Texas Outlaws and a Silver Bullet: Position Limits in the USA
In this first installment on position limits, Regulatory Guidance expert Greg Hotaling surveys the current landscape of position limits imposed for U.S.-listed commodity derivative holdings, which can affect investment firms and other speculative investors regardless of where they are based. Stay tuned for coverage of EU position limits in the next edition.
“Who shot J.R.?!” everyone wondered in 1980. Long before the final occupant of the Iron Throne transfixed our current generation, the question of who tried to knock off J.R. Ewing, in the hit American TV series Dallas, was splashed on the covers of national magazines, unashamedly pondered on nightly news TV (alongside a Presidential election and Iran hostage crisis), and personally posed to actor Larry Hagman by none other than the Queen of England.
What some market surveillance officials were also following was the actual inspiration behind Hagman’s conniving “J.R. Ewing” and his Texas oil family: the real-life bloodline whose fortunes and misfortunes ultimately came to a head at the very same time as the Dallas frenzy they inspired. They were the Hunts, notably brothers Nelson Bunker Hunt and William Herbert Hunt, Texas oil barons whose attempts to corner the silver market in 1979 had driven up the price of silver from $6 to almost $50 per oz. (Already by 1974, the Hunts had begun to take measures worthy of a primetime drama, amassing 55 million oz. of silver – 8% of the world’s deliverable supply – and loading most of it onto planes bound for Switzerland in the middle of the night, with their ranch cowboys serving as marksmen for security.)
As the exchanges CBOT and COMEX responded to the 1979 price spike with emergency position limits (maximums of 600 contracts and 2,000 contracts respectively) among other measures, the price declined sharply and by March 21, 1980 – the broadcast date of the Dallas cliffhanger – silver was down to $21 per oz. Just six days later, as selling pressure continued and with the Hunts unable to meet a margin call of $100 million, silver dipped below $11 and the sell-off expanded to the commodities and financial markets generally, in what would be dubbed the “Silver Thursday” crash. When the dust settled, the Hunt brothers were $1.5 billion in the red and, after several years of investigations and lawsuits, by 1988 declared bankruptcy and were found liable in a civil court for having conspired to manipulate silver prices. (Dallas, by the way, was following a similar trajectory, having slid from first to 21st in TV viewership.)
While the CFTC attracted criticism generally for not doing enough to stem the crisis, Chairman Jim Stone stood in the minority among his colleagues for acknowledging a threat to “the financial fabric of the United States.” Stone’s comments foreshadowed the CFTC’s current proposal to broaden the scope of its position limit regime: from nine core agricultural commodities to an expanded 25 core commodities that also include energy sources and metals (including, of course, silver). In these recent efforts, the CFTC has explicitly recognized that “speculative limits would have helped to prevent the buildup of the silver price spike of 1979-80.”
Whether the latest position limit proposal by the CFTC is a silver bullet that prevents market manipulation is debatable, but what is clear is that, if and when it becomes effective, it will change the way many market participants manage their relevant holdings. In fact, a major part of the proposal is directed at the very issue of what holdings are relevant: not only the larger number of underlying commodities covered (25), but also a broader set of instruments that are “economically equivalent” to standard futures, including swaps and cross-border OTC contracts.
Those more expansive requirements within the proposal are accompanied by some more lenient measures. Most of the limit levels relating to the current nine core agricultural commodities would be relaxed. As for the remaining 16 core commodities as proposed, the limits would apply only to the spot month (no “single month” or “all month” limits), and set at higher levels than those currently set by the exchanges. (A reminder here, that while the CFTC sets position limits for these U.S.-listed derivatives with “core” commodity underlyings, the U.S. exchanges are free to set lower limits on those products if they so choose. And perhaps even more importantly for market participants, U.S.-based exchanges such as CBOT, COMEX and ICE choose to impose their own position limits on hundreds of other commodity and financial derivatives that do not relate to core commodities.)
Qualifying for exemptions will also be easier under the CFTC’s proposal. 11 “enumerated” hedging exemptions are set forth, without the need for CFTC approval (Form 204 would be eliminated). Other “bona fide” hedging activities would also be deemed exempted, upon approval of the relevant exchange and as long as the CFTC does not object within 10 days.
Compliance professionals and other concerned parties would be forgiven for viewing this latest proposal with some fatigue, as it follows a string of unsuccessful CFTC position limit efforts since passage of the Dodd-Frank Act in 2010 (which amended the Commodity Exchange Act, to authorize the CFTC to establish position limits for an expanded set of instruments). The CFTC’s current proposal overrides several prior versions and underwent a public comment period that was extended until 15 May 2020. With more than 160 submissions received (you can view them here), it’s no surprise that one Commissioner has suggested that the proposal may be altered based on the comments. At the same time, some have suggested that the CFTC would be motivated to enact its proposal before the Presidential election in November. Once approved – whenever that may occur – the new regulations would take effect one year thereafter (to be precise, one year after their publication in the Federal Register). The takeaway for asset managers, therefore, is not one of immediate urgency, but rather to remain abreast of these developments which at some point may affect their commodity derivative holdings.
Meanwhile, the CFTC regulates the issue of aggregation – how each firm as a group must combine its various corporate entities for the purpose of adding up its holdings subject to the limits – under an entirely separate proposal that was approved in 2016. These aggregation rules currently relate only to the nine core commodities covered by the current CFTC position limit regime and would broaden to the relevant 25 core commodities once that separate proposal is enacted (as described above). Perhaps more significantly, the aggregation rules are the subject of extensive “no-action” relief provided by the CFTC – meaning that many of the new aggregation requirements do not apply – until at least 12 August 2022. The clear takeaway for investment firms with commodity derivative holdings, that don’t already benefit from a hedging exemption or other relief, is to become familiar with the aggregation requirements and related exemptions, as well as the CFTC’s relevant no-action relief (found here).
Finally, as to who shot J.R. in Dallas, that one you’ll need to figure out on your own. (No spoilers here, sorry.)
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