Excessive Speculation and Position
Limits in Energy Derivatives Markets

cmegroup.com

EXECUTIVE SUMMARY

is pushing these participants to exempt-over-the-counter (OTC)

During the period from 2002 to 2006, energy prices, like otherswap markets, foreign exchanges with less restrictive or non-existentcommodity prices, trended consistently higher and then increased

position limits requirements, and even domestic securities markets.

dramatically from 2007 to mid-2008, in many cases to historical highs.

Market participants are also developing other product substitutes that

Although the prices of most commodity products have since decreased

will allow investors to bypass the regulated exchange markets in thesigniﬁcantly from those highs, the prices experienced in 2008 triggered

United States.

a number of investigations and analyses of the causative factors underly-

CME Group supports the CFTC’s mission to ensure that energy markets

ing these price changes. For example, numerous hearings on the issue

effectively serve their important economic functions for the beneﬁt ofhave been held in both the Senate and the House of Representatives,

all market participants. Although the evidence is clear that speculative

and a review was conducted by the U.S. Government Accountability

position limits in the energy markets, beyond those already in place,Ofﬁce at the request of the House Agricultural Committee. Reports

are not warranted, we also recognize that conﬁdence in the futures

have been issued by academics and research groups addressing themarkets may be undermined by perceptions. Therefore, CME Group

topic. Nearly all economists that have carefully studied these markets

is proposing the following recommendations:have concluded that supply and demand fundamentals and othermacroeconomic factors were the cause of these price movements.1
However, a small but vocal group has argued that “excessive speculation” was, and remains, the cause of prices deemed to be “too high”
and they often point to the risk management activities of swap
dealers and index funds as the primary “speculative” force driving
high prices. These claims are unsupported by any empirical evidenceor legitimate economic analysis, including the Commodity Futures

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months combined, single months and the delivery period basedon traditional considerations, focusing on its open interest and,at or near the delivery period, the deliverable supply.
 <XZ_\oZ_Xe^\j_XccY\i\jgfej`Yc\]fiX[d`e`jk\i`e^`kj
hedge exemption program for its markets subject to its existing
exemption standards until such time as common exemption
standards are established by the CFTC. Swap dealers and index
funds will remain eligible for risk management exemptions to

Trading Commission’s (CFTC) own data and analysis.2 To the contrary,hedge bona ﬁde exposure but be subject to position limits forthe activity of speculators, as well as swap dealers and index funds,

their speculative proprietary trading.

are essential to creating the liquidity necessary for the efﬁcient functioning of the market and make it possible for traditional commercial

 K_\:=K:n`cc\jkXYc`j_Xjpjk\d]fii\gfik`e^f]\e[$lj\iFK:
positions and, after gaining authority to impose aggregate limits

participants to manage their risk.

that include OTC positions, be responsible for ensuring an end-

CME Group strongly opposes regulatory policies that unfairly

user’s combined on-exchange and OTC speculative positions

discriminate against index funds and swap dealers in their ability

do not exceed the aggregate total market position limit.

to access energy and commodity futures markets. There is alreadyWe are prepared to lead, but any steps taken to impose hard position

significant evidence that CFTC actions to repeal no-action letters

limits must support the national policy of enhancing transparent

that granted exemptions from position limits to two index funds

markets and central counterparty clearing and prevent market

and the rhetoric regarding the possible imposition of position limits

participants from moving away from the best regulated, moston swap dealers and index funds without allowance for exemptionstransparent, safest marketplace to less regulated or even completely

See e.g. Philip C. Abbott, Christopher Hurt, Wallace E. Tyner, “What’s Driving Food Prices,” Farm Foundation, Issue Report ( March 2009 Update); Ronald Trostle , “Global Agricultural Supply and Demand: Factors
Contributing to the Recent Increase in Food Commodity Prices,” A Report from the Economic Research Service of the USDA (July 2008); and Ennis Knupp & Associates, “The Role of Institutional Investors in Rising
Commodity Prices” (June 2008).

1

See also, U.S. Government Accountability Ofﬁce, Issues Involving the Use of the Futures Markets to Invest in Commodity Indexes, (Jan. 30, 2009), available at http://www.gao.gov/new.items/d09285r.pdf , which analyzed
the available data respecting any causal relationship between speculation and commodity prices and concluded that the eight empirical studies reviewed “generally found limited statistical evidence of a causal relationshipbetween speculation in the futures markets and changes in commodity prices – regardless of whether the studies focused on index traders, speciﬁcally, or speculators, generally.” Id at 5.

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Excessive Speculation and Position Limits in Energy Derivatives Markets

unregulated markets that are and will continue to be beyond the

The Hearings focused on concerns with “excessive speculation,” which

control of the Commission and Congress. Consequently, in conjunction

resurfaced when fuel and food prices spiked to levels that were shocking

with our adopting a hard limits regime, exempt commercial markets

to consumers and painful to the economy. Although prices later subsided(ECMs) and foreign boards of trade (FBOT) must do so as well for all

signiﬁcantly, the pressure to control a reoccurrence of price spikes has

similar contracts.

led to a search for a simple causal agent that can easily be neutralized.

Our proposed hard limits regime is intended to be administered in

The favored cause was speculators. But, speculators sell when they

a way that fosters competition among trading venues in all markets

think prices are too high and buy when they think prices are too low.

based solely on liquidity, technology, price, clearing capability and

They are not a unified voting block and are on both sides of every

quality and customer service, not regulatory arbitrage.3 We caution,market. Speculative selling and buying send signals to producers andhowever, that efforts to increase conﬁdence in the futures markets

processors that help keep our economy on an even keel. High futuresby imposing hard limits on energy products must be balanced withprices for corn induced farmers to bring new acreage to market. Highensuring that such limits do not have a detrimental effect on the priceforward energy prices encourage exploration and new technology todiscovery and hedging functions of futures markets or drive trading

exploit existing untapped reserves.

to unregulated markets. We believe that our carefully designed hard
limits regime accomplishes these goals and represents an immediate
improvement for those seeking to impose hard limits, while avoiding
any unintended harm to the U.S. markets and their users.

AN HISTORICAL PERSPECTIVE
In developing a method for imposing position limits on specificenergy products, it is also important to consider the history of
speculative trading and speculators in futures markets. In fact,
the theory that speculators on futures markets cause unwarranted
price volatility and excessively high or low prices is not new;Congress has been repeating that notion since at least 1850.

Futures markets perform two essential functions — they create a venue
for price discovery and they permit low cost hedging of risk. Futures
markets depend on short and long term speculators to make markets andprovide liquidity for hedgers. Futures markets cannot operate effectively
without speculators and speculators will not use futures markets if artiﬁcial barriers or tolls impede their access. As one noted scholar explains:“Large speculators are frequently the most efﬁcient bearers of
risk. In the old days, large individual traders played the role ofrisk bearers. Today, futures funds and hedge funds that allow
investors to diversify can perform this function. Unfortunately,
position limits prevent these traders from bearing as much risk
as they would like. Due to these limits, less risk-tolerant traders

Farmers and their legislative representatives regularly demand

must absorb additional risk. This leads to an incomplete transfer

the elimination of speculators on futures exchanges. However,of risk. This is costly.

the Commodity Exchange Act (CEA), which came into existencein the midst of an anti-speculation frenzy, does not limit speculation,but only “excessive speculation.” This is an implicit recognition of

Moreover, speculators are frequently well informed about supply
and demand fundamentals. Their trading forces prices towards
the level implied by this information. Since producers, consum-

an indisputable economic principle — futures markets cannot

ers, processors, and storers of commodities rely upon futures

operate without the participation of speculators. CFTC Chairman,

prices to guide their decisions, having more information embed-

Gary Gensler, recognized this principle in his recent testimony

ded in these prices will lead to better decisions. By limiting theat the Commission’s hearings on position limits in the energy

ability of informed individuals to trade, however, position limits

markets and exemptions therefrom (the Hearings).

reduce the ﬂow of information to the futures market.
This reduces the efﬁciency of resource allocation.” 4

2
See Commodity Futures Trading Commission, Commodity Swap Dealers & Index Traders with Commission Recommendations, (Sept. 11, 2008), available at http://www.cftc.gov/stellent/groups/public/@newsroom/documents/ﬁle/cftcstaffreportonswapdealers09.pdf

Should concerns that “excessive speculation” is driving commodity prices in the metals derivative markets or adversely impacting liquidity in such markets arise in the future, we are prepared to consider a similar hard
limits regime for metals contracts as well.

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Thus, position limits that are too broad indeed impede speculators’

Finally, the assertion that swap dealers were regularly and widely being

access to the futures markets, undermining “the ability of the futures

used as intermediaries by speculators and others who would not havemarkets to perform their essential functions.”5been entitled to a hedge exemption as a device to circumvent exchange
position limits has been contradicted by the information so far released

THE ROLE OF SWAP
DEALERS AND INDEX FUNDS

by the Commission of data obtained from swap dealers by use of its
special call authority.

The targets of the latest “excessive speculation” claims are index
funds and swap dealers. Neither, however, is engaged in traditional

Index Funds

speculative activity — namely, trying to beat the market. Rather,Index funds aggregate the buying and selling decisions of manyboth are engaged in legitimate risk management activity and contribute

thousands of investors, most of whom are diversifying their investment

positively to the overall functioning of the futures market. Moreover,portfolios and hedging inﬂation risks to their investment returns in

as discussed in more detail later in this paper, there is no reliable

order to maximize their retirement savings and their individual wealth.

economic evidence to support the contention that either market

Moreover, index funds supply a pool of stable, passive, unleveraged

participant drives commodity prices, including energy prices.

capital to bear commodity price risk.6 Thus, “by allowing commodity
producers to transfer their inherent commodity price risk exposure

Swap Dealers

to long-term investors who are better-suited to bear it, the participation

Swap dealers use futures markets to facilitate the hedging of moreof the index investors in the commodity futures markets lowers the costcomplex and speciﬁc risks accepted in connection with swap transactions with commercial customers and others, including institutional
investors who seek broad exposure to commodity prices as an inﬂation
hedge through commodity index swaps. Increased restrictions on swap
dealers’ ability to obtain exemptions from position limits will likely
cause two unintended yet foreseeable consequences. First, limiting
the hedge exemption for swap dealers could make it more costly forcommercial enterprises and institutional investors to execute strategies
in the OTC market to meet their hedging needs. Second, swap
dealers may well widen spreads in order to internalize risks or attempt
to hedge their risk through increased use of OTC instruments rather
than exchange-traded futures. Both strategies undercut current
regulatory and legislative efforts to reduce systemic risk by driving
OTC-generated risk into a central counterparty clearing context.

of capital to commodity producers, and by lowering costs helps to lower
commodity prices over the long run.”7
Moreover, index funds, like those swap dealers hedging commodity
index swaps, cannot make or receive delivery and consequently
they must sell their long positions in the nearby contract monthand establish long positions in a more distant month prior to thetermination of trading in the nearby contract. Therefore, index investors clearly do not create artiﬁcial demand for the physical commodity.
Denying index funds a risk based exemption from position limits will
preclude thousands of small investors from a cost effective means ofinvesting in commodities. More importantly, the absence of such an
exemption will reduce market liquidity and thereby increase the costsof hedging for producers, which costs will ultimately be passed on to
consumers. Thus, some of the most vocal proponents of eliminatingthese risk-based exemptions will, contrary to their stated expectations,see commodity prices increase as a result of the very action they areencouraging.

Craig Pirrong, Squeezes, Corpses, and the Anti-Manipulation Provisions of the Commodity Exchange Act, available at http://www.cato.org/pubs/regulation/regv17n4/reg17n4c.html
Id.
Testimony of Steven H. Strongin, Managing Director, Goldman, Sachs & Co. Before the Permanent Subcommittee on Investigations Committee on Homeland Security and Governmental Affairs, U.S. Senate (July 21, 2009)at 4, available at www.hsgac.senate.gov. (“Strongin Testimony”).
7
Id.
4
5

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Excessive Speculation and Position Limits in Energy Derivatives Markets

The Evidence

The debate regarding controlling excessive speculation in the energy

The assertion that commodity prices are being driven by swap dealersmarkets by means of position limits should be informed by two facts:

and index funds, directly and indirectly trading OTC with swap dealers,ﬁrst, it is rare for a single speculator, index trader or swap dealer torather than by the expected forces of supply and demand, does not have

have control of a large share of the open interest in any futures contract,a factual basis. Most every competent economist who has looked at realand second, efforts to control price or volatility by position limits

data, rather than anecdotes, and who has applied legitimate economic

has been a failed strategy. As an experienced futures trader in energy

analysis concludes that neither speculators, swap dealers nor index

products explains:funds are distorting commodity prices. Contrary to the assertion that

“The U.S. natural gas market is very robust. The NYMEX NG

these industry participants speculators are uniformly on the buy side

physically settled futures contract is very well designed withand are pushing prices up on that basis, the publicly available data hasdozens of companies able to both make and take delivery of

been relatively consistent over time in demonstrating that speculators

the product. . . . The NYMEX NG contract is managed throughin crude oil futures contracts have been relatively balanced as between

expiration without giving anyone the ability to manipulate

buy and sell positions in the market. In fact, The Wall Street Journal

the market for the physical product. A signiﬁcant amount ofsurveyed a signiﬁcant cross section of economists who agreed that:gas can be made available and delivered at contract speciﬁca-

8“The global surge in food and energy prices is being driven primarily
by fundamental market conditions, rather than an investment bubble . .
. .”9 The weight of the evidence and informed opinion conﬁrms that thehigh prices are a consequence of supply and demand factors external
to speculative trading and the hedging of swap dealers and index funds
on futures exchanges.

tions with minimal cost, and many users can actually makeuse of that product. At expiry, among many players available, awilling and knowledgeable buyer and seller, both having otheroptions, must agree to exchange Henry Hub natural gas at thesettlement price. The NG contract simply cannot deviate fromfair value at expiration. The fact that so little actually goes todelivery is a testament to the efﬁciency of this market.”Expert economists, however, are being ignored and important

Proponents of hard limits on speculative trading and the elimination

legislation and regulation is in danger of being shaped by spuriousof risk management exemptions believe that such limits will bringeconomics that is profoundly flawed in its methodology and logic.

commodity prices to some favored level — in the case of energy

Well-regarded economists who have reviewed the work of thecommodities - down; in the case of cattle - up. Not only is there“experts,” who have been lobbying for restrictive positions limits

a complete disconnect between the implied promise to drive

and the exclusion of swap dealers and index funds from futures

prices down or up (whichever the most vocal constituency desires)markets, have found, among other flaws, that the proponents

and the ability of position limits to deliver on that promise, butof the restrictions demonstrated:

improperly calibrated and administered position limits can easily(1) unfamiliarity with industry fundamentals resulting indistort markets and increase costs to hedgers, which in turn

misinterpretation of petroleum statistics; (2) confusion of theincreases costs to consumers.

consequence of demand for physical product and demand forderivatives; (3) use of overly simplistic models; (4) arbitrary andmeaningless characterization and measurement of “excessive
speculation”; (5) misstatement of volatility trends; and (6) conﬂationof speculation and market manipulation.

8
9David S. Jacks, Populists versus theorists: Futures markets and the volatility of prices, (June 2006), available at http://www.isda.org/speeches/pdf/Onion-futures-Annex.pdf.
Phil Izzo, Bubble Isn’t Big Factor in Inﬂation, WALL ST. J., May 9, 2008, at A2.

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THE SCOPE OF THE CFTC’S AUTHORITYRESPECTING POSITION LIMITS

provisions (including exemption and aggregation rules), subject to

The CFTC has adequate authority to set hard limits on energy contracts

exchange-set speculative position limits, which it has approved, as

trading on registered exchanges and, in limited circumstances, trading

violations of the Act.14 We do not believe that there is any reason toECMs, which have been essentially exempt from CFTC oversight.

deviate from this effective framework.

Section 4a(a) of the CEA directs the Commission to ﬁx position limits

The CFTC’s authority respecting position limits is conﬁned to futures

for a commodity traded on a “designated contract market” (DCM),

contracts traded on U.S. DCMs, DTEFs and price discovery contracts

i.e., regulated futures exchange, or a “derivatives transaction execution(SPDC) traded on ECMs. The statutory deﬁnition of an SPDC is very

facility” (DTEF) if it first finds that such action is “necessary tolimiting of the CFTC’s authority and, so far the only SPDC is natural

diminish, eliminate, or prevent” “sudden or unreasonable ﬂuctuations

gas. As Chairman Gensler acknowledged in his recent Congressionalor unwarranted changes in the price of such commodity.” However,testimony before the Senate Permanent Subcommittee on Investigations,the Commission’s direct use of the authority conferred in Section 4a(a)in view of the various exclusions and exemptions from CFTC authority

is neither required nor justiﬁed if the relevant designated contract

available for transactions executed in OTC market, the CFTC does notmarket has acted effectively to avoid “excessive speculation.” Indeed,currently have authority to impose federally mandated position limits

as the Commission has previously noted, the exchanges have thethat would extend to the traditional bilateral OTC market.

expertise and are in the best position to fix position limits for theircontracts.10 In fact, this determination led the Commission to delegate
to the exchanges authority to set position limits in non-enumerated
commodities, in the ﬁrst instances, almost 30 years ago.11

Commission oversight. The Commission has authority to enforce

Because the Commission has limited authority respecting theimposition of position limits across all markets in which positions inthe same underlying commodity may be assumed, we believe that new
self-imposed or CFTC-imposed restrictions on fully regulated DCMs

Since that time, the regulatory structure for speculative position

likely will have the predictable and inevitable effect of simply shifting

limits has been administered under a two-pronged framework; withtrading from regulated and transparent derivatives markets to lessenforcement of speculative position limits being shared by both theregulated markets such as ECMs, or unregulated, opaque markets,

Commission and the DCMs. Under the ﬁrst prong, the Commission

including, offshore Exchanges, offshore OTC Markets, U.S. physicalestablishes and enforces speculative position limits for futures contracts

markets and offshore physical markets, all of which are beyond theon a limited group of agricultural commodities. Under the second

Commission’s control respecting position limits. This result runs

prong, for all other commodities, individual DCMs, in fulﬁllment

counter to the public interest and current efforts by the Administrationof their obligations under the CEA’s Core Principles, establish andand Congress to limit systemic risk in the ﬁnancial system.15

12

13

enforce their own speculative position limits or position accountability

10

46 Fed. Reg. 50938, 50940

11

Id.

12

The Commission has consistently endorsed this framework when addressing issues related to speculative limits. See, e.g., 74 Fed. Reg. 12282; 72 Fed. Reg. 66097; 70 Fed. Reg. 12621; 69 Fed. Reg. 33874.

These “Federal limits” are enumerated in Commission regulation 150.2, and apply to the following futures and option markets: CBOT corn, oats, soybeans, wheat, soybean oil, and soybean meal; Minneapolis Grain
Exchange (MGX) hard red spring wheat and white wheat; ICE Futures U.S. (formerly the New York Board of Trade) cotton No. 2; and Kansas City Board of Trade (KCBT) hard winter wheat. The exchanges, under theirown rules, have adopted the Federal limits and enforce violations of these limits.

13

Violations of exchange-set speculative limits are subject to exchange disciplinary action; violations of exchange speculative limit rules approved by the Commission are subject to enforcement action by the Commission,in addition to any action that the exchanges may take.

14

15
This result also would seem contrary to the legislative intent underlying last year’s legislation imposing new CFTC oversight on certain contracts traded on the essentially unregulated exempt commercial markets.
Congress undertook this action after witnessing the results of the Amaranth experience. Using the market surveillance tool of position accountability levels, NYMEX staff members determined to direct Amaranth inAugust 2006 to reduce its open positions in the ﬁrst two nearby contract months based upon what they believed to be a signiﬁcant concentration in NYMEX markets in Natural Gas futures. However, this prudent regulatory
action by the regulated futures exchange simply resulted in a shift of positions by Amaranth from NYMEX to the Intercontinental Exchange (“ICE”), which was undetectable at that time both by NYMEX and the CFTC.

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Excessive Speculation and Position Limits in Energy Derivatives Markets

Nonetheless, there are steps that the Commission and Congress may

The United States has been the center of world trading because of its

take to provide the CFTC with adequate authority to cure the problem

ﬁrst mover advantage and its rational regulatory regime. If speculators

it perceives. Speciﬁcally, Congress can expand the CFTC’s power

and accumulators like swap dealers and index funds are restricted fromto cover certain U.S.-based behavior by amending the provisions of

trading world commodities such as oil and metals on U.S. exchanges

Section 2 of the CEA dealing with “excluded” commodities, as theand on the U.S. OTC market, their alternative is clear. They will turnterm is deﬁned in the CEA, to grant the CFTC authority to impose

to their foreign afﬁliates and the market will move offshore. Althoughand enforce position limits on positions taken in excluded OTC

Natural Gas delivered at Henry Hub is a natural U.S. product and it

transactions.

is not likely that that speciﬁc contract will move offshore, natural

Moreover, the ECM category should be eliminated in order to subject

gas is a global product and it is certain that a new global benchmark

these exchanges to the full panoply of the CFTC’s authority respecting position limits. Indeed, any trading facility that is now successfully
operating as an ECM can easily convert to a DTEF or DCM. A DTEF

contract will emerge on a foreign exchange if trading on U.S. markets
is constricted by inappropriate limits. The likely chain of effects ispredictable and unacceptable; liquidity of U.S. markets will be impaired

has an afﬁrmative obligation to deter market abuses and to implement

causing damage to the domestic natural gas industry.18

systems and procedures to comply with that obligation.16 DTEFs,

Even if Congress or the Commission could ﬁnd a legitimate basis to

however, are not explicitly obligated to comply with Core Principle

restrict or impede U.S. ﬁrms from participating in offshore markets,

5. Thus, to ensure DTEFs take appropriate action respecting position

the only consequence will be to disadvantage U.S. ﬁrms and U.S.

limits the CFTC should make Core Principle 517 applicable to DTEFs

markets. World prices will be set without U.S. participation. Thus,

trading enumerated or excluded commodities. The Commission has

the importance of precisely calibrated and properly administeredoversight powers to insure that these obligations are met. Once Core

position limits on energy contracts, along with a carefully managed

Principle 5 is applicable to DTEFs, this regulatory scheme would appear

exemption process, cannot be understated.

to provide an effective remedy to the problems identiﬁed with ECMs
without the need to revise the current structure.
We caution, however, that any regulatory or legislative action aimed
at constricting market activity without closing these regulatory gaps
is likely to drive business to a more amenable jurisdiction or to
unregulated markets; there is not likely to be a signiﬁcant impact on
the overall size of speculative and risk management positions. There
will, however, likely be damage to the liquidity of the regulated markets
with the attendant increases in costs to their users and, ultimately,
U.S. consumers.

16
CEA Section 5a (c)(2) provides as follows: Deterrence of abuses — The board of trade shall establish and enforce trading and participation rules that will deter abuses and has the capacity to detect, investigate, andenforce those rules, including means to-- (A) obtain information necessary to perform the functions required under this section; or (B) use technological means to — (i) provide market participants with impartial accessto the market; and (ii) capture information that may be used in establishing whether rule violations have occurred.
17Core Principle 5 of section 5(d) of the Act: POSITION LIMITATIONS OR ACCOUNTABILITY — To reduce the potential threat of market manipulation or congestion, especially during trading in the delivery month, theboard of trade shall adopt position limitations or position accountability for speculators, where necessary and appropriate. (b) Acceptable practices. (1) In order to diminish potential problems arising from excessively large
speculative positions, and to facilitate orderly liquidation of expiring futures contracts, markets may need to set limits
on traders’ positions for certain commodities.

Before the successful introduction of futures trading in 1983, the oil market had migrated through a series of non-competitive and non-transparent mechanisms for price determination. Before World War II, theTexas Railroad Commission oversaw production and price determination within the State of Texas. After the war, a corporate oligarchy — “the seven sisters”— organized a system for pricing based largely on netbacks togeographic points. In the early 1970s, OPEC, which was established in 1960, successfully asserted itself to take control of price determination. Though these three mechanisms were independent of each other, they shared
two signiﬁcant characteristics: prices were determined non-competitively and each process lacked transparency.
18

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CME GROUP/NYMEX RESPONSE
We recognize that conﬁdence in the markets may be undermined by
the perception that speculators may be driving commodity prices.
We also support the CFTC’s mission to ensure that the energy markets
subject to its regulation can operate efﬁciently to carry out theircore missions. The vocal public criticism respecting the impact of“speculative” trading on energy commodities strongly suggests thatthe imposition of hard limits in such markets may increase conﬁdence
in the futures markets, and in the U.S. markets overall. The effort toincrease conﬁdence in the futures markets by imposing hard limits
on energy products, however, must be delicately balanced with theneed to ensure that such limits do not have a detrimental effect on theprice discovery and hedging functions of futures markets. We believe

 K_\:=K:n`cc\jkXYc`j_Xjpjk\d]fii\gfik`e^f]\e[$user OTC positions and, after gaining authority to impose
aggregate limits that include OTC positions, be responsible
for ensuring an end-user’s combined on-exchange and OTC
speculative positions do not exceed the aggregate total market
position limit. The CFTC may grant exemptions for OTC
positions that represent hedging rather than speculative activity.

We are prepared to lead, but any steps taken to impose hard position
limits must support the national policy of enhancing transparent
markets and central counterparty clearing — which was reafﬁrmed
by Congress in its amendments to the CEA just last year — and prevent
market participants from moving away from the best regulated, mosttransparent, safest marketplace to less regulated or even completelythat a carefully designed hard limits regime can accomplish these goals.

unregulated markets that are and will continue to be beyond theAccordingly, we make the following recommendations, which arewith our adopting a hard limits regime, ECMs and FBOTs must do sodescribed in more detail below.

as well for all similar contracts. As previously noted, if these entities <XZ_i\^lcXk\[\oZ_Xe^\j_flc[j\kgfj`k`fec`d`kj]fiXcc

control of the Commission and Congress. Therefore, in conjunction

are not subject to a hard limit regime for all similar products, not justmonths combined, single months and the delivery period based

SPDC, hard limits at NYMEX will simply bleed business into unregulatedon traditional considerations, focusing on its open interest and,or less regulated venues. Additionally, placing DCMs, ECMs and FBOTs

at or near the delivery period, the deliverable supply. The CFTCon equal footing with respect to position limits will ensure that market

may alter or amend the limits set by an exchange or adopt a

competition among these trading platforms is based on liquidity,

formula to be applied separately by each exchange based ontechnology, clearing quality, price and customer service, and notfactors pertinent to its market if it ﬁnds that the exchange’s

regulatory arbitrage.

rules are inadequate to prevent the effects of “excessive
speculation.” <XZ_\oZ_Xe^\j_XccY\i\jgfej`Yc\]fiX[d`e`jk\i`e^`kj
hedge exemption program for its markets subject to its existing
exemption standards until such time as common exemption
standards are established by the CFTC. Each exchange will

Moreover, it is essential that the exchanges be permitted to continue
to administer exemptions from the speculative limits for risk mitigating
trades. The imposition of hard position limits, absent a hedge exemption
for swap dealers and index funds, on a U.S. futures exchangewith respect to a commodity that trades on a global basis, that iscontinue to funds will remain eligible for risk management

readily stored, that has numerous dedicated exchanges and a number

exemptions to hedge bona ﬁde exposure but be subject toof well-established OTC trading venues is unlikely to have any

position limits for their speculative proprietary trading.

significant commercial impact other than driving the prohibited
positions off-exchange or to venues outside the United States withpredictable harm to the U.S. regulated markets and their users(e.g., commercials, producers, consumers). Thus, it is essential thatswap dealers and index funds be allowed a risk offset exemption.

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Excessive Speculation and Position Limits in Energy Derivatives Markets

Position Limits – Calibrated
To Existing CFTC Authority

energy contracts, in addition to the current limits that apply during

NYMEX currently employs hard position limits during the last

single-month and all-months combined limits as well as concentration

three days of trading before the delivery period begins and position

ratio thresholds. This modiﬁed regime will include the administrationaccountability levels at other times to avoid congestion and otherof tailored hedge exemptions for swap dealers and index funds, thatmarket disrupting events that may ﬂow from excessive concentrations

reﬂect the individual circumstances of the participants and are limitedof positions. NYMEX’s administration of its accountability regime hasin duration and quantity, and as whole, should alleviate externalbeen discredited in the press simply by listing the number of tradersconcerns that positions held by these investors and hedgers will

who, and time periods during which, such traders held positions inincrease price volatility or artificially inflate or deflate prices.

excess of the accountability levels. Of course, current accountability

Each exchange and ECM, which is obligated to control excessive

levels are set as an early warning alert well below the level at which

speculation, has an obligation under the CEA to set its own limits

position concentrations present a market integrity concern.

in proportion to liquidity, volume, open interest and other factors

Consequently, traders frequently hold positions in excess of those

respecting trading for which it is directly responsible. It is contrarylevels for extended periods. For example, NYMEX’s accountability

to the purposes of the CEA’s prohibition on excessive speculation for

limits are set as a small percentage of the front month’s open interest:

an exchange with limited liquidity, volume and/or open interest to

the last three trading days of the expiration month, which will include

simply mimic the position limits set by the exchange on which it is

NYMEX Contract

Single-Month
Accountability
Level

Percentage of Front
Month FuturesEquivalentOpen
Interest

Crude Oil

10,0003%

Natural Gas

6,000

4%

attempting to free ride. For example, if NYMEX with substantial
volume, open interest and liquidity, sets its single-month position
limit at 20,000 and an exchange with one-fourth of NYMEX’s liquidity,
volume and open interest, simply expropriates that number, traders

RBOB Blendstock Gasoline

5,000

6%

would be able to exploit a position limit of 40,000 when the correct

Heating Oil

5,000

7%

level should have been 25,000 with no more than 20,000 on NYMEX
and 5,000 on the less liquid exchange.

It is well-understood in the industry and among CFTC staff that
traders can and do hold positions in excess of the accountability
levels without adversely impacting prices or volatility. The CFTC has
repeatedly found that the NYMEX’s administration of its accountability
levels is in compliance with its obligations under the CEA to prevent
excessive speculation, as interpreted by the CFTC in its “Acceptable
Practices” for Core Principle 5. Notwithstanding the success of
NYMEX’s accountability regime, as previously noted, we recognizethat concerns have been raised about accountability regimes for theenergy products and such concerns may be impacting conﬁdence inour markets. We are committed to working with the Commission andother market participants to address these issues in a way that ensurescontinued market integrity and competition among the markets.
To this end, if those ECMs and FBOT that trade energy products
agree to adopt comparable programs, we will adopt hard limits for9cmegroup.com

Proposed Principles For Single Exchange
Position Limits For Energy Contracts

Concentration: Concern that position limits calculated according to

Spot Limit: During a short period beginning near the termination

contract months will be addressed by including, on top of the positionof trading in a contract (last three days in energy) setting the position

limits, a ﬂexible concentration ratio threshold, which will be calculated

limit at 25 percent of deliverable supply for a physically deliveredon the basis of open interest in a single month. These concentration

contract is well-established and appropriate for the purposes ofthresholds will protect against the potentially disruptive effects ofminimizing the potential for manipulation and allowing for effective

excessive concentration by a single trader and allow the exchange

convergence of futures and cash. Financially-settled contracts

to direct a trader not to increase his position or to reduce his position.

referencing the physically-settled contract should have an equivalent,

The concentration ratio threshold will be ﬂexible enough to accommo-

but separate, spot limit.

date the development of liquidity in deferred month contracts and also

this formula will permit excessive concentration in some thinly traded

to ensure that participants can manage their positions appropriately.
Single-Month and All-Months Combined Limits: Single-month

Our proposed concentration threshold is 25 percent of open interest

limits should be a function of liquidity as the objective is to limit

in a single month that has developed liquidity.

the potential for the initiation or liquidation of a large position tocause price distortions. Our experience suggests that futures-equivalent
open interest in the lead month is an appropriate proxy for liquidity
on each exchange. We suggest that the single-month limit beestablished as 10 percent of the ﬁrst 25,000 contracts of open interest
with a 5 percent marginal increase for open interest in excess of 25,000
at each exchange – DCM, ECM or FBOT; the all-months-combined
limit would be 150 percent of the single-month limit and the all-months
limit would also be applicable to spread positions within the same
contract. Additionally, for physical and ﬁnancially settled contracts
based on the same underlying commodity and traded on the same exchange, the open interest (adjusted for contract size) will be calculated
across the products and a single aggregate limit will be established forthe full complement of such contracts.
This methodology allows for natural limitations of concentration inexcess of levels that a market can appropriately handle without risk
to the integrity of the market. This methodology also produces anatural aggregate limit across exchanges that is fairly applied andwhich fosters competition. It also produces a self-correcting limit
level based on periodic, sustained changes in open interest, and isaccomplished without requiring CFTC resources and interventionin administering exchange limits.

10

Excessive Speculation and Position Limits in Energy Derivatives Markets

Proposed Principles For Position
Limits – Cross-Market Aggregation

CONCLUSION

If the CFTC gains authority over OTC trading, and if it ﬁnds a means

life of this country for almost 100 years and, increasingly, are playing

to minimize the impact of transfers of trading to foreign jurisdictions

a critical role in the world economy. Futures markets permit thoseor to some variation of the cash/physical market, then the CFTC

who seek to minimize risk to quickly and efﬁciently ﬁnd those willingshould adopt an aggregate limit for the total positions held in all of

to take on that risk. While we understand that futures markets must

Regulated futures markets have played an integral role in the economic

the markets and apply the aggregate position limit at the level of theinstill confidence in all key stakeholders, it is also important toactual position owner/controller in accordance with the provisions ofrecognize that changes made to ensure public confidence without

CFTC Regulation 150.4 respecting aggregation. The CFTC-set aggregate

comprehensive analysis of the potential effects, may undermine

limits would be set in terms of equivalents of the largest most liquid

otherwise well functioning markets that have earned their status

futures contract. For example, the light sweet crude oil limit would be

as global benchmarks for price discovery and risk management.

set in terms of equivalents to the NYMEX contract WTI speciﬁcation,

Confidence clearly will not be enhanced by measures that impair

or 1,000 barrels per contract. In addition to the aggregate limit, eachliquidity and efficiency and that incentivize traders to utilize lessregulated exchange would continue to be responsible for enforcing its

transparent or offshore venues. We believe the approach outlined

exchange-speciﬁc limits.

in this White Paper addresses public concerns and protects the

In order to properly enforce aggregate limits, each of the ultimate
customers would need to be identiﬁed and its total derivatives position,
including U.S. futures, FBOT futures, SPDC, ETFs and OTC contracts

competitiveness and transparency of our domestic energy markets.
We look forward to working with the CFTC, Congress and otherregistered exchanges to put these recommendations into practice.

would be aggregated. The CFTC would identify traders whose aggregate
speculative on-exchange and related OTC positions exceeded the CFTC
aggregate limit and would be responsible for enforcing compliance withthe aggregate limit. The CFTC would also grant exemptions for OTC
positions that qualiﬁed for hedge treatment.
Assume that the one month aggregate limit for WTI was set by the
CFTC at 40,000 contract equivalents. A trader would be entitled toaccumulate and hold derivative contracts covering 40,000,000 barrels.
That trader would also be constrained by position limits set by DCMs
and ECMs. For example, based on open interest, the trader might beentitled to hold 20,000 contracts at NYMEX and 5,000 at ICE. The
remaining 15,000 contract equivalents could be held in some combination of ETF shares, OTC swaps and FBOT contracts. Traders will be
responsible for reporting their OTC positions directly to the CFTC.
The CFTC would be responsible for requiring the trader to reduce its
positions, but would not take an action that favors a particular venue.

11

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