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CFTC Recommends Changes After Studying Market Data

00:00AM Sep 11, 2008

via a special arrangement with Informa Economics, Inc.

Regulator's recommendations finally come

NOTE: This column is copyrighted material, therefore reproduction or retransmission is prohibited under U.S. copyright laws.

CFTC issues recommendations based on review of data collected from swap dealers and index traders. The Commodity Futures Trading Commission (CFTC or Commission) staff report released today contains recommendations on activities of swap dealers and commodity index traders.

The report's findings and recommendations are based on information obtained from an unprecedented June 2008 special call that Commission staff issued to quantify key components of the over-the-counter (OTC) swap and commodity index markets.

The special call included 43 request letters to 32 entities and their sub-entities seeking information on total swap and index activity in the futures and OTC markets, and asked responders to categorize the activities of their customers. Responders provided monthly data for the period of December 31, 2007 through June 30, 2008 and have a continuing obligation to provide monthly data to the Commission. The results from the special call represent a snapshot of the best data currently available concerning the trading activity of swap dealers and commodity index traders.

"This staff report was an enormous undertaking that provides a window into the complex activities of swap dealers and commodity index traders,” said CFTC Acting Chairman Walter Lukken. "Based on the staff report, the Commission is recommending preliminary actions to increase transparency and improve controls in the marketplace. The recommendations represent steps in modernizing the agency's approach to oversight, while ensuring that the markets remain competitive, open, and on U.S. soil.”

In analyzing the data, Commission staff focused on three quarterly dates for presenting data on four individual commodity markets. The report also included aggregate market data. The report made several findings, including:

  • The aggregate amount of commodity index trading occurring both OTC and on-exchange is estimated to be $200 billion as of June 30, 2008 – of which $161 billion was tied to commodities traded on U.S. markets regulated by the CFTC.
  • While there was an increase in the net notional value of commodity index business in crude oil futures, it appears to be due to an appreciation of the value of existing investments caused by the rise in crude oil prices and not the result of more money flowing into commodity index trading.
  • As crude oil prices were increasing during the period December 31, 2007 to June 30, 2008, the activity of commodity index traders in crude oil during this period reflected a net decline of futures equivalent contracts.
  • While the report is the best available data on the markets, it is not possible to measure the entire market due to the non-standardized nature of the contracts, and the general complexity and nature of the OTC swap market.

Based upon the staff's analysis, the Commission report includes the following recommendations:

1. Remove Swap Dealer from Commercial Category and Create New Swap Dealer Classification for Reporting Purposes: In order to provide for increased transparency of the exchange traded futures and options markets, the Commission has instructed the staff to develop a proposal to enhance and improve the CFTC‘s weekly Commitments of Traders Report by including more delineated trader classification categories beyond commercial and noncommercial, which may include at a minimum the addition of a separate category identifying the trading of swap dealers.

2. Develop and Publish a New Periodic Supplemental Report on OTC Swap Dealer Activity: In order to provide for increased transparency of OTC swap and commodity index activity, the Commission has instructed the staff to develop a proposal to collect and publish a periodic supplemental report on swap dealer activity. This report will provide a periodic  "look through" from swap dealers to their clients and identify the types and amounts of trading occurring through these intermediaries, including index trading.

3. Create a New CFTC Office of Data Collection with Enhanced Procedures and Staffing: In order to enhance the agency‘s data collection and dissemination responsibilities, the Commission has instructed its staff to develop a proposal to create a new office within the Division of Market Oversight, whose sole mission is to collect, verify, audit, and publish all the agency‘s COT information. The Commission has also instructed the staff to review its policies and procedures regarding data collection and to develop recommendations for improvements.

4. Develop "Long Form” Reporting for Certain Large Traders to More Accurately Assess Type of Trading Activity: The Commission has instructed staff to develop a supplemental information form for certain large traders on regulated futures exchanges that would collect additional information regarding the underlying transactions of these traders so there is a more precise understanding of the type and amount of trading occurring on these regulated markets.

5. Review Whether to Eliminate Bona Fide Hedge Exemptions for Swap Dealers and Create New Limited Risk Management Exemptions: The Commission has instructed staff to develop an advanced notice of proposed rulemaking that would review whether to eliminate the bona fide hedge exemption for swap dealers and replace it with a limited risk management exemption that is conditioned upon, among other things: 1) an obligation to report to the CFTC and applicable self regulatory organizations when certain noncommercial swap clients reach a certain position level and/or 2) a certification that none of a swap dealer‘s noncommercial swap clients exceed specified position limits in related exchange-traded commodities.

6. Additional Staffing and Resources: The Commission believes that substantial additional resources will be required to successfully implement the above recommendations. The CFTC devoted more than 30 employees and 4000 staff hours to this survey, which the Commission is now recommending to produce on a periodic basis. Other new  responsibilities will also require similar additional staff time and resources. Accordingly, the Commission respectfully recommends that Congress provide the Commission with funding adequate to meet its current mission, the expanded activities outlined herein, and any other additional responsibilities that Congress asks it to discharge.

7. Encourage Clearing of OTC Transactions: The Commission believes that market integrity, transparency, and availability of information related to OTC derivatives are improved when these transactions are subject to centralized clearing. Accordingly, the Commission will continue to promote policies that enhance and facilitate clearing of OTC derivatives whenever possible.

8. Review of Swap Dealer Commodity Research Independence: Many commodity swap dealers are large financial institutions engaged in a range of related financial activity, including commodity market research. Questions have been raised as to whether swap dealer futures trading activity is sufficiently independent of any related and published commodity market research. Accordingly, the Commission has instructed the staff to utilize existing authorities to conduct a review of the independence of swap dealers‘ futures trading activities from affiliated commodity research and report back to the Commission with any findings.

But there is not a unanimous view at the CFTC. Commissioner Bart Chilton dissented with the report's findings and recommendations, noting, "I do not believe the Commission‘s recommendations go far enough, and I have significant concerns relating to the underlying analysis on which the recommendations are based," Chilton said. "Specifically, I express doubts regarding the amount and type of data received in connection with the special call survey, the nature of the analysis, and I have a fundamental disagreement with certain conclusions underlying the Commission‘s recommendations."

What does Chilton recommend? Chilton urged the CFTC to make the following recommendations based on data received up to this point:

  • request that Congress provide specific statutory authorities to allow the Commission to obtain data regarding over-the-counter transactions that may impact exchange-traded markets;
  • request that Congress provide specific statutory authorities to allow the Commission to address market disturbances or violations of the Commodity Exchange Act, based on the data received pursuant regarding over-the-counter transactions;
  • request that Congress provide immediate authorization and appropriations for at least 100 additional FTEs to carry out these new responsibilities.

Comments: So will these recommendations go far enough to satisfy critics and those who insist speculators are the main force which has resulted in the commodity price movements seen this year? The short answer is "no." And certainly not in the view of CFTC's Chilton and likely others. So while there still is agreement that something needs to be done, that's where the agreement stops.


NOTE: This column is copyrighted material, therefore reproduction or retransmission is prohibited under U.S. copyright laws.