Significant technology adoption is required to distinguish between speculative and hedging trades under the Commodities Futures Trading Commission (CFTC)’s proposed new rulemaking for speculative position limits in commodities markets, a market participant, a lawyer, and a consultant agree.
“The mapping and allocation of trades between speculative and non-speculative buckets will involve a full spectrum view of the hedging strategies and transactions chains, especially for larger commodities houses given that the CFTC’s rules are likely to be extraterritorial. The limits will capture any trading on US exchanges irrespective of the location of the ultimate position holder,” says Azad Ali, partner at law firm Fieldfisher LLP.
“As opposed to doing it manually, it might be better to have a technology solution, but that would raise in itself a challenge to embed a technology solution to fulfil that function. I could well see that for certain types of larger commodity houses with a global footprint that solution would be useful,” he says.
Doug Gyani, principal consultant at Principia agrees.
“If you’ve got multiple locations, multiple affiliates using varying technologies across the globe, then you would have to have some kind of reporting and aggregation tool that sits across the entire enterprise that is going to look at the open positions, be able to filter out essentially what is being bona fide hedge and either opt that in or take it out of the calculations, depending on whether it is an effective hedge or not,” he says.
On March 13, commission chairman Christopher Giancarlo said that all five of the regulator’s commissioners were committed to moving forward with a final position limits rule. On May 14, Commissioner Dan Berkovitz told a conference that “although we do not yet have a proposal in front of us, I can tell you that I strongly support meaningful position limits to prevent excessive speculation in commodity markets.”
Berkovitz also said that Giancarlo expected the commission to have considered a position limits proposal by the end of the second quarter.
But the proposed rules could make things difficult, according to Sameer Soleja, CEO of Molecule.
“What is interesting about the statement is that it was focused on position limits for speculative positions, and that makes things a little bit harder because now we are veering into territory near hedge effectiveness and differentiating between speculative and hedging trades, which often ends up being a grey area,” says Soleja.
“From a technology perspective, the technology has been out there for quite some time to help with position limits and or position limits for speculative trading, the problem is we might end up gumming up the works for companies who trade both for hedging and speculative purposes. A lot of people do both trading for hedging and speculative purposes. What could be problematic is if suddenly, they now have to start labelling their transactions with for what purpose they were traded. There is some precedent for having to do that in different jurisdiction and, or for different types of trading.
“Each time there is a proposal like this, and a rule made like this it distorts the market in some way, whether it is a positive distortion, or a negative distortion is a matter of question, but each time it does, that distortion carries with it some costs. I would bet that the cost is not enormous, but it could also be that the cost ends up wiping out a type of trade, it really depends on the implementation,” he says.
In Europe, on May 24 the European Securities and Markets Authority (Esma) called for market participants to provide evidence on position limits in commodity derivatives. This is part of several reviews taking place under the Markets in Financial Instruments (Mifid II). Esma said it will give advice to the European Commission’s report “on the impact of position limits and position management on commodity derivatives markets by 31 March 2020.”