Final rule on speculators likely too little, too late for critics

October 18, 2011
Final rule on speculators likely too little, too late for critics
By Kevin G. Hall | McClatchy Newspapers

WASHINGTON _ A final rule is expected Tuesday that would curb the ability of large financial speculators to manipulate the price of oil and 27 other commodities, and it's sure to anger critics since the long-delayed rule is unlikely to become effective until mid-2012.

The Commodity Futures Trading Commission is expected to present and approve a rule for what's termed speculative position limits. These limits will be imposed on contracts traded for both next-month and future delivery of oil, corn, coffee, copper and numerous other products. The limits will then be adjusted either once a year, for energy and metals commodities, or every two years for farm products as the commission reviews market data.

The rules were to take effect in January 2011. They're sure to further anger those who pushed for tough limits since now they won't be effective until six months after the CFTC defines what qualifies as a "swap." That's a contract between two private parties in the vast so-called dark markets that until last year were completely unregulated.

CFTC staffers, who briefed reporters Monday on condition of anonymity because the rules had not been made public yet, said it'll be several more months before that crucial definition is finalized. It means the new tougher limits on oil speculation are likely to take hold around June 2012.

The distinction between speculation and excessive speculation has been very much in the public eye over the past four years, as oil prices raced far beyond what supply-and-demand fundamentals would seem to have dictated. A speculative oil-price spike earlier this year proved to be a major headwind against U.S. economic growth and reignited debate on the role of Wall Street money in oil markets.

One of the biggest critics of oil speculation, Sen. Bernie Sanders, a Vermont independent, didn't wait for the new rules to be announced. He made public an angry letter sent Monday to CFTC Chairman Gary Gensler_ whose nomination Sanders held up _ suggesting tougher rules are needed than those to be voted on Tuesday.

"The bottom line is we have a responsibility to ensure that the price of oil is no longer allowed to be driven up by the same Wall Street speculators who caused the devastating recession that working families are now experiencing," Sanders wrote. "That means the CFTC must finally do what the law mandates and end excessive oil speculation once and for all."

The broad congressional revamp of financial regulation in July 2010_ known as the Dodd-Frank Act _ instructed the CFTC to impose limits on how much of a given market any one trader or trading firm can hold. Just weeks ago, it looked like the commission couldn't get consensus, with the majority Democrats in disagreement among themselves.

One of them, Commissioner Bart Chilton, warned he wouldn't be party to a weak compromise. He insisted at minimum on a hard limit on speculators who hold contracts for next-month delivery of commodities, sometimes called spot-month contracts. He's now supportive, especially of the ability to toughen limits over time.

"While all of the limit levels will initially be identical, the rule provides that we reassess those levels to ensure recalibration to more appropriate levels if necessary," he told McClatchy. "Congress told us to implement these limits and belatedly we are doing so."

Another important change, he said, was that commodities exchanges no longer determine who is exempt from the rules. Previously Wall Street banks were granted what was called a hedge exemption that freed them from speculative limits, treating them as if they were the end user of oil or any other commodity.

"The Wild West of exempting traders from any trading levels whatsoever now ends. Any exemptions to limits will henceforth only be approved by the agency, not the exchanges, and under more strict guidelines than ever before," Chilton said. "A bona fide hedge will truly be a bona fide hedge, and traders will have to continually prove their business need to this agency."

Under the new rule, the limit on these next-month contracts would be set at 25 percent of the deliverable supply. This is in line with historical practices. But it now also would apply to the so-called paper contracts that are traded in the futures market, beyond the physical markets where traders actually take delivery of oil or other commodities.

For all products except natural gas, the CFTC has opted for a 1-to-1 ratio, where traders are subject to the same limits in the futures market as in the physical markets. This is a narrowing of past rules.

For natural gas, speculative contracts could exceed ones in the physical markets by a 5-to-1 ratio. That's because commodity exchanges have proven rules against excessive speculation in place for this particular product.

The CFTC also is expected to agree on limits on the trading of commodities contracts for months or years out from next-month delivery. These position limits apply to any given month and the sum of all future-month contracts. These limits involve a formula that prevents a trader or firm from having a position greater than 10 percent of the first 25,000 contracts trading in a given commodity such as oil or corn, and 2.5 percent of whatever amount exceeds that 25,000 threshold.

Sen. Sanders argued for a flat ban on any speculative position greater than 5 percent of the market instead of the 25 percent rate proposed in the final rule.

"That is much too weak and would have little if any impact on diminishing excessive speculation as required by statute," wrote Sanders.

However, CFTC staff insisted that the proposed final rule would have the real-world effect of limiting participation to below 5 percent for heavily traded commodities such as oil. That's because the 10 percent/2.5 percent formula in a market with millions of contracts, would add up to less than 5 percent of all contracts trading.

While the long-delayed rule on limits tries to thwart excessive speculation, at least one influential group thinks the effort misses the market. The group Better Markets released an exhaustive report on Friday that reviewed 27 years of market data and concluded that commodity index funds are pushing up food and energy prices.

These funds encourage investment in a basket of commodities contracts, through a strategy developed by big Wall Street banks. Better Markets wants these commodity index funds banned, arguing their buy-and-hold strategy by investors distorts the process of a buyer and seller of a commodity finding a rational, mutually agreed upon price.

ON THE WEB Traders and the boom-bust cycle in commodities prices
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