CFTC’s Proposal on Position Limits Won’t Affect Most End Users

Companies still wait for clarity on margin requirements on derivatives trades.

The Commodity Futures Trading Commission (CFTC) proposed new position limits for commodity derivatives last week, but that proposal isn’t expected to have much impact on most corporations that use derivatives to hedge risks. Meanwhile, companies are still waiting to learn whether U.S. banking regulators will require derivative end users to post margin.

The CFTC’s proposal to limit the number of contracts a single firm can hold in 28 different commodities follows a court’s rejection of a previous position-limit proposal from the commission.

Luke Zubrod, a director at Chatham Financial, downplayed the importance of the CFTC’s proposal for corporate end users, noting that the limits involve agricultural, metals and energy contracts. “The big areas of interest rates and foreign currencies are untouched by the position limits rules,” Zubrod said.

A company with some exposure to such commodities, like a supermarket chain that uses oil to make deliveries, “might be exposed to one of the oil contracts that shows up under this position limit rule, but you likely won’t be exposed to that to such a degree that you would worry about bumping up against those position limits,” he said.

The position limits could potentially affect liquidity and pricing for corporate end users that trade with an organization subject to the limits, Zubrod added.

Meanwhile, companies that use derivatives still have hanging over their heads the possibility that they could be subject to margin requirements. Corporations have argued that the capital tied up by margin requirements would weaken capital spending and could result in job losses.

U.S. banking regulators have been waiting for a report from a G-20 working group on margin requirements before coming out with their own proposal. That G-20 report, issued in September, suggested that corporate end users need not post margin.

Despite the G-20 group’s position, Zubrod said it seems likely U.S. regulators will require that corporate end-users post margin on derivatives. “What the Fed is clear about is that they don’t think they have the authority to put a margin exemption out there for anybody,” he said. “They did recommend a lighter touch with corporate end users, but they did recommend that corporate end users be subject to some sort of margin regime.

“Though I would be quite delighted to see that their re-proposed rule on margins changes their approach on end users, I think they’ll stay the course, and end users will still have a problem to deal with,” he said.

There have been attempts on the Hill to eliminate the prospect of a margin requirement for corporates. In June, the House of Representatives passed a measure, H.R. 634, that would exempt corporate end users from margin requirements, by a vote of 411 to 12.

The legislation seems to be off to a good start, but Zubrod, pictured at left, notes that at this point, “nothing is really moving in the Senate, let along anything connected with Dodd-Frank.”

The bill passed by the House is “very politically sympathetic and consistent with Congressional intent and has received broad bipartisan support in the House,” he said. “In spite of those things, they’re just running into the broader challenges in passing legislation in the Senate.”

When Jacob Lew was appointed Secretary of the Treasury, he wrote a letter indicating that Congress shouldn’t pass any changes on Dodd-Frank, “at least until the regulatory rule-making process has run its course,” Zubrod said. “For the time being, the administration and, by extension, the Democrats in the Senate have taken an approach of not opening the door to change.”

While corporate end users have been exempted from many Dodd-Frank derivatives rules, they’re likely to end up paying more to trade derivatives as banks pass on to their corporate customers the cost of complying with the new regulations. But Zubrod said it will take time for that price impact to become evident.

“The factors involving derivative pricing come from capital and margin requirements that become effective between now and 2019,” he said. “Therefore, the evolution in derivative pricing will unfold over that same time frame.”

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