Sunday, September 30, 2012

US judge strikes down CFTC commodity limits

The recent ISDA challenge to CFTC on commodity limits (discussed here) finally paid off. The nonsense about limits on futures holdings preventing "excessive speculation" that causes outsize swings in commodity prices was struck down in court. Politicians blaming the investment community for problems created by fiscal or monetary policy in the US or abroad never made sense. Grandma's multi-billion dollar state pension fund should not be prohibited from buying a basket of commodities (or investing in a fund that does) to protect against inflation risk. It's just silly.

Academic literature clearly points out that price fluctuations in commodities that had no futures contracts have been just as extreme as those traded on futures exchanges. And funds that take concentrated positions in commodities (such as commodity index funds and ETFs) are not the problem. In fact an OECD paper recently pointed out (see bottom of post) that the participation of index and swap funds in commodity markets may actually reduce volatility - possibly because of added liquidity.
OECD: - An unexpected finding was a negative relationship between index and swap fund positions and market volatility. That is, there is some evidence that increases in index trader positions are followed by lower market volatility. This result must be interpreted with considerable caution. The possibility still exists that trader positions are correlated with some third variable that is actually causing market volatility to decline. Nonetheless, this finding is contrary to popular notions about the market impact of index funds, but is not so surprising in light of the traditional problem in commodity futures markets of the lack of sufficient liquidity to meet hedging needs and to transfer risk.
A US district judge in DC agreed.
FT: - The “position limits” rule was to take effect in two weeks. It would have capped holdings of futures and options for 28 commodities and their derivatives, from crude oil to corn and cocoa, expanding existing limits to contracts for any delivery month.

Robert Wilkins, a US district judge in Washington, said on Friday the CFTC failed to heed instructions from Congress requiring it to determine that its rule was “necessary to diminish, eliminate or prevent” excessive speculation.

OECD paper
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