Wednesday, January 20, 2010

CFTC Position Limits

An excellent piece from the FT's Alphaville:
 
Energy analyst Olivier Jakob from Petromatrix has crunched through the CFTC’s proposals on position limits released last week.
His findings are worth flagging up because they differ to the consensus view that the proposals, if enforced, would be a benign influence on energy markets.
First, he guesstimates the limits would certainly affect at least one large Wall Street investment bank offering a leading commodity index. And while the bank — which he does not name — could apply for an exemption to a maximum of 130,000 WTI contracts on a single month, they would then be prohibited from holding speculative positions. In other words, would it be worth it?
According to Jakob, therefore, the limits create an uncomfortable situation for some of the larger Wall Street investment banks offering commodity indices — and could force them to choose between operating index and swap businesses versus proprietary books.
Furthermore, there isn’t an easy side-route out of the restrictions, say by starting subsidiary hedge funds or physical operations. That’s because the limits are imposed on an aggregate basis per owner institution — and when exemptions are granted, speculative operations are restricted. As Jakob noted:
Opening a series of hedge funds controlled by the Swap Dealers would not be a solution as the CFTC proposed rules would also make this illegal. Owning a Physical trading entity would also not be a solution as Commercials with limit exemption would be restricted from holding speculative positions and could not act as a Swap Dealer if their position is above two times the limits.
In smaller markets like heating oil, meanwhile, this could pose an even greater challenge for the banks, according to Jakob:
The greater problem might actually arise with Heating Oil which has a Single Month limit of 6’800 contract and given that some of the Wall Street Investment Banks offering leading Commodity Indices are also leading hedgers to the airline industry we would expect that a few Wall Street Investment Banks will hit the limit on Heating Oil which would then require an exemption, which then limits speculative activity.
And while ETFs like the United States Natural Gas fund — which famously broke through accountability limits in 2009 –  may have prepared for the CFTC ruling by moving into the bilateral and unregulated OTC swap market, they too might be restricted by the CFTC’s swap-dealer ruling. As Jakob noted:
Outside of bilateral swaps, the UNG is holding the equivalent only of about 36’000 contracts which would still be below the CFTC Single Month limit. However, the UNG would have to find Swap Dealers that would not be restricted themselves by limits, and since Swap Dealers that would have an exemption could be required by the CFTC to provide the list of clients and the daily activities with those clients, it could then become a risk factor for the Swap Dealers or any other entity that is fronting for a Fund that is itself subject to position limits.
Sounds like more of a headache than first anticipated.


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