CFTC Commissioner O'Malia Dissents from CFTC Final Rules Regarding Position Limits for Futures and Swaps
Sima Saran Ahuja | Bloomberg Law
Scott D. O’Malia, a Commissioner of the Commodity Futures Trading Commission (CFTC), dissented from the CFTC’s adoption of a final rule on position limits for futures and swaps primarily because he disagreed with the CFTC’s “restrictive” interpretation of Section 4A of the Commodity Exchange Act (CEA). Commissioner O’Malia contended that the CFTC did not balance position limits as “necessary and effective” against the “identifiable burdens” of “excessive speculation” on the liquidity and price discovery function of the futures and swaps markets.
Specifically, Commissioner O’Malia explained that he dissented from the rule because the CFTC implemented it without an “objective factual analysis” or “necessary data” to determine whether the rule will effectively prevent or deter “excessive speculation.” Moreover, in his view, the public rulemaking process was unproductive and “plagued by internal and public debates” regarding the CFTC’s motives for implementing the final rule.
Position Limits Rule
The position limits rule, adopted by a 3-2 vote, establishes: (1) hard federal position limits and position limit formulas for 28 physical commodity futures and swaps; and (2) aggregate position limits that apply across different trading venues to contracts based on the same underlying commodity. The final rule also implements a new, more limited, statutory definition of bona fide hedging transactions and revises account aggregation standards.
While Commissioner O’Malia is not opposed to position limits, he argued that they should be accompanied by “accountability” and “visibility” levels to trigger reporting obligations demonstrating the “complete picture of an entity’s trading.” According to Commissioner O’Malia, this approach would “provide a more refined regulatory tool to identify, deter, and respond” to price movements and distortions. As such, he would support position limits coupled with an accountability level that relied on a technology based, real-time surveillance program.
CFTC Ignored Congressional Intent
Commissioner O’Malia agrees that Congress directed the CFTC to establish, as appropriate, position limits 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.
His dissent, however, focused on whether Congress intended to eliminate its discretion and expertise in carrying out that directive. Indeed, he characterized the CFTC’s position that Congress “left it no choice” but to implement the final rule as “hyperbole” and a tactic to implement “draconian rules” against the threat of “excessive speculation in the commodity markets.” Instead, Commissioner O’Malia believes that the CFTC failed to comply with Congressional intent. Moreover, he suggested that the CFTC missed an opportunity to define “excessive speculation” likely to cause sudden or unwarranted commodity price movements.
He further asserted that the CFTC, in this instance, had abandoned its historical “more disciplined and fact-based” approach to adopting position limits. In the past, the CFTC relied on a report on speculative limits which found that while the CFTC was authorized to establish speculative limits, it was not required to do so. Against this backdrop, Commissioner O’Malia argued that the CFTC should establish position limits only if they are required and will effectively “curb excessive speculation.” By not following this precedent, Commissioner O’Malia claimed that the CFTC ignored the “plain language” of Section 4 of the CEA.
— “As Appropriate” Is the Key Clause
In so doing, Commissioner O’Malia continued, the CFTC glossed over the lynchpin clause of Section 4: “as appropriate . . . to the maximum extent practicable, in its discretion.” According to his analysis, this clause modifies the Congressional mandate for position limits and ignoring it results in a “narrow view” of the CFTC’s authority. By adding “as appropriate,” Commissioner O’Malia suggested that, through Section 4a(a)(1) of the CEA, Congress intended for the CFTC to set position limits supported by “empirical evidence demonstrating that [position limits] would diminish, eliminate, or prevent excessive speculation and were “essential and suitable” to address threats to commodity prices due to “excessive speculation.”
On the contrary, Commissioner O’Malia found that the CFTC did not provide any factual support or empirical evidence for the final position limits rule and thus could not assure Congress that they were effective or essential. To cure this deficiency, he proposed that, in the coming year, the CFTC utilize additional data about over-the-counter swaps markets to inform the rulemaking process. Specifically, Commissioner O’Malia argued that the CFTC “defer any decisions about the nature and extent of position limits . . . including any determinations as to appropriate formulas, until such time as we have had a meaningful opportunity to review and assess the new data and its relevance to any determinations regarding excessive speculation.”
Impact on Additional Regulatory Provisions
In his dissent, Commissioner O’Malia also highlighted other regulatory provisions that pose challenges to the implementation of the final position limits rule. Specifically, he explained that the CFTC (1) had restricted bona fide hedging activities such as anticipatory hedging for merchandisers, and (2) established overly-broad accounting aggregation standards.
— Bona Fide Hedging
According to Commissioner O’Malia, the CFTC narrowed the availability of bona fide hedging activities to negatively impact the cash commodity markets and the physical commodity marketplace by eliminating legitimate derivatives risk management strategies such as anticipatory hedging. To cure this problem, Commissioner O’Malia recommended a broader definition of bona fide hedging transactions and positions to “encompass” long-standing risk management practices. He further advocated preserving a process for bona fide hedgers to more expeditiously seek exemptions from non-enumerated hedging transactions. Arguing that the CFTC should have engaged in a separate rulemaking process to address bona fide hedging, Commissioner O’Malia remarked that the CFTC “chose form over function so that it could ‘check the box’ on its mandate.”
— Accounting Aggregation
In what he labeled an “attack” on commercial hedging, Commissioner O’Malia criticized the CFTC for developing a “flawed [accounting] aggregation rule that singles out owned-non financial firms for unique and unfair treatment under the rule” because such entities (energy producers or merchandisers) are not provided the same protections as hedge funds or index funds. Instead, he favors a tiered aggregation approach as a viable and fair solution. With previously available exemptions from the accounting aggregation rule now eliminated, Commissioner O’Malia warned that the rule may be overturned by a court for being “arbitrary and capricious” and “without legal rationale.”
Finally, Commissioner O’Malia noted that the CFTC did not engage in a rigorous cost-benefit analysis of the final position limits rule. In fact, he remarked that “it is utterly astounding that the [CFTC] has designed a rule to combat the unknown threat of ‘excessive speculation’ that will likely cost market participants $100 million dollars annually and yet [the CFTC] need not prove that such limits will in fact prevent such burdens.” Without quantitative data to support the cost-benefit analysis, Commissioner O’Malia remarked that this aspect of the final rule “may be susceptible to legal challenge.” For example, he explained that, with respect to bon fide hedging, approximately 200 entities will be impacted and result in a “total burden” of $29.8 million annually. In light of “current reporting regimes” and “development of universal entity, commodity, and transaction identifiers,” Commissioner O’Malia asserted that the CFTC could have formulated a more cost-effective and less burdensome alternative for bona fide hedging requirements.
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