Washington, 11 February 2011

The U.S. futures regulator's attempt to rein in speculation could give rise to a plethora of smaller market players, posing an oversight challenge for the understaffed agency, industry insiders said. The Commodity Futures Trading Commission is racing to implement by July dozens of new regulations mandated in the financial reform law that would change the way business is done in the futures market.

One proposal would establish limits on positions investors can hold in commodity markets, with the goal of preventing large payers controlling the market. But Gregory Mocek, a former enforcement director at the CFTC, said it is possible that imposing position limits could spur smaller firms without cutting back on the volume of activity in markets.

"You could see a lot more smaller operations depending upon how the rule plays out, and I'm not quite sure that's going to be in the best interest of the commission," Mocek, a partner at Cadwalader, Wickersham and Taft LLP, told Reuters on the sidelines of a Commodity Markets Council meeting.

A proliferation of smaller firms would mean more entities for the CFTC to regulate when it already has a lot on its plate, according to Mocek. In addition, simply dividing up positions among smaller firms may not do much to limit the volume of speculation in futures markets, Mocek said.

"If the purpose of position limits is to cut down on excessive speculation, then it's possible that may not achieve their goal," he said. Another industry source at the meeting, who declined to be identified because of the sensitivity of the subject, agreed the current proposal may lead to more entities in the market and not necessarily prevent speculative bubbles.

"The limit itself is not going to stop the market from overheating, it's not going to take out volatility," said the source, who added that the initial limits are high enough that many traders would be able to continue their current activity.

Ultimately, the CFTC should look to the characteristics of markets when setting their limits, said Thomas Erickson, a former CFTC commissioner.

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"There's nothing inherently wrong with position limits," Erickson, who is now a vice president at agricultural processor Bunge Ltd told Reuters at the meeting. "I think that the market is really an effective way to really be able to help direct the regulators to how do you assess what an appropriate limit might be." The commission should consider the underlying open interest and overall liquidity of each marketplace, Erickson added.

Like many other industry representatives at the meeting, Erickson raised concerns about the rapid pace and the order in which the commission is implementing the financial reform law.

The CFTC has proposed a series of detailed regulations to put the law into effect, but has yet to come out with a definition for the types of swaps products that will be covered, and has not finalized a regulation defining the types of market participants who will be most affected. Mocek said this could lead to legal issues for the commission as it attempts to carry out its new rules.

"There's a real possibility that the fact that the commission will put out the definition of a swap after it put out all these regulations will create problems for them in the enforcability of rules," Mocek said. "That should be a legitimate concern."

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