Position limits rejection lifts compliance burden

Rejection of Commodity Futures Trading Commission rule brings short-term relief and longer-term uncertainty, say consultants

Compliance: ruling should lighten the load

The recent court ruling that rejected a key Dodd-Frank rule on speculative position limits has provided a welcome dose of relief for energy firms, which have been racing to become compliant with a host of new swap regulations by October 12.

The introduction of position limits was just one of a number of regulatory measures triggered by the publication of swap definition rules in the Federal Register on August 13.

But despite the relief, there are also concerns the court ruling has increased the overall level of uncertainty around the new law by paving the way for further litigation aimed at the US Commodity Futures Trading Commission (CFTC) and its rule-making process.

In the September 28 ruling, Judge Robert Wilkins of the US district court for the District of Columbia sided with two industry groups – the International Swaps and Derivatives Association and the Securities Industry and Financial Markets Association (Sifma) – which sued the CFTC last year in a bid to block the rule. The judge said the CFTC had failed to demonstrate that the rule was 'necessary and appropriate' and instructed it to issue such a finding before attempting to promulgate the rule again – in effect, sending it back to the agency for further work.

Since his decision came just two weeks before the rule was set to take effect, energy companies had been working for months to become compliant with the new position limits regime, while keeping a close eye on developments in court. "People were definitely on overdrive to be done by October 12," says Bill Hederman, a Washington, DC-based director of the energy regulatory compliance group at Deloitte. "Companies that were concerned they might exceed position limits were working very diligently to get this in place... Having more time will be helpful for getting in compliance."

Having more time will be helpful for getting in compliance

Energy industry trade groups, including the American Petroleum Institute and the Edison Electric Institute (EEI), have welcomed the court ruling.

"We are happy with this ruling, as we had indicated in our initial comments that a necessity finding was required," says Lopa Parikh, director of federal regulatory affairs at EEI, which represents investor-owned utilities. "Our members have started the compliance process, but we had significant concerns with the final rule on which we were waiting for commission action."

Specifically, EEI had identified two areas in which the position limits rule was particularly burdensome for utilities and asked the CFTC for exemptions to address them. In the first, EEI asked whether certain kinds of power and gas transactions often used by utilities could qualify as ‘bona fide hedging transactions' exempt from the rule; in the second, it sought to change the way the CFTC required positions to be aggregated across different entities controlled by the same company. The commission had yet to respond to the EEI's petitions when Judge Wilkins issued his ruling.

"Given those two big outstanding concerns we had with the position limits final rule, we are happy with the district court's ruling and hope this will address our concerns," Parikh says.

Not everyone sees the position limits ruling as a full-fledged victory for the industry. Some market participants say it raises the level of uncertainty surrounding the CFTC's rule-making process by enabling further court challenges targeting specific Dodd-Frank rules. That could foster a 'wait-and-see' attitude as companies drag their feet on compliance, argues Deloitte's Hederman.

The court decision "creates even more uncertainty," says Brenda Boultwood, vice-president of industry solutions at MetricStream, a California-based vendor of governance, risk and compliance software. "We are really just seeing the beginning of the impacts of litigation on the rule-making process, and the larger impact will be major delays and increasing uncertainty for the market."

The position limits rule has been the subject of fierce controversy ever since it was first authorised by Congress as part of the Dodd-Frank Act. The rule, as finalised by the CFTC in October 2011, would have imposed limits on the size of positions that market participants could take in 28 physically delivered commodity derivatives contracts.

Advocates say such limits would help ensure rampant speculation does not lead to price jumps and excessive volatility, such as the 2008 spike in oil prices, which pushed prices of light sweet crude oil for front-month delivery up to an intraday high of $147.27 per barrel on CME Group's New York Mercantile Exchange. Critics say there is no conclusive evidence that the 2008 oil price spike was caused by speculation and argue position limits would be ineffective in curbing volatility.

Because of the difficulty of proving the risks of excessive speculation, some legal experts believe the CFTC will find it impossible to demonstrate that the position limits rule is ‘necessary and appropriate', which would effectively stifle its efforts to implement the rule. 

The CFTC has not yet indicated whether it will seek to issue such a finding or appeal the judge's decision.