Under this proposed process, market participants would be encouraged to submit their requests for bona fide hedge recognitions and spread exemptions as early as possible since proposed § 150.3(b) would not set a specific timeframe within which the Commission must make a determination for such requests. Further, all approved bona fide hedge recognitions and spread exemptions must be renewed if there are any changes to the information submitted as 271 The nature of such description would depend on the facts and circumstances, and different details may be required depending on the particular spread. 272 Where a person requests a bona fide hedge recognition within five business days after they exceed federal position limits, such person would be required to demonstrate that they encountered sudden or unforeseen circumstances that required them to exceed federal position limits before submitting and receiving approval of their bona fide hedge application. These applications submitted after a person has exceeded federal position limits should not be habitual and will be reviewed closely. If the Commission reviews such application and finds that the position does not qualify as a bona fide hedge, then the applicant would be required to bring their position into compliance within a commercially reasonable time, as determined by the Commission in consultation with the applicant and the applicable DCM or SEF. If the applicant brings the position into compliance within a commercially reasonable time, then the applicant will not be considered to have violated the position limits rules. Further, any intentional misstatements to the Commission, including statements to demonstrate why the bona fide hedging needs were sudden and unforeseen, would be a violation of sections 6(c)(2) and 9(a)(2) of the Act. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 part of the request, or upon request by the Commission or Commission staff.273 Finally, the Commission (and not staff) may revoke or modify any bona fide hedge recognition or spread exemption at any time if the Commission determines that the bona fide hedge recognition or spread exemption, or portions thereof, are no longer consistent with the applicable statutory and regulatory requirements.274 The Commission anticipates that most market participants would utilize the streamlined process set forth in proposed § 150.9 and described below, rather than the process as proposed in § 150.3(b), because exchanges would generally be able to make such determinations more efficiently than Commission staff, and because market participants are likely already familiar with the proposed processes set forth in § 150.9, which is intended to leverage the processes currently in place at the exchanges for addressing requests for exemptions from exchange-set limits. Nevertheless, proposed § 150.3(a)(1) and (2) clarify that market participants may seek relief from federal position limits for non-enumerated bona fide hedges and spread transactions that do not meet the proposed spread transactions definition directly from the Commission. After receiving any approval of a bona fide hedge or spread exemption from the Commission, the market participant would still be required to request a bona fide hedge recognition or spread exemption from the relevant exchange for purposes of exchange-set limits established pursuant to proposed § 150.5(a). c. Request for Comment The Commission requests comments on all aspects of proposed § 150.3(a)(1) and (2). The Commission also invites comment on the following: (28) Out of concern that large demand for delivery against long nearby futures positions may outpace demand on spot cash values, the Commission has 273 See proposed § 150.3(b)(5). Currently, the Commission does not require automatic updates to bona fide hedge applications, and does not require applications or updates thereto for spread exemptions, which are self-effectuating. Consistent with current practices, under proposed § 150.3(b)(5), the Commission would not require automatic annual updates to bona fide hedge and spread exemption applications; rather, updated applications would only be required if there are changes to information the requestor initially submitted or upon Commission request. This approach is different than the proposed streamlined process in § 150.9, which would require automatic annual updates to such applications, which is more consistent with current exchange practices. See, e.g., CME Rule 559. 274 This proposed authority to revoke or modify a bona fide hedge recognition or spread exemption would not be delegated to Commission staff. PO 00000 Frm 00045 Fmt 4701 Sfmt 4702 11639 previously discussed allowing cash and carry exemptions as spreads on the condition that the exchange ensures that exit points in cash and carry spread exemptions would facilitate an orderly liquidation.275 Should the Commission allow the granting of cash and carry exemptions under such conditions? If so, please explain why, including how such exemptions would be consistent with the Act and the Commission’s regulations. If not, please explain why not, and if other circumstances would be better, including better for preserving convergence, which is essential to properly functioning markets and price discovery. If cash and carry exemptions were allowed, how could an exchange ensure that exit points in cash and carry exemptions facilitate convergence of cash and futures? d. Financial Distress Exemptions Proposed § 150.3(a)(3) would allow for a financial distress exemption in certain situations, including the potential default or bankruptcy of a customer or a potential acquisition target. For example, in periods of financial distress, such as a customer default at an FCM or a potential bankruptcy of a market participant, it may be beneficial for a financiallysound market participant to take on the positions and corresponding risk of a less stable market participant, and in doing so, exceed federal speculative position limits. Pursuant to authority delegated under §§ 140.97 and 140.99, Commission staff previously granted exemptions in these types of situations to avoid sudden liquidations required to comply with a position limit.276 Such sudden liquidations could otherwise potentially hinder statutory objectives, including by reducing liquidity, disrupting price discovery, and/or increasing systemic risk.277 The proposed exemption would be available to positions of ‘‘a person, or related persons,’’ meaning that a financial distress exemption request should be specific to the circumstances of a particular person, or to persons related to that person, and not a more general request by a large group of unrelated people whose financial distress circumstances may differ from one another. The proposed exemption would be granted on a case by case basis in response to a request submitted pursuant to § 140.99, and would be 275 See, e.g., 2016 Reproposal, 81 FR 96704 at 96833. 276 See, e.g., CFTC Press Release No. 5551–08, CFTC Update on Efforts Underway to Oversee Markets, (Sept. 19, 2008), available at https:// www.cftc.gov/PressRoom/PressReleases/pr5551-08. 277 See 7 U.S.C. 6a(a)(3). E:\FR\FM\27FEP3.SGM 27FEP3 11640 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules evaluated based on the specific facts and circumstances of a particular person or related persons. Any such financial distress position would not be a bona fide hedging transaction or position unless it otherwise met the substantive and procedural requirements set forth in proposed §§ 150.1, 150.3, and 150.9, as applicable. e. Conditional Spot Month Exemption in Natural Gas Certain natural gas contracts are currently subject to exchange-set limits, but not federal limits.278 This proposal would apply federal limits to certain natural gas contracts for the first time by including the physically-settled NYMEX Henry Hub Natural Gas (‘‘NYMEX NG’’) contract as a core referenced futures contract listed in proposed § 150.2(d). As set forth in proposed Appendix E to part 150, that physically-settled contract, as well as any cash-settled natural gas contract that qualifies as a referenced contract,279 would be separately subject to a federal spot month limit, net long or net short, of 2,000 NYMEX NG equivalent-size contracts. Under the referenced contract definition in proposed § 150.1, ICE’s cash-settled Henry Hub LD1 contract, ICE’s Henry Financial Penultimate Fixed Price Futures, NYMEX’s cashsettled Henry Hub Natural Gas Last Day Financial Futures contract, Nodal Exchange’s (‘‘Nodal’’) cash-settled Henry Hub Monthly Natural Gas contract, and NFX cash-settled Henry Hub Natural Gas Financial Futures contract, for example, would each lotter on DSKBCFDHB2PROD with PROPOSALS3 278 Some examples include natural gas contracts that use the NYMEX NG futures contract as a reference price, such as ICE’s Henry Financial Penultimate Fixed Price Futures (PHH), options on Henry Penultimate Fixed Price (PHE), Henry Basis Futures (HEN) and Henry Swing Futures (HHD); NYMEX’s E-mini Natural Gas Futures (QG), Henry Hub Natural Gas Last Day Financial Futures (HH), and Henry Hub Natural Gas Financial Calendar Spread (3 Month) Option (G3); and Nasdaq Futures, Inc.’s (‘‘NFX’’) Henry Hub Natural Gas Financial Futures (HHQ), and Henry Hub Natural Gas Penultimate Financial Futures (NPQ). 279 Under the referenced contract definition proposed in § 150.1, cash-settled natural gas referenced contracts are those futures or options contracts, including spreads, that are: (1) Directly or indirectly linked, including being partially or fully settled on, or priced at a fixed differential to, the price of the physically-settled NYMEX NG core referenced futures contract; or (2) Directly or indirectly linked, including being partially or fully settled on, or priced at a fixed differential to, the price of the same commodity underlying the physically-settled NYMEX NG core referenced futures contract for delivery at the same location or locations as specified in the NYMEX NG core referenced futures contract. As proposed, the referenced contract definition does not include a location basis contract, a commodity index contract, or a trade option that meets the requirements of § 32.3 of this chapter. See proposed § 150.1. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 qualify as a referenced contract subject to federal limits by virtue of being cashsettled to the physically-settled NYMEX NG core referenced futures contract.280 Any other cash-settled contract that meets the referenced contract definition would also be subject to federal limits, as would an ‘‘economically equivalent swap,’’ as defined in proposed § 150.1, with respect to any natural gas referenced contract. Proposed § 150.3(a)(4) would permit a new federal conditional spot month limit exemption for certain cash-settled natural gas referenced contracts. Under proposed § 150.3(a)(4), market participants seeking to exceed the proposed 2,000 NYMEX NG equivalentsize contract spot month limit for a cash-settled natural gas referenced contract listed on any DCM could receive an exemption that would be capped at 10,000 NYMEX NG equivalent-size contracts net long or net short per DCM, plus an additional 10,000 NYMEX NG futures equivalent size contracts in economically equivalent swaps. A grant of such an exemption would be conditioned on the participant not holding or controlling any positions during the spot month in the physically-settled NYMEX NG core referenced futures contract.281 This proposed conditional exemption level of 10,000 contracts per DCM in natural gas would codify into federal regulations the industry practice of an exchange-set conditional limit that is five times the size of the spot month 280 On November 12, 2019, Nodal announced that it had reached an agreement to acquire the core assets of NFX. See Nodal Exchange Acquires U.S. Commodities Business of Nasdaq Futures, Inc. (NFX), Nodal Exchange website (Nov. 12, 2019), available at https://www.nodalexchange.com/wpcontent/uploads/20191112-Nodal-NFX-releaseFinal.pdf (press release). The acquisition includes all of NFX’s energy complex of futures and options contracts, including NFX’s Henry Hub Natural Gas Financial Futures contract. Because that contract will become part of Nodal’s offerings, that contract, as well as Nodal’s existing Henry Hub Monthly Natural Gas contract, would continue to qualify as referenced contracts under the proposed definition herein, and thus would be subject to federal limits by virtue of being cash-settled to the physicallysettled NYMEX NG core referenced futures contract. According to the November 12, 2019 press release, ‘‘Nodal Exchange and Nodal Clear plan to complete the integration of U.S. Power contracts by December 2019. U.S. Natural Gas, Crude Oil and Ferrous Metals contracts could transfer to Nodal as soon as spring 2020.’’ Id. 281 While the NYMEX NG is the only natural gas contract included as a core referenced futures contract in this release, the conditional spot month exemption proposed herein would also apply to any other physically-settled natural gas contract that the Commission may in the future designate as a core referenced futures contract, as well as to any physically-delivered contract that is substantially identical to the NYMEX NG and that qualifies as a referenced contract, or that qualifies as an economically equivalent swap. PO 00000 Frm 00046 Fmt 4701 Sfmt 4702 limit that has developed over time, and which the Commission preliminarily believes has functioned well. The practice balances the needs of certain market participants, who may currently hold or control 5,000 contracts in each DCM’s cash-settled natural gas futures contracts and prefer a sizeable position in a cash-settled contract in order to obtain the desired exposure without needing to make or take delivery of natural gas, with the policy objectives of the Commission, which has historically had concerns about the possibility of traders attempting to manipulate the physically-settled NYMEX NG contract (i.e., mark-the close) in order to benefit from a larger position in the cash-settled ICE LD1 Natural Gas Swap and/or NYMEX Henry Hub Natural Gas Last Day Financial Futures contract during the spot month as these contracts expired.282 NYMEX, ICE, NFX, and Nodal currently have rules in place establishing a conditional spot month limit exemption equivalent to up to 5,000 contracts (in NYMEX-equivalent size) for their respective cash-settled natural gas contracts, provided that the trader does not maintain a position in the physically-settled NYMEX NG contract during the spot month.283 Together, the ICE, NYMEX, NFX, and Nodal rules allow a trader to hold up to 20,000 (NYMEX-equivalent size) contracts during the spot month combined across ICE, NYMEX, NFX, and Nodal cash-settled natural gas contracts, provided the trader does not hold positions in excess of 5,000 282 As noted above, current exchange rules establish a spot month limit of 1,000 NYMEX equivalent sized contracts. The Commission proposes a federal spot month limit of 2,000 NYMEX equivalent sized contracts based on updated deliverable supply estimates. See supra Section II.B.2.b. (2020 proposed spot month limit chart). The proposed conditional spot month limit exemption of 10,000 contracts per exchange is thus five times the proposed federal spot month limit. 283 See ICE Rule 6.20(c), NYMEX Rule 559.F, NFX Rule Chapter V, Section 13(a), and Nodal Rule 6.5.2. The spot month for such contracts is three days. See also Position Limits, CMG Group website, available at https://www.cmegroup.com/marketregulation/position-limits.html (NYMEX position limits spreadsheet); Market Resources, ICE Futures website, available at https://www.theice.com/ futures-us/market-resources (ICE position limits spreadsheet). NYMEX rules establish an exchangeset spot month limit of 1,000 contracts for its physically-settled NYMEX NG Futures contract and a separate spot month limit of 1,000 contracts for its cash-settled Henry Hub Natural Gas Last Day Financial Futures contract. As the ICE natural gas contract is one quarter the size of the NYMEX contract, ICE’s exchange-set natural gas limits are shown in NYMEX equivalents throughout this section of the release. ICE thus has rules in place establishing an exchange-set spot month limit of 4,000 contracts (equivalent to 1,000 NYMEX contracts) for its cash-settled Henry Hub LD1 Fixed Price Futures contract. E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules contracts on any one DCM, and provided further that the trader does not hold any positions in the physicallysettled NYMEX NG contract during the spot month.284 The DCMs originally adopted these rules, in consultation with Commission staff, in large part to address historical concerns over the potential for manipulation of physically-settled natural gas contracts during the spot month in order to benefit positions in cash-settled natural gas contracts, and to accommodate certain trading dynamics unique to the natural gas contracts. In particular, in natural gas, open interest tends to decline in the NYMEX NG contract approaching expiration and tends to increase rapidly in the ICE cash-settled Henry Hub LD1 contract. These dynamics suggest that cashsettled natural gas contracts serve an important function for hedgers and speculators who wish to recreate and/or hedge the physically-settled NYMEX NG contract price without being required to make or take delivery. The condition in proposed § 150.3(a)(4), however, should remove the potential to manipulate the physically-settled natural gas contract in order to benefit a sizeable position in the cash-settled contract. To qualify for the exemption, market participants would not be permitted to hold any spot month positions in the physicallysettled contract. This proposed conditional exemption would prevent manipulation by traders with leveraged positions in the cash-settled contracts (in comparison to the level of the limit in the physical-delivery contract) who might otherwise attempt to mark the close or distort physical-delivery prices in the physically-settled contract to benefit their leveraged cash-settled positions. Thus, the exemption would establish a higher conditional limit for the cash-settled contract than for the physical-delivery contract, so long as the cash-settled positions are decoupled from spot-month positions in physicaldelivery contracts which set or affect the value of such cash-settled positions. While the Commission is unaware of any natural gas swaps that would qualify as ‘‘economically equivalent swaps,’’ the Commission proposes to apply the conditional exemption to swaps as well, provided that a given market participant’s positions in such cash-settled swaps do not exceed 10,000 futures-equivalent contracts and provided that the participant does not 284 In practice, a majority of the trading in such contracts is on ICE and NYMEX. As noted above, Nodal is acquiring NFX, including its Henry Hub Natural Gas Financial Futures contract. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 hold spot-month positions in physically settled natural gas contracts. Because swaps may generally be fungible across markets, that is, a position may be established on one SEF and offset on another SEF or OTC, the Commission proposes that economically equivalent swap contracts have a conditional spot month limit of 10,000 economically equivalent contracts in total across all SEFs and OTC. A market participant that sought to hold positions in both the NYMEX NG physically-settled contract and in any cash-settled natural gas contract would not be eligible for the proposed conditional exemption. Such a participant could only hold up to 2,000 contracts net long or net short across exchanges/OTC in physically-settled natural gas referenced contract(s), and another 2,000 contracts net long or net short across exchanges/OTC in cashsettled natural gas contract referenced contract(s).285 f. Exemption for Pre-Enactment Swaps and Transition Period Swaps In order to promote a smooth transition to compliance for swaps not previously subject to federal speculative position limits, proposed § 150.3(a)(5) would provide that federal speculative position limits shall not apply to positions acquired in good faith in any pre-enactment swap or in any transition period swap, in either case as defined by § 150.1.286 Any swap that meets the proposed economically equivalent swap definition, but that otherwise qualifies as a pre-enactment swap or transition period swap, would thus be exempt from federal speculative position limits. This exemption would be selfeffectuating and would not require a market participant to request relief. In order to further lessen the impact of the proposed federal limits on market participants, for purposes of complying with the proposed federal non-spot month limits, the proposed rule would also allow both pre-enactment swaps and transition period swaps to be netted with commodity derivative contracts acquired more than 60 days after publication of final rules in the Federal Register. Any such positions would not 285 See supra Section II.B.2.k. (discussion of netting). 286 ‘‘Pre-enactment swap’’ would mean any swap entered into prior to enactment of the Dodd-Frank Act of 2010 (July 21, 2010), the terms of which have not expired as of the date of enactment of that Act. ‘‘Transition period swap’’ would mean a swap entered into during the period commencing after the enactment of the Dodd-Frank Act of 2010 (July 21, 2010), and ending 60 days after the publication in the Federal Register of final amendments to this part implementing section 737 of the Dodd-Frank Act of 2010. PO 00000 Frm 00047 Fmt 4701 Sfmt 4702 11641 be permitted to be netted during the spot month so as to avoid rendering spot month limits ineffective—the Commission is particularly concerned about protecting the spot month in physical-delivery futures from price distortions or manipulation that would disrupt the hedging and price discovery utility of the futures contract. g. Previously-Granted Risk Management Exemptions As discussed elsewhere in this release, the Commission previously recognized, as bona fide hedges under § 1.47, certain risk-management positions in physical commodity futures and/or options on futures contracts thereon held outside of the spot month that were used to offset the risk of commodity index swaps and other related exposure, but that did not represent substitutes for transactions or positions to be taken in a physical marketing channel. However, as noted earlier in this release, the Commission interprets Dodd-Frank Act amendments to the CEA as eliminating the Commission’s authority to grant such relief unless the position satisfies the pass-through provision in CEA section 4a(c)(2)(B).287 Accordingly, to ensure consistency with the Dodd-Frank Act, the Commission will not recognize further risk management positions as bona fide hedges, unless the position otherwise satisfies the requirements of the pass-through provisions.288 In addition, the Commission proposes in § 150.3(c) that such previouslygranted exemptions shall not apply after the effective date of a final federal position limits rulemaking implementing the Dodd-Frank Act. Proposed § 150.3(c) uses the phrase ‘‘positions in financial instruments’’ to refer to such commodity index swaps and related exposure and would have the effect of revoking the ability to use previously-granted risk management exemptions once the limits proposed in § 150.2 go into effect. h. Recordkeeping Proposed § 150.3(d) establishes recordkeeping requirements for persons who claim any exemptions or relief under proposed § 150.3. Proposed § 150.3(d) should help to ensure that any person who claims any exemption permitted under proposed § 150.3 can demonstrate compliance with the applicable requirements. Under proposed § 150.3(d)(1), any persons 287 See supra Section II.A.1.c.ii.(1). (discussion of the temporary substitute test and risk-management exemptions). 288 See supra Section II.A.1.c.vi. (discussion of proposed pass-through language). E:\FR\FM\27FEP3.SGM 27FEP3 11642 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules claiming an exemption would be required to keep and maintain complete books and records concerning all details of their related cash, forward, futures, options on futures, and swap positions and transactions, including anticipated requirements, production and royalties, contracts for services, cash commodity products and by-products, crosscommodity hedges, and records of bona fide hedging swap counterparties. Proposed § 150.3(d)(2) addresses recordkeeping requirements related to the pass-through swap provision in the proposed definition of bona fide hedging transaction or position in proposed § 150.1.289 Under proposed § 150.3(d)(2), a pass-through swap counterparty, as contemplated by proposed § 150.1, that relies on a representation received from a bona fide hedging swap counterparty that a swap qualifies in good faith as a bona fide hedging position or transaction under proposed § 150.1, would be required to: (i) Maintain any written representation for at least two years following the expiration of the swap; and (ii) furnish the representation to the Commission upon request. i. Call for Information The Commission proposes to move existing § 150.3(b), which currently allows the Commission or certain Commission staff to make special calls to demand certain information regarding positions or trading, to proposed § 150.3(e), with some technical modifications. Together with the recordkeeping provision of proposed § 150.3(d), proposed § 150.3(e) should enable the Commission to monitor the use of exemptions from speculative position limits and help to ensure that any person who claims any exemption permitted by proposed § 150.3 can demonstrate compliance with the applicable requirements. lotter on DSKBCFDHB2PROD with PROPOSALS3 j. Aggregation of Accounts Proposed § 150.3(f) would clarify that entities required to aggregate under § 150.4 would be considered the same person for purposes of determining whether they are eligible for a bona fide hedge recognition under § 150.3(a)(1). k. Delegation of Authority Proposed § 150.3(g) would delegate authority to the Director of the Division of Market Oversight to: Grant financial distress exemptions pursuant to proposed § 150.3(a)(3); request additional information with respect to an exemption request pursuant to 289 See supra Section II.A.1.c.vi. (discussion of proposed pass-through language). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 proposed § 150.3(b)(2); determine, in consultation with the exchange and applicant, a commercially reasonable amount of time required for a person to bring its position within the federal position limits pursuant to proposed § 150.3(b)(3)(ii)(B); make a determination whether to recognize a position as a bona fide hedging transaction or to grant a spread exemption pursuant to proposed § 150.3(b)(4); and to request that a person submit updated materials or renew their request pursuant to proposed § 150.3(b)(2) or (5). This proposed delegation would enable the Division of Market Oversight to act quickly in the event of financial distress and in the other circumstances described above. l. Request for Comment The Commission requests comment on all aspects of proposed § 150.3. In addition, the Commission understands that there may be certain not-for-profit electric and natural gas utilities that have certain public service missions and that are prohibited, by their governing body, risk management policies, or otherwise, from speculating, and that would request relief from federal position limits once federal limits on swaps are implemented. The Commission requests comment on all aspects of the concept of an exemption from part 150 of the Commission’s regulations for certain not-for-profit electric and natural gas utility entities that have unique public service missions to provide reliable, affordable energy services to residential, commercial, and industrial customers, and that are prohibited from speculating. In addition, the Commission requests comment on whether the definition of ‘‘economically equivalent swap’’ would cover the types of hedging activities such utilities engage in with respect to their OTC swap activity. The Commission also invites comments on the following: (29) What are the overarching issues or concerns the Commission should consider regarding a potential exemption from position limits for such not- for-profit electric and natural gas utilities? (30) Are there certain provisions in part 150 of the Commission’s regulations that should apply to such not-for-profit electric and natural gas utilities even if the Commission were to grant such entities an exemption with respect to federal position limits? (31) Are there other types of entities, similar to the not-for-profit electric and natural gas utilities described above, for PO 00000 Frm 00048 Fmt 4701 Sfmt 4702 which the Commission should also consider granting such exemptive relief by rule, and why? (32) What types of conditions, restrictions, or criteria should the Commission consider applying with respect to such an exemption? (33) Should higher position limits in cash-settled natural gas futures be conditioned on the closing of any positions in the physically delivered natural gas contract? Are there characteristics of the natural gas futures markets that weigh in favor of or against the higher conditional limits? D. § 150.5—Exchange-Set Position Limits and Exemptions Therefrom 1. Background For the avoidance of confusion, the discussion of § 150.5 that follows addresses exchange-set limits and exemptions therefrom, not federal limits. For a discussion of the proposed processes by which an exemption may be recognized for purposes of federal limits, please see the discussion of proposed § 150.3 above and § 150.9 below. Under DCM Core Principle 5, DCMs shall adopt for each contract, as is necessary and appropriate, position limitations or position accountability for speculators, and, for any contract subject to a federal position limit, DCMs must establish exchange-set limits for that contract no higher than the federal limit level.290 Similarly, under SEF Core Principle 6, SEFs that are trading facilities shall adopt for each contract, as is necessary and appropriate, position limitations or position accountability for speculators, and, for any contract subject to a federal position limit, SEFs that are trading facilities must establish exchange-set limits for that contract no higher than the federal limit, and must monitor positions established on or through the SEF for compliance with the limit set by the Commission and the limit, if any, set by the SEF.291 Beyond these and other statutory and Commission requirements, unless otherwise determined by the Commission, DCM and SEF Core Principle 1 afford DCMs and SEFs ‘‘reasonable discretion’’ in establishing the manner in which they comply with the core principles.292 The current regulatory provisions governing exchange-set position limits and exemptions therefrom appear in § 150.5.293 To align § 150.5 with Dodd290 See 7 U.S.C. 7(d)(5). 7 U.S.C. 7b–3(f)(6). 292 See 7 U.S.C. 7(d)(1) and 7 U.S.C. 7b–3(f)(1). 293 17 CFR 150.5. 291 See E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Frank statutory changes 294 and with other changes proposed herein,295 the Commission proposes a new version of § 150.5. This new proposed § 150.5 would generally afford exchanges the discretion to decide for themselves how best to set limit levels and grant exemptions from such limits in a manner that best reflects their specific markets. lotter on DSKBCFDHB2PROD with PROPOSALS3 2. Implementation of Exchange-Set Limits on Swaps With respect to the DCM Core Principle 5 and SEF Core Principle 6 requirements addressing exchange-set limits on swaps, the Commission is preliminarily determining that it is reasonable to delay implementation because requiring compliance would be impracticable, and in some cases impossible, at this time.296 The Commission has previously explained why it has proposed to temporarily delay imposition of exchange-set position limits on swaps.297 The decision to delay imposing exchange-set position limits on swaps is based largely on the lack of exchange access to sufficient data regarding individual market participants’ open swap positions, which means that, without action to provide further access to swap data to exchanges, the exchanges cannot effectively monitor swap position limits. The Commission preliminarily believes that delayed implementation of exchange-set speculative position limits on swaps at this time is not inconsistent with the statutory objectives outlined in section 4a(a)(3) of the CEA: To diminish excessive speculation, to deter market manipulation, to ensure sufficient liquidity for bona fide hedgers, and to ensure that the price discovery function of the underlying market it not disrupted.298 Accordingly, while proposed § 150.5 will apply to DCMs and SEFs, the requirements associated with swaps would be enforced at a later time. In 294 While existing § 150.5 on its face only applies to contracts that are not subject to federal limits, DCM Core Principle 5, as amended by Dodd-Frank, and SEF Core Principle 6, establish requirements both for contracts that are, and are not, subject to federal limits. 7 U.S.C. 7(d)(5) and 7 U.S.C. 7b– 3(f)(6). 295 Significant changes proposed herein include the process set forth in proposed § 150.9 and revisions to the bona fide hedging definition proposed in § 150.1. 296 The Commission has observed in prior releases that courts have upheld relieving regulated entities of their statutory obligations where compliance is impossible or impracticable. 2016 Supplemental Proposal, 81 FR at 38462. 297 2016 Supplemental Proposal, 81 FR at 38459– 62; 2016 Reproposal, 81 FR at 96784–86. 298 7 U.S.C. 6a(a)(3). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 other words, exchanges must comply with proposed § 150.5 only with respect to futures and options on futures traded on DCMs, and with respect to swaps at a later time as determined by the Commission. 3. Existing § 150.5 As noted above, existing § 150.5 predates the Dodd-Frank Act and addresses the establishment of DCM-set position limits for all contracts not subject to federal limits under existing § 150.2 (aside from certain major foreign currencies).299 Existing § 150.5(a) authorizes DCMs to set different limits for different contracts and contract months, and permits DCMs to grant exemptions from DCM-set limits for spreads, straddles, or arbitrage trades. Existing § 150.5(b) provides a limited set of methodologies for DCMs to use in establishing initial limit levels, including separate maximum limit levels for spot month limits in physicaldelivery contracts, spot month limits in cash-settled contracts, non-spot month limits for tangible commodities other than energy, and non-spot month limits for energy products and non-tangible commodities, including financials.300 Existing § 150.5(c) provides that DCMs may adjust their speculative initial levels as follows: (i) No greater than 25 percent of deliverable supply for adjusted spot month levels in physically-delivered contracts; (ii) ‘‘no greater than necessary to minimize the potential for manipulation or distortion of the contract’s or the underlying commodity’s price’’ for adjusted spot month levels in cash-settled contracts; and (iii) for adjusted non-spot month limit levels, either no greater than 10 percent of open interest, up to 25,000 contracts, with a marginal increase of 2.5 percent thereafter, or based on position sizes customarily held by speculative traders on the DCM. Existing § 150.5(d) addresses bona fide hedging exemptions from DCM-set limits, including an exemption application process, providing that 299 Existing § 150.5(a) states that the requirement to set position limits shall not apply to futures or option contract markets on major foreign currencies, for which there is no legal impediment to delivery and for which there exists a highly liquid cash market. 17 CFR 150.5(a). 300 See 17 CFR 150.5(b)(1)–(3) (no greater than one-quarter of the estimated spot month deliverable supply for physical delivery contracts during the spot month; no greater than necessary to minimize the potential for manipulation or distortion of the contract’s or the underlying commodity’s price for cash-settled contracts during the spot month; no greater than 1,000 contracts for tangible commodities other than energy outside the spot month; and no greater than 5,000 contracts for energy products and nontangible commodities, including financials outside the spot month). PO 00000 Frm 00049 Fmt 4701 Sfmt 4702 11643 exchange-set speculative position limits shall not apply to bona fide hedging positions as defined by a DCM in accordance with the definition of bona fide hedging transactions and positions for excluded commodities in § 1.3. Existing § 150.5(d) also addresses factors for consideration by DCMs in recognizing bona fide hedging exemptions (or position accountability), including whether such positions ‘‘are not in accord with sound commercial practices or exceed an amount which may be established and liquidated in an orderly fashion.’’ 301 Existing § 150.5(e) permits DCMs in certain circumstances to submit for Commission approval, as a substitute for the position limits required under § 150.5(a), (b), and (c), a DCM rule requiring traders ‘‘to be accountable for large positions,’’ meaning that under certain circumstances, traders must provide information about their position upon request to the exchange, and/or consent to halt increasing further a position if so ordered by the exchange.302 Among other things, this provision includes open interest and volume-based parameters for determining when DCMs may do so.303 Existing § 150.5(f) provides that DCM speculative position limits adopted pursuant to § 150.5 shall not apply to certain positions acquired in good faith prior to the effective date of such limits or to a person that is registered as an FCM or as a floor broker under authority of the CEA except to the extent that transactions made by such person are made on behalf of or for the account or benefit of such person.304 This provision also provides that in addition to the express exemptions specified in § 150.5, a DCM may propose such other exemptions from the requirements of § 150.5 as are consistent with the purposes of § 150.5, and provides procedures for doing so.305 Finally, existing § 150.5(g) addresses aggregation of positions for which a person directly or indirectly controls trading. 4. Proposed § 150.5 Pursuant to CEA sections 5(d)(1) and 5h(f)(1), the Commission proposes a new version of § 150.5.306 Proposed § 150.5 is intended to provide the ability for DCMs and SEFs to set limit levels 301 See 17 CFR 150.5(d)(1). CFR 150.5(e). 303 17 CFR 150.5(e)(1)–(4). 304 17 CFR 150.5(f). 305 Id. 306 As mentioned above, while proposed § 150.5 will include references to swaps and SEFs, the proposed rule would initially only apply to DCMs, as requirements relating to exchange-set limits on swaps would be phased in at a later time. 302 17 E:\FR\FM\27FEP3.SGM 27FEP3 11644 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules and grant exemptions in a manner that best accommodates activity particular to their markets, while promoting compliance with DCM Core Principle 5 and SEF Core Principle 6 and ensuring consistency with other changes proposed herein, including the process for exchanges to administer applications for non-enumerated bona fide hedge exemptions for purposes of federal limits proposed in § 150.9.307 Proposed § 150.5 contains two main sub-sections, with each sub-section addressing a different category of contract: (i) Proposed § 150.5(a) would include rules governing exchange-set limits for contracts subject to federal limits; and (ii) proposed § 150.5(b) would include rules governing exchange-set limits for physical commodity contracts that are not subject to federal limits. As described in further detail below, the proposed provisions addressing exchange-set limits on contracts that are not subject to federal limits reflect a principles-based approach and include acceptable practices that provide for non-exclusive methods of compliance with the principles-based regulations. The Commission would therefore provide exchanges with the ability to set limits and grant exemptions in the manner that most suits their unique markets. Each proposed provision of § 150.5 is described in detail below. a. Proposed § 150.5(a)—Requirements for Exchange-Set Limits on Commodity Derivative Contracts Subject to Federal Limits Set Forth in § 150.2 lotter on DSKBCFDHB2PROD with PROPOSALS3 Proposed § 150.5(a) would apply to all contracts subject to the federal limits proposed in § 150.2 and, among other things, is intended to help ensure that exchange-set limits do not undermine the federal limits framework. Under proposed § 150.5(a)(1), for any contract subject to a federal limit, DCMs and, ultimately, SEFs, would be required to establish exchange-set limits for such contracts. Consistent with DCM Core Principle 5 and SEF Core Principle 6, the exchange-set limit levels on such contracts, whether cash-settled or physically-settled, and whether during or outside the spot month, would have to be no higher than the level specified for the applicable referenced contract in proposed § 150.2. Exchanges would be 307 To avoid confusion created by the parallel federal and exchange-set position limit frameworks, the Commission clarifies that proposed § 150.5 deals solely with exchange-set position limits and exemptions therefrom, whereas proposed § 150.9 deals solely with federal limits and recognition of exchange-granted exemptions and bona fide hedging determinations for purposes of federal limits. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 free to set position limits that are more stringent than the federal limit for a particular contract, and would also be permitted to adopt position accountability at a level lower than the federal limit, in addition to an exchange-set position limit that is equal to or less than the federal limit. Proposed § 150.5(a)(2) would permit exchanges to grant exemptions from exchange-set limits established under proposed § 150.5(a)(1) as follows: First, if such exemptions from exchange-set limits conform to the types of exemptions that may be granted for purposes of federal limits under proposed §§ 150.3(a)(1)(i), 150.3(a)(2)(i), and 150.3(a)(4)–(5) (enumerated bona fide hedge recognitions and spread exemptions that are listed in the spread transaction definition in proposed § 150.1, as well as exempt conditional spot month positions in natural gas and pre-enactment and transition period swaps), then the level of the exemption may exceed the applicable federal position limit under proposed § 150.2. Since the proposed exemptions listed above are self-effectuating for purposes of federal position limit levels, exchanges may grant such exemptions pursuant to proposed § 150.5(a)(2)(i). Second, if such exemptions from exchange-set limits conform to the exemptions from federal limits that may be granted under proposed §§ 150.3(a)(1)(ii) and 150.3(a)(2)(ii) (respectively, non-enumerated bona fide hedges and spread transactions that are not currently listed in the spread transaction definition in proposed § 150.1), then the level of the exemption may exceed the applicable federal position limit under proposed § 150.2, provided that the exemption for purposes of federal limits is first approved in accordance with proposed § 150.3(b) or § 150.9, as applicable. Third, if such exemptions conform to the exemptions from federal limits that may be granted under proposed § 150.3(a)(3) (financial distress positions), then the level of the exemption may exceed the applicable federal position limit under proposed § 150.2, provided that the Commission has first issued a letter approving such exemption pursuant to a request submitted under § 140.99.308 Finally, for purposes of exchange-set limits only, exchanges may grant exemption types that are not listed in 308 Under the proposal, requests for exemptions for financial distress positions would be submitted directly to the Commission (or delegated staff) for consideration, and any approval of such exemption would be issued in the form of an exemption letter from the Commission (or delegated staff) pursuant to § 140.99. PO 00000 Frm 00050 Fmt 4701 Sfmt 4702 § 150.3(a). However, in such cases, the exemption level would have to be capped at the level of the applicable federal position limit, so as not to undermine the federal limit framework, unless the Commission has first approved such exemption for purposes of federal limits pursuant to § 150.3(b). Exchanges that wish to offer exemptions from their own limits other than the types listed in proposed § 150.3(a) could also submit rules to the Commission allowing for such exemptions pursuant to part 40. The Commission would carefully review any such exemption types for compliance with applicable standards, including any statutory requirements 309 and Commission-set standards.310 Under proposed § 150.5(a)(2)(ii)(A), exchanges that wish to grant exemptions from their own limits would have to require traders to file an application. Aside from the requirements discussed below, including the requirement that the exchange collect cash-market and swaps market information from the applicant, exchanges would have flexibility to establish the application process as they see fit, including adopting protocols to reduce burdens by leveraging existing processes with which their participants are already familiar. For all exemption types, exchanges would have to generally require that such applications be filed in advance of the date such position would be in excess of the limits, but exchanges would be given the discretion to adopt rules allowing traders to file applications within five business days after a trader established such position. Exchanges wishing to grant such retroactive exemptions would have to require market participants to demonstrate circumstances warranting a sudden and unforeseen hedging need. Proposed § 150.5(a)(2)(ii)(B) would provide that exchanges must require that a trader reapply for the exemption granted under proposed § 150.5(a)(2) at least annually so that the exchange and the Commission can closely monitor exemptions for contracts subject to 309 For example, an exchange would not be permitted to adopt rules allowing for risk management exemptions in physical commodities because the Commission interprets Dodd-Frank amendments to CEA section 4a(c)(2) as prohibiting risk management exemptions in such commodities. See supra Section II.A.1.c.ii.(1). (discussion of the temporary substitute test and risk-management exemptions). 310 For example, as discussed below, proposed § 150.5(a)(2)(ii)(C) would require that exchanges take into account whether the requested exemption would result in positions that are not in accord with sound commercial practices in the relevant commodity derivative market and/or would not exceed an amount that may be established and liquidated in an orderly fashion in that market. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 federal speculative position limits, and to help ensure that the exchange and the Commission remain aware of the trader’s activities. Proposed § 150.5(a)(2)(ii)(C) would authorize exchanges to deny, limit, condition, or revoke any exemption request in accordance with exchange rules,311 and would set forth a principles-based standard for the granting of exemptions that do not conform to the type that the Commission may grant under proposed § 150.3(a). Specifically, exchanges would be required to take into account: (i) Whether the requested exemption from its limits would result in a position that is ‘‘not in accord with sound commercial practices’’ in the market in which the DCM is granting the exemption; and (ii) whether the requested exemption would result in a position that would ‘‘exceed an amount that may be established or liquidated in an orderly fashion in that market.’’ Exchanges’ evaluation of exemption requests against these standards would be a facts and circumstances determination. Activity may reflect ‘‘sound commercial practice’’ for a particular market or market participant but not for another. Similarly, activity may reflect ‘‘sound commercial practice’’ outside the spot month but not in the spot month. Further, activity with manipulative intent or effect, or that has the potential or effect of causing price distortion or disruption, would be inconsistent with ‘‘sound commercial practice,’’ even if common practice among market participants. While an exemption granted to an individual market participant may reflect ‘‘sound commercial practice’’ and may not ‘‘exceed an amount that may be established or liquidated in an orderly fashion in that market,’’ the Commission expects exchanges to also evaluate whether the granting of a particular exemption type to multiple participants could have a collective impact on the market in a manner inconsistent with ‘‘sound commercial practice’’ or in a manner that could result in a position that would ‘‘exceed an amount that may be established or liquidated in an orderly fashion in that market.’’ 311 Currently, DCMs review and set exemption levels annually based on the facts and circumstances of a particular exemption and the market conditions at that time. As such, a DCM may decide to deny, limit, condition, or revoke a particular exemption, typically, if the DCM determines that certain conditions have changed and warrant such action. This may happen if, for example, there are droughts, floods, embargoes, trade disputes, or other events that cause shocks to the supply or demand of a particular commodity and thus impact the DCM’s disposition of a particular exemption. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 The Commission understands that the above-described parameters for exemptions from exchange-set limits are generally consistent with current industry practice among DCMs. Bearing in mind that proposed § 150.5(a) would apply to contracts subject to federal limits, the Commission proposes codifying such parameters, as they would establish important, minimum standards needed for exchanges to administer, and the Commission to oversee, a robust program for granting exemptions from exchange-set limits in a manner that does not undermine the federal limits framework. Proposed § 150.5(a) also would afford exchanges the ability to generally oversee their programs for granting exemptions from exchange limits as they see fit, including to establish different application processes and requirements to accommodate the unique characteristics of different contracts. If adopted, changes proposed herein may result in certain ‘‘pre-existing positions’’ being subject to speculative position limits even though the position predated the adoption of such limits.312 So as not to undermine the federal position limits framework during the spot month, and to minimize disruption outside the spot month, the Commission proposes § 150.5(a)(3), which would require that during the spot month, for contracts subject to federal limits, exchanges must impose limits no larger than federal levels on ‘‘pre-existing positions,’’ other than for pre-enactment swaps and transition period swaps. However, outside the spot month, exchanges would not be required to impose limits on such positions, provided the position is acquired in good faith consistent with the ‘‘preexisting position’’ definition of proposed § 150.1, and provided further that if the person’s position is increased after the effective date of the limit, such pre-existing position, other than preenactment swaps and transition period swaps, along with the position increased after the effective date, would be attributed to the person. This provision is consistent with the proposed treatment of pre-existing positions for purposes of federal limits set forth in proposed § 150.2(g) and is intended to prevent spot month limits from being rendered ineffective. Not subjecting pre-existing positions to spot month limits could result in a large, pre-existing position either intentionally or unintentionally causing a disruption as it is rolled into the spot month, and the Commission is particularly concerned about protecting the spot month in physical-delivery futures from corners and squeezes. PO 00000 Frm 00051 Fmt 4701 Sfmt 4702 11645 Outside of the spot month, however, concerns over corners and squeezes may be less acute.313 Finally, the Commission seeks a balance between having sufficient information to oversee the exchangegranted exemptions, and not burdening exchanges with excessive periodic reporting requirements. The Commission thus proposes under § 150.5(a)(4) to require one monthly report by each exchange. Certain exchanges already voluntarily file these types of monthly reports with the Commission, and proposed § 150.5(a)(4) would standardize such reports for all exchanges that process applications for bona fide hedges, spread exemptions, and other exemptions for contracts that are subject to federal limits. The proposed report would provide information regarding the disposition of any application to recognize a position as a bona fide hedge (both enumerated and non-enumerated) or to grant a spread or other exemption, including any renewal, revocation of, or modification to the terms and conditions of, a prior recognition or exemption.314 As specified under proposed § 150.5(a)(4), the report would provide certain details regarding the bona fide hedging position or spread exemption, including: The effective date and expiration date of any recognition or exemption; any unique identifier assigned to track the application or position; identifying information about the applicant; the derivative contract or positions to which the application pertains; the maximum size of the commodity derivative position that is recognized or exempted by the exchange (including any ‘‘walk-down’’ requirements); 315 any size limitations the exchange sets for the position; and a brief narrative summarizing the applicant’s relevant cash market activity. 314 In the monthly report, exchanges may elect to list new recognitions or exemptions, and modifications to or revocations of prior recognitions and exemptions each month; alternatively, exchanges may submit cumulative monthly reports listing all active recognitions and exemptions (i.e., including exemptions that are not new or have not changed). 315 An exchange could determine to recognize as a bona fide hedge or spread exemption all, or a portion, of the commodity derivative position for which an application has been submitted, provided that such determination is made in accordance with the requirements of proposed § 150.5 and is consistent with the Act and the Commission’s regulations. In addition, an exchange could require that a bona fide hedging positon or spread position be subject to ‘‘walk-down’’ provisions that require the trader to scale down its positions in the spot month in order to reduce market congestion as needed based on the facts and circumstances. E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 11646 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules With respect to any unique identifiers to be included in the proposed monthly report, the exchange’s assignment of a unique identifier would assist the Commission’s tracking process. The unique identifier could apply to each of the bona fide hedge or spread exemption applications that the exchange receives, and, separately, each type of commodity derivative position that the exchange wishes to recognize as a bona fide hedge or spread exemption. Accordingly, the Commission suggests that, as a ‘‘best practice,’’ the exchange’s procedures for processing bona fide hedging position and spread exemption applications contemplate the assignment of such unique identifiers. The proposed report would also be required to specify the maximum size and/or size limitations by contract month and/or type of limit (e.g., spot month, single month, or all-monthscombined), as applicable. The proposed monthly report would be a critical element of the Commission’s surveillance program by facilitating its ability to track bona fide hedging positions and spread exemptions approved by exchanges. The proposed monthly report would also keep the Commission informed as to the manner in which an exchange is administering its application procedures, the exchange’s rationale for permitting large positions, and relevant cash market activity. The Commission expects that exchanges would be able to leverage their current exemption processes and recordkeeping procedures to generate such reports. In certain instances, information included in the proposed monthly report may prompt the Commission to request records required to be maintained by an exchange. For example, the Commission proposes that, for each derivative position that an exchange wishes to recognize as a bona fide hedge, or any revocation or modification of such recognition or exemption, the report would include a concise summary of the applicant’s activity in the cash markets and swaps markets for the commodity underlying the position. The Commission expects that this summary would focus on the facts and circumstances upon which an exchange based its determination to recognize a bona fide hedge, to grant a spread exemption, or to revoke or modify such recognition or exemption. In light of the information provided in the summary, or any other information included in the proposed monthly report regarding the position, the Commission may request the exchange’s complete record of the application. The Commission expects that it would only VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 need to request such complete records in the event that it noticed an issue that could cause market disruptions. Proposed § 150.5(a)(4) would require an exchange, unless instructed otherwise by the Commission, to submit such monthly reports according to the form and manner requirements the Commission specifies. In order to facilitate the processing of such reports, and the analysis of the information contained therein, the Commission would establish reporting and transmission standards. The proposal would also require that such reports be submitted to the Commission using an electronic data format, coding structure, and electronic data transmission procedures approved in writing by the Commission, as specified on its website.316 Request for Comment The Commission requests comment on all aspects of proposed § 150.5(a). The Commission also invites comments on the following: (34) The Commission has proposed that exchanges submit monthly reports under § 150.5(a)(4). Do exchanges prefer that the Commission specify a particular day each month as a deadline for submitting such monthly reports or do exchanges prefer to have discretion in determining which day to submit such reports? b. Proposed § 150.5(b)—Requirements and Acceptable Practices for ExchangeSet Limits on Commodity Derivative Contracts in a Physical Commodity That Are Not Subject to the Limits Set Forth in § 150.2 As described elsewhere in this release, the Commission is proposing federal speculative limits on 25 core referenced futures contracts and their respective referenced contracts.317 DCMs, and, ultimately, SEFs, listing physical commodity contracts for which federal limits do not apply would have to comply with proposed § 150.5(b), which includes a combination of rules and references to acceptable practices. Under proposed § 150.5(b), for physical commodity derivatives that are not subject to federal limits, whether cash-settled or physically-settled, exchanges would be subject to flexible standards during the product’s spot month and non-spot month. During the spot month, under proposed § 150.5(b)(1)(i), exchanges would be 316 The Commission would provide such form and manner instructions on the Forms and Submissions page at www.cftc.gov. Such instructions would likely be published in the form of a technical guidebook. 317 See infra Section III.F. PO 00000 Frm 00052 Fmt 4701 Sfmt 4702 required to establish position limits, and such limits would have to be set at a level that is no greater than 25 percent of deliverable supply. As described in detail in connection with the proposed federal spot month limits described above, it would be difficult, in the absence of other factors, for a participant to corner or squeeze a market if the participant holds less than or equal to 25 percent of deliverable supply, and the Commission has long used deliverable supply as the basis for spot month position limits due to concerns regarding corners, squeezes, and other settlement-period manipulative activity.318 The Commission recognizes, however, that there may be circumstances where an exchange may not wish to use the 25 percent formula, including, for example, if the contract is cash-settled, does not have a measurable deliverable supply, or if the exchange can demonstrate that a different parameter is better suited for a particular contract or market.319 Accordingly, the proposal would afford exchanges the ability to submit to the Commission alternative potential methodologies for calculating spot month limit levels required by proposed § 150.5(b)(1), provided that the limits are set at a level that is ‘‘necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract’s or the underlying commodity’s price or index.’’ This standard has appeared in existing § 150.5 since its adoption in connection with spot month limits on cash-settled contracts. As noted above, existing § 150.5 includes separate parameters for spot month limits in physical-delivery contracts and for cashsettled contracts, but does not include flexibility for exchanges to consider alternative parameters. In an effort to both simplify the regulation and provide the ability for exchanges to consider multiple parameters that may be better suited for certain products, the Commission proposes the above standard as a principles-based requirement for both cash-settled and physically-settled contracts subject to proposed § 150.5(b). Outside of the spot month, where, historically, attempts at certain types of market manipulation are generally less of a concern, proposed § 150.5(b)(2)(i) would allow exchanges to choose between position limits or position accountability for physical commodity 318 See supra Section II.B.2. (discussion of proposed § 150.2). 319 Guidance for calculating deliverable supply can be found in Appendix C to part 38. 17 CFR part 38, Appendix C. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 contracts that are not subject to federal limits. While exchanges would be provided the ability to decide whether to use limit levels or accountability levels for any such contract, under either approach, the exchange would have to set a level that is ‘‘necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract’s or the underlying commodity’s price or index.’’ To help exchanges efficiently demonstrate compliance with this standard for physical commodity contracts outside of the spot month, the Commission proposes separate acceptable practices for exchanges that wish to adopt non-spot month position limits and exchanges that wish to adopt non-spot month accountability.320 For exchanges that choose to adopt non-spot month position limits, rather than position accountability, proposed paragraph (a)(1) to Appendix F of part 150 would set forth non-exclusive acceptable practices. Under that provision, exchanges would be deemed in compliance with proposed § 150.5(b)(2)(i) if they set non-spot limit levels for each contract subject to § 150.5(b) at a level no greater than: (1) The average of historical position sizes held by speculative traders in the contract as a percentage of the contract’s open interest; 321 (2) the spot month limit level for the contract; (3) 5,000 contracts (scaled up proportionally to the ratio of the notional quantity per contract to the typical cash market transaction if the notional quantity per contract is smaller than the typical cash market transaction, or scaled down proportionally if the notional quantity per contract is larger than the typical cash market transaction); 322 or (4) 10 320 The acceptable practices proposed in Appendix F to part 150 herein reflect non-exclusive methods of compliance. Accordingly, the language of this proposed acceptable practice, along with the other acceptable practices proposed herein, uses the word ‘‘shall’’ not to indicate that the acceptable practice is a required method of compliance, but rather to indicate that in order to satisfy the acceptable practice, a market participant must (i.e., shall) establish compliance with that particular acceptable practice. 321 For example, if speculative traders in a particular contract typically make up 12 percent of open interest in that contract, the exchange could set limit levels no greater than 12 percent of open interest. 322 For exchanges that choose to adopt a non-spot month limit level of 5,000 contracts, this level assumes that the notional quantity per contract is set at a level that reflects the size of a typical cash market transaction in the underlying commodity. However, if the notional quantity of the contract is larger/smaller than the typical cash market transaction in the underlying commodity, then the DCM must reduce/increase the 5,000 contract nonspot month limit until it is proportional to the notional quantity of the contract relative to the VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 percent of open interest in that contract for the most recent calendar year up to 50,000 contracts, with a marginal increase of 2.5 percent of open interest thereafter.323 When evaluating average position sizes held by speculative traders, the Commission expects exchanges: (i) To be cognizant of speculative positions that are extraordinarily large relative to other speculative positions, and (ii) to not consider any such outliers in their calculations. These proposed parameters have largely appeared in existing § 150.5 for many years in connection with non-spot month limits, either for initial or subsequent levels.324 The Commission is of the view that these parameters would be useful, flexible standards to carry forward as acceptable practices. For example, the Commission expects that the 5,000-contract acceptable practice would be a useful benchmark for exchanges because it would allow them to establish limits and demonstrate compliance with Commission regulations in a relatively efficient manner, particularly for new contracts that have yet to establish open interest. Similarly, for purposes of exchange-set limits on physical commodity contracts that are not subject to federal limits, the Commission proposes to maintain the baseline 10, 2.5 percent formula as an acceptable practice. Because these parameters are simply acceptable practices, exchanges may, after evaluation, propose higher non-spot month limits or accountability levels. Along those lines, the Commission recognizes that other parameters may be preferable and/or just as effective, and typical cash market transaction. These required adjustments to the 5,000 contract metric are intended to avoid a circumstance where an exchange could allow excessive speculation by setting excessively large notional quantities relative to typical cash-market transaction sizes. For example, if the notional quantity per contract is set at 30,000 units, and the typical observed cash market transaction is 2,500 units, the notional quantity per contract would be 12 times larger than the typical cash market transaction. In that case, the non-spot month limit would need to be 12 times smaller than 5,000 (i.e., at 417 contracts.). Similarly, if the notional quantity per contract is 1,000 contracts, and the typical observed cash market transaction is 2,500 units, the notional quantity per contract would be 2.5 times smaller than the typical cash market transaction. In that case, the non-spot month limit would need to be 2.5 times larger than 5,000, and would need to be set at 12,500 contracts. 323 In connection with the proposed Appendix F to part 150 acceptable practices, open interest should be calculated by averaging the month-end open positions in a futures contract and its related option contract, on a delta-adjusted basis, for all months listed during the most recent calendar year. 324 17 CFR 150.5(b) and (c). Proposed § 150.5(b) would address physical commodity contracts that are not subject to federal limits. PO 00000 Frm 00053 Fmt 4701 Sfmt 4702 11647 would be open to considering alternative parameters submitted pursuant to part 40 of the Commission’s regulations, provided, at a minimum, that the parameter complies with § 150.5(b)(2)(i). The Commission encourages exchanges to submit potential new parameters to Commission staff in draft form prior to submitting them under part 40. For exchanges that choose to adopt position accountability, rather than limits, outside of the spot month, proposed paragraph (a)(2) of Appendix F to part 150 would set forth a nonexclusive acceptable practice that would permit exchanges to comply with proposed § 150.5(b)(2)(i) by adopting rules establishing ‘‘position accountability’’ as defined in proposed § 150.1. ‘‘Position accountability’’ would mean rules, submitted to the Commission pursuant to part 40, that require traders to, upon request by the exchange, consent to: (i) Provide information to the exchange about their position, including, but not limited to, information about the nature of the their positions, trading strategies, and hedging information; and (ii) halt further increases to their position or to reduce their position in an orderly manner.325 Proposed § 150.5(b)(3) addresses a circumstance where multiple exchanges list contracts that are substantially the same, including physically-settled contracts that have the same underlying commodity and delivery location, or cash-settled contracts that are directly or indirectly linked to a physically-settled contract. Under proposed § 150.5(b)(3), exchanges listing contracts that are substantially the same in this manner must either adopt ‘‘comparable’’ limits for such contracts, or demonstrate to the Commission how the non-comparable levels comply with the standards set forth in proposed § 150.5(b)(1) and (2). Such a determination also must address how the levels are necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract’s or the underlying commodity’s price or index. Proposed § 150.5(b)(3) would apply equally to cash-settled and physicallysettled contracts, and to limits during and outside of the spot month, as 325 While existing § 150.5(e) includes openinterest and volume-based limitations on the use of accountability, the Commission opts not to include such limitations in this proposal. Under the rules proposed herein, if an exchange submitted a part 40 filing seeking to adopt position accountability, the Commission would determine on a case-by-case basis whether such rules are consistent with the Act and the Commission’s regulations. The Commission does not want to use one-size-fits-all volume-based limitations for making such determinations. E:\FR\FM\27FEP3.SGM 27FEP3 11648 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 applicable.326 Proposed § 150.5(b)(3) is intended to help ensure that position limits established on one exchange would not jeopardize market integrity or otherwise harm other markets. Further, proposed § 150.5(b)(3) would be consistent with the Commission’s proposal to generally apply equivalent federal limits to linked contracts, including linked contracts listed on multiple exchanges.327 Finally, under proposed § 150.5(b)(4), exchanges would be permitted to grant exemptions from any limits established under proposed § 150.5(b). As noted, proposed § 150.5(b) would apply to physical commodity contracts not subject to federal limits; thus, exchanges would be given flexibility to grant exemptions in such contracts, including exemptions for both intramarket and intermarket spread positions,328 as well as other exemption types not explicitly listed in proposed § 150.3.329 However, such exchanges must require that traders apply for the exemption. In considering any such application, the exchanges would be required to take into account whether the exemption would result in a position that would not be in accord with ‘‘sound commercial practices’’ in the market for which the exchange is considering the application, and/or would ‘‘exceed an amount that may be established and liquidated in an orderly fashion in that market.’’ While exchanges would be subject to the requirements of § 150.5(a) and (b) described above, such proposed requirements are not intended to limit 326 For reasons discussed elsewhere in this release, this provision would not apply to natural gas contracts. See supra Section II.C.2.e. (discussion of proposed conditional spot month exemption in natural gas). 327 See supra Section II.A.16. (discussion of the proposed referenced contract definition and linked contracts). 328 The Commission understands an intramarket spread position to be a long position in one or more commodity derivative contracts in a particular commodity, or its products or its by-products, and a short position in one or more commodity derivative contracts in the same, or similar, commodity, or its products or by-products, on the same DCM. The Commission understands an intermarket spread position to be a long (or short) position in one or more commodity derivative contracts in a particular commodity, or its products or its by-products, at a particular DCM and a short (or long) position in one or more commodity derivative contracts in that same, or similar, commodity, or its products or its by-products, away from that particular DCM. For instance, the Commission would consider a spread between CBOT Wheat (W) futures and MGEX HRS Wheat (MWE) futures to be an intermarket spread based on the similarity of the commodities. 329 As noted above, proposed § 150.3 would allow for several exemption types, including: Bona fide hedging positions; certain spreads; financial distress positions; and conditional spot month limit exemption positions in natural gas. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 the discretion of exchanges to utilize other tools to protect their markets. Among other things, an exchange would have the discretion to: impose additional restrictions on a person with a long position in the spot month of a physical-delivery contract who stands for delivery, takes that delivery, then reestablishes a long position; establish limits on the amount of delivery instruments that a person may hold in a physical-delivery contract; and impose such other restrictions as it deems necessary to reduce the potential threat of market manipulation or congestion, to maintain orderly execution of transactions, or for such other purposes consistent with its responsibilities. c. Proposed § 150.5(c)—Requirements for Security Futures Products As the Commission has previously noted, security futures products and security options may serve economically equivalent or similar functions to one another.330 Therefore, when the Commission originally adopted position limits regulations for security futures products in part 41, it set levels that were generally comparable to, although not identical with, the limits that applied to options on individual securities.331 The Commission has pointed out that security futures products may be at a competitive disadvantage if position limits for security futures products vary too much from those of security options.332 As a result, the Commission in 2019 adopted amendments to the position limitations and accountability requirements for security futures products, noting that one goal was to provide a level regulatory playing field with security options.333 Proposed § 150.5(c), therefore, would include a cross-reference clarifying that for security futures products, position limitations and accountability requirements for exchanges are specified in § 41.25.334 This would allow the Commission to take into account the position limits regime that applies to security options when 330 See Position Limits and Position Accountability for Security Futures Products, 83 FR at 36799, 36802 (July 31, 2018). 331 Id. See also Listing Standards and Conditions for Trading Security Futures Products, 66 FR at 55078, 55082 (Nov. 1, 2001) (explaining the Commission’s adoption of position limits for security futures products). 332 See 83 FR at 36799, 36802 (July 31, 2018). 333 See Position Limits and Position Accountability for Security Futures Products, 84 FR at 51005, 51009 (Sept. 27, 2019). 334 See 17 CFR 41.25. Rule § 41.25 establishes conditions for the trading of security futures products. PO 00000 Frm 00054 Fmt 4701 Sfmt 4702 considering position limits regulations for security futures products. d. Proposed § 150.5(d)—Rules on Aggregation As noted earlier in this release, the Commission adopted in 2016 final aggregation rules under § 150.4 that apply to all contracts subject to federal limits. The Commission recognizes that with respect to contracts not subject to federal limits, market participants may find it burdensome if different exchanges adopt different aggregation standards. Accordingly, under proposed § 150.5(d), all DCMs, and, ultimately, SEFs, that list any physical commodity derivatives, regardless of whether the contract is subject to federal limits, would be required to adopt aggregation rules for such contracts that conform to § 150.4.335 Exchanges that list excluded commodities would be encouraged to also adopt aggregation rules that conform to § 150.4. Aggregation policies that otherwise vary from exchange to exchange would increase the administrative burden on a trader active on multiple exchanges, as well as increase the administrative burden on the Commission in monitoring and enforcing exchange-set position limits. e. Proposed § 150.5(e)—Requirements for Submissions to the Commission Proposed § 150.5(e) reflects that, consistent with the definition of ‘‘rule’’ in existing § 40.1, any exchange action establishing or modifying exchange-set position limits or exemptions therefrom, or position accountability, in any case pursuant to proposed § 150.5(a), (b), (c), or Appendix F to part 150, would qualify as a ‘‘rule’’ and must be submitted to the Commission as such pursuant to part 40 of the Commission’s regulations. Such rules would also include, among other things, parameters used for determining position limit levels, and policies and related processes setting forth parameters addressing, among other things, which types of exemptions are permitted, the parameters for the granting of such exemptions, and any exemption application requirements. 335 Under § 150.4, unless an exemption applies, a person’s positions must be aggregated with positions for which the person controls trading or for which the person holds a 10 percent or greater ownership interest. Commission Regulation § 150.4(b) sets forth several permissible exemptions from aggregation. See Final Aggregation Rulemaking, 81 FR at 91454. The Division of Market Oversight has issued time-limited no-action relief from some of the aggregation requirements contained in that rulemaking. See CFTC Letter No. 19–19 (July 31, 2019), available at https:// www.cftc.gov/csl/19–19/download. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Proposed § 150.5(e) further provides that exchanges would be required to review regularly 336 any position limit levels established under proposed § 150.5 to ensure the level continues to comply with the requirements of those sections. For example, in the case of § 150.5(b), exchanges would be expected to ensure the limits comply with the requirement that limits be set ‘‘at a level that is necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract’s or the underlying commodity’s price or index.’’ Exchanges would also be required to update such levels as needed, including if the levels no longer comply with the proposed rules. f. Delegation of Authority to the Director of the Division of Market Oversight The Commission proposes to delegate its authority, pursuant to proposed § 150.5(a)(4)(ii), to the Director of the Commission’s Division of Market Oversight, or such other employee(s) that the Director may designate from time to time, to provide instructions regarding the submission of information required to be reported by exchanges to the Commission on a monthly basis, and to determine the manner, format, coding structure, and electronic data transmission procedures for submitting such information. lotter on DSKBCFDHB2PROD with PROPOSALS3 g. Commission Enforcement of Exchange-Set Limits As discussed throughout this release, the framework for exchange-set limits operates in conjunction with the federal position limits framework. The Futures Trading Act of 1982 gave the Commission, under CEA section 4a(5) (since re-designated as section 4a(e)), the authority to directly enforce violations of exchange-set, Commissionapproved speculative position limits in addition to position limits established directly by the Commission.337 Since 2008, it has also been a violation of the Act for any person to violate an exchange position limit rule certified to the Commission by such exchange pursuant to CEA section 5c(c)(1).338 336 An acceptable, regular review regime would consist of both a periodic review and an eventspecific review (e.g., in the event of supply and demand shocks such as unanticipated shocks to supply and demand of the underlying commodity, geo-political shocks, and other events that may result in congestion and/or other disruptions). The Commission also expects that exchanges would reevaluate such levels in the event of unanticipated shocks to the supply or demand of the underlying commodity. 337 See Futures Trading Act of 1982, Public Law 97–444, 96 Stat. 2299–30 (1983). 338 See CFTC Reauthorization Act of 2008, Food, Conservation and Energy Act of 2008, Public Law VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Thus, under CEA section 4a(e), it is a violation of the Act for any person to violate an exchange position limit rule certified to or approved by the Commission, including to violate any subsequent amendments thereto, and the Commission has the authority to enforce those violations. h. Request for Comment The Commission requests comment on all aspects of proposed § 150.5. E. § 150.6—Scope Existing § 150.6 provides that nothing in this part shall be construed to affect any provisions of the Act relating to manipulation or corners nor to relieve any contract market or its governing board from responsibility under section 5(4) of the Act to prevent manipulation and corners.339 Position limits are meant to diminish, eliminate, or prevent excessive speculation and deter and prevent market manipulation, squeezes, and corners. The Commission stresses that nothing in the proposed revisions to part 150 would impact the antidisruptive, anti-cornering, and antimanipulation provisions of the Act and Commission regulations, including but not limited to CEA sections 6(c) or 9(a)(2) regarding manipulation, section 4c(a)(5) regarding disruptive practices including spoofing, or sections 180.1 and 180.2 of the Commission’s regulations regarding manipulative and deceptive practices. It may be possible for a trader to manipulate or attempt to manipulate the prices of futures contracts or the underlying commodity with a position that is within the federal position limits. It may also be possible for a trader holding a bona fide hedge recognition from the Commission or an exchange to manipulate or attempt to manipulate the markets. The Commission would not consider it a defense to a charge under the antimanipulation provisions of the Act or the regulations that a trader’s position was within position limits. Like existing § 150.6, proposed § 150.6 is intended to make clear that fulfillment of specific part 150 110–246, 122 Stat. 1624 (June 18, 2008) (also known as the ‘‘Farm Bill’’) (amending CEA section 4a(e), among other things, to assure that a violation of position limits, regardless of whether such position limits have been approved by or certified to the Commission, would constitute a violation of the Act that the Commission could independently enforce). See also Federal Speculative Position Limits for Referenced Energy Contracts and Associated Regulations, 75 FR at 4144, 4145 (Jan. 26, 2010) (summarizing the history of the Commission’s authority to directly enforce violations of exchangeset speculative position limits). 339 17 CFR 150.6. PO 00000 Frm 00055 Fmt 4701 Sfmt 4702 11649 requirements alone does not necessarily satisfy other obligations of an exchange. Proposed § 150.6 would provide that part 150 of the Commission’s regulations shall only be construed as having an effect on position limits set by the Commission or an exchange including any associated recordkeeping and reporting requirements. Proposed § 150.6 would provide further that nothing in part 150 shall affect any other provisions of the Act or Commission regulations including those relating to actual or attempted manipulation, corners, squeezes, fraudulent or deceptive conduct, or to prohibited transactions. For example, proposed § 150.5 would require DCMs, and, ultimately, SEFs, to impose and enforce exchange-set speculative position limits. The fulfillment of the requirements of § 150.5 alone would not satisfy any other legal obligations under the Act or Commission regulations applicable to exchanges to prevent manipulation and corners. Likewise, a market participant’s compliance with position limits or an exemption thereto does not confer any type of safe harbor or good faith defense to a claim that the participant had engaged in an attempted or perfected manipulation. Further, the proposed amendments are intended to help clarify that § 150.6 applies to: Regulations related to position limits found outside of part 150 of the Commission’s regulations (e.g., relevant sections of part 1 and part 19); and recordkeeping and reporting regulations associated with speculative position limits. F. § 150.8—Severability The Commission proposes to add new § 150.8 to provide for the severability of individual provisions of part 150. Should any provision(s) of part 150 be declared invalid, including the application thereof to any person or circumstance, § 150.8 would provide that all remaining provisions of part 150 shall not be affected to the extent that such remaining provisions, or the application thereof, can be given effect without the invalid provisions. G. § 150.9—Process for Recognizing Non-Enumerated Bona Fide Hedging Transactions or Positions With Respect to Federal Speculative Position Limits 1. Background and Overview For the nine legacy agricultural contracts currently subject to federal position limits, the Commission’s current processes for recognizing nonenumerated bona fide hedge positions and certain enumerated anticipatory bona fide hedge positions exist in E:\FR\FM\27FEP3.SGM 27FEP3 11650 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 parallel with exchange processes for granting exemptions from exchange-set limits, as described below. The exchange processes for granting exemptions vary by exchange, and generally do not mirror the Commission’s processes. Thus, when requesting certain bona fide hedging position recognitions that are not selfeffectuating, market participants must currently comply with the exchanges’ processes for exchange-set limits and the Commission’s processes for federal limits. Although this disparity is currently only an issue for the nine agricultural futures contracts subject to both federal and exchange-set limits, the parallel approaches may become more inefficient and burdensome once the Commission adopts limits on additional commodities. Accordingly, the Commission is proposing § 150.9 to establish a separate framework, applicable to proposed referenced contracts in all commodities, whereby a market participant who is seeking a bona fide hedge recognition that is not enumerated in proposed Appendix A can file one application with an exchange to receive a bona fide hedging recognition for purposes of both exchange-set limits and for federal limits.340 Given the proposal to significantly expand the list of enumerated hedges, the Commission expects the use of the proposed § 150.9 non-enumerated process described below would be rare and exceptional. This separate framework would be independent of, and serve as an alternative to, the Commission’s process for reviewing exemption requests under proposed § 150.3. Among other things, proposed § 150.9 would help to streamline the process by which nonenumerated bona fide hedge recognition requests are addressed, minimize disruptions by leveraging existing exchange-level processes with which many market participants are already familiar,341 and reduce inefficiencies created when market participants are 340 Alternatively, under the proposed framework, a trader could submit a request directly to the Commission pursuant to proposed § 150.3(b). A trader that submitted such a request directly to the Commission for purposes of federal limits would have to separately request an exemption from the applicable exchange for purposes of exchange-set limits. As discussed earlier in this release, the Commission proposes to separately allow for enumerated hedges and spreads that meet the ‘‘spread transaction’’ definition to be selfeffectuating. See supra Section II.C.2. (discussion of proposed § 150.3). 341 In particular, the Commission recognizes that, in the energy and metals spaces, market participants are familiar with exchange application processes and are not familiar with the Commission’s processes since, currently, there are no federal position limits for those commodities. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 required to comply with different federal and exchange-level processes. For instance, currently, market participants seeking recognitions of non-enumerated bona fide hedges for the nine legacy agricultural commodities must request recognitions from both the Commission under existing § 1.47, and from the relevant exchange. If the recognition is for an ‘‘enumerated’’ hedge under existing § 1.3 (other than anticipatory enumerated hedges), the market participant would not need to file an application with the Commission (as the enumerated hedge has a self-effectuating recognition for purposes of federal limits). If the exemption is for a ‘‘nonenumerated’’ hedge or certain enumerated anticipatory hedges under existing § 1.3, the market participant would need to file an application with the Commission pursuant to §§ 1.47 or 1.48, respectively. In either case, the market participant would also still need to seek an exchange exemption and file a Form 204/304 on a monthly basis with the Commission. As discussed more fully in this section, with respect to bona fide hedges that are not selfeffectuating for purposes of federal limits, proposed § 150.9 would permit such a market participant to file a single application with the exchange and relieve the market participant from having to separately file an application and/or monthly cash-market reporting information with the Commission. The existing Commission and exchange level approaches are described in more detail below, followed by a more detailed discussion of proposed § 150.9. 2. Existing Approaches for Recognizing Bona Fide Hedges The Commission’s authority and existing processes for recognizing bona fide hedges can be found in section 4a(c) of the Act, and §§ 1.3, 1.47, and 1.48 of the Commission’s regulations.342 In particular, CEA section 4a(c)(1) provides that no CFTC rule issued under CEA section 4a(a) applies to ‘‘transactions or positions which are shown to be bona fide hedging transactions or positions.’’ 343 Further, under the existing definition of ‘‘bona fide hedging transactions and positions’’ in § 1.3,344 paragraph (1) provides the Commission’s general definition of bona 342 See 7 U.S.C. 6a(c) and 17 CFR 1.3, 1.47, and 1.48. 343 7 U.S.C. 6a(c)(1). described above, the Commission proposes to move an amended version of the bona fide hedging definition from § 1.3 to § 150.1. See supra Section II.A. (discussion of proposed § 150.1). 344 As PO 00000 Frm 00056 Fmt 4701 Sfmt 4702 fide hedging transactions or positions; paragraph (2) provides a list of enumerated bona fide hedging positions that, generally, are self-effectuating, and must be reported (along with supporting cash-market information) to the Commission monthly on Form 204 after the positions are taken; 345 and paragraph (3) provides a procedure for market participants to seek recognition from the Commission for nonenumerated bona fide hedging positions. Under paragraph (3), any person that seeks Commission recognition of a position as a nonenumerated bona fide hedge must submit an application to the Commission in advance of taking on the position, and pursuant to the processes found in § 1.47 (30 days in advance for non-enumerated bona fide hedges) or § 1.48 (10 days in advance for enumerated anticipatory hedges), as applicable. b. Exchanges’ Existing Approach for Granting Bona Fide Hedge Exemptions 346 With Respect to Exchange-Set Limits Under DCM Core Principle 5,347 DCMs have, for some time, established exchange-set limits for futures contracts that are subject to federal limits, as well as for contracts that are not. In addition, under existing § 150.5(d), DCMs may grant exemptions to exchange-set position limits for positions that meet the Commission’s general definition of bona fide hedging transactions or positions as defined in paragraph (1) of § 1.3.348 As such, with respect to exchange-set limits, exchanges have adopted processes for handling trader requests for bona fide hedging exemptions, and generally have granted such requests pursuant to exchange rules that incorporate the Commission’s existing general definition of bona fide hedging transactions or positions in paragraph (1) of § 1.3.349 Accordingly, DCMs currently have rules and application forms in place to process applications to exempt bona fide 345 As described below, the Commission proposes to eliminate Form 204 and to rely instead on the cash-market information submitted to exchanges pursuant to proposed §§ 150.5 and 150.9. See infra Section II.H.3. (discussion of proposed amendments to part 19). 346 Exchange rules typically refer to ‘‘exemptions’’ in connection with bona fide hedging and spread positions, whereas the Commission uses the nomenclature ‘‘recognition’’ with respect to bona fide hedges, and ‘‘exemption’’ with respect to spreads. 347 7 U.S.C. 7(d)(5). 348 17 CFR 150.5(d). 349 See, e.g., CME Rule 559 and ICE Rule 6.29 (addressing position limits and exemptions). E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules hedging positions with respect to exchange-set position limits.350 Separately, under SEF Core Principle 6, currently SEFs are required to adopt, as is necessary and appropriate, position limits or position accountability levels for each swap contract to reduce the potential threat of market manipulation or congestion.351 For contracts that are subject to a federal position limit, the SEF must set its position limits at a level that is no higher than the federal limit, and must monitor positions established on or through the SEF for compliance with both the Commission’s federal limit and the exchange-set limit.352 Section 37.601 further implements SEF Core Principle 6 and specifies that until such time that SEFs are required to comply with the Commission’s position limits regulations, a SEF may refer to the associated guidance and/or acceptable practices set forth in Appendix B to part 37 of the Commission’s regulations.353 Currently, in practice, there are no federal position limits on swaps for which SEFs would be required to establish exchange-set limits. As noted above, the application processes currently used by exchanges are different than the Commission’s processes. In particular, exchanges typically use one application process to grant all exemption types, whereas the Commission has different processes for different exemptions, as explained below. Also, exchanges generally do not require the submission of monthly cashmarket information, whereas the Commission has various monthly reporting requirements under Form 204 and part 17 of the Commission’s regulations. Finally, exchanges generally require exemption applications to include cash-market information supporting positions that exceed the limits, to be filed annually prior to exceeding a position limit, and to be updated on an annual basis.354 The Commission, on the other hand, currently has different processes for permitting enumerated bona fide hedges and for recognizing positions as non- lotter on DSKBCFDHB2PROD with PROPOSALS3 350 Id. 351 7 U.S.C. 7b–3(f)(6). The Commission codified Core Principle 6 under § 37.600. 17 CFR 37.600. 352 Id. 353 17 CFR 37.601. Under Appendix B to part 37, for Required Transactions, as defined in § 37.9, SEFs may demonstrate compliance with SEF Core Principle 6 by setting and enforcing position limits or position accountability levels only with respect to trading on the SEF’s own market. For Permitted Transactions, as defined in § 37.9, SEFs may demonstrate compliance with SEF Core Principle 6 by setting and enforcing position accountability levels or by sending the Commission a list of Permitted Transactions traded on the SEF. 354 Id. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 enumerated bona fide hedges. Generally, for bona fide hedges enumerated in paragraph (2) of the bona fide hedge definition in § 1.3, no formal process is required by the Commission. Instead, such enumerated bona fide hedge recognitions are self-effectuating and Commission staff reviews monthly reporting of cash-market positions on existing Form 204 and part 17 position data to monitor such positions. Recognition requests for nonenumerated bona fide hedging positions and for certain enumerated anticipatory bona fide hedge positions, as explained above, must be submitted to the Commission pursuant to the processes in existing §§ 1.47 and 1.48 of the regulations, as applicable. 3. Proposed § 150.9 Under the proposed procedural framework, an exchange’s determination to recognize a non-enumerated bona fide hedge in accordance with proposed § 150.9 with respect to exchange-set limits would serve to inform the Commission’s own decision as to whether to recognize the exchange’s determination for purposes of federal speculative position limits set forth in proposed § 150.2. Among other conditions, the exchange would be required to base its determination on standards that conform to the Commission’s own standards for recognizing bona fide hedges for purposes of federal position limits. Further, the exchange’s determination with respect to its own position limits and application process would be subject to Commission review and oversight. These requirements would facilitate Commission review and determinations by ensuring that any bona fide hedge recognized by an exchange for purposes of exchange-set limits and in accordance with proposed § 150.9 conforms to the Commission’s standards. For a given referenced contract, proposed § 150.9 would potentially allow a person to exceed federal position limits if the exchange listing the contract has recognized the position as a bona fide hedge with respect to exchange-set limits. Under this framework, the exchange would make such determination with respect to its own speculative position limits, set in accordance with proposed § 150.5(a), and, unless the Commission denies or stays the application within ten business days (or two business days for applications, including retroactive applications, filed due to sudden or unforeseen circumstances), the exemption would be deemed approved for purposes of federal positions limits. PO 00000 Frm 00057 Fmt 4701 Sfmt 4702 11651 The exchange’s exemption would be valid only if the exchange meets the following additional conditions, each described in greater detail below: (1) The exchange maintains rules, approved by the Commission pursuant to § 40.5, that establish application processes for recognizing bona fide hedges in accordance with § 150.9; (2) the exchange meets specified prerequisites for granting such recognitions; (3) the exchange satisfies specified recordkeeping requirements; and (4) the exchange notifies the Commission and the applicant upon determining to recognize a bona fide hedging transaction or position. A person may exceed the applicable federal position limit ten business days (for new and annually renewed exemptions) or two business days (for applications, including retroactive applications, submitted due to sudden and unforeseen circumstances) after the exchange makes its determination, unless the Commission notifies the exchange and the applicant otherwise. The above-described elements of the proposed approach differ from the regulations proposed in the 2016 Reproposal, which did not require a 10day Commission review period. The 2016 Reproposal allowed DCMs and SEFs to recognize non-enumerated bona fide hedges for purposes of federal position limits.355 However, the 2016 Reproposal may not have conformed to the legal limits on what an agency may delegate to persons outside the agency.356 The 2016 Reproposal 355 Proposed § 150.9(a)(5) of the 2016 Reproposal provided that an applicant’s derivatives position shall be deemed to be recognized as a nonenumerated bona fide hedging position exempt from federal position limits at the time that a designated contract market or swap execution facility notifies an applicant that such designated contract market or swap execution facility will recognize such position as a non-enumerated bona fide hedging position. 356 In U.S. Telecom Ass’n v. FCC, the D.C. Circuit held ‘‘that, while federal agency officials may subdelegate their decision-making authority to subordinates absent evidence of contrary congressional intent, they may not subdelegate to outside entities—private or sovereign—absent affirmative evidence of authority to do so.’’ U.S. Telecom Ass’n v. FCC, 359 F.3d 554, 565–68 (D.C. Cir. 2004) (citing Shook v. District of Columbia Fin. Responsibility & Mgmt. Assistance Auth., 132 F.3d 775, 783–84 & n. 6 (D.C. Cir.1998); Nat’l Ass’n of Reg. Util. Comm’rs (‘‘NARUC’’) v. FCC, 737 F.2d 1095, 1143–44 & n. 41 (D.C. Cir.1984); Nat’l Park and Conservation Ass’n v. Stanton, 54 F.Supp.2d 7, 18–20 (D.D.C.1999). Nevertheless, the D.C. Circuit recognized three circumstances that the agency may ‘‘delegate’’ its authority to an outside party because they do not involve subdelegation of decisionmaking authority: (1) Establishing a reasonable condition for granting federal approval; (2) fact gathering; and (3) advice giving. The first instance involves conditioning of obtaining a permit on the approval by an outside entity as an element of its E:\FR\FM\27FEP3.SGM Continued 27FEP3 11652 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 delegated to the DCMs and SEFs a significant component of the Commission’s authority to recognize bona fide hedges for purposes of federal position limits. Under that proposal, the Commission did not have a substantial role in reviewing the DCMs’ or SEFs’ recognitions of non-enumerated bona fide hedges for purposes of federal position limits. Upon further reflection, the Commission believes that the 2016 Reproposal may not have retained enough authority with the Commission under case law on sub-delegation of agency decision making authority. Under the new proposed model, the Commission would be informed by the exchanges’ determinations to make the Commission’s own determination for purposes of federal position limits within a 10-day review period. Accordingly, the Commission would retain its decision-making authority with respect to the federal position limits and provide legal certainty to market participants of their determinations. Both DCMs and SEFs would be eligible to allow traders to utilize the processes set forth under proposed § 150.9. However, as a practical matter, the Commission expects that upon implementation of § 150.9, the process proposed therein will likely be used primarily by DCMs, rather than by SEFs, given that most economically equivalent swaps that would be subject to federal position limits are expected to be traded OTC and not executed on SEFs. The Commission emphasizes that proposed § 150.9 is intended to serve as a separate, self-contained process that is related to, but independent of, the proposed regulations governing: (1) The process in proposed § 150.3 for traders to apply directly to the Commission for a bona fide hedge recognition; and (2) exchange processes for establishing exchange-set limits and granting exemptions therefrom in proposed § 150.5. Proposed § 150.9 is intended to serve as a voluntary process exchanges can implement to provide additional flexibility for their market participants seeking non-enumerated bona fide hedges to file one application with an exchange to receive a recognition or exemption for purposes of both exchange-set limits and for federal decision process. The second provides the agency with nondiscretionary information gathering. The third allows a federal agency to turn to an outside entity for advice and policy recommendations, provided the agency makes the final decisions itself. Id. at 568. ‘‘An agency may not, however, merely ‘rubber-stamp’ decisions made by others under the guise of seeking their ‘advice,’ [ ], nor will vague or inadequate assertions of final reviewing authority save an unlawful subdelegation, [ ].’’ Id. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 limits. Proposed § 150.9 is discussed in greater detail below. risk management exemptions for such contracts.357 Request for Comment Request for Comment The Commission requests comment on all aspects of proposed § 150.9. The Commission also invites comments on the following: (37) Does the proposed compliance date of twelve-months after publication of a final federal position limits rulemaking in the Federal Register provide a sufficient amount of time for exchanges to update their exemption application procedures, as needed, and begin reviewing exemption applications in accordance with proposed § 150.9? If not, please provide an alternative longer timeline and reasons supporting a longer timeline. The Commission requests comment on all aspects of proposed § 150.9. The Commission also invites comments on the following: (35) Considering that the Commission’s proposed position limits would apply to OTC economically equivalent swaps, should the Commission develop a mechanism for exchanges to be involved in the review of non-enumerated bona fide hedge applications for OTC economically equivalent swaps? (36) If so, what, if any, role should exchanges play in the review of nonenumerated bona fide hedge applications for OTC economically equivalent swaps? a. Proposed § 150.9(a)—Approval of Rules Under proposed § 150.9(a), the exchange must have rules, adopted pursuant to the rule approval process in § 40.5 of the Commission’s regulations, establishing processes and standards in accordance with proposed § 150.9, described below. The Commission would review such rules to ensure that the exchange’s standards and processes for recognizing bona fide hedges from its own exchange-set limits conform to the Commission’s standards and processes for recognizing bona fide hedges from the federal limits. b. Proposed § 150.9(b)—Prerequisites for an Exchange To Recognize NonEnumerated Bona Fide Hedges in Accordance With This Section This section sets forth conditions that would require an exchange-recognized bona fide hedge to conform to the corresponding definitions or standards the Commission uses in proposed §§ 150.1 and 150.3 for purposes of the federal position limits regime. An exchange would be required to meet the following prerequisites with respect to recognizing bona fide hedging positions under proposed § 150.9(b): (i) The exchange lists the applicable referenced contract for trading; (ii) the position is consistent with both the definition of bona fide hedging transaction or position in proposed § 150.1 and section 4a(c)(2) of the Act; and (iii) the exchange does not recognize as bona fide hedges any positions that include commodity index contracts and one or more referenced contracts, nor does the exchange grant PO 00000 Frm 00058 Fmt 4701 Sfmt 4702 c. Proposed § 150.9(c)—Application Process Proposed § 150.9(c) sets forth the information and representations that the exchange, at a minimum, would be required to obtain from applicants as part of the application process for granting bona fide hedges. In this connection, exchanges may rely upon their existing application forms and processes in making such determinations, provided they collect the information outlined below. The Commission believes the information set forth below is sufficient for the exchange to determine, and the Commission to verify, whether a particular transaction or position satisfies the federal definition of bona fide hedging transaction for purposes of federal position limits. i. Proposed § 150.9(c)(1)—Required Information for Bona Fide Hedging Positions With respect to bona fide hedging positions in referenced contracts, proposed § 150.9(c)(1) would require that any application include: (i) A description of the position in the commodity derivative contract for which the application is submitted (which would include the name of the underlying commodity and the position size); (ii) information to demonstrate why the position satisfies section 4a(c)(2) of the Act and the definition of bona fide hedging transaction or position in proposed § 150.1, including factual and legal analysis; (iii) a 357 The Commission finds that financial products are not substitutes for positions taken or to be taken in a physical marketing channel. Thus, the offset of financial risks arising from financial products would be inconsistent with the definition of bona fide hedging transactions or positions for physical commodities in proposed § 150.1. See supra Section II.A.1.c.ii.(1) (discussion of the temporary substitute test and risk-management exemptions). E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules statement concerning the maximum size of all gross positions in derivative contracts for which the application is submitted (in order to provide a view of the true footprint of the position in the market); (iv) information regarding the applicant’s activity in the cash markets for the commodity underlying the position for which the application is submitted; 358 and (v) any other information the exchange requires, in its discretion, to enable the exchange to determine, and the Commission to verify, whether such position should be recognized as a bona fide hedge.359 These proposed application requirements are similar to current requirements for recognizing a bona fide hedging position under existing §§ 1.47 and 1.48. Market participants have raised concerns that such requirements, even if administered by the exchanges, would require hedging entities to change internal books and records to track which category of bona fide hedge a position would fall under. The Commission notes that, as part of this current proposal, exchanges would not need to require the identification of a hedging need against a particular identified category. So long as the requesting party satisfies all applicable requirements in proposed § 150.9, including demonstrating with a factual and legal analysis that a position would fit within the bona fide hedge definition, the Commission is not intending to require the hedging party’s books and records to identify the particular type of hedge being applied. lotter on DSKBCFDHB2PROD with PROPOSALS3 ii. Proposed § 150.9(c)(2)—Timing of Application The Commission does not propose to prescribe timelines (e.g., a specified number of days) for exchanges to review applications because the Commission believes that exchanges are in the best position to determine how to best accommodate the needs of their market participants. Rather, under proposed § 150.9(c)(2), the exchange must 358 The Commission would expect that exchanges would require applicants to provide cash market data for at least the prior year. 359 Under proposed § 150.9(c)(1)(iv) and (v), exchanges, in their discretion, could request additional information as necessary, including information for cash market data similar to what is required in the Commission’s existing Form 204. See infra Section II.H.3. (discussion of Form 204 and proposed amendments to part 19). Exchanges could also request a description of any positions in other commodity derivative contracts in the same commodity underlying the commodity derivative contract for which the application is submitted. Other commodity derivatives contracts could include other futures, options, and swaps (including OTC swaps) positions held by the applicant. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 separately require that applicants submit their application in advance of exceeding the applicable federal position limit for any given referenced contract. However, an exchange may adopt rules that allow a person to submit a bona fide hedge application within five days after the person has exceeded federal speculative limits if such person exceeds the limits due to sudden or unforeseen increases in its bona fide hedging needs. Where an applicant claims a sudden or unforeseen increase in its bona fide hedging needs, the proposed rules would require exchanges to require that the person provide materials demonstrating that the person exceeded the federal speculative limit due to sudden or unforeseen circumstances. Further, the Commission would caution exchanges that applications submitted after a person has exceeded federal position limits should not be habitual and should be reviewed closely. Finally, if the Commission finds that the position does not qualify as a bona fide hedge, then the applicant would be required to bring its position into compliance, and could face a position limits violation if it does not reduce the position within a commercially reasonable time. iii. Proposed § 150.9(c)(3)—Renewal of Applications Under proposed § 150.9(c)(3), the exchange must require that persons with bona fide hedging recognitions in referenced contracts granted pursuant to proposed § 150.9 reapply at least on an annual basis by updating their original application, and receive a notice of approval from the exchange prior to exceeding the applicable position limit. iv. Proposed § 150.9(c)(4)—Exchange Revocation Authority Under proposed § 150.9(c)(4), the exchange retains its authority to limit, condition, or revoke, at any time, any recognition previously issued pursuant to proposed § 150.9, for any reason, including if the exchange determines that the recognition is no longer consistent with the bona fide hedge definition in proposed § 150.1 or section 4a(c)(2) of the Act. Request for Comment The Commission requests comment on all aspects of proposed § 150.9. The Commission also invites comments on the following: (38) As described above, the Commission does not propose to prescribe timelines for exchanges to review applications. Please comment on what, if any, timing requirements the Commission should prescribe for PO 00000 Frm 00059 Fmt 4701 Sfmt 4702 11653 exchanges’ review of applications pursuant to proposed § 150.9. (39) Currently, certain exchanges allow for the submission of exemption requests up to five business days after the trader established the position that exceeded the exchange-set limit. Under proposed § 150.9, should exchanges continue to be permitted to recognize bona fide hedges and grant spread exemptions retroactively—up to five days after a trader has established a position that exceeds federal position limits? d. Proposed § 150.9(d)—Recordkeeping Proposed § 150.9(d) would set forth recordkeeping requirements for purposes of § 150.9. The required records would form a critical element of the Commission’s oversight of the exchanges’ application process and such records could be requested by the Commission as needed. Under proposed § 150.9(d), exchanges must maintain complete books and records of all activities relating to the processing and disposition of applications in a manner consistent with the Commission’s existing general regulations regarding recordkeeping.360 Such records must include all information and documents submitted by an applicant in connection with its application; records of oral and written communications between the exchange and the applicant in connection with the application; and information and documents in connection with the exchange’s analysis of and action on such application.361 Exchanges would also be required to maintain any documentation submitted by an applicant after the disposition of an application, including, for example, any reports or updates the applicant filed with the exchange. Exchanges would be required to store and produce records pursuant to existing § 1.31,362 and would be subject 360 Requirements regarding the keeping and inspection of all books and records required to be kept by the Act or the Commission’s regulations are found at § 1.31, 17 CFR 1.31. DCMs are already required to maintain records of their business activities in accordance with the requirements of § 1.31 of § 38.951, 17 CFR 38.951. 361 The Commission does not intend, in proposed § 150.9(d), to create any new obligation for an exchange to record conversations with applicants or their representatives; however, the Commission does expect that an exchange would preserve any written or electronic notes of verbal interactions with such parties. 362 Consistent with existing § 1.31, the Commission expects that these records would be readily available during the first two years of the required five year recordkeeping period for paper records, and readily accessible for the entire fiveyear recordkeeping period for electronic records. In addition, the Commission expects that records required to be maintained by an exchange pursuant E:\FR\FM\27FEP3.SGM Continued 27FEP3 11654 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules to requests for information pursuant to other applicable Commission regulations, including, for example, existing § 38.5.363 Request for Comment The Commission requests comment on all aspects of proposed § 150.9. The Commission also invites comments on the following: (40) Do the proposed recordkeeping requirements set forth in § 150.9 comport with existing practice? Are there any ways in which the Commission could streamline the proposed recordkeeping requirements while still maintaining access to sufficient information to carry out its statutory responsibilities? lotter on DSKBCFDHB2PROD with PROPOSALS3 e. Proposed § 150.9(e)—Process for a Person To Exceed Federal Position Limits Under proposed § 150.9(e), once an exchange recognizes a bona fide hedge with respect to its own speculative position limits established pursuant to § 150.5(a), a person could rely on such determination for purposes of exceeding federal position limits provided that specified conditions are met, including that the exchange provide the Commission with notice of any approved application as well as a copy of the application and any supporting materials, and the Commission does not object to the exchange’s determination. The exchange is only required to provide this notice to the Commission with respect to its initial (and not renewal) determinations for a particular application. Under proposed § 150.9(e), the exchange must provide such notice to the Commission concurrent with the notice provided to the applicant, and, except as provided below, a trader can exceed federal position limits ten business days after the exchange issues the required notification, provided the Commission does not notify the exchange or applicant otherwise. However, for a person with sudden or unforeseen bona fide hedging needs that has filed an application, pursuant to proposed § 150.9(c)(2)(ii), after they already exceeded federal speculative position limits, the exchange’s retroactive approval of such application would be deemed approved by the Commission two business days after the to this section would be readily accessible during the pendency of any application, and for two years following any disposition that did not recognize a derivative position as a bona fide hedge. 363 See 17 CFR 38.5 (requiring, in general, that upon request by the Commission, a DCM must file responsive information with the Commission, such as information related to its business, or a written demonstration of the DCM’s compliance with one or more core principles). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 exchange issues the required notification, provided the Commission does not notify the exchange or applicant otherwise. That is, the bona fide hedge recognition would be deemed approved by the Commission two business days after the exchange issues the required notification, unless the Commission notifies the exchange and the applicant otherwise during this two business day timeframe. Once those ten (or two) business days have passed, the person could rely on the bona fide hedge recognition both for purposes of exchange-set and federal limits, with the certainty that the Commission (and not Commission staff) would only revoke that determination in the limited circumstances set forth in proposed § 150.9(f)(1) and (2) described further below. However, under proposed § 150.9(e)(5), if, during the ten (or two) business day timeframe, the Commission notifies the exchange and applicant that the Commission (and not staff) has determined to stay the application, the person would not be able to rely on the exchange’s approval of the application for purposes of exceeding federal position limits, unless the Commission approves the application after further review. Separately, under proposed § 150.9(e)(5), the Commission (or Commission staff) may request additional information from the exchange or applicant in order to evaluate the application, and the exchange and applicant would have an opportunity to provide the Commission with any supplemental information requested to continue the application process. Any such request for additional information by the Commission (or staff), however, would not stay or toll the ten (or two) business day application review period. Further, under proposed § 150.9(e)(6), the applicant would not be subject to any finding of a position limits violation during the Commission’s review of the application. Or, if the Commission determines (in the case of retroactive applications) that the bona fide hedge is not approved for purposes of federal limits after a person has already exceeded federal position limits, the Commission would not find that the person has committed a position limits violation so long as the person brings the position into compliance within a commercially reasonable time. The Commission believes that the ten (or two) business day period to review exchange determinations under proposed § 150.9 would allow the Commission enough time to identify applications that may not comply with PO 00000 Frm 00060 Fmt 4701 Sfmt 4702 the proposed bona fide hedging position definition, while still providing a mechanism whereby market participants may exceed federal position limits pursuant to Commission determinations. Request for Comment The Commission requests comment on all aspects of proposed § 150.9. The Commission also invites comments on the following: (41) The Commission has proposed, in § 150.9(e)(3), a ten business day period for the Commission to review an exchange’s determination to recognize a bona fide hedge for purposes of the Commission approving such determination for federal position limits. Please comment on whether the review period is adequate, and if not, please comment on what would be an appropriate amount of time to allow the Commission to review exchange determinations while also providing a timely determination for the applicant. (42) The Commission has proposed a two business day review period for retroactive applications submitted to exchanges after a person has already exceeded federal position limits. Please comment on whether this time period properly balances the need for the Commission to oversee the administration of federal position limits with the need of hedging parties to have certainty regarding their positions that are already in excess of the federal position limits. (43) With respect to the Commission’s review authority in § 150.9(e)(5), if the Commission stays an application during the ten (or two) business-day review period, the Commission’s review, as would be the case for an exchange, would not be bound by any time limitation. Please comment on what, if any, timing requirements the Commission should prescribe for its review of applications pursuant to proposed § 150.9(e)(5). (44) Please comment on whether the Commission should permit a person to exceed federal position limits during the ten business day period for the Commission’s review of an exchangegranted exemption. (45) Under proposed § 150.9(e), an exchange is only required to notify the Commission of its initial approval of an exemption application (and not any renewal approvals). Should the Commission require that exchanges submit approved renewals of applications to the Commission for review and approval if there are material changes to the facts and circumstances underlying the renewal application? E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules f. Proposed § 150.9(f)—Commission Revocation of an Approved Application Proposed § 150.9(f) sets forth the limited circumstances under which the Commission would revoke a bona fide hedge recognition granted pursuant to proposed § 150.9. The Commission expects such revocation to be rare, and this authority would not be delegated to Commission staff. First, under proposed § 150.9(f)(1), if an exchange revokes its recognition of a bona fide hedge, then such bona fide hedge would also be deemed revoked for purposes of federal limits. Second, under proposed § 150.9(f)(2), if the Commission determines that an application that has been approved or deemed approved by the Commission is no longer consistent with the applicable sections of the Act and the Commission’s regulations, the Commission shall notify the person and exchange, and, after an opportunity to respond, the Commission can require the person to reduce the derivatives position within a commercially reasonable time, or otherwise come into compliance. In determining a commercially reasonable amount of time, the Commission must consult with the applicable exchange and applicant, and may consider factors including, among others, current market conditions and the protection of price discovery in the market. The Commission expects that it would only exercise its revocation authority under circumstances where the disposition of an application has resulted, or is likely to result, in price anomalies, threatened manipulation, actual manipulation, market disruptions, or disorderly markets. In addition, the Commission’s authority to require a market participant to reduce certain positions in proposed § 150.9(f)(2) would not be subject to the requirements of CEA section 8a(9), that is, the Commission would not be compelled to find that a CEA section 8a(9) emergency condition exists prior to requiring that a market participant reduce certain positions pursuant to proposed § 150.9(f)(2). If the Commission determines that a person must reduce its position or otherwise bring it into compliance, the Commission would not find that the person has committed a position limit violation so long as the person comes into compliance within the commercially reasonable time identified by the Commission in consultation with the applicable exchange and applicant. The Commission intends for persons to be able to rely on recognitions and exemptions granted pursuant to § 150.9 VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 with the certainty that the exchange decision would only be reversed in very limited circumstances. Any action compelling a market participant to reduce its position pursuant to § 150.9(f)(2) would be a Commission action, and would not be delegated to Commission staff. 364 g. Proposed § 150.9(g)—Delegation of Authority to the Director of the Division of Market Oversight The Commission proposes to delegate certain of its authorities under proposed § 150.9 to the Director of the Commission’s Division of Market Oversight, or such other employee(s) that the Director may designate from time to time. Proposed § 150.9(g)(1) would delegate the Commission’s authority, in § 150.9(e)(5), to request additional information from the exchange and applicant. The Commission does not propose, however, to delegate its authority, in proposed § 150.9(e)(5) and (6) to stay or reject such application, nor proposed § 150.9(f)(2), to revoke a bona fide hedge recognition granted pursuant to § 150.9 or to require an applicant to reduce its positions or otherwise come into compliance. The Commission believes that if an exchange’s disposition of an application raises concerns regarding consistency with the Act, presents novel or complex issues, or requires remediation, then the Commission, and not Commission staff, should make the final determination, after taking into consideration any supplemental information provided by the exchange or the applicant. As with all authorities delegated by the Commission to staff, the Commission would maintain the authority to consider any matter which has been delegated, including the proposed delegations in §§ 150.3 and 150.9 described above. The Commission will closely monitor staff administration of the proposed processes for granting bona fide hedge recognitions. H. Part 19 and Related Provisions— Reporting of Cash-Market Positions 1. Background Key reports currently used for purposes of monitoring compliance with federal position limits include 364 None of the provisions in proposed § 150.9 would compromise the Commission’s emergency authorities under CEA section 8a(9), including the Commission’s authority to fix ‘‘limits that may apply to a market position acquired in good faith prior to the effective date of the Commission’s action.’’ CEA section 8a(9). 7 U.S.C. 12a(9). PO 00000 Frm 00061 Fmt 4701 Sfmt 4702 11655 Form 204 365 and Form 304,366 known collectively as the ‘‘series ‘04’’ reports. Under existing § 19.01, market participants that hold bona fide hedging positions in excess of limits for the nine commodities currently subject to federal limits must justify such overages by filing the applicable report each month: Form 304 for cotton, and Form 204 for the other commodities.367 These reports are generally filed after exceeding the limit, show a snapshot of such traders’ cash positions on one given day each month, and are used by the Commission to determine whether a trader has sufficient cash positions that justify futures and options on futures positions above the speculative limits. 2. Proposed Elimination of Form 204 and Cash-Reporting Elements of Form 304 For the reasons set forth below, the Commission proposes to eliminate Form 204 and Parts I and II of existing Form 304, which requests information on cash-market positions for cotton akin to the information requested in Form 204.368 First, the Commission would no longer need the cash-market information currently reported on Forms 204 and 304 because the exchanges would collect, and make available to the Commission, cash-market information needed to assess whether any such position is a bona fide hedge.369 Further, the Commission would continue to have access to information, including cash-market information, by issuing special calls relating to positions exceeding limits. Second, Form 204 as currently constituted would be inadequate for the 365 CFTC Form 204: Statement of Cash Positions in Grains, Soybeans, Soybean Oil, and Soybean Meal, U.S. Commodity Futures Trading Commission website, available at https:// www.cftc.gov/sites/default/files/idc/groups/public/ @forms/documents/file/cftcform204.pdf (existing Form 204). 366 CFTC Form 304: Statement of Cash Positions in Cotton, U.S. Commodity Futures Trading Commission website, available at https:// www.cftc.gov/ucm/groups/public/@forms/ documents/file/cftcform304.pdf (existing Form 204). Parts I and II of Form 304 address fixed-price cash positions used to justify cotton positions in excess of federal limits. As described below, Part III of Form 304 addresses unfixed-price cotton ‘‘oncall’’ information, which is not used to justify cotton positions in excess of limits, but rather to allow the Commission to prepare its weekly cotton on-call report. 367 17 CFR 19.01. 368 Proposed amendments to Part III of the Form 304, which addresses cotton on-call, are discussed below. 369 The cash-market reporting regime discussed in this section of the release only pertains to bona fide hedges, not to spread exemptions, because the Commission has not traditionally relied on cashmarket information when reviewing requests for spread exemptions. E:\FR\FM\27FEP3.SGM 27FEP3 11656 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules reporting of cash-market positions relating to certain energy contracts which would be subject to federal limits for the first time under this proposal. For example, when compared to agricultural contracts, energy contracts generally expire more frequently, have a shorter delivery cycle, and have significantly more product grades. The information required by Form 204, as well as the timing and procedures for its filing, reflects the way agricultural contracts trade, but is inadequate for purposes of reporting cash-market information involving energy contracts. While the Commission considered proposing to modify Form 204 to cover energy and metal contracts, the Commission has opted instead to propose a more streamlined approach to cash-market reporting that reduces duplication between the Commission and the exchanges. In particular, to obtain information with respect to cash market positions, the Commission proposes to leverage the cash-market information reported to the exchanges, with some modifications. When granting exemptions from their own limits, exchanges do not use a monthly cash-market reporting framework akin to Form 204. Instead, exchanges generally require market participants who wish to exceed exchange-set limits, including for bona fide hedging positions, to submit an annual exemption application form in advance of exceeding the limit.370 Such applications are typically updated annually and generally include a month-by-month breakdown of cashmarket positions for the previous year supporting any position-limits overages during that period.371 To ensure that the Commission continues to have access to the same information on cash-market positions that is already provided to exchanges, the Commission proposes several reporting and recordkeeping requirements in §§ 150.3, 150.5, and 150.9, as discussed above.372 First, exchanges would be required to collect applications, updated at least on an annual basis, for purposes of granting 370 See, e.g., ICE Rule 6.29 and CME Rule 559. certain physically-delivered agricultural contracts, some exchanges may require that spot month exemption applications be renewed several times a year for each spot month, rather than annually. 372 As discussed earlier in this release, proposed § 150.9 also includes reporting and recordkeeping requirements pertaining to spread exemptions. Those requirements will not be discussed again in this section of the release, which addresses cashmarket reporting in connection with bona fide hedges. This section of the release focuses on the cash-market reporting requirements in § 150.9 that pertain to bona fide hedges. lotter on DSKBCFDHB2PROD with PROPOSALS3 371 For VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 bona fide hedge recognitions from exchange-set limits for contracts subject to federal limits,373 and for recognizing bona fide hedging positions for purposes of federal limits.374 Among other things, such applications would be required to include: (1) Information regarding the applicant’s activity in the cash markets for the underlying commodity; and (2) any other information to enable the exchange to determine, and the Commission to verify, whether the exchange may recognize such position as a bona fide hedge.375 Second, consistent with existing industry practice for certain exchanges, exchanges would be required to file monthly reports to the Commission showing, among other things, for all bona fide hedges (whether enumerated or non-enumerated), a concise summary of the applicant’s activity in the cash markets.376 Collectively, these proposed §§ 150.5 and 150.9 rules would provide the Commission with monthly information about all recognitions and exemptions granted for purposes of contracts subject to federal limits, including cash-market information supporting the applications, and annual information regarding all month-by-month cash-market positions used to support a bona fide hedging recognition. These reports would help the Commission verify that any person who claims a bona fide hedging position can demonstrate satisfaction of the relevant requirements. This information would also help the Commission perform market surveillance in order to detect and deter manipulation and abusive trading practices in physical commodity markets. While the Commission would no longer receive the monthly snapshot data currently included on Form 204, the Commission would have broad access, at any time, to the cash-market information described above, as well as any other data or information exchanges collect as part of their application processes.377 This would include any 373 See proposed § 150.5(a)(2)(ii)(A)(1). discussed above in connection with proposed § 150.9, market participants who wish to request a bona fide hedge recognition under § 150.9 would not be required to file such applications with both the exchange and the Commission. They would only file the applications with the exchange, which would then be subject to recordkeeping requirements in proposed § 150.9(d), as well as proposed §§ 150.5 and 150.9 requirements to provide certain information to the Commission on a monthly basis and upon demand. 375 See proposed § 150.9(c)(1)(iv)–(v). 376 See proposed § 150.5(a)(4). 377 See, e.g., proposed § 150.9(d) (requiring that all such records, including cash-market information submitted to the exchange, be kept in accordance with the requirements of § 1.31) and proposed § 19.00(b) (requiring, among other things, all 374 As PO 00000 Frm 00062 Fmt 4701 Sfmt 4702 updated application forms and periodic reports that exchanges may require applicants to file regarding their positions. To the extent that the Commission observes market activity or positions that warrant further investigation, § 150.9 would also provide the Commission with access to any supporting or related records the exchanges would be required to maintain.378 Furthermore, the proposed changes would not impact the Commission’s existing provisions for gathering information through special calls relating to positions exceeding limits and/or to reportable positions. Accordingly, as discussed further below, the Commission proposes that all persons exceeding the proposed limits set forth in § 150.2, as well as all persons holding or controlling reportable positions pursuant to § 15.00(p)(1), must file any pertinent information as instructed in a special call.379 Finally, the Commission understands that the exchanges maintain regular dialogue with their participants regarding cash-market positions, and that it is common for exchange surveillance staff to make informal inquiries of market participants, including if the exchange has questions about market events or a participant’s use of an exemption. The Commission encourages exchanges to continue this practice. Similarly, the Commission anticipates that its own staff would engage in dialogue with market participants, either through the use of informal conversations or, in limited circumstances, via special call authority. For market participants who are accustomed to filing Form 204s with information supporting classification as a federally enumerated hedging position, the proposed elimination of Form 204 would result in a slight change in practice. Under the proposed rules, such participants’ bona fide hedge recognitions could still be selfeffectuating for purposes of federal limits, provided the market participant also separately applies for a bona fide hedge exemption from exchange-set limits established pursuant to proposed § 150.5(a), and provided further that the participant submits the requisite cashmarket information to the exchange as required by proposed § 150.5(a)(2)(ii)(A)(1). persons exceeding speculative limits who have received a special call to file any pertinent information as specified in the call). 378 See proposed § 150.9(d). 379 See proposed § 19.00(b). E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 3. Proposed Changes to Parts 15 and 19 To Implement the Proposed Elimination of Form 204 and Portions of Form 304 The market and large-trader reporting rules are contained in parts 15 through 21 of the Commission’s regulations. Collectively, these reporting rules effectuate the Commission’s market and financial surveillance programs by enabling the Commission to gather information concerning the size and composition of the commodity derivative markets and to monitor and enforce any established speculative position limits, among other regulatory goals. To effectuate the proposed elimination of Form 204 and the cashmarket reporting components of Form 304, the Commission proposes corresponding amendments to certain provisions in parts 15 and 19. These amendments would eliminate: (i) Existing § 19.00(a)(1), which requires persons holding reportable positions which constitute bona fide hedging positions to file a Form 204; and (ii) existing § 19.01, which, among other things, sets forth the cash-market information required on Forms 204 and 304.380 Based on the proposed elimination of existing § 19.00(a)(1) and Form 204, the Commission also proposes to remove related provisions from: (i) The ‘‘reportable position’’ definition in § 15.00(p); (ii) the list of ‘‘persons required to report’’ in § 15.01; and (iii) the list of reporting forms in § 15.02. 4. Special Calls Notwithstanding the proposed elimination of Form 204, the Commission does not propose to make any significant substantive changes to information requirements relating to positions exceeding limits and/or to reportable positions. Accordingly, in proposed § 19.00(b), the Commission proposes that all persons exceeding the proposed limits set forth in § 150.2, as well as all persons holding or controlling reportable positions pursuant to § 15.00(p)(1), must file any pertinent information as instructed in a special call. This proposed provision is similar to existing § 19.00(a)(3), but would require any such person to file the information as instructed in the special call, rather than to file a series ’04 report.381 The Commission also proposes to add language to existing § 15.01(d) to clarify that persons who have received a special call are deemed ‘‘persons required to report’’ as defined in 380 17 381 17 CFR 19.01. CFR 19.00(a)(3). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 § 15.01.382 The Commission proposes this change to clarify an existing requirement found in § 19.00(a)(3), which requires persons holding or controlling positions that are reportable pursuant to § 15.00(p)(1) who have received a special call to respond.383 The proposed changes to part 19 operate in tandem with the proposed additional language for § 15.01(d) to reiterate the Commission’s existing special call authority without creating any new substantive reporting obligations. Finally, proposed § 19.03 would delegate authority to issue such special calls to the Director of the Division of Enforcement, and proposed § 19.03(b) would delegate to the Director of the Division of Enforcement the authority in proposed § 19.00(b) to provide instructions or to determine the format, coding structure, and electronic data transmission procedures for submitting data records and any other information required under part 19. 5. Form 304 Cotton On-Call Reporting With the proposed elimination of the cash-market reporting elements of Form 304 as described above, Form 304 would be used exclusively to collect the information needed to publish the Commission’s weekly cotton on call report, which shows the quantity of unfixed-price cash cotton purchases and sales that are outstanding against each cotton futures month.384 The requirements pertaining to that report would remain in proposed §§ 19.00(a) and 19.02, with minor modifications to existing provisions. The Commission proposes to update cross references (including to renumber § 19.00(a)(2) as § 19.00(a)) and to clarify and update the procedures and timing for the submission of Form 304. In particular, proposed § 19.02(b) would require that each Form 304 report be made weekly, dated as of the close of business on Friday, and filed not later than 9 a.m. Eastern Time on the third business day following that Friday using the format, coding structure, and electronic data transmission procedures approved in writing by the Commission. The Commission also proposes some modifications to the Form 304 itself, including conforming and technical changes to the organization, instructions, and required identifying information.385 382 17 CFR 15.01. CFR 19.00(a)(3). 384 Cotton On-Call, U.S. Commodity Futures Trading Commission website, available at https:// www.cftc.gov/MarketReports/CottonOnCall/ index.htm (weekly report). 385 Among other things, the proposed changes to the instructions would clarify that traders must 383 17 PO 00000 Frm 00063 Fmt 4701 Sfmt 4702 11657 Request for Comment The Commission requests comment on all aspects of the proposed amendments to Part 19 and related provisions. The Commission also invites comments on the following: (46) To what extent, and for what purpose, do market participants and others rely on the information contained in the Commission’s weekly cotton oncall report? (47) Does publication of the cotton oncall report create any informational advantages or disadvantages, and/or otherwise impact competition in any way? (48) Should the Commission stop publishing the cotton on-call report, but continue to collect, for internal use only, the information required in Part III of Form 304 (Unfixed-Price Cotton ‘‘On Call’’)? (49) Alternatively, should the Commission stop publishing the cotton on-call report and also eliminate the Form 304 altogether, including Part III? 6. Proposed Technical Changes to Part 17 Part 17 of the Commission’s regulations addresses reports by reporting markets, FCMs, clearing members, and foreign brokers.386 The Commission proposes to amend existing § 17.00(b), which addresses information to be furnished by FCMs, clearing members, and foreign brokers, to delete certain provisions related to aggregation, because those provisions have become duplicative of aggregation provisions that were adopted in § 150.4 in the 2016 Final Aggregation Rulemaking.387 The Commission also proposes to add a new provision, § 17.03(i), which delegates certain authority under § 17.00(b) to the Director of the Office of Data and Technology.388 identify themselves on Form 304 using their Public Trader Identification Number, in lieu of the CFTC Code Number required on previous versions of Form 304. This proposed change would help Commission staff to connect the various reports filed by the same market participants. This release includes a representation of the proposed Form 304, which would be submitted in an electronic format published pursuant to the proposed rules, either via the Commission’s web portal or via XML-based, secure FTP transmission. 386 17 CFR part 17. 387 See Final Aggregation Rulemaking. Specifically, the Commission proposes to delete paragraphs (1), (2), and (3) from § 17.00(b). 17 CFR 17.00(b). 388 Under § 150.4(e)(2), which was adopted in the 2016 Final Aggregation Rulemaking, the Director of the Division of Market Oversight is delegated authority to, among other things, provide instructions relating to the format, coding structure, and electronic data transmission procedures for submitting certain data records. 17 CFR 150.4(e)(2). A subsequent rulemaking changed this delegation E:\FR\FM\27FEP3.SGM Continued 27FEP3 11658 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules I. Removal of Part 151 Finally, the Commission is proposing to remove and reserve part 151 in response to its vacatur by the U.S. District Court for the District of Columbia,389 as well as in light of the proposed revisions to part 150 that conform part 150 to the amendments made to the CEA section 4a by the Dodd-Frank Act. III. Legal Matters lotter on DSKBCFDHB2PROD with PROPOSALS3 A. Introduction Section 737 (a)(4) of the Dodd-Frank Act,390 codified as section 4a(a)(2)(A) of the Commodity Exchange Act,391 states in relevant part that ‘‘the Commission shall’’ establish position limits for contracts in physical commodities other than excluded commodities ‘‘[i]n accordance with the standards set forth in’’ section 4a(a)(1), which primarily contains the Commission’s preexisting authority to establish such position limits as it ‘‘finds are necessary.’’ 392 In connection with the 2011 Final Rulemaking, the Commission determined that section 4a(a)(2)(A) is an unambiguous mandate to establish position limits for all physical commodities. In ISDA,393 however, the U.S. District Court for the District of Columbia held that the term ‘‘standards set forth in paragraph (1)’’ is ambiguous as to whether it includes the requirement under section 4a(a)(1) that before the Commission establishes a position limit, it must first find it ‘‘necessary’’ to do so. The court therefore vacated the 2011 Final Rulemaking and directed the Commission to determine, in light of the Commission’s ‘‘experience and expertise’’ ’’ and the ‘‘competing interests at stake,’’ whether section 4a(a)(2)(A) requires the Commission to make a necessity finding before establishing the relevant limits, or if section 4a(a)(2)(A) is a mandate from Congress to do so without that antecedent finding. Following the court’s order, the Commission subsequently determined that the ‘‘standards set forth in of authority from the Director of the Division of Market Oversight to the Director of the Office of Data and Technology, with the concurrence of the Director of the Division of Enforcement. See 82 FR at 28763 (June 26, 2017). The proposed addition of § 17.03(i) would conform § 17.03 to that change in delegation. 389 See supra note 11 and accompanying discussion. 390 Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, § 737(a)(4), Public Law 111– 203, 124 Stat. 1376, 1723 (July 21, 2010). 391 7 U.S.C. 6a(a)(2)(A). 392 7 U.S.C. 6a(a)(1). 393 887 F. Supp.2d 259. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 paragraph (1)’’ do not include the requirement in that paragraph that the Commission find position limits ‘‘necessary.’’ 394 Rather, the Commission determined, ‘‘the standards set forth in paragraph (1)’’ refer only to what the Commission called the ‘‘aggregation standard’’ and the ‘‘flexibility standard.’’ 395 The ‘‘aggregation standard’’ referred to directions under section 4a(a)(1)(A) that in determining whether any person has exceeded an applicable position limit, the Commission must aggregate the positions a party controls directly or indirectly, or held by two persons acting in concert ‘‘the same as if the positions were held by, or the trading were done by, a single person.’’ 396 The ‘‘flexibility standard’’ referred to the statement in section 4a(a)(1)(A) that ‘‘[n]othing in this section shall be construed to prohibit’’ the Commission from fixing different limits for different commodities, markets, futures, delivery months, numbers of days remaining on the contract, or for buying and selling operations.397 The Commission here preliminarily reaches a different conclusion. In light of its experience with and expertise in position limits and the competing interests at stake, the Commission now determines that it should interpret ‘‘the standards set forth in paragraph (1)’’ to include the traditional necessity and aggregation standards. The Commission also preliminarily determines that the ‘‘flexibility standard’’ is not an accurate way of describing the statute’s lack of a prohibition on differential limits, and therefore is not included in ‘‘the standards set forth in paragraph (1)’’ with which position limits must accord. However, even if that were not so, the Commission would still preliminarily determine that ‘‘the standards set forth in paragraph (1)’’ should be interpreted to include necessity. B. Key Statutory Provisions The Commission’s authority to establish position limits dates back to the Commodity Exchange Act of 1936.398 The relevant CEA language, now codified in its present form as section 4a(a)(1), states, among other things that the Commission ‘‘shall, from time to time . . . proclaim and fix such limits on the amounts of trading which may be done or positions which may be held by any person under such 394 See, e.g., 2013 Proposal, 78 FR at 75680, 75684. 395 See, e.g., id. 396 7 U.S.C. 6a(a)(1). 397 Id. 398 Public Law 74–675 § 5, 49 Stat. 1491, 1492 (June 15, 1936). PO 00000 Frm 00064 Fmt 4701 Sfmt 4702 contracts’’ as the Commission ‘‘finds are necessary to diminish, eliminate, or prevent such burden.’’ Thus, the Commission’s original authority to establish a position limit required it first to find that it was necessary to do so. Section 4a(a)(1) also includes what the Commission has referred to as the aggregation and flexibility standards. Section 4a(a)(2)(A) provides, in relevant part, that ‘‘[i]n accordance with the standards set forth in paragraph (1) of this subsection,’’ i.e., paragraph 4a(a)(1) discussed above, the Commission shall, by rule, regulation, or order establish limits on the amount of positions, as appropriate, other than bona fide hedge positions, that may be held by any person with respect to contracts of sale for future delivery or with respect to options on the contracts or commodities traded on or subject to the rules of a DCM. This direction applies only to physical commodities other than excluded commodities. Paragraph 4a(a)(2)(B) states that the limits for exempt physical commodities ‘‘required’’ under subparagraph (A) ‘‘shall’’ be established within 180 days, and for agricultural commodities the limits ‘‘required’’ under subparagraph (A) ‘‘shall’’ be established within 270 days. Paragraph 4a(a)(2)(C) establishes as a ‘‘goal’’ that the Commission ‘‘shall strive to ensure that trading on foreign boards of trade in the same commodity will be subject to comparable limits’’ and that any limits imposed by the Commission not cause price discovery to shift to foreign boards of trade. Next, paragraph 4a(a)(3) establishes certain requirements for position limits set pursuant to paragraph 4a(a)(2). It directs that when the Commission establishes ‘‘the limits required in paragraph (2),’’ it shall, ‘‘as appropriate,’’ set limits on the number of positions that may be held in the spot month, each other month, and the aggregate number of positions that may be held by any person for all months; and ‘‘to the extent practicable, in its discretion’’ the Commission shall fashion the limits to (i) ‘‘diminish, eliminate, or prevent excessive speculation as described under this section;’’ (ii) ‘‘deter and prevent market manipulation, squeezes, and corners;’’ (iii) ‘‘ensure sufficient market liquidity for bona fide hedgers;’’ and (iv) ‘‘ensure that the price discovery function of the underlying market is not disrupted.’’ Paragraph 4a(a)(5) adds a further requirement that when the Commission establishes limits under paragraph 4a(a)(2), the Commission must establish limits on the amount of positions, ‘‘as appropriate,’’ on swaps that are ‘‘economically equivalent’’ to futures E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules and options contracts subject to paragraph 4a(a)(2). C. Ambiguity of Section 4a With Respect to Necessity Finding The district court held that section 4a(a)(2) is ambiguous as to whether, before the Commission establishes a position limit, it must first find that a limit is ‘‘necessary.’’ The court found the phrase ‘‘[i]n accordance with the standards set forth in paragraph (1) of this subsection’’ unclear as to whether it includes the proviso in paragraph (1) that position limits be established only ‘‘as the Commission finds are necessary.’’ 399 The court noted that, by some definitions of ‘‘standard,’’ a requirement that position limits be ‘‘necessary’’ could qualify.400 The district court found the ambiguity compounded by the phrase ‘‘as appropriate’’ in sections 4a(a)(2)(A), 4a(a)(3), and 4a(a)(5).401 It was unclear to the court whether this phrase gives the Commission discretion not to impose position limits at all if it finds them not appropriate, or if the discretion extends only to determining ‘‘appropriate’’ levels at which to set the limits.402 Neither the grammar of the relevant provisions nor the available legislative history resolved these issues to the court’s satisfaction.403 In sum, ‘‘the Dodd-Frank amendments do not constitute a clear and unambiguous mandate to set position limits.’’ 404 The court therefore directed the Commission to resolve the ambiguity, not by ‘‘rest[ing] simply on its parsing of the statutory language,’’ but by ‘‘bring[ing] its experience and expertise to bear in light of the competing interests at stake.’’ 405 lotter on DSKBCFDHB2PROD with PROPOSALS3 D. Resolution of Ambiguity The Commission has applied its experience and expertise in light of the competing interests at stake and preliminarily determined that paragraph 4a(a)(2) should be interpreted as incorporating the requirement of paragraph 4a(a)(1) that position limits be established only ‘‘as the Commission finds are necessary.’’ This is based on a number of considerations. First, while the Commission has previously taken the position that necessity does not fall within the definition of the word ‘‘standard,’’ that view relied on only one of the many 399 ISDA, 887 F.Supp.2d at 274. 400 Id. 401 Id. at 276–278. 402 Id. 403 Id. 404 Id. 405 Id. at 280. at 281. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 dictionary definitions of ‘‘standard,’’ 406 and the Commission now believes it was an overly narrow interpretation. The word ‘‘standard’’ is used in different ways in different contexts, and many reasonable definitions would encompass ‘‘necessity.’’ 407 In legal contexts, ‘‘necessity’’ is routinely called a ‘‘standard.’’ 408 The Commission preliminarily believes that the more natural reading of ‘‘standard’’ in section 4a(a)(2)(A) does include the requirement of a necessity finding. Second, and relatedly, the Commission believes the term ‘‘standard’’ is a less natural fit for the language in subparagraph 4a(a)(1) that the Commission has previously called the ‘‘flexibility standard.’’ The sentence provides that ‘‘[n]othing in this section shall be construed to prohibit the Commission from fixing different trading or position limits for different’’ contracts or situations.409 Typically a legal standard constrains an agency’s discretion.410 But nothing in the so406 ISDA, Defendant Commodity Futures Trading Commission’s Cross-Motion for Summary Judgment at 24–25, (quoting definition of ‘‘standard’’ as ‘‘something set up and established by authority as a rule for the measure of quantity, weight, extent, value, or quality’’ from Merriam-Webster’s Collegiate Dictionary 1216 (11th ed. 2011)). 407 Black’s Law Dictionary 1624 (10th ed. 2014) (‘‘A criterion for measuring acceptability, quality, or accuracy.’’); The American Heritage Dictionary of the English Language (5th ed. 2011) (‘‘A degree or level of requirement, excellence, or attainment.’’); New Oxford American Dictionary 1699 (3rd ed. 2010) (‘‘an idea or thing used as a measure, norm, or model in comparative evaluations’’); The Random House Unabridged Dictionary 1857 (2d ed. 1993) (‘‘rule or principle that is used as a basis for judgment’’); XVI The Oxford English Dictionary 505 (2d ed. 1989) (‘‘A rule, principle, or means of judgment or estimation; a criterion, measure.’’). 408 Home Buyers Warranty Corp. v. Hanna, 750 F.3d 427, 435 (4th Cir. 2014) (applying a ‘‘ ‘necessity’ standard’’ under Fed. R. Civ. P. 19(a)(1)(A)); United States v. Cartagena, 593 F.3d 104, 111 n.4 (1st Cir. 2010) (discussing a ‘‘necessity standard’’ under the Omnibus Crime Control and Safe Streets Act of 1968); Fones4All Corp. v. F.C.C., 550 F.3d 811, 820 (9th Cir. 2008) (applying a ‘‘necessity standard’’ under the Telecommunications Act of 1996); Swonger v. Surface Transp. Bd., 265 F.3d 1135, 1141–42 (10th Cir. 2001) (applying a ‘‘necessity standard’’ under transportation law); see also Minnesota v. Mille Lacs Band of Chippewa Indians, 526 U.S. 172, 205 (1999) (‘‘conservation necessity standard’’); Int’l Union, United Auto., Aerospace & Agr. Implement Workers of Am., UAW v. Johnson Controls, Inc., 499 U.S. 187, 198 (1991) (‘‘business necessity standard’’). 409 7 U.S.C. 6a(a)(1)(A). 410 See, e.g., OSU Student Alliance v. Ray, 699 F.3d 1053, 1064 (9th Cir. 2012) (holding that the First Amendment was violated by enforcement of a rule that ‘‘created no standards to cabin discretion’’); Lenis v. U.S. Attorney General, 525 F.3d 1291, 1294 (11th Cir. 2008) (dismissing petition for review where agency procedural regulation ‘‘specifie[d] no standards for a court to use to cabin’’ the agency’s discretion); Tamenut v. Mukasey, 521 F.3d 1000, 1004 (8th Cir. 2008); Drake v. FAA, 291 F.3d 59, 71 (D.C. Cir. 2002) (similar). PO 00000 Frm 00065 Fmt 4701 Sfmt 4702 11659 called ‘‘flexibility’’ language constrains the Commission at all. In other words, the express lack of any prohibition of differential limits under section 4a(a)(1) is better understood as the absence of any standard.411 And if flexibility is not a standard, then necessity must be, because section 4a(a)(2)(A) refers to ‘‘standards,’’ plural. Third, the requirement that position limits be ‘‘appropriate’’ is an additional ground to interpret the statute as lacking an across-the board-mandate. In the past, the Commission has taken the view that the word ‘‘appropriate’’ as used in section 4a(a)(2)(A)—and in sections 4a(a)(3) and 4a(a)(5) in connection with position limits established pursuant to section 4a(a)(2)(A)—refers to position limit levels but not to the determination of whether to establish a limit.412 However, the Supreme Court has opined in the context of the Clean Air Act that ‘‘[n]o regulation is ‘appropriate’ if it does significantly more harm than good.’’ 413 That was not a CEA case, but the Commission finds the Court’s reasoning persuasive in this context. It is reasonable to interpret the direction to set a position limit ‘‘as appropriate’’ to mean that in a given context, it may be that no position limit is justified. Under an across-the-board mandate, however, the Commission would be compelled to impose some limit even if any level of position limit would do significantly more harm than good, including with respect to the public interests Congress set forth in section 4a(a)(1) itself and elsewhere in section 4a and the CEA generally.414 The Commission does not believe that is the best reading of section 4a(a)(2)(A). Rather, Congress’s use of ‘‘appropriate’’ in that section and elsewhere in the Dodd-Frank amendments is more consistent with a directive that the 411 Tamenut v. Mukasey, 521 F.3d 1000, 1004 (8th Cir. 2008) (explaining that a statute placing ‘‘no constraints on the [agency’s] discretion . . . specifie[d] no standards’’); United States v. Gonzalez-Aparicio, 663 F.3d 419, 435 (9th Cir. 2011) (Tashima, J., dissenting) (‘‘If we can pick whatever standard suits us, free from the direction of binding principles, then there is no standard at all.’’); Downs v. Am. Emp. Ins. Co., 423 F.2d 1160, 1163 (5th Cir. 1970) (‘‘best judgment is no standard at all’’). 412 E.g., ISDA, Commission Appellate Brief at 37– 38. 413 Michigan v. EPA, 135 S.Ct. 2699, 2707 (2015). Because Michigan was not a CEA case, the Commission does not mean to imply that Michigan would be controlling or compels any particular result in determining when a position limit is appropriate. To the contrary, the court in ISDA held that the CEA is ambiguous in that regard. The Commission merely finds the Supreme Court’s discussion in Michigan useful in reasonably resolving that ambiguity. 414 7 U.S.C. 5, 6a(a)(2)(C) and (a)(3)(B). E:\FR\FM\27FEP3.SGM 27FEP3 11660 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Commission consider all relevant factors and, on that basis, set an appropriate limit level—or no limit at all, if to establish one would contravene the public interests Congress articulated in section 4a(a)(1) and the CEA generally. That is also better policy. To be clear, this does not mean the Commission must conduct a formal cost-benefit analysis in which each advantage and disadvantage is assigned a monetary value. To the contrary, the Commission retains broad discretion to decide how to determine whether a position limit is appropriate.415 Fourth, mandatory federal position limits for all physical commodities would be a sea change in derivatives regulation, and the Commission does not believe it should infer that Congress would have acted so dramatically without speaking clearly and unequivocally.416 It is important to understand the reach of the proposition that the Commission must impose position limits for every physical commodity. The Commission estimates, based on information from the Commission’s surveillance system, that currently there are over 1,200 contracts on physical commodities listed on DCMs. Some of these contracts have little or no active trading.417 Absent clearer statutory language than is present in the statute, the Commission does not believe it should interpret the statute as though Congress had concerns about or even considered each and every one of the similar number of contracts listed at the time of DoddFrank. In a similar vein, the Commission previously has cited Senate Subcommittee’s staff studies of potential excessive speculation that preceded the enactment of section 4a(a)(2).418 But those studies covered only a few commodities—oil, natural gas, and wheat.419 While these studies demonstrate that Senate subcommittee’s concern with potential excessive 415 135 S.Ct. at 2707, 2711. Whiteman v. American Trucking Assns., Inc., 531 U.S. 457, 468 (2000) (Congress . . . does not alter the fundamental details of a regulatory scheme in vague terms. . . .’’); EEOC v. Staten Island Sav. Bank, 207 F.3d 144, (2d Cir. 2000) (‘‘we are reluctant to infer . . . a mandate for radical change absent a clearer legislative command’’); Canup v. Chipman-Union, Inc., 123 F.3d 1440, (11th Cir. 1997) (‘‘We would expect Congress to speak more clearly if it intended such a radical change. . . .’’). 417 See, e.g., Daily Agricultural Volume and Open Interest, CME Group website, available at https:// www.cmegroup.com/market-data/volume-openinterest/agriculture-commodities-volume.html (tables of daily trading volume and open interest for CME futures contracts). 418 E.g., 2013 Proposal, 78 FR at 75787 nn.122– 124; ISDA, Brief for Appellant Commodity Futures Trading Commission at 14–15. 419 Id. lotter on DSKBCFDHB2PROD with PROPOSALS3 416 E.g., VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 speculation, the Commission does not believe it should interpret a statute by extrapolating from one Senate subcommittee’s interest in three specific commodities to a requirement to impose limits on all of the many hundreds of physical futures contracts listed on exchanges, where Congress as a whole has not said so unambiguously. DCMs also regularly create new contracts. If Congress intended federal position limits to apply to all physical commodity contracts, the Commission would expect there to be a provision directing it to establish position limits on a continuous basis. There is no such provision—and Congress directed the Commission to complete its positionlimits rulemaking within 270 days.420 The only other relevant provision is the preexisting and broadly discretionary requirement that the Commission make an assessment ‘‘from time to time.’’ That structure is inconsistent, both as a statutory and policy matter, with an across-the-board mandate. Fifth, the Commission believes as a matter of policy judgment that requiring a necessity finding better carries out the purposes of section 4a. As Congress presumably was aware, position limits create costs as well as potential benefits. The Commission has recognized, and Congress also presumably understood, that there are costs even for well-crafted position limits. As discussed below in the Commission’s consideration of costs and benefits, market participants must monitor their positions and have safeguards in place to ensure compliance with limits. In addition to compliance costs, position limits may constrain some economically beneficial uses of derivatives, because a limit calculated to prevent excessive speculation or to restrict opportunities for manipulation may, in some circumstances, affect speculation that is desirable. While the Commission has designed limits to avoid interference with normal trading, certain negative effects cannot be ruled out. For example, to interpret section 4a(a)(2) as a mandate even where unnecessary could pose risks to liquidity and hedging. Well-calibrated position limits can protect liquidity by checking excessive speculation, but unnecessary limits can have the opposite effect by drawing capital out of markets. Indeed, the liquidity of a futures contract, upon which hedging depends, is directly related to the amount of speculation that takes place. Speculators contribute valuable liquidity to commodity markets, and section 4a(a)(1) identified ‘‘excessive 420 7 PO 00000 U.S.C. 6a(a)(2)(B). Frm 00066 Fmt 4701 Sfmt 4702 speculation’’—not all speculation—as ‘‘an undue burden on interstate commerce.’’ To needlessly reduce liquidity, impair price discovery, and make hedging more difficult for commodity end-users without sufficient beneficial effects on interstate commerce is unsound policy, as Congress has defined the policy. If Congress had drafted the statute unambiguously to reflect the judgment that these costs of position limits are justified in all instances, the Commission of course would follow it. Without such clarity, the Commission does not believe it should interpret the statute to impose those costs regardless of whether and to what extent doing so advances Congress’ stated goals. Sixth, while Congress has deemed position limits an effective tool, it is sound regulatory policy for the Commission to apply its experience and expertise to determine whether economic conditions with respect to a given commodity at a given point in time render it likely that position limits will achieve positive outcomes. A mandate without the requirement of a necessity finding would eliminate the Commission’s expertise and experience from the process and could lead to position limits that do not have significantly positive effects, or even position limits that are counterproductive. Necessity findings may also enhance public confidence that position limits in place are necessary to their statutory purposes, potentially improving public confidence in the markets themselves. It is therefore sound policy to construe the statute in a way that requires the Commission to make a necessity finding before establishing position limits.421 Finally, also as a matter of policy, the Commission’s approach will prevent market participants from suffering the costs of statutory ambiguity. Mandating position limits across all products would automatically impose costs on market participants regardless of whether doing so fulfills the purpose of section 4a. The associated compliance costs remain as long as those limits are in place. Reading a mandate into section 4a would exchange regulatory convenience, with or without any public benefit, for long-term burdens on market participants. The Commission does not believe that ambiguity should 421 The Commission also does not believe that establishing and enforcing position limits for all contracts on physical commodities, regardless of their importance to the price or delivery process of the underlying commodities or to the economy more broadly, would be a productive use of the public resources Congress has appropriated to the Commission. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 be resolved reflexively in a manner that shifts costs to market participants. Rather, the Commission believes that where an agency has discretion to choose from among reasonable alternative interpretations, it should not impose costs without a strong justification, which in this context would be lacking without a necessity finding. E. Evaluation of Considerations Relied Upon by the Commission in Previous Interpretation of Paragraph 4a(a)(2) As noted above, the Commission previously has identified a number of considerations it believed supported interpreting paragraph 4a(a)(2) to mandate position limits for all physical commodities other than excluded commodities, without the need for a necessity finding. Although the Administrative Procedure Act does not require the Commission to rebut those previous points, the Commission believes it is useful to discuss them. While certain of these considerations could support such an interpretation, the Commission is no longer persuaded that, on balance, they support interpreting paragraph 4a(a)(2) as an across-the-board mandate. Considerations on which the Commission previously relied include the following: 1. When Congress enacted paragraph 4a(a)(2), the text of what previously was paragraph 4a(a),422 already provided that the Commission ‘‘shall . . . proclaim and fix’’ position limits ‘‘as the Commission finds are necessary’’ to diminish, eliminate, or prevent the burdens on commerce associated with excessive speculation. This directive applied—and still applies—to all exchange-traded commodities, including the physical commodities that are the subject of paragraph 4a(a)(2). The Commission has previously reasoned that if paragraph 4a(a)(2) were not a mandate to establish position limits without such a necessity finding, it would be a nullity.423 That is, the Commission already had the authority to issue position limits, so 4a(a)(2) would add nothing were it not a mandate. The Commission is no longer convinced that is correct. Whereas the Commission’s preexisting authority under the predecessor to paragraph 4a(a)(1) directed the Commission to establish position limits ‘‘from time to time,’’ new paragraph 4a(a)(2) directed the 422 7 U.S.C. 6a(a). 2016 Reproposal, 81 FR at 96715, 96716 (discussing comments on past releases); 2013 Proposal, 78 FR at 75684. 423 E.g., VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Commission to consider position limits promptly within two specified time limits after Congress passed the DoddFrank Act. That is a new directive, and it is consistent with maintaining the requirement for, and preserving the benefits of, a necessity finding. This interpretation is also consistent with the Commission’s belief that Congress would not have intended a drastic mandate without a clear statement to that effect. This interpretation is likewise consistent with Congress’ addition of swaps to the Commission’s jurisdiction—it makes sense to direct the Commission to give prompt consideration to whether position limits are necessary at the same time Congress was expanding the Commission’s oversight responsibilities to new markets, and the Commission believes that is sound policy to ensure that the regime works well as a whole. Rather than leave it to the Commission’s preexisting discretion to set limits ‘‘from time to time,’’ it is reasonable to believe that Congress found it important for the Commission to focus on this issue at a time certain. In addition, paragraph 4a(a)(2) triggers other requirements added to section 4a(a) by Dodd-Frank and not included in paragraph 4a(a)(1). For example, as described above, paragraph 4a(a)(3)(B) identifies objectives the Commission is required to pursue in establishing position limits, including three, set forth in subparagraphs 4a(a)(3)(B)(ii)–(iv), that are not explicitly mentioned in paragraph 4a(a)(1). The Commission previously opined that paragraph 4a(a)(5), which directs the Commission to establish, position limits on swaps ‘‘economically equivalent’’ to futures subject to new position limits, would add nothing to paragraph 4a(a)(1), because if there were no mandate. The Commission no longer finds that reasoning persuasive. Paragraph 4a(a)(5) goes beyond paragraph 4a(a)(1), because it separately requires that when the Commission imposes limits on futures pursuant to paragraph 4a(a)(2), it also does so on economically equivalent swaps. Without that text, the Commission would have no such obligation to issue both types of limits at the same time. 2. The Commission has also previously been influenced by the requirements of paragraph 4a(a)(3), which directs the Commission, ‘‘as appropriate’’ when setting limits, to establish them for the spot month, each other month, and all months; and sets forth four policy objectives the Commission must pursue ‘‘to the PO 00000 Frm 00067 Fmt 4701 Sfmt 4702 11661 maximum extent practicable.’’ 424 The Commission described these as ‘‘constraints’’ and found it ‘‘unlikely’’ that Congress intended to place new constraints on the Commission’s preexisting authority to establish position limits, given the background of the amendments and in particular the studies that preceded their enactment.425 However, on further consideration of this statutory language, the Commission does not interpret that language as a set of constraints in the sense of directing the Commission to make less use of limits or to impose higher limits than in the past. Rather, it focuses the Commission’s decision process by identifying relevant objectives and directing the Commission to achieve them to the maximum extent practicable. Requiring the Commission to prioritize, to the extent practicable, preventing excessive speculation and manipulation, ensuring liquidity, and avoiding disruption of price discovery is reasonable regardless of whether there is an across-the-board mandate. In past releases the Commission has also suggested that it is unclear why Congress would have imposed the decisional ‘‘constraints’’ of paragraph 4a(a)(3) ‘‘with respect to physical commodities but not excluded commodities or others’’ unless this provision was enacted as part of a mandate to impose limits without a necessity finding.426 However, all of these relevant amendments pertain only to physical commodities other than excluded commodities. The Congressional studies that preceded the enactment of paragraph 4a(a)(2) demonstrated concern specifically with problems in markets for physical commodities such as oil and natural gas.427 It therefore is not surprising that Congress enacted provisions specifically addressing limits for physical commodities and not others, whether or not Congress intended a necessity finding. Those physical commodities were the focus of Congress’ concern. 3. The Commission has previously stated that the time requirements for establishing limits set forth in subparagraph 4a(a)(2)(B) are inconsistent with a necessity finding because, based on past experience, necessity findings for individual commodity markets cannot be made 424 7 U.S.C. 6a(a)(3). 2016 Reproposal, 81 FR at 96716 (discussing comments on earlier releases). 426 Id. 427 See, e.g., 2013 Proposal, 78 FR at 75682 and nn.24–26 (describing Congressional studies). 425 E.g., E:\FR\FM\27FEP3.SGM 27FEP3 11662 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 within the specified time periods.428 However, the fact that many decades ago a number of months may have elapsed between proposals and final position limits does not mean that much time was necessary then or is necessary now. There are a number of possible reasons, such as limits on agency resources and why the agency took that amount of time. It is not a like-to-like comparison, because the agencies acting many decades ago were not acting pursuant to a mandate. The speed with which an agency could or would enact discretionary position limits is not necessarily a good proxy for how long would be required under a mandate.429 There is accordingly no inconsistency, and thus the deadlines do not necessarily imply that Congress intended to eliminate a necessity finding for limits under paragraph 4a(a)(2). 4. The Commission previously has stated that Congress appears to have modeled the text of paragraph 4a(a)(2) on the text of the Commission’s 1981 rule requiring exchanges to set speculative position limits for all contracts.430 The Commission has further stated that the 1981 rule treated aggregation and flexibility as ‘‘standards,’’ and Congress therefore likely did the same in paragraph 4a(a)(2).431 The Commission no longer agrees with that description or that reasoning. Under the 1981 rule, former section 1.61(a) of the Commission’s regulations required exchanges to adopt position limits for all contracts listed to trade.432 The rule also established requirements similar to the current statutory aggregation requirements: Section 1.61(a) required that limits apply to positions a person may either ‘‘hold’’ or ‘‘control,’’ 433 section 1.61(g) established more detailed aggregation requirements.434 Section 1.61(a)(1) contained language the Commission has called the ‘‘flexibility standard,’’ i.e., that ‘‘nothing’’ in section 1.61 ‘‘shall be 428 E.g., 2016 Reproposal, 81 FR at 96708; 2013 Proposal, 78 FR at 75682, 75683. 429 The Commission’s reasoning in this respect has also assumed that a necessity finding means a granular market-by-market study of whether position limits will be useful for a given contract. As explained below, however, the Commission here preliminarily determines that such an analysis is not required. Under the Commission’s current preliminary interpretation of the necessity finding requirement, it would have been plausible to complete the required findings under the deadlines Congress established. 430 E.g., 2013 Proposal, 78 FR at 75683, 75684. 431 Id. 432 Establishment of Speculative Position Limits, 46 FR at 50945 (Oct. 16, 1981). 433 Id. 434 Id. at 50946. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 construed to prohibit a contract market from fixing different and separate position limits for different types of futures contracts based on the same commodity, different position limits for different futures, or for different delivery months, or from exempting positions which are normally known in the trade as ‘spreads, straddles or arbitrage’ or from fixing limits which apply to such positions which are different from limits fixed for other positions.’’ 435 Section 1.61(d)(1) of the rule required every exchange to submit information to the Commission demonstrating that it had ‘‘complied with the purpose and standards set forth in paragraph (a).’’ 436 In the 2013 and 2016 proposals, the Commission concluded that the cross-reference to the ‘‘standards set forth in paragraph (a)’’ meant both the aggregation and flexibility language, because both of those sets of language appear in paragraph (a). By contrast, paragraph (a) did not include a requirement for a necessity finding, since the 1981 rule required position limits on all actively traded contracts.437 On further review, the Commission does not find this reasoning persuasive. The ‘‘flexibility’’ language gave the exchange unfettered discretion to set different limits for different kinds of positions—there was expressly ‘‘nothing’’ in that language to limit the exchange’s discretion.438 In other words, there is nothing in that flexibility text with which to ‘‘comply,’’ so it cannot be part of what section 1.61(d)(1) referenced as a ‘‘standard’’ for which compliance must be demonstrated. As discussed above, ‘‘standard’’ is an ill-fitting label for this lack of a prohibition. Indeed, the 1981 release and associated 1980 NPRM did use the word ‘‘standard’’ to refer to certain language directing and constraining the discretion of the exchanges, a much more natural use of that word. For example, the preambles to both releases called requirements to aggregate certain holdings ‘‘aggregation standards.’’ 439 And, in both the 1980 NPRM (in the preamble) and the 1981 Final Rule (in rule text), the Commission used the word ‘‘standard’’ to describe factors, such as position sizes customarily held by speculative traders, that exchanges were required to consider in setting the level of position limits.440 435 Id. at 50945. 436 Id. Although the wording of the 1981 rule and paragraph 4a(a)(2) have similarities, there are also differences. These differences weaken the inference that Congress intended the statute to hew closely to the rule. There is no legislative history articulating any relationship between the two. And even if Congress in Dodd-Frank did borrow concepts from the 1981 rule, there is little reason to infer that Congress was borrowing the precise meaning of any individual word—much less that the use of ‘‘standards’’ includes what ‘‘nothing in this section shall be construed to prohibit . . . .’’ 5. In past releases the Commission has also observed that, in 1983, as part of the Futures Trading Act of 1982, Public Law 96–444, 96 Stat. 2294 (1983), Congress added a provision to the CEA making it a violation of the Act to violate exchange-set position limits, thus, in effect, ratifying the Commission’s 1981 rule.441 The Commission reasoned that this history supports the possibility that Congress could reasonably have followed an across-the-board approach here.442 But while that may be so, the Commission today does not find that mere possibility helpful in interpreting the ambiguous term ‘‘standards,’’ because there is no evidence that Congress in 1982 considered the lack of a prohibition on different position limit levels in the rule to be a ‘‘standard.’’ By extension, the Futures Trading Act does not bear on the Commission’s preliminary interpretation of ‘‘standards’’ in section 4a(a)(2)(A) today. 6. In briefs in the ISDA case, the Commission pointed out that CEA paragraphs 4a(a)(2)(B) and 4a(a)(3) repeatedly use the word ‘‘required’’ in connection with position limits established pursuant to paragraph 4a(a)(2), implying that the Commission is required to establish those limits regardless of whether it finds them to be necessary.443 But that is not the only way to interpret the word ‘‘required.’’ Position limits are required under certain circumstances even if there is no across-the-board mandate—i.e., when the Commission finds that they are ‘‘necessary.’’ Under the Commission’s current preliminary interpretation, the Commission was required to assess within a specified timeframe if position limits were ‘‘necessary’’ and, if so, section 4a(a)(2) states that the Commission ‘‘shall’’ establish them. 437 Id. 438 46 FR at 50945 (section 1.61(a)(1)). at 50943; Speculative Position Limits, 45 FR at 79834. 440 46 FR at 50945 (in section 1.61(a)(2)); 45 FR at 79833, 79834. 439 Id. PO 00000 Frm 00068 Fmt 4701 Sfmt 4702 441 See, e.g., 2016 Reproposal, 81 FR at 96709, 96710. 442 Id. at 96710. 443 E.g., ISDA, Brief for Appellant Commodity Futures Trading Commission at 26–27. E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Thus, the word ‘‘required’’ in paragraphs 4a(a)(2)(B) and 4a(a)(3) leaves open the question of whether paragraph 4a(a)(2) itself requires position limits for all physical commodity contracts or, on the other hand, only requires them where the Commission finds them necessary under the standards of paragraph 4a(a)(1). The use of the word ‘‘required’’ in paragraphs 4a(a)(2)(B) and 4a(a)(3) therefore does not resolve the ambiguity in the statute. For the same reason, the evolution of the statutory language during the legislative process, during which the word ‘‘may’’ was changed to ‘‘shall’’ in a number of places, also does not resolve the ambiguity.444 7. The Commission has pointed out that section 719 of the Dodd-Frank Act required the Commission to ‘‘conduct a study of the effects (if any) of the position limits imposed’’ pursuant to paragraph 4a(a)(2) and report the results to Congress within twelve months after the imposition of limits.445 The Commission has suggested that Congress would not have required such a study if paragraph 4a(a)(2) left the Commission with discretion to find that limits were unnecessary so that there would be nothing for the Commission to study and report on to Congress.446 However, while the study requirement implies that Congress perhaps anticipated that at least some limits would be imposed pursuant to paragraph 4a(a)(2), it leaves open the question of whether Congress mandated limits for every physical commodity without the need for a necessity finding. In addition, the phrase ‘‘the effects (if any)’’ language does not imply that Congress expected position limits on all physical commodities. This language simply recognizes that new position limits could be imposed, but have no demonstrable effects. 8. In past releases and court filings, the Commission has stated that the legislative history of section 4a, as amended by the Dodd-Frank Act, supports the conclusion that paragraph 4a(a)(2) requires the establishment of position limits for all physical commodities whether or not the Commission finds them necessary to achieve the objectives of the statute.447 However, the most relevant legislative history, taken as a whole, does not resolve the ambiguity in the statutory language or compel the conclusion that 444 See, e.g., 2013 Proposal, 78 FR at 75684, 75685 (discussing evolution of statutory language as supporting mandate). 445 See, e.g., id. at 75684. 446 See, e.g., id. 447 See, e.g., 2016 Reproposal, 81 FR at 96709. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Congress intended to drop the necessity finding requirement when it enacted paragraph 4a(a)(2) as part of the DoddFrank Act. The language of paragraph 4a(a)(2) derives from section 6(a) of a bill, the Derivatives Markets Transparency and Accountability Act of 2009, H.R. 977 (111th Cong.), which was approved by the House Committee on Agriculture in February of 2009.448 The committee report on this bill included explanatory language stating that the relevant provision required the Commission to set position limits ‘‘for all physical commodities other than excluded commodities.’’ 449 However, H.R. 977 was never approved by the full House of Representatives.450 The relevant language concerning position limits was incorporated into the House of Representatives version of what became the Dodd-Frank Act, H.R. 4173 (111th Cong.), as part of a floor amendment that was introduced by the chairman of the Committee on Agriculture.451 In explaining the amendment’s language regarding position limits, the chairman stated that it ‘‘strengthens confidence in position limits on physically deliverable commodities as a way to prevent excessive speculation trading’’ but did not specify that limits would be required for all physical commodities without the need for a necessity finding.452 The House of Representatives language regarding position limits was ultimately incorporated into the Dodd-Frank Act by a conference committee. However, the explanatory statement in the Conference report states, with respect to position limits, only that the act’s ‘‘regulatory framework outlines provisions for: . . . [p]osition limits on swaps contracts that perform or affect a significant price discovery function and requirements to aggregate limits across markets.’’ 453 In subsequent floor debate, the chairman of the House Agriculture Committee alluded to position limits provisions deriving from earlier bills reported by that committee, but did not 448 See H.R. Rep. 111–385 part 1 at 4 (Dec. 19, 2009). 449 Id. at 19. 450 See Actions—H.R.977—111th Congress (2009– 2010) Derivatives Markets Transparency and Accountability Act of 2009, Congress website, available at https://www.congress.gov/bill/111thcongress/house-bill/977/all-actions? overview=closed#tabs (bill history). 451 155 Cong. Rec. H14682, H14692 (daily ed. Dec. 10, 2009). 452 Id. at H14705. 453 Dodd-Frank Wall Street Reform and Consumer Protection Act, Conference Report to Accompany H.R. 4173 at 969 (H.R. Rep. 111–517 June 29, 2010). PO 00000 Frm 00069 Fmt 4701 Sfmt 4702 11663 describe them with specificity.454 In the Senate, the chairman of the Senate Committee on Agriculture, Nutrition, and Forestry stated that the conference bill would ‘‘grant broad authority to the Commodity Futures Trading Commission to once and for all set aggregate position limits across all markets on non-commercial market participants.’’ 455 The statement that the bill would grant ‘‘authority’’ to set position limits implies an exercise of judgement by the Commission in determining whether to set particular limits.456 Thus, this legislative history is itself ambiguous on the question of whether federal position limits are now mandatory on all physical commodities in the absence of a finding of necessity. Looking at legislative history in more general terms, the Commission, in past releases, has pointed out that the enactment of paragraph 4a(a)(2) followed congressional investigations in the late 1990s and early 2000s that concluded that excessive speculation accounted for volatility and prices increases in the markets for a number of commodities.457 However, while the history of congressional investigations supports the conclusion that Congress intended the Commission to take action with respect to position limits, it does not resolve the specific interpretive issue of whether the ‘‘[i]n accordance with the standards set forth in paragraph (1)’’ language that was ultimately enacted by Congress incorporates a necessity finding. As discussed above, the congressional investigations focused on only a few commodities, which weakens the inference that Congress considered the question of what speculative positions to limit a closed question. Overall, in past releases the Commission has expressed the view that construing section 4a as an ‘‘integrated whole’’ leads to the conclusion that paragraph 4a(a)(2) does not require a 454 He stated, ‘‘This conference report includes the tools we authorized [in response to concerns about excessive speculation] and the direction to the CFTC to mitigate outrageous price spikes we saw 2 years ago.’’ 156 Cong. Rec. H5245 (daily ed. June 30, 2010). 455 156 Cong. Rec. S5919 (daily ed. July 15, 2010). 456 In addition, the remainder of the Senate chairman’s floor statement with regard to position limits focused on volatility and price discovery problems arising from the use of commodity swaps, implying that her reference to setting position limits ‘‘across all markets’’ refers to Dodd-Frank’s extension of position limits authority to swaps markets. 156 Cong. Rec. at S5919–20 (daily ed. July 15, 2010). 457 See, e.g., 2016 Reproposal, 81 FR at 96711– 96713. E:\FR\FM\27FEP3.SGM 27FEP3 11664 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules necessity finding.458 However, for reasons explained above, the Commission preliminarily believes that the better interpretation is that prior to imposing position limits, it must make a finding that the position limits are necessary. F. Necessity Finding The Commission preliminarily finds that federal speculative position limits are necessary for the 25 core referenced futures contracts, and any associated referenced contracts. This preliminary finding is based on a combination of factors including: The particular importance of these contracts in the price discovery process for their respective underlying commodities; the fact that they require physical delivery of the underlying commodity; and, in some cases, the especially acute economic burdens that would arise from excessive speculation causing sudden or unreasonable fluctuations or unwarranted changes in the price of the commodities underlying these contracts. The Commission has preliminarily determined that the benefit of advancing the statutory goal of preventing those undue burdens with respect to these commodities in interstate commerce justifies the potential burdens or negative consequences associated with establishing these targeted position limits.459 lotter on DSKBCFDHB2PROD with PROPOSALS3 1. Meaning of ‘‘Necessary’’ Under Section 4a(a)(1) Section 4a(a)(1) of the Act contains a congressional finding that ‘‘[e]xcessive speculation . . . causing sudden or unreasonable fluctuations or unwarranted changes in . . . price . . . is an undue and unnecessary burden on interstate commerce in such commodity.’’ 460 For the purpose of ‘‘diminishing, eliminating, or preventing’’ that burden, section 4a(a)(1) tasks the Commission with establishing such position limits as it finds are ‘‘necessary.’’ 461 The Commission’s 458 See, e.g., 2016 Reproposal, 81 FR at 96713, 96714. 459 As discussed, the Commission is not proposing non-spot-month limits apart from the legacy agricultural contracts. Non-spot-month prices serve as references for cash-market transactions much less frequently than spot-month prices. Accordingly, the burdens of excessive speculation in non-spot-months on commodities in interstate commerce would be substantially less than the burdens of excessive speculation in spotmonths. It is also not possible to execute a corner or squeeze in non-spot-months. And because there generally are fewer market participants in non-spotmonths, holders of large speculative positions may play a more important role in providing liquidity to bona fide hedgers. 460 7 U.S.C. 6a(a)(1). 461 7 U.S.C. 6a(a)(1). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 analysis, therefore, proceeds on the basis of these legislative findings that excessive speculation threatens negative consequences for interstate commerce and the accompanying proposition that position limits are an effective tool to diminish, eliminate, or prevent the undue and unnecessary burdens Congress has targeted in the statute.462 The Commission will therefore determine whether position limits are necessary for a given contract, in light of those premises, considering facts and circumstances and economic factors. The statute does not define ‘‘necessary.’’ In legal contexts, the term can have ‘‘a spectrum of meanings.’’ 463 ‘‘At one end, it may ‘import an absolute physical necessity, so strong, that one thing, to which another may be termed necessary, cannot exist without that other;’ at the opposite, it may simply mean ‘no more than that one thing is convenient, or useful, or essential to another.’ ’’ 464 The Commission does not believe Congress intended either end of this spectrum in section 4a(a)(1). On one hand, ‘‘necessary’’ in this context cannot mean that position limits must be the only means capable of addressing the burdens associated with excessive speculation. The Act contains numerous provisions designed to prevent, diminish, or eliminate price disruptions or distortions or unreasonable volatility. For example, the Commission’s antimanipulation authority is designed to stop, redress, and deter intentional acts that may give rise to uneconomic prices or unreasonable volatility.465 Other examples include prohibitions on disruptive trading practices,466 certain core principles for contract markets,467 and the Commission’s emergency powers.468 Yet the Commission is directed by section 4a(a)(1) not only to impose position limits to diminish or eliminate sudden and unwarranted fluctuations in price caused by excessive speculation once those other protections have failed, it is directed to establish position limits as necessary to ‘‘prevent’’ those burdens on interstate commerce from arising in the first place. It makes little sense to suppose that Congress meant for the Commission to ‘‘prevent’’ unreasonable fluctuations or unwarranted price changes caused by excessive speculation only after they have already begun to occur, or when the Commission can somehow predict with confidence that the Act’s other tools will be absolutely ineffective.469 The Act uses the word ‘‘necessary’’ in a number of places to authorize measures it is highly unlikely Congress meant to apply only where the relevant policy goals will otherwise certainly fail.470 On the other hand, the Commission also does not believe that Congress intended position limits where they are merely ‘‘useful’’ or ‘‘convenient.’’ As explained above, Congress has already determined that position limits are useful in preventing undue burdens on interstate commerce associated with excessive speculation, but requires the Commission to make the further finding that they are also necessary. A ‘‘convenience’’ standard would be similarly toothless. Rather than accepting either extreme, the Commission preliminarily interprets that sections 4a(a)(1) and 4a(a)(2) direct the Commission to establish position 468 7 462 It is not the Commission’s role to determine if these findings are correct. See Public Citizen v. FTC, 869 F.2d 1541, 1557 (D.C. Cir. 1989) (‘‘[A]gencies surely do not have inherent authority to second-guess Congress’ calculations.’’); see also 46 FR at 50938, 50940 (‘‘Section 4a(1) [now 4a(a)(1)] represents an express Congressional finding that excessive speculation is harmful to the market, and a finding that speculative limits are an effective prophylactic measure.’’). 463 Jewell v. Life Ins. Co. of N. Am., 508 F.3d 1303, 1310 (10th Cir. 2007). 464 Jewell v. Life Ins. Co. of N. Am., 508 F.3d 1303, 1310 (10th Cir. 2007); see also Black’s Law Dictionary 1227 (3d ed. 1933) (‘‘As used in jurisprudence, the word ‘necessary’ does not always import an actual physical necessity, so strong that one thing, to which another may be termed ‘necessary,’ cannot exist without the other. . . . To employ the means necessary to an end is generally understood as employing any means calculated to produce the end, and not as being confined to those single means without which the end would be entirely unattainable.’’ (citing McCullouch v. Maryland, 4 Wheat. 216, 4 L. Ed. 579 (1819)). 465 7 U.S.C. 9(1), 9(3), 13(a)(2). 466 7 U.S.C. 6c(a). 467 7 U.S.C. 7(d). PO 00000 Frm 00070 Fmt 4701 Sfmt 4702 U.S.C. 12a(9). Nat. Res. Def. Council, Inc. v. Thomas, 838 F.2d 1224, 1236–37 (D.C. Cir. 1988) (‘‘[A] measure may be ’necessary’ even though acceptable alternatives have not been exhausted.’’); F.T.C. v. Rockefeller, 591 F.2d 182, 188 (2d Cir. 1979) (rejecting ‘‘the notion that ’necessary’ means that the [Federal Trade Commission] must pursue all other ‘reasonably available alternatives’’’ before undertaking the measure at issue). Indeed, where the Commission considers setting such prophylactic limits, it is unlikely to be knowable whether position limits will be the only effective tool. The existence of other tools to prevent unwarranted volatility and price changes may be relevant, but cannot be dispositive in all cases. 470 See, e.g., 7 U.S.C. 2(h)(4)(A) (empowering the Commission to prescribe rules ‘‘as determined by the Commission to be necessary to prevent evasions of the mandatory clearing requirements’’); 7 U.S.C. 2(h)(4)(B)(iii) (requiring that the Commission ‘‘shall’’ take such actions ‘‘as the Commission determines to be necessary’’ when it finds that certain swaps subject to the clearing requirement are not listed by any derivatives clearing organization); 7 U.S.C. 21(e) (subjecting registered persons to such ‘‘rules and regulations as the Commission may find necessary to protect the public interest and promote just and equitable principles of trade.’’). 469 See E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 limits where the Commission finds, based on the relevant facts and circumstances, that position limits would be an efficient mechanism to advance the congressional goal of preventing undue burdens on interstate commerce in the given underlying commodity caused by excessive speculation. For example, it may be that for a given commodity, volatility in derivatives markets would be unlikely to cause high levels of sudden or unreasonable fluctuations or unwarranted changes in the price of the underlying commodity and would have little overall impact on the national economy/interstate commerce. Under those circumstances, the Commission may find that position limits are unnecessary. There are, however, also contract markets in which volatility would be highly likely to cause sudden or unreasonable fluctuations or unwarranted changes in the price of the underlying commodity or have significantly negative effects on the broader economy. Even if such disruptions would be unlikely due to the characteristics of an individual market, the Commission may nevertheless determine that position limits are necessary as a prophylactic measure given the potential magnitude or impact of the event.471 Most commodities lie somewhere in between, with varying degrees of linkage between derivative contracts and cash-market prices, and differences in importance to the overall economy. There is no mathematical formula to make this determination, though the Commission will consider relevant data where it is available. The Commission must instead exercise its judgment in light of facts and circumstances, including its experience and expertise, to determine what limits are economically justified.472 In all instances, the Commission will consider the applicable costs and benefits as required under section 15(a) of the Act.473 With this interpretation of ‘‘necessary’’ in mind, the Commission below explains its selection of the 25 core referenced futures contracts, and 471 The Commission will also be mindful that the undue burdens Congress tasked the Commission with diminishing, eliminating, or preventing would not generally be borne exclusively by speculators or other participants in futures and swaps markets, but instead the public at large or a certain industry or sector of the economy. In a given context, the Commission may find that this factor supports a finding that position limits are necessary. 472 The Commission is well positioned to select from among all commodities within the scope of 4a(a)(1) and (2)(A), from its ongoing regulatory activities, including but not limited to market surveillance and product review. 473 7 U.S.C. 19(a). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 any associated referenced contracts. Going forward, the Commission will make this assessment ‘‘from time to time’’ as required under section 4a(a)(1). The Commission recognizes that this approach differs from that taken in earlier necessity findings. For example, when the Commission’s predecessor agency, the Commodity Exchange Commission (‘‘CEC’’), established position limits, it would publish them in the Federal Register along with necessity findings that were generally conclusory recitations of the statutory language.474 The published basis would be a recitation that trading of a given commodity for future delivery by a person who holds or controls a net position in excess of a given amount tends to cause sudden or unreasonable fluctuations or changes in the price of that commodity, not warranted by changes in the conditions of supply and demand.475 Apart from that, the CEC typically would refer to a public hearing, but provide no specifics of the evidence presented or what the CEC found persuasive.476 The CEC variously imposed limits one commodity at a time, or for several commodities at once.477 In 1981, the Commission issued a rule directing all exchanges to establish position limits for each contract not already subject to federal limits, and for which delivery months were listed to trade.478 There, as here, the Commission explained that section 4a(a)(1) represents an ‘‘express Congressional finding that excessive speculation is harmful to the market, and a finding that speculative limits are an effective prophylactic measure.’’ 479 The Commission observed that all futures markets share the salient characteristics that make position limits a useful tool to prevent the potential burdens of 474 See, e.g., Limits on Position and Daily Trading in Soybeans for Future Delivery, 16 FR at 8107 (Aug. 16, 1951); Findings of Fact, Conclusions, and Order in the Matter of Limits on Position and Daily Trading in Cotton for Future Delivery, 5 FR at 3198 (Aug. 28, 1940); In re Limits on Position and Daily Trading in Wheat, Corn, Oats, Barley, Rye, and Flaxseed, for Future Delivery, 3 FR at 3146, 3147 (Dec. 24, 1938). 475 See, e.g., Limits on Position and Daily Trading in Soybeans for Future Delivery, 16 FR at 8107 (Aug. 16, 1951); Findings of Fact, Conclusions, and Order in the Matter of Limits on Position and Daily Trading in Cotton for Future Delivery, 5 FR at 3198 (Aug. 28, 1940); In re Limits on Position and Daily Trading in Wheat, Corn, Oats, Barley, Rye, and Flaxseed, for Future Delivery, 3 FR at 3146, 3147 (Dec. 24, 1938). 476 The records available from the National Archives during this period are sparse. 477 Compare 5 FR at 3198 (cotton) with 3 FR at 3146, 3147 (six types of grain). 478 46 FR at 50945. 479 Id. at 50938, 50940. Section 4a(a)(1) was at the time numbered 4a(1). PO 00000 Frm 00071 Fmt 4701 Sfmt 4702 11665 excessive speculation. Specifically, ‘‘it appears that the capacity of any contract market to absorb the establishment and liquidation of large speculative positions in an orderly manner is related to the relative size of such positions, i.e., the capacity of the market is not unlimited.’’ 480 In 2013, the Commission proposed a necessity finding applicable to all physical commodities, and then reproposed it in 2016. In that finding, the Commission discussed incidents in which the Hunt family in 1979 and 1980 accumulated unusually large silver positions, and in which Amaranth Advisors L.L.C. in 2006 accumulated unusually large natural gas positions.481 The Commission preliminarily determined that the size of those positions contributed to unwarranted volatility and price changes in those respective markets, which imposed undue burdens on interstate commerce, and that position limits could have prevented this.482 The Commission here preliminarily finds those parts of the 2013 and 2016 proposed necessity finding to be beside the point, because Congress has already determined that excessive speculation can place undue burdens on interstate commerce in a commodity, and that position limits can diminish, eliminate, or prevent those burdens. In 2013 and 2016, the Commission also considered numerous studies concerning position limits.483 To the extent that those studies merely examined whether or not position limits are an effective tool, the Commission here does not find them directly relevant, again because Congress has already determined that position limits can be effective to diminish, eliminate, or prevent sudden or unreasonable fluctuations or unwarranted changes in commodity prices.484 In the 2013 and 2016 necessity findings, the Commission stated again that ‘‘all markets in physical commodities’’ are susceptible to the burdens of excessive speculation because all such markets have a finite ability to absorb the establishment and liquidation of large speculative positions in an orderly manner.485 The 480 46 FR at 50940 (Oct. 16, 1981). The Commission based this finding in part upon thenrecent events in the silver market, an apparent reference to the corner and squeeze perpetrated by members of the Hunt family in 1979 and 1980. 481 2013 Proposal, 78 FR at 75686, 75693. 482 Id. at 75691, 75193. 483 See 2016 Reproposal, 81 FR at 96894, 96924. 484 In any event, the Commission found those studies inconclusive. 2016 Reproposal, 81 FR at 96723. 485 2016 Reproposal, 81 FR at 96722; see also Corn Products Refining Co. v. Benson, 232 F.2d 554, E:\FR\FM\27FEP3.SGM Continued 27FEP3 11666 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 Commission here, however, preliminarily determines that this characteristic is not sufficient to support a finding that position limits are ‘‘necessary’’ for all physical commodities, within the meaning of section 4a(a)(1). Congress has already determined that excessive speculation can give rise to unwarranted burdens on interstate commerce and that position limits can be an effective tool to eliminate, diminish, or prevent those burdens. Yet the statute directs the Commission to establish position limits only when they are ‘‘necessary.’’ In that context, the Commission considers it unlikely that Congress intended the Commission to find that position limits are ‘‘necessary’’ even where facts and circumstances show the significant potential that they will cause disproportionate negative consequences for markets, market participants, or the commodity end users they are intended to protect. Similarly, because the Commission has preliminarily determined that section 4a(a)(2) does not mandate federal speculative position limits for all physical commodities,486 it cannot be that federal position limits are ‘‘necessary’’ for all physical commodities, within the meaning of section 4a(a)(1), on the basis of a property shared by all of them, i.e., a limited capacity to absorb the establishment and liquidation of large speculative positions in an orderly fashion. The Commission requests comments on all aspects of this interpretation of the requirement in section 4a(a)(1) of a necessity finding. 2. Necessity Findings as to the 25 Core Referenced Futures Contracts As noted above, the proposed rule would impose federal position limits on: 25 core referenced futures contracts, including 16 agricultural products, five metals products, and four energy products; any futures or options on futures directly or indirectly linked to the core referenced futures contracts; and any economically equivalent swaps. As discussed above, the Commission’s necessity analysis proceeds on the basis of certain propositions reflected in the text of section 4a(a)(1): First, that excessive speculation in derivatives markets can cause sudden or unreasonable fluctuations or unwarranted changes in the price of an 560 (1956) (finding it ‘‘obvious that transactions in such vast amounts as those involved here might cause ‘sudden or unreasonable fluctuations in the price’ of corn and hence be an undue and unnecessary burden on interstate commerce’’ (alteration omitted)). 486 See supra Section III.D. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 underlying commodity, i.e., fluctuations not attributable to the forces of supply of and demand for that underlying commodity; second, that such price fluctuations and changes are an undue and unnecessary burden on interstate commerce in that commodity, and; third, that position limits can diminish, eliminate, or prevent that burden. With those propositions established by Congress, the Commission’s task is to make the further determination of whether it is necessary to use position limits, Congress’s prescribed tool to address those burdens on interstate commerce, in light of the facts and circumstances. Unlike prior preliminary necessity findings which focused on evidence of excessive speculation in just wheat and natural gas, this necessity finding addresses all 25 core referenced futures contracts and focuses on two interrelated factors: (1) The importance of the derivatives markets to the underlying cash markets, including whether they call for physical delivery of the underlying commodity; and (2) the importance of the cash markets underlying the referenced futures contracts to the national economy. The Commission will apply the relevant facts and circumstances holistically rather than formulaically, in light of its experience and expertise. With respect to the first factor, the markets for the 25 core referenced futures contracts are large in terms of notional value and open interest, and are critically important to the underlying cash markets. These derivatives markets enable food processors, farmers, mining operations, utilities, textile merchants, confectioners, and others to hedge the risks associated with volatile changes in price that are the hallmark of cash commodity markets. Futures markets were established to allow industries that are vital to the U.S. economy and critical to the American public to accurately manage future receipts, expenses, and financial obligations with a high level of certainty. In general, futures markets perform valuable functions for society such as ‘‘price discovery’’ and by allowing counterparties to transfer price risk to their counterparty. The risk transfer function that the futures markets facilitate allows someone to hedge against price movements by establishing a price for a commodity for a time in the future. Prices in derivatives markets can inform the cash market prices of, for example, energy used in homes, cars, factories, and hospitals. More than 90 percent of Fortune 500 companies use derivatives to manage risk, and over 50 percent of PO 00000 Frm 00072 Fmt 4701 Sfmt 4702 all companies use derivatives in physical commodity markets such as the 25 core referenced futures contracts.487 The 25 core referenced futures contracts are vital for establishing reliable commodity prices and enabling the beneficial risk transfer between buyers and sellers of commodities, allowing participants to hedge risk and undertake planning with greater certainty. By providing a highly efficient marketplace for participants to offset risks, the 25 core referenced futures contracts attract a broad range of participants, including farmers, ranchers, producers, utilities, retailers, investors, banking institutions, and others. These participants hedge production costs and delivery prices so that, among other things, consumers can always find plenty of food at reliable prices on the grocery store shelves. Futures prices are used for pricing of cash market transactions but also serve as economic signals that help various members of society plan. These signals help farmers decide which crops to plant as well as assist producers to decide how to implement their production processes given the anticipated costs of various inputs and the anticipated prices of any anticipated finished products, and they serve similar functions in other areas of the economy. For the commodities that are the subject of this necessity finding, the Commission preliminarily has determined that there is a significant amount of participation in these commodity markets, both directly and indirectly, through price discovery signals.488 Two key features of the 25 core referenced futures contracts are the role they play in the price discovery process for their respective underlying commodities and the fact that they 487 ISDA Survey of the Derivatives Usage by the World’s Largest Companies 2009. It has also been estimated that the use of commercial derivatives added 1.1 percent to the size of the U.S. economy between 2003 and 2012. See Apanard Prabha et al., Deriving the Economic Impact of Derivatives, (Mar. 2014), available at https:// assets1b.milkeninstitute.org/assets/Publication/ ResearchReport/PDF/Derivatives-Report.pdf. 488 The Commission observes that there has been much written in the academic literature about price discovery of the 25 core referenced futures contracts. This demonstrates the importance of the commodities underlying such contracts in our society. The Commission’s Office of the Chief Economist conducted a preliminary search on the JSTOR and Science Direct academic research databases for journal articles that contain the key words: Price Discovery <Commodity Name> Futures. While the articles made varying conclusions regarding aspects of the futures markets, and in some cases position limits, almost all articles agreed that the futures markets in general are important for facilitating price discovery within their respective markets. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 require physical delivery of the underlying commodity. Price discovery is the process by which markets, through the interaction of buyers and sellers, produce prices that are used to value underlying futures contracts that allow society to infer the value of underlying physical commodities. Adjustments in futures market requirements and valuations by a diverse array of futures market participants, each with different perspectives and access to supply and demand information, can result in adjustments to the pricing of the commodities underlying the futures contract. The futures markets are generally the first to react to such pricemoving information, and price movements in the futures markets reflect a judgment of what is likely to happen in the future in the underlying cash markets. The 25 core referenced futures contracts were selected in part because they generally serve as reference prices for a large number of cash-market transactions, and the Commission knows from large trader reporting that there is a significant presence of commercial traders in these contracts, many of whom may be using the contracts for hedging and price discovery purposes. For example, a grain elevator may use the futures markets as a benchmark for the price it offers local farmers at harvest. In return, farmers look to futures prices to determine for themselves whether they are getting fair value for their crops. The physical delivery mechanism further links the cash and futures markets, with cash and futures prices expected to converge at settlement of the futures contract.489 In addition to facilitating price convergence, the physical delivery mechanism allows the 25 core referenced futures contracts to be an alternative means of obtaining or selling the underlying commodity for market participants. While most physicallysettled futures contracts are rolled-over or unwound and are not ultimately settled using the physical delivery mechanism, because the futures contracts have standardized terms and conditions that reflect the cash market commodity, participants can reasonably expect that the commodity sold or purchased will meet their needs.490 This 489 Futures contracts are traded for settlement at a date in the future. At a contract’s delivery month and date, a commodity cash market price and its futures price converge, allowing an efficient transfer of physical commodities between buyers and sellers of the futures contract. 490 Standardized terms and conditions for physically-settled futures contracts typically include delivery quantities, qualities, sizes, grades VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 physical delivery and price discovery process contributes to the complexity of the markets for the 25 core referenced futures contracts. If these markets function properly, American producers and consumers enjoy reliable commodity prices. Excessive speculation causing sudden or unreasonable fluctuations or unwarranted changes in the price of those commodities could, in some cases, have far reaching consequences for the U.S. economy by interfering with proper market functioning. The cash markets underlying the 25 core referenced futures contracts are to varying degrees vitally important to the U.S. economy, driving job growth, stimulating economic activity, and reducing trade deficits while impacting everyone from consumers to automobile manufacturers and farmers to financial institutions. These 25 cash markets include some of the largest cash markets in the world, contributing together, along with related industries, approximately 5 percent to the U.S. gross domestic product (‘‘GDP’’) directly and a further 10 percent indirectly.491 As described in detail below, the cash markets underlying the 25 core referenced futures contracts are critical to consumers, producers, and, in some cases, the overall economy. By ‘‘excessive speculation,’’ the Commission here refers to the accumulation of speculative positions of a size that threaten to cause the ills Congress addressed in Section 4a— sudden or unreasonable fluctuations or unwarranted changes in the price of the underlying commodity. These potentially violent price moves in the futures markets could impact producers such as utilities, farmers, ranchers, and other hedging market participants. Such unwarranted volatility could result in significant costs and price movements, compromising budgeting and planning, making it difficult for producers to manage the costs of farmlands and oil refineries, and impacting retailers’ ability to provide reliable prices to consumers for everything from cereal to gasoline. To be clear, volatility is sometimes warranted in the sense that it reflects legitimate forces of supply and demand, which can sometimes change very quickly. The purpose of and locations for delivery that are commonly used in the commodity cash market. 491 See The Bureau of Economic Analysis, U.S. Department of Commerce, Interactive Access to Industry Economic Accounts Data: GDP by Industry (Historical) that includes GDP contributions by U.S. Farms, Oil & Gas extraction, pipeline transportation, petroleum and coal products, utilities, mining and support activities, primary and fabricated metal products and finance in securities, commodity contracts and investments. PO 00000 Frm 00073 Fmt 4701 Sfmt 4702 11667 this proposed rule is not to constrain those legitimate price movements. Instead, the Commission’s purpose is to prevent volatility caused by excessive speculation, which Congress has deemed a potential burden on interstate commerce. Further, excessive speculation in the futures market could result in price uncertainty in the cash market, which in turn could cause periods of surplus or shortage that would not have occurred if prices were more reliable. Properly functioning futures markets free from excessive speculation are essential for hedging the volatility in cash markets for these commodities that are the result of real supply and demand. Specific attributes of the cash and derivatives markets for these 25 commodities are discussed below. 3. Agricultural Commodities Futures contracts on the 16 agricultural commodities are essential tools for hedging against price moves of these widely grown crops, and are key instruments in helping to smooth out volatility and to ensure that prices remain reliable and that food remains on the shelves. These agricultural futures contracts are used by grain elevators, farmers, merchants, and others and are particularly important because prices in the underlying cash markets swing regularly depending on factors such as crop conditions, weather, shipping issues, and political events. Settlement prices of futures contracts are made available to the public by exchanges in a process known as ‘‘price discovery.’’ To be an effective hedge for cash market prices, futures contracts should converge to the spot price at expiration of the futures contract. Otherwise, positions in a futures contract will be a less effective tool to hedge price risk in the cash market since the futures positions will less than perfectly offset cash market positions. Convergence is so important for the 16 agricultural contracts that exchanges have deliveries occurring during the spot month, unlike for the energy commodities covered by this proposal.492 This delivery mechanism helps to force convergence because shorts who can deliver cheaper than the futures prices may do so, and longs can stand in for delivery if it’s cheaper to 492 For energy contracts, physical delivery of the underlying commodity does not occur during the spot month. This allows time to schedule pipeline deliveries and so forth. Instead, a shipping certificate (a financial instrument claim to the physical product), not the underlying commodity, is the delivery instrument that is exchanged at expiration of the futures contract. E:\FR\FM\27FEP3.SGM 27FEP3 11668 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 obtain the underlying through the futures market than the cash market. The Commission does not collect information on all cash market transactions. Nevertheless, the Commission understands that futures prices are often used by counterparties to settle many cash-market transactions due to approximate convergence of the futures contract price to the cash-market price at expiration. Agricultural futures markets are some of the most active, and open interest on agricultural futures have some of the highest notional value. The CBOT Corn (C) and CBOT Soybean (S) contracts, for example, trade over 350,000 and 200,000 contracts respectively per day.493 Outstanding futures and options notional values range anywhere from approximately $ 71 billion for CBOT Corn (C) to approximately $ 70 million for CBOT Oats (O), with the other core referenced futures contracts on agricultural commodities all falling somewhere in between.494 The American agricultural market, including markets for the commodities underlying the 16 agricultural core referenced contracts, is foundational to the U.S. economy. Agricultural, food, and related industries contributed $ 1.053 trillion to the U.S. economy in 2017, representing 5.4 percent of U.S. GDP.495 In 2017, agriculture provided 21.6 million full and part time jobs, or 11 percent of total U.S. employment.496 Agriculture’s contribution to international trade is also sizeable. For fiscal year 2019, it was projected that agricultural exports would exceed $ 137 billion, with imports at $ 129 billion for a net balance of trade of $ 8 billion.497 This balance of trade is good for the nation and for American farmers. The U.S. commodity futures markets have provided risk mitigation and pricing 493 CME Group website, available at https:// www.cmegroup.com/trading/products/ #pageNumber=1&sortAsc=false&sortField=oi. 494 Notional values here and throughout this section of the release are derived from CFTC internal data obtained from the Commitments of Traders Reports. Notional value means the U.S. dollar value of both long and short contracts without adjusting for delta in options. Data is as of June 30, 2019. 495 What is Agriculture’s Share of the Overall U.S. Economy, USDA Economic Research Services, available at https://www.ers.usda.gov/dataproducts/chart-gallery/gallery/chart-detail/ ?chartId=58270. 496 Ag and Food Sales and the Economy, USDA Economic Research Services, available at https:// www.ers.usda.gov/data-products/ag-and-foodstatistics-charting-the-essentials/ag-and-foodsectors-and-the-economy. 497 Outlook for U.S. Agricultural Trade, USDA Economic Research Services, available at https:// www.ers.usda.gov/topics/international-markets-ustrade/us-agricultural-trade/outlook-for-usagricultural-trade. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 that reflects the economic value of the underlying commodity to farmers, ranchers, and producers. The 16 agricultural core referenced futures contracts 498 are key drivers to the success of the American agricultural industry. The commodities underlying these markets are used in a variety of consumer products including: Ingredients in animal feeds for production of meat and dairy (soybean meal and corn); margarine, shortening, paints, adhesives, and fertilizer (soybean oil); home furnishings and apparel (cotton); and food staples (corn, soybeans, wheat, oats, frozen orange juice, cattle, rough rice, cocoa, coffee, and sugar). The cash markets underlying the 16 agricultural core referenced futures contracts help create jobs and stimulate economic activity. The soybean meal market alone has an implied value to the U.S. economy through animal agriculture which contributed more than 1.8 million American jobs,499 and wheat remains the largest produced food grain in the United States, with planted acreage, production, and farm receipts ranking third after corn and soybeans.500 The United States is the world’s largest producer of beef, and also produced 327,000 metric tons of frozen orange juice in 2018.501 Total economic activity stimulated by the cotton crop is estimated at over $ 75 billion.502 Many of these markets are also significant export commodities, helping to reduce the trade deficit. The United States exports between 10 and 20 percent of its corn crop and 47 percent of its soybean crop, generating tens of billions of dollars in annual economic output.503 498 The 16 agricultural core referenced futures contracts are: CBOT Corn (C), CBOT Oats (O), CBOT Soybeans (S), CBOT Soybean Meal (SM), CBOT Soybean Oil (SO), CBOT Wheat (W), CBOT KC HRW Wheat (KW), ICE Cotton No. 2 (CT), MGEX HRS Wheat (MWE), CBOT Rough Rice (RR), CME Live Cattle (LC), ICE Cocoa (CC), ICE Coffee C (KC), ICE FCOJ–A (OJ), ICE U.S. Sugar No. 11 (SB), and ICE U.S. Sugar No. 16 (SF). 499 Decision Innovation Solutions, 2018 Soybean Meal Demand Assessment, United Soybean Board, available at https://www.unitedsoybean.org/wpcontent/uploads/LOW-RES-FY2018-Soybean-MealDemand-Analysis-1.pdf. 500 Wheat Sector at a Glance, USDA Economic Research Service, available at https:// www.ers.usda.gov/topics/crops/wheat/wheat-sectorat-a-glance. 501 Cattle & Beef Sector at a Glance, USDA Economic Research Service, available at https:// www.ers.usda.gov/topics/animal-products/cattlebeef/sector-at-a-glance. 502 World of Cotton, National Cotton Council of America, available at https://www.cotton.org/econ/ world/index.cfm. 503 Feedgrains Sector at a Glance, USDA Economic Research Service, available at https:// www.ers.usda.gov/topics/crops/corn-and-otherfeedgrains/feedgrains-sector-at-a-glance. PO 00000 Frm 00074 Fmt 4701 Sfmt 4702 Many of these agricultural commodities are also crucial to rural areas. In Arkansas alone, which ranks first among rice-producing states, the annual rice crop contributes $1.3 billion to the state’s economy and accounts for tens of thousands of jobs to an industry that contributes more than $35 billion to the U.S. economy on an annual basis.504 Similarly, the U.S. meat and poultry industry, which includes cattle, accounts for $1.02 trillion in total economic output equaling 5.6 percent of GDP, and is responsible for 5.4 million jobs.505 Coffee-related economic activity comprises 1.6 percent of total U.S. GDP,506 and U.S. sugar producers generate nearly $20 billion per year for the U.S. economy, supporting 142,000 jobs in 22 states.507 Even some of the smaller agricultural markets have a noteworthy economic impact.508 For example, oats are planted on over 2.6 million acres in the United States, with the total U.S. supply in the order of 182 million bushels,509 and in 2010 the United States exported chocolate and chocolate-type confectionary products worth $799 million to more than 50 countries around the world. 510 4. Metal Commodities The core referenced futures contracts on metal commodities play an important role in the price discovery process and are some of the most active and valuable in terms of notional value. 504 Where is Rice Grown, Think Rice website, available at https://www.thinkrice.com/on-the-farm/ where-is-rice-grown. 505 The United States Meat Industry at a Glance, North American Meat Institute website, available at https://www.meatinstitute.org/index.php?ht=d/sp/i/ 47465/pid/47465. 506 The Economic Impact of the Coffee Industry, National Coffee Association, available at https:// www.ncausa.org/Industry-Resources/EconomicImpact. 507 U.S. Sugar Industry, The Sugar Association, available at https://www.sugar.org/about/usindustry. While Sugar No. 11 (SB) is primarily an international benchmark, the contract is still used for price discovery and hedging within the United States and has significantly more open interest and daily volume than the domestic Sugar No. 16 (SF). As a pair, these two contracts are crucial tools for risk management and for ensuring reliable pricing, with much of the price discovery occurring in the higher-volume Sugar No. 11 (SB) contract. 508 Although the macroeconomic impact of these markets is smaller, the Commission reiterates that it has selected the 25 core referenced futures contracts also based on the importance of derivatives in these commodities to cash-market pricing. 509 Feed Outlook: May 2019, USDA Economic Research Service, available at https:// www.ers.usda.gov/publications/pub-details/ ?pubid=93094. 510 Economic Profile of the U.S. Chocolate Industry, World Cocoa Foundation, available at https://www.worldcocoafoundation.org/wp-content/ uploads/Economic_Profile_of_the_US_Chocolate_ Industry_2011.pdf. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 The Gold (GC) contract, for example, trades the equivalent of nearly 27 million ounces and 170,000 contracts daily. 511 Outstanding futures and options notional values range from approximately $234 billion in the case of Gold (GC), to approximately $2.34 billion in the case of Palladium (PA), with the other metals core referenced futures contracts all falling somewhere in between.512 Metals futures are used by a diverse array of commercial endusers to hedge their operations, including mining companies, merchants and refiners. The underlying commodities are also important to the U.S. economy. In 2018, U.S. mines produced $82.2 billion of raw materials, including the commodities underlying the five metals core referenced futures contracts: COMEX Gold (GC), COMEX Silver (SI), COMEX Copper (HG), NYMEX Platinum (PL), and NYMEX Palladium (PA).513 U.S. mines produced 6.6 million ounces of gold in 2018 worth around $9.24 billion as of July 1, 2019, and the United States holds the largest official gold reserves of any country, worth around $366 billion and representing 75 percent of the value of total U.S. foreign reserves.514 U.S. silver refineries produced around 52.5 million ounces of silver worth around $800 million in 2018 at current prices.515 Major industries, including steel, aerospace, and electronics, process and transform these materials, creating about $3.02 trillion in value-added products.516 The five metals commodities are key components of these products, including for use in: Batteries, solar panels, water purification systems, electronics, and chemical refining (silver); jewelry, electronics, and as a store of value (gold); building construction, transportation equipment, and industrial machinery (copper); automobile catalysts for diesel engines and in chemical, electric, medical and biomedical applications, and petroleum refining (platinum); and automobile 511 Gold Futures Quotes, CME Group website, available at https://www.cmegroup.com/trading/ metals/precious/gold_quotes_globex.html. 512 Calculations based on data submitted to the Commission pursuant to part 16 of the Commission’s regulations. 513 Mineral Commodity Summaries 2019, U.S. Geological Survey, available at https://prd-wret.s3us-west-2.amazonaws.com/assets/palladium/ production/atoms/files/mcs2019_all.pdf. 514 CPM Gold Yearbook 2019, CPM Group, available at https://www.cpmgroup.com/store/cpmgold-yearbook-2019; Goldhub, World Gold Council, available at https://www.gold.org/goldhub. 515 World Silver Survey 2019, The Silver Institute, available at https://www.silverinstitute.org/wpcontent/uploads/2019/04/WSS2019V3.pdf. 516 Id. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 catalysts for gasoline engines and in dental and medical applications (palladium). A disruption in any of these markets would impact highly important and sensitive industries, including those critical to national security, and would also impact the price of consumer products. The underlying metals markets also create jobs and contribute to GDP. Over 20,000 people were employed in U.S. gold and copper mines and mills in 2017 and 2018, metal ore mining contributed $54.5 billion to U.S. GDP in 2015, and the global copper mining industry drives more than 45 percent of the world’s GDP, either on a direct basis or through the use of products that facilitate other industries.517 The gold and silver markets are especially important because they serve as financial assets and a store of value for individual and institutional investors, including in times of economic or political uncertainty. Several exchange-traded funds (‘‘ETFs’’) that are important instruments for U.S. retail and institutional investors also hold significant quantities of these metals to back their shares. A disruption to any of these metals markets would thus not only impact producers and retailers, but also potentially retail and institutional investors. The iShares Silver Trust ETF, for example, holds around 323.3 million ounces of silver worth $4.93 billion, and the largest U.S. listed gold-backed ETF holds around 25.5 million ounces to back its shares worth around $35.7 billion.518 Platinum and palladium ETFs are worth hundreds of millions of dollars as well.519 5. Energy Commodities The energy core referenced futures markets are crucial tools for hedging price risk for commodities which can be 517 Creamer, Martin, Global Mining Derives 45%Plus of World GDP, Mining Weekly (July. 4, 2012), available at https://www.miningweekly.com/printversion/global-mining-drives-45-plus-of-world-gdpcutifani-2012-07-04. Platinum and palladium mine production in 2018 was less substantial, worth $114 million and $695 million, respectively (All such valuations throughout this release are at current prices as of July 2, 2019.). See Bloxham, Lucy, et al., Pgm Market Report May 2019, Johnson Matthey, available at https://www.platinum.matthey.com/ documents/new-item/pgm%20market%20reports/ pgm_market_report_may_19.pdf. However, derivatives contracts in those commodities do play a role in price discovery. 518 Historical Data, SPDR Gold Shares, available at https://www.spdrgoldshares.com/usa/historicaldata. Data as of July 1, 2019. 519 iShares Silver Trust Fund, iShares, available at https://www.ishares.com/us/products/239855/ ishares-silver-trust-fund/1521942788811. ajax?fileType=xls&fileName=iShares-Silver-Trust_ fund&dataType=fund, https:// www.aberdeenstandardetfs.us/institutional/us/enus/products/product/etfs-physical-platinum-sharespplt-arca#15. PO 00000 Frm 00075 Fmt 4701 Sfmt 4702 11669 highly volatile due to changes in weather, economic health, demandrelated price swings, and pipeline and supply availability or disruptions. These futures contracts are used by some of the largest refiners, exploration and production companies, distributors, and by other key players in the energy industry, and are some of the most widely traded and valuable contracts in the world in terms of notional value. The NYMEX Light Sweet Crude Oil (CL) contract, for example, is the world’s most liquid and actively traded crude oil contract, trading nearly 1.2 million contracts a day, and the NYMEX Henry Hub Natural Gas (NG) contract trades 400,000 contracts daily.520 Futures and option notional values range from $ 53 billion in the case of NYMEX NY Harbor RBOB Gasoline (RB) and NYMEX NY Harbor ULSD Heating Oil (HO), to $ 498 billion for NYMEX Light Sweet Crude Oil (CL).521 Some of the energy core referenced futures contracts also serve as key benchmarks for use in pricing cashmarket and other transactions. NYMEX NY Harbor RBOB Gasoline (RB) is the main benchmark used for pricing gasoline in the U.S. petroleum products market, a huge physical market with total U.S. refinery capacity of approximately 9.5 million barrels per day of gasoline.522 Similarly, the NYMEX NY Harbor ULSD Heating Oil (HO) contract is the main benchmark used for pricing the distillate products market, which includes diesel fuel, heating oil, and jet fuel. 523 The U.S. energy markets are some of the most important and complex in the world, contributing over $ 1.3 trillion to the U.S. economy.524 Crude oil, heating oil, gasoline, and natural gas, the commodities underlying the four energy core reference futures contracts,525 are key contributors to job growth and GDP. In 2015, the natural gas and oil industries supported 10.3 million jobs directly and indirectly, accounting for 5.6 percent of total U.S. employment, and generating $ 714 billion in wages to 520 Calculations based on data submitted to the Commission pursuant to part 16 of the Commission’s regulations. 521 Calculations based on data submitted to the Commission pursuant to part 16 of the Commission’s regulations. 522 CME Comment letter dated April 24, 2015 at 79. 523 Id. at 136. 524 Natural Gas and Oil National Factsheet, API Energy, available at https://www.api.org/∼/media/ Files/Policy/Jobs/National-Factsheet.pdf. 525 The four energy core referenced futures contracts are: NYMEX Light Sweet Crude Oil (CL), NYMEX NY Harbor ULSD Heating Oil (HO), NYMEX NY Harbor RBOB Gasoline (RB), and NYMEX Henry Hub Natural Gas (NG). E:\FR\FM\27FEP3.SGM 27FEP3 11670 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules account for 6.7 percent of national income.526 Crude oil alone, which is a key component in making gasoline, contributes 7.6 percent of total U.S. GDP. RBOB gasoline, which is a byproduct of crude oil that is used as fuel for vehicles and appliances, contributes $ 35.5 billion in income and $57 billion in economic activity.527 ULSD comprises all on-highway diesel fuel consumed in the United States, and is also commonly used as heating oil.528 Natural gas is similarly important, serving nearly 69 million homes, 185,400 factories, and 5.5 million businesses such as hotels, restaurants, hospitals, schools, and supermarkets. More than 2.5 million miles of pipeline transport natural gas to more than 178 million Americans.529 Natural gas is also a key input for electricity generation and comprises more than one quarter of all primary energy used in the United States. 530 U.S. agricultural producers also rely on an affordable, dependable supply of natural gas, as fertilizer used to grow crops is composed almost entirely of natural gas components. lotter on DSKBCFDHB2PROD with PROPOSALS3 6. Consistency With Commodity Indices The criteria underlying the Commission’s necessity finding is consistent with the criteria used by several widely tracked third party commodity index providers in determining the composition of their indices. Bloomberg selects commodities for its Bloomberg Commodity Index that in its view are ‘‘sufficiently significant to the world economy to merit consideration,’’ that are ‘‘tradeable through a qualifying related futures contract’’ and that generally are the ‘‘subject of at least one futures contract that trades on a U.S. exchange.’’ 531 526 Natural Gas and Oil National Factsheet, API Energy, available at https://www.api.org/∼/media/ Files/Policy/Jobs/National-Factsheet.pdf; PricewaterhouseCoopers, Impacts of the Natural Gas and Oil Industry on the US Economy in 2015, API Energy, available at https://www.api.org/∼/ media/Files/Policy/Jobs/Oil-and-Gas-2015Economic-Impacts-Final-Cover-07-17-2017.pdf. 527 PricewaterhouseCoopers, Impacts of the Natural Gas and Oil Industry on the US Economy in 2015, API Energy, at 12, available at https:// www.api.org/∼/media/Files/Policy/Jobs/Oil-andGas-2015-Economic-Impacts-Final-Cover-07-172017.pdf. 528 CME Comment Letter dated April 24, 2015 at 135. 529 Natural Gas: The Facts, American Gas Association, available at https://www.aga.org/ globalassets/2019-natural-gas-factsts-updated.pdf. 530 Id. 531 The Bloomberg Commodity Index Methodology, Bloomberg, at 17 (Dec. 2018) available at https://data.bloomberglp.com/ professional/sites/10/BCOM-MethodologyDecember-2019.pdf. The list of commodities that Bloomberg deems eligible for inclusion in its index VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Similarly, S&P’s GSCI index is, among other things, ‘‘designed to reflect the relative significance of each of the constituent commodities to the world economy.’’ 532 Applying these criteria, Bloomberg and S&P have deemed eligible for inclusion in their indices lists of commodities that overlap significantly with the Commission’s proposed list of 25 core referenced futures contracts. Independent index providers thus appear to have arrived at similar conclusions to the Commission’s preliminary necessity finding regarding the relative importance of certain commodity markets. 7. Conclusion This proposal only sets limits for referenced contracts for which a DCM currently lists a physically-settled core referenced futures contract. As discussed above, there are currently over 1,200 contracts on physical commodities listed on DCMs, and there are physical commodities other than those underlying the 25 core referenced futures contracts that are important to the national economy, including, for example, steel, butter, uranium, aluminum, lead, random length lumber, and ethanol. However, unlike the 25 core referenced futures contracts, the derivatives markets for those commodities are not as large as the markets for the 25 core referenced futures contracts and/or play a less significant role in the price discovery process. For example, the futures contracts on steel, butter, and uranium were not included as core referenced futures contracts because they are cash-settled contracts that settle to a third party index. Among the agricultural commodity futures listed on CME that are cash-settled only to an index are: class III milk, feeder cattle, and lean hogs. All three of these were included in the 2011 Final Rulemaking. Because there are no physically-settled futures contracts on these commodities, these cash-settled contracts would not qualify as referenced contracts are would not be subject to the proposed rule. While the futures contracts on aluminum, lead, random length lumber, and ethanol are physically settled contracts, their open interest and trading volume is lower than that of the CBOT Oats contract, which is the smallest market included among the 25 core referenced futures overlaps significantly with the Commission’s proposed list of 25 core referenced futures contracts. 532 S&P GSCI Methodology, S&P Dow Jones Indices, at 8 (Oct. 2019) available at https:// us.spindices.com/documents/methodologies/ methodology-sp-gsci.pdf?force_download=true. PO 00000 Frm 00076 Fmt 4701 Sfmt 4702 contracts as measured by open interest and volume. In that regard, based on FIA end of month open interest data and 12-month total trading volume data for December 2019, CBOT Oats had end of month open interest of 4,720 contracts and 12-month total trading volume ending in December 2019 of 162,682 round turn contracts.533 In comparison, the end of month December 2019 open interest and 12-month total trading volume ending in December 2019 for the other commodity futures contracts that were not selected to be included as core referenced futures contracts were as follows: COMEX Aluminum (267 OI/ 2,721 Vol), COMEX Lead (0 OI/0 Vol), CME Random Length Lumber (3,275 OI/ 11,893 Vol), and CBOT Ethanol (708 OI/ 2,686 Vol.). It would be impracticable for the Commission to analyze in comprehensive fashion all contracts that have either feature, so the Commission has chosen commodities for which the underlying and derivatives markets both play important economic roles, including the potential for especially acute burdens on a given commodity in interstate commerce that would arise from excessive speculation in derivatives markets. Line drawing of this nature is inherently inexact, and the Commission will revisit these and other contracts ‘‘from time to time’’ as the statute requires.534 Depending on facts and circumstances, including the Commission’s experience administering the proposed limits with respect to the 25 core referenced futures contracts, the Commission may determine that additional limits are necessary within the meaning of section 4a(a)(1). As discussed in the cost benefit consideration below, the Commission’s proposed limits are not without costs, and there are potential burdens or negative consequences associated with establishing the proposed limits.535 In particular, if the levels are set too high, there is a greater risk of excessive speculation that could harm market participants and the public. If the levels are set too low, transaction costs may rise and liquidity could be reduced.536 Nevertheless, the Commission preliminarily believes that the specific proposed limits applicable to the 25 core referenced futures contracts would 533 FIA notes that volume for exchange-traded futures is measured by the number of contracts traded on a round-trip basis to avoid doublecounting. Furthermore, FIA notes that open interest for exchange-traded futures is measured by the number of contracts outstanding at the end of the month. 534 CEA section 4a(a)(1). 535 See infra Section IV.A. (discussion of costbenefit considerations for the proposed changes). 536 See infra Section IV.A.2.a. (cost-benefit discussion of market liquidity and integrity). E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules limit such potential costs, and that the significant benefits associated with advancing the statutory goal of preventing the undue burdens associated with excessive speculation in these commodities justify the potential costs associated with establishing the proposed limits. G. Request for Comment The Commission requests comment on all aspects of the proposed necessity finding. The Commission also invites comments on the following: (50) Does the proposed necessity finding take into account the relevant factors to ascertain whether position limits would be necessary on a core referenced futures contract? (51) Does the proposed necessity finding base its analysis on the correct levels of trading volume and open interest? If not, what would be a more appropriate minimum level of trading volume and/or open interest upon which to evaluate whether federal position limits are necessary to prevent excessive speculation? (52) Are there particular attributes of any of the 25 proposed core referenced futures contracts that the Commission should consider when determining whether federal position limits are or are not necessary for that particular product? IV. Related Matters lotter on DSKBCFDHB2PROD with PROPOSALS3 A. Cost-Benefit Considerations 1. Introduction Section 15(a) of the Commodity Exchange Act (‘‘CEA’’ or ‘‘Act’’) requires the Commodity Futures Trading Commission (‘‘Commission’’) to consider the costs and benefits of its actions before promulgating a regulation under the CEA.537 Section 15(a) further specifies that the costs and benefits shall be evaluated in light of five broad areas of market and public concern: (1) Protection of market participants and the public; (2) efficiency, competitiveness, and financial integrity of futures markets; (3) price discovery; (4) sound risk management practices; and (5) other public interest considerations (collectively, the ‘‘section 15(a) factors’’).538 The Commission interprets section 15(a) to require the Commission to consider only those costs and benefits of its proposed changes that are attributable to the Commission’s discretionary determinations (i.e., changes that are not otherwise required by statute) compared to the existing 537 7 U.S.C. 19(a). 538 Id. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 status quo requirements. For this purpose, the status quo requirements include the CEA’s statutory requirements as well as any applicable Commission regulations that are consistent with the CEA.539 As a result, any proposed changes to the Commission’s regulations that are required by the CEA or other applicable statutes would not be deemed to be a discretionary change for purposes of discussing related costs and benefits. The Commission anticipates that the proposed position limits regulations will affect market participants differently depending on their business model and scale of participation in the commodity contracts that are covered by the proposal.540 The Commission also anticipates that the proposal may result in ‘‘programmatic’’ costs to some market participants. Generally, affected market participants may incur increased costs associated with developing or revising, implementing, and maintaining compliance functions and procedures. Such costs might include those related to the monitoring of positions in the relevant referenced contracts; related filing, reporting, and recordkeeping requirements, and the costs of changes to information technology systems. The Commission has preliminarily determined that it is not feasible to quantify the costs or benefits with reasonable precision and instead has identified and considered the costs and benefits qualitatively.541 The Commission believes that for many of 539 This cost-benefit consideration section is divided into seven parts, including this introductory section, each discussing their respective baseline benchmarks with respect to any applicable CEA or regulatory provisions. 540 For example, the proposal could result in increased costs to market participants who may need to adjust their trading and hedging strategies to ensure that their aggregate positions do not exceed federal position limits, particularly those who will be subject to federal position limits for the first time (i.e., those who may trade contracts for which there are currently no federal limits). On the other hand, existing costs could decrease for those existing traders whose positions would fall below the new proposed limits and therefore would not be forced to adjust their trading strategies and/or apply for exemptions from the limits, particularly if the Commission’s proposal improves market liquidity or other metrics of market health. Similarly, for those market participants who would become subject to the federal position limits, general costs would be lower to the extent such market participants can leverage their existing compliance infrastructure in connection with existing exchange position limit regimes relative to those market participants that do not currently have such systems. 541 With respect to the Commission’s analysis under its discussion of its obligations under the Paperwork Reduction Act (‘‘PRA’’), the Commission has endeavored to quantify certain costs and other burdens imposed on market participants related to collections of information as defined by the PRA. See generally Section IV.B. (discussing the Commission’s PRA determinations). PO 00000 Frm 00077 Fmt 4701 Sfmt 4702 11671 the costs and benefits that quantification is not feasible with reasonable precision because doing so would require understanding all market participants’ business models, operating models, cost structures, and hedging strategies, including an evaluation of the potential alternative hedging or business strategies that could be adopted under the proposal. Further, while Congress has tasked the Commission with establishing such position limits as the Commission finds are ‘‘necessary,’’ some of the benefits, such as mitigating or eliminating manipulation or excessive speculation, may be very difficult or infeasible to quantify. These benefits, moreover, would likely manifest over time and be distributed over the entire market. In light of these limitations, to inform its consideration of costs and benefits of the proposed regulations, the Commission in its discretion relies on: (1) Its experience and expertise in regulating the derivatives markets; (2) information gathered through public comment letters 542 and meetings with a broad range of market participants; and (3) certain Commission data, such as the Commission’s Large Trader Reporting System and data reported to swap data repositories. In addition to the specific questions included throughout the discussion below, the Commission generally requests comment on all aspects of its consideration of costs and benefits, including: Identification and assessment of any costs and benefits not discussed herein; data and any other information to assist or otherwise inform the Commission’s ability to quantify or qualify the costs and benefits of the proposed rules; and substantiating data, statistics, and any other information to support positions posited by commenters with respect to the Commission’s consideration of costs and benefits. The Commission preliminarily considers the benefits and costs discussed below in the context of international markets, because market participants and exchanges subject to the Commission’s jurisdiction for purposes of position limits may be organized outside of the United States; some industry leaders typically conduct operations both within and outside the United States; and market participants may follow substantially similar business practices wherever located. 542 While the general themes contained in comments submitted in response to prior proposals informed this rulemaking, the Commission is withdrawing the 2013 Proposal, the 2016 Supplemental Proposal, and the 2016 Reproposal. See supra Section I.A. E:\FR\FM\27FEP3.SGM 27FEP3 11672 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Where the Commission does not specifically refer to matters of location, the discussion of benefits and costs below refers to the effects of this proposal on all activity subject to the proposed regulations, whether by virtue of the activity’s physical location in the United States or by virtue of the activity’s connection with or effect on U.S. commerce under CEA section 2(i).543 The Commission will identify and discuss the costs and benefits organized conceptually by topic, and certain topics may generally correspond with a specific proposed regulatory section. The Commission’s discussion is organized as follows: (1) The scope of the commodity derivative contracts that would be subject to the proposed position limits framework, including with respect to the 25 proposed core referenced futures contracts and the proposed definitions of ‘‘referenced contract’’ and ‘‘economically equivalent swaps;’’ (2) the proposed federal position limit levels (proposed § 150.2); (3) the proposed federal bona fide hedging definition (proposed § 150.1) and other Commission exemptions from federal position limits (proposed § 150.3); (4) proposed streamlined process for the Commission and exchanges to recognize bona fide hedges and to grant exemptions for purposes of federal position limits (proposed §§ 150.3 and 150.9) and related reporting changes to part 19 of the Commission’s regulations; (5) the proposed exchange-set position limits framework and exchange-granted exemptions thereto (proposed § 150.5); and (6) the section 15(a) factors. 2. ‘‘Necessity Finding’’ and Scope of Referenced Futures Contracts Subject to Proposed Federal Position Limit Levels Federal spot and non-spot month limits currently apply to futures and options on futures on the nine legacy agricultural commodities.544 The Commission’s proposal would expand the scope of commodity derivative contracts currently subject to the Commission’s existing federal position limits framework 545 so that federal spot543 7 U.S.C. 2(i). nine legacy agricultural contracts currently subject to federal spot and non-spot month limits are: CBOT Corn (C), CBOT Oats (O), CBOT Soybeans (S), CBOT Wheat (W), CBOT Soybean Oil (SO), CBOT Soybean Meal (SM), MGEX Hard Red Spring Wheat (MWE), ICE Cotton No. 2 (CT), and CBOT KC Hard Red Winter Wheat (KW). 545 17 CFR 150.2. Because the Commission has not yet implemented the Dodd-Frank Act’s amendments to the CEA regarding position limits, except with respect to aggregation (see generally Final Aggregation Rulemaking, 81 FR at 91454) and lotter on DSKBCFDHB2PROD with PROPOSALS3 544 The VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 month limits would apply to futures and options on futures on 16 additional physical commodities, for a total of 25 physical commodities.546 The Commission has preliminarily interpreted CEA section 4a to require that the Commission must make an antecedent ‘‘necessity’’ finding that establishing federal position limits is ‘‘necessary’’ to diminish, eliminate, or prevent certain burdens on interstate commerce with respect to the physical commodities in question.547 As the statute does not define the term ‘‘necessary,’’ the Commission must apply its expertise in construing such term, and, as discussed further below, must do so consistent with the policy goals articulated by Congress, including in CEA sections 4a(a)(2)(C) and 4a(a)(3), as noted throughout this discussion of the Commission’s cost-benefit considerations.548 As discussed in greater detail in the preamble, the Commission proposes to establish position limits on futures and options on futures for these 25 commodities on the basis that position limits on such contracts are ‘‘necessary.’’ In determining to include the proposed 25 core referenced futures contracts within the proposed federal position limit framework, the Commission considered the vacated 2011 Position Limits Rulemaking’s amendments to 17 CFR 150.2 (see International Swaps and Derivatives Association v. United States Commodity Futures Trading Commission, 887 F. Supp. 2d 259 (D.D.C. 2012)), the baseline or status quo consists of the provisions of the CEA relating to position limits immediately prior to effectiveness of the Dodd-Frank Act amendments to the CEA and the relevant provisions of existing parts 1, 15, 17, 19, 37, 38, 140, and 150 of the Commission’s regulations, subject to the aforementioned exceptions. 546 The 16 proposed new products that would be subject to federal spot month limits would include seven agricultural (CME Live Cattle (LC), CBOT Rough Rice (RR), ICE Cocoa (CC), ICE Coffee C (KC), ICE FCOJ–A (OJ), ICE U.S. Sugar No. 11 (SB), and ICE U.S. Sugar No. 16 (SF)), four energy (NYMEX Light Sweet Crude Oil (CL), NYMEX New York Harbor ULSD Heating Oil (HO), NYMEX New York Harbor RBOB Gasoline (RB), NYMEX Henry Hub Natural Gas (NG)), and five metals (COMEX Gold (GC), COMEX Silver (SI), COMEX Copper (HG), NYMEX Palladium (PA), and NYMEX Platinum (PL)) contracts. 547 See supra Section III.F. (discussion of the necessity finding). 548 In promulgating the position limits framework, Congress instructed the Commission to consider several factors: First, CEA section 4a(a)(3) requires the Commission when establishing position limits, to the maximum extent practicable, in its discretion, to (i) diminish, eliminate, or prevent excessive speculation; (ii) deter and prevent market manipulation, squeezes, and corners; (iii) ensure sufficient market liquidity for bona fide hedgers; and (iv) ensure that the price discovery function of the underlying market is not disrupted. Second, CEA section 4a(a)(2)(C) requires the Commission to strive to ensure that any limits imposed by the Commission will not cause price discovery in a commodity subject to position limits to shift to trading on a foreign exchange. PO 00000 Frm 00078 Fmt 4701 Sfmt 4702 the effects that these contracts have on the underlying commodity, especially with respect to price discovery; the fact that they require physical delivery of the underlying commodity and therefore may be more affected by manipulation such as corners and squeezes compared to cash-settled contracts; and, in some cases, the especially acute economic burdens on interstate commerce that could arise from excessive speculation in these contracts causing sudden or unreasonable fluctuations or unwarranted changes in the price of the commodities underlying these contracts.549 More specifically, the 25 core referenced futures contracts were selected because they: (i) Physically settle, (ii) have high levels of open interest 550 and significant notional value of open interest,551 (iii) serve as a reference price for a significant number of swaps and/or cash market transactions, and/or (iv) have, in most cases, relatively higher average trading volumes.552 These factors reflect the important and varying degrees of linkage between the derivatives markets and the underlying cash markets. The Commission preliminarily acknowledges that there is no mathematical formula that would be dispositive, though the Commission has considered relevant data where it is available. As a result, the Commission preliminarily has concluded that it must exercise its judgment in light of facts and circumstances, including its experience and expertise, to determine whether federal position limit levels are economically justified. For example, based on its general experience, the Commission preliminarily recognizes that contracts that physically settle can, in certain circumstances during the spot month, be at risk of corners and squeezes, which could distort pricing and resource allocation, make it more costly to implement hedge strategies, and harm the underlying cash market. Similarly, certain contracts with higher 549 See supra Section III.F. (discussion of the necessity finding). 550 Open interest for this purpose includes the sum of open contracts, as defined in § 1.3 of the Commission’s regulations, in futures contracts and in futures option contracts converted to a futuresequivalent amount, as defined in current § 150.1(f) of the Commission’s regulations. See 17 CFR 1.3 and 150.1(f). 551 Notional value of open interest for this purpose is open interest multiplied by the unit of trading for the relevant futures contract multiplied by the price of that futures contract. 552 A combination of higher average trading volumes and open interest is an indicator of a contract’s market liquidity. Higher trading volumes make it more likely that the cost of transactions is lower with narrower bid-ask spreads. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 open interest and/or trading volume are more likely to serve as benchmarks and/ or references for pricing cash market and other transactions, meaning a distortion of the price of any such contract could potentially impact underlying cash markets that are important to interstate commerce.553 As discussed in more detail in connection with proposed § 150.2 below, the Commission preliminarily believes that establishing federal position limits at the proposed levels for the proposed 25 core referenced futures contracts and related referenced contracts would result in several benefits, including a reduction in the probability of excessive speculation and market manipulation (e.g., squeezes and corners) and the attendant harms to price discovery that may result. The Commission acknowledges, in connection with establishing federal position limit levels under proposed § 150.2 (discussed below), that position limits, especially if set too low, could adversely affect market liquidity and increase transaction costs, especially for bona fide hedgers, which ultimately might be passed on to the general public. However, the Commission is also cognizant that setting position limit levels too high may result in an increase in the possibility of excessive speculation and the harms that may result, such as sudden or unreasonable fluctuations or unwarranted changes in the price of the commodities underlying these contracts. For purposes of this discussion, rather than discussing the general potential benefits and costs of the federal position limit framework, the Commission will instead focus on the benefits and costs resulting from the Commission’s proposed necessity finding with respect to the 25 core referenced futures contracts.554 The Commission will address potential benefits and costs of its approach with respect to: (1) The liquidity and integrity of the futures and related options markets and (2) market participants and exchanges. a. Potential Impact of the Scope of the Commission’s Necessity Finding on Market Liquidity and Integrity The Commission has preliminarily determined that the 25 contracts that the Commission proposes to include in its necessity finding are among the most liquid physical commodity contracts, as measured by open interest and/or trading volume, and therefore, imposing 553 See supra Section III.F. (discussion of the necessity finding). 554 See supra Section III.F. (discussion of the necessity finding). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 positions limits on these contracts may impose costs on market participants by constraining liquidity. However, the Commission believes that the potential harmful effect on liquidity will be muted, as a result of the generally high levels of open interest and trading volumes of the respective 25 core referenced futures contracts.555 The Commission has preliminarily determined that, as a general matter, focusing on the 25 proposed core referenced futures contracts may benefit market integrity since these contracts generally are amongst the largest physically-settled contracts with respect to relative levels of open interest and/ or trading volumes. As a result, the Commission preliminarily believes that excessive speculation or potential market manipulation in such contracts would be more likely to affect more market participants and therefore potentially more likely to cause an undue and unnecessary burden (e.g., potential harm to market integrity or liquidity) on interstate commerce. Because each proposed core referenced futures contract is physically-settled, as opposed to cash-settled, the proposal focuses on preventing corners and squeezes in those contracts where such market manipulation could cause significant harm in the price discovery process for their respective underlying commodities.556 While the Commission recognizes that market participants may engage in market manipulation through cashsettled futures and options on futures, the Commission preliminarily has determined that focusing on the physically-settled core referenced futures contracts will benefit market integrity by reducing the risk of corners and squeezes in particular. In addition, not imposing position limits on additional commodities may foster nonexcessive speculation, leading to better prices and more efficient resource allocation in these commodities. This 555 The contracts that would be subject to the Commission’s proposal generally have higher trading volumes and open interest, which tend to have greater liquidity, including relatively narrower bid-ask spreads and relatively smaller price impacts from larger transaction sizes. Further, all other factors being equal, markets for contracts that are more illiquid tend to be more concentrated, so that a position limit on such contracts might reduce open interest on one side of the market, because a large trader would face the potential of being capped out by a position limit. For this reason, among others, the contracts to which the federal position limits in existing § 150.2 apply include some of the most liquid physical-delivery futures contracts. 556 The Commission must also make this determination in light of its limited available resources and responsibility to allocate taxpayer resources in an efficient manner to meet the goals of section 4a(a)(1), and the CEA generally. PO 00000 Frm 00079 Fmt 4701 Sfmt 4702 11673 may ultimately benefit commercial end users and possibly be passed on to the general public in the form of better pricing. As noted above, the scope of the Commission’s necessity finding with respect to the 25 proposed core referenced futures contracts will allow the Commission to focus on those contracts that, in general, the Commission preliminarily recognizes as having particular importance in the price discovery process for their respective underlying commodities as well as potentially acute economic burdens that would arise from excessive speculation causing sudden or unreasonable fluctuations or unwarranted changes in the commodity prices underlying these contracts. To the extent the Commission does not include additional commodities in its necessity finding, the Commission’s approach may also introduce additional costs in the form of loss of certain benefits associated with the proposed federal position limits framework, such as stronger prevention of market manipulation, such as corners and squeezes. Accordingly, the greater the potential benefits of the proposed federal position limits framework in general, the greater the potential cost in the reduction in market integrity in general from not including other possible commodities within the federal position limits framework (only to the extent any such additional commodities would be found to be ‘‘necessary’’ for purposes of CEA section 4a). Nonetheless, some of the potential harms to market integrity associated with not including additional commodities within the federal position limits framework could be mitigated to an extent by exchanges, which can use tools other than position limits, such as margin requirements or position accountability at lower levels than potential federal limits, to defend against certain market behavior. Similarly, for those contracts that would not be subject to the proposal, exchangeset position limits alternatively may achieve the same benefits discussed in connection with the proposed federal position limits. b. Potential Impact of the Scope of the Commission’s Necessity Finding on Market Participants and Exchanges The Commission acknowledges that the federal position limits proposed herein could impose certain administrative, logistical, technological, and financial burdens on exchanges and market participants, especially with respect to developing or expanding compliance systems and the adoption of monitoring policies. However, the E:\FR\FM\27FEP3.SGM 27FEP3 11674 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Commission preliminarily believes that its approach to delaying the effective date by 365 days from publication of any final rule in the Federal Register should mitigate compliance costs by permitting the update and build out of technological and compliance systems more gradually. It may also reduce the burdens on market participants not previously subject to position limits, who will have a longer period of time to determine whether they may qualify for certain bona fide hedging recognitions or other exemptions, and to possibly alter their trading or hedging strategies.557 Further, the delayed effective date will reduce the burdens on exchanges, market participants, and the Commission by providing each with more time to resolve technological and other challenges for compliance with the new regulations. In turn, the Commission preliminarily anticipates that the extra time provided by the delayed effective date will result in more robust systems for market oversight, which should better facilitate the implementation of the Commission’s position limits framework and avoid unnecessary market disruptions while exchanges and market participants prepare for its implementation. However, the longer the proposed delay in the proposal’s effective date, the longer it will take to realize the benefits identified above. 3. Federal Position Limit Levels (Proposed § 150.2) lotter on DSKBCFDHB2PROD with PROPOSALS3 a. General Approach Existing § 150.2 establishes position limit levels that apply net long or net short to futures and futures-equivalent options contracts on nine legacy physically-settled agricultural contracts.558 The Commission has previously set separate federal position limits for: (i) The spot month, and (ii) the single month and all-months combined limit levels (i.e., ‘‘non-spot months’’).559 For the existing spot month federal limit levels, the contract 557 Commenters on prior proposals have requested a sufficient phase-in period. See, e.g., 2016 Reproposal, 81 FR at 96815 (implementation timeline). 558 The nine legacy agricultural contracts currently subject to federal spot and non-spot month limits are: CBOT Corn (C), CBOT Oats (O), CBOT Soybeans (S), CBOT Wheat (W), CBOT Soybean Oil (SO), CBOT Soybean Meal (SM), MGEX Hard Red Spring Wheat (MWE), ICE Cotton No. 2 (CT), and CBOT KC Hard Red Winter Wheat (KW). 559 For clarity, limits for single and all-months combined apply separately. However, the Commission previously has applied the same limit levels to the single month and all-months combined. Accordingly, the Commission will discuss the single and all-months limits, i.e., the non-spot month limits, together. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 levels are based on 25 percent, or lower, of the estimated deliverable supply (‘‘EDS’’).560 For the existing single month and all-months combined limit levels, the levels are set at 10 percent of open interest for the first 25,000 contracts of open interest, with a marginal increase of 2.5 percent of open interest thereafter (the ‘‘10, 2.5 percent formula’’). Proposed § 150.2 would revise and expand the current federal position limits framework as follows: First, for spot month levels, proposed § 150.2 would (i) cover 16 additional physically-settled futures and related options contracts, based on the Commission’s existing approach of establishing limit levels at 25 percent or lower of EDS, for a total of 25 core referenced futures contracts subject to federal spot month limits (i.e., the nine legacy agricultural contracts plus the proposed 16 additional contracts); 561 and (ii) update the existing spot month levels for the nine legacy agricultural contracts based on revised EDS.562 Second, for non-spot month levels, proposed § 150.2 would revise the 10, 2.5 percent formula so that (i) the incremental 2.5 percent increase takes effect after 50,000 contracts of open interest, rather than after 25,000 contracts under the existing rule (the ‘‘marginal threshold level’’), and (ii) the limit levels will be calculated by applying the updated 10, 2.5 percent formula to open interest data for the periods from July 2017–June 2018 and July 2018–June 2019 of the applicable futures and delta adjusted futures options.563 560 See supra Section II.B.1—Existing § 150.2 (discussing that establishing spot month levels at 25 percent or less of EDS is consistent with past Commission practices). 561 The 16 proposed new products that would be subject to federal spot month limits would include seven agricultural (CME Live Cattle (LC), CBOT Rough Rice (RR), ICE Cocoa (CC), ICE Coffee C (KC), ICE FCOJ–A (OJ), ICE U.S. Sugar No. 11 (SB), and ICE U.S. Sugar No. 16 (SF)), four energy (NYMEX Light Sweet Crude Oil (CL), NYMEX NY Harbor ULSD Heating Oil (HO), NYMEX NY Harbor RBOB Gasoline (RB), and NYMEX Henry Hub Natural Gas (NG)), and five metals (COMEX Gold (GC), COMEX Silver (SI), COMEX Copper (HG), NYMEX Palladium (PA), and NYMEX Platinum (PL)) contracts. 562 The proposal would maintain the current spot month limits on CBOT Oats (O). 563 As discussed below, for most of the legacy agricultural commodities, this would result in a higher non-spot month limit. However, the Commission is not proposing to change the nonspot month limits for either CBOT Oats (O) or MGEX Hard Red Spring Wheat (MWE) based on the revised open interest since this would result in a reduction of non-spot month limits from 2,000 to 700 contracts for CBOT Oats (O) and 12,000 to 5,700 contracts for MGEX HRS Wheat (MWE). Similarly, the Commission also proposed to maintain the current non-spot month limit for CBOT KC Hard Red Winter Wheat (KW). PO 00000 Frm 00080 Fmt 4701 Sfmt 4702 Third, the proposed position limits framework would expand to cover (i) any cash-settled futures and related options contracts directly or indirectly linked to any of the 25 proposed physically-settled core referenced futures contracts as well as (ii) any economically equivalent swaps. For spot month positions, the proposed position limits would apply separately, net long or short, to cashsettled contracts and to physicallysettled contracts in the same commodity. This would result in a separate net long/short position for each category so that cash-settled contracts in a particular commodity would be netted with other cash-settled contracts in that commodity, and physically-settled contracts in a given commodity would be netted with other physically-settled contracts in that commodity; a cashsettled contract and a physically-settled contract would not net with one another. Outside the spot month, cash and physically-settled contracts in the same commodity would be netted together to determine a single net long/ short position. Fourth, proposed § 150.2 would subject certain pre-existing positions to federal position limits during the spot month but would grandfather certain pre-existing positions outside the spot month. In setting the federal position limit levels, the Commission seeks to advance the enumerated statutory objectives with respect to position limits in CEA section 4a(a)(3)(B).564 The Commission recognizes that relatively high limit levels may be more likely to support some of the statutory goals and less likely to advance others. For instance, a relatively higher limit level may be more likely to benefit market liquidity for hedgers or ensure that the price discovery of the underlying market is not disrupted, but may be less likely to benefit market integrity by being less effective at diminishing, eliminating, or preventing excessive speculation or at deterring and preventing market manipulation, corners, and squeezes. In particular, setting relatively high federal position limit levels may result in excessively large speculative positions and/or increased volatility, especially during speculative showdowns, which may cause some market participants to retreat from the commodities markets due to perceived decreases in market integrity. In turn, fewer market participants may result in lower liquidity levels for hedgers and harm to 564 See supra Section II.B.2.c. (for further discussion regarding the CEA’s statutory objectives for the federal position limits framework). E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 the price discovery function in the underlying markets. Conversely, setting a relatively lower federal limit level may be more likely to diminish, eliminate, or prevent excessive speculation, but may also limit the availability of certain hedging strategies, adversely affect levels of liquidity, and increase transaction costs.565 Additionally, setting federal position limits too low may cause nonexcessive speculation to exit a market, which could reduce liquidity, cause ‘‘choppy’’ 566 prices and reduced market efficiency, and increase option premia to compensate for the more volatile prices. The Commission in its discretion has nevertheless endeavored to set federal limit levels, to the maximum extent practicable, to benefit the statutory goals identified by Congress. As discussed above, the contracts that would be subject to the proposed federal limits are currently subject to either federal- or exchange-set limits (or both). To the extent that the proposed federal position limit levels are higher than the existing federal position limit levels for either the spot or non-spot month, market participants currently trading these contracts could engage in additional trading under the proposed federal limits in proposed § 150.2 that otherwise would be prohibited under existing § 150.2.567 On the other hand, to the extent an exchange-set limit level would be lower than its proposed corresponding federal limit, the proposed federal limit would not affect market participants since market participants would be required to comply with the lower exchange-set limit level (to the extent that the exchanges maintain their current levels).568 565 For example, relatively lower federal limits may adversely affect potential hedgers by reducing liquidity. In the case of reduced liquidity, a potential hedger may face unfavorable spreads and prices, in which case the hedger must choose either to delay implementing its hedging strategy and hope for more favorable spreads in the near future or to choose immediate execution (to the extent possible) at a less favorable price. 566 ‘‘Choppy’’ prices often refers to illiquidity in a market where transacted prices bounce between the bid and the ask prices. Market efficiency may be harmed in the sense that transacted prices might need to be adjusted for the bid-ask bounce to determine the fundamental value of the underlying contract. 567 For the spot month, all the legacy agricultural contracts other than CBOT Oats (O) would have higher federal levels. For the non-spot months, all the legacy agricultural contracts other than CBOT Oats (O), MGEX HRS Wheat (MWE), and CBOT KC HRW Wheat (KW), would have higher federal levels. 568 While the Commission proposes to generally either increase or maintain the federal position limits for both the spot-months and non-spot months compared to existing federal limits, where applicable, and exchange limits, the proposed VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 b. Spot Month Levels The Commission proposes to maintain 25 percent of EDS as a ceiling for federal limits. Based on the Commission’s experience overseeing federal position limits for decades and overseeing exchange-set position limits submitted to the Commission pursuant to part 40 of the Commission’s regulations, none of the proposed levels listed in Appendix E of part 150 of the Commission’s regulations appears to be so low as to reduce liquidity for bona fide hedgers or disrupt price discovery function of the underlying market, or so high as to invite excessive speculation, manipulation, corners, or squeezes because, among other things, any potential economic gains resulting from the manipulation may be insufficient to justify the potential costs, including the costs of acquiring, and ultimately offloading, the positions used to effect the manipulation. c. Levels Outside of the Spot Month i. The 10, 2.5 Percent Formula The Commission preliminarily has determined that the existing 10, 2.5 percent formula generally has functioned well for the existing nine legacy agricultural contracts and has successfully benefited the markets by taking into account the competing goals of facilitating both liquidity formation and price discovery while also protecting the markets from harmful market manipulation and excessive speculation. However, since the existing limit levels are based on open interest levels from 2009 (except for CBOT Oats (O), CBOT Soybeans (S), and ICE Cotton No. 2 (CT), for which existing levels are based on the respective open interest from 1999), the Commission is proposing to revise the levels based on the periods from July 2017–June 2018 and July 2018–June 2019 to reflect the general increases in open interest and trading volume that have occurred over time in the nine legacy agricultural contracts (other than CBOT Oats (O), MGEX HRS Wheat (MWE), and CBOT KC HRW Wheat (KW)).569 Since the federal level for COMEX Copper (HG) would be below the existing exchange-set level. Accordingly, market participants may have to change their trading behavior with respect to COMEX Copper (HG), which could impose compliance and transaction costs on these traders, to the extent their existing trading would violate the proposed lower federal limit levels. 569 For most of the legacy agricultural commodities, this would result in a higher non-spot month limit. However, the Commission is not proposing to change the non-spot month limits for either CBOT Oats (O) or MGEX HRS Wheat (MWE) based on the revised open interest since this would result in a reduction of non-spot month limits from 2,000 to 700 contracts for CBOT Oats (O) and PO 00000 Frm 00081 Fmt 4701 Sfmt 4702 11675 proposed increase for most of the federal non-spot position limits is predicated on the increase in open interest and trading volume, as reflected in the revised data reviewed by the Commission, the Commission preliminarily believes that its proposal may enhance, or at least should maintain, general liquidity, which the Commission preliminarily believes may benefit those with bona fide hedging positions, and commercial end users in general. On the other hand, the Commission understands that many market participants, especially commercial end users, generally believe that the existing non-spot month levels for the nine legacy agricultural commodities function well, including promoting liquidity and facilitating bona fide hedging in the respective markets. As a result, the Commission’s proposal may increase the risk of excessive speculation without achieving any concomitant benefits of increased liquidity for bona fide hedgers compared to the status quo. The Commission also preliminarily recognizes that there could be potential costs to keeping the existing 10, 2.5 percent formula (even if revised to reflect current open interest levels) compared to alternative formulae that would result in even higher federal position limit levels. First, while the 10, 2.5 percent formula may have reflected ‘‘normal’’ observed market activity through 1999 when the Commission adopted it, it no longer reflects current open interest figures. When adopting the 10, 2.5 percent formula in 1999, the Commission’s experience in these markets reflected aggregate futures and options open interest well below 500,000 contracts, which no longer reflects market reality.570 As the nine legacy agricultural contracts (with the exception of CBOT Oats (O)) all have open interest well above 25,000 12,000 to 5,700 contracts for MGEX HRS Wheat (MWE). Similarly, the Commission also proposed to maintain the current non-spot month limit for CBOT KC HRW Wheat (KW). See supra Section II.B.2.e. —Methodology for Setting Proposed NonSpot Month Limit Levels for further discussion. 570 See 64 FR at 24038, 24039 (May 5, 1999). As discussed in the preamble, the data show that by the 2015–2018 period, five of the nine legacy agricultural contracts had maximum open interest greater than 500,000 contracts. The contracts for CBOT Corn (C), CBOT Soybeans (S), and CBOT KC HRW Wheat (KW) saw increased maximum open interest by a factor of four to five times the maximum open interest during the years leading up to the Commission’s adoption of the 10, 2.5 percent formula in 1999. Similarly, the contracts for CBOT Soybean Meal (SM), CBOT Soybean Oil (SO), CBOT Wheat (W), and MGEX HRS Wheat (MWE) saw increased maximum open interest by a factor of three to four times. See supra Section II.B.2.e. —Methodology for Setting Proposed Non-Spot Month Limit Levels for further discussion. E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 11676 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules contracts, and in some cases above 500,000 contracts, the existing formula may act as a negative constraint on liquidity formation relative to the higher proposed formula. Further, if open interest continues to increase over time, the Commission anticipates that the existing 10, 2.5 percent formula could impose even greater marginal costs on bona fide hedgers by potentially constraining liquidity formation (i.e., as the open interest of a commodity contract increase, a greater relative proportion of the commodity’s open interest is subject to the 2.5 percent limit level rather than the initial 10 percent limit). In turn, this may increase costs to commercial firms, which may be passed to the public in the form of higher prices. Further, to the extent there may be certain liquidity constrains, the Commission has determined that this potential concern could be mitigated, at least in part, by the Commission’s proposed change to increase the marginal threshold level from 25,000 contracts to 50,000 contracts, which the Commission preliminarily believes should provide a conservative increase in the non-spot month limits for most contracts to better reflect the general increase observed in open interest across futures markets. The Commission acknowledges that the marginal threshold level could be increased above 50,000 contracts, but notes that each increase of 25,000 contracts in the marginal threshold level would only increase the permitted non-spot month level by 1,875 contracts (i.e., (10% of 25,000 contracts)—(2.5% of 25,000 contracts) = 1,875 contracts). The Commission has observed based on current data that this proposed change could benefit several market participants per legacy agricultural commodity who otherwise would bump up against the all-months and/or single month limits with based on the status quo threshold of 25,000 contracts. As a result, the Commission preliminarily has determined that changing the marginal threshold level could result in marginal benefits and costs for many of the legacy agricultural commodities, but the Commission acknowledges the proposed change is relatively minor compared to revising the existing 10, 2.5 percent formula based on updated open interest data. Second, the Commission preliminarily recognizes that an alternative formula that allows for higher non-spot limits, compared to the existing 10, 2.5 percent formula, could benefit liquidity and market efficiency by creating a framework that is more conducive to the larger liquidity VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 providers that have entered the market over time.571 Compared to when the Commission first adopted the 10, 2.5 percent formula, today there exist relatively more large non-commercial traders, such as banks, managed money traders, and swap dealers, which generally hold long positions and act as aggregators or market makers that provide liquidity to short positions (e.g., commercial hedgers).572 These dealers also function in the swaps market and use the futures market to hedge their exposures. Accordingly, to the extent that larger non-commercial market makers and liquidity providers have entered the market—particularly to the extent they are able to take offsetting positions to commercial short interests—a hypothetical alternative formula that would permit higher nonspot month limits might provide greater market liquidity, and possibly increased market efficiency, by allowing for greater market-making activities.573 However, the Commission believes that any purported benefits related to a hypothetical alternative formula that would allow for higher non-spot limits would be minimal at best. Specifically, bona fide hedgers and end users generally have not requested a revised formula to allow for significantly higher non-spot limits. Similarly, liquidity providers would still be able to maintain, and possibly increase, market making activities under the Commission’s proposal since the nonspot month limits will generally still increase under the existing 10, 2.5 percent formula to reflect the increase in open interest. Further, to the extent that the Commission’s proposal to eliminate the risk management exemption could theoretically force liquidity providers to reduce their trading activities, the Commission preliminarily believes that certain liquidity-providing activity of 571 See supra Section II.B.2.e.—Methodology for Setting Proposed Non-Spot Month Limit Levels for further discussion. 572 Id. 573 For example, the Commission is aware of several market makers that either have left particular commodity markets, or reduced their market making activities. See, e.g., McFarlane, Sarah, Major Oil Traders Don’t See Banks Returning to the Commodity Markets They Left, The Wall Street Journal (Mar. 28, 2017), available at https:// www.wsj.com/articles/major-oil-traders-dont-seebanks-returning-to-the-commodity-markets-theyleft-1490715761?mg=prod/com-wsj (describing how ‘‘Morgan Stanley sold its oil trading and storage business . . . and J.P. Morgan unloaded its physical commodities business . . . .’’); Decambre, Mark, Goldman Said to Plan Cuts to Commodity Trading Desk: WSJ, MarketWatch website (Feb. 5, 2019), https://www.marketwatch.com/story/goldman-saidto-plan-cuts-to-commodity-trading-desk-wsj-201902-05 (describing how Goldman Sachs ‘‘plans on making cuts within its commodity trading platform. . . .’’). PO 00000 Frm 00082 Fmt 4701 Sfmt 4702 the existing risk management exemption holders may still be permitted under the Commission’s proposal, either as a result of the proposed swap passthrough provision or because of the general increase in limits based on the revised open interest levels.574 The Commission also preliminarily recognizes an additional benefit to market integrity of the current proposal compared to a hypothetical alternative formula: While the Commission believes that the proposed pass-through swap provision is narrowly-tailored to enable liquidity providers to continue providing liquidity to bona fide hedgers, in contrast, an alternative formula that would allow higher limit levels for all market participants would also permit increased excessive speculation and increase the probability of market manipulation or harm the underlying price discovery function. Additionally, some have voiced general concern that permitting increased federal non-spot month limits in the nine legacy agricultural contracts (at any level), especially in connection with commodity indices, could disrupt price discovery and result in a lack of convergence between futures and cash prices, resulting in increased costs to end users, which ultimately could be borne by the public. The Commission has not seen data demonstrating this causal connection, but acknowledges arguments to that effect.575 Third, if the Commission’s proposed non-spot position limits would be too 574 See supra Section II.A.1.c.v. (preamble discussion of pass-through swap provision); see infra Section IV.A.4.b.i.(2). 575 As discussed in preamble Section II.B.2.e.— Methodology for Setting Proposed Non-Spot Month Limit Levels, one of the concerns that prompted the 2008 moratorium on granting risk management exemptions was a lack of convergence between futures and cash prices in wheat. Some at the time hypothesized that perhaps commodity index trading was a contributing factor to the lack of convergence, and, some have argued that this could harm price discovery since traders holding these positions may not react to market fundamentals, thereby exacerbating any problems with convergence. However, the Commission has determined for various reasons that risk management exemptions did not lead to the lack of convergence since the Commission understands that many commodity index traders vacate contracts before the spot month and therefore would not influence converge between the spot and futures price at expiration of the contract. Further, the risk-management exemptions granted prior to 2008 remain in effect, yet the Commission is unaware of any significant convergence problems relating to commodity index traders at this time. Additionally, there did not appear to be any convergence problems between the period when Commission staff initially granted risk management exemptions and 2007. Instead, the Commission believes that the convergence issues that started to occur around 2007 were due to the contract specification underpricing the option to store wheat for the long futures holder making the expiring futures price more valuable than spot wheat. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules high for a commodity, the proposal might be less effective in deterring excessive speculation and market manipulation for that commodity’s market. Conversely, if the Commission’s proposed position limit levels would be too low for a commodity, the proposal could unduly constrain liquidity for bona fide hedgers or result in a diminished price discovery function for that commodity’s underlying market. In either case, the Commission would view these as costs imposed on market participants. However, to the extent the Commission’s proposed non-spot limit levels could be too high, the Commission preliminarily believes these costs could be mitigated because exchanges would be able to establish lower non-spot month levels.576 Moreover, these concerns may be mitigated further to the extent that exchanges use other tools for protecting markets aside from position limits, such as establishing accountability levels below federal position limit levels or imposing liquidity and concentration surcharges to initial margin if vertically integrated with a derivatives clearing organization. Further, as discussed below, the Commission is proposing to maintain current non-spot limit levels for CBOT Oats (O), MGEX HRS Wheat (MWE), and CBOT KC HRW Wheat (KW), which otherwise would be lower based on current open interest levels for these contracts. lotter on DSKBCFDHB2PROD with PROPOSALS3 ii. Exceptions to the Proposed 10, 2.5 Percent Formula for CBOT Oats (O), MGEX Hard Red Spring Wheat (MWE), and CBOT Kansas City Hard Red Winter Wheat (KW) Based on the Commission’s experience since 2011 with non-spot 576 On the other hand, relying on exchanges may have potential costs because exchanges may have conflicting interests and therefore may not establish position limit (or accountability) levels lower than the proposed federal limits. For example, exchanges may not be incentivized to lower their limits due to competitive concerns with another exchange, or due to influence from a large customer. Conversely, exchange and Commission interests may be aligned to the extent that exchanges do have a countervailing interest to protect their markets from manipulation and price distortion: If market participants lose confidence in the contract as a tool for hedging, they will look for alternatives, possibly migrating to another product on a different exchange. The Commission is aware of at least one instance in which exchanges adopted spot-month position limits and/or adopted a lower exchange-set limit for particular futures contracts as a result of excessive manipulation and potential market manipulation. Similarly, exchanges remain subject to their core principle obligations to prevent manipulation, and the Commission conducts general market oversight through its own surveillance program. Accordingly, the Commission acknowledges such concerns about conflicting exchange incentives, but preliminarily believes that such concerns are mitigated for the foregoing reasons. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 month speculative position limit levels for MGEX HRS Wheat (‘‘MWE’’) and CBOT KC HRW Wheat (‘‘KW’’) core referenced futures contracts, the Commission is proposing to maintain the proposed limit levels for MWE and KW at the existing level of 12,000 contracts rather than reducing them to the lower level that would result from applying the proposed updated 10, 2.5 percent formula. Maintaining the status quo for the MWE and KW non-spot month limit levels would result in partial wheat parity between those two wheat contracts, but not with CBOT Wheat (‘‘W’’), which would increase to 19,300 contracts. The Commission preliminarily believes that this will benefit the MWE and KW markets since the two species of wheat are similar to one another; accordingly, decreasing the non-spot month levels for MWE could impose liquidity costs on the MWE market and harm bona fide hedgers, which could further harm liquidity or bona fide hedgers in the KW market. On the other hand, the Commission has determined not to raise the proposed limit levels for either KW or MWE to the limit level for W since the non-spot month level appears to be extraordinarily large in comparison to open interest in KW and MWE markets, and the limit level for the MWE contract is already larger than the limit level would be based on the 10, 2.5 percent formula. While W is a potential substitute for KW and MWE, it is not similar to the same extent that MWE and KW are to one another, and so the Commission has preliminarily determined that this is a reasonable compromise to maintain liquidity and price discovery while not unnecessarily inviting excessive speculation or potential market manipulation in the MWE and KW markets. Likewise, based on the Commission’s experience since 2011 with the non-spot month speculative position limit for CBOT Oats (O), the Commission is proposing the limit level at the current 2,000 contract level rather than reducing it to the lower level that would result from applying the updated 10, 2.5 formula based on current open interest. The Commission has preliminarily determined that there is no evidence of potential market manipulation or excessive speculation, and so there would be no perceived benefit to reducing the non-spot month limit for the CBOT Oats (O) contract, while reducing the level could impose liquidity costs. PO 00000 Frm 00083 Fmt 4701 Sfmt 4702 11677 d. Core Referenced Futures Contracts and Linked Referenced Contracts; Netting The definitions of the terms ‘‘core referenced futures contract’’ and ‘‘referenced contract’’ set the scope of contracts to which federal position limits apply. As discussed below, by applying the federal position limits to ‘‘referenced contracts,’’ the Commission’s proposal would expand the federal position limits beyond the proposed 25 physically-settled ‘‘core referenced futures contracts’’ listed in proposed Appendix E to part 150 by also including any cash-settled ‘‘referenced contracts’’ linked thereto as well as swaps that meet the proposed ‘‘economically equivalent swap’’ definition and thus qualify as ‘‘referenced contracts.’’ 577 i. Referenced Contracts The Commission preliminarily has determined that including futures contracts and options thereon that are ‘‘directly’’ or ‘‘indirectly linked’’ to the core referenced contracts, including cash-settled contracts, under the proposed definition of ‘‘referenced contract’’ would help prevent the evasion of federal position limits— especially during the spot month— through the creation of a financially equivalent contract that references the price of a core referenced futures contract. The Commission preliminarily has determined that this will benefit market integrity and potentially reduce costs to market participants that otherwise could result from market manipulation. The Commission also recognizes that including cash-settled contracts within the proposed federal position limits framework may impose additional compliance costs on market participants and exchanges. Further, the proposed federal position limits—especially outside the spot month—may not provide the benefits discussed above with respect to market integrity and manipulation because there is no physical delivery outside the spot month and therefore there is reduced concern for corners and squeezes. However, to the extent that there is manipulation of such non-spot, cashsettled contracts, the Commission’s authority to regulate and oversee futures and related options markets (other than through establishing federal position 577 As discussed in the preamble, the proposed position limits framework would also apply to physically-settled swaps that qualify as economically equivalent swaps. However, the Commission preliminarily believes that physicallysettled economically equivalent swaps would be few in number. E:\FR\FM\27FEP3.SGM 27FEP3 11678 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 limits) may also be effective in uncovering or preventing manipulation, especially in the non-spot cash markets, and may result in relatively lower compliance costs incurred by market participants. Similarly, the Commission preliminarily acknowledges that exchange oversight could provide the same benefit to market oversight and prevention of market manipulation, but with lower costs imposed on market participants—given the exchanges’ deep familiarity with their own markets and their ability to tailor a response to a particular market disruption—compared to federal position limits. The proposed ‘‘referenced contract’’ definition would also include ‘‘economically equivalent swaps,’’ and for the reasons discussed below would include a narrower set of swaps compared to the set of futures and options thereon that would be, under the proposed ‘‘referenced contract’’ definition, captured as either ‘‘directly’’ or ‘‘indirectly linked’’ to a core referenced futures contract.578 ii. Netting The Commission proposes to permit market participants to net positions outside the spot month in linked physically-settled and cash-settled referenced contracts, but during the spot month market participants would not be able to net their positions in cash-settled referenced contracts against their positions in physically-settled referenced contracts. The Commission preliminarily believes that its proposal would benefit liquidity formation and bona fide hedgers outside the spot months since the proposed netting rules would facilitate the management of risk on a portfolio basis for liquidity providers and market makers. In turn, improved liquidity may benefit bona fide hedgers and other end users by facilitating their hedging strategies and reducing related transaction costs (e.g., improving execution timing and reducing bid-ask spreads). On the other hand, the Commission recognizes that allowing such netting could increase transaction costs and harm market integrity by allowing for a greater possibility of market manipulation since market participants and speculators would be able to maintain larger gross positions outside the spot month. However, the Commission preliminarily has determined that such potential costs may be mitigated since concerns about corners and squeezes generally are less acute outside the spot month given there is no physical delivery involved, 578 See infra Section IV.A.3.d.iv. (discussion of economically equivalent swaps). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 and because there are tools other than federal position limits for preventing and deterring other types of manipulation, including banging the close, such as exchange-set limits and accountability and surveillance both at the exchange and federal level. Moreover, prohibiting the netting of physical and cash positions during the spot month should benefit bona fide hedgers as well as price discovery of the underlying markets since market makers and speculators would not be able to maintain a relatively large position in the physical markets by netting it against its positions in the cash markets.579 While this may increase compliance and transaction costs for speculators, it might benefit some bona fide hedgers and end users. It might also impose costs on exchanges, including increased surveillance and compliance costs and lost fees related to the trading that such market makers or speculators otherwise might engage in absent federal position limits or with the ability to their net physical and cash positions. iii. Exclusions From the ‘‘Referenced Contract’’ Definition First, while the proposed ‘‘referenced contract’’ definition would include linked contracts, it would explicitly exclude location basis contracts, which are contracts that reflect the difference between two delivery locations or quality grades of the same commodity.580 The Commission preliminarily believes that excluding location basis contracts from the ‘‘referenced contract’’ definition would benefit market integrity by preventing a trader from obtaining an extraordinarily large speculative position in the 579 Otherwise, a participant could maintain large, offsetting positions in excess of limits in both the physically-settled and cash-settled contract, which might harm market integrity and price discovery and undermine the federal position limits framework. For example, absent such a restriction in the spot month, a trader could stand for over 100 percent of deliverable supply during the spot month by holding a large long position in the physicaldelivery contract along with an offsetting short position in a cash-settled contract, which effectively would corner the market. 580 The term ‘‘location basis contract’’ generally means a derivative that is cash-settled based on the difference in price, directly or indirectly, of (1) a core referenced futures contract; and (2) the same commodity underlying a particular core referenced futures contract at a different delivery location than that of the core referenced futures contract. For clarity, a core referenced futures contract may have specifications that include multiple delivery points or different grades (i.e., the delivery price may be determined to be at par, a fixed discount to par, or a premium to par, depending on the grade or quality). The above discussion regarding location basis contracts is referring to delivery locations or quality grades other than those contemplated by the applicable core referenced futures contract. PO 00000 Frm 00084 Fmt 4701 Sfmt 4702 commodity underlying the referenced contract. Otherwise, absent the proposed exclusion, a market participant could increase its exposure in the commodity underlying the referenced contract by using the location basis contract to net down against its position in a referenced contract, and then further increase its position in the referenced contract that would otherwise by restricted by position limits. Similarly, the Commission preliminarily believes that this would reduce hedging costs for hedgers and commercial end-users, as they would be able to more efficiently hedge the cost of commodities at their preferred location without the risk of possibly hitting a position limits ceiling or incur compliance costs related to applying for a bona fide hedge related to such position. Excluding location basis contracts from the ‘‘referenced contract’’ definition also could impose costs for market participants that wish to trade location basis contracts since, as noted, such contracts would not be subject to federal limits and thus could be more easily subject to manipulation by a market participant that obtained an excessively large position. However, the Commission preliminarily believes such costs are mitigated because location basis contracts generally demonstrate less volatility and are less liquid than the core referenced futures contracts, meaning the Commission believes that it would be an inefficient method of manipulation (i.e., too costly to implement and therefore, the Commission believes that the probability of manipulation is low). Further, excluding location basis contracts from the ‘‘referenced contract’’ definition is consistent with existing market practice since the market treats a contract on one grade or delivery location of a commodity as different from another grade or delivery location. Accordingly, to the extent that the proposal is consistent with current market practice, any benefits or costs already may have been realized. Second, the Commission preliminarily has concluded that excluding commodity indices from the ‘‘referenced contract’’ definition would benefit market integrity by preventing speculators from using a commodity index contract to net down an outright position in a referenced contract that is a component of the commodity index contract, which would allow the speculator to take on large outright positions in the referenced contracts and therefore result in increased speculation, undermining the federal E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 position limits framework.581 However, the Commission preliminarily believes that its proposed exclusion could impose costs on market participants that trade commodity indices since, as noted, such contracts would not be subject to federal limits and thus could be more easily subject to manipulation by a market participant that obtained an excessively large position. The Commission preliminarily believes such costs would be mitigated because the commodities comprising the index would themselves be subject to limits, and because commodity index contracts generally tend to exhibit low volatility since they are diversified across many different commodities. Further, the Commission believes that it is possible that excluding commodity indices from the definition of ‘‘referenced contracts’’ could result in some trading shifting to commodity indices contracts, which may reduce liquidity in exchange-listed core referenced futures contracts, harm pre-trade transparency and the price discovery process in the futures markets, and further depress open interest (as volumes shift to index positions, which would not count toward open interest calculations). However, the Commission believes that the probability of this occurring is low because the Commission preliminarily believes that using indices is an inefficient means of obtaining exposure to a certain commodity. Under certain circumstances, a participant that has reached the applicable position limit could use a commodity index to purchase and weight a commodity index contract, 581 Further, the Commission believes that prohibiting the netting of a commodity index position with a referenced contract is required by its interpretation of the Dodd-Frank Act’s amendments to the CEA’s definition of ‘‘bona fide hedging transaction or position.’’ The Commission interprets the amended CEA definition to eliminate the Commission’s ability to recognize risk management positions as bona fide hedges or transactions. See infra Section IV.A.4.—Bona Fide Hedging and Spread and Other Exemptions from Federal Position Limits (proposed §§ 150.1 and 150.3) for further discussion. In this regard, the Commission has observed that it is common for swap dealers to enter into commodity index contracts with participants for which the contract would not qualify as a bona fide hedging position (e.g., with a pension fund). Failing to exclude commodity index contracts from the ‘‘referenced contract’’ definition could enable a swap dealer to use positions in commodity index contracts as a risk management hedge by netting down its offsetting outright futures positions in the components of the index. Permitting this type of risk management hedge would subvert the statutory pass-through swap language in CEA section 4a(c)(2)(B), which the Commission interprets as prohibiting the recognition of positions entered into for risk management purposes as bona fide hedges unless the swap dealer is entering into positions opposite a counterparty for which the swap position is a bona fide hedge. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 which is otherwise excluded from the ‘‘referenced contract’’ definition and therefore from federal position limits, in a manner that would allow the participant to exceed limits of the applicable referenced contract (i.e., the participant could be long outright in a referenced contract, purchase a commodity index contract that includes the applicable referenced contract as a component, and short the remaining components of the index. The Commission observes that these short positions would be subject to the proposed federal limits, so there would be a ceiling on this strategy and, in addition, it would be costly to potential manipulators because margin would have to be posted and exchanged to retain the positions. In this circumstance, excluding commodity indices from the ‘‘referenced contract’’ definition could impose costs on market integrity. However, the Commission preliminarily believes any related costs should be mitigated because proposed § 150.2 would include anti-evasion language that would deem such commodity index contract to be a referenced contract subject to federal limits. Also, analogous costs could apply to the discussion above regarding location basis contracts and such proposed anti-evasion provision would similarly cover location basis contracts.582 iv. Economically Equivalent Swaps The existing federal position limits framework does not include limit levels on swaps. The Dodd-Frank Act added CEA section 4a(a)(5), which requires that when the Commission imposes position limits on futures and options on futures pursuant to CEA section 4a(a)(2), the Commission also establish limits simultaneously for ‘‘economically equivalent’’ swaps ‘‘as appropriate.’’ 583 As the statute does not define the term ‘‘economically equivalent,’’ the Commission will apply its expertise in construing such term consistent with the policy goals articulated by Congress, including in CEA sections 4a(a)(2)(C) and 4a(a)(3) as discussed below. 582 Similarly, the proposed anti-evasion provision would also provide that a spread exemption would no longer apply. 583 CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5). In addition, CEA section 4a(a)(4) separately authorizes, but does not require, the Commission to impose federal limits on swaps that meet certain statutory criteria qualifying them as ‘‘significant price discovery function’’ swaps. 7 U.S.C. 6a(a)(4). The Commission reiterates, for the avoidance of doubt, that the definitions of ‘‘economically equivalent’’ in CEA section 4a(a)(5) and ‘‘significant price discovery function’’ in CEA section 4a(a)(4) are separate concepts and that contracts can be economically equivalent without serving a significant price discovery function. PO 00000 Frm 00085 Fmt 4701 Sfmt 4702 11679 Specifically, under the Commission’s proposed definition of ‘‘economically equivalent swap’’ set forth in proposed § 150.1, a swap would generally qualify as economically equivalent with respect to a particular referenced contract so long as the swap shares ‘‘identical material’’ contract specifications, terms, and conditions with the referenced contract, disregarding any differences with respect to lot size or notional amount, delivery dates diverging by less than one calendar day (other than for natural gas referenced contracts),584 or post-trade risk-management arrangements.585 As discussed further below, the Commission explains that the definition of ‘‘economically equivalent swaps’’ is relatively narrow, especially compared to the definition of ‘‘referenced contract’’ as applied to cash-settled look-alike contracts. The Commission preliminarily believes that the proposed definition of ‘‘economically equivalent swaps’’ would benefit (1) market integrity by protecting against excessive speculation and potential manipulation and (2) market liquidity by not favoring OTC or foreign markets over domestic markets. However, as discussed below, exchanges would be subject to delayed compliance with respect to the proposed § 150.5 requirements regarding exchange-set speculative position limits on swaps until such time that exchanges have access to sufficient data to monitor for limits on swaps across exchanges; as a result, exchangeset limits would not need to include, nor would exchanges be required to oversee, compliance with exchange-set position limits on swaps until such time. (1) Benefits and Costs Related to Market Integrity The Commission preliminarily believes that the proposed definition will benefit market integrity in two ways. First, the proposed definition would protect against excessive speculation and potential market manipulation by limiting the ability of speculators to obtain excessive positions through netting. For example, a more inclusive ‘‘economically equivalent’’ definition that would encompass additional swaps (e.g., swaps that may differ in their ‘‘material’’ terms or physical swaps with delivery dates that 584 As discussed below, the proposed definition of ‘‘economically equivalent swaps’’ with respect to natural gas referenced contracts would contain the same terms, except that it would include delivery dates diverging by less than two calendar days. 585 See supra Section II.A.4. (for further discussion regarding the Commission’s proposed definition of ‘‘economically equivalent swap’’). E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 11680 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules diverge by one day or more) could make it easier for market participants to inappropriately net down against their referenced contracts by allowing market participants to structure swaps that do not necessarily offer identical risk or economic exposure or sensitivity. In such a case, a market participant could enter into an OTC swap with a maturity that differs by days or even weeks in order to net down this position against its position in a referenced contract, enabling it to hold an even greater position in the referenced contract. Similarly, requiring ‘‘economically equivalent swaps’’ to share all material terms with their corresponding referenced contracts benefits market integrity by preventing market participants from escaping the position limits framework merely by altering non-material terms, such as holiday conventions. On the other hand, the Commission recognizes that such a narrow definition could impose costs on the marketplace by possibly permitting excessive speculation since market participants would not be subject to federal position limits if they were to enter into swaps that may have different material terms (e.g., penultimate swaps) 586 but may nonetheless be sufficiently correlated to their corresponding referenced contract. In this case, it is possible that there may be potential for excessive speculation, market manipulation such as squeezes and corners, insufficient market liquidity for bona fide hedgers, or disruption to the price discovery function. Nonetheless, to the extent that swaps currently are not subject to federal position limit levels, such potential costs would remain unchanged compared to the status quo. Second, the relatively narrow proposed definition benefits market integrity, and reduces associated compliance and implementation costs, by permitting exchanges, market participants, and the Commission to focus resources on those swaps that pose the greatest threat for facilitating corners and squeezes—that is, those swaps with substantially identical delivery dates and material economic terms to futures and options on futures subject to federal position limits. While swaps that have different material terms than their corresponding referenced contracts, including different delivery dates, may potentially be used for engaging in market manipulation, the 586 Or, in the case of natural gas referenced contracts, which would potentially include penultimate swaps as economically equivalent swaps, a swap with a maturity of less than one day away from the penultimate swap. See infra Section IV.A.3.d.iv.(3) (discussion of natural gas swaps). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 proposed definition would benefit market integrity by allowing exchanges and the Commission to focus on the most sensitive period of the spot month, including with respect to the Commission’s and exchanges’ various surveillance and enforcement functions. To the extent market participants would be able to use swaps that would not be covered by the proposed definition to effect market manipulation, such potential costs would not differ from the status quo since no swaps are currently covered by federal position limits. The Commission however acknowledges that its narrow definition may increase this cost, as fewer swaps will be covered under the limits. Further, the proposal to delay compliance with respect to exchange-set limits on swaps will benefit exchanges by facilitating exchanges’ ability to establish surveillance and compliance systems. As noted above, exchanges currently lack sufficient data regarding individual market participants’ open swap positions, which means that requiring exchanges to establish oversight over participants’ positions currently could impose substantial costs and also may be impractical to achieve. As a result, the Commission has preliminarily determined that allowing exchanges delayed compliance with respect to swaps would reduce unnecessary costs. Nonetheless, the Commission’s preliminary determination to permit exchanges to delay implementing federal position limits on swaps could incentivize market participants to leave the futures markets and instead transact in economically-equivalent swaps, which could reduce liquidity in the futures and related options markets, although the Commission recognizes that this concern should be mitigated by the reality that the Commission would still oversee and enforce federal position limits on economically equivalent swaps. Additionally, while futures and related options are subject to clearing and exchange oversight, economically equivalent swaps may be transacted bilaterally off-exchange (i.e., OTC swaps). As a result, it is relatively easy to create customized OTC swaps that may be highly correlated to a referenced contract, which would allow the market participant to create an exposure in the underlying commodity similar to the referenced contract’s exposure. Due to the relatively narrow proposed ‘‘economically equivalent swap’’ definition, the Commission preliminarily believes that it would not be difficult for market participants to avoid federal position limits by entering PO 00000 Frm 00086 Fmt 4701 Sfmt 4702 into such OTC swaps.587 While such swaps may not be perfectly correlated to their corresponding referenced contracts, market participants may find this risk acceptable in order to avoid federal position limits. An increase in OTC swaps at the expense of futures and options contracts may impose costs on market integrity due to lack of exchange oversight. If liquidity were to move from futures exchanges to the OTC swaps markets, non-dealer commercial entities may face increased transaction costs and widening spreads, as swap dealers gain market power in the OTC market relative to centralized exchange trading. The Commission is unable to quantify the costs of these potential harms. However, while the Commission acknowledges these potential costs, such costs to those contracts that already have limits on them already may have been realized in the marketplace because swaps are not subject to federal position limits under the status quo. Lastly, under this proposal, market participants would be able to determine whether a particular swap satisfies the definition of ‘‘economically equivalent swap,’’ as long as market participants make a reasonable, good faith effort in reaching their determination and are able to provide sufficient evidence, if requested, to support a reasonable, good faith effort. The Commission preliminarily anticipates that this flexibility will benefit market integrity by providing a greater level of certainty to market participants in contrast to the alternative in which market participants would be required to first submit swaps to the Commission staff and wait for feedback or approval. On the other hand, the Commission also recognizes that not having the Commission explicitly opine on whether a swap would qualify as economically equivalent could cause market participants to avoid entering into such swaps. In turn, this could lead to less efficient hedging strategies if the market participant is forced to turn to the futures markets (e.g., a market participant may choose to transact in the OTC swaps markets for various reasons, including liquidity, margin requirements, or simply better familiarity with ISDA and swap processes over exchange-traded futures). However, as noted below, the Commission reserves the right to declare 587 In contrast, since futures and options on futures contracts are created by exchanges and submitted to the Commission for either selfcertification or approval under part 40 of the Commission’s regulations, a market participant would not be able to customize an exchange-traded futures or options on futures contract. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules whether a swap or class of swaps is or is not economically equivalent, and a market participant could petition, or request informally, that the Commission make such a determination, although the Commission acknowledges that there could be costs associated with this, including delayed timing and monetary costs. Further, the Commission recognizes that requiring market participants to conduct reasonable due diligence and maintain related records also could impose new compliance costs. Additionally, the Commission recognizes that certain market participants could assert that an OTC swap is (or is not) ‘‘economically equivalent’’ depending upon whether such determination benefits the market participant. In such a case, market participants could theoretically subvert the intent of the federal position limits framework, although the Commission preliminarily believes that such potential costs would be mitigated due to its surveillance functions and the proposal to reserve the authority to declare that a particular swap or class of swaps either would or would not qualify as economically equivalent. lotter on DSKBCFDHB2PROD with PROPOSALS3 (2) The Proposed Definition Could Increase Benefits or Costs Related to Market Liquidity First, the proposed definition could benefit market liquidity by being, in general, less disruptive to the swaps markets, which in turn may reduce the potential for disruption for the price discovery function compared to an alternative in which the Commission would proposed a broader definition. For example, if the Commission were to adopt an alternative to its proposed ‘‘economically equivalent swap’’ definition that encompassed a broader range of swaps by including, for example, delivery dates that diverge by one or more calendar days—perhaps by several days or weeks—a speculator with a large portfolio of swaps could more easily bump up against the applicable position limits and therefore would have a strong incentive either to reduce its swaps activity or move its swaps activity to foreign jurisdictions. If there were many similarly situated speculators, the market for such swaps could become less liquid, which in turn could harm liquidity for bona fide hedgers as large liquidity providers could move to other markets. Second, the proposed definition could benefit market liquidity by being sufficiently narrow to reduce incentives for liquidity providers to move to foreign jurisdictions, such as the VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 European Union (‘‘EU’’).588 Additionally, the Commission preliminarily believes that proposing a definition similar to that used by the EU will benefit international comity.589 Further, since market participants trading in both U.S. and EU markets would find the proposed definition to be familiar, it may help reduce compliance costs for those market participants that already have systems and personnel in place to identify and monitor such swaps. (3) The Proposed Definition Could Create Benefits or Costs Related to Market Liquidity for the Natural Gas Market As discussed in greater detail in the preamble, the Commission recognizes that the market dynamics in natural gas 588 In this regard, the proposed definition is similar in certain ways to the EU definition for OTC contracts that are ‘‘economically equivalent’’ to commodity derivatives traded on an EU trading venue. The applicable European regulations define an OTC derivative to be ‘‘economically equivalent’’ when it has ‘‘identical contractual specifications, terms and conditions, excluding different lot size specifications, delivery dates diverging by less than one calendar day and different post trade risk management arrangements.’’ While the Commission’s proposed definition is similar, the Commission’s proposed definition requires ‘‘identical material’’ terms rather than simply ‘‘identical’’ terms. Further, the Commission’s proposed definition excludes different ‘‘lot size specifications or notional amounts’’ rather than referencing only ‘‘lot size’’ since swaps terminology usually refers to ‘‘notional amounts’’ rather than to ‘‘lot sizes.’’ See EU Commission Delegated Regulation (EU) 2017/591, 2017 O.J. (L 87). 589 Both the Commission’s definition and the applicable EU regulation are intended to prevent harmful netting. See European Securities and Markets Authority, Draft Regulatory Technical Standards on Methodology for Calculation and the Application of Position Limits for Commodity Derivatives Traded on Trading Venues and Economically Equivalent OTC Contracts, ESMA/ 2016/668 at 10 (May 2, 2016), available at https:// www.esma.europa.eu/sites/default/files/library/ 2016-668_opinion_on_draft_rts_21.pdf (‘‘[D]rafting the [economically equivalent OTC swap] definition in too wide a fashion carries an even higher risk of enabling circumvention of position limits by creating an ability to net off positions taken in onvenue contracts against only roughly similar OTC positions.’’) The applicable EU regulator, the European Securities and Markets Authority (‘‘ESMA’’), recently released a ‘‘consultation paper’’ discussing the status of the existing EU position limits regime and specific comments received from market participants. According to ESMA, no commenter, with one exception, supported changing the definition of an economically equivalent swap (referred to as an ‘‘economically equivalent OTC contract’’ or ‘‘EEOTC’’). ESMA further noted that for some respondents, ‘‘the mere fact that very few EEOTC contracts have been identified is no evidence that the regime is overly restrictive.’’ See European Securities and Markets Authority, Consultation Paper MiFID Review Report on Position Limits and Position Management Draft Technical Advice on Weekly Position Reports, ESMA70–156–1484 at 46, Question 15 (Nov. 5, 2019), available at https://www.esma.europa.eu/ document/consultation-paper-position-limits. PO 00000 Frm 00087 Fmt 4701 Sfmt 4702 11681 are unique in several respects, including the fact that unlike with respect to other core referenced futures contracts, for natural gas relatively liquid spot-month and penultimate cash-settled futures exist. As a result, the Commission believes that creating an exception to the proposed ‘‘economically equivalent swap’’ definition for natural gas would benefit market liquidity by not unnecessarily favoring existing penultimate contracts over spot contracts. The Commission is especially sensitive to potential market manipulation in the natural gas markets since market participants—to a significantly greater extent compared to the other core referenced futures contracts that are included in the proposal—regularly trade in both the physically-settled core referenced futures contract and the cash-settled look-alike referenced contracts. Accordingly, the Commission preliminarily has concluded that a slightly broader definition of ‘‘economically equivalent swap’’ would uniquely benefit the natural gas markets by helping to deter and prevent manipulation of a physically-settled contract to benefit a related cash-settled contract. e. Pre-Existing Positions Proposed § 150.2(g) would impose federal limits on ‘‘pre-existing positions’’—other than pre-enactment swaps and transition period swaps— during the spot month, while non-spot month pre-existing positions would not be subject to position limits as long as (i) the position was acquired in good faith consistent with the ‘‘pre-existing position’’ definition in proposed § 150.1; 590 and (ii) such position would be attributed to the person if the position increases after the limit’s effective date. The Commission believes that this approach would benefit market integrity since pre-existing positions (other than pre-enactment and transition period swaps) that exceed spot-month limits could result in market or price disruptions as positions are rolled into the spot month.591 However, the Commission acknowledges that the proposed ‘‘good-faith’’ standard also could impose certain costs on market integrity since an inherently subjective ‘‘good faith’’ standard could result in disparate treatment of traders by a 590 Proposed § 150.1 would define ‘‘pre-existing position’’ to mean ‘‘any position in a commodity derivative contract acquired in good faith prior to the effective date’’ of any applicable position limit. 591 The Commission is particularly concerned about protecting the spot month in physicaldelivery futures from corners and squeezes. E:\FR\FM\27FEP3.SGM 27FEP3 11682 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules particular exchange or across exchanges seeking a competitive advantage with one another and could impose trading costs on those traders given less advantageous treatment. For example, the Commission acknowledges that since it has given discretion to an exchange in interpreting this ‘‘good faith’’ standard, an exchange may be more liberal with concluding that a large trader or influential exchange member obtained a position in ‘‘good faith.’’ As a result, the proposal could potentially harm market integrity and/or increase transaction costs if an exchange were to benefit certain market participants compared to other market participants that receive relatively less advantageous treatment. However, the Commission believes the risk of any unscrupulous trader or exchange is mitigated since exchanges continue to be subject to Commission oversight and to DCM Core Principles 4 (‘‘prevention of market disruption’’) and 12 (‘‘protection of markets and market participants’’), among others, and since proposed § 150.2(g)(2) also would require that exchanges must attribute the position to the trader if its position increases after the position limit’s effective date. 4. Bona Fide Hedging and Spread and Other Exemptions From Federal Position Limits (Proposed §§ 150.1 and 150.3) lotter on DSKBCFDHB2PROD with PROPOSALS3 a. Background The proposal provides for several exemptions that, subject to certain conditions, would permit a trader to exceed the applicable federal position limit set forth under proposed § 150.2. Specifically, proposed § 150.3 would generally maintain, with certain modifications discussed below, the two existing federal exemptions for bona fide hedging positions and spread positions, and would include new federal exemptions for certain conditional spot month positions in natural gas, certain financial distress positions, and pre-enactment and transition period swaps. Proposed § 150.1 would set forth the proposed definitions for ‘‘bona fide hedging transactions or positions’’ and for ‘‘spread transactions.’’ 592 592 This discussion sometimes refers to the ‘‘bona fide hedging transactions or positions’’ definition as ‘‘bona fide hedges,’’ ‘‘bona fide hedging,’’ or ‘‘bona fide hedge positions.’’ For the purpose of this discussion, the terms have the same meaning. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 b. Bona Fide Hedging Definition; Enumerated Bona Fide Hedges; and Guidance on Measuring Risk The Commission is proposing several amendments related to bona fide hedges. First, the Commission is proposing to include a revised definition of ‘‘bona fide hedging transactions or positions’’ in § 150.1 to conform to the statutory bona fide hedge definition in CEA section 4a(c) as Congress amended it in the Dodd-Frank Act. As discussed in greater detail in the preamble, the Commission proposes to (1) revise the temporary substitute test, consistent with the Commission’s understanding of the Dodd-Frank Act’s amendments to section 4a of the CEA, to no longer recognize as bona fide hedges certain risk management positions; (2) revise the economically appropriate test to make explicit that the position must be economically appropriate to the reduction of ‘‘price risk’’; and (3) eliminate the incidental test and orderly trading requirement, which Dodd-Frank removed from section 4a of the CEA. The Commission preliminarily believes that these changes include non-discretionary changes that are required by Congress’s amendments to section 4a of the CEA. The Commission also proposes to revise the bona fide hedge definition to conform to the CEA’s statutory definition, which permits certain passthrough offsets.593 Second, the Commission would maintain the distinction between enumerated and non-enumerated bona fide hedges but would (1) move the currently-enumerated hedges in the existing definition of ‘‘bona fide hedging transactions and positions’’ currently found in Commission regulation § 1.3 to proposed Appendix A in part 150 that will serve as examples of positions that would comply with the proposed bona fide hedging definition; and (2) propose to make all existing enumerated bona fide hedges as well as additional enumerated hedges to be selfeffectuating for federal position limit purposes, without the need for prior Commission approval. In contrast, the existing enumerated anticipatory bona fide hedges are not currently selfeffectuating and require market participants to apply to the Commission for recognition. Third, the Commission is proposing guidance with respect to whether an 593 As discussed in Section II.A.—§ 150.1— Definitions of the preamble, the existing definition of ‘‘bona fide hedging transactions and positions’’ currently appears in § 1.3 of the Commission’s regulations; the proposal would move the revised definition to proposed § 150.1. PO 00000 Frm 00088 Fmt 4701 Sfmt 4702 entity may measure risk on a net or gross basis for purposes of determining its bona fide hedge positions. The Commission expects these proposed modifications will provide market participants with the ability to hedge, and exchanges with the ability to recognize hedges, in a manner that is consistent with common commercial hedging practices, reducing compliance costs and increase the benefits associated with sound risk management practices. i. Bona Fide Hedging Definition (1) Elimination of Risk Management Exemptions; Addition of the Proposed Pass-Through Swap Exemption First, the Commission has preliminarily determined that eliminating the risk-management exemption in physical commodity derivatives subject to federal speculative position limits, unless the position satisfies the pass-through/swap offset requirements in section 4a(c)(2)(B) of the CEA discussed further below, is consistent with Congressional and statutory intent, as evidenced by the Dodd-Frank Act’s amendments to the bona fide hedging definition in CEA section 4a(c)(2).594 Accordingly, once the proposed federal limit levels go into effect, market participants with positions that do not otherwise satisfy 594 See supra Section II.A.1.c.ii.(1). The existing bona fide hedging definition in § 1.3 requires that a position must ‘‘normally’’ represent a substitute for transactions or positions made at a later time in a physical marketing channel (i.e., the ‘‘temporary substitute test’’). The Dodd-Frank Act amended the temporary substitute language that previously appeared in the statute by removing the word ‘‘normally’’ from the phrase normally represents a substitute for transactions made or to be made or positions taken or to be taken at a later time in a physical marketing channel.’’ 7 U.S.C. 6a(c)(2)(A). The Commission preliminarily interprets this change as reflecting Congressional direction that a bona fide hedging position in physical commodities must always (and not just ‘‘normally’’) be in connection with the production, sale, or use of a physical cash-market commodity. Previously, the Commission stated that, among other things, the inclusion of the word ‘‘normally’’ in connection with the pre-Dodd-Frank version of the temporary substitute language indicated that the bona fide hedging definition should not be construed to apply only to firms using futures to reduce their exposures to risks in the cash market, and that to qualify as a bona fide hedge, a transaction in the futures market did not need to be a temporary substitute for a later transaction in the cash market. See Clarification of Certain Aspects of the Hedging Definition, 52 FR at 27195, 27196 (Jul. 20, 1987). In other words, that 1987 interpretation took the view that a futures position could still qualify as a bona fide hedging position even if it was not in connection with the production, sale, or use of a physical commodity. Accordingly, based on the Commission’s preliminary interpretation of the revised statutory definition of bona fide hedging in CEA section 4a(c)(2), risk-management hedges would not be recognized under the Commission’s proposed bona fide hedging definition. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 the proposed bona fide hedging definition or qualify for an exemption would no longer be able to rely on recognition of such risk-reducing techniques as bona fide hedges. Absent other factors, market participants who have, or have requested, a risk management exemption under the existing definition may resort to less effective hedging strategies resulting in, for example, increased costs for liquidity providers due to increased basis risk and/or decreased market efficiency due to higher transaction (i.e., hedging) costs. Moreover, absent other factors, by excluding risk management positions from the bona fide hedge definition (other than those positions that would meet the pass-through/swap offset requirement in the proposed bona fide hedge definition, discussed further below), the proposed definition may affect the overall level of liquidity in the market since dealers who approach or exceed the federal position limit may decide to pull back on providing liquidity, including to bona fide hedgers. On the other hand, the Commission believes that these potential costs could be mitigated for several reasons. First, the proposed bona fide hedging definition, consistent with the DoddFrank Act’s changes to CEA section 4a(c)(2), would permit the recognition as bona fide hedges of futures and options on futures positions that offset pass-through swaps entered into by dealers and other liquidity providers (the ‘‘pass-through swap counterparty’’) 595 opposite bona fide hedging swap counterparties (the ‘‘bona fide hedge counterparty’’), as long as: (1) The pass-through swap counterparty can demonstrate, upon request from the Commission and/or from an exchange, that the pass-through swap qualifies as a bona fide hedge for the bona fide hedge counterparty; and (2) the passthrough swap counterparty enters into a futures or option on a futures position or a swap position, in each case in the same physical commodity as the passthrough swap to offset and reduce the price risk attendant to the pass-through swap.596 Accordingly, a subset of risk 595 Such pass-through swap counterparties are typically swap dealers providing liquidity to bona fide hedgers. 596 See paragraph (2)(i) of the proposed bona fide hedging definition. Of course, if the pass-through swap qualifies as an ‘‘economically appropriate swap,’’ then the pass-through swap counterparty would not need to rely on the proposed passthrough swap provision since it may be able to offset its long (or short) position in the economically equivalent swap with the corresponding short (or long) position in the futures or option on futures position or on the opposite side of another economically equivalent swap. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 management exemption holders could continue to benefit from an exemption, and potential counterparties could benefit from the liquidity they provide, as long as the position being offset qualifies as a bona fide hedge for the counterparty. The Commission preliminarily has determined that any resulting costs or benefits related to the proposed passthrough swap exemption are a result of Congress’s amendments to CEA section 4a(c) rather than the Commission’s discretionary action. On the other hand, the Commission’s discretionary action to require the pass-through swap counterparty to create and maintain records to demonstrate the bona fides of the pass-through swap would cause the swap counterparty to incur marginal recordkeeping costs.597 The proposed pass-through swap provision, consistent with the DoddFrank Act’s changes to CEA section 4a(c)(2), also would address a situation where a participant who qualifies as a bona fide hedging swap counterparty (i.e., a participant with a position in a previously-entered into swap that qualified, at the time the swap was entered into, as a bona fide hedging position under the proposed definition) seeks, at some later time, to offset that swap position.598 Such step might be taken, for example, to respond to a change in the participant’s risk exposure in the underlying commodity. As a result, a participant could use futures or options on futures in excess of federal position limits to offset the price risk of a previously-entered into swap, which would allow the participant to exceed federal limits using either new futures or options on futures or swap positions that reduce the risk of the original swap. The Commission expects the passthrough swap provision to facilitate dynamic hedging by market participants. The Commission recognizes that a significant number of market participants use dynamic hedging to more effectively manage their portfolio risks. Therefore, this provision may increase operational efficiency. In addition, by permitting dynamic hedging, a greater number of dealers should be better able to provide liquidity to the market, as these dealers will be able to more effectively manage their risks by entering into pass-through swaps with bona fide hedgers as 597 To the extent that the pass-through swap counterparty is a swap dealer or major swap participant, they already may be subject to similar recordkeeping requirements under § 1.31 and part 23 of the Commission’s regulations. As a result, such costs may already have been realized. 598 See paragraph (2)(ii) of the proposed bona fide hedging transactions or positions definition. PO 00000 Frm 00089 Fmt 4701 Sfmt 4702 11683 counterparties. Moreover, market participants are not precluded from using swaps that are not ‘‘economically equivalent swap’’ for such risk management purposes since swaps that are not deemed to be ‘‘economically equivalent’’ to a referenced contract would not be subject to the Commission’s proposed position limits framework. The Commission preliminarily observes that market participants may not need to rely on the proposed passthrough swap provision to the extent such parties employ swaps that qualify as ‘‘economically equivalent swaps,’’ since such market participants may be able to net such swaps against the corresponding futures or options on futures. As a result, the Commission preliminarily anticipates that the proposed pass-through swap provision would benefit those bona fide hedgers and pass-through swap counterparties that use swaps that would not qualify as economically equivalent under the Commission’s proposal. To the extent market participants use swaps that would qualify as economically equivalent swaps, or could shift their trading strategies to use such swaps without incurring additional costs, the Commission preliminarily believes that the elimination of the risk management position would not necessarily result in market participants incurring costs or limiting their trading since they would be able to net the positions in economically equivalent swaps with their futures and options on futures positions, or with other economically equivalent swaps. Second, for the nine legacy agricultural contracts, the proposal would generally set federal non-spot month limit levels higher than existing non-spot limits, which may enable additional dealer activity described above.599 The remaining 16 core referenced futures contracts would be subject to existing exchange-set limits or accountability outside of the spot month, which does not represent a change from the status quo under existing or proposed § 150.5. The proposed higher levels with respect to the nine legacy agricultural contracts and the exchanges’ flexible accountability regimes with respect to the proposes new 16 core referenced futures contract should mitigate at least some potential costs related to the 599 Proposed § 150.2 generally would increase position limits for non-spot months for contracts that currently are subject to the federal position limits framework other than for CBOT Oats (O), CBOT KC HRW Wheat (KW), and MGEX HRS Wheat (MWE), for which the Commission would maintain existing levels. E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 11684 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules prohibition on recognizing risk management positions as bona fide hedges. Third, the proposal may improve market competitiveness and reduce transaction costs. As noted above, existing holders of the risk management exemption, and the levels permitted thereunder, are currently confidential, and the Commission is no longer granting new risk management exemptions to potential new liquidity providers. Accordingly, by eliminating the risk management exemption, the Commission’s proposal would benefit the public and strengthen market integrity by improving market transparency since certain dealers would no longer be able to maintain the grandfathered risk management exemption while other dealer lack this ability under the status quo. While the Commission believes that the risk management exemption may allow dealers to more effectively provide market making activities, which benefits market liquidity and ultimately leads to lower prices for end-users, as noted above, the potential costs resulting from removing the risk management exemption may be mitigated by the revised position limit levels that reflect current EDS for spot month levels and current open interest and trading volume for non-spot month levels. Therefore, the Commission believes that existing risk management exemption holders should be able to continue providing liquidity to bona fide hedgers, but acknowledges that some may not to the same degree as under the exemption; however, the Commission believes that any potential harm to liquidity should be mitigated. Further, the proposed spot month and non-spot month levels, which generally will be higher than the status quo, together with the elimination of the risk management exemptions that benefit only certain dealers, might enable new liquidity providers to enter the markets on a level playing field with the existing risk management exemption holders. With the possibility of additional liquidity providers, the proposed framework may strengthen market integrity by decreasing concentration risk potentially posed by too few market makers. However, the benefits to market liquidity the Commission describes above may be muted since this analysis is predicated, in part, on the understanding that dealers are the predominant large traders. Data in the Commission’s Supplementary COT and its underlying data indicate that riskmanagement exemption holders are not the only large participants in these markets—large commercial firms also VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 hold large positions in such commodities. (2) Limiting ‘‘Risk’’ to ‘‘Price’’ Risk; Elimination of the Incidental Test and Orderly Trading Requirement As discussed in the preamble, the proposed bona fide hedging definition’s ‘‘economically appropriate test’’ would clarify that only hedges that offset price risks could be recognized as bona fide hedging transactions or positions. The Commission does not believe that this clarification would impose any new costs or benefits, as it is consistent with both the existing bona fide hedging definition 600 as well as the Commission’s longstanding policy.601 Nonetheless, the Commission realizes that hedging occurs for more types of risks than price (e.g., volumetric hedging). Therefore, the Commission recognizes that by expressly limiting the bona fide hedge exemption to hedging only price risk, certain market participants may not be able to receive a bona fide hedging recognition, and for certain dealers, this may limit their ability to provide liquidity to the market because without being able to rely on bona fide hedging status, their trading activity would cause them to otherwise exceed federal limits. The Commission further would implement Congress’s Dodd-Frank Act amendments that eliminated the statutory bona fide hedge definition’s incidental test and orderly trading requirement by proposing to make the same changes to the Commission’s regulations. As discussed in the preamble, the Commission preliminarily believes that these proposed changes do not represent a change in policy or regulatory requirement. As a result, the Commission does not identify any costs or benefits related to these proposed changes. 600 The existing bona fide hedging definition in § 1.3 provides that no transactions or positions shall be classified as bona fide hedging unless their purpose is to offset price risks incidental to commercial cash or spot operations. (emphasis added). Accordingly, the proposed definition would merely move this requirement to the proposed definition’s revised ‘‘economically appropriate test’’ requirement. 601 For example, in promulgating existing § 1.3, the Commission explained that a bona fide hedging position must, among other things, ‘‘be economically appropriate to risk reduction, such risks must arise from operation of a commercial enterprise, and the price fluctuations of the futures contracts used in the transaction must be substantially related to fluctuations of the cash market value of the assets, liabilities or services being hedged.’’ Bona Fide Hedging Transactions or Positions, 42 FR at 14832, 14833 (Mar. 16, 1977). Dodd-Frank added CEA section 4a(c)(2), which copied the ‘‘economically appropriate test’’ from the Commission’s definition in § 1.3. See also 2013 Proposal, 78 FR at 75702, 75703. PO 00000 Frm 00090 Fmt 4701 Sfmt 4702 ii. Proposed Enumerated Bona Fide Hedges The Commission proposes enumerated bona fide hedges in Appendix A to part 150 of the Commission’s regulations to provide a list bona fide hedges that would include: (i) The existing enumerated hedges; and (ii) additional enumerated bona fide hedges. The Commission reinforces that hedging practices not otherwise listed may still be deemed, on a case-by-case basis, to comply with the proposed bona fide hedging definition (i.e., non-enumerated bona fide hedges). As discussed further below, the proposed enumerated bona fide hedges in Appendix A would be ‘‘selfeffectuating’’ for purposes of federal position limits levels, which are expected to reduce delays and compliance costs associated with requesting an exemption. Additionally, as part of the Commission’s proposal, the exchanges would have discretion to determine, for purposes of their own exchange-granted bona fide hedges, whether any of the proposed enumerated bona fide hedges in proposed Appendix A to part 150 of the Commission’s regulations would be permitted to be maintained during the lesser of the last five days of trading or the time period for the spot month in such contract (the ‘‘five-day rule’’), and the Commission’s proposal otherwise would not require any of the enumerated bona fide hedges to be subject to the five-day rule for purposes of federal position limits. Instead, the Commission expects exchanges to make their own determinations with respect to exchange-set limits as to whether it is appropriate to apply the five-day rule for a particular bona fide hedge type and commodity contract. The Commission has preliminarily determined that exchanges are well-informed with respect to their respective markets and well-positioned to make a determination with respect to imposing the five-day rule in connection with recognizing bona fide hedges for their respective commodity contracts. In general, the Commission believes that, on the one hand, limiting a trader’s ability to establish a position in this manner by requiring the five-day rule could result in increased costs related to operational inefficiencies, as a trader may believe that this is the most opportune time to hedge. On the other hand, the Commission believes that price convergence may be particularly sensitive to potential market manipulation or excessive speculation during this period. Accordingly, the Commission preliminarily believes that E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules the proposal to not impose the five-day rule with respect to any of the enumerated bona fide hedges for federal purposes but instead rely on exchange’s determination with respect to exchangegranted exemptions would help to better optimize these considerations. The Commission notes a potential cost for market integrity if exchanges fail to implement a five-day rule in order to encourage additional trading in order to increase profit, which could harm price convergence. However, the Commission believes this concern is mitigated since exchanges also have an economic incentive to ensure that price convergence occurs with their respective contracts since commercial end-users would be less willing to use such contracts for hedging purposes if price convergence would fail to occur in such contracts as they may generally desire to hedge cash market prices with futures contracts. lotter on DSKBCFDHB2PROD with PROPOSALS3 iii. Guidance for Measuring Risk on a Gross or Net Basis The Commission proposes guidance in paragraph (a) of Appendix B to part 150 on whether positions may be hedged on either a gross or net basis. Under the proposed guidance, among other things, a trader may measure risk on a gross basis if it would be consistent with the trader’s historical practice and is not intended to evade applicable limits. The key cost associated with allowing gross hedging is that it may provide opportunity for hidden speculative trading.602 Such risk is mitigated to a certain extent by the guidance’s provisos that the trader does not switch between net hedging and gross hedging in order to evade limits and that the DCM documents justifications for allowing gross hedging and maintains any relevant records in accordance with proposed § 150.9(d).603 However, the Commission also recognizes that there are myriad of ways in which organizations are structured and engage in commercial hedging practices, including the use of multi-line business strategies in certain industries that 602 For example, using gross hedging, a market participant could potentially point to a large long cash position as justification for a bona fide hedge, even though the participant, or an entity with which the participant is required to aggregate, has an equally large short cash position that would result in the participant having no net price risk to hedge as the participant had no price risk exposure to the commodity prior to establishing such derivative position. Instead, the participant created price risk exposure to the commodity by establishing the derivative position. 603 Under proposed § 150.3(b)(2) and (e) and proposed § 150.9(e)(5), and (g), the Commission would have access to any information related to the applicable exemption request. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 would be subject to federal position limits for the first time under this proposal and for which net hedging could impose significant costs or be operationally unfeasible. c. Spread Exemptions Under existing § 150.3, certain spread exemptions are self-effectuating. Specifically, existing § 150.3 allows for ‘‘spread or arbitrage positions’’ that are ‘‘between single months of a futures contract and/or, on a futures-equivalent basis, options thereon, outside of the spot month, in the same crop year; provided, however, that such spread or arbitrage positions, when combined with any other net positions in the single month, do not exceed the allmonths limit set forth in § 150.2.’’ 604 Proposed §§ 150.1 and 150.3 would amend the existing spread position exemption for federal limits by (i) listing specific spread transactions that may be granted; and (ii) other than for the listed spread positions, which would be selfeffectuating, requiring a person to apply for spread exemptions directly with the Commission pursuant to proposed § 150.3.605 In addition, the proposed rule would permit spread exemptions outside the same crop year and/or during the spot month.606 In connection with the spread exemption provisions, the Commission is relaxing the prohibition for contracts during the same crop year and/or the spot month so that exchanges are able to exempt spreads outside the same crop year and/or during the spot month. There may be benefits that result from permitting these types of spread exemptions. For example, the Commission believes that permitting spread exemptions not in the same crop year or during the spot month may 604 17 CFR 150.3. CEA section 4a(a)(1) provides the Commission with authority to exempt from position limits transactions ‘‘normally known to the trade’’ as ‘‘spreads’’ or ‘‘straddles’’ or ‘‘arbitrage’’ or to fix limits for such transactions or positions different from limits fixed for other transactions or positions. 605 The proposed ‘‘spread transactions’’ definition would list the most common types of spread positions, including: Calendar spreads, intercommodity spreads, quality differential spreads, processing spreads (such as energy ‘‘crack’’ or soybean ‘‘crush’’ spreads), product or by-product differential spreads, and futures-options spreads. Proposed § 150.3(b) also would permit market participants to apply to the Commission for other spread transactions. 606 As discussed under proposed § 150.3, spread exemptions identified in the proposed ‘‘spread transaction’’ definition in proposed § 150.1 would be self-effectuating similar to the status quo and would not represent a change to the status quo baseline. The related costs and benefits, particularly with respect to requesting exemptions with respect to spreads other than those identified in the proposed ‘‘spread transaction’’ definition, are discussed under the respective sections below. PO 00000 Frm 00091 Fmt 4701 Sfmt 4702 11685 potentially improve price discovery as well as provide market participants with the ability to use strategies involving spread positions, which may reduce hedging costs. As in the intermarket wheat example discussed below, the proposed spread relief not limited to the same crop year month may better link prices between two markets (e.g., the price of MGEX wheat futures and the price of CBOT wheat futures). Put another way, permitting spread exemptions outside the same crop year may enable pricing in two different but related markets for substitute goods to be more highly correlated, which, in this example, benefits market participants with a price exposure to the underlying protein content in wheat generally, rather than that of a particular commodity. However, the Commission also recognizes certain potential costs to permitting spread exemptions during the spot month, particularly to extend into the last five days of trading. This feature could raise the risk of allowing participants in the market at a time in the contract where only those interested in making or taking delivery should be present. When a contract goes into expiration, open interest and trading volume naturally decrease as traders not interested in making or taking delivery roll their positions into deferred calendar months. The presence of large spread positions so close to the expiration of a futures contract, which positions are normally tied to large liquidity providers, may actually lead to disruptions in the price discovery function of the contract by disrupting the futures/cash price convergence. This could lead to increased transaction costs and harm the hedging utility for endusers of the futures contract, which could lead to higher costs passed on to consumers. However, the Commission preliminarily believes that these concerns would be mitigated as exchanges would continue to apply their expertise in overseeing and maintaining the integrity of their markets. For example, an exchange could refuse to grant a spread exemption if the exchange believed it would harm its markets, require a participant to reduce its positions, or implement a five-day-rule for spread exemptions, as discussed above.607 Generally, the Commission preliminarily finds that, by allowing speculators to execute intermarket and intramarket spreads as proposed, speculators would be able to hold a greater amount of open interest in 607 See supra Section IV.A.4.b.ii. (discussion of the five-day rule). E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 11686 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules underlying contract(s), and therefore, bona fide hedgers may benefit from any increase in market liquidity. Spread exemptions may also lead to better price continuity and price discovery if market participants who seek to provide liquidity (for example, through entry of resting orders for spread trades between different contracts) receive a spread exemption, and thus would not otherwise be constrained by a position limit. For clarity, the Commission has identified the following two examples of spread positions that could benefit from the proposed spread exemption: • Reverse crush spread in soybeans on the CBOT subject to an intermarket spread exemption. In the case where soybeans are processed into two different products, soybean meal and soybean oil, the crush spread is the difference between the combined value of the products and the value of soybeans. There are two actors in this scenario: the speculator and the soybean processor. The spread’s value approximates the profit margin from actually crushing (or mashing) soybeans into meal and oil. The soybean processor may want to lock in the spread value as part of its hedging strategy, establishing a long position in soybean futures and short positions in soybean oil futures and soybean meal futures, as substitutes for the processor’s expected cash market transactions (the long position hedges the purchase of the anticipated inputs for processing and the short position hedges the sale of the anticipated soybean meal and oil products). On the other side of the processor’s crush spread, a speculator takes a short position in soybean futures against long positions in soybean meal futures and soybean oil futures. The soybean processor may be able to lock in a higher crush spread because of liquidity provided by such a speculator who may need to rely upon a spread exemption. In this example, the speculator is accepting basis risk represented by the crush spread, and the speculator is providing liquidity to the soybean processor. The crush spread positions may result in greater correlation between the futures prices of soybeans on the one hand and those of soybean oil and soybean meal on the other hand, which means that prices for all three products may move up or down together in a more correlated manner. • Wheat spread subject to intermarket spread exemptions. There are two actors in this scenario: the speculator and the wheat farmer. In this example, a farmer growing hard wheat would like to reduce the price risk of her crop by VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 shorting a MGEX wheat futures. There, however, may be no hedger, such as a mill, that is immediately available to trade at a desirable price for the farmer. There may be a speculator willing to offer liquidity to the hedger; however, the speculator may wish to reduce the risk of an outright long position in MGEX wheat futures through establishing a short position in CBOT wheat futures (soft wheat). Such a speculator, who otherwise would have been constrained by a position limit at MGEX and/or CBOT, may seek exemptions from MGEX and CBOT for an intermarket spread, that is, for a long position in MGEX wheat futures and a short position in CBOT wheat futures of the same maturity. As a result of the exchanges granting an intermarket spread exemption to such a speculator, who otherwise may be constrained by limits, the farmer might be able to transact at a higher price for hard wheat than might have existed absent the intermarket spread exemptions. Under this example, the speculator is accepting basis risk between hard wheat and soft wheat, reducing the risk of a position on one exchange by establishing a position on another exchange, and potentially providing liquidity to a hedger. Further, spread transactions may aid in price discovery regarding the relative protein content for each of the hard and soft wheat contracts. d. Conditional Spot Month Exemption Positions in Natural Gas Proposed § 150.3(a)(4) would provide a new federal conditional spot month limit exemption position for cashsettled natural gas contracts that would permit traders to acquire positions up to 10,000 NYMEX Henry Hub Natural Gas (NG) equivalent-size contracts (the federal spot month limit in proposed § 150.2 for NYMEX Henry Hub Natural Gas (NG) referenced contracts is otherwise 2,000 contracts in the aggregate across all one’s net positions) per exchange that lists the relevant natural gas cash-settled referenced contracts, along with an additional futures-adjusted 10,000 contracts of cash-settled economically equivalent swaps, as long as such person does not also hold positions in the physicallysettled natural gas referenced contract.608 NYMEX, ICE, Nasdaq Futures, and Nodal currently have rules in place establishing a conditional spot month limit exemption equivalent to up to 5,000 contracts in NYMEX-equivalent 608 The NYMEX Henry Hub Natural Gas (NG) contract is the only natural gas contract included as a core referenced futures contract under this proposal. PO 00000 Frm 00092 Fmt 4701 Sfmt 4702 size. By proposing to include the conditional exemption for purposes of federal limits on natural gas contracts, the Commission reduces the incentive and ability for a market participant to manipulate a large physically-settled position to benefit a linked cash-settled position. Further, the Commission has heeded natural gas traders’ concerns about disrupting market practices and harming liquidity in the cash-settled contract, which could increase the cost of hedging and possibly prevent convergence between the physical delivery futures and cash markets.609 While a trader with a position in the physical-delivery natural gas contract may incur costs associated with liquidating that position in order to meet the conditions of the federal exemption, such costs are incurred outside of the proposal, as the trader would have to do so as a condition of the exchange-level exemption under current exchange rules.610 e. Financial Distress Exemption Proposed § 150.3(a)(3) would provide an exemption for certain financial distress circumstances, including the default of a customer, affiliate, or acquisition target of the requesting entity that may require the requesting entity to take on, in short order, the positions of another entity. In codifying the Commission’s historical practice, the proposed rule accommodates transfers of positions from financially distressed firms to financially secure firms. The disorderly liquidation of a position threatens price impacts that may harm the efficiency and price discovery function of markets, and the proposal would make it less likely that positions will be prematurely or needlessly liquidated. The Commission has determined that costs related to filing and recordkeeping are likely to be minimal. The Commission cannot accurately estimate how often this exemption may be invoked because emergency or distressed market situations are unpredictable and dependent on a variety of firm and market-specific factors as well as general macroeconomic indicators.611 The Commission, nevertheless, believes that emergency or distressed market situations that might trigger the need for this exemption will be infrequent, and that codifying this historical practice 609 See 2016 Reproposal, 81 FR at 96862, 96863. ICE Rule 6.20(c) and NYMEX Rule 559.F. See, e.g., NASDAQ Futures Rule ch. v, section 13(a)(ii) and Nodal Exchange Rulebook Appendix C (equivalent rules of NASDAQ and Nodal exchanges). 611 See 2016 Reproposal, 81 FR at 96862, 96863. 610 See E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules will add transparency to the Commission’s oversight responsibilities. lotter on DSKBCFDHB2PROD with PROPOSALS3 f. Pre-Enactment and Transition Period Swaps Exemption Proposed § 150.3(a)(5) would also provide an exemption from position limits for positions acquired in good faith in any ‘‘pre-enactment swap,’’ or in any ‘‘transition period swap,’’ in either case as defined in proposed § 150.1. A person relying on this exemption may net such positions with post-effective date commodity derivative contracts for the purpose of complying with any nonspot-month speculative positions limits, but may not net against spot month positions. This exemption would be self-effectuating, and the Commission preliminarily believes that proposed § 150.3(a)(5) would benefit both individual market participants by lessening the impact of the proposed federal limits, and market liquidity in general as liquidity providers initially would not be forced to reduce or exit their positions. The proposal would benefit price discovery and convergence by prohibiting large traders seeking to roll their positions into the spot month from netting down positions in the spotmonth against their pre-enactment swap or transition period swap. The Commission acknowledges that, on its face, including a ‘‘good-faith’’ requirement in the proposed § 150.3(a)(5) could hypothetically diminish market integrity since determining whether a trader has acted in ‘‘good faith’’ is inherently subjective and could result in disparate treatment among traders, where certain traders may assert a more aggressive position in order to seek a competitive advantage over others. The Commission believes the risk of any such unscrupulous trader or exchange is mitigated since exchanges would still be subject to Commission oversight and to DCM Core Principles 4 (‘‘prevention of market disruption’’) and 12 (‘‘protection of markets and market participants’’), among others. The Commission has determined that market participants who voluntarily employ this exemption also will incur negligible recordkeeping costs. 5. Process for the Commission or Exchanges To Grant Exemptions and Bona Fide Hedge Recognitions for Purposes of Federal Limits (Proposed §§ 150.3 and 150.9) and Related Changes to Part 19 of the Commission’s Regulations Existing §§ 1.47 and 1.48 set forth the process for market participants to apply to the Commission for recognition of VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 certain bona fide hedges for purposes of federal limits, and existing § 150.3 sets forth a list of spread exemptions a person can rely on for purposes of federal limits. However, under existing Commission practices, spread exemptions and certain enumerated bona fide hedges are generally selfeffectuating and do not require market participants to apply to the Commission for purposes of federal position limits, although market participants are required to file Form 204 monthly reports 612 to justify certain position limit overages. Further, for those bona fide hedges for which market participants are required to apply to the Commission, existing regulations and market practice require market participants to apply both to the Commission for purposes of federal limits and also to the relevant exchanges for purposes of exchange-set limits. The Commission has preliminarily determined that this dual application process creates inefficiencies for market participants. Proposed §§ 150.3 and 150.9, taken together, would make several changes to the process of acquiring bona fide hedge recognitions and spread exemptions for federal position limits purposes. Proposed §§ 150.3 and 150.9 would maintain certain elements of the status quo while also adopting certain changes to facilitate the exemption process.613 First, with respect to the proposed enumerated bona fide hedges, proposed § 150.3 would maintain the status quo by providing that those enumerated bona fide hedges that currently are selfeffectuating for the nine legacy agricultural contracts would remain self-effectuating for the nine legacy agricultural contracts for purposes of federal position limits.614 Similarly, the enumerated bona fide hedges for the proposed additional 16 contracts that would be newly subject to federal position limits (i.e., those contracts other than the nine legacy agricultural contracts) also would be selfeffectuating for purposes of federal position limits. 612 In the case of cotton, market participants currently file the relevant portions of Form 304. 613 In this section the Commission discusses the costs and benefits related to the application process for these exemptions and bona fide hedge recognitions. For a discussion of the costs and benefits related to the scope of the exemptions and bona fide hedge recognitions, see supra Section IV.A.5.a.iv. 614 Under the status quo, market participants must apply to the Commission for recognition of certain enumerated anticipatory bona fide hedges. The Commission’s proposal also would make these enumerated anticipatory bona fide hedges selfeffectuating for the nine legacy agricultural contracts. PO 00000 Frm 00093 Fmt 4701 Sfmt 4702 11687 Second, for recognition of any nonenumerated bona fide hedge in connection with any referenced contract, market participants would be required to apply either directly to the Commission under proposed § 150.3 or through an exchange that adheres to certain requirements under proposed § 150.9. The Commission notes that existing regulations require market participants to apply to the Commission for recognition of non-enumerated bona fide hedges, and so the Commission’s proposal does not represent a change to the status quo in this respect for the nine legacy agricultural contracts. Third, proposed § 150.3 would maintain the status quo by providing that the most common spread exemptions for the nine legacy agricultural contracts would remain self-effectuating. Similarly, these common spread exemptions also would be self-effectuating for the proposed additional 16 contracts that would be newly subject to federal position limits. These common spread exemptions would be listed in the proposed ‘‘spread transaction’’ definition under proposed § 150.1.615 Fourth, for any spread exemption not listed in the proposed ‘‘spread transaction’’ definition, market participants would be required to apply directly to the Commission under proposed § 150.3. There would be no exception for the nine legacy agricultural products nor would market participants be permitted to apply through an exchange under proposed § 150.9 for these types of spread exemptions.616 The Commission anticipates that most—if not all—market participants would utilize the exchange-centric process set forth in proposed § 150.9 with respect to applying for recognition of non-enumerated bona fide hedges rather than apply directly to the Commission under proposed § 150.3 because market participants are likely already familiar with the proposed processes set forth in § 150.9, which is intended to leverage the processes currently in place at the exchanges for addressing requests bona fide hedge recognitions from exchange-set limits. In the sections below, the Commission will discuss the costs and benefits related to both processes. 615 The proposed ‘‘spread transaction’’ definition would include a calendar spread, intercommodity spread, quality differential spread, processing spread (such as energy ‘‘crack’’ or soybean ‘‘crush’’ spreads), product or by-product differential spread, or futures-option spread. 616 As discussed below, the proposal would also eliminate the Form 204 and the equivalent portions of the Form 304. E:\FR\FM\27FEP3.SGM 27FEP3 11688 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 a. Process for Requesting Exemptions and Bona Fide Hedge Recognitions Directly From the Commission (Proposed § 150.3) Under existing §§ 1.47 and 1.48, and existing § 150.3, the processes for obtaining a recognition of a bona fide hedge or for relying on a spread exemption, are similar in some respects and different in other respects than the proposed approach. Existing §§ 1.47 and 1.48 require market participants seeking recognition of non-enumerated bona fide hedges and enumerated anticipatory bona fide hedges, respectively, for federal position limits to apply directly to the Commission for prior approval. In contrast, existing non-anticipatory enumerated bona fide hedges and spread exemptions are self-effectuating, which means that market participants are not required to submit any information to the Commission for prior approval, although such market participants must subsequently file Form 204 or Form 304 each month in order to describe their cash market positions and justify their bona fide hedge position. There currently is no codified federal process related to financial distress exemptions or natural gas conditional spot month exemptions. For those market participants that would choose to apply directly to the Commission for recognition of nonenumerated bona fide hedges or spread exemptions not included in the proposed ‘‘spread transaction’’ definition, which in each case would not be self-effectuating under the proposal, proposed § 150.3 would provide a process for the Commission to review and approve requests. Under proposed § 150.3, any person seeking Commission recognition of these types of bona fide hedges or a spread exemptions (as opposed to applying to using the exchange-centric process under proposed § 150.9 described below) would be required to submit a request directly to the Commission and to provide information similar to what is currently required under existing §§ 1.47 and 1.48.617 617 For bona fide hedges and spread exemptions, this information would include: (i) A description of the position in the commodity derivative contract for which the application is submitted, including the name of the underlying commodity and the position size; (ii) information to demonstrate why the position meets the applicable requirements for a bona fide hedge or spread transaction; (iii) a statement concerning the maximum size of all gross positions in derivative contracts for which the application is submitted; (iv) for bona fide hedges, information regarding the applicant’s activity in the cash markets and swaps markets for the commodity underlying the position for which the application is submitted; and (v) any other information that VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 i. Existing Bona Fide Hedges That Currently Require Prior Submission to the Commission Under Existing §§ 1.47 and 1.48 for the Nine Legacy Agricultural Contracts Under the proposal, the Commission would maintain the distinction between enumerated bona fide hedges and nonenumerated bona fide hedges under proposed § 150.3: (1) Enumerated bona fide hedges would continue to be selfeffectuating; (2) enumerated anticipatory bona fide hedges would become self-effectuating so market participants would no longer need to apply to the Commission; and (3) nonenumerated bona fide hedges would still require market participants to apply for recognition. Market participants that choose to apply directly to the Commission for a bona fide hedge recognition (i.e., for non-enumerated bona fide hedges) would be subject to an application process that generally is similar to what the Commission currently administers for the nonenumerated bona fide hedges and the enumerated anticipatory bona fide hedges.618 With respect to enumerated anticipatory bona fide hedges for the nine legacy contracts, for which market participants currently are required to apply to the Commission for recognition for federal position limit purposes, the Commission preliminarily anticipates that the proposal would benefit market participants by making such hedges selfeffectuating.619 As a result, market participants will no longer be required to spend time and resources applying to the Commission. Further, for these enumerated anticipatory hedges, existing § 1.48 requires market participants to submit either an initial or supplemental application to the may help the Commission determine whether the position meets the applicable requirements for a bona fide hedge position or spread transaction. 618 As noted above, under the existing framework market participants are not required to apply for any type of bona fide hedge recognition or spread exemption from the Commission for any of the proposed additional 16 contracts that would be newly subject to federal position limits (i.e., those contracts other than the nine legacy agricultural contracts); rather, under the existing framework, such market participants must apply to the exchanges for bona fide hedge recognitions or exemptions for purposes of exchange-set position limits. Accordingly, to the extent that market participants would not need to apply to the Commission in connection with any of the proposed additional 16 contracts, the Commission’s proposal would not impose additional costs or benefits compared to the status quo. 619 As noted above, since market participants do not need to apply to the Commission for bona fide hedge recognition for any of the proposed additional 16 contracts that would be newly subject to federal position limits, the Commission’s proposal would not result in any additional costs or benefits to the extent such bona fide hedge recognitions would be self-effectuating. PO 00000 Frm 00094 Fmt 4701 Sfmt 4702 Commission 10 days prior to entering into the bona fide hedge that would cause the hedger to exceed federal position limits.620 Under existing § 1.48, market participants could proceed with their proposed bona fide hedges if the Commission does not notify a market participants otherwise within the specific 10-day period. Because bona fide hedgers could implement enumerated anticipatory bona fide hedges without waiting the requisite 10 days, they may be able to implement their hedging strategy more efficiently with reduced cost and risk. The Commission acknowledges that making such bona fide hedges easier to obtain could increase the possibility of excess speculation since anticipatory exemptions are theoretically more difficult to substantiate compared to the other existing enumerated bona fide hedges. However, the Commission has gained significant experience over the years with bona fide hedging practices in general and with enumerated anticipatory bona fide hedging practices in particular, and the Commission preliminarily has determined that making such hedges self-effectuating should not increase the risk of excessive speculation or market manipulation compared to the status quo. For non-enumerated bona fide hedges, existing § 1.47 requires market participants to submit (i) initial applications to the Commission 30 days prior to the date the market participant would exceed the applicable position limits and (ii) supplemental applications (i.e., applications for a market participant that desire to exceed the bona fide hedge amount provided in the person’s previous Commission filing) 10 days prior for Commission approval, and market participants can proceed with their proposed bona fide hedges if the Commission does not intervene within the specific time (e.g., either 10 days or 30 days). Proposed § 150.3 would similarly require market participants seeking recognition of a non-enumerated bona fide hedge for any of the proposed 25 core referenced futures contracts to apply to the Commission prior to exceeding federal position limits, but proposed § 150.3 would not prescribe a certain time period by which a bona fide hedger must apply or by which the 620 Under the Commission’s existing regulations, non-anticipatory enumerated bona fide hedges are self-effectuating, and market participants do not have to file any applications for recognition under existing Commission regulations. However, bona fide hedgers must file with the Commission monthly Form 204 (or Form 304 in connection with ICE Cotton No. 2 (CT)) reports discussing their underlying cash positions in order to substantiate their bona fide hedge positions. E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Commission must respond. The Commission preliminarily anticipates that the proposal would benefit bona fide hedgers by enabling them in many cases to generally implement their hedging strategies sooner than the existing 30-day or 10-day waiting period, in which case the Commission believes hedging-related costs would decrease. However, the Commission believes that there could also be circumstances in which the overall process could take longer than the existing timelines under § 1.47, which could increase hedging related costs if a bona fide hedger is compelled to wait longer, compared to existing Commission practices, before executing its hedging strategy. On the other hand, the Commission also recognizes that there could be potential costs to bona fide hedgers if under the proposal they are forced either to enter into less effective bona fide hedges or to wait to implement their hedging strategy, as a result of the potential uncertainty that could result from proposed § 150.3 not requiring the Commission to respond within a certain amount of time. The Commission believes this concern is mitigated to the extent market participants utilize the proposed § 150.3 process that would permit a market participant that demonstrates a ‘‘sudden or unforeseen’’ increase in its bona fide hedging needs to enter into a bona fide hedge without first obtaining the Commission’s prior approval, as long as the market participant submits a retroactive application to the Commission within five business days of exceeding the applicable position limit. The Commission preliminarily believes this ‘‘five-business day retroactive exemption’’ would benefit bona fide hedgers compared to existing §§ 1.47 and 1.48, which requires Commission prior approval, since hedgers that would qualify to exercise the five-business day retroactive exemption are also likely facing more acute hedging needs—with potentially commensurate costs if required to wait. This provision would also leverage, for federal position limit purposes, existing exchange practices for granting retroactive exemptions from exchange-set limits. On the other hand, the proposed fivebusiness day retroactive exemption could harm market liquidity and bona fide hedgers if the applicable exchange or the Commission were to not approve of the retroactive request, and the Commission subsequently required liquidation of the position in question. As a result, such possibility could cause market participants to either enter into smaller bona fide hedge positions than VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 they otherwise would or cause the bona fide hedger to delay entering into its hedge, in either case potentially causing bona fide hedgers to incur increased hedging costs. However, the Commission preliminarily believes this concern is partially mitigated since proposed § 150.3 would require the purported bona fide hedger to exit its position in a ‘‘commercially reasonable time,’’ which the Commission believes should partially mitigate any costs incurred by the market participant compared to either an alternative that would require the bona fide hedger to exit its position immediately, or the status quo where the market participant either is unable to enter into a hedge at all without Commission prior approval. ii. Spread Exemptions and NonEnumerated Bona Fide Hedges Proposed § 150.3 would impose a new requirement for market participants to (1) apply either directly to the Commission pursuant to proposed § 150.3 or to an exchange pursuant to proposed § 150.9 for any nonenumerated bona fide hedge; and (2) to apply directly to the Commission pursuant to proposed § 150.3 for any spread exemptions not identified in the proposed ‘‘spread transaction’’ definition for any of the proposed 25 core referenced futures contracts.621 As noted above, common spread exemptions (i.e., those identified in the proposed definition of ‘‘spread transaction’’ in proposed § 150.1) would remain self-effectuating for the nine legacy agricultural products and also would be self-effectuating for the 16 proposed core referenced futures contracts.622 Unlike non-enumerated bona fide hedges, for which market participants could apply directly to the Commission under proposed § 150.3 or through an exchange under proposed § 150.9, for spread exemptions not identified in the proposed ‘‘spread transaction’’ definition, market participants would be required to apply directly to the Commission under proposed § 150.3. As noted above, proposed § 150.3 also would maintain the status quo and 621 As discussed below, for spread exemptions not identified in the proposed ‘‘spread transaction’’ definition in proposed § 150.3, market participants would be required to apply directly to the Commission under proposed § 150.3 and would not be able to apply under proposed § 150.9. 622 Existing § 150.3(a)(2) does not specify a formal process for granting either spread exemptions or non-anticipatory enumerated bona fide hedges that are consistent with CEA section 4a(a)(1), so in practice spread exemptions and non-anticipatory enumerated bona fide hedges have been selfeffectuating. PO 00000 Frm 00095 Fmt 4701 Sfmt 4702 11689 continue to require any non-enumerated bona fide hedge in one of the nine legacy agricultural products to receive prior approval, and similarly would require prior approval for such nonenumerated bona fide hedges for the proposed additional 16 contracts that would be newly subject to federal position limits.623 The Commission anticipates that there will be no change to the status quo baseline with respect to the most common spread exemptions since these exemptions would be selfeffecting for purposes of federal position limits. To the extent market participants would be required to obtain prior approval for a non-enumerated bona fide hedge or spread exemption for any of the additional 16 contracts that would be newly subject to federal position limits, the Commission recognizes that proposed § 150.3 would impose costs on market participants who will now be required to spend time and resources submitting applications to the Commission (for certain spread exemptions) or to either the Commission or an exchange (for nonenumerated bona fide hedges) for prior approval for federal position limit purposes.624 Further, compared to the status quo in which the proposed new 16 contracts are not subject to federal position limits, the proposed process could increase uncertainty since market participants would be required to seek prior approval and wait up to 10 days. As a result, such uncertainty could cause market participants to either enter into smaller spread or bona fide hedging positions or do so at a later time. In either case, this could cause market participants to incur additional costs and/or implement less efficient hedging strategies. However, the Commission preliminarily believes that proposed § 150.3’s framework would be familiar to market participants that currently apply to the Commission for bona fide exemptions for the nine legacy agricultural products, which should serve to reduce costs for some market participants associated with obtaining recognition of a bona fide hedge or spread exemption from the Commission for federal limits for those market 623 The Commission discusses the costs and benefits related to the proposed process for nonenumerated bona fide hedge recognitions with respect to the nine legacy agricultural products in the above section. 624 The Commission’s Paperwork Reduction Act analysis identifies some of these information collection burdens in greater specificity. See supra Section IV.A.4.c. (discussing in greater detail the cost and benefits related to spread exemptions). E:\FR\FM\27FEP3.SGM 27FEP3 11690 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules participants.625 The Commission also preliminarily believes that this analysis also would apply to the nine legacy agricultural contracts for spread exemptions that are not listed in the proposed ‘‘spread transaction’’ definition and therefore also would require market participants to apply to the Commission for these types of spread exemptions for the first time for the nine legacy agricultural products. However, because the Commission preliminarily has determined that most spread transactions would be selfeffectuating (especially for the nine legacy agricultural contracts based on the Commission’s experience), the Commission believes that the proposal would impose only small costs with respect to spread exemptions for both the nine legacy agricultural contracts as well as the proposed additional 16 contracts that would be newly subject to federal position limits. While the Commission has years of experience granting and monitoring spread exemptions and enumerated and non-enumerated bona fide hedges for the nine legacy agricultural contracts, as well as overseeing exchange processes for administering exemptions from exchange-set limits on such commodities, the Commission does not have the same level of experience or comfort administering bona fide hedge recognitions and spread exemptions for the additional 16 contracts that would be subject to the proposed federal position limits and the new proposed exemption processes for the first time. Accordingly, the Commission preliminarily recognizes that permitting enumerated bona fide hedges and spread recognitions identified in the proposed ‘‘spread transaction’’ definition for these additional 16 contracts might not provide the purported benefits, or could result in increased costs, compared to the Commission’s experience with the nine legacy agricultural products. The Commission also preliminarily believes that the proposal will benefit lotter on DSKBCFDHB2PROD with PROPOSALS3 625 The Commission preliminarily anticipates that the proposed application process in § 150.3(b) could slightly reduce compliance-related costs, compared to the status quo application process to the Commission under existing §§ 1.47 and 1.48, because proposed § 150.3 would provide a single, standardized process for all bona fide hedge and spread exemption requests that is slightly less complex—and more clearly laid out in the proposed regulations—than the Commission’s existing application processes. Nonetheless, since the Commission anticipates that most market participants would apply directly to exchanges for bona fide hedges and spread exemptions when provided the option under proposed § 150.9, the Commission believes that most market participants would incur the costs and benefits discussed thereunder. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 market participants by providing market participants the option to choose the process for applying for a nonenumerated bona fide hedge (i.e., either directly with the Commission or, alternatively, through the exchangecentric process discussed under proposed § 150.9 below) for the additional 16 contracts that would be newly subject to federal position limits that would be more efficient given the market participants unique facts, circumstances, and experience.626 If a market participant chooses to apply through an exchange for federal position limits pursuant to proposed § 150.9, the market participant would also receive the added benefit of not being required to also submit another application directly to the Commission. The Commission anticipates that most market participants would apply directly to exchanges for nonenumerated bona fide hedges, pursuant to the proposed streamlined process § 150.9, as explained below, in which case the Commission believes that most market participants would incur the costs and benefits discussed thereunder. The Commission also preliminarily believes that this analysis also would apply with respect to non-enumerated bona fide hedges for the nine legacy agricultural contracts. iii. Exemption-Related Recordkeeping Proposed § 150.3(d) would require persons who avail themselves of any of the foregoing exemptions to maintain complete books and records relating to the subject position, and to make such records available to the Commission upon request under proposed § 150.3(e). These requirements would benefit market integrity by providing the Commission with the necessary information to monitor the use of exemptions from speculative position limits and help to ensure that any person who claims any exemption permitted by proposed § 150.3 can demonstrate compliance with the 626 As noted above, market participants seeking spread exemptions not listed in the proposed ‘‘spread transaction’’ definition in proposed § 150.1 would be required to apply directly with the Commission under proposed § 150.3 and would not be permitted to apply under proposed § 150.9. The Commission preliminarily recognizes that these types of spread exemptions are difficult to analyze compared to either the spread exemptions identified in proposed § 150.1 or bona fide hedges in general. Accordingly, the Commission preliminarily has determined to require market participants to apply directly to the Commission. Further, compared to the spread exemptions identified in proposed § 150.1, the Commission anticipates relatively few requests, and so does not believe the proposed application requirement will impose a large aggregate burden across market participants. PO 00000 Frm 00096 Fmt 4701 Sfmt 4702 applicable requirements. The Commission does not expect these requirements to impose significant new costs on market participants, as these requirements are in line with existing Commission and exchange-level recordkeeping obligations. iv. Exemption Renewals Consistent with existing §§ 1.47 and 1.48, with respect to any Commissionrecognized bona fide hedge or Commission-granted spread exemption pursuant to proposed § 150.3, the Commission would not require a market participant to reapply annually for bona fide hedges.627 The Commission preliminarily believes that this will reduce burdens on market participants but also recognizes that not requiring market participants to annually reapply ostensibly could harm market integrity since the Commission would not directly receive updated information with respect to particular bona fide hedgers or exemption holders prior to the trader excessing the applicable federal limits. However, the Commission preliminarily believes that any potential harm would be mitigated since the Commission, unlike exchanges, has access to aggregate market data, including positions held by individual market participants. Further, proposed § 150.3 would require a market participant to submit a new application if any information changes, or upon the Commission’s request. On the other hand, market participants would benefit by not being required to annually submit new applications, which the Commission preliminarily believes will reduce compliance costs. v. Exemptions for Financial Distress and Conditional Natural Gas Positions Proposed § 150.3 would codify the Commission’s existing informal practice with respect to exemptions for financial distress and conditional spot month limit exemption positions in natural gas. The same costs and benefits described above with respect to applications for bona fide hedge recognitions and spread exemptions would also apply. However, to the extent the Commission currently allows exemptions related to financial distress, the Commission preliminarily has determined that the costs and benefits with respect to the related application process already may be recognized by market participants. 627 As discussed below, with respect to exchangeset limits under proposed § 150.5 or the exchange process for federal limits under proposed § 150.9, market participants would be required to annually reapply to exchanges. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 b. Process for Market Participants To Apply to an Exchange for NonEnumerated Bona Fide Hedge Recognitions for Purposes of Federal Limits (Proposed § 150.9) and Related Changes to Part 19 of the Commission’s Regulations Proposed § 150.9 would provide a framework whereby a market participant could avoid the existing dual application process described above and, instead, file one application with an exchange to receive a nonenumerated bona fide hedging recognition, which as discussed previously would not be selfeffectuating for purposes of federal position limits. Under this process, a person would be allowed to exceed the federal limit levels following an exchange’s review and approval of an application for a bona fide hedge recognition or spread exemption, provided that the Commission during its review does not notify the exchange otherwise within a certain period of time thereafter. Market participants who do not elect to use the process in proposed § 150.9 for purposes of federal position limits would be required to request relief both directly from the Commission under proposed § 150.3, as discussed above, and also apply to the relevant exchange, consistent with existing practices.628 i. Proposed § 150.9—Establishment of General Exchange Process Pursuant to proposed § 150.9, exchanges that elect to process these applications would be required to file new rules or rule amendments with the Commission under § 40.5 of the Commission’s regulations and obtain from applicants all information to enable the exchange to determine, and the Commission to verify, that the facts and circumstances support a nonenumerated bona fide hedge recognition. The Commission initially believes that exchanges’ existing practices generally are consistent with the requirements of proposed § 150.9, and therefore exchanges would only incur marginal costs, if any, to modify their existing practices to comply. Similarly, the Commission preliminarily anticipates that establishing uniform, standardized exemption processes across exchanges would benefit market participants by reducing compliance costs. On the other hand, the Commission recognizes that exchanges that wish to participate in the 628 As noted above, the Commission preliminarily anticipates that most, if not all, market participants will use proposed § 150.9, rather than proposed § 150.3, where permitted. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 processing of applications with the Commission under proposed § 150.9 would be required to expend resources to establish a process consistent with the Commission’s proposal. However, to the extent exchanges have similar procedures, such benefits and costs may already have been realized by market participants and exchanges. The Commission preliminarily believes that there are significant benefits to the proposed § 150.9 process that would be largely realized by market participants. The Commission preliminarily has determined that the use of a single application to process both exchange and federal position limits will benefit market participants and exchanges by simplifying and streamlining the process. For applicants seeking recognition of a nonenumerated bona fide hedge, proposed § 150.9 should reduce duplicative efforts because applicants would be saved the expense of applying in parallel to both an exchange and the Commission for relief from exchange-set position limits and federal position limits, respectively. Because many exchanges already possess similar application processes with which market participants are likely accustomed, compliance costs should be decreased in the form of reduced application-production time by market participants and reduced response time by exchanges. As discussed above, in connection with the recognition of bona fide hedges for federal position limit purposes, current practices set forth in existing §§ 1.47 and 1.48 require market participants to differentiate between (i) enumerated non-anticipatory bona fide hedges that are self-effectuating, and (ii) enumerated anticipatory bona fide hedges and non-enumerated bona fide hedges for which market participants must apply to the Commission for prior approval. Under the proposal, the Commission would no longer distinguish among different types of enumerated bona fide hedges (e.g., anticipatory versus non-anticipatory enumerated bona fide hedges), and therefore, would not require exchanges to have separate processes for enumerated anticipatory positions under proposed § 150.9 for the nine legacy agricultural contracts. The Commission’s proposal would also eliminate the requirement for bona fide hedgers to file Form 204 or Form 304, as applicable, with respect to any bona fide hedge, whether enumerated or non- PO 00000 Frm 00097 Fmt 4701 Sfmt 4702 11691 enumerated.629 The Commission preliminarily expects this to benefit market participants by providing a more efficient and less complex process that is consistent with existing practices at the exchange-level. On the other hand, the Commission recognizes proposed § 150.9 would impose new costs related to nonenumerated bona fide hedges for the additional 16 contracts that would be newly subject to federal position limits. Under the proposal, market participants would now be required to submit applications to receive prior approval for federal position limits purposes. However, since the Commission preliminarily understands that exchanges already require market participants to submit applications and receive prior approval under exchangeset limits for all types of bona fide hedges, the Commission does not believe proposed § 150.9 would impose any additional incremental costs on market participants beyond those already incurred under exchanges’ existing processes. Accordingly, the Commission preliminarily believes that any costs already may have been realized by market participants. Further, the Commission preliminarily believes that employing a concurrent process with exchanges to oversee the non-enumerated bona fide hedges that would not be selfeffectuating for federal position limits purposes would benefit market integrity by ensuring that market participants are appropriately relying on such bona fide hedges and not entering into such positions in order to attempt to manipulate the market or evade position limits. However, to the extent that exchange oversight, consistent with Commission standards and DCM core principles, already exists, such benefits may already be realized. ii. Proposed § 150.9—Exchange Expertise, Market Integrity, and Commission Oversight For non-enumerated bona fide hedge recognitions that would require the Commission’s prior approval, the proposal would provide a framework that utilizes existing exchange resources and expertise so that fair access and liquidity are promoted at the same time market manipulations, squeezes, corners, and any other conduct that would disrupt markets are deterred and prevented. Proposed § 150.9 would build on existing exchange processes, which the Commission preliminarily 629 See infra Section II.H.3. (discussion of proposed changes to part 19 eliminating Form 204 and portions of Form 304). E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 11692 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules believes would strengthen the ability of the Commission and exchanges to monitor markets and trading strategies while reducing burdens on both the exchanges, which would administer the process, and market participants, who would utilize the process. For example, exchanges are familiar with their market participants’ commercial needs, practices, and trading strategies, and already evaluate hedging strategies in connection with setting and enforcing exchange-set position limits; accordingly, exchanges should be able to readily identify bona fide hedges.630 For these reasons, the Commission has preliminarily determined that allowing market participants to apply through an exchange under proposed § 150.9, rather than directly to the Commission as required under existing § 1.47, is likely to be more efficient than if the Commission itself initially had to review and approve all applications. The Commission preliminarily considers the increased efficiency in processing applications under proposed § 150.9 as a benefit to bona fide hedgers and liquidity providers. By having the availability of the exchange’s analysis and view of the markets, the Commission would be better informed in its review of the market participant and its application, which in turn may further benefit market participants in the form of administrative efficiency and regulatory consistency. However, the Commission recognizes additional costs for exchanges required to create and submit these real-time notices. To the extent exchanges already provide similar notice to the Commission or to market participants, or otherwise are required to notify the Commission under certain circumstances, such benefits and costs already may have been realized. On the other hand, to the extent exchanges would become more involved with respect to review and oversight of market participants’ bona fide hedges and spread exemptions, exchanges could incur additional costs. However, as noted, the Commission believes most of the costs have been realized by exchanges under current market practice. At the same time, the Commission also preliminarily recognizes that this aspect of the proposal could potentially harm market integrity. Absent other provisions, since exchanges profit from increased activity, an exchange could hypothetically seek a competitive advantage by offering excessively permissive exemptions, which could 630 For a discussion on the history of exemptions, see 2013 Proposal, 78 FR at 75703–75706. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 allow certain market participants to utilize non-enumerated bona fide hedge recognitions to engage in excessive speculation or to manipulate market prices. If an exchange engaged in such activity, other market participants would likely face greater costs through increased transaction fees, including forgoing trading opportunities resulting from market prices moving against market participants and/or preventing the market participant from executing at its desired prices, which may also further lead to inefficient hedging. However, the Commission preliminarily believes that these hypothetical costs are unfounded since under proposed § 150.9 the Commission would review the applications submitted by market participants for bona fide hedge recognitions and spread exemptions; the Commission emphasizes that proposed § 150.9 is not providing exchanges with an ability to recognize a bona fide hedge or grant an exemption for federal position limit purposes in lieu of a Commission review. Rather, proposed § 150.9(e) and (f) would require an exchange to provide the Commission with notice of the disposition of any application for purposes of exchange limits concurrently with the notice the exchange would provide to the applicant, and the Commission would have 10 business days to make its determination for federal position limits purposes (although, in connection with ‘‘sudden or unforeseen increases’’ in bona fide hedging needs, as discussed in connection with proposed § 150.3, proposed § 150.9 would require the Commission to make its determination within two business days). On the other hand, the Commission also recognizes that there could be potential costs to bona fide hedgers if under the proposal they are forced to wait up to 10 business days for the Commission to complete its review after the exchange’s initial review— especially compared to the status quo for the 16 commodities that would be subject to federal limits for the first time under this release and currently are not required to receive the Commission’s prior approval. As a result, the Commission preliminarily recognizes that a market participant could incur costs by waiting during the 10 business day period or be required to enter into a less efficient hedge, which would harm liquidity. However, the Commission believes this concern is mitigated since proposed § 150.9, similar to proposed § 150.3, would permit a market participant that demonstrates a ‘‘sudden or unforeseen’’ increase in its bona fide hedging needs PO 00000 Frm 00098 Fmt 4701 Sfmt 4702 to enter into a bona fide hedge without first obtaining the Commission’s prior approval, as long as the market participant submits a retroactive application to the Commission within five business days of exceeding the applicable position limit. In turn, the Commission would only have two business days (as opposed to the default 10 business days) to complete its review for federal purposes. The Commission preliminarily believes this ‘‘fivebusiness day retroactive exemption’’ would benefit bona fide hedgers compared to existing § 1.47, which requires Commission prior approval, since hedgers that would qualify to exercise the five-business day retroactive exemption are also likely facing more acute hedging needs—with potentially commensurate costs if required to wait. This provision would also leverage, for federal position limit purposes, existing exchange practices for granting retroactive exemptions from exchange-set limits. On the other hand, the proposed fivebusiness day retroactive exemption could harm market liquidity and bona fide hedgers since the Commission would be able to require a market participant to exit its position if the exchange or the Commission does not approve of the retroactive request, and such uncertainty could cause market participants to either enter into smaller bona fide hedge positions than it otherwise would or could cause the bona fide hedger to delay entering into its hedge, in either case potentially causing bona fide hedgers to incur increased hedging costs. However, the Commission preliminarily believes this concern is partially mitigated since proposed § 150.9 would require the purported bona fide hedger to exit its position in a ‘‘commercially reasonable time,’’ which the Commission believes should partially mitigate any costs incurred by the market participant compared to either an alternative that would require the bona fide hedger to exit its position immediately, or the status quo where the market participant either is unable to enter into a hedge at all without Commission approval. While existing § 1.47 does not require market participants to annually reapply for certain bona fide hedges, proposed § 150.9 would require market participants to reapply at least annually with exchanges for purposes of federal position limits. The Commission recognizes that requiring market participants to reapply annually could impose additional costs on those that are not currently required to do so. However, the Commission believes that this is consistent with industry practice E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules with respect to exchange-set limits and that market participants are familiar with exchanges’ exemption processes, which should reduce related costs.631 Further, the Commission preliminarily believes that market integrity would be strengthened by ensuring that exchanges receive updated trader information that may be relevant to the exchange’s oversight.632 However, to the extent any of these benefits and costs reflect current market practice, they already may have been realized by exchanges and market participants. In addition, the proposed exchangeto-Commission monthly report in proposed § 150.5(a)(4) would further detail the exchange’s disposition of a market participant’s application for recognition of a bona fide hedge position or spread exemption as well as the related position(s) in the underlying cash markets and swaps markets. The Commission believes that such reports would provide greater transparency by facilitating the tracking of these positions by the Commission and would further assist the Commission in ensuring that a market participant’s activities conform to the exchange’s rules and to the CEA. The combination of the ‘‘real-time’’ exchange notification and exchanges’ provision of monthly reports to the Commission under proposed §§ 150.9(e)(1) and 150.5(a)(4), respectively, would provide the Commission with enhanced surveillance tools on both a ‘‘real-time’’ and a monthly basis to ensure compliance with the requirements of this proposal. The Commission anticipates additional costs for exchanges required to create and submit monthly reports because the proposed rules would require exchanges to compile the necessary information in the form and manner required by the Commission. However, to the extent exchanges already provide similar notice to the Commission, or otherwise are required to notify the Commission under certain circumstances, such benefits and costs already may have been realized lotter on DSKBCFDHB2PROD with PROPOSALS3 iii. Proposed 150.9(d)—Recordkeeping Proposed § 150.9(d) would require exchanges to maintain complete books and records of all activities relating to 631 See infra Section IV.A.6. (discussing proposed § 150.5). 632 In contrast, the Commission, unlike exchanges, has access to aggregate market data, including positions held by individual market participants, and so the Commission has preliminarily determined that requiring market participants to apply annually under proposed § 150.3, absent any changes to their application, would not benefit market integrity to the same extent. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 the processing and disposition of any applications, including applicants’ submission materials, exchange notes, and determination documents.633 The Commission preliminarily believes that this will benefit market integrity and Commission oversight by ensuring that pertinent records will be readily accessible, as needed by the Commission. However, the Commission acknowledges that such requirements would impose costs on exchanges. Nonetheless, to the extent that exchanges are already required to maintain similar records, such costs and benefits already may be realized.634 iv. Proposed § 150.9 (g)—Commission Revocation of Previously-Approved Applications The Commission preliminarily acknowledges that there may be costs to market participants if the Commission revokes the hedge recognition for federal purposes under proposed § 150.9(f). Specifically, market participants could incur costs to unwind trades or reduce positions if the Commission required the market participant to do so under proposed § 150.9(f)(2). However, the potential cost to market participants would be mitigated under proposed § 150.9(f) since the Commission would provide a commercially reasonable time for a person to come back into compliance with the federal position limits, which the Commission believes should mitigate transaction costs to exit the position and allow a market participant the opportunity to potentially execute other hedging strategies. v. Proposed § 150.9—Commodity Indexes and Risk Management Exemptions Proposed § 150.9(b) would prohibit exchanges from recognizing as a bona fide hedge with respect to commodity index contracts. The Commission 633 Moreover, consistent with existing § 1.31, the Commission expects that these records would be readily accessible until the termination, maturity, or expiration date of the bona fide hedge recognition or exempt spread position and during the first two years of the subsequent, five-year retention period. 634 The Commission believes that exchanges that process applications for recognition of bona fide hedging transactions or positions and/or spread exemptions currently maintain records of such applications as required pursuant to other existing Commission regulations, including existing § 1.31. The Commission, however, also believes that proposed § 150.9(d) may impose additional recordkeeping obligations on such exchanges. The Commission estimates that each exchange electing to administer the proposed process would likely incur a de minimis cost annually to retain records for each proposed process compared to the status quo. See generally Section IV.B. (discussing the Commission’s PRA determinations). PO 00000 Frm 00099 Fmt 4701 Sfmt 4702 11693 recognizes that this proposed prohibition could alter trading strategies that currently use commodity index contracts as part of an entity’s risk management program. Although there likely would be a cost to change risk management strategies for entities that currently rely on a bona fide hedge recognition for positions in commodity index contracts, as discussed above, the Commission believes that such financial products are not substitutes for positions in a physical market and therefore do not satisfy the statutory requirement for a bona fide hedge under section 4a(c)(2) of the Act.635 In addition, the Commission further posits that this cost may be reduced or mitigated by the proposed increased in federal position limit levels set forth in proposed § 150.2 or by the implementation of the pass-through swap provision of the proposed bona fide hedge definition.636 c. Request for Comment (48) The Commission requests comment on its considerations of the benefits and costs of proposed § 150.3 and § 150.9. Are there additional benefits or costs that the Commission should consider? Has the Commission misidentified any benefits or costs? Commenters are encouraged to include both quantitative and qualitative assessments of these benefits and costs, as well as data or other information to support such assessments. (49) The Commission requests comment on whether a Commissionadministered process, such as the process in proposed § 150.3, would promote more consistent and efficient decision-making. Commenters are encouraged to include both quantitative and qualitative assessments, as well as data or other information to support such assessments. (50) The Commission recognizes there exist alternatives to proposed § 150.9. These include such alternatives as: (1) Not permitting exchanges to administer any process to recognize bona fide hedging transactions or positions or grant exempt spread positions for purposes of federal limits; or (2) maintaining the status quo. The Commission requests comment on whether an alternative to what is proposed would result in a superior cost-benefit profile, with support for any such position. 635 See supra Section III.F.6. (discussion of commodity indices); see supra Section IV.A.4.b.i.(1). (discussion of elimination of the risk management exemption). 636 See supra Section IV.A.4.b.i.(1). (discussion of the pass-through swap exemption). E:\FR\FM\27FEP3.SGM 27FEP3 11694 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 d. Related Changes to Part 19 of the Commission’s Regulations Regarding the Provision of Information by Market Participants Under existing regulations, the Commission relies on Form 204 637 and Form 304,638 known collectively as the ‘‘series ‘04’’ reports, to monitor for compliance with federal position limits. Under existing part 19, market participants that hold bona fide hedging positions in excess of federal limits for the nine legacy agricultural contracts currently subject to federal limits under existing § 150.2 must justify such overages by filing the applicable report (Form 304 for cotton and Form 204 for the other eight legacy commodities) each month.639 The Commission uses these reports to determine whether a trader has sufficient cash positions that justify futures and options on futures positions above the speculative limits. As discussed above, with respect to bona fide hedging positions, the Commission is proposing a streamlined approach under proposed § 150.9 to cash-market reporting that reduces duplication between the Commission and the exchanges. Generally, the Commission is proposing amendments to part 19 and related provisions in part 15 that would: (i) Eliminate Form 204; and (ii) amend the Form 304, in each case to remove any cash-market reporting requirements. Under this proposal, the Commission would instead rely on cash-market reporting submitted directly to the exchanges, pursuant to proposed §§ 150.5 and 150.9,640 or request cash-market information through a special call. 637 CFTC Form 204: Statement of Cash Positions in Grains, Soybeans, Soybean Oil, and Soybean Meal, U.S. Commodity Futures Trading Commission website, available at https:// www.cftc.gov/sites/default/files/idc/groups/public/ @forms/documents/file/cftcform204.pdf (existing Form 204). 638 CFTC Form 304: Statement of Cash Positions in Cotton, U.S. Commodity Futures Trading Commission website, available at https:// www.cftc.gov/ucm/groups/public/@forms/ documents/file/cftcform304.pdf (existing Form 204). Parts I and II of Form 304 address fixed-price cash positions used to justify cotton positions in excess of federal limits. As described below, Part III of Form 304 addresses unfixed price cotton ‘‘oncall’’ information, which is not used to justify cotton positions in excess of limits, but rather to allow the Commission to prepare its weekly cotton on-call report. 639 17 CFR 19.01. 640 See supra Section II.G.3. (discussion of proposed § 150.9). As discussed above, leveraging existing exchange application processes should avoid duplicative Commission and exchange procedures and increase the speed by which position limit exemption applications are addressed. While the Commission would recognize spread exemptions based on exchanges’ application processes that satisfy the requirements in proposed § 150.9, for purposes of federal limits, the cash- VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 The proposed cash-market and swapmarket reporting elements of §§ 150.5 and 150.9 discussed above are largely consistent with current market practices with respect to exchange-set limits and thus should not result in any new costs. The proposed elimination of Form 204 and the cash-market reporting segments of the Form 304 would eliminate a reporting burden and the costs associated thereto for market participants. Instead, market participants would realize significant benefits by being able to submit cash market reporting to one entity—the exchanges—instead of having to comply with duplicative reporting requirements between the Commission and applicable exchange, or implement new Commission processes for reporting cash market data for market participants who will be newly subject to position limits.641 Further, market participants are generally already familiar with exchange processes for reporting and recognizing bona fide hedging exemptions, which is an added benefit, especially for market participants that would be newly subject to federal position limits. Further, the proposed changes would not impact the Commission’s existing provisions for gathering information through special calls relating to positions exceeding limits and/or to reportable positions. Accordingly, as discussed above, the Commission proposes that all persons exceeding the proposed limits set forth in proposed § 150.2, as well as all persons holding or controlling reportable positions pursuant to existing § 15.00(p)(1), must file any pertinent information as instructed in a special call.642 This proposed provision is similar to existing § 19.00(a)(3), but would require any such person to file the information as instructed in the special call, rather than to file a series ’04 report.643 The Commission preliminarily believes that relying on its special call authority is less burdensome for market participants than the existing Forms 204 and 304 reporting costs, as special calls are discretionary requests for information whereas the series ‘04 reporting market reporting regime discussed in this section of the release only pertains to bona fide hedges, not to spread exemptions, because the Commission has not traditionally relied on cash-market information when reviewing requests for spread exemptions. 641 The Commission has noted that certain commodity markets will be subject to federal position limits for the first time. In addition, the existing Form 204 would be inadequate for reporting of cash-market positions relating to certain energy contracts that would be subject to federal limits for the first time under this proposal. 642 See proposed § 19.00(b). 643 17 CFR 19.00(a)(3). PO 00000 Frm 00100 Fmt 4701 Sfmt 4702 requirements are a monthly, recurring reporting burden for market participants. 6. Exchange-Set Position Limits (Proposed § 150.5) a. Introduction Existing § 150.5 addresses exchangeset position limits on contracts not subject to federal limits under existing § 150.2, and sets forth different standards for DCMs to apply in setting limit levels depending on whether the DCM is establishing limit levels: (1) On an initial or subsequent basis; (2) for cash-settled or physically-settled contracts; and (3) during or outside the spot month. In contrast, for physical commodity derivatives, proposed § 150.5(a) and (b) would (1) expand existing § 150.5’s framework to also cover contracts subject to federal limits under § 150.2; (2) simplify the existing standards that DCMs apply when establishing exchange-set position limits; and (3) provide non-exclusive acceptable practices for compliance with those standards.644 Additionally, proposed § 150.5(d) would require DCMs to adopt aggregation rules that conform to existing § 150.4.645 b. Physical Commodity Derivative Contracts Subject to Federal Position Limits Under § 150.5 (Proposed § 150.5(a)) i. Exchange-Set Position Limits and Related Exemption Process For contracts subject to federal limits under § 150.2, proposed § 150.5(a)(1) would require DCMs to establish exchange-set limits no higher than the level set by the Commission. This is not a new requirement, and merely restates the applicable requirement in DCM Core Principle 5.646 Proposed § 150.5(a)(2) would authorize DCMs to grant exemptions from such limits and is generally consistent with current industry practice. The Commission has 644 See 17 CFR 150.2. Existing § 150.5 addresses only contracts not subject to federal limits under existing § 150.2 (aside from certain major foreign currency contracts). To avoid confusion created by the parallel federal and exchange-set position limit frameworks, the Commission clarifies that proposed § 150.5 deals solely with exchange-set position limits and exemptions therefrom, whereas proposed § 150.9 deals solely with the process for purposes of federal limits. 645 See 17 CFR 150.4. 646 See Commission regulation § 38.300 (restating DCMs’ statutory obligations under the CEA § 5(d)(5), 7 U.S.C. 7(d)(5)). Accordingly, the Commission will not discuss any costs or benefits related to this proposed change since it merely reflects an existing regulatory and statutory obligation. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 preliminarily determined that codifying such practice would establish important, minimum standards needed for DCMs to administer—and the Commission to oversee—an effective and efficient program for granting exemptions to exchange-set limits in a manner that does not undermine the federal limits framework.647 In particular, proposed § 150.5(a)(2) would protect market integrity and prevent exchange-granted exemptions from undermining the federal limits framework by requiring DCMs to either conform their exemptions to the type the Commission would grant under proposed §§ 150.3 or 150.9, or to cap the exemption at the applicable federal limit level and to assess whether an exemption request would result in a position that is ‘‘not in accord with sound commercial practices’’ or would ‘‘exceed an amount that may be established or liquidated in an orderly fashion in that market.’’ Absent other factors, this element of the proposal could potentially increase compliance costs for traders since each DCM could establish different exemption-related rules and practices. However, to the extent that rules and procedures currently differ across exchanges, any compliance-related costs and benefits for traders may already be realized. Similarly, absent other provisions, a DCM could hypothetically seek a competitive advantage by offering excessively permissive exemptions, which could allow certain market participants to utilize exemptions in establishing sufficiently large positions to engage in excessive speculation and to manipulate market prices. However, proposed § 150.5(a)(2) would mitigate these risks by requiring that exemptions that do not conform to the types the Commission may grant under proposed § 150.3 could not exceed proposed § 150.2’s applicable federal limit unless the Commission has first approved such exemption. Moreover, before a DCM could permit a new exemption category, proposed § 150.5(e) would require a DCM to submit rules to the Commission allowing for such exemptions, allowing 647 This proposed standard is substantively consistent with current market practice. See, e.g., CME Rule 559 (providing that CME will consider, among other things, the ‘‘applicant’s business needs and financial status, as well as whether the positions can be established and liquidated in an orderly manner . . .’’) and ICE Rule 6.29 (requiring a statement that the applicant’s ‘‘positions will be initiated and liquidated in an orderly manner . . .’’). This proposed standard is also substantively similar to existing § 150.5’s standard and is not intended to be materially different. See existing § 150.5(d)(1) (an exemption may be limited if it would not be ‘‘in accord with sound commercial practices or exceed an amount which may be established and liquidated in orderly fashion.’’) 17 CFR 150.5(d)(1). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 the Commission to ensure that the proposed exemption type would be consistent with applicable requirements, including with the requirement that any resulting positions would be ‘‘in accord with sound commercial practices’’ and may be ‘‘established and liquidated in an orderly fashion.’’ Proposed § 150.5(a)(2) additionally would require traders to re-apply to the exchange at least annually for the exchange-level exemption. The Commission recognizes that requiring traders to re-apply annually could impose additional costs on traders that are not currently required to do so. However, the Commission believes this is industry practice among existing market participants, who are likely already familiar with DCMs’ exemption processes.648 This familiarity should reduce related costs, and the proposal should strengthen market integrity by ensuring that DCMs receive updated information related to a particular exemption. Proposed § 150.5(a)(2) also would require a DCM to provide the Commission with certain monthly reports regarding the disposition of any exemption application, including the recognition of any position as a bona fide hedge, the exemption of any spread transaction or other position, the revocation or modification or previously granted recognitions or exemptions, or the rejection of any application, as well as certain related information similar to the information that applicants must provide the Commission under proposed § 150.3 or an exchange under proposed § 150.9, including underlying cash-market and swap-market information related to bona fide hedge positions. The Commission generally recognizes that this monthly reporting requirement could impose additional costs on exchanges, although the Commission also preliminarily has determined that it would assist with its oversight functions and therefore benefit market integrity. The Commission discusses this proposed requirement in greater detail in its discussion of proposed § 150.9.649 Further, while existing § 150.5(d) does not explicitly address whether traders 648 As noted above, the Commission believes this requirement is consistent with current market practice. See, e.g., CME Rule 559 and ICE Rule 6.29. While ICE Rule 6.29 merely requires a trader to ‘‘submit to [ICE Exchange] a written request’’ without specifying how often a trader must reapply, the Commission understands from informal discussions between Commission staff and ICE that traders must generally submit annual updates. 649 See supra Section IV.A.5.b.ii. (discussion of monthly exchange-to-Commission report in proposed § 150.5(a)). PO 00000 Frm 00101 Fmt 4701 Sfmt 4702 11695 should request an exemption prior to taking on its position, proposed § 150.5(a)(2), in contrast, would explicitly authorize (but not require) DCMs to permit traders to file a retroactive exemption request due to ‘‘demonstrated sudden or unforeseen increases in its bona fide hedging needs,’’ but only within five business days after the trade and as long as the trader provides a supporting explanation.650 As noted above, these provisions are largely consistent with existing market practice, and to this extent, the benefits and costs already may have been realized by DCMs and market participants. ii. Pre-Existing Positions Proposed § 150.5(a)(3) would require DCMs to impose exchange-set position limits on ‘‘pre-existing positions,’’ other than pre-enactment swaps and transition period swaps, during the spot month, but not outside of the spot month, as long as any position outside of the spot month: (i) Was acquired in good faith consistent with the ‘‘preexisting position’’ definition in proposed § 150.1; 651 and (ii) would be attributed to the person if the position increases after the limit’s effective date. The Commission believes that this approach would benefit market integrity since pre-existing positions that exceed spot-month limits could result in market or price disruptions as positions are rolled into the spot month.652 However, the Commission acknowledges that, on its face, including a ‘‘good-faith’’ requirement in the proposed ‘‘preexisting position’’ definition could hypothetically diminish market integrity since determining whether a trader has acted in ‘‘good faith’’ is inherently subjective and could result in disparate treatment of traders by a particular exchange or across exchanges seeking a competitive advantage with one another. For example, with respect to a particular large or influential exchange member, an exchange could, in order to maintain the business relationship, be incentivized to be more liberal with its conclusion that the member obtained its position in ‘‘good faith,’’ or could be more liberal in 650 Certain exchanges currently allow for the submission of exemption requests up to five business days after the trader established the position that exceeded a limit in certain circumstances. See, e.g., CME Rule 559 and ICE’s ‘‘Guidance on Position Limits’’ (Mar. 2018). 651 Proposed § 150.1 would define ‘‘pre-existing position’’ to mean ‘‘any position in a commodity derivative contract acquired in good faith prior to the effective date’’ of any applicable position limit. 652 The Commission is particularly concerned about protecting the spot month in physicaldelivery futures from corners and squeezes. E:\FR\FM\27FEP3.SGM 27FEP3 11696 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules general in order to gain a competitive advantage. The Commission believes the risk of any such unscrupulous trader or exchange is mitigated since exchanges would still be subject to Commission oversight and to DCM Core Principles 4 (‘‘prevention of market disruption’’) and 12 (‘‘protection of markets and market participants’’), among others, and since proposed § 150.5(a)(3) also would require that exchanges must attribute the position to the trader if its position increases after the position limit’s effective date. c. Physical Commodity Derivative Contracts Not Yet Subject to Federal Position Limits Under § 150.2 (Proposed § 150.5(b)) lotter on DSKBCFDHB2PROD with PROPOSALS3 i. Spot Month Limits and Related Acceptable Practices For cash-settled contracts during the spot month, existing § 150.5 sets forth the following qualitative standard: exchange-set limits should be ‘‘no greater than necessary to minimize the potential for market manipulation or distortion of the contract’s or underling commodity’s price.’’ However, for physically-settled contracts, existing § 150.5 provides a one-size-fits-all parameter that exchange limits must be no greater than 25 percent of EDS. In contrast, the proposed standard for setting spot month limit levels for physical commodity derivative contracts not subject to federal position limits set forth in proposed § 150.5(b)(1) would not distinguish between cashsettled and physically-settled contracts, and instead would require DCMs to apply the existing § 150.5 qualitative standard to both.653 The Commission also proposes a related, non-exclusive acceptable practice that would deem exchange-set position limits for both cash-settled and physically-settled contracts subject to proposed § 150.5(b) to be in compliance if the limits are no higher than 25 percent of the spotmonth EDS. Applying the existing § 150.5 qualitative standard and non-exclusive acceptable practice in proposed 653 Proposed § 150.5(b)(1) would require DCMs to establish position limits for spot-month contracts at a level that is ‘‘necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract’s or the underlying commodity’s price or index.’’ Existing § 150.5 also distinguishes between ‘‘levels at designation’’ and ‘‘adjustments to levels,’’ although each category similarly incorporates the qualitative standard for cash-settled contracts and the 25-percent metric for physically-settled contracts. Proposed § 150.5(b) would eliminate this distinction. The Commission intends the proposed § 150.5(b)(1) standard to be substantively the same as the existing § 150.5 standard for cash-settled contracts, except that under proposed § 150.5(b)(1), the standard would apply to physically-settled contracts. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 150.5(b)(1), rather than a one-size-fits-all regulation, to both cash-settled and physically-settled contracts during the spot month is expected to enhance market integrity by permitting a DCM to establish a more tailored, productspecific approach by applying other parameters that may take into account the unique liquidity and other characteristics of the particular market and contract, which is not possible under the one-size-fits-all 25 percent EDS parameter set forth in existing § 150.5. While the Commission recognizes that the existing 25 percent EDS parameter has generally worked well, the Commission also recognizes that there may be circumstances where other parameters may be preferable and just as effective, if not more, including, for example, if the contract is cashsettled or does not have a reasonably accurate measurable deliverable supply, or if the DCM can demonstrate that a different parameter would better promote market integrity or efficiency for a particular contract or market. On the other hand, the Commission recognizes that proposed § 150.5(b)(1) could adversely affect market integrity by theoretically allowing DCMs to establish excessively high position limits in order to gain a competitive advantage, which also could harm the integrity of other markets that offer similar products.654 However, the Commission believes these potential risks would be mitigated since (i) proposed § 150.5(e) would require DCMs to submit proposed position limits to the Commission, which would review those rules for compliance with § 150.5(b), including to ensure that the proposed limits are ‘‘in accord with sound commercial practices’’ and that they may be ‘‘established and liquidated in an orderly fashion’’; and (ii) proposed § 150.5(b)(3) would require DCMs to adopt position limits for any new contract at a ‘‘comparable’’ level to existing contracts that are substantially similar (i.e., ‘‘look-alike contracts’’) on other exchanges unless the Commission approves otherwise. Moreover, this latter requirement also may reduce the amount of time and effort needed for the DCM and Commission staff to assess proposed limits for any new contract that competes with another DCM’s existing contract. 654 Since the existing § 150.5 framework already applies the proposed qualitative standard to cashsettled spot-month contracts, any new risks resulting from the proposed standard would occur only with respect to physically-settled contracts, which are currently subject to the one-size-fits-all 25-percent EDS parameter under the existing framework. PO 00000 Frm 00102 Fmt 4701 Sfmt 4702 ii. Non-Spot Month Limits/ Accountability Levels and Related Acceptable Practices Existing § 150.5 provides one-size-fitsall levels for non-spot month contracts and allows for position accountability after a contract’s initial listing only for those contracts that satisfy certain trading thresholds.655 In contrast, for contracts outside the spot-month, proposed § 150.5(b)(2) would require DCMs to establish either position limits or position accountability levels that satisfy the same proposed qualitative standard discussed above for spotmonth contracts.656 For DCMs that establish position limits, the Commission proposes related acceptable practices that would provide nonexclusive parameters that are generally consistent with existing § 150.5’s parameters for non-spot month contracts.657 For DCMs that establish 655 As noted above, in establishing the specific metric, existing § 150.5 distinguishes between ‘‘levels at designation’’ and ‘‘adjustments to [subsequent] levels.’’ Proposed § 150.5(b)(2) would eliminate this distinction and apply the qualitative standard for all non-spot month position limit and accountability levels. 656 DCM Core Principle 5 requires DCMs to establish either position limits or accountability for speculators. See Commission regulation § 38.300 (restating DCMs’ statutory obligations under the CEA § 5(d)(5)). Accordingly, inasmuch as proposed § 150.5(b)(2) would require DCMs to establish position limits or accountability, the proposal does not represent a change to the status quo baseline requirements. 657 Specifically, the acceptable practices proposed in Appendix F to part 150 would provide that DCMs would be deemed to comply with the proposed § 150.5(b)(2)(i) qualitative standard if they establish non-spot limit levels no greater than any one of the following: (1) Based on the average of historical positions sizes held by speculative traders in the contract as a percentage of open interest in that contract; (2) the spot month limit level for that contract; (3) 5,000 contracts (scaled up proportionally to the ratio of the notional quantity per contract to the typical cash market transaction if the notional quantity per contract is smaller than the typical cash market transaction, or scaled down proportionally if the notional quantity per contract is larger than the typical cash market transaction); or (4) 10 percent of open interest in that contract for the most recent calendar year up to 50,000 contracts, with a marginal increase of 2.5 percent of open interest thereafter. These proposed parameters have largely appeared in existing § 150.5 for many years in connection with non-spot month limits, either for levels at designation, or for subsequent levels, with certain revisions. For example, while existing § 150.5(b)(3) has provided a limit of 5,000 contracts for energy products, existing § 150.5(b)(2) provides a limit of 1,000 contracts for physical commodities other than energy products. The proposed acceptable practice parameters would create a uniform standard of 5,000 contracts for all physical commodities. The Commission expects that the 5,000 contract acceptable practice, for example, would be a useful rule of thumb for exchanges because it would allow them to establish limits and demonstrate compliance with Commission regulations in a relatively efficient manner, particularly for new contracts that have yet to establish open interest. The spot month limit level under item (2) above E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules position accountability, § 150.1’s proposed definition of ‘‘position accountability’’ would provide that a trader must reduce its position upon a DCM’s request, which is generally consistent with existing § 150.5’s framework, but would not distinguish between trading volume or contract type, like existing § 150.5. While DCMs would be provided the ability to decide whether to use limit levels or accountability levels for any such contract, under either approach, the DCM would have to set a level that is ‘‘necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract’s or the underlying commodity’s price or index.’’ Proposed § 150.5(b)(2) would benefit market efficiency by authorizing DCMs to determine whether position limits or accountability would be best-suited outside of the spot month based on the DCM’s knowledge of its markets. For example, position accountability could improve liquidity compared to position limits since liquidity providers may be more willing or able to participate in markets that do not have hard limits. As discussed above, DCMs are wellpositioned to understand their respective markets, and best practices in one market may differ in another market, including due to different market participants or liquidity characteristics of the underlying commodities. For DCMs that choose to establish position limits, the Commission believes that applying the proposed § 150.5 qualitative standard to contracts outside the spot-month would benefit market integrity by permitting a DCM to establish a more tailored, product-specific approach by applying other tools that may take into account the unique liquidity and other characteristics of the particular market and contract, which is not possible under the existing § 150.5 specific parameters for non-spot month contracts. While the Commission recognizes that the existing parameters may have been well-suited to market dynamics when initially promulgated, the Commission also recognizes that open interest may have changed for certain contracts subject to proposed § 150.5(b), and open interest will likely continue to change in the future (e.g., as new contracts may be introduced and as supply and/or demand may change for underlying commodities). In cases where open interest has not increased, the exchange may not need to change existing limit levels. But, for contracts would be a new parameter for non-spot month contracts. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 where open interest have increased, the exchange would be able to raise its limits to facilitate liquidity consistent with an orderly market. However, the Commission reiterates that the specific parameters in the proposed acceptable practices are merely non-exclusive examples, and an exchange would be able to establish higher (or lower) limits, provided the exchange submits its proposed limits to the Commission under proposed § 150.5(e) and explains how its proposed limits satisfy the proposed qualitative standard and are otherwise consistent with all applicable requirements. The Commission, however, recognizes that proposed § 150.5(b)(2) could adversely affect market integrity by potentially allowing DCMs to establish position accountability levels rather than position limits, regardless of whether the contract exceeds the volume-based thresholds provided in existing § 150.5. However, proposed § 150.5(e) would require DCMs to submit any proposed position accountability rules to the Commission for review, and the Commission would determine on a case-by-case basis whether such rules satisfy regulatory requirements, including the proposed qualitative standard. Similarly, in order to gain a competitive advantage, DCMs could theoretically set excessively high accountability (or position limit) levels, which also could potentially adversely affect markets with similar products. However, the Commission believes these risks would be mitigated since (i) proposed § 150.5(e) would require DCMs to submit proposed position accountability (or limits) to the Commission, which would review those rules for compliance with § 150.5(b), including to ensure that the exchange’s proposed accountability levels (or limits) are ‘‘necessary and appropriate to reduce the potential threat of market manipulation or price distortion’’ of the contract or underlying commodity; and (ii) proposed § 150.5(b)(3) would require DCMs to adopt position limits for any new contract at a ‘‘comparable’’ level to existing contracts that are substantially similar on other exchanges unless the Commission approves otherwise. iii. Exchange-Set Limits on Economically Equivalent Swaps As discussed above, swaps that would qualify as ‘‘economically equivalent swaps’’ would become subject to the federal position limits framework. However, the Commission is proposing to allow exchanges to delay compliance—including enforcing position limits—with respect to exchange-set limits on economically PO 00000 Frm 00103 Fmt 4701 Sfmt 4702 11697 equivalent swaps. The proposed delayed compliance would benefit the swaps markets by permitting SEFs and DCMs that list economically equivalent swaps more time to establish surveillance and compliance systems; as noted in the preamble, such exchanges currently lack sufficient data regarding individual market participants’ open swap positions, which means that requiring exchanges to establish oversight over participants’ positions currently would impose substantial costs and would be currently impracticable. Nonetheless, the Commission’s preliminary determination to permit exchanges to delay implementing federal position limits on swaps could incentivize market participants to leave the futures markets and instead transact in economically equivalent swaps, which could reduce liquidity in the futures and related options markets, which could also increase transaction and hedging costs. Delaying position limits on swaps therefore could harm market participants, especially endusers that do not transact in swaps, if many participants were to shift trading from the futures to the swaps markets. In turn, end-users could pass on some of these increased costs to the public at large.658 However, the Commission believes that these concerns would be mitigated to the extent the Commission would still oversee and enforce federal position limits even if the exchanges would not be required to do so. d. Position Aggregation Proposed § 150.5(d) would require all DCMs that list physical commodity derivative contracts to apply aggregation rules that conform to existing § 150.4, regardless of whether the contract is subject to federal position limits under § 150.2.659 The Commission believes 658 On the other hand, the Commission has not seen any shifting of liquidity to the swaps markets—or general attempts at market manipulation or evasion of federal position limits— with respect to the nine legacy core referenced futures contracts, even though swaps currently are not subject to federal or exchange position limits. 659 The Commission adopted final aggregation rules in 2016 under existing § 150.4, which applies to contracts subject to federal limits under § 150.2. See Final Aggregation Rulemaking, 81 FR at 91454. Under the Final Aggregation Rulemaking, unless an exemption applies, a person’s positions must be aggregated with positions for which the person controls trading or for which the person holds a 10 percent or greater ownership interest. The Division of Market Oversight has issued time-limited noaction relief from some of the aggregation requirements contained in that rulemaking. See CFTC Letter No. 19–19 (July 31, 2019), available at https://www.cftc.gov/csl/19-19/download. Commission regulation § 150.4(b) sets forth several permissible exemptions from aggregation. E:\FR\FM\27FEP3.SGM 27FEP3 11698 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules proposed § 150.5(d) would benefit market integrity in several ways. First, a harmonized approach to aggregation across exchanges that list physical commodity derivative contracts would prevent confusion that could result from divergent standards between federal limits under § 150.2 and exchange-set limits under § 150.5(b). As a result, proposed § 150.5(d) would provide uniformity, consistency, and reduced administrative burdens for traders who are active on multiple trading venues and/or trade similar physical contracts, regardless of whether the contracts are subject to § 150.2’s federal position limits. Second, a harmonized aggregation policy eliminates the potential for DCMs to use excessively permissive aggregation policies as a competitive advantage, which would impair the effectiveness of the Commission’s aggregation policy and limits framework. Third, since, for contracts subject to federal limits, proposed § 150.5(a) would require DCMs to set position limits at a level not higher than that set by the Commission under proposed § 150.2, differing aggregation standards could effectively lead to an exchange-set limit that is higher than that set by the Commission. Accordingly, harmonizing aggregation standards reinforces the efficacy and intended purpose of proposed §§ 150.2 and 150.5 and existing § 150.4 by eliminating DCMs’ ability to circumvent the applicable federal aggregation and position limits rules. To the extent a DCM currently is not applying the federal aggregation rules in existing § 150.4, or similar exchangebased rules, proposed § 150.5(d) could impose costs with respect to market participants trading referenced contracts for the proposed new 16 commodities that would become subject to federal position limits for the first time. Market participants would be required to update their trading and compliance systems to ensure they comply with the new aggregation rules. e. Request for Comment (51) The Commission requests comment on all aspects of the Commission’s cost-benefit discussion of the proposal. lotter on DSKBCFDHB2PROD with PROPOSALS3 7. Section 15(a) Factors 660 a. Protection of Market Participants and the Public A chief purpose of speculative position limits is to preserve the 660 The discussion here covers the proposed amendments that the Commission has identified as being relevant to the areas set out in section 15(a) of the CEA: (i) Protection of market participants and VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 integrity of derivatives markets for the benefit of commercial interests, producers, and other end- users that use these markets to hedge risk and of consumers that consume the underlying commodities. The Commission preliminarily believes that the proposed position limits regime would operate to deter excessive speculation and manipulation, such as squeezes and corners, which might impair the contract’s price discovery function and liquidity for hedgers—and ultimately, would protect the integrity and utility of the commodity markets for the benefit of both producers and consumers. At this time, the Commission is proposing to include the proposed 25 core referenced futures contracts within the proposed federal position limit framework. In selecting the proposed 25 core referenced contracts, the Commission, in accordance with its necessity analysis, considered the effects that these contracts have on the underlying commodity, especially with respect to price discovery; the fact that they require physical delivery of the underlying commodity; and, in some cases, the potentially acute economic burdens on interstate commerce that could arise from excessive speculation in these contracts causing sudden or unreasonable fluctuations or unwarranted changes in the price of the commodities underlying these contracts.661 Of particular importance are the proposed position limits during the spot month period because the Commission preliminarily believes that deterring and preventing manipulative behaviors, such as corners and squeezes, is more urgent during this period. The proposed spot month position limits are designed, among other things, to deter and prevent corners and squeezes as well as promote a more orderly liquidation process at expiration. By restricting derivatives positions to a proportion of the deliverable supply of the commodity, the spot month position limits reduce the possibility that a market participant can use derivatives, including referenced contracts, to affect the price of the cash commodity (and vice versa). Limiting a speculative position based on a percentage of deliverable supply also restricts a speculative trader’s ability to the public; (ii) efficiency, competitiveness, and financial integrity of futures markets; (iii) price discovery; (iv) sound risk management practices; and (v) other public interest considerations. For proposed amendments that are not specifically addressed, the Commission has not identified any effects. 661 See supra Section III.F.2. (discussion of the necessity findings as to the 25 core referenced futures contacts). PO 00000 Frm 00104 Fmt 4701 Sfmt 4702 establish a leveraged position in cashsettled derivative contracts, diminishing that trader’s incentive to manipulate the cash settlement price. As the Commission has determined in the preamble, the Commission has concluded that excessive speculation or manipulation may cause sudden or unreasonable fluctuations or unwarranted changes in the price of the commodities underlying these contracts.662 In this way, the Commission preliminarily believes that the proposed limits would benefit market participants that seek to hedge the spot price of a commodity at expiration, and benefit consumers who would be able to purchase underlying commodities for which prices are determined by fundamentals of supply and demand, rather than influenced by excessive speculation, manipulation, or other undue and unnecessary burdens on interstate commerce. The Commission preliminarily believes that the proposed Commission and exchange-centric processes for granting exemptions from federal limits, including non-enumerated bona fide hedging recognitions, would help ensure the hedging utility of the futures market for commercial end-users. First, the proposal to allow exchanges to leverage existing processes and their knowledge of their own markets, including participant positions and activities, along with their knowledge of the underlying commodity cash market, should allow for more timely review of exemption applications than if the Commission were to conduct such initial application reviews. This benefits the public by allowing producers and end-users of a commodity to more efficiently and predictably hedge their price risks, thus controlling costs that might be passed on to the public. Second, exchanges may be better-suited than the Commission to leverage their knowledge of their own markets, including participant positions and activities, along with their knowledge of the underlying commodity cash market, in order to recognize whether an applicant qualifies for an exemption and what the level for that exemption should be. This benefits market participants and the public by helping assure that exemption levels are set in a manner that meets the risk management needs of the applicant without negatively impacting the futures and cash market for that commodity. Third, allowing for exchange-granted spread exemptions could improve liquidity in all months 662 See supra Section III.F. (discussion of the necessity finding). E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules for a listed contract or across commodities, benefitting hedgers by providing tighter bid-ask spreads for out-right trades. Furthermore, traders using spreads can arbitrage price discrepancies between calendar months within the same commodity contract or price discrepancies between commodities, helping ensure that futures prices more accurately reflect the underlying market fundamentals for a commodity. Lastly, the Commission would review each application for bona fide hedge recognitions or spread exemptions (other than those bona fide hedges and spread exemptions that would be self-effectuating under the Commission’s proposal), but the proposal would allow the Commission to also leverage the exchange’s knowledge and experience of its own markets and market participants discussed above. The Commission also understands that there are costs to market participants and the public to setting the levels that are too high or too low. If the levels are set too high, there’s greater risk of excessive speculation, which may harm market participants and the public. Further, to the extent that the proposed limits are set at such a level that even without these proposed exemptions, the probability of nearing or breaching such levels may be negligible for most market participants, benefits associated with such exemptions may be reduced. Conversely, if the limits are set too low, transaction costs for market participants who are near or above the limit would rise as they transact in other instruments with higher transaction costs to obtain their desired level of speculative positions. Additionally, limits that are too low could incentivize speculators to leave the market and not be available to provide liquidity for hedgers, resulting in ‘‘choppy’’ prices. It is also possible for limits that are set too low to harm market efficiency because the views of some speculators might not be reflected fully in the price formation process. In setting the proposed limit levels, the Commission considered these factors in order to implement to the maximum extent practicable, as it finds necessary in its discretion, to apply the position limits framework articulated in CEA section 4a(a) to set federal position limits to protect market integrity and price discovery, thereby benefiting market participants and the public. b. Efficiency, Competitiveness, and Financial Integrity of Futures Markets Position limits help to prevent market manipulation or excessive speculation VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 that may unduly influence prices at the expense of the efficiency and integrity of markets. The proposed expansion of the federal position limits regime to 25 core referenced futures contracts (e.g., the existing nine legacy agricultural contracts and the 16 proposed new contracts) enhances the buffer against excessive speculation historically afforded to the nine legacy agricultural contracts exclusively, improving the financial integrity of those markets. Moreover, the proposed limits in proposed § 150.2 may promote market competitiveness by preventing a trader from gaining too much market power in the respective markets. Also, in the absence of position limits, market participants may be deterred from participating in a futures market if they perceive that there is a participant with an unusually large speculative position exerting what they believe is unreasonable market power. A lack of participation may harm liquidity, and consequently, may harm market efficiency. On the other hand, traders who find position limits overly constraining may seek to trade in substitute instruments— such as futures contracts or swaps that are similar to or correlated with (but not otherwise deemed to be a referenced contract), forward contracts, or trade options—in order to meet their demand for speculative instruments. These traders may also decide to not trade beyond the federal speculative position limit. Trading in substitute instruments may be less effective than trading in referenced contracts and, thus, may raise the transaction costs for such traders. In these circumstances, futures prices might not fully reflect all the speculative demand to hold the futures contract, because substitute instruments may not fully influence prices the same way that trading directly in the futures contract does. Thus, market efficiency might be harmed. The Commission preliminarily believes that focusing on the proposed 25 core referenced futures contracts, which generally have high levels of open interest and trading volume and/ or have been subject to existing federal position limits for many years, should in general be less disruptive for the derivatives markets that it regulates, which in turn may reduce the potential for disruption for the price discovery function of the underlying commodity markets as compared to including less liquid contracts (of course, only to the extent that the Commission would be able to make the requisite necessity finding for such contracts). Finally, the Commission preliminarily believes that the proposal to cease PO 00000 Frm 00105 Fmt 4701 Sfmt 4702 11699 recognizing certain risk management positions as bona fide hedges, coupled with the proposed increased non-spot month limit levels for the nine legacy agricultural contracts, will foster competition among swap dealers by subjecting all market participants, including all swap dealers, to the same non-spot month limit rather than to an inconsistent patchwork of staff-granted exemptions. Accommodating risk management activity by additional entities with higher limit levels may also help lessen the concentration risk potentially posed by a few commodity index traders holding exemptions that are not available to competing market participants. c. Price Discovery Market manipulation or excessive speculation may result in artificial prices. Position limits may help to prevent the price discovery function of the underlying commodity markets from being disrupted. Also, in the absence of position limits, market participants might elect to trade less as a result of a perception that the market pricing is unfair as a consequence of what they perceive is the exercise of too much market power by a larger speculator. Reduced liquidity may have a negative impact on price discovery. On the other hand, imposing position limits raises the concerns that liquidity and price discovery may be diminished, because certain market segments, i.e., speculative traders, are restricted. For certain commodities, the Commission proposes to set the levels of position limits at increased levels, to avoid harming liquidity that may be provided by speculators that would establish large positions, while restricting speculators from establishing extraordinarily large positions. The Commission further preliminarily believes that the bona fide hedging recognition and exemption processes will foster liquidity and potentially improve price discovery by making it easier for market participants to have their bona fide hedging recognitions and spread exemptions granted. In addition, position limits serve as a prophylactic measure that reduces market volatility due to a participant otherwise engaging in large trades that induce price impacts that interrupt price discovery. In particular, spot month position limits make it more difficult to mark the close of a futures contract to possibly benefit other contracts that settle on the closing futures price. Marking the close harms markets by spoiling convergence between futures prices and spot prices E:\FR\FM\27FEP3.SGM 27FEP3 11700 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules at expiration and damaging price discovery. lotter on DSKBCFDHB2PROD with PROPOSALS3 d. Sound Risk Management Practices Proposed exemptions for bona fide hedges help to ensure that market participants with positions that are hedging legitimate commercial needs are recognized as hedgers under the Commission’s speculative position limits regime. This promotes sound risk management practices. In addition, the Commission has crafted the proposed rules to ensure sufficient market liquidity for bona fide hedgers to the maximum extent practicable, e.g., through the proposals to: (1) Create a bona fide hedging definition that is broad enough to accommodate common commercial hedging practices, including anticipatory hedging, for a variety of commodity types; (2) maintain the status quo with respect to existing bona fide hedge recognitions and spread exemptions that would remain self-effectuating and make additional bona fide hedges selfeffectuating (i.e., certain anticipatory hedging); (3) provide additional ability for a streamlined process where market participants can make a single submission to an exchange in which the exchange and Commission would each review applications for non-enumerated bona fide hedge recognitions for purposes of federal and exchange-set limits that are in line with commercial hedging practices; and (4) to allow for a conditional spot month limit exemption in natural gas. To the extent that monitoring for position limits requires market participants to create internal risk limits and evaluate position size in relation to the market, position limits may also provide an incentive for market participants to engage in sound risk management practices. Further, sound risk management practices would be promoted by the proposal to allow for market participants to measure risk in the manner most suitable for their business (i.e., net versus gross hedging practices), rather than having to conform their hedging programs to a one-size-fits-all standard that may not be suitable for their risk management needs. Finally, the proposal to increase non-spot month limit levels for the nine legacy agricultural contracts to levels that reflect observed levels of trading activity, based on recent data reviewed by the Commission, should allow swap dealers, liquidity providers, market makers, and others who have risk management needs, but who are not hedging a physical commercial, to soundly manage their risks. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 e. Other Public Interest The Commission has not identified any additional public interest considerations related to the costs and benefits of this 2020 Proposal. f. Request for Comment (52) The Commission requests comment on all aspects of the Commission’s discussion of the 15(a) factors for this proposal. B. Paperwork Reduction Act 1. Overview Certain provisions of the proposed rule on position limits for derivatives would amend or impose new ‘‘collection of information’’ requirements as that term is defined under the Paperwork Reduction Act (‘‘PRA’’).663 An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number from the Office of Management and Budget (‘‘OMB’’). The proposed rule would modify the following existing collections of information previously approved by OMB and for which the Commodity Futures Trading Commission (‘‘Commission’’) has received control numbers: (i) OMB control number 3038– 0009 (Large Trader Reports), which generally covers Commission regulations in parts 15 through 21; (ii) OMB control number 3038–0013 (Aggregation of Positions), which covers Commission regulations in part 150; 664 and (iii) OMB control number 3038– 0093 (Provisions Common to Registered Entities), which covers Commission regulations in part 40. Certain provisions of the proposed rule would impose new collection of information requirements under the PRA. As a result, the Commission is proposing to revise OMB control numbers 3038–0009, 3038–0013, and 3038–0093 and is submitting this proposal to OMB for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. 2. Commission Reorganization of OMB Control Numbers 3038–0009 and 3038– 0013 The Commission is proposing two non-substantive changes so that all collections of information related solely to the Commission’s position limit 663 44 U.S.C. 3501 et seq. OMB control number 3038–0013 is titled ‘‘Aggregation of Positions.’’ The Commission proposes to rename the OMB control number ‘‘Position Limits’’ to better reflect the nature of the information collections covered by that OMB control number. 664 Currently, PO 00000 Frm 00106 Fmt 4701 Sfmt 4702 requirements are consolidated under one OMB control number.665 First, the Commission would transfer collections of information under part 19 (Reports by Persons Holding Bona Fide Hedge Positions and By Merchants and Dealers in Cotton) related to position limit requirements from OMB control number 3038–0009 to OMB control number 3038–0013. Second, the modified OMB control number 3038–0013 would be renamed as ‘‘Position Limits.’’ This renaming change is non-substantive and would allow for all collections of information related to the federal position limits requirements, including exemptions from speculative position limits and related large trader reporting, to be housed in one collection. One collection would make it easier for market participants to know where to find the relevant position limits PRA burdens. If the proposed rule is finalized, the remaining collections of information under OMB control number 3038–0009 would cover reports by various entities under parts 15, 17, and 21 666 of the Commission’s regulations, while OMB control number 3038–0013 would hold collections of information arising from parts 19 and 150. As discussed in section 3 below, this non-substantive reorganization would result in: (i) A decreased burden estimate under control number 3038– 0009 due to the transfer of the collection of information arising from obligations in part 19, and (ii) a corresponding increase of the amended part 19 burdens under control number 3038–0013. However, as discussed further below, the collection of information and burden hours arising from proposed part 19 that would be transferred to OMB control number 3038–0013 would be less than the existing burden estimate under OMB control number 3038–0009 since the Commission’s proposal would amend existing part 19 by eliminating existing Form 204 and certain parts of Form 304 and the reporting burdens related thereto. As a result, market participants would see a net reduction of collections of information and burden hours under revised part 19. 665 The Commission notes that certain collections of information under OMB control number 3038– 0093 relate to several Commission regulations in addition to the Commission’s proposed position limits framework. As a result, the collections of information discussed herein under this OMB control number 3038–0093 will not be consolidated under OMB control number 3038–0013. 666 As noted above, OMB control number 3038– 0009 generally covers Commission regulations in parts 15 through 21. However, it does not cover §§ 16.02, 17.01, 18.04, or 18.05, which are under OMB control number 3038–0103. Final Rule. 78 FR 69178 at 69200 (Nov. 18, 2013) (transferring §§ 16.02, 17.01, 18.04, and 18.05 to OMB Control Number 3038–0103). E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules ‘‘exchanges’’). Finally, the proposed rule would also amend part 40 to incorporate a new reporting obligation into the definition of ‘‘terms and conditions’’ in § 40.1(j) and result in a revised existing collection of information covered by OMB control number 3038–0093. 3. Collections of Information The proposed rule would amend existing regulations, and create new regulations, concerning speculative position limits. Among other amendments, the Commission’s proposed rule would include: (1) New and amended federal spot month limits for the proposed 25 physical commodity derivatives; (2) amended federal nonspot limits for the nine legacy agricultural commodities contracts currently subject to federal position limits; (3) amended rules governing exchange-set limit levels and grants of exemptions therefrom; (4) an amended process for requesting certain spread exemptions and non-enumerated bona fide hedge recognitions for purposes of federal position limits directly from the Commission; (5) a new exchangeadministered process for recognizing non-enumerated bona fide hedge positions from federal limit requirements; and (6) amendments to part 19 and related provisions that would eliminate certain reporting obligations that require traders to submit a Form 204 and Parts I and II of Form 304. Specifically, this proposal would amend parts 15, 17, 19, 40, and 150 of the Commission’s regulations to implement the proposed federal position limits framework. The proposal would also transfer an amended version of the ‘‘bona fide hedging transactions or positions’’ definition from existing § 1.3 to proposed § 150.1, and remove §§ 1.47, 1.48, and 140.97. The Commission’s proposal would revise existing collections of information covered by OMB control number 3038– 0009 by amending part 19, along with conforming changes to part 15, in order to narrow the scope of who is required to report under part 19.667 Furthermore, the proposed rule’s amendments to part 150 would revise existing collections of information covered by OMB control number 3038– 0013, including new reporting and recordkeeping requirements related to the application and request for relief from federal position limit requirements submitted to designated contract markets (‘‘DCMs’’) and swap execution facilities (‘‘SEFs’’) (collectively, a. OMB Control Number 3038–0009— Large Trader Reports; Part 19—Reports by Persons Holding Bona Fide Hedge Positions and by Merchants and Dealers in Cotton Under OMB control number 3038– 0009, the Commission currently estimates that the collections of information related to existing part 19, including Form 204 and Form 304, collectively known as the ‘‘Series ’04’’ reports, have a combined annual burden hours of 1,553 hours. Under existing part 19, market participants that hold bona fide hedging positions in excess of position limits for the nine legacy agricultural commodity contracts currently subject to federal limits must file a monthly report on Form 204 (or Parts I and II of Form 304 for cotton). These reports show a snapshot of traders’ cash positions on one given day each month, and are used by the Commission to determine whether a trader has sufficient cash positions to justify futures and options on futures positions above the applicable federal position limits in existing § 150.2. The Commission’s proposal would amend part 19 to remove these reporting obligations associated with Form 204 and Parts I and II of Form 304. As discussed under proposed § 150.9 below, the Commission preliminarily has determined that it may eliminate these forms and still receive adequate information to carry out its market and financial surveillance programs since its proposed amendments to §§ 150.5 and 150.9 would also enable the Commission to obtain the necessary information from the exchanges. To effect these changes to traders’ reporting obligations, the Commission would eliminate (i) existing § 19.00(a)(1), which requires the applicable persons to file a Form 204; and (ii) existing § 19.01, which among other things, sets forth the cash-market information required to be submitted on the Forms 204 and 304.668 The Commission would maintain Part 667 As noted above, the Commission would accomplish this by eliminating existing From 204 and Parts I and II of Form 304. Additionally, proposed changes to part 17, covered by OMB control number 3038–0009, would make conforming amendments to remove certain duplicative provisions and associated information collections related to aggregation of positions, which are in current § 150.4. These conforming changes would not impact the burden estimates of OMB control number 3038–0009. 668 As noted above, the proposed amendments to part 19 affect certain provisions of part 15 and § 17.00. Based on the proposed elimination of Form 204 and Parts I and II of Form 304, the Commission proposes conforming technical changes to remove related reporting provisions from (i) the ‘‘reportable position’’ definition in § 15.00(p); (ii) the list of ‘‘persons required to report’’ in § 15.01; and (iii) the list of reporting forms in § 15.02. These proposed conforming amendments to part 15 would not impact the existing burden estimates. VerDate Sep<11>2014 19:37 Feb 26, 2020 Jkt 250001 PO 00000 Frm 00107 Fmt 4701 Sfmt 4702 11701 III of Form 304, which requests information on unfixed-price ‘‘on call’’ purchases and sales of cotton and which the Commission utilizes to prepare its weekly cotton on-call report.669 The Commission would also maintain its existing special call authority under part 19. The supporting statement for the current active information collection request for part 19 under OMB control number 3038–0009 670 states that in 2014: (i) 135 reportable traders filed the Series ‘04 reports (i.e., Form 204 and Form 304 in the aggregate), (ii) totaling 3,105 Series ‘04 reports, for a total of (iii) 1,553 burden hours.671 However, based on more current and recent 2019 submission data, the Commission is revising its existing estimates slightly higher for the Series ’04 reports under part 19: • Form 204: 50 monthly reports, for an annual total of 600 reports (50 monthly reports × 12 months = 600 total annual reports) and 300 annual burden hours (600 annual Form 204s submitted × 0.5 hours per report = 300 aggregate annual burden hours for all Form 204s). • Form 304: 55 weekly reports, for an annual total of 2,860 reports (55 weekly reports × 52 weeks = 2,860 total annual reports) and 1,430 annual burden hours (2,860 annual Form 304s submitted × 0.5 hours per report = 1,430 aggregate annual burden hours for all Form 304s). Accordingly, based on the above revised estimates the Commission would revise its estimate of the current collections of information under existing part 19 to reflect that approximately 105 reportable traders 672 file a total of 3,460 responses annually 673 resulting in an aggregate annual burden of 1,730 hours.674 675 The 669 The Commission is proposing a technical change to Part III of Form 304 to require traders to identify themselves on the Form 304 using their Public Trader Identification Number, in lieu of the CFTC Code Number required on previous versions of the Form 304. However, the Commission preliminarily has determined that this would not result in any change to its existing PRA estimates with respect to the collections of information related to Part III of Form 304. 670 See ICR Reference No: 201906–3038–008. 671 3,105 Series ’04 submissions × 0.5 hours per submission = 1,553 aggregate burden hours for all submissions. The Commission notes that it has preliminarily estimated that it takes approximately 20 minutes to complete a Form 204 or 304. However, in order to err conservatively, the Commission now uses a figure of 30 minutes. 672 55 Form 304 reports + 50 Form 205 reports = 105 reportable traders. 673 2,860 Form 304s + 600 Form 204s = 3,460 total annual Series ’04 reports. 674 3,460 Series ’04 reports × 0.5 hours per report = 1,730 annual aggregate burden hours. 675 These revised estimates result in an increased estimate under existing part 19 of 355 Series ’04 E:\FR\FM\27FEP3.SGM Continued 27FEP3 11702 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 Commission’s proposal would reduce the current OMB control number 3038– 0009 by these revised burden estimates under part 19 as they would be transferred to OMB control number 3038–0013. With respect to the overall collections of information that would be transferred to OMB control number 3038–0013 based on the Commission’s revised part 19 estimate, the Commission estimates that the Commission’s proposal would reduce the collections of information in part 19 by 600 reports 676 and by 300 annual aggregate burden hours since the Commission’s proposal would eliminate Form 204, as discussed above.677 The Commission does not expect a change in the number of reportable traders that would be required to file Part III of Form 304.678 Thus, the Commission continues to expect approximately 55 weekly Form 304 reports, for an annual total of 2,860 reports 679 for an aggregate total of 1,430 burden hours, which information collection burdens would be transferred to OMB control number 3038–0013.680 In addition, the Commission would maintain its authority to issue special calls for information to any person claiming an exemption from speculative federal position limits. While the position limits framework will expand to traders in the proposed twenty-five commodities (an increase from the existing nine legacy agricultural products), the position limit levels themselves will also be higher. The higher position limit levels would result in a smaller universe of traders who may exceed the position limits and thus be subject to a special call for information on their large position(s). Taking into account the higher limits and smaller universe of traders who would likely exceed the position limits, the Commission estimates that it is likely to issue a special call for information to 4 reportable traders. The reports submitted by traders (3,460 estimated Series ’04 reports¥3,105 submissions from the Commission’s previous estimate = an increase of 355 response difference); an increase of 177 aggregate burden hours across all respondents (1,730 aggregate burden hours¥1,553 aggregate burden hours from the Commission’s previous estimate = an increase of 177 aggregate burden hours); and a decrease of 30 respondent traders (105 respondents¥135 respondents from the Commission’s previous estimate = a decrease of 30 respondents). 676 50 monthly Form 204 reports × 12 months = 600 total annual reports. 677 600 Form 204 reports × 0.5 burden hours per report = 300 aggregate annual burden hours. 678 Since the Commission’s proposal would eliminate Parts I and II of Form 304, proposed Form 304 would only refer to existing Part III of that form. 679 55 weekly Form 304 reports × 52 weeks = 2,860 total annual Form 304 reports. 680 2,860 Form 304 reports × 0.5 burden hours per report = 1,430 aggregate annual burden hours. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Commission preliminarily estimates that it would take approximately 5 hours to respond to a special call. The Commission therefore estimates that industry would incur a total of 20 aggregate annual burden hours.681 b. OMB Control Number 3038–0013— Aggregation of Positions (To Be Renamed ‘‘Position Limits’’) i. Introduction; Bona Fide Hedge Recognition and Exemption Process The Commission is proposing to amend the existing process for market participants to apply to obtain an exemption or recognition of a bona fide hedge position. Currently, the ‘‘bona fide hedging transaction or position’’ definition appears in existing § 1.3. Under existing §§ 1.47 and 1.48, a market participant must apply directly to the Commission to obtain a bona fide hedge recognition in accordance with § 1.3 for federal position limit purposes. Proposed §§ 150.3 and 150.9 would establish an amended process for obtaining a bona fide hedge exemption or recognition, which includes: (i) A new bona fide hedging definition in § 150.1, (ii) a new process administered by the exchanges in proposed § 150.9 for recognizing non-enumerated bona fide hedging positions for federal limit requirements, and (iii) an amended process to apply directly to the Commission for certain spread exemptions or for recognition of nonenumerated bona fide hedging positions. Proposed § 150.3 also would include new exemption types not explicitly listed in existing § 150.3. The Commission has previously estimated the combined annual burden hours for submitting applications under both §§ 1.47 and 1.48 to be 42 hours.682 The Commission’s proposal would maintain the existing process where market participants may apply directly to the Commission, although the Commission expects market participants to predominantly rely on the exchangeadministered process to obtain recognition of their non-enumerated bona fide hedging positions for purposes of federal position limit requirements. Enumerated bona fide hedge positions would remain selfeffectuating, which means that market 681 4 possible reportable traders × 5 hours each = 20 aggregate annual burden hours. 682 The supporting statement for a previous information collection request, ICR Reference No: 201808–3038–003, for OMB control number 3038– 0013, estimated that seven respondents would file the §§ 1.47 and 1.48 submissions, and that each respondent would file two submissions for a total of 14 annual submissions, requiring 3 hours per response, for a total of 42 burden hours for all respondents. PO 00000 Frm 00108 Fmt 4701 Sfmt 4702 participants would not need to apply to the Commission for purposes of federal position limits, although market participants would still need to apply to an exchange for recognition of bona fide hedge positions for purposes of exchange-set position limits. The Commission forms this expectation on the fact that all the contracts that will now be subject to federal position limits are already subject to exchange-set limits. Thus, most market participants are likely to already be familiar with an exchange-administered process, as is being proposed under § 150.9. Familiarity with an exchangeadministered process will result in operational efficiencies, such as completing one application for nonenumerated bona fide hedge requests for both federal and exchange-set limits and thus a reduced burden on market participants. As previously discussed, the proposal would move the ‘‘bona fide hedge transaction or position’’ definition to proposed § 150.1, and amend the definition to, among other things, remove the distinction between different types of enumerated bona fide hedge positions so that anticipatory enumerated bona fide hedges would be self-effectuating like other nonanticipatory enumerated bona fide hedges. The proposal would maintain the distinction between enumerated and non-enumerated bona fide hedges, and market participants would be required to apply for recognition of nonenumerated bona fide hedge positions either directly from the Commission pursuant to proposed § 150.3 or indirectly through an exchange-centric process under § 150.9.683 The Commission does not preliminarily believe that this amendment will have any PRA impacts since it is maintaining the status quo in which most enumerated bona fide hedges are selfeffectuating while requiring traders to apply to the Commission for recognition 683 Currently, in order to determine whether a futures, an option on a futures, or a swap position qualifies as a bona fide hedge, either (1) the position in question must qualify as an enumerated bona fide hedge, as defined in existing § 1.3, or (2) the trader must file a statement with the Commission, pursuant to existing § 1.47 (for non-enumerated bona fide hedges) and/or existing § 1.48 (for enumerated anticipatory bona fide hedges). The revised definition would be accompanied by an expanded list of enumerated bona fide hedges that would appear in acceptable practices, rather than in the definition. The Commission additionally proposes to include an additional enumerated bona fide hedge for anticipatory merchandizing, which would be self-effectuating like the other enumerated hedges. Under the existing framework, anticipatory merchandizing is considered to be a nonenumerated bona fide hedge. The Commission preliminarily does not expect this change to have any PRA impacts. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules of non-enumerated bona fide hedge positions. ii. § 150.2 Speculative Limits Under proposed § 150.2(f), upon request from the Commission, DCMs listing a core referenced futures contract would be required to supply to the Commission deliverable supply estimates for each core referenced futures contract listed at that DCM. DCMs would only be required to submit estimates if requested to do so by the Commission on an as-needed basis. When submitting estimates, DCMs would be required to provide a description of the methodology used to derive the estimate, as well as any statistical data supporting the estimate. Appendix C to part 38 sets forth guidance regarding estimating deliverable supply. Submitting deliverable supply estimates upon demand from the Commission for contracts subject to federal limits would be a new reporting obligation for DCMs. The Commission estimates that six DCMs would be required to submit initial deliverable supply estimates. The Commission estimates that it would request each DCM that lists a core referenced futures contract to file one initial report for each core reference futures contract it lists on its market. Such requests from the Commission would result in one initial submission for each of the proposed twenty-five core referenced futures contracts.684 The Commission further estimates that it will take 20 hours to complete and file each report for a total annual burden of 500 hours for all respondents.685 Accordingly, the proposed changes to § 150.2(f) would result in an initial, one-time increase to the current burden estimates of OMB control number 3038–0013 by an increase of 25 submissions across six respondent DCMs for the initial number of submissions for the twenty-five core referenced futures contracts and an initial, one-time burden of 500 hours. lotter on DSKBCFDHB2PROD with PROPOSALS3 iii. § 150.3 Exemptions From Federal Position Limit Requirements Market participants may currently apply directly to the Commission for 684 In 2018, the DCMs submitted deliverable supply estimates for all the commodities that would be subject to federal position limits. Thus, the Commission expects that the exchanges would be able to leverage these recent estimates to minimize the burden of the initial submission under the Commission’s proposal. 685 20 initial hours × 25 core referenced futures contracts = 500 one-time, aggregate burden hours. While there is an initial annual submission, the Commission does not expect to require the exchanges to resubmit the supply estimates on an annual basis. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 recognition of certain bona fide hedges under the process set forth in existing §§ 1.47 and 1.48. There is no existing process that is codified under the Commission’s regulations for spread exemptions or other exemptions included under proposed § 150.3. Proposed § 150.3 would specify the circumstances in which a trader could exceed federal position limits.686 With respect to non-enumerated bona fide hedge recognitions and spread exemptions not identified in the proposed ‘‘spread transaction’’ definition in proposed § 150.1, proposed § 150.3(b) would provide a process for market participants to request such bona fide hedge recognitions or spread exemptions directly from the Commission (as previously noted, both enumerated bona fide hedges and spread exemptions identified in the proposed ‘‘spread transaction’’ definition would be self-effectuating and would not require a market participant to submit a request). Proposed § 150.3(b), (d), and (e) set forth exemption-related reporting and recordkeeping requirements that impact the current burden estimates in OMB control number 3038–0013.687 The proposed collection of information is necessary for the Commission to determine whether to recognize a trader’s position as a bona fide hedge exempted from position limit requirements. Proposed § 150.3(b) establishes application filing requirements and recordkeeping and reporting requirements that are similar to existing requirements for bona fide hedge recognitions under existing §§ 1.47 and 1.48. Although these requirements in proposed § 150.3 would be new for market participants seeking spread exemptions (which are currently selfeffectuating), the proposed filing, recordkeeping, and reporting requirements in § 150.3(b) are otherwise 686 Proposed § 150.3(b) would include (1) recognitions of bona fide hedges under proposed § 150.3(b); (2) spread exemptions under proposed § 150.3(b); (3) financial distress positions a person could request from the Commission under § 140.99; and (4) exemptions for certain natural gas positions held during the spot month. Proposed § 150.3(b) would also exempt pre-enactment and transition period swaps. The enumerated bona fide hedge recognitions and spread exemptions identified in the proposed ‘‘spread transaction’’ definition in proposed § 150.1 would be self-effectuating. 687 Proposed § 150.3(f) clarifies the implications on entities required to aggregate accounts under § 150.4, and § 150.3(g) provides for delegation of certain authorities to the Director of the Division of Market Oversight. The proposed changes to §§ 150.3(f) and 150.3(g) do not impact the current estimates for these OMB control numbers. Also, the proposal reminds persons of the relief provisions in § 140.99, covered by OMB control number 3038– 0049, which does not impact the burden estimates. PO 00000 Frm 00109 Fmt 4701 Sfmt 4702 11703 familiar to market participants that have requested certain bona fide hedging recognitions from the Commission under existing regulations. The Commission estimates that very few or no traders would request recognition of a non-enumerated bona fide hedge, and those traders that do would likely prefer the exchangeadministered process in proposed § 150.9 (discussed further below) rather than apply directly to the Commission under proposed § 150.3(b). Similarly, the Commission estimates that very few or no traders would submit a request for a spread exemption since the Commission preliminarily has determined that the most common spread exemptions are included in the proposed ‘‘spread transaction’’ definition and therefore would be selfeffectuating and would not need approval for purposes of federal position limits. The Commission expects that traders are likely to rely on the § 150.3(b) process when dealing with a spread transaction or nonenumerated bona fide hedge position that poses a novel or complex question under the Commission’s rules. Particularly when the exchanges have not recognized that type of practice as a non-enumerated bona fide hedge previously, the Commission expects market participants to seek more regulatory clarity under proposed § 150.3(b). In the event a trader submits such request under proposed § 150.3, the Commission estimates that traders would file one request per year for a total of one annual request for all respondents. The Commission further estimates that in such situation, it would take 20 hours to complete and file each report, for a total of 20 aggregate annual burden hours for all traders. Proposed § 150.3(d) establishes recordkeeping requirements for persons who claim any exemptions or relief under proposed § 150.3. Proposed § 150.3(d) should help to ensure that if any person claims any exemption permitted under proposed § 150.3 such exemption holder can demonstrate compliance with the applicable requirements as follows: First, under proposed § 150.3(d)(1), any person claiming an exemption would be required to keep and maintain complete books and records concerning certain details.688 Proposed § 150.3(d)(1) 688 The requirement would include all details of related cash, forward, futures, options, and swap positions and transactions, including anticipated requirements, production and royalties, contracts for services, cash commodity products and by- E:\FR\FM\27FEP3.SGM Continued 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 11704 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules would establish recordkeeping requirements for any person relying on an exemption granted directly from the Commission. The Commission estimates that very few or no traders would claim an exemption directly from the Commission. In the event a trader requests an exemption, the Commission estimates that the trader would create one record per exemption per year for a total of one annual record for all respondents. The Commission further estimates that it will take one hour to comply with the recordkeeping requirement of § 150.3(d)(1) for a total of one aggregate annual burden hour for all traders. Second, under proposed § 150.3(d)(2), a pass-through swap counterparty, as defined by proposed § 150.1, that relies on a representation received from a bona fide hedging swap counterparty that the swap qualifies in good faith as a ‘‘bona fide hedging position or transaction,’’ as defined under proposed § 150.1, would be required to: (i) Maintain any written representation for at least two years following the expiration of the swap; and (ii) furnish the representation to the Commission upon demand. Proposed § 150.3(d)(2) would create a new recordkeeping obligation for certain persons relying on the proposed pass-through swap representations, and the Commission estimates that 425 traders would be requested to maintain the required records. The Commission estimates that each trader would maintain one record per year for a total of 425 aggregate annual records for all respondents. The Commission further estimates that it will take one hour to comply with the recordkeeping requirement of § 150.3(d) for a total of one annual burden hour for each trader and 425 aggregate annual burden hours for all traders. The Commission proposes to move existing § 150.3(b), which currently allows the Commission or certain Commission staff to make special calls to demand certain information regarding persons claiming exemptions, to proposed § 150.3(e), with some modifications to include swaps.689 Together with the recordkeeping provision of proposed § 150.3(d), proposed § 150.3(e) should enable the Commission to monitor the use of exemptions from speculative position limits and help to ensure that any person who claims any exemption permitted by proposed § 150.3 can products, cross-commodity hedges, and a record of bona fide hedging swap counterparties. 689 Proposed § 150.3(e) would refer to commodity derivative contracts, whereas current § 150.3(b) refers to futures and options. The proposed change would result in the inclusion of swaps. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 demonstrate compliance with the applicable requirements. The Commission’s existing collection under existing § 150.3 estimated that the Commission issues two special calls per year for information related to exemptions, and that each response to a special call for information takes 3 burden hours to complete. This includes two burden hours to fulfill reporting requirements and 1 burden hour related to recordkeeping for an aggregate total for all respondents of six annual burden hours, broken down into four aggregate annual burden hours for reporting and two aggregate annual burden hours for recordkeeping.690 The Commission estimates that proposed § 150.3(e) would impose information collection burdens related to special calls by the Commission on approximately 18 additional respondents, for an estimated 20 special calls per year.691 The Commission estimates that these 20 market participants would provide one submission per year to respond to the special call for a total of 20 annual submissions for all respondents. The Commission estimates it would take a market participant approximately 10 hours to complete a response to a special call. Therefore, the Commission estimates responses to special calls for information will take an aggregate total of 200 burden hours for all traders.692 The Commission notes that it is also maintaining its special call authority for reporting requirements under proposed part 19 discussed above. iv. § 150.5 Exchange Set Limits and Exemptions Amendments to § 150.5 would refine the process, and establish non-exclusive methodologies, by which exchanges may set exchange-level limits and grant exemptions therefrom, including separate methodologies for setting limit levels for contracts subject to federal limits (§ 150.5(a)), physical commodity derivatives not subject to federal limits 690 The special call authority under part 19 and the proposed special call authority discussed under § 150.3 would be similar in nature; however, part 19 would apply to special calls regarding bona fide hedge recognitions and related underlying cash market positions while the special calls under proposed § 150.3 would apply to the other exemptions under proposed § 150.3. 691 2 respondents subject to special calls under existing § 150.3 + 18 additional respondents under proposed § 150.3 = 20 total respondents. The Commission estimates, at least during the initial implementation period, that it is likely to issue more special calls for information to monitor compliance with position limits, particularly in the commodity markets that will now be subject to federal position limits for the first time. 692 20 special calls × 10 burden hours per call = 200 total burden hours. PO 00000 Frm 00110 Fmt 4701 Sfmt 4702 (§ 150.5(b)), and excluded commodity contracts (§ 150.5(c)).693 In compliance with part 40 of the Commission’s regulations, exchanges currently have policies and procedures in place to address exemptions from exchange set limits through their rulebooks. If the proposal is adopted, the Commission expects that the exchanges would accordingly update their rulebooks, both to conform to proposed new requirements and to incorporate the additional contracts that will be subject to federal position limits into their process for setting exchange-level limits and exemptions therefrom. The collections of information related to amended rulebooks under part 40 are covered by OMB control number 3038– 0093. Separately, the collections of information related to applications for exemptions from exchange-set limits are covered by OMB control number 3038– 0013. Under proposed § 150.5(a)(1), for any contract subject to a federal limit, DCMs and, ultimately, SEFs, would be required to establish exchange-set limits for such contracts. Under proposed § 150.5(a)(2), exchanges that wish to grant exemptions from exchange-set limits on commodity derivative contracts subject to federal limits would have to require traders to file an application to show a request for a bona fide hedge recognition or exemption conforms to a type that may be granted under proposed § 150.3(a)(1)–(4). Exchanges would have to require that such exchange-set limit exemption applications be filed in advance of the date such position would be in excess of the limits, but exchanges would be given the discretion to adopt rules allowing traders to file applications within five business days after a trader took on such position. Proposed § 150.5(a)(2) would also provide that exchanges must require that the trader reapply for the exemption at least annually. Proposed § 150.5(a)(4) would require each exchange to provide a monthly report showing the disposition of any exemption application, including the recognition of any position as a bona fide hedge, the exemption of any spread transaction, the renewal, revocation, or modification of a previously granted 693 Proposed § 150.5 addresses exchange-set position limits and exemptions therefrom, whereas proposed § 150.9 addresses federal limits and an exchange-administered process for purposes of federal limits where an applicant may apply through an exchange to the Commission for recognition of an non-enumerated bona fide hedge for purposes of federal position limits. E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 recognition or exemption, or the rejection of any application.694 These proposed collections of information related to exemptions from exchange-set limits are necessary to ensure that such exchange-set limits comply with Commission regulations, including that exchange limits are no higher than the applicable federal level; to establish minimum standards needed for exchanges to administer the exchange’s position limits framework; and to enable the Commission to oversee an exchange’s exemptions process to ensure it does not undermine the federal position limits framework. In addition, the Commission would use the information to confirm that exemptions are granted and renewed in accordance with the types of exemptions that may be granted under proposed § 150.3(a)(1)–(4). The Commission estimates under proposed § 150.5(a) that 425 traders would submit applications to claim spread exemptions and bona fide hedge recognitions from exchange-set position limits on commodity derivatives contracts subject to federal limits set forth in § 150.2. The Commission estimates that each trader on average would submit one application to an exchange each year for a total of 425 applications for all respondents. The Commission further estimates that it will take 2 hours to complete and file each application for a total of 2 annual burden hours for each trader and 850 aggregate burden hours for all traders.695 694 Additionally, each report should include the following details: (A) The date of disposition; (B) The effective date of the disposition; (C) The expiration date of any recognition or exemption; (D) Any unique identifier(s) the designated contract market or swap execution facility may assign to track the application, or the specific type of recognition or exemption; (E) If the application is for an enumerated bona fide hedging transaction or position, the name of the enumerated bona fide hedging transaction or position listed in Appendix A to this part; (F) If the application is for a spread transaction listed in the spread transaction definition in § 150.1, the name of the spread transaction as it is listed in § 150.1; (G) The identity of the applicant; (H) The listed commodity derivative contract or position(s) to which the application pertains; (I) The underlying cash commodity; (J) The maximum size of the commodity derivative position that is recognized by the designated contract market or swap execution facility as a bona fide hedging transaction or position, specified by contract month and by the type of limit as spot month, single month, or allmonths-combined, as applicable; (K) Any size limitations or conditions established for a spread exemption or other exemption; and (L) For bona fide hedging transactions or positions, a concise summary of the applicant’s activity in the cash markets and swaps markets for the commodity underlying the commodity derivative position for which the application was submitted. 695 To increase efficiency and reduce duplicative efforts, the proposed rule would permit an exchange to have a single process in place that VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 The Commission estimates under proposed § 150.5(a)(4) that six exchanges would provide monthly reports for a total of 72 monthly reports for all exchanges.696 The Commission further estimates that it will take 5 hours to complete and file each monthly report for a total of 60 annual burden hours for each exchange and 360 annual burden hours for all exchanges.697 Proposed § 150.5(b) would require exchanges, for physical commodity derivatives that are not subject to federal limits to set limits during the spot month and to set either limits or accountability outside of the spot month. Under proposed § 150.5(b)(3), where multiple exchanges list contracts that are substantially the same, including physically-settled contracts that have the same underlying commodity and delivery location, or cash-settled contracts that are directly or indirectly linked to a physically-settled contract, the exchange must either adopt ‘‘comparable’’ limits for such contracts, or demonstrate to the Commission how the non-comparable levels comply with the standards set forth in proposed § 150.5(b)(1) and (2). Such a determination also must address how the levels are necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract’s or the underlying commodity’s price or index. Proposed § 150.5(b)(3) is intended to help ensure that position limits established on one exchange would not jeopardize market integrity or otherwise harm other markets. This provision may also improve the efficiency with which exchanges adopt limits on newly-listed contracts that compete with an existing contract listed on another exchange and help reduce the amount of time and effort needed for Commission staff to assess the new limit levels. Further, proposed § 150.5(b)(3) would be consistent with the Commission’s proposal to generally apply equivalent federal limits to linked contracts, including linked contracts listed on multiple exchanges. would allow market participants to request nonenumerated bona fide hedge recognitions from both federal and exchange-set position limits at the same time. The Commission believes that under a single process, the estimated burdens under proposed § 150.5(a) discussed in this section for exemptions from exchange-set limits will include the burdens under the federal limit exemption process for nonenumerated bona fide hedges under proposed § 150.9 discussed below. 696 6 exchanges × 12 months = 72 total monthly reports per year. 697 5 hours per monthly report × 12 months = 60 hours per year for each exchange. 60 annual hours × 6 exchanges = 360 aggregate annual hours for all exchanges. PO 00000 Frm 00111 Fmt 4701 Sfmt 4702 11705 The Commission estimates that under proposed § 150.5(b)(3), six exchanges would make submissions to demonstrate to the Commission how the non-comparable levels comply with the standards set forth in proposed § 150.5(b)(1) and (2). The Commission estimates that each exchange on average would make 3 submissions each year for a total of 18 submissions for all exchanges. The Commission further estimates that it will take 10 hours to complete and file each submission for a total of 18 annual burden hours for each exchange and 180 burden hours for all exchanges.698 Proposed § 150.5(b)(4) would permit exchanges to grant exemptions from any exchange limit established for physical commodity contracts not subject to federal limits. To grant such exemptions, exchanges must require traders to file an application to show whether the requested exemption from exchange-set limits would be in accord with sound commercial practices in the relevant commodity derivative market and/or that may be established and liquidated in an orderly fashion in that market. This proposed collection of information is necessary to confirm that any exemptions granted from exchange limits on physical commodity contracts not subject to federal limits do not pose a threat of market manipulation or congestion, and maintains orderly execution of transactions. The Commission estimates that 200 traders would submit one application each year and that each application would take approximately two hours to complete, for an aggregate total of 400 burden hours per year for all traders. Proposed § 150.5(e) reflects that, consistent with the definition of ‘‘rule’’ in existing § 40.1, any exchange action establishing or modifying position limits or exemptions therefrom, or position accountability, in any case pursuant to proposed § 150.5(a), (b), (c), or Appendix F to part 150, would qualify as a ‘‘rule’’ and must be submitted to the Commission pursuant to part 40 of the Commission’s regulations. Proposed § 150.5(e) further provides that exchanges would be required to review regularly any position limit levels established under proposed § 150.5 to ensure the level continues to comply with the requirements of those sections. The Commission estimates under proposed § 150.5(e) that six exchanges would submit revised rulebooks to satisfy their compliance obligations under part 40. 698 18 estimated annual submissions × 10 burden hours per submission = 180 aggregate annual burden hours. E:\FR\FM\27FEP3.SGM 27FEP3 11706 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 The Commission estimates that each exchange on average would make 1 initial revision of its rulebook to reflect the new position limit framework for a total of 6 applications for all exchanges. The Commission further estimates that it will take 30 hours to revise a rulebook for a total of 30 annual burden hours for each exchange and 180 burden hours for all exchanges.699 This proposed collection of information is necessary to ensure that the exchanges’ rulebooks reflect the most up to date rules and requirements in compliance with the proposed position limits framework. The information would be used to confirm that exchanges are complying with their requirements to regularly review any position limit levels established under proposed § 150.5. v. § 150.9 Exchange Process for Bona Fide Hedge Recognitions From Federal Limits Proposed § 150.9 would establish a new streamlined process in which a trader could apply through an exchange to request a non-enumerated bona fide hedging recognition from federal position limits. As part of the process, proposed § 150.9 would create certain recordkeeping and reporting obligations on the market participant and the exchange, including: (i) An application to request non-enumerated bona fide hedge recognitions, which the trader would submit to the exchange and which the exchange would subsequently provide to the Commission if the exchange approves the application for purposes of exchange-set limits; (ii) a notification to the Commission and the applicant of the exchange’s determination for purposes of exchange limits regarding the trader’s request for recognition of a bona fide hedge or spread exemption; (iii) and a requirement to maintain full, complete and systematic records for Commission review of the exchange’s decisions. The Commission believes that the exchanges that will elect to process applications for non-enumerated bona fide hedging exemptions under proposed § 150.9(a) already have similar processes for the review and disposition of such exemption applications in place through their rulebooks for purposes of exchange-set position limits. Accordingly, the estimated burden on an exchange to comply with the proposed rule will be less burdensome because the exchanges may leverage their existing policies and procedures to comply with the proposed rule. The 699 6 initial applications × 30 burden hours = 180 initial aggregate burden hours. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Commission estimates that six exchanges would elect to process applications for non-enumerated bona fide hedge recognitions that would satisfy the federal position limit requirements under proposed § 150.9, and would be required to file amended rulebooks pursuant to part 40 of the Commission’s regulations. The Commission bases its estimate on the number of exchanges that have submitted similar rules to the Commission in the past. Proposed § 150.9(c) would require a trader to submit an application with sufficient information to enable the exchange to determine whether it should recognize a position as a bona fide hedge for purposes of federal position limits. Each applicant would need to reapply for its non-enumerated bona fide hedge recognition at least on an annual basis by updating its original application. The Commission expects that traders would benefit from the exchange-administered framework established under proposed § 150.9 because traders may submit one application to obtain a non-enumerated bona fide hedge recognition for purposes of both exchange-set and federal limits, as opposed to submitting separate applications to the Commission for federal position limit purposes and separate applications to an exchange for exchange limit purposes.700 Accordingly, the estimated burden for traders requesting non-enumerated bona fide hedge recognitions from exchangeset limits under § 150.5(a) would subsume the burden estimates in connection with proposed § 150.9 for requesting non-enumerated bona fide hedge recognition’s from federal limits since the Commission preliminarily believes exchanges would combine the two processes (i.e., any trader who applies through an exchange under proposed § 150.9 for a non-enumerated bona fide hedge for federal position limits purposes also would be deemed to be applying at the same time under proposed § 150.5(a) for exchange position limits purposes and thus it would not be appropriate to distinguish between the two for PRA purposes). Accordingly, the Commission preliminarily anticipates that 6 exchanges each would receive only one 700 The Commission believes the collections of information set forth above are necessary for the exchange to process requests for recognition of nonenumerated bona fide hedges for purposes of both exchange-set position limits and federal position limits. The information would be used by the exchange to determine, and the Commission to review and verify, whether the facts and circumstances demonstrate it is appropriate to recognize a position as a non-enumerated bona fide hedging transaction or position. PO 00000 Frm 00112 Fmt 4701 Sfmt 4702 application for a non-enumerated bona fide hedge recognition under proposed § 150.9 for a total of six aggregate annual applications for all exchanges; however, as noted above, this amount is included in the Commission’s estimate in connection with proposed § 150.5(a).701 Specifically, as discussed above in connection with proposed § 150.5(a), the Commission estimates under proposed §§ 150.5(a) and 150.9(a) that 425 traders would submit applications to claim exemptions and/or bona fide hedge recognitions for contracts subject to federal position limits as set forth in § 150.2.702 Proposed § 150.9(d) would require exchanges to keep full, complete, and systematic records, including all pertinent data and memoranda, of all activities relating to the processing of such applications and the disposition thereof. In addition, as provided for in proposed § 150.9(g), the Commission may, in its discretion, at any time, review the designated contract market’s records retained pursuant to proposed § 150.9(d). The proposed recordkeeping requirement is necessary for the Commission to review the exchanges’ processes, retention of records, and 701 As discussed above, the process and estimated burdens under proposed § 150.9 would not apply to § 150.5(b) because proposed § 150.5(b) applies to those physical commodity contracts that are not subject to federal limits (as opposed to proposed § 150.5(a), which applies to those contracts subject to federal limits). As a result, a trader that would use the process established under § 150.5(b) for exchange-set limits would not need to apply under proposed § 150.9 since the traders would not need a bona fide hedge recognition or an exemption from federal position limits. 702 As discussed in connection with proposed § 150.5(a) above, the Commission estimates that each trader on average would make one application each year for a total of 425 applications across all exchanges. The Commission further estimates that, for proposed §§ 150.5(a) and 150.9(a), taken together, it will take two hours to complete and file each application for a total of two annual burden hours for each trader and 850 aggregate annual burden hours for all traders. (425 annual applications × 2 burden hours per application = 850 aggregate annual burden hours). The Commission preliminarily anticipates that compared to proposed § 150.5(a), fewer traders will apply under proposed § 150.9 since proposed § 150.9 applies only to nonenumerated bona fide hedge recognitions for federal purposes. In comparison, while proposed § 150.5 would encompass these same applications for nonenumerated bona fide hedge recognitions (but for the purpose of exchange-set limits), proposed § 150.5(a) also would include enumerated bona fide hedge applications along with spread exemption requests. The Commission’s estimate of 850 aggregate annual burden hours encompasses all such requests from all traders. However, for the sake of clarity, the Commission preliminarily anticipates that 6 exchanges each would receive one application per year for a non-enumerated bona fide hedge under proposed § 150.9 (for a total of six applications across all exchanges); as noted, this burden is included in the Commission’s estimate of 425 annual applications in connection with its estimate under proposed § 150.5(a). E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 compliance with requirements established and implemented under this section. Proposed § 150.9(d) would create a new recordkeeping obligation consistent with the standards in existing § 1.31.703 The Commission estimates that six exchanges would each create one record in connection with proposed § 150.9 each year for a total of six annual records for all respondents. The Commission further estimates that it will take five hours to comply with the proposed recordkeeping requirement of § 150.9(d) for a total of five annual burden hours for each exchange and 30 aggregate annual burden hours across all exchanges. Proposed § 150.9(f) would allow the Commission to inspect such books and records.704 In the event the Commission exercises its authority to inspect such books and records, it estimates that the Commission would make an inspection to two exchanges per year and each exchange would incur four hours to make its books and records available to the Commission for review for a total of 8 aggregate annual burden hours for the two estimated respondent exchanges.705 Under proposed § 150.9(e), an exchange would need to provide an applicant and the Commission with notice of any approved application of an exchange’s determination to recognize bona fide hedges and grant spread exemptions with respect to its own position limits for purposes of exceeding the federal position limits. The proposed notification requirement is necessary to inform the Commission of the details of the type of bona fide hedge recognitions or spread exemptions being granted. The information would be used to keep the Commission informed as to the manner 703 Consistent with existing § 1.31, the Commission expects that these records would be readily available during the first two years of the required five year recordkeeping period for paper records, and readily accessible for the entire fiveyear recordkeeping period for electronic records. In addition, the Commission expects that records required to be maintained by an exchange pursuant to this section would be readily accessible during the pendency of any application, and for two years following any disposition that did not recognize a derivative position as a bona fide hedge. 704 Proposed § 150.9(g)(1) provides the Commission’s authority to, at its discretion, and at any time, review the exchange’s processes, retention of records, and compliance with requirements established and implemented under this section. Under proposed § 150.9(g)(2), if the Commission determines additional information is required to conduct its review, pursuant to proposed § 150.9(g)(1), then it would notify the exchange and the relevant market participant of any issues identified and provide them with ten business days to provide supplemental information. 705 2 exchanges per year subject to a Commission inspection × 4 hours per inspection request = 8 aggregate annual burden hours for all exchanges. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 in which an exchange administers its application procedures, and the exchange’s rationale for permitting large positions. The Commission estimates that under proposed § 150.9(e), 6 exchanges would submit notifications of approved application of an exchange’s determination to recognize nonenumerated bona fide hedges for purposes of exceeding the federal position limits. The Commission estimates that each exchange on average would make 2 notifications: one notification each to the applicant trader and to the Commission each year for a total of 12 notices for all exchanges. The Commission further estimates that it will take 0.5 hours to complete and file each notification for a total of one annual burden hour for each exchange and six burden hours for all exchanges.706 c. OMB Control Number 3038–0093— Provisions Common to Registered Entities 1. § 150.9(a) Under proposed § 150.9(a), exchanges that would like for their market participants to be able to exceed federal position limits based on a nonenumerated bona fide hedge recognition granted by the exchange with respect to its own limits must have rules, adopted pursuant to the rule approval process in § 40.5 of the Commission’s regulations, establishing processes consistent with the provisions of proposed § 150.9. The proposed collection of information is necessary to capture the new nonenumerated bona fide hedge process in the exchanges’ rulebook, which is subject to Commission approval. The information would be used to assess the process put in place by each exchange submitting amended rulebooks. The Commission has previously estimated the combined annual burden hours for both §§ 40.5 and 40.6 to be 7,000 hours.707 If the proposed rule is adopted, the Commission estimates that six exchanges would make one initial § 40.5 rule filings per year for a total of six one-time initial submissions for all exchanges. The Commission further estimates that the exchanges would employ a combination of in-house and 706 12 notices for all exchanges × 0.5 hours per notice = six (6) total burden hours across all exchanges. 707 The supporting statement for the current active information collection request, ICR Reference No: 201503–3038–002, for OMB control number 3038–0013, estimated that seven respondents would file the §§ 1.47 and 1.48 reports, and that each respondent would file two reports for a total of 14 annual responses, requiring three hour per response, for a total of 42 burden hours for all respondents. PO 00000 Frm 00113 Fmt 4701 Sfmt 4702 11707 outside legal and compliance counsel to update existing rulebooks and it will take 25 hours to complete and file each rule for a total 25 one-time burden hours for each exchange and 150 one-time burden hours for all exchanges. 2. Request for Comments on Collection The Commission invites the public and other Federal agencies to comment on any aspect of the proposed information collection requirements discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments in order to (i) evaluate whether the proposed collections of information are necessary for the proper performance of the functions of the Commission, including whether the information will have practical utility; (ii) evaluate the accuracy of the Commission’s estimate of the burden of the proposed collections of information; (iii) determine whether there are ways to enhance the quality, utility, and clarity of the information proposed to be collected; and (iv) minimize the burden of the proposed collections of information on those who are to respond, including through the use of appropriate automated collection techniques or other forms of information technology. Those desiring to submit comments on the proposed information collection requirements should submit them directly to the Office of Information and Regulatory Affairs, OMB, by fax at (202) 395–6566, or by email at OIRAsubmissions@omb.eop.gov. Please provide the Commission with a copy of submitted comments so that all comments can be summarized and addressed in the final rule preamble. Refer to the ADDRESSES section of this notice of proposed rulemaking for comment submission instructions to the Commission. A copy of the supporting statements for the collection of information discussed above may be obtained by visiting https:// www.RegInfo.gov. OMB is required to make a decision concerning the collection of information between 30 and 60 days after publication of this document in the Federal Register. Therefore, a comment is best assured of having its full effect if OMB receives it within 30 days of publication. C. Regulatory Flexibility Act The Regulatory Flexibility Act (‘‘RFA’’) requires that agencies consider whether the rules they propose will have a significant economic impact on a substantial number of small entities and, if so, provide a regulatory flexibility analysis respecting the E:\FR\FM\27FEP3.SGM 27FEP3 11708 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules impact.708 A regulatory flexibility analysis or certification typically is required for ‘‘any rule for which the agency publishes a general notice of proposed rulemaking pursuant to’’ the notice-and-comment provisions of the Administrative Procedure Act, 5 U.S.C. 553(b).709 The requirements related to the proposed amendments fall mainly on registered entities, exchanges, FCMs, swap dealers, clearing members, foreign brokers, and large traders. The Commission has previously determined that registered DCMs, FCMs, swap dealers, major swap participants, eligible contract participants, SEFs, clearing members, foreign brokers and large traders are not small entities for purposes of the RFA.710 Further, while the requirements under this rulemaking may impact nonfinancial end users, the Commission notes that position limits levels apply only to large traders. Accordingly, the Chairman, on behalf of the Commission, hereby certifies, on behalf of the Commission, pursuant to 5 U.S.C. 605(b), that the actions proposed to be taken herein would not have a significant economic impact on a substantial number of small entities. The Chairman made the same certification in the 2013 Proposal,711 the 2016 Supplemental Proposal,712 and the 2016 Reproposal.713 D. Antitrust Considerations Section 15(b) of the CEA requires the Commission to take into consideration the public interest to be protected by the antitrust laws and endeavor to take the least anticompetitive means of achieving the objectives of the Act, and the policies and purposes of the Act, in issuing any order or adopting any Commission rule or regulation (including any exemption under section 4(c) or 4c(b)), or in requiring or 708 44 U.S.C. 601 et seq. U.S.C. 601(2), 603–05. 710 See Policy Statement and Establishment of Definitions of ‘‘Small Entities’’ for Purposes of the Regulatory Flexibility Act, 47 FR 18618–19, Apr. 30, 1982 (DCMs, FCMs, and large traders) (‘‘RFA Small Entities Definitions’’); Opting Out of Segregation, 66 FR 20740–43, Apr. 25, 2001 (eligible contract participants); Position Limits for Futures and Swaps; Final Rule and Interim Final Rule, 76 FR 71626, 71680, Nov. 18, 2011 (clearing members); Core Principles and Other Requirements for Swap Execution Facilities, 78 FR 33476, 33548, Jun. 4, 2013 (SEFs); A New Regulatory Framework for Clearing Organizations, 66 FR 45604, 45609, Aug. 29, 2001 (DCOs); Registration of Swap Dealers and Major Swap Participants, 77 FR 2613, Jan. 19, 2012, (swap dealers and major swap participants); and Special Calls, 72 FR 50209, Aug. 31, 2007 (foreign brokers). 711 See 2013 Proposal, 78 FR at 75784. 712 See 2016 Supplemental Proposal, 81 FR at 38499. 713 See 2016 Reproposal, 81 FR at 96894. lotter on DSKBCFDHB2PROD with PROPOSALS3 709 5 VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 approving any bylaw, rule, or regulation of a contract market or registered futures association established pursuant to section 17 of the Act.714 The Commission believes that the public interest to be protected by the antitrust laws is generally to protect competition. The Commission requests comment on whether the proposed rule implicates any other specific public interest to be protected by the antitrust laws. The Commission has considered the proposed rules to determine whether they are anticompetitive and has preliminarily determined that the proposed rules could, in some circumstances, be anticompetitive because position limits at low levels are, to some degree, inherently anticompetitive. A more established DCM that already lists, or is first to list, a core referenced futures contract (an ‘‘incumbent DCM’’) has a competitive advantage over smaller DCMs seeking to expand or future entrant DCMs (collectively ‘‘entrant DCMs’’), even in the absence of position limits, because ‘‘liquidity attracts liquidity.’’ That is, a market participant seeking to execute a single transaction or, for that matter, establish a large position would, other things being equal, gravitate toward a more established facility that successfully lists a contract with relatively consistent volume and transparent pricing—where there is likely to be someone willing to take the other side of a trade. This is especially true if the market participant is already clearing other products with the incumbent DCM. This would tend to protect the incumbent DCM’s contract and reinforce the advantage of an incumbent DCM, which has to do less to keep and attract customers and should be able to keep more of the profits from trading volume. That is, the status of incumbency by itself may to some extent create a barrier to entry for an entrant DCM where the presence of a counterparty at the desired price is less assured. Position limits at low levels, especially in the non-spot month, may exacerbate the situation. If a market participant establishes a futures position on an incumbent DCM and then reaches the federal limit level on the incumbent DCM, it becomes even less likely that the market participant will migrate to an entrant DCM, because the federal limit would still apply and prevents the market participant from increasing its aggregate futures position where ever located. Higher volume may permit an incumbent DCM to charge lower transaction fees than an entrant DCM; the price concession that a market participant might have to absorb to establish a large position may be lower on an incumbent DCM than an entrant DCM. Both of these factors would inform a DCM’s decision regarding where to set the levels for its own exchange-set limits. Moreover, the incumbent DCM can use other tools to defend its advantage such as the implementation of new technologies, the use of various fees/charges and the application of exemptions to federal limits. The Commission preliminarily believes that the relatively high limit levels that the Commission proposes today do not at this time establish a barrier to entry or competitive restraint likely to facilitate anticompetitive effects in any relevant antitrust market for contract trading. This is because the limit levels that the Commission proposes today are based on recent data regarding deliverable supply and open interest. However, if the size of the relevant markets continues on an upward trend and the Commission does not adjust federal limit levels commensurately, limit levels that become stale over time could facilitate anticompetitive effects. The Commission requests comment on whether and in what circumstances adopting the proposed rules could be anticompetitive. The Commission has also preliminarily determined that the proposed rules serve the regulatory purpose of the Act ‘‘to deter and prevent price manipulation or any other disruptions to market integrity.’’ 715 The Commission proposes to implement the rules pursuant to section 4a(a) of the CEA, which articulates additional policies and purposes.716 The Commission has identified the following less anticompetitive means: Requiring derivatives clearing organizations (‘‘DCOs’’) to impose initial margin surcharges for position limits. This would be less anticompetitive because initial margin surcharges would still allow a large speculator to accumulate a futures position on another DCM if the speculator so desired while protecting against the price impact from a large price change against the speculator who would otherwise be forced to offload a position due to position limits. The Commission requests comment on whether there are other less anticompetitive means of achieving the relevant purposes of the Act. The Commission is not required to 715 Section 3(b) of the CEA, 7 U.S.C. 5(b). U.S.C. 7a(a) (burdens on interstate commerce; trading or position limits). 716 7 714 7 PO 00000 U.S.C. 19(b). Frm 00114 Fmt 4701 Sfmt 4702 E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules follow the least anticompetitive course of action. The Commission has examined whether requiring DCOs to impose initial margin surcharges for position limits in lieu of imposing position limits is feasible and has preliminarily determined that is not because it could be inconsistent with a relevant provision of the CEA and would require the Commission to revise its current regulations in part 39 to be more prescriptive and less principles-based. Thus, the Commission has preliminarily determined not to adopt this less anticompetitive means. Under section 5b(c)(2)(A)(ii) of the CEA 717 and the corresponding provision of the Commission’s current regulations, a registered DCO has ‘‘reasonable discretion in establishing the manner by which it complies with each core principle.’’ 718 Moreover, the Commission’s regulations already require DCOs to ‘‘establish initial margin requirements that are commensurate with the risks of each product and portfolio, including any unusual characteristics of, or risks associated with, particular products or portfolios . . ., ’’ 719 which would include large positions. DCOs are also already required to use models that take into account concentration, minimum liquidation time, and other risk factors inherent in large positions, and the Commission reviews these models.720 Finally, Congress has required that the Commission establish position limits ‘‘as the Commission finds are necessary.’’ 721 The Commission requests comment on its feasibility analysis. Authority: 7 U.S.C. 2, 5, 6a, 6c, 6f, 6g, 6i, 6k, 6m, 6n, 7, 7a, 9, 12a, 19, and 21, as amended by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111–203, 124 Stat. 1376 (2010). 17 CFR Part 19 Commodity futures, Cottons, Grains, Reporting and recordkeeping requirements, Swaps. ■ 17 CFR Part 40 Commodity futures, Reporting and recordkeeping requirements, Procedural rules. * 17 CFR Part 140 Authority delegations (Government agencies), Conflict of interests, Organizations and functions (Government agencies). 17 CFR Part 150 Bona fide hedging, Commodity futures, Cotton, Grains, Position limits, Referenced Contracts, Swaps. 17 CFR Part 151 Bona fide hedging, Commodity futures, Cotton, Grains, Position limits, Referenced Contracts, Swaps. For the reasons stated in the preamble, the Commodity Futures Trading Commission proposes to amend 17 CFR chapter I as follows: PART 1—GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT 1. The authority citation for part 1 continues to read as follows: ■ List of Subjects 17 CFR Part 1 § 1.3 17 CFR Part 15 lotter on DSKBCFDHB2PROD with PROPOSALS3 17 CFR Part 17 Brokers, Commodity futures, Reporting and recordkeeping requirements, Swaps. Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a–1, 7a–2, 7b, 7b–3, 8, 9, 10a, 12, 12a, 12c, 13a, 13a–1, 16, 16a, 19, 21, 23, and 24 (2012). Agricultural commodity, Agriculture, Brokers, Committees, Commodity futures, Conflicts of interest, Consumer protection, Definitions, Designated contract markets, Directors, Major swap participants, Minimum financial requirements for intermediaries, Reporting and recordkeeping requirements, Swap dealers, Swaps. Brokers, Commodity futures, Reporting and recordkeeping requirements, Swaps. [Amended] 2. In § 1.3, remove the definition of the term ‘‘bona fide hedging transactions and positions for excluded commodities.’’ ■ § 1.47 ■ [Removed and Reserved] 3. Remove and reserve § 1.47. § 1.48 ■ [Removed and Reserved] 4. Remove and reserve § 1.48. PART 15—REPORTS—GENERAL PROVISIONS 5. The authority citation for part 15 continues to read as follows: ■ 6. In § 15.00, revise paragraph (p)(1) to read as follows: § 15.00 Definitions of terms used in parts 15 to 19, and 21 of this chapter. * * * * (p) * * * (1) For reports specified in parts 17 and 18 and in § 19.00(a) and (b) of this chapter, any open contract position that at the close of the market on any business day equals or exceeds the quantity specified in § 15.03 in either: (i) Any one futures of any commodity on any one reporting market, excluding futures contracts against which notices of delivery have been stopped by a trader or issued by the clearing organization of the reporting market; or (ii) Long or short put or call options that exercise into the same future of any commodity, or other long or short put or call commodity options that have identical expirations and exercise into the same commodity, on any one reporting market. * * * * * ■ 7. In § 15.01, revise paragraph (d) to read as follows: § 15.01 Persons required to report. * * * * * (d) Persons, as specified in part 19 of this chapter, who: (1) Are merchants or dealers of cotton holding or controlling positions for future delivery in cotton that equal or exceed the amount set forth in § 15.03; or (2) Are persons who have received a special call from the Commission or its designee under § 19.00(b) of this chapter. * * * * * ■ 8. Revise § 15.02 to read as follows: § 15.02 Reporting forms. Forms on which to report may be obtained from any office of the Commission or via https://www.cftc.gov. Listed below are the forms to be used for the filing of reports. To determine who shall file these forms, refer to the Commission rule listed in the column opposite the form number. Form No. Title 40 ................... Statement of Reporting Trader ................................................................................................................................... 717 7 U.S.C. 7a–1(c)(2)(A)(ii). CFR 39.10(b). 719 17 718 17 VerDate Sep<11>2014 18:41 Feb 26, 2020 CFR 39.13(g)(2)(i). generally 17 CFR 39.13. 720 See Jkt 250001 11709 PO 00000 Frm 00115 Fmt 4701 Sfmt 4702 Rule 18.04 721 See supra Section III.F. (discussion of the necessity finding). E:\FR\FM\27FEP3.SGM 27FEP3 11710 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Form No. Title 71 ................... 101 ................. 102 ................. 304 ................. Identification of Omnibus Accounts and Sub-accounts .............................................................................................. Positions of Special Accounts .................................................................................................................................... Identification of Special Accounts, Volume Threshold Accounts, and Consolidated Accounts ................................. Statement of Cash Positions for Unfixed-Price Cotton ‘‘On Call’’ .............................................................................. (Approved by the Office of Management and Budget under control numbers 3038–0007, 3038–0009, 3038–0013, and 3038–0103.) PART 17—REPORTS BY REPORTING MARKETS, FUTURES COMMISSION MERCHANTS, CLEARING MEMBERS, AND FOREIGN BROKERS 9. The authority citation for part 17 continues to read as follows: ■ Authority: 7 U.S.C. 2, 6a, 6c, 6d, 6f, 6g, 6i, 6t, 7, 7a, and 12a. 10. In § 17.00, revise paragraph (b) introductory text to read as follows: ■ § 17.00 Information to be furnished by futures commission merchants, clearing members and foreign brokers. * * * * * (b) Interest in or control of several accounts. Except as otherwise instructed by the Commission or its designee and as specifically provided in § 150.4 of this chapter, if any person holds or has a financial interest in or controls more than one account, all such accounts shall be considered by the futures commission merchant, clearing member, or foreign broker as a single account for the purpose of determining special account status and for reporting purposes. * * * * * ■ 11. In § 17.03, add paragraph (i) to read as follows: § 17.03 Delegation of authority to the Director of the Office of Data and Technology or the Director of the Division of Market Oversight. lotter on DSKBCFDHB2PROD with PROPOSALS3 * * * * * (i) Pursuant to § 17.00(b), and as specifically provided in § 150.4 of this chapter, the authority shall be designated to the Director of the Office of Data and Technology to instruct a futures commission merchant, clearing member, or foreign broker to consider otherwise than as a single account for the purpose of determining special account status and for reporting purposes all accounts one person holds VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Rule or controls, or in which the person has a financial interest. ■ 12. Revise part 19 to read as follows: 17.01 17.00 17.01 19.00 Sec. 19.00 Who shall furnish information. 19.01 [Reserved] 19.02 Reports pertaining to cotton on call purchases and sales. 19.03 Delegation of authority to the Director of the Division of Market Oversight and the Director of the Division of Enforcement. 19.04–19.10 [Reserved] Appendix A to Part 19—Form 304 under § 19.00(a) shall file CFTC Form 304 reports showing the quantity of call cotton bought or sold on which the price has not been fixed, together with the respective futures on which the purchase or sale is based. As used herein, call cotton refers to spot cotton bought or sold, or contracted for purchase or sale at a price to be fixed later based upon a specified future. (b) Time and place of filing reports. Each CFTC Form 304 report shall be made weekly, dated as of the close of business on Friday, and filed not later than 9 a.m. Eastern Time on the third business day following that Friday using the format, coding structure, and electronic data transmission procedures approved in writing by the Commission. Authority: 7 U.S.C. 6g, 6c(b), 6i, and 12a(5). § 19.03 Delegation of authority to the Director of the Division of Enforcement. § 19.00 (a) The Commission hereby delegates, until it orders otherwise, to the Director of the Division of Enforcement, or such other employee or employees as the Director may designate from time to time, the authority in § 19.00(b) to issue special calls. (b) The Commission hereby delegates, until it orders otherwise, to the Director of the Division of Enforcement, or such other employee or employees as the Director may designate from time to time, the authority in § 19.00(b) to provide instructions or to determine the format, coding structure, and electronic data transmission procedures for submitting data records and any other information required under this part. (c) The Director of the Division of Enforcement may submit to the Commission for its consideration any matter which has been delegated in this section. (d) Nothing in this section prohibits the Commission, at its election, from exercising the authority delegated in this section. PART 19—REPORTS BY PERSONS HOLDING REPORTABLE POSITIONS IN EXCESS OF POSITION LIMITS, AND BY MERCHANTS AND DEALERS IN COTTON Who shall furnish information. (a) Persons filing cotton on call reports. Merchants and dealers of cotton holding or controlling positions for future delivery in cotton that are reportable pursuant to § 15.00(p)(1)(i) of this chapter shall file CFTC Form 304. (b) Persons responding to a special call. All persons: (1) Exceeding speculative position limits under § 150.2 of this chapter; or (2) Holding or controlling positions for future delivery that are reportable pursuant to § 15.00(p)(1) of this chapter and who have received a special call from the Commission or its designee shall file any pertinent information as instructed in the special call. Filings in response to a special call shall be made within one business day of receipt of the special call unless otherwise specified in the call. Such filing shall be transmitted using the format, coding structure, and electronic data submission procedures approved in writing by the Commission. § 19.01 [Reserved] § 19.02 Reports pertaining to cotton on call purchases and sales. (a) Information required. Persons required to file CFTC Form 304 reports PO 00000 Frm 00116 Fmt 4701 Sfmt 4702 § § 19.04–19.10 [Reserved] Appendix A to Part 19—Form 304 BILLING CODE 6351–01–P E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules 11711 CFTC FORM 304 Statement of Cash Positions for Unfixed-Price Cotton "On Call" NOTICE: Failure to file a report required by the Commodity Exchange Act ("CEA" or the "Act")1 and the regulations thereunder,2 or the filing of a report with the Commodity Futures Trading Commission ("CFTC" or "Commission") that includes a false, misleading, or fraudulent statement or omits material facts that are required to be reported therein or are necessary to make the report not misleading, may (a) constitute a violation of section 6(c)(2) of the Act (7 U.S.C. 9), section 9(a)(3) of the Act (7 U.S.C. 13(a)(3)), and/or section 1001 of Title 18, Crimes and Criminal Procedure (18 U.S.C. 1001) and (b) result in punishment by fine or imprisonment, or both. PRIVACY ACT NOTICE 7 U.S.C. 1, et seq. Unless otherwise noted, the rules and regulations referenced in this notice are found in chapter I of title 17 of the Code of Federal Regulations; 17 CFR chapter I. 1 2 VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 PO 00000 Frm 00117 Fmt 4701 Sfmt 4725 E:\FR\FM\27FEP3.SGM 27FEP3 EP27FE20.076</GPH> lotter on DSKBCFDHB2PROD with PROPOSALS3 The Commission's authority for soliciting this information is granted in sections 4i and 8 of the CEA and related regulations (see, e.g., 17 CFR 19.02). The information solicited from entities and individuals engaged in activities covered by the CEA is required to be provided to the CFTC, and failure to comply may result in the imposition of criminal or administrative sanctions (see, e.g., 7 U.S.C. 9 and 13a-l, and/or 18 U.S.C. 1001). The information requested is used by the Commission to prepare its cotton on-call report. The requested information may be used by the Commission in the conduct of investigations and litigation and, in limited circumstances, may be made public in accordance with provisions of the CEA and other applicable laws. It may also be disclosed to other government agencies and to contract markets to meet responsibilities assigned to them by law. The information will be maintained in, and any additional disclosures will be made in accordance with, the CFTC System of Records Notices, available on www.cftc.gov. 11712 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules BACKGROUND & INSTRUCTIONS Applicable Regulations: • 17 CPR 19.00(a) specifies who shall file Form 304. • 17 CPR 19.02(a) specifies the information required on Form 304. • 17 CPR 19.02(b) specifies the frequency (weekly), the report date (close of business on Friday), and the time (9 a.m. Eastern Time on the third business day following that Friday) and manner, for filing the Form 304. Please follow the instructions below to generate and submit the required filing. Relevant regulations are cited in parentheses() for reference. Unless the context requires otherwise, the terms used herein shall have the same meaning as ascribed in parts 15 to 21 of the Commission's regulations. Complete Form 304 as follows: The trader identification fields should be completed by all filers. This Form 304 requires traders to identify themselves using their Public Trader Identification Number, in lieu of the CFTC Code Number required on previous versions of the Form 304. This number is provided to traders who have previously filed Forms 40 or 102 with the Commission. Traders may contact the Commission to obtain this number if it is unknown. If a trader has a National Futures Association Identification Number ("NFA ID") and/or a Legal Entity Identifier ("LEI"), the trader should also identify itself using those numbers. Form 304 requires traders to identify the name of the reporting trader or firm and the contact information (including full name, address, phone number, and email address) for a natural person the Commission may contact regarding the submitted Form 304. The signature/authorization page shall be completed by all filers. This page shall include the name and position of the natural person filing Form 304 as well as the name of the reporting trader represented by that person. The trader certifying this Form 304 on the signature/authorization page should note that filing a report that includes a false, misleading, or fraudulent statement or omits material facts that are required to be reported therein or are necessary to make the report not misleading, may (a) constitute a violation of section 6(c)(2) of the Act (7 U.S.C. 9), section 9(a)(3) of the Act (7 U.S.C. 13(a)(3)), and/or section 1001 of Title 18, Crimes and Criminal Procedure (18 U.S.C. 1001) and (b) result in punishment by fine or imprisonment, or both. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 PO 00000 Frm 00118 Fmt 4701 Sfmt 4725 E:\FR\FM\27FEP3.SGM 27FEP3 EP27FE20.077</GPH> lotter on DSKBCFDHB2PROD with PROPOSALS3 Merchants and dealers of cotton shall report on Form 304. Report in hundreds of 500-lb. bales unfixed-price cotton "on-call" pursuant to§ 19.02(a) of the Commission's regulations. Include under "Call Purchases" stocks on hand for which price has not yet been fixed. For each listed stock, report the delivery month, delivery year, quantity of call purchases, and quantity of call sales. Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules 11713 Submitting Form 304: Once completed, please submit this form to the Commission pursuant to the instructions on www.cftc.gov or as otherwise directed by Commission staff. If submission attempts fail, the reporting trader shall contact the Commission at techsupport@cftc.gov for further technical support. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 PO 00000 Frm 00119 Fmt 4701 Sfmt 4725 E:\FR\FM\27FEP3.SGM 27FEP3 EP27FE20.078</GPH> lotter on DSKBCFDHB2PROD with PROPOSALS3 Please be advised that pursuant to 5 CPR 1320.5(b)(2)(i), you are not required to respond to this collection of information unless it displays a currently valid 0MB control number. lotter on DSKBCFDHB2PROD with PROPOSALS3 11714 VerDate Sep<11>2014 Jkt 250001 Name of Reporting Trader or Firm: PO 00000 Frm 00120 COMMODITY FUTURES TRADING COMMISSION FORM304 STATEMENT OF CASH POSITIONS FOR UNFIXED-PRICE COTTON "ON-CALL" Name of Person to Contact Regarding This Form: First Name Middle Name Last Name Suffix Fmt 4701 Contact Information: Address Phone Number Email Address Sfmt 4725 E:\FR\FM\27FEP3.SGM NOTICE: Failure lo lile a report required by the Commodity Exchange Act ("CEA" or the "Act") and the regulations thereunder, or the filing of a report with the Commodity Futures Trading Commission ("CFTC" or "Commission") that includes a false, misleading or fraudulent statement or omits material facts that are required to be reported therein or are necessary to make the report not misleading, may (a) constitute a violation of section 6(c)(2) of the Act (7 U.S.C. 9), section 9(a)(3) of the Act (7 U.S.C. l3(a)(3)), and/or section l001 of Title 18, Crimes and Criminal Procedure (18 U.S.C. l001) and (b) result inpunishmeut by fine or imprisonment, or both. Please be advised that pursuant to 5 CFR l320.5(b)(2)(i), you are not required to respond to this collection of information unless it displays a currently valid 0MB control number. Delivery Month 27FEP3 CF'l'C Form 304 (XX-XX) Previous Editions Obsolete EP27FE20.079</GPH> Legal Entity Identifier (LEI) Delivery Year Call Purchases ('00 bales) Call Sales ('00 bales) Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules 18:41 Feb 26, 2020 Identification Codes: NFAID lotter on DSKBCFDHB2PROD with PROPOSALS3 VerDate Sep<11>2014 Signature/ Electronic Authentication: Jkt 250001 D By checking this box and submitting this form (or by clicking "submit," "send," or any other analogous transmission command if transmitting electronically), I certify that I am duly authorized by the reporting trader identified below to provide the PO 00000 information and representations submitted on this Form 304, and that to the best of my knowledge the information and representations made herein are true and correct. Frm 00121 Fmt 4701 Reporting Trader Authorized Representative (Name and Position): Sfmt 4725 ------- (Name) --------- (Position) E:\FR\FM\27FEP3.SGM Submitted on behalf of: _ _ _ _ _ _ _ _ (Reporting Trader Name) 27FEP3 Date of Submission: ---------- CFTC Form 304 (XX-XX) Previous Editions Obsolete Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules 18:41 Feb 26, 2020 Please sign/authenticate the Form 304 prior to submitting. 11715 EP27FE20.080</GPH> lotter on DSKBCFDHB2PROD with PROPOSALS3 11716 VerDate Sep<11>2014 Jkt 250001 PO 00000 Frm 00122 Fmt 4701 Unfixed-price Cotton' fixed. Report in hund:r: Sfmt 4702 E:\FR\FM\27FEP3.SGM 27FEP3 EP27FE20.081</GPH> . . . - Delivery Month Delivery Year Call Purchases ('00 bales) I July 2017 2 I October 2017 66 Call Sales ('00 bales) I II I 18 80 11 I I Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules 18:41 Feb 26, 2020 Form 304, Example - July 2017 Call purchases of 200 bales and sales of 1,800 bales; October Call purchases of 6,600 bales and sales of 8,000 bales. Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules BILLING CODE 6351–01–C PART 40—PROVISIONS COMMON TO REGISTERED ENTITIES 13. The authority citation for part 40 continues to read as follows: ■ Authority: 7 U.S.C. 1a, 2, 5, 6, 7, 7a, 8 and 12, as amended by Titles VII and VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Pub. L. 111–203, 124 Stat. 1376 (2010). 14. In § 40.1, revise paragraphs (j)(1)(vii) and (j)(2)(vii) to read as follows: ■ § 40.1 Definitions. * * * * * (j) * * * (1) * * * (vii) Speculative position limits, position accountability standards, and position reporting requirements, including an indication as to whether the contract meets the definition of a referenced contract as defined in § 150.1 of this chapter, and, if so, the name of the core referenced futures contract on which the referenced contract is based. * * * * * (2) * * * (vii) Speculative position limits, position accountability standards, and position reporting requirements, including an indication as to whether the contract meets the definition of economically equivalent swap as defined in § 150.1 of this chapter, and, if so, the name of the referenced contract to which the swap is economically equivalent. * * * * * PART 140—ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION 15. The authority citation for part 140 continues to read as follows: ■ Authority: 7 U.S.C. 2(a)(12), 12a, 13(c), 13(d), 13(e), and 16(b). § 140.97 ■ [Removed and Reserved] 16. Remove and reserve § 140.97. PART 150—LIMITS ON POSITIONS 17. The authority citation for part 150 is revised to read as follows: lotter on DSKBCFDHB2PROD with PROPOSALS3 ■ Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6c, 6f, 6g, 6t, 12a, and 19, as amended by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111–203, 124 Stat. 1376 (2010). ■ 18. Revise § 150.1 to read as follows: § 150.1 Definitions. As used in this part— Bona fide hedging transactions or positions means a position in VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 commodity derivative contracts in a physical commodity, where: (1) Such position: (i) Represents a substitute for transactions made or to be made, or positions taken or to be taken, at a later time in a physical marketing channel; (ii) Is economically appropriate to the reduction of price risks in the conduct and management of a commercial enterprise; and (iii) Arises from the potential change in the value of— (A) Assets which a person owns, produces, manufactures, processes, or merchandises or anticipates owning, producing, manufacturing, processing, or merchandising; (B) Liabilities which a person owes or anticipates incurring; or (C) Services that a person provides or purchases, or anticipates providing or purchasing; or (2) Such position qualifies as: (i) Pass-through swap and passthrough swap offset pair. Paired positions of a pass-through swap and a pass-through swap offset, where: (A) The pass-through swap is a swap position entered into by one person for which the swap would qualify as a bona fide hedging transaction or position pursuant to paragraph (1) of this definition (the bona fide hedging swap counterparty) that is opposite another person (the pass-through swap counterparty); and (B) The pass-through swap offset is a futures, option on a futures, or swap position entered into by the passthrough swap counterparty in the same physical commodity as the pass-through swap, and which reduces the passthrough swap counterparty’s price risks attendant to that pass-through swap; and provided that the pass-through swap counterparty is able to demonstrate upon request that the passthrough swap qualifies as a bona fide hedging transaction or position pursuant to paragraph (1) of this definition; or (ii) Offsets of a bona fide hedger’s qualifying swap position. A futures, option on a futures, or swap position entered into by a bona fide hedging swap counterparty that reduces price risks attendant to a previously-enteredinto swap position that qualified as a bona fide hedging transaction or position at the time it was entered into for that counterparty pursuant to paragraph (1) of this definition. Commodity derivative contract means any futures, option on a futures, or swap contract in a commodity (other than a security futures product as defined in section 1a(45) of the Act). PO 00000 Frm 00123 Fmt 4701 Sfmt 4702 11717 Core referenced futures contract means a futures contract that is listed in § 150.2(d). Economically equivalent swap means, with respect to a particular referenced contract, any swap that has identical material contractual specifications, terms, and conditions to such referenced contract. (1) Other than as provided in paragraph (2) of this definition, for the purpose of determining whether a swap is an economically equivalent swap with respect to a particular referenced contract, the swap shall not be deemed to lack identical material contractual specifications, terms, and conditions due to different lot size specifications or notional amounts, delivery dates diverging by less than one calendar day, or different post-trade risk management arrangements. (2) With respect to any natural gas referenced contract, for the purpose of determining whether a swap is an economically equivalent swap to such referenced contract, the swap shall not be deemed to lack identical material contractual specifications, terms, and conditions due to different lot size specifications or notional amounts, delivery dates diverging by less than two calendar days, or different posttrade risk management arrangements. (3) With respect to any referenced contract or class of referenced contracts, the Commission may make a determination that any swap or class of swaps satisfies, or does not satisfy, this economically equivalent swap definition. Eligible affiliate means an entity with respect to which another person: (1) Directly or indirectly holds either: (i) A majority of the equity securities of such entity, or (ii) The right to receive upon dissolution of, or the contribution of, a majority of the capital of such entity; (2) Reports its financial statements on a consolidated basis under Generally Accepted Accounting Principles or International Financial Reporting Standards, and such consolidated financial statements include the financial results of such entity; and (3) Is required to aggregate the positions of such entity under § 150.4 and does not claim an exemption from aggregation for such entity. Eligible entity 1 means a commodity pool operator; the operator of a trading 1 The definition of the term eligible entity was amended by the Commission in a final rule published on December 16, 2016 (81 FR at 91454, 91489). Aside from proposing to remove the lettering from each of the defined terms and to display them in alphabetical order, the definition of E:\FR\FM\27FEP3.SGM Continued 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 11718 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules vehicle which is excluded, or which itself has qualified for exclusion from the definition of the term ‘‘pool’’ or ‘‘commodity pool operator,’’ respectively, under § 4.5 of this chapter; the limited partner, limited member or shareholder in a commodity pool the operator of which is exempt from registration under § 4.13 of this chapter; a commodity trading advisor; a bank or trust company; a savings association; an insurance company; or the separately organized affiliates of any of the above entities: (1) Which authorizes an independent account controller independently to control all trading decisions with respect to the eligible entity’s client positions and accounts that the independent account controller holds directly or indirectly, or on the eligible entity’s behalf, but without the eligible entity’s day-to-day direction; and (2) Which maintains: (i) Only such minimum control over the independent account controller as is consistent with its fiduciary responsibilities to the managed positions and accounts, and necessary to fulfill its duty to supervise diligently the trading done on its behalf; or (ii) If a limited partner, limited member or shareholder of a commodity pool the operator of which is exempt from registration under § 4.13 of this chapter, only such limited control as is consistent with its status. Entity means a ‘‘person’’ as defined in section 1a of the Act. Excluded commodity means an ‘‘excluded commodity’’ as defined in section 1a of the Act. Futures-equivalent means: (1) An option contract, whether an option on a future or an option that is a swap, which has been adjusted by an economically reasonable and analytically supported risk factor, or delta coefficient, for that option computed as of the previous day’s close or the current day’s close or contemporaneously during the trading day, and converted to an economically equivalent amount of an open position in a core referenced futures contract, provided however, if a participant’s position exceeds speculative position limits as a result of an option assignment, that participant is allowed one business day to liquidate the excess position without being considered in violation of the limits; (2) A futures contract which has been converted to an economically equivalent amount of an open position in a core referenced futures contract; and the term eligible entity would not be further amended by this proposal and is included solely to maintain the continuity of this definitions section. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 (3) A swap which has been converted to an economically equivalent amount of an open position in a core referenced futures contract. Independent account controller 2 means a person: (1) Who specifically is authorized by an eligible entity, as defined in this section, independently to control trading decisions on behalf of, but without the day-to-day direction of, the eligible entity; (2) Over whose trading the eligible entity maintains only such minimum control as is consistent with its fiduciary responsibilities for managed positions and accounts to fulfill its duty to supervise diligently the trading done on its behalf or as is consistent with such other legal rights or obligations which may be incumbent upon the eligible entity to fulfill; (3) Who trades independently of the eligible entity and of any other independent account controller trading for the eligible entity; (4) Who has no knowledge of trading decisions by any other independent account controller; and (5) Who is: (i) Registered as a futures commission merchant, an introducing broker, a commodity trading advisor, or an associated person of any such registrant, or (ii) A general partner, managing member or manager of a commodity pool the operator of which is excluded from registration under § 4.5(a)(4) of this chapter or § 4.13 of this chapter, provided that such general partner, managing member or manager complies with the requirements of § 150.4(c). Long position means, on a futuresequivalent basis, a long call option, a short put option, a long underlying futures contract, or a swap position that is equivalent to a long futures contract. Physical commodity means any agricultural commodity as that term is defined in § 1.3 of this chapter or any exempt commodity as that term is defined in section 1a of the Act. Position accountability means any bylaw, rule, regulation, or resolution that is submitted to the Commission pursuant to part 40 of this chapter in lieu of, or along with, a speculative position limit, and that requires a trader whose position exceeds the accountability level to consent to: (1) Provide information about its position to the designated contract market or 2 The definition of the term independent account controller was amended by the Commission in a final rule published on December 16, 2016 (81 FR at 91454, 91489). This term would not be further amended by this proposal and is included solely to maintain the continuity of this definitions section. PO 00000 Frm 00124 Fmt 4701 Sfmt 4702 swap execution facility; and (2) halt increasing further its position or reduce its position in an orderly manner, in each case as requested by the designated contract market or swap execution facility. Pre-enactment swap means any swap entered into prior to enactment of the Dodd-Frank Act of 2010 (July 21, 2010), the terms of which have not expired as of the date of enactment of that Act. Pre-existing position means any position in a commodity derivative contract acquired in good faith prior to the effective date of any bylaw, rule, regulation, or resolution that specifies a speculative position limit level or a subsequent change to that level. Referenced contract means: (1) A core referenced futures contract listed in § 150.2(d) or, on a futuresequivalent basis with respect to a particular core referenced futures contract, a futures contract or options on a futures contract, including a spread, that is either: (i) Directly or indirectly linked, including being partially or fully settled on, or priced at a fixed differential to, the price of that particular core referenced futures contract; or (ii) Directly or indirectly linked, including being partially or fully settled on, or priced at a fixed differential to, the price of the same commodity underlying that particular core referenced futures contract for delivery at the same location or locations as specified in that particular core referenced futures contract; or (2) On a futures-equivalent basis, an economically equivalent swap. (3) The definition of referenced contract does not include a location basis contract, a commodity index contract, any guarantee of a swap, or a trade option that meets the requirements of § 32.3 of this chapter. Short position means, on a futuresequivalent basis, a short call option, a long put option, a short underlying futures contract, or a swap position that is equivalent to a short futures contract. Speculative position limit means the maximum position, either net long or net short, in a commodity derivative contract that may be held or controlled by one person, absent an exemption, whether such limits are adopted for combined positions in all commodity derivative contracts in a particular commodity, including the spot month future and all single month futures (the spot month and all single month futures, cumulatively, ‘‘all-monthscombined’’), positions in a single month of commodity derivative contracts in a particular commodity other than the spot month future (‘‘single month’’), or E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules positions in the spot month of commodity derivative contacts in a particular commodity. Such a limit may be established under federal regulations or rules of a designated contract market or swap execution facility. For referenced contracts other than core referenced futures contracts, single month means the same period as that of the relevant core referenced futures contract. Spot month means: (1) For physical-delivery core referenced futures contracts, the period of time beginning at the earlier of the close of business on the trading day preceding the first day on which delivery notices can be issued by the clearing organization of a contract market, or the close of business on the trading day preceding the third-to-last trading day, until the contract expires, except as follows: (i) For ICE Futures U.S. Sugar No. 11 (SB) core referenced futures contract, the spot month means the period of time beginning at the opening of trading on the second business day following the expiration of the regular option contract traded on the expiring futures contract until the contract expires; (ii) For ICE Futures U.S. Sugar No. 16 (SF) core referenced futures contract, the spot month means the period of time beginning on the third-to-last trading day of the contract month until the contract expires; (iii) For Chicago Mercantile Exchange Live Cattle (LC) core referenced futures contract, the spot month means the period of time beginning at the close of trading on the fifth business day of the contract month until the contract expires; (2) For referenced contracts other than core referenced futures contracts, the spot month means the same period as that of the relevant core referenced futures contract. Spread transaction means either a calendar spread, intercommodity spread, quality differential spread, processing spread, product or byproduct differential spread, or futuresoption spread. Swap means ‘‘swap’’ as that term is defined in section 1a of the Act and as further defined in § 1.3 of this chapter. Swap dealer means ‘‘swap dealer’’ as that term is defined in section 1a of the Act and as further defined in § 1.3 of this chapter. Transition period swap means a swap entered into during the period commencing after the enactment of the Dodd-Frank Act of 2010 (July 21, 2010), and ending 60 days after the publication in the Federal Register of final 11719 amendments to this part implementing section 737 of the Dodd-Frank Act of 2010. ■ 19. Revise § 150.2 to read as follows: § 150.2 Federal speculative position limits. (a) Spot month speculative position limits. For physical-delivery referenced contracts and, separately, for cashsettled referenced contracts, no person may hold or control positions in the spot month, net long or net short, in excess of the levels specified by the Commission. (b) Single month and all-monthscombined speculative position limits. For any referenced contract, no person may hold or control positions in a single month or in all-months-combined (including the spot month), net long or net short, in excess of the levels specified by the Commission. (c) Relevant contract month. For purposes of this part, for referenced contracts other than core referenced futures contracts, the spot month and any single month shall be the same as those of the relevant core referenced futures contract. (d) Core referenced futures contracts. Federal speculative position limits apply to referenced contracts based on the following core referenced futures contracts: TABLE 1 TO PARAGRAPH (d)—CORE REFERENCED FUTURES CONTRACTS Commodity type Core referenced futures contract 1 Designated contract market Legacy Agricultural Chicago Board of Trade Corn (C). Oats (O). Soybeans (S). Soybean Meal (SM). Soybean Oil (SO). Wheat (W). Hard Winter Wheat (KW). ICE Futures U.S. Cotton No. 2 (CT). Minneapolis Grain Exchange Hard Red Spring Wheat (MWE). Other Agricultural Chicago Board of Trade Rough Rice (RR). Chicago Mercantile Exchange Live Cattle (LC). ICE Futures U.S. lotter on DSKBCFDHB2PROD with PROPOSALS3 Cocoa (CC). Coffee C (KC). FCOJ–A (OJ). U.S. Sugar No. 11 (SB). U.S. Sugar No. 16 (SF). Energy New York Mercantile Exchange Light Sweet Crude Oil (CL). NY Harbor ULSD (HO). RBOB Gasoline (RB). Henry Hub Natural Gas (NG). Metals Commodity Exchange, Inc. Gold (GC). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 PO 00000 Frm 00125 Fmt 4701 Sfmt 4702 E:\FR\FM\27FEP3.SGM 27FEP3 11720 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules TABLE 1 TO PARAGRAPH (d)—CORE REFERENCED FUTURES CONTRACTS—Continued Commodity type Core referenced futures contract 1 Designated contract market Silver (SI). Copper (HG). New York Mercantile Exchange Palladium (PA). Platinum (PL). lotter on DSKBCFDHB2PROD with PROPOSALS3 1 The core referenced futures contract includes any successor contracts. (e) Establishment of speculative position limit levels. The levels of federal speculative position limits are fixed by the Commission at the levels listed in appendix E to this part; provided however, compliance with such speculative limits shall not be required until 365 days after publication in the Federal Register. (f) Designated contract market estimates of deliverable supply. Each designated contract market listing a core referenced futures contract shall supply to the Commission an estimated spot month deliverable supply upon request by the Commission, and may supply such estimates to the Commission at any other time. Each estimate shall be accompanied by a description of the methodology used to derive the estimate and any statistical data supporting the estimate, and shall be submitted using the format and procedures approved in writing by the Commission. A designated contract market should use the guidance regarding deliverable supply in appendix C to part 38 of this chapter. (g) Pre-existing positions—(1) Preexisting positions in a spot month. A spot month speculative position limit established under this section shall apply to pre-existing positions other than pre-enactment swaps and transition period swaps. (2) Pre-existing positions in a nonspot month. A single month or allmonths-combined speculative position limit established under this section shall not apply to pre-existing positions, provided however, that if such position is not a pre-enactment swap or transition period swap then that position shall be attributed to the person if the person’s position is increased after the effective date of such limit. (h) Positions on foreign boards of trade. The speculative position limits established under this section shall apply to a person’s combined positions in referenced contracts, including positions executed on, or pursuant to the rules of a foreign board of trade, pursuant to section 4a(a)(6) of the Act, provided that: (1) Such referenced contracts settle against any price (including the daily or VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 final settlement price) of one or more contracts listed for trading on a designated contract market or swap execution facility that is a trading facility; and (2) The foreign board of trade makes available such referenced contracts to its members or other participants located in the United States through direct access to its electronic trading and order matching system. (i) Anti-evasion provision. For the purposes of applying the speculative position limits in this section, if used to willfully circumvent or evade speculative position limits: (1) A commodity index contract and/ or a location basis contract shall be considered to be a referenced contract; (2) A bona fide hedging transaction or position recognition or spread exemption shall no longer apply; and (3) A swap shall be considered to be an economically equivalent swap. (j) Delegation of authority to the Director of the Division of Market Oversight. (1) The Commission hereby delegates, until it orders otherwise, to the Director of the Division of Market Oversight or such other employee or employees as the Director may designate from time to time, the authority in paragraph (f) of this section to request estimated deliverable supply from a designated contract market and to provide the format and procedures for submitting such estimates. (2) The Director of the Division of Market Oversight may submit to the Commission for its consideration any matter which has been delegated in this section. (3) Nothing in this section prohibits the Commission, at its election, from exercising the authority delegated in this section. (k) Eligible affiliates and aggregation. For purposes of this part, if an eligible affiliate meets the conditions for any exemption from aggregation under § 150.4, the eligible affiliate may choose to utilize that exemption, or it may opt to be aggregated with its affiliated entities. ■ 20. Revise § 150.3 to read as follows: PO 00000 Frm 00126 Fmt 4701 Sfmt 4702 § 150.3 Exemptions. (a) Positions which may exceed limits. The speculative position limits set forth in § 150.2 may be exceeded to the extent that all applicable requirements in this part are met, provided that such positions are one of the following: (1) Bona fide hedging transactions or positions. Positions that comply with the bona fide hedging transaction or position definition in § 150.1, and are: (i) Enumerated in appendix A to this part; or (ii) Bona fide hedging transactions or positions, other than those enumerated in appendix A to this part, that are approved as non-enumerated bona fide hedging transactions or positions in accordance with paragraph (b)(4) of this section or § 150.9; (2) Spread transactions. Transactions that: (i) Meet the spread transaction definition in § 150.1; or (ii) Do not meet the spread transaction definition in § 150.1, but have been approved by the Commission pursuant to paragraph (b)(4) of this section. (3) Financial distress positions. Positions of a person, or related persons, under financial distress circumstances, when exempted by the Commission from any of the requirements of this part in response to a specific request made to the Commission pursuant to § 140.99 of this chapter, where financial distress circumstances include, but are not limited to, situations involving the potential default or bankruptcy of a customer of the requesting person or persons, an affiliate of the requesting person or persons, or a potential acquisition target of the requesting person or persons; (4) Conditional spot month limit exemption positions in natural gas. Spot month positions in natural gas cashsettled referenced contracts that exceed the spot month speculative position limit set forth in § 150.2, provided that such positions: (i) Do not exceed the equivalent of 10,000 contracts of the NYMEX Henry Hub Natural Gas core referenced futures contract per designated contract market that lists a natural gas cash-settled referenced contract; E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules (ii) Do not exceed 10,000 futures equivalent contracts in economically equivalent swaps in natural gas; and (iii) That the person holding or controlling such positions does not hold or control positions in spot-month physical-delivery referenced contracts in natural gas; or (5) Pre-enactment and transition period swaps exemption. The speculative position limits set forth in § 150.2 shall not apply to positions acquired in good faith in any preenactment swap, or in any transition period swap, in either case as defined by § 150.1; provided however, that a person may net such positions with post-effective date commodity derivative contracts for the purpose of complying with any non-spot month speculative position limit. (b) Application for relief. Any person with a position in a referenced contract seeking recognition of such position as a bona fide hedging transaction or position, in accordance with paragraph (a)(1)(ii) of this section, or seeking an exemption for a spread position in accordance with paragraphs (a)(2)(ii) of this section, in each case for purposes of federal speculative position limits set forth in § 150.2, may submit an application to the Commission in accordance with this section. (1) Required information. The application shall include the following information: (i) With respect to an application for a recognition of a bona fide hedging transaction or position: (A) A description of the position in the commodity derivative contract for which the application is submitted, including, but not limited to, the name of the underlying commodity and the derivative position size; (B) Information to demonstrate why the position satisfies the requirements of section 4a(c)(2) of the Act and the definition of bona fide hedging transaction or position in § 150.1, including factual and legal analysis; (C) A statement concerning the maximum size of all gross positions in commodity derivative contracts for which the application is submitted; (D) A description of the applicant’s activity in the cash markets and swaps markets for the commodity underlying the position for which the application is submitted, including, but not limited to, information regarding the offsetting cash positions; and (E) Any other information that may help the Commission determine whether the position satisfies the requirements of section 4a(c)(2) of the Act and the definition of bona fide VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 hedging transaction or position in § 150.1. (ii) With respect to an application for a spread exemption: (A) A description of the spread position for which the application is submitted; (B) A statement concerning the maximum size of all gross positions in commodity derivative contracts for which the application is submitted; and (C) Any other information that may help the Commission determine whether the position is consistent with section 4a(a)(3)(B) of the Act. (2) Additional information. If the Commission determines that it requires additional information in order to determine whether to recognize a position as a bona fide hedging transaction or position, or grant a spread exemption, the Commission shall: (i) Notify the applicant of any supplemental information required; and (ii) Provide the applicant with ten business days in which to provide the Commission with any supplemental information. (3) Timing of application. (i) Except as provided in paragraph (b)(3)(ii) of this section, a person seeking relief in accordance with this section must submit an application to the Commission and receive a notice of approval of such application prior to the date that the position for which the application was submitted would be in excess of the applicable federal speculative position limit set forth in § 150.2; (ii) A person may, however, due to demonstrated sudden or unforeseen increases in their bona fide hedging needs, submit an application for a recognition of a bona fide hedging transaction or position within five business days after the person established the position that exceeded the applicable federal speculative position limit. (A) Any application filed pursuant to paragraph (b)(3)(ii) of this section must include an explanation of the circumstances warranting the sudden or unforeseen increases in bona fide hedging needs. (B) If an application filed pursuant to paragraph (b)(3)(ii) of this section is denied, the person must bring its position within the federal speculative position limits within a commercially reasonable time, as determined by the Commission in consultation with the applicant and the applicable designated contract market or swap execution facility. (C) The Commission will not determine that the person holding the position has committed a position limits PO 00000 Frm 00127 Fmt 4701 Sfmt 4702 11721 violation during the period of the Commission’s review nor once the Commission has issued its determination. (4) Commission determination. After review of the application and any supplemental information provided by the requestor, the Commission will determine, with respect to the transaction or position for which the request is submitted, whether to recognize all or a specified portion of such transaction or position as a bona fide hedging transaction or position or whether to exempt all or a specified portion of such spread transaction, as applicable. The Commission shall notify the applicant of its determination, and an applicant may exceed federal speculative position limits set forth in § 150.2 upon receiving a notice of approval. (5) Renewal of application. With respect to any application approved by the Commission pursuant to this section, a person shall renew such application if the information provided pursuant to paragraph (b)(1) of this section changes or upon request by the Commission. (6) Commission revocation or modification. If the Commission determines, at any time, that a recognized bona fide hedging transaction or position is no longer consistent with section 4a(c)(2) of the Act or the definition of bona fide hedging transaction or position in § 150.1, or that a spread exemption is no longer consistent with section 4a(a)(3)(B) of the Act, the Commission shall notify the person holding such position and, in its discretion, revoke or modify the bona fide hedge recognition or spread exemption for purposes of federal speculative position limits and require the person to reduce the derivatives position within a commercially reasonable time or otherwise come into compliance. This notification shall briefly specify the nature of the issues raised and the specific provisions of the Act or the Commission’s regulations with which the position or application is, or appears to be, inconsistent. (c) Previously-granted risk management exemptions. Exemptions previously granted by the Commission under § 1.47 of this chapter, or by a designated contract market or swap execution facility, in either case to the extent that such exemptions are for the risk management of positions in financial instruments, including but not limited to index funds, shall not apply after the effective date of speculative position limit levels adopted, pursuant to § 150.2(e). Nothing in this paragraph E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 11722 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules shall preclude the Commission, a designated contract market, or swap execution facility from recognizing a bona fide hedging transaction or position for the former holder of such a risk management exemption if the position complies with the definition of bona fide hedging transaction or position under this part, including appendices hereto. (d) Recordkeeping. (1) Persons who avail themselves of exemptions or relief under this section shall keep and maintain complete books and records concerning all details of their related cash, forward, futures, options on futures, and swap positions and transactions, including anticipated requirements, production and royalties, contracts for services, cash commodity products and by-products, crosscommodity hedges, and records of bona fide hedging swap counterparties, and shall make such books and records available to the Commission upon request under paragraph (e) of this section. (2) Any person that relies on a representation received from another person that a swap qualifies as a passthrough swap under paragraph (2) of the definition of bona fide hedging transaction or position in § 150.1 shall keep and make available to the Commission upon request all relevant books and records supporting such a representation, including any record the person intends to use to demonstrate that the pass-through swap is a bona fide hedging transaction or position, for a period of at least two years following the expiration of the swap. (3) All books and records required to be kept pursuant to this section shall be kept in accordance with the requirements of § 1.31 of this chapter. (e) Call for information. Upon call by the Commission, the Director of the Division of Enforcement or the Director’s delegate, any person claiming an exemption from speculative position limits under this section shall provide to the Commission such information as specified in the call relating to the positions owned or controlled by that person; trading done pursuant to the claimed exemption; the commodity derivative contracts or cash market positions which support the claimed exemption; and the relevant business relationships supporting a claimed exemption. (f) Aggregation of accounts. Entities required to aggregate accounts or positions under § 150.4 shall be considered the same person for the purpose of determining whether they are eligible for an exemption under paragraphs (a)(1) through (4) of this VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 section with respect to such aggregated account or position. (g) Delegation of authority to the Director of the Division of Market Oversight. (1) The Commission hereby delegates, until it orders otherwise, to the Director of the Division of Market Oversight, or such other employee or employees as the Director may designate from time to time: (i) The authority in paragraph (a)(3) of this section to provide exemptions in circumstances of financial distress; (ii) The authority in paragraph (b)(2) of this section to request additional information with respect to a request for a bona fide hedging transaction or position recognition or spread exemption; (iii) The authority in paragraph (b)(3)(ii)(B) of this section to, if applicable, determine a commercially reasonable amount of time required for a person to bring its position within the federal speculative position limits: (iv) The authority in paragraph (b)(4) of this section to make a determination whether to recognize a position as a bona fide hedging transaction or position or to grant a spread exemption; and (v) The authority in paragraph (b)(2) or (b)(5) of this section to request that a person submit updated materials or renew their request with the Commission. (2) The Director of the Division of Market Oversight may submit to the Commission for its consideration any matter which has been delegated in this section. (3) Nothing in this section prohibits the Commission, at its election, from exercising the authority delegated in this section. ■ 21. Revise § 150.5 to read as follows: § 150.5 Exchange-set speculative position limits and exemptions therefrom. (a) Requirements for exchange-set limits on commodity derivative contracts subject to federal limits set forth in § 150.2—(1) Exchange-set limits. For any commodity derivative contract that is subject to a federal speculative position limit under § 150.2, a designated contract market or swap execution facility that is a trading facility shall set a speculative position limit no higher than the level specified in § 150.2. (2) Exemptions to exchange-set limits. A designated contract market or swap execution facility that is a trading facility may grant exemptions from any speculative position limits it sets under paragraph (a)(1) of this section in accordance with the following: PO 00000 Frm 00128 Fmt 4701 Sfmt 4702 (i) Exemption levels. Exemptions of the type that conform to the exemptions the Commission identified in: (A) Sections 150.3(a)(1)(i), (a)(2)(i), and (a)(4) through (5) may be granted at a level that exceeds the level of the applicable federal limit in § 150.2; (B) Sections 150.3(a)(1)(ii) and (a)(2)(ii) may be granted at a level that exceeds the level of the applicable federal limit in § 150.2, provided that, the exemption is first approved in accordance with § 150.3(b) or 150.9, as applicable; (C) Section 150.3(a)(3) may be granted at a level that exceeds the level of the applicable federal limit in § 150.2, provided that, the Commission has first approved such exemption pursuant to a request submitted under § 140.99 of this chapter; and (D) Exemptions of the type that do not conform to the exemptions identified in § 150.3(a) shall be granted at a level that is capped at the level of the applicable federal limit in § 150.2 and that complies with paragraph (a)(2)(ii)(C) of this section, unless the Commission has first approved such exemption pursuant to § 150.3(b) or pursuant to a request submitted under § 140.99. (ii) Application for exemption from exchange-set limits. A designated contract market or swap execution facility that is a trading facility that elects to grant exemptions under paragraph (a)(2)(i) of this section: (A) (1) Except as provided in paragraph (a)(2)(ii)(A)(2) of this section, shall require traders to file an application requesting such exemption in advance of the date that such position would be in excess of the limits then in effect. Such application shall include any information needed to enable the designated contract market or swap execution facility to determine, and the Commission to verify, whether the facts and circumstances demonstrate that the designated contract market or swap execution facility may grant an exemption. Any application for a bona fide hedging transaction or position shall include a description of the applicant’s activity in the cash markets and swaps markets for the commodity underlying the position for which the application is submitted, including, but not limited to, information regarding the offsetting cash positions. (2) The designated contract market or swap execution facility may, however, adopt rules that allow a person, due to demonstrated sudden or unforeseen increases in its bona fide hedging needs, to file an application to request a recognition of a bona fide hedging transaction or position within five business days after the person E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules established the position that exceeded the applicable exchange-set speculative position limit. (3) The designated contract market or swap execution facility must require that any application filed pursuant to paragraph (a)(2)(ii)(A)(2) of this section include an explanation of the circumstances warranting the sudden or unforeseen increases in bona fide hedging needs. (4) If an application filed pursuant to paragraph (a)(2)(ii)(A)(2) of this section is denied, the applicant must bring its position within the designated contract market or swap execution facility’s speculative position limits within a commercially reasonable time as determined by the designated contract market or swap execution facility. (5) The designated contract market, swap execution facility, or Commission will not determine that the person holding the position has committed a position limits violation during the period of the designated contract market or swap execution facility’s review nor once the designated contract market or swap execution facility has issued its determination; (B) Shall require, for any such exemption granted, that the trader reapply for the exemption at least on an annual basis; (C) May, in accordance with the designated contract market or swap execution facility’s rules, deny any such application, or limit, condition, or revoke any such exemption, at any time after providing notice to the applicant, and shall take into account whether the requested exemption would result in positions that would not be in accord with sound commercial practices in the relevant commodity derivative market and/or that would exceed an amount that may be established and liquidated in an orderly fashion in that market; and (D) Notwithstanding paragraph (a)(2)(ii)(C) of this section, may require persons with positions that comply either with the bona fide hedging transactions or positions definition or the spread transactions definition in § 150.1, as applicable, to exit any such positions in excess of limits during the lesser of the last five days of trading or the time period for the spot month in such physical-delivery contract, or to otherwise limit the size of such position. Designated contract markets and swap execution facilities may refer to paragraph (b) of appendix B to part 150 for guidance regarding the foregoing. (3) Exchange-set limits on pre-existing positions—(i) Pre-existing positions in a spot month. A designated contract market or swap execution facility that is VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 a trading facility shall require compliance with spot month exchangeset speculative position limits for preexisting positions in commodity derivative contracts other than preenactment swaps and transition period swaps. (ii) Pre-existing positions in a nonspot month. A single month or allmonths-combined speculative position limit established under paragraph (a)(1) of this section shall not apply to any pre-existing positions in commodity derivative contracts, provided however, that if such position is not a preenactment swap or transition period swap, then such position shall be attributed to the person if the person’s position is increased after the effective date of such limit. (4) Monthly reports detailing the disposition of each application. (i) For commodity derivative contracts subject to federal speculative position limits, the designated contract market or swap execution facility shall submit to the Commission a report each month showing the disposition of any exemption application, including the recognition of any position as a bona fide hedging transaction or position, the exemption of any spread transaction or other position, the renewal, revocation, or modification of a previously granted recognition or exemption, or the rejection of any application, as well as the following details: (A) The date of disposition; (B) The effective date of the disposition; (C) The expiration date of any recognition or exemption; (D) Any unique identifier(s) the designated contract market or swap execution facility may assign to track the application, or the specific type of recognition or exemption; (E) If the application is for an enumerated bona fide hedging transaction or position, the name of the enumerated bona fide hedging transaction or position listed in appendix A to this part; (F) If the application is for a spread transaction listed in the spread transaction definition in § 150.1, the name of the spread transaction as it is listed in § 150.1; (G) The identity of the applicant; (H) The listed commodity derivative contract or position(s) to which the application pertains; (I) The underlying cash commodity; (J) The maximum size of the commodity derivative position that is recognized by the designated contract market or swap execution facility as a bona fide hedging transaction or position, specified by contract month PO 00000 Frm 00129 Fmt 4701 Sfmt 4702 11723 and by the type of limit as spot month, single month, or all-months-combined, as applicable; (K) Any size limitations or conditions established for a spread exemption or other exemption; and (L) For bona fide hedging transactions or positions, a concise summary of the applicant’s activity in the cash markets and swaps markets for the commodity underlying the commodity derivative position for which the application was submitted. (ii) The designated contract market or swap execution facility shall submit to the Commission the information required by paragraph (a)(4)(i) of this section: (A) As specified by the Commission on the Forms and Submissions page at www.cftc.gov; and (B) Using the format, coding structure, and electronic data transmission procedures approved in writing by the Commission. (b) Requirements for exchange-set limits on commodity derivative contracts in a physical commodity that are not subject to the limits set forth in § 150.2—(1) Exchange-set spot month limits—(i) Spot month speculative position limit levels. For any commodity derivative contract subject to paragraph (b) of this section, a designated contract market or swap execution facility that is a trading facility shall establish speculative position limits for the spot month no greater than 25 percent of the estimated spot month deliverable supply, calculated separately for each month to be listed. (ii) Additional sources for compliance. Alternatively, a designated contract market or swap execution facility that is a trading facility may submit rules to the Commission establishing spot month speculative position limits other than as provided in paragraph (b)(1)(i) of this section, provided that the limits are set at a level that is necessary and appropriate to reduce the potential threat of market manipulation or price distortion of the contract’s or the underlying commodity’s price or index. (2) Exchange-set limits or accountability outside of the spot month—(i) Non-spot month speculative position limit or accountability levels. For any commodity derivative contract subject to paragraph (b) of this section, a designated contract market or swap execution facility that is a trading facility shall adopt either speculative position limits or position accountability outside of the spot month at a level that is necessary and appropriate to reduce the potential threat of market manipulation or price E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 11724 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules distortion of the contract’s or the underlying commodity’s price or index. (ii) Additional sources for compliance. A designated contract market or swap execution facility that is a trading facility may refer to the nonexclusive acceptable practices in paragraph (b) of appendix F of this part to demonstrate to the Commission compliance with the requirements of paragraph (b)(2)(i) of this section. (3) Look-alike contracts. For any newly listed commodity derivative contract subject to paragraph (b) of this section that is substantially the same as an existing contract listed on a designated contract market or swap execution facility that is a trading facility, a designated contract market or swap execution facility that is a trading facility listing such newly listed contract shall adopt spot month, individual month, and all-monthscombined speculative position limits comparable to those of the existing contract. Alternatively, if such designated contract market or swap execution facility seeks to adopt speculative position limits that are not comparable to those of the existing contract, such designated contract market or swap execution facility shall demonstrate to the Commission how the levels comply with paragraphs (b)(1) and/or (b)(2) of this section. (4) Exemptions to exchange-set limits. A designated contract market or swap execution facility that is a trading facility may grant exemptions from any speculative position limits it sets under paragraphs (b)(1) or (b)(2) of this section in accordance with the following: (i) Traders shall be required to apply to the designated contract market or swap execution facility for any such exemption from its speculative position limit rules; and (ii) A designated contract market or swap execution facility that is a trading facility may deny any such application, or limit, condition, or revoke any such exemption, at any time after providing notice to the applicant, and shall take into account whether the requested exemption would result in positions that would not be in accord with sound commercial practices in the relevant commodity derivative market and/or would exceed an amount that may be established and liquidated in an orderly fashion in that market. (c) Requirements for security futures products. For security futures products, speculative position limits and position accountability requirements are specified in § 41.25 of this chapter. (d) Rules on aggregation. For commodity derivative contracts in a physical commodity, a designated VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 contract market or swap execution facility that is a trading facility shall have aggregation rules that conform to § 150.4. (e) Requirements for submissions to the Commission. A designated contract market or swap execution facility that is a trading facility that adopts speculative position limits and/or position accountability levels pursuant to paragraphs (a) or (b) of this section, and/ or that elects to offer exemptions from any such levels pursuant to such paragraphs, shall submit to the Commission pursuant to part 40 of this chapter rules establishing such levels and/or exemptions. To the extent any such designated contract market or swap execution facility adopts speculative position limit levels, such part 40 submission shall also include the methodology by which such levels are calculated, and the designated contract market or swap execution facility shall review such speculative position limit levels regularly for compliance with this section and update such speculative position limit levels as needed. (f) Delegation of authority to the Director of the Division of Market Oversight—(1) Commission delegations. The Commission hereby delegates, until it orders otherwise, to the Director of the Division of Market Oversight, or such other employee or employees as the Director may designate from time to time, the authority in paragraph (a)(4)(ii) of this section to provide instructions regarding the submission to the Commission of information required to be reported, pursuant to paragraph (a)(4)(i) of this section, by a designated contract market or swap execution facility, to specify the manner for submitting such information on the Forms and Submissions page at www.cftc.gov and to determine the format, coding structure, and electronic data transmission procedures for submitting such information. (2) Commission consideration of delegated matter. The Director of the Division of Market Oversight may submit to the Commission for its consideration any matter which has been delegated in this section. (3) Commission authority. Nothing in this section prohibits the Commission, at its election, from exercising the authority delegated in this section. ■ 22. Revise § 150.6 to read as follows: § 150.6 Scope. This part shall only be construed as having an effect on speculative position limits set by the Commission or by a designated contract market or swap execution facility, including any PO 00000 Frm 00130 Fmt 4701 Sfmt 4702 associated recordkeeping and reporting regulations in this chapter. Nothing in this part shall be construed to relieve any contract market, swap execution facility, or its governing board from responsibility under section 5(d)(4) of the Act to prevent manipulation and corners. Further, nothing in this part shall be construed to affect any other provisions of the Act or Commission regulations, including, but not limited to, those relating to actual or attempted manipulation, corners, squeezes, fraudulent or deceptive conduct, or to prohibited transactions. § 150.7 ■ ■ [Reserved]. 23. Add and reserve § 150.7. 24. Add § 150.8 to read as follows: § 150.8 Severability. If any provision of this part, or the application thereof to any person or circumstances, is held invalid, such invalidity shall not affect the validity of other provisions or the application of such provision to other persons or circumstances that can be given effect without the invalid provision or application. ■ 25. Add § 150.9 to read as follows: § 150.9 Process for recognizing nonenumerated bona fide hedging transactions or positions with respect to federal speculative position limits. For purposes of federal speculative position limits, a person with a position in a referenced contract seeking recognition of such position as a nonenumerated bona fide hedging transaction or position, in accordance with § 150.3(a)(1)(ii), shall submit an application to the Commission, pursuant to § 150.3(b), or submit an application to a designated contract market or swap execution facility in accordance with this section. If such person submits an application to a designated contract market or swap execution facility in accordance with this section, and the designated contract market or swap execution facility, with respect to its own speculative position limits established pursuant to § 150.5(a), recognizes the person’s position as a non-enumerated bona fide hedging transaction or position, then the person may also exceed the applicable federal speculative position limit for such position, in accordance with paragraph (e) of this section. The designated contract market or swap execution facility may approve such applications only if the designated contract market or swap execution facility complies with the conditions set forth in paragraphs (a) through (e) of this section. (a) Approval of rules. The designated contract market or swap execution E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules facility maintains rules, consistent with the requirements of this section and approved by the Commission pursuant to § 40.5 of this chapter, that establish application processes and conditions for recognizing bona fide hedging transactions or positions. (b) Prerequisites for a designated contract market or swap execution facility to recognize bona fide hedging transactions or positions in accordance with this section. (1) The designated contract market or swap execution facility lists the applicable referenced contract for trading; (2) The position meets the definition of bona fide hedging transactions or positions in section 4a(c)(2) of the Act and the definition of bona fide hedging transactions or positions in § 150.1; and (3) The designated contract market or swap execution facility does not recognize as a bona fide hedging transaction or position any position involving a commodity index contract and one or more referenced contracts, including exemptions known as risk management exemptions. (c) Application process. The designated contract market or swap execution facility’s application process meets the following conditions: (1) Required application information. The designated contract market or swap execution facility requires the applicant to provide, and can obtain from the applicant, all information to enable the designated contract market or swap execution facility to determine, and the Commission to verify, whether the facts and circumstances demonstrate that the designated contract market or swap execution facility may recognize a position as a bona fide hedging transaction or position, including the following: (i) A description of the position in the commodity derivative contract for which the application is submitted, including but not limited to, the name of the underlying commodity and the derivative position size; (ii) Information to demonstrate why the position satisfies the requirements of section 4a(c)(2) of the Act and the definition of bona fide hedging transaction or position in § 150.1, including factual and legal analysis; (iii) A statement concerning the maximum size of all gross positions in commodity derivative contracts for which the application is submitted; (iv) A description of the applicant’s activity in the cash markets and the swaps markets for the commodity underlying the position for which the application is submitted, including, but not limited to, information regarding the offsetting cash positions; and VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 (v) Any other information the designated contract market or swap execution facility requires, in its discretion, to verify that the position complies with paragraph (b)(2) of this section, as applicable. (2) Timing of application. (i) Except as provided in paragraph (c)(2)(ii) of this section, the designated contract market or swap execution facility requires the applicant to submit an application and receive a notice of approval of such application prior to the date that the position for which such application was submitted would be in excess of the applicable federal speculative position limits. (ii) A designated contract market or swap execution facility may, however, adopt rules that allow a person to, due to demonstrated sudden or unforeseen increases in its bona fide hedging needs, file an application with the designated contract market or swap execution facility to request a recognition of a bona fide hedging transaction or position within five business days after the person established the position that exceeded the applicable federal speculative position limit. (A) The designated contract market or swap execution facility must require that any application filed pursuant to paragraph (c)(2)(ii) of this section include an explanation of the circumstances warranting the sudden or unforeseen increases in bona fide hedging needs. (B) If an application filed pursuant to paragraph (c)(2)(ii) of this section is denied by the designated contract market, swap execution facility, or Commission, the applicant must bring its position within the applicable federal speculative position limits within a commercially reasonable time as determined by the Commission in consultation with the applicant and the applicable designated contract market or swap execution facility. (C) The designated contract market, swap execution facility, or Commission will not determine that the person holding the position has committed a position limits violation during the period of the designated contract market, swap execution facility, or Commission’s review nor once a determination has been issued. (3) Renewal of applications. The designated contract market or swap execution facility requires each applicant to reapply for such recognition or exemption at least on an annual basis by updating the original application, and to receive a notice of approval of the renewal from the designated contract market or swap execution facility prior to the date that PO 00000 Frm 00131 Fmt 4701 Sfmt 4702 11725 such position would be in excess of the applicable federal speculative position limits. (4) Exchange revocation authority. The designated contract market or swap execution facility retains its authority to limit, condition, or revoke, at any time after providing notice to the applicant, any bona fide hedging transaction or position recognition for purposes of the designated contract market or swap execution facility’s speculative position limits established under § 150.5(a), for any reason as determined in the discretion of the designated contract market or swap execution facility, including if the designated contract market or swap execution facility determines that the position no longer meets the conditions set forth in paragraph (b) of this section, as applicable. (d) Recordkeeping. (1) The designated contract market or swap execution facility keeps full, complete, and systematic records, which include all pertinent data and memoranda, of all activities relating to the processing of such applications and the disposition thereof. Such records include: (i) Records of the designated contract market or swap execution facility’s recognition of any derivative position as a bona fide hedging transaction or position, revocation or modification of any such recognition, or the rejection of an application; (ii) All information and documents submitted by an applicant in connection with its application, including documentation and information that is submitted after the disposition of the application, and any withdrawal, supplementation, or update of any application; (iii) Records of oral and written communications between the designated contract market or swap execution facility and the applicant in connection with such application; and (iv) All information and documents in connection with the designated contract market or swap execution facility’s analysis of, and action(s) taken with respect to, such application. (2) All books and records required to be kept pursuant to this section shall be kept in accordance with the requirements of § 1.31 of this chapter. (e) Process for a person to exceed federal speculative position limits on a referenced contract—(1) Notification to the Commission. The designated contract market or swap execution facility must submit to the Commission a notification of each initial determination to recognize a bona fide hedging transaction or position in accordance with this section, E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 11726 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules concurrently with the notice of such determination the designated contract market or swap execution facility provides to the applicant. (2) Notification requirements. The notification in paragraph (e)(1) of this section shall include, at a minimum, the following information: (i) Name of the applicant; (ii) Brief description of the bona fide hedging transaction or position being recognized; (iii) Name of the contract(s) relevant to the recognition; (iv) The maximum size of the position that may exceed federal speculative position limits; (v) The effective date and expiration date of the recognition; (vi) An indication regarding whether the position may be maintained during the last five days of trading during the spot month, or the time period for the spot month; and (vii) A copy of the application and any supporting materials. (3) Exceeding federal speculative position limits on referenced contracts. A person may exceed federal speculative position limits on a referenced contract ten business days after the designated contract market or swap execution facility issues the notification required pursuant to paragraph (e)(1) of this section, unless the Commission notifies the designated contract market or swap execution facility and the applicant otherwise, pursuant to paragraph (e)(5) of this section, before the ten business day period expires. (4) Exceeding federal speculative position limits on referenced contracts due to sudden or unforeseen circumstances. If a person files an application for a recognition of a bona fide hedging transaction or position in accordance with paragraph (c)(2)(ii) of this section, then such person may rely on the designated contract market or swap execution facility’s determination to grant such recognition for purposes of federal speculative position limits two business days after the designated contract market or swap execution facility issues the notification required pursuant to paragraph (e)(1) of this section, unless the Commission notifies the designated contract market or swap execution facility and the applicant otherwise, pursuant to paragraph (e)(5) of this section, before the two business day period expires. (5) Commission stay of pending applications and requests for additional information. If the Commission determines to stay an application that requires additional time to analyze, or request additional information to VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 determine whether the position for which the application is submitted meets the conditions set forth in paragraph (b) of this section, the Commission shall notify the applicable designated contract market or swap execution facility and applicant of the Commission’s determination or request for any supplemental information required, and provide an opportunity for the applicant to respond with any supplemental information. (6) Commission determination. If the Commission determines that a position for which the application is submitted does not meet the conditions set forth in paragraph (b) of this section, the Commission shall: (i) Notify the designated contract market or swap execution facility and applicant, and, after providing an opportunity for the applicant to respond, the Commission may, in its discretion, reject the exchange’s determination for purposes of federal speculative position limits and, as applicable, require the person to reduce the derivatives position within a commercially reasonable time, as determined by the Commission in consultation with the applicant and the applicable designated contract market or swap execution facility, or otherwise come into compliance; and (ii) The Commission will not determine that the person holding the position has committed a position limits violation during the period of the Commission’s review nor once the Commission has issued its determination. (f) Commission revocation of approved applications. (1) If a designated contract market or swap execution facility limits, conditions, or revokes any recognition of a bona fide hedging transaction or position for purposes of the designated contract market or swap execution facility’s speculative position limits established under § 150.5(a), then such recognition will also be deemed limited, conditioned, or revoked for purposes of federal speculative position limits. (2) If the Commission determines, at any time, that a position that has been recognized as a bona fide hedging transaction or position has been granted for a position that, for purposes of federal speculative position limits, is no longer consistent with section 4a(c)(2) of the Act or the definition of bona fide hedging transaction or position in § 150.1, the following applies: (i) The Commission shall notify the person holding the position and, after providing an opportunity to respond, the Commission may, in its discretion, revoke the exchange’s determination for PO 00000 Frm 00132 Fmt 4701 Sfmt 4702 purposes of federal speculative position limits and require the person to reduce the derivatives position within a commercially reasonable time as determined by the Commission in consultation with the applicant and the applicable designated contract market or swap execution facility, or otherwise come into compliance; (ii) The Commission shall include in its notification a brief explanation of the nature of the issues raised and the specific provisions of the Act or the Commission’s regulations with which the position or application is, or appears to be, inconsistent; and (iii) The Commission shall not determine that the person holding the position has committed a position limits violation during the period of the Commission’s review nor once the Commission has issued its determination, provided the person reduced the derivatives position within a commercially reasonable time, as determined by the Commission in consultation with the applicant and the applicable designated contract market or swap execution facility, or otherwise came into compliance. (g) Delegation of authority to the Director of the Division of Market Oversight—(1) Commission delegations. The Commission hereby delegates, until it orders otherwise, to the Director of the Division of Market Oversight, or such other employee or employees as the Director may designate from time to time, the authority in paragraph (e)(5) of this section, to request additional information from the applicable designated contract market or swap execution facility and applicant; (2) Commission consideration of delegated matter. The Director of the Division of Market Oversight may submit to the Commission for its consideration any matter which has been delegated in this section. (3) Commission authority. Nothing in this section prohibits the Commission, at its election, from exercising the authority delegated in this section. ■ 26. Add appendices A through F to read as follows: Appendix A to Part 150—List of Enumerated Hedges Persons that follow specific practices outlined in the enumerated hedges in this appendix shall establish compliance with the bona fide hedging transactions or positions definition in § 150.1 and with § 150.3(a)(1)(i) without being required to request approval under § 150.3 or § 150.9 prior to exceeding the applicable federal speculative position limit. All other persons must request approval pursuant to § 150.3 or § 150.9 prior to exceeding the applicable federal speculative position limit. E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Compliance with an enumerated bona fide hedge listed below does not, however, diminish or replace, in any event, the obligations and requirements of the person to comply with the regulations provided under this part 150. The enumerated bona fide hedges do not state the exclusive means for establishing compliance with the bona fide hedging transactions or positions definition in § 150.1 or with the requirements of § 150.3(a)(1). (a) Enumerated hedges. The following positions comply with the bona fide hedging transactions or positions definition in § 150.1: (1) Hedges of unsold anticipated production. Short positions in commodity derivative contracts that do not exceed in quantity the person’s unsold anticipated production of the contract’s underlying cash commodity. (2) Hedges of offsetting unfixed-price cash commodity sales and purchases. Both short and long positions in commodity derivative contracts that do not exceed in quantity the amount of the contract’s underlying cash commodity that has been both bought and sold by the same person at unfixed prices: (A) Basis different delivery months in the same commodity derivative contract; or (B) Basis different commodity derivative contracts in the same commodity, regardless of whether the commodity derivative contracts are in the same calendar month. (3) Hedges of anticipated mineral royalties. Short positions in a person’s commodity derivative contracts offset by the anticipated change in value of mineral royalty rights that are owned by that person, provided that the royalty rights arise out of the production of the commodity underlying the commodity derivative contract. (4) Hedges of anticipated services. Short or long positions in a person’s commodity derivative contracts offset by the anticipated change in value of receipts or payments due or expected to be due under an executed contract for services held by that person, provided that the contract for services arises out of the production, manufacturing, processing, use, or transportation of the commodity underlying the commodity derivative contract. (5) Cross-commodity hedges. Positions in commodity derivative contracts described in paragraph (2) of the bona fide hedging transactions or positions definition in § 150.1 or in paragraphs (a)(1) through (a)(4) and paragraphs (a)(6) through (a)(9) of this appendix A may also be used to offset the risks arising from a commodity other than the cash commodity underlying a commodity derivative contract, provided that the fluctuations in value of the position in the commodity derivative contract, or the commodity underlying the commodity derivative contract, shall be substantially related to the fluctuations in value of the actual or anticipated cash position or passthrough swap. (6) Hedges of inventory and cash commodity fixed-price purchase contracts. Short positions in commodity derivative contracts that do not exceed in quantity the sum of the person’s ownership of inventory and fixed-price purchase contracts in the contract’s underlying cash commodity. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 (7) Hedges of cash commodity fixed-price sales contracts. Long positions in commodity derivative contracts that do not exceed in quantity the sum of the person’s fixed-price sales contracts in the contract’s underlying cash commodity and the quantity equivalent of fixed-price sales contracts of the cash products and by-products of such commodity. (8) Hedges by agents. Long or short positions in commodity derivative contracts by an agent who does not own or has not contracted to sell or purchase the commodity derivative contract’s underlying cash commodity at a fixed price, provided that the agent is responsible for merchandising the cash positions that are being offset in commodity derivative contracts and the agent has a contractual arrangement with the person who owns the commodity or holds the cash market commitment being offset. (9) Offsets of commodity trade options. Long or short positions in commodity derivative contracts that do not exceed in quantity, on a futures-equivalent basis, a position in a commodity trade option that meets the requirements of § 32.3 of this chapter. Such commodity trade option transaction, if it meets the requirements of § 32.3 of this chapter, may be deemed, for purposes of complying with this paragraph (a)(9) of this appendix A, a cash commodity purchase or sales contract as set forth in paragraphs (a)(6) or (a)(7) of this appendix A, as applicable. (10) Hedges of unfilled anticipated requirements. Long positions in commodity derivative contracts that do not exceed in quantity the person’s unfilled anticipated requirements for the contract’s underlying cash commodity, for processing, manufacturing, or use by that person, or for resale by a utility as it pertains to the utility’s obligations to meet the unfilled anticipated demand of its customers for the customer’s use. (11) Hedges of anticipated merchandising. Long or short positions in commodity derivative contracts that offset the anticipated change in value of the underlying commodity that a person anticipates purchasing or selling, provided that: (A) The position in the commodity derivative contract does not exceed in quantity twelve months’ of current or anticipated purchase or sale requirements of the same cash commodity that is anticipated to be purchased or sold; and (B) The person is a merchant handling the underlying commodity that is subject to the anticipatory merchandising hedge, and that such merchant is entering into the position solely for purposes related to its merchandising business and has a demonstrated history of buying and selling the underlying commodity for its merchandising business. Appendix B to Part 150—Guidance on Gross Hedging Positions and Positions Held During the Spot Period (a) Guidance on gross hedging positions. (1) A person’s gross hedging positions may be deemed in compliance with the bona fide hedging transactions or positions definition in § 150.1, provided that all applicable PO 00000 Frm 00133 Fmt 4701 Sfmt 4702 11727 regulatory requirements are met, including that the position is economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise and otherwise satisfies the bona fide hedging definition in § 150.1, and provided further that: (A) The manner in which the person measures risk is consistent and follows historical practice for that person; (B) The person is not measuring risk on a gross basis to evade the speculative position limits in § 150.2 or the aggregation rules in § 150.4; (C) The person is able to demonstrate compliance with paragraphs (A) and (B) upon the request of the Commission and/or of a designated contract market, including by providing information regarding the entities with which the person aggregates positions; and (D) A designated contract market or swap execution facility that recognizes a particular gross hedging position as bona fide pursuant to § 150.9 documents the justifications for doing so, and maintains records of such justifications in accordance with § 150.9(d). (b) Guidance regarding positions held during the spot period. Section 150.5(a)(2)(ii)(D) confirms the existing authority of designated contract markets and swap execution facilities to maintain rules that subject positions that comply with the bona fide hedging position or transaction definition in § 150.1 to a restriction that no such position is maintained in any physicaldelivery commodity derivative contract during the lesser of the last five days of trading or the time period for the spot month in such physical-delivery contract (the ‘‘spot period’’). Any such designated contract market or swap execution facility may waive any such restriction, including if: (1) The position complies with the bona fide hedging transaction or position definition in § 150.1; (2) There is an economically appropriate need to maintain such position in excess of federal speculative position limits during the spot period for such contract, and such need relates to the purchase or sale of a cash commodity; and (3) The person wishing to exceed federal position limits during the spot period: (A) Intends to make or take delivery during that time period; (B) Provides materials to the designated contract market or swap execution facility supporting a classification of the position as a bona fide hedging transaction or position and demonstrating facts and circumstances that would warrant holding such position in excess of limits during the spot period; (C) Demonstrates cash-market exposure inhand that is verified by the designated contract market or swap execution facility and that supports holding the position during the spot period; (D) Demonstrates that, for short positions, the delivery is feasible, meaning that the person has the ability to deliver against the short position (i.e., has inventory on hand in a deliverable location and in a condition in which the commodity can be used upon delivery); and (E) Demonstrates that, for long positions, the delivery is feasible, meaning that the E:\FR\FM\27FEP3.SGM 27FEP3 11728 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules person has the ability to take delivery at levels that are economically appropriate (i.e., the delivery comports with the person’s demonstrated need for the commodity and the contract is the cheapest source for that commodity). Appendix C to Part 150—Guidance Regarding the Referenced Contract Definition in § 150.1 This appendix C provides guidance regarding the ‘‘referenced contract’’ definition in § 150.1, which provides in paragraph (3) that the definition of referenced contract does not include a location basis contract, a commodity index contract, or a trade option that meets the requirements of § 32.3 of this chapter. The term referenced contract is used throughout part 150 of the Commission’s regulations to refer to contracts that are subject to federal limits. A position in a contract that is not a referenced contract is not subject to federal limits, and, as a consequence, cannot be netted with positions in referenced contracts for purposes of federal limits. This guidance is intended to clarify the types of contracts that would qualify as a location basis contract or commodity index contract. Compliance with this guidance does not diminish or replace, in any event, the obligations and requirements of any person to comply with the regulations provided under this part, or any other part of the Commission’s regulations. The guidance is for illustrative purposes only and does not state the exclusive means for a contract to qualify, or not qualify, as a referenced contract as defined in § 150.1, or to comply with any other provision in this part. (a) Guidance. (1) As provided in paragraph (3) of the ‘‘referenced contract’’ definition in § 150.1, the following types of contracts are not deemed referenced contracts, meaning such contracts are not subject to federal limits and cannot be netted with positions in referenced contracts for purposes of federal limits: location basis contracts; commodity index contracts; swap guarantees; and trade options that meet the requirements of § 32.3 of this chapter. (2) Location basis contract. For purposes of the referenced contract definition in § 150.1, a location basis contract means a commodity derivative contract that is cash-settled based on the difference in: (i) The price, directly or indirectly, of: (A) A particular core referenced futures contract; or (B) A commodity deliverable on a particular core referenced futures contract, whether at par, a fixed discount to par, or a premium to par; and (ii) The price, at a different delivery location or pricing point than that of the same particular core referenced futures contract, directly or indirectly, of: (A) A commodity deliverable on the same particular core referenced futures contract, whether at par, a fixed discount to par, or a premium to par; or (B) A commodity that is listed in appendix D to this part as substantially the same as a commodity underlying the same core referenced futures contract. (3) Commodity index contract. For purposes of the referenced contract definition in § 150.1, a commodity index contract means an agreement, contract, or transaction based on an index comprised of prices of commodities that are not the same or substantially the same and that is not a location basis contract, a calendar spread contract, or an intercommodity spread contract as such terms are defined in this guidance, where: (i) A calendar spread contract means a cash-settled agreement, contract, or transaction that represents the difference between the settlement price in one or a series of contract months of an agreement, contract, or transaction and the settlement price of another contract month or another series of contract months’ settlement prices for the same agreement, contract, or transaction; and (ii) An intercommodity spread contract means a cash-settled agreement, contract, or transaction that represents the difference between the settlement price of a referenced contract and the settlement price of another contract, agreement, or transaction that is based on a different commodity. Appendix D to Part 150—Commodities Listed as Substantially the Same for Purposes of the Term ‘‘Location Basis Contract’’ As Used in the Referenced Contract Definition The following table lists core referenced futures contracts and commodities that are treated as substantially the same as a commodity underlying a core referenced futures contract for purposes of the term ‘‘location basis contract’’ as used in the referenced contract definition under § 150.1, and as discussed in the associated appendix, Appendix C—Guidance Regarding the Referenced Contract Definition in § 150.1. LOCATION BASIS CONTRACT LIST OF SUBSTANTIALLY THE SAME COMMODITIES Core referenced futures contract Commodities considered substantially the same (regardless of location) NYMEX Light Sweet Crude Oil futures contract (CL): 1. Light Louisiana Sweet (LLS) Crude Oil. NYMEX New York Harbor ULSD Heating Oil futures contract (HO): 1. Chicago ULSD ........................... lotter on DSKBCFDHB2PROD with PROPOSALS3 2. Gulf Coast ULSD ....................... 3. California Air Resources Board Spec ULSD (CARB no. 2 oil). 4. Gas Oil Deliverable in Antwerp, Rotterdam, or Amsterdam Area. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 PO 00000 Frm 00134 Fmt 4701 Source(s) for specification of quality NYMEX Argus LLS vs. WTI (Argus) Trade Month futures contract (E5). NYMEX LLS (Argus) vs. WTI Financial futures contract (WJ). ICE Futures Europe Crude Diff—Argus LLS vs WTI 1st Line Swap futures contract (ARK). ICE Futures Europe Crude Diff—Argus LLS vs WTI Trade Month Swap futures contract (ARL). NYMEX Chicago ULSD (Platts) vs. NY Harbor ULSD Heating Oil futures contract (5C). NYMEX Group Three ULSD (Platts) vs. NY Harbor ULSD Heating Oil futures contract (A6). NYMEX Gulf Coast ULSD (Argus) Up-Down futures contract (US). NYMEX Gulf Coast ULSD (Argus) Up-Down BALMO futures contract (GUD). NYMEX Gulf Coast ULSD (Platts) Up-Down BALMO futures contract (1L). NYMEX Gulf Coast ULSD (Platts) Up-Down Spread futures contract (LT). ICE Futures Europe Diesel Diff- Gulf Coast vs Heating Oil 1st Line Swap futures contract (GOH). CME Clearing Europe Gulf Coast ULSD( Platts) vs. New York Heating Oil (NYMEX) Spread Calendar swap (ELT). CME Clearing Europe New York Heating Oil (NYMEX) vs. European Gasoil (IC) Spread Calendar swap (EHA). NYMEX Los Angeles CARB Diesel (OPIS) vs. NY Harbor ULSD Heating Oil futures contract (KL). ICE Futures Europe Gasoil futures contract (G). Sfmt 4702 E:\FR\FM\27FEP3.SGM 27FEP3 11729 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules LOCATION BASIS CONTRACT LIST OF SUBSTANTIALLY THE SAME COMMODITIES—Continued Commodities considered substantially the same (regardless of location) Core referenced futures contract NYMEX RBOB Gasoline futures contract (RB): 1. Chicago Unleaded 87 gasoline 2. Gulf Coast Conventional Blendstock for Oxygenated Blending (CBOB) 87. 3. Gulf Coast CBOB 87 (Summer Assessment). 4. Gulf Coast Unleaded 87 (Summer Assessment). 5. Gulf Coast Unleaded 87 ............ Source(s) for specification of quality ICE Futures Europe Heating Oil Arb—Heating Oil 1st Line vs Gasoil 1st Line Swap futures contract (HOT). ICE Futures Europe Heating Oil Arb—Heating Oil 1st Line vs Low Sulphur Gasoil 1st Line Swap futures contract (ULL). NYMEX NY Harbor ULSD Heating Oil vs. Gasoil futures contract (HA). NYMEX Chicago Unleaded Gasoline (Platts) vs. RBOB Gasoline futures contract (3C). NYMEX Group Three Unleaded Gasoline (Platts) vs. RBOB Gasoline futures contract (A8). NYMEX Gulf Coast CBOB Gasoline A1 (Platts) vs. RBOB Gasoline futures contract (CBA). NYMEX Gulf Coast Unl 87 (Argus) Up-Down futures contract (UZ). NYMEX Gulf Coast CBOB Gasoline A2 (Platts) vs. RBOB Gasoline futures contract (CRB). NYMEX Gulf Coast 87 Gasoline M2 (Platts) vs. RBOB Gasoline futures contract (RVG). NYMEX Gulf Coast 87 Gasoline M2 (Platts) vs. RBOB Gasoline BALMO futures contract (GBB). NYMEX Gulf Coast 87 Gasoline M2 (Argus) vs. RBOB Gasoline BALMO futures contract (RBG). NYMEX Gulf Coast Unl 87 (Platts) Up-Down BALMO futures contract (1K). NYMEX Gulf Coast Unl 87 Gasoline M1 (Platts) vs. RBOB Gasoline futures contract (RV). CME Clearing Europe Gulf Coast Unleaded 87 Gasoline M1 (Platts) vs. New York RBOB Gasoline (NYMEX) Spread Calendar swap (ERV). NYMEX Los Angeles CARBOB Gasoline (OPIS) vs. RBOB Gasoline futures contract (JL). 6. Los Angeles California Reformulated Blendstock for Oxygenate Blending (CARBOB) Regular. 7. Los Angeles California Refor- NYMEX Los Angeles CARBOB Gasoline (OPIS) vs. RBOB Gasoline mulated Blendstock for Oxygenfutures contract (JL). ate Blending (CARBOB) Premium. 8. Euro-BOB OXY NWE Barges ... NYMEX RBOB Gasoline vs. Euro-bob Oxy NWE Barges (Argus) (1000mt) futures contract (EXR). CME Clearing Europe New York RBOB Gasoline (NYMEX) vs. European Gasoline Euro-bob Oxy Barges NWE (Argus) (1000mt) Spread Calendar swap (EEXR). 9. Euro-BOB OXY FOB Rotterdam ICE Futures Europe Gasoline Diff—RBOB Gasoline 1st Line vs. Argus Euro-BOB OXY FOB Rotterdam Barge Swap futures contract (ROE). Appendix E to Part 150—Speculative Position Limit Levels lotter on DSKBCFDHB2PROD with PROPOSALS3 Contract Legacy Agricultural: Chicago Board of Trade Corn (C) ........................................................................................................... Chicago Board of Trade Oats (O) ........................................................................................................... Chicago Board of Trade Soybeans (S) ................................................................................................... Chicago Board of Trade Soybean Meal (SM) ......................................................................................... Chicago Board of Trade Soybean Oil (SO) ............................................................................................. Chicago Board of Trade Wheat (W) ........................................................................................................ Chicago Board of Trade KC HRW Wheat (KW) ...................................................................................... Minneapolis Grain Exchange Hard Red Spring Wheat (MWE) ............................................................... ICE Futures U.S. Cotton No. 2 (CT) ........................................................................................................ Other Agricultural: Chicago Board of Trade Rough Rice (RR) .............................................................................................. Chicago Mercantile Exchange Live Cattle (LC) ....................................................................................... ICE Futures U.S. Cocoa (CC) ................................................................................................................. ICE Futures U.S. Coffee C (KC) .............................................................................................................. ICE Futures U.S. FCOJ–A (OJ) ............................................................................................................... ICE Futures U.S. Sugar No. 11 (SB) ....................................................................................................... VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 PO 00000 Frm 00135 Single-month and all months Spot month Fmt 4701 Sfmt 4702 E:\FR\FM\27FEP3.SGM 1,200 600 1,200 1,500 1,100 1,200 1,200 1,200 1,800 800 1 600/300/200 4,900 1,700 2,200 25,800 27FEP3 57,800. 2,000. 27,300. 16,900. 17,400. 19,300. 12,000. 12,000. 11,900. Not Not Not Not Not Not Applicable. Applicable. Applicable. Applicable. Applicable. Applicable. 11730 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Contract ICE Futures U.S. Sugar No. 16 (SF) ....................................................................................................... Energy: New York Mercantile Exchange Henry Hub Natural Gas (NG) .............................................................. New York Mercantile Exchange Light Sweet Crude Oil (CL) .................................................................. 6,400 Not Applicable. 2 2,000 3 6,000/5,000/ Not Applicable. Not Applicable. 4,000 2,000 2,000 Not Applicable. Not Applicable. 1,000 6,000 3,000 50 500 Not Not Not Not Not New York Mercantile Exchange NY Harbor ULSD (HO) ........................................................................ New York Mercantile Exchange RBOB Gasoline (RB) ........................................................................... Metal: Commodity Exchange, Inc. Copper (HG) ................................................................................................ Commodity Exchange, Inc. Gold (GC) .................................................................................................... Commodity Exchange, Inc. Silver (SI) ..................................................................................................... New York Mercantile Exchange Palladium (PA) ..................................................................................... New York Mercantile Exchange Platinum (PL) ....................................................................................... Appendix F to Part 150—Guidance on, and Acceptable Practices in, Compliance With § 150.5 lotter on DSKBCFDHB2PROD with PROPOSALS3 The following are guidance and acceptable practices for compliance with § 150.5. Compliance with the acceptable practices and guidance does not diminish or replace, in any event, the obligations and requirements of the person to comply with the other regulations provided under this part. The acceptable practices and guidance are for illustrative purposes only and do not state the exclusive means for establishing compliance with § 150.5. (a) Acceptable practices for compliance with § 150.5(b)(2)(i) regarding exchange-set limits or accountability outside of the spot month. A designated contract market or swap execution facility that is a trading facility may satisfy § 150.5(b)(2)(i) by complying with either of the following acceptable practices: (1) Non-spot month speculative position limits. For any commodity derivative contract subject to § 150.5(b), a designated contract market or swap execution facility that is a trading facility sets individual single month or all-months-combined levels no greater than any one of the following: (i) The average of historical position sizes held by speculative traders in the contract as a percentage of the average combined futures and delta-adjusted option month-end open interest for that contract for the most recent calendar year; (ii) The level of the spot month limit for the contract; 1 Step-down spot month limits would be for positions net long or net short as follows: 600 contracts at the close of trading on the first business day following the first Friday of the contract month; 300 contracts at the close of trading on the business day prior to the last five trading days of the contract month; and 200 contracts at the close of trading on the business day prior to the last two trading days of the contract month. 2 See § 150.3 regarding the conditional spot month limit exemption for cash-settled positions in natural gas. 3 Step-down spot month limits would be for positions net long or net short as follows: 6,000 contracts at the close of trading three business days prior to the last trading day of the contract; 5,000 contracts at the close of trading two business days prior to the last trading day of the contract; and 4,000 contracts at the close of trading one business day prior to the last trading day of the contract. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 (iii) 5,000 contracts (scaled-down proportionally to the notional quantity per contract relative to the typical cash-market transaction if the notional quantity per contract is larger than the typical cash market transaction, and scaled up proportionally to the notional quantity per contract relative to the typical cash-market transaction if the notional quantity per contract is smaller than the typical cash market transaction); or (iv) 10 percent of the average combined futures and delta-adjusted option month-end open interest in the contract for the most recent calendar year up to 50,000 contracts, with a marginal increase of 2.5 percent of open interest thereafter. (2) Non-spot month position accountability. For any commodity derivative contract subject to § 150.5(b), a designated contract market or swap execution facility that is a trading facility adopts position accountability, as defined in § 150.1. (b) [Reserved] PART 151—[REMOVED AND RESERVED] 27. Under the authority of section 8a(5) of the Commodity Exchange Act, 7 U.S.C. 12a(5), remove and reserve part 151. ■ Issued in Washington, DC, on January 31, 2020, by the Commission. Christopher Kirkpatrick, Secretary of the Commission. Note: The following appendices will not appear in the Code of Federal Regulations. Appendices to Position Limits for Derivatives—Commission Voting Summary, Chairman’s Statement, and Commissioners’ Statements Appendix 1—Commission Voting Summary On this matter, Chairman Tarbert and Commissioners Quintenz and Stump voted in the affirmative. Commissioners Behnam and Berkovitz voted in the negative. PO 00000 Frm 00136 Single-month and all months Spot month Fmt 4701 Sfmt 4702 Applicable. Applicable. Applicable. Applicable. Applicable. Appendix 2—Supporting Statement of Chairman Heath Tarbert I am pleased to support the Commission’s proposed rule on limits for speculative positions in futures and derivatives markets. Today’s proposal is a pragmatic approach that will protect our agricultural, energy, and metals markets from excessive speculation. But just as importantly, it will ensure fair and easy access to these markets for businesses producing, consuming, and wholesaling commodities under our jurisdiction. When I came to the Commission, I set out several strategic goals. Among them is to regulate our derivatives markets to promote the interests of all Americans. Another goal is to enhance the regulatory experience of market participants. The proposal we are issuing today will deliver on both. We also drew from each of our agency core values to craft it—commitment, forward-thinking, teamwork, and clarity. Clarity is of particular importance here because, ultimately, markets and their participants deserve regulatory certainty. We provide that today. Making Our Markets Work for the American Economy If adopted, our proposal will help ensure that futures markets in agricultural, energy and metals commodities work for American households and businesses. Farmers, ranchers, energy producers, utilities, and manufacturers are the backbone of the American economy. Our derivatives markets generally, and in particular the markets addressed in this proposal, are designed specifically to allow these businesses to hedge their exposure to price changes. This Commission’s proposal will protect Americans from some of the most nefarious machinations in our derivatives markets. First, capping speculative positions in the covered derivatives contracts will help prevent cornering and squeezing. Such manipulative schemes can cause artificial prices and can injure the users of commodities linked to the futures markets. Limiting speculative positions can also reduce the likelihood of chaotic price swings caused by speculative gamesmanship. In effect, position limits should help ensure that prices in our markets reflect real supply and demand. Position limits are not a solution born inside the Washington Beltway and imposed E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 on the market from afar. Instead, they are one of many tools that exchanges have used since the 19th century to mitigate the potentially damaging effects of excessive speculation. They are a pragmatic, Midwestern solution to a real-world problem. Recognizing the usefulness of exchange-set limits, the Commission has worked collaboratively with our exchanges since 1981 to put sensible position limits and accountability levels on speculative positions in all physical commodity futures markets. Our proposal would also end the ‘‘risk management’’ exemption that has allowed banks, hedge funds, and trading firms to take large and purely speculative positions in agricultural markets. Nearly a decade ago, Congress directed the Commission to address this issue. Today we are acting. Some observers have gone so far as to call position limits ‘‘at best, a cure for a disease that does not exist or a placebo for one that does.’’ 1 I respectfully disagree. To be sure, position limits are not a silver bullet against the damaging impact of excessive speculative activity. But I also believe, as did Congress when it amended the Commodity Exchange Act, that position limits can help to ‘‘diminish, eliminate, or prevent’’ potential damage to the commodities markets that are so critical to our real economy. Still, setting limits requires balancing the competing need for liquidity in our markets against the potential for disruptive speculative positions. I believe that the spot month levels we are proposing are reasonably calibrated. They are based on the current rule of thumb that limits should be no more than 25 percent of the deliverable supply of the referenced commodity, in order to prevent corners and squeezes that everyone can agree are bad for the market. For the nine grain futures contracts currently subject to position limits,2 revising non-spot limits required the Commission to consider an additional complication. Eliminating the risk management exemption could potentially take away a source of liquidity further out the curve. For a farmer who needs to hedge the price risk on crops that are still in the ground, a bank with a risk management exemption may be the only willing buyer. To mitigate the impact of eliminating the risk management exemption, we have raised the non-spot month limits for the grain contracts. This should allow a broader set of market participants to provide liquidity and help farmers hedge their crop risk as far in advance as they need. Ensuring Access for Bona Fide Hedgers Position limits is the rare rule where the exception is as important as the rule itself. It cannot be said too often that these limits are on speculative activity. Congress has always intended that positions that are a bona fide hedge of price risk should not be subject to limits. It is critical, therefore, that we not disrupt the regulatory experience of American producers, middlemen, and end-users of 1 https://www.cftc.gov/PressRoom/ SpeechesTestimony/dunnstatement101811. 2 The proposal would not set non-spot month limits on the 16 contracts that are not currently subject to federal position limits. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 commodities. The greatest risk of a position limits rule is that hedgers are caught in the limits aimed at speculators. This could reduce their ability to protect themselves from risk, which could in turn negatively impact the broader economy. If a farmer cannot offset a risk on next year’s crop—if a refiner cannot offset a risk on crude oil for a new plant—or if a wholesaler cannot offset risks on inventory it is buying, those businesses will not expand their operations. Any position limits rule must therefore be written with those hedging needs in mind. Congress and the American people expect nothing less. The proposal addresses those needs through (i) a broad exemption for ‘‘bona fide’’ hedging, and (ii) a streamlined and non-intrusive process for recognizing those exemptions. On the first point, the proposal will expand the types of hedging strategies that are presumed to meet the bona fide hedging definition—and therefore be eligible for an exemption from position limits. For the first time, we have included anticipated merchandising, meaning that wholesalers and middlemen connecting producers and consumers could more readily hedge their risks. We have also expanded the definition to conform to the hedging strategies that are common in energy markets. This will ensure that the new federal speculative limits on energy markets do not inadvertently undermine the producers, refiners, pipeline operators, and utilities that keep this country running. On the second point, we have built on prior proposals to create a practical and efficient way for hedgers to avail themselves of the bona fide hedging exemption. Creating burdensome red tape or slowing down approvals to take on hedging positions could result in lost business opportunities for the participants we are called to protect. For parties whose hedging needs fit within the enumerated list, they could exceed federal position limits without requesting approval from the Commission. They also would not need to submit information on their cash market positions—a duplicative and burdensome exercise that is better handled by the exchanges. For parties whose hedging needs do not fit within the enumerated list, we are offering a process whereby an exchange could evaluate that hedging need. If the exchange finds that the need is a bona fide hedge not captured by our list, the exchange would notify the Commission. Unless the Commission votes to reject it within 10 business days, the exchange’s recognition would be deemed effective for purposes of federal position limits. Given our expanded definition of bona fide hedging, I anticipate that it would be a rare case that a market participant finds its legitimate hedging needs are not already covered in the list of enumerated exemptions. Still, this process would provide flexibility and legal certainty, without excessive red tape. Striking the Right Balance The Commission has grappled with position limits for a decade. The 2011 proposal was finalized, but struck down by a court because of concerns over its legal PO 00000 Frm 00137 Fmt 4701 Sfmt 4702 11731 justification. Subsequent proposals in 2013 and 2016 were never finalized, following pushback from market participants about access to bona fide hedge exemptions. The Commission and staff have worked with diligence and good faith to solve this puzzle. There are difficult, often competing interests to address in this seemingly simple rule. If an easy solution exists, I have no doubt that the Commission would have found it. Today’s proposal is the culmination of ten years of effort across four Chairmen’s tenures. I sincerely thank my predecessors, as well as the Commission staff, who have worked so hard for so long to strike the right balance. Each proposal and every piece of feedback has helped improve the proposal before the Commission today. I believe that the proposal offers the pragmatic, workable solution that would protect markets from corners and squeezes while preserving the ability of American businesses to manage their risks. Putting the Burden in the Right Place Finally, I want to draw attention to one fundamental shift in approach between prior position limits rules and the present proposal. Previously, the Commission had read the Commodity Exchange Act to require federal limits to be placed on every futures contract for a physical commodity. This would have required the Commission to evaluate approximately 1,200 individual contracts to determine the appropriate levels. The 2011 position limits rule was challenged in court on this ground and was struck down. The court found that the statute was ambiguous about whether the Commission must impose limits on all futures, or whether it should impose limits only ‘‘as the Commission finds are necessary[.]’’ The court said that ‘‘it is incumbent upon the agency not to rest simply on its parsing of the statutory language. It must bring its experience and expertise to bear in light of competing interests at stake to resolve the ambiguities in the statute.’’ 3 The Commission is now bringing its experience and expertise to bear on this matter. We have taken a big picture approach to determine when position limits are in fact necessary. In short, we are proposing that speculative limits are necessary for those futures contracts that are physically delivered and where the futures market is important in the price discovery process for the underlying commodity. The Commission also examined whether a disruption in the distribution of that commodity would have a significant impact on our economy. This has led us to propose limits on 25 physically delivered futures contracts,4 which covers the vast majority of trading volume and open interest in physically delivered derivatives. In addition to the nine grain futures contracts currently subject to federal limits, this 3 Int’l Swap Dealers Assoc. v. CFTC, 887 F.Supp.2d 259, 281 (D.D.C. 2012). 4 The proposal would also impose limits on approximately 400 other futures contracts that are linked, directly or indirectly, to the 25 core physically delivered contracts. E:\FR\FM\27FEP3.SGM 27FEP3 11732 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules includes the largest energy, metals, and other agricultural futures contracts. Position limits are like medicine; they can help cure a symptom but can have undesirable side effects. And like medicine, position limits should be prescribed only when necessary. I believe this change in the underlying rationale for the proposal will require thoughtful reflection before imposing additional position limits on additional contracts in the future. Position limits will always create a burden on someone in the market—whether a compliance burden on parties having to track their positions relative to limits, or potentially the loss of a business opportunity because the risks cannot be hedged. The statutory provisions on position limits can reasonably be read in two ways. The first reading would put the burden on the Commission to find position limits to be necessary before imposing them on new contracts. The second reading would mandate federal limits on all futures contracts irrespective of any need, reflexively putting placing a burden on all markets and all market participants. Given the choice of burdening a government agency or private enterprise, I think it is more prudent to put the burden on the government. That is what today’s proposal does. As Thomas Jefferson said, ‘‘Government exists for the interests of the governed, not for the governors.’’ lotter on DSKBCFDHB2PROD with PROPOSALS3 Appendix 3—Supporting Statement of Commissioner Brian Quintenz I am pleased to support the agency’s revitalized approach to position limits. Today’s iteration marks the CFTC’s fifth proposed position limits rule since the DoddFrank Act 1 amended the Commodity Exchange Act’s (CEA) section on position limits. This proposal is, by far, the strongest of them all. Today’s proposed rule promotes flexibility, certainty, and market integrity for endusers—farmers, ranchers, energy producers, transporters, processors, manufacturers, merchandisers, and all who use physicallysettled derivatives to risk manage their exposure to physical goods. The proposal includes an expansive list of enumerated and self-effectuating bona fide hedge exemptions, and a streamlined, exchange-centered process to adjudicate non-enumerated bona fide hedge exemption requests. Of the five proposed rules, this proposal is the most true to the CEA in many significant respects: By requiring, as has long been the Commission’s practice, a necessity finding before imposing limits, by including economically equivalent swaps, and, perhaps most importantly, by following Congress’ instruction that, ‘‘to the maximum extent practicable,’’ any limits set by the Commission balance the interests among promoting liquidity, deterring manipulation, squeezes, and corners, and ensuring the price discovery function of the underlying market is not disrupted.2 The confluence of these 1 76 FR 4752 (Jan. 26, 2011); 78 FR 75680 (Dec. 12, 2013); 81 FR 38458 (June 13, 2016) (‘‘supplemental proposal’’); and 81 FR 96704 (Dec. 30, 2016). The CEA addresses position limits in section (sec.) 4a (7 U.S.C. 6a). 2 Sec. 4a(a)(3). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 factors occurs most acutely in the spot month for physically-settled contracts where the delivery process and price convergence is most vulnerable to potential manipulation or disruption due to outsized positions. By focusing exclusively on spot month position limits in the new set of physically-settled (and closely related cash-settled) contracts, the proposal elegantly balances the countervailing policy interests enumerated in the statute. Necessity Finding Today’s proposal, unlike the recent prior proposals, premises new limits on a finding that they are necessary to diminish, eliminate, or prevent the burden on interstate commerce from extraordinary price movements caused by excessive speculation (‘‘necessity finding’’) in specific contracts, as Congress has long required in the CEA and its legislative precursors since 1936.3 I am pleased that the proposal complies with the District Court’s ruling in the ISDA-position limits litigation: That the Commission must decide whether section 4a of the CEA mandates the CFTC set new limits or only permits the CFTC to set such limits pursuant to a necessity finding.4 As the District Court noted, ‘‘the Dodd-Frank amendments do not constitute a clear and unambiguous mandate to set position limits.’’ 5 I agree with the proposal’s determination that, when read together, paragraphs (1) and (2) of section 4a demand a necessity finding. Section 4a(a)(2)(A) states that the Commission shall establish limits ‘‘in accordance with the standards set forth in paragraph (1) of this subsection.’’ 6 Paragraph (1) establishes the Commission’s authority to, ‘‘proclaim and fix such limits on the amounts of trading . . . as the Commission finds are necessary to diminish, eliminate or prevent [the] burden’’ on interstate commerce caused by unreasonable or unwarranted price moves associated with excessive speculation. This language dates back almost verbatim to legislation passed in 1936, in which Congress directed the CFTC’s precursor to make a necessity finding before imposing position limits. The Congressional report accompanying the CEA from the 74th Congress includes the following directive, ‘‘[Section 4a of the CEA] gives the Commodity Exchange Commission the power, after due notice and opportunity for hearing and a finding of a burden on interstate commerce caused by such speculation, to fix and proclaim limits on 3 Sec. 4a(1). et al. v CFTC, 887 F. Supp. 2d 259, 278 and 283–84 (D.D.C. Sept. 28, 2012). 5 Id. at 280. 6 Sec. 4a(a)(2)(A) (‘‘In accordance with the standards set forth in paragraph (1) of this subsection and consistent with the good faith exception cited in subsection (b)(2), with respect to physical commodities other than excluded commodities as defined by the Commission, the Commission shall by rule, regulation, or order establish limits on the amount of positions, as appropriate, other than bona fide hedge positions, that may be held by any person with respect to contracts of sale for future delivery or with respect to options on the contracts or commodities traded on or subject to the rules of a designated contract market.’’) 4 ISDA PO 00000 Frm 00138 Fmt 4701 Sfmt 4702 futures trading . . .’’ 7 In its ISDA opinion, the District Court noted the following: ‘‘This text clearly indicated that Congress intended for the CFTC to make a ‘finding of a burden on interstate commerce caused by such speculation’ prior to enacting position limits.’’ 8 I support the proposal’s view that the most natural reading of section 4a(a)(2)(A)’s reference to paragraph (1)’s ‘‘standards’’ is that it logically includes the ‘‘necessity’’ standard. Paragraph (1)’s requirement to make a necessity finding, along with the aggregation requirement, provide substantive guidance to the Commission about when and how position limits should be implemented. If Congress intended to mandate that the Commission impose position limits on all physical commodity derivatives, there is little reason it would have referred to paragraph (1) and the Commission’s long established practice of necessity findings. Instead, Congress intended to focus the Commission’s attention on whether position limits should be considered for a broader set of contracts than the legacy agricultural contracts, but did not mandate those limits be imposed. Setting New Limits ‘‘As Appropriate’’ The proposal preliminarily determines that position limits are necessary to diminish, eliminate, or prevent the burden on interstate commerce posed by unreasonable or unwarranted prices moves that are attributable to excessive speculation in 25 referenced commodity markets that each play a crucial role in the U.S. economy. I am aware that there is significant skepticism in the marketplace and among academics as to whether position limits are an appropriate tool to guard against extraordinary price movements caused by extraordinarily large position size. Some argue there is no evidence that excessive speculation currently exists in U.S. derivatives markets.9 Others believe that large and sudden price fluctuations are not caused by hyperspeculation, but rather by market participants’ interpretations of basic supply and demand fundamentals.10 In contrast, still 7 H.R. Rep. 74–421, at 5 (1935). F. Supp. 2d 259, 269 (fn 4). 9 Testimony of Erik Haas (Director, Market Regulation, ICE Futures U.S.) before the CFTC at 70 (Feb. 26, 2015) (‘‘We point out the makeup of these markets, primarily to show that any regulations aimed at excessive speculation is a solution to a nonexistent problem in these contracts.’’), available at: https://www.cftc.gov/idc/groups/public/@ aboutcftc/documents/file/emactranscript 022615.pdf. 10 BAHATTIN BUYUKSAHIN & JEFFREY HARRIS, CFTC, THE ROLE OF SPECULATORS IN THE CRUDE OIL FUTURES MARKET 1, 16–19 (2009) (‘‘Our results suggest that price changes leads the net position and net position changes of speculators and commodity swap dealers, with little or no feedback in the reverse direction. This uni-directional causality suggests that traditional speculators as well as commodity swap dealers are generally trend followers.’’), available at https:// www.cftc.gov/idc/groups/public/@swaps/ documents/file/plstudy_19_cftc.pdf; Testimony of Philip K. Verleger, Jr. before the CFTC, Aug. 5, 2009 (‘‘The increase in crude prices between 2007 and 2008 was caused by the incompatibility of environmental regulations with the then-current 8 887 E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 others believe that outsized speculative positions, however defined, may aggravate price volatility, leading to price run-ups or declines that are not fully supported by market fundamentals.11 In my opinion, position limits should not be viewed as a means to counteract long-term directional price moves. The CFTC is not a price setting agency and we should not impede the market from reflecting long term supply and demand fundamentals. It is worth noting that the physically-settled contract which has seen the largest sustained price increase recently is palladium,12 which has also seen its exchange-set position limit decline four times since 2014 to what is now the smallest limit of any contract in the referenced contract set.13 Nevertheless, between the start of 2018 and the end of 2019, palladium futures prices rose 76%.14 Taking these conflicting views and facts into account, it is clear the Commission correctly stated in its 2013 proposal, ‘‘there is a demonstrable lack of consensus in the [academic] studies’’ as to the effectiveness of position limits.15 With that healthy dose of skepticism, I think the proposal appropriately focuses on the time period and contract type where position limits can have the most positive, and the least negative, impact—the spot month of physically settled contracts—while also calibrating those limits to function as just one of many tools in the Commission’s regulatory toolbox that can be used to promote credible, well-functioning derivatives and cash commodity markets. Because of the significance of these 25 core referenced futures contracts to the underlying cash markets, the level of liquidity in the contracts, as well as the importance of these cash markets to the national economy, I think it is appropriate for the Commission to global crude supply. Speculation had nothing to do with the price rise.’’), available athttps:// www.cftc.gov/sites/default/files/idc/groups/public/ @newsroom/documents/file/hearing080509_ verleger.pdf. 11 For a discussion of studies discussing supply and demand fundamentals and the role of speculation, see 81 FR 96704, 96727 (Dec. 30, 2016). See, e.g., Hamilton, Causes and Consequences of the Oil Shock of 2007–2008, Brookings Paper on Economic Activity (2009); Chevallier, Price Relationships in Crude oil Futures: New Evidence from CFTC Disaggregated Data, Environmental Economics and Policy Studies (2012). 12 Platinum, gold slide as dollar soars; palladium eases off record, Reuters (Sept. 30, 2019), available at: https://www.reuters.com/article/global-precious/ precious-platinum-gold-slide-as-dollar-soarspalladium-eases-off-record-idUSL3N26L3UV. 13 Between 2014 and 2017, the CME Group lowered the spot month position limit in the contract four times, from 650, to 500, to 400, to 100, to the current limit of 50 (NYMEX regulation 40.6(a) certifications, filed with the CFTC, 14–463 (Oct. 31, 2014), 15–145 (Apr. 14, 2015), 15–377 (Aug. 27, 2015), and 17–227 (June 6, 2017)), available at: https://sirt.cftc.gov/sirt/sirt.aspx?Topic=Product TermsandConditions. 14 Palladium futures were at $1,087.35 on Jan. 2, 2018 and at $1,909.30 on Dec. 31, 2019. Historical prices available at: https:// futures.tradingcharts.com/historical/PA_/2009/0/ continuous.html. 15 78 FR 75694 (Dec. 12, 2013). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 protect the physical delivery process and promote convergence in these critical commodity markets. Further, the limits proposed today are higher than in the past, notably because the proposal utilizes current estimates of deliverable supply—numbers which haven’t been updated since 1999.16 I am interested to hear feedback from commenters about whether the estimates of deliverable supply, and the calibrated limits based off of them, are sufficiently tailored for the individual contracts. Taking End-Users Into Account Perhaps more than any other area of the CFTC’s regulations, position limits directly affect the participants in America’s real economy: Farmers, ranchers, energy producers, manufacturers, merchandisers, transporters, and other commercial end-users that use the derivatives market as a risk management tool to support their businesses. I am pleased that today’s proposal takes into account many of the serious concerns that end-users voiced in response to the CFTC’s previous five unsuccessful position limits proposals. Importantly, and in response to many comments, this proposal, for the first time, expands the possibility for enterprise-wide hedging,17 proposes an enumerated anticipated merchandising exemption,18 eliminates the ‘‘five-day rule’’ for enumerated hedges,19 and no longer requires the filing of certain cash market information with the Commission that the CFTC can obtain from exchanges.20 Regarding enterprise-wide hedging—otherwise known as ‘‘gross hedging’’—the proposal would provide an energy company, for example, with increased flexibility to hedge different units of its business separately if those units face different economic realities. With respect to cross-commodity hedging, today’s proposal completely rejects the arbitrary, unworkable, ill-informed, and frankly, ludicrous ‘‘quantitative test’’ from the 2013 proposal.21 That test would have required a correlation of at least 0.80 or greater in the spot markets prices of the two commodities for a time period of at least 36 months in order to qualify as a cross-hedge.22 Under this test, longstanding hedging practices in the electric power generation and transmission markets would have been prohibited. Today’s proposal not only shuns this Government-Knows-Best approach, it also proposes new flexibility for the crosscommodity hedging exemption, allowing it to be used in conjunction with other enumerated hedges.23 For example, a commodity merchant could rely on the enumerated hedge for unsold anticipated production to exceed limits in a futures contract subject to the CFTC’s limits in order to hedge exposure in a commodity for which 16 64 FR 24038 (May 5, 1999). Appendix B, paragraph (a). 18 Proposed Appendix A, paragraph (a)(11). 19 Preamble discussion of Proposed Enumerated Bona Fide Hedges for Physical Commodities. 20 Elimination of CFTC Form 204. 21 78 FR 75,717 (Dec. 12, 2013). 22 Id. 23 Proposed Appendix A, paragraph (a)(5). 17 Proposed PO 00000 Frm 00139 Fmt 4701 Sfmt 4702 11733 there is no futures contract, provided that the two commodities share substantially related fluctuations in value. Bona Fide Hedges and Coordination With Exchanges For those market participants who employ non-enumerated bona fide hedging practices in the marketplace, this proposal creates a streamlined, exchange-focused process to approve those requests for purposes of both exchange-set and federal limits. As the marketplaces for the core referenced futures contracts addressed by the proposal, the DCMs have significant experience in, and responsibility towards, a workable position limits regime. CEA core principles require DCMs and swap execution facilities to set position limits, or position accountability levels, for the contracts that they list in order to reduce the threat of market manipulation.24 DCMs have long administered position limits in futures contracts for which the CFTC has not set limits, including in certain agricultural, energy, and metals markets. In addition, the exchanges have been strong enforcers of their own rules: during 2018 and 2019, CME Group and ICE Futures US concluded 32 enforcement matters regarding position limits. As part of their stewardship of their own position limits regimes, DCMs have long granted bona fide hedging exemptions in those markets where there are no federal limits. Today’s proposal provides what I believe is a workable framework to utilize exchanges’ long standing expertise in granting exemptions that are not enumerated by CFTC rules.25 This proposed rule also recognizes that the CEA does not provide the Commission with free rein to delegate all of the authorities granted to it under the statute.26 The Commission itself, through a majority vote of the five Commissioners, retains the ability to reject an exchangegranted non-enumerated hedge request within 10 days of the exchange’s approval. The Commission has successfully and responsibly used a similar process for both new contract listings as well as exchange rule filings, and I am pleased to see the proposal expand that approach to non-enumerated hedge exemption requests that will limit the uncertainty for bone fide commercial market participants. I look forward to hearing from end-users about whether this proposal provides them the flexibility and certainty they need to manage their exposures in a way that reflects the complexities and realities of their physical businesses. In particular, I am interested to hear if the list of enumerated bona fide hedging exemptions should be broadened to recognize other types of common, legitimate commercial hedging activity. 24 DCM Core Principle 5 (sec. 5 of the CEA, 7 U.S.C. 7) (implemented by CFTC regulation 38.300) and SEF Core Principle 6 (sec. 5h of the CEA, 7 U.S.C. 7b-3) (implemented by CFTC regulation 37.600). 25 Proposed regulation 150.9. 26 Preamble discussion of proposed regulation 150.9, including references to cases pointing out the extent to which an agency can delegate to persons outside of the agency. E:\FR\FM\27FEP3.SGM 27FEP3 11734 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules Proposed Limits on Swaps The CEA requires the Commission to consider limits not only on exchange-traded futures and options, but also on ‘‘economically equivalent’’ swaps.27 Today’s proposal provides the market with far greater certainty on the universe of such swaps than the previous proposals. Prior proposals failed to sufficiently explain what constituted an ‘‘economically equivalent swap,’’ thereby ensuring that compliance with position limits was essentially unworkable, given realtime aggregation requirements and ambiguity over in-scope contracts. In stark contrast, today’s proposed rule narrows the scope of ‘‘economically equivalent’’ swaps to those with material contractual specifications, terms, and conditions that are identical to exchange-traded contracts.28 For example, in order for a swap to be considered ‘‘economically equivalent’’ to a physicallysettled core referenced futures contract, that swap would also have to be physicallysettled, because settlement type is considered a material contractual term. I believe the proposed narrowly-tailored definition will provide market participants with clarity over those contracts subject to position limits. I also welcome suggestions from commenters regarding ways in which the definition can be further refined to complement limits on exchange-traded contracts. Conclusion Section 2a(10) of the CEA is not an often cited passage of text. It describes the Seal of the United States Commodity Futures Trading Commission, and in particular, lists a number of symbols on the seal which represent the mission and legacy of our agency: The plough showing the agricultural origin of futures markets; the wheel of commerce illuminating the importance of hedging markets to the broader economy; and, the scale of balanced interests, proposing a fair weighing of competing or contradicting forces. As I think about the proposal in front of us today, I believe it speaks to all of those elements enshrined in our agency’s legacy, but the scale of balanced interests comes most to mind with this rule: new flexibility combined with new regulation, the removal of a few exemptions with the expansion or addition of others, the reliance on exchange expertise but with Commission review and oversight, and the balance of liquidity and price discovery against the threat of corners and squeezes. I am very pleased to support today’s revitalized, confined, and tempered approach to position limits and look forward to comment letters, particularly from the enduser community. lotter on DSKBCFDHB2PROD with PROPOSALS3 Appendix 4—Dissenting Statement of Commissioner Rostin Behnam Introduction The ceremony for the 92nd Academy Awards will air in a little over a week. I haven’t seen too many movies this year given my two young girls and hectic work schedule, but I did see ‘‘Ford v Ferrari.’’ 1 27 Sec. 4a(5). regulation 150.1. 1 Ford v Ferrari (Twentieth Century Fox 2019). 28 Proposed VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 ‘‘Ford v Ferrari’’ earned four award nominations, including best motion picture of the year. The film tells the true story of American car designer Carroll Shelby and British-born driver Ken Miles who built a race car for Ford Motor Company and competed with Enzo Ferrari’s dominating and iconic red racing cars at the 1966 24 Hours of Le Mans.2 This high drama action film focuses foremost on the relationship between Shelby and Miles—the co-designers and driver of Ford’s own iconic GT40—and their triumph over the competition, the course, the rulebook, and the bureaucracy. Even if you aren’t a car enthusiast, the action, acting, and accuracy of the story are well worth your time. However, there is a lot more to this movie than racing. There is a great scene where Miles is talking to his son about achieving the ‘‘perfect lap’’—no mistakes, every gear change, and every corner perfect. In response to his son’s observation that you can’t just ‘‘push the car hard’’ the whole time, Miles agrees, pensively staring down the track towards the setting sun. He says, ‘‘If you are going to push a piece of machinery to the limit, and expect it to hold together, you have to have some sense of where that limit is.’’ It’s been nine years since the Commission first set out to establish the position limits regime required by amendments to section 4a of the Commodity Exchange Act (the ‘‘Act’’ or ‘‘CEA’’), 3 under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.4 While I would like to be in a position to say that today’s proposed rule addressing Position Limits for Derivatives (the ‘‘Proposal’’) is leading us towards that ‘‘perfect lap,’’ I cannot. While the Proposal purports to respect Congressional intent and the purpose and language of CEA section 4a, in reality, it pushes the bounds of reasonable interpretation by deferring to the exchanges 5 and setting the Commission on a course where it will remain perpetually in the draft, unable to acquire the necessary experience to retake the lead in administering a position limits regime. In 2010 and the decades leading up to it, Congress understood that for the derivatives markets in physical commodities to perform optimally, there needed to be limits on the amount of control exerted by a single person (or persons acting in agreement). In tasking the Commission with establishing limits and the framework around their operation, Congress was aware of our relationship with the exchanges, but nevertheless opted for our experience and our expertise to meet the policy objectives of the Act. Right now, we are pushing to go faster and just get to the finish line, making real-time 2 Ford v Ferrari, Fox Movies, https:// www.foxmovies.com/movies/ford-v-ferrari (Last visited Jan. 28, 2020, 1:55 p.m.). 3 See Position Limits for Derivatives, 76 FR 4752 (proposed Jan. 26, 2011) (the ‘‘2011 Proposal’’). 4 The Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111–203 section 737, 124 Stat. 1376, 1722–25 (2010) (the ‘‘Dodd-Frank Act’’). 5 As in the Proposal, unless otherwise indicated, the use of the term ‘‘exchanges’’ throughout this statement refers to designated contract markets (‘‘DCMs’’) and swap execution facilities (‘‘SEFs’’). PO 00000 Frm 00140 Fmt 4701 Sfmt 4702 adjustments without regard for even trying for that ‘‘perfect lap.’’ It is unfortunate, but despite the Chairman’s leadership and the talented staff’s hard work, I do not believe that this Proposal will hold itself together. I must therefore, with all due respect, dissent. Deference to Our Detriment While I have a number of concerns with the Proposal, my principal disagreement is with the Commission’s determination to in effect disregard the tenets supporting the statutorily created parallel federal and exchange-set position limit regime, and take a back seat when it comes to administration and oversight. In doing so, the Commission claims victory for recognizing that the exchanges are better positioned in terms of resources, information, knowledge, and agility, and therefore ought to take the wheel. While the Commission believes it can withdraw and continue to maintain access to information that is critical to oversight, I fear that giving way absent sufficient understanding of what we are giving up, and planning for ad hoc Commission (and staff) determinations on key issues that are certain to come up, will let loose a different set of responsibilities that we have yet to consider. I believe the Proposal has many flaws that could be the subject of dissent. I am focusing my comments on those issues that I think are most critical for the public’s review. Based on consideration of the Commission’s mission, and Congressional intent as evinced in the Dodd-Frank Act amendments to CEA section 4a and elsewhere in the Act, I believe that (1) the Commission is required to establish position limits based on its reasoned and expert judgment within the parameters of the Act; (2) the Commission has not provided a rational basis for its determination not to propose federal limits outside of the spot month for referenced contracts based on commodities other than the nine legacy agricultural commodities; and (3) the Commission’s seemingly unlimited flexibility in proposing to (a) significantly broaden the bona fide hedging definition, (b) codify an expanded list of selfeffectuating enumerated bona fide hedges, (c) provide for exchange recognition of nonenumerated bona fide hedge exemptions with respect to federal limits, and (d) simultaneously eliminate notice and reporting mechanisms, is both inexplicably complicated to parse and inconsistent with Congressional intent. The Commission Is Required To Establish Position Limits The Proposal goes to great lengths to reconcile whether the CEA section 4a(a)(2)(A) requires the Commission to make an antecedent necessity finding before establishing any position limit,6 with the implication that if a necessity finding is required, then the Commission could rationalize imposing no limits at all. I do not believe it was necessary to rehash the legislative and regulatory histories to determine the Commission’s authority with respect to CEA section 4a. Nor do I believe it was worthwhile here to reply in such great 6 See E:\FR\FM\27FEP3.SGM Proposal at III. 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 depth to the U.S. District Court for the District of Columbia’s opinion vacating the Commission’s 2011 final rulemaking on Position Limits for Futures and Swaps.7 The Proposal uses a tremendous amount of text to try and flesh out what is meant by ‘‘necessary’’, and yet I fear it does not demonstrate the Commission’s ‘‘bringing its expertise and experience to bear when interpreting the statute,’’ giving effect to the meaning of each word in the statute, and providing an explanation for how any interpretation comports with the policy objectives of the Act as amended by the Dodd-Frank Act, as directed by the District Court.8 The Commission ought to avoid the temptation to retract when doing so requires the torture of strawmen. Not only do we look complacent, but we invite criticism for our unnecessary affront to the sensibilities of the public we serve. Looking back at the record, what is necessary is that the Commission complies with the mandate.9 In response to the District Court’s directive, the Commission could have gone back through its own records to the 2011 Proposal. If it had done so, it would have found that the Commission provided a review of CEA section 4a(a)—interpreting the various provisions, giving effect to each paragraph, acknowledging the Commission’s own informational and experiential limitations regarding the swaps markets at that time, and focusing on the Commission’s primary mission of fostering fair, open and efficient functioning of the commodity derivatives markets.10 Of note, ‘‘Critical to fulfilling this statutory mandate,’’ the Commission pronounced, ‘‘is protecting market users and the public from undue burdens that may result from ‘excessive speculation.’ ’’ 11 Federal position limits, as predetermined by Congress, are most certainly the only means towards addressing the burdens of excessive speculation when such limits must address a ‘‘proliferation of economically equivalent instruments trading in multiple trading venues.’’ 12 Exchange-set position limits or accountability levels simply cannot meet the mandate. In exercising its authority, the Commission may evaluate whether exchange-set position limits, accountability provisions, or other tools for contracts listed on such exchanges are currently in place to protect against manipulation, congestion, and price distortions.13 Such an evaluation—while permissible—is just one factor for consideration. The existence of exchange-set limits or accountability levels, on their own, 7 Int’l Swaps & Derivatives Ass’n v. CFTC, 887 F. Supp. 2d 259 (D.D.C. 2012). 8 Id. at 284. 9 The Proposal’s analysis in support of its denial of a mandate misconstrues form over substance and assumes the answer it is looking for by providing a misleading recitation of Michigan v. EPA, 135 S.Ct. 2699 (2015). In doing so, the Proposal seems to suggest that the Commission is free to ignore a Congressional mandate if it determines that Congress is wrong about the underlying policy. See Proposal at III.D. 10 76 FR at 4752–54. 11 Id. at 4753. 12 Id. at 4754–55. 13 See 76 FR at 4755. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 can neither predetermine deference nor be justified absent substantial consideration. The authority and jurisdiction of individual exchanges are necessarily different than that of the Commission. They do not always have congruent interests to the Commission in monitoring instruments that do not trade on or subject to the rules of their particular platform or the market participants that trade them. They do not have the attendant authority to determine key issues such as whether a swap performs or affects a significant price discovery function, or what instruments fit into the universe of economically equivalent swaps. They are not permitted to define bona fide hedging transactions or grant exemptions for purposes of federal position limits. It is therefore clear that CEA section 4a, as amended by the Dodd-Frank Act ‘‘warrants extension of Commission-set position limits beyond agricultural products to metals and energy commodities.’’ 14 Unsupportable Deference In spite of all of this—the foregoing mandate; the clear Congressional intent in CEA section 4a(a)(3)(A); and the Commission’s real experience and expertise (including its unique data repository)—the Commission only proposes to maintain federal non-spot month limits for the nine legacy agricultural contracts (with questionably appropriate modifications), ‘‘because the Commission has observed no reason to eliminate them.’’ 15 Essentially, in the Commission’s reasoned judgment, ‘‘if it ain’t broke, don’t fix it.’’ And so, the Commission, in keeping with this relatively riskless course of action, similarly was able to conclude that federal non-spot month limits are not necessary for the remaining 16 proposed core referenced futures contracts identified in the Proposal. The Commission provides two reasons in support of its determination, and neither sufficiently demonstrates that the Commission utilized its experience and expertise. Rather, the Commission backs into deferring to the exchanges’ authority to establish position limits or accountability levels. This course of action ignores the reality that Commission-set position limits serve a higher purpose than just addressing threats of market manipulation 16 or creating parameters for exchanges in establishing their own limits.17 The Proposal advocates that there is no need to disturb the status quo, despite the fact that we have nothing to compare it to. The Commission places a higher value on minimizing the impact on industry—which it appears to have not quantified for purposes of the Proposal—than actually evaluating the appropriateness of limits in light of the purposes of the Act and as described in CEA section 4a(a)(3). The first reason the Commission submits in defense of not proposing federal limits outside of the spot month for the 16 aforementioned contracts is that ‘‘corners and squeezes cannot occur outside the spot month . . . and there are other tools other than federal position limits for deterring and preventing manipulation outside of the spot month.’’ 18 The ‘‘other tools’’ include surveillance by the Commission and exchanges, coupled with exchange-set limits and/or accountability levels. As laid out in several paragraphs of the Proposal, the Commission would maintain a window into the setting of any limits or accountability levels that in its view are ‘‘an equally robust’’ alternative to federal non-spot month speculative position limits. In describing how accountability levels implemented by exchanges work, the Commission touts the flexibility in application because they provide exchanges—and not the Commission—the ability to ask questions about positions, determine if a position raises any concerns, provide an opportunity to intervene—or not—etc.19 While all of this reads well, it ignores Congressional intent. The Proposal never considers that Congress directed the Commission to establish limits—not accountability levels. Given the Commission’s ‘‘decades of experience in overseeing accountability levels implemented by the exchanges,’’ Congress would have been well aware that this alternative path would be a viable option if it were truly as robust in choosing the legislative language. But the Commission has failed to make that case. Foremost, federal position limits are aimed at diminishing, eliminating, and preventing sudden and unwarranted price changes. These sudden price changes may occur regardless of manipulative, intentional or reckless activity—both within and outside of the spot month. The Commission provides no explanation regarding how exchange-set limits or accountability levels would compare, in terms of effectiveness, to federal position limits, which among other things, must apply in the aggregate as mandated by CEA section 4a(a)(6). It is difficult to measure the robustness of a regime when there is nothing to compare it to. As well, the Commission’s observation that exchange-set accountability levels have ‘‘functioned asintended’’ until this point time, ignores the wider purpose and function of aggregate position limits established by the Commission, and is shortsighted given the ever expanding universe of economically equivalent instruments trading across multiple trading venues. Not to belabor the point, but it seems odd to conclude that Congress envisioned that its painstaking amendments to CEA section 4a were a directive for the Commission to check the box that the current system is working perfectly. The Commission’s second reason is that layering federal non-spot limits for the 16 contracts on top of existing exchange-set limit/accountability levels may only provide minimal benefits—if any—while sacrificing the benefits associated with flexible accountability levels.20 The Commission, 14 Id. at II.B.2.d. 7 U.S.C. 7(d)(5) and 7b–3(f)(6). 17 See, e.g., 7 U.S.C. 6a(e). 15 Proposal 18 Proposal 16 See 19 See PO 00000 Frm 00141 Fmt 4701 Sfmt 4702 11735 at II.B.2.d. id. 20 See id. E:\FR\FM\27FEP3.SGM 27FEP3 11736 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 again, ignores that Congress was clearly aware of the possible layering effect, and did not find it to be comparable let alone as robust.21 Moreover, the Commission fails to support or otherwise quantify its argument with data. Presumably, the Commission could calculate anticipated non-spot month position limits—based on the formula in the proposed part 150.2(e) (and described in section II.B.2. e. of the Proposal)—for the 16 proposed core referenced futures contracts that have never been subject to such limits. The Commission could have based its determination on aggregate position data it collects through surveillance, and it could have provided a rough estimate of the potential impact that limits may have, absent consideration of any of the proposed enumerated bona fide hedges or spread exemptions. While I am not sure such evidence if presented would have changed my mind, it certainly would have been helpful in determining the reasonableness of the Commission’s determination. What if? When muscles are overly flexible, they require appropriate strength to ensure that they can perform under stress. In addition to largely deferring to the exchanges in addressing excessive speculation outside of the spot-month for the majority of the 25 core referenced futures contracts, the Proposal also incorporates flexibility in a multitude of other ways. The Proposal would provide for significantly broader bona fide hedging opportunities that will be largely selfeffectuating; it would defer to the exchanges in recognizing non-enumerated bona fide hedging; and it would eliminate longstanding notice and reporting mechanisms. In proposing these various provisions, the Proposal flexes and contorts to accommodate each piece. In doing so, it seems the Commission will be left insufficient strength to accomplish its mandated role of exercising appropriate surveillance, monitoring, and enforcement authorities—and this will be to the detriment of the derivatives markets and the public we serve. The main point to get across here is that while I support enhancing the cooperation between the Commission and the exchanges, the Commission here is cooperating by dropping back and promising to remain in the draft—never able to fully compete, or take advantage of a ‘‘slingshot effect.’’ We will simply never gain the necessary direct experience with the new regime. The Commission lacks experience in administering spot month limits for 16 of the 25 core referenced futures contracts and lacks familiarity with both common commercial hedging practices for the 16 contracts and the proliferation of the use of the dozen or so self-effectuating enumerated hedges and spread exemptions (also largely selfeffectuating) being proposed. While prior drafts of the Proposal admitted this as recently as two weeks ago, the Commission determined to change course and quickly let 21 See, e.g., 7 U.S.C. 6a(e) (providing, among other things and consistent with core principles for DCMs and SEFs, that exchange-set position limits shall not be higher that the limits fixed by the Commission). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 go of the line. The Commission’s decision to essentially give up primary authority to recognize non-enumerated bona fide hedges, and to rely on the exchanges to collect and hold relevant cash market data for the Commission’s use only after requesting it, seems both careless and inconsistent with Congressional intent. For example, while the Proposal provides the Commission with the authority to reject an exchange’s granting of a non-enumerated bona fide hedge recognition, this determination must be in the form of a ‘‘Commission action,’’ and it must take place in the span of ten business days (or two in the case of sudden or unforeseen circumstances). Furthermore, the Proposal offers no guidance as to what factors the Commission may consider, or the criteria it may use to make the determination. This narrow window of time likely will not provide Commission staff with a reasonable timeframe to prepare the necessary documentation for the full Commission to deliberate and either request additional information, stay the application, or vote to accept the recognition.22 It seems more likely that the Commission will be unable to act within the ten or two-day window and the recognition will default to being approved. Regardless of what the Commission determines—even if it ultimately determines that a position for which an application for a bona fide hedge recognition does not meet the CEA definition of a bona fide hedge or the requirements in proposed part 150.9(b)— the Commission could not determine that the person holding the position has committed a position limits violation during the Commission’s ongoing review or upon issuing its determination. I have so many ‘‘what ifs’’ in response to this set up that I feel trapped. In the Proposal, the Commission requires exchanges to collect cash-market information from market participants requesting bona fide hedges, and to provide it to the Commission only upon request. The Proposal also eliminates Commission Form 204, which market participants currently file each month when they have bona fide hedging positions in excess of the federal limits. This form is a necessary mechanism by which market participants demonstrate cash-market positions justifying such overages. These changes may be well-intentioned, but they are ill-conceived in consideration of the various changes being proposed to the federal position limits regime. Foremost, under the Proposal, the Commission would receive a monthly report showing the exchange’s disposition of any applications to recognize a position as a bona fide hedge (both enumerated and nonenumerated) or to grant a spread or other exemption (including any renewal, revocation of, or modification of a prior recognition or exemption).23 While the Proposal argues that the monthly report would be a critical element of the Commission’s surveillance program by facilitating its ability to track bona fide 22 See Proposed part 150.9(e). Proposed Commission regulation 150.5(a)(4). 23 See PO 00000 Frm 00142 Fmt 4701 Sfmt 4702 hedging positions and spread exemptions approved by the exchanges,24 it would not itself appear to be useful in discerning any market participants ongoing justification for, or compliance with, self-effectuating or approved bona fide hedge, spread, or other exemption requirements. While the contents of the report may prompt the Commission to request records from the exchange, it is unclear what may be involved in the making of, and response to, such requests—including time and resources on both sides. Not to mention that the Proposal opines that exchanges would only collect responsive information on an annual basis,25 and part 150.9(e) does not require exchanges to notify the Commission of any renewal applications. Of course, the Proposal posits that the Commission would likely only need to make such requests ‘‘in the event that it noticed an issue that could cause market disruptions.’’ 26 My guess is that our surveillance staff and Division of Enforcement may have other ideas, but I will leave that with the ‘‘what ifs.’’ Conclusion The 24 Hours of Le Mans awards the victory to the car that covers the greatest distance in 24 hours. While the Proposal shoots for victory by similarly attempting to achieve a great amount over a short time period, I am concerned that all of it will not hold together. The Proposal attempts to justify deferring to the exchanges on just about everything, and in-so-doing it pushes to the back any earnest interpretation of the Commission’s mandate or the guiding Congressional intent. This is not cooperation, this is stepping-aside, backing down, giving way, and getting comfortable in the draft. I am not comfortable in this or any draft. It’s my understanding that the Commission has the tools and resources to develop a better sense of where federal position limits ought to be in order to achieve the purposes for which they were designed, while maintaining our natural, Congressionallymandated lead. The Proposal fails to recognize that Congress already set the course in directing us that our derivatives markets will operate optimally with limits— we just need to provide a sense of where they are. Perhaps the Proposal was just never aiming for the ‘‘perfect lap.’’ Appendix 5—Statement of Commissioner Dawn D. Stump Reasonably designed. Balanced in approach. And workable in practice—both for market participants and for the Commission. These are the 3 guideposts by which I have evaluated the proposal before us to update the Commission’s rules regarding position limits for derivatives. Is it reasonable in its design? Is it balanced in its approach? And is it workable in practice for 24 See Proposal at II.D.4. Proposal at I.B.7.a. and b. 26 Id. As well, the Proposal opines that the Commission’s reliance on the ‘‘limited circumstances’’ set forth in proposed part 150.9(f) under which it would revoke a bona fide hedge recognition granted by an exchange would be rarely exercised, suggesting a preference to defer to the judgment of the exchange. See Proposal at II.G.3.f. 25 See E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules both market participants and the Commission? Overall, I believe the answer to each of these questions is yes, and I therefore support the publication of this proposal for public comment. There is one question that I have not asked: Is it perfect? It is not. There are two particular areas discussed below that I believe can be improved—the list of enumerated hedging transactions and positions, and the process for reviewing hedging practices outside of that list. But in reality, how could a position limits proposal ever achieve perfection? In section 4a(a) of the Commodity Exchange Act (‘‘CEA’’),1 Congress has given the Commission the herculean task of adopting position limits that: • It finds necessary to diminish, eliminate, or prevent an undue and unnecessary burden on interstate commerce as a result of excessive speculation in derivatives; • Deter and prevent market manipulation, squeezes, and corners; • Ensure sufficient market liquidity for bona fide hedgers; 2 • Ensure that the price discovery function of the underlying market is not disrupted; • Do not cause price discovery to shift to trading on foreign boards of trade; and • Include economically equivalent swaps. And it must do so, according to the CEA’s purposes set out in section 3(b), through a system of effective self-regulation of trading facilities.3 These statutory objectives are not only numerous, but in many instances they are in tension with one another. As a result, it is not surprising that each of us will have a different view of the perfect position limits framework. Perfection simply cannot be the standard by which this proposal is judged. But after nearly a decade of false starts, I believe the proposal before us brings us close to the end of that long journey. It is reasonably designed. It is balanced in its approach. And it is workable in practice. I am pleased to support putting it before the public for comment. The Commission Has a Mandate To Impose Position Limits It Finds Are Necessary Background Before digging into the substantive provisions of the proposal, let me offer my view on a legal issue that has been debated seemingly without end throughout the past decade in the Commission’s rulemaking proceedings and in federal court. As noted in testimony by the CFTC’s General Counsel in July 2009, a year before the Dodd-Frank Act 4 became law, the CEA has always given the Commission a mandate to impose federal position limits—that is, a mandate to impose 1 CEA section 4a(a), 7 U.S.C. 6a(a). 4a(c) of the CEA further requires that the Commission’s position limit rules ‘‘permit producers, purchasers, sellers, middlemen, and users of a commodity or a product derived therefrom to hedge their legitimate anticipated business needs . . .’’ CEA section 4a(c), 7 U.S.C. 6a(c). 3 CEA section 3(b), 7 U.S.C. 5(b). 4 See Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111–203, 124 Stat. 1376 (2010) (‘‘Dodd-Frank Act’’). lotter on DSKBCFDHB2PROD with PROPOSALS3 2 Section VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 federal position limits that it finds are necessary.5 The issue that has consumed the agency, the industry, and the bar is this: Did the amendments to the CEA’s position limits provisions that were enacted as part of the Dodd-Frank Act strip the Commission of its discretion not to impose limits if it does not find them to be necessary? I consider it unfortunate that the Commission has spent so much time, energy, and resources on this debate. That time, energy, and resources would have been much better spent focusing on the development of a position limits framework that is reasonably designed, balanced in approach, and workable in practice for both market participants and the Commission—which simply cannot be said of the Commission’s prior efforts in this area. But, in the words of American writer Isaac Marion in his ‘‘zombie romance’’ novel Warm Bodies: ‘‘We are where we are, however we got here.’’ 6 And so, a few thoughts on necessity and mandates. In the ISDA v. CFTC case, a federal district court in 2012 vacated the Commission’s first post-Dodd-Frank Act attempt to adopt a position limits rulemaking. The court concluded that the Dodd-Frank Act amendments to the position limits provisions of the CEA ‘‘are ambiguous and lend themselves to more than one plausible interpretation.’’ Accordingly, it remanded the position limits rulemaking to the Commission to ‘‘bring its experience and expertise to bear in light of competing interests at stake’’ in order to ‘‘fill in the gaps and resolve the ambiguities.’’ 7 The Commission attempted to follow the court’s directive in a proposed position limits 5 ‘‘Position Limits and the Hedge Exemption, Brief Legislative History,’’ Testimony of General Counsel Dan M. Berkovitz, Commodity Futures Trading Commission, before Hearing on Speculative Position Limits in Energy Futures Markets at 1 (July 28, 2009) (‘‘Today, I will provide a brief legislative history of the mandate in the CEA concerning position limits and the exemption from those limits for bona fide hedging transactions. . . . Since its enactment in 1936, the Commodity Exchange Act (CEA) . . . has directed the Commodity Futures Trading Commission (CFTC) to establish such limits on trading ‘as the Commission finds are necessary to diminish, eliminate, or prevent such burden [on interstate commerce].’ The basic statutory mandate in Section 4a of the CEA to establish position limits to prevent such burdens has remained unchanged over the past seven decades) (emphasis added), available at https:// www.cftc.gov/PressRoom/SpeechesTestimony/ berkovitzstatement072809; see also, id. at 5 (‘‘By the mid-1930s . . . Congress finally provided a federal regulatory authority with the mandate and authority to establish and enforce limits on speculative trading. In Section 4a of the 1936 Act (CEA), the Congress . . . . directed the Commodity Exchange Commission [the CFTC’s predecessor agency] to establish such limits on trading ‘as the commission finds is [sic] necessary to diminish, eliminate, or prevent’ such burdens . . .’’) (emphasis added). 6 Isaac Marion, Warm Bodies and The New Hunger: A Special 5th Anniversary Edition, 97, Simon and Schuster (2016). 7 International Swaps and Derivatives Association v. U.S. Commodity Futures Trading Commission, 887 F.Supp. 2d 259, 281–282 (D.D.C. 2012) (emphasis in the original) (‘‘ISDA v. CFTC’’), citing PDK Labs. Inc. v. U.S. DEA, 362 F.3d 786, 794, 797– 98 (D.C. Cir. 2004). PO 00000 Frm 00143 Fmt 4701 Sfmt 4702 11737 rulemaking published in 2013. There, the Commission concluded that the Dodd-Frank Act required the agency to adopt position limits even in the absence of finding them necessary but, ‘‘in an abundance of caution,’’ also made a finding of necessity with respect to the position limits that it was proposing.8 The Commission promulgated this same analysis when, three years later, it reproposed its position limits rulemaking in 2016.9 The proposal before us today, by contrast, bases its proposed limits solely on finding them to be necessary—albeit a finding of necessity that is different from the one relied upon in the 2013 Proposal and the 2016 Re-Proposal. Practical Considerations I find the analysis put forward by our General Counsel’s Office in the proposed rulemaking before us today—which explains the Commission’s legal interpretation that its mandate to impose position limits under the CEA exists only when it finds the limits are necessary—to be well-reasoned and compelling. I add two practical considerations in support of that conclusion. First, if Congress in the Dodd-Frank Act had wanted to eliminate a necessity finding as a prerequisite to the imposition of position limits, it could simply have removed the requirement to find necessity that already existed in the CEA. That it did not do so indicates that on this point, the CEA both before and after the Dodd-Frank Act provides that the Commission has a mandate to impose position limits that it finds are necessary. Second, I do not believe that Congress would have directed the Commission to spend its limited resources developing and administering position limits that are not necessary. We must be careful stewards of the taxpayer dollars entrusted to us, and absent a clear statement of Congressional intent to do so, I do not believe those dollars should be spent on position limits that the Commission does not find to be necessary to achieve the objectives of the CEA. Statutory Analysis This section walks through some of the statutory text in CEA section 4a(a) that is relevant to the question of whether a finding of necessity is a prerequisite to the Commission’s mandate of imposing position limits. A diagram entitled ‘‘Commodity Exchange Act Section 4a(a): Finding Position Limits Necessary is a Prerequisite to the Mandate for Establishing Such’’ accompanies this statement on the Commission’s website, which may aid in reading the discussion. Subsection (1) of section 4a(a) is legacy text that has been in the CEA for decades. As noted above, it has long mandated that the Commission impose position limits that it finds necessary to diminish, eliminate, or prevent the burden on interstate commerce resulting from excessive speculation in derivatives. Subsection (2) of section 4a(a), on the other hand, was added to the CEA by the Dodd-Frank Act. 8 Position Limits for Derivatives, 78 FR 75680, 75685 (proposed Dec. 12, 2013) (‘‘2013 Proposal’’). 9 Position Limits for Derivatives, 81 FR 96704, 96716 (proposed Dec. 30, 2016) (‘‘2016 ReProposal’’). E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 11738 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules In my view, subsections (1) and (2) are linked, and cannot each be considered in isolation, because the Dodd-Frank Act specifically tied them together. First, subparagraph (A) of subsection (2) links the Commission’s obligation to set position limits to the ‘‘standards’’ set forth in subsection (1)—including the standard of finding necessity as a prerequisite to the mandate of imposing position limits. Then, subparagraph (B) of subsection (2) links the timing of issuing position limits to the limits required under subparagraph (A)—which, as noted, is connected to the standards set forth in subsection (1), including the standard of finding necessity. In sum, the new timing provisions in subparagraph (2)(B) apply to the requirement in subparagraph (2)(A). Subparagraph (2)(A), in turn, informs how Congress intended the Commission to establish limits, i.e., in specific accordance with the standards in subsection (1)—which includes the necessity standard. They are all linked. Yet, some have relied in isolation on the ‘‘shall . . . establish limits’’ wording in subparagraph (A) of subsection (2) to argue that the Dodd-Frank Act imposed a mandate on the Commission to establish position limits even in the absence of a finding of necessity. Some also have pointed to the timing provisions in subparagraph (B) of subsection (2) to argue that the Dodd-Frank Act imposed a mandate on the Commission to establish position limits because subparagraph (B) twice says that position limits ‘‘shall be established.’’ I agree that, under subparagraph (B), position limits ‘‘shall be established’’ as required under subparagraph (A)—but as noted, subparagraph (A) states that the Commission shall establish limits ‘‘[i]n accordance with the standards set forth in [subsection (1)].’’ This latter point cannot be overlooked or ignored. Some also have asked why Congress would add all this new language to CEA section 4a(a) if not to impose a new mandate. Yet, it makes perfect sense to me that while expanding the Commission’s authority to regulate swaps in the Dodd-Frank Act, Congress took the opportunity to review and enhance the Commission’s position limit authorities to ensure they were fit for purpose considering the addition of the new expanded authorities, including how swaps would be considered in the context of position limits. The timing of the review period was spelled out and the manner in which the Commission would go about establishing limits was refined to account for this massive change in oversight. But never did anyone suggest that the legacy language in subsection (1) of section 4a(a), including the required prerequisite of a necessity finding, had effectively been eliminated and replaced with a new mandate that would apply even in the absence of a necessity finding. Subsequent History Finally, as noted above, the court in ISDA v. CFTC instructed the Commission to use its ‘‘experience and expertise’’ to resolve the ambiguity it found in the statute. That experience and expertise cannot look only to the era in which these position limit VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 provisions were enacted. We are where we are, and so the application of the Commission’s experience and expertise must include a consideration of the substantial changes in the markets since that time. Given the intervention of a global financial crisis, it is hard to recall that the Dodd-Frank Act amendments to the CEA’s position limit provisions were borne at a time of skyrocketing energy prices during 2007– 2008. The price of oil climbed to over $147 a barrel in July 2008, which represented a 50% increase in one year and a seven-fold increase since 2002.10 Gas prices at the pump peaked at over $4 a gallon in June and July of 2008.11 Some at the time charged that these price spikes were caused by excessive speculation in futures contracts on energy commodities traded on U.S. futures exchanges—another topic of debate on which I will save my views for another day. But not surprisingly, legislation soon followed. By the end of 2008, the House of Representatives had passed amendments to the CEA’s position limit provisions,12 and after the Senate failed to act, the issue was subsequently addressed in the Dodd-Frank Act. How times have changed. The United States, due to a boom in oil and natural gas production relating to shale drilling and the development of liquefied natural gas, will soon become a net energy exporter.13 Although no new federal position limits have been imposed, prices of energy commodities have generally dropped and stabilized, and cries of excessive speculation in the derivatives markets are rare. Also, our derivatives markets have grown substantially. Global trading in listed futures and options increased from 22.4 billion contracts in 2010 to a record 34.47 billion contracts in 2019. Global open interest increased to a record 900 million contracts from 718.5 million in 2010.14 Applying our experience and expertise, what these developments teach us is that economic conditions change over time. Technology marches on. Markets evolve. And prices fluctuate in response to a myriad of influences. Having lived through the energy price increases of the mid-2000s, I do not minimize the pain they caused, or the importance of the Commission taking 10 Rebeka Kebede, Oil Hits Record Above $147, Reuters Business News, July 10, 2008, available at https://www.reuters.com/article/us-markets-oil/oilhits-record-above-147-idUST14048520080711. 11 Leigh Ann Caldwell, Face the Facts: A Fact Check on Gas Prices, CBS News Face the Nation, March 21, 2012, available at https:// www.cbsnews.com/news/face-the-facts-a-factcheck-on-gas-prices/. 12 Commodity Markets Transparency and Accountability Act of 2008, H.R. 6604, 110th Cong. sec. 8 (2008). 13 Tom DiChristopher, US to Become a Net Energy Exporter in 2020 for First Time in Nearly 70 Years, Energy Dept. Says, CNBC Business News, Energy, Jan. 24, 2019, available at https://www.cnbc.com/ 2019/01/24/us-becomes-a-net-energy-exporter-in2020-energy-dept-says.html. 14 Futures Industry Association, Global Futures and Options Trading Reaches Record Level in 2019, Jan. 16, 2020, available at https://fia.org/articles/ global-futures-and-options-trading-reaches-recordlevel-2019. PO 00000 Frm 00144 Fmt 4701 Sfmt 4702 appropriate steps to prevent excessive speculation in derivatives markets that can contribute to a burden on interstate commerce. Given the history of the past decade, however, I do not believe Congress intended, based on the moment in time of 2007–2008, to forever lock our derivatives markets into a straightjacket, or to deny the Commission the flexibility to draw conclusions of necessity based on particular circumstances. Returning to our zombie romance, I’m afraid I have not been fair to its author. That is because there is a second line to the quotation, which reads: ‘‘We are where we are, however we got here. What matters is where we go next.’’ 15 It is my fervent hope that the majority of comment letters we receive on today’s proposal provide constructive input on where the proposal would take us next with respect to position limits—and not simply fan the flames of the necessity debate. And it is the topic of where we go next that I will now turn. What position limits are necessary? Having concluded that the CEA mandates the Commission to impose position limits that it finds are necessary, the question then becomes: What position limits are necessary? In the 2013 Proposal, the Commission’s necessity finding determined that federal spot month position limits were necessary for 28 core referenced futures contracts on various agricultural, energy, and metals commodities. In the 2016 Re-Proposal, the Commission utilized the same necessity finding to determine that federal spot month limits were necessary for 25 of the 28 core referenced futures contracts for which they had been found necessary in 2013.16 And today’s proposal, although utilizing a different approach to the necessity finding, determines that federal spot month limits are necessary for the same 25 core referenced futures contracts for which they were found to be necessary in the 2016 Re-Proposal. In other words, three different iterations of the Commission have found federal spot month position limits to be necessary for these 25 core referenced futures contracts. That degree of consistency alone demonstrates the reasonableness of this determination. To be sure, both the 2013 Proposal and the 2016 Re-Proposal found federal position limits for non-spot months to be necessary for these 25 contracts, whereas today’s proposal does so for only the nine legacy agricultural contracts that are currently subject to federal non-spot month limits. Yet, the necessity findings in the 2013 Proposal and the 2016 Re-Proposal were based largely, if not entirely, on just two episodes: (1) The activity of the Hunt Brothers in the silver market in 1979–1980; and (2) the activity of the Amaranth hedge fund in the natural gas market in the mid-2000s. 15 See fn. 6, supra, at 97. 2016 Re-Proposal did not propose that federal position limits be imposed on three cashsettled futures contracts (Class III Milk, Feeder Cattle, and Lean Hogs) that were included as core referenced futures contracts in the 2013 Proposal. See 2016 Re-Proposal, 81 FR at 96740 n.368. 16 The E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 The Hunt Brothers silver episode and Amaranth natural gas episode occurred over 30 and over 15 years ago, respectively. It also should be noted that the Commission settled enforcement actions against both the Hunt Brothers and Amaranth charging that they had engaged in manipulation and/or attempted manipulation.17 Since that time, Congress has provided the Commission with enhanced anti-manipulation enforcement authority as part of the Dodd-Frank Act, which the Commission has used aggressively and serves as an effective tool to deter and combat potential manipulation involving trading in non-spot months. Again, I do not minimize the seriousness of the Hunt Brothers and Amaranth episodes, both of which had significant ramifications. But I am comfortable with the proposal’s determination that two dated episodes of manipulation during the past 30 years do not establish that it is necessary to take the drastic step of restricting trading (and liquidity) in non-spot months by imposing position limits for the core referenced futures contracts in these two commodities—let alone for the other 14 contracts at issue. I therefore support publishing the necessity finding in the proposal before us—including the limitation on proposed non-spot month limits to the nine legacy agricultural contracts—for public comment. Setting Limit Levels With respect to setting position limit levels, the Commission’s historical practice has been to set federal spot month levels at or below 25 percent of deliverable supply based on estimates provided by the exchanges and verified by the Commission. Yet, some of the deliverable supply estimates underlying the existing federal spot month limits on the nine legacy agricultural futures contracts have remained the same for decades, notwithstanding the revolutionary changes in U.S. futures markets and the explosive growth in trading volume over the years. These outdated delivery supply estimates require updating. The proposal adheres to the Commission’s historical approach, which is reasonable given the Commission’s years of experience administering federal spot month limits on the legacy agricultural contracts. And it provides a long-overdue update to deliverable supply estimates for those legacy contracts to reflect the realities of today’s markets. The proposed spot month limits for the 25 core referenced futures contracts are based on deliverable supply estimates of the exchanges that know their markets best, but that have been carefully analyzed by Commission staff to assure that they strike an appropriate balance between protecting market integrity and restricting liquidity for bona fide hedgers. For limit levels outside the spot month, the Commission historically has used a formula based on 10% of open interest for the first 25,000 contracts, with a marginal increase of 2.5% of open interest thereafter. Again, the proposal reasonably adheres to this general 17 The 2016 Re-Proposal acknowledged that ‘‘both episodes involved manipulative intent.’’ 2016 ReProposal, 81 FR at 96716. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 formula with which the Commission is familiar in proposing non-spot month limits for the nine legacy agricultural contracts, but it would apply the 2.5% calculation to open interest above 50,000 contracts rather than the current level of 25,000 contracts. Open interest has roughly doubled since federal limits were set for these markets, which has made the current non-spot month limits significantly more restrictive as the years have gone by. Nevertheless, I appreciate that such a change to established limits may raise concern. I am therefore pleased that the proposal includes a question asking whether the proposed increases in federal non-spot month limits should be implemented incrementally over a period of time, rather than immediately at the effective date. (There is additionally a question seeking input on the impact of increases in non-spot month limits for convergence that is of great interest to me.) Finally, it is important to remember that the 16 core referenced futures contracts for which federal non-spot month limits are not being proposed remain subject to exchangeset position limit levels or position accountability levels.18 The Commission has decades of experience overseeing accountability levels implemented by exchanges, including for all 16 contracts that would not be subject to federal limits outside the spot month under this proposal. Position accountability enables the exchange to obtain information about a potentially problematic position while it is at a relatively low level, and to require a trader to halt increasing that position or to reduce the position if the exchange considers it warranted. Exchange position accountability rules, in combination with market surveillance by both the exchanges and the Commission and the Commission’s enhanced anti-manipulation authority granted by the Dodd-Frank Act, provide a robust means of detecting and deterring problems in the outer months of a contract. The proposal reasonably continues to rely on these tools in the non-legacy contracts. Undoubtedly, there will be those who believe the proposed spot and non-spot month limits are too high, and others who consider them too low. I look forward to receiving public comments along these lines, but expect that any such comments will include market data and analysis for the Commission to consider in developing final rules. Bona Fide Hedging Transactions and Positions The CEA provides that the Commission’s position limit rules shall not apply to bona fide hedging transactions or positions. It gives the Commission the authority to define ‘‘bona fide hedging transactions and positions’’ with the purpose of ‘‘permit[ting] producers, purchasers, sellers, middlemen, and users of a commodity or a product derived therefrom to hedge their legitimate 18 The use of position accountability in lieu of hard limits is expressly permitted by the CEA for both designated contract markets, CEA section 5(d)(5), 7 U.S.C. 7(d)(5), and swap execution facilities, CEA section 5h(f)(6), 7 U.S.C. 7b-3(f)(6). PO 00000 Frm 00145 Fmt 4701 Sfmt 4702 11739 anticipated business needs . . .’’ 19 This serves as a statutory reminder of the fundamental point that the Commission is imposing speculative position limits, and since bona fide hedging is outside the scope of speculative activity, it is by definition outside the scope of the position limit rules. The Commission’s current definition of the term ‘‘bona fide hedging transactions and positions’’ is set out in what is referred to as ‘‘Rule 1.3(z).’’ In addition to providing a definition, Rule 1.3(z) also identifies certain specific ‘‘enumerated’’ hedging practices that the Commission recognizes as falling within the scope of that definition and therefore not subject to position limits. Other ‘‘nonenumerated’’ hedging practices can still be recognized as bona fide hedging, but only after a Commission review process. I am delighted that the proposal before us recognizes an expanded list of enumerated bona fide hedging practices than are currently recognized in Rule 1.3(z). This is entirely appropriate. Hedging practices at companies that produce, process, trade, and use agricultural, energy, and metals commodities are far more sophisticated, complex, and global than when the Commission last considered Rule 1.3(z). This is yet one more instance where the Commission’s position limit rules simply have not kept pace with developments in, and the realities of, the marketplace. In addition, the proposal would expand federal limits to contracts in commodities not previously subject to federal limits, and thus common hedging practices in the markets for those commodities must be considered for inclusion in the list of enumerated bona fide hedges. I am particularly pleased that, at my request, the proposal recognizes anticipatory merchandising as an enumerated bona fide hedge. After all, the CEA itself identifies anticipatory merchandising as bona fide hedging activity,20 and the Commission has previously granted non-enumerated hedge recognitions for anticipatory merchandising. There is no policy basis for distinguishing merchandising or anticipated merchandising from other activities in the physical supply chain. Although there must be appropriate safeguards against abuse, where merchandisers anticipate taking price risk, they should have the same opportunity as others in the physical supply chain to manage their risk through recognized riskreducing transactions that qualify as bona fide hedging. Although the proposal refers to enumerated bona fide hedges as ‘‘selfeffectuating’’ for purposes of federal limits, this is a bit of a misnomer. Even if a hedge is enumerated, the trader still must receive approval from the relevant exchange to 19 CEA section 4a(c)(1), 7 U.S.C. 6a(c)(1). section 4a(c)(2)(A)(iii)(I), 7 U.S.C. 6a(c)(2)(A)(iii)(I) (bona fide hedging transaction or position is a transaction or position that, among other things, ‘‘arises from the potential change in the value of . . . assets that a person owns, produces, manufactures, processes, or merchandises or anticipates owning, producing, manufacturing, processing, or merchandising . . .’’ (emphasis added)). 20 CEA E:\FR\FM\27FEP3.SGM 27FEP3 11740 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 exceed the exchange-set limits.21 This, too, is entirely appropriate. The exchanges know their markets, and they are very familiar with current hedging practices in agricultural, energy, and metals commodities, and thus are well-suited to apply the enumerated bona fide hedges in real-time. And, as noted above, Congress has declared it a purpose of the CEA to serve the public interest with respect to derivatives trading ‘‘through a system of effective self-regulation of trading facilities . . .’’ 22 I find perplexing what the proposal refers to as a ‘‘streamlined’’ process for recognizing non-enumerated bona fide hedging practices with respect to federal position limits. Pursuant to proposed 150.9, if an exchange recognizes a non-enumerated practice as a bona fide hedge for purposes of the exchange’s position limits, that recognition would apply to the federal limits as well, unless the Commission notifies the exchange and market participant otherwise. The Commission would have 10 business days for an initial application, or 2 business days in the case of a sudden or unforeseen increase in the applicant’s bona fide hedging needs, to approve or reject the exchange’s bona fide hedging recognition. I do not believe this ‘‘10/2-Day Rule’’ is workable in practice for either market participants or the Commission because it is both too long and too short. It is too long to be workable for market participants that may need to take a hedging position quickly, and it is too short for the Commission to meaningfully review the relevant circumstances and make a reasoned determination related to the exchange’s recognition of the hedge as bona fide. My preference would have been to propose that recognition of non-enumerated hedges be the responsibility of the exchanges that, again, are most familiar both with their own markets and with the hedging practices of participants in those markets. The Commission would monitor this process through our routine, ongoing review of the exchanges. I welcome public comment on the proposal’s legal discussion of the subdelegation of agency decision making authority as relevant to this question, and on how the proposed 10/2-Day Rule might be improved in a final rulemaking to make the process workable for market participants and the Commission alike. A Word About Economically Equivalent Swaps CEA section 4a(a)(5) provides that ‘‘[n]otwithstanding any other provision’’ in section 4a, the Commission’s position limit rules shall establish limits, ‘‘as appropriate,’’ with respect to economically equivalent swaps, and that such limits must be ‘‘develop[ed] concurrently’’ and ‘‘establish[ed] simultaneously’’ with the limits imposed on futures contracts and options on futures contracts.23 I share the view that section 4a(a)(5) thereby requires 21 Further, the absence of Commission approval of an enumerated bona fide hedge does not mean that the Commission has no access to data about the position or insight into the hedger’s trading activity. 22 See fn. 3, supra. 23 CEA section 4a(a)(5), 7 U.S.C. 6a(a)(5). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 that this rulemaking encompass economically equivalent swaps, although I invite public comment from those who believe another interpretation may be permissible and appropriate. The proposal sets forth a narrow definition of the term ‘‘economically equivalent swap,’’ which I believe is appropriate. A measured approach is reasonable given that: (1) The Commission’s regulatory regime for swaps remains in its relative infancy; (2) swaps have never been subject to position limits, be it federal or exchange-set limits; and (3) the implications of imposing position limits on economically equivalent swaps cannot be predicted with any degree of confidence at this time. Further, a measured approach is more workable because it is the Commission, rather than an exchange, that will be responsible for administering the new position limits regime for swaps given that: (1) Many swaps trade over-the-counter (‘‘OTC’’) so there is no exchange to fulfill this responsibility; and (2) for swaps traded on swap execution facilities (‘‘SEFs’’), those SEFs lack the information about a trader’s swap positions on other SEFs and OTC that would be necessary to fulfill this responsibility. That said, the proposed definition of an ‘‘economically equivalent swap’’ is broader than that used in the European position limits regime. In Europe, economic equivalence requires identical terms; the proposal, by contrast, requires only that material terms be identical. I look forward to receiving comment on this distinction, and the experience that market participants have had with the European application of position limits to swaps. Conclusion The fact that the Commission has been trying to update these rules for nearly a decade demonstrates the challenge presented by position limits. I am extremely grateful to the many members of our staff in the Division of Market Oversight, the Office of General Counsel, and the Chief Economist’s Office who have dedicated a significant portion of their lives to helping us try to meet that challenge. I also appreciate the efforts of my fellow Commissioners as well. Each of us has committed that we would work to finish a position limits rulemaking. The time has come. Overall, today’s proposal is reasonable in design, balanced in approach, and workable for both market participants and the Commission. I therefore support it. I ask market participants to view the proposal in that spirit. Please provide us with your constructive input on how we can make a good proposal even better. Appendix 6—Dissenting Statement of Commissioner Dan M. Berkovitz Introduction I dissent from today’s position limits proposal (‘‘Proposal’’). The Proposal would create an uncertain and unwieldy process with the Commission demoted from head coach over the hedge exemption process to Monday-morning quarterback for exchange PO 00000 Frm 00146 Fmt 4701 Sfmt 4702 determinations.1 The Proposal would abruptly increase position limits in many physical delivery agricultural, metals, and energy commodities, in some instances to multiples of their current levels. It would provide no opportunity for the Commission to monitor the effect of these increases, or to act if necessary to preserve market integrity. The Proposal provides inadequate explanation for other key approaches in the document, including the use of position accountability rather than numerical limits for energy and metals commodities in nonspot months. The Proposal also ignores Congress’s mandate in the Dodd-Frank Act, and reverses decades of legal interpretations of the Commodity Exchange Act (‘‘CEA’’) by the Commission and the courts regarding the Commission’s authority and responsibility to impose position limits. It would require, for the first time, the Commission to find that position limits are necessary for each commodity prior to imposing limits. I Support an Effective Position Limits Framework With Transparency and Certainty Position limits is one of the last remaining items in the Commission’s reform agenda arising from the Dodd-Frank Act. In the wake of the 2008 oil price spike to $147 per barrel, the Amaranth hedge fund’s dominance of the natural gas futures and swaps market, the rise of commodity index funds, and the financial crisis, Congress mandated that the Commission promptly establish, as appropriate, position limits and hedge exemptions for exempt and agricultural commodities and economically equivalent swaps. We must not forget the lessons from the financial crisis or prior episodes of excessive speculation, nor be lulled back into the belief that unfettered markets yield optimal outcomes. A meaningful, effective position limits regime was important to the reform agenda in 2010, and it must remain our goal today. I support an effective position limits regime that includes both effective limits on speculative positions and appropriate bona fide hedge exemptions to meet market participants’ legitimate commercial needs. Position limits are critical to preventing market manipulation or distortion due to excessively large speculative positions. Together, position limits and bona fide hedge exemptions promote the market integrity and the price discovery process, while enabling producers, end-users, merchants, and others to use the futures and swaps markets to manage their commercial risks. The DoddFrank Act, adopted by Congress in 2010 in the midst of the financial crisis, affirmed Congress’s commitment to federal speculative position limits and its determination that the Commission should act decisively to address excessive speculation in physical commodity markets. Since joining the Commission, I have traveled the country to meet with market participants in many segments of the physical commodity markets. I have been to soybean farms and rice mills in Arkansas, feedlots in Colorado, dairy co-ops and 1 See Position Limits for Derivatives (‘‘Proposal’’) at rule text section 150.9(e). E:\FR\FM\27FEP3.SGM 27FEP3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules cornfields in Minnesota, and grain mills and elevators in Kansas, Arkansas, Colorado, and Minnesota. I have met with coffee and cocoa graders in New York, energy companies in Texas, cotton merchandisers from Tennessee, and many others to understand how endusers participate in our markets. I have visited the CME in Chicago, ICE in New York, and the Minneapolis Grain Exchange in Minneapolis. The fundamental purpose of the commodity markets we oversee is to enable end-users to manage the price risks they face in their businesses. I am committed to ensuring that this rule is workable for endusers and provides them with sufficient clarity, predictability, and transparency. In my view, a position limits rule must meet three basic criteria. First, the rule must provide effective limits on speculative positions. Second, the rule must recognize legitimate bona fide hedging activities. The Commission should provide market participants with certainty regarding which activities constitute bona fide hedging and establish a workable, transparent process for qualifying additional types of activities as bona fide hedging. Such a process should recognize both the traditional role of the Commission in determining, generally, which activities constitute bona fide hedging, and the role of the exchanges in determining whether the specific activities of particular commercial market participants fall within such bona fide hedging categories as determined by the Commission. Third, from a legal perspective, a final rule must recognize that Congress has authorized and directed the Commission to promulgate position limits—without a predicate finding that position limits are necessary to prevent excessive speculation—and that the Commission has the flexibility to determine the appropriate tools and limits to accomplish that Congressional directive. Unfortunately, the Proposal fails to satisfy any of these criteria. The Proposal would greatly increase position limits in many physical delivery agricultural, metals, and energy commodities in spot and individual non-spot months, with no opportunity to monitor for or guard against adverse market impacts. Although I am pleased that the Proposal would no longer recognize risk management exemptions as bona fide hedges for physical commodities,2 the higher limits allowed under the Proposal could accommodate substantially more speculative positions,3 with potentially adverse impacts on markets. There is solid evidence that the financialization and growth of commodity index investments can raise commodity prices and negatively affect end-users in the real economy.4 The Proposal departs from the wellestablished roles of the Commission and exchanges in the bona fide hedge framework. As affirmed by the Dodd-Frank Act, it is the Commission’s responsibility to define what constitutes a bona fide hedge.5 For practical reasons, including limited Commission resources, I support delegating to exchanges the authority to determine whether a particular position, under the particular facts and circumstances presented, constitutes a bona fide hedge as defined by the Commission. The exchanges are well suited for this role and have decades of experience in making such determinations. However, the initial legal and policy determination of what types of positions constitute bona fide hedges must remain the Commission’s responsibility. The Proposal carries forward all of the bona fide hedges currently enumerated in the Commission’s rules, adds several additional categories to the list of enumerated hedges, and opens the door to an unlimited number of additional, undefined non-enumerated exemptions. The Proposal states, ‘‘the proposed enumerated hedges are in no way intended to limit the universe of hedging practices which could otherwise be recognized as bona fide.’’ 6 The ‘‘universe’’ is a very large place indeed. On the other hand, the Proposal does not address practices that market participants have urged the Commission to recognize as bona fide hedges, including practices currently recognized by the exchanges. The Proposal thus deprives end-users and other market participants of legal certainty regarding what constitutes a bona fide hedge for various practices currently permitted by the exchanges as bona fide hedges. Rather than determine whether to recognize these practices as bona fide hedges through notice and comment in today’s rulemaking, the Proposal contemplates that additional non-enumerated bona fide hedges should first be considered by the exchanges, and then reviewed by the Commission during a cramped 10-day retrospective review period.7 Determination of what constitutes a bona fide hedge for non-enumerated hedges would begin anew each time that an exchange must decide whether a purported bona fide hedge held by a market participant is consistent with the CEA, and then await the Commission’s retrospective review. Market participants should be able to discern whether particular types of practices qualify as bona fide hedging by reading the Commission’s rules and regulations rather than by engaging lawyers and lobbyists to 5 See CEA section 4a(c); 7 U.S.C. 6a(c). at preamble section II(A)(1)(c)(i) (emphasis added). 7 The Proposal would establish two distinct processes for recognition of non-enumerated hedges. One process would be Commission-based, but the Proposal anticipates that this process would rarely, if ever, be used by market participants. See Proposal at rule text section 150.3. The other, in proposed § 150.9(e), would require the Commission to retroactively review bona fide hedge exemptions approved by an exchange. See Proposal at rule text section 150.9(e). Such review would need to be conducted within business10 days, would involve the five-member Commission itself, and could be stayed for a longer period. 6 Proposal lotter on DSKBCFDHB2PROD with PROPOSALS3 2 See Proposal at preamble section II(A)(1)(c)(ii)(1). This change comports with amendments to the definition of bona fide hedging in CEA section 4a(c)(2) made by the Dodd-Frank Act. 3 Proposal at preamble section II(A)(1)(c)(ii)(1). 4 See, e.g., Ke Tang & Wei Xiong, Index Investment and Financialization of Commodities, 68 Financial Analysts Journal 54, 55 (2012); Luciana Juvenal & Ivan Petrella, Speculation in the Oil Market, Federal Reserve Bank of St. Louis, Working Paper 2011–027E (June 2012), available at https://research.stlouisfed.org/wp/2011/2011027.pdf. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 PO 00000 Frm 00147 Fmt 4701 Sfmt 4702 11741 guide them through an opaque, non-public process through the halls of the Commission’s headquarters in Washington, DC. The Commission has almost 40 years of experience with exchange implementation of position limits for energy and metals commodities, and more for agricultural commodities. Based on this experience, I support many of the types of bona fide hedges that exchanges recognize in these markets today. However, the Commission should recognize these exemptions in its own rules through prospective, notice and comment rulemaking, not delegate these determinations to the exchanges. The legal analysis in this Proposal is a convoluted and confusing legal interpretation of the Dodd-Frank Act that defies Congressional intent. It is implausible that in the aftermath of the financial crisis and the run-up to oil at $147 per barrel, Congress made it more difficult for the Commission to impose position limits. Yet that is the result of the Commission’s revisionist interpretation that a predicate finding of necessity (i.e., that position limits are necessary) is required for the imposition of a position limit for each commodity. Moreover, the Proposal’s finding of necessity for the 25 core reference futures contracts subject to the rule is unpersuasive both economically and legally, and is highly unlikely to survive legal challenge. The necessity finding largely consists of general economic statistics about the importance of the physical commodities underlying these futures contracts to commerce, together with statistics about open interest and trading volume in those futures contracts. These statistics bear little rational relationship to why position limits are necessary to prevent excessive speculation in derivative contracts for these commodities. For example, the imposition of limits on cocoa futures is justified on the basis that ‘‘in 2010 the United States exported chocolate and chocolate-type confectionary products worth $799 million to more than 50 countries around the world.’’ 8 There is a simpler, more logical, and defensible path forward, as I will outline later in this statement. I thank the Commission staff for working with my office on the Proposal. Although I am not able to support it as currently formulated, I look forward to working with my colleagues and staff to improve the Proposal so that it effectively protects our markets from excessive speculation and provides end-users and other market participants with the regulatory certainty they need. I encourage market participants to comment on the Proposal. Additional Flaws in the Proposal No Phase-In for Large Increase in Speculative Position Limits The Proposal would generally increase existing federal or exchange spot month position limits for 25 physical delivery agricultural, metals, and energy commodities by a factor of two or more.9 It would 8 Proposal 9 See E:\FR\FM\27FEP3.SGM at preamble section III(F)(3). Proposal at preamble section I(B). 27FEP3 11742 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules lotter on DSKBCFDHB2PROD with PROPOSALS3 substantially increase existing federal single month and all months combined limits for the nine legacy agricultural commodities. As examples, spot month limits on ICE’s frozen concentrated orange juice contract would increase from 300 to 2,200 contracts, and single month and all months combined limits on CBOT soybean meal would increase from 6,500 to 16,900 contracts.10 Single month and all months combined limits for CBOT corn would increase to 57,800 contracts.11 The proposed increases are largely due to increases in deliverable supply, and the new spot and non-spot month limits continue to reflect the Commission’s 25% and 10%/2.5% of deliverable supply formulas. The Proposal does not provide for phasing in the new, higher limits or for otherwise providing a transition period.12 It presents no analysis of the market’s ability to absorb these large increases without disruption, and no analysis of how large new speculative positions may affect the price discovery process. Large increases in the amounts of speculative activity in individual non-spot months have the potential to disrupt the convergence process and distort market signals regarding storage of commodities. The Proposal provides no analysis of whether these potential price distortions and their attendant detrimental consequences could be avoided by distributing the large increases in the numerical limits across several non-spot months, rather than permit such large positions in individual months. Instead, the Proposal would codify an abrupt increase 365 days after publication of any final rule in the Federal Register. A transition period or lower individual spot month limits would give the Commission the time and ability to mitigate any issues that may arise if markets are unable to absorb the higher limits in an orderly manner, and prevent disruption if necessary. It is a prudent measure that the Commission should adopt in any final rule. 2. Absence of Non-Spot Month Limits for Exempt and Certain Agricultural Commodities I am concerned with the Proposal’s failure to adopt federal non-spot limits for 16 energy, metals, and certain agricultural commodities included in the Proposal.13 CEA section 4a(a)(3) directs that the 10 Id. Other notable examples include increased spot limits for ICE U.S. Sugar No. 11 (SB) from 5,000 to 25,800 contracts; increased spot month limits for ICE Cotton No. 2 (CT) from 300 to 1,800 contracts; increased single month and all months combined limits for CBOT Soybean Oil (SO) from 8,000 to 17,400 contracts; and increased single month and all months combined limits for ICE Cotton No. 2 (CT) from 5,000 to 11,900 contracts. 11 Id. Although the proposed new limit for CBOT Corn (C) is less than twice the current limit (57,800 contracts proposed versus 33,000 contracts currently), it would still be a significantly larger position limit and the largest single month and all months combined limit in the Proposal. 12 See Proposal at rule text section 150.2 and Appendix E. 13 See Proposal at rule text section 150.5(b)(2), providing for exchange-set position limits or position accountability in non-spot months contracts not subject to federal speculative position limits. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 Commission ‘‘shall set limits’’ on positions held not only in the spot month, but also ‘‘each other month’’ and ‘‘for all months,’’ ‘‘as appropriate.’’ 14 Despite this directive, the Proposal does not adopt non-spot month limits for these commodities. It includes virtually no analysis of why the Commission believes that non-spot limits are not appropriate. Exchanges have demonstrated an ability to manage speculation and maintain orderly markets with position accountability in nonspot months. However, experiences such as the collapse of the Amaranth hedge fund in 2006 demonstrate how large trades in the non-spot month can also distort markets, widen spreads, and increase volatility.15 I believe the exchanges have learned from the Amaranth experience and that position accountability can be an effective tool, where appropriate. The Proposal, however, also fails to demonstrate why accountability levels, rather than numerical limits, are appropriate in light of the statutory directives in the CEA. It provides no discussion of the effect of applying the 10/2.5% formula to the energy and metals contracts covered by the Proposal, and why the application of this traditional formula would not be appropriate. Similarly, there is no analysis regarding the numerical limits that could result from applying the four factors specified in 4a(a)(3), and why such numerical limits would not be appropriate. 3. Definition of Economically Equivalent Swap The Proposal would define an economically equivalent swap as a swap that ‘‘shares identical material contractual specifications, terms, and conditions with the referenced contract . . . .’’ 16 The Proposal offers several rationales for this narrow definition that could potentially lend itself to evasion through financial engineering. One such rationale is that it would reduce market participants’ ability to net down their speculative positions through swaps that are not materially identical. While this and other rationales proffered in the Proposal have merit, the Commission must also ensure that economically equivalent swaps are not structured in a manner to evade federal or exchange regulation through minor modifications to material terms. I invite public comment on this issue. 4. The Proposal’s Necessity Finding Misconstrues the CEA as Amended by the Dodd-Frank Act The Proposal states that, for any particular commodity, ‘‘prior to imposing position limits, [the Commission] must make a finding that they are necessary.’’ 17 This is a reversal 14 CEA section 4a(a)(3); 7 U.S.C. 6a(a)(3). Excessive Speculation In the Natural Gas Market, Staff Report with Additional Minority Staff Views, Permanent Subcommittee on Investigations, United States Senate (2007). 16 Proposal at preamble section (II)(A)(4) and proposed rule text section 150.1. 17 Proposal at preamble section III(D). The Proposal also states that ‘‘[t]he Commission will therefore determine whether position limits are necessary for a given contract, in light of those premises, considering facts and circumstances and economic factors.’’ Proposal at preamble section III(F)(1). 15 See PO 00000 Frm 00148 Fmt 4701 Sfmt 4702 of prior Commission determinations.18 Neither the statutory language of CEA section 4a(a)(2), nor the district court’s decision in ISDA v. CFTC, compels this outcome.19 The Commission should not adopt it. Title VII of the Dodd-Frank Act amended CEA section 4a and directed in 4a(a)(2)(A) that ‘‘the Commission shall’’ establish position limits for agricultural and exempt physical commodities ‘‘as appropriate.’’ 20 In ISDA v. CFTC, the district court directed the Commission to resolve a perceived ambiguity in section 4a(a)(2)(A) by bringing the Commission’s ‘‘experience and expertise to bear in light of the competing interests at stake . . . .’’ 21 That experience includes over 80 years of position limits rulemakings, as described below. It provides ample practical and legal bases to determine that Congress intended the Commission to adopt federal position limits for certain commodities pursuant to CEA section 4a(a)(2). Starting in 1936, and across multiple iterations of the CEA and its predecessors, the CEA has consistently and continuously reflected Congress’s finding that excessive speculation in a commodity can cause sudden, unreasonable, and unwarranted movements in commodity prices that are undue burden on interstate commerce.22 Congress also has declared that ‘‘[f]or the purpose of diminishing, eliminating, or preventing such burden,’’ the Commission shall . . . proclaim and fix such [position] limits’’ that the Commission finds ‘‘are necessary to diminish, eliminate, or prevent such burden.’’ In plain English, Congress has found that excessive speculation is a burden on interstate commerce, and the CFTC is directed to impose position limits that are necessary to prevent that burden. Congress did not direct the Commission to study excessive speculation, to prepare any reports on excessive speculation, or to second-guess Congress’s finding that excessive speculation was a problem that needed to be prevented. Rather, Congress directed the Commission to impose position limits that the Commission believed were necessary to accomplish the statutory objectives. Following the passage of the 1936 Act, the Commission set position limits for grains in 1938, cotton in 1940, and soybeans in 1951. As the Proposal recognizes, in these rulemakings the Commission did not publish any analyses or make any ‘‘necessity finding,’’ other than to include a ‘‘recitation’’ of the statutory findings regarding the undue 18 The Proposal acknowledges ‘‘this approach differs from that taken in earlier necessity findings.’’ Proposal at preamble section III(F)(1). Specifically, the Proposal identifies different approaches taken in position limit rulemaking undertaken by the Commission’s predecessor agency, the Commodity Exchange Commission (‘‘CEC’’) from 1938 through 1951, the Commission’s 1981 rulemaking that required exchanges to impose position limits for each contract not already subject to a federal limit, and the proposed rulemakings in 2013 and 2016. Id. 19 Int’l Swaps and Derivatives Ass’n (‘‘ISDA’’) v. CFTC, 887 F. Supp. 2d 259 (D.D.C. 2012). 20 CEA section 4a(a)(2)(A); 7 U.S.C. 6a(a)(2)(A). 21 ISDA, 887 F. Supp. 2d at 281. 22 Commodity Exchange Act of 1936, P.O. 76– 675, 49 Stat. 1491 section 5. E:\FR\FM\27FEP3.SGM 27FEP3 lotter on DSKBCFDHB2PROD with PROPOSALS3 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules burdens on commerce that can be caused by excessively large positions. These rulemakings then set numerical limits on the amounts of commodity futures contracts that could be held. Court decisions from the 1950s through the 1970s in cases involving the application of the position limits rules reflect a commonsense reading: The statute mandates that the Commission establish position limits, while providing the Commission with discretion as to how to craft those limits. In Corn Refining Products v. Benson, 23 defendants challenged the suspension by the Secretary of Agriculture of their trading privileges on the Chicago Board of Trade for violating position limits in corn futures on the grounds that the statutory prohibition only applied to speculative positions. The U.S. Court of Appeals for the Second Circuit denied the appeal, stating in part: The discretionary powers of the Commission and the exemptions from the ‘trading limits’ established under the Act are carefully delineated in [section] 4a. The Commission is given discretionary power to prescribe ’ * * * different trading limits for different commodities, markets futures, or delivery months, or different trading limits for the purposes of buying and selling operations, or different limits for the purposes of subparagraphs (A) (i.e., with respect to trading during one business day) and (B) (i.e., with respect to the net long or net short position held at any one time) of this section * * * ’ . . . . Although [section] 4a expresses an intention to curb ‘excessive speculation,’ we think that the unequivocal reference to ‘trading,’ coupled with a specific and welldefined exemption for bona-fide hedging, clearly indicates that all trading in commodity futures was intended to be subject to trading limits unless within the terms of the exemptions. 24 In United States v. Cohen,25 the defendant challenged his criminal conviction for violating CEC trading limits in potato futures contracts. In upholding the conviction, the court of appeals stated that ‘‘[t]rading in potato futures, as for other commodities, is limited by statute and by regulations issued by the Commission. The statute here requires the Commission to fix a trading limit . . . .’’ 26 The court of appeals further observed: ‘‘Congress expressed in the statute a clear intention to eliminate excessive futures trading that can cause sudden or unreasonable fluctuations.’’ 27 In CFTC v. Hunt, 28 the Hunt brothers challenged the validity of the agency’s position limit on soybeans of three million bushels on the basis that the agency ‘‘made no analysis of the relationship between the size of soybean price changes and the size of the change in the net position of large traders. They argue[d] that there is no direct relationship between these phenomena, and, therefore, the regulation limiting the 23 232 F.2d 554 (2d Cir. 1956). at 560 (emphasis added). 25 448 F.2d 1224 (2d Cir. 1971). 26 Id. at 1225–6 (emphasis added). 27 Id. at 1227 (emphasis added). 28 591 F.2d 1211 (7th Cir. 1979). 24 Id. VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 positions and the trading of the large soybean traders is unreasonable.’’ 29 Fundamentally, the Hunts alleged that the agency failed to demonstrate that the limits were a reasonable means—or, alternatively put, ‘‘necessary’’— to prevent unwarranted price fluctuations in soybeans. ‘‘The essence of the Hunts’ attack on the validity of the regulation is their substantive contention that there is no connection between large scale speculation by individual traders and fluctuations in the soybean trading market.’’ 30 The U.S. Court of Appeals for the Seventh Circuit denied the Hunt brothers’ challenge. It held, ‘‘[t]he Commodity Exchange Authority, operating under an express congressional mandate to formulate limits on trading in order to forestall the evils of large scale speculation, was deciding on whether to raise its then existing limit on soybeans. . . . There is ample evidence in the record to support the regulation.’’ 31 The Hunt case also illustrates the difference between the requirement for a predicate finding of necessity and the requirement that the Commission’s rulemakings be supported by sufficient evidence. Under the Administrative Procedure Act (‘‘APA’’), the Commission’s regulations must not be ‘‘arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.’’ 32 To make this finding, ‘‘the court must consider whether the decision was based on a consideration of the relevant factors and whether there has been a clear error of judgment.’’ 33 In 1981, following the silver crisis of 1979– 1980, the Commission adopted a seminal final rule requiring exchanges to establish position limits for all commodities that did not have federal limits.34 In the final rulemaking, the Commission determined that predicate findings are not necessary in position limits rulemakings. It affirmed its long-standing statutory mandate going back 29 Id. at 1216. 30 Id. 31 Id. at 1218 (emphasis added). U.S.C. 706(2)(A). 33 Hunt, 591 F.2d at 1216. In the proposed regulation increasing the speculative position limits for soybeans from 2 million to 3 million bushels, the Commission’s predecessor, the Commodity Exchange Authority (‘‘Authority’’), did not make a soybean-specific finding that the limit of three million bushels was necessary to prevent undue burdens on commerce. Rather, the Authority relied on its 1938 and 1951 position limit rulemakings for the general principle that ‘‘the larger the net trades by large speculators, the more certain it becomes that prices will respond directly to trading.’’ Corn and Soybeans, Limits on Position and Daily Trading for Future Delivery, 36 FR 1340 (Jan. 28, 1971). The Authority then stated that its analysis of speculative trading between 1966 and 1969 ‘‘did not show that undue price fluctuations resulted from speculative trading as the trading by individual traders grew larger.’’ Id. Following a public hearing, the Authority adopted the proposed increase. See 36 FR 12163 (June 26, 1971). For the past 82 years, the Commission has relied on this general principle to justify its position limits regime. 34 During the silver crisis, the Hunt brothers and others attempted to corner the silver market through large physical and futures positions. The price of silver rose more than five-fold from August 1979 to January 1980. 32 5 PO 00000 Frm 00149 Fmt 4701 Sfmt 4702 11743 to 1936: ‘‘Section 4a(1) represents an express Congressional finding that excessive speculation is harmful to the market, and a finding that speculative limits are an effective prophylactic measure.’’ 35 The 1981 final rule found that ‘‘speculative position limits are appropriate for all contract markets irrespective of the characteristics of the underlying market.’’ 36 It required exchanges to adopt position limits for all listed contracts, and it did so based on statutory language that is nearly identical to CEA section 4a(a)(1).37 In the 1981 rulemaking, the Commission also responded to comments that the Commission had failed to ‘‘demonstrate[ ] that position limits provided necessary market protection,’’ or were appropriate for futures markets in ‘‘international soft’’ commodities, such as coffee, sugar, and cocoa. The Commission rejected comments that it was required to make predicate necessity findings for particular commodities. The Commission stated: The Commission believes that the observations concerning the general desirability of limits are contrary to Congressional findings in sections 3 and 4a of the Act and considerable years of Federal and contract market regulatory experience. . . . * * * As stated in the proposal, the prevention of large and/or abrupt price movements which are attributable to extraordinarily large speculative positions is a Congressionally endorsed regulatory objective of the Commission. Further, it is the Commission’s view that this objective is enhanced by speculative limits since it appears that the capacity of any contract market to absorb the establishment and liquidation of large speculative positions in an orderly manner is related to the relative size of such positions, i.e., the capacity of the market is not unlimited.38 In the ‘‘Legal Matters’’ section of the preamble, the Proposal would jettison the interpretation that has prevailed over the past four decades as the basis for the Commission’s position limits regime. Relying on a non sequitur incorporating a double negative, the Preamble brushes off nearly forty years of Commission jurisprudence: [B]ecause the Commission has preliminarily determined that section 4a(a)(2) does not mandate federal speculative limits for all commodities, it cannot be that federal position limits are ‘necessary’ for all physical commodities, within the meaning of section 4a(a)(1), on the basis of a property shared by all of them, i.e., a limited capacity to absorb the establishment and liquidation of large speculative positions in an orderly fashion.39 35 See Establishment of Speculative Positon Limits, 46 FR 50938, 50940 (Oct. 16, 1981) (‘‘1981 Position Limits Rule’’). 36 1981 Position Limits Rule at 50941. 37 In the proposed regulation, the Commission noted that as of April 1975, position limits were in effect for ‘‘almost all’’ actively traded commodities then under regulation. Speculative Position Limits, 45 FR 79831, 79832 (Dec. 2, 1980). 38 1981 Position Limits Rule at 50940. 39 Proposal at preamble section III(F)(1). E:\FR\FM\27FEP3.SGM 27FEP3 11744 Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Proposed Rules In 2010, Congress enacted Title VII of the Dodd-Frank Act and amended CEA section 4a by directing the Commission to establish speculative position limits for agricultural and exempt commodities and economically equivalent swaps.40 Congress also set forth criteria for the Commission to consider in establishing limits, including diminishing, eliminating, or preventing excessive speculation; deterring and preventing market manipulation; ensuring sufficient liquidity for bona fide hedgers; and ensuring that price discovery in the underlying market is not disrupted.41 Congress directed the Commission to establish the required speculative limits within tight deadlines of 180 days for exempt commodities and 270 days for agricultural commodities. It defies history and common sense to assert that the amendments to section 4a enacted by Congress in the Dodd-Frank Act made it more difficult for the Commission to impose position limits, such as by requiring predicate necessity findings on a commodityby-commodity basis. This is particularly true given Congress’s repeated use of mandatory words like ‘‘shall’’ and ‘‘required’’ and the tight timeframe to respond to the new Congressional directives. In light of the run up in the price of oil and the financial crisis that precipitated the legislation, it is unreasonable to interpret the Dodd-Frank amendments as creating new obstacles for the Commission to establish position limits for oil, natural gas, and other commodities whose significant price fluctuations had caused economic harm to consumers and businesses across the nation. The Commission’s interpretation is revisionist history. The Commission’s necessity finding that follows its legal analysis is sure to persuade no one. Unless substantially modified in the final rulemaking, it will likely doom this regulation as ‘‘arbitrary, capricious, or an abuse of discretion’’ under the APA. The lotter on DSKBCFDHB2PROD with PROPOSALS3 40 See CEA section 4a(a)(2); 7 U.S.C. 6a(a)(2); CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5). 41 See CEA section 4a(a)(3); 7 U.S.C. 6a(a)(3). VerDate Sep<11>2014 18:41 Feb 26, 2020 Jkt 250001 necessity finding for the 25 core referenced futures contracts selected for this rulemaking boils down to simplistic assertions that the futures contracts and economically equivalent swaps for these contracts ‘‘are large and critically important to the underlying cash markets.’’ 42 As part of the necessity finding for these 25 commodities, the Proposal presents general economic measures, such as production, trade, and manufacturing statistics, to illustrate the importance of these commodities to interstate commerce, and therefore for the need for position limits. On the other hand, the Proposal fails to present any rational reason as to why the economic trade, production, and value statistics for commodities other than the 25 core referenced futures contracts are insufficient to support a similar finding that position limits are necessary for futures contracts in those other commodities. For example, the Proposal justifies the exclusion of aluminum, lead, random length lumber, and ethanol as examples of contracts for which a necessity finding was not made on the basis that the open interest in these contracts is less than the open interest in the oat futures contracts. This comparison has no basis in rationality. The need for position limits for commodity futures contracts in aluminum, lead, lumber, and ethanol is not in any way rationally related to the open interest in those commodity futures contracts relative to the open interest in oat futures. The Proposal is rife with other such illogical statements. Fundamentally, general economic measures of commodity production, trade, and value are irrelevant with respect to the need for position limits to prevent excessive speculation. The Congress has found that position limits are an effective prophylactic tool to prevent excessive speculation for all commodities. The Congressional findings in CEA section 4a regarding the need for position limits are not limited to only the most important or the largest commodity markets. General economic data regarding a commodity in interstate commerce is irrelevant to the need for position limits for futures contracts for that commodity. The collapse of the Amaranth hedge fund in 2006 is another strong example of why a position limits regime is necessary to prevent excessive speculation, in this case in nonspot months. Amaranth was a large speculative hedge fund that at one point held some 100,000 natural gas contracts, or approximately 5% of all natural gas used in the U.S. in a year. As the Commission has explained in other position limits proposals since 2011, the collapse of Amaranth was a factor in the Dodd-Frank’s amendments to CEA section 4a. The Commission has ample practical experience and legal precedent to resolve the perceived ambiguity in CEA section 4a(a)(2) as instructed by the district court in ISDA v. CFTC without making the antecedent necessity finding now incorporated in the Proposal. Our remaining task is to design the overall position limits framework, including determining the appropriate limit levels, defining bona fide hedges through prospective rulemaking, and appropriately considering other options such as position accountability and exchange-set limits. Conclusion In CEA section 4a, Congress directed the Commission to establish position limits and appropriate hedge exemptions to prevent the undue burdens on interstate commerce that result from excessive speculation. Congress has also entrusted to the Commission’s discretion the appropriate regulatory tools to meet this mandate. Congress’ overarching policy directive for position limits is straightforward and has been remarkably consistent for 84 years. The Commission has had ten years, three prior proposals, one supplemental proposal, and hundreds of pages of comment letters to define bona fide hedge exemptions. Now is the time to finish the job, and to do it the right way. [FR Doc. 2020–02320 Filed 2–26–20; 8:45 am] 42 Proposal PO 00000 at preamble section III(F)(2). Frm 00150 Fmt 4701 Sfmt 9990 BILLING CODE 6351–01–P E:\FR\FM\27FEP3.SGM 27FEP3

Agencies

Commodity Futures Trading Commission

[Federal Register Volume 85, Number 39 (Thursday, February 27, 2020)]
[Proposed Rules]
[Pages 11596-11744]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-02320]



[[Page 11595]]

Vol. 85

Thursday,

No. 39

February 27, 2020

Part III





 Commodity Futures Trading Commission





-----------------------------------------------------------------------





17 CFR Parts 1, 15, 17, et al.





 Position Limits for Derivatives; Proposed Rule

Federal Register / Vol. 85 , No. 39 / Thursday, February 27, 2020 / 
Proposed Rules

[[Page 11596]]


-----------------------------------------------------------------------

COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 15, 17, 19, 40, 140, 150, and 151

RIN 3038-AD99


Position Limits for Derivatives

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rule.

-----------------------------------------------------------------------

SUMMARY: The Commodity Futures Trading Commission (``Commission'' or 
``CFTC'') is proposing amendments to regulations concerning speculative 
position limits to conform to the Wall Street Transparency and 
Accountability Act of 2010 (``Dodd-Frank Act'') amendments to the 
Commodity Exchange Act (``CEA'' or ``Act''). Among other amendments, 
the Commission proposes new and amended federal spot month limits for 
25 physical commodity derivatives; amended single month and all-months-
combined limits for most of the agricultural contracts currently 
subject to federal limits; new and amended definitions for use 
throughout the position limits regulations, including a revised 
definition of ``bona fide hedging transactions or positions'' and a new 
definition of ``economically equivalent swaps''; amended rules 
governing exchange-set limit levels and grants of exemptions therefrom; 
a new streamlined process for bona fide hedging recognitions for 
purposes of federal limits; new enumerated hedges; and amendments to 
certain regulatory provisions that would eliminate Form 204, enabling 
the Commission to leverage cash-market reporting submitted directly to 
the exchanges.

DATES: Comments must be received on or before April 29, 2020.

ADDRESSES: You may submit comments, identified by ``Position Limits for 
Derivatives'' and RIN 3038-AD99, by any of the following methods:
     CFTC Comments Portal: https://comments.cftc.gov. Select 
the ``Submit Comments'' link for this rulemaking and follow the 
instructions on the Public Comment Form.
     Mail: Send to Christopher Kirkpatrick, Secretary of the 
Commission, Commodity Futures Trading Commission, Three Lafayette 
Centre, 1155 21st Street NW, Washington, DC 20581.
     Hand Delivery/Courier: Follow the same instructions as for 
Mail, above.
    Please submit your comments using only one of these methods. To 
avoid possible delays with mail or in-person deliveries, submissions 
through the CFTC Comments Portal are encouraged.
    All comments must be submitted in English, or if not, be 
accompanied by an English translation. Comments will be posted as 
received to https://comments.cftc.gov. You should submit only 
information that you wish to make available publicly. If you wish the 
Commission to consider information that you believe is exempt from 
disclosure under the Freedom of Information Act (``FOIA''), a petition 
for confidential treatment of the exempt information may be submitted 
according to the procedures established in Sec.  145.9 of the 
Commission's regulations.\1\
---------------------------------------------------------------------------

    \1\ 17 CFR 145.9.
---------------------------------------------------------------------------

    The Commission reserves the right, but shall have no obligation, to 
review, pre-screen, filter, redact, refuse, or remove any or all 
submissions from https://www.comments.cftc.gov that it may deem to be 
inappropriate for publication, such as obscene language. All 
submissions that have been redacted or removed that contain comments on 
the merits of the rulemaking will be retained in the public comment 
file and will be considered as required under the Administrative 
Procedure Act and other applicable laws, and may be accessible under 
FOIA.

FOR FURTHER INFORMATION CONTACT: Aaron Brodsky, Senior Special Counsel, 
(202) 418-5349, [email protected]; Steven Benton, Industry Economist, 
(202) 418-5617, [email protected]; Jeanette Curtis, Special Counsel, 
(202) 418-5669, [email protected]; Steven Haidar, Special Counsel, (202) 
418-5611, [email protected]; Harold Hild, Policy Advisor, 202-418-5376, 
[email protected]; or Lillian Cardona, Special Counsel, (202) 418-5012, 
[email protected]; Division of Market Oversight, in each case at the 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street NW, Washington, DC 20581.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Background
    A. Introduction
    B. Executive Summary
    C. Summary of Proposed Amendments
    D. The Commission Preliminarily Construes CEA Section 4a(a) To 
Require the Commission To Make a Necessity Finding Before 
Establishing Position Limits for Physical Commodities Other Than 
Excluded Commodities
II. Proposed Rules
    A. Sec.  150.1--Definitions
    B. Sec.  150.2--Federal Limit Levels
    C. Sec.  150.3--Exemptions From Federal Position Limits
    D. Sec.  150.5--Exchange-Set Position Limits and Exemptions 
Therefrom
    E. Sec.  150.6--Scope
    F. Sec.  150.8--Severability
    G. Sec.  150.9--Process for Recognizing Non-Enumerated Bona Fide 
Hedging Transactions or Positions With Respect to Federal 
Speculative Position Limits
    H. Part 19 and Related Provisions--Reporting of Cash-Market 
Positions
    I. Removal of Part 151
III. Legal Matters
    A. Introduction
    B. Key Statutory Provisions
    C. Ambiguity of Section 4a With Respect to Necessity Finding
    D. Resolution of Ambiguity
    E. Evaluation of Considerations Relied Upon by the Commission in 
Previous Interpretation of Paragraph 4a(a)(2)
    F. Necessity Finding
    G. Request for Comment
IV. Related Matters
    A. Cost-Benefit Considerations
    B. Paperwork Reduction Act
    C. Regulatory Flexibility Act
    D. Antitrust Considerations

I. Background

A. Introduction

    The Commission has long established and enforced speculative 
position limits for futures and options on futures contracts on various 
agricultural commodities as authorized by the CEA.\2\ The existing part 
150 position limits regulations \3\ include three components: (1) The 
level of the limits, which currently apply to nine agricultural 
commodity derivatives contracts and set a maximum that restricts the 
number of speculative positions that a person may hold in the spot 
month, individual month, and all-months-combined; \4\ (2) exemptions 
for positions that constitute bona fide hedges and for certain other 
types of transactions; \5\ and (3) regulations to determine which 
accounts and positions a person must aggregate for the purpose of 
determining compliance with the position limit levels.\6\ The existing 
federal speculative position limits function in parallel to exchange-
set limits required by

[[Page 11597]]

designated contract market (``DCM'') Core Principle 5.\7\ Certain 
contracts are thus subject to both federal and DCM-set limits, whereas 
others are subject only to DCM-set limits and/or position 
accountability.
---------------------------------------------------------------------------

    \2\ 7 U.S.C. 1 et seq.
    \3\ 17 CFR part 150. Part 150 of the Commission's regulations 
establishes federal position limits (that is, position limits 
established by the Commission, as opposed to exchange-set limits) on 
nine agricultural contracts. Agricultural contracts refers to the 
list of commodities contained in the definition of ``commodity'' in 
CEA section 1a; 7 U.S.C. 1a. This list of agricultural contracts 
currently includes nine contracts: CBOT Corn (and Mini-Corn) (C), 
CBOT Oats (O), CBOT Soybeans (and Mini-Soybeans) (S), CBOT Wheat 
(and Mini-Wheat) (W), CBOT Soybean Oil (SO), CBOT Soybean Meal (SM), 
MGEX Hard Red Spring Wheat (MWE), CBOT KC Hard Red Winter Wheat 
(KW), and ICE Cotton No. 2 (CT). See 17 CFR 150.2. The position 
limits on these agricultural contracts are referred to as ``legacy'' 
limits because these contracts have been subject to federal position 
limits for decades.
    \4\ See 17 CFR 150.2.
    \5\ See 17 CFR 150.3.
    \6\ See 17 CFR 150.4.
    \7\ 7 U.S.C. 7(d)(5); 17 CFR 38.300.
---------------------------------------------------------------------------

    As part of the Dodd-Frank Act, Congress amended the CEA's position 
limits provisions, which, since 1936, have authorized the Commission 
(and its predecessor) to impose limits on speculative positions to 
prevent the harms caused by excessive speculation. As discussed below, 
the Commission interprets these amendments as, among other things, 
tasking the Commission with establishing such position limits as it 
finds are ``necessary'' for the purpose of ``diminishing, eliminating, 
or preventing'' ``[e]xcessive speculation . . . causing sudden or 
unreasonable fluctuations or unwarranted changes in . . . price . . .'' 
\8\ The Commission also interprets these amendments as tasking the 
Commission with establishing position limits on any ``economically 
equivalent'' swaps.\9\
---------------------------------------------------------------------------

    \8\ 7 U.S.C. 6a(a)(1); see infra Section III.F. (discussion of 
the necessity finding).
    \9\ 7 U.S.C. 6a(a)(5).
---------------------------------------------------------------------------

    The Commission previously issued proposed and final rules in 2011 
to implement the provisions of the Dodd-Frank Act regarding position 
limits and the bona fide hedge definition.\10\ A September 28, 2012 
order of the U.S. District Court for the District of Columbia vacated 
the 2011 Final Rulemaking, with the exception of the rule's amendments 
to 17 CFR 150.2.\11\
---------------------------------------------------------------------------

    \10\ Position Limits for Derivatives, 76 FR 4752 (Jan. 26, 
2011); Position Limits for Futures and Swaps, 76 FR 71626 (Nov. 18, 
2011) (``2011 Final Rulemaking'').
    \11\ Int'l Swaps & Derivatives Ass'n v. U.S. Commodity Futures 
Trading Comm'n, 887 F. Supp. 2d 259 (D.D.C. 2012) (``ISDA'').
---------------------------------------------------------------------------

    Subsequently, the Commission proposed position limits regulations 
in 2013 (``2013 Proposal''), June of 2016 (``2016 Supplemental 
Proposal''), and again in December of 2016 (``2016 Reproposal'').\12\ 
The 2016 Reproposal would have amended part 150 to, among other things: 
establish federal position limits for 25 physical commodity futures 
contracts and for ``economically equivalent'' futures, options on 
futures, and swaps; revise the existing exemptions from such limits, 
including for bona fide hedges; and establish a framework for exchanges 
\13\ to recognize certain positions as bona fide hedges, and thus 
exempt from position limits.
---------------------------------------------------------------------------

    \12\ Position Limits for Derivatives, 78 FR 75680 (Dec. 12, 
2013) (2013 Proposal); Position Limits for Derivatives: Certain 
Exemptions and Guidance, 81 FR 38458 (June 13, 2016) (2016 
Supplemental Proposal); and Position Limits for Derivatives, 81 FR 
96704 (Dec. 30, 2016) (2016 Reproposal).
    \13\ Unless indicated otherwise, the use of the term 
``exchanges'' throughout this proposal refers to DCMs and Swap 
Execution Facilities.
---------------------------------------------------------------------------

    To date, the Commission has not issued any final rulemaking based 
on the 2013 Proposal, 2016 Supplemental Proposal, or 2016 Reproposal. 
The 2016 Reproposal generally addressed comments received in response 
to those prior rulemakings. In a companion proposed rulemaking, the 
CFTC also proposed, and later adopted in 2016, amendments to rules 
governing aggregation of positions for purposes of compliance with 
federal position limits.\14\ These aggregation rules currently apply 
only to the nine agricultural contracts subject to existing federal 
limits, and going forward would apply to the commodities that would be 
subject to federal limits under this release.
---------------------------------------------------------------------------

    \14\ Aggregation of Positions, 81 FR 91454 (Dec. 16, 2016) 
(``Final Aggregation Rulemaking''); see 17 CFR 150.4. Under the 
Final Aggregation Rulemaking, unless an exemption applies, a 
person's positions must be aggregated with positions for which the 
person controls trading or for which the person holds a 10 percent 
or greater ownership interest. The Division of Market Oversight has 
issued time-limited no-action relief from some of the aggregation 
requirements contained in that rulemaking. See CFTC Letter No. 19-19 
(July 31, 2019), available at https://www.cftc.gov/csl/19-19/download.
---------------------------------------------------------------------------

    After reconsidering the prior proposals, including reviewing the 
comments responding thereto, the Commission is withdrawing from further 
consideration the 2013 Proposal, the 2016 Supplemental Proposal, and 
the 2016 Reproposal.\15\
---------------------------------------------------------------------------

    \15\ Because the earlier proposals are withdrawn, comments on 
them will not be part of the administrative record with respect to 
the current proposal, except where expressly referenced herein. 
Commenters should resubmit comments relevant to the subject 
proposal; commenters who wish to reference prior comment letters 
should cite those prior comment letters as specifically as possible.
---------------------------------------------------------------------------

    Instead, the Commission is now issuing a new proposal (``2020 
Proposal''). The 2020 Proposal is intended to (1) recognize differences 
across commodities and contracts, including differences in commercial 
hedging and cash-market reporting practices; (2) focus on derivatives 
contracts that are critical to price discovery and distribution of the 
underlying commodity such that the burden of excessive speculation in 
the derivatives contract may have a particularly acute impact on 
interstate commerce for that commodity; and (3) reduce duplication and 
inefficiency by leveraging existing expertise and processes at DCMs. 
For these general reasons, discussed in turn below, the Commission 
proposes new regulations, rather than finalizing the 2016 
Reproposal.\16\
---------------------------------------------------------------------------

    \16\ The specific proposed new regulations are discussed in 
detail later in this release.
---------------------------------------------------------------------------

    First, the Commission preliminarily believes that any position 
limits regime must take into account differences across commodity and 
contract types. The existing federal position limits regulations apply 
only to nine contracts, all of which are physically-settled futures on 
agricultural commodities. Limits on these commodities have been in 
place for decades, as have the federal program for exemptions from 
these limits and the federal rules governing DCM-set limits on such 
commodities. The existing framework is largely a historical remnant of 
an approach that predates cash-settled futures contracts, let alone 
swaps, institutional-investor interest in commodity indexes, and highly 
liquid energy markets. Congress has tasked the Commission with: 
Establishing such limits as it finds are ``necessary'' for the purpose 
of preventing the burdens associated with excessive speculation causing 
sudden or unreasonable fluctuations or unwarranted changes in price; 
and establishing limits on swaps that are ``economically equivalent'' 
to certain futures contracts. The Commission has preliminarily 
determined that an approach that is flexible enough to accommodate 
potential future, unpredictable developments in commercial hedging 
practices would be well-suited for the current derivatives markets by 
accommodating differences in commodity types, contract specifications, 
hedging practices, cash-market trading practices, organizational 
structures of hedging participants, and liquidity profiles of 
individual markets.
    The Commission proposes to build this flexibility into several 
parts of the proposed regulations, including: Exchange-set limits and/
or accountability, rather than federal limits, outside of the spot 
month for referenced contracts based on commodities other than the nine 
legacy agricultural commodities; the ability for exchanges to use more 
than one formula when setting their own limit levels; an updated 
formula for federal non-spot month levels on the nine legacy 
agricultural contracts that is calibrated to recently observed trading 
activity; a bona fide hedging definition that is broad enough to 
accommodate common commercial hedging practices, including anticipatory 
hedging practices such as anticipatory merchandising; a broader range 
of exchange-granted recognitions for purposes of federal and

[[Page 11598]]

exchange-set limits that are in line with common commercial hedging 
practices; the elimination of a restriction for purposes of federal 
limits on holding positions during the last trading days of the spot 
month; and broader discretion for market participants to measure risk 
in the manner most suitable for their business.
    Second, the proposal establishes limits on a limited set of 
commodities for which the Commission preliminarily finds that 
speculative position limits are necessary.\17\ As described below, this 
necessity finding is based on a combination of factors including: The 
particular importance of these contracts in the price discovery process 
for their respective underlying commodities, the fact that they require 
physical delivery of the underlying commodity, and, in some cases, the 
commodities' particular importance to the national economy and 
especially acute economic burdens on interstate commerce that would 
arise from excessive speculation causing sudden or unreasonable 
fluctuations or unwarranted changes in the price of the commodities 
underlying these contracts.\18\
---------------------------------------------------------------------------

    \17\ See infra Section III.F.
    \18\ See infra Section III.F.1.
---------------------------------------------------------------------------

    Third, the Commission preliminarily believes that there is an 
opportunity for greater collaboration between the Commission and the 
exchanges within the statutorily created parallel federal and exchange-
set position limit regimes. Given the exchanges' self-regulatory 
responsibilities, resources, deep knowledge of their markets and 
trading practices, close interactions with market participants, 
existing programs for addressing exemption requests, and ability to 
generally act more quickly than the Commission, the Commission 
preliminarily believes that cooperation between the Commission and the 
exchanges on position limits should not only be continued, but 
enhanced. For example, exchanges are particularly well-positioned to 
provide the Commission with estimates of deliverable supply, to 
recommend limit levels for the Commission's consideration, and to help 
administer the program for recognizing bona fide hedges. Further, given 
that the Commission is proposing to require exchanges to collect, and 
provide to the Commission upon request, cash-market information from 
market participants requesting bona fide hedges, the Commission also 
proposes to eliminate Form 204, which market participants with bona 
fide hedging positions in excess of limits currently file each month 
with the Commission to demonstrate cash-market positions justifying 
such overages. The Commission preliminarily believes that enhanced 
collaboration will maintain the Commission's access to information and 
result in a more efficient administrative process, in part by reducing 
duplication of efforts. The Commission invites comments on all aspects 
of this rulemaking.

B. Executive Summary

    This executive summary provides an overview of the key components 
of this proposal. The summary only highlights certain aspects of the 
proposed regulations and generally uses shorthand to summarize complex 
topics. The executive summary is neither intended to be a comprehensive 
recitation of the proposal nor intended to supplement, modify, or 
replace any interpretive or other language contained herein. Section II 
of this release includes a more detailed and comprehensive discussion 
of all of the proposed regulations, and Section V includes the actual 
regulations.
1. Contracts Subject to Federal Speculative Position Limits
    Federal speculative position limits would apply to ``referenced 
contracts,'' which include: (a) 25 ``core referenced futures 
contracts;'' (b) futures and options directly or indirectly linked to a 
core referenced futures contract; and (c) ``economically equivalent 
swaps.''
a. Core Referenced Futures Contracts
    Federal speculative position limits would apply to the following 25 
physically-settled core referenced futures contracts:
---------------------------------------------------------------------------

    \19\ While the Commission is proposing federal non-spot month 
limits only for the nine legacy agricultural core referenced futures 
contracts, exchanges would be required to establish, consistent with 
Commission standards set forth in this proposal, exchange-set 
position limits and/or position accountability levels in the non-
spot months for the non-legacy agricultural, metals, and energy core 
referenced futures contracts.

------------------------------------------------------------------------
                                   Non-legacy
Legacy agricultural (federal      agricultural         Metals (federal
  limits during and outside   (federal limits only   limits only during
       the spot month)           during the spot       the spot month)
                                    month) 19
------------------------------------------------------------------------
CBOT Corn (C)...............  CBOT Rough Rice (RR)  COMEX Gold (GC).
CBOT Oats (O)...............  ICE Cocoa (CC)......  COMEX Silver (SI)
CBOT Soybeans (S)...........  ICE Coffee C (KC)...  COMEX Copper (HG).
CBOT Wheat (W)..............  ICE FCOJ-A (OJ).....  NYMEX Platinum (PL).
CBOT Soybean Oil (SO).......  ICE U.S. Sugar No.    NYMEX Palladium
                               11 (SB).              (PA).
------------------------------------------------------------------------
CBOT Soybean Meal (SM)......  ICE U.S. Sugar No.     Energy
                               16 (SF).             (federal limits only
                                                     during the spot
                                                     month)
------------------------------------------------------------------------
MGEX Hard Red Spring Wheat    CME Live Cattle (LC)  NYMEX Henry Hub
 (MWE).                                              Natural Gas (NG).
ICE Cotton No. 2 (CT).......                        NYMEX Light Sweet
                                                     Crude Oil (CL).
CBOT KC Hard Red Winter                             NYMEX New York
 Wheat (KW).                                         Harbor ULSD Heating
                                                     Oil (HO).
                                                    NYMEX New York
                                                     Harbor RBOB
                                                     Gasoline (RB).
------------------------------------------------------------------------

b. Futures and Options on Futures Linked to a Core Referenced Futures 
Contract
    Referenced contracts would also include futures and options on 
futures that are directly or indirectly linked to the price of a core 
referenced futures contract or to the same commodity underlying the 
applicable core referenced futures contract for delivery at the same 
location as specified in that core referenced futures contract. 
Referenced contracts, however, would not include location basis 
contracts, commodity index contracts, swap guarantees, and trade 
options that meet certain requirements.

[[Page 11599]]

c. Economically Equivalent Swaps
    Referenced contracts would also include economically equivalent 
swaps, which would be defined as swaps with ``identical material'' 
contractual specifications, terms, and conditions to a referenced 
contract. Swaps in commodities other than natural gas that have 
identical material specifications, terms, and conditions to a 
referenced contract, but differences in lot size specifications, 
notional amounts, or delivery dates diverging by less than one calendar 
day, would still be deemed economically equivalent swaps. Natural gas 
swaps that have identical material specifications, terms, and 
conditions to a referenced contract, but differences in lot size 
specifications, notional amounts, or delivery dates diverging by less 
than two calendar days, would still be deemed economically equivalent 
swaps.
2. Federal Limit Levels During the Spot Month
    Federal spot month limits would apply to referenced contracts on 
all 25 core referenced futures contracts. The following proposed spot 
month limit levels, summarized in the table below, are set at or below 
25 percent of deliverable supply, as estimated using recent data 
provided by the DCM listing the core referenced futures contract, and 
verified by the Commission. The proposed spot month limits would apply 
on a futures-equivalent basis based on the size of the unit of trading 
of the relevant core referenced futures contract, and would apply 
``separately'' to physically-settled and cash-settled referenced 
contracts. Therefore, a market participant could net positions across 
physically-settled referenced contracts, and separately could net 
positions across cash-settled referenced contracts, but would not be 
permitted to net cash-settled referenced contracts with physically-
settled referenced contracts.
---------------------------------------------------------------------------

    \20\ The proposed federal spot month limit for Live Cattle would 
feature a step-down limit similar to the CME's existing Live Cattle 
step-down exchange set limit. The proposed federal spot month step-
down limit is: (1) 600 at the close of trading on the first business 
day following the first Friday of the contract month; (2) 300 at the 
close of trading on the business day prior to the last five trading 
days of the contract month; and (3) 200 at the close of trading on 
the business day prior to the last two trading days of the contract 
month.
    \21\ The proposed federal spot month limit for Light Sweet Crude 
Oil would feature the following step-down limit: (1) 6,000 contracts 
as of the close of trading three business days prior to the last 
trading day of the contract; (2) 5,000 contracts as of the close of 
trading two business days prior to the last trading day of the 
contract; and (3) 4,000 contracts as of the close of trading one 
business day prior to the last trading day of the contract.

----------------------------------------------------------------------------------------------------------------
                                                                                              Existing exchange-
         Core referenced futures contract           2020 Proposed spot    Existing federal      set spot month
                                                       month limit        spot month limit          limit
----------------------------------------------------------------------------------------------------------------
                                          Legacy Agricultural Contracts
----------------------------------------------------------------------------------------------------------------
CBOT Corn (C)....................................                1,200                  600                  600
CBOT Oats (O)....................................                  600                  600                  600
CBOT Soybeans (S)................................                1,200                  600                  600
CBOT Soybean Meal (SM)...........................                1,500                  720                  720
CBOT Soybean Oil (SO)............................                1,100                  540                  540
CBOT Wheat (W)...................................                1,200                  600  600/500/400/300/220
CBOT KC Hard Red Winter Wheat (KW)...............                1,200                  600                  600
MGEX Hard Red Spring Wheat (MWE).................                1,200                  600                  600
ICE Cotton No. 2 (CT)............................                1,800                  300                  300
----------------------------------------------------------------------------------------------------------------
                                          Other Agricultural Contracts
----------------------------------------------------------------------------------------------------------------
CME Live Cattle (LC).............................       20 600/300/200                  n/a          450/300/200
CBOT Rough Rice (RR).............................                  800                  n/a          600/200/250
ICE Cocoa (CC)...................................                4,900                  n/a                1,000
ICE Coffee C (KC)................................                1,700                  n/a                  500
ICE FCOJ-A (OJ)..................................                2,200                  n/a                  300
ICE U.S. Sugar No. 11 (SB).......................               25,800                  n/a                5,000
ICE U.S. Sugar No. 16 (SF).......................                6,400                  n/a                  n/a
----------------------------------------------------------------------------------------------------------------
                                                Metals Contracts
----------------------------------------------------------------------------------------------------------------
COMEX Gold (GC)..................................                6,000                  n/a                3,000
COMEX Silver (SI)................................                3,000                  n/a                1,500
COMEX Copper (HG)................................                1,000                  n/a                1,500
NYMEX Platinum (PL)..............................                  500                  n/a                  500
NYMEX Palladium (PA).............................                   50                  n/a                   50
----------------------------------------------------------------------------------------------------------------
                                                Energy Contracts
----------------------------------------------------------------------------------------------------------------
NYMEX Henry Hub Natural Gas (NG).................                2,000                  n/a                1,000
NYMEX Light Sweet Crude Oil (CL).................      21 6,000/5,000/                  n/a                3,000
                                                                 4,000
NYMEX New York Harbor ULSD Heating Oil (HO)......                2,000                  n/a                1,000
NYMEX New York Harbor RBOB Gasoline (RB).........                2,000                  n/a                1,000
----------------------------------------------------------------------------------------------------------------

3. Federal Limit Levels Outside of the Spot Month
    Federal limits outside of the spot month would apply only to 
referenced contracts based on the nine legacy agricultural commodities 
subject to existing federal limits. All other referenced contracts 
subject to federal limits would be subject to federal limits only 
during the spot month, as specified above, and otherwise would only be 
subject to exchange-set limits and/or position accountability levels 
outside of the spot month.

[[Page 11600]]

    The following proposed non-spot month limit levels, summarized in 
the table below, are set at 10 percent of open interest for the first 
50,000 contracts, with an incremental increase of 2.5 percent of open 
interest thereafter, and would apply on a futures-equivalent basis 
based on the size of the unit of trading of the relevant core 
referenced futures contract:

----------------------------------------------------------------------------------------------------------------
                                                           2020 Proposed     Existing federal  Existing exchange-
                                                          single month and   single month and   set single month
            Core referenced futures contract                 all-months        all-months-      and all-months-
                                                           combined limit     combined limit     combined limit
----------------------------------------------------------------------------------------------------------------
CBOT Corn (C)..........................................             57,800             33,000             33,000
CBOT Oats (O)..........................................              2,000              2,000              2,000
CBOT Soybean (S).......................................             27,300             15,000             15,000
CBOT Soybean Meal (SM).................................             16,900              6,500              6,500
CBOT Soybean Oil (SO)..................................             17,400              8,000              8,000
CBOT Wheat (W).........................................             19,300             12,000             12,000
CBOT KC HRW Wheat (KW).................................             12,000             12,000             12,000
MGEX HRS Wheat (MWE)...................................             12,000             12,000             12,000
ICE Cotton No. 2 (CT)..................................             11,900              5,000              5,000
----------------------------------------------------------------------------------------------------------------

4. Exchange-Set Limits and Exemptions Therefrom
a. Contracts Subject to Federal Limits
    An exchange that lists a contract subject to federal limits, as 
specified above, would be required to set its own limits for such 
contracts at a level that is no higher than the federal level. 
Exchanges would be allowed to grant exemptions from their own limits, 
provided the exemption does not subvert the federal limits 
framework.\22\
---------------------------------------------------------------------------

    \22\ In addition, as explained further below, exchanges may 
choose to participate in the Commission's new proposed streamlined 
process for reviewing bona fide hedge exemption applications for 
purposes of federal limits.
---------------------------------------------------------------------------

b. Physical Commodity Contracts Not Subject to Federal Limits
    For physical commodity contracts not subject to federal limits, an 
exchange would generally be required to set spot month limits no 
greater than 25 percent of deliverable supply, but would have 
flexibility to submit other approaches for review by the Commission, 
provided the approach results in spot month levels that are ``necessary 
and appropriate to reduce the potential threat of market manipulation 
or price distortion of the contract's or the underlying commodity's 
price or index'' and complies with all other applicable regulations.
    Outside of the spot month, such an exchange would have additional 
flexibility to set either position limits or position accountability 
levels, provided the levels are ``necessary and appropriate to reduce 
the potential threat of market manipulation or price distortion of the 
contract's or the underlying commodity's price or index.'' Non-
exclusive Acceptable Practices would provide several examples of 
formulas that the Commission has determined would meet this standard, 
but an exchange would have the flexibility to develop other approaches.
    Exchanges would be provided flexibility to grant a variety of 
exemption types, provided that the exchange must take into account 
whether the exemption would result in a position that would not be in 
accord with ``sound commercial practices'' in the market for which the 
exchange is considering the application, and/or would ``exceed an 
amount that may be established and liquidated in an orderly fashion in 
that market.''
5. Limits on ``Pre-Existing Positions''
    Certain ``Pre-Existing Positions'' that were entered into prior to 
the effective date of final position limits rules would not be subject 
to federal limits. Both ``Pre-Enactment Swaps,'' which are swaps 
entered into prior to the Dodd-Frank Act whose terms have not expired, 
and ``Transition Period Swaps,'' which are swaps entered into between 
July 22, 2010 and 60 days after the publication of final position 
limits rules, would not be subject to federal limits. All other ``Pre-
Existing Positions'' that are acquired in good faith prior to the 
effective date of final position limits rules would be subject to 
federal limits during, but not outside, the spot month.
6. Substantive Standards for Exemptions From Federal Limits
a. Bona Fide Hedge Recognition
    Hedging transactions or positions may continue to exceed federal 
limits if they satisfy all three elements of the ``general'' bona fide 
hedging definition: (1) The hedge represents a substitute for 
transactions or positions made at a later time in a physical marketing 
channel (``temporary substitute test''); (2) the hedge is economically 
appropriate to the reduction of risks in the conduct and management of 
a commercial enterprise (``economically appropriate test''); and (3) 
the hedge arises from the potential change in value of actual or 
anticipated assets, liabilities, or services (``change in value 
requirement''). The Commission proposes several changes to the existing 
bona fide hedging definition, including those described immediately 
below, and also proposes a streamlined process for granting bona fide 
hedge recognitions, described further below.
    First, for referenced contracts based on the 25 core referenced 
futures contracts listed in Sec.  150.2(d), the Commission would expand 
the current list of enumerated bona fide hedges to cover additional 
hedging practices included in the 2016 Reproposal, as well as hedges of 
anticipated merchandising.\23\ Persons who hold a bona fide hedging 
transaction or position in accordance with Sec.  150.1 in referenced 
contracts based on one of the 25 core referenced futures contracts and 
whose hedging practice is included in the list of enumerated hedges in 
Appendix A of part 150 would not be required to request prior approval 
from

[[Page 11601]]

the Commission to hold such bona fide hedge position. That is, such 
exemptions would be self-effectuating for purposes of federal 
speculative position limits, so a person would only be required to 
request the bona fide hedge exemption from the relevant exchange for 
purposes of exchange-set limits. Transactions or positions that do not 
fit within one of the enumerated hedges could still be recognized as a 
bona fide hedge, provided the Commission, or an exchange subject to 
Commission oversight, recognizes the position as such using one of the 
processes described below. The Commission would be open to adopting 
additional enumerated hedges as it becomes more comfortable with 
evolving hedging practices, particularly in the energy space, and 
provided the practices comply with the general bona fide hedging 
definition.
---------------------------------------------------------------------------

    \23\ The existing definition of ``bona fide hedging transactions 
and positions'' enumerates the following hedging transactions: (1) 
Hedges of inventory and cash commodity fixed-price purchase 
contracts under 1.3(z)(2)(i)(A); (2) hedges of unsold anticipated 
production under 1.3(z)(2)(i)(B); (3) hedges of cash commodity 
fixed-price sales contracts under 1.3(z)(2)(ii)(A); (4) certain 
cross-commodity hedges under 1.3(z)(2)(ii)(B); (5) hedges of 
unfilled anticipated requirements under 1.3(z)(2)(ii)(C) and (6) 
hedges of offsetting unfixed price cash commodity sales and 
purchases under 1.3(z)(2)(iii). The following additional hedging 
practices are not enumerated in the existing regulation, but are 
included as enumerated hedges in the 2020 Proposal: (1) Hedges by 
agents; (2) hedges of anticipated royalties; (3) hedges of services; 
(4) offsets of commodity trade options; and (5) hedges of 
anticipated merchandising.
---------------------------------------------------------------------------

    Second, the Commission is clarifying its position on whether and 
when market participants may measure risk on a gross basis rather than 
on a net basis in order to provide market participants with greater 
flexibility. Instead of only being permitted to hedge on a ``net 
basis'' except in a narrow set of circumstances, market participants 
would also now be able to hedge positions on a ``gross basis'' in 
certain circumstances, provided that the participant has done so over 
time in a consistent manner and is not doing so to evade the federal 
limits.
    Third, market participants would have additional leeway to hold 
bona fide hedging positions in excess of limits during the last five 
days of the spot period (or during the time period for the spot month 
if less than five days). The proposal would not include such a 
restriction for purposes of federal limits, and would make clear that 
exchanges continue to have the discretion to adopt such restrictions 
for purposes of exchange-set limits. The proposal would also include 
flexible guidance on the circumstances under which exchanges may waive 
any such limitation for purposes of their own limits.
    Finally, the proposal would modify the ``temporary substitute 
test'' to require that a bona fide hedging transaction or position in a 
physical commodity must always, and not just normally, be connected to 
the production, sale, or use of a physical cash-market commodity. 
Therefore, a market participant would generally no longer be allowed to 
treat positions entered into for ``risk management purposes'' \24\ as a 
bona fide hedge, unless the position qualifies as either (i) an offset 
of a pass-through swap, where the offset reduces price risk attendant 
to a pass-through swap executed opposite a counterparty for whom the 
swap qualifies as a bona fide hedge; or (ii) a ``swap offset,'' where 
the offset is used by a counterparty to reduce price risk attendant to 
a swap that qualifies as a bona fide hedge and that was previously 
entered into by that counterparty.
---------------------------------------------------------------------------

    \24\ The phrase ``risk management'' as used in this instance 
refers to derivatives positions, typically held by a swap dealer, 
used to offset a swap position, such as a commodity index swap, with 
another entity for which that swap is not a bona fide hedge.
---------------------------------------------------------------------------

b. Spread Exemption
    Transactions or positions may also continue to exceed federal 
limits if they qualify as a ``spread transaction,'' which includes the 
following common types of spreads: Calendar spreads, inter-commodity 
spreads, quality differential spreads, processing spreads (such as 
energy ``crack'' or soybean ``crush'' spreads), product or by-product 
differential spreads, or futures-option spreads. Spread exemptions may 
be granted using the process described below.
c. Financial Distress Exemption
    This exemption would allow a market participant to exceed federal 
limits if necessary to take on the positions and associated risk of 
another market participant during a potential default or bankruptcy 
situation. This exemption would be available on a case-by-case basis, 
depending on the facts and circumstances involved.
d. Conditional Spot Month Limit Exemption in Natural Gas
    The rules would allow market participants with cash-settled 
positions in natural gas to exceed the proposed 2,000 contract spot 
month limit, provided that the participant exits its spot month 
positions in the New York Mercantile Exchange (``NYMEX'') Henry Hub 
(NG) physically-settled natural gas contracts, and provided further 
that the participant's position in cash-settled natural gas contracts 
does not exceed 10,000 NYMEX Henry Hub Natural Gas (NG) equivalent-size 
natural gas contracts per DCM that lists a natural gas referenced 
contract. Such market participants would be permitted to hold an 
additional 10,000 contracts in cash-settled natural gas economically 
equivalent swaps.
7. Process for Requesting Bona Fide Hedge Recognitions and Spread 
Exemptions
a. Self-Effectuating Enumerated Bona Fide Hedges
    For referenced contracts based on any core referenced futures 
contract listed in Sec.  150.2(d), bona fide hedge recognitions for 
positions that fall within one of the proposed enumerated hedges, 
including the proposed anticipatory enumerated hedges, would be self-
effectuating for purposes of federal limits, provided the market 
participant separately applies to the relevant exchange for an 
exemption from exchange-set limits. Such market participants would no 
longer be required to file Form 204/304 with the Commission on a 
monthly basis to demonstrate cash-market positions justifying position 
limit overages. Instead, the Commission would have access to cash-
market information such market participants submit as part of their 
application to an exchange for an exemption from exchanges-set limits, 
typically filed on an annual basis.
b. Bona Fide Hedges That Are Not Self-Effectuating
    The Commission will consider adding to the proposed list of 
enumerated hedges at a later time once the Commission becomes more 
familiar with common commercial hedging practices for referenced 
contracts subject to federal position limits. Until that time, all bona 
fide hedging recognitions that are not enumerated in Appendix A of part 
150 would be granted pursuant to one of the proposed processes for 
requesting a non-enumerated bona fide hedge recognition, as explained 
below.
    A market participant seeking to exceed federal limits for a non-
enumerated bona fide hedging transaction or position would be able to 
choose whether to apply directly to the Commission or, alternatively, 
apply to the applicable exchange using a new proposed streamlined 
process. If applying directly to the Commission, the market participant 
would also have to separately apply to the relevant exchange for relief 
from exchange-set position limits. If applying to an exchange using the 
new proposed streamlined process, a market participant would be able to 
file an application with an exchange, generally at least annually, 
which would be valid both for purposes of federal and exchange-set 
limits. Under this streamlined process, if the exchange determines to 
grant a non-enumerated bona fide hedge recognition for purposes of its 
exchange-set limits, the

[[Page 11602]]

exchange must notify the Commission and the applicant simultaneously. 
Then, 10 business days (or two business days in the case of sudden or 
unforeseen bona fide hedging needs) after the exchange issues such a 
determination, the market participant could rely on the exchange's 
determination for purposes of federal limits unless the Commission (and 
not staff) notifies the market participant otherwise. After the 10 
business days expire, the bona fide hedge exemption would be valid both 
for purposes of federal and exchange position limits and the market 
participant would be able to take on a position that exceeds federal 
position limits. Under this streamlined process, during the 10 business 
day review period, any rejection of an exchange determination would 
require Commission action. Further, if, for purposes of federal 
position limits, the Commission determines to reject an application for 
exemption, the applicant would not be subject to any position limits 
violation during the period of the Commission's review nor once the 
Commission has issued its rejection, provided the person reduces the 
position within a commercially reasonable amount of time, as 
applicable.
    Under the proposal, positions that do not fall within one of the 
enumerated hedges could thus still be recognized as bona fide hedges, 
provided the exchange deems the position to comply with the general 
bona fide hedging definition, and provided that the Commission does not 
object to such a hedge within the ten-day (or two-day, as appropriate) 
window.
    Requests and approvals to exceed limits would generally have to be 
obtained in advance of taking on the position, but the proposed rule 
would allow market participants with sudden or unforeseen hedging needs 
to file a request for a bona fide hedge exemption within five business 
days of exceeding the limit. If the Commission rejects the application, 
the market participant would not be subject to a position limit 
violation, provided the participant reduces its position within a 
commercially reasonable amount of time.
    Among other changes, market participants would also no longer be 
required to file Form 204/304 with the Commission on a monthly basis to 
demonstrate cash-market positions justifying position limit overages.
c. Spread Exemptions
    For referenced contracts on any commodity, spread exemptions would 
be self-effectuating for purposes of federal limits, provided that the 
position: Falls within one of the categories set forth in the proposed 
``spread transaction'' definition,\25\ and provided further that the 
market participant separately applies to the applicable exchange for an 
exemption from exchange-set limits.
---------------------------------------------------------------------------

    \25\ The categories are: Calendar spreads, inter-commodity 
spreads, quality differential spreads, processing spreads (such as 
energy ``crack'' or soybean ``crush'' spreads), product or by-
product differential spreads, and futures-option spreads.
---------------------------------------------------------------------------

    Market participants with a spread position that does not fit within 
the ``spread transaction'' definition with respect to any of the 
commodities subject to the proposed federal limits may apply directly 
to the Commission, and must also separately apply to the applicable 
exchange.
8. Comment Period and Compliance Date
    The public may comment on these rules during a 90-day period that 
starts after this proposal has been approved by the Commission. Market 
participants and exchanges would be required to comply with any 
position limit rules finalized from herein no later than 365 days after 
publication in the Federal Register.

C. Summary of Proposed Amendments

    The Commission is proposing revisions to Sec. Sec.  150.1, 150.2, 
150.3, 150.5, and 150.6 and to parts 1, 15, 17, 19, 40, and 140, as 
well as the addition of Sec. Sec.  150.8, 150.9, and Appendices A-F to 
part 150.\26\ Most noteworthy, the Commission proposes the following 
amendments to the foregoing rule sections, each of which, along with 
all other proposed changes, is discussed in greater detail in Section 
II of this release. The following summary is not intended to provide a 
substantive overview of this proposal, but rather is intended to 
provide a guide to the rule sections that address each topic. Please 
see the executive summary above for an overview of this proposal 
organized by topic, rather than by section number.
---------------------------------------------------------------------------

    \26\ This 2020 Proposal does not propose to amend current Sec.  
150.4 dealing with aggregation of positions for purposes of 
compliance with federal position limits. Section 150.4 was amended 
in 2016 in a prior rulemaking. See Final Aggregation Rulemaking, 81 
FR at 91454.
---------------------------------------------------------------------------

     The Commission preliminarily finds that federal 
speculative position limits are necessary for 25 core referenced 
futures contracts and proposes federal limits on physically-settled and 
linked cash-settled futures, options on futures, and ``economically 
equivalent'' swaps for such commodities. The 25 core referenced futures 
contracts would include the nine ``legacy'' agricultural contracts 
currently subject to federal limits and 16 additional non-legacy 
contracts, which would include: seven additional agricultural 
contracts, four energy contracts, and five metals contracts.\27\ 
Federal spot and non-spot month limits would apply to the nine 
``legacy'' agricultural contracts currently subject to federal 
limits,\28\ and only federal spot month limits would apply to the 
additional 16 non-legacy contracts. Outside of the spot month, these 16 
non-legacy contracts would be subject to exchange-set limits and/or 
accountability levels if listed on an exchange.
---------------------------------------------------------------------------

    \27\ The seven additional agricultural contracts that would be 
subject to federal spot month limits are CME Live Cattle (LC), CBOT 
Rough Rice (RR), ICE Cocoa (CC), ICE Coffee C (KC), ICE FCOJ-A (OJ), 
ICE U.S. Sugar No. 11 (SB), and ICE U.S. Sugar No. 16 (SF). The four 
energy contracts that would be subject to federal spot month limits 
are: NYMEX Light Sweet Crude Oil (CL), NYMEX New York Harbor ULSD 
Heating Oil (HO), NYMEX New York Harbor RBOB Gasoline (RB), and 
NYMEX Henry Hub Natural Gas (NG). The five metals contracts that 
would be subject to federal spot month limits are: COMEX Gold (GC), 
COMEX Silver (SI), COMEX Copper (HG), NYMEX Palladium (PA), and 
NYMEX Platinum (PL). As discussed below, any contracts for which the 
Commission is proposing federal limits only during the spot month 
would be subject to exchange-set limits and/or accountability 
outside of the spot month.
    \28\ The Commission currently sets and enforces speculative 
position limits with respect to certain enumerated agricultural 
products. The ``enumerated'' agricultural products refer to the list 
of commodities contained in the definition of ``commodity'' in CEA 
section 1a; 7 U.S.C. 1a. These agricultural products consist of the 
following nine currently traded contracts: CBOT Corn (and Mini-Corn) 
(C), CBOT Oats (O), CBOT Soybeans (and Mini-Soybeans) (S), CBOT 
Wheat (and Mini-Wheat) (W), CBOT Soybean Oil (SO), CBOT Soybean Meal 
(SM), MGEX HRS Wheat (MWE), CBOT KC HRW Wheat (KW), and ICE Cotton 
No. 2 (CT). See 17 CFR 150.2.
---------------------------------------------------------------------------

     Amendments to Sec.  150.1 would add or revise several 
definitions for use throughout part 150, including: new definitions of 
the terms ``core referenced futures contract'' (pertaining to the 25 
physically-settled futures contracts explicitly listed in the 
regulations) and ``referenced contract'' (pertaining to contracts that 
have certain direct and/or indirect linkages to the core referenced 
futures contracts, and to ``economically equivalent swaps'') to be used 
as shorthand to refer to contracts subject to federal limits; a 
``spread transaction'' definition; and a definition of ``bona fide 
hedging transactions or positions'' that is broad enough to accommodate 
hedging practices in a variety of contract types, including hedging 
practices that may develop over time.
     Amendments to Sec.  150.2 would list the 25 core 
referenced futures contracts which, along with any associated 
referenced contracts, would be subject

[[Page 11603]]

to federal limits; and specify the proposed federal spot and non-spot 
month limit levels. Federal spot month limit levels would be set at or 
below 25 percent of deliverable supply, whereas federal non-spot month 
limit levels would be set at 10 percent of open interest for the first 
50,000 contracts of open interest, with an incremental increase of 2.5 
percent of open interest thereafter.
     Amendments to Sec.  150.3 would specify the types of 
positions for which exemptions from federal position limit requirements 
may be granted, and would set forth and/or reference the processes for 
requesting such exemptions, including recognitions of bona fide hedges 
and exemptions for spread positions, financial distress positions, 
certain natural gas positions held during the spot month, and pre-
enactment and transition period swaps. For all contracts subject to 
federal limits, bona fide hedge exemptions listed in Appendix A to part 
150 as an enumerated bona fide hedge would be self-effectuating for 
purposes of federal limits. For non-enumerated hedges, market 
participants must request approval in advance of taking a position that 
exceeds the federal position limit, except in the case of sudden or 
unforeseen hedging needs.
     Amendments to Sec.  150.5 would refine the process, and 
establish non-exclusive methodologies, by which exchanges may set 
exchange-level limits and grant exemptions therefrom with respect to 
futures and options on futures, including separate methodologies for 
contracts subject to federal limits and physical commodity derivatives 
not subject to federal limits.\29\ While the Commission will oversee 
compliance with federal position limits on swaps, amended Sec.  150.5 
would not apply to exchanges with respect to swaps until a later time 
once exchanges have access to sufficient data to monitor compliance 
with limits on swaps across exchanges.
---------------------------------------------------------------------------

    \29\ Proposed Sec.  150.5 addresses exchange-set position limits 
and exemptions therefrom, whereas proposed Sec.  150.3 addresses 
exemptions from federal limits, and proposed Sec.  150.9 addresses 
federal limits and acceptance of exchange-granted bona fide hedging 
recognitions for purposes of federal limits. Exchange rules 
typically refer to ``exemptions'' in connection with bona fide 
hedging and spread positions, whereas the Commission uses the 
nomenclature ``recognition'' with respect to bona fide hedges, and 
``exemption'' with respect to spreads.
---------------------------------------------------------------------------

     New Sec.  150.9 would establish a streamlined process for 
addressing requests for bona fide hedging recognitions for purposes of 
federal limits, leveraging off exchange expertise and resources while 
affording the Commission an opportunity to intervene as-needed. This 
process would be used by market participants with non-enumerated 
positions. Under the proposed rule, market participants could provide 
one application for a bona fide hedge to a designated contract market 
or swap execution facility, as applicable, and receive approval of such 
request for purposes of both exchange-set limits and federal limits.
     New Appendix A to part 150 would contain enumerated 
hedges, some of which appear in the definition of bona fide hedging 
transactions and positions in current Sec.  1.3, which would be 
examples of positions that would comply with the proposed bona fide 
hedging definition. As the enumerated hedges would be examples of bona 
fide hedging positions, positions that do not fall within any of the 
enumerated hedges could still potentially be recognized as bona fide 
hedging positions, provided the position otherwise complies with the 
proposed bona fide hedging definition and all other applicable 
requirements.
     Amendments to part 19 and related provisions would 
eliminate Form 204, enabling the Commission to leverage cash-market 
reporting submitted directly to the exchanges under Sec. Sec.  150.5 
and 150.9.

D. The Commission Preliminarily Construes CEA Section 4a(a) To Require 
the Commission To Make a Necessity Finding Before Establishing Position 
Limits for Physical Commodities Other Than Excluded Commodities

    The Commission is required by ISDA to determine whether CEA section 
4a(a)(2)(A) requires the Commission to find, before establishing a 
position limit, that such limit is ``necessary.'' \30\ The provision 
states in relevant part that ``the Commission shall'' establish 
position limits ``as appropriate'' for contracts in physical 
commodities other than excluded commodities ``[i]n accordance with the 
standards set forth in'' the preexisting section 4a(a)(1).\31\ That 
preexisting provision requires the Commission to establish position 
limits as it ``finds are necessary to diminish, eliminate, or prevent'' 
certain enumerated burdens on interstate commerce.\32\ In the 2011 
Final Rulemaking, the Commission interpreted this language as an 
unambiguous mandate to establish position limits without first finding 
that such limits are necessary, but with discretion to determine the 
``appropriate'' levels for each.\33\ In ISDA, the U.S. District Court 
for the District of Columbia disagreed and held that section 
4a(a)(2)(A) is ambiguous as to whether the ``standards set forth in 
paragraph (1)'' include the requirement of an antecedent finding that a 
position limit is necessary.\34\ The court vacated the 2011 Final 
Rulemaking and directed the Commission to apply its experience and 
expertise to resolve that ambiguity.\35\ The Commission has done so and 
preliminarily determines that section 4a(a)(2)(A) should be interpreted 
to require that before establishing position limits, the Commission 
must determine that limits are necessary.\36\ A full legal analysis is 
set forth infra at Section III.F.
---------------------------------------------------------------------------

    \30\ ISDA, 887 F.Supp.2d at 259, 281.
    \31\ 7 U.S.C. 6a(a)(2)(A).
    \32\ 7 U.S.C. 6a(a)(1).
    \33\ 2011 Final Rulemaking, 76 FR at 71626, 71627.
    \34\ ISDA, 887 F.Supp.2d at 279-280.
    \35\ Id. at 281.
    \36\ See infra Section III.F.
---------------------------------------------------------------------------

    The Commission preliminarily finds that position limits are 
necessary for the 25 core referenced futures contracts, and any 
associated referenced contracts. This preliminary finding is based on a 
combination of factors including: The particular importance of these 
contracts in the price discovery process for their respective 
underlying commodities, the fact that they require physical delivery of 
the underlying commodity, and, in some cases, the commodities' 
particular importance to the national economy and especially acute 
economic burdens that would arise from excessive speculation causing 
sudden or unreasonable fluctuations or unwarranted changes in the price 
of the commodities underlying these contracts.

II. Proposed Rules

A. Sec.  150.1--Definitions

    Definitions relevant to the existing position limits regime 
currently appear in both Sec. Sec.  1.3 and 150.1 of the Commission's 
regulations.\37\ The Commission proposes to update and supplement the 
definitions in Sec.  150.1, including by moving a revised definition of 
``bona fide hedging transactions and positions'' from Sec.  1.3 into 
Sec.  150.1. The proposed changes are intended, among other things, to 
conform the definitions to the Dodd-Frank Act amendments to the 
CEA.\38\

[[Page 11604]]

Each proposed defined term is discussed in alphabetical order below.
---------------------------------------------------------------------------

    \37\ 17 CFR 1.3 and 150.1, respectively.
    \38\ In addition to the amendments described below, the 
Commission proposes to re-order the defined terms so that they 
appear in alphabetical order, rather than in a lettered list, so 
that terms can be more quickly located. Moving forward, any new 
defined terms would be inserted in alphabetical order, as 
recommended by the Office of the Federal Register. See Document 
Drafting Handbook, Office of the Federal Register, National Archives 
and Records Administration, 2-31 (Revision 5, Oct. 2, 2017) 
(stating, ``[i]n sections or paragraphs containing only definitions, 
we recommend that you do not use paragraph designations if you list 
the terms in alphabetical order. Begin the definition paragraph with 
the term that you are defining.'').
---------------------------------------------------------------------------

1. ``Bona Fide Hedging Transactions or Positions''
a. Background
    Under CEA section 4a(c)(1), position limits shall not apply to 
transactions or positions that are ``shown to be bona fide hedging 
transactions or positions, as such terms shall be defined by the 
Commission . . . .'' \39\ The Dodd-Frank Act directed the Commission, 
for purposes of implementing CEA section 4a(a)(2), to adopt a 
definition consistent with CEA section 4a(c)(2).\40\ The current 
definition of ``bona fide hedging transactions and positions,'' which 
first appeared in Sec.  1.3 of the Commission's regulations in the 
1970s,\41\ is inconsistent, in certain ways described below, with the 
revised statutory definition in CEA section 4a(c)(2).
---------------------------------------------------------------------------

    \39\ 7 U.S.C. 6a(c)(1). While portions of the CEA and proposed 
Sec.  150.1 respectively refer, and would refer, to the phrase 
``bona fide hedging transactions or positions,'' the Commission may 
use the phrases ``bona fide hedging position,'' ``bona fide hedging 
definition,'' and ``bona fide hedge'' throughout this section of the 
release as shorthand to refer to the same.
    \40\ 7 U.S.C. 6a(c)(2).
    \41\ See, e.g., Definition of Bona Fide Hedging and Related 
Reporting Requirements, 42 FR 42748 (Aug. 24, 1977). Previously, the 
Secretary of Agriculture, pursuant to section 404 of the Commodity 
Futures Trading Commission Act of 1974 (Pub. L. 93-463), promulgated 
a definition of bona fide hedging transactions and positions. 
Hedging Definition, Reports, and Conforming Amendments, 40 FR 11560 
(Mar. 12, 1975). That definition, largely reflecting the statutory 
definition previously in effect, remained in effect until the newly-
established Commission defined that term. Id.
---------------------------------------------------------------------------

    Accordingly, and for the reasons outlined below, the Commission 
proposes to remove the current bona fide hedging definition from Sec.  
1.3 and replace it with an updated bona fide hedging definition that 
would appear alongside all of the other position limits related 
definitions in proposed Sec.  150.1.\42\ This definition would be 
applied in determining whether a position is a bona fide hedge that may 
exceed the proposed federal limits set forth in Sec.  150.2. The 
Commission's current bona fide hedging definition is described 
immediately below, followed by a discussion of the proposed new 
definition. This section of the release describes the substantive 
standards for bona fide hedges. The process for granting bona fide 
hedge recognitions is discussed later in this release in connection 
with proposed Sec. Sec.  150.3 and 150.9.\43\
---------------------------------------------------------------------------

    \42\ In a 2018 rulemaking, the Commission amended Sec.  1.3 to 
replace the sub-paragraphs that had for years been identified with 
an alphabetic designation for each defined term with an alphabetized 
list. See Definitions, 83 FR 7979 (Feb. 23, 2018). The bona fide 
hedging definition, therefore, is now a paragraph, located in 
alphabetical order, in Sec.  1.3, rather than in Sec.  1.3(z). 
Accordingly, for purposes of clarity and ease of discussion, when 
discussing the Commission's current version of the bona fide hedging 
definition, this release will refer to the bona fide hedging 
definition in Sec.  1.3.
    Further, the version of Sec.  1.3 that appears in the Code of 
Federal Regulations applies only to excluded commodities and is not 
the version of the bona fide hedging definition currently in effect. 
The version currently in effect, the substance of which remains as 
it was amended in 1987, applies to all commodities, not just to 
excluded commodities. See Revision of Federal Speculative Position 
Limits, 52 FR 38914 (Oct. 20, 1987). While the 2011 Final Rulemaking 
amended the Sec.  1.3 bona fide hedging definition to apply only to 
excluded commodities, that rulemaking was vacated, as noted 
previously, by a September 28, 2012 order of the U.S. District Court 
for the District of Columbia, with the exception of the rule's 
amendments to 17 CFR 150.2. Although the 2011 Final Rulemaking was 
vacated, the 2011 version of the bona fide hedging definition in 
Sec.  1.3, which applied only to excluded commodities, has not yet 
been formally removed from the Code of Federal Regulations. The 
currently-in-effect version of the Commission's bona fide hedging 
definition thus does not currently appear in the Code of Federal 
Regulations. The closest to a ``current'' version of the definition 
is the 2010 version of Sec.  1.3, which, while substantively 
current, still includes the ``(z)'' denomination that was removed in 
2018. The Commission proposes to address the need to formally remove 
the incorrect version of the bona fide hedging definition as part of 
this rulemaking.
    \43\ See infra Section II.C.2. (discussion of proposed Sec.  
150.3) and Section II.G.3. (discussion of proposed Sec.  150.9).
---------------------------------------------------------------------------

b. The Commission's Existing Bona Fide Hedging Definition in Sec.  1.3
    Paragraph (1) of the current bona fide hedging definition in Sec.  
1.3 contains what is currently labeled the ``general'' bona fide 
hedging definition, which has five key elements and requires that the 
position must: (1) ``normally'' represent a substitute for transactions 
or positions made at a later time in a physical marketing channel 
(``temporary substitute test''); (2) be economically appropriate to the 
reduction of risks in the conduct and management of a commercial 
enterprise (``economically appropriate test''); (3) arise from the 
potential change in value of actual or anticipated assets, liabilities, 
or services (``change in value requirement''); (4) have a purpose to 
offset price risks incidental to commercial cash or spot operations 
(``incidental test''); and (5) be established and liquidated in an 
orderly manner (``orderly trading requirement'').\44\
---------------------------------------------------------------------------

    \44\ 17 CFR 1.3.
---------------------------------------------------------------------------

    Additionally, paragraph (2) currently sets forth a non-exclusive 
list of four categories of ``enumerated'' hedging transactions that are 
included in the general bona fide hedging definition in paragraph (1). 
Market participants thus need not seek recognition from the Commission 
of such positions as bona fide hedges prior to exceeding limits for 
such positions; rather, market participants must simply report any such 
positions on the monthly Form 204, as required by part 19 of the 
Commission's regulations.\45\ The four existing categories of 
enumerated hedges are: (1) Hedges of ownership or fixed-price cash 
commodity purchases and hedges of unsold anticipated production; (2) 
hedges of fixed-price cash commodity sales and hedges of unfilled 
anticipated requirements; (3) hedges of offsetting unfixed-price cash 
commodity sales and purchases; and (4) cross-commodity hedges.\46\
---------------------------------------------------------------------------

    \45\ 17 CFR part 19.
    \46\ 17 CFR 1.3.
---------------------------------------------------------------------------

    Paragraph (3) of the current bona fide hedging definition states 
that the Commission may recognize non-enumerated bona fide hedging 
transactions and positions pursuant to a specific request by a market 
participant using the process described in Sec.  1.47 of the 
Commission's regulations.\47\
---------------------------------------------------------------------------

    \47\ Id.
---------------------------------------------------------------------------

c. Proposed Replacement of the Bona Fide Hedging Definition in Sec.  
1.3 With a New Bona Fide Hedging Definition in Sec.  150.1
i. Background
    The list of enumerated hedges found in paragraph (2) of the current 
bona fide hedging definition in Sec.  1.3 was developed at a time when 
only agricultural commodities were subject to federal limits, has not 
been updated since 1987,\48\ and is likely too narrow to reflect common 
commercial hedging practices, including for metal and energy contracts. 
Numerous market and regulatory developments have taken place since 
then, including, among other things, increased futures trading in the 
metals and energy markets, the development of the swaps markets, and 
the shift in trading from pits to electronic platforms. In addition, 
the CFMA \49\ and Dodd-Frank Act introduced various regulatory reforms, 
including the enactment of position limits core principles.\50\ The 
Commission is thus proposing to update its bona fide hedging definition 
to better conform to the current state of the law

[[Page 11605]]

and to better reflect market developments over time.
---------------------------------------------------------------------------

    \48\ See Revision of Federal Speculative Position Limits, 52 FR 
38914 (Oct. 20, 1987).
    \49\ Commodity Futures Modernization Act of 2000, Public Law 
106-554, 114 Stat. 2763 (Dec. 21, 2000).
    \50\ See 7 U.S.C. 7(d)(5) and 7 U.S.C. 7b-3(f)(6).
---------------------------------------------------------------------------

    While one option for doing so could be to expand the list of 
enumerated hedges to encompass a larger array of hedging strategies, 
the Commission does not view this alone to be a practical solution. It 
would be difficult to maintain a list that captures all hedging 
activity across commodity types, and any list would inherently fail to 
take into account future changes in industry practices and other 
developments. The Commission proposes to create a new bona fide hedging 
definition in proposed Sec.  150.1 that would work in connection with 
limits on a variety of commodity types and accommodate changing hedging 
practices over time. The Commission proposes to couple this updated 
definition with an expanded list of enumerated hedges. While positions 
that fall within the proposed enumerated hedges, discussed below, would 
be examples of positions that comply with the bona fide hedging 
definition, they would certainly not be the only types of positions 
that could be bona fide hedges. The proposed enumerated hedges are 
intended to ensure that the framework proposed herein does not reduce 
any clarity inherent in the existing framework; the proposed enumerated 
hedges are in no way intended to limit the universe of hedging 
practices that could otherwise be recognized as bona fide.
    The Commission anticipates these proposed modifications would 
provide a significant degree of flexibility to market participants in 
terms of how they hedge, and to exchanges in terms of how they evaluate 
transactions and positions for purposes of their position limit 
programs, without sacrificing any of the clarity provided by the 
existing bona fide hedging definition. Further, as described in detail 
in connection with the discussion of proposed Sec.  150.9 later in this 
release, the Commission anticipates that allowing the exchanges to 
process applications for bona fide hedges for purposes of federal 
limits would be significantly more efficient than the existing 
processes for exchanges and the Commission.\51\ The Commission 
discusses each element of the proposed bona fide hedging definition 
below, followed by a discussion of the proposed enumerated hedges. The 
Commission's intent with this proposal is to acknowledge to the 
greatest extent possible, consistent with the statutory language, 
existing bona fide hedging exemptions provided by exchanges.
---------------------------------------------------------------------------

    \51\ In this rulemaking, the Commission proposes to allow 
qualifying exchanges to process requests for non-enumerated bona 
fide hedge recognitions for purposes of federal limits. See infra 
Section II.G.3. (discussion of proposed Sec.  150.9).
---------------------------------------------------------------------------

ii. Proposed Bona Fide Hedging Definition for Physical Commodities
    The Commission proposes to maintain the general elements currently 
found in the bona fide hedging definition in Sec.  1.3 that conform to 
the revised statutory bona fide hedging definition in CEA section 
4a(c)(2), and proposes to eliminate the elements that do not. In 
particular, the Commission proposes to include the updated versions of 
the temporary substitute test, economically appropriate test, and 
change in value requirements that are described below, and eliminate 
the incidental test and orderly trading requirement, which are not 
included in the revised statutory text. Each of these proposed changes 
is described below.\52\
---------------------------------------------------------------------------

    \52\ Bona fide hedge recognition is determined based on the 
particular circumstances of a position or transaction and is not 
conferred on the basis of the involved market participant alone. 
Accordingly, while a particular position may qualify as a bona fide 
hedge for a given market participant, another position held by that 
same participant may not. Similarly, if a participant holds 
positions that are recognized as bona fide hedges, and holds other 
positions that are speculative, only the speculative positions would 
be subject to position limits.
---------------------------------------------------------------------------

(1) Temporary Substitute Test
    The language of the temporary substitute test that appears in the 
Commission's existing bona fide hedging definition is inconsistent in 
some ways with the language of the temporary substitute test that 
currently appears in the statute. In particular, the bona fide hedging 
definition in section 4a(c)(2)(A)(i) of the CEA currently provides, 
among other things, that a bona fide hedging position ``represents a 
substitute for transactions made or to be made or positions taken or to 
be taken at a later time in a physical marketing channel.'' \53\ The 
Commission's definition currently provides that a bona fide hedging 
position ``normally represent[s] a substitute for transactions to be 
made or positions to be taken at a later time in a physical marketing 
channel'' (emphasis added).\54\ The Dodd-Frank Act amended the 
temporary substitute language that previously appeared in the statute 
by removing the word ``normally'' from the phrase ``normally represents 
a substitute for transactions made or to be made or positions taken or 
to be taken at a later time in a physical marketing channel. . . .'' 
\55\ The Commission preliminarily interprets this change as reflecting 
Congressional direction that a bona fide hedging position in physical 
commodities must always (and not just ``normally'') be in connection 
with the production, sale, or use of a physical cash-market 
commodity.\56\
---------------------------------------------------------------------------

    \53\ 7 U.S.C. 6a(c)(2)(A)(i).
    \54\ 17 CFR 1.3.
    \55\ 7 U.S.C. 6a(c)(2)(A)(i).
    \56\ Previously, the Commission stated that, among other things, 
the inclusion of the word ``normally'' in connection with the pre-
Dodd-Frank Act version of the temporary substitute language 
indicated that the bona fide hedging definition should not be 
construed to apply only to firms using futures to reduce their 
exposures to risks in the cash market, and that to qualify as a bona 
fide hedge, a transaction in the futures market did not necessarily 
need to be a temporary substitute for a later transaction in the 
cash market. See Clarification of Certain Aspects of the Hedging 
Definition, 52 FR 27195, 27196 (July 20, 1987). In other words, that 
1987 interpretation took the view that a futures position could 
still qualify as a bona fide hedging position even if it was not in 
connection with the production, sale, or use of a physical 
commodity.
---------------------------------------------------------------------------

    Accordingly, the Commission preliminarily interprets this change to 
signal that the Commission should cease to recognize ``risk 
management'' positions as bona fide hedges for physical commodities, 
unless the position satisfies the pass-through swap/swap offset 
requirements in section 4a(c)(2)(B) of the CEA, discussed further 
below.\57\ In order to implement that statutory change, the Commission 
proposes a narrower bona fide hedging definition for physical 
commodities in proposed Sec.  150.1 that does not include the word 
``normally'' currently found in the temporary substitute language in 
paragraph (1) of the existing Sec.  1.3 bona fide hedging definition.
---------------------------------------------------------------------------

    \57\ 7 U.S.C. 6a(c)(2)(B). In connection with physical 
commodities, the phrase ``risk management exemption'' has 
historically been used by Commission staff to refer to non-
enumerated bona fide hedge recognitions granted under Sec.  1.47 to 
allow swap dealers and others to hold agricultural futures positions 
outside of the spot month in excess of federal limits in order to 
offset commodity index swap or related exposure, typically opposite 
an institutional investor for which the swap was not a bona fide 
hedge. As described below, due to differences in statutory language, 
the phrase ``risk management exemption'' often has a broader meaning 
in connection with excluded commodities than with physical 
commodities. See infra Section II.A.1.c.v. (discussion of proposed 
pass-through language).
---------------------------------------------------------------------------

    The practical effect of conforming the temporary substitute test in 
the regulation to the amended statutory provision would be to prevent 
market participants from treating positions entered into for risk 
management purposes as bona fide hedges for contracts subject to 
federal limits, unless the position qualifies under the pass-through 
swap provision in CEA section 4a(c)(2)(B).\58\ As noted above,

[[Page 11606]]

the Commission previously viewed positions in physical commodities, 
entered into for risk management purposes to offset the risk of swaps 
and other financial instruments and not as substitutes for transactions 
or positions to be taken in a physical marketing channel, as bona fide 
hedges. However, given the statutory change, positions that reduce the 
risk of such swaps and financial instruments would no longer meet the 
requirements for a bona fide hedging position under CEA section 
4a(c)(2) and under proposed Sec.  150.1. As discussed below, any such 
previously-granted risk management exemptions would generally no longer 
apply after the effective date of the speculative position limits 
proposed herein.\59\ Further, retaining such exemptions for swap 
intermediaries, without regard to the purpose of their counterparty's 
swap, would be inconsistent with the statutory restrictions on pass-
through swap offsets, which require that the swap position being offset 
qualify as a bona fide hedging position.\60\ Aside from this change, 
the Commission is not proposing any other modifications to its existing 
temporary substitute test.
---------------------------------------------------------------------------

    \58\ 7 U.S.C. 6a(c)(2)(B). See infra Section II.A.1.c.v. 
(discussion of proposed pass-through language). Excluded 
commodities, as described in further detail below, are not subject 
to the statutory bona fide hedging definition. Accordingly, the 
statutory restrictions on risk management exemptions that apply to 
physical commodities subject to federal limits do not apply to 
excluded commodities.
    \59\ See infra Section II.C.2.g. (discussion of revoking 
existing risk management exemptions).
    \60\ See 7 U.S.C. 6a(c)(2)(B)(i). The pass-through swap offset 
language in the proposed bona fide hedging definition is discussed 
in greater detail below.
---------------------------------------------------------------------------

    While the Commission preliminarily interprets the Dodd-Frank 
amendments to the CEA as constraining the Commission from recognizing 
as bona fide hedges risk management positions involving physical 
commodities, the Commission has in part addressed the hedging needs of 
persons seeking to offset the risk from swap books by proposing the 
pass-through swap and pass-through swap offset provisions discussed 
below.
    The Commission observes that while ``risk management'' positions 
would not qualify as bona fide hedges, some other provisions in this 
proposal may provide flexibility for existing and prospective risk 
management exemption holders in a manner that comports with the 
statute. In particular, the Commission anticipates that the proposal to 
limit the applicability of federal non-spot month limits to the nine 
legacy agricultural contracts,\61\ coupled with the proposed adjustment 
to non-spot limit levels based on updated open interest numbers for the 
nine legacy agricultural contracts currently subject to federal 
limits,\62\ may accommodate risk management activity that remains below 
the proposed levels in a manner that comports with the CEA. Further, to 
the extent that such activity would be opposite a counterparty for whom 
the swap is a bona fide hedge, the Commission would encourage 
intermediaries to consider whether they would qualify under the bona 
fide hedging position definition for the proposed pass-through swap 
treatment, which is explicitly authorized by the CEA and discussed in 
greater detail below.\63\ Moreover, while positions entered into for 
risk management purposes may no longer qualify as bona fide hedges, 
some may satisfy the proposed requirements for spread exemptions. 
Finally, consistent with existing industry practice, exchanges may 
continue to recognize risk management positions for contracts that are 
not subject to federal limits, including for excluded commodities.
---------------------------------------------------------------------------

    \61\ See infra Section II.B.2.d. (discussion of non-spot month 
limit levels).
    \62\ The proposed non-spot month levels for the nine legacy 
agricultural contracts were calculated using a methodology that, 
with the exception of CBOT Oats (O), CBOT KC HRW Wheat (KW), and 
MGEX HRS Wheat (MWE), would result in higher levels than under 
existing rules and prior proposals. See infra Section II.B.2.d 
(discussion of proposed non-spot month limit levels).
    \63\ See infra Section II.A.1.c.v. (discussion of proposed pass-
through language).
---------------------------------------------------------------------------

(2) Economically Appropriate Test
    The bona fide hedging definitions in section 4a(c)(2)(A)(ii) of the 
CEA and in existing Sec.  1.3 of the Commission's regulations both 
provide that a bona fide hedging position must be ``economically 
appropriate to the reduction of risks in the conduct and management of 
a commercial enterprise.'' \64\ The Commission proposes to replicate 
this standard in the new definition in Sec.  150.1, with one 
clarification: Consistent with the Commission's longstanding practice 
regarding what types of risk may be offset by bona fide hedging 
positions in excess of federal limits,\65\ the Commission proposes to 
make explicit that the word ``risks'' refers to, and is limited to, 
``price risk.'' This proposed clarification does not reflect any change 
in policy, as the Commission has, when defining bona fide hedging, 
historically focused on transactions that offset price risk.\66\
---------------------------------------------------------------------------

    \64\ 7 U.S.C. 6a(c)(2)(A)(ii) and 17 CFR 1.3.
    \65\ See, e.g., 2013 Proposal, 78 FR at 75709, 75710.
    \66\ For example, in promulgating existing Sec.  1.3, the 
Commission explained that a bona fide hedging position must, among 
other things, ``be economically appropriate to risk reduction, such 
risks must arise from operation of a commercial enterprise, and the 
price fluctuations of the futures contracts used in the transaction 
must be substantially related to fluctuations of the cash market 
value of the assets, liabilities or services being hedged.'' Bona 
Fide Hedging Transactions or Positions, 42 FR 14832, 14833 (Mar. 16, 
1977). ``Value'' is generally understood to mean price times 
quantity. Dodd-Frank added CEA section 4a(c)(2), which copied the 
economically appropriate test from the Commission's definition in 
Sec.  1.3. See also 2013 Proposal, 78 FR at 75702, 75703 (stating 
that the ``core of the Commission's approach to defining bona fide 
hedging over the years has focused on transactions that offset a 
recognized physical price risk'').
---------------------------------------------------------------------------

    Commenters have previously requested flexibility for hedges of non-
price risk.\67\ However, re-interpreting ``risk'' to mean something 
other than ``price risk'' would make determining whether a particular 
position is economically appropriate to the reduction of risk too 
subjective to effectively evaluate. While the Commission or an 
exchange's staff can objectively evaluate whether a particular 
derivatives position is an economically appropriate hedge of a price 
risk arising from an underlying cash-market transaction, including by 
assessing the correlations between the risk and the derivatives 
position, it would be more difficult, if not impossible, to objectively 
determine whether an offset of non-price risk is economically 
appropriate for the underlying risk. For example, for any given non-
price risk, such as political risk, there could be multiple 
commodities, directions, and contract months which a particular market 
participant may view as an economically appropriate offset for that 
risk, and multiple market participants might take different views on 
which offset is the most effective. Re-interpreting ``risk'' to mean 
something other than ``price risk'' would introduce an element of 
subjectivity that would make a federal position limit framework 
difficult, if not impossible, to administer.
---------------------------------------------------------------------------

    \67\ See, e.g., 2016 Reproposal, 81 FR at 96847.
---------------------------------------------------------------------------

    The Commission remains open to receiving new product submissions, 
and should those submissions include contracts or strategies that are 
used to hedge something other than price risk, the Commission could at 
that point evaluate whether to propose regulations that would recognize 
hedges of risks other than price risk as bona fide hedges.
(3) Change in Value Requirement
    The Commission proposes to retain the substance of the change in 
value requirement in existing Sec.  1.3, with some non-substantive 
technical modifications, including modifications to correct a 
typographical error.\68\ Aside

[[Page 11607]]

from the typographical error, the proposed Sec.  150.1 change in value 
requirement mirrors the Dodd-Frank Act's change in value requirement in 
CEA section 4a(c)(2)(A)(iii).\69\
---------------------------------------------------------------------------

    \68\ The Commission proposes to replace the phrase ``liabilities 
which a person owns,'' which appears in the statute erroneously, 
with ``liabilities which a person owes,'' which the Commission 
believes was the intended wording. The Commission interprets the 
word ``owns'' to be a typographical error. A person may owe on a 
liability, and may anticipate incurring a liability. If a person 
``owns'' a liability, such as a debt instrument issued by another, 
then such person owns an asset. The fact that assets are included in 
CEA section 4a(c)(2)(A)(iii)(I) further reinforces the Commission's 
interpretation that the reference to ``owns'' means ``owes.'' The 
Commission also proposes several other non-substantive modifications 
in sentence structure to improve clarity.
    \69\ 7 U.S.C. 6a(c)(2)(A)(iii).
---------------------------------------------------------------------------

(4) Incidental Test and Orderly Trading Requirement
    While the Commission proposes to maintain the substance of the 
three core elements of the existing bona fide hedging definition 
described above, with some modifications, the Commission also proposes 
to eliminate two elements contained in the existing Sec.  1.3 
definition: The incidental test and orderly trading requirement that 
currently appear in paragraph (1)(iii) of the Sec.  1.3 bona fide 
hedging definition.\70\
---------------------------------------------------------------------------

    \70\ 17 CFR 1.3.
---------------------------------------------------------------------------

    Notably, Congress eliminated the incidental test from the statutory 
bona fide hedging definition in CEA section 4a(c)(2).\71\ Further, the 
Commission views the incidental test as redundant because the 
Commission is proposing to maintain the change in value requirement 
(value is generally understood to mean price per unit times quantity of 
units), and the economically appropriate test, which includes the 
concept of the offset of price risks in the conduct and management of 
(i.e., incidental to) a commercial enterprise.
---------------------------------------------------------------------------

    \71\ 7 U.S.C. 6a(c)(2).
---------------------------------------------------------------------------

    The Commission does not view the proposed elimination of the 
incidental test in the definition that appears in the regulations as a 
change in policy. The proposed elimination would not result in any 
changes to the Commission's interpretation of the bona fide hedging 
definition for physical commodities.
    The Commission also preliminarily believes that the orderly trading 
requirement should be deleted from the definition in the Commission's 
regulations because the statutory bona fide hedging definition does not 
include an orderly trading requirement,\72\ and because the meaning of 
``orderly trading'' is unclear in the context of the over-the counter 
(``OTC'') swap market and in the context of permitted off-exchange 
transactions, such as exchange for physicals. The proposed elimination 
of the orderly trading requirement would also have no bearing on an 
exchange's ability to impose its own orderly trading requirement. 
Further, in proposing to eliminate the orderly trading requirement from 
the definition in the regulations, the Commission is not proposing any 
amendments or modified interpretations to any other related 
requirements, including to any of the anti-disruptive trading 
prohibitions in CEA section 4c(a)(5),\73\ or to any other statutory or 
regulatory provisions.
---------------------------------------------------------------------------

    \72\ The orderly trading requirement has been a part of the 
regulatory definition of bona fide hedging since 1975; see Hedging 
Definition, Reports, and Conforming Amendments, 40 FR 11560 (Mar. 
12, 1975). Prior to 1974, the orderly trading requirement was found 
in the statutory definition of bona fide hedging position; changes 
to the CEA in 1974 removed the statutory definition from CEA section 
4a(3).
    \73\ 7 U.S.C. 6c(a)(5).
---------------------------------------------------------------------------

    Taken together, the proposed retention of the updated temporary 
substitute test, economically appropriate test, and change in value 
requirement, coupled with the proposed elimination of the incidental 
test and orderly trading requirement, should reduce uncertainty by 
eliminating provisions that do not appear in the statute, and by 
clarifying the language of the remaining provisions. By reducing 
uncertainty surrounding some parts of the bona fide hedging definition 
for physical commodities, the Commission anticipates that, as described 
in greater detail elsewhere in this release, it would be easier going 
forward for the Commission, exchanges, and market participants to 
address whether novel trading practices or strategies may qualify as 
bona fide hedges.
iii. Proposed Enumerated Bona Fide Hedges for Physical Commodities
    Federal position limits currently only apply to referenced 
contracts based on nine legacy agricultural commodities, and, as 
mentioned above, the bona fide hedging definition in existing Sec.  1.3 
includes a list of four categories of enumerated hedges that may be 
exempt from federal position limits.\74\ So as not to reduce any of the 
clarity provided by the current list of enumerated hedges, the 
Commission proposes to maintain the existing enumerated hedges, some 
with modification, and, for the reasons described below, to expand this 
list. Such enumerated bona fide hedges would be self-effectuating for 
purposes of federal limits.\75\ The Commission also proposes to move 
the expanded list to proposed Appendix A to part 150 of the 
Commission's regulations. The Commission preliminarily believes that 
the list of enumerated hedges should appear in an appendix, rather than 
be included in the definition, because each enumerated hedge represents 
just one way, but not the only way, to satisfy the proposed bona fide 
hedging definition and Sec.  150.3(a)(1).\76\ In some places, as 
described below, the Commission proposes to modify and/or re-organize 
the language of the current enumerated hedges; such proposed changes 
are intended only to provide clarifications, and, unless indicated 
otherwise, are not intended to substantively modify the types of 
practices currently listed as enumerated hedges. In other places, 
however, the Commission proposes substantive changes to the existing 
enumerated hedges, including the elimination of the five-day rule for 
purposes of federal limits, while allowing exchanges to impose a five-
day rule, or similar restrictions, for purposes of exchange-set limits. 
With the exception of risk management positions previously recognized 
as bona fide hedges, and assuming all regulatory requirements continue 
to be satisfied, bona fide hedging recognitions that are currently in 
effect under the Commission's existing rules, either by virtue of Sec.  
1.47 or one of the enumerated hedges currently listed in Sec.  1.3, 
would be grandfathered once the rules proposed herein are adopted.
---------------------------------------------------------------------------

    \74\ 17 CFR 1.3.
    \75\ See infra Section II.C.2. (discussion of proposed Sec.  
150.3) and Section II.G.3. (discussion of proposed Sec.  150.9).
    \76\ As discussed below, proposed Sec.  150.3(a)(1) would allow 
a person to exceed position limits for bona fide hedging 
transactions or positions, as defined in proposed Sec.  150.1.
---------------------------------------------------------------------------

    When first proposed, the Commission viewed the enumerated bona fide 
hedges as conforming to the general definition of bona fide hedging 
``without further consideration as to the particulars of the case.'' 
\77\ Similarly, the proposed enumerated hedges would reflect fact 
patterns for which the Commission has preliminarily determined, based 
on experience over time, that no case-by-case determination, or review 
of additional details, by the Commission is needed to determine that 
the position or transaction is a bona fide hedge. This proposal would 
in no way foreclose the recognition of other hedging practices as bona 
fide hedges.
---------------------------------------------------------------------------

    \77\ Bona Fide Hedging Transactions or Positions, 42 FR 14832 
(Mar. 16, 1977).
---------------------------------------------------------------------------

    The Commission would be open, on a case-by-case basis, to 
recognizing as bona fide hedges positions or transactions that may fall 
outside the bounds of these enumerated hedges, but that nevertheless 
satisfy the proposed

[[Page 11608]]

bona fide hedging definition and section 4a(c)(2) of the CEA.\78\
---------------------------------------------------------------------------

    \78\ See infra Section II.G.3. (discussion of proposed Sec.  
150.9).
---------------------------------------------------------------------------

    The Commission does not anticipate that moving the list of 
enumerated hedges from the bona fide hedging definition to an appendix 
per se would have a substantial impact on market participants who seek 
clarity regarding bona fide hedges. However, the Commission is open to 
feedback on this point.
    Positions in referenced contracts subject to position limits that 
meet any of the proposed enumerated hedges would, for purposes of 
federal limits, meet the bona fide hedging definition in CEA section 
4a(c)(2)(A), as well as the Commission's proposed bona fide hedging 
definition in Sec.  150.1. Any such recognitions would be self-
effectuating for purposes of federal limits, provided the market 
participant separately requests an exemption from the applicable 
exchange-set limit established pursuant to proposed Sec.  150.5(a). The 
proposed enumerated hedges are each described below, followed by a 
discussion of the proposal's treatment of the five-day rule.
(1) Hedges of Unsold Anticipated Production
    This hedge is currently enumerated in paragraph (2)(i)(B) of the 
bona fide hedging definition in Sec.  1.3, and is subject to the five-
day rule. The Commission proposes to maintain it as an enumerated 
hedge, with the modification described below. This enumerated hedge 
would allow a market participant who anticipates production, but who 
has not yet produced anything, to enter into a short derivatives 
position in excess of limits to hedge the anticipated production.
    While existing paragraph (2)(i)(B) limits this enumerated hedge to 
twelve-months' unsold anticipated production, the Commission proposes 
to remove the twelve-month limitation. The twelve-month limitation may 
be unsuitable in connection with additional contracts based on 
agricultural and energy commodities covered by this release, which may 
have longer growth and/or production cycles than the nine legacy 
agricultural commodities. Commenters have also previously recommended 
removing the twelve-month limitation on agricultural production, 
stating that it is unnecessarily short in comparison to the expected 
life of investment in production facilities.\79\ The Commission 
preliminarily agrees.
---------------------------------------------------------------------------

    \79\ See, e.g., 2016 Reproposal, 81 FR at 96752.
---------------------------------------------------------------------------

(2) Hedges of Offsetting Unfixed Price Cash Commodity Sales and 
Purchases
    This hedge is currently enumerated in paragraph (2)(iii) of the 
bona fide hedging definition in Sec.  1.3 and is subject to the five-
day rule. The Commission proposes to maintain it as an enumerated 
hedge, with one proposed modification described below. This enumerated 
hedge allows a market participant to use commodity derivatives in 
excess of limits to offset an unfixed price cash commodity purchase 
coupled with an unfixed price cash commodity sale.
    Currently, under paragraph (2)(iii), the cash commodity must be 
bought and sold at unfixed prices at a basis to different delivery 
months, meaning the offsetting derivatives transaction would be used to 
reduce the risk arising from a time differential in the unfixed-price 
purchase and sale contracts.\80\ The Commission proposes to expand this 
provision to also permit the cash commodity to be bought and sold at 
unfixed prices at a basis to different commodity derivative contracts 
in the same commodity, even if the commodity derivative contracts are 
in the same calendar month. The Commission is proposing this change to 
allow a commercial enterprise to enter into the described derivatives 
transactions to reduce the risk arising from either (or both) a 
location differential \81\ or a time differential in unfixed-price 
purchase and sale contracts in the same cash commodity.
---------------------------------------------------------------------------

    \80\ The Commission stated when it proposed this enumerated 
hedge, ``[i]n particular, a cotton merchant may contract to purchase 
and sell cotton in the cash market in relation to the futures price 
in different delivery months for cotton, i.e., a basis purchase and 
a basis sale. Prior to the time when the price is fixed for each leg 
of such a cash position, the merchant is subject to a variation in 
the two futures contracts utilized for price basing. This variation 
can be offset by purchasing the future on which the sales were based 
[and] selling the future on which [the] purchases were based.'' 
Revision of Federal Speculative Position Limits, 51 FR 31648, 31650 
(Sept. 4, 1986).
    \81\ In the case of reducing the risk of a location 
differential, and where each of the underlying transactions in 
separate derivative contracts may be in the same contract month, a 
position in a basis contract would not be subject to position 
limits, as discussed in connection with paragraph (3) of the 
proposed definition of ``referenced contract.''
---------------------------------------------------------------------------

    Both an unfixed-price cash commodity purchase and an offsetting 
unfixed-price cash commodity sale must be in hand in order to be 
eligible for this enumerated hedge, because having both the unfixed-
price sale and purchase in hand would allow for an objective evaluation 
of the hedge.\82\ Absent either the unfixed-price purchase or the 
unfixed-price sale (or absent both), it would be less clear how the 
transaction could be classified as a bona fide hedge, that is, a 
transaction that reduces price risk.\83\
---------------------------------------------------------------------------

    \82\ For example, in the case of a calendar spread, having both 
the unfixed-price sale and purchase in hand would set the timeframe 
for the calendar month spread being used as the hedge.
    \83\ In 2013, the Commission provided an example regarding this 
enumerated hedge: ``The contemplated derivative positions will 
offset the risk that the difference in the expected delivery prices 
of the two unfixed-price cash contracts in the same commodity will 
change between the time the hedging transaction is entered and the 
time of fixing of the prices on the purchase and sales cash 
contracts. Therefore, the contemplated derivative positions are 
economically appropriate to the reduction of risk.'' 2013 Proposal, 
78 FR at 75715.
---------------------------------------------------------------------------

    This is not to say that an unfixed-price cash commodity purchase 
alone, or an unfixed-price cash commodity sale alone, could never be 
recognized as a bona fide hedge. Rather, an additional facts and 
circumstances analysis would be warranted in such cases.
    Further, upon fixing the price of, or taking delivery on, the 
purchase contract, the owner of the cash commodity may hold the short 
derivative leg of the spread as a hedge against a fixed-price purchase 
or inventory. However, the long derivative leg of the spread would no 
longer qualify as a bona fide hedging position, since the commercial 
entity has fixed the price or taken delivery on the purchase contract. 
Similarly, if the commercial entity first fixed the price of the sales 
contract, the long derivative leg of the spread may be held as a hedge 
against a fixed-price sale, but the short derivative leg of the spread 
would no longer qualify as a bona fide hedging position. Commercial 
entities in these circumstances thus may have to consider reducing 
certain positions in order to comply with the regulations proposed 
herein.
(3) Short Hedges of Anticipated Mineral Royalties
    The Commission is proposing a new acceptable practice that is not 
currently enumerated in Sec.  1.3 for short hedges of anticipated 
mineral royalties. The Commission previously adopted a similar 
provision as an enumerated hedge in part 151 in response to a request 
from commenters.\84\ The proposed provision would permit an owner of 
rights to a future royalty to lock in the price of anticipated mineral 
production by entering into a short position in excess of limits in a 
commodity derivative contract to offset the anticipated change in value 
of mineral royalty rights that are owned by that person and arise out 
of the production of a mineral commodity

[[Page 11609]]

(e.g., oil and gas).\85\ The Commission preliminarily believes that 
this remains a common hedging practice, and that positions that satisfy 
the requirements of this acceptable practice would conform to the 
general definition of bona fide hedging without further consideration 
as to the particulars of the case.
---------------------------------------------------------------------------

    \84\ See 2011 Final Rulemaking, 76 FR at 71646. As noted above, 
part 151 was subsequently vacated.
    \85\ A short position fixes the price of the anticipated 
receipts, removing exposure to change in value of the person's share 
of the production revenue. A person who has issued a royalty, in 
contrast, has, by definition, agreed to make a payment in exchange 
for value received or to be received (e.g., the right to extract a 
mineral). Upon extraction of a mineral and sale at the prevailing 
cash market price, the issuer of a royalty remits part of the 
proceeds in satisfaction of the royalty agreement. The issuer of a 
royalty, therefore, does not have price risk arising from that 
royalty agreement.
---------------------------------------------------------------------------

    The Commission proposes to limit this acceptable practice to 
mineral royalties; the Commission preliminarily believes that while 
royalties have been paid for use of land in agricultural production, 
the Commission has not received any evidence of a need for a bona fide 
hedge recognition from owners of agricultural production royalties. The 
Commission requests comment on whether and why such an exemption might 
be needed for owners of agricultural production or other royalties.
(4) Hedges of Anticipated Services
    The Commission is proposing a new enumerated hedge that is not 
currently enumerated in the Sec.  1.3 bona fide hedging definition for 
hedges of anticipated services. The Commission previously adopted a 
similar provision as an enumerated hedge in part 151 in response to a 
request from commenters.\86\ This enumerated hedge would recognize as a 
bona fide hedge a long or short derivatives position used to hedge the 
anticipated change in value of receipts or payments due or expected to 
be due under an executed contract for services arising out of the 
production, manufacturing, processing, use, or transportation of the 
commodity underlying the commodity derivative contract.\87\ The 
Commission preliminarily believes that this remains a common hedging 
practice, and that positions that satisfy the requirements of this 
acceptable practice would conform to the general definition of bona 
fide hedging without further consideration as to the particulars of the 
case.
---------------------------------------------------------------------------

    \86\ See 2011 Final Rulemaking, 76 FR at 71646. As noted above, 
part 151 was subsequently vacated.
    \87\ As the Commission previously stated, regarding a proposed 
hedge for services, ``crop insurance providers and other agents that 
provide services in the physical marketing channel could qualify for 
a bona fide hedge of their contracts for services arising out of the 
production of the commodity underlying a [commodity derivative 
contract].'' 2013 Proposal, 78 FR at 75716.
---------------------------------------------------------------------------

(5) Cross-Commodity Hedges
    Paragraph (2)(iv) of the existing Sec.  1.3 bona fide hedge 
definition enumerates the offset of cash purchases, sales, or purchases 
and sales with a commodity derivative other than the commodity that 
comprised the cash position(s).\88\ The Commission proposes to include 
this hedge in the enumerated hedges and expand its application such 
that cross-commodity hedges could be used to establish compliance with: 
Each of the proposed enumerated hedges listed in Appendix A to part 
150; \89\ and hedges in the proposed pass-through provisions under 
paragraph (2) of the proposed bona fide hedging definition discussed 
further below; provided, in each case, that the position satisfies each 
element of the relevant acceptable practice.\90\
---------------------------------------------------------------------------

    \88\ For example, existing paragraph (2)(iv) of the bona fide 
hedging definition recognizes as an enumerated hedge the offset of a 
cash-market position in one commodity, such as soybeans, through a 
derivatives position in a different commodity, such as soybean oil 
or soybean meal.
    \89\ Specifically, for: (i) Hedges of unsold anticipated 
production, (ii) hedges of offsetting unfixed-price cash commodity 
sales and purchases, (iii) hedges of anticipated mineral royalties, 
(iv) hedges of anticipated services, (v) hedges of inventory and 
cash commodity fixed-price purchase contracts, (vi) hedges of cash 
commodity fixed-price sales contracts, (vii) hedges by agents, and 
(viii) offsets of commodity trade options, a cross-commodity hedge 
could be used to offset risks arising from a commodity other than 
the cash commodity underlying the commodity derivatives contract.
    \90\ For example, an airline that wishes to hedge the price of 
jet fuel may enter into a swap with a swap dealer. In order to 
remain flat, the swap dealer may offset that swap with a futures 
position, for example, in ULSD. Subsequently, the airline may also 
offset the swap exposure using ULSD futures. In this example, under 
the pass-through swap language of proposed Sec.  150.1, the airline 
would be acting as a bona fide hedging swap counterparty and the 
swap dealer would be acting as a pass-through swap counterparty. In 
this example, provided each element of the enumerated hedge in 
paragraph (a)(5) of Appendix A, the pass-through swap provision in 
Sec.  150.1, and all other regulatory requirements are satisfied, 
the airline and swap dealer could each exceed limits in ULSD futures 
to offset their respective swap exposures to jet fuel. See infra 
Section II.A.1.c.v. (discussion of proposed pass-through language).
---------------------------------------------------------------------------

    This enumerated hedge is conditioned on the fluctuations in value 
of the position in the commodity derivative contract or of the 
underlying cash commodity being ``substantially related'' \91\ to the 
fluctuations in value of the actual or anticipated cash position or 
pass-through swap. To be ``substantially related,'' the derivative and 
cash market position, which may be in different commodities, should 
have a reasonable commercial relationship.\92\ For example, there is a 
reasonable commercial relationship between grain sorghum, used as a 
food grain for humans or as animal feedstock, with corn underlying a 
derivative. There currently is not a futures contract for grain sorghum 
grown in the United States listed on a U.S. DCM, so corn represents a 
substantially related commodity to grain sorghum in the United 
States.\93\ In contrast, there does not appear to be a reasonable 
commercial relationship between a physical commodity, say copper, and a 
broad-based stock price index, such as the S&P 500 Index, because these 
commodities are not reasonable substitutes for each other in that they 
have very different pricing drivers. That is, the price of a physical 
commodity is based on supply and demand, whereas the stock price index 
is based on various individual stock prices for different companies.
---------------------------------------------------------------------------

    \91\ See proposed Appendix A to part 150.
    \92\ Id.
    \93\ Grain sorghum was previously listed for trading on the 
Kansas City Board of Trade and Chicago Mercantile Exchange, but 
because of liquidity issues, grain buyers continued to use the more 
liquid corn futures contract, which suggests that the basis risk 
between corn futures and cash sorghum could be successfully managed 
with the corn futures contract.
---------------------------------------------------------------------------

(6) Hedges of Inventory and Cash Commodity Fixed-Price Purchase 
Contracts
    Hedges of inventory and cash-commodity fixed-price purchase 
contracts are included in paragraph (2)(i)(A) of the existing Sec.  1.3 
bona fide hedge definition, and the Commission proposes to include them 
as an enumerated hedge with minor modifications. This proposed 
enumerated hedge acknowledges that a commercial enterprise is exposed 
to price risk (e.g., that the market price of the inventory could 
decrease) if it has obtained inventory in the normal course of business 
or has entered into a fixed-price spot or forward purchase contract 
calling for delivery in the physical marketing channel of a cash-market 
commodity (or a combination of the two), and has not offset that price 
risk. Any such inventory, or a fixed-price purchase contract, must be 
on hand, as opposed to a non-fixed purchase contract or an anticipated 
purchase. To satisfy the requirements of this particular enumerated 
hedge, a bona fide hedge would be to establish a short position in a 
commodity derivative contract to offset such price risk. An exchange 
may require such short position holders to demonstrate the ability to 
deliver against the short

[[Page 11610]]

position in order to demonstrate a legitimate purpose for holding a 
position deep into the spot month.\94\
---------------------------------------------------------------------------

    \94\ For example, it would not appear to be economically 
appropriate to hold a short position in the spot month of a 
commodity derivative contract against fixed-price purchase contracts 
that provide for deferred delivery in comparison to the delivery 
period for the spot month commodity derivative contract. This is 
because the commodity under the cash contract would not be available 
for delivery on the commodity derivative contract.
---------------------------------------------------------------------------

(7) Hedges of Cash Commodity Fixed-Price Sales Contracts
    This hedge is enumerated in paragraphs (2)(ii)(A) and (B) of the 
existing Sec.  1.3 bona fide hedge definition, and the Commission 
proposes to maintain it as an enumerated hedge. This enumerated hedge 
acknowledges that a commercial enterprise is exposed to price risk 
(i.e., that the market price of a commodity might be higher than the 
price of a fixed-price sales contract for that commodity) if it has 
entered into a spot or forward fixed-price sales contract calling for 
delivery in the physical marketing channel of a cash-market commodity, 
and has not offset that price risk. To satisfy the requirements of this 
particular enumerated hedge, a bona fide hedge would be to establish a 
long position in a commodity derivative contract to offset such price 
risk.
(8) Hedges by Agents
    This proposed enumerated hedge is included in paragraph (3) of the 
existing Sec.  1.3 bona fide hedge definition as an example of a 
potential non-enumerated bona fide hedge. The Commission proposes to 
include this example as an enumerated hedge, with non-substantive 
modifications,\95\ because the Commission preliminarily believes that 
this is a common hedging practice, and that positions which satisfy the 
requirements of this enumerated hedge would conform to the general 
definition of bona fide hedging without further consideration as to the 
particulars of the case. This proposed provision would allow an agent 
who has the responsibility to trade cash commodities on behalf of 
another entity for which such positions would qualify as bona fide 
hedging positions to hedge those cash positions on a long or short 
basis. For example, an agent may trade on behalf of a farmer or a 
producer, or a government may wish to contract with a commercial firm 
to manage the government's cash wheat inventory; in such circumstances, 
the agent or the commercial firm would not take ownership of the 
commodity it trades on behalf of the farmer, producer, or government, 
but would be an agent eligible for an exemption to hedge the risks 
associated with such cash positions.
---------------------------------------------------------------------------

    \95\ For example, the Commission proposes to replace the phrase 
``offsetting cash commodity'' with ``contract's underlying cash 
commodity'' to use language that is consistent with the other 
proposed enumerated hedges.
---------------------------------------------------------------------------

(9) Offsets of Commodity Trade Options
    The Commission is proposing a new enumerated hedge to recognize 
certain offsets of commodity trade options as a bona fide hedge. Under 
this proposed enumerated hedge, a commodity trade option meeting the 
requirements of Sec.  32.3 \96\ of the Commission's regulations \97\ 
may be deemed a cash commodity fixed-price purchase or cash commodity 
fixed-price sales contract, as the case may be, provided that such 
option is adjusted on a futures-equivalent basis.\98\ Because the 
Commission proposes to include hedges of cash commodity fixed-price 
purchase contracts and hedges of cash commodity fixed-price sales 
contracts as enumerated hedges, the Commission also proposes to include 
hedges of commodity trade options as an enumerated hedge.
---------------------------------------------------------------------------

    \96\ 17 CFR 32.3. In order to qualify for the trade option 
exemption, Sec.  32.3 requires, among other things, that: (1) The 
offeror is either (i) an eligible contract participant, as defined 
in section 1a(18) of the Act, or (ii) offering or entering into the 
commodity trade option solely for purposes related to its business 
as a ``producer, processor, or commercial user of, or a merchant 
handling the commodity that is the subject of the'' trade option; 
and (2) the offeree is offered or entering into the commodity trade 
option solely for purposes related to its business as ``a producer, 
processor, or commercial user of, or a merchant handling the 
commodity that is the subject'' of the commodity trade option.
    \97\ 17 CFR 32.3.
    \98\ It may not be possible to compute a futures-equivalent 
basis for a trade option that does not have a fixed strike price. 
Thus, under this enumerated hedge, a market participant may not use 
a trade option as a basis for a bona fide hedging position until a 
fixed strike price reasonably may be determined. For example, a 
commodity trade option with a fixed strike price may be converted to 
a futures-equivalent basis, and, on that futures-equivalent basis, 
deemed a cash commodity sale contract, in the case of a short call 
option or long put option, or a cash commodity purchase contract, in 
the case of a long call option or short put option.
---------------------------------------------------------------------------

(10) Hedges of Unfilled Anticipated Requirements
    This proposed enumerated hedge appears in paragraph (2)(ii)(C) of 
the existing Sec.  1.3 bona fide hedge definition. The Commission 
proposes to include it as an enumerated hedge, with modification. To 
satisfy the requirements of this particular enumerated hedge, a bona 
fide hedge would be to establish a long position in a commodity 
derivative contract to offset the expected price risks associated with 
the anticipated future purchase of the cash-market commodity underlying 
the commodity derivative contract. Such unfilled anticipated 
requirements could include requirements for processing, manufacturing, 
use by that person, or resale by a utility to its customers.\99\ 
Consistent with the existing provision, for purposes of exchange-set 
limits, exchanges may wish to consider adopting rules providing that 
during the lesser of the last five days of trading (or such time period 
for the spot month), such positions must not exceed the person's 
unfilled anticipated requirements of the underlying cash commodity for 
that month and for the next succeeding month.\100\ Any such quantity 
limitation may help prevent the use of long futures to source large 
quantities of the underlying cash commodity. The Commission 
preliminarily believes that the two-month limitation would allow for an 
amount of activity that is in line with common commercial hedging 
practices, without jeopardizing any statutory objectives.
---------------------------------------------------------------------------

    \99\ The proposed inclusion of unfilled anticipated requirements 
for resale by a utility to its customers does not appear in the 
existing Sec.  1.3 bona fide hedging definition. This provision is 
analogous to the unfilled anticipated requirements provision of 
existing paragraph (2)(ii)(C) of the existing bona fide hedging 
definition, except the commodity is not for use by the same person 
(that is, the utility), but rather for anticipated use by the 
utility's customers. This would recognize a bona fide hedging 
position where a utility is required or encouraged by its public 
utility commission to hedge.
    \100\ This is essentially a less-restrictive version of the 
five-day rule, allowing a participant to hold a position during the 
end of the spot period if economically appropriate, but only up to 
two months' worth of anticipated requirements. The two-month 
quantity limitation has long-appeared in existing Sec.  1.3 as a 
measure to prevent the sourcing of massive quantities of the 
underlying in a short time period. 17 CFR 1.3.
---------------------------------------------------------------------------

    Although existing paragraph (2)(ii)(C) limits this enumerated hedge 
to twelve-months' unfilled anticipated requirements outside of the spot 
period, the Commission proposes to remove the twelve-month limitation 
because commenters have previously stated, and the Commission 
preliminarily believes, that there is a commercial need to hedge 
unfilled anticipated requirements for a time period longer than twelve 
months.\101\
---------------------------------------------------------------------------

    \101\ See, e.g., 2016 Reproposal, 81 FR at 96751.
---------------------------------------------------------------------------

(11) Hedges of Anticipated Merchandising
    The Commission is proposing a new enumerated hedge to recognize 
certain offsets of anticipated purchases or sales as a bona fide hedge. 
Under this proposed enumerated hedge, a merchant may establish a long 
or short position in

[[Page 11611]]

a commodity derivative contract to offset the anticipated change in 
value of the underlying commodity that the merchant anticipates 
purchasing or selling in the future. To safeguard against misuse, the 
enumerated hedge would be subject to certain conditions. First, the 
commodity derivative position must not exceed in quantity twelve 
months' of purchase or sale requirements of the same commodity that is 
anticipated to be merchandised. This requirement is intended to ensure 
that merchants are hedging their anticipated merchandising exposure to 
the value change of the underlying commodity, while calibrating the 
anticipated need within a reasonable timeframe and the limitations in 
physical commodity markets, such as annual production or processing 
capacity. Unlike in the enumerated hedge for unsold anticipated 
production, where the Commission is proposing to eliminate the twelve-
month limitation, the Commission has preliminarily determined that a 
twelve-month limitation for anticipatory merchandising is suitable in 
connection with contracts that are based on anticipated activity on 
yet-to-be established cash positions due to the uncertainty of 
forecasting such activity and, all else being equal, the increased risk 
of excessive speculation on the price of a commodity the longer the 
time period before the actual need arises.
    Second, the Commission is proposing to limit this enumerated hedge 
to merchants who are in the business of purchasing and selling the 
underlying commodity that is anticipated to be merchandised, and who 
can demonstrate that it is their historical practice to do so. Such 
demonstrated history should include a history of making and taking 
delivery of the underlying commodity, and a demonstration of an ability 
to store and move the underlying commodity. The Commission has a 
longstanding practice of providing exemptive relief to commercial 
market participants to enable physical commodity markets to continue to 
be well-functioning markets. The proposed anticipatory merchandising 
hedge requires that the person be a merchant handling the underlying 
commodity that is subject to the anticipatory merchandising hedge and 
that such merchant is entering into the anticipatory merchandising 
hedge solely for purposes related to its merchandising business. A 
merchandiser that lacks the requisite history of anticipatory 
merchandising activity could still potentially receive bona fide hedge 
recognition under the proposed non-enumerated process, so long as the 
merchandiser can otherwise show activities in the physical marketing 
channel, including, for example, arrangements to take or make delivery 
of the underlying commodity.
    The Commission preliminarily believes that anticipated 
merchandising is a hedging practice commonly used by some commodity 
market participants, and that merchandisers play an important role in 
the physical supply chain. Positions which satisfy the requirements of 
this acceptable practice would thus conform to the general definition 
of bona fide hedging.
    While each of the proposed enumerated hedges described above would 
be self-effectuating for purposes of federal limits, the Commission and 
the exchanges would continue to exercise close oversight over such 
positions to confirm that market participants' claimed exemptions are 
consistent with their cash-market activity. In particular, because all 
contracts subject to federal limits would also be subject to exchange-
set limits, all traders seeking to exceed federal position limits would 
have to request an exemption from the relevant exchange for purposes of 
the exchange limit, regardless of whether the position falls within one 
of the enumerated hedges. In other words, enumerated bona fide hedge 
recognitions that are self-effectuating for purposes of federal limits 
would not be self-effectuating for purposes of exchange limits.
    Exchanges have well-established programs for granting exemptions, 
including, in some cases, experience granting exemptions for 
anticipatory merchandising for certain traders in markets not currently 
subject to federal limits. As discussed in greater detail below, 
proposed Sec.  150.5 \102\ would ensure that such programs require, 
among other things, that: Exemption applications filed with an exchange 
include sufficient information to enable the exchange to determine, and 
the Commission to verify, whether the exchange may grant the exemption, 
including an indication of whether the position qualifies as an 
enumerated hedge for purposes of federal limits and a description of 
the applicant's activity in the underlying cash markets; and that the 
exchange provides the Commission with a monthly report showing the 
disposition of all exemption applications, including cash market 
information justifying the exemption. The Commission expects exchanges 
will be thoughtful and deliberate in granting exemptions, including 
anticipatory exemptions.
---------------------------------------------------------------------------

    \102\ See infra Section II.D.4. (discussion of proposed Sec.  
150.5).
---------------------------------------------------------------------------

    The Commission and the exchanges also have a variety of other tools 
designed to help prevent misuse of self-effectuating exemptions. For 
example, market participants who submit an application to an exchange 
as required under Sec.  150.5 would be subject to the Commission's 
false statements authority that carries with it substantial penalties 
under both the CEA and federal criminal statutes.\103\ Similarly, the 
Commission can use surveillance tools, special call authority, rule 
enforcement reviews, and other formal and informal avenues for 
obtaining additional information from exchanges and market participants 
in order to distinguish between true hedging needs and speculative 
trading masquerading as a bona fide hedge.
---------------------------------------------------------------------------

    \103\ CEA section 6(c)(2), 7 U.S.C. 9(2); CEA section 9(a)(3), 7 
U.S.C. 13(a)(3); CEA section 9(a)(4), 7 U.S.C. 13(a)(4); 18 U.S.C. 
1001.
---------------------------------------------------------------------------

    In the 2013 Proposal, the Commission previously addressed a 
petition for exemptive relief for 10 transactions described as bona 
fide hedging transactions by the Working Group of Commercial Energy 
Firms (which has since reconstituted itself as the ``Commercial Energy 
Working Group'') (``BFH Petition'').\104\ In the 2013 Proposal, the 
Commission included examples Nos. 1, 2, 6, 7 (scenario 1), and 8 as 
being permitted under the proposed definition of bona fide hedging.
---------------------------------------------------------------------------

    \104\ The Working Group BFH Petition is available at https://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/wgbfhpetition012012.pdf.
---------------------------------------------------------------------------

    With respect to the rules proposed herein, the Commission has 
preliminarily determined that example #4 (binding, irrevocable bids or 
offers) and #5 (timing of hedging physical transactions) from the BFH 
Petition potentially fit within the proposed Appendix A paragraph 
(a)(11) enumerated hedge of anticipatory merchandising, so long as the 
transaction complies with each condition of that proposed enumerated 
hedge.
    In addition, as discussed further below, because the Commission is 
also proposing to eliminate the five-day rule from the enumerated 
hedges to which the five-day rule currently applies, the Commission has 
preliminarily determined that example #9 (holding a cross-commodity 
hedge using a physical delivery contract into the spot month) and #10 
(holding a cross-commodity hedge using a physical delivery contract to 
meet unfilled anticipated

[[Page 11612]]

requirements) from the BFH Petition potentially fit within the proposed 
Appendix A paragraph (a)(5) enumerated hedge, so long as the 
transaction otherwise complies with the additional conditions of all 
applicable enumerated hedges and other requirements.
    Regarding examples #3 (unpriced physical purchase or sale 
commitments) and #7 (scenario 2) (use of physical delivery referenced 
contracts to hedge physical transactions using calendar month average 
pricing), while the Commission has preliminarily determined that the 
positions described within those examples do not fit within any of the 
proposed enumerated hedges, market participants seeking bona fide hedge 
recognition for such positions may apply for a non-enumerated 
recognition under proposed Sec. Sec.  150.3 or 150.9, and a facts and 
circumstances decision would be made.\105\ As included in the request 
for comment on this section, the Commission requests additional 
information on the scenarios listed above, particularly for the 
positions that the Commission preliminarily views as falling outside 
the proposed list of enumerated hedges.
---------------------------------------------------------------------------

    \105\ Similarly, other examples of anticipatory merchandising 
that have been described to the Commission in response to request 
for comment on proposed rulemakings on position limits (i.e., the 
storage hedge and hedges of assets owned or anticipated to be owned) 
would be the type of transactions that market participants may seek 
through one of the proposed processes for requesting a non-
enumerated bona fide hedge recognition.
---------------------------------------------------------------------------

iv. Elimination of a Federal Five Day Rule
    Under the existing bona fide hedging definition in Sec.  1.3, to 
help protect orderly trading and the integrity of the physical-delivery 
process, certain enumerated hedging positions in physical-delivery 
contracts are not recognized as bona fide hedges that may exceed limits 
when the position is held during the last five days of trading during 
the spot month. The goal of the five-day rule is to help ensure that 
only those participants who actually intend to make or take delivery 
maintain positions toward the end of the spot period.\106\ When the 
Commission adopted the five-day rule, it believed that, as a general 
matter, there is little commercial need to maintain such positions in 
the last five days.\107\ However, persons wishing to exceed position 
limits during the five last trading days could submit materials 
supporting a classification of the position as a bona fide hedge, based 
on the particular facts and circumstances.\108\
---------------------------------------------------------------------------

    \106\ Paragraphs (2)(i)(B), (ii)(C), (iii), and (iv) of the 
existing Sec.  1.3 bona fide hedging definition are subject to some 
form of the five-day rule.
    \107\ Definition of Bona Fide Hedging and Related Reporting 
Requirements, 42 FR 42748, 42750 (Aug. 24, 1977).
    \108\ Id.
---------------------------------------------------------------------------

    The Commission has viewed the five-day rule as an important way to 
help ensure that futures and cash-market prices converge and to prevent 
excessive speculation as a physical-delivery contract nears expiration, 
thereby protecting the integrity of the delivery process and the price 
discovery function of the market, and deterring or preventing types of 
market manipulations such as corners and squeezes. The enumerated 
hedges currently subject to the five-day rule are either: (i) 
Anticipatory in nature; or (ii) involve a situation where there is no 
need to make or take delivery. The Commission has historically 
questioned the need for such positions in excess of limits to be held 
into the spot period if the participant has no immediate plans and/or 
need to make or take delivery in the few remaining days of the spot 
period.\109\
---------------------------------------------------------------------------

    \109\ See, e.g., 42 FR at 42749.
---------------------------------------------------------------------------

    While the Commission continues to believe that the justifications 
described above for the existing five-day rule remain valid, the 
Commission has preliminarily determined that for contracts subject to 
federal limits, the exchanges, subject to Commission oversight, are 
better positioned to decide whether to apply the five-day rule in 
connection with their own exchange-set limits, or whether to apply 
other tools that may be equally effective. Accordingly, consistent with 
this proposal's focus on leveraging existing exchange practices and 
expertise when appropriate, the Commission proposes to eliminate the 
five-day rule from the enumerated hedges to which the five-day rule 
currently applies, and instead to afford exchanges with the discretion 
to apply, and when appropriate, waive the five-day rule (or similar 
restrictions) for purposes of their own limits.
    Allowing for such discretion will afford exchanges flexibility to 
quickly impose, modify, or waive any such limitation as circumstances 
dictate. While a strict five day rule may be inappropriate in certain 
circumstances, including when applied to energy contracts that 
typically have a shorter spot period than agricultural contracts,\110\ 
the flexible approach allowed for herein may allow for the development 
and implementation of additional solutions other than a five-day rule 
that protect convergence while minimizing the impact on market 
participants. The proposed approach would allow exchanges to design and 
tailor a variety of limitations to protect convergence during the spot 
period. For example, in certain circumstances, a smaller quantity 
restriction, rather than a complete restriction on holding positions in 
excess of limits during the spot period, may be effective at protecting 
convergence. Similarly, exchanges currently utilize other tools to 
achieve similar policy goals, such as by requiring market participants 
to ``step down'' the levels of their exemptions as they approach the 
spot period, or by establishing exchange-set speculative position 
limits that include a similar step down feature. As proposed Sec.  
150.5(a) would require that any exchange-set limits for contracts 
subject to federal limits must be less than or equal to the federal 
limit, any exchange application of the five day rule, or a similar 
restriction, would have the same effect as if administered by the 
Commission for purposes of federal speculative position limits.
---------------------------------------------------------------------------

    \110\ Energy contracts typically have a three-day spot period, 
whereas the spot period for agricultural contracts is typically two 
weeks.
---------------------------------------------------------------------------

    The Commission expects that exchanges would closely scrutinize any 
participant who requests a recognition during the last five days of the 
spot period or in the time period for the spot month.
    To assist exchanges that wish to establish a five-day rule, or a 
similar provision, the Commission proposes guidance in paragraph (b) of 
Appendix B that would set forth circumstances when a position held 
during the spot period may still qualify as a bona fide hedge. The 
guidance would provide that a position held during the spot period may 
still qualify as a bona fide hedging position, provided that, among 
other things: (1) The position complies with the bona fide hedging 
definition; and (2) there is an economically appropriate need to 
maintain such position in excess of federal speculative position limits 
during the spot period, and that need relates to the purchase or sale 
of a cash commodity.\111\
---------------------------------------------------------------------------

    \111\ For example, an economically appropriate need for soybeans 
would mean obtaining soybeans from a reasonable source (considering 
the marketplace) that is the least expensive, at or near the 
location required for the purchaser, and that such sourcing does not 
cause market disruptions or prices to spike.
---------------------------------------------------------------------------

    In addition, the guidance would provide that the person wishing to 
exceed federal position limits during the spot period: (1) Intends to 
make or take delivery during that period; (2) provides materials to the 
exchange supporting the waiver of the five-day rule; (3)

[[Page 11613]]

demonstrates supporting cash-market exposure in-hand that is verified 
by the exchange; (4) demonstrates that, for short positions, the 
delivery is feasible, meaning that the person has the ability to 
deliver against the short position; \112\ and (5) demonstrates that, 
for long positions, the delivery is feasible, meaning that the person 
has the ability to take delivery at levels that are economically 
appropriate.\113\ This proposed guidance is intended to include a non-
exclusive list of considerations for determining whether to waive a 
five-day rule established at the discretion of an exchange.
---------------------------------------------------------------------------

    \112\ That is, the person has inventory on-hand in a deliverable 
location and in a condition in which the commodity can be used upon 
delivery.
    \113\ That is, the delivery comports with the person's 
demonstrated need for the commodity, and the contract is the 
cheapest source for that commodity.
---------------------------------------------------------------------------

v. Guidance on Measuring Risk
    In prior proposals involving position limits, the Commission 
discussed the issue of whether the Commission may recognize as bona 
fide both ``gross hedging'' and ``net hedging.'' \114\ Such attempts 
reflected the Commission's longstanding preference for net hedging, 
which, although not stated explicitly in prior releases, has been 
underpinned by a concern that unfettered recognition of gross hedging 
could potentially allow for the cherry picking of positions in a manner 
that subverts the position limits rules.\115\
---------------------------------------------------------------------------

    \114\ Id. at 96747.
    \115\ For example, using gross hedging, a market participant 
could potentially point to a large long cash position as 
justification for a bona fide hedge, even though the participant, or 
an entity with which the participant is required to aggregate, has 
an equally large short cash position that would result in the 
participant having no net price risk to hedge as the participant had 
no price risk exposure to the commodity prior to establishing such 
derivative position. Instead, the participant created price risk 
exposure to the commodity by establishing the derivative position.
---------------------------------------------------------------------------

    In an effort to clarify its current view on this issue, the 
Commission proposes guidance in paragraph (a) to Appendix B. The 
Commission is of the preliminary view that there are myriad ways in 
which organizations are structured and engage in commercial hedging 
practices, including the use of multi-line business strategies in 
certain industries that would be subject to federal limits for the 
first time under this proposal. Accordingly, the Commission does not 
propose a one-size-fits-all approach to the manner in which risk is 
measured across an organization.
    The proposed guidance reflects the Commission's historical practice 
of recognizing positions hedged on a net basis as bona fide; \116\ 
however, as the Commission has also previously allowed, the proposed 
guidance also may in certain circumstances allow for the recognition of 
gross hedging as bona fide, provided that: (1) The manner in which the 
person measures risk is consistent over time and follows a person's 
regular, historical practice \117\ (meaning the person is not switching 
between net hedging and gross hedging on a selective basis simply to 
justify an increase in the size of his/her derivatives positions); (2) 
the person is not measuring risk on a gross basis to evade the limits 
set forth in proposed Sec.  150.2 and/or the aggregation rules 
currently set forth in Sec.  150.4; (3) the person is able to 
demonstrate (1) and (2) to the Commission and/or an exchange upon 
request; and (4) an exchange that recognizes a particular gross hedging 
position as a bona fide hedge pursuant to proposed Sec.  150.9 
documents the justifications for doing so and maintains records of such 
justifications in accordance with proposed Sec.  150.9(d).
---------------------------------------------------------------------------

    \116\ See 2016 Reproposal, 81 FR at 96747 (stating that gross 
hedging was economically appropriate in circumstances where ``net 
cash positions do not necessarily measure total risk exposure due to 
differences in the timing of cash commitments, the location of 
stocks, and differences in grades or the types of cash commodity.'') 
See also Bona Fide Hedging Transactions or Positions, 42 FR at 
14832, 14834 (Mar. 16, 1977) and Definition of Bona Fide Hedging and 
Related Reporting Requirements, 42 FR 42748, 42750 (Aug. 24, 1977).
    \117\ This proposed guidance on measuring risk is consistent in 
many ways with the manner in which the exchanges require their 
participants to measure and report risk, which is consistent with 
the Commission's requirements with respect to the reporting of risk. 
For example, under Sec.  17.00(d), futures commission merchants 
(``FCMs''), clearing members, and foreign brokers are required to 
report certain reportable net positions, while under Sec.  17.00(e), 
such entities may report gross positions in certain circumstances, 
including if the positions are reported to an exchange or the 
clearinghouse on a gross basis. 17 CFR 17.00. The Commission's 
understanding is that certain exchanges generally prefer, but do not 
require, their participants to report positions on a net basis. For 
those participants that elect to report positions on a gross basis, 
such exchanges require such participants to continue reporting that 
way, particularly through the spot period. The Commission 
preliminarily believes that such consistency is a strong indicator 
that the participant is not measuring risk on a gross basis simply 
to evade regulatory requirements.
---------------------------------------------------------------------------

    The Commission continues to believe that a gross hedge may be a 
bona fide hedge in circumstances where net cash positions do not 
necessarily measure total risk exposure due to differences in the 
timing of cash commitments, the location of stocks, and differences in 
grades or types of the cash commodity.\118\ However, the Commission 
clarifies that these may not be the only circumstances in which gross 
hedging may be recognized as bona fide. Like the analysis of whether a 
particular position satisfies the proposed bona fide hedge definition, 
the analysis of whether gross hedging may be utilized would involve a 
case-by-case determination made by the Commission and/or by an exchange 
using its expertise and knowledge of its participants as it considers 
applications under Sec.  150.9, subject to Commission review and 
oversight.
---------------------------------------------------------------------------

    \118\ See, e.g., Bona Fide Hedging Transactions or Positions, 42 
FR at 14834.
---------------------------------------------------------------------------

    The Commission believes that permitting market participants with 
bona fide hedges to use either or both gross or net hedging will help 
ensure that market participants are able to hedge efficiently. Large, 
complex entities may have hedging needs that cannot be efficiently and 
effectively met with either gross or net hedging. For instance, some 
firms may hedge on a global basis while others may hedge by trading 
desk or business line. Some risks that appear offsetting may in fact 
need to be treated separately where a difference in delivery location 
or date makes net hedging of those positions inappropriate.
    To prevent ``cherry-picking'' when determining whether to gross or 
net hedge certain risks, hedging entities should have policies and 
procedures setting out when gross and net hedging is appropriate. 
Consistent usage of appropriate gross and/or net hedging in line with 
such policies and procedures can demonstrate compliance with the 
Commission's regulations. On the other hand, usage of gross or net 
hedging that is inconsistent with an entity's policies or a change from 
gross to net hedging (or vice versa) could be an indication that an 
entity is seeking to evade position limits regulations.
vi. Pass-Through Provisions
    As the Commission has noted above, CEA section 4a(c)(2)(B) \119\ 
further contemplates bona fide hedges that by themselves do not meet 
the criteria of CEA section 4a(c)(2)(A), but that are executed by a 
pass-through swap counterparty opposite a bona fide hedging swap 
counterparty, or used by a bona fide hedging swap counterparty to 
offset its swap exposure that does satisfy CEA section 
4a(c)(2)(A).\120\ The

[[Page 11614]]

Commission preliminarily believes that, in affording bona fide hedging 
recognition to positions used to offset exposure opposite a bona fide 
hedging swap counterparty, Congress in CEA section 4a(c)(2)(B) 
intended: (1) To encourage the provision of liquidity to commercial 
entities that are hedging physical commodity price risk in a manner 
consistent with the bona fide hedging definition; but also (2) to 
prohibit risk management positions that are not opposite a bona fide 
hedging swap counterparty from being recognized as bona fide 
hedges.\121\
---------------------------------------------------------------------------

    \119\ 7 U.S.C. 6a(c)(2)(B).
    \120\ CEA section 4a(c)(2)(B)(i) recognizes as a bona fide 
hedging position a position that reduces risk attendant to a 
position resulting from a swap that was executed opposite a 
counterparty for which the transaction would qualify as a bona fide 
hedging transaction pursuant to 4a(c)(2)(A). 7 U.S.C. 
6a(c)(2)(B)(i). CEA section 4a(c)(2)(B)(ii) further recognizes as 
bona fide positions that reduce risks attendant to a position 
resulting from a swap that meets the requirements of 4a(c)(2)(A). 7 
U.S.C. 6a(c)(2)(B)(ii).
    \121\ As described above, the Commission has preliminarily 
interpreted the revised statutory temporary substitute test as 
limiting its authority to recognize risk management positions as 
bona fide hedges unless the position is used to offset exposure 
opposite a bona fide hedging swap counterparty.
---------------------------------------------------------------------------

    The Commission proposes to implement this pass-through swap 
language in paragraph (2) of the bona fide hedging definition for 
physical commodities in proposed Sec.  150.1. Each component of the 
proposed pass-through swap provision is described in turn below.
    Proposed paragraph (2)(i) of the bona fide hedging definition would 
address a situation where a particular swap qualifies as a bona fide 
hedge by satisfying the temporary substitute test, economically 
appropriate test, and change in value requirement under proposed 
paragraph (1) for one of the counterparties (the ``bona fide hedging 
swap counterparty''), but not for the other counterparty, and where 
those bona fides ``pass through'' from the bona fide hedging swap 
counterparty to the other counterparty (the ``pass-through swap 
counterparty''). The pass-through swap counterparty could be an entity 
such as a swap dealer, for example, that provides liquidity to the bona 
fide hedging swap counterparty.
    Under the proposed rule, the pass-through of the bona fides from 
the bona fide hedging swap counterparty to the pass-through swap 
counterparty would be contingent on: (1) The pass-through swap 
counterparty's ability to demonstrate that the pass-through swap is a 
bona fide hedge upon request from the Commission and/or from an 
exchange; \122\ and (2) the pass-through swap counterparty entering 
into a futures, option on a futures, or swap position in the same 
physical commodity as the pass-through swap to offset and reduce the 
price risk attendant to the pass-through swap.
---------------------------------------------------------------------------

    \122\ While proposed paragraph (2)(i) of the bona fide hedging 
definition in Sec.  150.1 would require the pass-through swap 
counterparty to be able to demonstrate the bona fides of the pass-
through swap upon request, the proposed rule would not prescribe the 
manner by which the pass-through swap counterparty obtains the 
information needed to support such a demonstration. The pass-through 
swap counterparty could base such a demonstration on a 
representation made by the bona fide hedging swap counterparty, and 
such determination may be made at the time when the parties enter 
into the swap, or at some later point. For the bona fides to pass-
through as described above, the swap position need only qualify as a 
bona fide hedging position at the time the swap was entered into.
---------------------------------------------------------------------------

    If the two conditions above are satisfied, then the bona fides of 
the bona fide hedging swap counterparty ``pass through'' to the pass-
through swap counterparty for purposes of recognizing as a bona fide 
hedge any futures, options on futures, or swap position entered into by 
the pass-through swap counterparty to offset the pass-through swap 
(i.e. to offset the swap opposite the bona fide hedging swap 
counterparty). The pass-through swap counterparty could thus exceed 
federal limits for the bona fide hedge swap opposite the bona fide 
hedging swap counterparty and for any offsetting futures, options on 
futures, or swap position in the same physical commodity, even though 
any such position on its own would not qualify as a bona fide hedge for 
the pass-through swap counterparty under proposed paragraph (1).
    Proposed paragraph (2)(ii) of the bona fide hedging definition 
would address a situation where a participant who qualifies as a bona 
fide hedging swap counterparty (i.e., a counterparty with a position in 
a previously-entered into swap that qualified, at the time the swap was 
entered into, as a bona fide hedge under paragraph (1)) seeks, at some 
later time, to offset that bona fide hedge swap position using futures, 
options on futures, or swaps in excess of limits. Such step might be 
taken, for example, to respond to a change in the bona fide hedging 
swap counterparty's risk exposure in the underlying commodity.\123\ 
Proposed paragraph (2)(ii) would allow such a bona fide hedging swap 
counterparty to use futures, options on futures, or swaps in excess of 
federal limits to offset the price risk of the previously-entered into 
swap, even though the offsetting position itself does not qualify for 
that participant as a bona fide hedge under paragraph (1).
---------------------------------------------------------------------------

    \123\ Examples of a change in the bona fide hedging swap 
counterparty's cash market price risk could include a change in the 
amount of the commodity that the hedger will be able to deliver due 
to drought, or conversely, higher than expected yield due to growing 
conditions.
---------------------------------------------------------------------------

    The proposed pass-through exemption under paragraph (2) would only 
apply to the pass-through swap counterparty's offset of the bona fide 
hedging swap, and/or to the bona fide hedging swap counterparty's 
offset of its bona fide hedging swap. Any further offsets would not be 
eligible for a pass-through exemption under (2) unless the offsets 
themselves meet the bona fide hedging definition. For instance, if 
Producer A enters into an OTC swap with Swap Dealer B, and the OTC swap 
qualifies as a bona fide hedge for Producer A, then Swap Dealer B could 
be eligible for a pass-through exemption to offset that swap in the 
futures market. However, if Swap Dealer B offsets its swap opposite 
Producer A using an OTC swap with Swap Dealer C, Swap Dealer C would 
not be eligible for a pass-through exemption.
    As discussed more fully above, the pass-through swap provision may 
help mitigate some of the potential impact resulting from the removal 
of the ``risk management'' exemptions that are currently in 
effect.\124\
---------------------------------------------------------------------------

    \124\ See supra Section II.A.1.c.ii.(1) (discussion of the 
temporary substitute test).
---------------------------------------------------------------------------

2. ``Commodity Derivative Contract''
    The Commission proposes to create the defined term ``commodity 
derivative contract'' for use throughout part 150 of the Commission's 
regulations as shorthand for any futures contract, option on a futures 
contract, or swap in a commodity (other than a security futures product 
as defined in CEA section 1a(45)).
3. ``Core Referenced Futures Contract''
    The Commission proposes to provide a list of 25 futures contracts 
in proposed Sec.  150.2(d) to which proposed position limit rules would 
apply. The Commission proposes the term ``core referenced futures 
contract'' as a short-hand phrase to denote such contracts.\125\ As per 
the ``referenced contract'' definition described below, position limits 
would also apply to any contract that is directly/indirectly linked to, 
or that has certain pricing relationships with, a core referenced 
futures contract.
---------------------------------------------------------------------------

    \125\ The selection of the proposed core referenced futures 
contracts is explained below in the discussion of proposed Sec.  
150.2.
---------------------------------------------------------------------------

4. ``Economically Equivalent Swap''
    CEA section 4a(a)(5) requires that when the Commission imposes 
limits on futures and options on futures pursuant to CEA section 
4a(a)(2), the Commission also establish limits simultaneously for 
``economically equivalent'' swaps ``as appropriate.'' \126\

[[Page 11615]]

As the statute does not define the term ``economically equivalent,'' 
the Commission must apply its expertise in construing such term, and, 
as discussed further below, must do so consistent with the policy goals 
articulated by Congress, including in CEA sections 4a(a)(2)(C) and 
4a(a)(3).
---------------------------------------------------------------------------

    \126\ CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5). In addition, CEA 
section 4a(a)(4) separately authorizes, but does not require, the 
Commission to impose federal limits on swaps that meet certain 
statutory criteria qualifying them as ``significant price discovery 
function'' swaps. 7 U.S.C. 6a(a)(4). The Commission reiterates, for 
the avoidance of doubt, that the definitions of ``economically 
equivalent'' in CEA section 4a(a)(5) and ``significant price 
discovery function'' in CEA section 4a(a)(4) are separate concepts 
and that contracts can be economically equivalent without serving a 
significant price discovery function. See 2016 Reproposal, 81 FR at 
96736 (the Commission noting that certain commenters may have been 
confusing the two definitions).
---------------------------------------------------------------------------

    Under the Commission's proposed definition of an ``economically 
equivalent swap,'' a swap on any referenced contract (including core 
referenced futures contracts), except for natural gas referenced 
contracts, would qualify as ``economically equivalent'' with respect to 
that referenced contract so long as the swap shares identical 
``material'' contractual specifications, terms, and conditions with the 
referenced contract, disregarding any differences with respect to: (i) 
Lot size or notional amount, (ii) delivery dates diverging by less than 
one calendar day (if the swap and referenced contract are physically-
settled), or (iii) post-trade risk management arrangements.\127\ For 
reasons described further below, natural gas swaps would qualify as 
economically equivalent with respect to a particular referenced 
contract under the same circumstances, except that physically-settled 
swaps with delivery dates diverging by less than two calendar days, 
rather than one calendar day, could qualify as economically equivalent.
---------------------------------------------------------------------------

    \127\ The proposed ``economically equivalent'' language is 
distinct from the terms ``futures equivalent,'' ``economically 
appropriate,'' and other similar terms used in the Commission's 
regulations. For the avoidance of doubt, the Commission's proposed 
definition of ``economically equivalent swap'' for the purposes of 
CEA section 4a(a)(5) does not impact the application of any such 
other terms as they appear in part 20 of the Commission's 
regulations, in the Commission's proposed bona fide hedge 
definition, or elsewhere.
---------------------------------------------------------------------------

    In promulgating the position limits framework, Congress instructed 
the Commission to consider several factors: First, CEA section 4a(a)(3) 
requires the Commission when establishing federal limits, to the 
maximum extent practicable, in its discretion, to (i) diminish, 
eliminate, or prevent excessive speculation; (ii) deter and prevent 
market manipulation, squeezes, and corners; (iii) ensure sufficient 
market liquidity for bona fide hedgers; and (iv) ensure that the price 
discovery function of the underlying market is not disrupted. Second, 
CEA section 4a(a)(2)(C) requires the Commission to strive to ensure 
that any limits imposed by the Commission will not cause price 
discovery in a commodity subject to federal limits to shift to trading 
on a foreign exchange.
    Accordingly, any definition of ``economically equivalent swap'' 
must consider these statutory objectives. The Commission also 
recognizes that physical commodity swaps are largely bilaterally 
negotiated, traded off-exchange (i.e., OTC), and potentially include 
customized (i.e., ``bespoke'') terms, while futures contracts are 
exchange traded with standardized terms. As explained further below, 
due to these differences between swaps and exchange-traded futures and 
options, the Commission has preliminarily determined that Congress's 
underlying policy goals in CEA section 4a(a)(2)(C) and (3) are best 
achieved by proposing a narrow definition of ``economically equivalent 
swaps,'' compared to the broader definition of ``referenced contract'' 
the Commission is proposing to apply to look-alike futures and related 
options.\128\
---------------------------------------------------------------------------

    \128\ The proposed definition of ``referenced contract'' would 
incorporate cash-settled look-alike futures contracts and related 
options that are either (i) directly or indirectly linked, including 
being partially or fully settled on, or priced at a fixed 
differential to, the price of that particular core referenced 
futures contract; or (ii) directly or indirectly linked, including 
being partially or fully settled on, or priced at a fixed 
differential to, the price of the same commodity underlying that 
particular core referenced futures contract for delivery at the same 
location or locations as specified in that particular core 
referenced futures contract. See infra Section II.A.16. (definition 
of ``referenced contract''). The proposed definition of 
``economically equivalent swap'' would be included as a type of 
``referenced contract,'' but, as discussed herein, would include a 
relatively narrower class of swaps compared to look-alike futures 
and options contracts, for the reasons discussed below.
---------------------------------------------------------------------------

    The Commission's proposed ``referenced contract'' definition in 
Sec.  150.1 would include ``economically equivalent swaps,'' meaning 
any economically equivalent swap would be subject to federal limits, 
and thus would be required to be added to, and could be netted against, 
as applicable, other referenced contracts in the same commodity for the 
purpose of determining one's aggregate positions for federal position 
limit levels.\129\ Any swap that is not deemed economically equivalent 
would not be a referenced contract, and thus could not be netted with 
referenced contracts nor would be required to be aggregated with any 
referenced contract for federal position limits purposes. The proposed 
definition is based on a number of considerations.
---------------------------------------------------------------------------

    \129\ See infra Section II.B.2.k. (discussion of netting).
---------------------------------------------------------------------------

    First, the proposed definition would support the statutory 
objectives in CEA section 4a(a)(3)(i) and (ii) by helping to prevent 
excessive speculation and market manipulation, including corners and 
squeezes, by: (1) Focusing on swaps that are the most economically 
equivalent in every significant way to futures or options on futures 
for which the Commission deems position limits to be necessary; \130\ 
and (2) simultaneously limiting the ability of speculators to obtain 
excessive positions through netting. Any swap that meets the proposed 
definition would offer identical risk sensitivity to its associated 
referenced futures or options on futures contract with respect to the 
underlying commodity, and thus could be used to effect a manipulation, 
benefit from a manipulation, or otherwise potentially distort prices in 
the same or similar manner as the associated futures or options on 
futures contract.
---------------------------------------------------------------------------

    \130\ See infra Section III.F. (necessity finding).
---------------------------------------------------------------------------

    Because OTC swaps are bilaterally negotiated and customizable, the 
Commission has preliminarily determined not to propose a more inclusive 
``economically equivalent swap'' definition that would encompass 
additional swaps because such definition could make it easier for 
market participants to inappropriately net down against their core 
referenced futures contracts by allowing market participants to 
structure swaps that do not necessarily offer identical risk or 
economic exposure or sensitivity. In contrast, the Commission 
preliminarily believes that this is less of a concern with exchange-
traded futures and related options since these instruments have 
standardized terms and are subject to exchange rules and oversight. As 
a result, the proposal would generally allow market participants to net 
certain positions in referenced contracts in the same commodity across 
economically equivalent swaps, futures, and options on futures, but the 
proposed economically equivalent swap definition would focus on swaps 
with identical material terms and conditions in order to reduce the 
ability of market participants to accumulate large, speculative 
positions in excess of federal limits by using tangentially-related 
(i.e., non-identical) swaps to net down such positions.
    Second, the proposed definition would address statutory objectives 
by focusing federal limits on those swaps that pose the greatest threat 
for facilitating corners and squeezes--that is, those swaps with 
similar delivery

[[Page 11616]]

dates and identical material economic terms to futures and options on 
futures subject to federal limits--while also minimizing market impact 
and liquidity for bona fide hedgers by not unnecessarily subjecting 
other swaps to the new federal framework. For example, if the 
Commission were to adopt an alternative definition of economically 
equivalent swap that encompassed a broader range of swaps by including 
delivery dates that diverge by one or more calendar days--perhaps by 
several days or weeks--a speculator with a large portfolio of swaps may 
be more likely to be constrained by the applicable position limits and 
therefore may have an incentive either to minimize its swaps activity, 
or move its swaps activity to foreign jurisdictions. If there were many 
similarly situated speculators, the market for such swaps could become 
less liquid, which in turn could harm liquidity for bona fide hedgers. 
As a result, the Commission has preliminarily determined that the 
proposed definition's relatively narrow scope of swaps reasonably 
balances the factors in CEA section 4a(a)(3)(B)(ii) and (iii) by 
decreasing the possibility of illiquid markets for bona fide hedgers on 
the one hand while, on the other hand, focusing on the prevention of 
market manipulation during the most sensitive period of the spot month 
as discussed above.
    Third, the proposed definition would help prevent regulatory 
arbitrage and would strengthen international comity. If the Commission 
proposed a definition that captured a broader range of swaps, U.S.-
based swaps activity could potentially migrate to other jurisdictions 
with a narrower definition, such as the European Union (``EU''). In 
this regard, the proposed definition is similar in certain ways to the 
EU definition for OTC contracts that are ``economically equivalent'' to 
commodity derivatives traded on an EU trading venue.\131\ The proposed 
definition of economically equivalent swaps thus furthers statutory 
goals, including those set forth in CEA section 4a(a)(2)(C), which 
requires the Commission to strive to ensure that any federal position 
limits are ``comparable'' to foreign exchanges and will not cause 
``price discovery . . . to shift to trading'' on foreign 
exchanges.\132\ Further, market participants trading in both U.S. and 
EU markets should find the proposed definition to be familiar, which 
may help reduce compliance costs for those market participants that 
already have systems and personnel in place to identify and monitor 
such swaps.
---------------------------------------------------------------------------

    \131\ See EU Commission Delegated Regulation (EU) 2017/591, 2017 
O.J. (L 87). The applicable European regulations define an OTC 
derivative to be ``economically equivalent'' when it has ``identical 
contractual specifications, terms and conditions, excluding 
different lot size specifications, delivery dates diverging by less 
than one calendar day and different post trade risk management 
arrangements.'' While the Commission's proposed definition is 
similar, the Commission's proposed definition requires ``identical 
material'' terms rather than ``identical'' terms. Further, the 
Commission's proposed definition excludes different ``lot size 
specifications or notional amounts'' rather than referencing only 
``lot size'' since swaps terminology usually refers to ``notional 
amounts'' rather than to ``lot sizes.''
    Both the Commission's definition and the applicable EU 
regulation are intended to prevent harmful netting. See European 
Securities and Markets Authority, Draft Regulatory Technical 
Standards on Methodology for Calculation and the Application of 
Position Limits for Commodity Derivatives Traded on Trading Venues 
and Economically Equivalent OTC Contracts, ESMA/2016/668 at 10 (May 
2, 2016), available at https://www.esma.europa.eu/sites/default/files/library/2016-668_opinion_on_draft_rts_21.pdf (``[D]rafting the 
[economically equivalent OTC swap] definition in too wide a fashion 
carries an even higher risk of enabling circumvention of position 
limits by creating an ability to net off positions taken in on-venue 
contracts against only roughly similar OTC positions.'').
    The applicable EU regulator, the European Securities and Markets 
Authority (``ESMA''), recently released a ``consultation paper'' 
discussing the status of the existing EU position limits regime and 
specific comments received from market participants. According to 
ESMA, no commenter, with one exception, supported changing the 
definition of an economically equivalent swap (referred to as an 
``economically equivalent OTC contract'' or ``EEOTC''). ESMA further 
noted that for some respondents, ``the mere fact that very few EEOTC 
contracts have been identified is no evidence that the regime is 
overly restrictive.'' See European Securities and Markets Authority, 
Consultation Paper MiFID Review Report on Position Limits and 
Position Management Draft Technical Advice on Weekly Position 
Reports, ESMA70-156-1484 at 46, Question 15 (Nov. 5, 2019), 
available at https://www.esma.europa.eu/document/consultation-paper-position-limits.
    \132\ 7 U.S.C. 6a(a)(2)(C).
---------------------------------------------------------------------------

    Each element of the proposed definition, as well as the proposed 
exclusions from the definition, is described below.
a. Scope of Identical Material Terms
    Only ``material'' contractual specifications, terms, and conditions 
would be relevant to the analysis of whether a particular swap would 
qualify as an economically equivalent swap. The proposed definition 
would thus not require that a swap be identical in all respects to a 
referenced contract in order to be deemed ``economically equivalent.'' 
``Material'' specifications, terms, and conditions would be limited to 
those provisions that drive the economic value of a swap, including 
with respect to pricing and risk. Examples of ``material'' provisions 
would include, for example: The underlying commodity, including 
commodity reference price and grade differentials; maturity or 
termination dates; settlement type (e.g., cash- versus physically-
settled); and, as applicable for physically-delivered swaps, delivery 
specifications, including commodity quality standards or delivery 
locations.\133\ Because settlement type would be considered to be a 
material ``contractual specification, term, or condition,'' a cash-
settled swap could only be deemed economically equivalent to a cash-
settled referenced contract, and a physically-settled swap could only 
be deemed economically equivalent to a physically-settled referenced 
contract; however, a cash-settled swap that initially did not qualify 
as ``economically equivalent'' due to no corresponding cash-settled 
referenced contract (i.e., no cash-settled look-alike futures 
contract), could subsequently become an ``economically equivalent 
swap'' if a cash-settled futures contract market were to develop. In 
addition, a swap that either references another referenced contract, or 
incorporates its terms by reference, would be deemed to share identical 
terms with the referenced contract and therefore would qualify as an 
economically equivalent swap.\134\ Any change in the material terms of 
such a swap, however, would render the swap no longer economically 
equivalent for position limits purposes.\135\
---------------------------------------------------------------------------

    \133\ When developing its definition of an ``economically 
equivalent swap,'' the Commission, based on its experience, 
preliminarily has determined that for a swap to be ``economically 
equivalent'' to a futures contract, the material contractual 
specifications, terms, and conditions would need to be identical. In 
making this determination, the Commission took into account, in 
regards to the economics of swaps, how a swap and a corresponding 
futures contract or option on a futures contract react to certain 
market factors and movements, the pricing variables used in 
calculating each instrument, the sensitivities of those variables, 
the ability of a market participant to gain the same type of 
exposures, and how the exposures move to changes in market 
conditions.
    \134\ For example, a cash-settled swap that either settles to 
the pricing of a corresponding cash-settled referenced contract, or 
incorporates by reference the terms of such referenced contract, 
could be deemed to be economically equivalent to the referenced 
contract.
    \135\ The Commission preliminarily recognizes that the material 
swap terms noted above are essential to determining the pricing and 
risk profile for swaps. However, there may be other contractual 
terms that also may be important for the counterparties but not 
necessarily ``material'' for purposes of position limits. For 
example, as discussed below, certain other terms, such as clearing 
arrangements or governing law, may not be material for the purpose 
of determining economic equivalence for federal position limits, but 
may nonetheless affect pricing and risk or otherwise be important to 
the counterparties.
---------------------------------------------------------------------------

    In contrast, the Commission generally would consider those swap 
contractual terms, provisions, or terminology (e.g., ISDA terms and 
definitions) that are unique to swaps (whether standardized

[[Page 11617]]

or bespoke) not to be material for purposes of determining whether a 
swap is economically equivalent to a particular referenced contract. 
For example, swap provisions or terms designating business day or 
holiday conventions, day count (e.g., 360 or actual), calculation 
agent, dispute resolution mechanisms, choice of law, or representations 
and warranties are generally unique to swaps and/or otherwise not 
material, and therefore would not be dispositive for determining 
whether a swap is economically equivalent.\136\
---------------------------------------------------------------------------

    \136\ Commodity swaps, which generally are traded OTC, are less 
standardized compared to exchange-traded futures and therefore must 
include these provisions in an ISDA master agreement between 
counterparties. While certain provisions, for example choice of law, 
dispute resolution mechanisms, or the general representations made 
in an ISDA master agreement, may be important considerations for the 
counterparties, the Commission would not deem such provisions 
material for purposes of determining economic equivalence under the 
federal position limits framework for the same reason the Commission 
would not deem a core referenced futures contract and a look-alike 
referenced contract to be economically different, even though the 
look-alike contract may be traded on a different exchange with 
different contractual representations, governing law, holidays, 
dispute resolution processes, or other provisions unique to the 
exchanges. Similarly, with respect to day counts, a swap could 
designate a day count that is different than the day count used in a 
referenced contract but adjust relevant swap economic terms (e.g., 
relevant rates or payments, fees, basis, etc.) to achieve the same 
economic exposure as the referenced contract. In such a case, the 
Commission may not find such differences to be material for purposes 
of determining the swap to be economically equivalent for federal 
position limits purposes.
---------------------------------------------------------------------------

    The Commission is unable to publish a list of swaps it would deem 
to be economically equivalent swaps because any such determination 
would involve a facts and circumstances analysis, and because most 
commodity swaps are created bilaterally between counterparties and 
traded OTC. Absent a requirement that market participants identify 
their economically equivalent swaps to the Commission on a regular 
basis, the Commission preliminarily believes that market participants 
are best positioned to determine whether particular swaps share 
identical material terms with referenced contracts and would therefore 
qualify as ``economically equivalent'' for purposes of federal position 
limits. However, the Commission understands that for certain bespoke 
swaps it may be unclear whether the facts and circumstances would 
demonstrate whether the swap qualifies as ``economically equivalent'' 
with respect to a referenced contract.
    The Commission emphasizes that under this proposal, market 
participants would have the discretion to make such determination as 
long as they make a reasonable, good faith effort in reaching their 
determination, and that the Commission would not bring any enforcement 
action for violating the Commission's speculative position limits 
against such market participants as long as the market participant 
performed the necessary due diligence and is able to provide sufficient 
evidence, if requested, to support its reasonable, good faith 
effort.\137\ Because market participants would be provided with 
discretion in making any ``economically equivalent'' swap 
determination, the Commission preliminarily anticipates that this 
flexibility should provide a greater level of certainty to market 
participants in contrast to the alternative in which market 
participants would be required to first submit swaps to the Commission 
staff and wait for feedback.\138\
---------------------------------------------------------------------------

    \137\ As noted below, the Commission reserves the authority 
under this proposal to determine that a particular swap or class of 
swaps either is or is not ``economically equivalent'' regardless of 
a market participant's determination. See infra Section II.A.4.d. 
(discussion of commission determination of economic equivalence). As 
long as the market participant made its determination, prior to such 
Commission determination, using reasonable, good faith efforts, the 
Commission would not take any enforcement action for violating the 
Commission's position limits regulations if the Commission's 
determination differs from the market participant's.
    \138\ As discussed under Section II.A.16. (definition of 
``referenced contract''), the Commission proposes to include a list 
of futures and related options that qualify as referenced contracts 
because such contracts are standardized and published by exchanges. 
In contrast, since swaps are largely bilaterally negotiated and OTC 
traded, a swap could have multiple permutations and any published 
list of economically equivalent swaps would be unhelpful or 
incomplete.
---------------------------------------------------------------------------

b. Exclusions From the Definition of ``Economically Equivalent Swap''
    As noted above, the Commission's proposed definition would 
expressly provide that differences in lot size or notional amount, 
delivery dates diverging by less than one calendar day (or less than 
two calendar days for natural gas), or post-trade risk management 
arrangements would not disqualify a swap from being deemed to be 
``economically equivalent'' to a particular referenced contract.
i. Delivery Dates Diverging by Less Than One Calendar Day
    The proposed definition as it applies to commodities other than 
natural gas would encompass swaps with delivery dates that diverge by 
less than one calendar day from that of a referenced contract.\139\ As 
a result, a swap with a delivery date that differs from that of a 
referenced contract by one calendar day or more would not be deemed to 
be economically equivalent under the Commission proposal, and such 
swaps would not be required to be added to, nor permitted to be netted 
against, any referenced contract when calculating one's compliance with 
federal position limit levels.\140\ The Commission recognizes that 
while a penultimate contract may be significantly correlated to its 
corresponding spot-month contract, it does not necessarily offer 
identical economic or risk exposure to the spot-month contract, and 
depending on the underlying commodity and market conditions, a market 
participant may open itself up to material basis risk by moving from 
the spot-month contract to a penultimate contract. Accordingly, the 
Commission has preliminarily determined that it would not be 
appropriate to permit market participants to net such penultimate 
positions against their core referenced futures contract positions 
since such positions do not necessarily reflect equivalent economic or 
risk exposure.
---------------------------------------------------------------------------

    \139\ This aspect of the proposed definition would be irrelevant 
for cash-settled swaps since ``delivery date'' applies only to 
physically-settled swaps.
    \140\ A swap as so described that is not ``economically 
equivalent'' would not be subject to a federal speculative position 
limit under this proposal.
---------------------------------------------------------------------------

ii. Post-Trade Risk Management
    The Commission is specifically excluding differences in post-trade 
risk management arrangements, such as clearing or margin, in 
determining whether a swap is economically equivalent. As noted above, 
many commodity swaps are traded OTC and may be uncleared or cleared at 
a different clearing house than the corresponding referenced 
contract.\141\ Moreover, since the core referenced futures contracts, 
along with futures contracts and options on futures in general, are 
traded on DCMs with vertically integrated clearing houses, as a 
practical matter, it is impossible for OTC commodity swaps, which 
historically have been uncleared, to share identical post-trade 
clearing house or other post-trade risk management arrangements with 
their associated core referenced futures contracts.
---------------------------------------------------------------------------

    \141\ Similar to the Commission's understanding of ``material'' 
terms, the Commission construes ``post-trade risk management 
arrangements'' to include various provisions included in standard 
swap agreements, including, for example: Margin or collateral 
requirements, including with respect to initial or variation margin; 
whether a swap is cleared, uncleared, or cleared at a different 
clearing house than the applicable referenced contract; close-out, 
netting, and related provisions; and different default or 
termination events and conditions.
---------------------------------------------------------------------------

    Therefore, if differences in post-trade risk management 
arrangements were sufficient to exclude a swap from economic 
equivalence to a core

[[Page 11618]]

referenced futures contract, then such an exclusion could otherwise 
render ineffective the Commission's statutory directive under CEA 
section 4a(a)(5) to include economically equivalent swaps within the 
federal position limits framework. Accordingly, the Commission has 
preliminarily determined that differences in post-trade risk management 
arrangements should not prevent a swap from qualifying as economically 
equivalent with an otherwise materially identical referenced contract.
iii. Lot Size or Notional Amount
    The last exclusion would clarify that differences in lot size or 
notional amount would not prevent a swap from being deemed to be 
economically equivalent to its corresponding referenced contract. The 
Commission's use of ``lot size'' and ``notional amount'' refer to the 
same general concept--while futures terminology usually employs ``lot 
size,'' swap terminology usually employs ``notional amount.'' 
Accordingly, the Commission proposes to use both terms to convey the 
same general meaning, and in this context does not mean to suggest a 
substantive difference between the two terms.
c. Economically Equivalent Natural Gas Swaps
    Market dynamics in natural gas are unique in several respects 
including, among other things, that ICE and NYMEX both list high volume 
contracts, whereas liquidity in other commodities tends to pool at a 
single DCM. As expiration approaches for natural gas contracts, volume 
tends to shift from the NYMEX core referenced futures contract 
(``NG''), which is physically settled, to an ICE contract, which is 
cash settled. This trend reflects certain market participants' desire 
for exposure to natural gas prices without having to make or take 
delivery.\142\ NYMEX and ICE also list several ``penultimate'' cash-
settled referenced contracts that use the price of the physically-
settled NYMEX contract as a reference price for cash settlement on the 
day before trading in the physically-settled NYMEX contract 
terminates.\143\ In order to recognize the existing natural gas 
markets, which include active and vibrant markets in penultimate 
natural gas contracts, the Commission thus proposes a slightly broader 
economically equivalent swap definition for natural gas so that swaps 
with delivery dates that diverge by less than two calendar days from an 
associated referenced contract could still be deemed economically 
equivalent and would be subject to federal limits. The Commission 
intends for this change to prevent and disincentivize manipulation and 
regulatory arbitrage and to prevent volume from shifting away from NG 
to penultimate natural gas contract futures and/or penultimate swap 
markets in order to avoid federal position limits.\144\
---------------------------------------------------------------------------

    \142\ In part to address historical concerns over the potential 
for manipulation of physically-settled natural gas contracts during 
the spot month in order to benefit positions in cash-settled natural 
gas contracts, the Commission proposes later in this release to 
allow for a higher ``conditional'' spot month limit in cash-settled 
natural gas referenced contracts under the condition that market 
participants seeking to utilize such conditional limit exit any 
positions in physically-settled natural gas referenced contracts. 
See infra Section II.C.2.e. (proposed conditional spot month limit 
exemption for natural gas).
    \143\ Such penultimate contracts include: ICE's Henry Financial 
Penultimate Fixed Price Futures (PHH) and options on Henry 
Penultimate Fixed Price (PHE), and NYMEX's Henry Hub Natural Gas 
Penultimate Financial Futures (NPG).
    \144\ As noted above, the Commission is proposing a relatively 
narrow ``economically equivalent swap'' definition in order to 
prevent market participants from inappropriately netting positions 
in core referenced futures contracts against swap positions further 
out on the curve. The Commission preliminarily acknowledges that 
liquidity could shift to penultimate swaps as a result but believes 
that, with the exception of natural gas, this concern is mitigated 
since certain constraints exist that militate against this 
occurring. First, there may be basis risk between the penultimate 
swap and the core referenced futures contract. Second, compared to 
most other contracts, the Commission believes that natural gas has a 
relatively liquid penultimate futures market that enables a market 
participant to hedge or set-off its penultimate swap position. Since 
the constraints described above do not necessarily apply to the 
natural gas futures markets, the Commission preliminarily believes 
that liquidity may be incentivized to shift from NG to penultimate 
natural gas swaps in order to avoid federal position limits in the 
absence of the Commission's proposed exception for natural gas in 
the ``economically equivalent swap'' definition.
---------------------------------------------------------------------------

d. Commission Determination of Economic Equivalence
    While the Commission would primarily rely on market participants to 
determine whether their swaps meet the proposed ``economically 
equivalent swap'' definition, the Commission is proposing paragraph (3) 
to the definition to clarify that the Commission may determine on its 
own initiative that any swap or class of swaps satisfies, or does not 
satisfy, the economically equivalent definition with respect to any 
referenced contract or class of referenced contracts. The Commission 
believes that this provision may provide the ability to offer clarity 
to the marketplace in cases where uncertainty exists as to whether 
certain swaps would qualify (or would not qualify) as ``economically 
equivalent,'' and therefore would be (or would not be) subject to the 
proposed federal position limits framework. Similarly, where market 
participants hold divergent views as to whether certain swaps qualify 
as ``economically equivalent,'' the Commission can ensure that all 
market participants treat OTC swaps with identical material terms 
similarly, and also would be able to serve as a backstop in case market 
participants fail to properly treat economically equivalent swaps as 
such. As noted above, the Commission would not take any enforcement 
action with respect to violating the Commission's position limits 
regulations if the Commission disagrees with a market participant's 
determination as long as the market participant is able to provide 
sufficient support to show that it made a reasonable, good faith effort 
in applying its discretion.\145\
---------------------------------------------------------------------------

    \145\ See supra II.A.4.a. (discussing market participants' 
discretion in determining whether a swap is economically 
equivalent).
---------------------------------------------------------------------------

5. ``Eligible Affiliate''
    The Commission proposes to create the new defined term ``eligible 
affiliate,'' which would be used in proposed Sec.  150.2(k), discussed 
in connection with proposed Sec.  150.2 below. As discussed further in 
that section of the release, an entity that qualifies as an ``eligible 
affiliate'' would be permitted to voluntarily aggregate its positions, 
even though it is eligible for an exemption from aggregation under 
Sec.  150.4(b).
6. ``Eligible Entity''
    The Commission adopted a revised ``eligible entity'' definition in 
the 2016 Final Aggregation Rulemaking.\146\ The Commission is not 
proposing any further amendments to this definition, but is including 
that revised definition in this document so that all defined terms are 
included. As noted above, the Commission is also proposing a non-
substantive change to remove the lettering from this and other 
definitions that appear lettered in existing Sec.  150.1, and to list 
the definitions in alphabetical order.
---------------------------------------------------------------------------

    \146\ See 17 CFR 150.1(d).
---------------------------------------------------------------------------

7. ``Entity''
    The Commission proposes defining ``entity'' to mean ``a `person' as 
defined in section 1a of the Act.'' \147\ The term, not defined in 
existing Sec.  150.1, is used throughout proposed part 150 of the 
Commission's regulations.
---------------------------------------------------------------------------

    \147\ 7 U.S.C. 1a(38).
---------------------------------------------------------------------------

8. ``Excluded Commodity''
    The phrase ``excluded commodity'' is defined in CEA section 1a(19), 
but is not defined or used in existing part 150 of the Commission's 
regulations. The

[[Page 11619]]

Commission proposes including a definition of ``excluded commodity'' in 
part 150 that references that term as defined in CEA section 
1a(19).\148\
---------------------------------------------------------------------------

    \148\ 7 U.S.C. 1a(19).
---------------------------------------------------------------------------

9. ``Futures-Equivalent''
    This phrase is currently defined in existing Sec.  150.1(f) and is 
used throughout existing part 150 of the Commission's regulations to 
describe the method for converting a position in an option on a futures 
contract to an economically equivalent amount in a futures contract. 
The Dodd-Frank Act amendments to CEA section 4a,\149\ in part, direct 
the Commission to apply aggregate federal position limits to physical 
commodity futures contracts and to swap contracts that are economically 
equivalent to such physical commodity futures on which the Commission 
has established limits. In order to aggregate positions in futures, 
options on futures, and swaps, it is necessary to adjust the position 
sizes, since such contracts may have varying units of trading (e.g., 
the amount of a commodity underlying a particular swap contract could 
be larger than the amount of a commodity underlying a core referenced 
futures contract). The Commission thus proposes to adjust position 
sizes to an equivalent position based on the size of the unit of 
trading of the core referenced futures contract. The phrase ``futures-
equivalent'' is used for that purpose throughout the proposed rules, 
including in connection with the ``referenced contract'' definition in 
proposed Sec.  150.1. The Commission also proposes broadening this 
definition to include references to the proposed term ``core referenced 
futures contracts.''
---------------------------------------------------------------------------

    \149\ Under CEA sections 4a(a)(2) and 4a(a)(5), speculative 
position limits apply to agricultural and exempt commodity swaps 
that are ``economically equivalent'' to DCM futures and options on 
futures contracts. 7 U.S.C. 6a(a)(2) and (5).
---------------------------------------------------------------------------

10. ``Independent Account Controller''
    The Commission adopted a revised ``independent account controller'' 
definition in the 2016 Final Aggregation Rule.\150\ The Commission is 
not proposing any further amendments to this definition, but is 
including that revised definition in this document so that all defined 
terms appear together.
---------------------------------------------------------------------------

    \150\ See 17 CFR 150.1(e).
---------------------------------------------------------------------------

11. ``Long Position''
    The phrase ``long position'' is currently defined in Sec.  150.1(g) 
to mean ``a long call option, a short put option or a long underlying 
futures contract.'' The Commission proposes to update this definition 
to apply to swaps and to clarify that such positions would be on a 
futures-equivalent basis. This provision would thus be applicable to 
options on futures and swaps such that a long position would also 
include a long futures-equivalent option on futures and a long futures-
equivalent swap.
12. ``Physical Commodity''
    The Commission proposes to define the term ``physical commodity'' 
for position limits purposes. Congress used the term ``physical 
commodity'' in CEA sections 4a(a)(2)(A) and 4a(a)(2)(B) to mean 
commodities ``other than excluded commodities as defined by the 
Commission.'' \151\ The proposed definition of ``physical commodity'' 
thus would include both exempt and agricultural commodities, but not 
excluded commodities.
---------------------------------------------------------------------------

    \151\ 7 U.S.C. 6a(a)(2)(A) and (B).
---------------------------------------------------------------------------

13. ``Position Accountability''
    Existing Sec.  150.5 permits position accountability in lieu of 
position limits in certain cases, but does not define the term 
``position accountability.'' The proposed amendments to Sec.  150.5 
would allow exchanges, in some cases, to adopt position accountability 
levels in lieu of, or in addition to, position limits. The Commission 
proposes a definition of ``position accountability'' for use throughout 
proposed Sec.  150.5 as discussed in greater detail in connection with 
proposed Sec.  150.5 below.
14. ``Pre-Enactment Swap''
    The Commission proposes to create the defined term ``pre-enactment 
swap'' to mean any swap entered into prior to enactment of the Dodd-
Frank Act of 2010 (July 21, 2010), the terms of which have not expired 
as of the date of enactment of that Act. As discussed in connection 
with proposed Sec.  150.3 later in this release, if acquired in good 
faith, such swaps would be exempt from federal speculative position 
limits, although such swaps could not be netted with post-effective 
date swaps for purposes of complying with spot month speculative 
position limits.
15. ``Pre-Existing Position''
    The Commission proposes to create the defined term ``pre-existing 
position'' to reference any position in a commodity derivative contract 
acquired in good faith prior to the effective date of a final federal 
position limit rulemaking. Proposed Sec.  150.2(g) would set forth the 
circumstances under which position limits would apply to such 
positions.
16. ``Referenced Contract''
    The nine contracts currently subject to federal limits, which are 
all physically-settled futures, are all listed in existing Sec.  
150.2.\152\ As the Commission is proposing to expand the position 
limits framework to cover certain cash-settled futures and options on 
futures contracts and certain economically equivalent swaps, the 
Commission proposes a new defined term, ``referenced contract,'' for 
use throughout proposed part 150 to refer to contracts that would be 
subject to federal limits.
---------------------------------------------------------------------------

    \152\ 17 CFR 150.2.
---------------------------------------------------------------------------

    The referenced contract definition would thus include: (1) Any core 
referenced futures contract listed in proposed Sec.  150.2(d); (2) any 
other contract (futures or option on futures), on a futures-equivalent 
basis with respect to a particular core referenced futures contract, 
that is directly or indirectly linked to the price of a core referenced 
futures contract, or that is directly or indirectly linked to the price 
of the same commodity underlying a core referenced futures contract 
(for delivery at the same location(s)); and (3) any economically 
equivalent swap, on a futures-equivalent basis.
    The proposed referenced contract definition would include look-
alike futures and options on futures contracts (as well as options or 
economically equivalent swaps with respect to such look-alike 
contracts) and contracts of the same commodity but different sizes 
(e.g., mini contracts). Positions in referenced contracts may in 
certain circumstances be netted with positions in other referenced 
contracts. However, to avoid evasion and undermining of the position 
limits framework, non-referenced contracts on the same commodity could 
not be used to net down positions in referenced contracts.\153\
---------------------------------------------------------------------------

    \153\ A more detailed discussion of when netting is permitted 
appears below. See infra Section II.B.2.k. (discussion of netting).
---------------------------------------------------------------------------

a. Cash-Settled Referenced Contracts
    Under these proposed provisions, federal limits would apply to all 
cash-settled futures and options on futures contracts on physical 
commodities that are linked in some manner, whether directly or 
indirectly, to physically-settled contracts subject to federal limits, 
and to any cash settled swaps that are deemed ``economically equivalent 
swaps'' with respect to a particular cash-settled referenced 
contract.\154\ While the Commission

[[Page 11620]]

acknowledges previous comments to the effect that cash-settled 
contracts are less susceptible to manipulation and thus should not be 
subject to federal limits, the Commission is of the view that generally 
speaking, linked cash-settled and physically-settled contracts form one 
market, and thus should be subject to federal limits. This view is 
informed by the Commission's experience overseeing derivatives markets, 
where it has observed that it is common for the same market participant 
to arbitrage linked cash- and physically-settled contracts, and where 
it has also observed instances where linked cash-settled and 
physically-settled contracts have been used together as part of a 
manipulation.\155\ In the Commission's view, cash-settled contracts are 
generally economically equivalent to physical-delivery contracts in the 
same commodity. In the absence of position limits, a trader with 
positions in both the physically-delivered and cash-settled contracts 
may have increased ability and incentive to manipulate one contract to 
benefit positions in the other.
---------------------------------------------------------------------------

    \154\ For example, ICE's Henry Penultimate Fixed Price Future, 
which cash-settles directly to NYMEX's Henry Hub Natural Gas core 
referenced futures contract, would be considered a referenced 
contract under the rules proposed herein.
    \155\ The Commission has previously found that traders with 
positions in look-alike cash-settled contracts may have an incentive 
to manipulate and undermine price discovery in the physical-delivery 
contracts to which the cash-settled contract is linked. The practice 
known as ``banging the close'' or ``marking the close'' is one such 
manipulative practice that the Commission prosecutes and that this 
proposal seeks to prevent.
---------------------------------------------------------------------------

    The proposal to include futures contracts and options on futures 
that are ``indirectly linked'' to the core referenced futures contract 
under the definition of ``referenced contract'' is intended to prevent 
the evasion of position limits through the creation of an economically 
equivalent futures contract or option on a future, as applicable, that 
does not directly reference the price of the core referenced futures 
contract. Such contracts that settle to the price of a referenced 
contract but not to the price of a core referenced futures contract, 
for example, would be indirectly linked to the core referenced futures 
contract.\156\
---------------------------------------------------------------------------

    \156\ As discussed above, the Commission is proposing a 
definition of ``economically equivalent swap'' that is narrower than 
the class of futures and options on futures that would be included 
as referenced contracts. See supra Section II.A.4. (discussion of 
economically equivalent swaps).
---------------------------------------------------------------------------

    On the other hand, an outright derivative contract whose settlement 
price is based on an index published by a price reporting agency that 
surveys cash market transaction prices (even if the cash market 
practice is to price at a differential to a futures contract) would not 
be directly or indirectly linked to the core referenced futures 
contract. Similarly, a physical-delivery derivative contract whose 
settlement price was based on the same underlying commodity at a 
different delivery location (e.g., a hypothetical physical-delivery 
futures contract on ultra-low sulfur diesel delivered at L.A. Harbor 
instead of the NYMEX ultra-low sulfur diesel futures contract delivered 
in New York Harbor core referenced futures contract) would not be 
linked, directly or indirectly, to the core referenced futures contract 
because the price of the physically-delivered L.A. Harbor contract 
would reflect the L.A. Harbor market price for ultra-low sulfur diesel.
b. Exclusions From the Referenced Contract Definition
    While the proposed referenced contract definition would include 
linked contracts, it would also explicitly exclude certain other types 
of contracts. Paragraph (3) of the proposed referenced contract 
definition would explicitly exclude from that definition a location 
basis contract, a commodity index contract, a swap guarantee, or a 
trade option that meets the requirements of Sec.  32.3 of this chapter.
    First, failing to exclude location basis contracts from the 
referenced contract definition could enable speculators to net portions 
of the location basis contract with outright positions in one of the 
locations comprising the basis contract, which would permit 
extraordinarily large speculative positions in the outright 
contract.\157\ For example, under the proposed rules, a large outright 
position in Henry Hub Natural Gas futures could not be netted down 
against a location basis contract that cash-settles to the difference 
in price between Gulf Coast Natural Gas and Henry Hub Natural Gas. 
Absent the proposed exclusion, a market participant could otherwise 
increase its exposure in the outright contract by using the location 
basis contract to net down, and then increase further, an outright 
contract position that would otherwise be restricted by position 
limits.\158\ Further, excluding location basis contracts from the 
referenced contract definition may allow commercial end-users to more 
efficiently hedge the cost of commodities at their preferred location.
---------------------------------------------------------------------------

    \157\ See infra Section II.B.2.k. (discussion of netting).
    \158\ While excluding location basis contracts from the 
referenced contract definition would prevent the circumstance 
described above, it would also mean that location basis contracts 
would not be subject to federal limits. The Commission would be 
comfortable with this outcome because location basis contracts 
generally demonstrate minimal volatility and are typically 
significantly less liquid than the core referenced futures 
contracts, meaning they would be more costly to try to use in a 
manipulation.
---------------------------------------------------------------------------

    Similarly, the proposed exclusion of commodity index contracts from 
the referenced contract definition would help ensure that market 
participants could not use a position in a commodity index contract to 
net down an outright position that was a component of the commodity 
index contract. If the Commission did not exclude commodity index 
contracts, then speculators would be allowed to take on massive 
outright positions in referenced contracts, which could lead to 
excessive speculation.
    As noted above, it is common for swap dealers to enter into 
commodity index contracts with participants for which the contract 
would not qualify as a bona fide hedging position (e.g., with a pension 
fund). Failing to exclude commodity index contracts from the referenced 
contract definition could enable a swap dealer to use positions in 
commodity index contracts to net down offsetting outright futures 
positions in the components of the index. This would have the effect of 
subverting the statutory pass-through swap language in CEA section 
4a(c)(2)(B), which is intended to foreclose the recognition of 
positions entered into for risk management purposes as bona fide hedges 
unless the swap dealer is entering into positions opposite a 
counterparty for which the swap position is a bona fide hedge.\159\
---------------------------------------------------------------------------

    \159\ 7 U.S.C. 6a(c)(2)(B). While excluding commodity index 
contracts from the referenced contract definition would prevent the 
potentially risky netting circumstance described above, it would 
also mean that commodity index contracts would not be subject to 
federal limits. The Commission would be comfortable with this 
outcome because the commodities comprising the index would 
themselves be subject to limits, and because commodity index 
contracts generally tend to exhibit low volatility since they are 
diversified across many different commodities.
---------------------------------------------------------------------------

    In order to clarify the types of contracts that would qualify as 
location basis contracts and commodity index contracts, and thus would 
be excluded from the referenced contract definition, the Commission 
proposes guidance in Appendix C to part 150 of the Commission's 
regulations. The proposed guidance would include information which 
would help define the parameters of the terms ``location basis 
contract'' and ``commodity index contract.'' To the extent a particular 
contract fits within the proposed guidance, such contract would not be 
a referenced contract, would not be subject to federal limits, and 
could not

[[Page 11621]]

be used to net down positions in referenced contracts.\160\
---------------------------------------------------------------------------

    \160\ See infra Section II.B.2.k. (discussion of netting).
---------------------------------------------------------------------------

    Second, swap guarantees are explicitly excluded from the proposed 
referenced contract definition. In connection with further defining the 
term ``swap'' jointly with the Securities and Exchange Commission in 
connection with the ``Product Definition Adopting Release,'' \161\ the 
Commission interpreted the term ``swap'' (that is not a ``security-
based swap'' or ``mixed swap'') to include a guarantee of such swap, to 
the extent that a counterparty to a swap position would have recourse 
to the guarantor in connection with the position.\162\ Excluding 
guarantees of swaps from the definition of referenced contract should 
help avoid any potential confusion regarding the application of 
position limits to guarantees of swaps. The Commission understands that 
swap guarantees generally serve as insurance, and in many cases swap 
guarantors guarantee the performance of an affiliate in order to entice 
a counterparty to enter into a swap with such guarantor's affiliate. As 
a result, the Commission preliminarily believes that swap guarantees 
neither contribute to excessive speculation, market manipulation, 
squeezes, or corners nor were contemplated by Congress when Congress 
articulated its policy goals in CEA sections 4a(a)(1)-(3).\163\
---------------------------------------------------------------------------

    \161\ See generally Further Definition of ``Swap,'' ``Security-
Based Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps; 
Security-Based Swap Agreement Recordkeeping, 77 FR 48207 (Aug. 13, 
2012) (``Product Definitions Adopting Release'').
    \162\ See id. at 48226.
    \163\ To the extent that swap guarantees may lower costs for 
uncleared OTC swaps in particular by incentivizing counterparties to 
agree to the swap, excluding swap guarantees arguably may improve 
market liquidity, which is consistent with the CEA's statutory goals 
in CEA section 4a(a)(3)(B) to ensure sufficient liquidity for bona 
fide hedgers when establishing its position limit framework.
---------------------------------------------------------------------------

    Third, trade options that meet the requirements of Sec.  32.3 would 
also be excluded from the proposed referenced contract definition. The 
Commission has traditionally exempted trade options from a number of 
Commission requirements because they are typically used by end-users to 
hedge physical risk and thus do not contribute to excessive 
speculation. Trade options are not subject to position limits under 
current regulations, and the proposed exclusion of trade options from 
the referenced contract definition would simply codify existing 
practice.\164\
---------------------------------------------------------------------------

    \164\ In the trade options final rule, the Commission stated its 
belief that federal limits should not apply to trade options, and 
expressed an intention to address trade options in the context of 
any final rulemaking on position limits. See Trade Options, 81 FR at 
14966, 14971 (Mar. 21, 2016).
---------------------------------------------------------------------------

c. List of Referenced Contracts
    In an effort to provide clarity to market participants regarding 
which exchange-traded contracts are subject to federal limits, the 
Commission anticipates publishing, and regularly updating, a list of 
such contracts on its website.\165\ The Commission thus proposes to 
publish a CFTC Staff Workbook of Commodity Derivative Contracts under 
the Regulations Regarding Position Limits for Derivatives along with 
this release, which would provide a non-exhaustive list of referenced 
contracts and may be helpful to market participants in determining 
categories of contracts that would fit within the referenced contract 
definition. As always, market participants may request clarification 
from the Commission.
---------------------------------------------------------------------------

    \165\ As discussed above, the Commission will provide market 
participants with reasonable, good-faith discretion to determine 
whether a swap would qualify as economically equivalent for federal 
position limit purposes. See supra Section II.A.4. (discussion of 
economically equivalent swaps).
---------------------------------------------------------------------------

    In order to ensure that the list remains up-to-date and accurate, 
the Commission is proposing changes to certain provisions of part 40 of 
its regulations which pertain to the collection of position limits 
information through the filing of product terms and conditions 
submissions. In particular, under existing rules, including Sec. Sec.  
40.2, 40.3, and 40.4, DCMs and SEFs are required to comply with certain 
submission requirements related to the listing of certain products. 
Many of the required submissions must include the product's ``terms and 
conditions,'' which is defined in Sec.  40.1(j) and which includes, 
under Sec.  40.1(j)(1)(vii), ``Position limits, position accountability 
standards, and position reporting requirements.'' The Commission 
proposes to expand Sec.  40.1(j)(1)(vii), which addresses futures and 
options on futures, to also include an indication as to whether the 
contract meets the definition of a referenced contract as defined in 
Sec.  150.1, and, if so, the name of the core referenced futures 
contract on which the referenced contract is based. The Commission 
proposes to also expand Sec.  40.1(j)(2)(vii), which addresses swaps, 
to include an indication as to whether the contract meets the 
definition of economically equivalent swap as defined in Sec.  150.1 of 
this chapter, and, if so, the name of the referenced contract to which 
the swap is economically equivalent. This information would enable the 
Commission to maintain on its website, www.cftc.gov, an up-to-date list 
of DCM and SEF contracts subject to federal limits.
17. ``Short Position''
    The Commission proposes to expand the existing definition of 
``short position,'' currently defined in Sec.  150.1(h), to include 
swaps and to clarify that any such positions would be measured on a 
futures-equivalent basis.
18. ``Speculative Position Limit''
    The Commission proposes to define the term ``speculative position 
limit'' for use throughout part 150 of the Commission's regulations to 
refer to federal or exchange-set limits, net long or net short, 
including single month, spot month, and all-months-combined limits. 
This proposed definition is not intended to limit the authority of 
exchanges to adopt other types of limits that do not meet the 
``speculative position limit definition,'' such as a limit on gross 
long or gross short positions, or a limit on holding or controlling 
delivery instruments.
19. ``Spot Month,'' ``Single Month,'' and ``All-Months''
    The Commission proposes to expand the existing definition of ``spot 
month'' to account for the fact that the proposed limits would apply to 
both physically-settled and certain cash-settled contracts, to clarify 
that the spot month for referenced contracts would be the same period 
as that of the relevant core referenced futures contract, and to 
account for variations in spot month conventions that differ by 
commodity. In particular, for the ICE U.S. Sugar No. 11 (SB) core 
referenced futures contract, the spot month would mean the period of 
time beginning at the opening of trading on the second business day 
following the expiration of the regular option contract traded on the 
expiring futures contract until the contract expires. For the ICE U.S. 
Sugar No. 16 (SF) core referenced futures contract, the spot month 
would mean the period of time beginning on the third-to-last trading 
day of the contract month until the contract expires. For the CME Live 
Cattle (LC) core referenced futures contract, the spot month would mean 
the period of time beginning at the close of trading on the fifth 
business day of the contract month until the contract expires.
    The Commission also proposes to eliminate the existing definitions 
of ``single month'' and ``all-months'' because the definitions for 
those terms would be built into the proposed definition of 
``speculative position limits'' described above.

[[Page 11622]]

20. ``Spread Transaction''
    The Commission proposes to incorporate a definition for 
transactions normally known to the trade as ``spreads,'' which would 
list the types of transactions that could qualify for spread exemptions 
for purposes of federal position limits. The proposed list would cover 
common types of inter-commodity and intra-commodity spreads such as: 
Calendar spreads; quality differential spreads; processing spreads 
(such as energy ``crack'' or soybean ``crush'' spreads); product or by-
product differential spreads; and futures-options spreads.\166\ 
Separately, under proposed Sec.  150.3(a)(2)(ii), the Commission could 
determine to exempt any other spread transaction that is not included 
in the spread transaction definition, but that the Commission has 
determined is consistent with CEA section 4a(a)(3)(B),\167\ and 
exempted, pursuant to proposed Sec.  150.3(b).
---------------------------------------------------------------------------

    \166\ For example, trading activity in many commodity derivative 
markets is concentrated in the nearby contract month, but a hedger 
may need to offset risk in deferred months where derivative trading 
activity may be less active. A calendar spread trader could provide 
liquidity without exposing himself or herself to the price risk 
inherent in an outright position in a deferred month. Processing 
spreads can serve a similar function. For example, a soybean 
processor may seek to hedge his or her processing costs by entering 
into a ``crush'' spread, i.e., going long soybeans and short soybean 
meal and oil. A speculator could facilitate the hedger's ability to 
do such a transaction by entering into a ``reverse crush'' spread 
(i.e., going short soybeans and long soybean meal and oil). Quality 
differential spreads, and product or by-product differential 
spreads, may serve similar liquidity-enhancing functions when 
spreading a position in an actively traded commodity derivatives 
market such as CBOT Wheat (W) against a position in another actively 
traded market, such as MGEX Wheat.
    \167\ As noted above, CEA section 4a(a)(3)(B) provides that the 
Commission shall set limits ``to the maximum extent practicable, in 
its discretion--(i) to diminish, eliminate, or prevent excessive 
speculation as described under this section; (ii) to deter and 
prevent market manipulation, squeezes, and corners; (iii) to ensure 
sufficient market liquidity for bona fide hedgers; and (iv) to 
ensure that the price discovery function of the underlying market is 
not disrupted.''
---------------------------------------------------------------------------

21. ``Swap'' and ``Swap Dealer''
    The Commission proposes to incorporate the definitions of ``swap'' 
and ``swap dealer'' as they are defined in section 1a of the Act and 
Sec.  1.3 of this chapter.\168\
---------------------------------------------------------------------------

    \168\ 7 U.S.C. 1a(47) and 1a(49); 17 CFR 1.3.
---------------------------------------------------------------------------

22. ``Transition Period Swap''
    The Commission proposes to create the defined term ``transition 
period swap'' to mean any swap entered into during the period 
commencing July 22, 2010 and ending 60 days after the publication of a 
final federal position limits rulemaking in the Federal Register, the 
terms of which have not expired as of that date. As discussed in 
connection with proposed Sec.  150.3 later in this release, if acquired 
in good faith, such swaps would be exempt from federal speculative 
position limits, although such swaps could not be netted with post-
effective date swaps for purposes of complying with spot month 
speculative position limits.
    Finally, the Commission proposes to eliminate existing Sec.  
150.1(i), which includes a chart specifying the ``first delivery month 
of the crop year'' for certain commodities. The crop year definition 
had been pertinent for purposes of the spread exemption to the 
individual month limit in current Sec.  150.3(a)(3), which limits 
spreads to those between individual months in the same crop year and to 
a level no more than that of the all-months limit. This provision was 
pertinent at a time when the single month and all months combined 
limits were different. Now that the current and proposed single month 
and all months combined limits are the same, and now that the 
Commission is proposing a new process for granting spread exemptions in 
Sec.  150.3, this provision is no longer needed.
23. Request for Comment
    The Commission requests comment on all aspects of the proposed 
amendments and additions to the definitions in Sec.  150.1. The 
Commission also invites comments on the following:
    (1) Should the Commission include the enumerated hedges in 
regulations, rather than in an appendix of acceptable practices? Why or 
why not?
    (2) Should the Commission list any additional common commercial 
hedging practices as enumerated hedges?
    (3) The Commission proposes to eliminate the five day rule on 
federal position limits, instead allowing exchanges discretion on 
whether to apply or waive any five day rule or equivalent on their 
exchange position limits. The Commission believes that the five day 
rule can be an important way to help ensure that futures and cash 
market prices converge. As such, should the Commission require that 
exchanges apply the five day rule to some or all bona fide hedging 
positions and/or spread exemptions? If so, to which bona fide hedging 
positions? Should the exchanges retain the ability to waive such five 
day rule?
    (4) The Commission requests comment on the nature of anticipated 
merchandising exemptions that have been granted by DCMs in connection 
with the 16 non-legacy commodities or in connection with exemptions 
from exchange limits in 9 legacy commodities.
    (5) To what extent do the enumerated hedges proposed in this 
release encompass the types of positions discussed in the BFH Petition? 
Should additional types of positions identified in the BFH Petition, 
including examples nos. 3 (unpriced physical purchase and sale 
commitments) and 7 (scenario 2) (use of physical delivery referenced 
contracts to hedge physical transactions using calendar month averaging 
pricing), be enumerated as bona fide hedges, after notice and comment?
    (6) The Commission requests comment as to whether price risk is 
attributable to a variety of factors, including political and weather 
risk, and could therefore allow hedging political, weather, or other 
risks, or whether price risk is something narrower in the application 
of bona fide hedging.
    (7) While an ``economically equivalent swap'' qualifies as a 
referenced contract under paragraph (2) of the ``referenced contract'' 
definition, paragraph (1) of the ``referenced contract'' definition 
applies a broader test to determine whether futures contracts or 
options on a futures contract would qualify as a referenced contract. 
Instead of a separate definition for ``economically equivalent swaps,'' 
should the same test (e.g., paragraph (1) of the ``referenced 
contract'' definition) that applies to futures and options on futures 
for determining status as ``referenced contracts'' also apply to 
determine whether a swap is an ``economically equivalent swap,'' and 
therefore a ``referenced contract''? Why or why not?
    (8) The Commission is proposing to define ``economically equivalent 
swap'' in a manner that is generally consistent with the EU's 
definition, with the exception that a swap must have ``identical 
material'' terms, disregarding differences in lot size or notional 
amount, delivery dates diverging by less than one calendar day (or for 
natural gas, by less than two calendar days), or post-trade risk 
management arrangements. Is this approach either too narrow or too 
broad? Why or why not?
    (9) The Commission requests comment how a market participant 
subject to both the CFTC's and EU's position limits regimes expects to 
comply with both regimes for contracts subject to both regimes.
    (10) With respect to economically equivalent swaps, the Commission 
proposes an exception that would capture penultimate swaps only for 
natural gas contracts, including

[[Page 11623]]

penultimate swaps on the NYMEX NG core referenced futures contract. Is 
this exception for such penultimate natural gas swaps appropriate, or 
should economically equivalent natural gas swaps be treated the same as 
other economically equivalent swaps? Why or why not?
    (11) Should the Commission broaden the definition of ``economically 
equivalent swap'' to include penultimate referenced contracts for all 
(or at least a subset of) commodities subject to federal position 
limits? Why or why not?
    (12) The Commission is proposing that a physically-settled swap may 
qualify as economically equivalent even if its delivery date diverges 
by less than one calendar day from its corresponding physically-settled 
referenced contract. Should the Commission include a similar provision 
for cash-settled swaps where cash-settled swaps could qualify as 
economically equivalent if their cash settlement price determination 
diverged from their corresponding cash-settled referenced contract by 
less than one calendar day?
    (13) Under the proposed definition of ``economically equivalent 
swaps,'' a cash-settled swap that otherwise shares identical material 
terms with a physically-settled referenced contract (and vice-versa) 
would not be deemed to be economically equivalent due to the difference 
in settlement type. Should the Commission consider treating swaps that 
share identical material terms, other than settlement type (i.e., cash-
settled versus physically-settled swaps), to be economically 
equivalent? Why or why not?
    (14) Consistent with the 2016 Reproposal, the Commission is 
proposing to explicitly exclude swap guarantees from the referenced 
contract definition.\169\ Should the Commission again propose to 
exclude swap guarantees from the referenced contract definition? Why or 
why not? If the Commission does exclude swap guarantees, should such 
exclusion be limited to guarantees for affiliated entities only? Why or 
why not?
---------------------------------------------------------------------------

    \169\ See 2016 Reproposal, 81 FR at 96966.
---------------------------------------------------------------------------

    (15) Please indicate if any updates or other modifications are 
needed to: (1) The proposed list of referenced contracts that would 
appear in the CFTC Staff Workbook of Commodity Derivative Contracts 
Under the Regulations Regarding Position Limits for Derivatives posted 
on the Commission's website; \170\ or (2) the proposed Appendix D to 
part 150 list of commodities deemed ``substantially the same'' for 
purposes of the term ``location basis contract'' as used in the 
proposed ``referenced contract'' definition.
---------------------------------------------------------------------------

    \170\ Position Limits for Derivatives, U.S. Commodity Futures 
Trading Commission website, available at https://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/PositionLimitsforDerivatives/index.htm.
---------------------------------------------------------------------------

    (16) Should the Commission require exchanges to maintain a list of 
referenced contracts and location basis contracts listed on their 
platforms?
    (17) The Commission has previously requested, and commenters have 
previously provided, a list of risks other than price risk for which 
commercial enterprises commonly need to hedge.\171\ Please explain 
which hedges of non-price risks could be objectively and systematically 
verified as bona fide hedges by the Commission, and how the Commission 
would verify that such positions are bona fide hedges, including how 
the Commission would consistently and definitively quantify and assess 
whether any such hedges of non-price risks are bona fide hedges that 
comply with the proposed bona fide hedging definition.
---------------------------------------------------------------------------

    \171\ See, e.g., National Gas Supply Association Comment Letter 
at 4 (Feb. 28, 2017) in response to 2016 Reproposal (listing 
operational risk, liquidity risk, credit risk, locational risk, and 
seasonal risk).
---------------------------------------------------------------------------

    (18) The Commission proposes to define spread transactions to 
include: Either a calendar spread, intercommodity spread, quality 
differential spread, processing spread (such as energy ``crack'' or 
soybean ``crush'' spreads), product or by-product differential spread, 
or futures-option spread. Are there other types of transactions 
commonly known to the trade as ``spreads'' that the Commission should 
include in its spread transaction definition? Please provide any 
examples or descriptions that will help the Commission determine 
whether such transactions would be consistent with CEA section 
4a(a)(3)(B) and should be included in the definition of spread 
transaction.
    (19) Should the Commission require market participants that trade 
economically equivalent swaps OTC, rather than on a SEF or DCM, to 
self-identify and report to the Commission that in their view, such 
swaps meet the Commission's proposed economically equivalent swap 
definition?

B. Sec.  150.2--Federal Limit Levels

1. Existing Sec.  150.2
    Federal spot month, single month, and all-months-combined position 
limits currently apply to nine physically-settled futures contracts on 
agricultural commodities listed in existing Sec.  150.2, and, on a 
futures-equivalent basis, to options contracts thereon. Existing 
federal limit levels set forth in Sec.  150.2 \172\ apply net long or 
net short and are as follows:
---------------------------------------------------------------------------

    \172\ 17 CFR 150.2.

 Existing Legacy Agricultural Contract Federal Spot Month, Single Month,
                  and All-Months-Combined Limit Levels
------------------------------------------------------------------------
                                                        Single month and
             Contract                Spot month limit     all-months-
                                                         combined limit
------------------------------------------------------------------------
Chicago Board of Trade (``CBOT'')                 600             33,000
 Corn (C).........................
CBOT Oats (O).....................                600              2,000
CBOT Soybeans (S).................                600             15,000
CBOT Soybean Meal (SM)............                720              6,500
CBOT Soybean Oil (SO).............                540              8,000
CBOT Kansas City Hard Red Winter                  600             12,000
 Wheat (KW).......................
CBOT Wheat (W)....................                600             12,000
ICE Futures U.S. (``ICE'') Cotton                 300              5,000
 No. 2 (CT).......................
Minneapolis Grain Exchange                        600             12,000
 (``MGEX'') Hard Red Spring Wheat
 (MWE)............................
------------------------------------------------------------------------


[[Page 11624]]

    While not explicit in Sec.  150.2, the Commission's practice has 
been to set spot month limit levels at or below 25 percent of 
deliverable supply based on DCM estimates of deliverable supply 
verified by the Commission, and to set limit levels outside of the spot 
month at 10 percent of open interest for the first 25,000 contracts of 
open interest, with a marginal increase of 2.5 percent of open interest 
thereafter.
2. Proposed Sec.  150.2 \173\
---------------------------------------------------------------------------

    \173\ This portion of the release is organized by subject 
matter, rather than by lettered provision, and will proceed in the 
following order: (1) Contracts subject to federal limits; (2) 
proposed spot month limit levels; (3) proposed methodology for 
setting spot month limit levels; (4) proposed non-spot month limit 
levels; (5) proposed methodology for setting non-spot month limit 
levels; (6) subsequent levels; (7) relevant contract month for 
purposes of referenced contracts; (8) limits on pre-existing 
positions; (9) limits for positions on foreign boards of trade; (10) 
anti-evasion provision; (11) netting of positions; (12) eligible 
affiliates and aggregation; and (13) request for comment.
---------------------------------------------------------------------------

a. Contracts Subject to Federal Limits
    The Commission proposes to establish federal limits on the 25 core 
referenced futures contracts listed in proposed Sec.  150.2(d),\174\ 
and on their associated referenced contracts, which would include swaps 
that qualify as ``economically equivalent swaps.'' \175\ The Commission 
proposes to establish position limits on futures and options on these 
25 commodities on the basis that position limits on such contracts are 
``necessary.'' A discussion of the necessity finding and the 
characteristics of the 25 core referenced futures contracts is in 
Section III.F.
---------------------------------------------------------------------------

    \174\ Proposed Sec.  150.2(d) provides that each core referenced 
futures contract includes any ``successor'' contracts. An example of 
a successor contract would be the RBOB Gasoline contract that was 
listed due to a change in gasoline specifications and that 
ultimately replaced the Unleaded Gasoline contract. For some time, 
both contracts were listed for trading to allow open interest to 
migrate to the new RBOB contract; once trading migrated, the 
Unleaded Gasoline contract was delisted.
    \175\ As described above, the proposed term ``referenced 
contract'' includes: (1) Futures and options on futures contracts 
that, with respect to a particular core referenced futures contract, 
are directly or indirectly linked to the price of that core 
referenced futures contract, or directly or indirectly linked to the 
price of the same commodity underlying the core referenced futures 
contract for delivery at the same location; and (2) ``economically 
equivalent swaps.'' See proposed ``referenced contract'' and 
``economically equivalent swap'' definitions in 150.1.
---------------------------------------------------------------------------

    In order to comply with CEA section 4a(a)(5), the Commission also 
proposes to establish limits on swaps that are ``economically 
equivalent'' to the above.\176\ As discussed above, under the 
Commission's proposed definition of ``economically equivalent swap'' 
set forth in Sec.  150.1, a swap would generally qualify as 
economically equivalent with respect to a particular referenced 
contract so long as the swap shares identical material contract 
specifications, terms, and conditions with the referenced contract, 
disregarding any differences with respect to lot size or notional 
amount, delivery dates diverging by less than one calendar day, (or for 
natural gas, by less than two calendar days) or post-trade risk-
management arrangements.\177\
---------------------------------------------------------------------------

    \176\ CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5).
    \177\ See infra Section II.A.4. (definition of ``economically 
equivalent swap'').
---------------------------------------------------------------------------

    As described in greater detail below, the proposed federal limits 
would apply during all contract months for the nine legacy agricultural 
commodity contracts and only during the spot month for the 16 other 
commodity contracts.
    Proposed Sec.  150.2(e) would provide that the levels set forth 
below for the 25 contracts are listed in Appendix E to part 150 of the 
Commission's regulations and would set the compliance date for such 
levels at 365 days after publication of final position limits 
regulations in the Federal Register.
b. Proposed Federal Spot Month Limit Levels
    Under the rules proposed herein, federal spot month limit levels 
would apply to all 25 core referenced futures contracts, and any 
associated referenced contracts.\178\ Federal spot month limits for 
referenced contracts on all 25 commodities are essential for deterring 
and preventing excessive speculation, manipulation, corners and 
squeezes.\179\ Proposed Sec.  150.2(e) provides that federal spot month 
levels are set forth in proposed Appendix E to part 150 and are as 
follows:
---------------------------------------------------------------------------

    \178\ As described below, federal non-spot month limit levels 
would only apply to the nine legacy agricultural commodities. The 16 
non-legacy commodities would be subject to federal limits during the 
spot month, and exchange-set limits and/or accountability outside of 
the spot month. See infra Section II.B.2.d. (discussion of proposed 
non-spot month limit levels).
    \179\ See infra Section III. (Legal Matters).
    \180\ CBOT's existing exchange-set limit for Wheat (W) is 600 
contracts. However, for its May contract month, CBOT has a variable 
spot limit that is dependent upon the deliverable supply that it 
publishes from the CBOT's Stocks and Grain report on the Friday 
preceding the first notice day for the May contract month. In the 
last five trading days of the expiring futures month in May, the 
speculative position limit is: (1) 600 contracts if deliverable 
supplies are at or above 2,400 contracts; (2) 500 contracts if 
deliverable supplies are between 2,000 and 2,399 contracts; (3) 400 
contracts if deliverable supplies are between 1,600 and 1,999 
contracts; (4) 300 contracts if deliverable supplies are between 
1,200 and 1,599 contracts; and (5) 220 contracts if deliverable 
supplies are below 1,200 contracts.
    \181\ The proposed federal spot month limit for CME Live Cattle 
(LC) would feature a step-down limit similar to the CME's existing 
Live Cattle (LC) step-down exchange set limit. The proposed federal 
spot month step down limit is: (1) 600 at the close of trading on 
the first business day following the first Friday of the contract 
month; (2) 300 at the close of trading on the business day prior to 
the last five trading days of the contract month; and (3) 200 at the 
close of trading on the business day prior to the last two trading 
days of the contract month.
    \182\ CME's existing exchange-set limit for Live Cattle (LC) has 
a step-down spot month limit: (1) 450 at the close of trading on the 
first business day following the first Friday of the contract month; 
(2) 300 at the close of trading on the business day prior to the 
last five trading days of the contract month; and (3) 200 at the 
close of trading on the business day prior to the last two trading 
days of the contract month.
    \183\ CBOT's existing exchange-set spot month limit for Rough 
Rice (RR) is 600 contracts for all contract months. However, for 
July and September, there is a step-down limit from 600 contracts. 
In the last five trading days of the expiring futures month, the 
speculative position limit for the July futures month steps down to 
200 contracts from 600 contracts and the speculative position limit 
for the September futures month steps down to 250 contracts from 600 
contracts.
    \184\ NYMEX recommends implementing a step-down federal spot 
position limit for its Light Sweet Crude Oil (CL) futures contract: 
(1) 6,000 contracts as of the close of trading three business days 
prior to the last trading day of the contract; (2) 5,000 contracts 
as of the close of trading two business days prior to the last 
trading day of the contract; and (3) 4,000 contracts as of the close 
of trading one business day prior to the last trading day of the 
contract.

----------------------------------------------------------------------------------------------------------------
                                          2020 Proposed spot     Existing federal spot    Existing exchange-set
   Core referenced futures contract          month limit              month limit            spot month limit
----------------------------------------------------------------------------------------------------------------
                                          Legacy Agricultural Contracts
----------------------------------------------------------------------------------------------------------------
CBOT Corn (C)........................                    1,200                      600                      600
CBOT Oats (O)........................                      600                      600                      600
CBOT Soybeans (S)....................                    1,200                      600                      600
CBOT Soybean Meal (SM)...............                    1,500                      720                      720
CBOT Soybean Oil (SO)................                    1,100                      540                      540
CBOT Wheat (W).......................                    1,200                      600   \180\ 600/500/400/300/
                                                                                                             220
CBOT KC HRW Wheat (KW)...............                    1,200                      600                      600

[[Page 11625]]

 
MGEX HRS Wheat (MWE).................                    1,200                      600                      600
ICE Cotton No. 2 (CT)................                    1,800                      300                      300
----------------------------------------------------------------------------------------------------------------
                                          Other Agricultural Contracts
----------------------------------------------------------------------------------------------------------------
CME Live Cattle (LC).................        \181\ 600/300/200                      n/a        \182\ 450/300/200
CBOT Rough Rice (RR).................                      800                      n/a        \183\ 600/200/250
ICE Cocoa (CC).......................                    4,900                      n/a                    1,000
ICE Coffee C (KC)....................                    1,700                      n/a                      500
ICE FCOJ-A (OJ)......................                    2,200                      n/a                      300
ICE U.S. Sugar No. 11 (SB)...........                   25,800                      n/a                    5,000
ICE U.S. Sugar No. 16 (SF)...........                    6,400                      n/a                      n/a
----------------------------------------------------------------------------------------------------------------
                                                Metals Contracts
----------------------------------------------------------------------------------------------------------------
COMEX Gold (GC)......................                    6,000                      n/a                    3,000
COMEX Silver (SI)....................                    3,000                      n/a                    1,500
COMEX Copper (HG)....................                    1,000                      n/a                    1,500
NYMEX Platinum (PL)..................                      500                      n/a                      500
NYMEX Palladium (PA).................                       50                      n/a                       50
----------------------------------------------------------------------------------------------------------------
                                                Energy Contracts
----------------------------------------------------------------------------------------------------------------
NYMEX Light Sweet Crude Oil (CL).....  \184\ 6,000/5,000/4,000                      n/a                    3,000
NYMEX NYH ULSD Heating Oil (HO)......                    2,000                      n/a                    1,000
NYMEX NYH RBOB Gasoline (RB).........                    2,000                      n/a                    1,000
NYMEX Henry Hub Natural Gas (NG).....                    2,000                      n/a                    1,000
----------------------------------------------------------------------------------------------------------------

    Limits for any contract with a proposed limit above 100 contracts 
would be rounded up to the nearest 100 contracts from the exchange-
recommended level and/or from 25 percent of deliverable supply.
c. Process for Calculating Federal Spot Month Limit Levels
    The existing federal spot month limit levels on the nine legacy 
agricultural contracts have remained constant for decades, yet the 
markets have changed significantly during that time period, including 
the advent of electronic trading and the implementation of extended 
trading hours. Further, open interest and trading volume have since 
reached record levels, and some of the deliverable supply estimates on 
which the existing federal spot month limits were originally based are 
now decades out of date. In light of these and other factors, CME 
Group, ICE, and MGEX recommended federal spot month limit levels for 
each of their respective core referenced futures contracts, including 
contracts that would be subject to federal limits for the first time 
under this proposal.\185\ Commission staff reviewed these 
recommendations and conducted its own analysis of them, including by 
requesting additional information and by independently assessing the 
recommended levels using its own experience, observations, and 
knowledge. The Commission proposes to adopt each of the exchange-
recommended levels as federal spot month limit levels.
---------------------------------------------------------------------------

    \185\ See ICE Comment Letter at 8 (May 14, 2019); MGEX Comment 
Letter at 2, 4-8 (Aug. 31, 2018); and Summary DSE Proposed Limits, 
CME Group Comment Letter (Nov. 26, 2019), available at https://comments.cftc.gov (comment file for RIN 3038-AD99).
---------------------------------------------------------------------------

    In setting federal limits, the Commission considers the four policy 
objectives in CEA section 4a(a)(3)(B). That is, to set limits, to the 
maximum extent practicable, in its discretion, to: (1) Diminish, 
eliminate, or prevent excessive speculation; (2) deter and prevent 
market manipulation, squeezes, and corners; (3) ensure sufficient 
market liquidity for bona fide hedgers; and (4) ensure that the price 
discovery function of the underlying market is not disrupted.\186\ In 
setting federal position limit levels, the Commission endeavors to 
maximize these objectives by setting limits that are low enough to 
prevent excessive speculation, manipulation, squeezes, and corners that 
could disrupt price discovery, but high enough so as not to restrict 
liquidity for bona fide hedgers.
---------------------------------------------------------------------------

    \186\ 7 U.S.C. 6a(a)(3)(B).
---------------------------------------------------------------------------

    Based on the Commission's experience overseeing federal position 
limits for decades, and overseeing exchange-set position limits 
submitted to the Commission pursuant to part 40 of its regulations, the 
Commission has analyzed and evaluated the information provided by CME 
Group, ICE, and MGEX, and preliminarily finds that none of the 
recommended levels considered in preparing this release appear 
improperly calibrated such that they might hinder liquidity for bona 
fide hedgers, or invite excessive speculation, manipulation, corners, 
or squeezes, including activity that could impact price discovery. For 
these reasons, discussed in turn below, the Commission preliminarily 
believes that the DCMs' recommended spot month limit levels all further 
the statutory objectives set forth in CEA section 4a(a)(3)(B).\187\
---------------------------------------------------------------------------

    \187\ 7 U.S.C. 6a(a)(3)(B).
---------------------------------------------------------------------------

i. The Proposed Spot Month Limit Levels Are Low Enough To Prevent 
Excessive Speculation and Protect Price Discovery
    All 25 of the exchange-recommended levels are at or below 25 
percent of deliverable supply.\188\ The Commission has long used 
deliverable supply as the basis for spot month position limits due to 
concerns regarding corners, squeezes, and other settlement-period 
manipulative activity.\189\ It would be difficult, in the absence of 
other factors, for a participant to corner or squeeze a market if the 
participant holds less than or equal to 25 percent of deliverable 
supply because, among other things, any

[[Page 11626]]

potential economic gains resulting from the manipulation may be 
insufficient to justify the potential costs, including the costs of 
acquiring, and ultimately offloading, the positions used to effectuate 
the manipulation.
---------------------------------------------------------------------------

    \188\ The recommended levels range from approximately 7 percent 
of deliverable supply to 25 percent of deliverable supply.
    \189\ See, e.g., Revision of Federal Speculative Position Limits 
and Associated Rules, 64 FR 24038 (May 5, 1999).
---------------------------------------------------------------------------

    By restricting positions to a proportion of the deliverable supply 
of the commodity, the spot month position limits require that no one 
speculator can hold a position larger than 25 percent of deliverable 
supply, reducing the possibility that a market participant can use 
derivatives, including referenced contracts, to affect the price of the 
cash commodity (and vice versa). Limiting a speculative position based 
on a percentage of deliverable supply also restricts a speculative 
trader's ability to establish a leveraged position in cash-settled 
derivative contracts, reducing that trader's incentive to manipulate 
the cash settlement price.\190\ Further, by proposing levels that are 
sufficiently low to prevent market manipulation, including corners and 
squeezes, the proposed levels also help ensure that the price discovery 
function of the underlying market is not disrupted because markets that 
are free from corners, squeezes, and other manipulative activity 
reflect fundamentals of supply and demand rather than artificial 
pressures.
---------------------------------------------------------------------------

    \190\ Id.
---------------------------------------------------------------------------

    Each of the exchange-recommended levels is based on a percentage of 
deliverable supply estimated by the relevant exchange and submitted to 
the Commission for review.\191\ The Commission has closely assessed the 
estimates, which CME Group, ICE, and MGEX updated with recent data 
using the methodologies they used during the 2016 Reproposal.\192\ The 
Commission hereby verifies that the estimates submitted by the 
exchanges are reasonable.
---------------------------------------------------------------------------

    \191\ See ICE Comment Letter at 8 (May 14, 2019); MGEX Comment 
Letter at 2, 4-8 (Aug. 31, 2018); and Summary DSE Proposed Limits, 
CME Group Comment Letter (Nov. 26, 2019), available at https://comments.cftc.gov (comment file for RIN 3038-AD99).CME Group 
submitted updated estimates of deliverable supply and recommended 
federal spot month limit levels for CBOT Corn (C), CBOT Oats (O), 
CBOT Rough Rice (RR), CBOT Soybeans (S), CBOT Soybean Meal (SM), 
CBOT Soybean Oil (SO), CBOT Wheat (W), and CBOT KC HRW Wheat (KW); 
COMEX Gold (GC), COMEX Silver (SI), NYMEX Platinum (PL), NYMEX 
Palladium (PA), and COMEX Copper (HG); and NYMEX Henry Hub Natural 
Gas (NG), NYMEX Light Sweet Crude Oil (CL), NYMEX NY Harbor ULSD 
Heating Oil (HO), and NYMEX NY Harbor RBOB Gasoline (RB). ICE 
submitted updated estimates of deliverable supply and recommended 
federal spot month limit levels for ICE Cocoa (CC), ICE Coffee C 
(KC), ICE Cotton No. 2 (CT), ICE FCOJ-A (OJ), ICE U.S. Sugar No. 11 
(SB), and ICE U.S. Sugar No. 16 (SF). MGEX submitted an updated 
deliverable supply estimate and indicated that if the Commission 
adopted a specific spot month position limit, MGEX believes the 
federal spot month limit level for MGEX Hard Red Spring Wheat (MWE) 
should be no less than 1,000 contracts. Commission staff reviewed 
the exchange submissions and conducted its own research. Commission 
staff reviewed the data submitted, confirmed that the data submitted 
accurately reflected the source data, and considered whether the 
data sources were authoritative. Commission staff considered whether 
the assumptions made by the exchanges in the submissions were 
acceptable, or whether alternative assumptions would lead to similar 
results. In some cases, Commission staff conducted trade source 
interviews. Commission staff replicated the calculations included in 
the submissions.
    \192\ See CME Group Comment Letter (Apr. 15, 2016); CME Group 
Comment Letter (addressing natural gas) (Sept. 15, 2016); CME Group 
Comment Letter (addressing ULSD) (Sept. 15, 2016); ICE Comment 
Letter (Apr. 20, 2016); and MGEX Comment Letter (Jul. 13, 2016), 
available at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1772&ctl00_ctl00_cphContentMain_MainContent_gvCommentListChangePage=8_50. At that time, the Commission reviewed the 
methodologies that the DCMs used to prepare the estimates, among 
other things, and verified the deliverable supply estimates as 
reasonable. See 2016 Reproposal, 81 FR at 96754.
---------------------------------------------------------------------------

    In verifying the DCMs' estimates of deliverable supply, the 
Commission is not endorsing any particular methodology for estimating 
deliverable supply beyond what is already set forth in Appendix C to 
part 38 of the Commission's regulations.\193\ As circumstances change 
over time, such DCMs may need to adjust the methodology, assumptions, 
and allowances that they use to estimate deliverable supply to reflect 
then current market conditions and other relevant factors.
---------------------------------------------------------------------------

    \193\ 17 CFR part 38, Appendix C.
---------------------------------------------------------------------------

ii. The Proposed Spot Month Limit Levels are High Enough To Ensure 
Sufficient Market Liquidity for Bona Fide Hedgers
    Section 4a(a)(1) of the CEA addresses ``excessive speculation. . 
.causing sudden or unreasonable fluctuations or unwarranted [price] 
changes . . .'' \194\ Speculative activity that is not ``excessive'' in 
this manner is not a focus of section 4a(a)(1). Rather, speculative 
activity may generate liquidity by enabling market participants with 
bona fide hedging positions to trade more efficiently. Setting position 
limits too low could result in reduced liquidity, including for bona 
fide hedgers. The Commission has not observed, or received any 
complaints about, a lack of liquidity for bona fide hedgers in the 
markets for the 25 core referenced futures contracts. In fact, as 
described later in this release, the 25 core referenced futures 
contracts represent some of the most liquid markets overseen by the 
Commission.\195\ Market developments that have taken place since 
federal spot month limits were last amended decades ago, such as 
electronic trading and expanded trading hours, have likely only 
contributed to these already liquid markets.\196\ Market participants 
have more opportunities than ever to enter, trade, or exit a position. 
By proposing to generally increase the existing federal spot month 
limit levels, and by proposing federal spot month limit levels that are 
generally equal to or higher than existing exchange-set levels,\197\ 
yet in all cases still low enough to prevent excessive speculation, 
manipulation, corners and squeezes, the Commission does not expect the 
proposed limits to result in a reduction in liquidity for bona fide 
hedgers.
---------------------------------------------------------------------------

    \194\ CEA section 4a(a)(1); 7 U.S.C. 6a(a)(1).
    \195\ See infra Section III.F.
    \196\ With the exception of CBOT Oats (O), open interest for the 
legacy agricultural commodities has increased dramatically over the 
past several decades, some by a factor of four.
    \197\ While the proposed spot month limit levels are generally 
higher than the existing federal or exchange-set levels, the 
proposed federal level for COMEX Copper (HG) is below the existing 
exchange-set level, the proposed federal level for CBOT Oats (O) is 
the same as the existing federal and exchange-set level, and the 
proposed federal levels for NYMEX Platinum (PL) and NYMEX Palladium 
(PA) are the same as the existing exchange-set levels.
---------------------------------------------------------------------------

iii. The Proposed Spot Month Limit Levels Fall Within a Range of 
Acceptable Levels
    ICE and MGEX recommended federal spot month limit levels at 25 
percent of deliverable supply, while CME Group generally recommended 
levels below 25 percent of deliverable supply.\198\ These

[[Page 11627]]

distinctions reflect philosophical and other differences among the 
exchanges and differences between the core referenced futures contracts 
and their underlying commodities, including a preference on the part of 
CME Group not to increase existing limit levels applicable to its core 
referenced futures contracts too drastically.\199\ The Commission has 
previously stated that ``there is a range of acceptable limit levels,'' 
\200\ and continues to believe this is true, both for spot and non-spot 
month limits. There is no single ``correct'' spot month limit level for 
a given contract, and it is likely that a number of limit levels within 
a certain range could effectively address the 4a(a)(3) factors. While 
the CME Group, ICE, and MGEX recommended levels all fall at different 
ends of the deliverable supply range, the levels all fall at or below 
25 percent of deliverable supply, which is critical for protecting the 
spot month from excessive speculation, manipulation, corners and 
squeezes.
---------------------------------------------------------------------------

    \198\ For the following core referenced futures contracts, CME 
Group recommended spot month levels below 25 percent of deliverable 
supply: CBOT Corn (C) (9.22% of deliverable supply), CBOT Oats (O) 
(19.29%), CBOT Soybeans (S) (15.86%), CBOT Soybean Meal (SM) 
(16.77%), Soybean Oil (SO) (8.31%), CBOT Wheat (W) (9.24%), CBOT KC 
HRW Wheat (KW) (9.24%), CME Live Cattle (LC) (step-down limits 
15.86%-7.93%-5.29%), CBOT Rough Rice (RR) (8.94%), COMEX Gold (GC) 
(12.72%), COMEX Silver (SI) (12.62%), COMEX Copper (HG) (9.66%), 
NYMEX Platinum (PL) (13.60%), NYMEX Palladium (PA) (17.18%), NYMEX 
Light Sweet Crude Oil (CL) (step-down limits 11.16%-9.30%-7.44%), 
NYMEX NYH ULSD Heating Oil (HO) (10.85%), and NYMEX NYH RBOB 
Gasoline (RB) (7.41%). CME Group recommended spot month levels at 25 
percent of estimated deliverable supply for NYMEX Henry Hub Natural 
Gas (NG). ICE and MGEX recommended limit levels at 25 percent of 
estimated deliverable supply for each of their core referenced 
futures contracts: Cocoa (CC), Coffee C (KC), FCOJ-A (OJ), Cotton 
No. 2 (CT), U.S. Sugar No. 11 (SB), and U.S. Sugar No. 16 (SF) on 
ICE, and Hard Red Spring Wheat (MWE) on MGEX. See ICE Comment Letter 
at 1-7 (May 14, 2019); MGEX Comment Letter at 2, 4-8 (Aug. 31, 
2018); and Summary DSE Proposed Limits, CME Group Comment Letter 
(Nov. 26, 2019), available at https://comments.cftc.gov (comment 
file for RIN 3038-AD99).
    \199\ CME Group has indicated that for its own exchange-set 
limits, it historically has not typically set the limit at the full 
25 percent of deliverable supply when launching a new product, 
regardless of asset class or commodity. CME Group's recommended spot 
month limit levels are based on observations regarding the 
orderliness of liquidations and monitoring for appropriate price 
convergence. CME Group indicated that the recommended levels reflect 
a measured approach calibrated to avoid the risk of disruption to 
its markets, and stated that upon analyzing a reasonable body of 
data relating to the expirations with the recommended spot month 
limit levels, CME Group would consider in the future making any 
recommendations for increases in limits if any additional increases 
were appropriate. Summary DSE Proposed Limits, CME Group Comment 
Letter (Nov. 26, 2019), available at https://comments.cftc.gov 
(comment file for RIN 3038-AD99).
    \200\ See, e.g., Revision of Federal Speculative Position 
Limits, 57 FR at 12766, 12770 (Apr. 13, 1992).
---------------------------------------------------------------------------

iv. The Proposed Spot Month Limit Levels Account for Differences 
Between Markets
    In addition to being high enough to ensure sufficient liquidity, 
and low enough to prevent excessive speculation and manipulation, the 
proposed spot month limit levels are also calibrated to further address 
CEA section 4a(a)(3) by accounting for differences between markets for 
the core referenced futures contracts and for their underlying 
commodities.\201\
---------------------------------------------------------------------------

    \201\ Commenters, including those responding to the 2016 
Reproposal, have previously requested that limit levels should be 
set on a commodity-by-commodity basis to recognize differences among 
commodities, including differences in liquidity, seasonality, and 
other economic factors. See, e.g., AQR Capital Management Comment 
Letter at 12 (Feb. 28, 2017); Copperwood Asset Management Comment 
Letter at 3 (Feb. 28, 2017); Managed Funds Association, Asset 
Management Group of the Securities Industry and Financial Markets 
Association, and the Alternative Investment Management Association 
Comment Letter at 9-12 (Feb. 28, 2017); and National Grain and Feed 
Association Comment Letter at 2 (Feb. 28, 2017).
---------------------------------------------------------------------------

    For the agricultural commodities, the Commission considered a 
variety of factors in evaluating the exchange-recommended spot month 
levels, including concentration and composition of market participants, 
the historical price volatility of the commodity, convergence between 
the futures and cash market prices at the expiration of the contract, 
and the Commission's experience observing how the supplies of 
agricultural commodities are affected by weather (drought, flooding, or 
optimal growing conditions), storage costs, and delivery mechanisms. In 
the Commission's view, the exchanges' recommended spot month levels for 
each of the agricultural contracts would allow for speculators to be 
present in the market while preventing speculative positions from being 
so large as to harm convergence and otherwise hinder statutory 
objectives.
    The Commission also considered the delivery mechanisms for the 
agricultural commodities in assessing the exchange-recommended spot 
month levels. For example, for the CME Live Cattle (LC) contract, the 
Commission considered the physical limitation that exists on how many 
cattle can be processed (inspected, graded, and weighed) at the 
delivery facilities. CME Group currently has an exchange-set step-down 
spot month limit, and recommended a federal step-down limit for CME 
Live Cattle (LC) of 600/300/200 contracts in order to avoid congestion 
and to foster convergence by gradually reducing the limit levels in a 
manner that meets the processing capacity of the delivery facilities. 
The Commission proposes to adopt this step-down limit due to the unique 
attributes of the CME Live Cattle (LC) contract.
    For the metals contracts, which are all listed on NYMEX, the 
Commission took delivery mechanisms, among other factors, into account 
in assessing the recommended spot month limit levels. Upon expiration, 
the long for each metals contract receives the ownership certificate 
(warrant) for the metal already in the warehouse/depository and can 
continue to store the metal where it is, load-out the metal, or short a 
futures contract to sell the ownership certificate. This delivery 
mechanism, which allows for the resale of the warrant while the metal 
remains in the warehouse, provides for relatively inexpensive and 
simple delivery when compared to the delivery mechanisms for other 
commodity types. Further, metals tend not to spoil and are cheap to 
store on a per dollar basis compared to other commodities. As metals 
are generally easier to obtain, store, and sell than other commodity 
types, it is also potentially cheaper to accomplish a corner or squeeze 
in metals than in other commodity types. The Commission has previously 
observed manipulative activity in metals as evidenced by the Hunt 
Brother silver and Sumitomo copper events. The Commission kept this 
history in mind in accepting CME Group's recommendation to take a 
fairly cautious approach with respect to the recommended levels for 
each metal contract, which are each well below 25 percent of 
deliverable supply.\202\ Commission staff has, however, reviewed each 
of the metals contracts previously and confirms that these contracts 
satisfy all regulatory requirements, including the DCM Core Principle 3 
requirement that the contracts are not readily susceptible to 
manipulation.
---------------------------------------------------------------------------

    \202\ As noted above, CME Group's recommended federal level of 
1,000 for COMEX Copper (HG) is below the existing exchange-set level 
of 1,500, and CME Group's recommended federal levels for NYMEX 
Platinum (PL) and NYMEX Palladium (PA) are equal to the existing 
exchange-set levels of 500 and 50, respectively. CME Group 
recommended federal levels of 6,000 for COMEX Gold (GC) and 3,000 
for COMEX Silver (SI), which would represent an increase over the 
existing exchange-set levels of 3,000 and 1,500, respectively. While 
CME Group's recommended federal COMEX Gold (GC) and COMEX Silver 
(SI) levels are higher than the existing exchange-set levels, the 
recommended levels still represent only approximately 13 percent of 
deliverable supply each. Summary DSE Proposed Limits, CME Group 
Comment Letter (Nov. 26, 2019), available at https://comments.cftc.gov (comment file for RIN 3038-AD99).
---------------------------------------------------------------------------

    Additionally, the Commission considered the volatility in the 
estimated deliverable supply for metals. For the COMEX Copper (HG) 
contract, the estimated deliverable supply for copper (measured by 
copper stocks in COMEX-approved warehouses) has experienced 
considerable volatility during the past decade, resulting in COMEX 
amending its exchange-set spot month position limit multiple times, 
decreasing or increasing the limit level to reflect the amount of 
copper in its approved warehouses.\203\ Similarly, volatility in 
deliverable supplies has been observed for the NYMEX Palladium (PA) 
contract, where production of palladium from major producers has been 
declining while demand for palladium by the auto

[[Page 11628]]

industry for catalytic converters has increased. This trend in 
palladium stocks in exchange-approved depositories has been observed 
since 2014. In a series of amendments, NYMEX reduced its exchange-set 
spot month limit from 650 contracts to below 200 contracts over 
time.\204\
---------------------------------------------------------------------------

    \203\ The volatility was based on factors such as the bust in 
the housing market in 2008, the severe recession in the United 
States in 2009, and high demand for copper exports to China, which 
has grown continually over the past 20 years.
    \204\ See, e.g., NYMEX Submissions Nos. 14-463 (Oct. 31, 2014), 
15-145 (Apr. 14, 2015), and 15-377 (Aug. 27, 2015).
---------------------------------------------------------------------------

    The Commission has not observed similar volatility in the 
deliverable supply estimates for agricultural or energy commodities. 
Given this history of volatility in deliverable supply estimates for 
metals, if the Commission were to set limit levels at, rather than 
below, 25 percent of deliverable supply, and if deliverable supply were 
to subsequently change drastically, the spot month limit level could 
end up being well above (or below) 25 percent of deliverable supply, 
and thus potentially too high (or too low) to further statutory 
objectives.
    For the energy complex, the Commission considered factors such as 
the underlying infrastructure and connectivity. For example, as of 
2017, generally, out of commodities underlying the core referenced 
futures contracts in energy, natural gas had the most robust 
infrastructure for moving the commodity, with over 1,600,000 miles of 
pipeline (including distribution mains, transmission pipelines, and 
gathering lines) in the United States, compared to only 215,000 miles 
of pipeline for oil (including crude and product lines).\205\ The 
robust infrastructure for moving natural gas supports CME Group's 
recommended spot month limit level at 25 percent of estimated 
deliverable supply for the NYMEX Henry Hub Natural Gas (NG) contract, 
while comparatively smaller crude oil and crude product pipeline 
infrastructure support CME Group's recommended spot month limit levels 
below 25 percent of estimated deliverable supply for the NYMEX Light 
Sweet Crude Oil (CL) and NYMEX NYH RBOB Gasoline (RB) contracts.
---------------------------------------------------------------------------

    \205\ See U.S. Oil and Gas Pipeline Mileage, Bureau of 
Transportation Statistics website, available at www.bts.gov/content/us-oil-and-gas-pipeline-mileage.
---------------------------------------------------------------------------

    The Commission also considered factors such as the large amounts of 
liquidity in the cash-settled natural gas referenced contracts relative 
to the physically settled NYMEX Henry Hub Natural Gas (NG) core 
referenced futures contract. For that contract, CME Group recommended 
setting the spot month limit at 25 percent of estimated deliverable 
supply (2,000 contract spot month limit) with a conditional limit 
exemption of 10,000 contracts net long or net short conditioned on the 
participant not holding or controlling any positions during the spot 
month in the physically-settled NYMEX Henry Hub Natural Gas (NG) core 
referenced futures contract. Speculators who desire price exposure to 
natural gas will likely trade in the cash-settled contracts because, 
generally, they do not have the ability to make or take delivery; 
trading in the cash-settled contract removes the chance that they may 
be unable to exit the physically-settled NYMEX Henry Hub Natural Gas 
(NG) contract and be selected to make or take delivery of natural gas. 
Thus, speculators are likely to remain out of the NYMEX Henry Hub 
Natural Gas (NG) contract during the spot month. Since corners and 
squeezes cannot be effected using cash settled contracts, the 
Commission proposes a spot month limit set at 25 percent of deliverable 
supply for the NYMEX Henry Hub Natural Gas (NG) core referenced futures 
contract.
    Further, for certain energy commodities, CME Group recommended 
step-down limits, including for commodities where delivery constraints 
could hinder convergence or where market participants otherwise 
provided feedback that such limits would help maintain orderly markets. 
In the case of NYMEX Light Sweet Crude Oil (CL), CME Group currently 
has a single spot-month limit of 3,000 contracts, but is recommending a 
step down limit that would end at 4,000 contracts (step-down limits of 
6,000/5,000/4,000). Historically, as liquidity decreases in the 
contract, the exchange would have a step down mechanism in its 
exemptions that it had granted to force market participants to lower 
their positions to the current 3,000 contract spot month limit. Given 
the recommended increase to a final step-down limit of 4,000 contracts, 
the exchange, through feedback from market participants, recommended a 
step-down spot month limit that would in effect provide the same 
diminishing effect on positions.
d. Proposed Federal Single Month and All-Months Combined (``Non-Spot 
Month'') Limit Levels
    Under the rules proposed herein, federal non-spot month limits 
would only apply to the nine agricultural commodities currently subject 
to federal limits. The 16 additional contracts covered by this proposal 
would be subject to federal limits only during the spot month, and 
exchange-set limits and/or accountability requirements outside of the 
spot month.\206\
---------------------------------------------------------------------------

    \206\ Market Resources, ICE Futures website, available at 
https://www.theice.com/futures-us/market-resources (ICE exchange-set 
position limits); Position Limits, CME Group website, available at 
https://www.cmegroup.com/market-regulation/position-limits.html; 
Rules and Regulations of the Minneapolis Grain Exchange, Inc., MGEX, 
available at https://www.mgex.com/documents/Rulebook_051.pdf (MGEX 
exchange-set position limits).
---------------------------------------------------------------------------

    The Commission proposes to maintain federal non-spot month limits 
for the nine legacy agricultural contracts, with the modifications set 
forth below, because the Commission has observed no reason to eliminate 
them. These non-spot month limits have been in place for decades, and 
while the Commission is proposing to modify the limit levels,\207\ 
removing the levels entirely could potentially result in market 
disruption. In fact, commercial market participants trading the nine 
legacy agricultural contracts have requested that the Commission 
maintain federal limits outside the spot month in order to promote 
market integrity. For the following reasons, however, the Commission is 
not proposing limits outside the spot month for the other 16 contracts.
---------------------------------------------------------------------------

    \207\ See infra Section II.B.2.e.

---------------------------------------------------------------------------

[[Page 11629]]

    First, corners and squeezes cannot occur outside the spot month 
when there is no threat of delivery, and there are tools other than 
federal position limits for deterring and preventing manipulation 
outside of the spot month.\208\ Surveillance at both the exchange and 
federal level, coupled with exchange-set limits and/or accountability, 
would continue to offer strong deterrence and protection against 
manipulation outside of the spot month. In particular, under this 
proposal, for the 16 contracts that would be subject to federal limits 
only during the spot month, exchanges would be required to establish 
either position limit levels or position accountability levels outside 
of the spot month.\209\ Any such accountability and limit levels would 
be subject to standards established by the Commission including, among 
other things, that any such levels be ``necessary and appropriate to 
reduce the potential threat of market manipulation or price distortion 
of the contract's or the underlying commodity's price or index.'' \210\ 
Exchanges would also be required to submit any rules adopting or 
modifying such position limit and/or accountability levels to the 
Commission pursuant to part 40 of the Commission's regulations.\211\
---------------------------------------------------------------------------

    \208\ In the case of certain commodities where open interest in 
the deferred month contracts may be much larger, it may become 
difficult to exert market power via concentrated futures positions. 
For example, a participant with a large cash-market position and a 
large deferred futures position may attempt to move cash markets in 
order to benefit that deferred futures position. Any attempt to do 
so could become muted due to general futures market resistance from 
multiple vested interests present in that deferred futures month 
(i.e., the overall size of the deferred contracts may be too large 
for one individual to influence via cash market activity). However, 
if a large position accumulated over time in a particular deferred 
month is held into the spot month, it is possible that such 
positions could form the groundwork for an attempted corner or 
squeeze in the spot month.
    \209\ See infra Section II.D.4. (discussion of proposed Sec.  
150.5).
    \210\ Id.
    \211\ Under the proposed ``position accountability'' definition 
in Sec.  150.1, DCM accountability rules would have to require a 
trader whose position exceeds the accountability level to consent 
to: (1) Provide information about its position to the DCM; and (2) 
halt increasing further its position or reduce its position in an 
orderly manner, in each case as requested by the DCM.
---------------------------------------------------------------------------

    Exchange position accountability establishes a level at which an 
exchange will ask traders additional questions, including regarding the 
trader's purpose for the position, and will evaluate existing market 
conditions. If the position does not raise any concerns, the exchange 
will allow the trader to exceed the accountability level. If the 
position raises concerns, the exchange has the authority to instruct 
the trader not to increase the position further, or to reduce the 
position. Accountability is a particularly flexible and effective tool 
because it provides the exchanges with an opportunity to intervene once 
a position hits a relatively low level, while still affording market 
participants with the flexibility to establish a large position when 
warranted by the nature of the position and the condition of the 
market.
    The Commission has decades of experience overseeing accountability 
levels implemented by exchanges,\212\ including for all 16 contracts 
that would not be subject to federal limits outside of the spot month 
under this proposal. Such accountability levels apply to all 
participants on the exchange, whether commercial or non-commercial, and 
regardless of whether the participant would qualify for an exemption. 
In the Commission's experience, these levels have functioned as-
intended, and the Commission views exchange accountability outside of 
the spot month as an equally robust, yet more flexible, alternative to 
federal non-spot month speculative position limits.
---------------------------------------------------------------------------

    \212\ See, e.g., 56 FR 51687 (Oct. 15, 1991) (permitting CME to 
establish position accountability for certain financial contracts 
traded on CME), Speculative Position Limits--Exemptions from 
Commission Rule 1.61, 57 FR 29064 (June 30, 1992) (permitting the 
use of accountability for trading in energy commodity contracts), 
and 17 CFR 150.5(e) (2009) (formally recognizing the practice of 
accountability for contracts that met specified standards).
---------------------------------------------------------------------------

    Second, applying federal limits during the spot month to referenced 
contracts based on all 25 core referenced futures contracts, and 
outside of the spot month only to referenced contracts based on the 
nine legacy agricultural commodities, furthers statutory goals while 
minimizing the impact on existing industry practice and leveraging 
existing exchange-set limits and accountability levels that appear to 
have functioned well. The Commission thus endeavors to minimize market 
disruption that could result from eliminating existing federal non-spot 
month limits on certain agricultural commodities and from adding new 
non-spot limits on certain metals and energy commodities that have 
never been subject to federal limits. Layering federal non-spot month 
limits for the 16 additional contracts on top of existing exchange-set 
limit/accountability levels may only provide minimal benefits, if any, 
and would forego the benefits associated with flexible accountability 
levels, which provide many of the same protections as hard limits but 
with significantly more flexibility for market participants to exceed 
the accountability level in cases where the position would not harm the 
market.
    As set forth in proposed Sec.  150.2(e), proposed federal non-spot 
month levels applicable to referenced contracts based on the nine 
legacy agricultural contracts are listed in proposed Appendix E and are 
as follows:

----------------------------------------------------------------------------------------------------------------
                                                                   2020 Proposed
                                                                   single month
                                                                  and all-months     Existing        Existing
                                                                      combined        federal      exchange-set
                Core referenced futures contract                   limit  based    single month    single month
                                                                  on new  10/2.5     and  all-       and  all-
                                                                    formula for       months-         months-
                                                                   first 50,000   combined limit  combined limit
                                                                        OI
----------------------------------------------------------------------------------------------------------------
CBOT Corn (C)...................................................          57,800          33,000          33,000
CBOT Oats (O)...................................................           2,000           2,000           2,000
CBOT Soybeans (S)...............................................          27,300          15,000          15,000
CBOT Soybean Meal (SM)..........................................          16,900           6,500           6,500
CBOT Soybean Oil (SO)...........................................          17,400           8,000           8,000
CBOT Wheat (W)..................................................          19,300          12,000          12,000
KC HRW Wheat (KW)...............................................          12,000          12,000          12,000
MGEX HRS Wheat (MWE)............................................          12,000          12,000          12,000
ICE Cotton No. 2 (CT)...........................................          11,900           5,000           5,000
----------------------------------------------------------------------------------------------------------------


[[Page 11630]]

e. Methodology for Setting Proposed Non-Spot Month Limit Levels
    The Commission's practice has been to set non-spot month limit 
levels for the nine legacy agricultural contracts at 10 percent of the 
open interest for the first 25,000 contracts and 2.5 percent of the 
open interest thereafter (the ``10, 2.5 percent formula'').\213\ The 
existing non-spot month limit levels have not been updated to reflect 
changes in open interest data in over a decade, and the 10, 2.5 percent 
formula has been used since the 1990s, and was based on the 
Commission's experience up until that time.\214\ The Commission's 
adoption of the 10, 2.5 percent formula was based on two primary 
factors: growth in open interest and the size of large traders' 
positions.\215\
---------------------------------------------------------------------------

    \213\ For example, assume a commodity contract has an aggregate 
open interest of 200,000 contracts over the past 12 month period. 
Applying the 10, 2.5 percent formula to an aggregate open interest 
of 200,000 contracts would yield a non-spot month limit of 6,875 
contracts. That is, 10 percent of the first 25,000 contracts would 
equal 2,500 contracts (25,000 contracts x 0.10 = 2,500 contracts). 
Then add 2.5 percent of the remaining 175,000 of aggregate open 
interest or 4,375 contracts (175,000 contracts x 0.025 = 4,375 
contracts) for a total non-spot month limit of 6,875 contracts 
(2,500 contracts + 4,375 contracts = 6,875 contracts).
    \214\ See, e.g., Revision of Federal Speculative Position Limits 
and Associated Rules, 64 FR at 24038 (May 5, 1999) (increasing 
deferred-month limit levels based on 10 percent of open interest up 
to an open interest of 25,000 contracts, with a marginal increase of 
2.5 percent thereafter). Prior to 1999, the Commission had given 
little weight to the size of open interest in the contract in 
determining the position limit level--instead, the Commission's 
traditional standard was to set limit levels based on the 
distribution of speculative traders in the market. See, e.g., 64 FR 
at 24039; Revision of Federal Speculative Position Limits and 
Associated Rules, 63 FR at 38525, 38527 (July 17, 1998).
    \215\ See 64 FR at 24038. See also 63 FR at 38525, 38527 (The 
1998 proposed revisions to non-spot month levels, which were 
eventually adopted in 1999, were based upon two criteria: ``(1) the 
distribution of speculative traders in the markets; and (2) the size 
of open interest.'').
---------------------------------------------------------------------------

    The Commission proposes to maintain the 10, 2.5 percent formula for 
non-spot limits, with the limited change that the 2.5 percent 
calculation will be applied to open interest above 50,000 contracts 
rather than to the current level of 25,000 contracts. The Commission 
believes that this change is warranted due to the significant overall 
increase in open interest in these markets, which has roughly doubled 
since federal limits were set on these markets. The Commission would 
apply the modified formula to recent open interest data for the periods 
from July 2017-June 2018 and July 2018-June 2019 of the applicable 
futures and delta adjusted futures options. The resulting proposed 
limit levels, set forth in the second column in the table above, would 
generally be higher than existing limit levels, with the exception of 
CBOT Oats (O), CBOT KC HRW Wheat (KW), and MGEX HRS Wheat (MWE), where 
proposed levels would remain at the existing levels.
    The Commission continues to believe that a formula based on a 
percentage of open interest is an appropriate tool for establishing 
limits outside the spot month. As the Commission stated when it 
initially proposed to use an open interest formula, taking open 
interest into account ``will permit speculative position limits to 
reflect better the changing needs and composition of the futures 
markets . . .'' \216\ Open interest is a measure of market activity 
that reflects the number of contracts that are ``open'' or live, where 
each contract of open interest represents both a long and a short 
position. Relative to contracts with smaller open interest, contracts 
with larger open interest may be better able to mitigate the disruptive 
impact of excessive speculation because there may be more activity to 
oppose, diffuse, or otherwise counter a potential pricing disruption. 
Limiting positions to a percentage of open interest: (1) Helps ensure 
that positions are not so large relative to observed market activity 
that they risk disrupting the market; (2) allows speculators to hold 
sufficient contracts to provide a healthy level of liquidity for 
hedgers; and (3) allows for increases in position limits and position 
sizes as markets expand and become more active.
---------------------------------------------------------------------------

    \216\ Revision of Federal Speculative Position Limits, 57 FR 
12766, 12770 (Apr. 13, 1992). The Commission also stated that 
providing for a marginal increase was ``based upon the universal 
observation that the size of the largest individual positions in a 
market do not continue to grow in proportion with increases in the 
overall open interest of the market.'' Id.
---------------------------------------------------------------------------

    While the Commission continues to prefer a formula based on a 
percentage of open interest, market and potential regulatory changes 
counsel in favor of proposing a slight modification to the existing 
formula. In particular, as discussed in detail below, open interest has 
grown, and market composition has changed, significantly since the 
1990s. The proposed increase in the open interest portion of the non-
spot month limit formula from 25,000 to 50,000 contracts would provide 
a modest increase in the non-spot month limit of 1,875 contracts (over 
what the limit would be if the 10, 2.5 percent formula were applied at 
25,000 contracts), assuming the underlying commodity futures market has 
open interest of at least 50,000 contracts. The Commission believes 
that the amended non-spot month formula would provide a conservative 
increase in the non-spot month limits for most contracts to better 
reflect the general increase observed in open interest across futures 
markets since the late 1990s, as discussed below.
i. Increases in Open Interest
    The table below provides data that describes the market environment 
during the period prior to, and subsequent to, the adoption of the 10, 
2.5 percent formula by the Commission in 1999. The data includes 
futures contracts and the delta-adjusted options on futures open 
interest.\217\ The first column of the table provides the maximum open 
interest in the nine legacy agricultural contracts over the five year 
period ending in 1999. The CBOT Corn (C) contract had maximum open 
interest of approximately 463,000 contracts, and the CBOT Soybeans (S) 
contract had maximum open interest of approximately 227,000 contracts. 
The other seven contracts had maximum open interest figures that ranged 
from less than 20,000 contracts for CBOT Oats (O) to approximately 
172,000 for CBOT Soybean Oil (SO). Hence, when adopting the 10, 2.5 
percent formula in 1999, the Commission's experience in these markets 
was of aggregate futures and options on futures open interest well 
below 500,000 contracts.
---------------------------------------------------------------------------

    \217\ Delta is a ratio comparing the change in the price of an 
asset (a futures contract) to the corresponding change in the price 
of its derivative (an option on that futures contract) and has a 
value that ranges between zero and one. In-the-money call options 
get closer to 1 as their expiration approaches. At-the-money call 
options typically have a delta of 0.5, and the delta of out-of-the-
money call options approaches 0 as expiration nears. The deeper in-
the-money the call option, the closer the delta will be to 1, and 
the more the option will behave like the underlying asset. Thus, 
delta-adjusted options on futures will represent the total position 
of those options as if they were converted to futures.

                     Table--Maximum Futures and Options on Futures Open Interest, 1994-2018
----------------------------------------------------------------------------------------------------------------
                                     1994-1999       2000-2004       2005-2009       2010-2014       2015-2018
----------------------------------------------------------------------------------------------------------------
CBOT Corn (C)...................         463,386         828,176       1,897,484       2,052,678       2,201,990
ICE Cotton No. 2 (CT)...........         122,989         140,240         388,336         296,596         344,302

[[Page 11631]]

 
CBOT Oats (O)...................          18,879          17,939          16,860          15,375          11,313
CBOT Soybeans (S)...............         227,379         327,276         672,061         991,258         997,881
CBOT Soybean Meal (SM)..........         155,658         183,255         241,917         392,265         544,363
CBOT Soybean Oil (SO)...........         172,424         191,337         328,050         395,743         547,784
CBOT Wheat (W)..................         163,193         187,181         507,401         576,333         621,750
CBOT Wheat: Kansas City Hard Red          76,435          87,611         159,332         189,972         311,592
 Winter (KW)....................
MGEX Wheat: Minneapolis Hard Red          24,999          36,155          57,765          68,409          80,635
 Spring (MWE)...................
----------------------------------------------------------------------------------------------------------------

    The table also displays the maximum open interest figures for 
subsequent periods up to, and including, 2018. The maximum open 
interest for all of these contracts, except for oats, generally 
increased over the period.\218\ By the 2015-2018 period covered in the 
last column of the table, five of the contracts had maximum open 
interest greater than 500,000 contracts. The contracts for CBOT Corn 
(C), CBOT Soybeans (S), and CBOT Hard Red Winter Wheat (KW) saw maximum 
open interest increase by a factor of four to five times the maximum 
open interest during the 1994-1999 period leading up to the 
Commission's adoption of the 10, 2.5 percent formula in 1999.
---------------------------------------------------------------------------

    \218\ See infra Section II.B.2.e.iii. (discussion of proposed 
non-spot month limit level for CBOT Oats (O)).
---------------------------------------------------------------------------

ii. Changes in Market Composition
    As open interest has increased, the current non-spot limits have 
become significantly more restrictive over time. In particular, because 
the 2.5 percent incremental increase applies after the first 25,000 
contracts of open interest, limits on commodities with open interest 
above 25,000 contracts (i.e., all commodities other than oats) continue 
to increase at a much slower rate of 2.5 percent rather than 10 
percent, as for the first 25,000 contracts. This gradual increase was 
less of a problem in the latter part of the 1990s, for example, when 
open interest in each of the nine legacy agricultural contracts was 
below 500,000, and in many cases below 200,000. More recently, however, 
open interest has grown above 500,000 for a majority of the legacy 
contracts. The 10, 2.5 percent formula has thus become more restrictive 
for market participants, including those entities with positions that 
may not be eligible for a bona fide hedging exemption, but who might 
otherwise provide valuable liquidity to commercial firms.
    This problem has become worse over time because dealers play a much 
more significant role in the market today than at the time the 
Commission adopted the 10, 2.5 percent formula. Prior to 1999, the 
Commission regulated physical commodity markets where the largest 
participants were often large commercial interests who held short 
positions. The offsetting positions were often held by small, 
individual traders, who tended to be long.\219\ Several years after the 
Commission adopted the 10, 2.5 percent formula, the composition of 
futures market participants changed, as dealers began to enter the 
physical commodity futures market in larger size. The table below 
presents data from the Commission's publicly available ``Bank 
Participation Report'' (``BPR''), as of the December report for 2002-
2018.\220\ The table displays the number of banks holding reportable 
positions for the seven futures contracts for which federal limits 
apply and that were reported in the BPR.\221\ The report presents data 
for every market where five or more banks hold reportable positions. 
The BPR is based on the same large-trader reporting system database 
used to generate the Commission's Commitments of Traders (``COT'') 
report.\222\
---------------------------------------------------------------------------

    \219\ Stewart, Blair, An Analysis of Speculative Trading in 
Grain Futures, Technical Bulletin No. 1001, U.S. Department of 
Agriculture (Oct. 1949).
    \220\ Bank Participation Reports, U.S. Commodity Futures Trading 
Commission website, available at https://www.cftc.gov/MarketReports/BankParticipationReports/index.htm .
    \221\ The term ``reportable position'' is defined in Sec.  
15.00(p) of the Commission's regulations. 17 CFR 15.00(p).
    \222\ Commitments of Traders, U.S. Commodity Futures Trading 
Commission website, available at www.cftc.gov/MarketReports/CommitmentsofTraders/index.htm. There are generally still as many 
large commercial traders in the markets today as there were in the 
1990s.
---------------------------------------------------------------------------

    No data was reported for the seven futures contracts in December 
2002, indicating that fewer than five banks held reportable positions 
at the time of the report. The December 2003 report shows that five or 
more banks held reportable positions in four of the commodity futures. 
The number of banks with reportable positions generally increased in 
the early to mid-2000s. As described in the Commission's 2008 Staff 
Report on Commodity Swap Dealers & Index Traders, major changes in the 
composition of futures markets developed over the 20 years prior to 
2008, including an influx of swap dealers (``SDs''), affiliated with 
banks or other large financial institutions, acting as aggregators or 
market makers and providing swaps to commercial hedgers and to other 
market participants.\223\ The dealers functioned in the swaps market 
and also used the futures markets to hedge their exposures. When the 
Commission adopted the 10, 2.5 percent formula in 1999, it had limited 
experience with physical commodity derivatives markets in which such 
banks were significant participants.
---------------------------------------------------------------------------

    \223\ Staff Report on Commodity Swap Dealers & Index Traders 
with Commission Recommendations, U.S. Commodity Futures Trading 
Commission (Sept. 2008), available at https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/cftcstaffreportonswapdealers09.pdf.

                                         Table--Number of Reporting Commercial Banks With Long Futures Positions
--------------------------------------------------------------------------------------------------------------------------------------------------------
                  Year                         Corn           Cotton         Soybeans      Soybean meal     Soybean oil        Wheat        Wheat KCBT
--------------------------------------------------------------------------------------------------------------------------------------------------------
2002....................................              NR              NR              NR              NR              NR              NR              NR
2003....................................               5               6               7              NR              NR               5              NR
2004....................................               5              10               7              NR              NR               7              NR
2005....................................              10               8               6              NR               5               9               9
2006....................................              11              11               9              NR               7              14               7
2007....................................              13               8              12              NR               6              14               6
2008....................................              17              13              16              NR               6              14               9

[[Page 11632]]

 
2009....................................               8               8               8              NR              NR              13              NR
2010....................................               7               7               7              NR              NR              11              NR
2011....................................              10              11               9               5               5              10              NR
2012....................................               8              10              11               6               6              13               5
2013....................................              11              11              13              10               6              11               5
2014....................................              15              12              15              10               9              15               6
2015....................................              12              13              13              12               9              16               9
2016....................................              15              14              15              12              10              15               6
2017....................................              16              13              12              11               9              16               8
2018....................................              16              15              18              15              13              18              12
--------------------------------------------------------------------------------------------------------------------------------------------------------
NR = ``Not Reported''.

    For 2003, the first year in the report with reported data on the 
futures for these physical commodities, the BPR showed, as displayed in 
the table below, that the reporting banks held modest positions, 
totaling 3.4 percent of futures long open interest for wheat and 
smaller positions in other futures. The positions displayed in the 
table below increased over the next several years, generally peaking 
around 2005/2006 as a fraction of the long open interest.

                                          Table--Percent of Futures Long Open Interest Held by Commercial Banks
--------------------------------------------------------------------------------------------------------------------------------------------------------
               Year (Dec.)                     Corn           Cotton         Soybeans      Soybean meal     Soybean oil        Wheat        Wheat KCBT
--------------------------------------------------------------------------------------------------------------------------------------------------------
2002....................................              NR              NR              NR              NR              NR              NR              NR
2003....................................            1.5%            1.4%            0.8%              NR              NR            3.4%              NR
2004....................................             7.0             6.5             3.6              NR              NR            14.5              NR
2005....................................            12.5            13.8             8.3              NR             6.8            20.2             5.2
2006....................................             9.4            14.2             7.7              NR             6.7            17.0             6.9
2007....................................             9.2             9.7             6.7              NR             6.5            13.5             5.5
2008....................................             8.9            18.2            10.0              NR             6.4            18.7             7.1
2009....................................             4.3             6.5             3.6              NR              NR             9.3              NR
2010....................................             3.7             2.5             4.7              NR              NR             6.9              NR
2011....................................             4.1             3.3             4.9             1.9             4.4             7.7              NR
2012....................................             4.7             9.9             3.7             5.8             5.5             7.4             3.5
2013....................................             5.3             9.1             4.4             7.0             4.1             6.2             6.4
2014....................................             9.7            10.0             6.3             6.7             6.5             7.7            10.1
2015....................................             8.1            10.1             5.0             5.9             6.4             7.8             4.3
2016....................................             8.1             8.5             7.1            10.7             6.6             7.3             5.2
2017....................................             5.5             9.5             4.3             9.1             7.3             7.7             4.8
2018....................................             5.8             8.3             5.9             9.2             7.6            10.2             7.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
NR = ``Not Reported''.

iii. Proposed Non-Spot Month Limits for Hard Red Wheat and Oats
    The Commission proposes partial wheat parity outside of the spot 
month: limits for CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) would 
be set at 12,000 contracts, while limits for CBOT Wheat (W) would be 
set at 19,300 contracts. Based on the Commission's experience since 
2011 with non-spot month speculative position limit levels at 12,000 
for the CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) core referenced 
futures contracts, the Commission is proposing to maintain the current 
non-spot month limit levels for those two contracts, rather than 
reducing the existing levels to the lower levels that would result from 
applying the proposed modified 10, 2.5 percent formula.\224\ The 
current 12,000 contract level appears to have functioned well for these 
contracts, and the Commission sees no market-based reason to reduce the 
levels.
---------------------------------------------------------------------------

    \224\ Applying the proposed modified 10, 2.5 percent formula to 
recent open interest data for these two contracts would result in 
limit levels of 11,900 and 5,700, respectively.
---------------------------------------------------------------------------

    CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) are both hard red 
wheats representing about 60 percent of the wheat grown in the United 
States \225\ and about 80 percent of the wheat grown in Canada.\226\ 
Although the CBOT Wheat (W) contract allows for delivery of hard red 
wheat, it typically sees deliveries of soft white wheat varieties, 
which comprises a smaller percentage of the wheat grown in North 
America. Even though the CBOT Wheat (W) contract has the majority of 
liquidity among the three wheat contracts as measured by open interest 
and trading volume, it is the hard red wheats that make up the bulk of 
wheat crops in North America. Thus, the Commission proposes to maintain 
the non-spot month limit for the CBOT KC HRW Wheat (KW) contract and 
MGEX HRS Wheat (MWE) contract at the 12,000 contract level even though 
both contracts would have a lower non-spot month limit based solely on 
the open interest formula. The Commission preliminarily believes that 
maintaining partial parity and the existing non-spot month limits in 
this manner will benefit the MWE and KW markets since the two species 
of wheat are similar (i.e., hard red wheat) to one another relative to 
CBOT Wheat (W), which is soft white

[[Page 11633]]

wheat; and as a result, the Commission has preliminarily determined 
that decreasing the non-spot month levels for MWE could impose 
liquidity costs on the MWE market and harm bona fide hedgers, which 
could further harm liquidity for bona fide hedgers in the related KW 
market.
---------------------------------------------------------------------------

    \225\ Wheat Sector at a Glance, USDA Economic Research Service, 
available at https://www.ers.usda.gov/topics/crops/wheat/wheat-sector-at-a-glance.
    \226\ Estimated Areas, Yield, Production, Average Farm Price and 
Total Farm Value of Principal Field Crops, In Metric and Imperial 
Units, Statistics Canada website, available at https://www150.statcan.gc.ca/t1/tbl1/en/tv.action?pid=3210035901.
---------------------------------------------------------------------------

    However, the Commission has determined not to raise the proposed 
limit levels for CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) to the 
proposed 19,300 contract limit level for CBOT Wheat (W) because 19,300 
contracts appears to be extraordinarily large in comparison to open 
interest in the CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) 
markets, and the limit levels for both contracts are already larger 
than a limit level based on the 10, 2.5 percent formula. The Commission 
is concerned that substantially raising non-spot limits on the KW or 
MWE contracts could create a greater likelihood of excessive 
speculation given their smaller overall trading relative to the CBOT 
Wheat (W) contract. In response to prior proposals, which would have 
resulted in lower non-spot limits for MWE, MGEX had requested parity 
among all wheat contracts. In part, MGEX reasoned that intermarket 
spread trading among the three contracts is vital to their price 
discovery function.\227\ The Commission notes that intermarket 
spreading is permitted under this proposal.\228\ The intermarket spread 
exemption should address any concerns over the loss of liquidity in 
spread trades among the three wheat contracts.
---------------------------------------------------------------------------

    \227\ See Statement of Layne Carlson, CFTC Agricultural Advisory 
Committee meeting, Sept. 22, 2015, at 38-44.
    \228\ See supra Section II.A.20. (definition of spread 
transaction).
---------------------------------------------------------------------------

    Likewise, based on the Commission's experience since 2011 with the 
current non-spot month speculative position limit of 2,000 contracts 
for CBOT Oats (O), the Commission is proposing to maintain the current 
2,000 contract level rather than reducing it to the lower levels that 
would result from applying the updated 10, 2.5 formula.\229\ The 
existing 2,000 contract limit for CBOT Oats (O) appears to have 
functioned well, and the Commission sees no reason to reduce it.
---------------------------------------------------------------------------

    \229\ Applying the proposed modified 10, 2.5 percent formula to 
recent open interest data for oats would result in a 700 contract 
limit level.
---------------------------------------------------------------------------

    While retaining the existing non-spot month limits for the MWE and 
KW contracts and for CBOT Oats (O) does break with the proposed non-
spot month formula, the Commission has confidence that the existing 
contract limits should continue to be appropriate for these contracts. 
Furthermore, even when relying on a single criterion, such as 
percentage of open interest, the Commission has historically recognized 
that there can ``result . . . a range of acceptable position limit 
levels.'' \230\
---------------------------------------------------------------------------

    \230\ Revision of Speculative Position Limits, 57 FR 12770, 
12766 (Apr. 13, 1992). See also Revision of Speculative Position 
Limits and Associated Rules, 63 FR at 38525, 38527 (July 17, 1998). 
Cf. 2013 Proposal, 78 FR at 75729 (there may be range of spot month 
limits that maximize policy objectives).
---------------------------------------------------------------------------

    For all of the core referenced contracts, based on decades of 
experience overseeing exchange-set position limits and administering 
its own federal position limits regime, the Commission is of the view 
that the proposed non-spot month limit levels are also low enough to 
diminish, eliminate, or prevent excessive speculation, and to deter and 
prevent market manipulation, squeezes, and corners. The Commission has 
previously studied prior increases in federal non-spot month limits and 
concluded that the overall impact was modest, and that any changes in 
market performance were most likely attributable to factors other than 
changes in the federal position limit rules.\231\ The Commission has 
since gained further experience which supports that conclusion, 
including by monitoring amendments to position limit levels by 
exchanges. Further, given the significant increases in open interest 
and changes in market composition that have occurred since the 1990s, 
the Commission is comfortable that the proposal to amend the 10, 2.5 
percent formula will adequately address each of the policy objectives 
set forth in CEA section 4a(a)(3).\232\
---------------------------------------------------------------------------

    \231\ 64 FR 24038, 24039 (May 5, 1999).
    \232\ 7 U.S.C. 6a(a)(3)(B).
---------------------------------------------------------------------------

iv. Conclusion
    With the exception of the CBOT KC HRW Wheat (KW), MGEX HRS Wheat 
(MWE), and CBOT Oats (O) contracts, as noted above, the proposed 
formula would result in higher non-spot month limit levels than those 
currently in place. Furthermore, as noted above, under the rules 
proposed herein, the nine legacy agricultural contracts would be the 
only contracts subject to limits outside of the spot month. Aside from 
the CBOT Oats (O) contract, these contracts all have high open 
interest, and thus their pricing may be less likely to be affected by 
the trading of large position holders in non-spot months. Further, 
consistent with the approach proposed herein to leverage existing 
exchange-level programs and expertise, the proposed federal non-spot 
month limit levels would serve simply as ceilings--exchanges would 
remain free to set exchange levels below the federal limit. The 
exchanges currently have systems and processes in place to monitor and 
surveil their markets in real time, and have the ability, and 
regulatory responsibility, to act quickly in the event of a 
disturbance.\233\
---------------------------------------------------------------------------

    \233\ For example, under DCM Core Principle 4, DCMs are required 
to ``have the capacity and responsibility to prevent manipulation, 
price distortion, and disruptions of the delivery or cash-settlement 
process through market surveillance, compliance, and enforcement 
practices and procedures,'' including ``methods for conducting real-
time monitoring of trading'' and ``comprehensive and accurate trade 
reconstructions.'' 7 U.S.C. 7(d)(4).
---------------------------------------------------------------------------

    Additionally, exchanges have tools other than position limits for 
protecting markets. For instance, exchanges can establish position 
accountability levels well below a position limit level, and can impose 
liquidity and concentration surcharges to initial margin if they are 
vertically integrated with a derivatives clearing organization. One 
reason that the Commission is proposing to update the formula for 
calculating non-spot month limit levels is that the exchanges may be 
able in certain circumstances to act much more quickly than the 
Commission, including quickly altering their own limits and 
accountability levels based on changing market conditions. Any decrease 
in an exchange-set limit would effectively lower the federal limit for 
that contract, as market participants would be required to comply with 
both federal and exchange-set limits, and as the Commission has the 
authority to enforce violations of both federal and exchange-set 
limits.\234\
---------------------------------------------------------------------------

    \234\ See infra Section II.D.4.g. (discussion of Commission 
enforcement of exchange-set limits).
---------------------------------------------------------------------------

f. Subsequent Spot and Non-Spot Month Limit Levels
    Prior to amending any of the proposed spot or non-spot month 
levels, if adopted, the Commission would provide for public notice and 
comment by publishing the proposed levels in the Federal Register. 
Under proposed Sec.  150.2(f), should the Commission wish to rely on 
exchange estimates of deliverable supply to update spot month 
speculative limit levels, DCMs would be required to supply to the 
Commission deliverable supply estimates upon request. Proposed Sec.  
150.2(j) would delegate the authority to make such requests to the 
Director of the Division of Market Oversight.
    Recognizing that estimating deliverable supply can be a time and 
resource consuming process for DCMs and for the Commission, the 
Commission is not proposing to require

[[Page 11634]]

DCMs to submit such estimates on a regular basis; instead, DCMs would 
be required to submit estimates of deliverable supply if requested by 
the Commission.\235\ DCMs would also have the option of submitting 
estimates of deliverable supply and/or recommended speculative position 
limit levels if they wanted the Commission to consider them when 
setting/adjusting federal limit levels. Any such information would be 
included in a Commission action proposing changes to the levels. The 
Commission encourages exchanges to submit such estimates and 
recommendations voluntarily, as the exchanges are uniquely situated to 
recommend updated levels due to their knowledge of individual contract 
markets. When submitting estimates, DCMs would be required under 
proposed Sec.  150.2(f) to provide a description of the methodology 
used to derive the estimate, as well as any statistical data supporting 
the estimate, so that the Commission can verify that the estimate is 
reasonable. DCMs should consult the guidance regarding estimating 
deliverable supply set forth in Appendix C to part 38.\236\
---------------------------------------------------------------------------

    \235\ For example, if a contract has problems with pricing 
convergence between the futures and the cash market, it could be a 
symptom of a deliverable supply issue in the market. In such a 
situation, the Commission may request an updated deliverable supply 
estimate from the relevant DCM to help identify the possible cause 
of the pricing anomaly.
    \236\ 17 CFR part 38, Appendix C.
---------------------------------------------------------------------------

g. Relevant Contract Month
    Proposed Sec.  150.2(c) clarifies that the spot month and single 
month for any given referenced contract is determined by the spot month 
and single month of the core referenced futures contract to which that 
referenced contract is linked. This requires that referenced contracts 
be linked to the core referenced futures contract in order to be netted 
for position limit purposes. For example, for the NYMEX NY Harbor ULSD 
Heating Oil (HO) futures core referenced futures contract, the spot 
month period starts at the close of trading three business days prior 
to the last trading day of the contract. The spot month period for the 
NYMEX NY Harbor ULSD Financial (MPX) futures referenced contract would 
thus start at the same time--the close of trading three business days 
prior to the last trading day of the core referenced futures contract.
h. Limits on ``Pre-Existing Positions''
    Under proposed Sec.  150.2(g)(1), other than pre-enactment swaps 
and transition period swaps as defined in proposed Sec.  150.1, ``pre-
existing positions,'' defined in proposed Sec.  150.1 as positions 
established in good faith prior to the effective date of a final 
federal position limits rulemaking, would be subject to federal spot 
month limit levels. This clarification is intended to avoid rendering 
spot month limits ineffective--failing to apply spot month limits to 
such pre-existing positions could result in a large, pre-existing 
position either intentionally or unintentionally causing a disruption 
to the price discovery function of the core referenced futures contract 
as positions are rolled into the spot month. The Commission is 
particularly concerned about protecting the spot month in physical-
delivery futures from price distortions or manipulation that would 
disrupt the hedging and price discovery utility of the futures 
contract.
    Proposed Sec.  150.2(g)(2) would provide that the proposed non-spot 
month limit levels would not apply to positions acquired in good faith 
prior to the effective date of such limit, recognizing that pre-
existing large positions may have a relatively less disruptive effect 
outside of the spot month than during the spot month given that 
physical delivery occurs only during the spot month. However, other 
than pre-enactment swaps and transition period swaps, any pre-existing 
positions held outside the spot month would be attributed to such 
person if the person's position is increased after the effective date 
of a final federal position limits rulemaking.
i. Positions on Foreign Boards of Trade
    CEA section 4a(a)(6) directs the Commission to, among other things, 
establish limits on the aggregate number of positions in contracts 
based upon the same underlying commodity that may be held by any person 
across contracts listed by DCMs, certain contracts traded on a foreign 
board of trade (``FBOT'') with linkages to a contract traded on a 
registered entity, and swap contracts that perform or affect a 
significant price discovery function with respect to regulated 
entities.\237\ Pursuant to that directive, proposed Sec.  150.2(h) 
would apply the proposed limits to a market participant's aggregate 
positions in referenced contracts executed on a DCM and on, or pursuant 
to the rules of, an FBOT, provided that the referenced contracts settle 
against a price of a contract listed for trading on a DCM or SEF, and 
that the FBOT makes such contract available in the United States 
through ``direct access.'' \238\ In other words, a market participant's 
positions in referenced contracts listed on a DCM and on an FBOT 
registered to provide direct access would collectively have to stay 
below the federal limit level for the relevant core referenced futures 
contract. The Commission preliminarily believes that, as proposed, 
Sec.  150.2(h) would lessen regulatory arbitrage by eliminating a 
potential loophole whereby a market participant could accumulate 
positions on certain FBOTs in excess of limits in referenced 
contracts.\239\
---------------------------------------------------------------------------

    \237\ 7 U.S.C. 6a(a)(6).
    \238\ Commission regulation Sec.  48.2(c) defines ``direct 
access'' to mean an explicit grant of authority by a foreign board 
of trade to an identified member or other participant located in the 
United States to enter trades directly into the trade matching 
system of the foreign board of trade. 17 CFR 48.2(c).
    \239\ In addition, CEA section 4(b)(1)(B) prohibits the 
Commission from permitting an FBOT to provide direct access to its 
trading system to its participants located in the United States 
unless the Commission determines, in regards to any FBOT contract 
that settles against any price of one or more contracts listed for 
trading on a registered entity, that the FBOT (or its foreign 
futures authority) adopts position limits that are comparable to the 
position limits adopted by the registered entity. 7 U.S.C. 
6(b)(1)(B). CEA section 4(b)(1)(B) provides that the Commission may 
not permit a foreign board of trade to provide to the members of the 
foreign board of trade or other participants located in the United 
States direct access to the electronic trading and order-matching 
system of the foreign board of trade with respect to an agreement, 
contract, or transaction that settles against any price (including 
the daily or final settlement price) of 1 or more contracts listed 
for trading on a registered entity, unless the Commission determines 
that the foreign board of trade (or the foreign futures authority 
that oversees the foreign board of trade) adopts position limits 
(including related hedge exemption provisions) for the agreement, 
contract, or transaction that are comparable to the position limits 
(including related hedge exemption provisions) adopted by the 
registered entity for the 1 or more contracts against which the 
agreement, contract, or transaction traded on the foreign board of 
trade settles.
---------------------------------------------------------------------------

j. Anti-Evasion
    Pursuant to the Commission's rulemaking authority in section 8a(5) 
of the CEA,\240\ the Commission proposes Sec.  150.2(i), which is 
intended to deter and prevent a number of potential methods of evading 
the position limits proposed herein. The proposed anti-evasion 
provision is not intended to capture a trading strategy merely because 
it may result in smaller position size for purposes of position limits, 
but rather is intended to deter and prevent cases of willful evasion of 
federal position limits, the specifics of which the Commission may be 
unable to anticipate. The proposed federal position limit requirements 
would apply during the spot month for all referenced contracts subject 
to federal limits and non-spot position limit requirements would only 
apply for the nine legacy agricultural contracts.

[[Page 11635]]

Under this proposed framework, and because the threat of corners and 
squeezes is the greatest in the spot month, the Commission 
preliminarily anticipates that it may focus its attention on anti-
evasion activity during the spot month.
---------------------------------------------------------------------------

    \240\ 7 U.S.C. 12a(5).
---------------------------------------------------------------------------

    First, the proposed rule would consider a commodity index contract 
and/or location basis contract used to willfully circumvent position 
limits to be a referenced contract subject to federal limits. Because 
commodity index contracts and location basis contracts are excluded 
from the proposed ``referenced contract'' definition and thus not 
subject to federal limits,\241\ the Commission intends that proposed 
Sec.  150.2(i) would close a potential loophole whereby a market 
participant who has reached its limits could purchase a commodity index 
contract in a manner that allowed the participant to exceed limits when 
taking into account the weighting in the component commodities of the 
index contract. The proposed rule would close a similar potential 
loophole with respect to location basis contracts.
---------------------------------------------------------------------------

    \241\ See supra Section II.A.16.b. (explanation of proposed 
exclusions from the ``referenced contract'' definition).
---------------------------------------------------------------------------

    Second, proposed Sec.  150.2(i) would provide that a bona fide 
hedge recognition or spread exemption would no longer apply if used to 
willfully circumvent speculative position limits. This provision is 
intended to help ensure that bona fide hedge recognitions and spread 
exemptions are granted and utilized in a manner that comports with the 
CEA and Commission regulations, and that the ability to obtain a bona 
fide hedge recognition or spread exemption does not become an avenue 
for market participants to inappropriately exceed speculative position 
limits.
    Third, a swap contract used to willfully circumvent speculative 
position limits would be deemed an economically equivalent swap, and 
thus a referenced contract, even if the swap does not meet the 
economically equivalent swap definition set forth in proposed Sec.  
150.1. This provision is intended to deter and prevent the structuring 
of a swap in order to willfully evade speculative position limits.
    The determination of whether particular conduct is intended to 
circumvent or evade requires a facts and circumstances analysis. In 
preliminarily interpreting these anti-evasion rules, the Commission is 
guided by its interpretations of anti-evasion provisions appearing 
elsewhere in the Commission's regulations, including the interpretation 
of the anti-evasion rules that the Commission adopted in its 
rulemakings to further define the term ``swap'' and to establish a 
clearing requirement under section 2(h)(1)(A) of the CEA.\242\
---------------------------------------------------------------------------

    \242\ See Further Definition of ``Swap,'' ``Security-Based 
Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps; 
Security-Based Swap Agreement Recordkeeping, 77 FR 48207, 48297-
48303 (Aug. 13, 2012); Clearing Requirement Determination Under 
Section 2(h) of the CEA, 77 FR 74284, 74317-74319 (Dec. 13, 2012).
---------------------------------------------------------------------------

    Generally, consistent with those interpretations, in evaluating 
whether conduct constitutes evasion, the Commission would consider, 
among other things, the extent to which the person lacked a legitimate 
business purpose for structuring the transaction in that particular 
manner. For example, an analysis of how a swap was structured could 
reveal that persons crafted derivatives transactions, structured 
entities, or conducted themselves in a manner without a legitimate 
business purpose and with the intent to willfully evade position limits 
by structuring a swap such that it would not meet the proposed 
``economically equivalent swap'' definition. As stated in a prior 
rulemaking, a person's specific consideration of, for example, costs or 
regulatory burdens, including the avoidance thereof, is not, in and of 
itself, dispositive that the person is acting without a legitimate 
business purpose in a particular case.\243\ The Commission will view 
legitimate business purpose considerations on a case-by-case basis in 
conjunction with all other relevant facts and circumstances.
---------------------------------------------------------------------------

    \243\ See Clearing Requirements Determination Under Section 2(h) 
of the CEA, 77 FR at 74319.
---------------------------------------------------------------------------

    Further, as part of its facts and circumstances analysis, the 
Commission would look at factors such as the historical practices 
behind the market participant and transaction in question. For example, 
with respect to Sec.  150.2(i)(3), the Commission would consider 
whether a market participant has a history of structuring its swaps one 
way, but then starts structuring its swaps a different way around the 
time the participant risked exceeding a speculative position limit as a 
result of its swap position, such as by modifying the delivery date or 
other material terms and conditions such that the swap no longer meets 
the definition of an ``economically equivalent swap.''
    Consistent with interpretive language in prior rulemakings 
addressing evasion,\244\ when determining whether a particular activity 
constitutes willful evasion, the Commission will consider the extent to 
which the activity involves deceit, deception, or other unlawful or 
illegitimate activity. Although it is likely that fraud, deceit, or 
unlawful activity will be present where willful evasion has occurred, 
the Commission does not believe that these factors are a prerequisite 
to an evasion finding because a position that does not involve fraud, 
deceit, or unlawful activity could still lack a legitimate business 
purpose or involve other indicia of evasive activity. The presence or 
absence of fraud, deceit, or unlawful activity is one fact the 
Commission will consider when evaluating a person's activity. That 
said, the proposed anti-evasion provision does require willfulness, 
i.e. ``scienter.'' The Commission will interpret ``willful'' consistent 
with how the Commission has in the past, that acting either 
intentionally or with reckless disregard constitutes acting 
``willfully.'' \245\
---------------------------------------------------------------------------

    \244\ See Further Definition of ``Swap,'' ``Security-Based 
Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps; 
Security-Based Swap Agreement Recordkeeping, 77 FR 48207, 48297-
48303 and Clearing Requirement Determination Under Section 2(h) of 
the CEA, 77 FR 74284, 74317-74319.
    \245\ See In re Squadrito, [1990-1992 Transfer Binder] Comm. 
Fut. L. Rep. (CCH) ] 25,262 (CFTC Mar. 27, 1992) (adopting 
definition of ``willful'' in McLaughlin v. Richland Shoe Co., 486 
U.S. 128 (1987)).
---------------------------------------------------------------------------

    In determining whether a transaction has been entered into or 
structured willfully to evade position limits, the Commission will not 
consider the form, label, or written documentation as dispositive. The 
Commission also is not requiring a pattern of evasive transactions as a 
prerequisite to prove evasion, although such a pattern may be one 
factor in analyzing whether evasion has occurred. In instances where 
one party willfully structures a transaction to evade but the other 
counterparty does not, proposed Sec.  150.2(i) would apply to the party 
who willfully structured the transaction to evade.
    Finally, entering into transactions that qualify for the forward 
exclusion from the swap definition shall not be considered evasive. 
However, in circumstances where a transaction does not, in fact, 
qualify for the forward exclusion, the transaction may or may not be 
evasive depending on an analysis of all relevant facts and 
circumstances.
k. Netting
    For the reasons discussed above, the referenced contract definition 
in proposed Sec.  150.1 includes, among other things, cash-settled 
contracts that are linked, either directly or indirectly, to a core 
referenced futures contract; and any ``economically equivalent

[[Page 11636]]

swaps.'' \246\ Under proposed Sec.  150.2(a), federal spot month limits 
would apply to physical-delivery referenced contracts separately from 
federal spot month limits applied to cash-settled referenced contracts, 
meaning that during the spot month, positions in physically-settled 
contracts may not be netted with positions in linked cash-settled 
contracts. Specifically, all of a trader's positions (long or short) in 
a given physically-settled referenced contract (across all exchanges 
and OTC as applicable) \247\ are netted and subject to the spot month 
limit for the relevant commodity, and all of such trader's positions in 
any cash-settled referenced contracts (across all exchanges and OTC as 
applicable) linked to such physically-settled core referenced futures 
contract are netted and independently (rather than collectively along 
with the physically-settled positions) subject to the federal spot 
month limit for that commodity.\248\ A position in a commodity contract 
that is not a referenced contract is therefore not subject to federal 
limits, and, as a consequence, cannot be netted with positions in 
referenced contracts for purposes of federal limits.\249\ For example, 
a swap that is not a referenced contract because it does not meet the 
economically equivalent swap definition could not be netted with 
positions in a referenced contract.
---------------------------------------------------------------------------

    \246\ See supra Section II.A.16. (discussion of the proposed 
referenced contract definition).
    \247\ In practice, the only physically-settled referenced 
contracts under this proposal would be the 25 core referenced 
futures contracts, none of which are listed on multiple DCMs, 
although there could potentially be physically-settled OTC swaps 
that would satisfy the ``economically equivalent swap'' definition 
and therefore would also qualify as referenced contracts.
    \248\ Consistent with CEA section 4a(a)(6), this would include 
positions across exchanges.
    \249\ Proposed Appendix C to part 150 provides guidance 
regarding the referenced contract definition, including that the 
following types of contracts are not deemed referenced contracts, 
meaning such contracts are not subject to federal limits and cannot 
be netted with positions in referenced contracts for purposes of 
federal limits: Location basis contracts; commodity index contracts; 
and trade options that meet the requirements of 17 CFR 32.3.
---------------------------------------------------------------------------

    Allowing the netting of linked physically-settled and cash-settled 
contracts during the spot month could lead to disruptions in the price 
discovery function of the core referenced futures contract or allow a 
market participant to manipulate the price of the core referenced 
futures contract. Absent separate spot month limits for physically-
settled and cash-settled contracts, the spot month limit would be 
rendered ineffective, as a participant could maintain large positions 
in excess of limits in both the physically-settled contract and the 
linked cash-settled contract, enabling the participant to disrupt the 
price discovery function as the contracts go to expiration by taking 
large opposite positions in the physically-settled core referenced 
futures and cash-settled referenced contracts, or potentially allowing 
a participant to effect a corner or squeeze.\250\
---------------------------------------------------------------------------

    \250\ For example, absent such a restriction in the spot month, 
a trader could stand for 100 percent of deliverable supply during 
the spot month by holding a large long position in the physical-
delivery contract along with an offsetting short position in a cash-
settled contract, which effectively would corner the market.
---------------------------------------------------------------------------

    Proposed Sec.  150.2(b), which would establish limits outside the 
spot month, does not use the ``separately'' language. Accordingly, 
outside of the spot month, participants may net positions in linked 
physically-settled and cash-settled referenced contracts, because there 
is no immediate threat of delivery.
    Finally, proposed Sec.  150.2(a) and (b) also provide that spot and 
non-spot limits apply ``net long or net short.'' Consistent with 
existing Sec.  150.2, this language requires that, both during and 
outside the spot month, and subject to the provisions governing netting 
described above, a given participant's long positions in a particular 
contract be aggregated (including across exchanges and OTC as 
applicable), and a participant's short positions be aggregated 
(including across exchanges and OTC as applicable), and those aggregate 
long and short positons be netted--in other words, it is the net value 
that is subject to federal limits.
    Consistent with current and historical practice, the speculative 
position limits proposed herein would apply to positions throughout 
each trading session, including as of the close of each trading 
session.\251\
---------------------------------------------------------------------------

    \251\ See, e.g., Elimination of Daily Speculative Trading 
Limits, 44 FR 7124, 7125 (Feb. 6, 1979).
---------------------------------------------------------------------------

l. ``Eligible Affiliates'' and Aggregation
    Proposed Sec.  150.2(k) addresses entities that qualify as an 
``eligible affiliate'' as defined in proposed Sec.  150.1. Under the 
proposed definition, an ``eligible affiliate'' includes certain 
entities that, among other things, are required to aggregate their 
positions under Sec.  150.4 and that do not claim an exemption from 
aggregation. There may be certain entities that are eligible for an 
exemption from aggregation but that prefer to aggregate rather than 
disaggregate their positions; for example, when aggregation would 
result in advantageous netting of positions with affiliated entities. 
Proposed Sec.  150.2(k) is intended to address such a circumstance by 
making clear that an ``eligible affiliate'' may opt to aggregate its 
positions even though it is eligible to disaggregate.
m. Request for Comment
    The Commission requests comment on all aspects of proposed Sec.  
150.2. The Commission also invites comments on the following:
    (20) Are there legitimate strategies on which the Commission should 
offer guidance with respect to the anti-evasion provision?
    (21) Should the Commission list by regulation specific factors/
circumstances in which it may set spot month limits with other than the 
at or below 25 percent of deliverable supply formula, and non-spot 
month limits with other than the modified 10, 2.5 percent formula 
proposed herein? If so, please provide examples of any such factors, 
including an explanation of whether and why different formulas make 
sense for different commodities.
    (22) Is the proposed compliance date of twelve months after 
publication of a final federal position limits rulemaking in the 
Federal Register an appropriate amount of time for compliance? If not, 
please provide reasons supporting a different timeline. Do market 
participants support delaying compliance until one year after a DCM has 
had its new Sec.  150.9 rules approved by the Commission under Sec.  
40.5?
    (23) The Commission understands that it may be possible for a 
market participant trading options to start a trading day below the 
delta-adjusted federal speculative position limit for that option, but 
end up above such limit as the option becomes in-the-money during the 
spot month. Should the Commission allow for a one-day grace period with 
respect to federal position limits for market participants who have 
exercised options that were out-of-the money on the previous trading 
day but that become in-the-money during the trading day in the spot 
month?
    (24) Given that the contracts in corn and soybean complex are more 
liquid than CBOT Oats (O) and the MGEX HRS (MWE) wheat contract, should 
the Commission employ a higher open interest formula for corn and the 
soybean complex?
    (25) Should the Commission phase-in the proposed increased federal 
non-spot month limits incrementally over a period of time, rather than 
implementing the entire increase upon the effective date? Please 
explain why or why not. If so, please comment on an appropriate phase-
in schedule, including whether different

[[Page 11637]]

commodities should be subject to different schedules.
    (26) The Commission is aware that the non-spot month open interest 
is skewed to the first new crop (usually December or November) for the 
nine legacy agricultural contracts. The Commission understands that 
cotton may be unique because it has an extended harvest period starting 
in July in the south and working its way north until November. There 
may be some concern with positions being rolled from the prompt month 
into deferred contract months causing disruption to the price discovery 
function of the Cotton futures. Should the Commission consider lowering 
the single month limit to a percentage of the all months limits for 
Cotton? If so, what percentage of the all month limit should be used 
for the single month limit? Please provide a rationale for your 
percentage.
    (27) Should the Commission allow market participants who qualify 
for the conditional spot month limit in natural gas to net cash-settled 
natural gas referenced contracts across DCMs? Why or why not?

C. Sec.  150.3--Exemptions From Federal Position Limits

1. Existing Sec. Sec.  150.3, 1.47, and 1.48
    Existing Sec.  150.3(a), which pre-dates the Dodd-Frank Act, lists 
positions that may, under certain circumstances, exceed federal limits: 
(1) Bona fide hedging transactions, as defined in the current bona fide 
hedging definition in Sec.  1.3; and (2) certain spread or arbitrage 
positions.\252\ So that the Commission can effectively oversee the use 
of such exemptions, existing Sec.  150.3(b) provides that the 
Commission or certain Commission staff may make special calls to demand 
certain information from exemption holders, including information 
regarding positions owned or controlled by that person, trading done 
pursuant to that exemption, and positions that support the claimed 
exemption.\253\ Existing Sec.  150.3(a) allows for bona fide hedging 
transactions to exceed federal limits, and the current process for a 
person to request such recognitions for non-enumerated hedges appears 
in Sec.  1.47.\254\ Under that provision, persons seeking recognition 
by the Commission of a non-enumerated bona fide hedging transaction or 
position must file statements with the Commission.\255\ Initial 
statements must be filed with the Commission at least 30 days in 
advance of exceeding the limit. \256\ Similarly, existing Sec.  1.48 
sets forth the process for market participants to file an application 
with the Commission to recognize certain enumerated anticipatory 
positions as bona fide hedging positions.\257\ Under that provision, 
such recognitions must be requested 10 days in advance of exceeding the 
limit.\258\
---------------------------------------------------------------------------

    \252\ 17 CFR 150.3(a).
    \253\ 17 CFR 150.3(b).
    \254\ 17 CFR 1.47.
    \255\ 17 CFR 1.47(a).
    \256\ 17 CFR 1.47(b).
    \257\ 17 CFR 1.48.
    \258\ Id.
---------------------------------------------------------------------------

    Further, the Commission provides self-effectuating spread 
exemptions for the nine legacy agricultural contracts currently subject 
to federal limits, but does not specify a formal process for granting 
such spread exemptions.\259\ The Commission's authority and existing 
regulation for exempting certain spread positions can be found in 
section 4a(a)(1) of the Act and existing Sec.  150.3(a)(3) of the 
Commission's regulations, respectively.\260\ In particular, CEA section 
4a(a)(1) provides the Commission with authority to exempt from position 
limits transactions ``normally known to the trade as `spreads' or 
`straddles' or `arbitrage.' ''
---------------------------------------------------------------------------

    \259\ Since 1938, the Commission (known as the Commodity 
Exchange Commission in 1938) has recognized the use of spread 
positions to facilitate liquidity and hedging. Notice of Proposed 
Order in the Matter of Limits on Position and Daily Trading in Grain 
for Future Delivery, 3 FR 1408 (June 14, 1938).
    \260\ See 7 U.S.C. 6a(a)(1) and 17 CFR 150.3(a)(3) (providing 
that the position limits set in Sec.  150.2 may be exceeded to the 
extent such positions are: Spread or arbitrage positions between 
single months of a futures contract and/or, on a futures-equivalent 
basis, options thereon, outside of the spot month, in the same crop 
year; provided, however, that such spread or arbitrage positions, 
when combined with any other net positions in the single month, do 
not exceed the all-months limit set forth in Sec.  150.2.). Although 
existing Sec.  150.3(a)(3) does not specify a formal process for 
granting spread exemptions, the Commission is able to monitor 
traders' gross and net positions using part 17 data, the monthly 
Form 204, and information from the applicable DCMs to identify any 
such spread positions.
---------------------------------------------------------------------------

2. Proposed Sec.  150.3
    As described elsewhere in this release, the Commission is proposing 
a new bona fide hedging definition in Sec.  150.1 (described above) and 
a new streamlined process in proposed Sec.  150.9 for recognizing non-
enumerated bona fide hedging positions (described further below). The 
Commission thus proposes to update Sec.  150.3 to conform to those new 
proposed provisions. Proposed Sec.  150.3 also includes new exemption 
types not explicitly listed in existing Sec.  150.3, including: (i) 
Exemptions for financial distress situations; (ii) conditional 
exemptions for certain spot month positions in cash-settled natural gas 
contracts; and (iii) exemptions for pre-enactment swaps and transition 
period swaps.\261\ Proposed Sec.  150.3(b)-(g) respectively address: 
Requests for relief from position limits submitted directly to the 
Commission or Commission staff (rather than to an exchange under 
proposed Sec.  150.9, as discussed further below); previously-granted 
risk management exemptions to position limits; exemption-related 
recordkeeping and special-call requirements; the aggregation of 
accounts; and the delegation of certain authorities to the Director of 
the Division of Market Oversight.
---------------------------------------------------------------------------

    \261\ The Commission revised Sec.  150.3(a) in 2016, relocating 
the independent account controller aggregation exemption from Sec.  
150.3(a)(4) in order to consolidate it with the Commission's 
aggregation requirements in Sec.  150.4(b)(4). See Final Aggregation 
Rulemaking, 81 FR at 91489-90.
---------------------------------------------------------------------------

a. Bona Fide Hedging Positions and Spread Exemptions
    The Commission has years of experience granting and monitoring 
spread exemptions, and enumerated and non-enumerated bona fide hedges, 
as well as overseeing exchange processes for administering exemptions 
from exchange-set limits on such contracts. As a result of this 
experience, the Commission has determined to continue to allow self-
effectuating enumerated bona fide hedges and certain spread exemptions 
for all contracts that would be subject to federal position limits, as 
explained further below.
i. Bona Fide Hedging Positions
    First, under proposed Sec.  150.3(a)(1)(i), bona fide hedge 
recognitions for positions in referenced contracts that fall within one 
of the proposed enumerated hedges set forth in proposed Appendix A to 
part 150, discussed above, would be self-effectuating for purposes of 
federal position limits. Market participants would thus not be required 
to request Commission approval prior to exceeding federal position 
limits in such cases, but would be required to request a bona fide 
hedge exemption from the relevant exchange for purposes of exchange-set 
limits established pursuant to proposed Sec.  150.5(a), and submit 
required cash-market information to the exchange as part of such 
request.\262\ The Commission has also determined to allow the proposed 
enumerated anticipatory bona fide hedges (some of which are not 
currently self-effectuating and thus are required to be approved by the 
Commission under existing Sec.  1.48) to be self-effectuating for 
purposes of federal limits (and thus would not require prior

[[Page 11638]]

Commission approval for such enumerated anticipatory hedges). The 
Commission may consider expanding the proposed list of enumerated 
hedges at a later time, after notice and comment, as it gains 
experience with the new federal position limits framework proposed 
herein.
---------------------------------------------------------------------------

    \262\ See infra Section II.D.4.a. See also proposed Sec.  
150.5(a)(2)(ii)(A)(1).
---------------------------------------------------------------------------

    Second, under proposed Sec.  150.3(a)(1)(ii), for positions in 
referenced contracts that do not fit within one of the proposed 
enumerated hedges in Appendix A, (i.e., non-enumerated bona fide 
hedges), market participants must request approval from the Commission, 
or from an exchange, prior to exceeding federal limits. Such exemptions 
thus would not be self-effectuating and market participants in such 
cases would have two options for requesting such a non-enumerated bona 
fide hedge recognition: (1) Apply directly to the Commission in 
accordance with proposed Sec.  150.3(b) (described below), and 
separately also apply to an exchange pursuant to exchange rules 
established under proposed Sec.  150.5(a); \263\ or, alternatively (2) 
apply to an exchange pursuant to proposed Sec.  150.9 for a non-
enumerated bona fide hedge recognition that could be valid both for 
purposes of federal and exchange-set position limit requirements, 
unless the Commission (and not staff) objects to the exchange's 
determination within a limited period of time.\264\ As discussed 
elsewhere in this release, market participants relying on enumerated or 
non-enumerated bona fide hedge recognitions would no longer have to 
file the monthly Form 204/304 with supporting cash market 
information.\265\
---------------------------------------------------------------------------

    \263\ See infra Section II.D.4. (discussion of proposed Sec.  
150.5).
    \264\ See infra Section II.G.3. (discussion of proposed Sec.  
150.9).
    \265\ See infra Section II.H.2. (discussion of the proposed 
elimination of Form 204).
---------------------------------------------------------------------------

ii. Spread Exemptions
    Under proposed Sec.  150.3(a)(2)(i), spread exemptions for 
positions in referenced contracts would be self-effectuating, provided 
that the position fits within one of the types of spreads listed in the 
spread transaction definition in proposed Sec.  150.1,\266\ and 
provided further that the market participant separately requests a 
spread exemption from the relevant exchange's limits established 
pursuant to proposed Sec.  150.5(a).
---------------------------------------------------------------------------

    \266\ See supra Section II.A.20. (proposed definition of 
``spread transaction'' in Sec.  150.1, which would cover: Calendar 
spreads; quality differential spreads; processing spreads (such as 
energy ``crack'' or soybean ``crush'' spreads); product or by-
product differential spreads; and futures-options spreads.)
---------------------------------------------------------------------------

    The Commission anticipates that such spread exemptions might 
include spreads that are ``legged in,'' that is, carried out in two 
steps, or alternatively are ``combination trades,'' that is, all 
components of the spread are executed simultaneously or near 
simultaneously. The list of spread transactions in proposed Sec.  150.1 
reflects the most common types of spread strategies for which the 
Commission and/or exchanges have previously granted spread exemptions.
    Under proposed Sec.  150.3(a)(2)(ii), for all contracts subject to 
federal limits, if the spread position does not fit within one of the 
spreads listed in the spread transaction definition in proposed Sec.  
150.1, market participants must apply for the spread exemption relief 
directly from the Commission in accordance with proposed Sec.  
150.3(b). The market participant must receive notification of the 
approved spread exemption under proposed Sec.  150.3(b)(4) before 
exceeding the federal speculative position limits for that spread 
position. The Commission may consider expanding the proposed spread 
transactions definition at a later time, after notice and comment, as 
it gains experience with the new federal position limits framework 
proposed herein.
iii. Removal of Existing Sec. Sec.  1.47, 1.48, and 140.97
    Given the proposal set forth in Sec.  150.9, as described in detail 
below, to allow for a streamlined process for recognizing bona fide 
hedges for purposes of federal limits,\267\ the Commission also 
proposes to delete existing Sec. Sec.  1.47 and 1.48. The Commission 
preliminarily believes that overall, the proposed approach would lead 
to a more efficient bona fide hedge recognition process. As the 
Commission proposes to delete Sec. Sec.  1.47 and 1.48, the Commission 
also proposes to delete existing Sec.  140.97, which delegates to the 
Director of the Division of Enforcement or his designee authority 
regarding requests for classification of positions as bona fide hedges 
under existing Sec. Sec.  1.47 and 1.48.\268\
---------------------------------------------------------------------------

    \267\ Id.
    \268\ 17 CFR 140.97.
---------------------------------------------------------------------------

    The Commission does not intend the proposed replacement of 
Sec. Sec.  1.47 and 1.48 to have any bearing on bona fide hedges 
previously recognized under those provisions. With the exception of 
certain recognitions for risk management positions discussed below, 
positions that were previously recognized as bona fide hedges under 
Sec. Sec.  1.47 or 1.48 would continue to be recognized, provided they 
continue to meet the statutory bona fide hedging definition and all 
other existing and proposed requirements.
b. Process for Requesting Commission-Provided Relief for Non-Enumerated 
Bona Fide Hedges and Spread Exemptions
    Under the proposed rules, non-enumerated bona fide hedging 
recognitions may only be granted by the Commission as proposed in Sec.  
150.3(b), or under the streamlined process proposed in Sec.  150.9. 
Further, spread exemptions that do not meet the proposed spread 
transaction definition may only be granted by the Commission as 
proposed in Sec.  150.3(b). Under the Commission process in Sec.  
150.3(b), a person seeking a bona fide hedge recognition or spread 
exemption may submit a request to the Commission.
    With respect to bona fide hedge recognitions, such request must 
include: (i) A description of the position in the commodity derivative 
contract for which the application is submitted, including the name of 
the underlying commodity and the position size; (ii) information to 
demonstrate why the position satisfies section 4a(c)(2) of the Act and 
the definition of bona fide hedging transaction or position in proposed 
Sec.  150.1, including factual and legal analysis; (iii) a statement 
concerning the maximum size of all gross positions in derivative 
contracts for which the application is submitted (in order to provide a 
view of the true footprint of the position in the market); (iv) 
information regarding the applicant's activity in the cash markets and 
the swaps markets for the commodity underlying the position for which 
the application is submitted; \269\ and (v) any other information that 
may help the Commission determine whether the position meets the 
requirements of section 4a(c)(2) of the Act and the definition of bona 
fide hedging transaction or position in Sec.  150.1.\270\
---------------------------------------------------------------------------

    \269\ The Commission would expect that applicants would provide 
cash market data for at least the prior year.
    \270\ For example, the Commission may, in its discretion, 
request a description of any positions in other commodity derivative 
contracts in the same commodity underlying the commodity derivative 
contract for which the application is submitted. Other commodity 
derivatives contracts could include other futures, options, and 
swaps (including over-the-counter swaps) positions held by the 
applicant.
---------------------------------------------------------------------------

    With respect to spread exemptions, such request must include: (i) A 
description of the spread transaction for which the exemption 
application is

[[Page 11639]]

submitted; \271\ (ii) a statement concerning the maximum size of all 
gross positions in derivative contracts for which the application is 
submitted; and (iii) any other information that may help the Commission 
determine whether the position is consistent with section 4a(a)(3)(B) 
of the Act.
---------------------------------------------------------------------------

    \271\ The nature of such description would depend on the facts 
and circumstances, and different details may be required depending 
on the particular spread.
---------------------------------------------------------------------------

    Under proposed Sec.  150.3(b)(2), the Commission, or Commission 
staff pursuant to delegated authority proposed in Sec.  150.3(g), may 
request additional information from the requestor and must provide the 
requestor with ten business days to respond. Under proposed Sec.  
150.3(b)(3) and (4), the requestor, however, may not exceed federal 
position limits unless it receives a notice of approval from the 
Commission or from Commission staff pursuant to delegated authority 
proposed in Sec.  150.3(g); provided however, that, due to demonstrated 
sudden or unforeseen increases in its bona fide hedging needs, a person 
may request a recognition of a bona fide hedging transaction or 
position within five business days after the person established the 
position that exceeded the federal speculative position limit.\272\
---------------------------------------------------------------------------

    \272\ Where a person requests a bona fide hedge recognition 
within five business days after they exceed federal position limits, 
such person would be required to demonstrate that they encountered 
sudden or unforeseen circumstances that required them to exceed 
federal position limits before submitting and receiving approval of 
their bona fide hedge application. These applications submitted 
after a person has exceeded federal position limits should not be 
habitual and will be reviewed closely. If the Commission reviews 
such application and finds that the position does not qualify as a 
bona fide hedge, then the applicant would be required to bring their 
position into compliance within a commercially reasonable time, as 
determined by the Commission in consultation with the applicant and 
the applicable DCM or SEF. If the applicant brings the position into 
compliance within a commercially reasonable time, then the applicant 
will not be considered to have violated the position limits rules. 
Further, any intentional misstatements to the Commission, including 
statements to demonstrate why the bona fide hedging needs were 
sudden and unforeseen, would be a violation of sections 6(c)(2) and 
9(a)(2) of the Act.
---------------------------------------------------------------------------

    Under this proposed process, market participants would be 
encouraged to submit their requests for bona fide hedge recognitions 
and spread exemptions as early as possible since proposed Sec.  
150.3(b) would not set a specific timeframe within which the Commission 
must make a determination for such requests.
    Further, all approved bona fide hedge recognitions and spread 
exemptions must be renewed if there are any changes to the information 
submitted as part of the request, or upon request by the Commission or 
Commission staff.\273\ Finally, the Commission (and not staff) may 
revoke or modify any bona fide hedge recognition or spread exemption at 
any time if the Commission determines that the bona fide hedge 
recognition or spread exemption, or portions thereof, are no longer 
consistent with the applicable statutory and regulatory 
requirements.\274\
---------------------------------------------------------------------------

    \273\ See proposed Sec.  150.3(b)(5). Currently, the Commission 
does not require automatic updates to bona fide hedge applications, 
and does not require applications or updates thereto for spread 
exemptions, which are self-effectuating. Consistent with current 
practices, under proposed Sec.  150.3(b)(5), the Commission would 
not require automatic annual updates to bona fide hedge and spread 
exemption applications; rather, updated applications would only be 
required if there are changes to information the requestor initially 
submitted or upon Commission request. This approach is different 
than the proposed streamlined process in Sec.  150.9, which would 
require automatic annual updates to such applications, which is more 
consistent with current exchange practices. See, e.g., CME Rule 559.
    \274\ This proposed authority to revoke or modify a bona fide 
hedge recognition or spread exemption would not be delegated to 
Commission staff.
---------------------------------------------------------------------------

    The Commission anticipates that most market participants would 
utilize the streamlined process set forth in proposed Sec.  150.9 and 
described below, rather than the process as proposed in Sec.  150.3(b), 
because exchanges would generally be able to make such determinations 
more efficiently than Commission staff, and because market participants 
are likely already familiar with the proposed processes set forth in 
Sec.  150.9, which is intended to leverage the processes currently in 
place at the exchanges for addressing requests for exemptions from 
exchange-set limits. Nevertheless, proposed Sec.  150.3(a)(1) and (2) 
clarify that market participants may seek relief from federal position 
limits for non-enumerated bona fide hedges and spread transactions that 
do not meet the proposed spread transactions definition directly from 
the Commission. After receiving any approval of a bona fide hedge or 
spread exemption from the Commission, the market participant would 
still be required to request a bona fide hedge recognition or spread 
exemption from the relevant exchange for purposes of exchange-set 
limits established pursuant to proposed Sec.  150.5(a).
c. Request for Comment
    The Commission requests comments on all aspects of proposed Sec.  
150.3(a)(1) and (2). The Commission also invites comment on the 
following:
    (28) Out of concern that large demand for delivery against long 
nearby futures positions may outpace demand on spot cash values, the 
Commission has previously discussed allowing cash and carry exemptions 
as spreads on the condition that the exchange ensures that exit points 
in cash and carry spread exemptions would facilitate an orderly 
liquidation.\275\ Should the Commission allow the granting of cash and 
carry exemptions under such conditions? If so, please explain why, 
including how such exemptions would be consistent with the Act and the 
Commission's regulations. If not, please explain why not, and if other 
circumstances would be better, including better for preserving 
convergence, which is essential to properly functioning markets and 
price discovery. If cash and carry exemptions were allowed, how could 
an exchange ensure that exit points in cash and carry exemptions 
facilitate convergence of cash and futures?
---------------------------------------------------------------------------

    \275\ See, e.g., 2016 Reproposal, 81 FR 96704 at 96833.
---------------------------------------------------------------------------

d. Financial Distress Exemptions
    Proposed Sec.  150.3(a)(3) would allow for a financial distress 
exemption in certain situations, including the potential default or 
bankruptcy of a customer or a potential acquisition target. For 
example, in periods of financial distress, such as a customer default 
at an FCM or a potential bankruptcy of a market participant, it may be 
beneficial for a financially-sound market participant to take on the 
positions and corresponding risk of a less stable market participant, 
and in doing so, exceed federal speculative position limits. Pursuant 
to authority delegated under Sec. Sec.  140.97 and 140.99, Commission 
staff previously granted exemptions in these types of situations to 
avoid sudden liquidations required to comply with a position 
limit.\276\ Such sudden liquidations could otherwise potentially hinder 
statutory objectives, including by reducing liquidity, disrupting price 
discovery, and/or increasing systemic risk.\277\
---------------------------------------------------------------------------

    \276\ See, e.g., CFTC Press Release No. 5551-08, CFTC Update on 
Efforts Underway to Oversee Markets, (Sept. 19, 2008), available at 
https://www.cftc.gov/PressRoom/PressReleases/pr5551-08.
    \277\ See 7 U.S.C. 6a(a)(3).
---------------------------------------------------------------------------

    The proposed exemption would be available to positions of ``a 
person, or related persons,'' meaning that a financial distress 
exemption request should be specific to the circumstances of a 
particular person, or to persons related to that person, and not a more 
general request by a large group of unrelated people whose financial 
distress circumstances may differ from one another. The proposed 
exemption would be granted on a case by case basis in response to a 
request submitted pursuant to Sec.  140.99, and would be

[[Page 11640]]

evaluated based on the specific facts and circumstances of a particular 
person or related persons. Any such financial distress position would 
not be a bona fide hedging transaction or position unless it otherwise 
met the substantive and procedural requirements set forth in proposed 
Sec. Sec.  150.1, 150.3, and 150.9, as applicable.
e. Conditional Spot Month Exemption in Natural Gas
    Certain natural gas contracts are currently subject to exchange-set 
limits, but not federal limits.\278\ This proposal would apply federal 
limits to certain natural gas contracts for the first time by including 
the physically-settled NYMEX Henry Hub Natural Gas (``NYMEX NG'') 
contract as a core referenced futures contract listed in proposed Sec.  
150.2(d). As set forth in proposed Appendix E to part 150, that 
physically-settled contract, as well as any cash-settled natural gas 
contract that qualifies as a referenced contract,\279\ would be 
separately subject to a federal spot month limit, net long or net 
short, of 2,000 NYMEX NG equivalent-size contracts.
---------------------------------------------------------------------------

    \278\ Some examples include natural gas contracts that use the 
NYMEX NG futures contract as a reference price, such as ICE's Henry 
Financial Penultimate Fixed Price Futures (PHH), options on Henry 
Penultimate Fixed Price (PHE), Henry Basis Futures (HEN) and Henry 
Swing Futures (HHD); NYMEX's E-mini Natural Gas Futures (QG), Henry 
Hub Natural Gas Last Day Financial Futures (HH), and Henry Hub 
Natural Gas Financial Calendar Spread (3 Month) Option (G3); and 
Nasdaq Futures, Inc.'s (``NFX'') Henry Hub Natural Gas Financial 
Futures (HHQ), and Henry Hub Natural Gas Penultimate Financial 
Futures (NPQ).
    \279\ Under the referenced contract definition proposed in Sec.  
150.1, cash-settled natural gas referenced contracts are those 
futures or options contracts, including spreads, that are:
    (1) Directly or indirectly linked, including being partially or 
fully settled on, or priced at a fixed differential to, the price of 
the physically-settled NYMEX NG core referenced futures contract; or
    (2) Directly or indirectly linked, including being partially or 
fully settled on, or priced at a fixed differential to, the price of 
the same commodity underlying the physically-settled NYMEX NG core 
referenced futures contract for delivery at the same location or 
locations as specified in the NYMEX NG core referenced futures 
contract. As proposed, the referenced contract definition does not 
include a location basis contract, a commodity index contract, or a 
trade option that meets the requirements of Sec.  32.3 of this 
chapter. See proposed Sec.  150.1.
---------------------------------------------------------------------------

    Under the referenced contract definition in proposed Sec.  150.1, 
ICE's cash-settled Henry Hub LD1 contract, ICE's Henry Financial 
Penultimate Fixed Price Futures, NYMEX's cash-settled Henry Hub Natural 
Gas Last Day Financial Futures contract, Nodal Exchange's (``Nodal'') 
cash-settled Henry Hub Monthly Natural Gas contract, and NFX cash-
settled Henry Hub Natural Gas Financial Futures contract, for example, 
would each qualify as a referenced contract subject to federal limits 
by virtue of being cash-settled to the physically-settled NYMEX NG core 
referenced futures contract.\280\ Any other cash-settled contract that 
meets the referenced contract definition would also be subject to 
federal limits, as would an ``economically equivalent swap,'' as 
defined in proposed Sec.  150.1, with respect to any natural gas 
referenced contract.
---------------------------------------------------------------------------

    \280\ On November 12, 2019, Nodal announced that it had reached 
an agreement to acquire the core assets of NFX. See Nodal Exchange 
Acquires U.S. Commodities Business of Nasdaq Futures, Inc. (NFX), 
Nodal Exchange website (Nov. 12, 2019), available at https://www.nodalexchange.com/wp-content/uploads/20191112-Nodal-NFX-release-Final.pdf (press release). The acquisition includes all of NFX's 
energy complex of futures and options contracts, including NFX's 
Henry Hub Natural Gas Financial Futures contract. Because that 
contract will become part of Nodal's offerings, that contract, as 
well as Nodal's existing Henry Hub Monthly Natural Gas contract, 
would continue to qualify as referenced contracts under the proposed 
definition herein, and thus would be subject to federal limits by 
virtue of being cash-settled to the physically-settled NYMEX NG core 
referenced futures contract. According to the November 12, 2019 
press release, ``Nodal Exchange and Nodal Clear plan to complete the 
integration of U.S. Power contracts by December 2019. U.S. Natural 
Gas, Crude Oil and Ferrous Metals contracts could transfer to Nodal 
as soon as spring 2020.'' Id.
---------------------------------------------------------------------------

    Proposed Sec.  150.3(a)(4) would permit a new federal conditional 
spot month limit exemption for certain cash-settled natural gas 
referenced contracts. Under proposed Sec.  150.3(a)(4), market 
participants seeking to exceed the proposed 2,000 NYMEX NG equivalent-
size contract spot month limit for a cash-settled natural gas 
referenced contract listed on any DCM could receive an exemption that 
would be capped at 10,000 NYMEX NG equivalent-size contracts net long 
or net short per DCM, plus an additional 10,000 NYMEX NG futures 
equivalent size contracts in economically equivalent swaps. A grant of 
such an exemption would be conditioned on the participant not holding 
or controlling any positions during the spot month in the physically-
settled NYMEX NG core referenced futures contract.\281\
---------------------------------------------------------------------------

    \281\ While the NYMEX NG is the only natural gas contract 
included as a core referenced futures contract in this release, the 
conditional spot month exemption proposed herein would also apply to 
any other physically-settled natural gas contract that the 
Commission may in the future designate as a core referenced futures 
contract, as well as to any physically-delivered contract that is 
substantially identical to the NYMEX NG and that qualifies as a 
referenced contract, or that qualifies as an economically equivalent 
swap.
---------------------------------------------------------------------------

    This proposed conditional exemption level of 10,000 contracts per 
DCM in natural gas would codify into federal regulations the industry 
practice of an exchange-set conditional limit that is five times the 
size of the spot month limit that has developed over time, and which 
the Commission preliminarily believes has functioned well. The practice 
balances the needs of certain market participants, who may currently 
hold or control 5,000 contracts in each DCM's cash-settled natural gas 
futures contracts and prefer a sizeable position in a cash-settled 
contract in order to obtain the desired exposure without needing to 
make or take delivery of natural gas, with the policy objectives of the 
Commission, which has historically had concerns about the possibility 
of traders attempting to manipulate the physically-settled NYMEX NG 
contract (i.e., mark-the close) in order to benefit from a larger 
position in the cash-settled ICE LD1 Natural Gas Swap and/or NYMEX 
Henry Hub Natural Gas Last Day Financial Futures contract during the 
spot month as these contracts expired.\282\
---------------------------------------------------------------------------

    \282\ As noted above, current exchange rules establish a spot 
month limit of 1,000 NYMEX equivalent sized contracts. The 
Commission proposes a federal spot month limit of 2,000 NYMEX 
equivalent sized contracts based on updated deliverable supply 
estimates. See supra Section II.B.2.b. (2020 proposed spot month 
limit chart). The proposed conditional spot month limit exemption of 
10,000 contracts per exchange is thus five times the proposed 
federal spot month limit.
---------------------------------------------------------------------------

    NYMEX, ICE, NFX, and Nodal currently have rules in place 
establishing a conditional spot month limit exemption equivalent to up 
to 5,000 contracts (in NYMEX-equivalent size) for their respective 
cash-settled natural gas contracts, provided that the trader does not 
maintain a position in the physically-settled NYMEX NG contract during 
the spot month.\283\ Together, the ICE, NYMEX, NFX, and Nodal rules 
allow a trader to hold up to 20,000 (NYMEX-equivalent size) contracts 
during the spot month combined across ICE, NYMEX, NFX, and Nodal cash-
settled natural gas contracts, provided the trader does not hold 
positions in excess of 5,000

[[Page 11641]]

contracts on any one DCM, and provided further that the trader does not 
hold any positions in the physically-settled NYMEX NG contract during 
the spot month.\284\
---------------------------------------------------------------------------

    \283\ See ICE Rule 6.20(c), NYMEX Rule 559.F, NFX Rule Chapter 
V, Section 13(a), and Nodal Rule 6.5.2. The spot month for such 
contracts is three days. See also Position Limits, CMG Group 
website, available at https://www.cmegroup.com/market-regulation/position-limits.html (NYMEX position limits spreadsheet); Market 
Resources, ICE Futures website, available at https://www.theice.com/futures-us/market-resources (ICE position limits spreadsheet). NYMEX 
rules establish an exchange-set spot month limit of 1,000 contracts 
for its physically-settled NYMEX NG Futures contract and a separate 
spot month limit of 1,000 contracts for its cash-settled Henry Hub 
Natural Gas Last Day Financial Futures contract. As the ICE natural 
gas contract is one quarter the size of the NYMEX contract, ICE's 
exchange-set natural gas limits are shown in NYMEX equivalents 
throughout this section of the release. ICE thus has rules in place 
establishing an exchange-set spot month limit of 4,000 contracts 
(equivalent to 1,000 NYMEX contracts) for its cash-settled Henry Hub 
LD1 Fixed Price Futures contract.
    \284\ In practice, a majority of the trading in such contracts 
is on ICE and NYMEX. As noted above, Nodal is acquiring NFX, 
including its Henry Hub Natural Gas Financial Futures contract.
---------------------------------------------------------------------------

    The DCMs originally adopted these rules, in consultation with 
Commission staff, in large part to address historical concerns over the 
potential for manipulation of physically-settled natural gas contracts 
during the spot month in order to benefit positions in cash-settled 
natural gas contracts, and to accommodate certain trading dynamics 
unique to the natural gas contracts. In particular, in natural gas, 
open interest tends to decline in the NYMEX NG contract approaching 
expiration and tends to increase rapidly in the ICE cash-settled Henry 
Hub LD1 contract. These dynamics suggest that cash-settled natural gas 
contracts serve an important function for hedgers and speculators who 
wish to recreate and/or hedge the physically-settled NYMEX NG contract 
price without being required to make or take delivery.
    The condition in proposed Sec.  150.3(a)(4), however, should remove 
the potential to manipulate the physically-settled natural gas contract 
in order to benefit a sizeable position in the cash-settled contract. 
To qualify for the exemption, market participants would not be 
permitted to hold any spot month positions in the physically-settled 
contract. This proposed conditional exemption would prevent 
manipulation by traders with leveraged positions in the cash-settled 
contracts (in comparison to the level of the limit in the physical-
delivery contract) who might otherwise attempt to mark the close or 
distort physical-delivery prices in the physically-settled contract to 
benefit their leveraged cash-settled positions. Thus, the exemption 
would establish a higher conditional limit for the cash-settled 
contract than for the physical-delivery contract, so long as the cash-
settled positions are decoupled from spot-month positions in physical-
delivery contracts which set or affect the value of such cash-settled 
positions.
    While the Commission is unaware of any natural gas swaps that would 
qualify as ``economically equivalent swaps,'' the Commission proposes 
to apply the conditional exemption to swaps as well, provided that a 
given market participant's positions in such cash-settled swaps do not 
exceed 10,000 futures-equivalent contracts and provided that the 
participant does not hold spot-month positions in physically settled 
natural gas contracts. Because swaps may generally be fungible across 
markets, that is, a position may be established on one SEF and offset 
on another SEF or OTC, the Commission proposes that economically 
equivalent swap contracts have a conditional spot month limit of 10,000 
economically equivalent contracts in total across all SEFs and OTC.
    A market participant that sought to hold positions in both the 
NYMEX NG physically-settled contract and in any cash-settled natural 
gas contract would not be eligible for the proposed conditional 
exemption. Such a participant could only hold up to 2,000 contracts net 
long or net short across exchanges/OTC in physically-settled natural 
gas referenced contract(s), and another 2,000 contracts net long or net 
short across exchanges/OTC in cash-settled natural gas contract 
referenced contract(s).\285\
---------------------------------------------------------------------------

    \285\ See supra Section II.B.2.k. (discussion of netting).
---------------------------------------------------------------------------

f. Exemption for Pre-Enactment Swaps and Transition Period Swaps
    In order to promote a smooth transition to compliance for swaps not 
previously subject to federal speculative position limits, proposed 
Sec.  150.3(a)(5) would provide that federal speculative position 
limits shall not apply to positions acquired in good faith in any pre-
enactment swap or in any transition period swap, in either case as 
defined by Sec.  150.1.\286\ Any swap that meets the proposed 
economically equivalent swap definition, but that otherwise qualifies 
as a pre-enactment swap or transition period swap, would thus be exempt 
from federal speculative position limits. This exemption would be self-
effectuating and would not require a market participant to request 
relief.
---------------------------------------------------------------------------

    \286\ ``Pre-enactment swap'' would mean any swap entered into 
prior to enactment of the Dodd-Frank Act of 2010 (July 21, 2010), 
the terms of which have not expired as of the date of enactment of 
that Act. ``Transition period swap'' would mean a swap entered into 
during the period commencing after the enactment of the Dodd-Frank 
Act of 2010 (July 21, 2010), and ending 60 days after the 
publication in the Federal Register of final amendments to this part 
implementing section 737 of the Dodd-Frank Act of 2010.
---------------------------------------------------------------------------

    In order to further lessen the impact of the proposed federal 
limits on market participants, for purposes of complying with the 
proposed federal non-spot month limits, the proposed rule would also 
allow both pre-enactment swaps and transition period swaps to be netted 
with commodity derivative contracts acquired more than 60 days after 
publication of final rules in the Federal Register. Any such positions 
would not be permitted to be netted during the spot month so as to 
avoid rendering spot month limits ineffective--the Commission is 
particularly concerned about protecting the spot month in physical-
delivery futures from price distortions or manipulation that would 
disrupt the hedging and price discovery utility of the futures 
contract.
g. Previously-Granted Risk Management Exemptions
    As discussed elsewhere in this release, the Commission previously 
recognized, as bona fide hedges under Sec.  1.47, certain risk-
management positions in physical commodity futures and/or options on 
futures contracts thereon held outside of the spot month that were used 
to offset the risk of commodity index swaps and other related exposure, 
but that did not represent substitutes for transactions or positions to 
be taken in a physical marketing channel. However, as noted earlier in 
this release, the Commission interprets Dodd-Frank Act amendments to 
the CEA as eliminating the Commission's authority to grant such relief 
unless the position satisfies the pass-through provision in CEA section 
4a(c)(2)(B).\287\ Accordingly, to ensure consistency with the Dodd-
Frank Act, the Commission will not recognize further risk management 
positions as bona fide hedges, unless the position otherwise satisfies 
the requirements of the pass-through provisions.\288\
---------------------------------------------------------------------------

    \287\ See supra Section II.A.1.c.ii.(1). (discussion of the 
temporary substitute test and risk-management exemptions).
    \288\ See supra Section II.A.1.c.vi. (discussion of proposed 
pass-through language).
---------------------------------------------------------------------------

    In addition, the Commission proposes in Sec.  150.3(c) that such 
previously-granted exemptions shall not apply after the effective date 
of a final federal position limits rulemaking implementing the Dodd-
Frank Act. Proposed Sec.  150.3(c) uses the phrase ``positions in 
financial instruments'' to refer to such commodity index swaps and 
related exposure and would have the effect of revoking the ability to 
use previously-granted risk management exemptions once the limits 
proposed in Sec.  150.2 go into effect.
h. Recordkeeping
    Proposed Sec.  150.3(d) establishes recordkeeping requirements for 
persons who claim any exemptions or relief under proposed Sec.  150.3. 
Proposed Sec.  150.3(d) should help to ensure that any person who 
claims any exemption permitted under proposed Sec.  150.3 can 
demonstrate compliance with the applicable requirements. Under proposed 
Sec.  150.3(d)(1), any persons

[[Page 11642]]

claiming an exemption would be required to keep and maintain complete 
books and records concerning all details of their related cash, 
forward, futures, options on futures, and swap positions and 
transactions, including anticipated requirements, production and 
royalties, contracts for services, cash commodity products and by-
products, cross-commodity hedges, and records of bona fide hedging swap 
counterparties.
    Proposed Sec.  150.3(d)(2) addresses recordkeeping requirements 
related to the pass-through swap provision in the proposed definition 
of bona fide hedging transaction or position in proposed Sec.  
150.1.\289\ Under proposed Sec.  150.3(d)(2), a pass-through swap 
counterparty, as contemplated by proposed Sec.  150.1, that relies on a 
representation received from a bona fide hedging swap counterparty that 
a swap qualifies in good faith as a bona fide hedging position or 
transaction under proposed Sec.  150.1, would be required to: (i) 
Maintain any written representation for at least two years following 
the expiration of the swap; and (ii) furnish the representation to the 
Commission upon request.
---------------------------------------------------------------------------

    \289\ See supra Section II.A.1.c.vi. (discussion of proposed 
pass-through language).
---------------------------------------------------------------------------

i. Call for Information
    The Commission proposes to move existing Sec.  150.3(b), which 
currently allows the Commission or certain Commission staff to make 
special calls to demand certain information regarding positions or 
trading, to proposed Sec.  150.3(e), with some technical modifications. 
Together with the recordkeeping provision of proposed Sec.  150.3(d), 
proposed Sec.  150.3(e) should enable the Commission to monitor the use 
of exemptions from speculative position limits and help to ensure that 
any person who claims any exemption permitted by proposed Sec.  150.3 
can demonstrate compliance with the applicable requirements.
j. Aggregation of Accounts
    Proposed Sec.  150.3(f) would clarify that entities required to 
aggregate under Sec.  150.4 would be considered the same person for 
purposes of determining whether they are eligible for a bona fide hedge 
recognition under Sec.  150.3(a)(1).
k. Delegation of Authority
    Proposed Sec.  150.3(g) would delegate authority to the Director of 
the Division of Market Oversight to: Grant financial distress 
exemptions pursuant to proposed Sec.  150.3(a)(3); request additional 
information with respect to an exemption request pursuant to proposed 
Sec.  150.3(b)(2); determine, in consultation with the exchange and 
applicant, a commercially reasonable amount of time required for a 
person to bring its position within the federal position limits 
pursuant to proposed Sec.  150.3(b)(3)(ii)(B); make a determination 
whether to recognize a position as a bona fide hedging transaction or 
to grant a spread exemption pursuant to proposed Sec.  150.3(b)(4); and 
to request that a person submit updated materials or renew their 
request pursuant to proposed Sec.  150.3(b)(2) or (5). This proposed 
delegation would enable the Division of Market Oversight to act quickly 
in the event of financial distress and in the other circumstances 
described above.
l. Request for Comment
    The Commission requests comment on all aspects of proposed Sec.  
150.3. In addition, the Commission understands that there may be 
certain not-for-profit electric and natural gas utilities that have 
certain public service missions and that are prohibited, by their 
governing body, risk management policies, or otherwise, from 
speculating, and that would request relief from federal position limits 
once federal limits on swaps are implemented. The Commission requests 
comment on all aspects of the concept of an exemption from part 150 of 
the Commission's regulations for certain not-for-profit electric and 
natural gas utility entities that have unique public service missions 
to provide reliable, affordable energy services to residential, 
commercial, and industrial customers, and that are prohibited from 
speculating. In addition, the Commission requests comment on whether 
the definition of ``economically equivalent swap'' would cover the 
types of hedging activities such utilities engage in with respect to 
their OTC swap activity.
    The Commission also invites comments on the following:
    (29) What are the overarching issues or concerns the Commission 
should consider regarding a potential exemption from position limits 
for such not- for-profit electric and natural gas utilities?
    (30) Are there certain provisions in part 150 of the Commission's 
regulations that should apply to such not-for-profit electric and 
natural gas utilities even if the Commission were to grant such 
entities an exemption with respect to federal position limits?
    (31) Are there other types of entities, similar to the not-for-
profit electric and natural gas utilities described above, for which 
the Commission should also consider granting such exemptive relief by 
rule, and why?
    (32) What types of conditions, restrictions, or criteria should the 
Commission consider applying with respect to such an exemption?
    (33) Should higher position limits in cash-settled natural gas 
futures be conditioned on the closing of any positions in the 
physically delivered natural gas contract? Are there characteristics of 
the natural gas futures markets that weigh in favor of or against the 
higher conditional limits?

D. Sec.  150.5--Exchange-Set Position Limits and Exemptions Therefrom

1. Background
    For the avoidance of confusion, the discussion of Sec.  150.5 that 
follows addresses exchange-set limits and exemptions therefrom, not 
federal limits. For a discussion of the proposed processes by which an 
exemption may be recognized for purposes of federal limits, please see 
the discussion of proposed Sec.  150.3 above and Sec.  150.9 below.
    Under DCM Core Principle 5, DCMs shall adopt for each contract, as 
is necessary and appropriate, position limitations or position 
accountability for speculators, and, for any contract subject to a 
federal position limit, DCMs must establish exchange-set limits for 
that contract no higher than the federal limit level.\290\ Similarly, 
under SEF Core Principle 6, SEFs that are trading facilities shall 
adopt for each contract, as is necessary and appropriate, position 
limitations or position accountability for speculators, and, for any 
contract subject to a federal position limit, SEFs that are trading 
facilities must establish exchange-set limits for that contract no 
higher than the federal limit, and must monitor positions established 
on or through the SEF for compliance with the limit set by the 
Commission and the limit, if any, set by the SEF.\291\ Beyond these and 
other statutory and Commission requirements, unless otherwise 
determined by the Commission, DCM and SEF Core Principle 1 afford DCMs 
and SEFs ``reasonable discretion'' in establishing the manner in which 
they comply with the core principles.\292\
---------------------------------------------------------------------------

    \290\ See 7 U.S.C. 7(d)(5).
    \291\ See 7 U.S.C. 7b-3(f)(6).
    \292\ See 7 U.S.C. 7(d)(1) and 7 U.S.C. 7b-3(f)(1).
---------------------------------------------------------------------------

    The current regulatory provisions governing exchange-set position 
limits and exemptions therefrom appear in Sec.  150.5.\293\ To align 
Sec.  150.5 with Dodd-

[[Page 11643]]

Frank statutory changes \294\ and with other changes proposed 
herein,\295\ the Commission proposes a new version of Sec.  150.5. This 
new proposed Sec.  150.5 would generally afford exchanges the 
discretion to decide for themselves how best to set limit levels and 
grant exemptions from such limits in a manner that best reflects their 
specific markets.
---------------------------------------------------------------------------

    \293\ 17 CFR 150.5.
    \294\ While existing Sec.  150.5 on its face only applies to 
contracts that are not subject to federal limits, DCM Core Principle 
5, as amended by Dodd-Frank, and SEF Core Principle 6, establish 
requirements both for contracts that are, and are not, subject to 
federal limits. 7 U.S.C. 7(d)(5) and 7 U.S.C. 7b-3(f)(6).
    \295\ Significant changes proposed herein include the process 
set forth in proposed Sec.  150.9 and revisions to the bona fide 
hedging definition proposed in Sec.  150.1.
---------------------------------------------------------------------------

2. Implementation of Exchange-Set Limits on Swaps
    With respect to the DCM Core Principle 5 and SEF Core Principle 6 
requirements addressing exchange-set limits on swaps, the Commission is 
preliminarily determining that it is reasonable to delay implementation 
because requiring compliance would be impracticable, and in some cases 
impossible, at this time.\296\
---------------------------------------------------------------------------

    \296\ The Commission has observed in prior releases that courts 
have upheld relieving regulated entities of their statutory 
obligations where compliance is impossible or impracticable. 2016 
Supplemental Proposal, 81 FR at 38462.
---------------------------------------------------------------------------

    The Commission has previously explained why it has proposed to 
temporarily delay imposition of exchange-set position limits on 
swaps.\297\ The decision to delay imposing exchange-set position limits 
on swaps is based largely on the lack of exchange access to sufficient 
data regarding individual market participants' open swap positions, 
which means that, without action to provide further access to swap data 
to exchanges, the exchanges cannot effectively monitor swap position 
limits.
---------------------------------------------------------------------------

    \297\ 2016 Supplemental Proposal, 81 FR at 38459-62; 2016 
Reproposal, 81 FR at 96784-86.
---------------------------------------------------------------------------

    The Commission preliminarily believes that delayed implementation 
of exchange-set speculative position limits on swaps at this time is 
not inconsistent with the statutory objectives outlined in section 
4a(a)(3) of the CEA: To diminish excessive speculation, to deter market 
manipulation, to ensure sufficient liquidity for bona fide hedgers, and 
to ensure that the price discovery function of the underlying market it 
not disrupted.\298\
---------------------------------------------------------------------------

    \298\ 7 U.S.C. 6a(a)(3).
---------------------------------------------------------------------------

    Accordingly, while proposed Sec.  150.5 will apply to DCMs and 
SEFs, the requirements associated with swaps would be enforced at a 
later time. In other words, exchanges must comply with proposed Sec.  
150.5 only with respect to futures and options on futures traded on 
DCMs, and with respect to swaps at a later time as determined by the 
Commission.
3. Existing Sec.  150.5
    As noted above, existing Sec.  150.5 pre-dates the Dodd-Frank Act 
and addresses the establishment of DCM-set position limits for all 
contracts not subject to federal limits under existing Sec.  150.2 
(aside from certain major foreign currencies).\299\ Existing Sec.  
150.5(a) authorizes DCMs to set different limits for different 
contracts and contract months, and permits DCMs to grant exemptions 
from DCM-set limits for spreads, straddles, or arbitrage trades.
---------------------------------------------------------------------------

    \299\ Existing Sec.  150.5(a) states that the requirement to set 
position limits shall not apply to futures or option contract 
markets on major foreign currencies, for which there is no legal 
impediment to delivery and for which there exists a highly liquid 
cash market. 17 CFR 150.5(a).
---------------------------------------------------------------------------

    Existing Sec.  150.5(b) provides a limited set of methodologies for 
DCMs to use in establishing initial limit levels, including separate 
maximum limit levels for spot month limits in physical-delivery 
contracts, spot month limits in cash-settled contracts, non-spot month 
limits for tangible commodities other than energy, and non-spot month 
limits for energy products and non-tangible commodities, including 
financials.\300\ Existing Sec.  150.5(c) provides that DCMs may adjust 
their speculative initial levels as follows: (i) No greater than 25 
percent of deliverable supply for adjusted spot month levels in 
physically-delivered contracts; (ii) ``no greater than necessary to 
minimize the potential for manipulation or distortion of the contract's 
or the underlying commodity's price'' for adjusted spot month levels in 
cash-settled contracts; and (iii) for adjusted non-spot month limit 
levels, either no greater than 10 percent of open interest, up to 
25,000 contracts, with a marginal increase of 2.5 percent thereafter, 
or based on position sizes customarily held by speculative traders on 
the DCM.
---------------------------------------------------------------------------

    \300\ See 17 CFR 150.5(b)(1)-(3) (no greater than one-quarter of 
the estimated spot month deliverable supply for physical delivery 
contracts during the spot month; no greater than necessary to 
minimize the potential for manipulation or distortion of the 
contract's or the underlying commodity's price for cash-settled 
contracts during the spot month; no greater than 1,000 contracts for 
tangible commodities other than energy outside the spot month; and 
no greater than 5,000 contracts for energy products and nontangible 
commodities, including financials outside the spot month).
---------------------------------------------------------------------------

    Existing Sec.  150.5(d) addresses bona fide hedging exemptions from 
DCM-set limits, including an exemption application process, providing 
that exchange-set speculative position limits shall not apply to bona 
fide hedging positions as defined by a DCM in accordance with the 
definition of bona fide hedging transactions and positions for excluded 
commodities in Sec.  1.3. Existing Sec.  150.5(d) also addresses 
factors for consideration by DCMs in recognizing bona fide hedging 
exemptions (or position accountability), including whether such 
positions ``are not in accord with sound commercial practices or exceed 
an amount which may be established and liquidated in an orderly 
fashion.'' \301\
---------------------------------------------------------------------------

    \301\ See 17 CFR 150.5(d)(1).
---------------------------------------------------------------------------

    Existing Sec.  150.5(e) permits DCMs in certain circumstances to 
submit for Commission approval, as a substitute for the position limits 
required under Sec.  150.5(a), (b), and (c), a DCM rule requiring 
traders ``to be accountable for large positions,'' meaning that under 
certain circumstances, traders must provide information about their 
position upon request to the exchange, and/or consent to halt 
increasing further a position if so ordered by the exchange.\302\ Among 
other things, this provision includes open interest and volume-based 
parameters for determining when DCMs may do so.\303\
---------------------------------------------------------------------------

    \302\ 17 CFR 150.5(e).
    \303\ 17 CFR 150.5(e)(1)-(4).
---------------------------------------------------------------------------

    Existing Sec.  150.5(f) provides that DCM speculative position 
limits adopted pursuant to Sec.  150.5 shall not apply to certain 
positions acquired in good faith prior to the effective date of such 
limits or to a person that is registered as an FCM or as a floor broker 
under authority of the CEA except to the extent that transactions made 
by such person are made on behalf of or for the account or benefit of 
such person.\304\ This provision also provides that in addition to the 
express exemptions specified in Sec.  150.5, a DCM may propose such 
other exemptions from the requirements of Sec.  150.5 as are consistent 
with the purposes of Sec.  150.5, and provides procedures for doing 
so.\305\ Finally, existing Sec.  150.5(g) addresses aggregation of 
positions for which a person directly or indirectly controls trading.
---------------------------------------------------------------------------

    \304\ 17 CFR 150.5(f).
    \305\ Id.
---------------------------------------------------------------------------

4. Proposed Sec.  150.5
    Pursuant to CEA sections 5(d)(1) and 5h(f)(1), the Commission 
proposes a new version of Sec.  150.5.\306\ Proposed Sec.  150.5 is 
intended to provide the ability for DCMs and SEFs to set limit levels

[[Page 11644]]

and grant exemptions in a manner that best accommodates activity 
particular to their markets, while promoting compliance with DCM Core 
Principle 5 and SEF Core Principle 6 and ensuring consistency with 
other changes proposed herein, including the process for exchanges to 
administer applications for non-enumerated bona fide hedge exemptions 
for purposes of federal limits proposed in Sec.  150.9.\307\
---------------------------------------------------------------------------

    \306\ As mentioned above, while proposed Sec.  150.5 will 
include references to swaps and SEFs, the proposed rule would 
initially only apply to DCMs, as requirements relating to exchange-
set limits on swaps would be phased in at a later time.
    \307\ To avoid confusion created by the parallel federal and 
exchange-set position limit frameworks, the Commission clarifies 
that proposed Sec.  150.5 deals solely with exchange-set position 
limits and exemptions therefrom, whereas proposed Sec.  150.9 deals 
solely with federal limits and recognition of exchange-granted 
exemptions and bona fide hedging determinations for purposes of 
federal limits.
---------------------------------------------------------------------------

    Proposed Sec.  150.5 contains two main sub-sections, with each sub-
section addressing a different category of contract: (i) Proposed Sec.  
150.5(a) would include rules governing exchange-set limits for 
contracts subject to federal limits; and (ii) proposed Sec.  150.5(b) 
would include rules governing exchange-set limits for physical 
commodity contracts that are not subject to federal limits.
    As described in further detail below, the proposed provisions 
addressing exchange-set limits on contracts that are not subject to 
federal limits reflect a principles-based approach and include 
acceptable practices that provide for non-exclusive methods of 
compliance with the principles-based regulations. The Commission would 
therefore provide exchanges with the ability to set limits and grant 
exemptions in the manner that most suits their unique markets. Each 
proposed provision of Sec.  150.5 is described in detail below.
a. Proposed Sec.  150.5(a)--Requirements for Exchange-Set Limits on 
Commodity Derivative Contracts Subject to Federal Limits Set Forth in 
Sec.  150.2
    Proposed Sec.  150.5(a) would apply to all contracts subject to the 
federal limits proposed in Sec.  150.2 and, among other things, is 
intended to help ensure that exchange-set limits do not undermine the 
federal limits framework. Under proposed Sec.  150.5(a)(1), for any 
contract subject to a federal limit, DCMs and, ultimately, SEFs, would 
be required to establish exchange-set limits for such contracts. 
Consistent with DCM Core Principle 5 and SEF Core Principle 6, the 
exchange-set limit levels on such contracts, whether cash-settled or 
physically-settled, and whether during or outside the spot month, would 
have to be no higher than the level specified for the applicable 
referenced contract in proposed Sec.  150.2. Exchanges would be free to 
set position limits that are more stringent than the federal limit for 
a particular contract, and would also be permitted to adopt position 
accountability at a level lower than the federal limit, in addition to 
an exchange-set position limit that is equal to or less than the 
federal limit.
    Proposed Sec.  150.5(a)(2) would permit exchanges to grant 
exemptions from exchange-set limits established under proposed Sec.  
150.5(a)(1) as follows:
    First, if such exemptions from exchange-set limits conform to the 
types of exemptions that may be granted for purposes of federal limits 
under proposed Sec. Sec.  150.3(a)(1)(i), 150.3(a)(2)(i), and 
150.3(a)(4)-(5) (enumerated bona fide hedge recognitions and spread 
exemptions that are listed in the spread transaction definition in 
proposed Sec.  150.1, as well as exempt conditional spot month 
positions in natural gas and pre-enactment and transition period 
swaps), then the level of the exemption may exceed the applicable 
federal position limit under proposed Sec.  150.2. Since the proposed 
exemptions listed above are self-effectuating for purposes of federal 
position limit levels, exchanges may grant such exemptions pursuant to 
proposed Sec.  150.5(a)(2)(i).
    Second, if such exemptions from exchange-set limits conform to the 
exemptions from federal limits that may be granted under proposed 
Sec. Sec.  150.3(a)(1)(ii) and 150.3(a)(2)(ii) (respectively, non-
enumerated bona fide hedges and spread transactions that are not 
currently listed in the spread transaction definition in proposed Sec.  
150.1), then the level of the exemption may exceed the applicable 
federal position limit under proposed Sec.  150.2, provided that the 
exemption for purposes of federal limits is first approved in 
accordance with proposed Sec.  150.3(b) or Sec.  150.9, as applicable.
    Third, if such exemptions conform to the exemptions from federal 
limits that may be granted under proposed Sec.  150.3(a)(3) (financial 
distress positions), then the level of the exemption may exceed the 
applicable federal position limit under proposed Sec.  150.2, provided 
that the Commission has first issued a letter approving such exemption 
pursuant to a request submitted under Sec.  140.99.\308\
---------------------------------------------------------------------------

    \308\ Under the proposal, requests for exemptions for financial 
distress positions would be submitted directly to the Commission (or 
delegated staff) for consideration, and any approval of such 
exemption would be issued in the form of an exemption letter from 
the Commission (or delegated staff) pursuant to Sec.  140.99.
---------------------------------------------------------------------------

    Finally, for purposes of exchange-set limits only, exchanges may 
grant exemption types that are not listed in Sec.  150.3(a). However, 
in such cases, the exemption level would have to be capped at the level 
of the applicable federal position limit, so as not to undermine the 
federal limit framework, unless the Commission has first approved such 
exemption for purposes of federal limits pursuant to Sec.  150.3(b).
    Exchanges that wish to offer exemptions from their own limits other 
than the types listed in proposed Sec.  150.3(a) could also submit 
rules to the Commission allowing for such exemptions pursuant to part 
40. The Commission would carefully review any such exemption types for 
compliance with applicable standards, including any statutory 
requirements \309\ and Commission-set standards.\310\
---------------------------------------------------------------------------

    \309\ For example, an exchange would not be permitted to adopt 
rules allowing for risk management exemptions in physical 
commodities because the Commission interprets Dodd-Frank amendments 
to CEA section 4a(c)(2) as prohibiting risk management exemptions in 
such commodities. See supra Section II.A.1.c.ii.(1). (discussion of 
the temporary substitute test and risk-management exemptions).
    \310\ For example, as discussed below, proposed Sec.  
150.5(a)(2)(ii)(C) would require that exchanges take into account 
whether the requested exemption would result in positions that are 
not in accord with sound commercial practices in the relevant 
commodity derivative market and/or would not exceed an amount that 
may be established and liquidated in an orderly fashion in that 
market.
---------------------------------------------------------------------------

    Under proposed Sec.  150.5(a)(2)(ii)(A), exchanges that wish to 
grant exemptions from their own limits would have to require traders to 
file an application. Aside from the requirements discussed below, 
including the requirement that the exchange collect cash-market and 
swaps market information from the applicant, exchanges would have 
flexibility to establish the application process as they see fit, 
including adopting protocols to reduce burdens by leveraging existing 
processes with which their participants are already familiar. For all 
exemption types, exchanges would have to generally require that such 
applications be filed in advance of the date such position would be in 
excess of the limits, but exchanges would be given the discretion to 
adopt rules allowing traders to file applications within five business 
days after a trader established such position. Exchanges wishing to 
grant such retroactive exemptions would have to require market 
participants to demonstrate circumstances warranting a sudden and 
unforeseen hedging need.
    Proposed Sec.  150.5(a)(2)(ii)(B) would provide that exchanges must 
require that a trader reapply for the exemption granted under proposed 
Sec.  150.5(a)(2) at least annually so that the exchange and the 
Commission can closely monitor exemptions for contracts subject to

[[Page 11645]]

federal speculative position limits, and to help ensure that the 
exchange and the Commission remain aware of the trader's activities. 
Proposed Sec.  150.5(a)(2)(ii)(C) would authorize exchanges to deny, 
limit, condition, or revoke any exemption request in accordance with 
exchange rules,\311\ and would set forth a principles-based standard 
for the granting of exemptions that do not conform to the type that the 
Commission may grant under proposed Sec.  150.3(a). Specifically, 
exchanges would be required to take into account: (i) Whether the 
requested exemption from its limits would result in a position that is 
``not in accord with sound commercial practices'' in the market in 
which the DCM is granting the exemption; and (ii) whether the requested 
exemption would result in a position that would ``exceed an amount that 
may be established or liquidated in an orderly fashion in that 
market.'' Exchanges' evaluation of exemption requests against these 
standards would be a facts and circumstances determination.
---------------------------------------------------------------------------

    \311\ Currently, DCMs review and set exemption levels annually 
based on the facts and circumstances of a particular exemption and 
the market conditions at that time. As such, a DCM may decide to 
deny, limit, condition, or revoke a particular exemption, typically, 
if the DCM determines that certain conditions have changed and 
warrant such action. This may happen if, for example, there are 
droughts, floods, embargoes, trade disputes, or other events that 
cause shocks to the supply or demand of a particular commodity and 
thus impact the DCM's disposition of a particular exemption.
---------------------------------------------------------------------------

    Activity may reflect ``sound commercial practice'' for a particular 
market or market participant but not for another. Similarly, activity 
may reflect ``sound commercial practice'' outside the spot month but 
not in the spot month. Further, activity with manipulative intent or 
effect, or that has the potential or effect of causing price distortion 
or disruption, would be inconsistent with ``sound commercial 
practice,'' even if common practice among market participants. While an 
exemption granted to an individual market participant may reflect 
``sound commercial practice'' and may not ``exceed an amount that may 
be established or liquidated in an orderly fashion in that market,'' 
the Commission expects exchanges to also evaluate whether the granting 
of a particular exemption type to multiple participants could have a 
collective impact on the market in a manner inconsistent with ``sound 
commercial practice'' or in a manner that could result in a position 
that would ``exceed an amount that may be established or liquidated in 
an orderly fashion in that market.''
    The Commission understands that the above-described parameters for 
exemptions from exchange-set limits are generally consistent with 
current industry practice among DCMs. Bearing in mind that proposed 
Sec.  150.5(a) would apply to contracts subject to federal limits, the 
Commission proposes codifying such parameters, as they would establish 
important, minimum standards needed for exchanges to administer, and 
the Commission to oversee, a robust program for granting exemptions 
from exchange-set limits in a manner that does not undermine the 
federal limits framework. Proposed Sec.  150.5(a) also would afford 
exchanges the ability to generally oversee their programs for granting 
exemptions from exchange limits as they see fit, including to establish 
different application processes and requirements to accommodate the 
unique characteristics of different contracts.
    If adopted, changes proposed herein may result in certain ``pre-
existing positions'' being subject to speculative position limits even 
though the position predated the adoption of such limits.\312\ So as 
not to undermine the federal position limits framework during the spot 
month, and to minimize disruption outside the spot month, the 
Commission proposes Sec.  150.5(a)(3), which would require that during 
the spot month, for contracts subject to federal limits, exchanges must 
impose limits no larger than federal levels on ``pre-existing 
positions,'' other than for pre-enactment swaps and transition period 
swaps.
    However, outside the spot month, exchanges would not be required to 
impose limits on such positions, provided the position is acquired in 
good faith consistent with the ``pre-existing position'' definition of 
proposed Sec.  150.1, and provided further that if the person's 
position is increased after the effective date of the limit, such pre-
existing position, other than pre-enactment swaps and transition period 
swaps, along with the position increased after the effective date, 
would be attributed to the person. This provision is consistent with 
the proposed treatment of pre-existing positions for purposes of 
federal limits set forth in proposed Sec.  150.2(g) and is intended to 
prevent spot month limits from being rendered ineffective.
    Not subjecting pre-existing positions to spot month limits could 
result in a large, pre-existing position either intentionally or 
unintentionally causing a disruption as it is rolled into the spot 
month, and the Commission is particularly concerned about protecting 
the spot month in physical-delivery futures from corners and squeezes. 
Outside of the spot month, however, concerns over corners and squeezes 
may be less acute.\313\
    Finally, the Commission seeks a balance between having sufficient 
information to oversee the exchange-granted exemptions, and not 
burdening exchanges with excessive periodic reporting requirements. The 
Commission thus proposes under Sec.  150.5(a)(4) to require one monthly 
report by each exchange. Certain exchanges already voluntarily file 
these types of monthly reports with the Commission, and proposed Sec.  
150.5(a)(4) would standardize such reports for all exchanges that 
process applications for bona fide hedges, spread exemptions, and other 
exemptions for contracts that are subject to federal limits. The 
proposed report would provide information regarding the disposition of 
any application to recognize a position as a bona fide hedge (both 
enumerated and non-enumerated) or to grant a spread or other exemption, 
including any renewal, revocation of, or modification to the terms and 
conditions of, a prior recognition or exemption.\314\
---------------------------------------------------------------------------

    \314\ In the monthly report, exchanges may elect to list new 
recognitions or exemptions, and modifications to or revocations of 
prior recognitions and exemptions each month; alternatively, 
exchanges may submit cumulative monthly reports listing all active 
recognitions and exemptions (i.e., including exemptions that are not 
new or have not changed).
---------------------------------------------------------------------------

    As specified under proposed Sec.  150.5(a)(4), the report would 
provide certain details regarding the bona fide hedging position or 
spread exemption, including: The effective date and expiration date of 
any recognition or exemption; any unique identifier assigned to track 
the application or position; identifying information about the 
applicant; the derivative contract or positions to which the 
application pertains; the maximum size of the commodity derivative 
position that is recognized or exempted by the exchange (including any 
``walk-down'' requirements); \315\ any size limitations the exchange 
sets for the position; and a brief narrative summarizing the 
applicant's relevant cash market activity.
---------------------------------------------------------------------------

    \315\ An exchange could determine to recognize as a bona fide 
hedge or spread exemption all, or a portion, of the commodity 
derivative position for which an application has been submitted, 
provided that such determination is made in accordance with the 
requirements of proposed Sec.  150.5 and is consistent with the Act 
and the Commission's regulations. In addition, an exchange could 
require that a bona fide hedging positon or spread position be 
subject to ``walk-down'' provisions that require the trader to scale 
down its positions in the spot month in order to reduce market 
congestion as needed based on the facts and circumstances.

---------------------------------------------------------------------------

[[Page 11646]]

    With respect to any unique identifiers to be included in the 
proposed monthly report, the exchange's assignment of a unique 
identifier would assist the Commission's tracking process. The unique 
identifier could apply to each of the bona fide hedge or spread 
exemption applications that the exchange receives, and, separately, 
each type of commodity derivative position that the exchange wishes to 
recognize as a bona fide hedge or spread exemption. Accordingly, the 
Commission suggests that, as a ``best practice,'' the exchange's 
procedures for processing bona fide hedging position and spread 
exemption applications contemplate the assignment of such unique 
identifiers.
    The proposed report would also be required to specify the maximum 
size and/or size limitations by contract month and/or type of limit 
(e.g., spot month, single month, or all-months-combined), as 
applicable.
    The proposed monthly report would be a critical element of the 
Commission's surveillance program by facilitating its ability to track 
bona fide hedging positions and spread exemptions approved by 
exchanges. The proposed monthly report would also keep the Commission 
informed as to the manner in which an exchange is administering its 
application procedures, the exchange's rationale for permitting large 
positions, and relevant cash market activity. The Commission expects 
that exchanges would be able to leverage their current exemption 
processes and recordkeeping procedures to generate such reports.
    In certain instances, information included in the proposed monthly 
report may prompt the Commission to request records required to be 
maintained by an exchange. For example, the Commission proposes that, 
for each derivative position that an exchange wishes to recognize as a 
bona fide hedge, or any revocation or modification of such recognition 
or exemption, the report would include a concise summary of the 
applicant's activity in the cash markets and swaps markets for the 
commodity underlying the position. The Commission expects that this 
summary would focus on the facts and circumstances upon which an 
exchange based its determination to recognize a bona fide hedge, to 
grant a spread exemption, or to revoke or modify such recognition or 
exemption. In light of the information provided in the summary, or any 
other information included in the proposed monthly report regarding the 
position, the Commission may request the exchange's complete record of 
the application. The Commission expects that it would only need to 
request such complete records in the event that it noticed an issue 
that could cause market disruptions.
    Proposed Sec.  150.5(a)(4) would require an exchange, unless 
instructed otherwise by the Commission, to submit such monthly reports 
according to the form and manner requirements the Commission specifies. 
In order to facilitate the processing of such reports, and the analysis 
of the information contained therein, the Commission would establish 
reporting and transmission standards. The proposal would also require 
that such reports be submitted to the Commission using an electronic 
data format, coding structure, and electronic data transmission 
procedures approved in writing by the Commission, as specified on its 
website.\316\
---------------------------------------------------------------------------

    \316\ The Commission would provide such form and manner 
instructions on the Forms and Submissions page at www.cftc.gov. Such 
instructions would likely be published in the form of a technical 
guidebook.
---------------------------------------------------------------------------

Request for Comment
    The Commission requests comment on all aspects of proposed Sec.  
150.5(a). The Commission also invites comments on the following:
    (34) The Commission has proposed that exchanges submit monthly 
reports under Sec.  150.5(a)(4). Do exchanges prefer that the 
Commission specify a particular day each month as a deadline for 
submitting such monthly reports or do exchanges prefer to have 
discretion in determining which day to submit such reports?
b. Proposed Sec.  150.5(b)--Requirements and Acceptable Practices for 
Exchange-Set Limits on Commodity Derivative Contracts in a Physical 
Commodity That Are Not Subject to the Limits Set Forth in Sec.  150.2
    As described elsewhere in this release, the Commission is proposing 
federal speculative limits on 25 core referenced futures contracts and 
their respective referenced contracts.\317\ DCMs, and, ultimately, 
SEFs, listing physical commodity contracts for which federal limits do 
not apply would have to comply with proposed Sec.  150.5(b), which 
includes a combination of rules and references to acceptable practices.
---------------------------------------------------------------------------

    \317\ See infra Section III.F.
---------------------------------------------------------------------------

    Under proposed Sec.  150.5(b), for physical commodity derivatives 
that are not subject to federal limits, whether cash-settled or 
physically-settled, exchanges would be subject to flexible standards 
during the product's spot month and non-spot month. During the spot 
month, under proposed Sec.  150.5(b)(1)(i), exchanges would be required 
to establish position limits, and such limits would have to be set at a 
level that is no greater than 25 percent of deliverable supply. As 
described in detail in connection with the proposed federal spot month 
limits described above, it would be difficult, in the absence of other 
factors, for a participant to corner or squeeze a market if the 
participant holds less than or equal to 25 percent of deliverable 
supply, and the Commission has long used deliverable supply as the 
basis for spot month position limits due to concerns regarding corners, 
squeezes, and other settlement-period manipulative activity.\318\
---------------------------------------------------------------------------

    \318\ See supra Section II.B.2. (discussion of proposed Sec.  
150.2).
---------------------------------------------------------------------------

    The Commission recognizes, however, that there may be circumstances 
where an exchange may not wish to use the 25 percent formula, 
including, for example, if the contract is cash-settled, does not have 
a measurable deliverable supply, or if the exchange can demonstrate 
that a different parameter is better suited for a particular contract 
or market.\319\ Accordingly, the proposal would afford exchanges the 
ability to submit to the Commission alternative potential methodologies 
for calculating spot month limit levels required by proposed Sec.  
150.5(b)(1), provided that the limits are set at a level that is 
``necessary and appropriate to reduce the potential threat of market 
manipulation or price distortion of the contract's or the underlying 
commodity's price or index.'' This standard has appeared in existing 
Sec.  150.5 since its adoption in connection with spot month limits on 
cash-settled contracts. As noted above, existing Sec.  150.5 includes 
separate parameters for spot month limits in physical-delivery 
contracts and for cash-settled contracts, but does not include 
flexibility for exchanges to consider alternative parameters. In an 
effort to both simplify the regulation and provide the ability for 
exchanges to consider multiple parameters that may be better suited for 
certain products, the Commission proposes the above standard as a 
principles-based requirement for both cash-settled and physically-
settled contracts subject to proposed Sec.  150.5(b).
---------------------------------------------------------------------------

    \319\ Guidance for calculating deliverable supply can be found 
in Appendix C to part 38. 17 CFR part 38, Appendix C.
---------------------------------------------------------------------------

    Outside of the spot month, where, historically, attempts at certain 
types of market manipulation are generally less of a concern, proposed 
Sec.  150.5(b)(2)(i) would allow exchanges to choose between position 
limits or position accountability for physical commodity

[[Page 11647]]

contracts that are not subject to federal limits. While exchanges would 
be provided the ability to decide whether to use limit levels or 
accountability levels for any such contract, under either approach, the 
exchange would have to set a level that is ``necessary and appropriate 
to reduce the potential threat of market manipulation or price 
distortion of the contract's or the underlying commodity's price or 
index.''
    To help exchanges efficiently demonstrate compliance with this 
standard for physical commodity contracts outside of the spot month, 
the Commission proposes separate acceptable practices for exchanges 
that wish to adopt non-spot month position limits and exchanges that 
wish to adopt non-spot month accountability.\320\ For exchanges that 
choose to adopt non-spot month position limits, rather than position 
accountability, proposed paragraph (a)(1) to Appendix F of part 150 
would set forth non-exclusive acceptable practices. Under that 
provision, exchanges would be deemed in compliance with proposed Sec.  
150.5(b)(2)(i) if they set non-spot limit levels for each contract 
subject to Sec.  150.5(b) at a level no greater than: (1) The average 
of historical position sizes held by speculative traders in the 
contract as a percentage of the contract's open interest; \321\ (2) the 
spot month limit level for the contract; (3) 5,000 contracts (scaled up 
proportionally to the ratio of the notional quantity per contract to 
the typical cash market transaction if the notional quantity per 
contract is smaller than the typical cash market transaction, or scaled 
down proportionally if the notional quantity per contract is larger 
than the typical cash market transaction); \322\ or (4) 10 percent of 
open interest in that contract for the most recent calendar year up to 
50,000 contracts, with a marginal increase of 2.5 percent of open 
interest thereafter.\323\ When evaluating average position sizes held 
by speculative traders, the Commission expects exchanges: (i) To be 
cognizant of speculative positions that are extraordinarily large 
relative to other speculative positions, and (ii) to not consider any 
such outliers in their calculations.
---------------------------------------------------------------------------

    \320\ The acceptable practices proposed in Appendix F to part 
150 herein reflect non-exclusive methods of compliance. Accordingly, 
the language of this proposed acceptable practice, along with the 
other acceptable practices proposed herein, uses the word ``shall'' 
not to indicate that the acceptable practice is a required method of 
compliance, but rather to indicate that in order to satisfy the 
acceptable practice, a market participant must (i.e., shall) 
establish compliance with that particular acceptable practice.
    \321\ For example, if speculative traders in a particular 
contract typically make up 12 percent of open interest in that 
contract, the exchange could set limit levels no greater than 12 
percent of open interest.
    \322\ For exchanges that choose to adopt a non-spot month limit 
level of 5,000 contracts, this level assumes that the notional 
quantity per contract is set at a level that reflects the size of a 
typical cash market transaction in the underlying commodity. 
However, if the notional quantity of the contract is larger/smaller 
than the typical cash market transaction in the underlying 
commodity, then the DCM must reduce/increase the 5,000 contract non-
spot month limit until it is proportional to the notional quantity 
of the contract relative to the typical cash market transaction. 
These required adjustments to the 5,000 contract metric are intended 
to avoid a circumstance where an exchange could allow excessive 
speculation by setting excessively large notional quantities 
relative to typical cash-market transaction sizes. For example, if 
the notional quantity per contract is set at 30,000 units, and the 
typical observed cash market transaction is 2,500 units, the 
notional quantity per contract would be 12 times larger than the 
typical cash market transaction. In that case, the non-spot month 
limit would need to be 12 times smaller than 5,000 (i.e., at 417 
contracts.). Similarly, if the notional quantity per contract is 
1,000 contracts, and the typical observed cash market transaction is 
2,500 units, the notional quantity per contract would be 2.5 times 
smaller than the typical cash market transaction. In that case, the 
non-spot month limit would need to be 2.5 times larger than 5,000, 
and would need to be set at 12,500 contracts.
    \323\ In connection with the proposed Appendix F to part 150 
acceptable practices, open interest should be calculated by 
averaging the month-end open positions in a futures contract and its 
related option contract, on a delta-adjusted basis, for all months 
listed during the most recent calendar year.
---------------------------------------------------------------------------

    These proposed parameters have largely appeared in existing Sec.  
150.5 for many years in connection with non-spot month limits, either 
for initial or subsequent levels.\324\ The Commission is of the view 
that these parameters would be useful, flexible standards to carry 
forward as acceptable practices. For example, the Commission expects 
that the 5,000-contract acceptable practice would be a useful benchmark 
for exchanges because it would allow them to establish limits and 
demonstrate compliance with Commission regulations in a relatively 
efficient manner, particularly for new contracts that have yet to 
establish open interest. Similarly, for purposes of exchange-set limits 
on physical commodity contracts that are not subject to federal limits, 
the Commission proposes to maintain the baseline 10, 2.5 percent 
formula as an acceptable practice. Because these parameters are simply 
acceptable practices, exchanges may, after evaluation, propose higher 
non-spot month limits or accountability levels.
---------------------------------------------------------------------------

    \324\ 17 CFR 150.5(b) and (c). Proposed Sec.  150.5(b) would 
address physical commodity contracts that are not subject to federal 
limits.
---------------------------------------------------------------------------

    Along those lines, the Commission recognizes that other parameters 
may be preferable and/or just as effective, and would be open to 
considering alternative parameters submitted pursuant to part 40 of the 
Commission's regulations, provided, at a minimum, that the parameter 
complies with Sec.  150.5(b)(2)(i). The Commission encourages exchanges 
to submit potential new parameters to Commission staff in draft form 
prior to submitting them under part 40.
    For exchanges that choose to adopt position accountability, rather 
than limits, outside of the spot month, proposed paragraph (a)(2) of 
Appendix F to part 150 would set forth a non-exclusive acceptable 
practice that would permit exchanges to comply with proposed Sec.  
150.5(b)(2)(i) by adopting rules establishing ``position 
accountability'' as defined in proposed Sec.  150.1. ``Position 
accountability'' would mean rules, submitted to the Commission pursuant 
to part 40, that require traders to, upon request by the exchange, 
consent to: (i) Provide information to the exchange about their 
position, including, but not limited to, information about the nature 
of the their positions, trading strategies, and hedging information; 
and (ii) halt further increases to their position or to reduce their 
position in an orderly manner.\325\
---------------------------------------------------------------------------

    \325\ While existing Sec.  150.5(e) includes open-interest and 
volume-based limitations on the use of accountability, the 
Commission opts not to include such limitations in this proposal. 
Under the rules proposed herein, if an exchange submitted a part 40 
filing seeking to adopt position accountability, the Commission 
would determine on a case-by-case basis whether such rules are 
consistent with the Act and the Commission's regulations. The 
Commission does not want to use one-size-fits-all volume-based 
limitations for making such determinations.
---------------------------------------------------------------------------

    Proposed Sec.  150.5(b)(3) addresses a circumstance where multiple 
exchanges list contracts that are substantially the same, including 
physically-settled contracts that have the same underlying commodity 
and delivery location, or cash-settled contracts that are directly or 
indirectly linked to a physically-settled contract. Under proposed 
Sec.  150.5(b)(3), exchanges listing contracts that are substantially 
the same in this manner must either adopt ``comparable'' limits for 
such contracts, or demonstrate to the Commission how the non-comparable 
levels comply with the standards set forth in proposed Sec.  
150.5(b)(1) and (2). Such a determination also must address how the 
levels are necessary and appropriate to reduce the potential threat of 
market manipulation or price distortion of the contract's or the 
underlying commodity's price or index. Proposed Sec.  150.5(b)(3) would 
apply equally to cash-settled and physically-settled contracts, and to 
limits during and outside of the spot month, as

[[Page 11648]]

applicable.\326\ Proposed Sec.  150.5(b)(3) is intended to help ensure 
that position limits established on one exchange would not jeopardize 
market integrity or otherwise harm other markets. Further, proposed 
Sec.  150.5(b)(3) would be consistent with the Commission's proposal to 
generally apply equivalent federal limits to linked contracts, 
including linked contracts listed on multiple exchanges.\327\
---------------------------------------------------------------------------

    \326\ For reasons discussed elsewhere in this release, this 
provision would not apply to natural gas contracts. See supra 
Section II.C.2.e. (discussion of proposed conditional spot month 
exemption in natural gas).
    \327\ See supra Section II.A.16. (discussion of the proposed 
referenced contract definition and linked contracts).
---------------------------------------------------------------------------

    Finally, under proposed Sec.  150.5(b)(4), exchanges would be 
permitted to grant exemptions from any limits established under 
proposed Sec.  150.5(b). As noted, proposed Sec.  150.5(b) would apply 
to physical commodity contracts not subject to federal limits; thus, 
exchanges would be given flexibility to grant exemptions in such 
contracts, including exemptions for both intramarket and intermarket 
spread positions,\328\ as well as other exemption types not explicitly 
listed in proposed Sec.  150.3.\329\ However, such exchanges must 
require that traders apply for the exemption. In considering any such 
application, the exchanges would be required to take into account 
whether the exemption would result in a position that would not be in 
accord with ``sound commercial practices'' in the market for which the 
exchange is considering the application, and/or would ``exceed an 
amount that may be established and liquidated in an orderly fashion in 
that market.''
---------------------------------------------------------------------------

    \328\ The Commission understands an intramarket spread position 
to be a long position in one or more commodity derivative contracts 
in a particular commodity, or its products or its by-products, and a 
short position in one or more commodity derivative contracts in the 
same, or similar, commodity, or its products or by-products, on the 
same DCM. The Commission understands an intermarket spread position 
to be a long (or short) position in one or more commodity derivative 
contracts in a particular commodity, or its products or its by-
products, at a particular DCM and a short (or long) position in one 
or more commodity derivative contracts in that same, or similar, 
commodity, or its products or its by-products, away from that 
particular DCM. For instance, the Commission would consider a spread 
between CBOT Wheat (W) futures and MGEX HRS Wheat (MWE) futures to 
be an intermarket spread based on the similarity of the commodities.
    \329\ As noted above, proposed Sec.  150.3 would allow for 
several exemption types, including: Bona fide hedging positions; 
certain spreads; financial distress positions; and conditional spot 
month limit exemption positions in natural gas.
---------------------------------------------------------------------------

    While exchanges would be subject to the requirements of Sec.  
150.5(a) and (b) described above, such proposed requirements are not 
intended to limit the discretion of exchanges to utilize other tools to 
protect their markets. Among other things, an exchange would have the 
discretion to: impose additional restrictions on a person with a long 
position in the spot month of a physical-delivery contract who stands 
for delivery, takes that delivery, then re-establishes a long position; 
establish limits on the amount of delivery instruments that a person 
may hold in a physical-delivery contract; and impose such other 
restrictions as it deems necessary to reduce the potential threat of 
market manipulation or congestion, to maintain orderly execution of 
transactions, or for such other purposes consistent with its 
responsibilities.
c. Proposed Sec.  150.5(c)--Requirements for Security Futures Products
    As the Commission has previously noted, security futures products 
and security options may serve economically equivalent or similar 
functions to one another.\330\ Therefore, when the Commission 
originally adopted position limits regulations for security futures 
products in part 41, it set levels that were generally comparable to, 
although not identical with, the limits that applied to options on 
individual securities.\331\ The Commission has pointed out that 
security futures products may be at a competitive disadvantage if 
position limits for security futures products vary too much from those 
of security options.\332\ As a result, the Commission in 2019 adopted 
amendments to the position limitations and accountability requirements 
for security futures products, noting that one goal was to provide a 
level regulatory playing field with security options.\333\ Proposed 
Sec.  150.5(c), therefore, would include a cross-reference clarifying 
that for security futures products, position limitations and 
accountability requirements for exchanges are specified in Sec.  
41.25.\334\ This would allow the Commission to take into account the 
position limits regime that applies to security options when 
considering position limits regulations for security futures products.
---------------------------------------------------------------------------

    \330\ See Position Limits and Position Accountability for 
Security Futures Products, 83 FR at 36799, 36802 (July 31, 2018).
    \331\ Id. See also Listing Standards and Conditions for Trading 
Security Futures Products, 66 FR at 55078, 55082 (Nov. 1, 2001) 
(explaining the Commission's adoption of position limits for 
security futures products).
    \332\ See 83 FR at 36799, 36802 (July 31, 2018).
    \333\ See Position Limits and Position Accountability for 
Security Futures Products, 84 FR at 51005, 51009 (Sept. 27, 2019).
    \334\ See 17 CFR 41.25. Rule Sec.  41.25 establishes conditions 
for the trading of security futures products.
---------------------------------------------------------------------------

d. Proposed Sec.  150.5(d)--Rules on Aggregation
    As noted earlier in this release, the Commission adopted in 2016 
final aggregation rules under Sec.  150.4 that apply to all contracts 
subject to federal limits. The Commission recognizes that with respect 
to contracts not subject to federal limits, market participants may 
find it burdensome if different exchanges adopt different aggregation 
standards. Accordingly, under proposed Sec.  150.5(d), all DCMs, and, 
ultimately, SEFs, that list any physical commodity derivatives, 
regardless of whether the contract is subject to federal limits, would 
be required to adopt aggregation rules for such contracts that conform 
to Sec.  150.4.\335\ Exchanges that list excluded commodities would be 
encouraged to also adopt aggregation rules that conform to Sec.  150.4. 
Aggregation policies that otherwise vary from exchange to exchange 
would increase the administrative burden on a trader active on multiple 
exchanges, as well as increase the administrative burden on the 
Commission in monitoring and enforcing exchange-set position limits.
---------------------------------------------------------------------------

    \335\ Under Sec.  150.4, unless an exemption applies, a person's 
positions must be aggregated with positions for which the person 
controls trading or for which the person holds a 10 percent or 
greater ownership interest. Commission Regulation Sec.  150.4(b) 
sets forth several permissible exemptions from aggregation. See 
Final Aggregation Rulemaking, 81 FR at 91454. The Division of Market 
Oversight has issued time-limited no-action relief from some of the 
aggregation requirements contained in that rulemaking. See CFTC 
Letter No. 19-19 (July 31, 2019), available at https://www.cftc.gov/csl/19-19/download.
---------------------------------------------------------------------------

e. Proposed Sec.  150.5(e)--Requirements for Submissions to the 
Commission
    Proposed Sec.  150.5(e) reflects that, consistent with the 
definition of ``rule'' in existing Sec.  40.1, any exchange action 
establishing or modifying exchange-set position limits or exemptions 
therefrom, or position accountability, in any case pursuant to proposed 
Sec.  150.5(a), (b), (c), or Appendix F to part 150, would qualify as a 
``rule'' and must be submitted to the Commission as such pursuant to 
part 40 of the Commission's regulations. Such rules would also include, 
among other things, parameters used for determining position limit 
levels, and policies and related processes setting forth parameters 
addressing, among other things, which types of exemptions are 
permitted, the parameters for the granting of such exemptions, and any 
exemption application requirements.

[[Page 11649]]

    Proposed Sec.  150.5(e) further provides that exchanges would be 
required to review regularly \336\ any position limit levels 
established under proposed Sec.  150.5 to ensure the level continues to 
comply with the requirements of those sections. For example, in the 
case of Sec.  150.5(b), exchanges would be expected to ensure the 
limits comply with the requirement that limits be set ``at a level that 
is necessary and appropriate to reduce the potential threat of market 
manipulation or price distortion of the contract's or the underlying 
commodity's price or index.'' Exchanges would also be required to 
update such levels as needed, including if the levels no longer comply 
with the proposed rules.
---------------------------------------------------------------------------

    \336\ An acceptable, regular review regime would consist of both 
a periodic review and an event-specific review (e.g., in the event 
of supply and demand shocks such as unanticipated shocks to supply 
and demand of the underlying commodity, geo-political shocks, and 
other events that may result in congestion and/or other 
disruptions). The Commission also expects that exchanges would re-
evaluate such levels in the event of unanticipated shocks to the 
supply or demand of the underlying commodity.
---------------------------------------------------------------------------

f. Delegation of Authority to the Director of the Division of Market 
Oversight
    The Commission proposes to delegate its authority, pursuant to 
proposed Sec.  150.5(a)(4)(ii), to the Director of the Commission's 
Division of Market Oversight, or such other employee(s) that the 
Director may designate from time to time, to provide instructions 
regarding the submission of information required to be reported by 
exchanges to the Commission on a monthly basis, and to determine the 
manner, format, coding structure, and electronic data transmission 
procedures for submitting such information.
g. Commission Enforcement of Exchange-Set Limits
    As discussed throughout this release, the framework for exchange-
set limits operates in conjunction with the federal position limits 
framework. The Futures Trading Act of 1982 gave the Commission, under 
CEA section 4a(5) (since re-designated as section 4a(e)), the authority 
to directly enforce violations of exchange-set, Commission-approved 
speculative position limits in addition to position limits established 
directly by the Commission.\337\ Since 2008, it has also been a 
violation of the Act for any person to violate an exchange position 
limit rule certified to the Commission by such exchange pursuant to CEA 
section 5c(c)(1).\338\ Thus, under CEA section 4a(e), it is a violation 
of the Act for any person to violate an exchange position limit rule 
certified to or approved by the Commission, including to violate any 
subsequent amendments thereto, and the Commission has the authority to 
enforce those violations.
---------------------------------------------------------------------------

    \337\ See Futures Trading Act of 1982, Public Law 97-444, 96 
Stat. 2299-30 (1983).
    \338\ See CFTC Reauthorization Act of 2008, Food, Conservation 
and Energy Act of 2008, Public Law 110-246, 122 Stat. 1624 (June 18, 
2008) (also known as the ``Farm Bill'') (amending CEA section 4a(e), 
among other things, to assure that a violation of position limits, 
regardless of whether such position limits have been approved by or 
certified to the Commission, would constitute a violation of the Act 
that the Commission could independently enforce). See also Federal 
Speculative Position Limits for Referenced Energy Contracts and 
Associated Regulations, 75 FR at 4144, 4145 (Jan. 26, 2010) 
(summarizing the history of the Commission's authority to directly 
enforce violations of exchange-set speculative position limits).
---------------------------------------------------------------------------

h. Request for Comment
    The Commission requests comment on all aspects of proposed Sec.  
150.5.

E. Sec.  150.6--Scope

    Existing Sec.  150.6 provides that nothing in this part shall be 
construed to affect any provisions of the Act relating to manipulation 
or corners nor to relieve any contract market or its governing board 
from responsibility under section 5(4) of the Act to prevent 
manipulation and corners.\339\
---------------------------------------------------------------------------

    \339\ 17 CFR 150.6.
---------------------------------------------------------------------------

    Position limits are meant to diminish, eliminate, or prevent 
excessive speculation and deter and prevent market manipulation, 
squeezes, and corners. The Commission stresses that nothing in the 
proposed revisions to part 150 would impact the anti-disruptive, anti-
cornering, and anti-manipulation provisions of the Act and Commission 
regulations, including but not limited to CEA sections 6(c) or 9(a)(2) 
regarding manipulation, section 4c(a)(5) regarding disruptive practices 
including spoofing, or sections 180.1 and 180.2 of the Commission's 
regulations regarding manipulative and deceptive practices. It may be 
possible for a trader to manipulate or attempt to manipulate the prices 
of futures contracts or the underlying commodity with a position that 
is within the federal position limits. It may also be possible for a 
trader holding a bona fide hedge recognition from the Commission or an 
exchange to manipulate or attempt to manipulate the markets. The 
Commission would not consider it a defense to a charge under the anti-
manipulation provisions of the Act or the regulations that a trader's 
position was within position limits.
    Like existing Sec.  150.6, proposed Sec.  150.6 is intended to make 
clear that fulfillment of specific part 150 requirements alone does not 
necessarily satisfy other obligations of an exchange. Proposed Sec.  
150.6 would provide that part 150 of the Commission's regulations shall 
only be construed as having an effect on position limits set by the 
Commission or an exchange including any associated recordkeeping and 
reporting requirements. Proposed Sec.  150.6 would provide further that 
nothing in part 150 shall affect any other provisions of the Act or 
Commission regulations including those relating to actual or attempted 
manipulation, corners, squeezes, fraudulent or deceptive conduct, or to 
prohibited transactions. For example, proposed Sec.  150.5 would 
require DCMs, and, ultimately, SEFs, to impose and enforce exchange-set 
speculative position limits. The fulfillment of the requirements of 
Sec.  150.5 alone would not satisfy any other legal obligations under 
the Act or Commission regulations applicable to exchanges to prevent 
manipulation and corners. Likewise, a market participant's compliance 
with position limits or an exemption thereto does not confer any type 
of safe harbor or good faith defense to a claim that the participant 
had engaged in an attempted or perfected manipulation.
    Further, the proposed amendments are intended to help clarify that 
Sec.  150.6 applies to: Regulations related to position limits found 
outside of part 150 of the Commission's regulations (e.g., relevant 
sections of part 1 and part 19); and recordkeeping and reporting 
regulations associated with speculative position limits.

F. Sec.  150.8--Severability

    The Commission proposes to add new Sec.  150.8 to provide for the 
severability of individual provisions of part 150. Should any 
provision(s) of part 150 be declared invalid, including the application 
thereof to any person or circumstance, Sec.  150.8 would provide that 
all remaining provisions of part 150 shall not be affected to the 
extent that such remaining provisions, or the application thereof, can 
be given effect without the invalid provisions.

G. Sec.  150.9--Process for Recognizing Non-Enumerated Bona Fide 
Hedging Transactions or Positions With Respect to Federal Speculative 
Position Limits

1. Background and Overview
    For the nine legacy agricultural contracts currently subject to 
federal position limits, the Commission's current processes for 
recognizing non-enumerated bona fide hedge positions and certain 
enumerated anticipatory bona fide hedge positions exist in

[[Page 11650]]

parallel with exchange processes for granting exemptions from exchange-
set limits, as described below. The exchange processes for granting 
exemptions vary by exchange, and generally do not mirror the 
Commission's processes. Thus, when requesting certain bona fide hedging 
position recognitions that are not self-effectuating, market 
participants must currently comply with the exchanges' processes for 
exchange-set limits and the Commission's processes for federal limits. 
Although this disparity is currently only an issue for the nine 
agricultural futures contracts subject to both federal and exchange-set 
limits, the parallel approaches may become more inefficient and 
burdensome once the Commission adopts limits on additional commodities.
    Accordingly, the Commission is proposing Sec.  150.9 to establish a 
separate framework, applicable to proposed referenced contracts in all 
commodities, whereby a market participant who is seeking a bona fide 
hedge recognition that is not enumerated in proposed Appendix A can 
file one application with an exchange to receive a bona fide hedging 
recognition for purposes of both exchange-set limits and for federal 
limits.\340\ Given the proposal to significantly expand the list of 
enumerated hedges, the Commission expects the use of the proposed Sec.  
150.9 non-enumerated process described below would be rare and 
exceptional. This separate framework would be independent of, and serve 
as an alternative to, the Commission's process for reviewing exemption 
requests under proposed Sec.  150.3. Among other things, proposed Sec.  
150.9 would help to streamline the process by which non-enumerated bona 
fide hedge recognition requests are addressed, minimize disruptions by 
leveraging existing exchange-level processes with which many market 
participants are already familiar,\341\ and reduce inefficiencies 
created when market participants are required to comply with different 
federal and exchange-level processes.
---------------------------------------------------------------------------

    \340\ Alternatively, under the proposed framework, a trader 
could submit a request directly to the Commission pursuant to 
proposed Sec.  150.3(b). A trader that submitted such a request 
directly to the Commission for purposes of federal limits would have 
to separately request an exemption from the applicable exchange for 
purposes of exchange-set limits. As discussed earlier in this 
release, the Commission proposes to separately allow for enumerated 
hedges and spreads that meet the ``spread transaction'' definition 
to be self-effectuating. See supra Section II.C.2. (discussion of 
proposed Sec.  150.3).
    \341\ In particular, the Commission recognizes that, in the 
energy and metals spaces, market participants are familiar with 
exchange application processes and are not familiar with the 
Commission's processes since, currently, there are no federal 
position limits for those commodities.
---------------------------------------------------------------------------

    For instance, currently, market participants seeking recognitions 
of non-enumerated bona fide hedges for the nine legacy agricultural 
commodities must request recognitions from both the Commission under 
existing Sec.  1.47, and from the relevant exchange. If the recognition 
is for an ``enumerated'' hedge under existing Sec.  1.3 (other than 
anticipatory enumerated hedges), the market participant would not need 
to file an application with the Commission (as the enumerated hedge has 
a self-effectuating recognition for purposes of federal limits).
    If the exemption is for a ``non-enumerated'' hedge or certain 
enumerated anticipatory hedges under existing Sec.  1.3, the market 
participant would need to file an application with the Commission 
pursuant to Sec. Sec.  1.47 or 1.48, respectively. In either case, the 
market participant would also still need to seek an exchange exemption 
and file a Form 204/304 on a monthly basis with the Commission. As 
discussed more fully in this section, with respect to bona fide hedges 
that are not self-effectuating for purposes of federal limits, proposed 
Sec.  150.9 would permit such a market participant to file a single 
application with the exchange and relieve the market participant from 
having to separately file an application and/or monthly cash-market 
reporting information with the Commission.
    The existing Commission and exchange level approaches are described 
in more detail below, followed by a more detailed discussion of 
proposed Sec.  150.9.
2. Existing Approaches for Recognizing Bona Fide Hedges
    The Commission's authority and existing processes for recognizing 
bona fide hedges can be found in section 4a(c) of the Act, and 
Sec. Sec.  1.3, 1.47, and 1.48 of the Commission's regulations.\342\ In 
particular, CEA section 4a(c)(1) provides that no CFTC rule issued 
under CEA section 4a(a) applies to ``transactions or positions which 
are shown to be bona fide hedging transactions or positions.'' \343\ 
Further, under the existing definition of ``bona fide hedging 
transactions and positions'' in Sec.  1.3,\344\ paragraph (1) provides 
the Commission's general definition of bona fide hedging transactions 
or positions; paragraph (2) provides a list of enumerated bona fide 
hedging positions that, generally, are self-effectuating, and must be 
reported (along with supporting cash-market information) to the 
Commission monthly on Form 204 after the positions are taken; \345\ and 
paragraph (3) provides a procedure for market participants to seek 
recognition from the Commission for non-enumerated bona fide hedging 
positions. Under paragraph (3), any person that seeks Commission 
recognition of a position as a non-enumerated bona fide hedge must 
submit an application to the Commission in advance of taking on the 
position, and pursuant to the processes found in Sec.  1.47 (30 days in 
advance for non-enumerated bona fide hedges) or Sec.  1.48 (10 days in 
advance for enumerated anticipatory hedges), as applicable.
---------------------------------------------------------------------------

    \342\ See 7 U.S.C. 6a(c) and 17 CFR 1.3, 1.47, and 1.48.
    \343\ 7 U.S.C. 6a(c)(1).
    \344\ As described above, the Commission proposes to move an 
amended version of the bona fide hedging definition from Sec.  1.3 
to Sec.  150.1. See supra Section II.A. (discussion of proposed 
Sec.  150.1).
    \345\ As described below, the Commission proposes to eliminate 
Form 204 and to rely instead on the cash-market information 
submitted to exchanges pursuant to proposed Sec. Sec.  150.5 and 
150.9. See infra Section II.H.3. (discussion of proposed amendments 
to part 19).
---------------------------------------------------------------------------

b. Exchanges' Existing Approach for Granting Bona Fide Hedge Exemptions 
\346\ With Respect to Exchange-Set Limits
---------------------------------------------------------------------------

    \346\ Exchange rules typically refer to ``exemptions'' in 
connection with bona fide hedging and spread positions, whereas the 
Commission uses the nomenclature ``recognition'' with respect to 
bona fide hedges, and ``exemption'' with respect to spreads.
---------------------------------------------------------------------------

    Under DCM Core Principle 5,\347\ DCMs have, for some time, 
established exchange-set limits for futures contracts that are subject 
to federal limits, as well as for contracts that are not. In addition, 
under existing Sec.  150.5(d), DCMs may grant exemptions to exchange-
set position limits for positions that meet the Commission's general 
definition of bona fide hedging transactions or positions as defined in 
paragraph (1) of Sec.  1.3.\348\ As such, with respect to exchange-set 
limits, exchanges have adopted processes for handling trader requests 
for bona fide hedging exemptions, and generally have granted such 
requests pursuant to exchange rules that incorporate the Commission's 
existing general definition of bona fide hedging transactions or 
positions in paragraph (1) of Sec.  1.3.\349\ Accordingly, DCMs 
currently have rules and application forms in place to process 
applications to exempt bona fide

[[Page 11651]]

hedging positions with respect to exchange-set position limits.\350\
---------------------------------------------------------------------------

    \347\ 7 U.S.C. 7(d)(5).
    \348\ 17 CFR 150.5(d).
    \349\ See, e.g., CME Rule 559 and ICE Rule 6.29 (addressing 
position limits and exemptions).
    \350\ Id.
---------------------------------------------------------------------------

    Separately, under SEF Core Principle 6, currently SEFs are required 
to adopt, as is necessary and appropriate, position limits or position 
accountability levels for each swap contract to reduce the potential 
threat of market manipulation or congestion.\351\ For contracts that 
are subject to a federal position limit, the SEF must set its position 
limits at a level that is no higher than the federal limit, and must 
monitor positions established on or through the SEF for compliance with 
both the Commission's federal limit and the exchange-set limit.\352\ 
Section 37.601 further implements SEF Core Principle 6 and specifies 
that until such time that SEFs are required to comply with the 
Commission's position limits regulations, a SEF may refer to the 
associated guidance and/or acceptable practices set forth in Appendix B 
to part 37 of the Commission's regulations.\353\ Currently, in 
practice, there are no federal position limits on swaps for which SEFs 
would be required to establish exchange-set limits.
---------------------------------------------------------------------------

    \351\ 7 U.S.C. 7b-3(f)(6). The Commission codified Core 
Principle 6 under Sec.  37.600. 17 CFR 37.600.
    \352\ Id.
    \353\ 17 CFR 37.601. Under Appendix B to part 37, for Required 
Transactions, as defined in Sec.  37.9, SEFs may demonstrate 
compliance with SEF Core Principle 6 by setting and enforcing 
position limits or position accountability levels only with respect 
to trading on the SEF's own market. For Permitted Transactions, as 
defined in Sec.  37.9, SEFs may demonstrate compliance with SEF Core 
Principle 6 by setting and enforcing position accountability levels 
or by sending the Commission a list of Permitted Transactions traded 
on the SEF.
---------------------------------------------------------------------------

    As noted above, the application processes currently used by 
exchanges are different than the Commission's processes. In particular, 
exchanges typically use one application process to grant all exemption 
types, whereas the Commission has different processes for different 
exemptions, as explained below. Also, exchanges generally do not 
require the submission of monthly cash-market information, whereas the 
Commission has various monthly reporting requirements under Form 204 
and part 17 of the Commission's regulations. Finally, exchanges 
generally require exemption applications to include cash-market 
information supporting positions that exceed the limits, to be filed 
annually prior to exceeding a position limit, and to be updated on an 
annual basis.\354\
---------------------------------------------------------------------------

    \354\ Id.
---------------------------------------------------------------------------

    The Commission, on the other hand, currently has different 
processes for permitting enumerated bona fide hedges and for 
recognizing positions as non-enumerated bona fide hedges. Generally, 
for bona fide hedges enumerated in paragraph (2) of the bona fide hedge 
definition in Sec.  1.3, no formal process is required by the 
Commission. Instead, such enumerated bona fide hedge recognitions are 
self-effectuating and Commission staff reviews monthly reporting of 
cash-market positions on existing Form 204 and part 17 position data to 
monitor such positions. Recognition requests for non-enumerated bona 
fide hedging positions and for certain enumerated anticipatory bona 
fide hedge positions, as explained above, must be submitted to the 
Commission pursuant to the processes in existing Sec. Sec.  1.47 and 
1.48 of the regulations, as applicable.
3. Proposed Sec.  150.9
    Under the proposed procedural framework, an exchange's 
determination to recognize a non-enumerated bona fide hedge in 
accordance with proposed Sec.  150.9 with respect to exchange-set 
limits would serve to inform the Commission's own decision as to 
whether to recognize the exchange's determination for purposes of 
federal speculative position limits set forth in proposed Sec.  150.2. 
Among other conditions, the exchange would be required to base its 
determination on standards that conform to the Commission's own 
standards for recognizing bona fide hedges for purposes of federal 
position limits. Further, the exchange's determination with respect to 
its own position limits and application process would be subject to 
Commission review and oversight. These requirements would facilitate 
Commission review and determinations by ensuring that any bona fide 
hedge recognized by an exchange for purposes of exchange-set limits and 
in accordance with proposed Sec.  150.9 conforms to the Commission's 
standards.
    For a given referenced contract, proposed Sec.  150.9 would 
potentially allow a person to exceed federal position limits if the 
exchange listing the contract has recognized the position as a bona 
fide hedge with respect to exchange-set limits. Under this framework, 
the exchange would make such determination with respect to its own 
speculative position limits, set in accordance with proposed Sec.  
150.5(a), and, unless the Commission denies or stays the application 
within ten business days (or two business days for applications, 
including retroactive applications, filed due to sudden or unforeseen 
circumstances), the exemption would be deemed approved for purposes of 
federal positions limits.
    The exchange's exemption would be valid only if the exchange meets 
the following additional conditions, each described in greater detail 
below: (1) The exchange maintains rules, approved by the Commission 
pursuant to Sec.  40.5, that establish application processes for 
recognizing bona fide hedges in accordance with Sec.  150.9; (2) the 
exchange meets specified prerequisites for granting such recognitions; 
(3) the exchange satisfies specified recordkeeping requirements; and 
(4) the exchange notifies the Commission and the applicant upon 
determining to recognize a bona fide hedging transaction or position. A 
person may exceed the applicable federal position limit ten business 
days (for new and annually renewed exemptions) or two business days 
(for applications, including retroactive applications, submitted due to 
sudden and unforeseen circumstances) after the exchange makes its 
determination, unless the Commission notifies the exchange and the 
applicant otherwise.
    The above-described elements of the proposed approach differ from 
the regulations proposed in the 2016 Reproposal, which did not require 
a 10-day Commission review period. The 2016 Reproposal allowed DCMs and 
SEFs to recognize non-enumerated bona fide hedges for purposes of 
federal position limits.\355\ However, the 2016 Reproposal may not have 
conformed to the legal limits on what an agency may delegate to persons 
outside the agency.\356\ The 2016 Reproposal

[[Page 11652]]

delegated to the DCMs and SEFs a significant component of the 
Commission's authority to recognize bona fide hedges for purposes of 
federal position limits. Under that proposal, the Commission did not 
have a substantial role in reviewing the DCMs' or SEFs' recognitions of 
non-enumerated bona fide hedges for purposes of federal position 
limits. Upon further reflection, the Commission believes that the 2016 
Reproposal may not have retained enough authority with the Commission 
under case law on sub-delegation of agency decision making authority. 
Under the new proposed model, the Commission would be informed by the 
exchanges' determinations to make the Commission's own determination 
for purposes of federal position limits within a 10-day review period. 
Accordingly, the Commission would retain its decision-making authority 
with respect to the federal position limits and provide legal certainty 
to market participants of their determinations.
---------------------------------------------------------------------------

    \355\ Proposed Sec.  150.9(a)(5) of the 2016 Reproposal provided 
that an applicant's derivatives position shall be deemed to be 
recognized as a non-enumerated bona fide hedging position exempt 
from federal position limits at the time that a designated contract 
market or swap execution facility notifies an applicant that such 
designated contract market or swap execution facility will recognize 
such position as a non-enumerated bona fide hedging position.
    \356\ In U.S. Telecom Ass'n v. FCC, the D.C. Circuit held 
``that, while federal agency officials may subdelegate their 
decision-making authority to subordinates absent evidence of 
contrary congressional intent, they may not subdelegate to outside 
entities--private or sovereign--absent affirmative evidence of 
authority to do so.'' U.S. Telecom Ass'n v. FCC, 359 F.3d 554, 565-
68 (D.C. Cir. 2004) (citing Shook v. District of Columbia Fin. 
Responsibility & Mgmt. Assistance Auth., 132 F.3d 775, 783-84 & n. 6 
(D.C. Cir.1998); Nat'l Ass'n of Reg. Util. Comm'rs (``NARUC'') v. 
FCC, 737 F.2d 1095, 1143-44 & n. 41 (D.C. Cir.1984); Nat'l Park and 
Conservation Ass'n v. Stanton, 54 F.Supp.2d 7, 18-20 (D.D.C.1999). 
Nevertheless, the D.C. Circuit recognized three circumstances that 
the agency may ``delegate'' its authority to an outside party 
because they do not involve subdelegation of decision-making 
authority: (1) Establishing a reasonable condition for granting 
federal approval; (2) fact gathering; and (3) advice giving. The 
first instance involves conditioning of obtaining a permit on the 
approval by an outside entity as an element of its decision process. 
The second provides the agency with nondiscretionary information 
gathering. The third allows a federal agency to turn to an outside 
entity for advice and policy recommendations, provided the agency 
makes the final decisions itself. Id. at 568. ``An agency may not, 
however, merely `rubber-stamp' decisions made by others under the 
guise of seeking their `advice,' [ ], nor will vague or inadequate 
assertions of final reviewing authority save an unlawful 
subdelegation, [ ].'' Id.
---------------------------------------------------------------------------

    Both DCMs and SEFs would be eligible to allow traders to utilize 
the processes set forth under proposed Sec.  150.9. However, as a 
practical matter, the Commission expects that upon implementation of 
Sec.  150.9, the process proposed therein will likely be used primarily 
by DCMs, rather than by SEFs, given that most economically equivalent 
swaps that would be subject to federal position limits are expected to 
be traded OTC and not executed on SEFs.
    The Commission emphasizes that proposed Sec.  150.9 is intended to 
serve as a separate, self-contained process that is related to, but 
independent of, the proposed regulations governing: (1) The process in 
proposed Sec.  150.3 for traders to apply directly to the Commission 
for a bona fide hedge recognition; and (2) exchange processes for 
establishing exchange-set limits and granting exemptions therefrom in 
proposed Sec.  150.5. Proposed Sec.  150.9 is intended to serve as a 
voluntary process exchanges can implement to provide additional 
flexibility for their market participants seeking non-enumerated bona 
fide hedges to file one application with an exchange to receive a 
recognition or exemption for purposes of both exchange-set limits and 
for federal limits. Proposed Sec.  150.9 is discussed in greater detail 
below.
Request for Comment
    The Commission requests comment on all aspects of proposed Sec.  
150.9. The Commission also invites comments on the following:
    (35) Considering that the Commission's proposed position limits 
would apply to OTC economically equivalent swaps, should the Commission 
develop a mechanism for exchanges to be involved in the review of non-
enumerated bona fide hedge applications for OTC economically equivalent 
swaps?
    (36) If so, what, if any, role should exchanges play in the review 
of non- enumerated bona fide hedge applications for OTC economically 
equivalent swaps?
a. Proposed Sec.  150.9(a)--Approval of Rules
    Under proposed Sec.  150.9(a), the exchange must have rules, 
adopted pursuant to the rule approval process in Sec.  40.5 of the 
Commission's regulations, establishing processes and standards in 
accordance with proposed Sec.  150.9, described below. The Commission 
would review such rules to ensure that the exchange's standards and 
processes for recognizing bona fide hedges from its own exchange-set 
limits conform to the Commission's standards and processes for 
recognizing bona fide hedges from the federal limits.
b. Proposed Sec.  150.9(b)--Prerequisites for an Exchange To Recognize 
Non-Enumerated Bona Fide Hedges in Accordance With This Section
    This section sets forth conditions that would require an exchange-
recognized bona fide hedge to conform to the corresponding definitions 
or standards the Commission uses in proposed Sec. Sec.  150.1 and 150.3 
for purposes of the federal position limits regime.
    An exchange would be required to meet the following prerequisites 
with respect to recognizing bona fide hedging positions under proposed 
Sec.  150.9(b): (i) The exchange lists the applicable referenced 
contract for trading; (ii) the position is consistent with both the 
definition of bona fide hedging transaction or position in proposed 
Sec.  150.1 and section 4a(c)(2) of the Act; and (iii) the exchange 
does not recognize as bona fide hedges any positions that include 
commodity index contracts and one or more referenced contracts, nor 
does the exchange grant risk management exemptions for such 
contracts.\357\
---------------------------------------------------------------------------

    \357\ The Commission finds that financial products are not 
substitutes for positions taken or to be taken in a physical 
marketing channel. Thus, the offset of financial risks arising from 
financial products would be inconsistent with the definition of bona 
fide hedging transactions or positions for physical commodities in 
proposed Sec.  150.1. See supra Section II.A.1.c.ii.(1) (discussion 
of the temporary substitute test and risk-management exemptions).
---------------------------------------------------------------------------

Request for Comment
    The Commission requests comment on all aspects of proposed Sec.  
150.9. The Commission also invites comments on the following:
    (37) Does the proposed compliance date of twelve-months after 
publication of a final federal position limits rulemaking in the 
Federal Register provide a sufficient amount of time for exchanges to 
update their exemption application procedures, as needed, and begin 
reviewing exemption applications in accordance with proposed Sec.  
150.9? If not, please provide an alternative longer timeline and 
reasons supporting a longer timeline.
c. Proposed Sec.  150.9(c)--Application Process
    Proposed Sec.  150.9(c) sets forth the information and 
representations that the exchange, at a minimum, would be required to 
obtain from applicants as part of the application process for granting 
bona fide hedges. In this connection, exchanges may rely upon their 
existing application forms and processes in making such determinations, 
provided they collect the information outlined below. The Commission 
believes the information set forth below is sufficient for the exchange 
to determine, and the Commission to verify, whether a particular 
transaction or position satisfies the federal definition of bona fide 
hedging transaction for purposes of federal position limits.
i. Proposed Sec.  150.9(c)(1)--Required Information for Bona Fide 
Hedging Positions
    With respect to bona fide hedging positions in referenced 
contracts, proposed Sec.  150.9(c)(1) would require that any 
application include: (i) A description of the position in the commodity 
derivative contract for which the application is submitted (which would 
include the name of the underlying commodity and the position size); 
(ii) information to demonstrate why the position satisfies section 
4a(c)(2) of the Act and the definition of bona fide hedging transaction 
or position in proposed Sec.  150.1, including factual and legal 
analysis; (iii) a

[[Page 11653]]

statement concerning the maximum size of all gross positions in 
derivative contracts for which the application is submitted (in order 
to provide a view of the true footprint of the position in the market); 
(iv) information regarding the applicant's activity in the cash markets 
for the commodity underlying the position for which the application is 
submitted; \358\ and (v) any other information the exchange requires, 
in its discretion, to enable the exchange to determine, and the 
Commission to verify, whether such position should be recognized as a 
bona fide hedge.\359\ These proposed application requirements are 
similar to current requirements for recognizing a bona fide hedging 
position under existing Sec. Sec.  1.47 and 1.48.
---------------------------------------------------------------------------

    \358\ The Commission would expect that exchanges would require 
applicants to provide cash market data for at least the prior year.
    \359\ Under proposed Sec.  150.9(c)(1)(iv) and (v), exchanges, 
in their discretion, could request additional information as 
necessary, including information for cash market data similar to 
what is required in the Commission's existing Form 204. See infra 
Section II.H.3. (discussion of Form 204 and proposed amendments to 
part 19). Exchanges could also request a description of any 
positions in other commodity derivative contracts in the same 
commodity underlying the commodity derivative contract for which the 
application is submitted. Other commodity derivatives contracts 
could include other futures, options, and swaps (including OTC 
swaps) positions held by the applicant.
---------------------------------------------------------------------------

    Market participants have raised concerns that such requirements, 
even if administered by the exchanges, would require hedging entities 
to change internal books and records to track which category of bona 
fide hedge a position would fall under. The Commission notes that, as 
part of this current proposal, exchanges would not need to require the 
identification of a hedging need against a particular identified 
category. So long as the requesting party satisfies all applicable 
requirements in proposed Sec.  150.9, including demonstrating with a 
factual and legal analysis that a position would fit within the bona 
fide hedge definition, the Commission is not intending to require the 
hedging party's books and records to identify the particular type of 
hedge being applied.
ii. Proposed Sec.  150.9(c)(2)--Timing of Application
    The Commission does not propose to prescribe timelines (e.g., a 
specified number of days) for exchanges to review applications because 
the Commission believes that exchanges are in the best position to 
determine how to best accommodate the needs of their market 
participants. Rather, under proposed Sec.  150.9(c)(2), the exchange 
must separately require that applicants submit their application in 
advance of exceeding the applicable federal position limit for any 
given referenced contract. However, an exchange may adopt rules that 
allow a person to submit a bona fide hedge application within five days 
after the person has exceeded federal speculative limits if such person 
exceeds the limits due to sudden or unforeseen increases in its bona 
fide hedging needs. Where an applicant claims a sudden or unforeseen 
increase in its bona fide hedging needs, the proposed rules would 
require exchanges to require that the person provide materials 
demonstrating that the person exceeded the federal speculative limit 
due to sudden or unforeseen circumstances. Further, the Commission 
would caution exchanges that applications submitted after a person has 
exceeded federal position limits should not be habitual and should be 
reviewed closely. Finally, if the Commission finds that the position 
does not qualify as a bona fide hedge, then the applicant would be 
required to bring its position into compliance, and could face a 
position limits violation if it does not reduce the position within a 
commercially reasonable time.
iii. Proposed Sec.  150.9(c)(3)--Renewal of Applications
    Under proposed Sec.  150.9(c)(3), the exchange must require that 
persons with bona fide hedging recognitions in referenced contracts 
granted pursuant to proposed Sec.  150.9 reapply at least on an annual 
basis by updating their original application, and receive a notice of 
approval from the exchange prior to exceeding the applicable position 
limit.
iv. Proposed Sec.  150.9(c)(4)--Exchange Revocation Authority
    Under proposed Sec.  150.9(c)(4), the exchange retains its 
authority to limit, condition, or revoke, at any time, any recognition 
previously issued pursuant to proposed Sec.  150.9, for any reason, 
including if the exchange determines that the recognition is no longer 
consistent with the bona fide hedge definition in proposed Sec.  150.1 
or section 4a(c)(2) of the Act.
Request for Comment
    The Commission requests comment on all aspects of proposed Sec.  
150.9. The Commission also invites comments on the following:
    (38) As described above, the Commission does not propose to 
prescribe timelines for exchanges to review applications. Please 
comment on what, if any, timing requirements the Commission should 
prescribe for exchanges' review of applications pursuant to proposed 
Sec.  150.9.
    (39) Currently, certain exchanges allow for the submission of 
exemption requests up to five business days after the trader 
established the position that exceeded the exchange-set limit. Under 
proposed Sec.  150.9, should exchanges continue to be permitted to 
recognize bona fide hedges and grant spread exemptions retroactively--
up to five days after a trader has established a position that exceeds 
federal position limits?
d. Proposed Sec.  150.9(d)--Recordkeeping
    Proposed Sec.  150.9(d) would set forth recordkeeping requirements 
for purposes of Sec.  150.9. The required records would form a critical 
element of the Commission's oversight of the exchanges' application 
process and such records could be requested by the Commission as 
needed. Under proposed Sec.  150.9(d), exchanges must maintain complete 
books and records of all activities relating to the processing and 
disposition of applications in a manner consistent with the 
Commission's existing general regulations regarding recordkeeping.\360\ 
Such records must include all information and documents submitted by an 
applicant in connection with its application; records of oral and 
written communications between the exchange and the applicant in 
connection with the application; and information and documents in 
connection with the exchange's analysis of and action on such 
application.\361\ Exchanges would also be required to maintain any 
documentation submitted by an applicant after the disposition of an 
application, including, for example, any reports or updates the 
applicant filed with the exchange.
---------------------------------------------------------------------------

    \360\ Requirements regarding the keeping and inspection of all 
books and records required to be kept by the Act or the Commission's 
regulations are found at Sec.  1.31, 17 CFR 1.31. DCMs are already 
required to maintain records of their business activities in 
accordance with the requirements of Sec.  1.31 of Sec.  38.951, 17 
CFR 38.951.
    \361\ The Commission does not intend, in proposed Sec.  
150.9(d), to create any new obligation for an exchange to record 
conversations with applicants or their representatives; however, the 
Commission does expect that an exchange would preserve any written 
or electronic notes of verbal interactions with such parties.
---------------------------------------------------------------------------

    Exchanges would be required to store and produce records pursuant 
to existing Sec.  1.31,\362\ and would be subject

[[Page 11654]]

to requests for information pursuant to other applicable Commission 
regulations, including, for example, existing Sec.  38.5.\363\
---------------------------------------------------------------------------

    \362\ Consistent with existing Sec.  1.31, the Commission 
expects that these records would be readily available during the 
first two years of the required five year recordkeeping period for 
paper records, and readily accessible for the entire five-year 
recordkeeping period for electronic records. In addition, the 
Commission expects that records required to be maintained by an 
exchange pursuant to this section would be readily accessible during 
the pendency of any application, and for two years following any 
disposition that did not recognize a derivative position as a bona 
fide hedge.
    \363\ See 17 CFR 38.5 (requiring, in general, that upon request 
by the Commission, a DCM must file responsive information with the 
Commission, such as information related to its business, or a 
written demonstration of the DCM's compliance with one or more core 
principles).
---------------------------------------------------------------------------

Request for Comment
    The Commission requests comment on all aspects of proposed Sec.  
150.9. The Commission also invites comments on the following:
    (40) Do the proposed recordkeeping requirements set forth in Sec.  
150.9 comport with existing practice? Are there any ways in which the 
Commission could streamline the proposed recordkeeping requirements 
while still maintaining access to sufficient information to carry out 
its statutory responsibilities?
e. Proposed Sec.  150.9(e)--Process for a Person To Exceed Federal 
Position Limits
    Under proposed Sec.  150.9(e), once an exchange recognizes a bona 
fide hedge with respect to its own speculative position limits 
established pursuant to Sec.  150.5(a), a person could rely on such 
determination for purposes of exceeding federal position limits 
provided that specified conditions are met, including that the exchange 
provide the Commission with notice of any approved application as well 
as a copy of the application and any supporting materials, and the 
Commission does not object to the exchange's determination. The 
exchange is only required to provide this notice to the Commission with 
respect to its initial (and not renewal) determinations for a 
particular application. Under proposed Sec.  150.9(e), the exchange 
must provide such notice to the Commission concurrent with the notice 
provided to the applicant, and, except as provided below, a trader can 
exceed federal position limits ten business days after the exchange 
issues the required notification, provided the Commission does not 
notify the exchange or applicant otherwise.
    However, for a person with sudden or unforeseen bona fide hedging 
needs that has filed an application, pursuant to proposed Sec.  
150.9(c)(2)(ii), after they already exceeded federal speculative 
position limits, the exchange's retroactive approval of such 
application would be deemed approved by the Commission two business 
days after the exchange issues the required notification, provided the 
Commission does not notify the exchange or applicant otherwise. That 
is, the bona fide hedge recognition would be deemed approved by the 
Commission two business days after the exchange issues the required 
notification, unless the Commission notifies the exchange and the 
applicant otherwise during this two business day timeframe.
    Once those ten (or two) business days have passed, the person could 
rely on the bona fide hedge recognition both for purposes of exchange-
set and federal limits, with the certainty that the Commission (and not 
Commission staff) would only revoke that determination in the limited 
circumstances set forth in proposed Sec.  150.9(f)(1) and (2) described 
further below.
    However, under proposed Sec.  150.9(e)(5), if, during the ten (or 
two) business day timeframe, the Commission notifies the exchange and 
applicant that the Commission (and not staff) has determined to stay 
the application, the person would not be able to rely on the exchange's 
approval of the application for purposes of exceeding federal position 
limits, unless the Commission approves the application after further 
review.
    Separately, under proposed Sec.  150.9(e)(5), the Commission (or 
Commission staff) may request additional information from the exchange 
or applicant in order to evaluate the application, and the exchange and 
applicant would have an opportunity to provide the Commission with any 
supplemental information requested to continue the application process. 
Any such request for additional information by the Commission (or 
staff), however, would not stay or toll the ten (or two) business day 
application review period.
    Further, under proposed Sec.  150.9(e)(6), the applicant would not 
be subject to any finding of a position limits violation during the 
Commission's review of the application. Or, if the Commission 
determines (in the case of retroactive applications) that the bona fide 
hedge is not approved for purposes of federal limits after a person has 
already exceeded federal position limits, the Commission would not find 
that the person has committed a position limits violation so long as 
the person brings the position into compliance within a commercially 
reasonable time.
    The Commission believes that the ten (or two) business day period 
to review exchange determinations under proposed Sec.  150.9 would 
allow the Commission enough time to identify applications that may not 
comply with the proposed bona fide hedging position definition, while 
still providing a mechanism whereby market participants may exceed 
federal position limits pursuant to Commission determinations.
Request for Comment
    The Commission requests comment on all aspects of proposed Sec.  
150.9. The Commission also invites comments on the following:
    (41) The Commission has proposed, in Sec.  150.9(e)(3), a ten 
business day period for the Commission to review an exchange's 
determination to recognize a bona fide hedge for purposes of the 
Commission approving such determination for federal position limits. 
Please comment on whether the review period is adequate, and if not, 
please comment on what would be an appropriate amount of time to allow 
the Commission to review exchange determinations while also providing a 
timely determination for the applicant.
    (42) The Commission has proposed a two business day review period 
for retroactive applications submitted to exchanges after a person has 
already exceeded federal position limits. Please comment on whether 
this time period properly balances the need for the Commission to 
oversee the administration of federal position limits with the need of 
hedging parties to have certainty regarding their positions that are 
already in excess of the federal position limits.
    (43) With respect to the Commission's review authority in Sec.  
150.9(e)(5), if the Commission stays an application during the ten (or 
two) business-day review period, the Commission's review, as would be 
the case for an exchange, would not be bound by any time limitation. 
Please comment on what, if any, timing requirements the Commission 
should prescribe for its review of applications pursuant to proposed 
Sec.  150.9(e)(5).
    (44) Please comment on whether the Commission should permit a 
person to exceed federal position limits during the ten business day 
period for the Commission's review of an exchange-granted exemption.
    (45) Under proposed Sec.  150.9(e), an exchange is only required to 
notify the Commission of its initial approval of an exemption 
application (and not any renewal approvals). Should the Commission 
require that exchanges submit approved renewals of applications to the 
Commission for review and approval if there are material changes to the 
facts and circumstances underlying the renewal application?

[[Page 11655]]

f. Proposed Sec.  150.9(f)--Commission Revocation of an Approved 
Application
    Proposed Sec.  150.9(f) sets forth the limited circumstances under 
which the Commission would revoke a bona fide hedge recognition granted 
pursuant to proposed Sec.  150.9. The Commission expects such 
revocation to be rare, and this authority would not be delegated to 
Commission staff. First, under proposed Sec.  150.9(f)(1), if an 
exchange revokes its recognition of a bona fide hedge, then such bona 
fide hedge would also be deemed revoked for purposes of federal limits.
    Second, under proposed Sec.  150.9(f)(2), if the Commission 
determines that an application that has been approved or deemed 
approved by the Commission is no longer consistent with the applicable 
sections of the Act and the Commission's regulations, the Commission 
shall notify the person and exchange, and, after an opportunity to 
respond, the Commission can require the person to reduce the 
derivatives position within a commercially reasonable time, or 
otherwise come into compliance. In determining a commercially 
reasonable amount of time, the Commission must consult with the 
applicable exchange and applicant, and may consider factors including, 
among others, current market conditions and the protection of price 
discovery in the market.
    The Commission expects that it would only exercise its revocation 
authority under circumstances where the disposition of an application 
has resulted, or is likely to result, in price anomalies, threatened 
manipulation, actual manipulation, market disruptions, or disorderly 
markets. In addition, the Commission's authority to require a market 
participant to reduce certain positions in proposed Sec.  150.9(f)(2) 
would not be subject to the requirements of CEA section 8a(9), that is, 
the Commission would not be compelled to find that a CEA section 8a(9) 
emergency condition exists prior to requiring that a market participant 
reduce certain positions pursuant to proposed Sec.  150.9(f)(2).
    If the Commission determines that a person must reduce its position 
or otherwise bring it into compliance, the Commission would not find 
that the person has committed a position limit violation so long as the 
person comes into compliance within the commercially reasonable time 
identified by the Commission in consultation with the applicable 
exchange and applicant. The Commission intends for persons to be able 
to rely on recognitions and exemptions granted pursuant to Sec.  150.9 
with the certainty that the exchange decision would only be reversed in 
very limited circumstances. Any action compelling a market participant 
to reduce its position pursuant to Sec.  150.9(f)(2) would be a 
Commission action, and would not be delegated to Commission staff. 
\364\
---------------------------------------------------------------------------

    \364\ None of the provisions in proposed Sec.  150.9 would 
compromise the Commission's emergency authorities under CEA section 
8a(9), including the Commission's authority to fix ``limits that may 
apply to a market position acquired in good faith prior to the 
effective date of the Commission's action.'' CEA section 8a(9). 7 
U.S.C. 12a(9).
---------------------------------------------------------------------------

g. Proposed Sec.  150.9(g)--Delegation of Authority to the Director of 
the Division of Market Oversight
    The Commission proposes to delegate certain of its authorities 
under proposed Sec.  150.9 to the Director of the Commission's Division 
of Market Oversight, or such other employee(s) that the Director may 
designate from time to time. Proposed Sec.  150.9(g)(1) would delegate 
the Commission's authority, in Sec.  150.9(e)(5), to request additional 
information from the exchange and applicant.
    The Commission does not propose, however, to delegate its 
authority, in proposed Sec.  150.9(e)(5) and (6) to stay or reject such 
application, nor proposed Sec.  150.9(f)(2), to revoke a bona fide 
hedge recognition granted pursuant to Sec.  150.9 or to require an 
applicant to reduce its positions or otherwise come into compliance. 
The Commission believes that if an exchange's disposition of an 
application raises concerns regarding consistency with the Act, 
presents novel or complex issues, or requires remediation, then the 
Commission, and not Commission staff, should make the final 
determination, after taking into consideration any supplemental 
information provided by the exchange or the applicant.
    As with all authorities delegated by the Commission to staff, the 
Commission would maintain the authority to consider any matter which 
has been delegated, including the proposed delegations in Sec. Sec.  
150.3 and 150.9 described above. The Commission will closely monitor 
staff administration of the proposed processes for granting bona fide 
hedge recognitions.

H. Part 19 and Related Provisions--Reporting of Cash-Market Positions

1. Background
    Key reports currently used for purposes of monitoring compliance 
with federal position limits include Form 204 \365\ and Form 304,\366\ 
known collectively as the ``series `04'' reports. Under existing Sec.  
19.01, market participants that hold bona fide hedging positions in 
excess of limits for the nine commodities currently subject to federal 
limits must justify such overages by filing the applicable report each 
month: Form 304 for cotton, and Form 204 for the other 
commodities.\367\ These reports are generally filed after exceeding the 
limit, show a snapshot of such traders' cash positions on one given day 
each month, and are used by the Commission to determine whether a 
trader has sufficient cash positions that justify futures and options 
on futures positions above the speculative limits.
---------------------------------------------------------------------------

    \365\ CFTC Form 204: Statement of Cash Positions in Grains, 
Soybeans, Soybean Oil, and Soybean Meal, U.S. Commodity Futures 
Trading Commission website, available at https://www.cftc.gov/sites/default/files/idc/groups/public/@forms/documents/file/cftcform204.pdf (existing Form 204).
    \366\ CFTC Form 304: Statement of Cash Positions in Cotton, U.S. 
Commodity Futures Trading Commission website, available at https://www.cftc.gov/ucm/groups/public/@forms/documents/file/cftcform304.pdf 
(existing Form 204). Parts I and II of Form 304 address fixed-price 
cash positions used to justify cotton positions in excess of federal 
limits. As described below, Part III of Form 304 addresses unfixed-
price cotton ``on-call'' information, which is not used to justify 
cotton positions in excess of limits, but rather to allow the 
Commission to prepare its weekly cotton on-call report.
    \367\ 17 CFR 19.01.
---------------------------------------------------------------------------

2. Proposed Elimination of Form 204 and Cash-Reporting Elements of Form 
304
    For the reasons set forth below, the Commission proposes to 
eliminate Form 204 and Parts I and II of existing Form 304, which 
requests information on cash-market positions for cotton akin to the 
information requested in Form 204.\368\
---------------------------------------------------------------------------

    \368\ Proposed amendments to Part III of the Form 304, which 
addresses cotton on-call, are discussed below.
---------------------------------------------------------------------------

    First, the Commission would no longer need the cash-market 
information currently reported on Forms 204 and 304 because the 
exchanges would collect, and make available to the Commission, cash-
market information needed to assess whether any such position is a bona 
fide hedge.\369\ Further, the Commission would continue to have access 
to information, including cash-market information, by issuing special 
calls relating to positions exceeding limits.
---------------------------------------------------------------------------

    \369\ The cash-market reporting regime discussed in this section 
of the release only pertains to bona fide hedges, not to spread 
exemptions, because the Commission has not traditionally relied on 
cash-market information when reviewing requests for spread 
exemptions.
---------------------------------------------------------------------------

    Second, Form 204 as currently constituted would be inadequate for 
the

[[Page 11656]]

reporting of cash-market positions relating to certain energy contracts 
which would be subject to federal limits for the first time under this 
proposal. For example, when compared to agricultural contracts, energy 
contracts generally expire more frequently, have a shorter delivery 
cycle, and have significantly more product grades. The information 
required by Form 204, as well as the timing and procedures for its 
filing, reflects the way agricultural contracts trade, but is 
inadequate for purposes of reporting cash-market information involving 
energy contracts.
    While the Commission considered proposing to modify Form 204 to 
cover energy and metal contracts, the Commission has opted instead to 
propose a more streamlined approach to cash-market reporting that 
reduces duplication between the Commission and the exchanges. In 
particular, to obtain information with respect to cash market 
positions, the Commission proposes to leverage the cash-market 
information reported to the exchanges, with some modifications. When 
granting exemptions from their own limits, exchanges do not use a 
monthly cash-market reporting framework akin to Form 204. Instead, 
exchanges generally require market participants who wish to exceed 
exchange-set limits, including for bona fide hedging positions, to 
submit an annual exemption application form in advance of exceeding the 
limit.\370\ Such applications are typically updated annually and 
generally include a month-by-month breakdown of cash-market positions 
for the previous year supporting any position-limits overages during 
that period.\371\
---------------------------------------------------------------------------

    \370\ See, e.g., ICE Rule 6.29 and CME Rule 559.
    \371\ For certain physically-delivered agricultural contracts, 
some exchanges may require that spot month exemption applications be 
renewed several times a year for each spot month, rather than 
annually.
---------------------------------------------------------------------------

    To ensure that the Commission continues to have access to the same 
information on cash-market positions that is already provided to 
exchanges, the Commission proposes several reporting and recordkeeping 
requirements in Sec. Sec.  150.3, 150.5, and 150.9, as discussed 
above.\372\ First, exchanges would be required to collect applications, 
updated at least on an annual basis, for purposes of granting bona fide 
hedge recognitions from exchange-set limits for contracts subject to 
federal limits,\373\ and for recognizing bona fide hedging positions 
for purposes of federal limits.\374\ Among other things, such 
applications would be required to include: (1) Information regarding 
the applicant's activity in the cash markets for the underlying 
commodity; and (2) any other information to enable the exchange to 
determine, and the Commission to verify, whether the exchange may 
recognize such position as a bona fide hedge.\375\ Second, consistent 
with existing industry practice for certain exchanges, exchanges would 
be required to file monthly reports to the Commission showing, among 
other things, for all bona fide hedges (whether enumerated or non-
enumerated), a concise summary of the applicant's activity in the cash 
markets.\376\
---------------------------------------------------------------------------

    \372\ As discussed earlier in this release, proposed Sec.  150.9 
also includes reporting and recordkeeping requirements pertaining to 
spread exemptions. Those requirements will not be discussed again in 
this section of the release, which addresses cash-market reporting 
in connection with bona fide hedges. This section of the release 
focuses on the cash-market reporting requirements in Sec.  150.9 
that pertain to bona fide hedges.
    \373\ See proposed Sec.  150.5(a)(2)(ii)(A)(1).
    \374\ As discussed above in connection with proposed Sec.  
150.9, market participants who wish to request a bona fide hedge 
recognition under Sec.  150.9 would not be required to file such 
applications with both the exchange and the Commission. They would 
only file the applications with the exchange, which would then be 
subject to recordkeeping requirements in proposed Sec.  150.9(d), as 
well as proposed Sec. Sec.  150.5 and 150.9 requirements to provide 
certain information to the Commission on a monthly basis and upon 
demand.
    \375\ See proposed Sec.  150.9(c)(1)(iv)-(v).
    \376\ See proposed Sec.  150.5(a)(4).
---------------------------------------------------------------------------

    Collectively, these proposed Sec. Sec.  150.5 and 150.9 rules would 
provide the Commission with monthly information about all recognitions 
and exemptions granted for purposes of contracts subject to federal 
limits, including cash-market information supporting the applications, 
and annual information regarding all month-by-month cash-market 
positions used to support a bona fide hedging recognition. These 
reports would help the Commission verify that any person who claims a 
bona fide hedging position can demonstrate satisfaction of the relevant 
requirements. This information would also help the Commission perform 
market surveillance in order to detect and deter manipulation and 
abusive trading practices in physical commodity markets.
    While the Commission would no longer receive the monthly snapshot 
data currently included on Form 204, the Commission would have broad 
access, at any time, to the cash-market information described above, as 
well as any other data or information exchanges collect as part of 
their application processes.\377\ This would include any updated 
application forms and periodic reports that exchanges may require 
applicants to file regarding their positions. To the extent that the 
Commission observes market activity or positions that warrant further 
investigation, Sec.  150.9 would also provide the Commission with 
access to any supporting or related records the exchanges would be 
required to maintain.\378\
---------------------------------------------------------------------------

    \377\ See, e.g., proposed Sec.  150.9(d) (requiring that all 
such records, including cash-market information submitted to the 
exchange, be kept in accordance with the requirements of Sec.  1.31) 
and proposed Sec.  19.00(b) (requiring, among other things, all 
persons exceeding speculative limits who have received a special 
call to file any pertinent information as specified in the call).
    \378\ See proposed Sec.  150.9(d).
---------------------------------------------------------------------------

    Furthermore, the proposed changes would not impact the Commission's 
existing provisions for gathering information through special calls 
relating to positions exceeding limits and/or to reportable positions. 
Accordingly, as discussed further below, the Commission proposes that 
all persons exceeding the proposed limits set forth in Sec.  150.2, as 
well as all persons holding or controlling reportable positions 
pursuant to Sec.  15.00(p)(1), must file any pertinent information as 
instructed in a special call.\379\
---------------------------------------------------------------------------

    \379\ See proposed Sec.  19.00(b).
---------------------------------------------------------------------------

    Finally, the Commission understands that the exchanges maintain 
regular dialogue with their participants regarding cash-market 
positions, and that it is common for exchange surveillance staff to 
make informal inquiries of market participants, including if the 
exchange has questions about market events or a participant's use of an 
exemption. The Commission encourages exchanges to continue this 
practice. Similarly, the Commission anticipates that its own staff 
would engage in dialogue with market participants, either through the 
use of informal conversations or, in limited circumstances, via special 
call authority.
    For market participants who are accustomed to filing Form 204s with 
information supporting classification as a federally enumerated hedging 
position, the proposed elimination of Form 204 would result in a slight 
change in practice. Under the proposed rules, such participants' bona 
fide hedge recognitions could still be self-effectuating for purposes 
of federal limits, provided the market participant also separately 
applies for a bona fide hedge exemption from exchange-set limits 
established pursuant to proposed Sec.  150.5(a), and provided further 
that the participant submits the requisite cash-market information to 
the exchange as required by proposed Sec.  150.5(a)(2)(ii)(A)(1).

[[Page 11657]]

3. Proposed Changes to Parts 15 and 19 To Implement the Proposed 
Elimination of Form 204 and Portions of Form 304
    The market and large-trader reporting rules are contained in parts 
15 through 21 of the Commission's regulations. Collectively, these 
reporting rules effectuate the Commission's market and financial 
surveillance programs by enabling the Commission to gather information 
concerning the size and composition of the commodity derivative markets 
and to monitor and enforce any established speculative position limits, 
among other regulatory goals.
    To effectuate the proposed elimination of Form 204 and the cash-
market reporting components of Form 304, the Commission proposes 
corresponding amendments to certain provisions in parts 15 and 19. 
These amendments would eliminate: (i) Existing Sec.  19.00(a)(1), which 
requires persons holding reportable positions which constitute bona 
fide hedging positions to file a Form 204; and (ii) existing Sec.  
19.01, which, among other things, sets forth the cash-market 
information required on Forms 204 and 304.\380\ Based on the proposed 
elimination of existing Sec.  19.00(a)(1) and Form 204, the Commission 
also proposes to remove related provisions from: (i) The ``reportable 
position'' definition in Sec.  15.00(p); (ii) the list of ``persons 
required to report'' in Sec.  15.01; and (iii) the list of reporting 
forms in Sec.  15.02.
---------------------------------------------------------------------------

    \380\ 17 CFR 19.01.
---------------------------------------------------------------------------

4. Special Calls
    Notwithstanding the proposed elimination of Form 204, the 
Commission does not propose to make any significant substantive changes 
to information requirements relating to positions exceeding limits and/
or to reportable positions. Accordingly, in proposed Sec.  19.00(b), 
the Commission proposes that all persons exceeding the proposed limits 
set forth in Sec.  150.2, as well as all persons holding or controlling 
reportable positions pursuant to Sec.  15.00(p)(1), must file any 
pertinent information as instructed in a special call. This proposed 
provision is similar to existing Sec.  19.00(a)(3), but would require 
any such person to file the information as instructed in the special 
call, rather than to file a series '04 report.\381\
---------------------------------------------------------------------------

    \381\ 17 CFR 19.00(a)(3).
---------------------------------------------------------------------------

    The Commission also proposes to add language to existing Sec.  
15.01(d) to clarify that persons who have received a special call are 
deemed ``persons required to report'' as defined in Sec.  15.01.\382\ 
The Commission proposes this change to clarify an existing requirement 
found in Sec.  19.00(a)(3), which requires persons holding or 
controlling positions that are reportable pursuant to Sec.  15.00(p)(1) 
who have received a special call to respond.\383\ The proposed changes 
to part 19 operate in tandem with the proposed additional language for 
Sec.  15.01(d) to reiterate the Commission's existing special call 
authority without creating any new substantive reporting obligations. 
Finally, proposed Sec.  19.03 would delegate authority to issue such 
special calls to the Director of the Division of Enforcement, and 
proposed Sec.  19.03(b) would delegate to the Director of the Division 
of Enforcement the authority in proposed Sec.  19.00(b) to provide 
instructions or to determine the format, coding structure, and 
electronic data transmission procedures for submitting data records and 
any other information required under part 19.
---------------------------------------------------------------------------

    \382\ 17 CFR 15.01.
    \383\ 17 CFR 19.00(a)(3).
---------------------------------------------------------------------------

5. Form 304 Cotton On-Call Reporting
    With the proposed elimination of the cash-market reporting elements 
of Form 304 as described above, Form 304 would be used exclusively to 
collect the information needed to publish the Commission's weekly 
cotton on call report, which shows the quantity of unfixed-price cash 
cotton purchases and sales that are outstanding against each cotton 
futures month.\384\ The requirements pertaining to that report would 
remain in proposed Sec. Sec.  19.00(a) and 19.02, with minor 
modifications to existing provisions. The Commission proposes to update 
cross references (including to renumber Sec.  19.00(a)(2) as Sec.  
19.00(a)) and to clarify and update the procedures and timing for the 
submission of Form 304. In particular, proposed Sec.  19.02(b) would 
require that each Form 304 report be made weekly, dated as of the close 
of business on Friday, and filed not later than 9 a.m. Eastern Time on 
the third business day following that Friday using the format, coding 
structure, and electronic data transmission procedures approved in 
writing by the Commission. The Commission also proposes some 
modifications to the Form 304 itself, including conforming and 
technical changes to the organization, instructions, and required 
identifying information.\385\
---------------------------------------------------------------------------

    \384\ Cotton On-Call, U.S. Commodity Futures Trading Commission 
website, available at https://www.cftc.gov/MarketReports/CottonOnCall/index.htm (weekly report).
    \385\ Among other things, the proposed changes to the 
instructions would clarify that traders must identify themselves on 
Form 304 using their Public Trader Identification Number, in lieu of 
the CFTC Code Number required on previous versions of Form 304. This 
proposed change would help Commission staff to connect the various 
reports filed by the same market participants. This release includes 
a representation of the proposed Form 304, which would be submitted 
in an electronic format published pursuant to the proposed rules, 
either via the Commission's web portal or via XML-based, secure FTP 
transmission.
---------------------------------------------------------------------------

Request for Comment
    The Commission requests comment on all aspects of the proposed 
amendments to Part 19 and related provisions. The Commission also 
invites comments on the following:
    (46) To what extent, and for what purpose, do market participants 
and others rely on the information contained in the Commission's weekly 
cotton on-call report?
    (47) Does publication of the cotton on-call report create any 
informational advantages or disadvantages, and/or otherwise impact 
competition in any way?
    (48) Should the Commission stop publishing the cotton on-call 
report, but continue to collect, for internal use only, the information 
required in Part III of Form 304 (Unfixed-Price Cotton ``On Call'')?
    (49) Alternatively, should the Commission stop publishing the 
cotton on-call report and also eliminate the Form 304 altogether, 
including Part III?
6. Proposed Technical Changes to Part 17
    Part 17 of the Commission's regulations addresses reports by 
reporting markets, FCMs, clearing members, and foreign brokers.\386\ 
The Commission proposes to amend existing Sec.  17.00(b), which 
addresses information to be furnished by FCMs, clearing members, and 
foreign brokers, to delete certain provisions related to aggregation, 
because those provisions have become duplicative of aggregation 
provisions that were adopted in Sec.  150.4 in the 2016 Final 
Aggregation Rulemaking.\387\ The Commission also proposes to add a new 
provision, Sec.  17.03(i), which delegates certain authority under 
Sec.  17.00(b) to the Director of the Office of Data and 
Technology.\388\
---------------------------------------------------------------------------

    \386\ 17 CFR part 17.
    \387\ See Final Aggregation Rulemaking. Specifically, the 
Commission proposes to delete paragraphs (1), (2), and (3) from 
Sec.  17.00(b). 17 CFR 17.00(b).
    \388\ Under Sec.  150.4(e)(2), which was adopted in the 2016 
Final Aggregation Rulemaking, the Director of the Division of Market 
Oversight is delegated authority to, among other things, provide 
instructions relating to the format, coding structure, and 
electronic data transmission procedures for submitting certain data 
records. 17 CFR 150.4(e)(2). A subsequent rulemaking changed this 
delegation of authority from the Director of the Division of Market 
Oversight to the Director of the Office of Data and Technology, with 
the concurrence of the Director of the Division of Enforcement. See 
82 FR at 28763 (June 26, 2017). The proposed addition of Sec.  
17.03(i) would conform Sec.  17.03 to that change in delegation.

---------------------------------------------------------------------------

[[Page 11658]]

I. Removal of Part 151

    Finally, the Commission is proposing to remove and reserve part 151 
in response to its vacatur by the U.S. District Court for the District 
of Columbia,\389\ as well as in light of the proposed revisions to part 
150 that conform part 150 to the amendments made to the CEA section 4a 
by the Dodd-Frank Act.
---------------------------------------------------------------------------

    \389\ See supra note 11 and accompanying discussion.
---------------------------------------------------------------------------

III. Legal Matters

A. Introduction

    Section 737 (a)(4) of the Dodd-Frank Act,\390\ codified as section 
4a(a)(2)(A) of the Commodity Exchange Act,\391\ states in relevant part 
that ``the Commission shall'' establish position limits for contracts 
in physical commodities other than excluded commodities ``[i]n 
accordance with the standards set forth in'' section 4a(a)(1), which 
primarily contains the Commission's preexisting authority to establish 
such position limits as it ``finds are necessary.'' \392\ In connection 
with the 2011 Final Rulemaking, the Commission determined that section 
4a(a)(2)(A) is an unambiguous mandate to establish position limits for 
all physical commodities. In ISDA,\393\ however, the U.S. District 
Court for the District of Columbia held that the term ``standards set 
forth in paragraph (1)'' is ambiguous as to whether it includes the 
requirement under section 4a(a)(1) that before the Commission 
establishes a position limit, it must first find it ``necessary'' to do 
so. The court therefore vacated the 2011 Final Rulemaking and directed 
the Commission to determine, in light of the Commission's ``experience 
and expertise'' '' and the ``competing interests at stake,'' whether 
section 4a(a)(2)(A) requires the Commission to make a necessity finding 
before establishing the relevant limits, or if section 4a(a)(2)(A) is a 
mandate from Congress to do so without that antecedent finding.
---------------------------------------------------------------------------

    \390\ Dodd-Frank Wall Street Reform and Consumer Protection Act 
of 2010, Sec.  737(a)(4), Public Law 111-203, 124 Stat. 1376, 1723 
(July 21, 2010).
    \391\ 7 U.S.C. 6a(a)(2)(A).
    \392\ 7 U.S.C. 6a(a)(1).
    \393\ 887 F. Supp.2d 259.
---------------------------------------------------------------------------

    Following the court's order, the Commission subsequently determined 
that the ``standards set forth in paragraph (1)'' do not include the 
requirement in that paragraph that the Commission find position limits 
``necessary.'' \394\ Rather, the Commission determined, ``the standards 
set forth in paragraph (1)'' refer only to what the Commission called 
the ``aggregation standard'' and the ``flexibility standard.'' \395\ 
The ``aggregation standard'' referred to directions under section 
4a(a)(1)(A) that in determining whether any person has exceeded an 
applicable position limit, the Commission must aggregate the positions 
a party controls directly or indirectly, or held by two persons acting 
in concert ``the same as if the positions were held by, or the trading 
were done by, a single person.'' \396\ The ``flexibility standard'' 
referred to the statement in section 4a(a)(1)(A) that ``[n]othing in 
this section shall be construed to prohibit'' the Commission from 
fixing different limits for different commodities, markets, futures, 
delivery months, numbers of days remaining on the contract, or for 
buying and selling operations.\397\
---------------------------------------------------------------------------

    \394\ See, e.g., 2013 Proposal, 78 FR at 75680, 75684.
    \395\ See, e.g., id.
    \396\ 7 U.S.C. 6a(a)(1).
    \397\ Id.
---------------------------------------------------------------------------

    The Commission here preliminarily reaches a different conclusion. 
In light of its experience with and expertise in position limits and 
the competing interests at stake, the Commission now determines that it 
should interpret ``the standards set forth in paragraph (1)'' to 
include the traditional necessity and aggregation standards. The 
Commission also preliminarily determines that the ``flexibility 
standard'' is not an accurate way of describing the statute's lack of a 
prohibition on differential limits, and therefore is not included in 
``the standards set forth in paragraph (1)'' with which position limits 
must accord. However, even if that were not so, the Commission would 
still preliminarily determine that ``the standards set forth in 
paragraph (1)'' should be interpreted to include necessity.

B. Key Statutory Provisions

    The Commission's authority to establish position limits dates back 
to the Commodity Exchange Act of 1936.\398\ The relevant CEA language, 
now codified in its present form as section 4a(a)(1), states, among 
other things that the Commission ``shall, from time to time . . . 
proclaim and fix such limits on the amounts of trading which may be 
done or positions which may be held by any person under such 
contracts'' as the Commission ``finds are necessary to diminish, 
eliminate, or prevent such burden.'' Thus, the Commission's original 
authority to establish a position limit required it first to find that 
it was necessary to do so. Section 4a(a)(1) also includes what the 
Commission has referred to as the aggregation and flexibility 
standards.
---------------------------------------------------------------------------

    \398\ Public Law 74-675 Sec.  5, 49 Stat. 1491, 1492 (June 15, 
1936).
---------------------------------------------------------------------------

    Section 4a(a)(2)(A) provides, in relevant part, that ``[i]n 
accordance with the standards set forth in paragraph (1) of this 
subsection,'' i.e., paragraph 4a(a)(1) discussed above, the Commission 
shall, by rule, regulation, or order establish limits on the amount of 
positions, as appropriate, other than bona fide hedge positions, that 
may be held by any person with respect to contracts of sale for future 
delivery or with respect to options on the contracts or commodities 
traded on or subject to the rules of a DCM. This direction applies only 
to physical commodities other than excluded commodities. Paragraph 
4a(a)(2)(B) states that the limits for exempt physical commodities 
``required'' under subparagraph (A) ``shall'' be established within 180 
days, and for agricultural commodities the limits ``required'' under 
subparagraph (A) ``shall'' be established within 270 days. Paragraph 
4a(a)(2)(C) establishes as a ``goal'' that the Commission ``shall 
strive to ensure that trading on foreign boards of trade in the same 
commodity will be subject to comparable limits'' and that any limits 
imposed by the Commission not cause price discovery to shift to foreign 
boards of trade.
    Next, paragraph 4a(a)(3) establishes certain requirements for 
position limits set pursuant to paragraph 4a(a)(2). It directs that 
when the Commission establishes ``the limits required in paragraph 
(2),'' it shall, ``as appropriate,'' set limits on the number of 
positions that may be held in the spot month, each other month, and the 
aggregate number of positions that may be held by any person for all 
months; and ``to the extent practicable, in its discretion'' the 
Commission shall fashion the limits to (i) ``diminish, eliminate, or 
prevent excessive speculation as described under this section;'' (ii) 
``deter and prevent market manipulation, squeezes, and corners;'' (iii) 
``ensure sufficient market liquidity for bona fide hedgers;'' and (iv) 
``ensure that the price discovery function of the underlying market is 
not disrupted.''
    Paragraph 4a(a)(5) adds a further requirement that when the 
Commission establishes limits under paragraph 4a(a)(2), the Commission 
must establish limits on the amount of positions, ``as appropriate,'' 
on swaps that are ``economically equivalent'' to futures

[[Page 11659]]

and options contracts subject to paragraph 4a(a)(2).

C. Ambiguity of Section 4a With Respect to Necessity Finding

    The district court held that section 4a(a)(2) is ambiguous as to 
whether, before the Commission establishes a position limit, it must 
first find that a limit is ``necessary.'' The court found the phrase 
``[i]n accordance with the standards set forth in paragraph (1) of this 
subsection'' unclear as to whether it includes the proviso in paragraph 
(1) that position limits be established only ``as the Commission finds 
are necessary.'' \399\ The court noted that, by some definitions of 
``standard,'' a requirement that position limits be ``necessary'' could 
qualify.\400\
---------------------------------------------------------------------------

    \399\ ISDA, 887 F.Supp.2d at 274.
    \400\ Id.
---------------------------------------------------------------------------

    The district court found the ambiguity compounded by the phrase 
``as appropriate'' in sections 4a(a)(2)(A), 4a(a)(3), and 
4a(a)(5).\401\ It was unclear to the court whether this phrase gives 
the Commission discretion not to impose position limits at all if it 
finds them not appropriate, or if the discretion extends only to 
determining ``appropriate'' levels at which to set the limits.\402\ 
Neither the grammar of the relevant provisions nor the available 
legislative history resolved these issues to the court's 
satisfaction.\403\ In sum, ``the Dodd-Frank amendments do not 
constitute a clear and unambiguous mandate to set position limits.'' 
\404\ The court therefore directed the Commission to resolve the 
ambiguity, not by ``rest[ing] simply on its parsing of the statutory 
language,'' but by ``bring[ing] its experience and expertise to bear in 
light of the competing interests at stake.'' \405\
---------------------------------------------------------------------------

    \401\ Id. at 276-278.
    \402\ Id.
    \403\ Id.
    \404\ Id. at 280.
    \405\ Id. at 281.
---------------------------------------------------------------------------

D. Resolution of Ambiguity

    The Commission has applied its experience and expertise in light of 
the competing interests at stake and preliminarily determined that 
paragraph 4a(a)(2) should be interpreted as incorporating the 
requirement of paragraph 4a(a)(1) that position limits be established 
only ``as the Commission finds are necessary.'' This is based on a 
number of considerations.
    First, while the Commission has previously taken the position that 
necessity does not fall within the definition of the word ``standard,'' 
that view relied on only one of the many dictionary definitions of 
``standard,'' \406\ and the Commission now believes it was an overly 
narrow interpretation. The word ``standard'' is used in different ways 
in different contexts, and many reasonable definitions would encompass 
``necessity.'' \407\ In legal contexts, ``necessity'' is routinely 
called a ``standard.'' \408\ The Commission preliminarily believes that 
the more natural reading of ``standard'' in section 4a(a)(2)(A) does 
include the requirement of a necessity finding.
---------------------------------------------------------------------------

    \406\ ISDA, Defendant Commodity Futures Trading Commission's 
Cross-Motion for Summary Judgment at 24-25, (quoting definition of 
``standard'' as ``something set up and established by authority as a 
rule for the measure of quantity, weight, extent, value, or 
quality'' from Merriam-Webster's Collegiate Dictionary 1216 (11th 
ed. 2011)).
    \407\ Black's Law Dictionary 1624 (10th ed. 2014) (``A criterion 
for measuring acceptability, quality, or accuracy.''); The American 
Heritage Dictionary of the English Language (5th ed. 2011) (``A 
degree or level of requirement, excellence, or attainment.''); New 
Oxford American Dictionary 1699 (3rd ed. 2010) (``an idea or thing 
used as a measure, norm, or model in comparative evaluations''); The 
Random House Unabridged Dictionary 1857 (2d ed. 1993) (``rule or 
principle that is used as a basis for judgment''); XVI The Oxford 
English Dictionary 505 (2d ed. 1989) (``A rule, principle, or means 
of judgment or estimation; a criterion, measure.'').
    \408\ Home Buyers Warranty Corp. v. Hanna, 750 F.3d 427, 435 
(4th Cir. 2014) (applying a `` `necessity' standard'' under Fed. R. 
Civ. P. 19(a)(1)(A)); United States v. Cartagena, 593 F.3d 104, 111 
n.4 (1st Cir. 2010) (discussing a ``necessity standard'' under the 
Omnibus Crime Control and Safe Streets Act of 1968); Fones4All Corp. 
v. F.C.C., 550 F.3d 811, 820 (9th Cir. 2008) (applying a ``necessity 
standard'' under the Telecommunications Act of 1996); Swonger v. 
Surface Transp. Bd., 265 F.3d 1135, 1141-42 (10th Cir. 2001) 
(applying a ``necessity standard'' under transportation law); see 
also Minnesota v. Mille Lacs Band of Chippewa Indians, 526 U.S. 172, 
205 (1999) (``conservation necessity standard''); Int'l Union, 
United Auto., Aerospace & Agr. Implement Workers of Am., UAW v. 
Johnson Controls, Inc., 499 U.S. 187, 198 (1991) (``business 
necessity standard'').
---------------------------------------------------------------------------

    Second, and relatedly, the Commission believes the term 
``standard'' is a less natural fit for the language in subparagraph 
4a(a)(1) that the Commission has previously called the ``flexibility 
standard.'' The sentence provides that ``[n]othing in this section 
shall be construed to prohibit the Commission from fixing different 
trading or position limits for different'' contracts or 
situations.\409\ Typically a legal standard constrains an agency's 
discretion.\410\ But nothing in the so-called ``flexibility'' language 
constrains the Commission at all. In other words, the express lack of 
any prohibition of differential limits under section 4a(a)(1) is better 
understood as the absence of any standard.\411\ And if flexibility is 
not a standard, then necessity must be, because section 4a(a)(2)(A) 
refers to ``standards,'' plural.
---------------------------------------------------------------------------

    \409\ 7 U.S.C. 6a(a)(1)(A).
    \410\ See, e.g., OSU Student Alliance v. Ray, 699 F.3d 1053, 
1064 (9th Cir. 2012) (holding that the First Amendment was violated 
by enforcement of a rule that ``created no standards to cabin 
discretion''); Lenis v. U.S. Attorney General, 525 F.3d 1291, 1294 
(11th Cir. 2008) (dismissing petition for review where agency 
procedural regulation ``specifie[d] no standards for a court to use 
to cabin'' the agency's discretion); Tamenut v. Mukasey, 521 F.3d 
1000, 1004 (8th Cir. 2008); Drake v. FAA, 291 F.3d 59, 71 (D.C. Cir. 
2002) (similar).
    \411\ Tamenut v. Mukasey, 521 F.3d 1000, 1004 (8th Cir. 2008) 
(explaining that a statute placing ``no constraints on the 
[agency's] discretion . . . specifie[d] no standards''); United 
States v. Gonzalez-Aparicio, 663 F.3d 419, 435 (9th Cir. 2011) 
(Tashima, J., dissenting) (``If we can pick whatever standard suits 
us, free from the direction of binding principles, then there is no 
standard at all.''); Downs v. Am. Emp. Ins. Co., 423 F.2d 1160, 1163 
(5th Cir. 1970) (``best judgment is no standard at all'').
---------------------------------------------------------------------------

    Third, the requirement that position limits be ``appropriate'' is 
an additional ground to interpret the statute as lacking an across-the 
board-mandate. In the past, the Commission has taken the view that the 
word ``appropriate'' as used in section 4a(a)(2)(A)--and in sections 
4a(a)(3) and 4a(a)(5) in connection with position limits established 
pursuant to section 4a(a)(2)(A)--refers to position limit levels but 
not to the determination of whether to establish a limit.\412\ However, 
the Supreme Court has opined in the context of the Clean Air Act that 
``[n]o regulation is `appropriate' if it does significantly more harm 
than good.'' \413\ That was not a CEA case, but the Commission finds 
the Court's reasoning persuasive in this context.
---------------------------------------------------------------------------

    \412\ E.g., ISDA, Commission Appellate Brief at 37-38.
    \413\ Michigan v. EPA, 135 S.Ct. 2699, 2707 (2015). Because 
Michigan was not a CEA case, the Commission does not mean to imply 
that Michigan would be controlling or compels any particular result 
in determining when a position limit is appropriate. To the 
contrary, the court in ISDA held that the CEA is ambiguous in that 
regard. The Commission merely finds the Supreme Court's discussion 
in Michigan useful in reasonably resolving that ambiguity.
---------------------------------------------------------------------------

    It is reasonable to interpret the direction to set a position limit 
``as appropriate'' to mean that in a given context, it may be that no 
position limit is justified. Under an across-the-board mandate, 
however, the Commission would be compelled to impose some limit even if 
any level of position limit would do significantly more harm than good, 
including with respect to the public interests Congress set forth in 
section 4a(a)(1) itself and elsewhere in section 4a and the CEA 
generally.\414\ The Commission does not believe that is the best 
reading of section 4a(a)(2)(A). Rather, Congress's use of 
``appropriate'' in that section and elsewhere in the Dodd-Frank 
amendments is more consistent with a directive that the

[[Page 11660]]

Commission consider all relevant factors and, on that basis, set an 
appropriate limit level--or no limit at all, if to establish one would 
contravene the public interests Congress articulated in section 
4a(a)(1) and the CEA generally. That is also better policy. To be 
clear, this does not mean the Commission must conduct a formal cost-
benefit analysis in which each advantage and disadvantage is assigned a 
monetary value. To the contrary, the Commission retains broad 
discretion to decide how to determine whether a position limit is 
appropriate.\415\
---------------------------------------------------------------------------

    \414\ 7 U.S.C. 5, 6a(a)(2)(C) and (a)(3)(B).
    \415\ 135 S.Ct. at 2707, 2711.
---------------------------------------------------------------------------

    Fourth, mandatory federal position limits for all physical 
commodities would be a sea change in derivatives regulation, and the 
Commission does not believe it should infer that Congress would have 
acted so dramatically without speaking clearly and unequivocally.\416\ 
It is important to understand the reach of the proposition that the 
Commission must impose position limits for every physical commodity. 
The Commission estimates, based on information from the Commission's 
surveillance system, that currently there are over 1,200 contracts on 
physical commodities listed on DCMs. Some of these contracts have 
little or no active trading.\417\ Absent clearer statutory language 
than is present in the statute, the Commission does not believe it 
should interpret the statute as though Congress had concerns about or 
even considered each and every one of the similar number of contracts 
listed at the time of Dodd-Frank. In a similar vein, the Commission 
previously has cited Senate Subcommittee's staff studies of potential 
excessive speculation that preceded the enactment of section 
4a(a)(2).\418\ But those studies covered only a few commodities--oil, 
natural gas, and wheat.\419\ While these studies demonstrate that 
Senate subcommittee's concern with potential excessive speculation, the 
Commission does not believe it should interpret a statute by 
extrapolating from one Senate subcommittee's interest in three specific 
commodities to a requirement to impose limits on all of the many 
hundreds of physical futures contracts listed on exchanges, where 
Congress as a whole has not said so unambiguously.
---------------------------------------------------------------------------

    \416\ E.g., Whiteman v. American Trucking Assns., Inc., 531 U.S. 
457, 468 (2000) (Congress . . . does not alter the fundamental 
details of a regulatory scheme in vague terms. . . .''); EEOC v. 
Staten Island Sav. Bank, 207 F.3d 144, (2d Cir. 2000) (``we are 
reluctant to infer . . . a mandate for radical change absent a 
clearer legislative command''); Canup v. Chipman-Union, Inc., 123 
F.3d 1440, (11th Cir. 1997) (``We would expect Congress to speak 
more clearly if it intended such a radical change. . . .'').
    \417\ See, e.g., Daily Agricultural Volume and Open Interest, 
CME Group website, available at https://www.cmegroup.com/market-data/volume-open-interest/agriculture-commodities-volume.html 
(tables of daily trading volume and open interest for CME futures 
contracts).
    \418\ E.g., 2013 Proposal, 78 FR at 75787 nn.122-124; ISDA, 
Brief for Appellant Commodity Futures Trading Commission at 14-15.
    \419\ Id.
---------------------------------------------------------------------------

    DCMs also regularly create new contracts. If Congress intended 
federal position limits to apply to all physical commodity contracts, 
the Commission would expect there to be a provision directing it to 
establish position limits on a continuous basis. There is no such 
provision--and Congress directed the Commission to complete its 
position-limits rulemaking within 270 days.\420\ The only other 
relevant provision is the preexisting and broadly discretionary 
requirement that the Commission make an assessment ``from time to 
time.'' That structure is inconsistent, both as a statutory and policy 
matter, with an across-the-board mandate.
---------------------------------------------------------------------------

    \420\ 7 U.S.C. 6a(a)(2)(B).
---------------------------------------------------------------------------

    Fifth, the Commission believes as a matter of policy judgment that 
requiring a necessity finding better carries out the purposes of 
section 4a. As Congress presumably was aware, position limits create 
costs as well as potential benefits.
    The Commission has recognized, and Congress also presumably 
understood, that there are costs even for well-crafted position limits. 
As discussed below in the Commission's consideration of costs and 
benefits, market participants must monitor their positions and have 
safeguards in place to ensure compliance with limits. In addition to 
compliance costs, position limits may constrain some economically 
beneficial uses of derivatives, because a limit calculated to prevent 
excessive speculation or to restrict opportunities for manipulation 
may, in some circumstances, affect speculation that is desirable. While 
the Commission has designed limits to avoid interference with normal 
trading, certain negative effects cannot be ruled out.
    For example, to interpret section 4a(a)(2) as a mandate even where 
unnecessary could pose risks to liquidity and hedging. Well-calibrated 
position limits can protect liquidity by checking excessive 
speculation, but unnecessary limits can have the opposite effect by 
drawing capital out of markets. Indeed, the liquidity of a futures 
contract, upon which hedging depends, is directly related to the amount 
of speculation that takes place. Speculators contribute valuable 
liquidity to commodity markets, and section 4a(a)(1) identified 
``excessive speculation''--not all speculation--as ``an undue burden on 
interstate commerce.'' To needlessly reduce liquidity, impair price 
discovery, and make hedging more difficult for commodity end-users 
without sufficient beneficial effects on interstate commerce is unsound 
policy, as Congress has defined the policy. If Congress had drafted the 
statute unambiguously to reflect the judgment that these costs of 
position limits are justified in all instances, the Commission of 
course would follow it. Without such clarity, the Commission does not 
believe it should interpret the statute to impose those costs 
regardless of whether and to what extent doing so advances Congress' 
stated goals.
    Sixth, while Congress has deemed position limits an effective tool, 
it is sound regulatory policy for the Commission to apply its 
experience and expertise to determine whether economic conditions with 
respect to a given commodity at a given point in time render it likely 
that position limits will achieve positive outcomes. A mandate without 
the requirement of a necessity finding would eliminate the Commission's 
expertise and experience from the process and could lead to position 
limits that do not have significantly positive effects, or even 
position limits that are counterproductive. Necessity findings may also 
enhance public confidence that position limits in place are necessary 
to their statutory purposes, potentially improving public confidence in 
the markets themselves. It is therefore sound policy to construe the 
statute in a way that requires the Commission to make a necessity 
finding before establishing position limits.\421\
---------------------------------------------------------------------------

    \421\ The Commission also does not believe that establishing and 
enforcing position limits for all contracts on physical commodities, 
regardless of their importance to the price or delivery process of 
the underlying commodities or to the economy more broadly, would be 
a productive use of the public resources Congress has appropriated 
to the Commission.
---------------------------------------------------------------------------

    Finally, also as a matter of policy, the Commission's approach will 
prevent market participants from suffering the costs of statutory 
ambiguity. Mandating position limits across all products would 
automatically impose costs on market participants regardless of whether 
doing so fulfills the purpose of section 4a. The associated compliance 
costs remain as long as those limits are in place. Reading a mandate 
into section 4a would exchange regulatory convenience, with or without 
any public benefit, for long-term burdens on market participants. The 
Commission does not believe that ambiguity should

[[Page 11661]]

be resolved reflexively in a manner that shifts costs to market 
participants. Rather, the Commission believes that where an agency has 
discretion to choose from among reasonable alternative interpretations, 
it should not impose costs without a strong justification, which in 
this context would be lacking without a necessity finding.

E. Evaluation of Considerations Relied Upon by the Commission in 
Previous Interpretation of Paragraph 4a(a)(2)

    As noted above, the Commission previously has identified a number 
of considerations it believed supported interpreting paragraph 4a(a)(2) 
to mandate position limits for all physical commodities other than 
excluded commodities, without the need for a necessity finding. 
Although the Administrative Procedure Act does not require the 
Commission to rebut those previous points, the Commission believes it 
is useful to discuss them. While certain of these considerations could 
support such an interpretation, the Commission is no longer persuaded 
that, on balance, they support interpreting paragraph 4a(a)(2) as an 
across-the-board mandate. Considerations on which the Commission 
previously relied include the following:
    1. When Congress enacted paragraph 4a(a)(2), the text of what 
previously was paragraph 4a(a),\422\ already provided that the 
Commission ``shall . . . proclaim and fix'' position limits ``as the 
Commission finds are necessary'' to diminish, eliminate, or prevent the 
burdens on commerce associated with excessive speculation. This 
directive applied--and still applies--to all exchange-traded 
commodities, including the physical commodities that are the subject of 
paragraph 4a(a)(2). The Commission has previously reasoned that if 
paragraph 4a(a)(2) were not a mandate to establish position limits 
without such a necessity finding, it would be a nullity.\423\ That is, 
the Commission already had the authority to issue position limits, so 
4a(a)(2) would add nothing were it not a mandate. The Commission is no 
longer convinced that is correct.
---------------------------------------------------------------------------

    \422\ 7 U.S.C. 6a(a).
    \423\ E.g., 2016 Reproposal, 81 FR at 96715, 96716 (discussing 
comments on past releases); 2013 Proposal, 78 FR at 75684.
---------------------------------------------------------------------------

    Whereas the Commission's preexisting authority under the 
predecessor to paragraph 4a(a)(1) directed the Commission to establish 
position limits ``from time to time,'' new paragraph 4a(a)(2) directed 
the Commission to consider position limits promptly within two 
specified time limits after Congress passed the Dodd-Frank Act. That is 
a new directive, and it is consistent with maintaining the requirement 
for, and preserving the benefits of, a necessity finding. This 
interpretation is also consistent with the Commission's belief that 
Congress would not have intended a drastic mandate without a clear 
statement to that effect. This interpretation is likewise consistent 
with Congress' addition of swaps to the Commission's jurisdiction--it 
makes sense to direct the Commission to give prompt consideration to 
whether position limits are necessary at the same time Congress was 
expanding the Commission's oversight responsibilities to new markets, 
and the Commission believes that is sound policy to ensure that the 
regime works well as a whole. Rather than leave it to the Commission's 
preexisting discretion to set limits ``from time to time,'' it is 
reasonable to believe that Congress found it important for the 
Commission to focus on this issue at a time certain.
    In addition, paragraph 4a(a)(2) triggers other requirements added 
to section 4a(a) by Dodd-Frank and not included in paragraph 4a(a)(1). 
For example, as described above, paragraph 4a(a)(3)(B) identifies 
objectives the Commission is required to pursue in establishing 
position limits, including three, set forth in subparagraphs 
4a(a)(3)(B)(ii)-(iv), that are not explicitly mentioned in paragraph 
4a(a)(1). The Commission previously opined that paragraph 4a(a)(5), 
which directs the Commission to establish, position limits on swaps 
``economically equivalent'' to futures subject to new position limits, 
would add nothing to paragraph 4a(a)(1), because if there were no 
mandate. The Commission no longer finds that reasoning persuasive. 
Paragraph 4a(a)(5) goes beyond paragraph 4a(a)(1), because it 
separately requires that when the Commission imposes limits on futures 
pursuant to paragraph 4a(a)(2), it also does so on economically 
equivalent swaps. Without that text, the Commission would have no such 
obligation to issue both types of limits at the same time.
    2. The Commission has also previously been influenced by the 
requirements of paragraph 4a(a)(3), which directs the Commission, ``as 
appropriate'' when setting limits, to establish them for the spot 
month, each other month, and all months; and sets forth four policy 
objectives the Commission must pursue ``to the maximum extent 
practicable.'' \424\ The Commission described these as ``constraints'' 
and found it ``unlikely'' that Congress intended to place new 
constraints on the Commission's preexisting authority to establish 
position limits, given the background of the amendments and in 
particular the studies that preceded their enactment.\425\ However, on 
further consideration of this statutory language, the Commission does 
not interpret that language as a set of constraints in the sense of 
directing the Commission to make less use of limits or to impose higher 
limits than in the past. Rather, it focuses the Commission's decision 
process by identifying relevant objectives and directing the Commission 
to achieve them to the maximum extent practicable. Requiring the 
Commission to prioritize, to the extent practicable, preventing 
excessive speculation and manipulation, ensuring liquidity, and 
avoiding disruption of price discovery is reasonable regardless of 
whether there is an across-the-board mandate.
---------------------------------------------------------------------------

    \424\ 7 U.S.C. 6a(a)(3).
    \425\ E.g., 2016 Reproposal, 81 FR at 96716 (discussing comments 
on earlier releases).
---------------------------------------------------------------------------

    In past releases the Commission has also suggested that it is 
unclear why Congress would have imposed the decisional ``constraints'' 
of paragraph 4a(a)(3) ``with respect to physical commodities but not 
excluded commodities or others'' unless this provision was enacted as 
part of a mandate to impose limits without a necessity finding.\426\ 
However, all of these relevant amendments pertain only to physical 
commodities other than excluded commodities. The Congressional studies 
that preceded the enactment of paragraph 4a(a)(2) demonstrated concern 
specifically with problems in markets for physical commodities such as 
oil and natural gas.\427\ It therefore is not surprising that Congress 
enacted provisions specifically addressing limits for physical 
commodities and not others, whether or not Congress intended a 
necessity finding. Those physical commodities were the focus of 
Congress' concern.
---------------------------------------------------------------------------

    \426\ Id.
    \427\ See, e.g., 2013 Proposal, 78 FR at 75682 and nn.24-26 
(describing Congressional studies).
---------------------------------------------------------------------------

    3. The Commission has previously stated that the time requirements 
for establishing limits set forth in subparagraph 4a(a)(2)(B) are 
inconsistent with a necessity finding because, based on past 
experience, necessity findings for individual commodity markets cannot 
be made

[[Page 11662]]

within the specified time periods.\428\ However, the fact that many 
decades ago a number of months may have elapsed between proposals and 
final position limits does not mean that much time was necessary then 
or is necessary now. There are a number of possible reasons, such as 
limits on agency resources and why the agency took that amount of time. 
It is not a like-to-like comparison, because the agencies acting many 
decades ago were not acting pursuant to a mandate. The speed with which 
an agency could or would enact discretionary position limits is not 
necessarily a good proxy for how long would be required under a 
mandate.\429\ There is accordingly no inconsistency, and thus the 
deadlines do not necessarily imply that Congress intended to eliminate 
a necessity finding for limits under paragraph 4a(a)(2).
---------------------------------------------------------------------------

    \428\ E.g., 2016 Reproposal, 81 FR at 96708; 2013 Proposal, 78 
FR at 75682, 75683.
    \429\ The Commission's reasoning in this respect has also 
assumed that a necessity finding means a granular market-by-market 
study of whether position limits will be useful for a given 
contract. As explained below, however, the Commission here 
preliminarily determines that such an analysis is not required. 
Under the Commission's current preliminary interpretation of the 
necessity finding requirement, it would have been plausible to 
complete the required findings under the deadlines Congress 
established.
---------------------------------------------------------------------------

    4. The Commission previously has stated that Congress appears to 
have modeled the text of paragraph 4a(a)(2) on the text of the 
Commission's 1981 rule requiring exchanges to set speculative position 
limits for all contracts.\430\ The Commission has further stated that 
the 1981 rule treated aggregation and flexibility as ``standards,'' and 
Congress therefore likely did the same in paragraph 4a(a)(2).\431\ The 
Commission no longer agrees with that description or that reasoning.
---------------------------------------------------------------------------

    \430\ E.g., 2013 Proposal, 78 FR at 75683, 75684.
    \431\ Id.
---------------------------------------------------------------------------

    Under the 1981 rule, former section 1.61(a) of the Commission's 
regulations required exchanges to adopt position limits for all 
contracts listed to trade.\432\ The rule also established requirements 
similar to the current statutory aggregation requirements: Section 
1.61(a) required that limits apply to positions a person may either 
``hold'' or ``control,'' \433\ section 1.61(g) established more 
detailed aggregation requirements.\434\ Section 1.61(a)(1) contained 
language the Commission has called the ``flexibility standard,'' i.e., 
that ``nothing'' in section 1.61 ``shall be construed to prohibit a 
contract market from fixing different and separate position limits for 
different types of futures contracts based on the same commodity, 
different position limits for different futures, or for different 
delivery months, or from exempting positions which are normally known 
in the trade as `spreads, straddles or arbitrage' or from fixing limits 
which apply to such positions which are different from limits fixed for 
other positions.'' \435\ Section 1.61(d)(1) of the rule required every 
exchange to submit information to the Commission demonstrating that it 
had ``complied with the purpose and standards set forth in paragraph 
(a).'' \436\ In the 2013 and 2016 proposals, the Commission concluded 
that the cross-reference to the ``standards set forth in paragraph 
(a)'' meant both the aggregation and flexibility language, because both 
of those sets of language appear in paragraph (a). By contrast, 
paragraph (a) did not include a requirement for a necessity finding, 
since the 1981 rule required position limits on all actively traded 
contracts.\437\
---------------------------------------------------------------------------

    \432\ Establishment of Speculative Position Limits, 46 FR at 
50945 (Oct. 16, 1981).
    \433\ Id.
    \434\ Id. at 50946.
    \435\ Id. at 50945.
    \436\ Id.
    \437\ Id.
---------------------------------------------------------------------------

    On further review, the Commission does not find this reasoning 
persuasive. The ``flexibility'' language gave the exchange unfettered 
discretion to set different limits for different kinds of positions--
there was expressly ``nothing'' in that language to limit the 
exchange's discretion.\438\ In other words, there is nothing in that 
flexibility text with which to ``comply,'' so it cannot be part of what 
section 1.61(d)(1) referenced as a ``standard'' for which compliance 
must be demonstrated.
---------------------------------------------------------------------------

    \438\ 46 FR at 50945 (section 1.61(a)(1)).
---------------------------------------------------------------------------

    As discussed above, ``standard'' is an ill-fitting label for this 
lack of a prohibition. Indeed, the 1981 release and associated 1980 
NPRM did use the word ``standard'' to refer to certain language 
directing and constraining the discretion of the exchanges, a much more 
natural use of that word. For example, the preambles to both releases 
called requirements to aggregate certain holdings ``aggregation 
standards.'' \439\ And, in both the 1980 NPRM (in the preamble) and the 
1981 Final Rule (in rule text), the Commission used the word 
``standard'' to describe factors, such as position sizes customarily 
held by speculative traders, that exchanges were required to consider 
in setting the level of position limits.\440\
---------------------------------------------------------------------------

    \439\ Id. at 50943; Speculative Position Limits, 45 FR at 79834.
    \440\ 46 FR at 50945 (in section 1.61(a)(2)); 45 FR at 79833, 
79834.
---------------------------------------------------------------------------

    Although the wording of the 1981 rule and paragraph 4a(a)(2) have 
similarities, there are also differences. These differences weaken the 
inference that Congress intended the statute to hew closely to the 
rule. There is no legislative history articulating any relationship 
between the two. And even if Congress in Dodd-Frank did borrow concepts 
from the 1981 rule, there is little reason to infer that Congress was 
borrowing the precise meaning of any individual word--much less that 
the use of ``standards'' includes what ``nothing in this section shall 
be construed to prohibit . . . .''
    5. In past releases the Commission has also observed that, in 1983, 
as part of the Futures Trading Act of 1982, Public Law 96-444, 96 Stat. 
2294 (1983), Congress added a provision to the CEA making it a 
violation of the Act to violate exchange-set position limits, thus, in 
effect, ratifying the Commission's 1981 rule.\441\ The Commission 
reasoned that this history supports the possibility that Congress could 
reasonably have followed an across-the-board approach here.\442\ But 
while that may be so, the Commission today does not find that mere 
possibility helpful in interpreting the ambiguous term ``standards,'' 
because there is no evidence that Congress in 1982 considered the lack 
of a prohibition on different position limit levels in the rule to be a 
``standard.'' By extension, the Futures Trading Act does not bear on 
the Commission's preliminary interpretation of ``standards'' in section 
4a(a)(2)(A) today.
---------------------------------------------------------------------------

    \441\ See, e.g., 2016 Reproposal, 81 FR at 96709, 96710.
    \442\ Id. at 96710.
---------------------------------------------------------------------------

    6. In briefs in the ISDA case, the Commission pointed out that CEA 
paragraphs 4a(a)(2)(B) and 4a(a)(3) repeatedly use the word 
``required'' in connection with position limits established pursuant to 
paragraph 4a(a)(2), implying that the Commission is required to 
establish those limits regardless of whether it finds them to be 
necessary.\443\ But that is not the only way to interpret the word 
``required.'' Position limits are required under certain circumstances 
even if there is no across-the-board mandate--i.e., when the Commission 
finds that they are ``necessary.'' Under the Commission's current 
preliminary interpretation, the Commission was required to assess 
within a specified timeframe if position limits were ``necessary'' and, 
if so, section 4a(a)(2) states that the Commission ``shall'' establish 
them.

[[Page 11663]]

Thus, the word ``required'' in paragraphs 4a(a)(2)(B) and 4a(a)(3) 
leaves open the question of whether paragraph 4a(a)(2) itself requires 
position limits for all physical commodity contracts or, on the other 
hand, only requires them where the Commission finds them necessary 
under the standards of paragraph 4a(a)(1). The use of the word 
``required'' in paragraphs 4a(a)(2)(B) and 4a(a)(3) therefore does not 
resolve the ambiguity in the statute. For the same reason, the 
evolution of the statutory language during the legislative process, 
during which the word ``may'' was changed to ``shall'' in a number of 
places, also does not resolve the ambiguity.\444\
---------------------------------------------------------------------------

    \443\ E.g., ISDA, Brief for Appellant Commodity Futures Trading 
Commission at 26-27.
    \444\ See, e.g., 2013 Proposal, 78 FR at 75684, 75685 
(discussing evolution of statutory language as supporting mandate).
---------------------------------------------------------------------------

    7. The Commission has pointed out that section 719 of the Dodd-
Frank Act required the Commission to ``conduct a study of the effects 
(if any) of the position limits imposed'' pursuant to paragraph 
4a(a)(2) and report the results to Congress within twelve months after 
the imposition of limits.\445\ The Commission has suggested that 
Congress would not have required such a study if paragraph 4a(a)(2) 
left the Commission with discretion to find that limits were 
unnecessary so that there would be nothing for the Commission to study 
and report on to Congress.\446\ However, while the study requirement 
implies that Congress perhaps anticipated that at least some limits 
would be imposed pursuant to paragraph 4a(a)(2), it leaves open the 
question of whether Congress mandated limits for every physical 
commodity without the need for a necessity finding. In addition, the 
phrase ``the effects (if any)'' language does not imply that Congress 
expected position limits on all physical commodities. This language 
simply recognizes that new position limits could be imposed, but have 
no demonstrable effects.
---------------------------------------------------------------------------

    \445\ See, e.g., id. at 75684.
    \446\ See, e.g., id.
---------------------------------------------------------------------------

    8. In past releases and court filings, the Commission has stated 
that the legislative history of section 4a, as amended by the Dodd-
Frank Act, supports the conclusion that paragraph 4a(a)(2) requires the 
establishment of position limits for all physical commodities whether 
or not the Commission finds them necessary to achieve the objectives of 
the statute.\447\ However, the most relevant legislative history, taken 
as a whole, does not resolve the ambiguity in the statutory language or 
compel the conclusion that Congress intended to drop the necessity 
finding requirement when it enacted paragraph 4a(a)(2) as part of the 
Dodd-Frank Act.
---------------------------------------------------------------------------

    \447\ See, e.g., 2016 Reproposal, 81 FR at 96709.
---------------------------------------------------------------------------

    The language of paragraph 4a(a)(2) derives from section 6(a) of a 
bill, the Derivatives Markets Transparency and Accountability Act of 
2009, H.R. 977 (111th Cong.), which was approved by the House Committee 
on Agriculture in February of 2009.\448\ The committee report on this 
bill included explanatory language stating that the relevant provision 
required the Commission to set position limits ``for all physical 
commodities other than excluded commodities.'' \449\ However, H.R. 977 
was never approved by the full House of Representatives.\450\
---------------------------------------------------------------------------

    \448\ See H.R. Rep. 111-385 part 1 at 4 (Dec. 19, 2009).
    \449\ Id. at 19.
    \450\ See Actions--H.R.977--111th Congress (2009-2010) 
Derivatives Markets Transparency and Accountability Act of 2009, 
Congress website, available at https://www.congress.gov/bill/111th-congress/house-bill/977/all-actions?overview=closed#tabs (bill 
history).
---------------------------------------------------------------------------

    The relevant language concerning position limits was incorporated 
into the House of Representatives version of what became the Dodd-Frank 
Act, H.R. 4173 (111th Cong.), as part of a floor amendment that was 
introduced by the chairman of the Committee on Agriculture.\451\ In 
explaining the amendment's language regarding position limits, the 
chairman stated that it ``strengthens confidence in position limits on 
physically deliverable commodities as a way to prevent excessive 
speculation trading'' but did not specify that limits would be required 
for all physical commodities without the need for a necessity 
finding.\452\ The House of Representatives language regarding position 
limits was ultimately incorporated into the Dodd-Frank Act by a 
conference committee. However, the explanatory statement in the 
Conference report states, with respect to position limits, only that 
the act's ``regulatory framework outlines provisions for: . . . 
[p]osition limits on swaps contracts that perform or affect a 
significant price discovery function and requirements to aggregate 
limits across markets.'' \453\
---------------------------------------------------------------------------

    \451\ 155 Cong. Rec. H14682, H14692 (daily ed. Dec. 10, 2009).
    \452\ Id. at H14705.
    \453\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Conference Report to Accompany H.R. 4173 at 969 (H.R. Rep. 111-517 
June 29, 2010).
---------------------------------------------------------------------------

    In subsequent floor debate, the chairman of the House Agriculture 
Committee alluded to position limits provisions deriving from earlier 
bills reported by that committee, but did not describe them with 
specificity.\454\ In the Senate, the chairman of the Senate Committee 
on Agriculture, Nutrition, and Forestry stated that the conference bill 
would ``grant broad authority to the Commodity Futures Trading 
Commission to once and for all set aggregate position limits across all 
markets on non-commercial market participants.'' \455\ The statement 
that the bill would grant ``authority'' to set position limits implies 
an exercise of judgement by the Commission in determining whether to 
set particular limits.\456\ Thus, this legislative history is itself 
ambiguous on the question of whether federal position limits are now 
mandatory on all physical commodities in the absence of a finding of 
necessity.
---------------------------------------------------------------------------

    \454\ He stated, ``This conference report includes the tools we 
authorized [in response to concerns about excessive speculation] and 
the direction to the CFTC to mitigate outrageous price spikes we saw 
2 years ago.'' 156 Cong. Rec. H5245 (daily ed. June 30, 2010).
    \455\ 156 Cong. Rec. S5919 (daily ed. July 15, 2010).
    \456\ In addition, the remainder of the Senate chairman's floor 
statement with regard to position limits focused on volatility and 
price discovery problems arising from the use of commodity swaps, 
implying that her reference to setting position limits ``across all 
markets'' refers to Dodd-Frank's extension of position limits 
authority to swaps markets. 156 Cong. Rec. at S5919-20 (daily ed. 
July 15, 2010).
---------------------------------------------------------------------------

    Looking at legislative history in more general terms, the 
Commission, in past releases, has pointed out that the enactment of 
paragraph 4a(a)(2) followed congressional investigations in the late 
1990s and early 2000s that concluded that excessive speculation 
accounted for volatility and prices increases in the markets for a 
number of commodities.\457\ However, while the history of congressional 
investigations supports the conclusion that Congress intended the 
Commission to take action with respect to position limits, it does not 
resolve the specific interpretive issue of whether the ``[i]n 
accordance with the standards set forth in paragraph (1)'' language 
that was ultimately enacted by Congress incorporates a necessity 
finding. As discussed above, the congressional investigations focused 
on only a few commodities, which weakens the inference that Congress 
considered the question of what speculative positions to limit a closed 
question.
---------------------------------------------------------------------------

    \457\ See, e.g., 2016 Reproposal, 81 FR at 96711-96713.
---------------------------------------------------------------------------

    Overall, in past releases the Commission has expressed the view 
that construing section 4a as an ``integrated whole'' leads to the 
conclusion that paragraph 4a(a)(2) does not require a

[[Page 11664]]

necessity finding.\458\ However, for reasons explained above, the 
Commission preliminarily believes that the better interpretation is 
that prior to imposing position limits, it must make a finding that the 
position limits are necessary.
---------------------------------------------------------------------------

    \458\ See, e.g., 2016 Reproposal, 81 FR at 96713, 96714.
---------------------------------------------------------------------------

F. Necessity Finding

    The Commission preliminarily finds that federal speculative 
position limits are necessary for the 25 core referenced futures 
contracts, and any associated referenced contracts. This preliminary 
finding is based on a combination of factors including: The particular 
importance of these contracts in the price discovery process for their 
respective underlying commodities; the fact that they require physical 
delivery of the underlying commodity; and, in some cases, the 
especially acute economic burdens that would arise from excessive 
speculation causing sudden or unreasonable fluctuations or unwarranted 
changes in the price of the commodities underlying these contracts. The 
Commission has preliminarily determined that the benefit of advancing 
the statutory goal of preventing those undue burdens with respect to 
these commodities in interstate commerce justifies the potential 
burdens or negative consequences associated with establishing these 
targeted position limits.\459\
---------------------------------------------------------------------------

    \459\ As discussed, the Commission is not proposing non-spot-
month limits apart from the legacy agricultural contracts. Non-spot-
month prices serve as references for cash-market transactions much 
less frequently than spot-month prices. Accordingly, the burdens of 
excessive speculation in non-spot-months on commodities in 
interstate commerce would be substantially less than the burdens of 
excessive speculation in spot-months. It is also not possible to 
execute a corner or squeeze in non-spot-months. And because there 
generally are fewer market participants in non-spot-months, holders 
of large speculative positions may play a more important role in 
providing liquidity to bona fide hedgers.
---------------------------------------------------------------------------

1. Meaning of ``Necessary'' Under Section 4a(a)(1)
    Section 4a(a)(1) of the Act contains a congressional finding that 
``[e]xcessive speculation . . . causing sudden or unreasonable 
fluctuations or unwarranted changes in . . . price . . . is an undue 
and unnecessary burden on interstate commerce in such commodity.'' 
\460\ For the purpose of ``diminishing, eliminating, or preventing'' 
that burden, section 4a(a)(1) tasks the Commission with establishing 
such position limits as it finds are ``necessary.'' \461\ The 
Commission's analysis, therefore, proceeds on the basis of these 
legislative findings that excessive speculation threatens negative 
consequences for interstate commerce and the accompanying proposition 
that position limits are an effective tool to diminish, eliminate, or 
prevent the undue and unnecessary burdens Congress has targeted in the 
statute.\462\ The Commission will therefore determine whether position 
limits are necessary for a given contract, in light of those premises, 
considering facts and circumstances and economic factors.
---------------------------------------------------------------------------

    \460\ 7 U.S.C. 6a(a)(1).
    \461\ 7 U.S.C. 6a(a)(1).
    \462\ It is not the Commission's role to determine if these 
findings are correct. See Public Citizen v. FTC, 869 F.2d 1541, 1557 
(D.C. Cir. 1989) (``[A]gencies surely do not have inherent authority 
to second-guess Congress' calculations.''); see also 46 FR at 50938, 
50940 (``Section 4a(1) [now 4a(a)(1)] represents an express 
Congressional finding that excessive speculation is harmful to the 
market, and a finding that speculative limits are an effective 
prophylactic measure.'').
---------------------------------------------------------------------------

    The statute does not define ``necessary.'' In legal contexts, the 
term can have ``a spectrum of meanings.'' \463\ ``At one end, it may 
`import an absolute physical necessity, so strong, that one thing, to 
which another may be termed necessary, cannot exist without that 
other;' at the opposite, it may simply mean `no more than that one 
thing is convenient, or useful, or essential to another.' '' \464\ The 
Commission does not believe Congress intended either end of this 
spectrum in section 4a(a)(1). On one hand, ``necessary'' in this 
context cannot mean that position limits must be the only means capable 
of addressing the burdens associated with excessive speculation. The 
Act contains numerous provisions designed to prevent, diminish, or 
eliminate price disruptions or distortions or unreasonable volatility. 
For example, the Commission's anti-manipulation authority is designed 
to stop, redress, and deter intentional acts that may give rise to 
uneconomic prices or unreasonable volatility.\465\ Other examples 
include prohibitions on disruptive trading practices,\466\ certain core 
principles for contract markets,\467\ and the Commission's emergency 
powers.\468\
---------------------------------------------------------------------------

    \463\ Jewell v. Life Ins. Co. of N. Am., 508 F.3d 1303, 1310 
(10th Cir. 2007).
    \464\ Jewell v. Life Ins. Co. of N. Am., 508 F.3d 1303, 1310 
(10th Cir. 2007); see also Black's Law Dictionary 1227 (3d ed. 1933) 
(``As used in jurisprudence, the word `necessary' does not always 
import an actual physical necessity, so strong that one thing, to 
which another may be termed `necessary,' cannot exist without the 
other. . . . To employ the means necessary to an end is generally 
understood as employing any means calculated to produce the end, and 
not as being confined to those single means without which the end 
would be entirely unattainable.'' (citing McCullouch v. Maryland, 4 
Wheat. 216, 4 L. Ed. 579 (1819)).
    \465\ 7 U.S.C. 9(1), 9(3), 13(a)(2).
    \466\ 7 U.S.C. 6c(a).
    \467\ 7 U.S.C. 7(d).
    \468\ 7 U.S.C. 12a(9).
---------------------------------------------------------------------------

    Yet the Commission is directed by section 4a(a)(1) not only to 
impose position limits to diminish or eliminate sudden and unwarranted 
fluctuations in price caused by excessive speculation once those other 
protections have failed, it is directed to establish position limits as 
necessary to ``prevent'' those burdens on interstate commerce from 
arising in the first place. It makes little sense to suppose that 
Congress meant for the Commission to ``prevent'' unreasonable 
fluctuations or unwarranted price changes caused by excessive 
speculation only after they have already begun to occur, or when the 
Commission can somehow predict with confidence that the Act's other 
tools will be absolutely ineffective.\469\ The Act uses the word 
``necessary'' in a number of places to authorize measures it is highly 
unlikely Congress meant to apply only where the relevant policy goals 
will otherwise certainly fail.\470\
---------------------------------------------------------------------------

    \469\ See Nat. Res. Def. Council, Inc. v. Thomas, 838 F.2d 1224, 
1236-37 (D.C. Cir. 1988) (``[A] measure may be 'necessary' even 
though acceptable alternatives have not been exhausted.''); F.T.C. 
v. Rockefeller, 591 F.2d 182, 188 (2d Cir. 1979) (rejecting ``the 
notion that 'necessary' means that the [Federal Trade Commission] 
must pursue all other `reasonably available alternatives''' before 
undertaking the measure at issue). Indeed, where the Commission 
considers setting such prophylactic limits, it is unlikely to be 
knowable whether position limits will be the only effective tool. 
The existence of other tools to prevent unwarranted volatility and 
price changes may be relevant, but cannot be dispositive in all 
cases.
    \470\ See, e.g., 7 U.S.C. 2(h)(4)(A) (empowering the Commission 
to prescribe rules ``as determined by the Commission to be necessary 
to prevent evasions of the mandatory clearing requirements''); 7 
U.S.C. 2(h)(4)(B)(iii) (requiring that the Commission ``shall'' take 
such actions ``as the Commission determines to be necessary'' when 
it finds that certain swaps subject to the clearing requirement are 
not listed by any derivatives clearing organization); 7 U.S.C. 21(e) 
(subjecting registered persons to such ``rules and regulations as 
the Commission may find necessary to protect the public interest and 
promote just and equitable principles of trade.'').
---------------------------------------------------------------------------

    On the other hand, the Commission also does not believe that 
Congress intended position limits where they are merely ``useful'' or 
``convenient.'' As explained above, Congress has already determined 
that position limits are useful in preventing undue burdens on 
interstate commerce associated with excessive speculation, but requires 
the Commission to make the further finding that they are also 
necessary. A ``convenience'' standard would be similarly toothless.
    Rather than accepting either extreme, the Commission preliminarily 
interprets that sections 4a(a)(1) and 4a(a)(2) direct the Commission to 
establish position

[[Page 11665]]

limits where the Commission finds, based on the relevant facts and 
circumstances, that position limits would be an efficient mechanism to 
advance the congressional goal of preventing undue burdens on 
interstate commerce in the given underlying commodity caused by 
excessive speculation. For example, it may be that for a given 
commodity, volatility in derivatives markets would be unlikely to cause 
high levels of sudden or unreasonable fluctuations or unwarranted 
changes in the price of the underlying commodity and would have little 
overall impact on the national economy/interstate commerce. Under those 
circumstances, the Commission may find that position limits are 
unnecessary. There are, however, also contract markets in which 
volatility would be highly likely to cause sudden or unreasonable 
fluctuations or unwarranted changes in the price of the underlying 
commodity or have significantly negative effects on the broader 
economy. Even if such disruptions would be unlikely due to the 
characteristics of an individual market, the Commission may 
nevertheless determine that position limits are necessary as a 
prophylactic measure given the potential magnitude or impact of the 
event.\471\
---------------------------------------------------------------------------

    \471\ The Commission will also be mindful that the undue burdens 
Congress tasked the Commission with diminishing, eliminating, or 
preventing would not generally be borne exclusively by speculators 
or other participants in futures and swaps markets, but instead the 
public at large or a certain industry or sector of the economy. In a 
given context, the Commission may find that this factor supports a 
finding that position limits are necessary.
---------------------------------------------------------------------------

    Most commodities lie somewhere in between, with varying degrees of 
linkage between derivative contracts and cash-market prices, and 
differences in importance to the overall economy. There is no 
mathematical formula to make this determination, though the Commission 
will consider relevant data where it is available. The Commission must 
instead exercise its judgment in light of facts and circumstances, 
including its experience and expertise, to determine what limits are 
economically justified.\472\ In all instances, the Commission will 
consider the applicable costs and benefits as required under section 
15(a) of the Act.\473\ With this interpretation of ``necessary'' in 
mind, the Commission below explains its selection of the 25 core 
referenced futures contracts, and any associated referenced contracts. 
Going forward, the Commission will make this assessment ``from time to 
time'' as required under section 4a(a)(1).
---------------------------------------------------------------------------

    \472\ The Commission is well positioned to select from among all 
commodities within the scope of 4a(a)(1) and (2)(A), from its 
ongoing regulatory activities, including but not limited to market 
surveillance and product review.
    \473\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

    The Commission recognizes that this approach differs from that 
taken in earlier necessity findings. For example, when the Commission's 
predecessor agency, the Commodity Exchange Commission (``CEC''), 
established position limits, it would publish them in the Federal 
Register along with necessity findings that were generally conclusory 
recitations of the statutory language.\474\ The published basis would 
be a recitation that trading of a given commodity for future delivery 
by a person who holds or controls a net position in excess of a given 
amount tends to cause sudden or unreasonable fluctuations or changes in 
the price of that commodity, not warranted by changes in the conditions 
of supply and demand.\475\ Apart from that, the CEC typically would 
refer to a public hearing, but provide no specifics of the evidence 
presented or what the CEC found persuasive.\476\ The CEC variously 
imposed limits one commodity at a time, or for several commodities at 
once.\477\
---------------------------------------------------------------------------

    \474\ See, e.g., Limits on Position and Daily Trading in 
Soybeans for Future Delivery, 16 FR at 8107 (Aug. 16, 1951); 
Findings of Fact, Conclusions, and Order in the Matter of Limits on 
Position and Daily Trading in Cotton for Future Delivery, 5 FR at 
3198 (Aug. 28, 1940); In re Limits on Position and Daily Trading in 
Wheat, Corn, Oats, Barley, Rye, and Flaxseed, for Future Delivery, 3 
FR at 3146, 3147 (Dec. 24, 1938).
    \475\ See, e.g., Limits on Position and Daily Trading in 
Soybeans for Future Delivery, 16 FR at 8107 (Aug. 16, 1951); 
Findings of Fact, Conclusions, and Order in the Matter of Limits on 
Position and Daily Trading in Cotton for Future Delivery, 5 FR at 
3198 (Aug. 28, 1940); In re Limits on Position and Daily Trading in 
Wheat, Corn, Oats, Barley, Rye, and Flaxseed, for Future Delivery, 3 
FR at 3146, 3147 (Dec. 24, 1938).
    \476\ The records available from the National Archives during 
this period are sparse.
    \477\ Compare 5 FR at 3198 (cotton) with 3 FR at 3146, 3147 (six 
types of grain).
---------------------------------------------------------------------------

    In 1981, the Commission issued a rule directing all exchanges to 
establish position limits for each contract not already subject to 
federal limits, and for which delivery months were listed to 
trade.\478\ There, as here, the Commission explained that section 
4a(a)(1) represents an ``express Congressional finding that excessive 
speculation is harmful to the market, and a finding that speculative 
limits are an effective prophylactic measure.'' \479\ The Commission 
observed that all futures markets share the salient characteristics 
that make position limits a useful tool to prevent the potential 
burdens of excessive speculation. Specifically, ``it appears that the 
capacity of any contract market to absorb the establishment and 
liquidation of large speculative positions in an orderly manner is 
related to the relative size of such positions, i.e., the capacity of 
the market is not unlimited.'' \480\
---------------------------------------------------------------------------

    \478\ 46 FR at 50945.
    \479\ Id. at 50938, 50940. Section 4a(a)(1) was at the time 
numbered 4a(1).
    \480\ 46 FR at 50940 (Oct. 16, 1981). The Commission based this 
finding in part upon then-recent events in the silver market, an 
apparent reference to the corner and squeeze perpetrated by members 
of the Hunt family in 1979 and 1980.
---------------------------------------------------------------------------

    In 2013, the Commission proposed a necessity finding applicable to 
all physical commodities, and then reproposed it in 2016. In that 
finding, the Commission discussed incidents in which the Hunt family in 
1979 and 1980 accumulated unusually large silver positions, and in 
which Amaranth Advisors L.L.C. in 2006 accumulated unusually large 
natural gas positions.\481\ The Commission preliminarily determined 
that the size of those positions contributed to unwarranted volatility 
and price changes in those respective markets, which imposed undue 
burdens on interstate commerce, and that position limits could have 
prevented this.\482\ The Commission here preliminarily finds those 
parts of the 2013 and 2016 proposed necessity finding to be beside the 
point, because Congress has already determined that excessive 
speculation can place undue burdens on interstate commerce in a 
commodity, and that position limits can diminish, eliminate, or prevent 
those burdens. In 2013 and 2016, the Commission also considered 
numerous studies concerning position limits.\483\ To the extent that 
those studies merely examined whether or not position limits are an 
effective tool, the Commission here does not find them directly 
relevant, again because Congress has already determined that position 
limits can be effective to diminish, eliminate, or prevent sudden or 
unreasonable fluctuations or unwarranted changes in commodity 
prices.\484\
---------------------------------------------------------------------------

    \481\ 2013 Proposal, 78 FR at 75686, 75693.
    \482\ Id. at 75691, 75193.
    \483\ See 2016 Reproposal, 81 FR at 96894, 96924.
    \484\ In any event, the Commission found those studies 
inconclusive. 2016 Reproposal, 81 FR at 96723.
---------------------------------------------------------------------------

    In the 2013 and 2016 necessity findings, the Commission stated 
again that ``all markets in physical commodities'' are susceptible to 
the burdens of excessive speculation because all such markets have a 
finite ability to absorb the establishment and liquidation of large 
speculative positions in an orderly manner.\485\ The

[[Page 11666]]

Commission here, however, preliminarily determines that this 
characteristic is not sufficient to support a finding that position 
limits are ``necessary'' for all physical commodities, within the 
meaning of section 4a(a)(1). Congress has already determined that 
excessive speculation can give rise to unwarranted burdens on 
interstate commerce and that position limits can be an effective tool 
to eliminate, diminish, or prevent those burdens. Yet the statute 
directs the Commission to establish position limits only when they are 
``necessary.'' In that context, the Commission considers it unlikely 
that Congress intended the Commission to find that position limits are 
``necessary'' even where facts and circumstances show the significant 
potential that they will cause disproportionate negative consequences 
for markets, market participants, or the commodity end users they are 
intended to protect. Similarly, because the Commission has 
preliminarily determined that section 4a(a)(2) does not mandate federal 
speculative position limits for all physical commodities,\486\ it 
cannot be that federal position limits are ``necessary'' for all 
physical commodities, within the meaning of section 4a(a)(1), on the 
basis of a property shared by all of them, i.e., a limited capacity to 
absorb the establishment and liquidation of large speculative positions 
in an orderly fashion.
---------------------------------------------------------------------------

    \485\ 2016 Reproposal, 81 FR at 96722; see also Corn Products 
Refining Co. v. Benson, 232 F.2d 554, 560 (1956) (finding it 
``obvious that transactions in such vast amounts as those involved 
here might cause `sudden or unreasonable fluctuations in the price' 
of corn and hence be an undue and unnecessary burden on interstate 
commerce'' (alteration omitted)).
    \486\ See supra Section III.D.
---------------------------------------------------------------------------

    The Commission requests comments on all aspects of this 
interpretation of the requirement in section 4a(a)(1) of a necessity 
finding.
2. Necessity Findings as to the 25 Core Referenced Futures Contracts
    As noted above, the proposed rule would impose federal position 
limits on: 25 core referenced futures contracts, including 16 
agricultural products, five metals products, and four energy products; 
any futures or options on futures directly or indirectly linked to the 
core referenced futures contracts; and any economically equivalent 
swaps. As discussed above, the Commission's necessity analysis proceeds 
on the basis of certain propositions reflected in the text of section 
4a(a)(1): First, that excessive speculation in derivatives markets can 
cause sudden or unreasonable fluctuations or unwarranted changes in the 
price of an underlying commodity, i.e., fluctuations not attributable 
to the forces of supply of and demand for that underlying commodity; 
second, that such price fluctuations and changes are an undue and 
unnecessary burden on interstate commerce in that commodity, and; 
third, that position limits can diminish, eliminate, or prevent that 
burden. With those propositions established by Congress, the 
Commission's task is to make the further determination of whether it is 
necessary to use position limits, Congress's prescribed tool to address 
those burdens on interstate commerce, in light of the facts and 
circumstances. Unlike prior preliminary necessity findings which 
focused on evidence of excessive speculation in just wheat and natural 
gas, this necessity finding addresses all 25 core referenced futures 
contracts and focuses on two interrelated factors: (1) The importance 
of the derivatives markets to the underlying cash markets, including 
whether they call for physical delivery of the underlying commodity; 
and (2) the importance of the cash markets underlying the referenced 
futures contracts to the national economy. The Commission will apply 
the relevant facts and circumstances holistically rather than 
formulaically, in light of its experience and expertise.
    With respect to the first factor, the markets for the 25 core 
referenced futures contracts are large in terms of notional value and 
open interest, and are critically important to the underlying cash 
markets. These derivatives markets enable food processors, farmers, 
mining operations, utilities, textile merchants, confectioners, and 
others to hedge the risks associated with volatile changes in price 
that are the hallmark of cash commodity markets.
    Futures markets were established to allow industries that are vital 
to the U.S. economy and critical to the American public to accurately 
manage future receipts, expenses, and financial obligations with a high 
level of certainty. In general, futures markets perform valuable 
functions for society such as ``price discovery'' and by allowing 
counterparties to transfer price risk to their counterparty. The risk 
transfer function that the futures markets facilitate allows someone to 
hedge against price movements by establishing a price for a commodity 
for a time in the future. Prices in derivatives markets can inform the 
cash market prices of, for example, energy used in homes, cars, 
factories, and hospitals. More than 90 percent of Fortune 500 companies 
use derivatives to manage risk, and over 50 percent of all companies 
use derivatives in physical commodity markets such as the 25 core 
referenced futures contracts.\487\
---------------------------------------------------------------------------

    \487\ ISDA Survey of the Derivatives Usage by the World's 
Largest Companies 2009. It has also been estimated that the use of 
commercial derivatives added 1.1 percent to the size of the U.S. 
economy between 2003 and 2012. See Apanard Prabha et al., Deriving 
the Economic Impact of Derivatives, (Mar. 2014), available at https://assets1b.milkeninstitute.org/assets/Publication/ResearchReport/PDF/Derivatives-Report.pdf.
---------------------------------------------------------------------------

    The 25 core referenced futures contracts are vital for establishing 
reliable commodity prices and enabling the beneficial risk transfer 
between buyers and sellers of commodities, allowing participants to 
hedge risk and undertake planning with greater certainty. By providing 
a highly efficient marketplace for participants to offset risks, the 25 
core referenced futures contracts attract a broad range of 
participants, including farmers, ranchers, producers, utilities, 
retailers, investors, banking institutions, and others. These 
participants hedge production costs and delivery prices so that, among 
other things, consumers can always find plenty of food at reliable 
prices on the grocery store shelves.
    Futures prices are used for pricing of cash market transactions but 
also serve as economic signals that help various members of society 
plan. These signals help farmers decide which crops to plant as well as 
assist producers to decide how to implement their production processes 
given the anticipated costs of various inputs and the anticipated 
prices of any anticipated finished products, and they serve similar 
functions in other areas of the economy. For the commodities that are 
the subject of this necessity finding, the Commission preliminarily has 
determined that there is a significant amount of participation in these 
commodity markets, both directly and indirectly, through price 
discovery signals.\488\
---------------------------------------------------------------------------

    \488\ The Commission observes that there has been much written 
in the academic literature about price discovery of the 25 core 
referenced futures contracts. This demonstrates the importance of 
the commodities underlying such contracts in our society. The 
Commission's Office of the Chief Economist conducted a preliminary 
search on the JSTOR and Science Direct academic research databases 
for journal articles that contain the key words: Price Discovery 
 Futures. While the articles made varying 
conclusions regarding aspects of the futures markets, and in some 
cases position limits, almost all articles agreed that the futures 
markets in general are important for facilitating price discovery 
within their respective markets.
---------------------------------------------------------------------------

    Two key features of the 25 core referenced futures contracts are 
the role they play in the price discovery process for their respective 
underlying commodities and the fact that they

[[Page 11667]]

require physical delivery of the underlying commodity. Price discovery 
is the process by which markets, through the interaction of buyers and 
sellers, produce prices that are used to value underlying futures 
contracts that allow society to infer the value of underlying physical 
commodities. Adjustments in futures market requirements and valuations 
by a diverse array of futures market participants, each with different 
perspectives and access to supply and demand information, can result in 
adjustments to the pricing of the commodities underlying the futures 
contract. The futures markets are generally the first to react to such 
price-moving information, and price movements in the futures markets 
reflect a judgment of what is likely to happen in the future in the 
underlying cash markets. The 25 core referenced futures contracts were 
selected in part because they generally serve as reference prices for a 
large number of cash-market transactions, and the Commission knows from 
large trader reporting that there is a significant presence of 
commercial traders in these contracts, many of whom may be using the 
contracts for hedging and price discovery purposes.
    For example, a grain elevator may use the futures markets as a 
benchmark for the price it offers local farmers at harvest. In return, 
farmers look to futures prices to determine for themselves whether they 
are getting fair value for their crops. The physical delivery mechanism 
further links the cash and futures markets, with cash and futures 
prices expected to converge at settlement of the futures contract.\489\ 
In addition to facilitating price convergence, the physical delivery 
mechanism allows the 25 core referenced futures contracts to be an 
alternative means of obtaining or selling the underlying commodity for 
market participants. While most physically-settled futures contracts 
are rolled-over or unwound and are not ultimately settled using the 
physical delivery mechanism, because the futures contracts have 
standardized terms and conditions that reflect the cash market 
commodity, participants can reasonably expect that the commodity sold 
or purchased will meet their needs.\490\ This physical delivery and 
price discovery process contributes to the complexity of the markets 
for the 25 core referenced futures contracts. If these markets function 
properly, American producers and consumers enjoy reliable commodity 
prices. Excessive speculation causing sudden or unreasonable 
fluctuations or unwarranted changes in the price of those commodities 
could, in some cases, have far reaching consequences for the U.S. 
economy by interfering with proper market functioning.
---------------------------------------------------------------------------

    \489\ Futures contracts are traded for settlement at a date in 
the future. At a contract's delivery month and date, a commodity 
cash market price and its futures price converge, allowing an 
efficient transfer of physical commodities between buyers and 
sellers of the futures contract.
    \490\ Standardized terms and conditions for physically-settled 
futures contracts typically include delivery quantities, qualities, 
sizes, grades and locations for delivery that are commonly used in 
the commodity cash market.
---------------------------------------------------------------------------

    The cash markets underlying the 25 core referenced futures 
contracts are to varying degrees vitally important to the U.S. economy, 
driving job growth, stimulating economic activity, and reducing trade 
deficits while impacting everyone from consumers to automobile 
manufacturers and farmers to financial institutions. These 25 cash 
markets include some of the largest cash markets in the world, 
contributing together, along with related industries, approximately 5 
percent to the U.S. gross domestic product (``GDP'') directly and a 
further 10 percent indirectly.\491\ As described in detail below, the 
cash markets underlying the 25 core referenced futures contracts are 
critical to consumers, producers, and, in some cases, the overall 
economy.
---------------------------------------------------------------------------

    \491\ See The Bureau of Economic Analysis, U.S. Department of 
Commerce, Interactive Access to Industry Economic Accounts Data: GDP 
by Industry (Historical) that includes GDP contributions by U.S. 
Farms, Oil & Gas extraction, pipeline transportation, petroleum and 
coal products, utilities, mining and support activities, primary and 
fabricated metal products and finance in securities, commodity 
contracts and investments.
---------------------------------------------------------------------------

    By ``excessive speculation,'' the Commission here refers to the 
accumulation of speculative positions of a size that threaten to cause 
the ills Congress addressed in Section 4a--sudden or unreasonable 
fluctuations or unwarranted changes in the price of the underlying 
commodity. These potentially violent price moves in the futures markets 
could impact producers such as utilities, farmers, ranchers, and other 
hedging market participants. Such unwarranted volatility could result 
in significant costs and price movements, compromising budgeting and 
planning, making it difficult for producers to manage the costs of 
farmlands and oil refineries, and impacting retailers' ability to 
provide reliable prices to consumers for everything from cereal to 
gasoline. To be clear, volatility is sometimes warranted in the sense 
that it reflects legitimate forces of supply and demand, which can 
sometimes change very quickly. The purpose of this proposed rule is not 
to constrain those legitimate price movements. Instead, the 
Commission's purpose is to prevent volatility caused by excessive 
speculation, which Congress has deemed a potential burden on interstate 
commerce.
    Further, excessive speculation in the futures market could result 
in price uncertainty in the cash market, which in turn could cause 
periods of surplus or shortage that would not have occurred if prices 
were more reliable. Properly functioning futures markets free from 
excessive speculation are essential for hedging the volatility in cash 
markets for these commodities that are the result of real supply and 
demand. Specific attributes of the cash and derivatives markets for 
these 25 commodities are discussed below.
3. Agricultural Commodities
    Futures contracts on the 16 agricultural commodities are essential 
tools for hedging against price moves of these widely grown crops, and 
are key instruments in helping to smooth out volatility and to ensure 
that prices remain reliable and that food remains on the shelves. These 
agricultural futures contracts are used by grain elevators, farmers, 
merchants, and others and are particularly important because prices in 
the underlying cash markets swing regularly depending on factors such 
as crop conditions, weather, shipping issues, and political events.
    Settlement prices of futures contracts are made available to the 
public by exchanges in a process known as ``price discovery.'' To be an 
effective hedge for cash market prices, futures contracts should 
converge to the spot price at expiration of the futures contract. 
Otherwise, positions in a futures contract will be a less effective 
tool to hedge price risk in the cash market since the futures positions 
will less than perfectly offset cash market positions. Convergence is 
so important for the 16 agricultural contracts that exchanges have 
deliveries occurring during the spot month, unlike for the energy 
commodities covered by this proposal.\492\ This delivery mechanism 
helps to force convergence because shorts who can deliver cheaper than 
the futures prices may do so, and longs can stand in for delivery if 
it's cheaper to

[[Page 11668]]

obtain the underlying through the futures market than the cash market. 
The Commission does not collect information on all cash market 
transactions. Nevertheless, the Commission understands that futures 
prices are often used by counterparties to settle many cash-market 
transactions due to approximate convergence of the futures contract 
price to the cash-market price at expiration.
---------------------------------------------------------------------------

    \492\ For energy contracts, physical delivery of the underlying 
commodity does not occur during the spot month. This allows time to 
schedule pipeline deliveries and so forth. Instead, a shipping 
certificate (a financial instrument claim to the physical product), 
not the underlying commodity, is the delivery instrument that is 
exchanged at expiration of the futures contract.
---------------------------------------------------------------------------

    Agricultural futures markets are some of the most active, and open 
interest on agricultural futures have some of the highest notional 
value. The CBOT Corn (C) and CBOT Soybean (S) contracts, for example, 
trade over 350,000 and 200,000 contracts respectively per day.\493\ 
Outstanding futures and options notional values range anywhere from 
approximately $ 71 billion for CBOT Corn (C) to approximately $ 70 
million for CBOT Oats (O), with the other core referenced futures 
contracts on agricultural commodities all falling somewhere in 
between.\494\
---------------------------------------------------------------------------

    \493\ CME Group website, available at https://www.cmegroup.com/trading/products/#pageNumber=1&sortAsc=false&sortField=oi.
    \494\ Notional values here and throughout this section of the 
release are derived from CFTC internal data obtained from the 
Commitments of Traders Reports. Notional value means the U.S. dollar 
value of both long and short contracts without adjusting for delta 
in options. Data is as of June 30, 2019.
---------------------------------------------------------------------------

    The American agricultural market, including markets for the 
commodities underlying the 16 agricultural core referenced contracts, 
is foundational to the U.S. economy. Agricultural, food, and related 
industries contributed $ 1.053 trillion to the U.S. economy in 2017, 
representing 5.4 percent of U.S. GDP.\495\ In 2017, agriculture 
provided 21.6 million full and part time jobs, or 11 percent of total 
U.S. employment.\496\ Agriculture's contribution to international trade 
is also sizeable. For fiscal year 2019, it was projected that 
agricultural exports would exceed $ 137 billion, with imports at $ 129 
billion for a net balance of trade of $ 8 billion.\497\ This balance of 
trade is good for the nation and for American farmers. The U.S. 
commodity futures markets have provided risk mitigation and pricing 
that reflects the economic value of the underlying commodity to 
farmers, ranchers, and producers.
---------------------------------------------------------------------------

    \495\ What is Agriculture's Share of the Overall U.S. Economy, 
USDA Economic Research Services, available at https://www.ers.usda.gov/data-products/chart-gallery/gallery/chart-detail/?chartId=58270.
    \496\ Ag and Food Sales and the Economy, USDA Economic Research 
Services, available at https://www.ers.usda.gov/data-products/ag-and-food-statistics-charting-the-essentials/ag-and-food-sectors-and-the-economy.
    \497\ Outlook for U.S. Agricultural Trade, USDA Economic 
Research Services, available at https://www.ers.usda.gov/topics/international-markets-us-trade/us-agricultural-trade/outlook-for-us-agricultural-trade.
---------------------------------------------------------------------------

    The 16 agricultural core referenced futures contracts \498\ are key 
drivers to the success of the American agricultural industry. The 
commodities underlying these markets are used in a variety of consumer 
products including: Ingredients in animal feeds for production of meat 
and dairy (soybean meal and corn); margarine, shortening, paints, 
adhesives, and fertilizer (soybean oil); home furnishings and apparel 
(cotton); and food staples (corn, soybeans, wheat, oats, frozen orange 
juice, cattle, rough rice, cocoa, coffee, and sugar).
---------------------------------------------------------------------------

    \498\ The 16 agricultural core referenced futures contracts are: 
CBOT Corn (C), CBOT Oats (O), CBOT Soybeans (S), CBOT Soybean Meal 
(SM), CBOT Soybean Oil (SO), CBOT Wheat (W), CBOT KC HRW Wheat (KW), 
ICE Cotton No. 2 (CT), MGEX HRS Wheat (MWE), CBOT Rough Rice (RR), 
CME Live Cattle (LC), ICE Cocoa (CC), ICE Coffee C (KC), ICE FCOJ-A 
(OJ), ICE U.S. Sugar No. 11 (SB), and ICE U.S. Sugar No. 16 (SF).
---------------------------------------------------------------------------

    The cash markets underlying the 16 agricultural core referenced 
futures contracts help create jobs and stimulate economic activity. The 
soybean meal market alone has an implied value to the U.S. economy 
through animal agriculture which contributed more than 1.8 million 
American jobs,\499\ and wheat remains the largest produced food grain 
in the United States, with planted acreage, production, and farm 
receipts ranking third after corn and soybeans.\500\ The United States 
is the world's largest producer of beef, and also produced 327,000 
metric tons of frozen orange juice in 2018.\501\ Total economic 
activity stimulated by the cotton crop is estimated at over $ 75 
billion.\502\ Many of these markets are also significant export 
commodities, helping to reduce the trade deficit. The United States 
exports between 10 and 20 percent of its corn crop and 47 percent of 
its soybean crop, generating tens of billions of dollars in annual 
economic output.\503\
---------------------------------------------------------------------------

    \499\ Decision Innovation Solutions, 2018 Soybean Meal Demand 
Assessment, United Soybean Board, available at https://www.unitedsoybean.org/wp-content/uploads/LOW-RES-FY2018-Soybean-Meal-Demand-Analysis-1.pdf.
    \500\ Wheat Sector at a Glance, USDA Economic Research Service, 
available at https://www.ers.usda.gov/topics/crops/wheat/wheat-sector-at-a-glance.
    \501\ Cattle & Beef Sector at a Glance, USDA Economic Research 
Service, available at https://www.ers.usda.gov/topics/animal-products/cattle-beef/sector-at-a-glance.
    \502\ World of Cotton, National Cotton Council of America, 
available at https://www.cotton.org/econ/world/index.cfm.
    \503\ Feedgrains Sector at a Glance, USDA Economic Research 
Service, available at https://www.ers.usda.gov/topics/crops/corn-and-other-feedgrains/feedgrains-sector-at-a-glance.
---------------------------------------------------------------------------

    Many of these agricultural commodities are also crucial to rural 
areas. In Arkansas alone, which ranks first among rice-producing 
states, the annual rice crop contributes $1.3 billion to the state's 
economy and accounts for tens of thousands of jobs to an industry that 
contributes more than $35 billion to the U.S. economy on an annual 
basis.\504\ Similarly, the U.S. meat and poultry industry, which 
includes cattle, accounts for $1.02 trillion in total economic output 
equaling 5.6 percent of GDP, and is responsible for 5.4 million 
jobs.\505\ Coffee-related economic activity comprises 1.6 percent of 
total U.S. GDP,\506\ and U.S. sugar producers generate nearly $20 
billion per year for the U.S. economy, supporting 142,000 jobs in 22 
states.\507\ Even some of the smaller agricultural markets have a 
noteworthy economic impact.\508\ For example, oats are planted on over 
2.6 million acres in the United States, with the total U.S. supply in 
the order of 182 million bushels,\509\ and in 2010 the United States 
exported chocolate and chocolate-type confectionary products worth $799 
million to more than 50 countries around the world. \510\
---------------------------------------------------------------------------

    \504\ Where is Rice Grown, Think Rice website, available at 
https://www.thinkrice.com/on-the-farm/where-is-rice-grown.
    \505\ The United States Meat Industry at a Glance, North 
American Meat Institute website, available at https://www.meatinstitute.org/index.php?ht=d/sp/i/47465/pid/47465.
    \506\ The Economic Impact of the Coffee Industry, National 
Coffee Association, available at https://www.ncausa.org/Industry-Resources/Economic-Impact.
    \507\ U.S. Sugar Industry, The Sugar Association, available at 
https://www.sugar.org/about/us-industry. While Sugar No. 11 (SB) is 
primarily an international benchmark, the contract is still used for 
price discovery and hedging within the United States and has 
significantly more open interest and daily volume than the domestic 
Sugar No. 16 (SF). As a pair, these two contracts are crucial tools 
for risk management and for ensuring reliable pricing, with much of 
the price discovery occurring in the higher-volume Sugar No. 11 (SB) 
contract.
    \508\ Although the macroeconomic impact of these markets is 
smaller, the Commission reiterates that it has selected the 25 core 
referenced futures contracts also based on the importance of 
derivatives in these commodities to cash-market pricing.
    \509\ Feed Outlook: May 2019, USDA Economic Research Service, 
available at https://www.ers.usda.gov/publications/pub-details/?pubid=93094.
    \510\ Economic Profile of the U.S. Chocolate Industry, World 
Cocoa Foundation, available at https://www.worldcocoafoundation.org/wp-content/uploads/Economic_Profile_of_the_US_Chocolate_Industry_2011.pdf.
---------------------------------------------------------------------------

4. Metal Commodities
    The core referenced futures contracts on metal commodities play an 
important role in the price discovery process and are some of the most 
active and valuable in terms of notional value.

[[Page 11669]]

The Gold (GC) contract, for example, trades the equivalent of nearly 27 
million ounces and 170,000 contracts daily. \511\ Outstanding futures 
and options notional values range from approximately $234 billion in 
the case of Gold (GC), to approximately $2.34 billion in the case of 
Palladium (PA), with the other metals core referenced futures contracts 
all falling somewhere in between.\512\ Metals futures are used by a 
diverse array of commercial end-users to hedge their operations, 
including mining companies, merchants and refiners.
---------------------------------------------------------------------------

    \511\ Gold Futures Quotes, CME Group website, available at 
https://www.cmegroup.com/trading/metals/precious/gold_quotes_globex.html.
    \512\ Calculations based on data submitted to the Commission 
pursuant to part 16 of the Commission's regulations.
---------------------------------------------------------------------------

    The underlying commodities are also important to the U.S. economy. 
In 2018, U.S. mines produced $82.2 billion of raw materials, including 
the commodities underlying the five metals core referenced futures 
contracts: COMEX Gold (GC), COMEX Silver (SI), COMEX Copper (HG), NYMEX 
Platinum (PL), and NYMEX Palladium (PA).\513\ U.S. mines produced 6.6 
million ounces of gold in 2018 worth around $9.24 billion as of July 1, 
2019, and the United States holds the largest official gold reserves of 
any country, worth around $366 billion and representing 75 percent of 
the value of total U.S. foreign reserves.\514\ U.S. silver refineries 
produced around 52.5 million ounces of silver worth around $800 million 
in 2018 at current prices.\515\
---------------------------------------------------------------------------

    \513\ Mineral Commodity Summaries 2019, U.S. Geological Survey, 
available at https://prd-wret.s3-us-west-2.amazonaws.com/assets/palladium/production/atoms/files/mcs2019_all.pdf.
    \514\ CPM Gold Yearbook 2019, CPM Group, available at https://www.cpmgroup.com/store/cpm-gold-yearbook-2019; Goldhub, World Gold 
Council, available at https://www.gold.org/goldhub.
    \515\ World Silver Survey 2019, The Silver Institute, available 
at https://www.silverinstitute.org/wp-content/uploads/2019/04/WSS2019V3.pdf.
---------------------------------------------------------------------------

    Major industries, including steel, aerospace, and electronics, 
process and transform these materials, creating about $3.02 trillion in 
value-added products.\516\ The five metals commodities are key 
components of these products, including for use in: Batteries, solar 
panels, water purification systems, electronics, and chemical refining 
(silver); jewelry, electronics, and as a store of value (gold); 
building construction, transportation equipment, and industrial 
machinery (copper); automobile catalysts for diesel engines and in 
chemical, electric, medical and biomedical applications, and petroleum 
refining (platinum); and automobile catalysts for gasoline engines and 
in dental and medical applications (palladium). A disruption in any of 
these markets would impact highly important and sensitive industries, 
including those critical to national security, and would also impact 
the price of consumer products.
---------------------------------------------------------------------------

    \516\ Id.
---------------------------------------------------------------------------

    The underlying metals markets also create jobs and contribute to 
GDP. Over 20,000 people were employed in U.S. gold and copper mines and 
mills in 2017 and 2018, metal ore mining contributed $54.5 billion to 
U.S. GDP in 2015, and the global copper mining industry drives more 
than 45 percent of the world's GDP, either on a direct basis or through 
the use of products that facilitate other industries.\517\
---------------------------------------------------------------------------

    \517\ Creamer, Martin, Global Mining Derives 45%-Plus of World 
GDP, Mining Weekly (July. 4, 2012), available at https://www.miningweekly.com/print-version/global-mining-drives-45-plus-of-world-gdp-cutifani-2012-07-04. Platinum and palladium mine 
production in 2018 was less substantial, worth $114 million and $695 
million, respectively (All such valuations throughout this release 
are at current prices as of July 2, 2019.). See Bloxham, Lucy, et 
al., Pgm Market Report May 2019, Johnson Matthey, available at 
https://www.platinum.matthey.com/documents/new-item/pgm%20market%20reports/pgm_market_report_may_19.pdf. However, 
derivatives contracts in those commodities do play a role in price 
discovery.
---------------------------------------------------------------------------

    The gold and silver markets are especially important because they 
serve as financial assets and a store of value for individual and 
institutional investors, including in times of economic or political 
uncertainty. Several exchange-traded funds (``ETFs'') that are 
important instruments for U.S. retail and institutional investors also 
hold significant quantities of these metals to back their shares. A 
disruption to any of these metals markets would thus not only impact 
producers and retailers, but also potentially retail and institutional 
investors. The iShares Silver Trust ETF, for example, holds around 
323.3 million ounces of silver worth $4.93 billion, and the largest 
U.S. listed gold-backed ETF holds around 25.5 million ounces to back 
its shares worth around $35.7 billion.\518\ Platinum and palladium ETFs 
are worth hundreds of millions of dollars as well.\519\
---------------------------------------------------------------------------

    \518\ Historical Data, SPDR Gold Shares, available at https://www.spdrgoldshares.com/usa/historical-data. Data as of July 1, 2019.
    \519\ iShares Silver Trust Fund, iShares, available at https://www.ishares.com/us/products/239855/ishares-silver-trust-fund/1521942788811.ajax?fileType=xls&fileName=iShares-Silver-Trust_fund&dataType=fund, https://www.aberdeenstandardetfs.us/institutional/us/en-us/products/product/etfs-physical-platinum-shares-pplt-arca#15.
---------------------------------------------------------------------------

5. Energy Commodities
    The energy core referenced futures markets are crucial tools for 
hedging price risk for commodities which can be highly volatile due to 
changes in weather, economic health, demand-related price swings, and 
pipeline and supply availability or disruptions. These futures 
contracts are used by some of the largest refiners, exploration and 
production companies, distributors, and by other key players in the 
energy industry, and are some of the most widely traded and valuable 
contracts in the world in terms of notional value. The NYMEX Light 
Sweet Crude Oil (CL) contract, for example, is the world's most liquid 
and actively traded crude oil contract, trading nearly 1.2 million 
contracts a day, and the NYMEX Henry Hub Natural Gas (NG) contract 
trades 400,000 contracts daily.\520\ Futures and option notional values 
range from $ 53 billion in the case of NYMEX NY Harbor RBOB Gasoline 
(RB) and NYMEX NY Harbor ULSD Heating Oil (HO), to $ 498 billion for 
NYMEX Light Sweet Crude Oil (CL).\521\
---------------------------------------------------------------------------

    \520\ Calculations based on data submitted to the Commission 
pursuant to part 16 of the Commission's regulations.
    \521\ Calculations based on data submitted to the Commission 
pursuant to part 16 of the Commission's regulations.
---------------------------------------------------------------------------

    Some of the energy core referenced futures contracts also serve as 
key benchmarks for use in pricing cash-market and other transactions. 
NYMEX NY Harbor RBOB Gasoline (RB) is the main benchmark used for 
pricing gasoline in the U.S. petroleum products market, a huge physical 
market with total U.S. refinery capacity of approximately 9.5 million 
barrels per day of gasoline.\522\ Similarly, the NYMEX NY Harbor ULSD 
Heating Oil (HO) contract is the main benchmark used for pricing the 
distillate products market, which includes diesel fuel, heating oil, 
and jet fuel. \523\
---------------------------------------------------------------------------

    \522\ CME Comment letter dated April 24, 2015 at 79.
    \523\ Id. at 136.
---------------------------------------------------------------------------

    The U.S. energy markets are some of the most important and complex 
in the world, contributing over $ 1.3 trillion to the U.S. 
economy.\524\ Crude oil, heating oil, gasoline, and natural gas, the 
commodities underlying the four energy core reference futures 
contracts,\525\ are key contributors to job growth and GDP. In 2015, 
the natural gas and oil industries supported 10.3 million jobs directly 
and indirectly, accounting for 5.6 percent of total U.S. employment, 
and generating $ 714 billion in wages to

[[Page 11670]]

account for 6.7 percent of national income.\526\ Crude oil alone, which 
is a key component in making gasoline, contributes 7.6 percent of total 
U.S. GDP. RBOB gasoline, which is a byproduct of crude oil that is used 
as fuel for vehicles and appliances, contributes $ 35.5 billion in 
income and $57 billion in economic activity.\527\ ULSD comprises all 
on-highway diesel fuel consumed in the United States, and is also 
commonly used as heating oil.\528\
---------------------------------------------------------------------------

    \524\ Natural Gas and Oil National Factsheet, API Energy, 
available at https://www.api.org/~/media/Files/Policy/Jobs/National-
Factsheet.pdf.
    \525\ The four energy core referenced futures contracts are: 
NYMEX Light Sweet Crude Oil (CL), NYMEX NY Harbor ULSD Heating Oil 
(HO), NYMEX NY Harbor RBOB Gasoline (RB), and NYMEX Henry Hub 
Natural Gas (NG).
    \526\ Natural Gas and Oil National Factsheet, API Energy, 
available at https://www.api.org/~/media/Files/Policy/Jobs/National-
Factsheet.pdf; PricewaterhouseCoopers, Impacts of the Natural Gas 
and Oil Industry on the US Economy in 2015, API Energy, available at 
https://www.api.org/~/media/Files/Policy/Jobs/Oil-and-Gas-2015-
Economic-Impacts-Final-Cover-07-17-2017.pdf.
    \527\ PricewaterhouseCoopers, Impacts of the Natural Gas and Oil 
Industry on the US Economy in 2015, API Energy, at 12, available at 
https://www.api.org/~/media/Files/Policy/Jobs/Oil-and-Gas-2015-
Economic-Impacts-Final-Cover-07-17-2017.pdf.
    \528\ CME Comment Letter dated April 24, 2015 at 135.
---------------------------------------------------------------------------

    Natural gas is similarly important, serving nearly 69 million 
homes, 185,400 factories, and 5.5 million businesses such as hotels, 
restaurants, hospitals, schools, and supermarkets. More than 2.5 
million miles of pipeline transport natural gas to more than 178 
million Americans.\529\ Natural gas is also a key input for electricity 
generation and comprises more than one quarter of all primary energy 
used in the United States. \530\ U.S. agricultural producers also rely 
on an affordable, dependable supply of natural gas, as fertilizer used 
to grow crops is composed almost entirely of natural gas components.
---------------------------------------------------------------------------

    \529\ Natural Gas: The Facts, American Gas Association, 
available at https://www.aga.org/globalassets/2019-natural-gas-factsts-updated.pdf.
    \530\ Id.
---------------------------------------------------------------------------

6. Consistency With Commodity Indices
    The criteria underlying the Commission's necessity finding is 
consistent with the criteria used by several widely tracked third party 
commodity index providers in determining the composition of their 
indices. Bloomberg selects commodities for its Bloomberg Commodity 
Index that in its view are ``sufficiently significant to the world 
economy to merit consideration,'' that are ``tradeable through a 
qualifying related futures contract'' and that generally are the 
``subject of at least one futures contract that trades on a U.S. 
exchange.'' \531\ Similarly, S&P's GSCI index is, among other things, 
``designed to reflect the relative significance of each of the 
constituent commodities to the world economy.'' \532\ Applying these 
criteria, Bloomberg and S&P have deemed eligible for inclusion in their 
indices lists of commodities that overlap significantly with the 
Commission's proposed list of 25 core referenced futures contracts. 
Independent index providers thus appear to have arrived at similar 
conclusions to the Commission's preliminary necessity finding regarding 
the relative importance of certain commodity markets.
---------------------------------------------------------------------------

    \531\ The Bloomberg Commodity Index Methodology, Bloomberg, at 
17 (Dec. 2018) available at https://data.bloomberglp.com/professional/sites/10/BCOM-Methodology-December-2019.pdf. The list 
of commodities that Bloomberg deems eligible for inclusion in its 
index overlaps significantly with the Commission's proposed list of 
25 core referenced futures contracts.
    \532\ S&P GSCI Methodology, S&P Dow Jones Indices, at 8 (Oct. 
2019) available at https://us.spindices.com/documents/methodologies/methodology-sp-gsci.pdf?force_download=true.
---------------------------------------------------------------------------

7. Conclusion
    This proposal only sets limits for referenced contracts for which a 
DCM currently lists a physically-settled core referenced futures 
contract. As discussed above, there are currently over 1,200 contracts 
on physical commodities listed on DCMs, and there are physical 
commodities other than those underlying the 25 core referenced futures 
contracts that are important to the national economy, including, for 
example, steel, butter, uranium, aluminum, lead, random length lumber, 
and ethanol. However, unlike the 25 core referenced futures contracts, 
the derivatives markets for those commodities are not as large as the 
markets for the 25 core referenced futures contracts and/or play a less 
significant role in the price discovery process.
    For example, the futures contracts on steel, butter, and uranium 
were not included as core referenced futures contracts because they are 
cash-settled contracts that settle to a third party index. Among the 
agricultural commodity futures listed on CME that are cash-settled only 
to an index are: class III milk, feeder cattle, and lean hogs. All 
three of these were included in the 2011 Final Rulemaking. Because 
there are no physically-settled futures contracts on these commodities, 
these cash-settled contracts would not qualify as referenced contracts 
are would not be subject to the proposed rule. While the futures 
contracts on aluminum, lead, random length lumber, and ethanol are 
physically settled contracts, their open interest and trading volume is 
lower than that of the CBOT Oats contract, which is the smallest market 
included among the 25 core referenced futures contracts as measured by 
open interest and volume. In that regard, based on FIA end of month 
open interest data and 12-month total trading volume data for December 
2019, CBOT Oats had end of month open interest of 4,720 contracts and 
12-month total trading volume ending in December 2019 of 162,682 round 
turn contracts.\533\ In comparison, the end of month December 2019 open 
interest and 12-month total trading volume ending in December 2019 for 
the other commodity futures contracts that were not selected to be 
included as core referenced futures contracts were as follows: COMEX 
Aluminum (267 OI/2,721 Vol), COMEX Lead (0 OI/0 Vol), CME Random Length 
Lumber (3,275 OI/11,893 Vol), and CBOT Ethanol (708 OI/2,686 Vol.). It 
would be impracticable for the Commission to analyze in comprehensive 
fashion all contracts that have either feature, so the Commission has 
chosen commodities for which the underlying and derivatives markets 
both play important economic roles, including the potential for 
especially acute burdens on a given commodity in interstate commerce 
that would arise from excessive speculation in derivatives markets. 
Line drawing of this nature is inherently inexact, and the Commission 
will revisit these and other contracts ``from time to time'' as the 
statute requires.\534\ Depending on facts and circumstances, including 
the Commission's experience administering the proposed limits with 
respect to the 25 core referenced futures contracts, the Commission may 
determine that additional limits are necessary within the meaning of 
section 4a(a)(1).
---------------------------------------------------------------------------

    \533\ FIA notes that volume for exchange-traded futures is 
measured by the number of contracts traded on a round-trip basis to 
avoid double-counting. Furthermore, FIA notes that open interest for 
exchange-traded futures is measured by the number of contracts 
outstanding at the end of the month.
    \534\ CEA section 4a(a)(1).
---------------------------------------------------------------------------

    As discussed in the cost benefit consideration below, the 
Commission's proposed limits are not without costs, and there are 
potential burdens or negative consequences associated with establishing 
the proposed limits.\535\ In particular, if the levels are set too 
high, there is a greater risk of excessive speculation that could harm 
market participants and the public. If the levels are set too low, 
transaction costs may rise and liquidity could be reduced.\536\ 
Nevertheless, the Commission preliminarily believes that the specific 
proposed limits applicable to the 25 core referenced futures contracts 
would

[[Page 11671]]

limit such potential costs, and that the significant benefits 
associated with advancing the statutory goal of preventing the undue 
burdens associated with excessive speculation in these commodities 
justify the potential costs associated with establishing the proposed 
limits.
---------------------------------------------------------------------------

    \535\ See infra Section IV.A. (discussion of cost-benefit 
considerations for the proposed changes).
    \536\ See infra Section IV.A.2.a. (cost-benefit discussion of 
market liquidity and integrity).
---------------------------------------------------------------------------

G. Request for Comment
    The Commission requests comment on all aspects of the proposed 
necessity finding. The Commission also invites comments on the 
following:
    (50) Does the proposed necessity finding take into account the 
relevant factors to ascertain whether position limits would be 
necessary on a core referenced futures contract?
    (51) Does the proposed necessity finding base its analysis on the 
correct levels of trading volume and open interest? If not, what would 
be a more appropriate minimum level of trading volume and/or open 
interest upon which to evaluate whether federal position limits are 
necessary to prevent excessive speculation?
    (52) Are there particular attributes of any of the 25 proposed core 
referenced futures contracts that the Commission should consider when 
determining whether federal position limits are or are not necessary 
for that particular product?

IV. Related Matters

A. Cost-Benefit Considerations

1. Introduction
    Section 15(a) of the Commodity Exchange Act (``CEA'' or ``Act'') 
requires the Commodity Futures Trading Commission (``Commission'') to 
consider the costs and benefits of its actions before promulgating a 
regulation under the CEA.\537\ Section 15(a) further specifies that the 
costs and benefits shall be evaluated in light of five broad areas of 
market and public concern: (1) Protection of market participants and 
the public; (2) efficiency, competitiveness, and financial integrity of 
futures markets; (3) price discovery; (4) sound risk management 
practices; and (5) other public interest considerations (collectively, 
the ``section 15(a) factors'').\538\
---------------------------------------------------------------------------

    \537\ 7 U.S.C. 19(a).
    \538\ Id.
---------------------------------------------------------------------------

    The Commission interprets section 15(a) to require the Commission 
to consider only those costs and benefits of its proposed changes that 
are attributable to the Commission's discretionary determinations 
(i.e., changes that are not otherwise required by statute) compared to 
the existing status quo requirements. For this purpose, the status quo 
requirements include the CEA's statutory requirements as well as any 
applicable Commission regulations that are consistent with the 
CEA.\539\ As a result, any proposed changes to the Commission's 
regulations that are required by the CEA or other applicable statutes 
would not be deemed to be a discretionary change for purposes of 
discussing related costs and benefits.
---------------------------------------------------------------------------

    \539\ This cost-benefit consideration section is divided into 
seven parts, including this introductory section, each discussing 
their respective baseline benchmarks with respect to any applicable 
CEA or regulatory provisions.
---------------------------------------------------------------------------

    The Commission anticipates that the proposed position limits 
regulations will affect market participants differently depending on 
their business model and scale of participation in the commodity 
contracts that are covered by the proposal.\540\ The Commission also 
anticipates that the proposal may result in ``programmatic'' costs to 
some market participants. Generally, affected market participants may 
incur increased costs associated with developing or revising, 
implementing, and maintaining compliance functions and procedures. Such 
costs might include those related to the monitoring of positions in the 
relevant referenced contracts; related filing, reporting, and 
recordkeeping requirements, and the costs of changes to information 
technology systems.
---------------------------------------------------------------------------

    \540\ For example, the proposal could result in increased costs 
to market participants who may need to adjust their trading and 
hedging strategies to ensure that their aggregate positions do not 
exceed federal position limits, particularly those who will be 
subject to federal position limits for the first time (i.e., those 
who may trade contracts for which there are currently no federal 
limits). On the other hand, existing costs could decrease for those 
existing traders whose positions would fall below the new proposed 
limits and therefore would not be forced to adjust their trading 
strategies and/or apply for exemptions from the limits, particularly 
if the Commission's proposal improves market liquidity or other 
metrics of market health. Similarly, for those market participants 
who would become subject to the federal position limits, general 
costs would be lower to the extent such market participants can 
leverage their existing compliance infrastructure in connection with 
existing exchange position limit regimes relative to those market 
participants that do not currently have such systems.
---------------------------------------------------------------------------

    The Commission has preliminarily determined that it is not feasible 
to quantify the costs or benefits with reasonable precision and instead 
has identified and considered the costs and benefits 
qualitatively.\541\ The Commission believes that for many of the costs 
and benefits that quantification is not feasible with reasonable 
precision because doing so would require understanding all market 
participants' business models, operating models, cost structures, and 
hedging strategies, including an evaluation of the potential 
alternative hedging or business strategies that could be adopted under 
the proposal. Further, while Congress has tasked the Commission with 
establishing such position limits as the Commission finds are 
``necessary,'' some of the benefits, such as mitigating or eliminating 
manipulation or excessive speculation, may be very difficult or 
infeasible to quantify. These benefits, moreover, would likely manifest 
over time and be distributed over the entire market.
---------------------------------------------------------------------------

    \541\ With respect to the Commission's analysis under its 
discussion of its obligations under the Paperwork Reduction Act 
(``PRA''), the Commission has endeavored to quantify certain costs 
and other burdens imposed on market participants related to 
collections of information as defined by the PRA. See generally 
Section IV.B. (discussing the Commission's PRA determinations).
---------------------------------------------------------------------------

    In light of these limitations, to inform its consideration of costs 
and benefits of the proposed regulations, the Commission in its 
discretion relies on: (1) Its experience and expertise in regulating 
the derivatives markets; (2) information gathered through public 
comment letters \542\ and meetings with a broad range of market 
participants; and (3) certain Commission data, such as the Commission's 
Large Trader Reporting System and data reported to swap data 
repositories.
---------------------------------------------------------------------------

    \542\ While the general themes contained in comments submitted 
in response to prior proposals informed this rulemaking, the 
Commission is withdrawing the 2013 Proposal, the 2016 Supplemental 
Proposal, and the 2016 Reproposal. See supra Section I.A.
---------------------------------------------------------------------------

    In addition to the specific questions included throughout the 
discussion below, the Commission generally requests comment on all 
aspects of its consideration of costs and benefits, including: 
Identification and assessment of any costs and benefits not discussed 
herein; data and any other information to assist or otherwise inform 
the Commission's ability to quantify or qualify the costs and benefits 
of the proposed rules; and substantiating data, statistics, and any 
other information to support positions posited by commenters with 
respect to the Commission's consideration of costs and benefits.
    The Commission preliminarily considers the benefits and costs 
discussed below in the context of international markets, because market 
participants and exchanges subject to the Commission's jurisdiction for 
purposes of position limits may be organized outside of the United 
States; some industry leaders typically conduct operations both within 
and outside the United States; and market participants may follow 
substantially similar business practices wherever located.

[[Page 11672]]

Where the Commission does not specifically refer to matters of 
location, the discussion of benefits and costs below refers to the 
effects of this proposal on all activity subject to the proposed 
regulations, whether by virtue of the activity's physical location in 
the United States or by virtue of the activity's connection with or 
effect on U.S. commerce under CEA section 2(i).\543\
---------------------------------------------------------------------------

    \543\ 7 U.S.C. 2(i).
---------------------------------------------------------------------------

    The Commission will identify and discuss the costs and benefits 
organized conceptually by topic, and certain topics may generally 
correspond with a specific proposed regulatory section. The 
Commission's discussion is organized as follows: (1) The scope of the 
commodity derivative contracts that would be subject to the proposed 
position limits framework, including with respect to the 25 proposed 
core referenced futures contracts and the proposed definitions of 
``referenced contract'' and ``economically equivalent swaps;'' (2) the 
proposed federal position limit levels (proposed Sec.  150.2); (3) the 
proposed federal bona fide hedging definition (proposed Sec.  150.1) 
and other Commission exemptions from federal position limits (proposed 
Sec.  150.3); (4) proposed streamlined process for the Commission and 
exchanges to recognize bona fide hedges and to grant exemptions for 
purposes of federal position limits (proposed Sec. Sec.  150.3 and 
150.9) and related reporting changes to part 19 of the Commission's 
regulations; (5) the proposed exchange-set position limits framework 
and exchange-granted exemptions thereto (proposed Sec.  150.5); and (6) 
the section 15(a) factors.
2. ``Necessity Finding'' and Scope of Referenced Futures Contracts 
Subject to Proposed Federal Position Limit Levels
    Federal spot and non-spot month limits currently apply to futures 
and options on futures on the nine legacy agricultural 
commodities.\544\ The Commission's proposal would expand the scope of 
commodity derivative contracts currently subject to the Commission's 
existing federal position limits framework \545\ so that federal spot-
month limits would apply to futures and options on futures on 16 
additional physical commodities, for a total of 25 physical 
commodities.\546\
---------------------------------------------------------------------------

    \544\ The nine legacy agricultural contracts currently subject 
to federal spot and non-spot month limits are: CBOT Corn (C), CBOT 
Oats (O), CBOT Soybeans (S), CBOT Wheat (W), CBOT Soybean Oil (SO), 
CBOT Soybean Meal (SM), MGEX Hard Red Spring Wheat (MWE), ICE Cotton 
No. 2 (CT), and CBOT KC Hard Red Winter Wheat (KW).
    \545\ 17 CFR 150.2. Because the Commission has not yet 
implemented the Dodd-Frank Act's amendments to the CEA regarding 
position limits, except with respect to aggregation (see generally 
Final Aggregation Rulemaking, 81 FR at 91454) and the vacated 2011 
Position Limits Rulemaking's amendments to 17 CFR 150.2 (see 
International Swaps and Derivatives Association v. United States 
Commodity Futures Trading Commission, 887 F. Supp. 2d 259 (D.D.C. 
2012)), the baseline or status quo consists of the provisions of the 
CEA relating to position limits immediately prior to effectiveness 
of the Dodd-Frank Act amendments to the CEA and the relevant 
provisions of existing parts 1, 15, 17, 19, 37, 38, 140, and 150 of 
the Commission's regulations, subject to the aforementioned 
exceptions.
    \546\ The 16 proposed new products that would be subject to 
federal spot month limits would include seven agricultural (CME Live 
Cattle (LC), CBOT Rough Rice (RR), ICE Cocoa (CC), ICE Coffee C 
(KC), ICE FCOJ-A (OJ), ICE U.S. Sugar No. 11 (SB), and ICE U.S. 
Sugar No. 16 (SF)), four energy (NYMEX Light Sweet Crude Oil (CL), 
NYMEX New York Harbor ULSD Heating Oil (HO), NYMEX New York Harbor 
RBOB Gasoline (RB), NYMEX Henry Hub Natural Gas (NG)), and five 
metals (COMEX Gold (GC), COMEX Silver (SI), COMEX Copper (HG), NYMEX 
Palladium (PA), and NYMEX Platinum (PL)) contracts.
---------------------------------------------------------------------------

    The Commission has preliminarily interpreted CEA section 4a to 
require that the Commission must make an antecedent ``necessity'' 
finding that establishing federal position limits is ``necessary'' to 
diminish, eliminate, or prevent certain burdens on interstate commerce 
with respect to the physical commodities in question.\547\ As the 
statute does not define the term ``necessary,'' the Commission must 
apply its expertise in construing such term, and, as discussed further 
below, must do so consistent with the policy goals articulated by 
Congress, including in CEA sections 4a(a)(2)(C) and 4a(a)(3), as noted 
throughout this discussion of the Commission's cost-benefit 
considerations.\548\ As discussed in greater detail in the preamble, 
the Commission proposes to establish position limits on futures and 
options on futures for these 25 commodities on the basis that position 
limits on such contracts are ``necessary.'' In determining to include 
the proposed 25 core referenced futures contracts within the proposed 
federal position limit framework, the Commission considered the effects 
that these contracts have on the underlying commodity, especially with 
respect to price discovery; the fact that they require physical 
delivery of the underlying commodity and therefore may be more affected 
by manipulation such as corners and squeezes compared to cash-settled 
contracts; and, in some cases, the especially acute economic burdens on 
interstate commerce that could arise from excessive speculation in 
these contracts causing sudden or unreasonable fluctuations or 
unwarranted changes in the price of the commodities underlying these 
contracts.\549\
---------------------------------------------------------------------------

    \547\ See supra Section III.F. (discussion of the necessity 
finding).
    \548\ In promulgating the position limits framework, Congress 
instructed the Commission to consider several factors: First, CEA 
section 4a(a)(3) requires the Commission when establishing position 
limits, to the maximum extent practicable, in its discretion, to (i) 
diminish, eliminate, or prevent excessive speculation; (ii) deter 
and prevent market manipulation, squeezes, and corners; (iii) ensure 
sufficient market liquidity for bona fide hedgers; and (iv) ensure 
that the price discovery function of the underlying market is not 
disrupted. Second, CEA section 4a(a)(2)(C) requires the Commission 
to strive to ensure that any limits imposed by the Commission will 
not cause price discovery in a commodity subject to position limits 
to shift to trading on a foreign exchange.
    \549\ See supra Section III.F. (discussion of the necessity 
finding).
---------------------------------------------------------------------------

    More specifically, the 25 core referenced futures contracts were 
selected because they: (i) Physically settle, (ii) have high levels of 
open interest \550\ and significant notional value of open 
interest,\551\ (iii) serve as a reference price for a significant 
number of swaps and/or cash market transactions, and/or (iv) have, in 
most cases, relatively higher average trading volumes.\552\ These 
factors reflect the important and varying degrees of linkage between 
the derivatives markets and the underlying cash markets. The Commission 
preliminarily acknowledges that there is no mathematical formula that 
would be dispositive, though the Commission has considered relevant 
data where it is available.
---------------------------------------------------------------------------

    \550\ Open interest for this purpose includes the sum of open 
contracts, as defined in Sec.  1.3 of the Commission's regulations, 
in futures contracts and in futures option contracts converted to a 
futures-equivalent amount, as defined in current Sec.  150.1(f) of 
the Commission's regulations. See 17 CFR 1.3 and 150.1(f).
    \551\ Notional value of open interest for this purpose is open 
interest multiplied by the unit of trading for the relevant futures 
contract multiplied by the price of that futures contract.
    \552\ A combination of higher average trading volumes and open 
interest is an indicator of a contract's market liquidity. Higher 
trading volumes make it more likely that the cost of transactions is 
lower with narrower bid-ask spreads.
---------------------------------------------------------------------------

    As a result, the Commission preliminarily has concluded that it 
must exercise its judgment in light of facts and circumstances, 
including its experience and expertise, to determine whether federal 
position limit levels are economically justified. For example, based on 
its general experience, the Commission preliminarily recognizes that 
contracts that physically settle can, in certain circumstances during 
the spot month, be at risk of corners and squeezes, which could distort 
pricing and resource allocation, make it more costly to implement hedge 
strategies, and harm the underlying cash market. Similarly, certain 
contracts with higher

[[Page 11673]]

open interest and/or trading volume are more likely to serve as 
benchmarks and/or references for pricing cash market and other 
transactions, meaning a distortion of the price of any such contract 
could potentially impact underlying cash markets that are important to 
interstate commerce.\553\
---------------------------------------------------------------------------

    \553\ See supra Section III.F. (discussion of the necessity 
finding).
---------------------------------------------------------------------------

    As discussed in more detail in connection with proposed Sec.  150.2 
below, the Commission preliminarily believes that establishing federal 
position limits at the proposed levels for the proposed 25 core 
referenced futures contracts and related referenced contracts would 
result in several benefits, including a reduction in the probability of 
excessive speculation and market manipulation (e.g., squeezes and 
corners) and the attendant harms to price discovery that may result. 
The Commission acknowledges, in connection with establishing federal 
position limit levels under proposed Sec.  150.2 (discussed below), 
that position limits, especially if set too low, could adversely affect 
market liquidity and increase transaction costs, especially for bona 
fide hedgers, which ultimately might be passed on to the general 
public. However, the Commission is also cognizant that setting position 
limit levels too high may result in an increase in the possibility of 
excessive speculation and the harms that may result, such as sudden or 
unreasonable fluctuations or unwarranted changes in the price of the 
commodities underlying these contracts.
    For purposes of this discussion, rather than discussing the general 
potential benefits and costs of the federal position limit framework, 
the Commission will instead focus on the benefits and costs resulting 
from the Commission's proposed necessity finding with respect to the 25 
core referenced futures contracts.\554\ The Commission will address 
potential benefits and costs of its approach with respect to: (1) The 
liquidity and integrity of the futures and related options markets and 
(2) market participants and exchanges.
---------------------------------------------------------------------------

    \554\ See supra Section III.F. (discussion of the necessity 
finding).
---------------------------------------------------------------------------

a. Potential Impact of the Scope of the Commission's Necessity Finding 
on Market Liquidity and Integrity
    The Commission has preliminarily determined that the 25 contracts 
that the Commission proposes to include in its necessity finding are 
among the most liquid physical commodity contracts, as measured by open 
interest and/or trading volume, and therefore, imposing positions 
limits on these contracts may impose costs on market participants by 
constraining liquidity. However, the Commission believes that the 
potential harmful effect on liquidity will be muted, as a result of the 
generally high levels of open interest and trading volumes of the 
respective 25 core referenced futures contracts.\555\
---------------------------------------------------------------------------

    \555\ The contracts that would be subject to the Commission's 
proposal generally have higher trading volumes and open interest, 
which tend to have greater liquidity, including relatively narrower 
bid-ask spreads and relatively smaller price impacts from larger 
transaction sizes. Further, all other factors being equal, markets 
for contracts that are more illiquid tend to be more concentrated, 
so that a position limit on such contracts might reduce open 
interest on one side of the market, because a large trader would 
face the potential of being capped out by a position limit. For this 
reason, among others, the contracts to which the federal position 
limits in existing Sec.  150.2 apply include some of the most liquid 
physical-delivery futures contracts.
---------------------------------------------------------------------------

    The Commission has preliminarily determined that, as a general 
matter, focusing on the 25 proposed core referenced futures contracts 
may benefit market integrity since these contracts generally are 
amongst the largest physically-settled contracts with respect to 
relative levels of open interest and/or trading volumes. As a result, 
the Commission preliminarily believes that excessive speculation or 
potential market manipulation in such contracts would be more likely to 
affect more market participants and therefore potentially more likely 
to cause an undue and unnecessary burden (e.g., potential harm to 
market integrity or liquidity) on interstate commerce. Because each 
proposed core referenced futures contract is physically-settled, as 
opposed to cash-settled, the proposal focuses on preventing corners and 
squeezes in those contracts where such market manipulation could cause 
significant harm in the price discovery process for their respective 
underlying commodities.\556\
---------------------------------------------------------------------------

    \556\ The Commission must also make this determination in light 
of its limited available resources and responsibility to allocate 
taxpayer resources in an efficient manner to meet the goals of 
section 4a(a)(1), and the CEA generally.
---------------------------------------------------------------------------

    While the Commission recognizes that market participants may engage 
in market manipulation through cash-settled futures and options on 
futures, the Commission preliminarily has determined that focusing on 
the physically-settled core referenced futures contracts will benefit 
market integrity by reducing the risk of corners and squeezes in 
particular. In addition, not imposing position limits on additional 
commodities may foster non-excessive speculation, leading to better 
prices and more efficient resource allocation in these commodities. 
This may ultimately benefit commercial end users and possibly be passed 
on to the general public in the form of better pricing. As noted above, 
the scope of the Commission's necessity finding with respect to the 25 
proposed core referenced futures contracts will allow the Commission to 
focus on those contracts that, in general, the Commission preliminarily 
recognizes as having particular importance in the price discovery 
process for their respective underlying commodities as well as 
potentially acute economic burdens that would arise from excessive 
speculation causing sudden or unreasonable fluctuations or unwarranted 
changes in the commodity prices underlying these contracts.
    To the extent the Commission does not include additional 
commodities in its necessity finding, the Commission's approach may 
also introduce additional costs in the form of loss of certain benefits 
associated with the proposed federal position limits framework, such as 
stronger prevention of market manipulation, such as corners and 
squeezes. Accordingly, the greater the potential benefits of the 
proposed federal position limits framework in general, the greater the 
potential cost in the reduction in market integrity in general from not 
including other possible commodities within the federal position limits 
framework (only to the extent any such additional commodities would be 
found to be ``necessary'' for purposes of CEA section 4a). Nonetheless, 
some of the potential harms to market integrity associated with not 
including additional commodities within the federal position limits 
framework could be mitigated to an extent by exchanges, which can use 
tools other than position limits, such as margin requirements or 
position accountability at lower levels than potential federal limits, 
to defend against certain market behavior. Similarly, for those 
contracts that would not be subject to the proposal, exchange-set 
position limits alternatively may achieve the same benefits discussed 
in connection with the proposed federal position limits.
b. Potential Impact of the Scope of the Commission's Necessity Finding 
on Market Participants and Exchanges
    The Commission acknowledges that the federal position limits 
proposed herein could impose certain administrative, logistical, 
technological, and financial burdens on exchanges and market 
participants, especially with respect to developing or expanding 
compliance systems and the adoption of monitoring policies. However, 
the

[[Page 11674]]

Commission preliminarily believes that its approach to delaying the 
effective date by 365 days from publication of any final rule in the 
Federal Register should mitigate compliance costs by permitting the 
update and build out of technological and compliance systems more 
gradually. It may also reduce the burdens on market participants not 
previously subject to position limits, who will have a longer period of 
time to determine whether they may qualify for certain bona fide 
hedging recognitions or other exemptions, and to possibly alter their 
trading or hedging strategies.\557\ Further, the delayed effective date 
will reduce the burdens on exchanges, market participants, and the 
Commission by providing each with more time to resolve technological 
and other challenges for compliance with the new regulations. In turn, 
the Commission preliminarily anticipates that the extra time provided 
by the delayed effective date will result in more robust systems for 
market oversight, which should better facilitate the implementation of 
the Commission's position limits framework and avoid unnecessary market 
disruptions while exchanges and market participants prepare for its 
implementation. However, the longer the proposed delay in the 
proposal's effective date, the longer it will take to realize the 
benefits identified above.
---------------------------------------------------------------------------

    \557\ Commenters on prior proposals have requested a sufficient 
phase-in period. See, e.g., 2016 Reproposal, 81 FR at 96815 
(implementation timeline).
---------------------------------------------------------------------------

3. Federal Position Limit Levels (Proposed Sec.  150.2)
a. General Approach
    Existing Sec.  150.2 establishes position limit levels that apply 
net long or net short to futures and futures-equivalent options 
contracts on nine legacy physically-settled agricultural 
contracts.\558\ The Commission has previously set separate federal 
position limits for: (i) The spot month, and (ii) the single month and 
all-months combined limit levels (i.e., ``non-spot months'').\559\ For 
the existing spot month federal limit levels, the contract levels are 
based on 25 percent, or lower, of the estimated deliverable supply 
(``EDS'').\560\ For the existing single month and all-months combined 
limit levels, the levels are set at 10 percent of open interest for the 
first 25,000 contracts of open interest, with a marginal increase of 
2.5 percent of open interest thereafter (the ``10, 2.5 percent 
formula'').
---------------------------------------------------------------------------

    \558\ The nine legacy agricultural contracts currently subject 
to federal spot and non-spot month limits are: CBOT Corn (C), CBOT 
Oats (O), CBOT Soybeans (S), CBOT Wheat (W), CBOT Soybean Oil (SO), 
CBOT Soybean Meal (SM), MGEX Hard Red Spring Wheat (MWE), ICE Cotton 
No. 2 (CT), and CBOT KC Hard Red Winter Wheat (KW).
    \559\ For clarity, limits for single and all-months combined 
apply separately. However, the Commission previously has applied the 
same limit levels to the single month and all-months combined. 
Accordingly, the Commission will discuss the single and all-months 
limits, i.e., the non-spot month limits, together.
    \560\ See supra Section II.B.1--Existing Sec.  150.2 (discussing 
that establishing spot month levels at 25 percent or less of EDS is 
consistent with past Commission practices).
---------------------------------------------------------------------------

    Proposed Sec.  150.2 would revise and expand the current federal 
position limits framework as follows: First, for spot month levels, 
proposed Sec.  150.2 would (i) cover 16 additional physically-settled 
futures and related options contracts, based on the Commission's 
existing approach of establishing limit levels at 25 percent or lower 
of EDS, for a total of 25 core referenced futures contracts subject to 
federal spot month limits (i.e., the nine legacy agricultural contracts 
plus the proposed 16 additional contracts); \561\ and (ii) update the 
existing spot month levels for the nine legacy agricultural contracts 
based on revised EDS.\562\
---------------------------------------------------------------------------

    \561\ The 16 proposed new products that would be subject to 
federal spot month limits would include seven agricultural (CME Live 
Cattle (LC), CBOT Rough Rice (RR), ICE Cocoa (CC), ICE Coffee C 
(KC), ICE FCOJ-A (OJ), ICE U.S. Sugar No. 11 (SB), and ICE U.S. 
Sugar No. 16 (SF)), four energy (NYMEX Light Sweet Crude Oil (CL), 
NYMEX NY Harbor ULSD Heating Oil (HO), NYMEX NY Harbor RBOB Gasoline 
(RB), and NYMEX Henry Hub Natural Gas (NG)), and five metals (COMEX 
Gold (GC), COMEX Silver (SI), COMEX Copper (HG), NYMEX Palladium 
(PA), and NYMEX Platinum (PL)) contracts.
    \562\ The proposal would maintain the current spot month limits 
on CBOT Oats (O).
---------------------------------------------------------------------------

    Second, for non-spot month levels, proposed Sec.  150.2 would 
revise the 10, 2.5 percent formula so that (i) the incremental 2.5 
percent increase takes effect after 50,000 contracts of open interest, 
rather than after 25,000 contracts under the existing rule (the 
``marginal threshold level''), and (ii) the limit levels will be 
calculated by applying the updated 10, 2.5 percent formula to open 
interest data for the periods from July 2017-June 2018 and July 2018-
June 2019 of the applicable futures and delta adjusted futures 
options.\563\
---------------------------------------------------------------------------

    \563\ As discussed below, for most of the legacy agricultural 
commodities, this would result in a higher non-spot month limit. 
However, the Commission is not proposing to change the non-spot 
month limits for either CBOT Oats (O) or MGEX Hard Red Spring Wheat 
(MWE) based on the revised open interest since this would result in 
a reduction of non-spot month limits from 2,000 to 700 contracts for 
CBOT Oats (O) and 12,000 to 5,700 contracts for MGEX HRS Wheat 
(MWE). Similarly, the Commission also proposed to maintain the 
current non-spot month limit for CBOT KC Hard Red Winter Wheat (KW).
---------------------------------------------------------------------------

    Third, the proposed position limits framework would expand to cover 
(i) any cash-settled futures and related options contracts directly or 
indirectly linked to any of the 25 proposed physically-settled core 
referenced futures contracts as well as (ii) any economically 
equivalent swaps.
    For spot month positions, the proposed position limits would apply 
separately, net long or short, to cash-settled contracts and to 
physically-settled contracts in the same commodity. This would result 
in a separate net long/short position for each category so that cash-
settled contracts in a particular commodity would be netted with other 
cash-settled contracts in that commodity, and physically-settled 
contracts in a given commodity would be netted with other physically-
settled contracts in that commodity; a cash-settled contract and a 
physically-settled contract would not net with one another. Outside the 
spot month, cash and physically-settled contracts in the same commodity 
would be netted together to determine a single net long/short position.
    Fourth, proposed Sec.  150.2 would subject certain pre-existing 
positions to federal position limits during the spot month but would 
grandfather certain pre-existing positions outside the spot month.
    In setting the federal position limit levels, the Commission seeks 
to advance the enumerated statutory objectives with respect to position 
limits in CEA section 4a(a)(3)(B).\564\ The Commission recognizes that 
relatively high limit levels may be more likely to support some of the 
statutory goals and less likely to advance others. For instance, a 
relatively higher limit level may be more likely to benefit market 
liquidity for hedgers or ensure that the price discovery of the 
underlying market is not disrupted, but may be less likely to benefit 
market integrity by being less effective at diminishing, eliminating, 
or preventing excessive speculation or at deterring and preventing 
market manipulation, corners, and squeezes. In particular, setting 
relatively high federal position limit levels may result in excessively 
large speculative positions and/or increased volatility, especially 
during speculative showdowns, which may cause some market participants 
to retreat from the commodities markets due to perceived decreases in 
market integrity. In turn, fewer market participants may result in 
lower liquidity levels for hedgers and harm to

[[Page 11675]]

the price discovery function in the underlying markets.
---------------------------------------------------------------------------

    \564\ See supra Section II.B.2.c. (for further discussion 
regarding the CEA's statutory objectives for the federal position 
limits framework).
---------------------------------------------------------------------------

    Conversely, setting a relatively lower federal limit level may be 
more likely to diminish, eliminate, or prevent excessive speculation, 
but may also limit the availability of certain hedging strategies, 
adversely affect levels of liquidity, and increase transaction 
costs.\565\ Additionally, setting federal position limits too low may 
cause non-excessive speculation to exit a market, which could reduce 
liquidity, cause ``choppy'' \566\ prices and reduced market efficiency, 
and increase option premia to compensate for the more volatile prices. 
The Commission in its discretion has nevertheless endeavored to set 
federal limit levels, to the maximum extent practicable, to benefit the 
statutory goals identified by Congress.
---------------------------------------------------------------------------

    \565\ For example, relatively lower federal limits may adversely 
affect potential hedgers by reducing liquidity. In the case of 
reduced liquidity, a potential hedger may face unfavorable spreads 
and prices, in which case the hedger must choose either to delay 
implementing its hedging strategy and hope for more favorable 
spreads in the near future or to choose immediate execution (to the 
extent possible) at a less favorable price.
    \566\ ``Choppy'' prices often refers to illiquidity in a market 
where transacted prices bounce between the bid and the ask prices. 
Market efficiency may be harmed in the sense that transacted prices 
might need to be adjusted for the bid-ask bounce to determine the 
fundamental value of the underlying contract.
---------------------------------------------------------------------------

    As discussed above, the contracts that would be subject to the 
proposed federal limits are currently subject to either federal- or 
exchange-set limits (or both). To the extent that the proposed federal 
position limit levels are higher than the existing federal position 
limit levels for either the spot or non-spot month, market participants 
currently trading these contracts could engage in additional trading 
under the proposed federal limits in proposed Sec.  150.2 that 
otherwise would be prohibited under existing Sec.  150.2.\567\ On the 
other hand, to the extent an exchange-set limit level would be lower 
than its proposed corresponding federal limit, the proposed federal 
limit would not affect market participants since market participants 
would be required to comply with the lower exchange-set limit level (to 
the extent that the exchanges maintain their current levels).\568\
---------------------------------------------------------------------------

    \567\ For the spot month, all the legacy agricultural contracts 
other than CBOT Oats (O) would have higher federal levels. For the 
non-spot months, all the legacy agricultural contracts other than 
CBOT Oats (O), MGEX HRS Wheat (MWE), and CBOT KC HRW Wheat (KW), 
would have higher federal levels.
    \568\ While the Commission proposes to generally either increase 
or maintain the federal position limits for both the spot-months and 
non-spot months compared to existing federal limits, where 
applicable, and exchange limits, the proposed federal level for 
COMEX Copper (HG) would be below the existing exchange-set level. 
Accordingly, market participants may have to change their trading 
behavior with respect to COMEX Copper (HG), which could impose 
compliance and transaction costs on these traders, to the extent 
their existing trading would violate the proposed lower federal 
limit levels.
---------------------------------------------------------------------------

b. Spot Month Levels
    The Commission proposes to maintain 25 percent of EDS as a ceiling 
for federal limits. Based on the Commission's experience overseeing 
federal position limits for decades and overseeing exchange-set 
position limits submitted to the Commission pursuant to part 40 of the 
Commission's regulations, none of the proposed levels listed in 
Appendix E of part 150 of the Commission's regulations appears to be so 
low as to reduce liquidity for bona fide hedgers or disrupt price 
discovery function of the underlying market, or so high as to invite 
excessive speculation, manipulation, corners, or squeezes because, 
among other things, any potential economic gains resulting from the 
manipulation may be insufficient to justify the potential costs, 
including the costs of acquiring, and ultimately offloading, the 
positions used to effect the manipulation.
c. Levels Outside of the Spot Month
i. The 10, 2.5 Percent Formula
    The Commission preliminarily has determined that the existing 10, 
2.5 percent formula generally has functioned well for the existing nine 
legacy agricultural contracts and has successfully benefited the 
markets by taking into account the competing goals of facilitating both 
liquidity formation and price discovery while also protecting the 
markets from harmful market manipulation and excessive speculation. 
However, since the existing limit levels are based on open interest 
levels from 2009 (except for CBOT Oats (O), CBOT Soybeans (S), and ICE 
Cotton No. 2 (CT), for which existing levels are based on the 
respective open interest from 1999), the Commission is proposing to 
revise the levels based on the periods from July 2017-June 2018 and 
July 2018-June 2019 to reflect the general increases in open interest 
and trading volume that have occurred over time in the nine legacy 
agricultural contracts (other than CBOT Oats (O), MGEX HRS Wheat (MWE), 
and CBOT KC HRW Wheat (KW)).\569\ Since the proposed increase for most 
of the federal non-spot position limits is predicated on the increase 
in open interest and trading volume, as reflected in the revised data 
reviewed by the Commission, the Commission preliminarily believes that 
its proposal may enhance, or at least should maintain, general 
liquidity, which the Commission preliminarily believes may benefit 
those with bona fide hedging positions, and commercial end users in 
general. On the other hand, the Commission understands that many market 
participants, especially commercial end users, generally believe that 
the existing non-spot month levels for the nine legacy agricultural 
commodities function well, including promoting liquidity and 
facilitating bona fide hedging in the respective markets. As a result, 
the Commission's proposal may increase the risk of excessive 
speculation without achieving any concomitant benefits of increased 
liquidity for bona fide hedgers compared to the status quo.
---------------------------------------------------------------------------

    \569\ For most of the legacy agricultural commodities, this 
would result in a higher non-spot month limit. However, the 
Commission is not proposing to change the non-spot month limits for 
either CBOT Oats (O) or MGEX HRS Wheat (MWE) based on the revised 
open interest since this would result in a reduction of non-spot 
month limits from 2,000 to 700 contracts for CBOT Oats (O) and 
12,000 to 5,700 contracts for MGEX HRS Wheat (MWE). Similarly, the 
Commission also proposed to maintain the current non-spot month 
limit for CBOT KC HRW Wheat (KW). See supra Section II.B.2.e. --
Methodology for Setting Proposed Non-Spot Month Limit Levels for 
further discussion.
---------------------------------------------------------------------------

    The Commission also preliminarily recognizes that there could be 
potential costs to keeping the existing 10, 2.5 percent formula (even 
if revised to reflect current open interest levels) compared to 
alternative formulae that would result in even higher federal position 
limit levels. First, while the 10, 2.5 percent formula may have 
reflected ``normal'' observed market activity through 1999 when the 
Commission adopted it, it no longer reflects current open interest 
figures. When adopting the 10, 2.5 percent formula in 1999, the 
Commission's experience in these markets reflected aggregate futures 
and options open interest well below 500,000 contracts, which no longer 
reflects market reality.\570\ As the nine legacy agricultural contracts 
(with the exception of CBOT Oats (O)) all have open interest well above 
25,000

[[Page 11676]]

contracts, and in some cases above 500,000 contracts, the existing 
formula may act as a negative constraint on liquidity formation 
relative to the higher proposed formula. Further, if open interest 
continues to increase over time, the Commission anticipates that the 
existing 10, 2.5 percent formula could impose even greater marginal 
costs on bona fide hedgers by potentially constraining liquidity 
formation (i.e., as the open interest of a commodity contract increase, 
a greater relative proportion of the commodity's open interest is 
subject to the 2.5 percent limit level rather than the initial 10 
percent limit). In turn, this may increase costs to commercial firms, 
which may be passed to the public in the form of higher prices.
---------------------------------------------------------------------------

    \570\ See 64 FR at 24038, 24039 (May 5, 1999). As discussed in 
the preamble, the data show that by the 2015-2018 period, five of 
the nine legacy agricultural contracts had maximum open interest 
greater than 500,000 contracts. The contracts for CBOT Corn (C), 
CBOT Soybeans (S), and CBOT KC HRW Wheat (KW) saw increased maximum 
open interest by a factor of four to five times the maximum open 
interest during the years leading up to the Commission's adoption of 
the 10, 2.5 percent formula in 1999. Similarly, the contracts for 
CBOT Soybean Meal (SM), CBOT Soybean Oil (SO), CBOT Wheat (W), and 
MGEX HRS Wheat (MWE) saw increased maximum open interest by a factor 
of three to four times. See supra Section II.B.2.e. --Methodology 
for Setting Proposed Non-Spot Month Limit Levels for further 
discussion.
---------------------------------------------------------------------------

    Further, to the extent there may be certain liquidity constrains, 
the Commission has determined that this potential concern could be 
mitigated, at least in part, by the Commission's proposed change to 
increase the marginal threshold level from 25,000 contracts to 50,000 
contracts, which the Commission preliminarily believes should provide a 
conservative increase in the non-spot month limits for most contracts 
to better reflect the general increase observed in open interest across 
futures markets. The Commission acknowledges that the marginal 
threshold level could be increased above 50,000 contracts, but notes 
that each increase of 25,000 contracts in the marginal threshold level 
would only increase the permitted non-spot month level by 1,875 
contracts (i.e., (10% of 25,000 contracts)--(2.5% of 25,000 contracts) 
= 1,875 contracts). The Commission has observed based on current data 
that this proposed change could benefit several market participants per 
legacy agricultural commodity who otherwise would bump up against the 
all-months and/or single month limits with based on the status quo 
threshold of 25,000 contracts. As a result, the Commission 
preliminarily has determined that changing the marginal threshold level 
could result in marginal benefits and costs for many of the legacy 
agricultural commodities, but the Commission acknowledges the proposed 
change is relatively minor compared to revising the existing 10, 2.5 
percent formula based on updated open interest data.
    Second, the Commission preliminarily recognizes that an alternative 
formula that allows for higher non-spot limits, compared to the 
existing 10, 2.5 percent formula, could benefit liquidity and market 
efficiency by creating a framework that is more conducive to the larger 
liquidity providers that have entered the market over time.\571\ 
Compared to when the Commission first adopted the 10, 2.5 percent 
formula, today there exist relatively more large non-commercial 
traders, such as banks, managed money traders, and swap dealers, which 
generally hold long positions and act as aggregators or market makers 
that provide liquidity to short positions (e.g., commercial 
hedgers).\572\ These dealers also function in the swaps market and use 
the futures market to hedge their exposures. Accordingly, to the extent 
that larger non-commercial market makers and liquidity providers have 
entered the market--particularly to the extent they are able to take 
offsetting positions to commercial short interests--a hypothetical 
alternative formula that would permit higher non-spot month limits 
might provide greater market liquidity, and possibly increased market 
efficiency, by allowing for greater market-making activities.\573\
---------------------------------------------------------------------------

    \571\ See supra Section II.B.2.e.--Methodology for Setting 
Proposed Non-Spot Month Limit Levels for further discussion.
    \572\ Id.
    \573\ For example, the Commission is aware of several market 
makers that either have left particular commodity markets, or 
reduced their market making activities. See, e.g., McFarlane, Sarah, 
Major Oil Traders Don't See Banks Returning to the Commodity Markets 
They Left, The Wall Street Journal (Mar. 28, 2017), available at 
https://www.wsj.com/articles/major-oil-traders-dont-see-banks-returning-to-the-commodity-markets-they-left-1490715761?mg=prod/com-
wsj (describing how ``Morgan Stanley sold its oil trading and 
storage business . . . and J.P. Morgan unloaded its physical 
commodities business . . . .''); Decambre, Mark, Goldman Said to 
Plan Cuts to Commodity Trading Desk: WSJ, MarketWatch website (Feb. 
5, 2019), https://www.marketwatch.com/story/goldman-said-to-plan-cuts-to-commodity-trading-desk-wsj-2019-02-05 (describing how 
Goldman Sachs ``plans on making cuts within its commodity trading 
platform. . . .'').
---------------------------------------------------------------------------

    However, the Commission believes that any purported benefits 
related to a hypothetical alternative formula that would allow for 
higher non-spot limits would be minimal at best. Specifically, bona 
fide hedgers and end users generally have not requested a revised 
formula to allow for significantly higher non-spot limits. Similarly, 
liquidity providers would still be able to maintain, and possibly 
increase, market making activities under the Commission's proposal 
since the non-spot month limits will generally still increase under the 
existing 10, 2.5 percent formula to reflect the increase in open 
interest. Further, to the extent that the Commission's proposal to 
eliminate the risk management exemption could theoretically force 
liquidity providers to reduce their trading activities, the Commission 
preliminarily believes that certain liquidity-providing activity of the 
existing risk management exemption holders may still be permitted under 
the Commission's proposal, either as a result of the proposed swap 
pass-through provision or because of the general increase in limits 
based on the revised open interest levels.\574\ The Commission also 
preliminarily recognizes an additional benefit to market integrity of 
the current proposal compared to a hypothetical alternative formula: 
While the Commission believes that the proposed pass-through swap 
provision is narrowly-tailored to enable liquidity providers to 
continue providing liquidity to bona fide hedgers, in contrast, an 
alternative formula that would allow higher limit levels for all market 
participants would also permit increased excessive speculation and 
increase the probability of market manipulation or harm the underlying 
price discovery function.
---------------------------------------------------------------------------

    \574\ See supra Section II.A.1.c.v. (preamble discussion of 
pass-through swap provision); see infra Section IV.A.4.b.i.(2).
---------------------------------------------------------------------------

    Additionally, some have voiced general concern that permitting 
increased federal non-spot month limits in the nine legacy agricultural 
contracts (at any level), especially in connection with commodity 
indices, could disrupt price discovery and result in a lack of 
convergence between futures and cash prices, resulting in increased 
costs to end users, which ultimately could be borne by the public. The 
Commission has not seen data demonstrating this causal connection, but 
acknowledges arguments to that effect.\575\
---------------------------------------------------------------------------

    \575\ As discussed in preamble Section II.B.2.e.--Methodology 
for Setting Proposed Non-Spot Month Limit Levels, one of the 
concerns that prompted the 2008 moratorium on granting risk 
management exemptions was a lack of convergence between futures and 
cash prices in wheat. Some at the time hypothesized that perhaps 
commodity index trading was a contributing factor to the lack of 
convergence, and, some have argued that this could harm price 
discovery since traders holding these positions may not react to 
market fundamentals, thereby exacerbating any problems with 
convergence. However, the Commission has determined for various 
reasons that risk management exemptions did not lead to the lack of 
convergence since the Commission understands that many commodity 
index traders vacate contracts before the spot month and therefore 
would not influence converge between the spot and futures price at 
expiration of the contract. Further, the risk-management exemptions 
granted prior to 2008 remain in effect, yet the Commission is 
unaware of any significant convergence problems relating to 
commodity index traders at this time. Additionally, there did not 
appear to be any convergence problems between the period when 
Commission staff initially granted risk management exemptions and 
2007. Instead, the Commission believes that the convergence issues 
that started to occur around 2007 were due to the contract 
specification underpricing the option to store wheat for the long 
futures holder making the expiring futures price more valuable than 
spot wheat.
---------------------------------------------------------------------------

    Third, if the Commission's proposed non-spot position limits would 
be too

[[Page 11677]]

high for a commodity, the proposal might be less effective in deterring 
excessive speculation and market manipulation for that commodity's 
market. Conversely, if the Commission's proposed position limit levels 
would be too low for a commodity, the proposal could unduly constrain 
liquidity for bona fide hedgers or result in a diminished price 
discovery function for that commodity's underlying market. In either 
case, the Commission would view these as costs imposed on market 
participants. However, to the extent the Commission's proposed non-spot 
limit levels could be too high, the Commission preliminarily believes 
these costs could be mitigated because exchanges would be able to 
establish lower non-spot month levels.\576\ Moreover, these concerns 
may be mitigated further to the extent that exchanges use other tools 
for protecting markets aside from position limits, such as establishing 
accountability levels below federal position limit levels or imposing 
liquidity and concentration surcharges to initial margin if vertically 
integrated with a derivatives clearing organization. Further, as 
discussed below, the Commission is proposing to maintain current non-
spot limit levels for CBOT Oats (O), MGEX HRS Wheat (MWE), and CBOT KC 
HRW Wheat (KW), which otherwise would be lower based on current open 
interest levels for these contracts.
---------------------------------------------------------------------------

    \576\ On the other hand, relying on exchanges may have potential 
costs because exchanges may have conflicting interests and therefore 
may not establish position limit (or accountability) levels lower 
than the proposed federal limits. For example, exchanges may not be 
incentivized to lower their limits due to competitive concerns with 
another exchange, or due to influence from a large customer. 
Conversely, exchange and Commission interests may be aligned to the 
extent that exchanges do have a countervailing interest to protect 
their markets from manipulation and price distortion: If market 
participants lose confidence in the contract as a tool for hedging, 
they will look for alternatives, possibly migrating to another 
product on a different exchange. The Commission is aware of at least 
one instance in which exchanges adopted spot-month position limits 
and/or adopted a lower exchange-set limit for particular futures 
contracts as a result of excessive manipulation and potential market 
manipulation. Similarly, exchanges remain subject to their core 
principle obligations to prevent manipulation, and the Commission 
conducts general market oversight through its own surveillance 
program. Accordingly, the Commission acknowledges such concerns 
about conflicting exchange incentives, but preliminarily believes 
that such concerns are mitigated for the foregoing reasons.
---------------------------------------------------------------------------

ii. Exceptions to the Proposed 10, 2.5 Percent Formula for CBOT Oats 
(O), MGEX Hard Red Spring Wheat (MWE), and CBOT Kansas City Hard Red 
Winter Wheat (KW)
    Based on the Commission's experience since 2011 with non-spot month 
speculative position limit levels for MGEX HRS Wheat (``MWE'') and CBOT 
KC HRW Wheat (``KW'') core referenced futures contracts, the Commission 
is proposing to maintain the proposed limit levels for MWE and KW at 
the existing level of 12,000 contracts rather than reducing them to the 
lower level that would result from applying the proposed updated 10, 
2.5 percent formula. Maintaining the status quo for the MWE and KW non-
spot month limit levels would result in partial wheat parity between 
those two wheat contracts, but not with CBOT Wheat (``W''), which would 
increase to 19,300 contracts. The Commission preliminarily believes 
that this will benefit the MWE and KW markets since the two species of 
wheat are similar to one another; accordingly, decreasing the non-spot 
month levels for MWE could impose liquidity costs on the MWE market and 
harm bona fide hedgers, which could further harm liquidity or bona fide 
hedgers in the KW market. On the other hand, the Commission has 
determined not to raise the proposed limit levels for either KW or MWE 
to the limit level for W since the non-spot month level appears to be 
extraordinarily large in comparison to open interest in KW and MWE 
markets, and the limit level for the MWE contract is already larger 
than the limit level would be based on the 10, 2.5 percent formula. 
While W is a potential substitute for KW and MWE, it is not similar to 
the same extent that MWE and KW are to one another, and so the 
Commission has preliminarily determined that this is a reasonable 
compromise to maintain liquidity and price discovery while not 
unnecessarily inviting excessive speculation or potential market 
manipulation in the MWE and KW markets.
    Likewise, based on the Commission's experience since 2011 with the 
non-spot month speculative position limit for CBOT Oats (O), the 
Commission is proposing the limit level at the current 2,000 contract 
level rather than reducing it to the lower level that would result from 
applying the updated 10, 2.5 formula based on current open interest. 
The Commission has preliminarily determined that there is no evidence 
of potential market manipulation or excessive speculation, and so there 
would be no perceived benefit to reducing the non-spot month limit for 
the CBOT Oats (O) contract, while reducing the level could impose 
liquidity costs.
d. Core Referenced Futures Contracts and Linked Referenced Contracts; 
Netting
    The definitions of the terms ``core referenced futures contract'' 
and ``referenced contract'' set the scope of contracts to which federal 
position limits apply. As discussed below, by applying the federal 
position limits to ``referenced contracts,'' the Commission's proposal 
would expand the federal position limits beyond the proposed 25 
physically-settled ``core referenced futures contracts'' listed in 
proposed Appendix E to part 150 by also including any cash-settled 
``referenced contracts'' linked thereto as well as swaps that meet the 
proposed ``economically equivalent swap'' definition and thus qualify 
as ``referenced contracts.'' \577\
---------------------------------------------------------------------------

    \577\ As discussed in the preamble, the proposed position limits 
framework would also apply to physically-settled swaps that qualify 
as economically equivalent swaps. However, the Commission 
preliminarily believes that physically-settled economically 
equivalent swaps would be few in number.
---------------------------------------------------------------------------

i. Referenced Contracts
    The Commission preliminarily has determined that including futures 
contracts and options thereon that are ``directly'' or ``indirectly 
linked'' to the core referenced contracts, including cash-settled 
contracts, under the proposed definition of ``referenced contract'' 
would help prevent the evasion of federal position limits--especially 
during the spot month--through the creation of a financially equivalent 
contract that references the price of a core referenced futures 
contract. The Commission preliminarily has determined that this will 
benefit market integrity and potentially reduce costs to market 
participants that otherwise could result from market manipulation.
    The Commission also recognizes that including cash-settled 
contracts within the proposed federal position limits framework may 
impose additional compliance costs on market participants and 
exchanges. Further, the proposed federal position limits--especially 
outside the spot month--may not provide the benefits discussed above 
with respect to market integrity and manipulation because there is no 
physical delivery outside the spot month and therefore there is reduced 
concern for corners and squeezes. However, to the extent that there is 
manipulation of such non-spot, cash-settled contracts, the Commission's 
authority to regulate and oversee futures and related options markets 
(other than through establishing federal position

[[Page 11678]]

limits) may also be effective in uncovering or preventing manipulation, 
especially in the non-spot cash markets, and may result in relatively 
lower compliance costs incurred by market participants. Similarly, the 
Commission preliminarily acknowledges that exchange oversight could 
provide the same benefit to market oversight and prevention of market 
manipulation, but with lower costs imposed on market participants--
given the exchanges' deep familiarity with their own markets and their 
ability to tailor a response to a particular market disruption--
compared to federal position limits.
    The proposed ``referenced contract'' definition would also include 
``economically equivalent swaps,'' and for the reasons discussed below 
would include a narrower set of swaps compared to the set of futures 
and options thereon that would be, under the proposed ``referenced 
contract'' definition, captured as either ``directly'' or ``indirectly 
linked'' to a core referenced futures contract.\578\
---------------------------------------------------------------------------

    \578\ See infra Section IV.A.3.d.iv. (discussion of economically 
equivalent swaps).
---------------------------------------------------------------------------

ii. Netting
    The Commission proposes to permit market participants to net 
positions outside the spot month in linked physically-settled and cash-
settled referenced contracts, but during the spot month market 
participants would not be able to net their positions in cash-settled 
referenced contracts against their positions in physically-settled 
referenced contracts. The Commission preliminarily believes that its 
proposal would benefit liquidity formation and bona fide hedgers 
outside the spot months since the proposed netting rules would 
facilitate the management of risk on a portfolio basis for liquidity 
providers and market makers. In turn, improved liquidity may benefit 
bona fide hedgers and other end users by facilitating their hedging 
strategies and reducing related transaction costs (e.g., improving 
execution timing and reducing bid-ask spreads). On the other hand, the 
Commission recognizes that allowing such netting could increase 
transaction costs and harm market integrity by allowing for a greater 
possibility of market manipulation since market participants and 
speculators would be able to maintain larger gross positions outside 
the spot month. However, the Commission preliminarily has determined 
that such potential costs may be mitigated since concerns about corners 
and squeezes generally are less acute outside the spot month given 
there is no physical delivery involved, and because there are tools 
other than federal position limits for preventing and deterring other 
types of manipulation, including banging the close, such as exchange-
set limits and accountability and surveillance both at the exchange and 
federal level. Moreover, prohibiting the netting of physical and cash 
positions during the spot month should benefit bona fide hedgers as 
well as price discovery of the underlying markets since market makers 
and speculators would not be able to maintain a relatively large 
position in the physical markets by netting it against its positions in 
the cash markets.\579\ While this may increase compliance and 
transaction costs for speculators, it might benefit some bona fide 
hedgers and end users. It might also impose costs on exchanges, 
including increased surveillance and compliance costs and lost fees 
related to the trading that such market makers or speculators otherwise 
might engage in absent federal position limits or with the ability to 
their net physical and cash positions.
---------------------------------------------------------------------------

    \579\ Otherwise, a participant could maintain large, offsetting 
positions in excess of limits in both the physically-settled and 
cash-settled contract, which might harm market integrity and price 
discovery and undermine the federal position limits framework. For 
example, absent such a restriction in the spot month, a trader could 
stand for over 100 percent of deliverable supply during the spot 
month by holding a large long position in the physical-delivery 
contract along with an offsetting short position in a cash-settled 
contract, which effectively would corner the market.
---------------------------------------------------------------------------

iii. Exclusions From the ``Referenced Contract'' Definition
    First, while the proposed ``referenced contract'' definition would 
include linked contracts, it would explicitly exclude location basis 
contracts, which are contracts that reflect the difference between two 
delivery locations or quality grades of the same commodity.\580\ The 
Commission preliminarily believes that excluding location basis 
contracts from the ``referenced contract'' definition would benefit 
market integrity by preventing a trader from obtaining an 
extraordinarily large speculative position in the commodity underlying 
the referenced contract. Otherwise, absent the proposed exclusion, a 
market participant could increase its exposure in the commodity 
underlying the referenced contract by using the location basis contract 
to net down against its position in a referenced contract, and then 
further increase its position in the referenced contract that would 
otherwise by restricted by position limits. Similarly, the Commission 
preliminarily believes that this would reduce hedging costs for hedgers 
and commercial end-users, as they would be able to more efficiently 
hedge the cost of commodities at their preferred location without the 
risk of possibly hitting a position limits ceiling or incur compliance 
costs related to applying for a bona fide hedge related to such 
position.
---------------------------------------------------------------------------

    \580\ The term ``location basis contract'' generally means a 
derivative that is cash-settled based on the difference in price, 
directly or indirectly, of (1) a core referenced futures contract; 
and (2) the same commodity underlying a particular core referenced 
futures contract at a different delivery location than that of the 
core referenced futures contract. For clarity, a core referenced 
futures contract may have specifications that include multiple 
delivery points or different grades (i.e., the delivery price may be 
determined to be at par, a fixed discount to par, or a premium to 
par, depending on the grade or quality). The above discussion 
regarding location basis contracts is referring to delivery 
locations or quality grades other than those contemplated by the 
applicable core referenced futures contract.
---------------------------------------------------------------------------

    Excluding location basis contracts from the ``referenced contract'' 
definition also could impose costs for market participants that wish to 
trade location basis contracts since, as noted, such contracts would 
not be subject to federal limits and thus could be more easily subject 
to manipulation by a market participant that obtained an excessively 
large position. However, the Commission preliminarily believes such 
costs are mitigated because location basis contracts generally 
demonstrate less volatility and are less liquid than the core 
referenced futures contracts, meaning the Commission believes that it 
would be an inefficient method of manipulation (i.e., too costly to 
implement and therefore, the Commission believes that the probability 
of manipulation is low). Further, excluding location basis contracts 
from the ``referenced contract'' definition is consistent with existing 
market practice since the market treats a contract on one grade or 
delivery location of a commodity as different from another grade or 
delivery location. Accordingly, to the extent that the proposal is 
consistent with current market practice, any benefits or costs already 
may have been realized.
    Second, the Commission preliminarily has concluded that excluding 
commodity indices from the ``referenced contract'' definition would 
benefit market integrity by preventing speculators from using a 
commodity index contract to net down an outright position in a 
referenced contract that is a component of the commodity index 
contract, which would allow the speculator to take on large outright 
positions in the referenced contracts and therefore result in increased 
speculation, undermining the federal

[[Page 11679]]

position limits framework.\581\ However, the Commission preliminarily 
believes that its proposed exclusion could impose costs on market 
participants that trade commodity indices since, as noted, such 
contracts would not be subject to federal limits and thus could be more 
easily subject to manipulation by a market participant that obtained an 
excessively large position. The Commission preliminarily believes such 
costs would be mitigated because the commodities comprising the index 
would themselves be subject to limits, and because commodity index 
contracts generally tend to exhibit low volatility since they are 
diversified across many different commodities. Further, the Commission 
believes that it is possible that excluding commodity indices from the 
definition of ``referenced contracts'' could result in some trading 
shifting to commodity indices contracts, which may reduce liquidity in 
exchange-listed core referenced futures contracts, harm pre-trade 
transparency and the price discovery process in the futures markets, 
and further depress open interest (as volumes shift to index positions, 
which would not count toward open interest calculations). However, the 
Commission believes that the probability of this occurring is low 
because the Commission preliminarily believes that using indices is an 
inefficient means of obtaining exposure to a certain commodity.
---------------------------------------------------------------------------

    \581\ Further, the Commission believes that prohibiting the 
netting of a commodity index position with a referenced contract is 
required by its interpretation of the Dodd-Frank Act's amendments to 
the CEA's definition of ``bona fide hedging transaction or 
position.'' The Commission interprets the amended CEA definition to 
eliminate the Commission's ability to recognize risk management 
positions as bona fide hedges or transactions. See infra Section 
IV.A.4.--Bona Fide Hedging and Spread and Other Exemptions from 
Federal Position Limits (proposed Sec. Sec.  150.1 and 150.3) for 
further discussion. In this regard, the Commission has observed that 
it is common for swap dealers to enter into commodity index 
contracts with participants for which the contract would not qualify 
as a bona fide hedging position (e.g., with a pension fund). Failing 
to exclude commodity index contracts from the ``referenced 
contract'' definition could enable a swap dealer to use positions in 
commodity index contracts as a risk management hedge by netting down 
its offsetting outright futures positions in the components of the 
index. Permitting this type of risk management hedge would subvert 
the statutory pass-through swap language in CEA section 4a(c)(2)(B), 
which the Commission interprets as prohibiting the recognition of 
positions entered into for risk management purposes as bona fide 
hedges unless the swap dealer is entering into positions opposite a 
counterparty for which the swap position is a bona fide hedge.
---------------------------------------------------------------------------

    Under certain circumstances, a participant that has reached the 
applicable position limit could use a commodity index to purchase and 
weight a commodity index contract, which is otherwise excluded from the 
``referenced contract'' definition and therefore from federal position 
limits, in a manner that would allow the participant to exceed limits 
of the applicable referenced contract (i.e., the participant could be 
long outright in a referenced contract, purchase a commodity index 
contract that includes the applicable referenced contract as a 
component, and short the remaining components of the index. The 
Commission observes that these short positions would be subject to the 
proposed federal limits, so there would be a ceiling on this strategy 
and, in addition, it would be costly to potential manipulators because 
margin would have to be posted and exchanged to retain the positions. 
In this circumstance, excluding commodity indices from the ``referenced 
contract'' definition could impose costs on market integrity. However, 
the Commission preliminarily believes any related costs should be 
mitigated because proposed Sec.  150.2 would include anti-evasion 
language that would deem such commodity index contract to be a 
referenced contract subject to federal limits. Also, analogous costs 
could apply to the discussion above regarding location basis contracts 
and such proposed anti-evasion provision would similarly cover location 
basis contracts.\582\
---------------------------------------------------------------------------

    \582\ Similarly, the proposed anti-evasion provision would also 
provide that a spread exemption would no longer apply.
---------------------------------------------------------------------------

iv. Economically Equivalent Swaps
    The existing federal position limits framework does not include 
limit levels on swaps. The Dodd-Frank Act added CEA section 4a(a)(5), 
which requires that when the Commission imposes position limits on 
futures and options on futures pursuant to CEA section 4a(a)(2), the 
Commission also establish limits simultaneously for ``economically 
equivalent'' swaps ``as appropriate.'' \583\ As the statute does not 
define the term ``economically equivalent,'' the Commission will apply 
its expertise in construing such term consistent with the policy goals 
articulated by Congress, including in CEA sections 4a(a)(2)(C) and 
4a(a)(3) as discussed below. Specifically, under the Commission's 
proposed definition of ``economically equivalent swap'' set forth in 
proposed Sec.  150.1, a swap would generally qualify as economically 
equivalent with respect to a particular referenced contract so long as 
the swap shares ``identical material'' contract specifications, terms, 
and conditions with the referenced contract, disregarding any 
differences with respect to lot size or notional amount, delivery dates 
diverging by less than one calendar day (other than for natural gas 
referenced contracts),\584\ or post-trade risk-management 
arrangements.\585\ As discussed further below, the Commission explains 
that the definition of ``economically equivalent swaps'' is relatively 
narrow, especially compared to the definition of ``referenced 
contract'' as applied to cash-settled look-alike contracts.
---------------------------------------------------------------------------

    \583\ CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5). In addition, CEA 
section 4a(a)(4) separately authorizes, but does not require, the 
Commission to impose federal limits on swaps that meet certain 
statutory criteria qualifying them as ``significant price discovery 
function'' swaps. 7 U.S.C. 6a(a)(4). The Commission reiterates, for 
the avoidance of doubt, that the definitions of ``economically 
equivalent'' in CEA section 4a(a)(5) and ``significant price 
discovery function'' in CEA section 4a(a)(4) are separate concepts 
and that contracts can be economically equivalent without serving a 
significant price discovery function.
    \584\ As discussed below, the proposed definition of 
``economically equivalent swaps'' with respect to natural gas 
referenced contracts would contain the same terms, except that it 
would include delivery dates diverging by less than two calendar 
days.
    \585\ See supra Section II.A.4. (for further discussion 
regarding the Commission's proposed definition of ``economically 
equivalent swap'').
---------------------------------------------------------------------------

    The Commission preliminarily believes that the proposed definition 
of ``economically equivalent swaps'' would benefit (1) market integrity 
by protecting against excessive speculation and potential manipulation 
and (2) market liquidity by not favoring OTC or foreign markets over 
domestic markets. However, as discussed below, exchanges would be 
subject to delayed compliance with respect to the proposed Sec.  150.5 
requirements regarding exchange-set speculative position limits on 
swaps until such time that exchanges have access to sufficient data to 
monitor for limits on swaps across exchanges; as a result, exchange-set 
limits would not need to include, nor would exchanges be required to 
oversee, compliance with exchange-set position limits on swaps until 
such time.
(1) Benefits and Costs Related to Market Integrity
    The Commission preliminarily believes that the proposed definition 
will benefit market integrity in two ways. First, the proposed 
definition would protect against excessive speculation and potential 
market manipulation by limiting the ability of speculators to obtain 
excessive positions through netting. For example, a more inclusive 
``economically equivalent'' definition that would encompass additional 
swaps (e.g., swaps that may differ in their ``material'' terms or 
physical swaps with delivery dates that

[[Page 11680]]

diverge by one day or more) could make it easier for market 
participants to inappropriately net down against their referenced 
contracts by allowing market participants to structure swaps that do 
not necessarily offer identical risk or economic exposure or 
sensitivity. In such a case, a market participant could enter into an 
OTC swap with a maturity that differs by days or even weeks in order to 
net down this position against its position in a referenced contract, 
enabling it to hold an even greater position in the referenced 
contract.
    Similarly, requiring ``economically equivalent swaps'' to share all 
material terms with their corresponding referenced contracts benefits 
market integrity by preventing market participants from escaping the 
position limits framework merely by altering non-material terms, such 
as holiday conventions. On the other hand, the Commission recognizes 
that such a narrow definition could impose costs on the marketplace by 
possibly permitting excessive speculation since market participants 
would not be subject to federal position limits if they were to enter 
into swaps that may have different material terms (e.g., penultimate 
swaps) \586\ but may nonetheless be sufficiently correlated to their 
corresponding referenced contract. In this case, it is possible that 
there may be potential for excessive speculation, market manipulation 
such as squeezes and corners, insufficient market liquidity for bona 
fide hedgers, or disruption to the price discovery function. 
Nonetheless, to the extent that swaps currently are not subject to 
federal position limit levels, such potential costs would remain 
unchanged compared to the status quo.
---------------------------------------------------------------------------

    \586\ Or, in the case of natural gas referenced contracts, which 
would potentially include penultimate swaps as economically 
equivalent swaps, a swap with a maturity of less than one day away 
from the penultimate swap. See infra Section IV.A.3.d.iv.(3) 
(discussion of natural gas swaps).
---------------------------------------------------------------------------

    Second, the relatively narrow proposed definition benefits market 
integrity, and reduces associated compliance and implementation costs, 
by permitting exchanges, market participants, and the Commission to 
focus resources on those swaps that pose the greatest threat for 
facilitating corners and squeezes--that is, those swaps with 
substantially identical delivery dates and material economic terms to 
futures and options on futures subject to federal position limits. 
While swaps that have different material terms than their corresponding 
referenced contracts, including different delivery dates, may 
potentially be used for engaging in market manipulation, the proposed 
definition would benefit market integrity by allowing exchanges and the 
Commission to focus on the most sensitive period of the spot month, 
including with respect to the Commission's and exchanges' various 
surveillance and enforcement functions. To the extent market 
participants would be able to use swaps that would not be covered by 
the proposed definition to effect market manipulation, such potential 
costs would not differ from the status quo since no swaps are currently 
covered by federal position limits. The Commission however acknowledges 
that its narrow definition may increase this cost, as fewer swaps will 
be covered under the limits.
    Further, the proposal to delay compliance with respect to exchange-
set limits on swaps will benefit exchanges by facilitating exchanges' 
ability to establish surveillance and compliance systems. As noted 
above, exchanges currently lack sufficient data regarding individual 
market participants' open swap positions, which means that requiring 
exchanges to establish oversight over participants' positions currently 
could impose substantial costs and also may be impractical to achieve. 
As a result, the Commission has preliminarily determined that allowing 
exchanges delayed compliance with respect to swaps would reduce 
unnecessary costs. Nonetheless, the Commission's preliminary 
determination to permit exchanges to delay implementing federal 
position limits on swaps could incentivize market participants to leave 
the futures markets and instead transact in economically-equivalent 
swaps, which could reduce liquidity in the futures and related options 
markets, although the Commission recognizes that this concern should be 
mitigated by the reality that the Commission would still oversee and 
enforce federal position limits on economically equivalent swaps.
    Additionally, while futures and related options are subject to 
clearing and exchange oversight, economically equivalent swaps may be 
transacted bilaterally off-exchange (i.e., OTC swaps). As a result, it 
is relatively easy to create customized OTC swaps that may be highly 
correlated to a referenced contract, which would allow the market 
participant to create an exposure in the underlying commodity similar 
to the referenced contract's exposure. Due to the relatively narrow 
proposed ``economically equivalent swap'' definition, the Commission 
preliminarily believes that it would not be difficult for market 
participants to avoid federal position limits by entering into such OTC 
swaps.\587\ While such swaps may not be perfectly correlated to their 
corresponding referenced contracts, market participants may find this 
risk acceptable in order to avoid federal position limits. An increase 
in OTC swaps at the expense of futures and options contracts may impose 
costs on market integrity due to lack of exchange oversight. If 
liquidity were to move from futures exchanges to the OTC swaps markets, 
non-dealer commercial entities may face increased transaction costs and 
widening spreads, as swap dealers gain market power in the OTC market 
relative to centralized exchange trading. The Commission is unable to 
quantify the costs of these potential harms. However, while the 
Commission acknowledges these potential costs, such costs to those 
contracts that already have limits on them already may have been 
realized in the marketplace because swaps are not subject to federal 
position limits under the status quo.
---------------------------------------------------------------------------

    \587\ In contrast, since futures and options on futures 
contracts are created by exchanges and submitted to the Commission 
for either self-certification or approval under part 40 of the 
Commission's regulations, a market participant would not be able to 
customize an exchange-traded futures or options on futures contract.
---------------------------------------------------------------------------

    Lastly, under this proposal, market participants would be able to 
determine whether a particular swap satisfies the definition of 
``economically equivalent swap,'' as long as market participants make a 
reasonable, good faith effort in reaching their determination and are 
able to provide sufficient evidence, if requested, to support a 
reasonable, good faith effort. The Commission preliminarily anticipates 
that this flexibility will benefit market integrity by providing a 
greater level of certainty to market participants in contrast to the 
alternative in which market participants would be required to first 
submit swaps to the Commission staff and wait for feedback or approval. 
On the other hand, the Commission also recognizes that not having the 
Commission explicitly opine on whether a swap would qualify as 
economically equivalent could cause market participants to avoid 
entering into such swaps. In turn, this could lead to less efficient 
hedging strategies if the market participant is forced to turn to the 
futures markets (e.g., a market participant may choose to transact in 
the OTC swaps markets for various reasons, including liquidity, margin 
requirements, or simply better familiarity with ISDA and swap processes 
over exchange-traded futures). However, as noted below, the Commission 
reserves the right to declare

[[Page 11681]]

whether a swap or class of swaps is or is not economically equivalent, 
and a market participant could petition, or request informally, that 
the Commission make such a determination, although the Commission 
acknowledges that there could be costs associated with this, including 
delayed timing and monetary costs.
    Further, the Commission recognizes that requiring market 
participants to conduct reasonable due diligence and maintain related 
records also could impose new compliance costs. Additionally, the 
Commission recognizes that certain market participants could assert 
that an OTC swap is (or is not) ``economically equivalent'' depending 
upon whether such determination benefits the market participant. In 
such a case, market participants could theoretically subvert the intent 
of the federal position limits framework, although the Commission 
preliminarily believes that such potential costs would be mitigated due 
to its surveillance functions and the proposal to reserve the authority 
to declare that a particular swap or class of swaps either would or 
would not qualify as economically equivalent.
(2) The Proposed Definition Could Increase Benefits or Costs Related to 
Market Liquidity
    First, the proposed definition could benefit market liquidity by 
being, in general, less disruptive to the swaps markets, which in turn 
may reduce the potential for disruption for the price discovery 
function compared to an alternative in which the Commission would 
proposed a broader definition. For example, if the Commission were to 
adopt an alternative to its proposed ``economically equivalent swap'' 
definition that encompassed a broader range of swaps by including, for 
example, delivery dates that diverge by one or more calendar days--
perhaps by several days or weeks--a speculator with a large portfolio 
of swaps could more easily bump up against the applicable position 
limits and therefore would have a strong incentive either to reduce its 
swaps activity or move its swaps activity to foreign jurisdictions. If 
there were many similarly situated speculators, the market for such 
swaps could become less liquid, which in turn could harm liquidity for 
bona fide hedgers as large liquidity providers could move to other 
markets.
    Second, the proposed definition could benefit market liquidity by 
being sufficiently narrow to reduce incentives for liquidity providers 
to move to foreign jurisdictions, such as the European Union 
(``EU'').\588\ Additionally, the Commission preliminarily believes that 
proposing a definition similar to that used by the EU will benefit 
international comity.\589\ Further, since market participants trading 
in both U.S. and EU markets would find the proposed definition to be 
familiar, it may help reduce compliance costs for those market 
participants that already have systems and personnel in place to 
identify and monitor such swaps.
---------------------------------------------------------------------------

    \588\ In this regard, the proposed definition is similar in 
certain ways to the EU definition for OTC contracts that are 
``economically equivalent'' to commodity derivatives traded on an EU 
trading venue. The applicable European regulations define an OTC 
derivative to be ``economically equivalent'' when it has ``identical 
contractual specifications, terms and conditions, excluding 
different lot size specifications, delivery dates diverging by less 
than one calendar day and different post trade risk management 
arrangements.'' While the Commission's proposed definition is 
similar, the Commission's proposed definition requires ``identical 
material'' terms rather than simply ``identical'' terms. Further, 
the Commission's proposed definition excludes different ``lot size 
specifications or notional amounts'' rather than referencing only 
``lot size'' since swaps terminology usually refers to ``notional 
amounts'' rather than to ``lot sizes.'' See EU Commission Delegated 
Regulation (EU) 2017/591, 2017 O.J. (L 87).
    \589\ Both the Commission's definition and the applicable EU 
regulation are intended to prevent harmful netting. See European 
Securities and Markets Authority, Draft Regulatory Technical 
Standards on Methodology for Calculation and the Application of 
Position Limits for Commodity Derivatives Traded on Trading Venues 
and Economically Equivalent OTC Contracts, ESMA/2016/668 at 10 (May 
2, 2016), available at https://www.esma.europa.eu/sites/default/files/library/2016-668_opinion_on_draft_rts_21.pdf (``[D]rafting the 
[economically equivalent OTC swap] definition in too wide a fashion 
carries an even higher risk of enabling circumvention of position 
limits by creating an ability to net off positions taken in on-venue 
contracts against only roughly similar OTC positions.'')
    The applicable EU regulator, the European Securities and Markets 
Authority (``ESMA''), recently released a ``consultation paper'' 
discussing the status of the existing EU position limits regime and 
specific comments received from market participants. According to 
ESMA, no commenter, with one exception, supported changing the 
definition of an economically equivalent swap (referred to as an 
``economically equivalent OTC contract'' or ``EEOTC''). ESMA further 
noted that for some respondents, ``the mere fact that very few EEOTC 
contracts have been identified is no evidence that the regime is 
overly restrictive.'' See European Securities and Markets Authority, 
Consultation Paper MiFID Review Report on Position Limits and 
Position Management Draft Technical Advice on Weekly Position 
Reports, ESMA70-156-1484 at 46, Question 15 (Nov. 5, 2019), 
available at https://www.esma.europa.eu/document/consultation-paper-position-limits.
---------------------------------------------------------------------------

(3) The Proposed Definition Could Create Benefits or Costs Related to 
Market Liquidity for the Natural Gas Market
    As discussed in greater detail in the preamble, the Commission 
recognizes that the market dynamics in natural gas are unique in 
several respects, including the fact that unlike with respect to other 
core referenced futures contracts, for natural gas relatively liquid 
spot-month and penultimate cash-settled futures exist. As a result, the 
Commission believes that creating an exception to the proposed 
``economically equivalent swap'' definition for natural gas would 
benefit market liquidity by not unnecessarily favoring existing 
penultimate contracts over spot contracts. The Commission is especially 
sensitive to potential market manipulation in the natural gas markets 
since market participants--to a significantly greater extent compared 
to the other core referenced futures contracts that are included in the 
proposal--regularly trade in both the physically-settled core 
referenced futures contract and the cash-settled look-alike referenced 
contracts. Accordingly, the Commission preliminarily has concluded that 
a slightly broader definition of ``economically equivalent swap'' would 
uniquely benefit the natural gas markets by helping to deter and 
prevent manipulation of a physically-settled contract to benefit a 
related cash-settled contract.
e. Pre-Existing Positions
    Proposed Sec.  150.2(g) would impose federal limits on ``pre-
existing positions''--other than pre-enactment swaps and transition 
period swaps--during the spot month, while non-spot month pre-existing 
positions would not be subject to position limits as long as (i) the 
position was acquired in good faith consistent with the ``pre-existing 
position'' definition in proposed Sec.  150.1; \590\ and (ii) such 
position would be attributed to the person if the position increases 
after the limit's effective date.
---------------------------------------------------------------------------

    \590\ Proposed Sec.  150.1 would define ``pre-existing 
position'' to mean ``any position in a commodity derivative contract 
acquired in good faith prior to the effective date'' of any 
applicable position limit.
---------------------------------------------------------------------------

    The Commission believes that this approach would benefit market 
integrity since pre-existing positions (other than pre-enactment and 
transition period swaps) that exceed spot-month limits could result in 
market or price disruptions as positions are rolled into the spot 
month.\591\ However, the Commission acknowledges that the proposed 
``good-faith'' standard also could impose certain costs on market 
integrity since an inherently subjective ``good faith'' standard could 
result in disparate treatment of traders by a

[[Page 11682]]

particular exchange or across exchanges seeking a competitive advantage 
with one another and could impose trading costs on those traders given 
less advantageous treatment. For example, the Commission acknowledges 
that since it has given discretion to an exchange in interpreting this 
``good faith'' standard, an exchange may be more liberal with 
concluding that a large trader or influential exchange member obtained 
a position in ``good faith.'' As a result, the proposal could 
potentially harm market integrity and/or increase transaction costs if 
an exchange were to benefit certain market participants compared to 
other market participants that receive relatively less advantageous 
treatment. However, the Commission believes the risk of any 
unscrupulous trader or exchange is mitigated since exchanges continue 
to be subject to Commission oversight and to DCM Core Principles 4 
(``prevention of market disruption'') and 12 (``protection of markets 
and market participants''), among others, and since proposed Sec.  
150.2(g)(2) also would require that exchanges must attribute the 
position to the trader if its position increases after the position 
limit's effective date.
---------------------------------------------------------------------------

    \591\ The Commission is particularly concerned about protecting 
the spot month in physical-delivery futures from corners and 
squeezes.
---------------------------------------------------------------------------

4. Bona Fide Hedging and Spread and Other Exemptions From Federal 
Position Limits (Proposed Sec. Sec.  150.1 and 150.3)
a. Background
    The proposal provides for several exemptions that, subject to 
certain conditions, would permit a trader to exceed the applicable 
federal position limit set forth under proposed Sec.  150.2. 
Specifically, proposed Sec.  150.3 would generally maintain, with 
certain modifications discussed below, the two existing federal 
exemptions for bona fide hedging positions and spread positions, and 
would include new federal exemptions for certain conditional spot month 
positions in natural gas, certain financial distress positions, and 
pre-enactment and transition period swaps. Proposed Sec.  150.1 would 
set forth the proposed definitions for ``bona fide hedging transactions 
or positions'' and for ``spread transactions.'' \592\
---------------------------------------------------------------------------

    \592\ This discussion sometimes refers to the ``bona fide 
hedging transactions or positions'' definition as ``bona fide 
hedges,'' ``bona fide hedging,'' or ``bona fide hedge positions.'' 
For the purpose of this discussion, the terms have the same meaning.
---------------------------------------------------------------------------

b. Bona Fide Hedging Definition; Enumerated Bona Fide Hedges; and 
Guidance on Measuring Risk
    The Commission is proposing several amendments related to bona fide 
hedges. First, the Commission is proposing to include a revised 
definition of ``bona fide hedging transactions or positions'' in Sec.  
150.1 to conform to the statutory bona fide hedge definition in CEA 
section 4a(c) as Congress amended it in the Dodd-Frank Act. As 
discussed in greater detail in the preamble, the Commission proposes to 
(1) revise the temporary substitute test, consistent with the 
Commission's understanding of the Dodd-Frank Act's amendments to 
section 4a of the CEA, to no longer recognize as bona fide hedges 
certain risk management positions; (2) revise the economically 
appropriate test to make explicit that the position must be 
economically appropriate to the reduction of ``price risk''; and (3) 
eliminate the incidental test and orderly trading requirement, which 
Dodd-Frank removed from section 4a of the CEA. The Commission 
preliminarily believes that these changes include non-discretionary 
changes that are required by Congress's amendments to section 4a of the 
CEA. The Commission also proposes to revise the bona fide hedge 
definition to conform to the CEA's statutory definition, which permits 
certain pass-through offsets.\593\
---------------------------------------------------------------------------

    \593\ As discussed in Section II.A.--Sec.  150.1--Definitions of 
the preamble, the existing definition of ``bona fide hedging 
transactions and positions'' currently appears in Sec.  1.3 of the 
Commission's regulations; the proposal would move the revised 
definition to proposed Sec.  150.1.
---------------------------------------------------------------------------

    Second, the Commission would maintain the distinction between 
enumerated and non-enumerated bona fide hedges but would (1) move the 
currently-enumerated hedges in the existing definition of ``bona fide 
hedging transactions and positions'' currently found in Commission 
regulation Sec.  1.3 to proposed Appendix A in part 150 that will serve 
as examples of positions that would comply with the proposed bona fide 
hedging definition; and (2) propose to make all existing enumerated 
bona fide hedges as well as additional enumerated hedges to be self-
effectuating for federal position limit purposes, without the need for 
prior Commission approval. In contrast, the existing enumerated 
anticipatory bona fide hedges are not currently self-effectuating and 
require market participants to apply to the Commission for recognition.
    Third, the Commission is proposing guidance with respect to whether 
an entity may measure risk on a net or gross basis for purposes of 
determining its bona fide hedge positions.
    The Commission expects these proposed modifications will provide 
market participants with the ability to hedge, and exchanges with the 
ability to recognize hedges, in a manner that is consistent with common 
commercial hedging practices, reducing compliance costs and increase 
the benefits associated with sound risk management practices.
i. Bona Fide Hedging Definition
(1) Elimination of Risk Management Exemptions; Addition of the Proposed 
Pass-Through Swap Exemption
    First, the Commission has preliminarily determined that eliminating 
the risk-management exemption in physical commodity derivatives subject 
to federal speculative position limits, unless the position satisfies 
the pass-through/swap offset requirements in section 4a(c)(2)(B) of the 
CEA discussed further below, is consistent with Congressional and 
statutory intent, as evidenced by the Dodd-Frank Act's amendments to 
the bona fide hedging definition in CEA section 4a(c)(2).\594\ 
Accordingly, once the proposed federal limit levels go into effect, 
market participants with positions that do not otherwise satisfy

[[Page 11683]]

the proposed bona fide hedging definition or qualify for an exemption 
would no longer be able to rely on recognition of such risk-reducing 
techniques as bona fide hedges. Absent other factors, market 
participants who have, or have requested, a risk management exemption 
under the existing definition may resort to less effective hedging 
strategies resulting in, for example, increased costs for liquidity 
providers due to increased basis risk and/or decreased market 
efficiency due to higher transaction (i.e., hedging) costs. Moreover, 
absent other factors, by excluding risk management positions from the 
bona fide hedge definition (other than those positions that would meet 
the pass-through/swap offset requirement in the proposed bona fide 
hedge definition, discussed further below), the proposed definition may 
affect the overall level of liquidity in the market since dealers who 
approach or exceed the federal position limit may decide to pull back 
on providing liquidity, including to bona fide hedgers.
---------------------------------------------------------------------------

    \594\ See supra Section II.A.1.c.ii.(1). The existing bona fide 
hedging definition in Sec.  1.3 requires that a position must 
``normally'' represent a substitute for transactions or positions 
made at a later time in a physical marketing channel (i.e., the 
``temporary substitute test''). The Dodd-Frank Act amended the 
temporary substitute language that previously appeared in the 
statute by removing the word ``normally'' from the phrase normally 
represents a substitute for transactions made or to be made or 
positions taken or to be taken at a later time in a physical 
marketing channel.'' 7 U.S.C. 6a(c)(2)(A). The Commission 
preliminarily interprets this change as reflecting Congressional 
direction that a bona fide hedging position in physical commodities 
must always (and not just ``normally'') be in connection with the 
production, sale, or use of a physical cash-market commodity.
    Previously, the Commission stated that, among other things, the 
inclusion of the word ``normally'' in connection with the pre-Dodd-
Frank version of the temporary substitute language indicated that 
the bona fide hedging definition should not be construed to apply 
only to firms using futures to reduce their exposures to risks in 
the cash market, and that to qualify as a bona fide hedge, a 
transaction in the futures market did not need to be a temporary 
substitute for a later transaction in the cash market. See 
Clarification of Certain Aspects of the Hedging Definition, 52 FR at 
27195, 27196 (Jul. 20, 1987). In other words, that 1987 
interpretation took the view that a futures position could still 
qualify as a bona fide hedging position even if it was not in 
connection with the production, sale, or use of a physical 
commodity. Accordingly, based on the Commission's preliminary 
interpretation of the revised statutory definition of bona fide 
hedging in CEA section 4a(c)(2), risk-management hedges would not be 
recognized under the Commission's proposed bona fide hedging 
definition.
---------------------------------------------------------------------------

    On the other hand, the Commission believes that these potential 
costs could be mitigated for several reasons. First, the proposed bona 
fide hedging definition, consistent with the Dodd-Frank Act's changes 
to CEA section 4a(c)(2), would permit the recognition as bona fide 
hedges of futures and options on futures positions that offset pass-
through swaps entered into by dealers and other liquidity providers 
(the ``pass-through swap counterparty'') \595\ opposite bona fide 
hedging swap counterparties (the ``bona fide hedge counterparty''), as 
long as: (1) The pass-through swap counterparty can demonstrate, upon 
request from the Commission and/or from an exchange, that the pass-
through swap qualifies as a bona fide hedge for the bona fide hedge 
counterparty; and (2) the pass-through swap counterparty enters into a 
futures or option on a futures position or a swap position, in each 
case in the same physical commodity as the pass-through swap to offset 
and reduce the price risk attendant to the pass-through swap.\596\ 
Accordingly, a subset of risk management exemption holders could 
continue to benefit from an exemption, and potential counterparties 
could benefit from the liquidity they provide, as long as the position 
being offset qualifies as a bona fide hedge for the counterparty.
---------------------------------------------------------------------------

    \595\ Such pass-through swap counterparties are typically swap 
dealers providing liquidity to bona fide hedgers.
    \596\ See paragraph (2)(i) of the proposed bona fide hedging 
definition. Of course, if the pass-through swap qualifies as an 
``economically appropriate swap,'' then the pass-through swap 
counterparty would not need to rely on the proposed pass-through 
swap provision since it may be able to offset its long (or short) 
position in the economically equivalent swap with the corresponding 
short (or long) position in the futures or option on futures 
position or on the opposite side of another economically equivalent 
swap.
---------------------------------------------------------------------------

    The Commission preliminarily has determined that any resulting 
costs or benefits related to the proposed pass-through swap exemption 
are a result of Congress's amendments to CEA section 4a(c) rather than 
the Commission's discretionary action. On the other hand, the 
Commission's discretionary action to require the pass-through swap 
counterparty to create and maintain records to demonstrate the bona 
fides of the pass-through swap would cause the swap counterparty to 
incur marginal recordkeeping costs.\597\
---------------------------------------------------------------------------

    \597\ To the extent that the pass-through swap counterparty is a 
swap dealer or major swap participant, they already may be subject 
to similar recordkeeping requirements under Sec.  1.31 and part 23 
of the Commission's regulations. As a result, such costs may already 
have been realized.
---------------------------------------------------------------------------

    The proposed pass-through swap provision, consistent with the Dodd-
Frank Act's changes to CEA section 4a(c)(2), also would address a 
situation where a participant who qualifies as a bona fide hedging swap 
counterparty (i.e., a participant with a position in a previously-
entered into swap that qualified, at the time the swap was entered 
into, as a bona fide hedging position under the proposed definition) 
seeks, at some later time, to offset that swap position.\598\ Such step 
might be taken, for example, to respond to a change in the 
participant's risk exposure in the underlying commodity. As a result, a 
participant could use futures or options on futures in excess of 
federal position limits to offset the price risk of a previously-
entered into swap, which would allow the participant to exceed federal 
limits using either new futures or options on futures or swap positions 
that reduce the risk of the original swap.
---------------------------------------------------------------------------

    \598\ See paragraph (2)(ii) of the proposed bona fide hedging 
transactions or positions definition.
---------------------------------------------------------------------------

    The Commission expects the pass-through swap provision to 
facilitate dynamic hedging by market participants. The Commission 
recognizes that a significant number of market participants use dynamic 
hedging to more effectively manage their portfolio risks. Therefore, 
this provision may increase operational efficiency. In addition, by 
permitting dynamic hedging, a greater number of dealers should be 
better able to provide liquidity to the market, as these dealers will 
be able to more effectively manage their risks by entering into pass-
through swaps with bona fide hedgers as counterparties. Moreover, 
market participants are not precluded from using swaps that are not 
``economically equivalent swap'' for such risk management purposes 
since swaps that are not deemed to be ``economically equivalent'' to a 
referenced contract would not be subject to the Commission's proposed 
position limits framework.
    The Commission preliminarily observes that market participants may 
not need to rely on the proposed pass-through swap provision to the 
extent such parties employ swaps that qualify as ``economically 
equivalent swaps,'' since such market participants may be able to net 
such swaps against the corresponding futures or options on futures. As 
a result, the Commission preliminarily anticipates that the proposed 
pass-through swap provision would benefit those bona fide hedgers and 
pass-through swap counterparties that use swaps that would not qualify 
as economically equivalent under the Commission's proposal. To the 
extent market participants use swaps that would qualify as economically 
equivalent swaps, or could shift their trading strategies to use such 
swaps without incurring additional costs, the Commission preliminarily 
believes that the elimination of the risk management position would not 
necessarily result in market participants incurring costs or limiting 
their trading since they would be able to net the positions in 
economically equivalent swaps with their futures and options on futures 
positions, or with other economically equivalent swaps.
    Second, for the nine legacy agricultural contracts, the proposal 
would generally set federal non-spot month limit levels higher than 
existing non-spot limits, which may enable additional dealer activity 
described above.\599\ The remaining 16 core referenced futures 
contracts would be subject to existing exchange-set limits or 
accountability outside of the spot month, which does not represent a 
change from the status quo under existing or proposed Sec.  150.5. The 
proposed higher levels with respect to the nine legacy agricultural 
contracts and the exchanges' flexible accountability regimes with 
respect to the proposes new 16 core referenced futures contract should 
mitigate at least some potential costs related to the

[[Page 11684]]

prohibition on recognizing risk management positions as bona fide 
hedges.
---------------------------------------------------------------------------

    \599\ Proposed Sec.  150.2 generally would increase position 
limits for non-spot months for contracts that currently are subject 
to the federal position limits framework other than for CBOT Oats 
(O), CBOT KC HRW Wheat (KW), and MGEX HRS Wheat (MWE), for which the 
Commission would maintain existing levels.
---------------------------------------------------------------------------

    Third, the proposal may improve market competitiveness and reduce 
transaction costs. As noted above, existing holders of the risk 
management exemption, and the levels permitted thereunder, are 
currently confidential, and the Commission is no longer granting new 
risk management exemptions to potential new liquidity providers. 
Accordingly, by eliminating the risk management exemption, the 
Commission's proposal would benefit the public and strengthen market 
integrity by improving market transparency since certain dealers would 
no longer be able to maintain the grandfathered risk management 
exemption while other dealer lack this ability under the status quo. 
While the Commission believes that the risk management exemption may 
allow dealers to more effectively provide market making activities, 
which benefits market liquidity and ultimately leads to lower prices 
for end-users, as noted above, the potential costs resulting from 
removing the risk management exemption may be mitigated by the revised 
position limit levels that reflect current EDS for spot month levels 
and current open interest and trading volume for non-spot month levels. 
Therefore, the Commission believes that existing risk management 
exemption holders should be able to continue providing liquidity to 
bona fide hedgers, but acknowledges that some may not to the same 
degree as under the exemption; however, the Commission believes that 
any potential harm to liquidity should be mitigated.
    Further, the proposed spot month and non-spot month levels, which 
generally will be higher than the status quo, together with the 
elimination of the risk management exemptions that benefit only certain 
dealers, might enable new liquidity providers to enter the markets on a 
level playing field with the existing risk management exemption 
holders. With the possibility of additional liquidity providers, the 
proposed framework may strengthen market integrity by decreasing 
concentration risk potentially posed by too few market makers. However, 
the benefits to market liquidity the Commission describes above may be 
muted since this analysis is predicated, in part, on the understanding 
that dealers are the predominant large traders. Data in the 
Commission's Supplementary COT and its underlying data indicate that 
risk-management exemption holders are not the only large participants 
in these markets--large commercial firms also hold large positions in 
such commodities.
(2) Limiting ``Risk'' to ``Price'' Risk; Elimination of the Incidental 
Test and Orderly Trading Requirement
    As discussed in the preamble, the proposed bona fide hedging 
definition's ``economically appropriate test'' would clarify that only 
hedges that offset price risks could be recognized as bona fide hedging 
transactions or positions. The Commission does not believe that this 
clarification would impose any new costs or benefits, as it is 
consistent with both the existing bona fide hedging definition \600\ as 
well as the Commission's longstanding policy.\601\ Nonetheless, the 
Commission realizes that hedging occurs for more types of risks than 
price (e.g., volumetric hedging). Therefore, the Commission recognizes 
that by expressly limiting the bona fide hedge exemption to hedging 
only price risk, certain market participants may not be able to receive 
a bona fide hedging recognition, and for certain dealers, this may 
limit their ability to provide liquidity to the market because without 
being able to rely on bona fide hedging status, their trading activity 
would cause them to otherwise exceed federal limits.
---------------------------------------------------------------------------

    \600\ The existing bona fide hedging definition in Sec.  1.3 
provides that no transactions or positions shall be classified as 
bona fide hedging unless their purpose is to offset price risks 
incidental to commercial cash or spot operations. (emphasis added). 
Accordingly, the proposed definition would merely move this 
requirement to the proposed definition's revised ``economically 
appropriate test'' requirement.
    \601\ For example, in promulgating existing Sec.  1.3, the 
Commission explained that a bona fide hedging position must, among 
other things, ``be economically appropriate to risk reduction, such 
risks must arise from operation of a commercial enterprise, and the 
price fluctuations of the futures contracts used in the transaction 
must be substantially related to fluctuations of the cash market 
value of the assets, liabilities or services being hedged.'' Bona 
Fide Hedging Transactions or Positions, 42 FR at 14832, 14833 (Mar. 
16, 1977). Dodd-Frank added CEA section 4a(c)(2), which copied the 
``economically appropriate test'' from the Commission's definition 
in Sec.  1.3. See also 2013 Proposal, 78 FR at 75702, 75703.
---------------------------------------------------------------------------

    The Commission further would implement Congress's Dodd-Frank Act 
amendments that eliminated the statutory bona fide hedge definition's 
incidental test and orderly trading requirement by proposing to make 
the same changes to the Commission's regulations. As discussed in the 
preamble, the Commission preliminarily believes that these proposed 
changes do not represent a change in policy or regulatory requirement. 
As a result, the Commission does not identify any costs or benefits 
related to these proposed changes.
ii. Proposed Enumerated Bona Fide Hedges
    The Commission proposes enumerated bona fide hedges in Appendix A 
to part 150 of the Commission's regulations to provide a list bona fide 
hedges that would include: (i) The existing enumerated hedges; and (ii) 
additional enumerated bona fide hedges. The Commission reinforces that 
hedging practices not otherwise listed may still be deemed, on a case-
by-case basis, to comply with the proposed bona fide hedging definition 
(i.e., non-enumerated bona fide hedges). As discussed further below, 
the proposed enumerated bona fide hedges in Appendix A would be ``self-
effectuating'' for purposes of federal position limits levels, which 
are expected to reduce delays and compliance costs associated with 
requesting an exemption.
    Additionally, as part of the Commission's proposal, the exchanges 
would have discretion to determine, for purposes of their own exchange-
granted bona fide hedges, whether any of the proposed enumerated bona 
fide hedges in proposed Appendix A to part 150 of the Commission's 
regulations would be permitted to be maintained during the lesser of 
the last five days of trading or the time period for the spot month in 
such contract (the ``five-day rule''), and the Commission's proposal 
otherwise would not require any of the enumerated bona fide hedges to 
be subject to the five-day rule for purposes of federal position 
limits. Instead, the Commission expects exchanges to make their own 
determinations with respect to exchange-set limits as to whether it is 
appropriate to apply the five-day rule for a particular bona fide hedge 
type and commodity contract. The Commission has preliminarily 
determined that exchanges are well-informed with respect to their 
respective markets and well-positioned to make a determination with 
respect to imposing the five-day rule in connection with recognizing 
bona fide hedges for their respective commodity contracts. In general, 
the Commission believes that, on the one hand, limiting a trader's 
ability to establish a position in this manner by requiring the five-
day rule could result in increased costs related to operational 
inefficiencies, as a trader may believe that this is the most opportune 
time to hedge. On the other hand, the Commission believes that price 
convergence may be particularly sensitive to potential market 
manipulation or excessive speculation during this period. Accordingly, 
the Commission preliminarily believes that

[[Page 11685]]

the proposal to not impose the five-day rule with respect to any of the 
enumerated bona fide hedges for federal purposes but instead rely on 
exchange's determination with respect to exchange-granted exemptions 
would help to better optimize these considerations. The Commission 
notes a potential cost for market integrity if exchanges fail to 
implement a five-day rule in order to encourage additional trading in 
order to increase profit, which could harm price convergence. However, 
the Commission believes this concern is mitigated since exchanges also 
have an economic incentive to ensure that price convergence occurs with 
their respective contracts since commercial end-users would be less 
willing to use such contracts for hedging purposes if price convergence 
would fail to occur in such contracts as they may generally desire to 
hedge cash market prices with futures contracts.
iii. Guidance for Measuring Risk on a Gross or Net Basis
    The Commission proposes guidance in paragraph (a) of Appendix B to 
part 150 on whether positions may be hedged on either a gross or net 
basis. Under the proposed guidance, among other things, a trader may 
measure risk on a gross basis if it would be consistent with the 
trader's historical practice and is not intended to evade applicable 
limits. The key cost associated with allowing gross hedging is that it 
may provide opportunity for hidden speculative trading.\602\
---------------------------------------------------------------------------

    \602\ For example, using gross hedging, a market participant 
could potentially point to a large long cash position as 
justification for a bona fide hedge, even though the participant, or 
an entity with which the participant is required to aggregate, has 
an equally large short cash position that would result in the 
participant having no net price risk to hedge as the participant had 
no price risk exposure to the commodity prior to establishing such 
derivative position. Instead, the participant created price risk 
exposure to the commodity by establishing the derivative position.
---------------------------------------------------------------------------

    Such risk is mitigated to a certain extent by the guidance's 
provisos that the trader does not switch between net hedging and gross 
hedging in order to evade limits and that the DCM documents 
justifications for allowing gross hedging and maintains any relevant 
records in accordance with proposed Sec.  150.9(d).\603\ However, the 
Commission also recognizes that there are myriad of ways in which 
organizations are structured and engage in commercial hedging 
practices, including the use of multi-line business strategies in 
certain industries that would be subject to federal position limits for 
the first time under this proposal and for which net hedging could 
impose significant costs or be operationally unfeasible.
---------------------------------------------------------------------------

    \603\ Under proposed Sec.  150.3(b)(2) and (e) and proposed 
Sec.  150.9(e)(5), and (g), the Commission would have access to any 
information related to the applicable exemption request.
---------------------------------------------------------------------------

c. Spread Exemptions
    Under existing Sec.  150.3, certain spread exemptions are self-
effectuating. Specifically, existing Sec.  150.3 allows for ``spread or 
arbitrage positions'' that are ``between single months of a futures 
contract and/or, on a futures-equivalent basis, options thereon, 
outside of the spot month, in the same crop year; provided, however, 
that such spread or arbitrage positions, when combined with any other 
net positions in the single month, do not exceed the all-months limit 
set forth in Sec.  150.2.'' \604\ Proposed Sec. Sec.  150.1 and 150.3 
would amend the existing spread position exemption for federal limits 
by (i) listing specific spread transactions that may be granted; and 
(ii) other than for the listed spread positions, which would be self-
effectuating, requiring a person to apply for spread exemptions 
directly with the Commission pursuant to proposed Sec.  150.3.\605\ In 
addition, the proposed rule would permit spread exemptions outside the 
same crop year and/or during the spot month.\606\
---------------------------------------------------------------------------

    \604\ 17 CFR 150.3. CEA section 4a(a)(1) provides the Commission 
with authority to exempt from position limits transactions 
``normally known to the trade'' as ``spreads'' or ``straddles'' or 
``arbitrage'' or to fix limits for such transactions or positions 
different from limits fixed for other transactions or positions.
    \605\ The proposed ``spread transactions'' definition would list 
the most common types of spread positions, including: Calendar 
spreads, intercommodity spreads, quality differential spreads, 
processing spreads (such as energy ``crack'' or soybean ``crush'' 
spreads), product or by-product differential spreads, and futures-
options spreads. Proposed Sec.  150.3(b) also would permit market 
participants to apply to the Commission for other spread 
transactions.
    \606\ As discussed under proposed Sec.  150.3, spread exemptions 
identified in the proposed ``spread transaction'' definition in 
proposed Sec.  150.1 would be self-effectuating similar to the 
status quo and would not represent a change to the status quo 
baseline. The related costs and benefits, particularly with respect 
to requesting exemptions with respect to spreads other than those 
identified in the proposed ``spread transaction'' definition, are 
discussed under the respective sections below.
---------------------------------------------------------------------------

    In connection with the spread exemption provisions, the Commission 
is relaxing the prohibition for contracts during the same crop year 
and/or the spot month so that exchanges are able to exempt spreads 
outside the same crop year and/or during the spot month. There may be 
benefits that result from permitting these types of spread exemptions. 
For example, the Commission believes that permitting spread exemptions 
not in the same crop year or during the spot month may potentially 
improve price discovery as well as provide market participants with the 
ability to use strategies involving spread positions, which may reduce 
hedging costs.
    As in the intermarket wheat example discussed below, the proposed 
spread relief not limited to the same crop year month may better link 
prices between two markets (e.g., the price of MGEX wheat futures and 
the price of CBOT wheat futures). Put another way, permitting spread 
exemptions outside the same crop year may enable pricing in two 
different but related markets for substitute goods to be more highly 
correlated, which, in this example, benefits market participants with a 
price exposure to the underlying protein content in wheat generally, 
rather than that of a particular commodity.
    However, the Commission also recognizes certain potential costs to 
permitting spread exemptions during the spot month, particularly to 
extend into the last five days of trading. This feature could raise the 
risk of allowing participants in the market at a time in the contract 
where only those interested in making or taking delivery should be 
present. When a contract goes into expiration, open interest and 
trading volume naturally decrease as traders not interested in making 
or taking delivery roll their positions into deferred calendar months. 
The presence of large spread positions so close to the expiration of a 
futures contract, which positions are normally tied to large liquidity 
providers, may actually lead to disruptions in the price discovery 
function of the contract by disrupting the futures/cash price 
convergence. This could lead to increased transaction costs and harm 
the hedging utility for end-users of the futures contract, which could 
lead to higher costs passed on to consumers. However, the Commission 
preliminarily believes that these concerns would be mitigated as 
exchanges would continue to apply their expertise in overseeing and 
maintaining the integrity of their markets. For example, an exchange 
could refuse to grant a spread exemption if the exchange believed it 
would harm its markets, require a participant to reduce its positions, 
or implement a five-day-rule for spread exemptions, as discussed 
above.\607\
---------------------------------------------------------------------------

    \607\ See supra Section IV.A.4.b.ii. (discussion of the five-day 
rule).
---------------------------------------------------------------------------

    Generally, the Commission preliminarily finds that, by allowing 
speculators to execute intermarket and intramarket spreads as proposed, 
speculators would be able to hold a greater amount of open interest in

[[Page 11686]]

underlying contract(s), and therefore, bona fide hedgers may benefit 
from any increase in market liquidity. Spread exemptions may also lead 
to better price continuity and price discovery if market participants 
who seek to provide liquidity (for example, through entry of resting 
orders for spread trades between different contracts) receive a spread 
exemption, and thus would not otherwise be constrained by a position 
limit.
    For clarity, the Commission has identified the following two 
examples of spread positions that could benefit from the proposed 
spread exemption:
     Reverse crush spread in soybeans on the CBOT subject to an 
intermarket spread exemption. In the case where soybeans are processed 
into two different products, soybean meal and soybean oil, the crush 
spread is the difference between the combined value of the products and 
the value of soybeans. There are two actors in this scenario: the 
speculator and the soybean processor. The spread's value approximates 
the profit margin from actually crushing (or mashing) soybeans into 
meal and oil. The soybean processor may want to lock in the spread 
value as part of its hedging strategy, establishing a long position in 
soybean futures and short positions in soybean oil futures and soybean 
meal futures, as substitutes for the processor's expected cash market 
transactions (the long position hedges the purchase of the anticipated 
inputs for processing and the short position hedges the sale of the 
anticipated soybean meal and oil products). On the other side of the 
processor's crush spread, a speculator takes a short position in 
soybean futures against long positions in soybean meal futures and 
soybean oil futures. The soybean processor may be able to lock in a 
higher crush spread because of liquidity provided by such a speculator 
who may need to rely upon a spread exemption. In this example, the 
speculator is accepting basis risk represented by the crush spread, and 
the speculator is providing liquidity to the soybean processor. The 
crush spread positions may result in greater correlation between the 
futures prices of soybeans on the one hand and those of soybean oil and 
soybean meal on the other hand, which means that prices for all three 
products may move up or down together in a more correlated manner.
     Wheat spread subject to intermarket spread exemptions. 
There are two actors in this scenario: the speculator and the wheat 
farmer. In this example, a farmer growing hard wheat would like to 
reduce the price risk of her crop by shorting a MGEX wheat futures. 
There, however, may be no hedger, such as a mill, that is immediately 
available to trade at a desirable price for the farmer. There may be a 
speculator willing to offer liquidity to the hedger; however, the 
speculator may wish to reduce the risk of an outright long position in 
MGEX wheat futures through establishing a short position in CBOT wheat 
futures (soft wheat). Such a speculator, who otherwise would have been 
constrained by a position limit at MGEX and/or CBOT, may seek 
exemptions from MGEX and CBOT for an intermarket spread, that is, for a 
long position in MGEX wheat futures and a short position in CBOT wheat 
futures of the same maturity. As a result of the exchanges granting an 
intermarket spread exemption to such a speculator, who otherwise may be 
constrained by limits, the farmer might be able to transact at a higher 
price for hard wheat than might have existed absent the intermarket 
spread exemptions. Under this example, the speculator is accepting 
basis risk between hard wheat and soft wheat, reducing the risk of a 
position on one exchange by establishing a position on another 
exchange, and potentially providing liquidity to a hedger. Further, 
spread transactions may aid in price discovery regarding the relative 
protein content for each of the hard and soft wheat contracts.
d. Conditional Spot Month Exemption Positions in Natural Gas
    Proposed Sec.  150.3(a)(4) would provide a new federal conditional 
spot month limit exemption position for cash-settled natural gas 
contracts that would permit traders to acquire positions up to 10,000 
NYMEX Henry Hub Natural Gas (NG) equivalent-size contracts (the federal 
spot month limit in proposed Sec.  150.2 for NYMEX Henry Hub Natural 
Gas (NG) referenced contracts is otherwise 2,000 contracts in the 
aggregate across all one's net positions) per exchange that lists the 
relevant natural gas cash-settled referenced contracts, along with an 
additional futures-adjusted 10,000 contracts of cash-settled 
economically equivalent swaps, as long as such person does not also 
hold positions in the physically-settled natural gas referenced 
contract.\608\ NYMEX, ICE, Nasdaq Futures, and Nodal currently have 
rules in place establishing a conditional spot month limit exemption 
equivalent to up to 5,000 contracts in NYMEX-equivalent size. By 
proposing to include the conditional exemption for purposes of federal 
limits on natural gas contracts, the Commission reduces the incentive 
and ability for a market participant to manipulate a large physically-
settled position to benefit a linked cash-settled position.
---------------------------------------------------------------------------

    \608\ The NYMEX Henry Hub Natural Gas (NG) contract is the only 
natural gas contract included as a core referenced futures contract 
under this proposal.
---------------------------------------------------------------------------

    Further, the Commission has heeded natural gas traders' concerns 
about disrupting market practices and harming liquidity in the cash-
settled contract, which could increase the cost of hedging and possibly 
prevent convergence between the physical delivery futures and cash 
markets.\609\ While a trader with a position in the physical-delivery 
natural gas contract may incur costs associated with liquidating that 
position in order to meet the conditions of the federal exemption, such 
costs are incurred outside of the proposal, as the trader would have to 
do so as a condition of the exchange-level exemption under current 
exchange rules.\610\
---------------------------------------------------------------------------

    \609\ See 2016 Reproposal, 81 FR at 96862, 96863.
    \610\ See ICE Rule 6.20(c) and NYMEX Rule 559.F. See, e.g., 
NASDAQ Futures Rule ch. v, section 13(a)(ii) and Nodal Exchange 
Rulebook Appendix C (equivalent rules of NASDAQ and Nodal 
exchanges).
---------------------------------------------------------------------------

e. Financial Distress Exemption
    Proposed Sec.  150.3(a)(3) would provide an exemption for certain 
financial distress circumstances, including the default of a customer, 
affiliate, or acquisition target of the requesting entity that may 
require the requesting entity to take on, in short order, the positions 
of another entity. In codifying the Commission's historical practice, 
the proposed rule accommodates transfers of positions from financially 
distressed firms to financially secure firms. The disorderly 
liquidation of a position threatens price impacts that may harm the 
efficiency and price discovery function of markets, and the proposal 
would make it less likely that positions will be prematurely or 
needlessly liquidated. The Commission has determined that costs related 
to filing and recordkeeping are likely to be minimal. The Commission 
cannot accurately estimate how often this exemption may be invoked 
because emergency or distressed market situations are unpredictable and 
dependent on a variety of firm and market-specific factors as well as 
general macroeconomic indicators.\611\ The Commission, nevertheless, 
believes that emergency or distressed market situations that might 
trigger the need for this exemption will be infrequent, and that 
codifying this historical practice

[[Page 11687]]

will add transparency to the Commission's oversight responsibilities.
---------------------------------------------------------------------------

    \611\ See 2016 Reproposal, 81 FR at 96862, 96863.
---------------------------------------------------------------------------

f. Pre-Enactment and Transition Period Swaps Exemption
    Proposed Sec.  150.3(a)(5) would also provide an exemption from 
position limits for positions acquired in good faith in any ``pre-
enactment swap,'' or in any ``transition period swap,'' in either case 
as defined in proposed Sec.  150.1. A person relying on this exemption 
may net such positions with post-effective date commodity derivative 
contracts for the purpose of complying with any non-spot-month 
speculative positions limits, but may not net against spot month 
positions. This exemption would be self-effectuating, and the 
Commission preliminarily believes that proposed Sec.  150.3(a)(5) would 
benefit both individual market participants by lessening the impact of 
the proposed federal limits, and market liquidity in general as 
liquidity providers initially would not be forced to reduce or exit 
their positions.
    The proposal would benefit price discovery and convergence by 
prohibiting large traders seeking to roll their positions into the spot 
month from netting down positions in the spot-month against their pre-
enactment swap or transition period swap. The Commission acknowledges 
that, on its face, including a ``good-faith'' requirement in the 
proposed Sec.  150.3(a)(5) could hypothetically diminish market 
integrity since determining whether a trader has acted in ``good 
faith'' is inherently subjective and could result in disparate 
treatment among traders, where certain traders may assert a more 
aggressive position in order to seek a competitive advantage over 
others. The Commission believes the risk of any such unscrupulous 
trader or exchange is mitigated since exchanges would still be subject 
to Commission oversight and to DCM Core Principles 4 (``prevention of 
market disruption'') and 12 (``protection of markets and market 
participants''), among others. The Commission has determined that 
market participants who voluntarily employ this exemption also will 
incur negligible recordkeeping costs.
5. Process for the Commission or Exchanges To Grant Exemptions and Bona 
Fide Hedge Recognitions for Purposes of Federal Limits (Proposed 
Sec. Sec.  150.3 and 150.9) and Related Changes to Part 19 of the 
Commission's Regulations
    Existing Sec. Sec.  1.47 and 1.48 set forth the process for market 
participants to apply to the Commission for recognition of certain bona 
fide hedges for purposes of federal limits, and existing Sec.  150.3 
sets forth a list of spread exemptions a person can rely on for 
purposes of federal limits. However, under existing Commission 
practices, spread exemptions and certain enumerated bona fide hedges 
are generally self-effectuating and do not require market participants 
to apply to the Commission for purposes of federal position limits, 
although market participants are required to file Form 204 monthly 
reports \612\ to justify certain position limit overages. Further, for 
those bona fide hedges for which market participants are required to 
apply to the Commission, existing regulations and market practice 
require market participants to apply both to the Commission for 
purposes of federal limits and also to the relevant exchanges for 
purposes of exchange-set limits. The Commission has preliminarily 
determined that this dual application process creates inefficiencies 
for market participants.
---------------------------------------------------------------------------

    \612\ In the case of cotton, market participants currently file 
the relevant portions of Form 304.
---------------------------------------------------------------------------

    Proposed Sec. Sec.  150.3 and 150.9, taken together, would make 
several changes to the process of acquiring bona fide hedge 
recognitions and spread exemptions for federal position limits 
purposes. Proposed Sec. Sec.  150.3 and 150.9 would maintain certain 
elements of the status quo while also adopting certain changes to 
facilitate the exemption process.\613\
---------------------------------------------------------------------------

    \613\ In this section the Commission discusses the costs and 
benefits related to the application process for these exemptions and 
bona fide hedge recognitions. For a discussion of the costs and 
benefits related to the scope of the exemptions and bona fide hedge 
recognitions, see supra Section IV.A.5.a.iv.
---------------------------------------------------------------------------

    First, with respect to the proposed enumerated bona fide hedges, 
proposed Sec.  150.3 would maintain the status quo by providing that 
those enumerated bona fide hedges that currently are self-effectuating 
for the nine legacy agricultural contracts would remain self-
effectuating for the nine legacy agricultural contracts for purposes of 
federal position limits.\614\ Similarly, the enumerated bona fide 
hedges for the proposed additional 16 contracts that would be newly 
subject to federal position limits (i.e., those contracts other than 
the nine legacy agricultural contracts) also would be self-effectuating 
for purposes of federal position limits.
---------------------------------------------------------------------------

    \614\ Under the status quo, market participants must apply to 
the Commission for recognition of certain enumerated anticipatory 
bona fide hedges. The Commission's proposal also would make these 
enumerated anticipatory bona fide hedges self-effectuating for the 
nine legacy agricultural contracts.
---------------------------------------------------------------------------

    Second, for recognition of any non-enumerated bona fide hedge in 
connection with any referenced contract, market participants would be 
required to apply either directly to the Commission under proposed 
Sec.  150.3 or through an exchange that adheres to certain requirements 
under proposed Sec.  150.9. The Commission notes that existing 
regulations require market participants to apply to the Commission for 
recognition of non-enumerated bona fide hedges, and so the Commission's 
proposal does not represent a change to the status quo in this respect 
for the nine legacy agricultural contracts.
    Third, proposed Sec.  150.3 would maintain the status quo by 
providing that the most common spread exemptions for the nine legacy 
agricultural contracts would remain self-effectuating. Similarly, these 
common spread exemptions also would be self-effectuating for the 
proposed additional 16 contracts that would be newly subject to federal 
position limits. These common spread exemptions would be listed in the 
proposed ``spread transaction'' definition under proposed Sec.  
150.1.\615\
---------------------------------------------------------------------------

    \615\ The proposed ``spread transaction'' definition would 
include a calendar spread, intercommodity spread, quality 
differential spread, processing spread (such as energy ``crack'' or 
soybean ``crush'' spreads), product or by-product differential 
spread, or futures-option spread.
---------------------------------------------------------------------------

    Fourth, for any spread exemption not listed in the proposed 
``spread transaction'' definition, market participants would be 
required to apply directly to the Commission under proposed Sec.  
150.3. There would be no exception for the nine legacy agricultural 
products nor would market participants be permitted to apply through an 
exchange under proposed Sec.  150.9 for these types of spread 
exemptions.\616\
---------------------------------------------------------------------------

    \616\ As discussed below, the proposal would also eliminate the 
Form 204 and the equivalent portions of the Form 304.
---------------------------------------------------------------------------

    The Commission anticipates that most--if not all--market 
participants would utilize the exchange-centric process set forth in 
proposed Sec.  150.9 with respect to applying for recognition of non-
enumerated bona fide hedges rather than apply directly to the 
Commission under proposed Sec.  150.3 because market participants are 
likely already familiar with the proposed processes set forth in Sec.  
150.9, which is intended to leverage the processes currently in place 
at the exchanges for addressing requests bona fide hedge recognitions 
from exchange-set limits. In the sections below, the Commission will 
discuss the costs and benefits related to both processes.

[[Page 11688]]

a. Process for Requesting Exemptions and Bona Fide Hedge Recognitions 
Directly From the Commission (Proposed Sec.  150.3)
    Under existing Sec. Sec.  1.47 and 1.48, and existing Sec.  150.3, 
the processes for obtaining a recognition of a bona fide hedge or for 
relying on a spread exemption, are similar in some respects and 
different in other respects than the proposed approach. Existing 
Sec. Sec.  1.47 and 1.48 require market participants seeking 
recognition of non-enumerated bona fide hedges and enumerated 
anticipatory bona fide hedges, respectively, for federal position 
limits to apply directly to the Commission for prior approval.
    In contrast, existing non-anticipatory enumerated bona fide hedges 
and spread exemptions are self-effectuating, which means that market 
participants are not required to submit any information to the 
Commission for prior approval, although such market participants must 
subsequently file Form 204 or Form 304 each month in order to describe 
their cash market positions and justify their bona fide hedge position. 
There currently is no codified federal process related to financial 
distress exemptions or natural gas conditional spot month exemptions.
    For those market participants that would choose to apply directly 
to the Commission for recognition of non-enumerated bona fide hedges or 
spread exemptions not included in the proposed ``spread transaction'' 
definition, which in each case would not be self-effectuating under the 
proposal, proposed Sec.  150.3 would provide a process for the 
Commission to review and approve requests. Under proposed Sec.  150.3, 
any person seeking Commission recognition of these types of bona fide 
hedges or a spread exemptions (as opposed to applying to using the 
exchange-centric process under proposed Sec.  150.9 described below) 
would be required to submit a request directly to the Commission and to 
provide information similar to what is currently required under 
existing Sec. Sec.  1.47 and 1.48.\617\
---------------------------------------------------------------------------

    \617\ For bona fide hedges and spread exemptions, this 
information would include: (i) A description of the position in the 
commodity derivative contract for which the application is 
submitted, including the name of the underlying commodity and the 
position size; (ii) information to demonstrate why the position 
meets the applicable requirements for a bona fide hedge or spread 
transaction; (iii) a statement concerning the maximum size of all 
gross positions in derivative contracts for which the application is 
submitted; (iv) for bona fide hedges, information regarding the 
applicant's activity in the cash markets and swaps markets for the 
commodity underlying the position for which the application is 
submitted; and (v) any other information that may help the 
Commission determine whether the position meets the applicable 
requirements for a bona fide hedge position or spread transaction.
---------------------------------------------------------------------------

i. Existing Bona Fide Hedges That Currently Require Prior Submission to 
the Commission Under Existing Sec. Sec.  1.47 and 1.48 for the Nine 
Legacy Agricultural Contracts
    Under the proposal, the Commission would maintain the distinction 
between enumerated bona fide hedges and non-enumerated bona fide hedges 
under proposed Sec.  150.3: (1) Enumerated bona fide hedges would 
continue to be self-effectuating; (2) enumerated anticipatory bona fide 
hedges would become self-effectuating so market participants would no 
longer need to apply to the Commission; and (3) non-enumerated bona 
fide hedges would still require market participants to apply for 
recognition. Market participants that choose to apply directly to the 
Commission for a bona fide hedge recognition (i.e., for non-enumerated 
bona fide hedges) would be subject to an application process that 
generally is similar to what the Commission currently administers for 
the non-enumerated bona fide hedges and the enumerated anticipatory 
bona fide hedges.\618\ With respect to enumerated anticipatory bona 
fide hedges for the nine legacy contracts, for which market 
participants currently are required to apply to the Commission for 
recognition for federal position limit purposes, the Commission 
preliminarily anticipates that the proposal would benefit market 
participants by making such hedges self-effectuating.\619\ As a result, 
market participants will no longer be required to spend time and 
resources applying to the Commission. Further, for these enumerated 
anticipatory hedges, existing Sec.  1.48 requires market participants 
to submit either an initial or supplemental application to the 
Commission 10 days prior to entering into the bona fide hedge that 
would cause the hedger to exceed federal position limits.\620\ Under 
existing Sec.  1.48, market participants could proceed with their 
proposed bona fide hedges if the Commission does not notify a market 
participants otherwise within the specific 10-day period. Because bona 
fide hedgers could implement enumerated anticipatory bona fide hedges 
without waiting the requisite 10 days, they may be able to implement 
their hedging strategy more efficiently with reduced cost and risk. The 
Commission acknowledges that making such bona fide hedges easier to 
obtain could increase the possibility of excess speculation since 
anticipatory exemptions are theoretically more difficult to 
substantiate compared to the other existing enumerated bona fide 
hedges. However, the Commission has gained significant experience over 
the years with bona fide hedging practices in general and with 
enumerated anticipatory bona fide hedging practices in particular, and 
the Commission preliminarily has determined that making such hedges 
self-effectuating should not increase the risk of excessive speculation 
or market manipulation compared to the status quo.
---------------------------------------------------------------------------

    \618\ As noted above, under the existing framework market 
participants are not required to apply for any type of bona fide 
hedge recognition or spread exemption from the Commission for any of 
the proposed additional 16 contracts that would be newly subject to 
federal position limits (i.e., those contracts other than the nine 
legacy agricultural contracts); rather, under the existing 
framework, such market participants must apply to the exchanges for 
bona fide hedge recognitions or exemptions for purposes of exchange-
set position limits. Accordingly, to the extent that market 
participants would not need to apply to the Commission in connection 
with any of the proposed additional 16 contracts, the Commission's 
proposal would not impose additional costs or benefits compared to 
the status quo.
    \619\ As noted above, since market participants do not need to 
apply to the Commission for bona fide hedge recognition for any of 
the proposed additional 16 contracts that would be newly subject to 
federal position limits, the Commission's proposal would not result 
in any additional costs or benefits to the extent such bona fide 
hedge recognitions would be self-effectuating.
    \620\ Under the Commission's existing regulations, non-
anticipatory enumerated bona fide hedges are self-effectuating, and 
market participants do not have to file any applications for 
recognition under existing Commission regulations. However, bona 
fide hedgers must file with the Commission monthly Form 204 (or Form 
304 in connection with ICE Cotton No. 2 (CT)) reports discussing 
their underlying cash positions in order to substantiate their bona 
fide hedge positions.
---------------------------------------------------------------------------

    For non-enumerated bona fide hedges, existing Sec.  1.47 requires 
market participants to submit (i) initial applications to the 
Commission 30 days prior to the date the market participant would 
exceed the applicable position limits and (ii) supplemental 
applications (i.e., applications for a market participant that desire 
to exceed the bona fide hedge amount provided in the person's previous 
Commission filing) 10 days prior for Commission approval, and market 
participants can proceed with their proposed bona fide hedges if the 
Commission does not intervene within the specific time (e.g., either 10 
days or 30 days).
    Proposed Sec.  150.3 would similarly require market participants 
seeking recognition of a non-enumerated bona fide hedge for any of the 
proposed 25 core referenced futures contracts to apply to the 
Commission prior to exceeding federal position limits, but proposed 
Sec.  150.3 would not prescribe a certain time period by which a bona 
fide hedger must apply or by which the

[[Page 11689]]

Commission must respond. The Commission preliminarily anticipates that 
the proposal would benefit bona fide hedgers by enabling them in many 
cases to generally implement their hedging strategies sooner than the 
existing 30-day or 10-day waiting period, in which case the Commission 
believes hedging-related costs would decrease. However, the Commission 
believes that there could also be circumstances in which the overall 
process could take longer than the existing timelines under Sec.  1.47, 
which could increase hedging related costs if a bona fide hedger is 
compelled to wait longer, compared to existing Commission practices, 
before executing its hedging strategy.
    On the other hand, the Commission also recognizes that there could 
be potential costs to bona fide hedgers if under the proposal they are 
forced either to enter into less effective bona fide hedges or to wait 
to implement their hedging strategy, as a result of the potential 
uncertainty that could result from proposed Sec.  150.3 not requiring 
the Commission to respond within a certain amount of time. The 
Commission believes this concern is mitigated to the extent market 
participants utilize the proposed Sec.  150.3 process that would permit 
a market participant that demonstrates a ``sudden or unforeseen'' 
increase in its bona fide hedging needs to enter into a bona fide hedge 
without first obtaining the Commission's prior approval, as long as the 
market participant submits a retroactive application to the Commission 
within five business days of exceeding the applicable position limit. 
The Commission preliminarily believes this ``five-business day 
retroactive exemption'' would benefit bona fide hedgers compared to 
existing Sec. Sec.  1.47 and 1.48, which requires Commission prior 
approval, since hedgers that would qualify to exercise the five-
business day retroactive exemption are also likely facing more acute 
hedging needs--with potentially commensurate costs if required to wait. 
This provision would also leverage, for federal position limit 
purposes, existing exchange practices for granting retroactive 
exemptions from exchange-set limits.
    On the other hand, the proposed five-business day retroactive 
exemption could harm market liquidity and bona fide hedgers if the 
applicable exchange or the Commission were to not approve of the 
retroactive request, and the Commission subsequently required 
liquidation of the position in question. As a result, such possibility 
could cause market participants to either enter into smaller bona fide 
hedge positions than they otherwise would or cause the bona fide hedger 
to delay entering into its hedge, in either case potentially causing 
bona fide hedgers to incur increased hedging costs.
    However, the Commission preliminarily believes this concern is 
partially mitigated since proposed Sec.  150.3 would require the 
purported bona fide hedger to exit its position in a ``commercially 
reasonable time,'' which the Commission believes should partially 
mitigate any costs incurred by the market participant compared to 
either an alternative that would require the bona fide hedger to exit 
its position immediately, or the status quo where the market 
participant either is unable to enter into a hedge at all without 
Commission prior approval.
ii. Spread Exemptions and Non-Enumerated Bona Fide Hedges
    Proposed Sec.  150.3 would impose a new requirement for market 
participants to (1) apply either directly to the Commission pursuant to 
proposed Sec.  150.3 or to an exchange pursuant to proposed Sec.  150.9 
for any non-enumerated bona fide hedge; and (2) to apply directly to 
the Commission pursuant to proposed Sec.  150.3 for any spread 
exemptions not identified in the proposed ``spread transaction'' 
definition for any of the proposed 25 core referenced futures 
contracts.\621\ As noted above, common spread exemptions (i.e., those 
identified in the proposed definition of ``spread transaction'' in 
proposed Sec.  150.1) would remain self-effectuating for the nine 
legacy agricultural products and also would be self-effectuating for 
the 16 proposed core referenced futures contracts.\622\ Unlike non-
enumerated bona fide hedges, for which market participants could apply 
directly to the Commission under proposed Sec.  150.3 or through an 
exchange under proposed Sec.  150.9, for spread exemptions not 
identified in the proposed ``spread transaction'' definition, market 
participants would be required to apply directly to the Commission 
under proposed Sec.  150.3.
---------------------------------------------------------------------------

    \621\ As discussed below, for spread exemptions not identified 
in the proposed ``spread transaction'' definition in proposed Sec.  
150.3, market participants would be required to apply directly to 
the Commission under proposed Sec.  150.3 and would not be able to 
apply under proposed Sec.  150.9.
    \622\ Existing Sec.  150.3(a)(2) does not specify a formal 
process for granting either spread exemptions or non-anticipatory 
enumerated bona fide hedges that are consistent with CEA section 
4a(a)(1), so in practice spread exemptions and non-anticipatory 
enumerated bona fide hedges have been self-effectuating.
---------------------------------------------------------------------------

    As noted above, proposed Sec.  150.3 also would maintain the status 
quo and continue to require any non-enumerated bona fide hedge in one 
of the nine legacy agricultural products to receive prior approval, and 
similarly would require prior approval for such non-enumerated bona 
fide hedges for the proposed additional 16 contracts that would be 
newly subject to federal position limits.\623\ The Commission 
anticipates that there will be no change to the status quo baseline 
with respect to the most common spread exemptions since these 
exemptions would be self-effecting for purposes of federal position 
limits.
---------------------------------------------------------------------------

    \623\ The Commission discusses the costs and benefits related to 
the proposed process for non-enumerated bona fide hedge recognitions 
with respect to the nine legacy agricultural products in the above 
section.
---------------------------------------------------------------------------

    To the extent market participants would be required to obtain prior 
approval for a non-enumerated bona fide hedge or spread exemption for 
any of the additional 16 contracts that would be newly subject to 
federal position limits, the Commission recognizes that proposed Sec.  
150.3 would impose costs on market participants who will now be 
required to spend time and resources submitting applications to the 
Commission (for certain spread exemptions) or to either the Commission 
or an exchange (for non-enumerated bona fide hedges) for prior approval 
for federal position limit purposes.\624\ Further, compared to the 
status quo in which the proposed new 16 contracts are not subject to 
federal position limits, the proposed process could increase 
uncertainty since market participants would be required to seek prior 
approval and wait up to 10 days. As a result, such uncertainty could 
cause market participants to either enter into smaller spread or bona 
fide hedging positions or do so at a later time. In either case, this 
could cause market participants to incur additional costs and/or 
implement less efficient hedging strategies. However, the Commission 
preliminarily believes that proposed Sec.  150.3's framework would be 
familiar to market participants that currently apply to the Commission 
for bona fide exemptions for the nine legacy agricultural products, 
which should serve to reduce costs for some market participants 
associated with obtaining recognition of a bona fide hedge or spread 
exemption from the Commission for federal limits for those market

[[Page 11690]]

participants.\625\ The Commission also preliminarily believes that this 
analysis also would apply to the nine legacy agricultural contracts for 
spread exemptions that are not listed in the proposed ``spread 
transaction'' definition and therefore also would require market 
participants to apply to the Commission for these types of spread 
exemptions for the first time for the nine legacy agricultural 
products. However, because the Commission preliminarily has determined 
that most spread transactions would be self-effectuating (especially 
for the nine legacy agricultural contracts based on the Commission's 
experience), the Commission believes that the proposal would impose 
only small costs with respect to spread exemptions for both the nine 
legacy agricultural contracts as well as the proposed additional 16 
contracts that would be newly subject to federal position limits.
---------------------------------------------------------------------------

    \624\ The Commission's Paperwork Reduction Act analysis 
identifies some of these information collection burdens in greater 
specificity. See supra Section IV.A.4.c. (discussing in greater 
detail the cost and benefits related to spread exemptions).
    \625\ The Commission preliminarily anticipates that the proposed 
application process in Sec.  150.3(b) could slightly reduce 
compliance-related costs, compared to the status quo application 
process to the Commission under existing Sec. Sec.  1.47 and 1.48, 
because proposed Sec.  150.3 would provide a single, standardized 
process for all bona fide hedge and spread exemption requests that 
is slightly less complex--and more clearly laid out in the proposed 
regulations--than the Commission's existing application processes. 
Nonetheless, since the Commission anticipates that most market 
participants would apply directly to exchanges for bona fide hedges 
and spread exemptions when provided the option under proposed Sec.  
150.9, the Commission believes that most market participants would 
incur the costs and benefits discussed thereunder.
---------------------------------------------------------------------------

    While the Commission has years of experience granting and 
monitoring spread exemptions and enumerated and non-enumerated bona 
fide hedges for the nine legacy agricultural contracts, as well as 
overseeing exchange processes for administering exemptions from 
exchange-set limits on such commodities, the Commission does not have 
the same level of experience or comfort administering bona fide hedge 
recognitions and spread exemptions for the additional 16 contracts that 
would be subject to the proposed federal position limits and the new 
proposed exemption processes for the first time. Accordingly, the 
Commission preliminarily recognizes that permitting enumerated bona 
fide hedges and spread recognitions identified in the proposed ``spread 
transaction'' definition for these additional 16 contracts might not 
provide the purported benefits, or could result in increased costs, 
compared to the Commission's experience with the nine legacy 
agricultural products.
    The Commission also preliminarily believes that the proposal will 
benefit market participants by providing market participants the option 
to choose the process for applying for a non-enumerated bona fide hedge 
(i.e., either directly with the Commission or, alternatively, through 
the exchange-centric process discussed under proposed Sec.  150.9 
below) for the additional 16 contracts that would be newly subject to 
federal position limits that would be more efficient given the market 
participants unique facts, circumstances, and experience.\626\ If a 
market participant chooses to apply through an exchange for federal 
position limits pursuant to proposed Sec.  150.9, the market 
participant would also receive the added benefit of not being required 
to also submit another application directly to the Commission. The 
Commission anticipates that most market participants would apply 
directly to exchanges for non-enumerated bona fide hedges, pursuant to 
the proposed streamlined process Sec.  150.9, as explained below, in 
which case the Commission believes that most market participants would 
incur the costs and benefits discussed thereunder. The Commission also 
preliminarily believes that this analysis also would apply with respect 
to non-enumerated bona fide hedges for the nine legacy agricultural 
contracts.
---------------------------------------------------------------------------

    \626\ As noted above, market participants seeking spread 
exemptions not listed in the proposed ``spread transaction'' 
definition in proposed Sec.  150.1 would be required to apply 
directly with the Commission under proposed Sec.  150.3 and would 
not be permitted to apply under proposed Sec.  150.9. The Commission 
preliminarily recognizes that these types of spread exemptions are 
difficult to analyze compared to either the spread exemptions 
identified in proposed Sec.  150.1 or bona fide hedges in general. 
Accordingly, the Commission preliminarily has determined to require 
market participants to apply directly to the Commission. Further, 
compared to the spread exemptions identified in proposed Sec.  
150.1, the Commission anticipates relatively few requests, and so 
does not believe the proposed application requirement will impose a 
large aggregate burden across market participants.
---------------------------------------------------------------------------

iii. Exemption-Related Recordkeeping
    Proposed Sec.  150.3(d) would require persons who avail themselves 
of any of the foregoing exemptions to maintain complete books and 
records relating to the subject position, and to make such records 
available to the Commission upon request under proposed Sec.  150.3(e). 
These requirements would benefit market integrity by providing the 
Commission with the necessary information to monitor the use of 
exemptions from speculative position limits and help to ensure that any 
person who claims any exemption permitted by proposed Sec.  150.3 can 
demonstrate compliance with the applicable requirements. The Commission 
does not expect these requirements to impose significant new costs on 
market participants, as these requirements are in line with existing 
Commission and exchange-level recordkeeping obligations.
iv. Exemption Renewals
    Consistent with existing Sec. Sec.  1.47 and 1.48, with respect to 
any Commission-recognized bona fide hedge or Commission-granted spread 
exemption pursuant to proposed Sec.  150.3, the Commission would not 
require a market participant to reapply annually for bona fide 
hedges.\627\ The Commission preliminarily believes that this will 
reduce burdens on market participants but also recognizes that not 
requiring market participants to annually reapply ostensibly could harm 
market integrity since the Commission would not directly receive 
updated information with respect to particular bona fide hedgers or 
exemption holders prior to the trader excessing the applicable federal 
limits.
---------------------------------------------------------------------------

    \627\ As discussed below, with respect to exchange-set limits 
under proposed Sec.  150.5 or the exchange process for federal 
limits under proposed Sec.  150.9, market participants would be 
required to annually reapply to exchanges.
---------------------------------------------------------------------------

    However, the Commission preliminarily believes that any potential 
harm would be mitigated since the Commission, unlike exchanges, has 
access to aggregate market data, including positions held by individual 
market participants. Further, proposed Sec.  150.3 would require a 
market participant to submit a new application if any information 
changes, or upon the Commission's request. On the other hand, market 
participants would benefit by not being required to annually submit new 
applications, which the Commission preliminarily believes will reduce 
compliance costs.
v. Exemptions for Financial Distress and Conditional Natural Gas 
Positions
    Proposed Sec.  150.3 would codify the Commission's existing 
informal practice with respect to exemptions for financial distress and 
conditional spot month limit exemption positions in natural gas. The 
same costs and benefits described above with respect to applications 
for bona fide hedge recognitions and spread exemptions would also 
apply. However, to the extent the Commission currently allows 
exemptions related to financial distress, the Commission preliminarily 
has determined that the costs and benefits with respect to the related 
application process already may be recognized by market participants.

[[Page 11691]]

b. Process for Market Participants To Apply to an Exchange for Non-
Enumerated Bona Fide Hedge Recognitions for Purposes of Federal Limits 
(Proposed Sec.  150.9) and Related Changes to Part 19 of the 
Commission's Regulations
    Proposed Sec.  150.9 would provide a framework whereby a market 
participant could avoid the existing dual application process described 
above and, instead, file one application with an exchange to receive a 
non-enumerated bona fide hedging recognition, which as discussed 
previously would not be self-effectuating for purposes of federal 
position limits. Under this process, a person would be allowed to 
exceed the federal limit levels following an exchange's review and 
approval of an application for a bona fide hedge recognition or spread 
exemption, provided that the Commission during its review does not 
notify the exchange otherwise within a certain period of time 
thereafter. Market participants who do not elect to use the process in 
proposed Sec.  150.9 for purposes of federal position limits would be 
required to request relief both directly from the Commission under 
proposed Sec.  150.3, as discussed above, and also apply to the 
relevant exchange, consistent with existing practices.\628\
---------------------------------------------------------------------------

    \628\ As noted above, the Commission preliminarily anticipates 
that most, if not all, market participants will use proposed Sec.  
150.9, rather than proposed Sec.  150.3, where permitted.
---------------------------------------------------------------------------

i. Proposed Sec.  150.9--Establishment of General Exchange Process
    Pursuant to proposed Sec.  150.9, exchanges that elect to process 
these applications would be required to file new rules or rule 
amendments with the Commission under Sec.  40.5 of the Commission's 
regulations and obtain from applicants all information to enable the 
exchange to determine, and the Commission to verify, that the facts and 
circumstances support a non-enumerated bona fide hedge recognition. The 
Commission initially believes that exchanges' existing practices 
generally are consistent with the requirements of proposed Sec.  150.9, 
and therefore exchanges would only incur marginal costs, if any, to 
modify their existing practices to comply. Similarly, the Commission 
preliminarily anticipates that establishing uniform, standardized 
exemption processes across exchanges would benefit market participants 
by reducing compliance costs. On the other hand, the Commission 
recognizes that exchanges that wish to participate in the processing of 
applications with the Commission under proposed Sec.  150.9 would be 
required to expend resources to establish a process consistent with the 
Commission's proposal. However, to the extent exchanges have similar 
procedures, such benefits and costs may already have been realized by 
market participants and exchanges.
    The Commission preliminarily believes that there are significant 
benefits to the proposed Sec.  150.9 process that would be largely 
realized by market participants. The Commission preliminarily has 
determined that the use of a single application to process both 
exchange and federal position limits will benefit market participants 
and exchanges by simplifying and streamlining the process. For 
applicants seeking recognition of a non-enumerated bona fide hedge, 
proposed Sec.  150.9 should reduce duplicative efforts because 
applicants would be saved the expense of applying in parallel to both 
an exchange and the Commission for relief from exchange-set position 
limits and federal position limits, respectively. Because many 
exchanges already possess similar application processes with which 
market participants are likely accustomed, compliance costs should be 
decreased in the form of reduced application-production time by market 
participants and reduced response time by exchanges.
    As discussed above, in connection with the recognition of bona fide 
hedges for federal position limit purposes, current practices set forth 
in existing Sec. Sec.  1.47 and 1.48 require market participants to 
differentiate between (i) enumerated non-anticipatory bona fide hedges 
that are self-effectuating, and (ii) enumerated anticipatory bona fide 
hedges and non-enumerated bona fide hedges for which market 
participants must apply to the Commission for prior approval. Under the 
proposal, the Commission would no longer distinguish among different 
types of enumerated bona fide hedges (e.g., anticipatory versus non-
anticipatory enumerated bona fide hedges), and therefore, would not 
require exchanges to have separate processes for enumerated 
anticipatory positions under proposed Sec.  150.9 for the nine legacy 
agricultural contracts. The Commission's proposal would also eliminate 
the requirement for bona fide hedgers to file Form 204 or Form 304, as 
applicable, with respect to any bona fide hedge, whether enumerated or 
non-enumerated.\629\ The Commission preliminarily expects this to 
benefit market participants by providing a more efficient and less 
complex process that is consistent with existing practices at the 
exchange-level.
---------------------------------------------------------------------------

    \629\ See infra Section II.H.3. (discussion of proposed changes 
to part 19 eliminating Form 204 and portions of Form 304).
---------------------------------------------------------------------------

    On the other hand, the Commission recognizes proposed Sec.  150.9 
would impose new costs related to non-enumerated bona fide hedges for 
the additional 16 contracts that would be newly subject to federal 
position limits. Under the proposal, market participants would now be 
required to submit applications to receive prior approval for federal 
position limits purposes. However, since the Commission preliminarily 
understands that exchanges already require market participants to 
submit applications and receive prior approval under exchange-set 
limits for all types of bona fide hedges, the Commission does not 
believe proposed Sec.  150.9 would impose any additional incremental 
costs on market participants beyond those already incurred under 
exchanges' existing processes. Accordingly, the Commission 
preliminarily believes that any costs already may have been realized by 
market participants.
    Further, the Commission preliminarily believes that employing a 
concurrent process with exchanges to oversee the non-enumerated bona 
fide hedges that would not be self-effectuating for federal position 
limits purposes would benefit market integrity by ensuring that market 
participants are appropriately relying on such bona fide hedges and not 
entering into such positions in order to attempt to manipulate the 
market or evade position limits. However, to the extent that exchange 
oversight, consistent with Commission standards and DCM core 
principles, already exists, such benefits may already be realized.
ii. Proposed Sec.  150.9--Exchange Expertise, Market Integrity, and 
Commission Oversight
    For non-enumerated bona fide hedge recognitions that would require 
the Commission's prior approval, the proposal would provide a framework 
that utilizes existing exchange resources and expertise so that fair 
access and liquidity are promoted at the same time market 
manipulations, squeezes, corners, and any other conduct that would 
disrupt markets are deterred and prevented. Proposed Sec.  150.9 would 
build on existing exchange processes, which the Commission 
preliminarily

[[Page 11692]]

believes would strengthen the ability of the Commission and exchanges 
to monitor markets and trading strategies while reducing burdens on 
both the exchanges, which would administer the process, and market 
participants, who would utilize the process. For example, exchanges are 
familiar with their market participants' commercial needs, practices, 
and trading strategies, and already evaluate hedging strategies in 
connection with setting and enforcing exchange-set position limits; 
accordingly, exchanges should be able to readily identify bona fide 
hedges.\630\
---------------------------------------------------------------------------

    \630\ For a discussion on the history of exemptions, see 2013 
Proposal, 78 FR at 75703-75706.
---------------------------------------------------------------------------

    For these reasons, the Commission has preliminarily determined that 
allowing market participants to apply through an exchange under 
proposed Sec.  150.9, rather than directly to the Commission as 
required under existing Sec.  1.47, is likely to be more efficient than 
if the Commission itself initially had to review and approve all 
applications. The Commission preliminarily considers the increased 
efficiency in processing applications under proposed Sec.  150.9 as a 
benefit to bona fide hedgers and liquidity providers. By having the 
availability of the exchange's analysis and view of the markets, the 
Commission would be better informed in its review of the market 
participant and its application, which in turn may further benefit 
market participants in the form of administrative efficiency and 
regulatory consistency. However, the Commission recognizes additional 
costs for exchanges required to create and submit these real-time 
notices. To the extent exchanges already provide similar notice to the 
Commission or to market participants, or otherwise are required to 
notify the Commission under certain circumstances, such benefits and 
costs already may have been realized.
    On the other hand, to the extent exchanges would become more 
involved with respect to review and oversight of market participants' 
bona fide hedges and spread exemptions, exchanges could incur 
additional costs. However, as noted, the Commission believes most of 
the costs have been realized by exchanges under current market 
practice.
    At the same time, the Commission also preliminarily recognizes that 
this aspect of the proposal could potentially harm market integrity. 
Absent other provisions, since exchanges profit from increased 
activity, an exchange could hypothetically seek a competitive advantage 
by offering excessively permissive exemptions, which could allow 
certain market participants to utilize non-enumerated bona fide hedge 
recognitions to engage in excessive speculation or to manipulate market 
prices. If an exchange engaged in such activity, other market 
participants would likely face greater costs through increased 
transaction fees, including forgoing trading opportunities resulting 
from market prices moving against market participants and/or preventing 
the market participant from executing at its desired prices, which may 
also further lead to inefficient hedging. However, the Commission 
preliminarily believes that these hypothetical costs are unfounded 
since under proposed Sec.  150.9 the Commission would review the 
applications submitted by market participants for bona fide hedge 
recognitions and spread exemptions; the Commission emphasizes that 
proposed Sec.  150.9 is not providing exchanges with an ability to 
recognize a bona fide hedge or grant an exemption for federal position 
limit purposes in lieu of a Commission review. Rather, proposed Sec.  
150.9(e) and (f) would require an exchange to provide the Commission 
with notice of the disposition of any application for purposes of 
exchange limits concurrently with the notice the exchange would provide 
to the applicant, and the Commission would have 10 business days to 
make its determination for federal position limits purposes (although, 
in connection with ``sudden or unforeseen increases'' in bona fide 
hedging needs, as discussed in connection with proposed Sec.  150.3, 
proposed Sec.  150.9 would require the Commission to make its 
determination within two business days).
    On the other hand, the Commission also recognizes that there could 
be potential costs to bona fide hedgers if under the proposal they are 
forced to wait up to 10 business days for the Commission to complete 
its review after the exchange's initial review--especially compared to 
the status quo for the 16 commodities that would be subject to federal 
limits for the first time under this release and currently are not 
required to receive the Commission's prior approval. As a result, the 
Commission preliminarily recognizes that a market participant could 
incur costs by waiting during the 10 business day period or be required 
to enter into a less efficient hedge, which would harm liquidity. 
However, the Commission believes this concern is mitigated since 
proposed Sec.  150.9, similar to proposed Sec.  150.3, would permit a 
market participant that demonstrates a ``sudden or unforeseen'' 
increase in its bona fide hedging needs to enter into a bona fide hedge 
without first obtaining the Commission's prior approval, as long as the 
market participant submits a retroactive application to the Commission 
within five business days of exceeding the applicable position limit. 
In turn, the Commission would only have two business days (as opposed 
to the default 10 business days) to complete its review for federal 
purposes. The Commission preliminarily believes this ``five-business 
day retroactive exemption'' would benefit bona fide hedgers compared to 
existing Sec.  1.47, which requires Commission prior approval, since 
hedgers that would qualify to exercise the five-business day 
retroactive exemption are also likely facing more acute hedging needs--
with potentially commensurate costs if required to wait. This provision 
would also leverage, for federal position limit purposes, existing 
exchange practices for granting retroactive exemptions from exchange-
set limits.
    On the other hand, the proposed five-business day retroactive 
exemption could harm market liquidity and bona fide hedgers since the 
Commission would be able to require a market participant to exit its 
position if the exchange or the Commission does not approve of the 
retroactive request, and such uncertainty could cause market 
participants to either enter into smaller bona fide hedge positions 
than it otherwise would or could cause the bona fide hedger to delay 
entering into its hedge, in either case potentially causing bona fide 
hedgers to incur increased hedging costs. However, the Commission 
preliminarily believes this concern is partially mitigated since 
proposed Sec.  150.9 would require the purported bona fide hedger to 
exit its position in a ``commercially reasonable time,'' which the 
Commission believes should partially mitigate any costs incurred by the 
market participant compared to either an alternative that would require 
the bona fide hedger to exit its position immediately, or the status 
quo where the market participant either is unable to enter into a hedge 
at all without Commission approval.
    While existing Sec.  1.47 does not require market participants to 
annually reapply for certain bona fide hedges, proposed Sec.  150.9 
would require market participants to reapply at least annually with 
exchanges for purposes of federal position limits. The Commission 
recognizes that requiring market participants to reapply annually could 
impose additional costs on those that are not currently required to do 
so. However, the Commission believes that this is consistent with 
industry practice

[[Page 11693]]

with respect to exchange-set limits and that market participants are 
familiar with exchanges' exemption processes, which should reduce 
related costs.\631\ Further, the Commission preliminarily believes that 
market integrity would be strengthened by ensuring that exchanges 
receive updated trader information that may be relevant to the 
exchange's oversight.\632\ However, to the extent any of these benefits 
and costs reflect current market practice, they already may have been 
realized by exchanges and market participants.
---------------------------------------------------------------------------

    \631\ See infra Section IV.A.6. (discussing proposed Sec.  
150.5).
    \632\ In contrast, the Commission, unlike exchanges, has access 
to aggregate market data, including positions held by individual 
market participants, and so the Commission has preliminarily 
determined that requiring market participants to apply annually 
under proposed Sec.  150.3, absent any changes to their application, 
would not benefit market integrity to the same extent.
---------------------------------------------------------------------------

    In addition, the proposed exchange-to-Commission monthly report in 
proposed Sec.  150.5(a)(4) would further detail the exchange's 
disposition of a market participant's application for recognition of a 
bona fide hedge position or spread exemption as well as the related 
position(s) in the underlying cash markets and swaps markets. The 
Commission believes that such reports would provide greater 
transparency by facilitating the tracking of these positions by the 
Commission and would further assist the Commission in ensuring that a 
market participant's activities conform to the exchange's rules and to 
the CEA. The combination of the ``real-time'' exchange notification and 
exchanges' provision of monthly reports to the Commission under 
proposed Sec. Sec.  150.9(e)(1) and 150.5(a)(4), respectively, would 
provide the Commission with enhanced surveillance tools on both a 
``real-time'' and a monthly basis to ensure compliance with the 
requirements of this proposal. The Commission anticipates additional 
costs for exchanges required to create and submit monthly reports 
because the proposed rules would require exchanges to compile the 
necessary information in the form and manner required by the 
Commission. However, to the extent exchanges already provide similar 
notice to the Commission, or otherwise are required to notify the 
Commission under certain circumstances, such benefits and costs already 
may have been realized
iii. Proposed 150.9(d)--Recordkeeping
    Proposed Sec.  150.9(d) would require exchanges to maintain 
complete books and records of all activities relating to the processing 
and disposition of any applications, including applicants' submission 
materials, exchange notes, and determination documents.\633\ The 
Commission preliminarily believes that this will benefit market 
integrity and Commission oversight by ensuring that pertinent records 
will be readily accessible, as needed by the Commission. However, the 
Commission acknowledges that such requirements would impose costs on 
exchanges. Nonetheless, to the extent that exchanges are already 
required to maintain similar records, such costs and benefits already 
may be realized.\634\
---------------------------------------------------------------------------

    \633\ Moreover, consistent with existing Sec.  1.31, the 
Commission expects that these records would be readily accessible 
until the termination, maturity, or expiration date of the bona fide 
hedge recognition or exempt spread position and during the first two 
years of the subsequent, five-year retention period.
    \634\ The Commission believes that exchanges that process 
applications for recognition of bona fide hedging transactions or 
positions and/or spread exemptions currently maintain records of 
such applications as required pursuant to other existing Commission 
regulations, including existing Sec.  1.31. The Commission, however, 
also believes that proposed Sec.  150.9(d) may impose additional 
recordkeeping obligations on such exchanges. The Commission 
estimates that each exchange electing to administer the proposed 
process would likely incur a de minimis cost annually to retain 
records for each proposed process compared to the status quo. See 
generally Section IV.B. (discussing the Commission's PRA 
determinations).
---------------------------------------------------------------------------

iv. Proposed Sec.  150.9 (g)--Commission Revocation of Previously-
Approved Applications
    The Commission preliminarily acknowledges that there may be costs 
to market participants if the Commission revokes the hedge recognition 
for federal purposes under proposed Sec.  150.9(f). Specifically, 
market participants could incur costs to unwind trades or reduce 
positions if the Commission required the market participant to do so 
under proposed Sec.  150.9(f)(2).
    However, the potential cost to market participants would be 
mitigated under proposed Sec.  150.9(f) since the Commission would 
provide a commercially reasonable time for a person to come back into 
compliance with the federal position limits, which the Commission 
believes should mitigate transaction costs to exit the position and 
allow a market participant the opportunity to potentially execute other 
hedging strategies.
v. Proposed Sec.  150.9--Commodity Indexes and Risk Management 
Exemptions
    Proposed Sec.  150.9(b) would prohibit exchanges from recognizing 
as a bona fide hedge with respect to commodity index contracts. The 
Commission recognizes that this proposed prohibition could alter 
trading strategies that currently use commodity index contracts as part 
of an entity's risk management program. Although there likely would be 
a cost to change risk management strategies for entities that currently 
rely on a bona fide hedge recognition for positions in commodity index 
contracts, as discussed above, the Commission believes that such 
financial products are not substitutes for positions in a physical 
market and therefore do not satisfy the statutory requirement for a 
bona fide hedge under section 4a(c)(2) of the Act.\635\ In addition, 
the Commission further posits that this cost may be reduced or 
mitigated by the proposed increased in federal position limit levels 
set forth in proposed Sec.  150.2 or by the implementation of the pass-
through swap provision of the proposed bona fide hedge definition.\636\
---------------------------------------------------------------------------

    \635\ See supra Section III.F.6. (discussion of commodity 
indices); see supra Section IV.A.4.b.i.(1). (discussion of 
elimination of the risk management exemption).
    \636\ See supra Section IV.A.4.b.i.(1). (discussion of the pass-
through swap exemption).
---------------------------------------------------------------------------

c. Request for Comment
    (48) The Commission requests comment on its considerations of the 
benefits and costs of proposed Sec.  150.3 and Sec.  150.9. Are there 
additional benefits or costs that the Commission should consider? Has 
the Commission misidentified any benefits or costs? Commenters are 
encouraged to include both quantitative and qualitative assessments of 
these benefits and costs, as well as data or other information to 
support such assessments.
    (49) The Commission requests comment on whether a Commission-
administered process, such as the process in proposed Sec.  150.3, 
would promote more consistent and efficient decision-making. Commenters 
are encouraged to include both quantitative and qualitative 
assessments, as well as data or other information to support such 
assessments.
    (50) The Commission recognizes there exist alternatives to proposed 
Sec.  150.9. These include such alternatives as: (1) Not permitting 
exchanges to administer any process to recognize bona fide hedging 
transactions or positions or grant exempt spread positions for purposes 
of federal limits; or (2) maintaining the status quo. The Commission 
requests comment on whether an alternative to what is proposed would 
result in a superior cost-benefit profile, with support for any such 
position.

[[Page 11694]]

d. Related Changes to Part 19 of the Commission's Regulations Regarding 
the Provision of Information by Market Participants
    Under existing regulations, the Commission relies on Form 204 \637\ 
and Form 304,\638\ known collectively as the ``series `04'' reports, to 
monitor for compliance with federal position limits. Under existing 
part 19, market participants that hold bona fide hedging positions in 
excess of federal limits for the nine legacy agricultural contracts 
currently subject to federal limits under existing Sec.  150.2 must 
justify such overages by filing the applicable report (Form 304 for 
cotton and Form 204 for the other eight legacy commodities) each 
month.\639\ The Commission uses these reports to determine whether a 
trader has sufficient cash positions that justify futures and options 
on futures positions above the speculative limits.
---------------------------------------------------------------------------

    \637\ CFTC Form 204: Statement of Cash Positions in Grains, 
Soybeans, Soybean Oil, and Soybean Meal, U.S. Commodity Futures 
Trading Commission website, available at https://www.cftc.gov/sites/default/files/idc/groups/public/@forms/documents/file/cftcform204.pdf (existing Form 204).
    \638\ CFTC Form 304: Statement of Cash Positions in Cotton, U.S. 
Commodity Futures Trading Commission website, available at https://www.cftc.gov/ucm/groups/public/@forms/documents/file/cftcform304.pdf 
(existing Form 204). Parts I and II of Form 304 address fixed-price 
cash positions used to justify cotton positions in excess of federal 
limits. As described below, Part III of Form 304 addresses unfixed 
price cotton ``on-call'' information, which is not used to justify 
cotton positions in excess of limits, but rather to allow the 
Commission to prepare its weekly cotton on-call report.
    \639\ 17 CFR 19.01.
---------------------------------------------------------------------------

    As discussed above, with respect to bona fide hedging positions, 
the Commission is proposing a streamlined approach under proposed Sec.  
150.9 to cash-market reporting that reduces duplication between the 
Commission and the exchanges. Generally, the Commission is proposing 
amendments to part 19 and related provisions in part 15 that would: (i) 
Eliminate Form 204; and (ii) amend the Form 304, in each case to remove 
any cash-market reporting requirements. Under this proposal, the 
Commission would instead rely on cash-market reporting submitted 
directly to the exchanges, pursuant to proposed Sec. Sec.  150.5 and 
150.9,\640\ or request cash-market information through a special call.
---------------------------------------------------------------------------

    \640\ See supra Section II.G.3. (discussion of proposed Sec.  
150.9). As discussed above, leveraging existing exchange application 
processes should avoid duplicative Commission and exchange 
procedures and increase the speed by which position limit exemption 
applications are addressed. While the Commission would recognize 
spread exemptions based on exchanges' application processes that 
satisfy the requirements in proposed Sec.  150.9, for purposes of 
federal limits, the cash-market reporting regime discussed in this 
section of the release only pertains to bona fide hedges, not to 
spread exemptions, because the Commission has not traditionally 
relied on cash-market information when reviewing requests for spread 
exemptions.
---------------------------------------------------------------------------

    The proposed cash-market and swap-market reporting elements of 
Sec. Sec.  150.5 and 150.9 discussed above are largely consistent with 
current market practices with respect to exchange-set limits and thus 
should not result in any new costs. The proposed elimination of Form 
204 and the cash-market reporting segments of the Form 304 would 
eliminate a reporting burden and the costs associated thereto for 
market participants. Instead, market participants would realize 
significant benefits by being able to submit cash market reporting to 
one entity--the exchanges--instead of having to comply with duplicative 
reporting requirements between the Commission and applicable exchange, 
or implement new Commission processes for reporting cash market data 
for market participants who will be newly subject to position 
limits.\641\ Further, market participants are generally already 
familiar with exchange processes for reporting and recognizing bona 
fide hedging exemptions, which is an added benefit, especially for 
market participants that would be newly subject to federal position 
limits.
---------------------------------------------------------------------------

    \641\ The Commission has noted that certain commodity markets 
will be subject to federal position limits for the first time. In 
addition, the existing Form 204 would be inadequate for reporting of 
cash-market positions relating to certain energy contracts that 
would be subject to federal limits for the first time under this 
proposal.
---------------------------------------------------------------------------

    Further, the proposed changes would not impact the Commission's 
existing provisions for gathering information through special calls 
relating to positions exceeding limits and/or to reportable positions. 
Accordingly, as discussed above, the Commission proposes that all 
persons exceeding the proposed limits set forth in proposed Sec.  
150.2, as well as all persons holding or controlling reportable 
positions pursuant to existing Sec.  15.00(p)(1), must file any 
pertinent information as instructed in a special call.\642\ This 
proposed provision is similar to existing Sec.  19.00(a)(3), but would 
require any such person to file the information as instructed in the 
special call, rather than to file a series '04 report.\643\ The 
Commission preliminarily believes that relying on its special call 
authority is less burdensome for market participants than the existing 
Forms 204 and 304 reporting costs, as special calls are discretionary 
requests for information whereas the series `04 reporting requirements 
are a monthly, recurring reporting burden for market participants.
---------------------------------------------------------------------------

    \642\ See proposed Sec.  19.00(b).
    \643\ 17 CFR 19.00(a)(3).
---------------------------------------------------------------------------

6. Exchange-Set Position Limits (Proposed Sec.  150.5)
a. Introduction
    Existing Sec.  150.5 addresses exchange-set position limits on 
contracts not subject to federal limits under existing Sec.  150.2, and 
sets forth different standards for DCMs to apply in setting limit 
levels depending on whether the DCM is establishing limit levels: (1) 
On an initial or subsequent basis; (2) for cash-settled or physically-
settled contracts; and (3) during or outside the spot month.
    In contrast, for physical commodity derivatives, proposed Sec.  
150.5(a) and (b) would (1) expand existing Sec.  150.5's framework to 
also cover contracts subject to federal limits under Sec.  150.2; (2) 
simplify the existing standards that DCMs apply when establishing 
exchange-set position limits; and (3) provide non-exclusive acceptable 
practices for compliance with those standards.\644\ Additionally, 
proposed Sec.  150.5(d) would require DCMs to adopt aggregation rules 
that conform to existing Sec.  150.4.\645\
---------------------------------------------------------------------------

    \644\ See 17 CFR 150.2. Existing Sec.  150.5 addresses only 
contracts not subject to federal limits under existing Sec.  150.2 
(aside from certain major foreign currency contracts). To avoid 
confusion created by the parallel federal and exchange-set position 
limit frameworks, the Commission clarifies that proposed Sec.  150.5 
deals solely with exchange-set position limits and exemptions 
therefrom, whereas proposed Sec.  150.9 deals solely with the 
process for purposes of federal limits.
    \645\ See 17 CFR 150.4.
---------------------------------------------------------------------------

b. Physical Commodity Derivative Contracts Subject to Federal Position 
Limits Under Sec.  150.5 (Proposed Sec.  150.5(a))
i. Exchange-Set Position Limits and Related Exemption Process
    For contracts subject to federal limits under Sec.  150.2, proposed 
Sec.  150.5(a)(1) would require DCMs to establish exchange-set limits 
no higher than the level set by the Commission. This is not a new 
requirement, and merely restates the applicable requirement in DCM Core 
Principle 5.\646\
---------------------------------------------------------------------------

    \646\ See Commission regulation Sec.  38.300 (restating DCMs' 
statutory obligations under the CEA Sec.  5(d)(5), 7 U.S.C. 
7(d)(5)). Accordingly, the Commission will not discuss any costs or 
benefits related to this proposed change since it merely reflects an 
existing regulatory and statutory obligation.
---------------------------------------------------------------------------

    Proposed Sec.  150.5(a)(2) would authorize DCMs to grant exemptions 
from such limits and is generally consistent with current industry 
practice. The Commission has

[[Page 11695]]

preliminarily determined that codifying such practice would establish 
important, minimum standards needed for DCMs to administer--and the 
Commission to oversee--an effective and efficient program for granting 
exemptions to exchange-set limits in a manner that does not undermine 
the federal limits framework.\647\ In particular, proposed Sec.  
150.5(a)(2) would protect market integrity and prevent exchange-granted 
exemptions from undermining the federal limits framework by requiring 
DCMs to either conform their exemptions to the type the Commission 
would grant under proposed Sec. Sec.  150.3 or 150.9, or to cap the 
exemption at the applicable federal limit level and to assess whether 
an exemption request would result in a position that is ``not in accord 
with sound commercial practices'' or would ``exceed an amount that may 
be established or liquidated in an orderly fashion in that market.''
---------------------------------------------------------------------------

    \647\ This proposed standard is substantively consistent with 
current market practice. See, e.g., CME Rule 559 (providing that CME 
will consider, among other things, the ``applicant's business needs 
and financial status, as well as whether the positions can be 
established and liquidated in an orderly manner . . .'') and ICE 
Rule 6.29 (requiring a statement that the applicant's ``positions 
will be initiated and liquidated in an orderly manner . . .''). This 
proposed standard is also substantively similar to existing Sec.  
150.5's standard and is not intended to be materially different. See 
existing Sec.  150.5(d)(1) (an exemption may be limited if it would 
not be ``in accord with sound commercial practices or exceed an 
amount which may be established and liquidated in orderly 
fashion.'') 17 CFR 150.5(d)(1).
---------------------------------------------------------------------------

    Absent other factors, this element of the proposal could 
potentially increase compliance costs for traders since each DCM could 
establish different exemption-related rules and practices. However, to 
the extent that rules and procedures currently differ across exchanges, 
any compliance-related costs and benefits for traders may already be 
realized. Similarly, absent other provisions, a DCM could 
hypothetically seek a competitive advantage by offering excessively 
permissive exemptions, which could allow certain market participants to 
utilize exemptions in establishing sufficiently large positions to 
engage in excessive speculation and to manipulate market prices. 
However, proposed Sec.  150.5(a)(2) would mitigate these risks by 
requiring that exemptions that do not conform to the types the 
Commission may grant under proposed Sec.  150.3 could not exceed 
proposed Sec.  150.2's applicable federal limit unless the Commission 
has first approved such exemption. Moreover, before a DCM could permit 
a new exemption category, proposed Sec.  150.5(e) would require a DCM 
to submit rules to the Commission allowing for such exemptions, 
allowing the Commission to ensure that the proposed exemption type 
would be consistent with applicable requirements, including with the 
requirement that any resulting positions would be ``in accord with 
sound commercial practices'' and may be ``established and liquidated in 
an orderly fashion.''
    Proposed Sec.  150.5(a)(2) additionally would require traders to 
re-apply to the exchange at least annually for the exchange-level 
exemption. The Commission recognizes that requiring traders to re-apply 
annually could impose additional costs on traders that are not 
currently required to do so. However, the Commission believes this is 
industry practice among existing market participants, who are likely 
already familiar with DCMs' exemption processes.\648\ This familiarity 
should reduce related costs, and the proposal should strengthen market 
integrity by ensuring that DCMs receive updated information related to 
a particular exemption.
---------------------------------------------------------------------------

    \648\ As noted above, the Commission believes this requirement 
is consistent with current market practice. See, e.g., CME Rule 559 
and ICE Rule 6.29. While ICE Rule 6.29 merely requires a trader to 
``submit to [ICE Exchange] a written request'' without specifying 
how often a trader must reapply, the Commission understands from 
informal discussions between Commission staff and ICE that traders 
must generally submit annual updates.
---------------------------------------------------------------------------

    Proposed Sec.  150.5(a)(2) also would require a DCM to provide the 
Commission with certain monthly reports regarding the disposition of 
any exemption application, including the recognition of any position as 
a bona fide hedge, the exemption of any spread transaction or other 
position, the revocation or modification or previously granted 
recognitions or exemptions, or the rejection of any application, as 
well as certain related information similar to the information that 
applicants must provide the Commission under proposed Sec.  150.3 or an 
exchange under proposed Sec.  150.9, including underlying cash-market 
and swap-market information related to bona fide hedge positions. The 
Commission generally recognizes that this monthly reporting requirement 
could impose additional costs on exchanges, although the Commission 
also preliminarily has determined that it would assist with its 
oversight functions and therefore benefit market integrity. The 
Commission discusses this proposed requirement in greater detail in its 
discussion of proposed Sec.  150.9.\649\
---------------------------------------------------------------------------

    \649\ See supra Section IV.A.5.b.ii. (discussion of monthly 
exchange-to-Commission report in proposed Sec.  150.5(a)).
---------------------------------------------------------------------------

    Further, while existing Sec.  150.5(d) does not explicitly address 
whether traders should request an exemption prior to taking on its 
position, proposed Sec.  150.5(a)(2), in contrast, would explicitly 
authorize (but not require) DCMs to permit traders to file a 
retroactive exemption request due to ``demonstrated sudden or 
unforeseen increases in its bona fide hedging needs,'' but only within 
five business days after the trade and as long as the trader provides a 
supporting explanation.\650\ As noted above, these provisions are 
largely consistent with existing market practice, and to this extent, 
the benefits and costs already may have been realized by DCMs and 
market participants.
---------------------------------------------------------------------------

    \650\ Certain exchanges currently allow for the submission of 
exemption requests up to five business days after the trader 
established the position that exceeded a limit in certain 
circumstances. See, e.g., CME Rule 559 and ICE's ``Guidance on 
Position Limits'' (Mar. 2018).
---------------------------------------------------------------------------

ii. Pre-Existing Positions
    Proposed Sec.  150.5(a)(3) would require DCMs to impose exchange-
set position limits on ``pre-existing positions,'' other than pre-
enactment swaps and transition period swaps, during the spot month, but 
not outside of the spot month, as long as any position outside of the 
spot month: (i) Was acquired in good faith consistent with the ``pre-
existing position'' definition in proposed Sec.  150.1; \651\ and (ii) 
would be attributed to the person if the position increases after the 
limit's effective date. The Commission believes that this approach 
would benefit market integrity since pre-existing positions that exceed 
spot-month limits could result in market or price disruptions as 
positions are rolled into the spot month.\652\ However, the Commission 
acknowledges that, on its face, including a ``good-faith'' requirement 
in the proposed ``pre-existing position'' definition could 
hypothetically diminish market integrity since determining whether a 
trader has acted in ``good faith'' is inherently subjective and could 
result in disparate treatment of traders by a particular exchange or 
across exchanges seeking a competitive advantage with one another. For 
example, with respect to a particular large or influential exchange 
member, an exchange could, in order to maintain the business 
relationship, be incentivized to be more liberal with its conclusion 
that the member obtained its position in ``good faith,'' or could be 
more liberal in

[[Page 11696]]

general in order to gain a competitive advantage. The Commission 
believes the risk of any such unscrupulous trader or exchange is 
mitigated since exchanges would still be subject to Commission 
oversight and to DCM Core Principles 4 (``prevention of market 
disruption'') and 12 (``protection of markets and market 
participants''), among others, and since proposed Sec.  150.5(a)(3) 
also would require that exchanges must attribute the position to the 
trader if its position increases after the position limit's effective 
date.
---------------------------------------------------------------------------

    \651\ Proposed Sec.  150.1 would define ``pre-existing 
position'' to mean ``any position in a commodity derivative contract 
acquired in good faith prior to the effective date'' of any 
applicable position limit.
    \652\ The Commission is particularly concerned about protecting 
the spot month in physical-delivery futures from corners and 
squeezes.
---------------------------------------------------------------------------

c. Physical Commodity Derivative Contracts Not Yet Subject to Federal 
Position Limits Under Sec.  150.2 (Proposed Sec.  150.5(b))
i. Spot Month Limits and Related Acceptable Practices
    For cash-settled contracts during the spot month, existing Sec.  
150.5 sets forth the following qualitative standard: exchange-set 
limits should be ``no greater than necessary to minimize the potential 
for market manipulation or distortion of the contract's or underling 
commodity's price.'' However, for physically-settled contracts, 
existing Sec.  150.5 provides a one-size-fits-all parameter that 
exchange limits must be no greater than 25 percent of EDS.
    In contrast, the proposed standard for setting spot month limit 
levels for physical commodity derivative contracts not subject to 
federal position limits set forth in proposed Sec.  150.5(b)(1) would 
not distinguish between cash-settled and physically-settled contracts, 
and instead would require DCMs to apply the existing Sec.  150.5 
qualitative standard to both.\653\ The Commission also proposes a 
related, non-exclusive acceptable practice that would deem exchange-set 
position limits for both cash-settled and physically-settled contracts 
subject to proposed Sec.  150.5(b) to be in compliance if the limits 
are no higher than 25 percent of the spot-month EDS.
---------------------------------------------------------------------------

    \653\ Proposed Sec.  150.5(b)(1) would require DCMs to establish 
position limits for spot-month contracts at a level that is 
``necessary and appropriate to reduce the potential threat of market 
manipulation or price distortion of the contract's or the underlying 
commodity's price or index.'' Existing Sec.  150.5 also 
distinguishes between ``levels at designation'' and ``adjustments to 
levels,'' although each category similarly incorporates the 
qualitative standard for cash-settled contracts and the 25-percent 
metric for physically-settled contracts. Proposed Sec.  150.5(b) 
would eliminate this distinction. The Commission intends the 
proposed Sec.  150.5(b)(1) standard to be substantively the same as 
the existing Sec.  150.5 standard for cash-settled contracts, except 
that under proposed Sec.  150.5(b)(1), the standard would apply to 
physically-settled contracts.
---------------------------------------------------------------------------

    Applying the existing Sec.  150.5 qualitative standard and non-
exclusive acceptable practice in proposed 150.5(b)(1), rather than a 
one-size-fits-all regulation, to both cash-settled and physically-
settled contracts during the spot month is expected to enhance market 
integrity by permitting a DCM to establish a more tailored, product-
specific approach by applying other parameters that may take into 
account the unique liquidity and other characteristics of the 
particular market and contract, which is not possible under the one-
size-fits-all 25 percent EDS parameter set forth in existing Sec.  
150.5. While the Commission recognizes that the existing 25 percent EDS 
parameter has generally worked well, the Commission also recognizes 
that there may be circumstances where other parameters may be 
preferable and just as effective, if not more, including, for example, 
if the contract is cash-settled or does not have a reasonably accurate 
measurable deliverable supply, or if the DCM can demonstrate that a 
different parameter would better promote market integrity or efficiency 
for a particular contract or market.
    On the other hand, the Commission recognizes that proposed Sec.  
150.5(b)(1) could adversely affect market integrity by theoretically 
allowing DCMs to establish excessively high position limits in order to 
gain a competitive advantage, which also could harm the integrity of 
other markets that offer similar products.\654\ However, the Commission 
believes these potential risks would be mitigated since (i) proposed 
Sec.  150.5(e) would require DCMs to submit proposed position limits to 
the Commission, which would review those rules for compliance with 
Sec.  150.5(b), including to ensure that the proposed limits are ``in 
accord with sound commercial practices'' and that they may be 
``established and liquidated in an orderly fashion''; and (ii) proposed 
Sec.  150.5(b)(3) would require DCMs to adopt position limits for any 
new contract at a ``comparable'' level to existing contracts that are 
substantially similar (i.e., ``look-alike contracts'') on other 
exchanges unless the Commission approves otherwise. Moreover, this 
latter requirement also may reduce the amount of time and effort needed 
for the DCM and Commission staff to assess proposed limits for any new 
contract that competes with another DCM's existing contract.
---------------------------------------------------------------------------

    \654\ Since the existing Sec.  150.5 framework already applies 
the proposed qualitative standard to cash-settled spot-month 
contracts, any new risks resulting from the proposed standard would 
occur only with respect to physically-settled contracts, which are 
currently subject to the one-size-fits-all 25-percent EDS parameter 
under the existing framework.
---------------------------------------------------------------------------

ii. Non-Spot Month Limits/Accountability Levels and Related Acceptable 
Practices
    Existing Sec.  150.5 provides one-size-fits-all levels for non-spot 
month contracts and allows for position accountability after a 
contract's initial listing only for those contracts that satisfy 
certain trading thresholds.\655\ In contrast, for contracts outside the 
spot-month, proposed Sec.  150.5(b)(2) would require DCMs to establish 
either position limits or position accountability levels that satisfy 
the same proposed qualitative standard discussed above for spot-month 
contracts.\656\ For DCMs that establish position limits, the Commission 
proposes related acceptable practices that would provide non-exclusive 
parameters that are generally consistent with existing Sec.  150.5's 
parameters for non-spot month contracts.\657\ For DCMs that establish

[[Page 11697]]

position accountability, Sec.  150.1's proposed definition of 
``position accountability'' would provide that a trader must reduce its 
position upon a DCM's request, which is generally consistent with 
existing Sec.  150.5's framework, but would not distinguish between 
trading volume or contract type, like existing Sec.  150.5. While DCMs 
would be provided the ability to decide whether to use limit levels or 
accountability levels for any such contract, under either approach, the 
DCM would have to set a level that is ``necessary and appropriate to 
reduce the potential threat of market manipulation or price distortion 
of the contract's or the underlying commodity's price or index.''
---------------------------------------------------------------------------

    \655\ As noted above, in establishing the specific metric, 
existing Sec.  150.5 distinguishes between ``levels at designation'' 
and ``adjustments to [subsequent] levels.'' Proposed Sec.  
150.5(b)(2) would eliminate this distinction and apply the 
qualitative standard for all non-spot month position limit and 
accountability levels.
    \656\ DCM Core Principle 5 requires DCMs to establish either 
position limits or accountability for speculators. See Commission 
regulation Sec.  38.300 (restating DCMs' statutory obligations under 
the CEA Sec.  5(d)(5)). Accordingly, inasmuch as proposed Sec.  
150.5(b)(2) would require DCMs to establish position limits or 
accountability, the proposal does not represent a change to the 
status quo baseline requirements.
    \657\ Specifically, the acceptable practices proposed in 
Appendix F to part 150 would provide that DCMs would be deemed to 
comply with the proposed Sec.  150.5(b)(2)(i) qualitative standard 
if they establish non-spot limit levels no greater than any one of 
the following: (1) Based on the average of historical positions 
sizes held by speculative traders in the contract as a percentage of 
open interest in that contract; (2) the spot month limit level for 
that contract; (3) 5,000 contracts (scaled up proportionally to the 
ratio of the notional quantity per contract to the typical cash 
market transaction if the notional quantity per contract is smaller 
than the typical cash market transaction, or scaled down 
proportionally if the notional quantity per contract is larger than 
the typical cash market transaction); or (4) 10 percent of open 
interest in that contract for the most recent calendar year up to 
50,000 contracts, with a marginal increase of 2.5 percent of open 
interest thereafter.
    These proposed parameters have largely appeared in existing 
Sec.  150.5 for many years in connection with non-spot month limits, 
either for levels at designation, or for subsequent levels, with 
certain revisions. For example, while existing Sec.  150.5(b)(3) has 
provided a limit of 5,000 contracts for energy products, existing 
Sec.  150.5(b)(2) provides a limit of 1,000 contracts for physical 
commodities other than energy products. The proposed acceptable 
practice parameters would create a uniform standard of 5,000 
contracts for all physical commodities. The Commission expects that 
the 5,000 contract acceptable practice, for example, would be a 
useful rule of thumb for exchanges because it would allow them to 
establish limits and demonstrate compliance with Commission 
regulations in a relatively efficient manner, particularly for new 
contracts that have yet to establish open interest. The spot month 
limit level under item (2) above would be a new parameter for non-
spot month contracts.
---------------------------------------------------------------------------

    Proposed Sec.  150.5(b)(2) would benefit market efficiency by 
authorizing DCMs to determine whether position limits or accountability 
would be best-suited outside of the spot month based on the DCM's 
knowledge of its markets. For example, position accountability could 
improve liquidity compared to position limits since liquidity providers 
may be more willing or able to participate in markets that do not have 
hard limits. As discussed above, DCMs are well-positioned to understand 
their respective markets, and best practices in one market may differ 
in another market, including due to different market participants or 
liquidity characteristics of the underlying commodities. For DCMs that 
choose to establish position limits, the Commission believes that 
applying the proposed Sec.  150.5 qualitative standard to contracts 
outside the spot-month would benefit market integrity by permitting a 
DCM to establish a more tailored, product-specific approach by applying 
other tools that may take into account the unique liquidity and other 
characteristics of the particular market and contract, which is not 
possible under the existing Sec.  150.5 specific parameters for non-
spot month contracts. While the Commission recognizes that the existing 
parameters may have been well-suited to market dynamics when initially 
promulgated, the Commission also recognizes that open interest may have 
changed for certain contracts subject to proposed Sec.  150.5(b), and 
open interest will likely continue to change in the future (e.g., as 
new contracts may be introduced and as supply and/or demand may change 
for underlying commodities). In cases where open interest has not 
increased, the exchange may not need to change existing limit levels. 
But, for contracts where open interest have increased, the exchange 
would be able to raise its limits to facilitate liquidity consistent 
with an orderly market. However, the Commission reiterates that the 
specific parameters in the proposed acceptable practices are merely 
non-exclusive examples, and an exchange would be able to establish 
higher (or lower) limits, provided the exchange submits its proposed 
limits to the Commission under proposed Sec.  150.5(e) and explains how 
its proposed limits satisfy the proposed qualitative standard and are 
otherwise consistent with all applicable requirements.
    The Commission, however, recognizes that proposed Sec.  150.5(b)(2) 
could adversely affect market integrity by potentially allowing DCMs to 
establish position accountability levels rather than position limits, 
regardless of whether the contract exceeds the volume-based thresholds 
provided in existing Sec.  150.5. However, proposed Sec.  150.5(e) 
would require DCMs to submit any proposed position accountability rules 
to the Commission for review, and the Commission would determine on a 
case-by-case basis whether such rules satisfy regulatory requirements, 
including the proposed qualitative standard. Similarly, in order to 
gain a competitive advantage, DCMs could theoretically set excessively 
high accountability (or position limit) levels, which also could 
potentially adversely affect markets with similar products. However, 
the Commission believes these risks would be mitigated since (i) 
proposed Sec.  150.5(e) would require DCMs to submit proposed position 
accountability (or limits) to the Commission, which would review those 
rules for compliance with Sec.  150.5(b), including to ensure that the 
exchange's proposed accountability levels (or limits) are ``necessary 
and appropriate to reduce the potential threat of market manipulation 
or price distortion'' of the contract or underlying commodity; and (ii) 
proposed Sec.  150.5(b)(3) would require DCMs to adopt position limits 
for any new contract at a ``comparable'' level to existing contracts 
that are substantially similar on other exchanges unless the Commission 
approves otherwise.
iii. Exchange-Set Limits on Economically Equivalent Swaps
    As discussed above, swaps that would qualify as ``economically 
equivalent swaps'' would become subject to the federal position limits 
framework. However, the Commission is proposing to allow exchanges to 
delay compliance--including enforcing position limits--with respect to 
exchange-set limits on economically equivalent swaps. The proposed 
delayed compliance would benefit the swaps markets by permitting SEFs 
and DCMs that list economically equivalent swaps more time to establish 
surveillance and compliance systems; as noted in the preamble, such 
exchanges currently lack sufficient data regarding individual market 
participants' open swap positions, which means that requiring exchanges 
to establish oversight over participants' positions currently would 
impose substantial costs and would be currently impracticable.
    Nonetheless, the Commission's preliminary determination to permit 
exchanges to delay implementing federal position limits on swaps could 
incentivize market participants to leave the futures markets and 
instead transact in economically equivalent swaps, which could reduce 
liquidity in the futures and related options markets, which could also 
increase transaction and hedging costs. Delaying position limits on 
swaps therefore could harm market participants, especially end-users 
that do not transact in swaps, if many participants were to shift 
trading from the futures to the swaps markets. In turn, end-users could 
pass on some of these increased costs to the public at large.\658\ 
However, the Commission believes that these concerns would be mitigated 
to the extent the Commission would still oversee and enforce federal 
position limits even if the exchanges would not be required to do so.
---------------------------------------------------------------------------

    \658\ On the other hand, the Commission has not seen any 
shifting of liquidity to the swaps markets--or general attempts at 
market manipulation or evasion of federal position limits--with 
respect to the nine legacy core referenced futures contracts, even 
though swaps currently are not subject to federal or exchange 
position limits.
---------------------------------------------------------------------------

d. Position Aggregation
    Proposed Sec.  150.5(d) would require all DCMs that list physical 
commodity derivative contracts to apply aggregation rules that conform 
to existing Sec.  150.4, regardless of whether the contract is subject 
to federal position limits under Sec.  150.2.\659\ The Commission 
believes

[[Page 11698]]

proposed Sec.  150.5(d) would benefit market integrity in several ways. 
First, a harmonized approach to aggregation across exchanges that list 
physical commodity derivative contracts would prevent confusion that 
could result from divergent standards between federal limits under 
Sec.  150.2 and exchange-set limits under Sec.  150.5(b). As a result, 
proposed Sec.  150.5(d) would provide uniformity, consistency, and 
reduced administrative burdens for traders who are active on multiple 
trading venues and/or trade similar physical contracts, regardless of 
whether the contracts are subject to Sec.  150.2's federal position 
limits. Second, a harmonized aggregation policy eliminates the 
potential for DCMs to use excessively permissive aggregation policies 
as a competitive advantage, which would impair the effectiveness of the 
Commission's aggregation policy and limits framework. Third, since, for 
contracts subject to federal limits, proposed Sec.  150.5(a) would 
require DCMs to set position limits at a level not higher than that set 
by the Commission under proposed Sec.  150.2, differing aggregation 
standards could effectively lead to an exchange-set limit that is 
higher than that set by the Commission. Accordingly, harmonizing 
aggregation standards reinforces the efficacy and intended purpose of 
proposed Sec. Sec.  150.2 and 150.5 and existing Sec.  150.4 by 
eliminating DCMs' ability to circumvent the applicable federal 
aggregation and position limits rules.
---------------------------------------------------------------------------

    \659\ The Commission adopted final aggregation rules in 2016 
under existing Sec.  150.4, which applies to contracts subject to 
federal limits under Sec.  150.2. See Final Aggregation Rulemaking, 
81 FR at 91454. Under the Final Aggregation Rulemaking, unless an 
exemption applies, a person's positions must be aggregated with 
positions for which the person controls trading or for which the 
person holds a 10 percent or greater ownership interest. The 
Division of Market Oversight has issued time-limited no-action 
relief from some of the aggregation requirements contained in that 
rulemaking. See CFTC Letter No. 19-19 (July 31, 2019), available at 
https://www.cftc.gov/csl/19-19/download. Commission regulation Sec.  
150.4(b) sets forth several permissible exemptions from aggregation.
---------------------------------------------------------------------------

    To the extent a DCM currently is not applying the federal 
aggregation rules in existing Sec.  150.4, or similar exchange-based 
rules, proposed Sec.  150.5(d) could impose costs with respect to 
market participants trading referenced contracts for the proposed new 
16 commodities that would become subject to federal position limits for 
the first time. Market participants would be required to update their 
trading and compliance systems to ensure they comply with the new 
aggregation rules.
e. Request for Comment
    (51) The Commission requests comment on all aspects of the 
Commission's cost-benefit discussion of the proposal.
7. Section 15(a) Factors \660\
---------------------------------------------------------------------------

    \660\ The discussion here covers the proposed amendments that 
the Commission has identified as being relevant to the areas set out 
in section 15(a) of the CEA: (i) Protection of market participants 
and the public; (ii) efficiency, competitiveness, and financial 
integrity of futures markets; (iii) price discovery; (iv) sound risk 
management practices; and (v) other public interest considerations. 
For proposed amendments that are not specifically addressed, the 
Commission has not identified any effects.
---------------------------------------------------------------------------

a. Protection of Market Participants and the Public
    A chief purpose of speculative position limits is to preserve the 
integrity of derivatives markets for the benefit of commercial 
interests, producers, and other end- users that use these markets to 
hedge risk and of consumers that consume the underlying commodities. 
The Commission preliminarily believes that the proposed position limits 
regime would operate to deter excessive speculation and manipulation, 
such as squeezes and corners, which might impair the contract's price 
discovery function and liquidity for hedgers--and ultimately, would 
protect the integrity and utility of the commodity markets for the 
benefit of both producers and consumers.
    At this time, the Commission is proposing to include the proposed 
25 core referenced futures contracts within the proposed federal 
position limit framework. In selecting the proposed 25 core referenced 
contracts, the Commission, in accordance with its necessity analysis, 
considered the effects that these contracts have on the underlying 
commodity, especially with respect to price discovery; the fact that 
they require physical delivery of the underlying commodity; and, in 
some cases, the potentially acute economic burdens on interstate 
commerce that could arise from excessive speculation in these contracts 
causing sudden or unreasonable fluctuations or unwarranted changes in 
the price of the commodities underlying these contracts.\661\
---------------------------------------------------------------------------

    \661\ See supra Section III.F.2. (discussion of the necessity 
findings as to the 25 core referenced futures contacts).
---------------------------------------------------------------------------

    Of particular importance are the proposed position limits during 
the spot month period because the Commission preliminarily believes 
that deterring and preventing manipulative behaviors, such as corners 
and squeezes, is more urgent during this period. The proposed spot 
month position limits are designed, among other things, to deter and 
prevent corners and squeezes as well as promote a more orderly 
liquidation process at expiration. By restricting derivatives positions 
to a proportion of the deliverable supply of the commodity, the spot 
month position limits reduce the possibility that a market participant 
can use derivatives, including referenced contracts, to affect the 
price of the cash commodity (and vice versa). Limiting a speculative 
position based on a percentage of deliverable supply also restricts a 
speculative trader's ability to establish a leveraged position in cash-
settled derivative contracts, diminishing that trader's incentive to 
manipulate the cash settlement price. As the Commission has determined 
in the preamble, the Commission has concluded that excessive 
speculation or manipulation may cause sudden or unreasonable 
fluctuations or unwarranted changes in the price of the commodities 
underlying these contracts.\662\ In this way, the Commission 
preliminarily believes that the proposed limits would benefit market 
participants that seek to hedge the spot price of a commodity at 
expiration, and benefit consumers who would be able to purchase 
underlying commodities for which prices are determined by fundamentals 
of supply and demand, rather than influenced by excessive speculation, 
manipulation, or other undue and unnecessary burdens on interstate 
commerce.
---------------------------------------------------------------------------

    \662\ See supra Section III.F. (discussion of the necessity 
finding).
---------------------------------------------------------------------------

    The Commission preliminarily believes that the proposed Commission 
and exchange-centric processes for granting exemptions from federal 
limits, including non-enumerated bona fide hedging recognitions, would 
help ensure the hedging utility of the futures market for commercial 
end-users. First, the proposal to allow exchanges to leverage existing 
processes and their knowledge of their own markets, including 
participant positions and activities, along with their knowledge of the 
underlying commodity cash market, should allow for more timely review 
of exemption applications than if the Commission were to conduct such 
initial application reviews. This benefits the public by allowing 
producers and end-users of a commodity to more efficiently and 
predictably hedge their price risks, thus controlling costs that might 
be passed on to the public. Second, exchanges may be better-suited than 
the Commission to leverage their knowledge of their own markets, 
including participant positions and activities, along with their 
knowledge of the underlying commodity cash market, in order to 
recognize whether an applicant qualifies for an exemption and what the 
level for that exemption should be. This benefits market participants 
and the public by helping assure that exemption levels are set in a 
manner that meets the risk management needs of the applicant without 
negatively impacting the futures and cash market for that commodity. 
Third, allowing for exchange-granted spread exemptions could improve 
liquidity in all months

[[Page 11699]]

for a listed contract or across commodities, benefitting hedgers by 
providing tighter bid-ask spreads for out-right trades. Furthermore, 
traders using spreads can arbitrage price discrepancies between 
calendar months within the same commodity contract or price 
discrepancies between commodities, helping ensure that futures prices 
more accurately reflect the underlying market fundamentals for a 
commodity. Lastly, the Commission would review each application for 
bona fide hedge recognitions or spread exemptions (other than those 
bona fide hedges and spread exemptions that would be self-effectuating 
under the Commission's proposal), but the proposal would allow the 
Commission to also leverage the exchange's knowledge and experience of 
its own markets and market participants discussed above.
    The Commission also understands that there are costs to market 
participants and the public to setting the levels that are too high or 
too low. If the levels are set too high, there's greater risk of 
excessive speculation, which may harm market participants and the 
public. Further, to the extent that the proposed limits are set at such 
a level that even without these proposed exemptions, the probability of 
nearing or breaching such levels may be negligible for most market 
participants, benefits associated with such exemptions may be reduced.
    Conversely, if the limits are set too low, transaction costs for 
market participants who are near or above the limit would rise as they 
transact in other instruments with higher transaction costs to obtain 
their desired level of speculative positions. Additionally, limits that 
are too low could incentivize speculators to leave the market and not 
be available to provide liquidity for hedgers, resulting in ``choppy'' 
prices. It is also possible for limits that are set too low to harm 
market efficiency because the views of some speculators might not be 
reflected fully in the price formation process.
    In setting the proposed limit levels, the Commission considered 
these factors in order to implement to the maximum extent practicable, 
as it finds necessary in its discretion, to apply the position limits 
framework articulated in CEA section 4a(a) to set federal position 
limits to protect market integrity and price discovery, thereby 
benefiting market participants and the public.
b. Efficiency, Competitiveness, and Financial Integrity of Futures 
Markets
    Position limits help to prevent market manipulation or excessive 
speculation that may unduly influence prices at the expense of the 
efficiency and integrity of markets. The proposed expansion of the 
federal position limits regime to 25 core referenced futures contracts 
(e.g., the existing nine legacy agricultural contracts and the 16 
proposed new contracts) enhances the buffer against excessive 
speculation historically afforded to the nine legacy agricultural 
contracts exclusively, improving the financial integrity of those 
markets. Moreover, the proposed limits in proposed Sec.  150.2 may 
promote market competitiveness by preventing a trader from gaining too 
much market power in the respective markets.
    Also, in the absence of position limits, market participants may be 
deterred from participating in a futures market if they perceive that 
there is a participant with an unusually large speculative position 
exerting what they believe is unreasonable market power. A lack of 
participation may harm liquidity, and consequently, may harm market 
efficiency.
    On the other hand, traders who find position limits overly 
constraining may seek to trade in substitute instruments--such as 
futures contracts or swaps that are similar to or correlated with (but 
not otherwise deemed to be a referenced contract), forward contracts, 
or trade options--in order to meet their demand for speculative 
instruments. These traders may also decide to not trade beyond the 
federal speculative position limit. Trading in substitute instruments 
may be less effective than trading in referenced contracts and, thus, 
may raise the transaction costs for such traders. In these 
circumstances, futures prices might not fully reflect all the 
speculative demand to hold the futures contract, because substitute 
instruments may not fully influence prices the same way that trading 
directly in the futures contract does. Thus, market efficiency might be 
harmed.
    The Commission preliminarily believes that focusing on the proposed 
25 core referenced futures contracts, which generally have high levels 
of open interest and trading volume and/or have been subject to 
existing federal position limits for many years, should in general be 
less disruptive for the derivatives markets that it regulates, which in 
turn may reduce the potential for disruption for the price discovery 
function of the underlying commodity markets as compared to including 
less liquid contracts (of course, only to the extent that the 
Commission would be able to make the requisite necessity finding for 
such contracts).
    Finally, the Commission preliminarily believes that the proposal to 
cease recognizing certain risk management positions as bona fide 
hedges, coupled with the proposed increased non-spot month limit levels 
for the nine legacy agricultural contracts, will foster competition 
among swap dealers by subjecting all market participants, including all 
swap dealers, to the same non-spot month limit rather than to an 
inconsistent patchwork of staff-granted exemptions. Accommodating risk 
management activity by additional entities with higher limit levels may 
also help lessen the concentration risk potentially posed by a few 
commodity index traders holding exemptions that are not available to 
competing market participants.
c. Price Discovery
    Market manipulation or excessive speculation may result in 
artificial prices. Position limits may help to prevent the price 
discovery function of the underlying commodity markets from being 
disrupted. Also, in the absence of position limits, market participants 
might elect to trade less as a result of a perception that the market 
pricing is unfair as a consequence of what they perceive is the 
exercise of too much market power by a larger speculator. Reduced 
liquidity may have a negative impact on price discovery.
    On the other hand, imposing position limits raises the concerns 
that liquidity and price discovery may be diminished, because certain 
market segments, i.e., speculative traders, are restricted. For certain 
commodities, the Commission proposes to set the levels of position 
limits at increased levels, to avoid harming liquidity that may be 
provided by speculators that would establish large positions, while 
restricting speculators from establishing extraordinarily large 
positions. The Commission further preliminarily believes that the bona 
fide hedging recognition and exemption processes will foster liquidity 
and potentially improve price discovery by making it easier for market 
participants to have their bona fide hedging recognitions and spread 
exemptions granted.
    In addition, position limits serve as a prophylactic measure that 
reduces market volatility due to a participant otherwise engaging in 
large trades that induce price impacts that interrupt price discovery. 
In particular, spot month position limits make it more difficult to 
mark the close of a futures contract to possibly benefit other 
contracts that settle on the closing futures price. Marking the close 
harms markets by spoiling convergence between futures prices and spot 
prices

[[Page 11700]]

at expiration and damaging price discovery.
d. Sound Risk Management Practices
    Proposed exemptions for bona fide hedges help to ensure that market 
participants with positions that are hedging legitimate commercial 
needs are recognized as hedgers under the Commission's speculative 
position limits regime. This promotes sound risk management practices. 
In addition, the Commission has crafted the proposed rules to ensure 
sufficient market liquidity for bona fide hedgers to the maximum extent 
practicable, e.g., through the proposals to: (1) Create a bona fide 
hedging definition that is broad enough to accommodate common 
commercial hedging practices, including anticipatory hedging, for a 
variety of commodity types; (2) maintain the status quo with respect to 
existing bona fide hedge recognitions and spread exemptions that would 
remain self-effectuating and make additional bona fide hedges self-
effectuating (i.e., certain anticipatory hedging); (3) provide 
additional ability for a streamlined process where market participants 
can make a single submission to an exchange in which the exchange and 
Commission would each review applications for non-enumerated bona fide 
hedge recognitions for purposes of federal and exchange-set limits that 
are in line with commercial hedging practices; and (4) to allow for a 
conditional spot month limit exemption in natural gas.
    To the extent that monitoring for position limits requires market 
participants to create internal risk limits and evaluate position size 
in relation to the market, position limits may also provide an 
incentive for market participants to engage in sound risk management 
practices. Further, sound risk management practices would be promoted 
by the proposal to allow for market participants to measure risk in the 
manner most suitable for their business (i.e., net versus gross hedging 
practices), rather than having to conform their hedging programs to a 
one-size-fits-all standard that may not be suitable for their risk 
management needs. Finally, the proposal to increase non-spot month 
limit levels for the nine legacy agricultural contracts to levels that 
reflect observed levels of trading activity, based on recent data 
reviewed by the Commission, should allow swap dealers, liquidity 
providers, market makers, and others who have risk management needs, 
but who are not hedging a physical commercial, to soundly manage their 
risks.
e. Other Public Interest
    The Commission has not identified any additional public interest 
considerations related to the costs and benefits of this 2020 Proposal.
f. Request for Comment
    (52) The Commission requests comment on all aspects of the 
Commission's discussion of the 15(a) factors for this proposal.

B. Paperwork Reduction Act

1. Overview
    Certain provisions of the proposed rule on position limits for 
derivatives would amend or impose new ``collection of information'' 
requirements as that term is defined under the Paperwork Reduction Act 
(``PRA'').\663\ An agency may not conduct or sponsor, and a person is 
not required to respond to, a collection of information unless it 
displays a valid control number from the Office of Management and 
Budget (``OMB''). The proposed rule would modify the following existing 
collections of information previously approved by OMB and for which the 
Commodity Futures Trading Commission (``Commission'') has received 
control numbers: (i) OMB control number 3038-0009 (Large Trader 
Reports), which generally covers Commission regulations in parts 15 
through 21; (ii) OMB control number 3038-0013 (Aggregation of 
Positions), which covers Commission regulations in part 150; \664\ and 
(iii) OMB control number 3038-0093 (Provisions Common to Registered 
Entities), which covers Commission regulations in part 40.
---------------------------------------------------------------------------

    \663\ 44 U.S.C. 3501 et seq.
    \664\ Currently, OMB control number 3038-0013 is titled 
``Aggregation of Positions.'' The Commission proposes to rename the 
OMB control number ``Position Limits'' to better reflect the nature 
of the information collections covered by that OMB control number.
---------------------------------------------------------------------------

    Certain provisions of the proposed rule would impose new collection 
of information requirements under the PRA. As a result, the Commission 
is proposing to revise OMB control numbers 3038-0009, 3038-0013, and 
3038-0093 and is submitting this proposal to OMB for review in 
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.
2. Commission Reorganization of OMB Control Numbers 3038-0009 and 3038-
0013
    The Commission is proposing two non-substantive changes so that all 
collections of information related solely to the Commission's position 
limit requirements are consolidated under one OMB control number.\665\ 
First, the Commission would transfer collections of information under 
part 19 (Reports by Persons Holding Bona Fide Hedge Positions and By 
Merchants and Dealers in Cotton) related to position limit requirements 
from OMB control number 3038-0009 to OMB control number 3038-0013. 
Second, the modified OMB control number 3038-0013 would be renamed as 
``Position Limits.'' This renaming change is non-substantive and would 
allow for all collections of information related to the federal 
position limits requirements, including exemptions from speculative 
position limits and related large trader reporting, to be housed in one 
collection.
---------------------------------------------------------------------------

    \665\ The Commission notes that certain collections of 
information under OMB control number 3038-0093 relate to several 
Commission regulations in addition to the Commission's proposed 
position limits framework. As a result, the collections of 
information discussed herein under this OMB control number 3038-0093 
will not be consolidated under OMB control number 3038-0013.
---------------------------------------------------------------------------

    One collection would make it easier for market participants to know 
where to find the relevant position limits PRA burdens. If the proposed 
rule is finalized, the remaining collections of information under OMB 
control number 3038-0009 would cover reports by various entities under 
parts 15, 17, and 21 \666\ of the Commission's regulations, while OMB 
control number 3038-0013 would hold collections of information arising 
from parts 19 and 150.
---------------------------------------------------------------------------

    \666\ As noted above, OMB control number 3038-0009 generally 
covers Commission regulations in parts 15 through 21. However, it 
does not cover Sec. Sec.  16.02, 17.01, 18.04, or 18.05, which are 
under OMB control number 3038-0103. Final Rule. 78 FR 69178 at 69200 
(Nov. 18, 2013) (transferring Sec. Sec.  16.02, 17.01, 18.04, and 
18.05 to OMB Control Number 3038-0103).
---------------------------------------------------------------------------

    As discussed in section 3 below, this non-substantive 
reorganization would result in: (i) A decreased burden estimate under 
control number 3038-0009 due to the transfer of the collection of 
information arising from obligations in part 19, and (ii) a 
corresponding increase of the amended part 19 burdens under control 
number 3038-0013. However, as discussed further below, the collection 
of information and burden hours arising from proposed part 19 that 
would be transferred to OMB control number 3038-0013 would be less than 
the existing burden estimate under OMB control number 3038-0009 since 
the Commission's proposal would amend existing part 19 by eliminating 
existing Form 204 and certain parts of Form 304 and the reporting 
burdens related thereto. As a result, market participants would see a 
net reduction of collections of information and burden hours under 
revised part 19.

[[Page 11701]]

3. Collections of Information
    The proposed rule would amend existing regulations, and create new 
regulations, concerning speculative position limits. Among other 
amendments, the Commission's proposed rule would include: (1) New and 
amended federal spot month limits for the proposed 25 physical 
commodity derivatives; (2) amended federal non-spot limits for the nine 
legacy agricultural commodities contracts currently subject to federal 
position limits; (3) amended rules governing exchange-set limit levels 
and grants of exemptions therefrom; (4) an amended process for 
requesting certain spread exemptions and non-enumerated bona fide hedge 
recognitions for purposes of federal position limits directly from the 
Commission; (5) a new exchange-administered process for recognizing 
non-enumerated bona fide hedge positions from federal limit 
requirements; and (6) amendments to part 19 and related provisions that 
would eliminate certain reporting obligations that require traders to 
submit a Form 204 and Parts I and II of Form 304.
    Specifically, this proposal would amend parts 15, 17, 19, 40, and 
150 of the Commission's regulations to implement the proposed federal 
position limits framework. The proposal would also transfer an amended 
version of the ``bona fide hedging transactions or positions'' 
definition from existing Sec.  1.3 to proposed Sec.  150.1, and remove 
Sec. Sec.  1.47, 1.48, and 140.97. The Commission's proposal would 
revise existing collections of information covered by OMB control 
number 3038-0009 by amending part 19, along with conforming changes to 
part 15, in order to narrow the scope of who is required to report 
under part 19.\667\
---------------------------------------------------------------------------

    \667\ As noted above, the Commission would accomplish this by 
eliminating existing From 204 and Parts I and II of Form 304. 
Additionally, proposed changes to part 17, covered by OMB control 
number 3038-0009, would make conforming amendments to remove certain 
duplicative provisions and associated information collections 
related to aggregation of positions, which are in current Sec.  
150.4. These conforming changes would not impact the burden 
estimates of OMB control number 3038-0009.
---------------------------------------------------------------------------

    Furthermore, the proposed rule's amendments to part 150 would 
revise existing collections of information covered by OMB control 
number 3038-0013, including new reporting and recordkeeping 
requirements related to the application and request for relief from 
federal position limit requirements submitted to designated contract 
markets (``DCMs'') and swap execution facilities (``SEFs'') 
(collectively, ``exchanges''). Finally, the proposed rule would also 
amend part 40 to incorporate a new reporting obligation into the 
definition of ``terms and conditions'' in Sec.  40.1(j) and result in a 
revised existing collection of information covered by OMB control 
number 3038-0093.
a. OMB Control Number 3038-0009--Large Trader Reports; Part 19--Reports 
by Persons Holding Bona Fide Hedge Positions and by Merchants and 
Dealers in Cotton
    Under OMB control number 3038-0009, the Commission currently 
estimates that the collections of information related to existing part 
19, including Form 204 and Form 304, collectively known as the ``Series 
'04'' reports, have a combined annual burden hours of 1,553 hours. 
Under existing part 19, market participants that hold bona fide hedging 
positions in excess of position limits for the nine legacy agricultural 
commodity contracts currently subject to federal limits must file a 
monthly report on Form 204 (or Parts I and II of Form 304 for cotton). 
These reports show a snapshot of traders' cash positions on one given 
day each month, and are used by the Commission to determine whether a 
trader has sufficient cash positions to justify futures and options on 
futures positions above the applicable federal position limits in 
existing Sec.  150.2.
    The Commission's proposal would amend part 19 to remove these 
reporting obligations associated with Form 204 and Parts I and II of 
Form 304. As discussed under proposed Sec.  150.9 below, the Commission 
preliminarily has determined that it may eliminate these forms and 
still receive adequate information to carry out its market and 
financial surveillance programs since its proposed amendments to 
Sec. Sec.  150.5 and 150.9 would also enable the Commission to obtain 
the necessary information from the exchanges. To effect these changes 
to traders' reporting obligations, the Commission would eliminate (i) 
existing Sec.  19.00(a)(1), which requires the applicable persons to 
file a Form 204; and (ii) existing Sec.  19.01, which among other 
things, sets forth the cash-market information required to be submitted 
on the Forms 204 and 304.\668\ The Commission would maintain Part III 
of Form 304, which requests information on unfixed-price ``on call'' 
purchases and sales of cotton and which the Commission utilizes to 
prepare its weekly cotton on-call report.\669\ The Commission would 
also maintain its existing special call authority under part 19.
---------------------------------------------------------------------------

    \668\ As noted above, the proposed amendments to part 19 affect 
certain provisions of part 15 and Sec.  17.00. Based on the proposed 
elimination of Form 204 and Parts I and II of Form 304, the 
Commission proposes conforming technical changes to remove related 
reporting provisions from (i) the ``reportable position'' definition 
in Sec.  15.00(p); (ii) the list of ``persons required to report'' 
in Sec.  15.01; and (iii) the list of reporting forms in Sec.  
15.02. These proposed conforming amendments to part 15 would not 
impact the existing burden estimates.
    \669\ The Commission is proposing a technical change to Part III 
of Form 304 to require traders to identify themselves on the Form 
304 using their Public Trader Identification Number, in lieu of the 
CFTC Code Number required on previous versions of the Form 304. 
However, the Commission preliminarily has determined that this would 
not result in any change to its existing PRA estimates with respect 
to the collections of information related to Part III of Form 304.
---------------------------------------------------------------------------

    The supporting statement for the current active information 
collection request for part 19 under OMB control number 3038-0009 \670\ 
states that in 2014: (i) 135 reportable traders filed the Series `04 
reports (i.e., Form 204 and Form 304 in the aggregate), (ii) totaling 
3,105 Series `04 reports, for a total of (iii) 1,553 burden hours.\671\ 
However, based on more current and recent 2019 submission data, the 
Commission is revising its existing estimates slightly higher for the 
Series '04 reports under part 19:
---------------------------------------------------------------------------

    \670\ See ICR Reference No: 201906-3038-008.
    \671\ 3,105 Series '04 submissions x 0.5 hours per submission = 
1,553 aggregate burden hours for all submissions. The Commission 
notes that it has preliminarily estimated that it takes 
approximately 20 minutes to complete a Form 204 or 304. However, in 
order to err conservatively, the Commission now uses a figure of 30 
minutes.
---------------------------------------------------------------------------

     Form 204: 50 monthly reports, for an annual total of 600 
reports (50 monthly reports x 12 months = 600 total annual reports) and 
300 annual burden hours (600 annual Form 204s submitted x 0.5 hours per 
report = 300 aggregate annual burden hours for all Form 204s).
     Form 304: 55 weekly reports, for an annual total of 2,860 
reports (55 weekly reports x 52 weeks = 2,860 total annual reports) and 
1,430 annual burden hours (2,860 annual Form 304s submitted x 0.5 hours 
per report = 1,430 aggregate annual burden hours for all Form 304s).
    Accordingly, based on the above revised estimates the Commission 
would revise its estimate of the current collections of information 
under existing part 19 to reflect that approximately 105 reportable 
traders \672\ file a total of 3,460 responses annually \673\ resulting 
in an aggregate annual burden of 1,730 hours.^{674 675} The

[[Page 11702]]

Commission's proposal would reduce the current OMB control number 3038-
0009 by these revised burden estimates under part 19 as they would be 
transferred to OMB control number 3038-0013.
---------------------------------------------------------------------------

    \672\ 55 Form 304 reports + 50 Form 205 reports = 105 reportable 
traders.
    \673\ 2,860 Form 304s + 600 Form 204s = 3,460 total annual 
Series '04 reports.
    \674\ 3,460 Series '04 reports x 0.5 hours per report = 1,730 
annual aggregate burden hours.
    \675\ These revised estimates result in an increased estimate 
under existing part 19 of 355 Series '04 reports submitted by 
traders (3,460 estimated Series '04 reports-3,105 submissions from 
the Commission's previous estimate = an increase of 355 response 
difference); an increase of 177 aggregate burden hours across all 
respondents (1,730 aggregate burden hours-1,553 aggregate burden 
hours from the Commission's previous estimate = an increase of 177 
aggregate burden hours); and a decrease of 30 respondent traders 
(105 respondents-135 respondents from the Commission's previous 
estimate = a decrease of 30 respondents).
---------------------------------------------------------------------------

    With respect to the overall collections of information that would 
be transferred to OMB control number 3038-0013 based on the 
Commission's revised part 19 estimate, the Commission estimates that 
the Commission's proposal would reduce the collections of information 
in part 19 by 600 reports \676\ and by 300 annual aggregate burden 
hours since the Commission's proposal would eliminate Form 204, as 
discussed above.\677\ The Commission does not expect a change in the 
number of reportable traders that would be required to file Part III of 
Form 304.\678\ Thus, the Commission continues to expect approximately 
55 weekly Form 304 reports, for an annual total of 2,860 reports \679\ 
for an aggregate total of 1,430 burden hours, which information 
collection burdens would be transferred to OMB control number 3038-
0013.\680\
---------------------------------------------------------------------------

    \676\ 50 monthly Form 204 reports x 12 months = 600 total annual 
reports.
    \677\ 600 Form 204 reports x 0.5 burden hours per report = 300 
aggregate annual burden hours.
    \678\ Since the Commission's proposal would eliminate Parts I 
and II of Form 304, proposed Form 304 would only refer to existing 
Part III of that form.
    \679\ 55 weekly Form 304 reports x 52 weeks = 2,860 total annual 
Form 304 reports.
    \680\ 2,860 Form 304 reports x 0.5 burden hours per report = 
1,430 aggregate annual burden hours.
---------------------------------------------------------------------------

    In addition, the Commission would maintain its authority to issue 
special calls for information to any person claiming an exemption from 
speculative federal position limits. While the position limits 
framework will expand to traders in the proposed twenty-five 
commodities (an increase from the existing nine legacy agricultural 
products), the position limit levels themselves will also be higher. 
The higher position limit levels would result in a smaller universe of 
traders who may exceed the position limits and thus be subject to a 
special call for information on their large position(s). Taking into 
account the higher limits and smaller universe of traders who would 
likely exceed the position limits, the Commission estimates that it is 
likely to issue a special call for information to 4 reportable traders. 
The Commission preliminarily estimates that it would take approximately 
5 hours to respond to a special call. The Commission therefore 
estimates that industry would incur a total of 20 aggregate annual 
burden hours.\681\
---------------------------------------------------------------------------

    \681\ 4 possible reportable traders x 5 hours each = 20 
aggregate annual burden hours.
---------------------------------------------------------------------------

b. OMB Control Number 3038-0013--Aggregation of Positions (To Be 
Renamed ``Position Limits'')
i. Introduction; Bona Fide Hedge Recognition and Exemption Process
    The Commission is proposing to amend the existing process for 
market participants to apply to obtain an exemption or recognition of a 
bona fide hedge position. Currently, the ``bona fide hedging 
transaction or position'' definition appears in existing Sec.  1.3. 
Under existing Sec. Sec.  1.47 and 1.48, a market participant must 
apply directly to the Commission to obtain a bona fide hedge 
recognition in accordance with Sec.  1.3 for federal position limit 
purposes.
    Proposed Sec. Sec.  150.3 and 150.9 would establish an amended 
process for obtaining a bona fide hedge exemption or recognition, which 
includes: (i) A new bona fide hedging definition in Sec.  150.1, (ii) a 
new process administered by the exchanges in proposed Sec.  150.9 for 
recognizing non-enumerated bona fide hedging positions for federal 
limit requirements, and (iii) an amended process to apply directly to 
the Commission for certain spread exemptions or for recognition of non-
enumerated bona fide hedging positions. Proposed Sec.  150.3 also would 
include new exemption types not explicitly listed in existing Sec.  
150.3.
    The Commission has previously estimated the combined annual burden 
hours for submitting applications under both Sec. Sec.  1.47 and 1.48 
to be 42 hours.\682\ The Commission's proposal would maintain the 
existing process where market participants may apply directly to the 
Commission, although the Commission expects market participants to 
predominantly rely on the exchange-administered process to obtain 
recognition of their non-enumerated bona fide hedging positions for 
purposes of federal position limit requirements. Enumerated bona fide 
hedge positions would remain self-effectuating, which means that market 
participants would not need to apply to the Commission for purposes of 
federal position limits, although market participants would still need 
to apply to an exchange for recognition of bona fide hedge positions 
for purposes of exchange-set position limits. The Commission forms this 
expectation on the fact that all the contracts that will now be subject 
to federal position limits are already subject to exchange-set limits. 
Thus, most market participants are likely to already be familiar with 
an exchange-administered process, as is being proposed under Sec.  
150.9. Familiarity with an exchange-administered process will result in 
operational efficiencies, such as completing one application for non-
enumerated bona fide hedge requests for both federal and exchange-set 
limits and thus a reduced burden on market participants.
---------------------------------------------------------------------------

    \682\ The supporting statement for a previous information 
collection request, ICR Reference No: 201808-3038-003, for OMB 
control number 3038-0013, estimated that seven respondents would 
file the Sec. Sec.  1.47 and 1.48 submissions, and that each 
respondent would file two submissions for a total of 14 annual 
submissions, requiring 3 hours per response, for a total of 42 
burden hours for all respondents.
---------------------------------------------------------------------------

    As previously discussed, the proposal would move the ``bona fide 
hedge transaction or position'' definition to proposed Sec.  150.1, and 
amend the definition to, among other things, remove the distinction 
between different types of enumerated bona fide hedge positions so that 
anticipatory enumerated bona fide hedges would be self-effectuating 
like other non-anticipatory enumerated bona fide hedges. The proposal 
would maintain the distinction between enumerated and non-enumerated 
bona fide hedges, and market participants would be required to apply 
for recognition of non-enumerated bona fide hedge positions either 
directly from the Commission pursuant to proposed Sec.  150.3 or 
indirectly through an exchange-centric process under Sec.  150.9.\683\ 
The Commission does not preliminarily believe that this amendment will 
have any PRA impacts since it is maintaining the status quo in which 
most enumerated bona fide hedges are self-effectuating while requiring 
traders to apply to the Commission for recognition

[[Page 11703]]

of non-enumerated bona fide hedge positions.
---------------------------------------------------------------------------

    \683\ Currently, in order to determine whether a futures, an 
option on a futures, or a swap position qualifies as a bona fide 
hedge, either (1) the position in question must qualify as an 
enumerated bona fide hedge, as defined in existing Sec.  1.3, or (2) 
the trader must file a statement with the Commission, pursuant to 
existing Sec.  1.47 (for non-enumerated bona fide hedges) and/or 
existing Sec.  1.48 (for enumerated anticipatory bona fide hedges). 
The revised definition would be accompanied by an expanded list of 
enumerated bona fide hedges that would appear in acceptable 
practices, rather than in the definition. The Commission 
additionally proposes to include an additional enumerated bona fide 
hedge for anticipatory merchandizing, which would be self-
effectuating like the other enumerated hedges. Under the existing 
framework, anticipatory merchandizing is considered to be a non-
enumerated bona fide hedge. The Commission preliminarily does not 
expect this change to have any PRA impacts.
---------------------------------------------------------------------------

ii. Sec.  150.2 Speculative Limits
    Under proposed Sec.  150.2(f), upon request from the Commission, 
DCMs listing a core referenced futures contract would be required to 
supply to the Commission deliverable supply estimates for each core 
referenced futures contract listed at that DCM. DCMs would only be 
required to submit estimates if requested to do so by the Commission on 
an as-needed basis. When submitting estimates, DCMs would be required 
to provide a description of the methodology used to derive the 
estimate, as well as any statistical data supporting the estimate. 
Appendix C to part 38 sets forth guidance regarding estimating 
deliverable supply.
    Submitting deliverable supply estimates upon demand from the 
Commission for contracts subject to federal limits would be a new 
reporting obligation for DCMs. The Commission estimates that six DCMs 
would be required to submit initial deliverable supply estimates. The 
Commission estimates that it would request each DCM that lists a core 
referenced futures contract to file one initial report for each core 
reference futures contract it lists on its market. Such requests from 
the Commission would result in one initial submission for each of the 
proposed twenty-five core referenced futures contracts.\684\ The 
Commission further estimates that it will take 20 hours to complete and 
file each report for a total annual burden of 500 hours for all 
respondents.\685\ Accordingly, the proposed changes to Sec.  150.2(f) 
would result in an initial, one-time increase to the current burden 
estimates of OMB control number 3038-0013 by an increase of 25 
submissions across six respondent DCMs for the initial number of 
submissions for the twenty-five core referenced futures contracts and 
an initial, one-time burden of 500 hours.
---------------------------------------------------------------------------

    \684\ In 2018, the DCMs submitted deliverable supply estimates 
for all the commodities that would be subject to federal position 
limits. Thus, the Commission expects that the exchanges would be 
able to leverage these recent estimates to minimize the burden of 
the initial submission under the Commission's proposal.
    \685\ 20 initial hours x 25 core referenced futures contracts = 
500 one-time, aggregate burden hours. While there is an initial 
annual submission, the Commission does not expect to require the 
exchanges to resubmit the supply estimates on an annual basis.
---------------------------------------------------------------------------

iii. Sec.  150.3 Exemptions From Federal Position Limit Requirements
    Market participants may currently apply directly to the Commission 
for recognition of certain bona fide hedges under the process set forth 
in existing Sec. Sec.  1.47 and 1.48. There is no existing process that 
is codified under the Commission's regulations for spread exemptions or 
other exemptions included under proposed Sec.  150.3.
    Proposed Sec.  150.3 would specify the circumstances in which a 
trader could exceed federal position limits.\686\ With respect to non-
enumerated bona fide hedge recognitions and spread exemptions not 
identified in the proposed ``spread transaction'' definition in 
proposed Sec.  150.1, proposed Sec.  150.3(b) would provide a process 
for market participants to request such bona fide hedge recognitions or 
spread exemptions directly from the Commission (as previously noted, 
both enumerated bona fide hedges and spread exemptions identified in 
the proposed ``spread transaction'' definition would be self-
effectuating and would not require a market participant to submit a 
request). Proposed Sec.  150.3(b), (d), and (e) set forth exemption-
related reporting and recordkeeping requirements that impact the 
current burden estimates in OMB control number 3038-0013.\687\ The 
proposed collection of information is necessary for the Commission to 
determine whether to recognize a trader's position as a bona fide hedge 
exempted from position limit requirements.
---------------------------------------------------------------------------

    \686\ Proposed Sec.  150.3(b) would include (1) recognitions of 
bona fide hedges under proposed Sec.  150.3(b); (2) spread 
exemptions under proposed Sec.  150.3(b); (3) financial distress 
positions a person could request from the Commission under Sec.  
140.99; and (4) exemptions for certain natural gas positions held 
during the spot month. Proposed Sec.  150.3(b) would also exempt 
pre-enactment and transition period swaps. The enumerated bona fide 
hedge recognitions and spread exemptions identified in the proposed 
``spread transaction'' definition in proposed Sec.  150.1 would be 
self-effectuating.
    \687\ Proposed Sec.  150.3(f) clarifies the implications on 
entities required to aggregate accounts under Sec.  150.4, and Sec.  
150.3(g) provides for delegation of certain authorities to the 
Director of the Division of Market Oversight. The proposed changes 
to Sec. Sec.  150.3(f) and 150.3(g) do not impact the current 
estimates for these OMB control numbers. Also, the proposal reminds 
persons of the relief provisions in Sec.  140.99, covered by OMB 
control number 3038-0049, which does not impact the burden 
estimates.
---------------------------------------------------------------------------

    Proposed Sec.  150.3(b) establishes application filing requirements 
and recordkeeping and reporting requirements that are similar to 
existing requirements for bona fide hedge recognitions under existing 
Sec. Sec.  1.47 and 1.48. Although these requirements in proposed Sec.  
150.3 would be new for market participants seeking spread exemptions 
(which are currently self-effectuating), the proposed filing, 
recordkeeping, and reporting requirements in Sec.  150.3(b) are 
otherwise familiar to market participants that have requested certain 
bona fide hedging recognitions from the Commission under existing 
regulations.
    The Commission estimates that very few or no traders would request 
recognition of a non-enumerated bona fide hedge, and those traders that 
do would likely prefer the exchange-administered process in proposed 
Sec.  150.9 (discussed further below) rather than apply directly to the 
Commission under proposed Sec.  150.3(b). Similarly, the Commission 
estimates that very few or no traders would submit a request for a 
spread exemption since the Commission preliminarily has determined that 
the most common spread exemptions are included in the proposed ``spread 
transaction'' definition and therefore would be self-effectuating and 
would not need approval for purposes of federal position limits. The 
Commission expects that traders are likely to rely on the Sec.  
150.3(b) process when dealing with a spread transaction or non-
enumerated bona fide hedge position that poses a novel or complex 
question under the Commission's rules. Particularly when the exchanges 
have not recognized that type of practice as a non-enumerated bona fide 
hedge previously, the Commission expects market participants to seek 
more regulatory clarity under proposed Sec.  150.3(b). In the event a 
trader submits such request under proposed Sec.  150.3, the Commission 
estimates that traders would file one request per year for a total of 
one annual request for all respondents. The Commission further 
estimates that in such situation, it would take 20 hours to complete 
and file each report, for a total of 20 aggregate annual burden hours 
for all traders.
    Proposed Sec.  150.3(d) establishes recordkeeping requirements for 
persons who claim any exemptions or relief under proposed Sec.  150.3. 
Proposed Sec.  150.3(d) should help to ensure that if any person claims 
any exemption permitted under proposed Sec.  150.3 such exemption 
holder can demonstrate compliance with the applicable requirements as 
follows:
    First, under proposed Sec.  150.3(d)(1), any person claiming an 
exemption would be required to keep and maintain complete books and 
records concerning certain details.\688\ Proposed Sec.  150.3(d)(1)

[[Page 11704]]

would establish recordkeeping requirements for any person relying on an 
exemption granted directly from the Commission. The Commission 
estimates that very few or no traders would claim an exemption directly 
from the Commission. In the event a trader requests an exemption, the 
Commission estimates that the trader would create one record per 
exemption per year for a total of one annual record for all 
respondents. The Commission further estimates that it will take one 
hour to comply with the recordkeeping requirement of Sec.  150.3(d)(1) 
for a total of one aggregate annual burden hour for all traders.
---------------------------------------------------------------------------

    \688\ The requirement would include all details of related cash, 
forward, futures, options, and swap positions and transactions, 
including anticipated requirements, production and royalties, 
contracts for services, cash commodity products and by-products, 
cross-commodity hedges, and a record of bona fide hedging swap 
counterparties.
---------------------------------------------------------------------------

    Second, under proposed Sec.  150.3(d)(2), a pass-through swap 
counterparty, as defined by proposed Sec.  150.1, that relies on a 
representation received from a bona fide hedging swap counterparty that 
the swap qualifies in good faith as a ``bona fide hedging position or 
transaction,'' as defined under proposed Sec.  150.1, would be required 
to: (i) Maintain any written representation for at least two years 
following the expiration of the swap; and (ii) furnish the 
representation to the Commission upon demand. Proposed Sec.  
150.3(d)(2) would create a new recordkeeping obligation for certain 
persons relying on the proposed pass-through swap representations, and 
the Commission estimates that 425 traders would be requested to 
maintain the required records. The Commission estimates that each 
trader would maintain one record per year for a total of 425 aggregate 
annual records for all respondents. The Commission further estimates 
that it will take one hour to comply with the recordkeeping requirement 
of Sec.  150.3(d) for a total of one annual burden hour for each trader 
and 425 aggregate annual burden hours for all traders.
    The Commission proposes to move existing Sec.  150.3(b), which 
currently allows the Commission or certain Commission staff to make 
special calls to demand certain information regarding persons claiming 
exemptions, to proposed Sec.  150.3(e), with some modifications to 
include swaps.\689\ Together with the recordkeeping provision of 
proposed Sec.  150.3(d), proposed Sec.  150.3(e) should enable the 
Commission to monitor the use of exemptions from speculative position 
limits and help to ensure that any person who claims any exemption 
permitted by proposed Sec.  150.3 can demonstrate compliance with the 
applicable requirements. The Commission's existing collection under 
existing Sec.  150.3 estimated that the Commission issues two special 
calls per year for information related to exemptions, and that each 
response to a special call for information takes 3 burden hours to 
complete. This includes two burden hours to fulfill reporting 
requirements and 1 burden hour related to recordkeeping for an 
aggregate total for all respondents of six annual burden hours, broken 
down into four aggregate annual burden hours for reporting and two 
aggregate annual burden hours for recordkeeping.\690\
---------------------------------------------------------------------------

    \689\ Proposed Sec.  150.3(e) would refer to commodity 
derivative contracts, whereas current Sec.  150.3(b) refers to 
futures and options. The proposed change would result in the 
inclusion of swaps.
    \690\ The special call authority under part 19 and the proposed 
special call authority discussed under Sec.  150.3 would be similar 
in nature; however, part 19 would apply to special calls regarding 
bona fide hedge recognitions and related underlying cash market 
positions while the special calls under proposed Sec.  150.3 would 
apply to the other exemptions under proposed Sec.  150.3.
---------------------------------------------------------------------------

    The Commission estimates that proposed Sec.  150.3(e) would impose 
information collection burdens related to special calls by the 
Commission on approximately 18 additional respondents, for an estimated 
20 special calls per year.\691\ The Commission estimates that these 20 
market participants would provide one submission per year to respond to 
the special call for a total of 20 annual submissions for all 
respondents. The Commission estimates it would take a market 
participant approximately 10 hours to complete a response to a special 
call. Therefore, the Commission estimates responses to special calls 
for information will take an aggregate total of 200 burden hours for 
all traders.\692\ The Commission notes that it is also maintaining its 
special call authority for reporting requirements under proposed part 
19 discussed above.
---------------------------------------------------------------------------

    \691\ 2 respondents subject to special calls under existing 
Sec.  150.3 + 18 additional respondents under proposed Sec.  150.3 = 
20 total respondents. The Commission estimates, at least during the 
initial implementation period, that it is likely to issue more 
special calls for information to monitor compliance with position 
limits, particularly in the commodity markets that will now be 
subject to federal position limits for the first time.
    \692\ 20 special calls x 10 burden hours per call = 200 total 
burden hours.
---------------------------------------------------------------------------

iv. Sec.  150.5 Exchange Set Limits and Exemptions
    Amendments to Sec.  150.5 would refine the process, and establish 
non-exclusive methodologies, by which exchanges may set exchange-level 
limits and grant exemptions therefrom, including separate methodologies 
for setting limit levels for contracts subject to federal limits (Sec.  
150.5(a)), physical commodity derivatives not subject to federal limits 
(Sec.  150.5(b)), and excluded commodity contracts (Sec.  
150.5(c)).\693\ In compliance with part 40 of the Commission's 
regulations, exchanges currently have policies and procedures in place 
to address exemptions from exchange set limits through their rulebooks. 
If the proposal is adopted, the Commission expects that the exchanges 
would accordingly update their rulebooks, both to conform to proposed 
new requirements and to incorporate the additional contracts that will 
be subject to federal position limits into their process for setting 
exchange-level limits and exemptions therefrom.
---------------------------------------------------------------------------

    \693\ Proposed Sec.  150.5 addresses exchange-set position 
limits and exemptions therefrom, whereas proposed Sec.  150.9 
addresses federal limits and an exchange-administered process for 
purposes of federal limits where an applicant may apply through an 
exchange to the Commission for recognition of an non-enumerated bona 
fide hedge for purposes of federal position limits.
---------------------------------------------------------------------------

    The collections of information related to amended rulebooks under 
part 40 are covered by OMB control number 3038-0093. Separately, the 
collections of information related to applications for exemptions from 
exchange-set limits are covered by OMB control number 3038-0013.
    Under proposed Sec.  150.5(a)(1), for any contract subject to a 
federal limit, DCMs and, ultimately, SEFs, would be required to 
establish exchange-set limits for such contracts. Under proposed Sec.  
150.5(a)(2), exchanges that wish to grant exemptions from exchange-set 
limits on commodity derivative contracts subject to federal limits 
would have to require traders to file an application to show a request 
for a bona fide hedge recognition or exemption conforms to a type that 
may be granted under proposed Sec.  150.3(a)(1)-(4). Exchanges would 
have to require that such exchange-set limit exemption applications be 
filed in advance of the date such position would be in excess of the 
limits, but exchanges would be given the discretion to adopt rules 
allowing traders to file applications within five business days after a 
trader took on such position. Proposed Sec.  150.5(a)(2) would also 
provide that exchanges must require that the trader reapply for the 
exemption at least annually. Proposed Sec.  150.5(a)(4) would require 
each exchange to provide a monthly report showing the disposition of 
any exemption application, including the recognition of any position as 
a bona fide hedge, the exemption of any spread transaction, the 
renewal, revocation, or modification of a previously granted

[[Page 11705]]

recognition or exemption, or the rejection of any application.\694\
---------------------------------------------------------------------------

    \694\ Additionally, each report should include the following 
details: (A) The date of disposition; (B) The effective date of the 
disposition; (C) The expiration date of any recognition or 
exemption; (D) Any unique identifier(s) the designated contract 
market or swap execution facility may assign to track the 
application, or the specific type of recognition or exemption; (E) 
If the application is for an enumerated bona fide hedging 
transaction or position, the name of the enumerated bona fide 
hedging transaction or position listed in Appendix A to this part; 
(F) If the application is for a spread transaction listed in the 
spread transaction definition in Sec.  150.1, the name of the spread 
transaction as it is listed in Sec.  150.1; (G) The identity of the 
applicant; (H) The listed commodity derivative contract or 
position(s) to which the application pertains; (I) The underlying 
cash commodity; (J) The maximum size of the commodity derivative 
position that is recognized by the designated contract market or 
swap execution facility as a bona fide hedging transaction or 
position, specified by contract month and by the type of limit as 
spot month, single month, or all-months-combined, as applicable; (K) 
Any size limitations or conditions established for a spread 
exemption or other exemption; and (L) For bona fide hedging 
transactions or positions, a concise summary of the applicant's 
activity in the cash markets and swaps markets for the commodity 
underlying the commodity derivative position for which the 
application was submitted.
---------------------------------------------------------------------------

    These proposed collections of information related to exemptions 
from exchange-set limits are necessary to ensure that such exchange-set 
limits comply with Commission regulations, including that exchange 
limits are no higher than the applicable federal level; to establish 
minimum standards needed for exchanges to administer the exchange's 
position limits framework; and to enable the Commission to oversee an 
exchange's exemptions process to ensure it does not undermine the 
federal position limits framework. In addition, the Commission would 
use the information to confirm that exemptions are granted and renewed 
in accordance with the types of exemptions that may be granted under 
proposed Sec.  150.3(a)(1)-(4).
    The Commission estimates under proposed Sec.  150.5(a) that 425 
traders would submit applications to claim spread exemptions and bona 
fide hedge recognitions from exchange-set position limits on commodity 
derivatives contracts subject to federal limits set forth in Sec.  
150.2. The Commission estimates that each trader on average would 
submit one application to an exchange each year for a total of 425 
applications for all respondents. The Commission further estimates that 
it will take 2 hours to complete and file each application for a total 
of 2 annual burden hours for each trader and 850 aggregate burden hours 
for all traders.\695\
---------------------------------------------------------------------------

    \695\ To increase efficiency and reduce duplicative efforts, the 
proposed rule would permit an exchange to have a single process in 
place that would allow market participants to request non-enumerated 
bona fide hedge recognitions from both federal and exchange-set 
position limits at the same time. The Commission believes that under 
a single process, the estimated burdens under proposed Sec.  
150.5(a) discussed in this section for exemptions from exchange-set 
limits will include the burdens under the federal limit exemption 
process for non-enumerated bona fide hedges under proposed Sec.  
150.9 discussed below.
---------------------------------------------------------------------------

    The Commission estimates under proposed Sec.  150.5(a)(4) that six 
exchanges would provide monthly reports for a total of 72 monthly 
reports for all exchanges.\696\ The Commission further estimates that 
it will take 5 hours to complete and file each monthly report for a 
total of 60 annual burden hours for each exchange and 360 annual burden 
hours for all exchanges.\697\
---------------------------------------------------------------------------

    \696\ 6 exchanges x 12 months = 72 total monthly reports per 
year.
    \697\ 5 hours per monthly report x 12 months = 60 hours per year 
for each exchange. 60 annual hours x 6 exchanges = 360 aggregate 
annual hours for all exchanges.
---------------------------------------------------------------------------

    Proposed Sec.  150.5(b) would require exchanges, for physical 
commodity derivatives that are not subject to federal limits to set 
limits during the spot month and to set either limits or accountability 
outside of the spot month. Under proposed Sec.  150.5(b)(3), where 
multiple exchanges list contracts that are substantially the same, 
including physically-settled contracts that have the same underlying 
commodity and delivery location, or cash-settled contracts that are 
directly or indirectly linked to a physically-settled contract, the 
exchange must either adopt ``comparable'' limits for such contracts, or 
demonstrate to the Commission how the non-comparable levels comply with 
the standards set forth in proposed Sec.  150.5(b)(1) and (2). Such a 
determination also must address how the levels are necessary and 
appropriate to reduce the potential threat of market manipulation or 
price distortion of the contract's or the underlying commodity's price 
or index. Proposed Sec.  150.5(b)(3) is intended to help ensure that 
position limits established on one exchange would not jeopardize market 
integrity or otherwise harm other markets. This provision may also 
improve the efficiency with which exchanges adopt limits on newly-
listed contracts that compete with an existing contract listed on 
another exchange and help reduce the amount of time and effort needed 
for Commission staff to assess the new limit levels. Further, proposed 
Sec.  150.5(b)(3) would be consistent with the Commission's proposal to 
generally apply equivalent federal limits to linked contracts, 
including linked contracts listed on multiple exchanges.
    The Commission estimates that under proposed Sec.  150.5(b)(3), six 
exchanges would make submissions to demonstrate to the Commission how 
the non-comparable levels comply with the standards set forth in 
proposed Sec.  150.5(b)(1) and (2). The Commission estimates that each 
exchange on average would make 3 submissions each year for a total of 
18 submissions for all exchanges. The Commission further estimates that 
it will take 10 hours to complete and file each submission for a total 
of 18 annual burden hours for each exchange and 180 burden hours for 
all exchanges.\698\
---------------------------------------------------------------------------

    \698\ 18 estimated annual submissions x 10 burden hours per 
submission = 180 aggregate annual burden hours.
---------------------------------------------------------------------------

    Proposed Sec.  150.5(b)(4) would permit exchanges to grant 
exemptions from any exchange limit established for physical commodity 
contracts not subject to federal limits. To grant such exemptions, 
exchanges must require traders to file an application to show whether 
the requested exemption from exchange-set limits would be in accord 
with sound commercial practices in the relevant commodity derivative 
market and/or that may be established and liquidated in an orderly 
fashion in that market. This proposed collection of information is 
necessary to confirm that any exemptions granted from exchange limits 
on physical commodity contracts not subject to federal limits do not 
pose a threat of market manipulation or congestion, and maintains 
orderly execution of transactions. The Commission estimates that 200 
traders would submit one application each year and that each 
application would take approximately two hours to complete, for an 
aggregate total of 400 burden hours per year for all traders.
    Proposed Sec.  150.5(e) reflects that, consistent with the 
definition of ``rule'' in existing Sec.  40.1, any exchange action 
establishing or modifying position limits or exemptions therefrom, or 
position accountability, in any case pursuant to proposed Sec.  
150.5(a), (b), (c), or Appendix F to part 150, would qualify as a 
``rule'' and must be submitted to the Commission pursuant to part 40 of 
the Commission's regulations. Proposed Sec.  150.5(e) further provides 
that exchanges would be required to review regularly any position limit 
levels established under proposed Sec.  150.5 to ensure the level 
continues to comply with the requirements of those sections. The 
Commission estimates under proposed Sec.  150.5(e) that six exchanges 
would submit revised rulebooks to satisfy their compliance obligations 
under part 40.

[[Page 11706]]

The Commission estimates that each exchange on average would make 1 
initial revision of its rulebook to reflect the new position limit 
framework for a total of 6 applications for all exchanges. The 
Commission further estimates that it will take 30 hours to revise a 
rulebook for a total of 30 annual burden hours for each exchange and 
180 burden hours for all exchanges.\699\
---------------------------------------------------------------------------

    \699\ 6 initial applications x 30 burden hours = 180 initial 
aggregate burden hours.
---------------------------------------------------------------------------

    This proposed collection of information is necessary to ensure that 
the exchanges' rulebooks reflect the most up to date rules and 
requirements in compliance with the proposed position limits framework. 
The information would be used to confirm that exchanges are complying 
with their requirements to regularly review any position limit levels 
established under proposed Sec.  150.5.
v. Sec.  150.9 Exchange Process for Bona Fide Hedge Recognitions From 
Federal Limits
    Proposed Sec.  150.9 would establish a new streamlined process in 
which a trader could apply through an exchange to request a non-
enumerated bona fide hedging recognition from federal position limits. 
As part of the process, proposed Sec.  150.9 would create certain 
recordkeeping and reporting obligations on the market participant and 
the exchange, including: (i) An application to request non-enumerated 
bona fide hedge recognitions, which the trader would submit to the 
exchange and which the exchange would subsequently provide to the 
Commission if the exchange approves the application for purposes of 
exchange-set limits; (ii) a notification to the Commission and the 
applicant of the exchange's determination for purposes of exchange 
limits regarding the trader's request for recognition of a bona fide 
hedge or spread exemption; (iii) and a requirement to maintain full, 
complete and systematic records for Commission review of the exchange's 
decisions. The Commission believes that the exchanges that will elect 
to process applications for non-enumerated bona fide hedging exemptions 
under proposed Sec.  150.9(a) already have similar processes for the 
review and disposition of such exemption applications in place through 
their rulebooks for purposes of exchange-set position limits.
    Accordingly, the estimated burden on an exchange to comply with the 
proposed rule will be less burdensome because the exchanges may 
leverage their existing policies and procedures to comply with the 
proposed rule. The Commission estimates that six exchanges would elect 
to process applications for non-enumerated bona fide hedge recognitions 
that would satisfy the federal position limit requirements under 
proposed Sec.  150.9, and would be required to file amended rulebooks 
pursuant to part 40 of the Commission's regulations. The Commission 
bases its estimate on the number of exchanges that have submitted 
similar rules to the Commission in the past.
    Proposed Sec.  150.9(c) would require a trader to submit an 
application with sufficient information to enable the exchange to 
determine whether it should recognize a position as a bona fide hedge 
for purposes of federal position limits. Each applicant would need to 
reapply for its non-enumerated bona fide hedge recognition at least on 
an annual basis by updating its original application. The Commission 
expects that traders would benefit from the exchange-administered 
framework established under proposed Sec.  150.9 because traders may 
submit one application to obtain a non-enumerated bona fide hedge 
recognition for purposes of both exchange-set and federal limits, as 
opposed to submitting separate applications to the Commission for 
federal position limit purposes and separate applications to an 
exchange for exchange limit purposes.\700\
---------------------------------------------------------------------------

    \700\ The Commission believes the collections of information set 
forth above are necessary for the exchange to process requests for 
recognition of non-enumerated bona fide hedges for purposes of both 
exchange-set position limits and federal position limits. The 
information would be used by the exchange to determine, and the 
Commission to review and verify, whether the facts and circumstances 
demonstrate it is appropriate to recognize a position as a non-
enumerated bona fide hedging transaction or position.
---------------------------------------------------------------------------

    Accordingly, the estimated burden for traders requesting non-
enumerated bona fide hedge recognitions from exchange-set limits under 
Sec.  150.5(a) would subsume the burden estimates in connection with 
proposed Sec.  150.9 for requesting non-enumerated bona fide hedge 
recognition's from federal limits since the Commission preliminarily 
believes exchanges would combine the two processes (i.e., any trader 
who applies through an exchange under proposed Sec.  150.9 for a non-
enumerated bona fide hedge for federal position limits purposes also 
would be deemed to be applying at the same time under proposed Sec.  
150.5(a) for exchange position limits purposes and thus it would not be 
appropriate to distinguish between the two for PRA purposes). 
Accordingly, the Commission preliminarily anticipates that 6 exchanges 
each would receive only one application for a non-enumerated bona fide 
hedge recognition under proposed Sec.  150.9 for a total of six 
aggregate annual applications for all exchanges; however, as noted 
above, this amount is included in the Commission's estimate in 
connection with proposed Sec.  150.5(a).\701\ Specifically, as 
discussed above in connection with proposed Sec.  150.5(a), the 
Commission estimates under proposed Sec. Sec.  150.5(a) and 150.9(a) 
that 425 traders would submit applications to claim exemptions and/or 
bona fide hedge recognitions for contracts subject to federal position 
limits as set forth in Sec.  150.2.\702\
---------------------------------------------------------------------------

    \701\ As discussed above, the process and estimated burdens 
under proposed Sec.  150.9 would not apply to Sec.  150.5(b) because 
proposed Sec.  150.5(b) applies to those physical commodity 
contracts that are not subject to federal limits (as opposed to 
proposed Sec.  150.5(a), which applies to those contracts subject to 
federal limits). As a result, a trader that would use the process 
established under Sec.  150.5(b) for exchange-set limits would not 
need to apply under proposed Sec.  150.9 since the traders would not 
need a bona fide hedge recognition or an exemption from federal 
position limits.
    \702\ As discussed in connection with proposed Sec.  150.5(a) 
above, the Commission estimates that each trader on average would 
make one application each year for a total of 425 applications 
across all exchanges. The Commission further estimates that, for 
proposed Sec. Sec.  150.5(a) and 150.9(a), taken together, it will 
take two hours to complete and file each application for a total of 
two annual burden hours for each trader and 850 aggregate annual 
burden hours for all traders. (425 annual applications x 2 burden 
hours per application = 850 aggregate annual burden hours). The 
Commission preliminarily anticipates that compared to proposed Sec.  
150.5(a), fewer traders will apply under proposed Sec.  150.9 since 
proposed Sec.  150.9 applies only to non-enumerated bona fide hedge 
recognitions for federal purposes. In comparison, while proposed 
Sec.  150.5 would encompass these same applications for non-
enumerated bona fide hedge recognitions (but for the purpose of 
exchange-set limits), proposed Sec.  150.5(a) also would include 
enumerated bona fide hedge applications along with spread exemption 
requests. The Commission's estimate of 850 aggregate annual burden 
hours encompasses all such requests from all traders. However, for 
the sake of clarity, the Commission preliminarily anticipates that 6 
exchanges each would receive one application per year for a non-
enumerated bona fide hedge under proposed Sec.  150.9 (for a total 
of six applications across all exchanges); as noted, this burden is 
included in the Commission's estimate of 425 annual applications in 
connection with its estimate under proposed Sec.  150.5(a).
---------------------------------------------------------------------------

    Proposed Sec.  150.9(d) would require exchanges to keep full, 
complete, and systematic records, including all pertinent data and 
memoranda, of all activities relating to the processing of such 
applications and the disposition thereof. In addition, as provided for 
in proposed Sec.  150.9(g), the Commission may, in its discretion, at 
any time, review the designated contract market's records retained 
pursuant to proposed Sec.  150.9(d). The proposed recordkeeping 
requirement is necessary for the Commission to review the exchanges' 
processes, retention of records, and

[[Page 11707]]

compliance with requirements established and implemented under this 
section.
    Proposed Sec.  150.9(d) would create a new recordkeeping obligation 
consistent with the standards in existing Sec.  1.31.\703\ The 
Commission estimates that six exchanges would each create one record in 
connection with proposed Sec.  150.9 each year for a total of six 
annual records for all respondents. The Commission further estimates 
that it will take five hours to comply with the proposed recordkeeping 
requirement of Sec.  150.9(d) for a total of five annual burden hours 
for each exchange and 30 aggregate annual burden hours across all 
exchanges.
---------------------------------------------------------------------------

    \703\ Consistent with existing Sec.  1.31, the Commission 
expects that these records would be readily available during the 
first two years of the required five year recordkeeping period for 
paper records, and readily accessible for the entire five-year 
recordkeeping period for electronic records. In addition, the 
Commission expects that records required to be maintained by an 
exchange pursuant to this section would be readily accessible during 
the pendency of any application, and for two years following any 
disposition that did not recognize a derivative position as a bona 
fide hedge.
---------------------------------------------------------------------------

    Proposed Sec.  150.9(f) would allow the Commission to inspect such 
books and records.\704\ In the event the Commission exercises its 
authority to inspect such books and records, it estimates that the 
Commission would make an inspection to two exchanges per year and each 
exchange would incur four hours to make its books and records available 
to the Commission for review for a total of 8 aggregate annual burden 
hours for the two estimated respondent exchanges.\705\
---------------------------------------------------------------------------

    \704\ Proposed Sec.  150.9(g)(1) provides the Commission's 
authority to, at its discretion, and at any time, review the 
exchange's processes, retention of records, and compliance with 
requirements established and implemented under this section. Under 
proposed Sec.  150.9(g)(2), if the Commission determines additional 
information is required to conduct its review, pursuant to proposed 
Sec.  150.9(g)(1), then it would notify the exchange and the 
relevant market participant of any issues identified and provide 
them with ten business days to provide supplemental information.
    \705\ 2 exchanges per year subject to a Commission inspection x 
4 hours per inspection request = 8 aggregate annual burden hours for 
all exchanges.
---------------------------------------------------------------------------

    Under proposed Sec.  150.9(e), an exchange would need to provide an 
applicant and the Commission with notice of any approved application of 
an exchange's determination to recognize bona fide hedges and grant 
spread exemptions with respect to its own position limits for purposes 
of exceeding the federal position limits. The proposed notification 
requirement is necessary to inform the Commission of the details of the 
type of bona fide hedge recognitions or spread exemptions being 
granted. The information would be used to keep the Commission informed 
as to the manner in which an exchange administers its application 
procedures, and the exchange's rationale for permitting large 
positions.
    The Commission estimates that under proposed Sec.  150.9(e), 6 
exchanges would submit notifications of approved application of an 
exchange's determination to recognize non-enumerated bona fide hedges 
for purposes of exceeding the federal position limits. The Commission 
estimates that each exchange on average would make 2 notifications: one 
notification each to the applicant trader and to the Commission each 
year for a total of 12 notices for all exchanges. The Commission 
further estimates that it will take 0.5 hours to complete and file each 
notification for a total of one annual burden hour for each exchange 
and six burden hours for all exchanges.\706\
---------------------------------------------------------------------------

    \706\ 12 notices for all exchanges x 0.5 hours per notice = six 
(6) total burden hours across all exchanges.
---------------------------------------------------------------------------

c. OMB Control Number 3038-0093--Provisions Common to Registered 
Entities
1. Sec.  150.9(a)
    Under proposed Sec.  150.9(a), exchanges that would like for their 
market participants to be able to exceed federal position limits based 
on a non-enumerated bona fide hedge recognition granted by the exchange 
with respect to its own limits must have rules, adopted pursuant to the 
rule approval process in Sec.  40.5 of the Commission's regulations, 
establishing processes consistent with the provisions of proposed Sec.  
150.9. The proposed collection of information is necessary to capture 
the new non-enumerated bona fide hedge process in the exchanges' 
rulebook, which is subject to Commission approval. The information 
would be used to assess the process put in place by each exchange 
submitting amended rulebooks.
    The Commission has previously estimated the combined annual burden 
hours for both Sec. Sec.  40.5 and 40.6 to be 7,000 hours.\707\ If the 
proposed rule is adopted, the Commission estimates that six exchanges 
would make one initial Sec.  40.5 rule filings per year for a total of 
six one-time initial submissions for all exchanges. The Commission 
further estimates that the exchanges would employ a combination of in-
house and outside legal and compliance counsel to update existing 
rulebooks and it will take 25 hours to complete and file each rule for 
a total 25 one-time burden hours for each exchange and 150 one-time 
burden hours for all exchanges.
---------------------------------------------------------------------------

    \707\ The supporting statement for the current active 
information collection request, ICR Reference No: 201503-3038-002, 
for OMB control number 3038-0013, estimated that seven respondents 
would file the Sec. Sec.  1.47 and 1.48 reports, and that each 
respondent would file two reports for a total of 14 annual 
responses, requiring three hour per response, for a total of 42 
burden hours for all respondents.
---------------------------------------------------------------------------

2. Request for Comments on Collection
    The Commission invites the public and other Federal agencies to 
comment on any aspect of the proposed information collection 
requirements discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the 
Commission solicits comments in order to (i) evaluate whether the 
proposed collections of information are necessary for the proper 
performance of the functions of the Commission, including whether the 
information will have practical utility; (ii) evaluate the accuracy of 
the Commission's estimate of the burden of the proposed collections of 
information; (iii) determine whether there are ways to enhance the 
quality, utility, and clarity of the information proposed to be 
collected; and (iv) minimize the burden of the proposed collections of 
information on those who are to respond, including through the use of 
appropriate automated collection techniques or other forms of 
information technology.
    Those desiring to submit comments on the proposed information 
collection requirements should submit them directly to the Office of 
Information and Regulatory Affairs, OMB, by fax at (202) 395-6566, or 
by email at [email protected]. Please provide the Commission 
with a copy of submitted comments so that all comments can be 
summarized and addressed in the final rule preamble. Refer to the 
ADDRESSES section of this notice of proposed rulemaking for comment 
submission instructions to the Commission. A copy of the supporting 
statements for the collection of information discussed above may be 
obtained by visiting https://www.RegInfo.gov. OMB is required to make a 
decision concerning the collection of information between 30 and 60 
days after publication of this document in the Federal Register. 
Therefore, a comment is best assured of having its full effect if OMB 
receives it within 30 days of publication.

C. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires that agencies 
consider whether the rules they propose will have a significant 
economic impact on a substantial number of small entities and, if so, 
provide a regulatory flexibility analysis respecting the

[[Page 11708]]

impact.\708\ A regulatory flexibility analysis or certification 
typically is required for ``any rule for which the agency publishes a 
general notice of proposed rulemaking pursuant to'' the notice-and-
comment provisions of the Administrative Procedure Act, 5 U.S.C. 
553(b).\709\ The requirements related to the proposed amendments fall 
mainly on registered entities, exchanges, FCMs, swap dealers, clearing 
members, foreign brokers, and large traders. The Commission has 
previously determined that registered DCMs, FCMs, swap dealers, major 
swap participants, eligible contract participants, SEFs, clearing 
members, foreign brokers and large traders are not small entities for 
purposes of the RFA.\710\
---------------------------------------------------------------------------

    \708\ 44 U.S.C. 601 et seq.
    \709\ 5 U.S.C. 601(2), 603-05.
    \710\ See Policy Statement and Establishment of Definitions of 
``Small Entities'' for Purposes of the Regulatory Flexibility Act, 
47 FR 18618-19, Apr. 30, 1982 (DCMs, FCMs, and large traders) (``RFA 
Small Entities Definitions''); Opting Out of Segregation, 66 FR 
20740-43, Apr. 25, 2001 (eligible contract participants); Position 
Limits for Futures and Swaps; Final Rule and Interim Final Rule, 76 
FR 71626, 71680, Nov. 18, 2011 (clearing members); Core Principles 
and Other Requirements for Swap Execution Facilities, 78 FR 33476, 
33548, Jun. 4, 2013 (SEFs); A New Regulatory Framework for Clearing 
Organizations, 66 FR 45604, 45609, Aug. 29, 2001 (DCOs); 
Registration of Swap Dealers and Major Swap Participants, 77 FR 
2613, Jan. 19, 2012, (swap dealers and major swap participants); and 
Special Calls, 72 FR 50209, Aug. 31, 2007 (foreign brokers).
---------------------------------------------------------------------------

    Further, while the requirements under this rulemaking may impact 
nonfinancial end users, the Commission notes that position limits 
levels apply only to large traders. Accordingly, the Chairman, on 
behalf of the Commission, hereby certifies, on behalf of the 
Commission, pursuant to 5 U.S.C. 605(b), that the actions proposed to 
be taken herein would not have a significant economic impact on a 
substantial number of small entities. The Chairman made the same 
certification in the 2013 Proposal,\711\ the 2016 Supplemental 
Proposal,\712\ and the 2016 Reproposal.\713\
---------------------------------------------------------------------------

    \711\ See 2013 Proposal, 78 FR at 75784.
    \712\ See 2016 Supplemental Proposal, 81 FR at 38499.
    \713\ See 2016 Reproposal, 81 FR at 96894.
---------------------------------------------------------------------------

D. Antitrust Considerations

    Section 15(b) of the CEA requires the Commission to take into 
consideration the public interest to be protected by the antitrust laws 
and endeavor to take the least anticompetitive means of achieving the 
objectives of the Act, and the policies and purposes of the Act, in 
issuing any order or adopting any Commission rule or regulation 
(including any exemption under section 4(c) or 4c(b)), or in requiring 
or approving any bylaw, rule, or regulation of a contract market or 
registered futures association established pursuant to section 17 of 
the Act.\714\
---------------------------------------------------------------------------

    \714\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------

    The Commission believes that the public interest to be protected by 
the antitrust laws is generally to protect competition. The Commission 
requests comment on whether the proposed rule implicates any other 
specific public interest to be protected by the antitrust laws.
    The Commission has considered the proposed rules to determine 
whether they are anticompetitive and has preliminarily determined that 
the proposed rules could, in some circumstances, be anticompetitive 
because position limits at low levels are, to some degree, inherently 
anticompetitive. A more established DCM that already lists, or is first 
to list, a core referenced futures contract (an ``incumbent DCM'') has 
a competitive advantage over smaller DCMs seeking to expand or future 
entrant DCMs (collectively ``entrant DCMs''), even in the absence of 
position limits, because ``liquidity attracts liquidity.'' That is, a 
market participant seeking to execute a single transaction or, for that 
matter, establish a large position would, other things being equal, 
gravitate toward a more established facility that successfully lists a 
contract with relatively consistent volume and transparent pricing--
where there is likely to be someone willing to take the other side of a 
trade. This is especially true if the market participant is already 
clearing other products with the incumbent DCM. This would tend to 
protect the incumbent DCM's contract and reinforce the advantage of an 
incumbent DCM, which has to do less to keep and attract customers and 
should be able to keep more of the profits from trading volume. That 
is, the status of incumbency by itself may to some extent create a 
barrier to entry for an entrant DCM where the presence of a 
counterparty at the desired price is less assured. Position limits at 
low levels, especially in the non-spot month, may exacerbate the 
situation. If a market participant establishes a futures position on an 
incumbent DCM and then reaches the federal limit level on the incumbent 
DCM, it becomes even less likely that the market participant will 
migrate to an entrant DCM, because the federal limit would still apply 
and prevents the market participant from increasing its aggregate 
futures position where ever located. Higher volume may permit an 
incumbent DCM to charge lower transaction fees than an entrant DCM; the 
price concession that a market participant might have to absorb to 
establish a large position may be lower on an incumbent DCM than an 
entrant DCM. Both of these factors would inform a DCM's decision 
regarding where to set the levels for its own exchange-set limits. 
Moreover, the incumbent DCM can use other tools to defend its advantage 
such as the implementation of new technologies, the use of various 
fees/charges and the application of exemptions to federal limits. The 
Commission preliminarily believes that the relatively high limit levels 
that the Commission proposes today do not at this time establish a 
barrier to entry or competitive restraint likely to facilitate 
anticompetitive effects in any relevant antitrust market for contract 
trading. This is because the limit levels that the Commission proposes 
today are based on recent data regarding deliverable supply and open 
interest. However, if the size of the relevant markets continues on an 
upward trend and the Commission does not adjust federal limit levels 
commensurately, limit levels that become stale over time could 
facilitate anticompetitive effects. The Commission requests comment on 
whether and in what circumstances adopting the proposed rules could be 
anticompetitive.
    The Commission has also preliminarily determined that the proposed 
rules serve the regulatory purpose of the Act ``to deter and prevent 
price manipulation or any other disruptions to market integrity.'' 
\715\ The Commission proposes to implement the rules pursuant to 
section 4a(a) of the CEA, which articulates additional policies and 
purposes.\716\
---------------------------------------------------------------------------

    \715\ Section 3(b) of the CEA, 7 U.S.C. 5(b).
    \716\ 7 U.S.C. 7a(a) (burdens on interstate commerce; trading or 
position limits).
---------------------------------------------------------------------------

    The Commission has identified the following less anticompetitive 
means: Requiring derivatives clearing organizations (``DCOs'') to 
impose initial margin surcharges for position limits. This would be 
less anticompetitive because initial margin surcharges would still 
allow a large speculator to accumulate a futures position on another 
DCM if the speculator so desired while protecting against the price 
impact from a large price change against the speculator who would 
otherwise be forced to offload a position due to position limits. The 
Commission requests comment on whether there are other less 
anticompetitive means of achieving the relevant purposes of the Act. 
The Commission is not required to

[[Page 11709]]

follow the least anticompetitive course of action.
    The Commission has examined whether requiring DCOs to impose 
initial margin surcharges for position limits in lieu of imposing 
position limits is feasible and has preliminarily determined that is 
not because it could be inconsistent with a relevant provision of the 
CEA and would require the Commission to revise its current regulations 
in part 39 to be more prescriptive and less principles-based. Thus, the 
Commission has preliminarily determined not to adopt this less 
anticompetitive means. Under section 5b(c)(2)(A)(ii) of the CEA \717\ 
and the corresponding provision of the Commission's current 
regulations, a registered DCO has ``reasonable discretion in 
establishing the manner by which it complies with each core 
principle.'' \718\ Moreover, the Commission's regulations already 
require DCOs to ``establish initial margin requirements that are 
commensurate with the risks of each product and portfolio, including 
any unusual characteristics of, or risks associated with, particular 
products or portfolios . . ., '' \719\ which would include large 
positions. DCOs are also already required to use models that take into 
account concentration, minimum liquidation time, and other risk factors 
inherent in large positions, and the Commission reviews these 
models.\720\ Finally, Congress has required that the Commission 
establish position limits ``as the Commission finds are necessary.'' 
\721\ The Commission requests comment on its feasibility analysis.
---------------------------------------------------------------------------

    \717\ 7 U.S.C. 7a-1(c)(2)(A)(ii).
    \718\ 17 CFR 39.10(b).
    \719\ 17 CFR 39.13(g)(2)(i).
    \720\ See generally 17 CFR 39.13.
    \721\ See supra Section III.F. (discussion of the necessity 
finding).
---------------------------------------------------------------------------

List of Subjects

17 CFR Part 1

    Agricultural commodity, Agriculture, Brokers, Committees, Commodity 
futures, Conflicts of interest, Consumer protection, Definitions, 
Designated contract markets, Directors, Major swap participants, 
Minimum financial requirements for intermediaries, Reporting and 
recordkeeping requirements, Swap dealers, Swaps.

17 CFR Part 15

    Brokers, Commodity futures, Reporting and recordkeeping 
requirements, Swaps.

17 CFR Part 17

    Brokers, Commodity futures, Reporting and recordkeeping 
requirements, Swaps.

17 CFR Part 19

    Commodity futures, Cottons, Grains, Reporting and recordkeeping 
requirements, Swaps.

17 CFR Part 40

    Commodity futures, Reporting and recordkeeping requirements, 
Procedural rules.

17 CFR Part 140

    Authority delegations (Government agencies), Conflict of interests, 
Organizations and functions (Government agencies).

17 CFR Part 150

    Bona fide hedging, Commodity futures, Cotton, Grains, Position 
limits, Referenced Contracts, Swaps.

17 CFR Part 151

    Bona fide hedging, Commodity futures, Cotton, Grains, Position 
limits, Referenced Contracts, Swaps.

    For the reasons stated in the preamble, the Commodity Futures 
Trading Commission proposes to amend 17 CFR chapter I as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

0
1. The authority citation for part 1 continues to read as follows:

    Authority:  7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 
6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8, 
9, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24 
(2012).


Sec.  1.3   [Amended]

0
2. In Sec.  1.3, remove the definition of the term ``bona fide hedging 
transactions and positions for excluded commodities.''


Sec.  1.47   [Removed and Reserved]

0
3. Remove and reserve Sec.  1.47.


Sec.  1.48   [Removed and Reserved]

0
4. Remove and reserve Sec.  1.48.

PART 15--REPORTS--GENERAL PROVISIONS

0
5. The authority citation for part 15 continues to read as follows:

    Authority:  7 U.S.C. 2, 5, 6a, 6c, 6f, 6g, 6i, 6k, 6m, 6n, 7, 
7a, 9, 12a, 19, and 21, as amended by Title VII of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 
Stat. 1376 (2010).

0
6. In Sec.  15.00, revise paragraph (p)(1) to read as follows:


Sec.  15.00   Definitions of terms used in parts 15 to 19, and 21 of 
this chapter.

* * * * *
    (p) * * *
    (1) For reports specified in parts 17 and 18 and in Sec.  19.00(a) 
and (b) of this chapter, any open contract position that at the close 
of the market on any business day equals or exceeds the quantity 
specified in Sec.  15.03 in either:
    (i) Any one futures of any commodity on any one reporting market, 
excluding futures contracts against which notices of delivery have been 
stopped by a trader or issued by the clearing organization of the 
reporting market; or
    (ii) Long or short put or call options that exercise into the same 
future of any commodity, or other long or short put or call commodity 
options that have identical expirations and exercise into the same 
commodity, on any one reporting market.
* * * * *
0
7. In Sec.  15.01, revise paragraph (d) to read as follows:


Sec.  15.01   Persons required to report.

* * * * *
    (d) Persons, as specified in part 19 of this chapter, who:
    (1) Are merchants or dealers of cotton holding or controlling 
positions for future delivery in cotton that equal or exceed the amount 
set forth in Sec.  15.03; or
    (2) Are persons who have received a special call from the 
Commission or its designee under Sec.  19.00(b) of this chapter.
* * * * *
0
8. Revise Sec.  15.02 to read as follows:


Sec.  15.02   Reporting forms.

    Forms on which to report may be obtained from any office of the 
Commission or via https://www.cftc.gov. Listed below are the forms to 
be used for the filing of reports. To determine who shall file these 
forms, refer to the Commission rule listed in the column opposite the 
form number.

----------------------------------------------------------------------------------------------------------------
               Form No.                                            Title                                 Rule
----------------------------------------------------------------------------------------------------------------
40....................................  Statement of Reporting Trader..............................        18.04

[[Page 11710]]

 
71....................................  Identification of Omnibus Accounts and Sub-accounts........        17.01
101...................................  Positions of Special Accounts..............................        17.00
102...................................  Identification of Special Accounts, Volume Threshold               17.01
                                         Accounts, and Consolidated Accounts.
304...................................  Statement of Cash Positions for Unfixed-Price Cotton ``On          19.00
                                         Call''.
----------------------------------------------------------------------------------------------------------------


(Approved by the Office of Management and Budget under control numbers 
3038-0007, 3038-0009, 3038-0013, and 3038-0103.)

PART 17--REPORTS BY REPORTING MARKETS, FUTURES COMMISSION 
MERCHANTS, CLEARING MEMBERS, AND FOREIGN BROKERS

0
9. The authority citation for part 17 continues to read as follows:

    Authority:  7 U.S.C. 2, 6a, 6c, 6d, 6f, 6g, 6i, 6t, 7, 7a, and 
12a.

0
10. In Sec.  17.00, revise paragraph (b) introductory text to read as 
follows:


Sec.  17.00   Information to be furnished by futures commission 
merchants, clearing members and foreign brokers.

* * * * *
    (b) Interest in or control of several accounts. Except as otherwise 
instructed by the Commission or its designee and as specifically 
provided in Sec.  150.4 of this chapter, if any person holds or has a 
financial interest in or controls more than one account, all such 
accounts shall be considered by the futures commission merchant, 
clearing member, or foreign broker as a single account for the purpose 
of determining special account status and for reporting purposes.
* * * * *
0
11. In Sec.  17.03, add paragraph (i) to read as follows:


Sec.  17.03   Delegation of authority to the Director of the Office of 
Data and Technology or the Director of the Division of Market 
Oversight.

* * * * *
    (i) Pursuant to Sec.  17.00(b), and as specifically provided in 
Sec.  150.4 of this chapter, the authority shall be designated to the 
Director of the Office of Data and Technology to instruct a futures 
commission merchant, clearing member, or foreign broker to consider 
otherwise than as a single account for the purpose of determining 
special account status and for reporting purposes all accounts one 
person holds or controls, or in which the person has a financial 
interest.
0
12. Revise part 19 to read as follows:

PART 19--REPORTS BY PERSONS HOLDING REPORTABLE POSITIONS IN EXCESS 
OF POSITION LIMITS, AND BY MERCHANTS AND DEALERS IN COTTON

Sec.
19.00 Who shall furnish information.
19.01 [Reserved]
19.02 Reports pertaining to cotton on call purchases and sales.
19.03 Delegation of authority to the Director of the Division of 
Market Oversight and the Director of the Division of Enforcement.
19.04-19.10 [Reserved]
Appendix A to Part 19--Form 304

    Authority: 7 U.S.C. 6g, 6c(b), 6i, and 12a(5).


Sec.  19.00   Who shall furnish information.

    (a) Persons filing cotton on call reports. Merchants and dealers of 
cotton holding or controlling positions for future delivery in cotton 
that are reportable pursuant to Sec.  15.00(p)(1)(i) of this chapter 
shall file CFTC Form 304.
    (b) Persons responding to a special call. All persons:
    (1) Exceeding speculative position limits under Sec.  150.2 of this 
chapter; or
    (2) Holding or controlling positions for future delivery that are 
reportable pursuant to Sec.  15.00(p)(1) of this chapter and who have 
received a special call from the Commission or its designee shall file 
any pertinent information as instructed in the special call. Filings in 
response to a special call shall be made within one business day of 
receipt of the special call unless otherwise specified in the call. 
Such filing shall be transmitted using the format, coding structure, 
and electronic data submission procedures approved in writing by the 
Commission.


Sec.  19.01   [Reserved]


Sec.  19.02   Reports pertaining to cotton on call purchases and sales.

    (a) Information required. Persons required to file CFTC Form 304 
reports under Sec.  19.00(a) shall file CFTC Form 304 reports showing 
the quantity of call cotton bought or sold on which the price has not 
been fixed, together with the respective futures on which the purchase 
or sale is based. As used herein, call cotton refers to spot cotton 
bought or sold, or contracted for purchase or sale at a price to be 
fixed later based upon a specified future.
    (b) Time and place of filing reports. Each CFTC Form 304 report 
shall be made weekly, dated as of the close of business on Friday, and 
filed not later than 9 a.m. Eastern Time on the third business day 
following that Friday using the format, coding structure, and 
electronic data transmission procedures approved in writing by the 
Commission.


Sec.  19.03   Delegation of authority to the Director of the Division 
of Enforcement.

    (a) The Commission hereby delegates, until it orders otherwise, to 
the Director of the Division of Enforcement, or such other employee or 
employees as the Director may designate from time to time, the 
authority in Sec.  19.00(b) to issue special calls.
    (b) The Commission hereby delegates, until it orders otherwise, to 
the Director of the Division of Enforcement, or such other employee or 
employees as the Director may designate from time to time, the 
authority in Sec.  19.00(b) to provide instructions or to determine the 
format, coding structure, and electronic data transmission procedures 
for submitting data records and any other information required under 
this part.
    (c) The Director of the Division of Enforcement may submit to the 
Commission for its consideration any matter which has been delegated in 
this section.
    (d) Nothing in this section prohibits the Commission, at its 
election, from exercising the authority delegated in this section.


Sec.  Sec.  19.04-19.10   [Reserved]

Appendix A to Part 19--Form 304

BILLING CODE 6351-01-P

[[Page 11711]]

[GRAPHIC] [TIFF OMITTED] TP27FE20.076


[[Page 11712]]


[GRAPHIC] [TIFF OMITTED] TP27FE20.077


[[Page 11713]]


[GRAPHIC] [TIFF OMITTED] TP27FE20.078


[[Page 11714]]


[GRAPHIC] [TIFF OMITTED] TP27FE20.079


[[Page 11715]]


[GRAPHIC] [TIFF OMITTED] TP27FE20.080


[[Page 11716]]


[GRAPHIC] [TIFF OMITTED] TP27FE20.081


[[Page 11717]]


BILLING CODE 6351-01-C

PART 40--PROVISIONS COMMON TO REGISTERED ENTITIES

0
13. The authority citation for part 40 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 5, 6, 7, 7a, 8 and 12, as amended by 
Titles VII and VIII of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, Public Pub. L. 111-203, 124 Stat. 1376 
(2010).

0
14. In Sec.  40.1, revise paragraphs (j)(1)(vii) and (j)(2)(vii) to 
read as follows:


Sec.  40.1   Definitions.

* * * * *
    (j) * * *
    (1) * * *
    (vii) Speculative position limits, position accountability 
standards, and position reporting requirements, including an indication 
as to whether the contract meets the definition of a referenced 
contract as defined in Sec.  150.1 of this chapter, and, if so, the 
name of the core referenced futures contract on which the referenced 
contract is based.
* * * * *
    (2) * * *
    (vii) Speculative position limits, position accountability 
standards, and position reporting requirements, including an indication 
as to whether the contract meets the definition of economically 
equivalent swap as defined in Sec.  150.1 of this chapter, and, if so, 
the name of the referenced contract to which the swap is economically 
equivalent.
* * * * *

PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION

0
15. The authority citation for part 140 continues to read as follows:

    Authority:  7 U.S.C. 2(a)(12), 12a, 13(c), 13(d), 13(e), and 
16(b).


Sec.  140.97   [Removed and Reserved]

0
16. Remove and reserve Sec.  140.97.

PART 150--LIMITS ON POSITIONS

0
17. The authority citation for part 150 is revised to read as follows:

    Authority:  7 U.S.C. 1a, 2, 5, 6, 6a, 6c, 6f, 6g, 6t, 12a, and 
19, as amended by Title VII of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

0
18. Revise Sec.  150.1 to read as follows:


Sec.  150.1   Definitions.

    As used in this part--
    Bona fide hedging transactions or positions means a position in 
commodity derivative contracts in a physical commodity, where:
    (1) Such position:
    (i) Represents a substitute for transactions made or to be made, or 
positions taken or to be taken, at a later time in a physical marketing 
channel;
    (ii) Is economically appropriate to the reduction of price risks in 
the conduct and management of a commercial enterprise; and
    (iii) Arises from the potential change in the value of--
    (A) Assets which a person owns, produces, manufactures, processes, 
or merchandises or anticipates owning, producing, manufacturing, 
processing, or merchandising;
    (B) Liabilities which a person owes or anticipates incurring; or
    (C) Services that a person provides or purchases, or anticipates 
providing or purchasing; or
    (2) Such position qualifies as:
    (i) Pass-through swap and pass-through swap offset pair. Paired 
positions of a pass-through swap and a pass-through swap offset, where:
    (A) The pass-through swap is a swap position entered into by one 
person for which the swap would qualify as a bona fide hedging 
transaction or position pursuant to paragraph (1) of this definition 
(the bona fide hedging swap counterparty) that is opposite another 
person (the pass-through swap counterparty); and
    (B) The pass-through swap offset is a futures, option on a futures, 
or swap position entered into by the pass-through swap counterparty in 
the same physical commodity as the pass-through swap, and which reduces 
the pass-through swap counterparty's price risks attendant to that 
pass-through swap; and provided that the pass-through swap counterparty 
is able to demonstrate upon request that the pass-through swap 
qualifies as a bona fide hedging transaction or position pursuant to 
paragraph (1) of this definition; or
    (ii) Offsets of a bona fide hedger's qualifying swap position. A 
futures, option on a futures, or swap position entered into by a bona 
fide hedging swap counterparty that reduces price risks attendant to a 
previously-entered-into swap position that qualified as a bona fide 
hedging transaction or position at the time it was entered into for 
that counterparty pursuant to paragraph (1) of this definition.
    Commodity derivative contract means any futures, option on a 
futures, or swap contract in a commodity (other than a security futures 
product as defined in section 1a(45) of the Act).
    Core referenced futures contract means a futures contract that is 
listed in Sec.  150.2(d).
    Economically equivalent swap means, with respect to a particular 
referenced contract, any swap that has identical material contractual 
specifications, terms, and conditions to such referenced contract.
    (1) Other than as provided in paragraph (2) of this definition, for 
the purpose of determining whether a swap is an economically equivalent 
swap with respect to a particular referenced contract, the swap shall 
not be deemed to lack identical material contractual specifications, 
terms, and conditions due to different lot size specifications or 
notional amounts, delivery dates diverging by less than one calendar 
day, or different post-trade risk management arrangements.
    (2) With respect to any natural gas referenced contract, for the 
purpose of determining whether a swap is an economically equivalent 
swap to such referenced contract, the swap shall not be deemed to lack 
identical material contractual specifications, terms, and conditions 
due to different lot size specifications or notional amounts, delivery 
dates diverging by less than two calendar days, or different post-trade 
risk management arrangements.
    (3) With respect to any referenced contract or class of referenced 
contracts, the Commission may make a determination that any swap or 
class of swaps satisfies, or does not satisfy, this economically 
equivalent swap definition.
    Eligible affiliate means an entity with respect to which another 
person:
    (1) Directly or indirectly holds either:
    (i) A majority of the equity securities of such entity, or
    (ii) The right to receive upon dissolution of, or the contribution 
of, a majority of the capital of such entity;
    (2) Reports its financial statements on a consolidated basis under 
Generally Accepted Accounting Principles or International Financial 
Reporting Standards, and such consolidated financial statements include 
the financial results of such entity; and
    (3) Is required to aggregate the positions of such entity under 
Sec.  150.4 and does not claim an exemption from aggregation for such 
entity.
    Eligible entity \1\ means a commodity pool operator; the operator 
of a trading

[[Page 11718]]

vehicle which is excluded, or which itself has qualified for exclusion 
from the definition of the term ``pool'' or ``commodity pool 
operator,'' respectively, under Sec.  4.5 of this chapter; the limited 
partner, limited member or shareholder in a commodity pool the operator 
of which is exempt from registration under Sec.  4.13 of this chapter; 
a commodity trading advisor; a bank or trust company; a savings 
association; an insurance company; or the separately organized 
affiliates of any of the above entities:
---------------------------------------------------------------------------

    \1\ The definition of the term eligible entity was amended by 
the Commission in a final rule published on December 16, 2016 (81 FR 
at 91454, 91489). Aside from proposing to remove the lettering from 
each of the defined terms and to display them in alphabetical order, 
the definition of the term eligible entity would not be further 
amended by this proposal and is included solely to maintain the 
continuity of this definitions section.
---------------------------------------------------------------------------

    (1) Which authorizes an independent account controller 
independently to control all trading decisions with respect to the 
eligible entity's client positions and accounts that the independent 
account controller holds directly or indirectly, or on the eligible 
entity's behalf, but without the eligible entity's day-to-day 
direction; and
    (2) Which maintains:
    (i) Only such minimum control over the independent account 
controller as is consistent with its fiduciary responsibilities to the 
managed positions and accounts, and necessary to fulfill its duty to 
supervise diligently the trading done on its behalf; or
    (ii) If a limited partner, limited member or shareholder of a 
commodity pool the operator of which is exempt from registration under 
Sec.  4.13 of this chapter, only such limited control as is consistent 
with its status.
    Entity means a ``person'' as defined in section 1a of the Act.
    Excluded commodity means an ``excluded commodity'' as defined in 
section 1a of the Act.
    Futures-equivalent means:
    (1) An option contract, whether an option on a future or an option 
that is a swap, which has been adjusted by an economically reasonable 
and analytically supported risk factor, or delta coefficient, for that 
option computed as of the previous day's close or the current day's 
close or contemporaneously during the trading day, and converted to an 
economically equivalent amount of an open position in a core referenced 
futures contract, provided however, if a participant's position exceeds 
speculative position limits as a result of an option assignment, that 
participant is allowed one business day to liquidate the excess 
position without being considered in violation of the limits;
    (2) A futures contract which has been converted to an economically 
equivalent amount of an open position in a core referenced futures 
contract; and
    (3) A swap which has been converted to an economically equivalent 
amount of an open position in a core referenced futures contract.
    Independent account controller \2\ means a person:
---------------------------------------------------------------------------

    \2\ The definition of the term independent account controller 
was amended by the Commission in a final rule published on December 
16, 2016 (81 FR at 91454, 91489). This term would not be further 
amended by this proposal and is included solely to maintain the 
continuity of this definitions section.
---------------------------------------------------------------------------

    (1) Who specifically is authorized by an eligible entity, as 
defined in this section, independently to control trading decisions on 
behalf of, but without the day-to-day direction of, the eligible 
entity;
    (2) Over whose trading the eligible entity maintains only such 
minimum control as is consistent with its fiduciary responsibilities 
for managed positions and accounts to fulfill its duty to supervise 
diligently the trading done on its behalf or as is consistent with such 
other legal rights or obligations which may be incumbent upon the 
eligible entity to fulfill;
    (3) Who trades independently of the eligible entity and of any 
other independent account controller trading for the eligible entity;
    (4) Who has no knowledge of trading decisions by any other 
independent account controller; and
    (5) Who is:
    (i) Registered as a futures commission merchant, an introducing 
broker, a commodity trading advisor, or an associated person of any 
such registrant, or
    (ii) A general partner, managing member or manager of a commodity 
pool the operator of which is excluded from registration under Sec.  
4.5(a)(4) of this chapter or Sec.  4.13 of this chapter, provided that 
such general partner, managing member or manager complies with the 
requirements of Sec.  150.4(c).
    Long position means, on a futures-equivalent basis, a long call 
option, a short put option, a long underlying futures contract, or a 
swap position that is equivalent to a long futures contract.
    Physical commodity means any agricultural commodity as that term is 
defined in Sec.  1.3 of this chapter or any exempt commodity as that 
term is defined in section 1a of the Act.
    Position accountability means any bylaw, rule, regulation, or 
resolution that is submitted to the Commission pursuant to part 40 of 
this chapter in lieu of, or along with, a speculative position limit, 
and that requires a trader whose position exceeds the accountability 
level to consent to: (1) Provide information about its position to the 
designated contract market or swap execution facility; and (2) halt 
increasing further its position or reduce its position in an orderly 
manner, in each case as requested by the designated contract market or 
swap execution facility.
    Pre-enactment swap means any swap entered into prior to enactment 
of the Dodd-Frank Act of 2010 (July 21, 2010), the terms of which have 
not expired as of the date of enactment of that Act.
    Pre-existing position means any position in a commodity derivative 
contract acquired in good faith prior to the effective date of any 
bylaw, rule, regulation, or resolution that specifies a speculative 
position limit level or a subsequent change to that level.
    Referenced contract means:
    (1) A core referenced futures contract listed in Sec.  150.2(d) or, 
on a futures-equivalent basis with respect to a particular core 
referenced futures contract, a futures contract or options on a futures 
contract, including a spread, that is either:
    (i) Directly or indirectly linked, including being partially or 
fully settled on, or priced at a fixed differential to, the price of 
that particular core referenced futures contract; or
    (ii) Directly or indirectly linked, including being partially or 
fully settled on, or priced at a fixed differential to, the price of 
the same commodity underlying that particular core referenced futures 
contract for delivery at the same location or locations as specified in 
that particular core referenced futures contract; or
    (2) On a futures-equivalent basis, an economically equivalent swap.
    (3) The definition of referenced contract does not include a 
location basis contract, a commodity index contract, any guarantee of a 
swap, or a trade option that meets the requirements of Sec.  32.3 of 
this chapter.
    Short position means, on a futures-equivalent basis, a short call 
option, a long put option, a short underlying futures contract, or a 
swap position that is equivalent to a short futures contract.
    Speculative position limit means the maximum position, either net 
long or net short, in a commodity derivative contract that may be held 
or controlled by one person, absent an exemption, whether such limits 
are adopted for combined positions in all commodity derivative 
contracts in a particular commodity, including the spot month future 
and all single month futures (the spot month and all single month 
futures, cumulatively, ``all-months-combined''), positions in a single 
month of commodity derivative contracts in a particular commodity other 
than the spot month future (``single month''), or

[[Page 11719]]

positions in the spot month of commodity derivative contacts in a 
particular commodity. Such a limit may be established under federal 
regulations or rules of a designated contract market or swap execution 
facility. For referenced contracts other than core referenced futures 
contracts, single month means the same period as that of the relevant 
core referenced futures contract.
    Spot month means:
    (1) For physical-delivery core referenced futures contracts, the 
period of time beginning at the earlier of the close of business on the 
trading day preceding the first day on which delivery notices can be 
issued by the clearing organization of a contract market, or the close 
of business on the trading day preceding the third-to-last trading day, 
until the contract expires, except as follows:
    (i) For ICE Futures U.S. Sugar No. 11 (SB) core referenced futures 
contract, the spot month means the period of time beginning at the 
opening of trading on the second business day following the expiration 
of the regular option contract traded on the expiring futures contract 
until the contract expires;
    (ii) For ICE Futures U.S. Sugar No. 16 (SF) core referenced futures 
contract, the spot month means the period of time beginning on the 
third-to-last trading day of the contract month until the contract 
expires;
    (iii) For Chicago Mercantile Exchange Live Cattle (LC) core 
referenced futures contract, the spot month means the period of time 
beginning at the close of trading on the fifth business day of the 
contract month until the contract expires;
    (2) For referenced contracts other than core referenced futures 
contracts, the spot month means the same period as that of the relevant 
core referenced futures contract.
    Spread transaction means either a calendar spread, intercommodity 
spread, quality differential spread, processing spread, product or by-
product differential spread, or futures-option spread.
    Swap means ``swap'' as that term is defined in section 1a of the 
Act and as further defined in Sec.  1.3 of this chapter.
    Swap dealer means ``swap dealer'' as that term is defined in 
section 1a of the Act and as further defined in Sec.  1.3 of this 
chapter.
    Transition period swap means a swap entered into during the period 
commencing after the enactment of the Dodd-Frank Act of 2010 (July 21, 
2010), and ending 60 days after the publication in the Federal Register 
of final amendments to this part implementing section 737 of the Dodd-
Frank Act of 2010.
0
19. Revise Sec.  150.2 to read as follows:


Sec.  150.2   Federal speculative position limits.

    (a) Spot month speculative position limits. For physical-delivery 
referenced contracts and, separately, for cash-settled referenced 
contracts, no person may hold or control positions in the spot month, 
net long or net short, in excess of the levels specified by the 
Commission.
    (b) Single month and all-months-combined speculative position 
limits. For any referenced contract, no person may hold or control 
positions in a single month or in all-months-combined (including the 
spot month), net long or net short, in excess of the levels specified 
by the Commission.
    (c) Relevant contract month. For purposes of this part, for 
referenced contracts other than core referenced futures contracts, the 
spot month and any single month shall be the same as those of the 
relevant core referenced futures contract.
    (d) Core referenced futures contracts. Federal speculative position 
limits apply to referenced contracts based on the following core 
referenced futures contracts:

       Table 1 to Paragraph (d)--Core Referenced Futures Contracts
------------------------------------------------------------------------
                                                        Core referenced
         Commodity type               Designated       futures contract
                                    contract market           \1\
------------------------------------------------------------------------
Legacy Agricultural
                                  Chicago Board of
                                   Trade
                                                      Corn (C).
                                                      Oats (O).
                                                      Soybeans (S).
                                                      Soybean Meal (SM).
                                                      Soybean Oil (SO).
                                                      Wheat (W).
                                                      Hard Winter Wheat
                                                       (KW).
                                  ICE Futures U.S.
                                                      Cotton No. 2 (CT).
                                  Minneapolis Grain
                                   Exchange
                                                      Hard Red Spring
                                                       Wheat (MWE).
Other Agricultural
                                  Chicago Board of
                                   Trade
                                                      Rough Rice (RR).
                                  Chicago Mercantile
                                   Exchange
                                                      Live Cattle (LC).
                                  ICE Futures U.S.
                                                      Cocoa (CC).
                                                      Coffee C (KC).
                                                      FCOJ-A (OJ).
                                                      U.S. Sugar No. 11
                                                       (SB).
                                                      U.S. Sugar No. 16
                                                       (SF).
Energy
                                  New York
                                   Mercantile
                                   Exchange
                                                      Light Sweet Crude
                                                       Oil (CL).
                                                      NY Harbor ULSD
                                                       (HO).
                                                      RBOB Gasoline
                                                       (RB).
                                                      Henry Hub Natural
                                                       Gas (NG).
Metals
                                  Commodity
                                   Exchange, Inc.
                                                      Gold (GC).

[[Page 11720]]

 
                                                      Silver (SI).
                                                      Copper (HG).
                                  New York
                                   Mercantile
                                   Exchange
                                                      Palladium (PA).
                                                      Platinum (PL).
------------------------------------------------------------------------
\1\ The core referenced futures contract includes any successor
  contracts.

    (e) Establishment of speculative position limit levels. The levels 
of federal speculative position limits are fixed by the Commission at 
the levels listed in appendix E to this part; provided however, 
compliance with such speculative limits shall not be required until 365 
days after publication in the Federal Register.
    (f) Designated contract market estimates of deliverable supply. 
Each designated contract market listing a core referenced futures 
contract shall supply to the Commission an estimated spot month 
deliverable supply upon request by the Commission, and may supply such 
estimates to the Commission at any other time. Each estimate shall be 
accompanied by a description of the methodology used to derive the 
estimate and any statistical data supporting the estimate, and shall be 
submitted using the format and procedures approved in writing by the 
Commission. A designated contract market should use the guidance 
regarding deliverable supply in appendix C to part 38 of this chapter.
    (g) Pre-existing positions--(1) Pre-existing positions in a spot 
month. A spot month speculative position limit established under this 
section shall apply to pre-existing positions other than pre-enactment 
swaps and transition period swaps.
    (2) Pre-existing positions in a non-spot month. A single month or 
all-months-combined speculative position limit established under this 
section shall not apply to pre-existing positions, provided however, 
that if such position is not a pre-enactment swap or transition period 
swap then that position shall be attributed to the person if the 
person's position is increased after the effective date of such limit.
    (h) Positions on foreign boards of trade. The speculative position 
limits established under this section shall apply to a person's 
combined positions in referenced contracts, including positions 
executed on, or pursuant to the rules of a foreign board of trade, 
pursuant to section 4a(a)(6) of the Act, provided that:
    (1) Such referenced contracts settle against any price (including 
the daily or final settlement price) of one or more contracts listed 
for trading on a designated contract market or swap execution facility 
that is a trading facility; and
    (2) The foreign board of trade makes available such referenced 
contracts to its members or other participants located in the United 
States through direct access to its electronic trading and order 
matching system.
    (i) Anti-evasion provision. For the purposes of applying the 
speculative position limits in this section, if used to willfully 
circumvent or evade speculative position limits:
    (1) A commodity index contract and/or a location basis contract 
shall be considered to be a referenced contract;
    (2) A bona fide hedging transaction or position recognition or 
spread exemption shall no longer apply; and
    (3) A swap shall be considered to be an economically equivalent 
swap.
    (j) Delegation of authority to the Director of the Division of 
Market Oversight. (1) The Commission hereby delegates, until it orders 
otherwise, to the Director of the Division of Market Oversight or such 
other employee or employees as the Director may designate from time to 
time, the authority in paragraph (f) of this section to request 
estimated deliverable supply from a designated contract market and to 
provide the format and procedures for submitting such estimates.
    (2) The Director of the Division of Market Oversight may submit to 
the Commission for its consideration any matter which has been 
delegated in this section.
    (3) Nothing in this section prohibits the Commission, at its 
election, from exercising the authority delegated in this section.
    (k) Eligible affiliates and aggregation. For purposes of this part, 
if an eligible affiliate meets the conditions for any exemption from 
aggregation under Sec.  150.4, the eligible affiliate may choose to 
utilize that exemption, or it may opt to be aggregated with its 
affiliated entities.
0
20. Revise Sec.  150.3 to read as follows:


Sec.  150.3  Exemptions.

    (a) Positions which may exceed limits. The speculative position 
limits set forth in Sec.  150.2 may be exceeded to the extent that all 
applicable requirements in this part are met, provided that such 
positions are one of the following:
    (1) Bona fide hedging transactions or positions. Positions that 
comply with the bona fide hedging transaction or position definition in 
Sec.  150.1, and are:
    (i) Enumerated in appendix A to this part; or
    (ii) Bona fide hedging transactions or positions, other than those 
enumerated in appendix A to this part, that are approved as non-
enumerated bona fide hedging transactions or positions in accordance 
with paragraph (b)(4) of this section or Sec.  150.9;
    (2) Spread transactions. Transactions that:
    (i) Meet the spread transaction definition in Sec.  150.1; or
    (ii) Do not meet the spread transaction definition in Sec.  150.1, 
but have been approved by the Commission pursuant to paragraph (b)(4) 
of this section.
    (3) Financial distress positions. Positions of a person, or related 
persons, under financial distress circumstances, when exempted by the 
Commission from any of the requirements of this part in response to a 
specific request made to the Commission pursuant to Sec.  140.99 of 
this chapter, where financial distress circumstances include, but are 
not limited to, situations involving the potential default or 
bankruptcy of a customer of the requesting person or persons, an 
affiliate of the requesting person or persons, or a potential 
acquisition target of the requesting person or persons;
    (4) Conditional spot month limit exemption positions in natural 
gas. Spot month positions in natural gas cash-settled referenced 
contracts that exceed the spot month speculative position limit set 
forth in Sec.  150.2, provided that such positions:
    (i) Do not exceed the equivalent of 10,000 contracts of the NYMEX 
Henry Hub Natural Gas core referenced futures contract per designated 
contract market that lists a natural gas cash-settled referenced 
contract;

[[Page 11721]]

    (ii) Do not exceed 10,000 futures equivalent contracts in 
economically equivalent swaps in natural gas; and
    (iii) That the person holding or controlling such positions does 
not hold or control positions in spot-month physical-delivery 
referenced contracts in natural gas; or
    (5) Pre-enactment and transition period swaps exemption. The 
speculative position limits set forth in Sec.  150.2 shall not apply to 
positions acquired in good faith in any pre-enactment swap, or in any 
transition period swap, in either case as defined by Sec.  150.1; 
provided however, that a person may net such positions with post-
effective date commodity derivative contracts for the purpose of 
complying with any non-spot month speculative position limit.
    (b) Application for relief. Any person with a position in a 
referenced contract seeking recognition of such position as a bona fide 
hedging transaction or position, in accordance with paragraph 
(a)(1)(ii) of this section, or seeking an exemption for a spread 
position in accordance with paragraphs (a)(2)(ii) of this section, in 
each case for purposes of federal speculative position limits set forth 
in Sec.  150.2, may submit an application to the Commission in 
accordance with this section.
    (1) Required information. The application shall include the 
following information:
    (i) With respect to an application for a recognition of a bona fide 
hedging transaction or position:
    (A) A description of the position in the commodity derivative 
contract for which the application is submitted, including, but not 
limited to, the name of the underlying commodity and the derivative 
position size;
    (B) Information to demonstrate why the position satisfies the 
requirements of section 4a(c)(2) of the Act and the definition of bona 
fide hedging transaction or position in Sec.  150.1, including factual 
and legal analysis;
    (C) A statement concerning the maximum size of all gross positions 
in commodity derivative contracts for which the application is 
submitted;
    (D) A description of the applicant's activity in the cash markets 
and swaps markets for the commodity underlying the position for which 
the application is submitted, including, but not limited to, 
information regarding the offsetting cash positions; and
    (E) Any other information that may help the Commission determine 
whether the position satisfies the requirements of section 4a(c)(2) of 
the Act and the definition of bona fide hedging transaction or position 
in Sec.  150.1.
    (ii) With respect to an application for a spread exemption:
    (A) A description of the spread position for which the application 
is submitted;
    (B) A statement concerning the maximum size of all gross positions 
in commodity derivative contracts for which the application is 
submitted; and
    (C) Any other information that may help the Commission determine 
whether the position is consistent with section 4a(a)(3)(B) of the Act.
    (2) Additional information. If the Commission determines that it 
requires additional information in order to determine whether to 
recognize a position as a bona fide hedging transaction or position, or 
grant a spread exemption, the Commission shall:
    (i) Notify the applicant of any supplemental information required; 
and
    (ii) Provide the applicant with ten business days in which to 
provide the Commission with any supplemental information.
    (3) Timing of application. (i) Except as provided in paragraph 
(b)(3)(ii) of this section, a person seeking relief in accordance with 
this section must submit an application to the Commission and receive a 
notice of approval of such application prior to the date that the 
position for which the application was submitted would be in excess of 
the applicable federal speculative position limit set forth in Sec.  
150.2;
    (ii) A person may, however, due to demonstrated sudden or 
unforeseen increases in their bona fide hedging needs, submit an 
application for a recognition of a bona fide hedging transaction or 
position within five business days after the person established the 
position that exceeded the applicable federal speculative position 
limit.
    (A) Any application filed pursuant to paragraph (b)(3)(ii) of this 
section must include an explanation of the circumstances warranting the 
sudden or unforeseen increases in bona fide hedging needs.
    (B) If an application filed pursuant to paragraph (b)(3)(ii) of 
this section is denied, the person must bring its position within the 
federal speculative position limits within a commercially reasonable 
time, as determined by the Commission in consultation with the 
applicant and the applicable designated contract market or swap 
execution facility.
    (C) The Commission will not determine that the person holding the 
position has committed a position limits violation during the period of 
the Commission's review nor once the Commission has issued its 
determination.
    (4) Commission determination. After review of the application and 
any supplemental information provided by the requestor, the Commission 
will determine, with respect to the transaction or position for which 
the request is submitted, whether to recognize all or a specified 
portion of such transaction or position as a bona fide hedging 
transaction or position or whether to exempt all or a specified portion 
of such spread transaction, as applicable. The Commission shall notify 
the applicant of its determination, and an applicant may exceed federal 
speculative position limits set forth in Sec.  150.2 upon receiving a 
notice of approval.
    (5) Renewal of application. With respect to any application 
approved by the Commission pursuant to this section, a person shall 
renew such application if the information provided pursuant to 
paragraph (b)(1) of this section changes or upon request by the 
Commission.
    (6) Commission revocation or modification. If the Commission 
determines, at any time, that a recognized bona fide hedging 
transaction or position is no longer consistent with section 4a(c)(2) 
of the Act or the definition of bona fide hedging transaction or 
position in Sec.  150.1, or that a spread exemption is no longer 
consistent with section 4a(a)(3)(B) of the Act, the Commission shall 
notify the person holding such position and, in its discretion, revoke 
or modify the bona fide hedge recognition or spread exemption for 
purposes of federal speculative position limits and require the person 
to reduce the derivatives position within a commercially reasonable 
time or otherwise come into compliance. This notification shall briefly 
specify the nature of the issues raised and the specific provisions of 
the Act or the Commission's regulations with which the position or 
application is, or appears to be, inconsistent.
    (c) Previously-granted risk management exemptions. Exemptions 
previously granted by the Commission under Sec.  1.47 of this chapter, 
or by a designated contract market or swap execution facility, in 
either case to the extent that such exemptions are for the risk 
management of positions in financial instruments, including but not 
limited to index funds, shall not apply after the effective date of 
speculative position limit levels adopted, pursuant to Sec.  150.2(e). 
Nothing in this paragraph

[[Page 11722]]

shall preclude the Commission, a designated contract market, or swap 
execution facility from recognizing a bona fide hedging transaction or 
position for the former holder of such a risk management exemption if 
the position complies with the definition of bona fide hedging 
transaction or position under this part, including appendices hereto.
    (d) Recordkeeping. (1) Persons who avail themselves of exemptions 
or relief under this section shall keep and maintain complete books and 
records concerning all details of their related cash, forward, futures, 
options on futures, and swap positions and transactions, including 
anticipated requirements, production and royalties, contracts for 
services, cash commodity products and by-products, cross-commodity 
hedges, and records of bona fide hedging swap counterparties, and shall 
make such books and records available to the Commission upon request 
under paragraph (e) of this section.
    (2) Any person that relies on a representation received from 
another person that a swap qualifies as a pass-through swap under 
paragraph (2) of the definition of bona fide hedging transaction or 
position in Sec.  150.1 shall keep and make available to the Commission 
upon request all relevant books and records supporting such a 
representation, including any record the person intends to use to 
demonstrate that the pass-through swap is a bona fide hedging 
transaction or position, for a period of at least two years following 
the expiration of the swap.
    (3) All books and records required to be kept pursuant to this 
section shall be kept in accordance with the requirements of Sec.  1.31 
of this chapter.
    (e) Call for information. Upon call by the Commission, the Director 
of the Division of Enforcement or the Director's delegate, any person 
claiming an exemption from speculative position limits under this 
section shall provide to the Commission such information as specified 
in the call relating to the positions owned or controlled by that 
person; trading done pursuant to the claimed exemption; the commodity 
derivative contracts or cash market positions which support the claimed 
exemption; and the relevant business relationships supporting a claimed 
exemption.
    (f) Aggregation of accounts. Entities required to aggregate 
accounts or positions under Sec.  150.4 shall be considered the same 
person for the purpose of determining whether they are eligible for an 
exemption under paragraphs (a)(1) through (4) of this section with 
respect to such aggregated account or position.
    (g) Delegation of authority to the Director of the Division of 
Market Oversight. (1) The Commission hereby delegates, until it orders 
otherwise, to the Director of the Division of Market Oversight, or such 
other employee or employees as the Director may designate from time to 
time:
    (i) The authority in paragraph (a)(3) of this section to provide 
exemptions in circumstances of financial distress;
    (ii) The authority in paragraph (b)(2) of this section to request 
additional information with respect to a request for a bona fide 
hedging transaction or position recognition or spread exemption;
    (iii) The authority in paragraph (b)(3)(ii)(B) of this section to, 
if applicable, determine a commercially reasonable amount of time 
required for a person to bring its position within the federal 
speculative position limits:
    (iv) The authority in paragraph (b)(4) of this section to make a 
determination whether to recognize a position as a bona fide hedging 
transaction or position or to grant a spread exemption; and
    (v) The authority in paragraph (b)(2) or (b)(5) of this section to 
request that a person submit updated materials or renew their request 
with the Commission.
    (2) The Director of the Division of Market Oversight may submit to 
the Commission for its consideration any matter which has been 
delegated in this section.
    (3) Nothing in this section prohibits the Commission, at its 
election, from exercising the authority delegated in this section.
0
21. Revise Sec.  150.5 to read as follows:


Sec.  150.5   Exchange-set speculative position limits and exemptions 
therefrom.

    (a) Requirements for exchange-set limits on commodity derivative 
contracts subject to federal limits set forth in Sec.  150.2--(1) 
Exchange-set limits. For any commodity derivative contract that is 
subject to a federal speculative position limit under Sec.  150.2, a 
designated contract market or swap execution facility that is a trading 
facility shall set a speculative position limit no higher than the 
level specified in Sec.  150.2.
    (2) Exemptions to exchange-set limits. A designated contract market 
or swap execution facility that is a trading facility may grant 
exemptions from any speculative position limits it sets under paragraph 
(a)(1) of this section in accordance with the following:
    (i) Exemption levels. Exemptions of the type that conform to the 
exemptions the Commission identified in:
    (A) Sections 150.3(a)(1)(i), (a)(2)(i), and (a)(4) through (5) may 
be granted at a level that exceeds the level of the applicable federal 
limit in Sec.  150.2;
    (B) Sections 150.3(a)(1)(ii) and (a)(2)(ii) may be granted at a 
level that exceeds the level of the applicable federal limit in Sec.  
150.2, provided that, the exemption is first approved in accordance 
with Sec.  150.3(b) or 150.9, as applicable;
    (C) Section 150.3(a)(3) may be granted at a level that exceeds the 
level of the applicable federal limit in Sec.  150.2, provided that, 
the Commission has first approved such exemption pursuant to a request 
submitted under Sec.  140.99 of this chapter; and
    (D) Exemptions of the type that do not conform to the exemptions 
identified in Sec.  150.3(a) shall be granted at a level that is capped 
at the level of the applicable federal limit in Sec.  150.2 and that 
complies with paragraph (a)(2)(ii)(C) of this section, unless the 
Commission has first approved such exemption pursuant to Sec.  150.3(b) 
or pursuant to a request submitted under Sec.  140.99.
    (ii) Application for exemption from exchange-set limits. A 
designated contract market or swap execution facility that is a trading 
facility that elects to grant exemptions under paragraph (a)(2)(i) of 
this section:
    (A) (1) Except as provided in paragraph (a)(2)(ii)(A)(2) of this 
section, shall require traders to file an application requesting such 
exemption in advance of the date that such position would be in excess 
of the limits then in effect. Such application shall include any 
information needed to enable the designated contract market or swap 
execution facility to determine, and the Commission to verify, whether 
the facts and circumstances demonstrate that the designated contract 
market or swap execution facility may grant an exemption. Any 
application for a bona fide hedging transaction or position shall 
include a description of the applicant's activity in the cash markets 
and swaps markets for the commodity underlying the position for which 
the application is submitted, including, but not limited to, 
information regarding the offsetting cash positions.
    (2) The designated contract market or swap execution facility may, 
however, adopt rules that allow a person, due to demonstrated sudden or 
unforeseen increases in its bona fide hedging needs, to file an 
application to request a recognition of a bona fide hedging transaction 
or position within five business days after the person

[[Page 11723]]

established the position that exceeded the applicable exchange-set 
speculative position limit.
    (3) The designated contract market or swap execution facility must 
require that any application filed pursuant to paragraph 
(a)(2)(ii)(A)(2) of this section include an explanation of the 
circumstances warranting the sudden or unforeseen increases in bona 
fide hedging needs.
    (4) If an application filed pursuant to paragraph (a)(2)(ii)(A)(2) 
of this section is denied, the applicant must bring its position within 
the designated contract market or swap execution facility's speculative 
position limits within a commercially reasonable time as determined by 
the designated contract market or swap execution facility.
    (5) The designated contract market, swap execution facility, or 
Commission will not determine that the person holding the position has 
committed a position limits violation during the period of the 
designated contract market or swap execution facility's review nor once 
the designated contract market or swap execution facility has issued 
its determination;
    (B) Shall require, for any such exemption granted, that the trader 
re-apply for the exemption at least on an annual basis;
    (C) May, in accordance with the designated contract market or swap 
execution facility's rules, deny any such application, or limit, 
condition, or revoke any such exemption, at any time after providing 
notice to the applicant, and shall take into account whether the 
requested exemption would result in positions that would not be in 
accord with sound commercial practices in the relevant commodity 
derivative market and/or that would exceed an amount that may be 
established and liquidated in an orderly fashion in that market; and
    (D) Notwithstanding paragraph (a)(2)(ii)(C) of this section, may 
require persons with positions that comply either with the bona fide 
hedging transactions or positions definition or the spread transactions 
definition in Sec.  150.1, as applicable, to exit any such positions in 
excess of limits during the lesser of the last five days of trading or 
the time period for the spot month in such physical-delivery contract, 
or to otherwise limit the size of such position. Designated contract 
markets and swap execution facilities may refer to paragraph (b) of 
appendix B to part 150 for guidance regarding the foregoing.
    (3) Exchange-set limits on pre-existing positions--(i) Pre-existing 
positions in a spot month. A designated contract market or swap 
execution facility that is a trading facility shall require compliance 
with spot month exchange-set speculative position limits for pre-
existing positions in commodity derivative contracts other than pre-
enactment swaps and transition period swaps.
    (ii) Pre-existing positions in a non-spot month. A single month or 
all-months-combined speculative position limit established under 
paragraph (a)(1) of this section shall not apply to any pre-existing 
positions in commodity derivative contracts, provided however, that if 
such position is not a pre-enactment swap or transition period swap, 
then such position shall be attributed to the person if the person's 
position is increased after the effective date of such limit.
    (4) Monthly reports detailing the disposition of each application. 
(i) For commodity derivative contracts subject to federal speculative 
position limits, the designated contract market or swap execution 
facility shall submit to the Commission a report each month showing the 
disposition of any exemption application, including the recognition of 
any position as a bona fide hedging transaction or position, the 
exemption of any spread transaction or other position, the renewal, 
revocation, or modification of a previously granted recognition or 
exemption, or the rejection of any application, as well as the 
following details:
    (A) The date of disposition;
    (B) The effective date of the disposition;
    (C) The expiration date of any recognition or exemption;
    (D) Any unique identifier(s) the designated contract market or swap 
execution facility may assign to track the application, or the specific 
type of recognition or exemption;
    (E) If the application is for an enumerated bona fide hedging 
transaction or position, the name of the enumerated bona fide hedging 
transaction or position listed in appendix A to this part;
    (F) If the application is for a spread transaction listed in the 
spread transaction definition in Sec.  150.1, the name of the spread 
transaction as it is listed in Sec.  150.1;
    (G) The identity of the applicant;
    (H) The listed commodity derivative contract or position(s) to 
which the application pertains;
    (I) The underlying cash commodity;
    (J) The maximum size of the commodity derivative position that is 
recognized by the designated contract market or swap execution facility 
as a bona fide hedging transaction or position, specified by contract 
month and by the type of limit as spot month, single month, or all-
months-combined, as applicable;
    (K) Any size limitations or conditions established for a spread 
exemption or other exemption; and
    (L) For bona fide hedging transactions or positions, a concise 
summary of the applicant's activity in the cash markets and swaps 
markets for the commodity underlying the commodity derivative position 
for which the application was submitted.
    (ii) The designated contract market or swap execution facility 
shall submit to the Commission the information required by paragraph 
(a)(4)(i) of this section:
    (A) As specified by the Commission on the Forms and Submissions 
page at www.cftc.gov; and
    (B) Using the format, coding structure, and electronic data 
transmission procedures approved in writing by the Commission.
    (b) Requirements for exchange-set limits on commodity derivative 
contracts in a physical commodity that are not subject to the limits 
set forth in Sec.  150.2--(1) Exchange-set spot month limits--(i) Spot 
month speculative position limit levels. For any commodity derivative 
contract subject to paragraph (b) of this section, a designated 
contract market or swap execution facility that is a trading facility 
shall establish speculative position limits for the spot month no 
greater than 25 percent of the estimated spot month deliverable supply, 
calculated separately for each month to be listed.
    (ii) Additional sources for compliance. Alternatively, a designated 
contract market or swap execution facility that is a trading facility 
may submit rules to the Commission establishing spot month speculative 
position limits other than as provided in paragraph (b)(1)(i) of this 
section, provided that the limits are set at a level that is necessary 
and appropriate to reduce the potential threat of market manipulation 
or price distortion of the contract's or the underlying commodity's 
price or index.
    (2) Exchange-set limits or accountability outside of the spot 
month--(i) Non-spot month speculative position limit or accountability 
levels. For any commodity derivative contract subject to paragraph (b) 
of this section, a designated contract market or swap execution 
facility that is a trading facility shall adopt either speculative 
position limits or position accountability outside of the spot month at 
a level that is necessary and appropriate to reduce the potential 
threat of market manipulation or price

[[Page 11724]]

distortion of the contract's or the underlying commodity's price or 
index.
    (ii) Additional sources for compliance. A designated contract 
market or swap execution facility that is a trading facility may refer 
to the non-exclusive acceptable practices in paragraph (b) of appendix 
F of this part to demonstrate to the Commission compliance with the 
requirements of paragraph (b)(2)(i) of this section.
    (3) Look-alike contracts. For any newly listed commodity derivative 
contract subject to paragraph (b) of this section that is substantially 
the same as an existing contract listed on a designated contract market 
or swap execution facility that is a trading facility, a designated 
contract market or swap execution facility that is a trading facility 
listing such newly listed contract shall adopt spot month, individual 
month, and all-months-combined speculative position limits comparable 
to those of the existing contract. Alternatively, if such designated 
contract market or swap execution facility seeks to adopt speculative 
position limits that are not comparable to those of the existing 
contract, such designated contract market or swap execution facility 
shall demonstrate to the Commission how the levels comply with 
paragraphs (b)(1) and/or (b)(2) of this section.
    (4) Exemptions to exchange-set limits. A designated contract market 
or swap execution facility that is a trading facility may grant 
exemptions from any speculative position limits it sets under 
paragraphs (b)(1) or (b)(2) of this section in accordance with the 
following:
    (i) Traders shall be required to apply to the designated contract 
market or swap execution facility for any such exemption from its 
speculative position limit rules; and
    (ii) A designated contract market or swap execution facility that 
is a trading facility may deny any such application, or limit, 
condition, or revoke any such exemption, at any time after providing 
notice to the applicant, and shall take into account whether the 
requested exemption would result in positions that would not be in 
accord with sound commercial practices in the relevant commodity 
derivative market and/or would exceed an amount that may be established 
and liquidated in an orderly fashion in that market.
    (c) Requirements for security futures products. For security 
futures products, speculative position limits and position 
accountability requirements are specified in Sec.  41.25 of this 
chapter.
    (d) Rules on aggregation. For commodity derivative contracts in a 
physical commodity, a designated contract market or swap execution 
facility that is a trading facility shall have aggregation rules that 
conform to Sec.  150.4.
    (e) Requirements for submissions to the Commission. A designated 
contract market or swap execution facility that is a trading facility 
that adopts speculative position limits and/or position accountability 
levels pursuant to paragraphs (a) or (b) of this section, and/or that 
elects to offer exemptions from any such levels pursuant to such 
paragraphs, shall submit to the Commission pursuant to part 40 of this 
chapter rules establishing such levels and/or exemptions. To the extent 
any such designated contract market or swap execution facility adopts 
speculative position limit levels, such part 40 submission shall also 
include the methodology by which such levels are calculated, and the 
designated contract market or swap execution facility shall review such 
speculative position limit levels regularly for compliance with this 
section and update such speculative position limit levels as needed.
    (f) Delegation of authority to the Director of the Division of 
Market Oversight--(1) Commission delegations. The Commission hereby 
delegates, until it orders otherwise, to the Director of the Division 
of Market Oversight, or such other employee or employees as the 
Director may designate from time to time, the authority in paragraph 
(a)(4)(ii) of this section to provide instructions regarding the 
submission to the Commission of information required to be reported, 
pursuant to paragraph (a)(4)(i) of this section, by a designated 
contract market or swap execution facility, to specify the manner for 
submitting such information on the Forms and Submissions page at 
www.cftc.gov and to determine the format, coding structure, and 
electronic data transmission procedures for submitting such 
information.
    (2) Commission consideration of delegated matter. The Director of 
the Division of Market Oversight may submit to the Commission for its 
consideration any matter which has been delegated in this section.
    (3) Commission authority. Nothing in this section prohibits the 
Commission, at its election, from exercising the authority delegated in 
this section.
0
22. Revise Sec.  150.6 to read as follows:


Sec.  150.6  Scope.

    This part shall only be construed as having an effect on 
speculative position limits set by the Commission or by a designated 
contract market or swap execution facility, including any associated 
recordkeeping and reporting regulations in this chapter. Nothing in 
this part shall be construed to relieve any contract market, swap 
execution facility, or its governing board from responsibility under 
section 5(d)(4) of the Act to prevent manipulation and corners. 
Further, nothing in this part shall be construed to affect any other 
provisions of the Act or Commission regulations, including, but not 
limited to, those relating to actual or attempted manipulation, 
corners, squeezes, fraudulent or deceptive conduct, or to prohibited 
transactions.


Sec.  150.7  [Reserved].

0
23. Add and reserve Sec.  150.7.
0
24. Add Sec.  150.8 to read as follows:


Sec.  150.8  Severability.

    If any provision of this part, or the application thereof to any 
person or circumstances, is held invalid, such invalidity shall not 
affect the validity of other provisions or the application of such 
provision to other persons or circumstances that can be given effect 
without the invalid provision or application.
0
25. Add Sec.  150.9 to read as follows:


Sec.  150.9  Process for recognizing non-enumerated bona fide hedging 
transactions or positions with respect to federal speculative position 
limits.

    For purposes of federal speculative position limits, a person with 
a position in a referenced contract seeking recognition of such 
position as a non-enumerated bona fide hedging transaction or position, 
in accordance with Sec.  150.3(a)(1)(ii), shall submit an application 
to the Commission, pursuant to Sec.  150.3(b), or submit an application 
to a designated contract market or swap execution facility in 
accordance with this section. If such person submits an application to 
a designated contract market or swap execution facility in accordance 
with this section, and the designated contract market or swap execution 
facility, with respect to its own speculative position limits 
established pursuant to Sec.  150.5(a), recognizes the person's 
position as a non-enumerated bona fide hedging transaction or position, 
then the person may also exceed the applicable federal speculative 
position limit for such position, in accordance with paragraph (e) of 
this section. The designated contract market or swap execution facility 
may approve such applications only if the designated contract market or 
swap execution facility complies with the conditions set forth in 
paragraphs (a) through (e) of this section.
    (a) Approval of rules. The designated contract market or swap 
execution

[[Page 11725]]

facility maintains rules, consistent with the requirements of this 
section and approved by the Commission pursuant to Sec.  40.5 of this 
chapter, that establish application processes and conditions for 
recognizing bona fide hedging transactions or positions.
    (b) Prerequisites for a designated contract market or swap 
execution facility to recognize bona fide hedging transactions or 
positions in accordance with this section. (1) The designated contract 
market or swap execution facility lists the applicable referenced 
contract for trading;
    (2) The position meets the definition of bona fide hedging 
transactions or positions in section 4a(c)(2) of the Act and the 
definition of bona fide hedging transactions or positions in Sec.  
150.1; and
    (3) The designated contract market or swap execution facility does 
not recognize as a bona fide hedging transaction or position any 
position involving a commodity index contract and one or more 
referenced contracts, including exemptions known as risk management 
exemptions.
    (c) Application process. The designated contract market or swap 
execution facility's application process meets the following 
conditions:
    (1) Required application information. The designated contract 
market or swap execution facility requires the applicant to provide, 
and can obtain from the applicant, all information to enable the 
designated contract market or swap execution facility to determine, and 
the Commission to verify, whether the facts and circumstances 
demonstrate that the designated contract market or swap execution 
facility may recognize a position as a bona fide hedging transaction or 
position, including the following:
    (i) A description of the position in the commodity derivative 
contract for which the application is submitted, including but not 
limited to, the name of the underlying commodity and the derivative 
position size;
    (ii) Information to demonstrate why the position satisfies the 
requirements of section 4a(c)(2) of the Act and the definition of bona 
fide hedging transaction or position in Sec.  150.1, including factual 
and legal analysis;
    (iii) A statement concerning the maximum size of all gross 
positions in commodity derivative contracts for which the application 
is submitted;
    (iv) A description of the applicant's activity in the cash markets 
and the swaps markets for the commodity underlying the position for 
which the application is submitted, including, but not limited to, 
information regarding the offsetting cash positions; and
    (v) Any other information the designated contract market or swap 
execution facility requires, in its discretion, to verify that the 
position complies with paragraph (b)(2) of this section, as applicable.
    (2) Timing of application. (i) Except as provided in paragraph 
(c)(2)(ii) of this section, the designated contract market or swap 
execution facility requires the applicant to submit an application and 
receive a notice of approval of such application prior to the date that 
the position for which such application was submitted would be in 
excess of the applicable federal speculative position limits.
    (ii) A designated contract market or swap execution facility may, 
however, adopt rules that allow a person to, due to demonstrated sudden 
or unforeseen increases in its bona fide hedging needs, file an 
application with the designated contract market or swap execution 
facility to request a recognition of a bona fide hedging transaction or 
position within five business days after the person established the 
position that exceeded the applicable federal speculative position 
limit.
    (A) The designated contract market or swap execution facility must 
require that any application filed pursuant to paragraph (c)(2)(ii) of 
this section include an explanation of the circumstances warranting the 
sudden or unforeseen increases in bona fide hedging needs.
    (B) If an application filed pursuant to paragraph (c)(2)(ii) of 
this section is denied by the designated contract market, swap 
execution facility, or Commission, the applicant must bring its 
position within the applicable federal speculative position limits 
within a commercially reasonable time as determined by the Commission 
in consultation with the applicant and the applicable designated 
contract market or swap execution facility.
    (C) The designated contract market, swap execution facility, or 
Commission will not determine that the person holding the position has 
committed a position limits violation during the period of the 
designated contract market, swap execution facility, or Commission's 
review nor once a determination has been issued.
    (3) Renewal of applications. The designated contract market or swap 
execution facility requires each applicant to reapply for such 
recognition or exemption at least on an annual basis by updating the 
original application, and to receive a notice of approval of the 
renewal from the designated contract market or swap execution facility 
prior to the date that such position would be in excess of the 
applicable federal speculative position limits.
    (4) Exchange revocation authority. The designated contract market 
or swap execution facility retains its authority to limit, condition, 
or revoke, at any time after providing notice to the applicant, any 
bona fide hedging transaction or position recognition for purposes of 
the designated contract market or swap execution facility's speculative 
position limits established under Sec.  150.5(a), for any reason as 
determined in the discretion of the designated contract market or swap 
execution facility, including if the designated contract market or swap 
execution facility determines that the position no longer meets the 
conditions set forth in paragraph (b) of this section, as applicable.
    (d) Recordkeeping. (1) The designated contract market or swap 
execution facility keeps full, complete, and systematic records, which 
include all pertinent data and memoranda, of all activities relating to 
the processing of such applications and the disposition thereof. Such 
records include:
    (i) Records of the designated contract market or swap execution 
facility's recognition of any derivative position as a bona fide 
hedging transaction or position, revocation or modification of any such 
recognition, or the rejection of an application;
    (ii) All information and documents submitted by an applicant in 
connection with its application, including documentation and 
information that is submitted after the disposition of the application, 
and any withdrawal, supplementation, or update of any application;
    (iii) Records of oral and written communications between the 
designated contract market or swap execution facility and the applicant 
in connection with such application; and
    (iv) All information and documents in connection with the 
designated contract market or swap execution facility's analysis of, 
and action(s) taken with respect to, such application.
    (2) All books and records required to be kept pursuant to this 
section shall be kept in accordance with the requirements of Sec.  1.31 
of this chapter.
    (e) Process for a person to exceed federal speculative position 
limits on a referenced contract--(1) Notification to the Commission. 
The designated contract market or swap execution facility must submit 
to the Commission a notification of each initial determination to 
recognize a bona fide hedging transaction or position in accordance 
with this section,

[[Page 11726]]

concurrently with the notice of such determination the designated 
contract market or swap execution facility provides to the applicant.
    (2) Notification requirements. The notification in paragraph (e)(1) 
of this section shall include, at a minimum, the following information:
    (i) Name of the applicant;
    (ii) Brief description of the bona fide hedging transaction or 
position being recognized;
    (iii) Name of the contract(s) relevant to the recognition;
    (iv) The maximum size of the position that may exceed federal 
speculative position limits;
    (v) The effective date and expiration date of the recognition;
    (vi) An indication regarding whether the position may be maintained 
during the last five days of trading during the spot month, or the time 
period for the spot month; and
    (vii) A copy of the application and any supporting materials.
    (3) Exceeding federal speculative position limits on referenced 
contracts. A person may exceed federal speculative position limits on a 
referenced contract ten business days after the designated contract 
market or swap execution facility issues the notification required 
pursuant to paragraph (e)(1) of this section, unless the Commission 
notifies the designated contract market or swap execution facility and 
the applicant otherwise, pursuant to paragraph (e)(5) of this section, 
before the ten business day period expires.
    (4) Exceeding federal speculative position limits on referenced 
contracts due to sudden or unforeseen circumstances. If a person files 
an application for a recognition of a bona fide hedging transaction or 
position in accordance with paragraph (c)(2)(ii) of this section, then 
such person may rely on the designated contract market or swap 
execution facility's determination to grant such recognition for 
purposes of federal speculative position limits two business days after 
the designated contract market or swap execution facility issues the 
notification required pursuant to paragraph (e)(1) of this section, 
unless the Commission notifies the designated contract market or swap 
execution facility and the applicant otherwise, pursuant to paragraph 
(e)(5) of this section, before the two business day period expires.
    (5) Commission stay of pending applications and requests for 
additional information. If the Commission determines to stay an 
application that requires additional time to analyze, or request 
additional information to determine whether the position for which the 
application is submitted meets the conditions set forth in paragraph 
(b) of this section, the Commission shall notify the applicable 
designated contract market or swap execution facility and applicant of 
the Commission's determination or request for any supplemental 
information required, and provide an opportunity for the applicant to 
respond with any supplemental information.
    (6) Commission determination. If the Commission determines that a 
position for which the application is submitted does not meet the 
conditions set forth in paragraph (b) of this section, the Commission 
shall:
    (i) Notify the designated contract market or swap execution 
facility and applicant, and, after providing an opportunity for the 
applicant to respond, the Commission may, in its discretion, reject the 
exchange's determination for purposes of federal speculative position 
limits and, as applicable, require the person to reduce the derivatives 
position within a commercially reasonable time, as determined by the 
Commission in consultation with the applicant and the applicable 
designated contract market or swap execution facility, or otherwise 
come into compliance; and
    (ii) The Commission will not determine that the person holding the 
position has committed a position limits violation during the period of 
the Commission's review nor once the Commission has issued its 
determination.
    (f) Commission revocation of approved applications. (1) If a 
designated contract market or swap execution facility limits, 
conditions, or revokes any recognition of a bona fide hedging 
transaction or position for purposes of the designated contract market 
or swap execution facility's speculative position limits established 
under Sec.  150.5(a), then such recognition will also be deemed 
limited, conditioned, or revoked for purposes of federal speculative 
position limits.
    (2) If the Commission determines, at any time, that a position that 
has been recognized as a bona fide hedging transaction or position has 
been granted for a position that, for purposes of federal speculative 
position limits, is no longer consistent with section 4a(c)(2) of the 
Act or the definition of bona fide hedging transaction or position in 
Sec.  150.1, the following applies:
    (i) The Commission shall notify the person holding the position 
and, after providing an opportunity to respond, the Commission may, in 
its discretion, revoke the exchange's determination for purposes of 
federal speculative position limits and require the person to reduce 
the derivatives position within a commercially reasonable time as 
determined by the Commission in consultation with the applicant and the 
applicable designated contract market or swap execution facility, or 
otherwise come into compliance;
    (ii) The Commission shall include in its notification a brief 
explanation of the nature of the issues raised and the specific 
provisions of the Act or the Commission's regulations with which the 
position or application is, or appears to be, inconsistent; and
    (iii) The Commission shall not determine that the person holding 
the position has committed a position limits violation during the 
period of the Commission's review nor once the Commission has issued 
its determination, provided the person reduced the derivatives position 
within a commercially reasonable time, as determined by the Commission 
in consultation with the applicant and the applicable designated 
contract market or swap execution facility, or otherwise came into 
compliance.
    (g) Delegation of authority to the Director of the Division of 
Market Oversight--(1) Commission delegations. The Commission hereby 
delegates, until it orders otherwise, to the Director of the Division 
of Market Oversight, or such other employee or employees as the 
Director may designate from time to time, the authority in paragraph 
(e)(5) of this section, to request additional information from the 
applicable designated contract market or swap execution facility and 
applicant;
    (2) Commission consideration of delegated matter. The Director of 
the Division of Market Oversight may submit to the Commission for its 
consideration any matter which has been delegated in this section.
    (3) Commission authority. Nothing in this section prohibits the 
Commission, at its election, from exercising the authority delegated in 
this section.
0
26. Add appendices A through F to read as follows:

Appendix A to Part 150--List of Enumerated Hedges

    Persons that follow specific practices outlined in the 
enumerated hedges in this appendix shall establish compliance with 
the bona fide hedging transactions or positions definition in Sec.  
150.1 and with Sec.  150.3(a)(1)(i) without being required to 
request approval under Sec.  150.3 or Sec.  150.9 prior to exceeding 
the applicable federal speculative position limit. All other persons 
must request approval pursuant to Sec.  150.3 or Sec.  150.9 prior 
to exceeding the applicable federal speculative position limit.

[[Page 11727]]

    Compliance with an enumerated bona fide hedge listed below does 
not, however, diminish or replace, in any event, the obligations and 
requirements of the person to comply with the regulations provided 
under this part 150. The enumerated bona fide hedges do not state 
the exclusive means for establishing compliance with the bona fide 
hedging transactions or positions definition in Sec.  150.1 or with 
the requirements of Sec.  150.3(a)(1).
    (a) Enumerated hedges. The following positions comply with the 
bona fide hedging transactions or positions definition in Sec.  
150.1:
    (1) Hedges of unsold anticipated production. Short positions in 
commodity derivative contracts that do not exceed in quantity the 
person's unsold anticipated production of the contract's underlying 
cash commodity.
    (2) Hedges of offsetting unfixed-price cash commodity sales and 
purchases. Both short and long positions in commodity derivative 
contracts that do not exceed in quantity the amount of the 
contract's underlying cash commodity that has been both bought and 
sold by the same person at unfixed prices:
    (A) Basis different delivery months in the same commodity 
derivative contract; or
    (B) Basis different commodity derivative contracts in the same 
commodity, regardless of whether the commodity derivative contracts 
are in the same calendar month.
    (3) Hedges of anticipated mineral royalties. Short positions in 
a person's commodity derivative contracts offset by the anticipated 
change in value of mineral royalty rights that are owned by that 
person, provided that the royalty rights arise out of the production 
of the commodity underlying the commodity derivative contract.
    (4) Hedges of anticipated services. Short or long positions in a 
person's commodity derivative contracts offset by the anticipated 
change in value of receipts or payments due or expected to be due 
under an executed contract for services held by that person, 
provided that the contract for services arises out of the 
production, manufacturing, processing, use, or transportation of the 
commodity underlying the commodity derivative contract.
    (5) Cross-commodity hedges. Positions in commodity derivative 
contracts described in paragraph (2) of the bona fide hedging 
transactions or positions definition in Sec.  150.1 or in paragraphs 
(a)(1) through (a)(4) and paragraphs (a)(6) through (a)(9) of this 
appendix A may also be used to offset the risks arising from a 
commodity other than the cash commodity underlying a commodity 
derivative contract, provided that the fluctuations in value of the 
position in the commodity derivative contract, or the commodity 
underlying the commodity derivative contract, shall be substantially 
related to the fluctuations in value of the actual or anticipated 
cash position or pass-through swap.
    (6) Hedges of inventory and cash commodity fixed-price purchase 
contracts. Short positions in commodity derivative contracts that do 
not exceed in quantity the sum of the person's ownership of 
inventory and fixed-price purchase contracts in the contract's 
underlying cash commodity.
    (7) Hedges of cash commodity fixed-price sales contracts. Long 
positions in commodity derivative contracts that do not exceed in 
quantity the sum of the person's fixed-price sales contracts in the 
contract's underlying cash commodity and the quantity equivalent of 
fixed-price sales contracts of the cash products and by-products of 
such commodity.
    (8) Hedges by agents. Long or short positions in commodity 
derivative contracts by an agent who does not own or has not 
contracted to sell or purchase the commodity derivative contract's 
underlying cash commodity at a fixed price, provided that the agent 
is responsible for merchandising the cash positions that are being 
offset in commodity derivative contracts and the agent has a 
contractual arrangement with the person who owns the commodity or 
holds the cash market commitment being offset.
    (9) Offsets of commodity trade options. Long or short positions 
in commodity derivative contracts that do not exceed in quantity, on 
a futures-equivalent basis, a position in a commodity trade option 
that meets the requirements of Sec.  32.3 of this chapter. Such 
commodity trade option transaction, if it meets the requirements of 
Sec.  32.3 of this chapter, may be deemed, for purposes of complying 
with this paragraph (a)(9) of this appendix A, a cash commodity 
purchase or sales contract as set forth in paragraphs (a)(6) or 
(a)(7) of this appendix A, as applicable.
    (10) Hedges of unfilled anticipated requirements. Long positions 
in commodity derivative contracts that do not exceed in quantity the 
person's unfilled anticipated requirements for the contract's 
underlying cash commodity, for processing, manufacturing, or use by 
that person, or for resale by a utility as it pertains to the 
utility's obligations to meet the unfilled anticipated demand of its 
customers for the customer's use.
    (11) Hedges of anticipated merchandising. Long or short 
positions in commodity derivative contracts that offset the 
anticipated change in value of the underlying commodity that a 
person anticipates purchasing or selling, provided that:
    (A) The position in the commodity derivative contract does not 
exceed in quantity twelve months' of current or anticipated purchase 
or sale requirements of the same cash commodity that is anticipated 
to be purchased or sold; and
    (B) The person is a merchant handling the underlying commodity 
that is subject to the anticipatory merchandising hedge, and that 
such merchant is entering into the position solely for purposes 
related to its merchandising business and has a demonstrated history 
of buying and selling the underlying commodity for its merchandising 
business.

Appendix B to Part 150--Guidance on Gross Hedging Positions and 
Positions Held During the Spot Period

    (a) Guidance on gross hedging positions. (1) A person's gross 
hedging positions may be deemed in compliance with the bona fide 
hedging transactions or positions definition in Sec.  150.1, 
provided that all applicable regulatory requirements are met, 
including that the position is economically appropriate to the 
reduction of risks in the conduct and management of a commercial 
enterprise and otherwise satisfies the bona fide hedging definition 
in Sec.  150.1, and provided further that:
    (A) The manner in which the person measures risk is consistent 
and follows historical practice for that person;
    (B) The person is not measuring risk on a gross basis to evade 
the speculative position limits in Sec.  150.2 or the aggregation 
rules in Sec.  150.4;
    (C) The person is able to demonstrate compliance with paragraphs 
(A) and (B) upon the request of the Commission and/or of a 
designated contract market, including by providing information 
regarding the entities with which the person aggregates positions; 
and
    (D) A designated contract market or swap execution facility that 
recognizes a particular gross hedging position as bona fide pursuant 
to Sec.  150.9 documents the justifications for doing so, and 
maintains records of such justifications in accordance with Sec.  
150.9(d).
    (b) Guidance regarding positions held during the spot period. 
Section 150.5(a)(2)(ii)(D) confirms the existing authority of 
designated contract markets and swap execution facilities to 
maintain rules that subject positions that comply with the bona fide 
hedging position or transaction definition in Sec.  150.1 to a 
restriction that no such position is maintained in any physical-
delivery commodity derivative contract during the lesser of the last 
five days of trading or the time period for the spot month in such 
physical-delivery contract (the ``spot period''). Any such 
designated contract market or swap execution facility may waive any 
such restriction, including if:
    (1) The position complies with the bona fide hedging transaction 
or position definition in Sec.  150.1;
    (2) There is an economically appropriate need to maintain such 
position in excess of federal speculative position limits during the 
spot period for such contract, and such need relates to the purchase 
or sale of a cash commodity; and
    (3) The person wishing to exceed federal position limits during 
the spot period:
    (A) Intends to make or take delivery during that time period;
    (B) Provides materials to the designated contract market or swap 
execution facility supporting a classification of the position as a 
bona fide hedging transaction or position and demonstrating facts 
and circumstances that would warrant holding such position in excess 
of limits during the spot period;
    (C) Demonstrates cash-market exposure in-hand that is verified 
by the designated contract market or swap execution facility and 
that supports holding the position during the spot period;
    (D) Demonstrates that, for short positions, the delivery is 
feasible, meaning that the person has the ability to deliver against 
the short position (i.e., has inventory on hand in a deliverable 
location and in a condition in which the commodity can be used upon 
delivery); and
    (E) Demonstrates that, for long positions, the delivery is 
feasible, meaning that the

[[Page 11728]]

person has the ability to take delivery at levels that are 
economically appropriate (i.e., the delivery comports with the 
person's demonstrated need for the commodity and the contract is the 
cheapest source for that commodity).

Appendix C to Part 150--Guidance Regarding the Referenced Contract 
Definition in Sec.  150.1

    This appendix C provides guidance regarding the ``referenced 
contract'' definition in Sec.  150.1, which provides in paragraph 
(3) that the definition of referenced contract does not include a 
location basis contract, a commodity index contract, or a trade 
option that meets the requirements of Sec.  32.3 of this chapter. 
The term referenced contract is used throughout part 150 of the 
Commission's regulations to refer to contracts that are subject to 
federal limits. A position in a contract that is not a referenced 
contract is not subject to federal limits, and, as a consequence, 
cannot be netted with positions in referenced contracts for purposes 
of federal limits. This guidance is intended to clarify the types of 
contracts that would qualify as a location basis contract or 
commodity index contract.
    Compliance with this guidance does not diminish or replace, in 
any event, the obligations and requirements of any person to comply 
with the regulations provided under this part, or any other part of 
the Commission's regulations. The guidance is for illustrative 
purposes only and does not state the exclusive means for a contract 
to qualify, or not qualify, as a referenced contract as defined in 
Sec.  150.1, or to comply with any other provision in this part.
    (a) Guidance. (1) As provided in paragraph (3) of the 
``referenced contract'' definition in Sec.  150.1, the following 
types of contracts are not deemed referenced contracts, meaning such 
contracts are not subject to federal limits and cannot be netted 
with positions in referenced contracts for purposes of federal 
limits: location basis contracts; commodity index contracts; swap 
guarantees; and trade options that meet the requirements of Sec.  
32.3 of this chapter.
    (2) Location basis contract. For purposes of the referenced 
contract definition in Sec.  150.1, a location basis contract means 
a commodity derivative contract that is cash-settled based on the 
difference in:
    (i) The price, directly or indirectly, of:
    (A) A particular core referenced futures contract; or
    (B) A commodity deliverable on a particular core referenced 
futures contract, whether at par, a fixed discount to par, or a 
premium to par; and
    (ii) The price, at a different delivery location or pricing 
point than that of the same particular core referenced futures 
contract, directly or indirectly, of:
    (A) A commodity deliverable on the same particular core 
referenced futures contract, whether at par, a fixed discount to 
par, or a premium to par; or
    (B) A commodity that is listed in appendix D to this part as 
substantially the same as a commodity underlying the same core 
referenced futures contract.
    (3) Commodity index contract. For purposes of the referenced 
contract definition in Sec.  150.1, a commodity index contract means 
an agreement, contract, or transaction based on an index comprised 
of prices of commodities that are not the same or substantially the 
same and that is not a location basis contract, a calendar spread 
contract, or an intercommodity spread contract as such terms are 
defined in this guidance, where:
    (i) A calendar spread contract means a cash-settled agreement, 
contract, or transaction that represents the difference between the 
settlement price in one or a series of contract months of an 
agreement, contract, or transaction and the settlement price of 
another contract month or another series of contract months' 
settlement prices for the same agreement, contract, or transaction; 
and
    (ii) An intercommodity spread contract means a cash-settled 
agreement, contract, or transaction that represents the difference 
between the settlement price of a referenced contract and the 
settlement price of another contract, agreement, or transaction that 
is based on a different commodity.

Appendix D to Part 150--Commodities Listed as Substantially the Same 
for Purposes of the Term ``Location Basis Contract'' As Used in the 
Referenced Contract Definition

    The following table lists core referenced futures contracts and 
commodities that are treated as substantially the same as a 
commodity underlying a core referenced futures contract for purposes 
of the term ``location basis contract'' as used in the referenced 
contract definition under Sec.  150.1, and as discussed in the 
associated appendix, Appendix C--Guidance Regarding the Referenced 
Contract Definition in Sec.  150.1.

   Location Basis Contract List of Substantially the Same Commodities
------------------------------------------------------------------------
                                   Commodities
                                    considered         Source(s) for
    Core referenced futures     substantially the     specification of
           contract              same (regardless         quality
                                   of location)
------------------------------------------------------------------------
NYMEX Light Sweet Crude Oil     1. Light           NYMEX Argus LLS vs.
 futures contract (CL):          Louisiana Sweet    WTI (Argus) Trade
                                 (LLS) Crude Oil.   Month futures
                                                    contract (E5).
                                                   NYMEX LLS (Argus) vs.
                                                    WTI Financial
                                                    futures contract
                                                    (WJ).
                                                   ICE Futures Europe
                                                    Crude Diff--Argus
                                                    LLS vs WTI 1st Line
                                                    Swap futures
                                                    contract (ARK).
                                                   ICE Futures Europe
                                                    Crude Diff--Argus
                                                    LLS vs WTI Trade
                                                    Month Swap futures
                                                    contract (ARL).
NYMEX New York Harbor ULSD      1. Chicago ULSD..  NYMEX Chicago ULSD
 Heating Oil futures contract                       (Platts) vs. NY
 (HO):                                              Harbor ULSD Heating
                                                    Oil futures contract
                                                    (5C).
                                2. Gulf Coast      NYMEX Group Three
                                 ULSD.              ULSD (Platts) vs. NY
                                                    Harbor ULSD Heating
                                                    Oil futures contract
                                                    (A6).
                                                   NYMEX Gulf Coast ULSD
                                                    (Argus) Up-Down
                                                    futures contract
                                                    (US).
                                                   NYMEX Gulf Coast ULSD
                                                    (Argus) Up-Down
                                                    BALMO futures
                                                    contract (GUD).
                                                   NYMEX Gulf Coast ULSD
                                                    (Platts) Up-Down
                                                    BALMO futures
                                                    contract (1L).
                                                   NYMEX Gulf Coast ULSD
                                                    (Platts) Up-Down
                                                    Spread futures
                                                    contract (LT).
                                                   ICE Futures Europe
                                                    Diesel Diff- Gulf
                                                    Coast vs Heating Oil
                                                    1st Line Swap
                                                    futures contract
                                                    (GOH).
                                                   CME Clearing Europe
                                                    Gulf Coast ULSD(
                                                    Platts) vs. New York
                                                    Heating Oil (NYMEX)
                                                    Spread Calendar swap
                                                    (ELT).
                                                   CME Clearing Europe
                                                    New York Heating Oil
                                                    (NYMEX) vs. European
                                                    Gasoil (IC) Spread
                                                    Calendar swap (EHA).
                                3. California Air  NYMEX Los Angeles
                                 Resources Board    CARB Diesel (OPIS)
                                 Spec ULSD (CARB    vs. NY Harbor ULSD
                                 no. 2 oil).        Heating Oil futures
                                                    contract (KL).
                                4. Gas Oil         ICE Futures Europe
                                 Deliverable in     Gasoil futures
                                 Antwerp,           contract (G).
                                 Rotterdam, or
                                 Amsterdam Area.

[[Page 11729]]

 
                                                   ICE Futures Europe
                                                    Heating Oil Arb--
                                                    Heating Oil 1st Line
                                                    vs Gasoil 1st Line
                                                    Swap futures
                                                    contract (HOT).
                                                   ICE Futures Europe
                                                    Heating Oil Arb--
                                                    Heating Oil 1st Line
                                                    vs Low Sulphur
                                                    Gasoil 1st Line Swap
                                                    futures contract
                                                    (ULL).
                                                   NYMEX NY Harbor ULSD
                                                    Heating Oil vs.
                                                    Gasoil futures
                                                    contract (HA).
NYMEX RBOB Gasoline futures     1. Chicago         NYMEX Chicago
 contract (RB):                  Unleaded 87        Unleaded Gasoline
                                 gasoline.          (Platts) vs. RBOB
                                                    Gasoline futures
                                                    contract (3C).
                                                   NYMEX Group Three
                                                    Unleaded Gasoline
                                                    (Platts) vs. RBOB
                                                    Gasoline futures
                                                    contract (A8).
                                2. Gulf Coast      NYMEX Gulf Coast CBOB
                                 Conventional       Gasoline A1 (Platts)
                                 Blendstock for     vs. RBOB Gasoline
                                 Oxygenated         futures contract
                                 Blending (CBOB)    (CBA).
                                 87.               NYMEX Gulf Coast Unl
                                                    87 (Argus) Up-Down
                                                    futures contract
                                                    (UZ).
                                3. Gulf Coast      NYMEX Gulf Coast CBOB
                                 CBOB 87 (Summer    Gasoline A2 (Platts)
                                 Assessment).       vs. RBOB Gasoline
                                                    futures contract
                                                    (CRB).
                                4. Gulf Coast      NYMEX Gulf Coast 87
                                 Unleaded 87        Gasoline M2 (Platts)
                                 (Summer            vs. RBOB Gasoline
                                 Assessment).       futures contract
                                                    (RVG).
                                                   NYMEX Gulf Coast 87
                                                    Gasoline M2 (Platts)
                                                    vs. RBOB Gasoline
                                                    BALMO futures
                                                    contract (GBB).
                                                   NYMEX Gulf Coast 87
                                                    Gasoline M2 (Argus)
                                                    vs. RBOB Gasoline
                                                    BALMO futures
                                                    contract (RBG).
                                5. Gulf Coast      NYMEX Gulf Coast Unl
                                 Unleaded 87.       87 (Platts) Up-Down
                                                    BALMO futures
                                                    contract (1K).
                                                   NYMEX Gulf Coast Unl
                                                    87 Gasoline M1
                                                    (Platts) vs. RBOB
                                                    Gasoline futures
                                                    contract (RV).
                                                   CME Clearing Europe
                                                    Gulf Coast Unleaded
                                                    87 Gasoline M1
                                                    (Platts) vs. New
                                                    York RBOB Gasoline
                                                    (NYMEX) Spread
                                                    Calendar swap (ERV).
                                6. Los Angeles     NYMEX Los Angeles
                                 California         CARBOB Gasoline
                                 Reformulated       (OPIS) vs. RBOB
                                 Blendstock for     Gasoline futures
                                 Oxygenate          contract (JL).
                                 Blending
                                 (CARBOB) Regular.
                                7. Los Angeles     NYMEX Los Angeles
                                 California         CARBOB Gasoline
                                 Reformulated       (OPIS) vs. RBOB
                                 Blendstock for     Gasoline futures
                                 Oxygenate          contract (JL).
                                 Blending
                                 (CARBOB) Premium.
                                8. Euro-BOB OXY    NYMEX RBOB Gasoline
                                 NWE Barges.        vs. Euro-bob Oxy NWE
                                                    Barges (Argus)
                                                    (1000mt) futures
                                                    contract (EXR).
                                                   CME Clearing Europe
                                                    New York RBOB
                                                    Gasoline (NYMEX) vs.
                                                    European Gasoline
                                                    Euro-bob Oxy Barges
                                                    NWE (Argus) (1000mt)
                                                    Spread Calendar swap
                                                    (EEXR).
                                9. Euro-BOB OXY    ICE Futures Europe
                                 FOB Rotterdam.     Gasoline Diff--RBOB
                                                    Gasoline 1st Line
                                                    vs. Argus Euro-BOB
                                                    OXY FOB Rotterdam
                                                    Barge Swap futures
                                                    contract (ROE).
------------------------------------------------------------------------

Appendix E to Part 150--Speculative Position Limit Levels

------------------------------------------------------------------------
                                                  Single-month and all
           Contract              Spot month              months
------------------------------------------------------------------------
Legacy Agricultural:
    Chicago Board of Trade              1,200  57,800.
     Corn (C).
    Chicago Board of Trade                600  2,000.
     Oats (O).
    Chicago Board of Trade              1,200  27,300.
     Soybeans (S).
    Chicago Board of Trade              1,500  16,900.
     Soybean Meal (SM).
    Chicago Board of Trade              1,100  17,400.
     Soybean Oil (SO).
    Chicago Board of Trade              1,200  19,300.
     Wheat (W).
    Chicago Board of Trade KC           1,200  12,000.
     HRW Wheat (KW).
    Minneapolis Grain                   1,200  12,000.
     Exchange Hard Red Spring
     Wheat (MWE).
    ICE Futures U.S. Cotton             1,800  11,900.
     No. 2 (CT).
Other Agricultural:
    Chicago Board of Trade                800  Not Applicable.
     Rough Rice (RR).
    Chicago Mercantile           \1\ 600/300/  Not Applicable.
     Exchange Live Cattle                 200
     (LC).
    ICE Futures U.S. Cocoa              4,900  Not Applicable.
     (CC).
    ICE Futures U.S. Coffee C           1,700  Not Applicable.
     (KC).
    ICE Futures U.S. FCOJ-A             2,200  Not Applicable.
     (OJ).
    ICE Futures U.S. Sugar             25,800  Not Applicable.
     No. 11 (SB).

[[Page 11730]]

 
    ICE Futures U.S. Sugar              6,400  Not Applicable.
     No. 16 (SF).
Energy:
    New York Mercantile             \2\ 2,000  Not Applicable.
     Exchange Henry Hub
     Natural Gas (NG).
    New York Mercantile            \3\ 6,000/  Not Applicable.
     Exchange Light Sweet         5,000/4,000
     Crude Oil (CL).
    New York Mercantile                 2,000  Not Applicable.
     Exchange NY Harbor ULSD
     (HO).
    New York Mercantile                 2,000  Not Applicable.
     Exchange RBOB Gasoline
     (RB).
Metal:
    Commodity Exchange, Inc.            1,000  Not Applicable.
     Copper (HG).
    Commodity Exchange, Inc.            6,000  Not Applicable.
     Gold (GC).
    Commodity Exchange, Inc.            3,000  Not Applicable.
     Silver (SI).
    New York Mercantile                    50  Not Applicable.
     Exchange Palladium (PA).
    New York Mercantile                   500  Not Applicable.
     Exchange Platinum (PL).
------------------------------------------------------------------------

Appendix F to Part 150--Guidance on, and Acceptable Practices in, 
Compliance With Sec.  150.5

    The following are guidance and acceptable practices for 
compliance with Sec.  150.5. Compliance with the acceptable 
practices and guidance does not diminish or replace, in any event, 
the obligations and requirements of the person to comply with the 
other regulations provided under this part. The acceptable practices 
and guidance are for illustrative purposes only and do not state the 
exclusive means for establishing compliance with Sec.  150.5.
---------------------------------------------------------------------------

    \1\ Step-down spot month limits would be for positions net long 
or net short as follows: 600 contracts at the close of trading on 
the first business day following the first Friday of the contract 
month; 300 contracts at the close of trading on the business day 
prior to the last five trading days of the contract month; and 200 
contracts at the close of trading on the business day prior to the 
last two trading days of the contract month.
    \2\ See Sec.  150.3 regarding the conditional spot month limit 
exemption for cash-settled positions in natural gas.
    \3\ Step-down spot month limits would be for positions net long 
or net short as follows: 6,000 contracts at the close of trading 
three business days prior to the last trading day of the contract; 
5,000 contracts at the close of trading two business days prior to 
the last trading day of the contract; and 4,000 contracts at the 
close of trading one business day prior to the last trading day of 
the contract.
---------------------------------------------------------------------------

    (a) Acceptable practices for compliance with Sec.  
150.5(b)(2)(i) regarding exchange-set limits or accountability 
outside of the spot month. A designated contract market or swap 
execution facility that is a trading facility may satisfy Sec.  
150.5(b)(2)(i) by complying with either of the following acceptable 
practices:
    (1) Non-spot month speculative position limits. For any 
commodity derivative contract subject to Sec.  150.5(b), a 
designated contract market or swap execution facility that is a 
trading facility sets individual single month or all-months-combined 
levels no greater than any one of the following:
    (i) The average of historical position sizes held by speculative 
traders in the contract as a percentage of the average combined 
futures and delta-adjusted option month-end open interest for that 
contract for the most recent calendar year;
    (ii) The level of the spot month limit for the contract;
    (iii) 5,000 contracts (scaled-down proportionally to the 
notional quantity per contract relative to the typical cash-market 
transaction if the notional quantity per contract is larger than the 
typical cash market transaction, and scaled up proportionally to the 
notional quantity per contract relative to the typical cash-market 
transaction if the notional quantity per contract is smaller than 
the typical cash market transaction); or
    (iv) 10 percent of the average combined futures and delta-
adjusted option month-end open interest in the contract for the most 
recent calendar year up to 50,000 contracts, with a marginal 
increase of 2.5 percent of open interest thereafter.
    (2) Non-spot month position accountability. For any commodity 
derivative contract subject to Sec.  150.5(b), a designated contract 
market or swap execution facility that is a trading facility adopts 
position accountability, as defined in Sec.  150.1.
    (b) [Reserved]

PART 151--[REMOVED AND RESERVED]

0
27. Under the authority of section 8a(5) of the Commodity Exchange Act, 
7 U.S.C. 12a(5), remove and reserve part 151.

    Issued in Washington, DC, on January 31, 2020, by the 
Commission.
Christopher Kirkpatrick,
Secretary of the Commission.

    Note: The following appendices will not appear in the Code of 
Federal Regulations.

Appendices to Position Limits for Derivatives--Commission Voting 
Summary, Chairman's Statement, and Commissioners' Statements

Appendix 1--Commission Voting Summary

    On this matter, Chairman Tarbert and Commissioners Quintenz and 
Stump voted in the affirmative. Commissioners Behnam and Berkovitz 
voted in the negative.

Appendix 2--Supporting Statement of Chairman Heath Tarbert

    I am pleased to support the Commission's proposed rule on limits 
for speculative positions in futures and derivatives markets. 
Today's proposal is a pragmatic approach that will protect our 
agricultural, energy, and metals markets from excessive speculation. 
But just as importantly, it will ensure fair and easy access to 
these markets for businesses producing, consuming, and wholesaling 
commodities under our jurisdiction.
    When I came to the Commission, I set out several strategic 
goals. Among them is to regulate our derivatives markets to promote 
the interests of all Americans. Another goal is to enhance the 
regulatory experience of market participants. The proposal we are 
issuing today will deliver on both. We also drew from each of our 
agency core values to craft it--commitment, forward-thinking, 
teamwork, and clarity. Clarity is of particular importance here 
because, ultimately, markets and their participants deserve 
regulatory certainty. We provide that today.

Making Our Markets Work for the American Economy

    If adopted, our proposal will help ensure that futures markets 
in agricultural, energy and metals commodities work for American 
households and businesses. Farmers, ranchers, energy producers, 
utilities, and manufacturers are the backbone of the American 
economy. Our derivatives markets generally, and in particular the 
markets addressed in this proposal, are designed specifically to 
allow these businesses to hedge their exposure to price changes.
    This Commission's proposal will protect Americans from some of 
the most nefarious machinations in our derivatives markets. First, 
capping speculative positions in the covered derivatives contracts 
will help prevent cornering and squeezing. Such manipulative schemes 
can cause artificial prices and can injure the users of commodities 
linked to the futures markets. Limiting speculative positions can 
also reduce the likelihood of chaotic price swings caused by 
speculative gamesmanship. In effect, position limits should help 
ensure that prices in our markets reflect real supply and demand.
    Position limits are not a solution born inside the Washington 
Beltway and imposed

[[Page 11731]]

on the market from afar. Instead, they are one of many tools that 
exchanges have used since the 19th century to mitigate the 
potentially damaging effects of excessive speculation. They are a 
pragmatic, Midwestern solution to a real-world problem. Recognizing 
the usefulness of exchange-set limits, the Commission has worked 
collaboratively with our exchanges since 1981 to put sensible 
position limits and accountability levels on speculative positions 
in all physical commodity futures markets.
    Our proposal would also end the ``risk management'' exemption 
that has allowed banks, hedge funds, and trading firms to take large 
and purely speculative positions in agricultural markets. Nearly a 
decade ago, Congress directed the Commission to address this issue. 
Today we are acting.
    Some observers have gone so far as to call position limits ``at 
best, a cure for a disease that does not exist or a placebo for one 
that does.'' \1\ I respectfully disagree. To be sure, position 
limits are not a silver bullet against the damaging impact of 
excessive speculative activity. But I also believe, as did Congress 
when it amended the Commodity Exchange Act, that position limits can 
help to ``diminish, eliminate, or prevent'' potential damage to the 
commodities markets that are so critical to our real economy.
---------------------------------------------------------------------------

    \1\ https://www.cftc.gov/PressRoom/SpeechesTestimony/dunnstatement101811.
---------------------------------------------------------------------------

    Still, setting limits requires balancing the competing need for 
liquidity in our markets against the potential for disruptive 
speculative positions. I believe that the spot month levels we are 
proposing are reasonably calibrated. They are based on the current 
rule of thumb that limits should be no more than 25 percent of the 
deliverable supply of the referenced commodity, in order to prevent 
corners and squeezes that everyone can agree are bad for the market.
    For the nine grain futures contracts currently subject to 
position limits,\2\ revising non-spot limits required the Commission 
to consider an additional complication. Eliminating the risk 
management exemption could potentially take away a source of 
liquidity further out the curve. For a farmer who needs to hedge the 
price risk on crops that are still in the ground, a bank with a risk 
management exemption may be the only willing buyer. To mitigate the 
impact of eliminating the risk management exemption, we have raised 
the non-spot month limits for the grain contracts. This should allow 
a broader set of market participants to provide liquidity and help 
farmers hedge their crop risk as far in advance as they need.
---------------------------------------------------------------------------

    \2\ The proposal would not set non-spot month limits on the 16 
contracts that are not currently subject to federal position limits.
---------------------------------------------------------------------------

Ensuring Access for Bona Fide Hedgers

    Position limits is the rare rule where the exception is as 
important as the rule itself. It cannot be said too often that these 
limits are on speculative activity. Congress has always intended 
that positions that are a bona fide hedge of price risk should not 
be subject to limits.
    It is critical, therefore, that we not disrupt the regulatory 
experience of American producers, middlemen, and end-users of 
commodities. The greatest risk of a position limits rule is that 
hedgers are caught in the limits aimed at speculators. This could 
reduce their ability to protect themselves from risk, which could in 
turn negatively impact the broader economy. If a farmer cannot 
offset a risk on next year's crop--if a refiner cannot offset a risk 
on crude oil for a new plant--or if a wholesaler cannot offset risks 
on inventory it is buying, those businesses will not expand their 
operations.
    Any position limits rule must therefore be written with those 
hedging needs in mind. Congress and the American people expect 
nothing less. The proposal addresses those needs through (i) a broad 
exemption for ``bona fide'' hedging, and (ii) a streamlined and non-
intrusive process for recognizing those exemptions.
    On the first point, the proposal will expand the types of 
hedging strategies that are presumed to meet the bona fide hedging 
definition--and therefore be eligible for an exemption from position 
limits. For the first time, we have included anticipated 
merchandising, meaning that wholesalers and middlemen connecting 
producers and consumers could more readily hedge their risks. We 
have also expanded the definition to conform to the hedging 
strategies that are common in energy markets. This will ensure that 
the new federal speculative limits on energy markets do not 
inadvertently undermine the producers, refiners, pipeline operators, 
and utilities that keep this country running.
    On the second point, we have built on prior proposals to create 
a practical and efficient way for hedgers to avail themselves of the 
bona fide hedging exemption. Creating burdensome red tape or slowing 
down approvals to take on hedging positions could result in lost 
business opportunities for the participants we are called to 
protect.
    For parties whose hedging needs fit within the enumerated list, 
they could exceed federal position limits without requesting 
approval from the Commission. They also would not need to submit 
information on their cash market positions--a duplicative and 
burdensome exercise that is better handled by the exchanges.
    For parties whose hedging needs do not fit within the enumerated 
list, we are offering a process whereby an exchange could evaluate 
that hedging need. If the exchange finds that the need is a bona 
fide hedge not captured by our list, the exchange would notify the 
Commission. Unless the Commission votes to reject it within 10 
business days, the exchange's recognition would be deemed effective 
for purposes of federal position limits. Given our expanded 
definition of bona fide hedging, I anticipate that it would be a 
rare case that a market participant finds its legitimate hedging 
needs are not already covered in the list of enumerated exemptions. 
Still, this process would provide flexibility and legal certainty, 
without excessive red tape.

Striking the Right Balance

    The Commission has grappled with position limits for a decade. 
The 2011 proposal was finalized, but struck down by a court because 
of concerns over its legal justification. Subsequent proposals in 
2013 and 2016 were never finalized, following pushback from market 
participants about access to bona fide hedge exemptions. The 
Commission and staff have worked with diligence and good faith to 
solve this puzzle. There are difficult, often competing interests to 
address in this seemingly simple rule. If an easy solution exists, I 
have no doubt that the Commission would have found it.
    Today's proposal is the culmination of ten years of effort 
across four Chairmen's tenures. I sincerely thank my predecessors, 
as well as the Commission staff, who have worked so hard for so long 
to strike the right balance. Each proposal and every piece of 
feedback has helped improve the proposal before the Commission 
today. I believe that the proposal offers the pragmatic, workable 
solution that would protect markets from corners and squeezes while 
preserving the ability of American businesses to manage their risks.

Putting the Burden in the Right Place

    Finally, I want to draw attention to one fundamental shift in 
approach between prior position limits rules and the present 
proposal. Previously, the Commission had read the Commodity Exchange 
Act to require federal limits to be placed on every futures contract 
for a physical commodity. This would have required the Commission to 
evaluate approximately 1,200 individual contracts to determine the 
appropriate levels.
    The 2011 position limits rule was challenged in court on this 
ground and was struck down. The court found that the statute was 
ambiguous about whether the Commission must impose limits on all 
futures, or whether it should impose limits only ``as the Commission 
finds are necessary[.]'' The court said that ``it is incumbent upon 
the agency not to rest simply on its parsing of the statutory 
language. It must bring its experience and expertise to bear in 
light of competing interests at stake to resolve the ambiguities in 
the statute.'' \3\
---------------------------------------------------------------------------

    \3\ Int'l Swap Dealers Assoc. v. CFTC, 887 F.Supp.2d 259, 281 
(D.D.C. 2012).
---------------------------------------------------------------------------

    The Commission is now bringing its experience and expertise to 
bear on this matter. We have taken a big picture approach to 
determine when position limits are in fact necessary. In short, we 
are proposing that speculative limits are necessary for those 
futures contracts that are physically delivered and where the 
futures market is important in the price discovery process for the 
underlying commodity. The Commission also examined whether a 
disruption in the distribution of that commodity would have a 
significant impact on our economy. This has led us to propose limits 
on 25 physically delivered futures contracts,\4\ which covers the 
vast majority of trading volume and open interest in physically 
delivered derivatives. In addition to the nine grain futures 
contracts currently subject to federal limits, this

[[Page 11732]]

includes the largest energy, metals, and other agricultural futures 
contracts.
---------------------------------------------------------------------------

    \4\ The proposal would also impose limits on approximately 400 
other futures contracts that are linked, directly or indirectly, to 
the 25 core physically delivered contracts.
---------------------------------------------------------------------------

    Position limits are like medicine; they can help cure a symptom 
but can have undesirable side effects. And like medicine, position 
limits should be prescribed only when necessary. I believe this 
change in the underlying rationale for the proposal will require 
thoughtful reflection before imposing additional position limits on 
additional contracts in the future. Position limits will always 
create a burden on someone in the market--whether a compliance 
burden on parties having to track their positions relative to 
limits, or potentially the loss of a business opportunity because 
the risks cannot be hedged.
    The statutory provisions on position limits can reasonably be 
read in two ways. The first reading would put the burden on the 
Commission to find position limits to be necessary before imposing 
them on new contracts. The second reading would mandate federal 
limits on all futures contracts irrespective of any need, 
reflexively putting placing a burden on all markets and all market 
participants. Given the choice of burdening a government agency or 
private enterprise, I think it is more prudent to put the burden on 
the government. That is what today's proposal does. As Thomas 
Jefferson said, ``Government exists for the interests of the 
governed, not for the governors.''

Appendix 3--Supporting Statement of Commissioner Brian Quintenz

    I am pleased to support the agency's revitalized approach to 
position limits. Today's iteration marks the CFTC's fifth proposed 
position limits rule since the Dodd-Frank Act \1\ amended the 
Commodity Exchange Act's (CEA) section on position limits. This 
proposal is, by far, the strongest of them all.
---------------------------------------------------------------------------

    \1\ 76 FR 4752 (Jan. 26, 2011); 78 FR 75680 (Dec. 12, 2013); 81 
FR 38458 (June 13, 2016) (``supplemental proposal''); and 81 FR 
96704 (Dec. 30, 2016). The CEA addresses position limits in section 
(sec.) 4a (7 U.S.C. 6a).
---------------------------------------------------------------------------

    Today's proposed rule promotes flexibility, certainty, and 
market integrity for end-users--farmers, ranchers, energy producers, 
transporters, processors, manufacturers, merchandisers, and all who 
use physically-settled derivatives to risk manage their exposure to 
physical goods. The proposal includes an expansive list of 
enumerated and self-effectuating bona fide hedge exemptions, and a 
streamlined, exchange-centered process to adjudicate non-enumerated 
bona fide hedge exemption requests.
    Of the five proposed rules, this proposal is the most true to 
the CEA in many significant respects: By requiring, as has long been 
the Commission's practice, a necessity finding before imposing 
limits, by including economically equivalent swaps, and, perhaps 
most importantly, by following Congress' instruction that, ``to the 
maximum extent practicable,'' any limits set by the Commission 
balance the interests among promoting liquidity, deterring 
manipulation, squeezes, and corners, and ensuring the price 
discovery function of the underlying market is not disrupted.\2\ The 
confluence of these factors occurs most acutely in the spot month 
for physically-settled contracts where the delivery process and 
price convergence is most vulnerable to potential manipulation or 
disruption due to outsized positions. By focusing exclusively on 
spot month position limits in the new set of physically-settled (and 
closely related cash-settled) contracts, the proposal elegantly 
balances the countervailing policy interests enumerated in the 
statute.
---------------------------------------------------------------------------

    \2\ Sec. 4a(a)(3).
---------------------------------------------------------------------------

Necessity Finding

    Today's proposal, unlike the recent prior proposals, premises 
new limits on a finding that they are necessary to diminish, 
eliminate, or prevent the burden on interstate commerce from 
extraordinary price movements caused by excessive speculation 
(``necessity finding'') in specific contracts, as Congress has long 
required in the CEA and its legislative precursors since 1936.\3\ I 
am pleased that the proposal complies with the District Court's 
ruling in the ISDA-position limits litigation: That the Commission 
must decide whether section 4a of the CEA mandates the CFTC set new 
limits or only permits the CFTC to set such limits pursuant to a 
necessity finding.\4\ As the District Court noted, ``the Dodd-Frank 
amendments do not constitute a clear and unambiguous mandate to set 
position limits.'' \5\ I agree with the proposal's determination 
that, when read together, paragraphs (1) and (2) of section 4a 
demand a necessity finding.
---------------------------------------------------------------------------

    \3\ Sec. 4a(1).
    \4\ ISDA et al. v CFTC, 887 F. Supp. 2d 259, 278 and 283-84 
(D.D.C. Sept. 28, 2012).
    \5\ Id. at 280.
---------------------------------------------------------------------------

    Section 4a(a)(2)(A) states that the Commission shall establish 
limits ``in accordance with the standards set forth in paragraph (1) 
of this subsection.'' \6\ Paragraph (1) establishes the Commission's 
authority to, ``proclaim and fix such limits on the amounts of 
trading . . . as the Commission finds are necessary to diminish, 
eliminate or prevent [the] burden'' on interstate commerce caused by 
unreasonable or unwarranted price moves associated with excessive 
speculation. This language dates back almost verbatim to legislation 
passed in 1936, in which Congress directed the CFTC's precursor to 
make a necessity finding before imposing position limits. The 
Congressional report accompanying the CEA from the 74th Congress 
includes the following directive, ``[Section 4a of the CEA] gives 
the Commodity Exchange Commission the power, after due notice and 
opportunity for hearing and a finding of a burden on interstate 
commerce caused by such speculation, to fix and proclaim limits on 
futures trading . . .'' \7\ In its ISDA opinion, the District Court 
noted the following: ``This text clearly indicated that Congress 
intended for the CFTC to make a `finding of a burden on interstate 
commerce caused by such speculation' prior to enacting position 
limits.'' \8\
---------------------------------------------------------------------------

    \6\ Sec. 4a(a)(2)(A) (``In accordance with the standards set 
forth in paragraph (1) of this subsection and consistent with the 
good faith exception cited in subsection (b)(2), with respect to 
physical commodities other than excluded commodities as defined by 
the Commission, the Commission shall by rule, regulation, or order 
establish limits on the amount of positions, as appropriate, other 
than bona fide hedge positions, that may be held by any person with 
respect to contracts of sale for future delivery or with respect to 
options on the contracts or commodities traded on or subject to the 
rules of a designated contract market.'')
    \7\ H.R. Rep. 74-421, at 5 (1935).
    \8\ 887 F. Supp. 2d 259, 269 (fn 4).
---------------------------------------------------------------------------

    I support the proposal's view that the most natural reading of 
section 4a(a)(2)(A)'s reference to paragraph (1)'s ``standards'' is 
that it logically includes the ``necessity'' standard. Paragraph 
(1)'s requirement to make a necessity finding, along with the 
aggregation requirement, provide substantive guidance to the 
Commission about when and how position limits should be implemented.
    If Congress intended to mandate that the Commission impose 
position limits on all physical commodity derivatives, there is 
little reason it would have referred to paragraph (1) and the 
Commission's long established practice of necessity findings. 
Instead, Congress intended to focus the Commission's attention on 
whether position limits should be considered for a broader set of 
contracts than the legacy agricultural contracts, but did not 
mandate those limits be imposed.

Setting New Limits ``As Appropriate''

    The proposal preliminarily determines that position limits are 
necessary to diminish, eliminate, or prevent the burden on 
interstate commerce posed by unreasonable or unwarranted prices 
moves that are attributable to excessive speculation in 25 
referenced commodity markets that each play a crucial role in the 
U.S. economy. I am aware that there is significant skepticism in the 
marketplace and among academics as to whether position limits are an 
appropriate tool to guard against extraordinary price movements 
caused by extraordinarily large position size. Some argue there is 
no evidence that excessive speculation currently exists in U.S. 
derivatives markets.\9\ Others believe that large and sudden price 
fluctuations are not caused by hyper-speculation, but rather by 
market participants' interpretations of basic supply and demand 
fundamentals.\10\ In contrast, still

[[Page 11733]]

others believe that outsized speculative positions, however defined, 
may aggravate price volatility, leading to price run-ups or declines 
that are not fully supported by market fundamentals.\11\
---------------------------------------------------------------------------

    \9\ Testimony of Erik Haas (Director, Market Regulation, ICE 
Futures U.S.) before the CFTC at 70 (Feb. 26, 2015) (``We point out 
the makeup of these markets, primarily to show that any regulations 
aimed at excessive speculation is a solution to a nonexistent 
problem in these contracts.''), available at: https://www.cftc.gov/idc/groups/public/@aboutcftc/documents/file/emactranscript022615.pdf.
    \10\ BAHATTIN BUYUKSAHIN & JEFFREY HARRIS, CFTC, THE ROLE OF 
SPECULATORS IN THE CRUDE OIL FUTURES MARKET 1, 16-19 (2009) (``Our 
results suggest that price changes leads the net position and net 
position changes of speculators and commodity swap dealers, with 
little or no feedback in the reverse direction. This uni-directional 
causality suggests that traditional speculators as well as commodity 
swap dealers are generally trend followers.''), available at https://www.cftc.gov/idc/groups/public/@swaps/documents/file/plstudy_19_cftc.pdf; Testimony of Philip K. Verleger, Jr. before the 
CFTC, Aug. 5, 2009 (``The increase in crude prices between 2007 and 
2008 was caused by the incompatibility of environmental regulations 
with the then-current global crude supply. Speculation had nothing 
to do with the price rise.''), available athttps://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/hearing080509_verleger.pdf.
    \11\ For a discussion of studies discussing supply and demand 
fundamentals and the role of speculation, see 81 FR 96704, 96727 
(Dec. 30, 2016). See, e.g., Hamilton, Causes and Consequences of the 
Oil Shock of 2007-2008, Brookings Paper on Economic Activity (2009); 
Chevallier, Price Relationships in Crude oil Futures: New Evidence 
from CFTC Disaggregated Data, Environmental Economics and Policy 
Studies (2012).
---------------------------------------------------------------------------

    In my opinion, position limits should not be viewed as a means 
to counteract long-term directional price moves. The CFTC is not a 
price setting agency and we should not impede the market from 
reflecting long term supply and demand fundamentals. It is worth 
noting that the physically-settled contract which has seen the 
largest sustained price increase recently is palladium,\12\ which 
has also seen its exchange-set position limit decline four times 
since 2014 to what is now the smallest limit of any contract in the 
referenced contract set.\13\ Nevertheless, between the start of 2018 
and the end of 2019, palladium futures prices rose 76%.\14\ Taking 
these conflicting views and facts into account, it is clear the 
Commission correctly stated in its 2013 proposal, ``there is a 
demonstrable lack of consensus in the [academic] studies'' as to the 
effectiveness of position limits.\15\
---------------------------------------------------------------------------

    \12\ Platinum, gold slide as dollar soars; palladium eases off 
record, Reuters (Sept. 30, 2019), available at: https://www.reuters.com/article/global-precious/precious-platinum-gold-slide-as-dollar-soars-palladium-eases-off-record-idUSL3N26L3UV.
    \13\ Between 2014 and 2017, the CME Group lowered the spot month 
position limit in the contract four times, from 650, to 500, to 400, 
to 100, to the current limit of 50 (NYMEX regulation 40.6(a) 
certifications, filed with the CFTC, 14-463 (Oct. 31, 2014), 15-145 
(Apr. 14, 2015), 15-377 (Aug. 27, 2015), and 17-227 (June 6, 2017)), 
available at: https://sirt.cftc.gov/sirt/sirt.aspx?Topic=ProductTermsandConditions.
    \14\ Palladium futures were at $1,087.35 on Jan. 2, 2018 and at 
$1,909.30 on Dec. 31, 2019. Historical prices available at: https://futures.tradingcharts.com/historical/PA_/2009/0/continuous.html.
    \15\ 78 FR 75694 (Dec. 12, 2013).
---------------------------------------------------------------------------

    With that healthy dose of skepticism, I think the proposal 
appropriately focuses on the time period and contract type where 
position limits can have the most positive, and the least negative, 
impact--the spot month of physically settled contracts--while also 
calibrating those limits to function as just one of many tools in 
the Commission's regulatory toolbox that can be used to promote 
credible, well-functioning derivatives and cash commodity markets.
    Because of the significance of these 25 core referenced futures 
contracts to the underlying cash markets, the level of liquidity in 
the contracts, as well as the importance of these cash markets to 
the national economy, I think it is appropriate for the Commission 
to protect the physical delivery process and promote convergence in 
these critical commodity markets. Further, the limits proposed today 
are higher than in the past, notably because the proposal utilizes 
current estimates of deliverable supply--numbers which haven't been 
updated since 1999.\16\ I am interested to hear feedback from 
commenters about whether the estimates of deliverable supply, and 
the calibrated limits based off of them, are sufficiently tailored 
for the individual contracts.
---------------------------------------------------------------------------

    \16\ 64 FR 24038 (May 5, 1999).
---------------------------------------------------------------------------

Taking End-Users Into Account

    Perhaps more than any other area of the CFTC's regulations, 
position limits directly affect the participants in America's real 
economy: Farmers, ranchers, energy producers, manufacturers, 
merchandisers, transporters, and other commercial end-users that use 
the derivatives market as a risk management tool to support their 
businesses. I am pleased that today's proposal takes into account 
many of the serious concerns that end-users voiced in response to 
the CFTC's previous five unsuccessful position limits proposals.
    Importantly, and in response to many comments, this proposal, 
for the first time, expands the possibility for enterprise-wide 
hedging,\17\ proposes an enumerated anticipated merchandising 
exemption,\18\ eliminates the ``five-day rule'' for enumerated 
hedges,\19\ and no longer requires the filing of certain cash market 
information with the Commission that the CFTC can obtain from 
exchanges.\20\ Regarding enterprise-wide hedging--otherwise known as 
``gross hedging''--the proposal would provide an energy company, for 
example, with increased flexibility to hedge different units of its 
business separately if those units face different economic 
realities.
---------------------------------------------------------------------------

    \17\ Proposed Appendix B, paragraph (a).
    \18\ Proposed Appendix A, paragraph (a)(11).
    \19\ Preamble discussion of Proposed Enumerated Bona Fide Hedges 
for Physical Commodities.
    \20\ Elimination of CFTC Form 204.
---------------------------------------------------------------------------

    With respect to cross-commodity hedging, today's proposal 
completely rejects the arbitrary, unworkable, ill-informed, and 
frankly, ludicrous ``quantitative test'' from the 2013 proposal.\21\ 
That test would have required a correlation of at least 0.80 or 
greater in the spot markets prices of the two commodities for a time 
period of at least 36 months in order to qualify as a cross-
hedge.\22\ Under this test, longstanding hedging practices in the 
electric power generation and transmission markets would have been 
prohibited. Today's proposal not only shuns this Government-Knows-
Best approach, it also proposes new flexibility for the cross-
commodity hedging exemption, allowing it to be used in conjunction 
with other enumerated hedges.\23\ For example, a commodity merchant 
could rely on the enumerated hedge for unsold anticipated production 
to exceed limits in a futures contract subject to the CFTC's limits 
in order to hedge exposure in a commodity for which there is no 
futures contract, provided that the two commodities share 
substantially related fluctuations in value.
---------------------------------------------------------------------------

    \21\ 78 FR 75,717 (Dec. 12, 2013).
    \22\ Id.
    \23\ Proposed Appendix A, paragraph (a)(5).
---------------------------------------------------------------------------

Bona Fide Hedges and Coordination With Exchanges

    For those market participants who employ non-enumerated bona 
fide hedging practices in the marketplace, this proposal creates a 
streamlined, exchange-focused process to approve those requests for 
purposes of both exchange-set and federal limits. As the 
marketplaces for the core referenced futures contracts addressed by 
the proposal, the DCMs have significant experience in, and 
responsibility towards, a workable position limits regime. CEA core 
principles require DCMs and swap execution facilities to set 
position limits, or position accountability levels, for the 
contracts that they list in order to reduce the threat of market 
manipulation.\24\ DCMs have long administered position limits in 
futures contracts for which the CFTC has not set limits, including 
in certain agricultural, energy, and metals markets. In addition, 
the exchanges have been strong enforcers of their own rules: during 
2018 and 2019, CME Group and ICE Futures US concluded 32 enforcement 
matters regarding position limits.
---------------------------------------------------------------------------

    \24\ DCM Core Principle 5 (sec. 5 of the CEA, 7 U.S.C. 7) 
(implemented by CFTC regulation 38.300) and SEF Core Principle 6 
(sec. 5h of the CEA, 7 U.S.C. 7b-3) (implemented by CFTC regulation 
37.600).
---------------------------------------------------------------------------

    As part of their stewardship of their own position limits 
regimes, DCMs have long granted bona fide hedging exemptions in 
those markets where there are no federal limits. Today's proposal 
provides what I believe is a workable framework to utilize 
exchanges' long standing expertise in granting exemptions that are 
not enumerated by CFTC rules.\25\ This proposed rule also recognizes 
that the CEA does not provide the Commission with free rein to 
delegate all of the authorities granted to it under the statute.\26\ 
The Commission itself, through a majority vote of the five 
Commissioners, retains the ability to reject an exchange-granted 
non-enumerated hedge request within 10 days of the exchange's 
approval. The Commission has successfully and responsibly used a 
similar process for both new contract listings as well as exchange 
rule filings, and I am pleased to see the proposal expand that 
approach to non-enumerated hedge exemption requests that will limit 
the uncertainty for bone fide commercial market participants.
---------------------------------------------------------------------------

    \25\ Proposed regulation 150.9.
    \26\ Preamble discussion of proposed regulation 150.9, including 
references to cases pointing out the extent to which an agency can 
delegate to persons outside of the agency.
---------------------------------------------------------------------------

    I look forward to hearing from end-users about whether this 
proposal provides them the flexibility and certainty they need to 
manage their exposures in a way that reflects the complexities and 
realities of their physical businesses. In particular, I am 
interested to hear if the list of enumerated bona fide hedging 
exemptions should be broadened to recognize other types of common, 
legitimate commercial hedging activity.

[[Page 11734]]

Proposed Limits on Swaps

    The CEA requires the Commission to consider limits not only on 
exchange-traded futures and options, but also on ``economically 
equivalent'' swaps.\27\ Today's proposal provides the market with 
far greater certainty on the universe of such swaps than the 
previous proposals. Prior proposals failed to sufficiently explain 
what constituted an ``economically equivalent swap,'' thereby 
ensuring that compliance with position limits was essentially 
unworkable, given real-time aggregation requirements and ambiguity 
over in-scope contracts. In stark contrast, today's proposed rule 
narrows the scope of ``economically equivalent'' swaps to those with 
material contractual specifications, terms, and conditions that are 
identical to exchange-traded contracts.\28\ For example, in order 
for a swap to be considered ``economically equivalent'' to a 
physically-settled core referenced futures contract, that swap would 
also have to be physically-settled, because settlement type is 
considered a material contractual term. I believe the proposed 
narrowly-tailored definition will provide market participants with 
clarity over those contracts subject to position limits. I also 
welcome suggestions from commenters regarding ways in which the 
definition can be further refined to complement limits on exchange-
traded contracts.
---------------------------------------------------------------------------

    \27\ Sec. 4a(5).
    \28\ Proposed regulation 150.1.
---------------------------------------------------------------------------

Conclusion

    Section 2a(10) of the CEA is not an often cited passage of text. 
It describes the Seal of the United States Commodity Futures Trading 
Commission, and in particular, lists a number of symbols on the seal 
which represent the mission and legacy of our agency: The plough 
showing the agricultural origin of futures markets; the wheel of 
commerce illuminating the importance of hedging markets to the 
broader economy; and, the scale of balanced interests, proposing a 
fair weighing of competing or contradicting forces.
    As I think about the proposal in front of us today, I believe it 
speaks to all of those elements enshrined in our agency's legacy, 
but the scale of balanced interests comes most to mind with this 
rule: new flexibility combined with new regulation, the removal of a 
few exemptions with the expansion or addition of others, the 
reliance on exchange expertise but with Commission review and 
oversight, and the balance of liquidity and price discovery against 
the threat of corners and squeezes. I am very pleased to support 
today's revitalized, confined, and tempered approach to position 
limits and look forward to comment letters, particularly from the 
end-user community.

Appendix 4--Dissenting Statement of Commissioner Rostin Behnam 
Introduction

    The ceremony for the 92nd Academy Awards will air in a little 
over a week. I haven't seen too many movies this year given my two 
young girls and hectic work schedule, but I did see ``Ford v 
Ferrari.'' \1\ ``Ford v Ferrari'' earned four award nominations, 
including best motion picture of the year. The film tells the true 
story of American car designer Carroll Shelby and British-born 
driver Ken Miles who built a race car for Ford Motor Company and 
competed with Enzo Ferrari's dominating and iconic red racing cars 
at the 1966 24 Hours of Le Mans.\2\ This high drama action film 
focuses foremost on the relationship between Shelby and Miles--the 
co-designers and driver of Ford's own iconic GT40--and their triumph 
over the competition, the course, the rulebook, and the bureaucracy. 
Even if you aren't a car enthusiast, the action, acting, and 
accuracy of the story are well worth your time. However, there is a 
lot more to this movie than racing.
---------------------------------------------------------------------------

    \1\ Ford v Ferrari (Twentieth Century Fox 2019).
    \2\ Ford v Ferrari, Fox Movies, https://www.foxmovies.com/movies/ford-v-ferrari (Last visited Jan. 28, 2020, 1:55 p.m.).
---------------------------------------------------------------------------

    There is a great scene where Miles is talking to his son about 
achieving the ``perfect lap''--no mistakes, every gear change, and 
every corner perfect. In response to his son's observation that you 
can't just ``push the car hard'' the whole time, Miles agrees, 
pensively staring down the track towards the setting sun. He says, 
``If you are going to push a piece of machinery to the limit, and 
expect it to hold together, you have to have some sense of where 
that limit is.''
    It's been nine years since the Commission first set out to 
establish the position limits regime required by amendments to 
section 4a of the Commodity Exchange Act (the ``Act'' or ``CEA''), 
\3\ under the Dodd-Frank Wall Street Reform and Consumer Protection 
Act of 2010.\4\ While I would like to be in a position to say that 
today's proposed rule addressing Position Limits for Derivatives 
(the ``Proposal'') is leading us towards that ``perfect lap,'' I 
cannot. While the Proposal purports to respect Congressional intent 
and the purpose and language of CEA section 4a, in reality, it 
pushes the bounds of reasonable interpretation by deferring to the 
exchanges \5\ and setting the Commission on a course where it will 
remain perpetually in the draft, unable to acquire the necessary 
experience to retake the lead in administering a position limits 
regime.
---------------------------------------------------------------------------

    \3\ See Position Limits for Derivatives, 76 FR 4752 (proposed 
Jan. 26, 2011) (the ``2011 Proposal'').
    \4\ The Dodd-Frank Wall Street Reform and Consumer Protection 
Act, Public Law 111-203 section 737, 124 Stat. 1376, 1722-25 (2010) 
(the ``Dodd-Frank Act'').
    \5\ As in the Proposal, unless otherwise indicated, the use of 
the term ``exchanges'' throughout this statement refers to 
designated contract markets (``DCMs'') and swap execution facilities 
(``SEFs'').
---------------------------------------------------------------------------

    In 2010 and the decades leading up to it, Congress understood 
that for the derivatives markets in physical commodities to perform 
optimally, there needed to be limits on the amount of control 
exerted by a single person (or persons acting in agreement). In 
tasking the Commission with establishing limits and the framework 
around their operation, Congress was aware of our relationship with 
the exchanges, but nevertheless opted for our experience and our 
expertise to meet the policy objectives of the Act.
    Right now, we are pushing to go faster and just get to the 
finish line, making real-time adjustments without regard for even 
trying for that ``perfect lap.'' It is unfortunate, but despite the 
Chairman's leadership and the talented staff's hard work, I do not 
believe that this Proposal will hold itself together. I must 
therefore, with all due respect, dissent.

Deference to Our Detriment

    While I have a number of concerns with the Proposal, my 
principal disagreement is with the Commission's determination to in 
effect disregard the tenets supporting the statutorily created 
parallel federal and exchange-set position limit regime, and take a 
back seat when it comes to administration and oversight. In doing 
so, the Commission claims victory for recognizing that the exchanges 
are better positioned in terms of resources, information, knowledge, 
and agility, and therefore ought to take the wheel. While the 
Commission believes it can withdraw and continue to maintain access 
to information that is critical to oversight, I fear that giving way 
absent sufficient understanding of what we are giving up, and 
planning for ad hoc Commission (and staff) determinations on key 
issues that are certain to come up, will let loose a different set 
of responsibilities that we have yet to consider.
    I believe the Proposal has many flaws that could be the subject 
of dissent. I am focusing my comments on those issues that I think 
are most critical for the public's review. Based on consideration of 
the Commission's mission, and Congressional intent as evinced in the 
Dodd-Frank Act amendments to CEA section 4a and elsewhere in the 
Act, I believe that (1) the Commission is required to establish 
position limits based on its reasoned and expert judgment within the 
parameters of the Act; (2) the Commission has not provided a 
rational basis for its determination not to propose federal limits 
outside of the spot month for referenced contracts based on 
commodities other than the nine legacy agricultural commodities; and 
(3) the Commission's seemingly unlimited flexibility in proposing to 
(a) significantly broaden the bona fide hedging definition, (b) 
codify an expanded list of self-effectuating enumerated bona fide 
hedges, (c) provide for exchange recognition of non-enumerated bona 
fide hedge exemptions with respect to federal limits, and (d) 
simultaneously eliminate notice and reporting mechanisms, is both 
inexplicably complicated to parse and inconsistent with 
Congressional intent.

The Commission Is Required To Establish Position Limits

    The Proposal goes to great lengths to reconcile whether the CEA 
section 4a(a)(2)(A) requires the Commission to make an antecedent 
necessity finding before establishing any position limit,\6\ with 
the implication that if a necessity finding is required, then the 
Commission could rationalize imposing no limits at all. I do not 
believe it was necessary to rehash the legislative and regulatory 
histories to determine the Commission's authority with respect to 
CEA section 4a. Nor do I believe it was worthwhile here to reply in 
such great

[[Page 11735]]

depth to the U.S. District Court for the District of Columbia's 
opinion vacating the Commission's 2011 final rulemaking on Position 
Limits for Futures and Swaps.\7\ The Proposal uses a tremendous 
amount of text to try and flesh out what is meant by ``necessary'', 
and yet I fear it does not demonstrate the Commission's ``bringing 
its expertise and experience to bear when interpreting the 
statute,'' giving effect to the meaning of each word in the statute, 
and providing an explanation for how any interpretation comports 
with the policy objectives of the Act as amended by the Dodd-Frank 
Act, as directed by the District Court.\8\ The Commission ought to 
avoid the temptation to retract when doing so requires the torture 
of strawmen. Not only do we look complacent, but we invite criticism 
for our unnecessary affront to the sensibilities of the public we 
serve.
---------------------------------------------------------------------------

    \6\ See Proposal at III.
    \7\ Int'l Swaps & Derivatives Ass'n v. CFTC, 887 F. Supp. 2d 259 
(D.D.C. 2012).
    \8\ Id. at 284.
---------------------------------------------------------------------------

    Looking back at the record, what is necessary is that the 
Commission complies with the mandate.\9\ In response to the District 
Court's directive, the Commission could have gone back through its 
own records to the 2011 Proposal. If it had done so, it would have 
found that the Commission provided a review of CEA section 4a(a)--
interpreting the various provisions, giving effect to each 
paragraph, acknowledging the Commission's own informational and 
experiential limitations regarding the swaps markets at that time, 
and focusing on the Commission's primary mission of fostering fair, 
open and efficient functioning of the commodity derivatives 
markets.\10\ Of note, ``Critical to fulfilling this statutory 
mandate,'' the Commission pronounced, ``is protecting market users 
and the public from undue burdens that may result from `excessive 
speculation.' '' \11\ Federal position limits, as predetermined by 
Congress, are most certainly the only means towards addressing the 
burdens of excessive speculation when such limits must address a 
``proliferation of economically equivalent instruments trading in 
multiple trading venues.'' \12\ Exchange-set position limits or 
accountability levels simply cannot meet the mandate.
---------------------------------------------------------------------------

    \9\ The Proposal's analysis in support of its denial of a 
mandate misconstrues form over substance and assumes the answer it 
is looking for by providing a misleading recitation of Michigan v. 
EPA, 135 S.Ct. 2699 (2015). In doing so, the Proposal seems to 
suggest that the Commission is free to ignore a Congressional 
mandate if it determines that Congress is wrong about the underlying 
policy. See Proposal at III.D.
    \10\ 76 FR at 4752-54.
    \11\ Id. at 4753.
    \12\ Id. at 4754-55.
---------------------------------------------------------------------------

    In exercising its authority, the Commission may evaluate whether 
exchange-set position limits, accountability provisions, or other 
tools for contracts listed on such exchanges are currently in place 
to protect against manipulation, congestion, and price 
distortions.\13\ Such an evaluation--while permissible--is just one 
factor for consideration. The existence of exchange-set limits or 
accountability levels, on their own, can neither predetermine 
deference nor be justified absent substantial consideration. The 
authority and jurisdiction of individual exchanges are necessarily 
different than that of the Commission. They do not always have 
congruent interests to the Commission in monitoring instruments that 
do not trade on or subject to the rules of their particular platform 
or the market participants that trade them. They do not have the 
attendant authority to determine key issues such as whether a swap 
performs or affects a significant price discovery function, or what 
instruments fit into the universe of economically equivalent swaps. 
They are not permitted to define bona fide hedging transactions or 
grant exemptions for purposes of federal position limits. It is 
therefore clear that CEA section 4a, as amended by the Dodd-Frank 
Act ``warrants extension of Commission-set position limits beyond 
agricultural products to metals and energy commodities.'' \14\
---------------------------------------------------------------------------

    \13\ See 76 FR at 4755.
    \14\ Id.
---------------------------------------------------------------------------

Unsupportable Deference

    In spite of all of this--the foregoing mandate; the clear 
Congressional intent in CEA section 4a(a)(3)(A); and the 
Commission's real experience and expertise (including its unique 
data repository)--the Commission only proposes to maintain federal 
non-spot month limits for the nine legacy agricultural contracts 
(with questionably appropriate modifications), ``because the 
Commission has observed no reason to eliminate them.'' \15\ 
Essentially, in the Commission's reasoned judgment, ``if it ain't 
broke, don't fix it.'' And so, the Commission, in keeping with this 
relatively riskless course of action, similarly was able to conclude 
that federal non-spot month limits are not necessary for the 
remaining 16 proposed core referenced futures contracts identified 
in the Proposal.
---------------------------------------------------------------------------

    \15\ Proposal at II.B.2.d.
---------------------------------------------------------------------------

    The Commission provides two reasons in support of its 
determination, and neither sufficiently demonstrates that the 
Commission utilized its experience and expertise. Rather, the 
Commission backs into deferring to the exchanges' authority to 
establish position limits or accountability levels. This course of 
action ignores the reality that Commission-set position limits serve 
a higher purpose than just addressing threats of market manipulation 
\16\ or creating parameters for exchanges in establishing their own 
limits.\17\ The Proposal advocates that there is no need to disturb 
the status quo, despite the fact that we have nothing to compare it 
to. The Commission places a higher value on minimizing the impact on 
industry--which it appears to have not quantified for purposes of 
the Proposal--than actually evaluating the appropriateness of limits 
in light of the purposes of the Act and as described in CEA section 
4a(a)(3).
---------------------------------------------------------------------------

    \16\ See 7 U.S.C. 7(d)(5) and 7b-3(f)(6).
    \17\ See, e.g., 7 U.S.C. 6a(e).
---------------------------------------------------------------------------

    The first reason the Commission submits in defense of not 
proposing federal limits outside of the spot month for the 16 
aforementioned contracts is that ``corners and squeezes cannot occur 
outside the spot month . . . and there are other tools other than 
federal position limits for deterring and preventing manipulation 
outside of the spot month.'' \18\ The ``other tools'' include 
surveillance by the Commission and exchanges, coupled with exchange-
set limits and/or accountability levels. As laid out in several 
paragraphs of the Proposal, the Commission would maintain a window 
into the setting of any limits or accountability levels that in its 
view are ``an equally robust'' alternative to federal non-spot month 
speculative position limits. In describing how accountability levels 
implemented by exchanges work, the Commission touts the flexibility 
in application because they provide exchanges--and not the 
Commission--the ability to ask questions about positions, determine 
if a position raises any concerns, provide an opportunity to 
intervene--or not--etc.\19\
---------------------------------------------------------------------------

    \18\ Proposal at II.B.2.d.
    \19\ See id.
---------------------------------------------------------------------------

    While all of this reads well, it ignores Congressional intent. 
The Proposal never considers that Congress directed the Commission 
to establish limits--not accountability levels. Given the 
Commission's ``decades of experience in overseeing accountability 
levels implemented by the exchanges,'' Congress would have been well 
aware that this alternative path would be a viable option if it were 
truly as robust in choosing the legislative language. But the 
Commission has failed to make that case. Foremost, federal position 
limits are aimed at diminishing, eliminating, and preventing sudden 
and unwarranted price changes. These sudden price changes may occur 
regardless of manipulative, intentional or reckless activity--both 
within and outside of the spot month. The Commission provides no 
explanation regarding how exchange-set limits or accountability 
levels would compare, in terms of effectiveness, to federal position 
limits, which among other things, must apply in the aggregate as 
mandated by CEA section 4a(a)(6). It is difficult to measure the 
robustness of a regime when there is nothing to compare it to. As 
well, the Commission's observation that exchange-set accountability 
levels have ``functioned as-intended'' until this point time, 
ignores the wider purpose and function of aggregate position limits 
established by the Commission, and is shortsighted given the ever 
expanding universe of economically equivalent instruments trading 
across multiple trading venues. Not to belabor the point, but it 
seems odd to conclude that Congress envisioned that its painstaking 
amendments to CEA section 4a were a directive for the Commission to 
check the box that the current system is working perfectly.
    The Commission's second reason is that layering federal non-spot 
limits for the 16 contracts on top of existing exchange-set limit/
accountability levels may only provide minimal benefits--if any--
while sacrificing the benefits associated with flexible 
accountability levels.\20\ The Commission,

[[Page 11736]]

again, ignores that Congress was clearly aware of the possible 
layering effect, and did not find it to be comparable let alone as 
robust.\21\ Moreover, the Commission fails to support or otherwise 
quantify its argument with data. Presumably, the Commission could 
calculate anticipated non-spot month position limits--based on the 
formula in the proposed part 150.2(e) (and described in section 
II.B.2. e. of the Proposal)--for the 16 proposed core referenced 
futures contracts that have never been subject to such limits. The 
Commission could have based its determination on aggregate position 
data it collects through surveillance, and it could have provided a 
rough estimate of the potential impact that limits may have, absent 
consideration of any of the proposed enumerated bona fide hedges or 
spread exemptions. While I am not sure such evidence if presented 
would have changed my mind, it certainly would have been helpful in 
determining the reasonableness of the Commission's determination.
---------------------------------------------------------------------------

    \20\ See id.
    \21\ See, e.g., 7 U.S.C. 6a(e) (providing, among other things 
and consistent with core principles for DCMs and SEFs, that 
exchange-set position limits shall not be higher that the limits 
fixed by the Commission).
---------------------------------------------------------------------------

What if?

    When muscles are overly flexible, they require appropriate 
strength to ensure that they can perform under stress. In addition 
to largely deferring to the exchanges in addressing excessive 
speculation outside of the spot-month for the majority of the 25 
core referenced futures contracts, the Proposal also incorporates 
flexibility in a multitude of other ways. The Proposal would provide 
for significantly broader bona fide hedging opportunities that will 
be largely self-effectuating; it would defer to the exchanges in 
recognizing non-enumerated bona fide hedging; and it would eliminate 
longstanding notice and reporting mechanisms. In proposing these 
various provisions, the Proposal flexes and contorts to accommodate 
each piece. In doing so, it seems the Commission will be left 
insufficient strength to accomplish its mandated role of exercising 
appropriate surveillance, monitoring, and enforcement authorities--
and this will be to the detriment of the derivatives markets and the 
public we serve.
    The main point to get across here is that while I support 
enhancing the cooperation between the Commission and the exchanges, 
the Commission here is cooperating by dropping back and promising to 
remain in the draft--never able to fully compete, or take advantage 
of a ``slingshot effect.'' We will simply never gain the necessary 
direct experience with the new regime. The Commission lacks 
experience in administering spot month limits for 16 of the 25 core 
referenced futures contracts and lacks familiarity with both common 
commercial hedging practices for the 16 contracts and the 
proliferation of the use of the dozen or so self-effectuating 
enumerated hedges and spread exemptions (also largely self-
effectuating) being proposed. While prior drafts of the Proposal 
admitted this as recently as two weeks ago, the Commission 
determined to change course and quickly let go of the line. The 
Commission's decision to essentially give up primary authority to 
recognize non-enumerated bona fide hedges, and to rely on the 
exchanges to collect and hold relevant cash market data for the 
Commission's use only after requesting it, seems both careless and 
inconsistent with Congressional intent.
    For example, while the Proposal provides the Commission with the 
authority to reject an exchange's granting of a non-enumerated bona 
fide hedge recognition, this determination must be in the form of a 
``Commission action,'' and it must take place in the span of ten 
business days (or two in the case of sudden or unforeseen 
circumstances). Furthermore, the Proposal offers no guidance as to 
what factors the Commission may consider, or the criteria it may use 
to make the determination. This narrow window of time likely will 
not provide Commission staff with a reasonable timeframe to prepare 
the necessary documentation for the full Commission to deliberate 
and either request additional information, stay the application, or 
vote to accept the recognition.\22\ It seems more likely that the 
Commission will be unable to act within the ten or two-day window 
and the recognition will default to being approved. Regardless of 
what the Commission determines--even if it ultimately determines 
that a position for which an application for a bona fide hedge 
recognition does not meet the CEA definition of a bona fide hedge or 
the requirements in proposed part 150.9(b)--the Commission could not 
determine that the person holding the position has committed a 
position limits violation during the Commission's ongoing review or 
upon issuing its determination. I have so many ``what ifs'' in 
response to this set up that I feel trapped.
---------------------------------------------------------------------------

    \22\ See Proposed part 150.9(e).
---------------------------------------------------------------------------

    In the Proposal, the Commission requires exchanges to collect 
cash-market information from market participants requesting bona 
fide hedges, and to provide it to the Commission only upon request. 
The Proposal also eliminates Commission Form 204, which market 
participants currently file each month when they have bona fide 
hedging positions in excess of the federal limits. This form is a 
necessary mechanism by which market participants demonstrate cash-
market positions justifying such overages. These changes may be 
well-intentioned, but they are ill-conceived in consideration of the 
various changes being proposed to the federal position limits 
regime.
    Foremost, under the Proposal, the Commission would receive a 
monthly report showing the exchange's disposition of any 
applications to recognize a position as a bona fide hedge (both 
enumerated and non-enumerated) or to grant a spread or other 
exemption (including any renewal, revocation of, or modification of 
a prior recognition or exemption).\23\ While the Proposal argues 
that the monthly report would be a critical element of the 
Commission's surveillance program by facilitating its ability to 
track bona fide hedging positions and spread exemptions approved by 
the exchanges,\24\ it would not itself appear to be useful in 
discerning any market participants ongoing justification for, or 
compliance with, self-effectuating or approved bona fide hedge, 
spread, or other exemption requirements. While the contents of the 
report may prompt the Commission to request records from the 
exchange, it is unclear what may be involved in the making of, and 
response to, such requests--including time and resources on both 
sides. Not to mention that the Proposal opines that exchanges would 
only collect responsive information on an annual basis,\25\ and part 
150.9(e) does not require exchanges to notify the Commission of any 
renewal applications. Of course, the Proposal posits that the 
Commission would likely only need to make such requests ``in the 
event that it noticed an issue that could cause market 
disruptions.'' \26\ My guess is that our surveillance staff and 
Division of Enforcement may have other ideas, but I will leave that 
with the ``what ifs.''
---------------------------------------------------------------------------

    \23\ See Proposed Commission regulation 150.5(a)(4).
    \24\ See Proposal at II.D.4.
    \25\ See Proposal at I.B.7.a. and b.
    \26\ Id. As well, the Proposal opines that the Commission's 
reliance on the ``limited circumstances'' set forth in proposed part 
150.9(f) under which it would revoke a bona fide hedge recognition 
granted by an exchange would be rarely exercised, suggesting a 
preference to defer to the judgment of the exchange. See Proposal at 
II.G.3.f.
---------------------------------------------------------------------------

Conclusion

    The 24 Hours of Le Mans awards the victory to the car that 
covers the greatest distance in 24 hours. While the Proposal shoots 
for victory by similarly attempting to achieve a great amount over a 
short time period, I am concerned that all of it will not hold 
together. The Proposal attempts to justify deferring to the 
exchanges on just about everything, and in-so-doing it pushes to the 
back any earnest interpretation of the Commission's mandate or the 
guiding Congressional intent. This is not cooperation, this is 
stepping-aside, backing down, giving way, and getting comfortable in 
the draft. I am not comfortable in this or any draft. It's my 
understanding that the Commission has the tools and resources to 
develop a better sense of where federal position limits ought to be 
in order to achieve the purposes for which they were designed, while 
maintaining our natural, Congressionally-mandated lead. The Proposal 
fails to recognize that Congress already set the course in directing 
us that our derivatives markets will operate optimally with limits--
we just need to provide a sense of where they are. Perhaps the 
Proposal was just never aiming for the ``perfect lap.''

Appendix 5--Statement of Commissioner Dawn D. Stump

    Reasonably designed. Balanced in approach. And workable in 
practice--both for market participants and for the Commission. These 
are the 3 guideposts by which I have evaluated the proposal before 
us to update the Commission's rules regarding position limits for 
derivatives. Is it reasonable in its design? Is it balanced in its 
approach? And is it workable in practice for

[[Page 11737]]

both market participants and the Commission? Overall, I believe the 
answer to each of these questions is yes, and I therefore support 
the publication of this proposal for public comment.
    There is one question that I have not asked: Is it perfect? It 
is not. There are two particular areas discussed below that I 
believe can be improved--the list of enumerated hedging transactions 
and positions, and the process for reviewing hedging practices 
outside of that list.
    But in reality, how could a position limits proposal ever 
achieve perfection? In section 4a(a) of the Commodity Exchange Act 
(``CEA''),\1\ Congress has given the Commission the herculean task 
of adopting position limits that:
---------------------------------------------------------------------------

    \1\ CEA section 4a(a), 7 U.S.C. 6a(a).
---------------------------------------------------------------------------

     It finds necessary to diminish, eliminate, or prevent 
an undue and unnecessary burden on interstate commerce as a result 
of excessive speculation in derivatives;
     Deter and prevent market manipulation, squeezes, and 
corners;
     Ensure sufficient market liquidity for bona fide 
hedgers; \2\
---------------------------------------------------------------------------

    \2\ Section 4a(c) of the CEA further requires that the 
Commission's position limit rules ``permit producers, purchasers, 
sellers, middlemen, and users of a commodity or a product derived 
therefrom to hedge their legitimate anticipated business needs . . 
.'' CEA section 4a(c), 7 U.S.C. 6a(c).
---------------------------------------------------------------------------

     Ensure that the price discovery function of the 
underlying market is not disrupted;
     Do not cause price discovery to shift to trading on 
foreign boards of trade; and
     Include economically equivalent swaps.
    And it must do so, according to the CEA's purposes set out in 
section 3(b), through a system of effective self-regulation of 
trading facilities.\3\
---------------------------------------------------------------------------

    \3\ CEA section 3(b), 7 U.S.C. 5(b).
---------------------------------------------------------------------------

    These statutory objectives are not only numerous, but in many 
instances they are in tension with one another. As a result, it is 
not surprising that each of us will have a different view of the 
perfect position limits framework. Perfection simply cannot be the 
standard by which this proposal is judged.
    But after nearly a decade of false starts, I believe the 
proposal before us brings us close to the end of that long journey. 
It is reasonably designed. It is balanced in its approach. And it is 
workable in practice. I am pleased to support putting it before the 
public for comment.

The Commission Has a Mandate To Impose Position Limits It Finds Are 
Necessary

Background

    Before digging into the substantive provisions of the proposal, 
let me offer my view on a legal issue that has been debated 
seemingly without end throughout the past decade in the Commission's 
rulemaking proceedings and in federal court. As noted in testimony 
by the CFTC's General Counsel in July 2009, a year before the Dodd-
Frank Act \4\ became law, the CEA has always given the Commission a 
mandate to impose federal position limits--that is, a mandate to 
impose federal position limits that it finds are necessary.\5\ The 
issue that has consumed the agency, the industry, and the bar is 
this: Did the amendments to the CEA's position limits provisions 
that were enacted as part of the Dodd-Frank Act strip the Commission 
of its discretion not to impose limits if it does not find them to 
be necessary?
---------------------------------------------------------------------------

    \4\ See Dodd-Frank Wall Street Reform and Consumer Protection 
Act, Public Law 111-203, 124 Stat. 1376 (2010) (``Dodd-Frank Act'').
    \5\ ``Position Limits and the Hedge Exemption, Brief Legislative 
History,'' Testimony of General Counsel Dan M. Berkovitz, Commodity 
Futures Trading Commission, before Hearing on Speculative Position 
Limits in Energy Futures Markets at 1 (July 28, 2009) (``Today, I 
will provide a brief legislative history of the mandate in the CEA 
concerning position limits and the exemption from those limits for 
bona fide hedging transactions. . . . Since its enactment in 1936, 
the Commodity Exchange Act (CEA) . . . has directed the Commodity 
Futures Trading Commission (CFTC) to establish such limits on 
trading `as the Commission finds are necessary to diminish, 
eliminate, or prevent such burden [on interstate commerce].' The 
basic statutory mandate in Section 4a of the CEA to establish 
position limits to prevent such burdens has remained unchanged over 
the past seven decades) (emphasis added), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement072809; 
see also, id. at 5 (``By the mid-1930s . . . Congress finally 
provided a federal regulatory authority with the mandate and 
authority to establish and enforce limits on speculative trading. In 
Section 4a of the 1936 Act (CEA), the Congress . . . . directed the 
Commodity Exchange Commission [the CFTC's predecessor agency] to 
establish such limits on trading `as the commission finds is [sic] 
necessary to diminish, eliminate, or prevent' such burdens . . .'') 
(emphasis added).
---------------------------------------------------------------------------

    I consider it unfortunate that the Commission has spent so much 
time, energy, and resources on this debate. That time, energy, and 
resources would have been much better spent focusing on the 
development of a position limits framework that is reasonably 
designed, balanced in approach, and workable in practice for both 
market participants and the Commission--which simply cannot be said 
of the Commission's prior efforts in this area. But, in the words of 
American writer Isaac Marion in his ``zombie romance'' novel Warm 
Bodies: ``We are where we are, however we got here.'' \6\ And so, a 
few thoughts on necessity and mandates.
---------------------------------------------------------------------------

    \6\ Isaac Marion, Warm Bodies and The New Hunger: A Special 5th 
Anniversary Edition, 97, Simon and Schuster (2016).
---------------------------------------------------------------------------

    In the ISDA v. CFTC case, a federal district court in 2012 
vacated the Commission's first post-Dodd-Frank Act attempt to adopt 
a position limits rulemaking. The court concluded that the Dodd-
Frank Act amendments to the position limits provisions of the CEA 
``are ambiguous and lend themselves to more than one plausible 
interpretation.'' Accordingly, it remanded the position limits 
rulemaking to the Commission to ``bring its experience and expertise 
to bear in light of competing interests at stake'' in order to 
``fill in the gaps and resolve the ambiguities.'' \7\
---------------------------------------------------------------------------

    \7\ International Swaps and Derivatives Association v. U.S. 
Commodity Futures Trading Commission, 887 F.Supp. 2d 259, 281-282 
(D.D.C. 2012) (emphasis in the original) (``ISDA v. CFTC''), citing 
PDK Labs. Inc. v. U.S. DEA, 362 F.3d 786, 794, 797-98 (D.C. Cir. 
2004).
---------------------------------------------------------------------------

    The Commission attempted to follow the court's directive in a 
proposed position limits rulemaking published in 2013. There, the 
Commission concluded that the Dodd-Frank Act required the agency to 
adopt position limits even in the absence of finding them necessary 
but, ``in an abundance of caution,'' also made a finding of 
necessity with respect to the position limits that it was 
proposing.\8\ The Commission promulgated this same analysis when, 
three years later, it re-proposed its position limits rulemaking in 
2016.\9\ The proposal before us today, by contrast, bases its 
proposed limits solely on finding them to be necessary--albeit a 
finding of necessity that is different from the one relied upon in 
the 2013 Proposal and the 2016 Re-Proposal.
---------------------------------------------------------------------------

    \8\ Position Limits for Derivatives, 78 FR 75680, 75685 
(proposed Dec. 12, 2013) (``2013 Proposal'').
    \9\ Position Limits for Derivatives, 81 FR 96704, 96716 
(proposed Dec. 30, 2016) (``2016 Re-Proposal'').
---------------------------------------------------------------------------

Practical Considerations

    I find the analysis put forward by our General Counsel's Office 
in the proposed rulemaking before us today--which explains the 
Commission's legal interpretation that its mandate to impose 
position limits under the CEA exists only when it finds the limits 
are necessary--to be well-reasoned and compelling. I add two 
practical considerations in support of that conclusion.
    First, if Congress in the Dodd-Frank Act had wanted to eliminate 
a necessity finding as a prerequisite to the imposition of position 
limits, it could simply have removed the requirement to find 
necessity that already existed in the CEA. That it did not do so 
indicates that on this point, the CEA both before and after the 
Dodd-Frank Act provides that the Commission has a mandate to impose 
position limits that it finds are necessary.
    Second, I do not believe that Congress would have directed the 
Commission to spend its limited resources developing and 
administering position limits that are not necessary. We must be 
careful stewards of the taxpayer dollars entrusted to us, and absent 
a clear statement of Congressional intent to do so, I do not believe 
those dollars should be spent on position limits that the Commission 
does not find to be necessary to achieve the objectives of the CEA.

Statutory Analysis

    This section walks through some of the statutory text in CEA 
section 4a(a) that is relevant to the question of whether a finding 
of necessity is a prerequisite to the Commission's mandate of 
imposing position limits. A diagram entitled ``Commodity Exchange 
Act Section 4a(a): Finding Position Limits Necessary is a 
Prerequisite to the Mandate for Establishing Such'' accompanies this 
statement on the Commission's website, which may aid in reading the 
discussion.
    Subsection (1) of section 4a(a) is legacy text that has been in 
the CEA for decades. As noted above, it has long mandated that the 
Commission impose position limits that it finds necessary to 
diminish, eliminate, or prevent the burden on interstate commerce 
resulting from excessive speculation in derivatives. Subsection (2) 
of section 4a(a), on the other hand, was added to the CEA by the 
Dodd-Frank Act.

[[Page 11738]]

    In my view, subsections (1) and (2) are linked, and cannot each 
be considered in isolation, because the Dodd-Frank Act specifically 
tied them together. First, subparagraph (A) of subsection (2) links 
the Commission's obligation to set position limits to the 
``standards'' set forth in subsection (1)--including the standard of 
finding necessity as a prerequisite to the mandate of imposing 
position limits. Then, subparagraph (B) of subsection (2) links the 
timing of issuing position limits to the limits required under 
subparagraph (A)--which, as noted, is connected to the standards set 
forth in subsection (1), including the standard of finding 
necessity.
    In sum, the new timing provisions in subparagraph (2)(B) apply 
to the requirement in subparagraph (2)(A). Subparagraph (2)(A), in 
turn, informs how Congress intended the Commission to establish 
limits, i.e., in specific accordance with the standards in 
subsection (1)--which includes the necessity standard. They are all 
linked.
    Yet, some have relied in isolation on the ``shall . . . 
establish limits'' wording in subparagraph (A) of subsection (2) to 
argue that the Dodd-Frank Act imposed a mandate on the Commission to 
establish position limits even in the absence of a finding of 
necessity. Some also have pointed to the timing provisions in 
subparagraph (B) of subsection (2) to argue that the Dodd-Frank Act 
imposed a mandate on the Commission to establish position limits 
because subparagraph (B) twice says that position limits ``shall be 
established.'' I agree that, under subparagraph (B), position limits 
``shall be established'' as required under subparagraph (A)--but as 
noted, subparagraph (A) states that the Commission shall establish 
limits ``[i]n accordance with the standards set forth in [subsection 
(1)].'' This latter point cannot be overlooked or ignored.
    Some also have asked why Congress would add all this new 
language to CEA section 4a(a) if not to impose a new mandate. Yet, 
it makes perfect sense to me that while expanding the Commission's 
authority to regulate swaps in the Dodd-Frank Act, Congress took the 
opportunity to review and enhance the Commission's position limit 
authorities to ensure they were fit for purpose considering the 
addition of the new expanded authorities, including how swaps would 
be considered in the context of position limits. The timing of the 
review period was spelled out and the manner in which the Commission 
would go about establishing limits was refined to account for this 
massive change in oversight.
    But never did anyone suggest that the legacy language in 
subsection (1) of section 4a(a), including the required prerequisite 
of a necessity finding, had effectively been eliminated and replaced 
with a new mandate that would apply even in the absence of a 
necessity finding.

Subsequent History

    Finally, as noted above, the court in ISDA v. CFTC instructed 
the Commission to use its ``experience and expertise'' to resolve 
the ambiguity it found in the statute. That experience and expertise 
cannot look only to the era in which these position limit provisions 
were enacted. We are where we are, and so the application of the 
Commission's experience and expertise must include a consideration 
of the substantial changes in the markets since that time.
    Given the intervention of a global financial crisis, it is hard 
to recall that the Dodd-Frank Act amendments to the CEA's position 
limit provisions were borne at a time of skyrocketing energy prices 
during 2007-2008. The price of oil climbed to over $147 a barrel in 
July 2008, which represented a 50% increase in one year and a seven-
fold increase since 2002.\10\ Gas prices at the pump peaked at over 
$4 a gallon in June and July of 2008.\11\
---------------------------------------------------------------------------

    \10\ Rebeka Kebede, Oil Hits Record Above $147, Reuters Business 
News, July 10, 2008, available at https://www.reuters.com/article/us-markets-oil/oil-hits-record-above-147-idUST14048520080711.
    \11\ Leigh Ann Caldwell, Face the Facts: A Fact Check on Gas 
Prices, CBS News Face the Nation, March 21, 2012, available at 
https://www.cbsnews.com/news/face-the-facts-a-fact-check-on-gas-prices/.
---------------------------------------------------------------------------

    Some at the time charged that these price spikes were caused by 
excessive speculation in futures contracts on energy commodities 
traded on U.S. futures exchanges--another topic of debate on which I 
will save my views for another day. But not surprisingly, 
legislation soon followed. By the end of 2008, the House of 
Representatives had passed amendments to the CEA's position limit 
provisions,\12\ and after the Senate failed to act, the issue was 
subsequently addressed in the Dodd-Frank Act.
---------------------------------------------------------------------------

    \12\ Commodity Markets Transparency and Accountability Act of 
2008, H.R. 6604, 110th Cong. sec. 8 (2008).
---------------------------------------------------------------------------

    How times have changed. The United States, due to a boom in oil 
and natural gas production relating to shale drilling and the 
development of liquefied natural gas, will soon become a net energy 
exporter.\13\ Although no new federal position limits have been 
imposed, prices of energy commodities have generally dropped and 
stabilized, and cries of excessive speculation in the derivatives 
markets are rare. Also, our derivatives markets have grown 
substantially. Global trading in listed futures and options 
increased from 22.4 billion contracts in 2010 to a record 34.47 
billion contracts in 2019. Global open interest increased to a 
record 900 million contracts from 718.5 million in 2010.\14\
---------------------------------------------------------------------------

    \13\ Tom DiChristopher, US to Become a Net Energy Exporter in 
2020 for First Time in Nearly 70 Years, Energy Dept. Says, CNBC 
Business News, Energy, Jan. 24, 2019, available at https://www.cnbc.com/2019/01/24/us-becomes-a-net-energy-exporter-in-2020-energy-dept-says.html.
    \14\ Futures Industry Association, Global Futures and Options 
Trading Reaches Record Level in 2019, Jan. 16, 2020, available at 
https://fia.org/articles/global-futures-and-options-trading-reaches-record-level-2019.
---------------------------------------------------------------------------

    Applying our experience and expertise, what these developments 
teach us is that economic conditions change over time. Technology 
marches on. Markets evolve. And prices fluctuate in response to a 
myriad of influences. Having lived through the energy price 
increases of the mid-2000s, I do not minimize the pain they caused, 
or the importance of the Commission taking appropriate steps to 
prevent excessive speculation in derivatives markets that can 
contribute to a burden on interstate commerce. Given the history of 
the past decade, however, I do not believe Congress intended, based 
on the moment in time of 2007-2008, to forever lock our derivatives 
markets into a straightjacket, or to deny the Commission the 
flexibility to draw conclusions of necessity based on particular 
circumstances.
    Returning to our zombie romance, I'm afraid I have not been fair 
to its author. That is because there is a second line to the 
quotation, which reads: ``We are where we are, however we got here. 
What matters is where we go next.'' \15\
---------------------------------------------------------------------------

    \15\ See fn. 6, supra, at 97.
---------------------------------------------------------------------------

    It is my fervent hope that the majority of comment letters we 
receive on today's proposal provide constructive input on where the 
proposal would take us next with respect to position limits--and not 
simply fan the flames of the necessity debate. And it is the topic 
of where we go next that I will now turn.

What position limits are necessary?

    Having concluded that the CEA mandates the Commission to impose 
position limits that it finds are necessary, the question then 
becomes: What position limits are necessary?
    In the 2013 Proposal, the Commission's necessity finding 
determined that federal spot month position limits were necessary 
for 28 core referenced futures contracts on various agricultural, 
energy, and metals commodities. In the 2016 Re-Proposal, the 
Commission utilized the same necessity finding to determine that 
federal spot month limits were necessary for 25 of the 28 core 
referenced futures contracts for which they had been found necessary 
in 2013.\16\ And today's proposal, although utilizing a different 
approach to the necessity finding, determines that federal spot 
month limits are necessary for the same 25 core referenced futures 
contracts for which they were found to be necessary in the 2016 Re-
Proposal.
---------------------------------------------------------------------------

    \16\ The 2016 Re-Proposal did not propose that federal position 
limits be imposed on three cash-settled futures contracts (Class III 
Milk, Feeder Cattle, and Lean Hogs) that were included as core 
referenced futures contracts in the 2013 Proposal. See 2016 Re-
Proposal, 81 FR at 96740 n.368.
---------------------------------------------------------------------------

    In other words, three different iterations of the Commission 
have found federal spot month position limits to be necessary for 
these 25 core referenced futures contracts. That degree of 
consistency alone demonstrates the reasonableness of this 
determination.
    To be sure, both the 2013 Proposal and the 2016 Re-Proposal 
found federal position limits for non-spot months to be necessary 
for these 25 contracts, whereas today's proposal does so for only 
the nine legacy agricultural contracts that are currently subject to 
federal non-spot month limits. Yet, the necessity findings in the 
2013 Proposal and the 2016 Re-Proposal were based largely, if not 
entirely, on just two episodes: (1) The activity of the Hunt 
Brothers in the silver market in 1979-1980; and (2) the activity of 
the Amaranth hedge fund in the natural gas market in the mid-2000s.

[[Page 11739]]

    The Hunt Brothers silver episode and Amaranth natural gas 
episode occurred over 30 and over 15 years ago, respectively. It 
also should be noted that the Commission settled enforcement actions 
against both the Hunt Brothers and Amaranth charging that they had 
engaged in manipulation and/or attempted manipulation.\17\ Since 
that time, Congress has provided the Commission with enhanced anti-
manipulation enforcement authority as part of the Dodd-Frank Act, 
which the Commission has used aggressively and serves as an 
effective tool to deter and combat potential manipulation involving 
trading in non-spot months.
---------------------------------------------------------------------------

    \17\ The 2016 Re-Proposal acknowledged that ``both episodes 
involved manipulative intent.'' 2016 Re-Proposal, 81 FR at 96716.
---------------------------------------------------------------------------

    Again, I do not minimize the seriousness of the Hunt Brothers 
and Amaranth episodes, both of which had significant ramifications. 
But I am comfortable with the proposal's determination that two 
dated episodes of manipulation during the past 30 years do not 
establish that it is necessary to take the drastic step of 
restricting trading (and liquidity) in non-spot months by imposing 
position limits for the core referenced futures contracts in these 
two commodities--let alone for the other 14 contracts at issue. I 
therefore support publishing the necessity finding in the proposal 
before us--including the limitation on proposed non-spot month 
limits to the nine legacy agricultural contracts--for public 
comment.

Setting Limit Levels

    With respect to setting position limit levels, the Commission's 
historical practice has been to set federal spot month levels at or 
below 25 percent of deliverable supply based on estimates provided 
by the exchanges and verified by the Commission. Yet, some of the 
deliverable supply estimates underlying the existing federal spot 
month limits on the nine legacy agricultural futures contracts have 
remained the same for decades, notwithstanding the revolutionary 
changes in U.S. futures markets and the explosive growth in trading 
volume over the years. These outdated delivery supply estimates 
require updating.
    The proposal adheres to the Commission's historical approach, 
which is reasonable given the Commission's years of experience 
administering federal spot month limits on the legacy agricultural 
contracts. And it provides a long-overdue update to deliverable 
supply estimates for those legacy contracts to reflect the realities 
of today's markets. The proposed spot month limits for the 25 core 
referenced futures contracts are based on deliverable supply 
estimates of the exchanges that know their markets best, but that 
have been carefully analyzed by Commission staff to assure that they 
strike an appropriate balance between protecting market integrity 
and restricting liquidity for bona fide hedgers.
    For limit levels outside the spot month, the Commission 
historically has used a formula based on 10% of open interest for 
the first 25,000 contracts, with a marginal increase of 2.5% of open 
interest thereafter. Again, the proposal reasonably adheres to this 
general formula with which the Commission is familiar in proposing 
non-spot month limits for the nine legacy agricultural contracts, 
but it would apply the 2.5% calculation to open interest above 
50,000 contracts rather than the current level of 25,000 contracts.
    Open interest has roughly doubled since federal limits were set 
for these markets, which has made the current non-spot month limits 
significantly more restrictive as the years have gone by. 
Nevertheless, I appreciate that such a change to established limits 
may raise concern. I am therefore pleased that the proposal includes 
a question asking whether the proposed increases in federal non-spot 
month limits should be implemented incrementally over a period of 
time, rather than immediately at the effective date. (There is 
additionally a question seeking input on the impact of increases in 
non-spot month limits for convergence that is of great interest to 
me.)
    Finally, it is important to remember that the 16 core referenced 
futures contracts for which federal non-spot month limits are not 
being proposed remain subject to exchange-set position limit levels 
or position accountability levels.\18\ The Commission has decades of 
experience overseeing accountability levels implemented by 
exchanges, including for all 16 contracts that would not be subject 
to federal limits outside the spot month under this proposal. 
Position accountability enables the exchange to obtain information 
about a potentially problematic position while it is at a relatively 
low level, and to require a trader to halt increasing that position 
or to reduce the position if the exchange considers it warranted. 
Exchange position accountability rules, in combination with market 
surveillance by both the exchanges and the Commission and the 
Commission's enhanced anti-manipulation authority granted by the 
Dodd-Frank Act, provide a robust means of detecting and deterring 
problems in the outer months of a contract. The proposal reasonably 
continues to rely on these tools in the non-legacy contracts.
---------------------------------------------------------------------------

    \18\ The use of position accountability in lieu of hard limits 
is expressly permitted by the CEA for both designated contract 
markets, CEA section 5(d)(5), 7 U.S.C. 7(d)(5), and swap execution 
facilities, CEA section 5h(f)(6), 7 U.S.C. 7b-3(f)(6).
---------------------------------------------------------------------------

    Undoubtedly, there will be those who believe the proposed spot 
and non-spot month limits are too high, and others who consider them 
too low. I look forward to receiving public comments along these 
lines, but expect that any such comments will include market data 
and analysis for the Commission to consider in developing final 
rules.

Bona Fide Hedging Transactions and Positions

    The CEA provides that the Commission's position limit rules 
shall not apply to bona fide hedging transactions or positions. It 
gives the Commission the authority to define ``bona fide hedging 
transactions and positions'' with the purpose of ``permit[ting] 
producers, purchasers, sellers, middlemen, and users of a commodity 
or a product derived therefrom to hedge their legitimate anticipated 
business needs . . .'' \19\ This serves as a statutory reminder of 
the fundamental point that the Commission is imposing speculative 
position limits, and since bona fide hedging is outside the scope of 
speculative activity, it is by definition outside the scope of the 
position limit rules.
---------------------------------------------------------------------------

    \19\ CEA section 4a(c)(1), 7 U.S.C. 6a(c)(1).
---------------------------------------------------------------------------

    The Commission's current definition of the term ``bona fide 
hedging transactions and positions'' is set out in what is referred 
to as ``Rule 1.3(z).'' In addition to providing a definition, Rule 
1.3(z) also identifies certain specific ``enumerated'' hedging 
practices that the Commission recognizes as falling within the scope 
of that definition and therefore not subject to position limits. 
Other ``non-enumerated'' hedging practices can still be recognized 
as bona fide hedging, but only after a Commission review process.
    I am delighted that the proposal before us recognizes an 
expanded list of enumerated bona fide hedging practices than are 
currently recognized in Rule 1.3(z). This is entirely appropriate. 
Hedging practices at companies that produce, process, trade, and use 
agricultural, energy, and metals commodities are far more 
sophisticated, complex, and global than when the Commission last 
considered Rule 1.3(z). This is yet one more instance where the 
Commission's position limit rules simply have not kept pace with 
developments in, and the realities of, the marketplace. In addition, 
the proposal would expand federal limits to contracts in commodities 
not previously subject to federal limits, and thus common hedging 
practices in the markets for those commodities must be considered 
for inclusion in the list of enumerated bona fide hedges.
    I am particularly pleased that, at my request, the proposal 
recognizes anticipatory merchandising as an enumerated bona fide 
hedge. After all, the CEA itself identifies anticipatory 
merchandising as bona fide hedging activity,\20\ and the Commission 
has previously granted non-enumerated hedge recognitions for 
anticipatory merchandising. There is no policy basis for 
distinguishing merchandising or anticipated merchandising from other 
activities in the physical supply chain. Although there must be 
appropriate safeguards against abuse, where merchandisers anticipate 
taking price risk, they should have the same opportunity as others 
in the physical supply chain to manage their risk through recognized 
risk-reducing transactions that qualify as bona fide hedging.
---------------------------------------------------------------------------

    \20\ CEA section 4a(c)(2)(A)(iii)(I), 7 U.S.C. 
6a(c)(2)(A)(iii)(I) (bona fide hedging transaction or position is a 
transaction or position that, among other things, ``arises from the 
potential change in the value of . . . assets that a person owns, 
produces, manufactures, processes, or merchandises or anticipates 
owning, producing, manufacturing, processing, or merchandising . . 
.'' (emphasis added)).
---------------------------------------------------------------------------

    Although the proposal refers to enumerated bona fide hedges as 
``self-effectuating'' for purposes of federal limits, this is a bit 
of a misnomer. Even if a hedge is enumerated, the trader still must 
receive approval from the relevant exchange to

[[Page 11740]]

exceed the exchange-set limits.\21\ This, too, is entirely 
appropriate. The exchanges know their markets, and they are very 
familiar with current hedging practices in agricultural, energy, and 
metals commodities, and thus are well-suited to apply the enumerated 
bona fide hedges in real-time. And, as noted above, Congress has 
declared it a purpose of the CEA to serve the public interest with 
respect to derivatives trading ``through a system of effective self-
regulation of trading facilities . . .'' \22\
---------------------------------------------------------------------------

    \21\ Further, the absence of Commission approval of an 
enumerated bona fide hedge does not mean that the Commission has no 
access to data about the position or insight into the hedger's 
trading activity.
    \22\ See fn. 3, supra.
---------------------------------------------------------------------------

    I find perplexing what the proposal refers to as a 
``streamlined'' process for recognizing non-enumerated bona fide 
hedging practices with respect to federal position limits. Pursuant 
to proposed 150.9, if an exchange recognizes a non-enumerated 
practice as a bona fide hedge for purposes of the exchange's 
position limits, that recognition would apply to the federal limits 
as well, unless the Commission notifies the exchange and market 
participant otherwise. The Commission would have 10 business days 
for an initial application, or 2 business days in the case of a 
sudden or unforeseen increase in the applicant's bona fide hedging 
needs, to approve or reject the exchange's bona fide hedging 
recognition.
    I do not believe this ``10/2-Day Rule'' is workable in practice 
for either market participants or the Commission because it is both 
too long and too short. It is too long to be workable for market 
participants that may need to take a hedging position quickly, and 
it is too short for the Commission to meaningfully review the 
relevant circumstances and make a reasoned determination related to 
the exchange's recognition of the hedge as bona fide.
    My preference would have been to propose that recognition of 
non-enumerated hedges be the responsibility of the exchanges that, 
again, are most familiar both with their own markets and with the 
hedging practices of participants in those markets. The Commission 
would monitor this process through our routine, ongoing review of 
the exchanges. I welcome public comment on the proposal's legal 
discussion of the sub-delegation of agency decision making authority 
as relevant to this question, and on how the proposed 10/2-Day Rule 
might be improved in a final rulemaking to make the process workable 
for market participants and the Commission alike.

A Word About Economically Equivalent Swaps

    CEA section 4a(a)(5) provides that ``[n]otwithstanding any other 
provision'' in section 4a, the Commission's position limit rules 
shall establish limits, ``as appropriate,'' with respect to 
economically equivalent swaps, and that such limits must be 
``develop[ed] concurrently'' and ``establish[ed] simultaneously'' 
with the limits imposed on futures contracts and options on futures 
contracts.\23\ I share the view that section 4a(a)(5) thereby 
requires that this rulemaking encompass economically equivalent 
swaps, although I invite public comment from those who believe 
another interpretation may be permissible and appropriate.
---------------------------------------------------------------------------

    \23\ CEA section 4a(a)(5), 7 U.S.C. 6a(a)(5).
---------------------------------------------------------------------------

    The proposal sets forth a narrow definition of the term 
``economically equivalent swap,'' which I believe is appropriate. A 
measured approach is reasonable given that: (1) The Commission's 
regulatory regime for swaps remains in its relative infancy; (2) 
swaps have never been subject to position limits, be it federal or 
exchange-set limits; and (3) the implications of imposing position 
limits on economically equivalent swaps cannot be predicted with any 
degree of confidence at this time. Further, a measured approach is 
more workable because it is the Commission, rather than an exchange, 
that will be responsible for administering the new position limits 
regime for swaps given that: (1) Many swaps trade over-the-counter 
(``OTC'') so there is no exchange to fulfill this responsibility; 
and (2) for swaps traded on swap execution facilities (``SEFs''), 
those SEFs lack the information about a trader's swap positions on 
other SEFs and OTC that would be necessary to fulfill this 
responsibility.
    That said, the proposed definition of an ``economically 
equivalent swap'' is broader than that used in the European position 
limits regime. In Europe, economic equivalence requires identical 
terms; the proposal, by contrast, requires only that material terms 
be identical. I look forward to receiving comment on this 
distinction, and the experience that market participants have had 
with the European application of position limits to swaps.

Conclusion

    The fact that the Commission has been trying to update these 
rules for nearly a decade demonstrates the challenge presented by 
position limits. I am extremely grateful to the many members of our 
staff in the Division of Market Oversight, the Office of General 
Counsel, and the Chief Economist's Office who have dedicated a 
significant portion of their lives to helping us try to meet that 
challenge. I also appreciate the efforts of my fellow Commissioners 
as well.
    Each of us has committed that we would work to finish a position 
limits rulemaking. The time has come. Overall, today's proposal is 
reasonable in design, balanced in approach, and workable for both 
market participants and the Commission. I therefore support it.
    I ask market participants to view the proposal in that spirit. 
Please provide us with your constructive input on how we can make a 
good proposal even better.

Appendix 6--Dissenting Statement of Commissioner Dan M. Berkovitz

Introduction

    I dissent from today's position limits proposal (``Proposal''). 
The Proposal would create an uncertain and unwieldy process with the 
Commission demoted from head coach over the hedge exemption process 
to Monday-morning quarterback for exchange determinations.\1\ The 
Proposal would abruptly increase position limits in many physical 
delivery agricultural, metals, and energy commodities, in some 
instances to multiples of their current levels. It would provide no 
opportunity for the Commission to monitor the effect of these 
increases, or to act if necessary to preserve market integrity. The 
Proposal provides inadequate explanation for other key approaches in 
the document, including the use of position accountability rather 
than numerical limits for energy and metals commodities in non-spot 
months. The Proposal also ignores Congress's mandate in the Dodd-
Frank Act, and reverses decades of legal interpretations of the 
Commodity Exchange Act (``CEA'') by the Commission and the courts 
regarding the Commission's authority and responsibility to impose 
position limits. It would require, for the first time, the 
Commission to find that position limits are necessary for each 
commodity prior to imposing limits.
---------------------------------------------------------------------------

    \1\ See Position Limits for Derivatives (``Proposal'') at rule 
text section 150.9(e).
---------------------------------------------------------------------------

I Support an Effective Position Limits Framework With Transparency 
and Certainty

    Position limits is one of the last remaining items in the 
Commission's reform agenda arising from the Dodd-Frank Act. In the 
wake of the 2008 oil price spike to $147 per barrel, the Amaranth 
hedge fund's dominance of the natural gas futures and swaps market, 
the rise of commodity index funds, and the financial crisis, 
Congress mandated that the Commission promptly establish, as 
appropriate, position limits and hedge exemptions for exempt and 
agricultural commodities and economically equivalent swaps. We must 
not forget the lessons from the financial crisis or prior episodes 
of excessive speculation, nor be lulled back into the belief that 
unfettered markets yield optimal outcomes. A meaningful, effective 
position limits regime was important to the reform agenda in 2010, 
and it must remain our goal today.
    I support an effective position limits regime that includes both 
effective limits on speculative positions and appropriate bona fide 
hedge exemptions to meet market participants' legitimate commercial 
needs. Position limits are critical to preventing market 
manipulation or distortion due to excessively large speculative 
positions. Together, position limits and bona fide hedge exemptions 
promote the market integrity and the price discovery process, while 
enabling producers, end-users, merchants, and others to use the 
futures and swaps markets to manage their commercial risks. The 
Dodd-Frank Act, adopted by Congress in 2010 in the midst of the 
financial crisis, affirmed Congress's commitment to federal 
speculative position limits and its determination that the 
Commission should act decisively to address excessive speculation in 
physical commodity markets.
    Since joining the Commission, I have traveled the country to 
meet with market participants in many segments of the physical 
commodity markets. I have been to soybean farms and rice mills in 
Arkansas, feedlots in Colorado, dairy co-ops and

[[Page 11741]]

cornfields in Minnesota, and grain mills and elevators in Kansas, 
Arkansas, Colorado, and Minnesota. I have met with coffee and cocoa 
graders in New York, energy companies in Texas, cotton merchandisers 
from Tennessee, and many others to understand how end-users 
participate in our markets. I have visited the CME in Chicago, ICE 
in New York, and the Minneapolis Grain Exchange in Minneapolis. The 
fundamental purpose of the commodity markets we oversee is to enable 
end-users to manage the price risks they face in their businesses. I 
am committed to ensuring that this rule is workable for end-users 
and provides them with sufficient clarity, predictability, and 
transparency.
    In my view, a position limits rule must meet three basic 
criteria. First, the rule must provide effective limits on 
speculative positions. Second, the rule must recognize legitimate 
bona fide hedging activities. The Commission should provide market 
participants with certainty regarding which activities constitute 
bona fide hedging and establish a workable, transparent process for 
qualifying additional types of activities as bona fide hedging. Such 
a process should recognize both the traditional role of the 
Commission in determining, generally, which activities constitute 
bona fide hedging, and the role of the exchanges in determining 
whether the specific activities of particular commercial market 
participants fall within such bona fide hedging categories as 
determined by the Commission.
    Third, from a legal perspective, a final rule must recognize 
that Congress has authorized and directed the Commission to 
promulgate position limits--without a predicate finding that 
position limits are necessary to prevent excessive speculation--and 
that the Commission has the flexibility to determine the appropriate 
tools and limits to accomplish that Congressional directive.
    Unfortunately, the Proposal fails to satisfy any of these 
criteria. The Proposal would greatly increase position limits in 
many physical delivery agricultural, metals, and energy commodities 
in spot and individual non-spot months, with no opportunity to 
monitor for or guard against adverse market impacts. Although I am 
pleased that the Proposal would no longer recognize risk management 
exemptions as bona fide hedges for physical commodities,\2\ the 
higher limits allowed under the Proposal could accommodate 
substantially more speculative positions,\3\ with potentially 
adverse impacts on markets. There is solid evidence that the 
financialization and growth of commodity index investments can raise 
commodity prices and negatively affect end-users in the real 
economy.\4\
---------------------------------------------------------------------------

    \2\ See Proposal at preamble section II(A)(1)(c)(ii)(1). This 
change comports with amendments to the definition of bona fide 
hedging in CEA section 4a(c)(2) made by the Dodd-Frank Act.
    \3\ Proposal at preamble section II(A)(1)(c)(ii)(1).
    \4\ See, e.g., Ke Tang & Wei Xiong, Index Investment and 
Financialization of Commodities, 68 Financial Analysts Journal 54, 
55 (2012); Luciana Juvenal & Ivan Petrella, Speculation in the Oil 
Market, Federal Reserve Bank of St. Louis, Working Paper 2011-027E 
(June 2012), available at https://research.stlouisfed.org/wp/2011/2011-027.pdf.
---------------------------------------------------------------------------

    The Proposal departs from the well-established roles of the 
Commission and exchanges in the bona fide hedge framework. As 
affirmed by the Dodd-Frank Act, it is the Commission's 
responsibility to define what constitutes a bona fide hedge.\5\ For 
practical reasons, including limited Commission resources, I support 
delegating to exchanges the authority to determine whether a 
particular position, under the particular facts and circumstances 
presented, constitutes a bona fide hedge as defined by the 
Commission. The exchanges are well suited for this role and have 
decades of experience in making such determinations. However, the 
initial legal and policy determination of what types of positions 
constitute bona fide hedges must remain the Commission's 
responsibility.
---------------------------------------------------------------------------

    \5\ See CEA section 4a(c); 7 U.S.C. 6a(c).
---------------------------------------------------------------------------

    The Proposal carries forward all of the bona fide hedges 
currently enumerated in the Commission's rules, adds several 
additional categories to the list of enumerated hedges, and opens 
the door to an unlimited number of additional, undefined non-
enumerated exemptions. The Proposal states, ``the proposed 
enumerated hedges are in no way intended to limit the universe of 
hedging practices which could otherwise be recognized as bona 
fide.'' \6\ The ``universe'' is a very large place indeed.
---------------------------------------------------------------------------

    \6\ Proposal at preamble section II(A)(1)(c)(i) (emphasis 
added).
---------------------------------------------------------------------------

    On the other hand, the Proposal does not address practices that 
market participants have urged the Commission to recognize as bona 
fide hedges, including practices currently recognized by the 
exchanges. The Proposal thus deprives end-users and other market 
participants of legal certainty regarding what constitutes a bona 
fide hedge for various practices currently permitted by the 
exchanges as bona fide hedges.
    Rather than determine whether to recognize these practices as 
bona fide hedges through notice and comment in today's rulemaking, 
the Proposal contemplates that additional non-enumerated bona fide 
hedges should first be considered by the exchanges, and then 
reviewed by the Commission during a cramped 10-day retrospective 
review period.\7\ Determination of what constitutes a bona fide 
hedge for non-enumerated hedges would begin anew each time that an 
exchange must decide whether a purported bona fide hedge held by a 
market participant is consistent with the CEA, and then await the 
Commission's retrospective review. Market participants should be 
able to discern whether particular types of practices qualify as 
bona fide hedging by reading the Commission's rules and regulations 
rather than by engaging lawyers and lobbyists to guide them through 
an opaque, non-public process through the halls of the Commission's 
headquarters in Washington, DC.
---------------------------------------------------------------------------

    \7\ The Proposal would establish two distinct processes for 
recognition of non-enumerated hedges. One process would be 
Commission-based, but the Proposal anticipates that this process 
would rarely, if ever, be used by market participants. See Proposal 
at rule text section 150.3. The other, in proposed Sec.  150.9(e), 
would require the Commission to retroactively review bona fide hedge 
exemptions approved by an exchange. See Proposal at rule text 
section 150.9(e). Such review would need to be conducted within 
business10 days, would involve the five-member Commission itself, 
and could be stayed for a longer period.
---------------------------------------------------------------------------

    The Commission has almost 40 years of experience with exchange 
implementation of position limits for energy and metals commodities, 
and more for agricultural commodities. Based on this experience, I 
support many of the types of bona fide hedges that exchanges 
recognize in these markets today. However, the Commission should 
recognize these exemptions in its own rules through prospective, 
notice and comment rulemaking, not delegate these determinations to 
the exchanges.
    The legal analysis in this Proposal is a convoluted and 
confusing legal interpretation of the Dodd-Frank Act that defies 
Congressional intent. It is implausible that in the aftermath of the 
financial crisis and the run-up to oil at $147 per barrel, Congress 
made it more difficult for the Commission to impose position limits. 
Yet that is the result of the Commission's revisionist 
interpretation that a predicate finding of necessity (i.e., that 
position limits are necessary) is required for the imposition of a 
position limit for each commodity. Moreover, the Proposal's finding 
of necessity for the 25 core reference futures contracts subject to 
the rule is unpersuasive both economically and legally, and is 
highly unlikely to survive legal challenge. The necessity finding 
largely consists of general economic statistics about the importance 
of the physical commodities underlying these futures contracts to 
commerce, together with statistics about open interest and trading 
volume in those futures contracts. These statistics bear little 
rational relationship to why position limits are necessary to 
prevent excessive speculation in derivative contracts for these 
commodities. For example, the imposition of limits on cocoa futures 
is justified on the basis that ``in 2010 the United States exported 
chocolate and chocolate-type confectionary products worth $799 
million to more than 50 countries around the world.'' \8\ There is a 
simpler, more logical, and defensible path forward, as I will 
outline later in this statement.
---------------------------------------------------------------------------

    \8\ Proposal at preamble section III(F)(3).
---------------------------------------------------------------------------

    I thank the Commission staff for working with my office on the 
Proposal. Although I am not able to support it as currently 
formulated, I look forward to working with my colleagues and staff 
to improve the Proposal so that it effectively protects our markets 
from excessive speculation and provides end-users and other market 
participants with the regulatory certainty they need. I encourage 
market participants to comment on the Proposal.

Additional Flaws in the Proposal

No Phase-In for Large Increase in Speculative Position Limits

    The Proposal would generally increase existing federal or 
exchange spot month position limits for 25 physical delivery 
agricultural, metals, and energy commodities by a factor of two or 
more.\9\ It would

[[Page 11742]]

substantially increase existing federal single month and all months 
combined limits for the nine legacy agricultural commodities. As 
examples, spot month limits on ICE's frozen concentrated orange 
juice contract would increase from 300 to 2,200 contracts, and 
single month and all months combined limits on CBOT soybean meal 
would increase from 6,500 to 16,900 contracts.\10\ Single month and 
all months combined limits for CBOT corn would increase to 57,800 
contracts.\11\ The proposed increases are largely due to increases 
in deliverable supply, and the new spot and non-spot month limits 
continue to reflect the Commission's 25% and 10%/2.5% of deliverable 
supply formulas.
---------------------------------------------------------------------------

    \9\ See Proposal at preamble section I(B).
    \10\ Id. Other notable examples include increased spot limits 
for ICE U.S. Sugar No. 11 (SB) from 5,000 to 25,800 contracts; 
increased spot month limits for ICE Cotton No. 2 (CT) from 300 to 
1,800 contracts; increased single month and all months combined 
limits for CBOT Soybean Oil (SO) from 8,000 to 17,400 contracts; and 
increased single month and all months combined limits for ICE Cotton 
No. 2 (CT) from 5,000 to 11,900 contracts.
    \11\ Id. Although the proposed new limit for CBOT Corn (C) is 
less than twice the current limit (57,800 contracts proposed versus 
33,000 contracts currently), it would still be a significantly 
larger position limit and the largest single month and all months 
combined limit in the Proposal.
---------------------------------------------------------------------------

    The Proposal does not provide for phasing in the new, higher 
limits or for otherwise providing a transition period.\12\ It 
presents no analysis of the market's ability to absorb these large 
increases without disruption, and no analysis of how large new 
speculative positions may affect the price discovery process.
---------------------------------------------------------------------------

    \12\ See Proposal at rule text section 150.2 and Appendix E.
---------------------------------------------------------------------------

    Large increases in the amounts of speculative activity in 
individual non-spot months have the potential to disrupt the 
convergence process and distort market signals regarding storage of 
commodities. The Proposal provides no analysis of whether these 
potential price distortions and their attendant detrimental 
consequences could be avoided by distributing the large increases in 
the numerical limits across several non-spot months, rather than 
permit such large positions in individual months. Instead, the 
Proposal would codify an abrupt increase 365 days after publication 
of any final rule in the Federal Register. A transition period or 
lower individual spot month limits would give the Commission the 
time and ability to mitigate any issues that may arise if markets 
are unable to absorb the higher limits in an orderly manner, and 
prevent disruption if necessary. It is a prudent measure that the 
Commission should adopt in any final rule.

2. Absence of Non-Spot Month Limits for Exempt and Certain Agricultural 
Commodities

    I am concerned with the Proposal's failure to adopt federal non-
spot limits for 16 energy, metals, and certain agricultural 
commodities included in the Proposal.\13\ CEA section 4a(a)(3) 
directs that the Commission ``shall set limits'' on positions held 
not only in the spot month, but also ``each other month'' and ``for 
all months,'' ``as appropriate.'' \14\ Despite this directive, the 
Proposal does not adopt non-spot month limits for these commodities. 
It includes virtually no analysis of why the Commission believes 
that non-spot limits are not appropriate.
---------------------------------------------------------------------------

    \13\ See Proposal at rule text section 150.5(b)(2), providing 
for exchange-set position limits or position accountability in non-
spot months contracts not subject to federal speculative position 
limits.
    \14\ CEA section 4a(a)(3); 7 U.S.C. 6a(a)(3).
---------------------------------------------------------------------------

    Exchanges have demonstrated an ability to manage speculation and 
maintain orderly markets with position accountability in non-spot 
months. However, experiences such as the collapse of the Amaranth 
hedge fund in 2006 demonstrate how large trades in the non-spot 
month can also distort markets, widen spreads, and increase 
volatility.\15\ I believe the exchanges have learned from the 
Amaranth experience and that position accountability can be an 
effective tool, where appropriate. The Proposal, however, also fails 
to demonstrate why accountability levels, rather than numerical 
limits, are appropriate in light of the statutory directives in the 
CEA. It provides no discussion of the effect of applying the 10/2.5% 
formula to the energy and metals contracts covered by the Proposal, 
and why the application of this traditional formula would not be 
appropriate. Similarly, there is no analysis regarding the numerical 
limits that could result from applying the four factors specified in 
4a(a)(3), and why such numerical limits would not be appropriate.
---------------------------------------------------------------------------

    \15\ See Excessive Speculation In the Natural Gas Market, Staff 
Report with Additional Minority Staff Views, Permanent Subcommittee 
on Investigations, United States Senate (2007).
---------------------------------------------------------------------------

3. Definition of Economically Equivalent Swap

    The Proposal would define an economically equivalent swap as a 
swap that ``shares identical material contractual specifications, 
terms, and conditions with the referenced contract . . . .'' \16\ 
The Proposal offers several rationales for this narrow definition 
that could potentially lend itself to evasion through financial 
engineering. One such rationale is that it would reduce market 
participants' ability to net down their speculative positions 
through swaps that are not materially identical. While this and 
other rationales proffered in the Proposal have merit, the 
Commission must also ensure that economically equivalent swaps are 
not structured in a manner to evade federal or exchange regulation 
through minor modifications to material terms. I invite public 
comment on this issue.
---------------------------------------------------------------------------

    \16\ Proposal at preamble section (II)(A)(4) and proposed rule 
text section 150.1.
---------------------------------------------------------------------------

4. The Proposal's Necessity Finding Misconstrues the CEA as Amended by 
the Dodd-Frank Act

    The Proposal states that, for any particular commodity, ``prior 
to imposing position limits, [the Commission] must make a finding 
that they are necessary.'' \17\ This is a reversal of prior 
Commission determinations.\18\ Neither the statutory language of CEA 
section 4a(a)(2), nor the district court's decision in ISDA v. CFTC, 
compels this outcome.\19\ The Commission should not adopt it.
---------------------------------------------------------------------------

    \17\ Proposal at preamble section III(D). The Proposal also 
states that ``[t]he Commission will therefore determine whether 
position limits are necessary for a given contract, in light of 
those premises, considering facts and circumstances and economic 
factors.'' Proposal at preamble section III(F)(1).
    \18\ The Proposal acknowledges ``this approach differs from that 
taken in earlier necessity findings.'' Proposal at preamble section 
III(F)(1). Specifically, the Proposal identifies different 
approaches taken in position limit rulemaking undertaken by the 
Commission's predecessor agency, the Commodity Exchange Commission 
(``CEC'') from 1938 through 1951, the Commission's 1981 rulemaking 
that required exchanges to impose position limits for each contract 
not already subject to a federal limit, and the proposed rulemakings 
in 2013 and 2016. Id.
    \19\ Int'l Swaps and Derivatives Ass'n (``ISDA'') v. CFTC, 887 
F. Supp. 2d 259 (D.D.C. 2012).
---------------------------------------------------------------------------

    Title VII of the Dodd-Frank Act amended CEA section 4a and 
directed in 4a(a)(2)(A) that ``the Commission shall'' establish 
position limits for agricultural and exempt physical commodities 
``as appropriate.'' \20\ In ISDA v. CFTC, the district court 
directed the Commission to resolve a perceived ambiguity in section 
4a(a)(2)(A) by bringing the Commission's ``experience and expertise 
to bear in light of the competing interests at stake . . . .'' \21\ 
That experience includes over 80 years of position limits 
rulemakings, as described below. It provides ample practical and 
legal bases to determine that Congress intended the Commission to 
adopt federal position limits for certain commodities pursuant to 
CEA section 4a(a)(2).
---------------------------------------------------------------------------

    \20\ CEA section 4a(a)(2)(A); 7 U.S.C. 6a(a)(2)(A).
    \21\ ISDA, 887 F. Supp. 2d at 281.
---------------------------------------------------------------------------

    Starting in 1936, and across multiple iterations of the CEA and 
its predecessors, the CEA has consistently and continuously 
reflected Congress's finding that excessive speculation in a 
commodity can cause sudden, unreasonable, and unwarranted movements 
in commodity prices that are undue burden on interstate 
commerce.\22\ Congress also has declared that ``[f]or the purpose of 
diminishing, eliminating, or preventing such burden,'' the 
Commission shall . . . proclaim and fix such [position] limits'' 
that the Commission finds ``are necessary to diminish, eliminate, or 
prevent such burden.'' In plain English, Congress has found that 
excessive speculation is a burden on interstate commerce, and the 
CFTC is directed to impose position limits that are necessary to 
prevent that burden. Congress did not direct the Commission to study 
excessive speculation, to prepare any reports on excessive 
speculation, or to second-guess Congress's finding that excessive 
speculation was a problem that needed to be prevented. Rather, 
Congress directed the Commission to impose position limits that the 
Commission believed were necessary to accomplish the statutory 
objectives.
---------------------------------------------------------------------------

    \22\ Commodity Exchange Act of 1936, P.O. 76-675, 49 Stat. 1491 
section 5.
---------------------------------------------------------------------------

    Following the passage of the 1936 Act, the Commission set 
position limits for grains in 1938, cotton in 1940, and soybeans in 
1951. As the Proposal recognizes, in these rulemakings the 
Commission did not publish any analyses or make any ``necessity 
finding,'' other than to include a ``recitation'' of the statutory 
findings regarding the undue

[[Page 11743]]

burdens on commerce that can be caused by excessively large 
positions. These rulemakings then set numerical limits on the 
amounts of commodity futures contracts that could be held.
    Court decisions from the 1950s through the 1970s in cases 
involving the application of the position limits rules reflect a 
common-sense reading: The statute mandates that the Commission 
establish position limits, while providing the Commission with 
discretion as to how to craft those limits. In Corn Refining 
Products v. Benson, \23\ defendants challenged the suspension by the 
Secretary of Agriculture of their trading privileges on the Chicago 
Board of Trade for violating position limits in corn futures on the 
grounds that the statutory prohibition only applied to speculative 
positions. The U.S. Court of Appeals for the Second Circuit denied 
the appeal, stating in part:
---------------------------------------------------------------------------

    \23\ 232 F.2d 554 (2d Cir. 1956).

    The discretionary powers of the Commission and the exemptions 
from the `trading limits' established under the Act are carefully 
delineated in [section] 4a. The Commission is given discretionary 
power to prescribe ' * * * different trading limits for different 
commodities, markets futures, or delivery months, or different 
trading limits for the purposes of buying and selling operations, or 
different limits for the purposes of subparagraphs (A) (i.e., with 
respect to trading during one business day) and (B) (i.e., with 
respect to the net long or net short position held at any one time) 
of this section * * * ' . . . .
    Although [section] 4a expresses an intention to curb `excessive 
speculation,' we think that the unequivocal reference to `trading,' 
coupled with a specific and well-defined exemption for bona-fide 
hedging, clearly indicates that all trading in commodity futures was 
intended to be subject to trading limits unless within the terms of 
the exemptions. \24\
---------------------------------------------------------------------------

    \24\ Id. at 560 (emphasis added).

    In United States v. Cohen,\25\ the defendant challenged his 
criminal conviction for violating CEC trading limits in potato 
futures contracts. In upholding the conviction, the court of appeals 
stated that ``[t]rading in potato futures, as for other commodities, 
is limited by statute and by regulations issued by the Commission. 
The statute here requires the Commission to fix a trading limit . . 
. .'' \26\ The court of appeals further observed: ``Congress 
expressed in the statute a clear intention to eliminate excessive 
futures trading that can cause sudden or unreasonable 
fluctuations.'' \27\
---------------------------------------------------------------------------

    \25\ 448 F.2d 1224 (2d Cir. 1971).
    \26\ Id. at 1225-6 (emphasis added).
    \27\ Id. at 1227 (emphasis added).
---------------------------------------------------------------------------

    In CFTC v. Hunt, \28\ the Hunt brothers challenged the validity 
of the agency's position limit on soybeans of three million bushels 
on the basis that the agency ``made no analysis of the relationship 
between the size of soybean price changes and the size of the change 
in the net position of large traders. They argue[d] that there is no 
direct relationship between these phenomena, and, therefore, the 
regulation limiting the positions and the trading of the large 
soybean traders is unreasonable.'' \29\ Fundamentally, the Hunts 
alleged that the agency failed to demonstrate that the limits were a 
reasonable means--or, alternatively put, ``necessary''--to prevent 
unwarranted price fluctuations in soybeans. ``The essence of the 
Hunts' attack on the validity of the regulation is their substantive 
contention that there is no connection between large scale 
speculation by individual traders and fluctuations in the soybean 
trading market.'' \30\
---------------------------------------------------------------------------

    \28\ 591 F.2d 1211 (7th Cir. 1979).
    \29\ Id. at 1216.
    \30\ Id.
---------------------------------------------------------------------------

    The U.S. Court of Appeals for the Seventh Circuit denied the 
Hunt brothers' challenge. It held, ``[t]he Commodity Exchange 
Authority, operating under an express congressional mandate to 
formulate limits on trading in order to forestall the evils of large 
scale speculation, was deciding on whether to raise its then 
existing limit on soybeans. . . . There is ample evidence in the 
record to support the regulation.'' \31\
---------------------------------------------------------------------------

    \31\ Id. at 1218 (emphasis added).
---------------------------------------------------------------------------

    The Hunt case also illustrates the difference between the 
requirement for a predicate finding of necessity and the requirement 
that the Commission's rulemakings be supported by sufficient 
evidence. Under the Administrative Procedure Act (``APA''), the 
Commission's regulations must not be ``arbitrary, capricious, an 
abuse of discretion, or otherwise not in accordance with law.'' \32\ 
To make this finding, ``the court must consider whether the decision 
was based on a consideration of the relevant factors and whether 
there has been a clear error of judgment.'' \33\
---------------------------------------------------------------------------

    \32\ 5 U.S.C. 706(2)(A).
    \33\ Hunt, 591 F.2d at 1216. In the proposed regulation 
increasing the speculative position limits for soybeans from 2 
million to 3 million bushels, the Commission's predecessor, the 
Commodity Exchange Authority (``Authority''), did not make a 
soybean-specific finding that the limit of three million bushels was 
necessary to prevent undue burdens on commerce. Rather, the 
Authority relied on its 1938 and 1951 position limit rulemakings for 
the general principle that ``the larger the net trades by large 
speculators, the more certain it becomes that prices will respond 
directly to trading.'' Corn and Soybeans, Limits on Position and 
Daily Trading for Future Delivery, 36 FR 1340 (Jan. 28, 1971). The 
Authority then stated that its analysis of speculative trading 
between 1966 and 1969 ``did not show that undue price fluctuations 
resulted from speculative trading as the trading by individual 
traders grew larger.'' Id. Following a public hearing, the Authority 
adopted the proposed increase. See 36 FR 12163 (June 26, 1971). For 
the past 82 years, the Commission has relied on this general 
principle to justify its position limits regime.
---------------------------------------------------------------------------

    In 1981, following the silver crisis of 1979-1980, the 
Commission adopted a seminal final rule requiring exchanges to 
establish position limits for all commodities that did not have 
federal limits.\34\ In the final rulemaking, the Commission 
determined that predicate findings are not necessary in position 
limits rulemakings. It affirmed its long-standing statutory mandate 
going back to 1936: ``Section 4a(1) represents an express 
Congressional finding that excessive speculation is harmful to the 
market, and a finding that speculative limits are an effective 
prophylactic measure.'' \35\ The 1981 final rule found that 
``speculative position limits are appropriate for all contract 
markets irrespective of the characteristics of the underlying 
market.'' \36\ It required exchanges to adopt position limits for 
all listed contracts, and it did so based on statutory language that 
is nearly identical to CEA section 4a(a)(1).\37\
---------------------------------------------------------------------------

    \34\ During the silver crisis, the Hunt brothers and others 
attempted to corner the silver market through large physical and 
futures positions. The price of silver rose more than five-fold from 
August 1979 to January 1980.
    \35\ See Establishment of Speculative Positon Limits, 46 FR 
50938, 50940 (Oct. 16, 1981) (``1981 Position Limits Rule'').
    \36\ 1981 Position Limits Rule at 50941.
    \37\ In the proposed regulation, the Commission noted that as of 
April 1975, position limits were in effect for ``almost all'' 
actively traded commodities then under regulation. Speculative 
Position Limits, 45 FR 79831, 79832 (Dec. 2, 1980).
---------------------------------------------------------------------------

    In the 1981 rulemaking, the Commission also responded to 
comments that the Commission had failed to ``demonstrate[ ] that 
position limits provided necessary market protection,'' or were 
appropriate for futures markets in ``international soft'' 
commodities, such as coffee, sugar, and cocoa. The Commission 
rejected comments that it was required to make predicate necessity 
findings for particular commodities. The Commission stated:

    The Commission believes that the observations concerning the 
general desirability of limits are contrary to Congressional 
findings in sections 3 and 4a of the Act and considerable years of 
Federal and contract market regulatory experience. . . .
     * * *
    As stated in the proposal, the prevention of large and/or abrupt 
price movements which are attributable to extraordinarily large 
speculative positions is a Congressionally endorsed regulatory 
objective of the Commission. Further, it is the Commission's view 
that this objective is enhanced by speculative limits since it 
appears that the capacity of any contract market to absorb the 
establishment and liquidation of large speculative positions in an 
orderly manner is related to the relative size of such positions, 
i.e., the capacity of the market is not unlimited.\38\
---------------------------------------------------------------------------

    \38\ 1981 Position Limits Rule at 50940.

    In the ``Legal Matters'' section of the preamble, the Proposal 
would jettison the interpretation that has prevailed over the past 
four decades as the basis for the Commission's position limits 
regime. Relying on a non sequitur incorporating a double negative, 
the Preamble brushes off nearly forty years of Commission 
---------------------------------------------------------------------------
jurisprudence:

    [B]ecause the Commission has preliminarily determined that 
section 4a(a)(2) does not mandate federal speculative limits for all 
commodities, it cannot be that federal position limits are 
`necessary' for all physical commodities, within the meaning of 
section 4a(a)(1), on the basis of a property shared by all of them, 
i.e., a limited capacity to absorb the establishment and liquidation 
of large speculative positions in an orderly fashion.\39\
---------------------------------------------------------------------------

    \39\ Proposal at preamble section III(F)(1).


[[Page 11744]]


---------------------------------------------------------------------------

    In 2010, Congress enacted Title VII of the Dodd-Frank Act and 
amended CEA section 4a by directing the Commission to establish 
speculative position limits for agricultural and exempt commodities 
and economically equivalent swaps.\40\ Congress also set forth 
criteria for the Commission to consider in establishing limits, 
including diminishing, eliminating, or preventing excessive 
speculation; deterring and preventing market manipulation; ensuring 
sufficient liquidity for bona fide hedgers; and ensuring that price 
discovery in the underlying market is not disrupted.\41\ Congress 
directed the Commission to establish the required speculative limits 
within tight deadlines of 180 days for exempt commodities and 270 
days for agricultural commodities.
---------------------------------------------------------------------------

    \40\ See CEA section 4a(a)(2); 7 U.S.C. 6a(a)(2); CEA section 
4a(a)(5); 7 U.S.C. 6a(a)(5).
    \41\ See CEA section 4a(a)(3); 7 U.S.C. 6a(a)(3).
---------------------------------------------------------------------------

    It defies history and common sense to assert that the amendments 
to section 4a enacted by Congress in the Dodd-Frank Act made it more 
difficult for the Commission to impose position limits, such as by 
requiring predicate necessity findings on a commodity-by-commodity 
basis. This is particularly true given Congress's repeated use of 
mandatory words like ``shall'' and ``required'' and the tight 
timeframe to respond to the new Congressional directives. In light 
of the run up in the price of oil and the financial crisis that 
precipitated the legislation, it is unreasonable to interpret the 
Dodd-Frank amendments as creating new obstacles for the Commission 
to establish position limits for oil, natural gas, and other 
commodities whose significant price fluctuations had caused economic 
harm to consumers and businesses across the nation. The Commission's 
interpretation is revisionist history.
    The Commission's necessity finding that follows its legal 
analysis is sure to persuade no one. Unless substantially modified 
in the final rulemaking, it will likely doom this regulation as 
``arbitrary, capricious, or an abuse of discretion'' under the APA. 
The necessity finding for the 25 core referenced futures contracts 
selected for this rulemaking boils down to simplistic assertions 
that the futures contracts and economically equivalent swaps for 
these contracts ``are large and critically important to the 
underlying cash markets.'' \42\ As part of the necessity finding for 
these 25 commodities, the Proposal presents general economic 
measures, such as production, trade, and manufacturing statistics, 
to illustrate the importance of these commodities to interstate 
commerce, and therefore for the need for position limits. On the 
other hand, the Proposal fails to present any rational reason as to 
why the economic trade, production, and value statistics for 
commodities other than the 25 core referenced futures contracts are 
insufficient to support a similar finding that position limits are 
necessary for futures contracts in those other commodities.
---------------------------------------------------------------------------

    \42\ Proposal at preamble section III(F)(2).
---------------------------------------------------------------------------

    For example, the Proposal justifies the exclusion of aluminum, 
lead, random length lumber, and ethanol as examples of contracts for 
which a necessity finding was not made on the basis that the open 
interest in these contracts is less than the open interest in the 
oat futures contracts. This comparison has no basis in rationality. 
The need for position limits for commodity futures contracts in 
aluminum, lead, lumber, and ethanol is not in any way rationally 
related to the open interest in those commodity futures contracts 
relative to the open interest in oat futures. The Proposal is rife 
with other such illogical statements.
    Fundamentally, general economic measures of commodity 
production, trade, and value are irrelevant with respect to the need 
for position limits to prevent excessive speculation. The Congress 
has found that position limits are an effective prophylactic tool to 
prevent excessive speculation for all commodities. The Congressional 
findings in CEA section 4a regarding the need for position limits 
are not limited to only the most important or the largest commodity 
markets. General economic data regarding a commodity in interstate 
commerce is irrelevant to the need for position limits for futures 
contracts for that commodity.
    The collapse of the Amaranth hedge fund in 2006 is another 
strong example of why a position limits regime is necessary to 
prevent excessive speculation, in this case in non-spot months. 
Amaranth was a large speculative hedge fund that at one point held 
some 100,000 natural gas contracts, or approximately 5% of all 
natural gas used in the U.S. in a year. As the Commission has 
explained in other position limits proposals since 2011, the 
collapse of Amaranth was a factor in the Dodd-Frank's amendments to 
CEA section 4a.
    The Commission has ample practical experience and legal 
precedent to resolve the perceived ambiguity in CEA section 4a(a)(2) 
as instructed by the district court in ISDA v. CFTC without making 
the antecedent necessity finding now incorporated in the Proposal. 
Our remaining task is to design the overall position limits 
framework, including determining the appropriate limit levels, 
defining bona fide hedges through prospective rulemaking, and 
appropriately considering other options such as position 
accountability and exchange-set limits.

Conclusion

    In CEA section 4a, Congress directed the Commission to establish 
position limits and appropriate hedge exemptions to prevent the 
undue burdens on interstate commerce that result from excessive 
speculation. Congress has also entrusted to the Commission's 
discretion the appropriate regulatory tools to meet this mandate. 
Congress' overarching policy directive for position limits is 
straightforward and has been remarkably consistent for 84 years. The 
Commission has had ten years, three prior proposals, one 
supplemental proposal, and hundreds of pages of comment letters to 
define bona fide hedge exemptions. Now is the time to finish the 
job, and to do it the right way.

[FR Doc. 2020-02320 Filed 2-26-20; 8:45 am]
 BILLING CODE 6351-01-P

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.