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Thursday, February 26, 2015

CFTC COMMISSIONER GIANCARLO'S REMARKS AT ENERGY AND ENVIRONMENTAL MARKETS ADVISORY COMMITTEE

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 

Opening Statement of Commissioner J. Christopher Giancarlo Before the First Meeting of the CFTC’s Energy and Environmental Markets Advisory Committee

February 26, 2015

Good morning and welcome to the inaugural meeting of the CFTC’s reconstituted Energy and Environmental Markets Advisory Committee (EEMAC). Congress created the EEMAC as part of the Dodd-Frank Act because it recognized the critical need for a forum in which “exchanges, firms, end users and regulators” could advise the Commission of their concerns regarding “energy and environmental markets and their regulation by the Commission.”1 Congress was so concerned that the Commission know the effects its rules and policies have on energy and environmental markets that it mandated the EEMAC hold at least two public meetings each year.2 Disappointingly, no EEMAC meetings have been held since the Dodd-Frank Act was signed into law.

As a new Commissioner and the sponsor of the EEMAC, I take the Dodd-Frank mandate seriously. I am pleased to convene the first of what I hope are many productive EEMAC meetings to maintain a healthy dialogue between the Commission and the energy and environmental market participants. That dialogue is especially crucial in the wake of the Dodd-Frank Act because Commission policies have a significantly more profound impact on energy markets than they ever have, and at the same time, the energy and environmental markets are undergoing the most sweeping technological and structural changes in a generation.

In my limited time as a CFTC Commissioner, I have met with coal miners in Kentucky, oil refiners in Texas, and natural gas pipeline operators in Louisiana. They all impressed upon me their deep concern over the form and substance of the Commission’s proposed position limits regime on energy derivatives.3 The CFTC has already held two public events to solicit feedback from market participants on these proposals during my time at the Commission. I believe the Commission will greatly benefit from a similar session dealing with the energy sector.

Energy production in the U.S. has changed significantly in the last decade, with production of oil and natural gas increasing dramatically as a result of horizontal drilling and hydraulic fracturing, among other factors.4 And in the last few months, we have all noticed a dramatic fall in energy prices, with gas falling to, as low as, $2.00 per gallon at the pump. In view of the dramatic changes in U.S. energy markets, a further session exploring the unique concerns of energy market participants regarding the position limits proposals will ensure that the Commission has a complete picture of the consequences of these proposals on all aspects of the energy and environmental markets.

The purpose of today’s meeting is to have a lively dialogue on three important topics of concern.

Panel I: What Does the Data Show?

First and foremost is an examination of the research and data supporting the proposed position limits rules. In 2011, when the Commission voted on its first proposal to implement the new Dodd-Frank federal position limits regime, former Commissioner Mike Dunn registered his belief that price volatility in physical commodities is primarily driven by changes in supply and demand.5 Commissioner Dunn explained that “to date[,] CFTC staff has been unable to find any reliable economic analysis to support either the contention that excessive speculation is affecting the market[s] we regulate or that position limits will prevent excessive speculation.”6 Fast forwarding to the present day, the CFTC’s current position limits proposal is primarily reliant on studies of two major market events dating from 1979 and 2006 to conclude that position limits are necessary to diminish, eliminate or prevent excessive speculation.7 I hope that our first panel – and subsequent Federal Register comments – augments the Commission’s assessment of the need for, and efficacy of position limits, especially in light of the current conditions in the U.S. energy markets.

Panel II: Designated Contract Market Experience with Position Limits and Trading Liquidity.

The second panel will examine a critical attribute of position limits: liquidity. Congress expressed an explicit concern that the Commission set position limits in a way that maintains liquidity for hedgers.8 Although we must be attentive to liquidity issues in the spot month, liquidity takes on even greater importance outside of the spot month because that is where liquidity is often the hardest to find. In addition, as I have noted in other contexts, liquidity is the vital component of healthy and vibrant derivatives markets. The Commission should heed the prescription of Dodd-Frank and carefully analyze the effects of its rules on available liquidity to avoid systemic risk.9

This second panel will consider the experiences of the two major U.S. futures exchanges in balancing position limits and trading liquidity. Before the Commission makes any final determination of the necessity of position limits, it must make doubly sure that any rules enacted preserve liquidity for hedgers and do not unduly reduce the liquidity that is critical to well-running, orderly markets. Hearing from folks with decades of front-line experience administering position limits for energy markets is a good place to start.

Panel III: Bona Fide Hedging.

And last, but certainly not least, our third panel will tackle a critical component of the position limits rules: the bona fide hedging exemption. Congress instructed the Commission to write rules exempting bona fide hedges from any position limits rules.10 Crafting proper bona fide hedge exemptions has long been a challenging proposition for the Commission, with several commissioners on both sides of the aisle expressing concerns that the Commission’s definitions of bona fide hedging are too narrow.11 The Commission has proposed a significant reorganization of its bona fide hedging policy, which eliminates the possibility of any unenumerated hedges. The Commission has instead proposed a multi-part definition of bona fide hedging, which includes common requirements for all hedges, special requirements for hedges of a physical commodity, separate categories of enumerated hedges, and additional restrictions on the use of cross-commodity hedges.12 The Commission proposes to interpret these provisions with a series of 14 pre-approved examples. Staff guidance is available for other transactions, but such transactions carry risk of non-approval as a bona fide hedge, which could leave market participants in peril of having positions over the applicable limit.13

I and others have expressed concern that bona fide hedging rules structured in this way impose federal regulatory edicts in place of business judgment in everyday commercial risk management. This panel should give us a greater understanding of the background and evolution of Commission hedging policy, as well as an understanding of the real world implications that the proposed bona fide hedging rules will have on U.S. energy market participants.

As we get started this morning, I want to extend a special welcome to Administrator Adam Sieminski of the U.S. Energy Information Administration, who will give an update on the current conditions in the U.S. energy markets. Thank you also to the other witnesses who have prepared thoughtful presentations. In addition, I want to thank all of the Commission staff who worked so hard to arrange this meeting. And of course, I would like to thank all of the Members and Associate Members of the EEMAC for volunteering their time and expertise. We are all grateful for your service.

Since the EEMAC has no statutory Chairman, each meeting will be chaired by a different member of the Committee. I am pleased to announce that Jim Allison, an EEMAC member, has agreed to chair today’s meeting. Thanks, Jim. I would like to recognize Chairman Massad and the other commissioners to make their opening remarks.

1 Dodd Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203 (2010) (“Dodd-Frank”) § 751; see also 7 U.S.C. §2(a)(15)(A).

2 7 U.S.C. § 2(a)(15)(B)(i).

3 See Position Limits for Derivatives, 78 Fed. Reg. 75680 (Dec. 12, 2013); Aggregation of Positions, 78 Fed Reg. 68946 (Nov. 15, 2013).

4 See Administrator Adam Sieminski, Energy Information Agency, U.S. Department of Energy, Statement Before the U.S. Senate Committee on Energy and Natural Resources (July 16, 2013), available at http://www.energy.senate.gov/public/index.cfm/files/serve?File_id=bb2fa999-fe76-4c27-9853-fc21b7b3601e; see also Scott Nyquist and Susan Lund, “Shale Revolution: Opportunity to Jump-Start Economic Growth,” Forbes (Nov. 19, 2014), available at http://www.forbes.com/sites/realspin/2014/11/19/the-shale-revolution-is-an-opportunity-to-jump-start-economic-growth-in-u-s/.

5 Open Meeting on the Ninth Series of Proposed Rulemakings Under the Dodd-Frank Act, Transcript (Jan. 13, 2011) at 7-9.

6 Id. at 9.

7 See 78 Fed. Reg. at 75685-96.

8 7 U.S.C. § 4a(a)(3)(B)(iii).

9 See, e.g., J. Christopher Giancarlo, Pro-Reform Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-Frank, (Jan. 29, 2015) at 52-54.

10 See generally, 7 U.S.C. § 4a(c)(1).

11 See, e.g., Open Meeting on Two Final Rule Proposals Under the Dodd-Frank Act, Transcript (Oct. 18, 2011) at 19 (Comm’r Sommers explaining that Commission unnecessarily narrowed the bona fide hedge exemptions beyond what was required by the Dodd-Frank Act); id. at 26 (Comm’r Chilton agreeing with some of Commissioner Sommers’ concerns on bona fide hedging).

12 See 78 Fed. Reg. at 75706, 75823-24 (proposed Rule 150.1 defining bona fide hedges).

13 78 Fed. Reg. at 75835-39 (proposed Appendix C to Part 150).

Last Updated: February 26, 2015

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