Washington, 13 August 2010

U.S. regulators run the risk of setting commodity market position limits too low or too high because the deadline for the curbs comes before they will be able to assess the true size of the vast, opaque swaps market, according to an official who has opposed limits in the past.

The sweeping Wall Street reform law last month mandated that the Commodity Futures Trading Commission set position limits for energy and metals markets in 180 days, and agricultural futures and swaps in 270 days -- but a deadline for collecting data on the over-the-counter swaps markets comes later, in 360 days.

That timeline puts the CFTC in the tricky position of attempting to set limits without knowing the scale of the market that it's regulating, warned CFTC Commissioner Jill Sommers, a Republican who worked for the Chicago Mercantile Exchange and the International Swaps and Derivatives Association trade group before her appointment in 2007.

"From my perspective, I am not supportive of moving forward with limits until we're able to see the whole market," Sommers told Reuters. "I think that you run the risk of not having the appropriate formula or position size," she said.

SOMMERS OPPOSED FIRST PLAN

Sommers, one of five commissioners at the helm of the futures regulator, opposed the release of a proposal the CFTC issued in January to set limits for energy markets because of the "piecemeal" approach she said it took to markets.

The proposal responded to complaints from consumers and energy users in the wake of record-high prices seen in 2008 -- but sparked a furious reaction from companies that trade the markets for profit. Banks like Morgan Stanley and Deutsche Bank said the plan would limit the utility of U.S. futures markets, and energy companies like Royal Dutch Shell and Vitol said the plan was structurally flawed and would raise costs.

At the time, the CFTC did not have oversight of over-thecounter markets -- something the new law, which applies to all commodities, has changed. The new oversight can help the CFTC find the right formula for position limits, Sommers said.

The law will require all swaps to be reported to the regulator, a power that will give it deep insight into what had been an opaque market worth a total of $615 trillion, although only $3 trillion of that is in commodities.

First, the CFTC must write rules establishing how that reporting will take place, one of many rule-making topics it will grapple with over the next year. But in the meantime, it will have to set limits for speculators across both futures markets -- which are tracked and regulated -- and the OTC markets. "Because of these deadlines that were sort of arbitrarily put into the (law), it makes it very difficult for us to do this appropriately," Sommers said. "You're not seeing the whole market, which was the problem back in January," she said.

HOPES FOR INTERIM SOLUTION

Sommers said she is keen to see whether CFTC staff will be able to propose some "middle ground" as a solution to the timing problem of the new rules, but said she did not know the details of what they were considering.

The commissioners have ultimate approval over new regulations. In January, two other commissioners were concerned about the proposed limits. Sommers' fellow Republican on the panel, Scott O'Malia, has also recently said the CFTC will need a better handle on data to track traders' positions. Michael Dunn, a Democrat, had expressed reservations but said last week the new law has made some of his concerns "a moot point."

Chairman Gary Gensler and fellow Democratic Commissioner Bart Chilton have been strong proponents of limits. The CFTC will formally withdraw the January rule in coming days as its prepares to repropose a broadened set of regulations, Gensler said this week, emphasizing the CFTC will meet its statutory deadlines.

CAN CFTC SALVAGE PARTS OF JAN RULE?

CFTC staff will need to determine a new formula before the agency proposes its new rule, and must also wrestle with controversial features of its first framework, Sommers said. A plan to combine all speculative positions by ownership -- even when trades are done under accounts with independent control -- drew fire from energy traders, who said it would be impossible to manage administratively. "I don't know if that part survives. We may have to modify our approach to aggregating based on the comments we received," Sommers said.

Sommers said she thinks the new law won't change the tenor of the debate over position limits. "Fundamentally, people said, 'If you're going to impose limits, just make sure they're fair and that they're not so constraining that you push the market somewhere else.'"

Establishing position limits in the United States will continue to create the risk of pushing trade overseas to markets beyond the CFTC's authority, Sommers said. "There's lots of other oil contracts traded around the world," she said.

Ends --