Financial Reform. Task Force. CFTC Publishes Final Rules on Position Limits: Limited Comment Period Closes on January 17, 2012

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1 CFTC Publishes Final Rules on Position Limits: Limited Comment Period Closes on January 17, 2012 by Jeffrey Sherman, with assistance from Peggy Heeg, Michael Loesch, Lui Chambers, and Rabeha Kamaluddin On November 18, 2011, the Commodity Futures Trading Commission s ( CFTC or Commission ) long-awaited final rules establishing federal position limits pursuant to its authority under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act ( Dodd-Frank ) were published in the Federal Register, to be effective, in large part, 60 days after the term swap is further defined under Dodd-Frank. 1 The CFTC is expected to finalize the final swap definition early next year, which translates to a late Quarter 1 or early Quarter 2, 2012 effective date for the position limits rules. A portion of the final rules, relating to the spot-month position limits, has been designated as an interim final rule, which provides for an additional 60-day comment period. Comments on the interim final rule are due on January 17, The position limit rules, which were approved in the CFTC s October 18, 2011 open meeting in a 3-2 vote divided along party lines, have been the subject of considerable controversy and delay since the draft rulemaking was first proposed on January 26, The final vote came after the Commission postponed consideration of the rules in two previously scheduled meetings and after it modified the rules at the last minute during a break in the October 18 meeting. Commissioners Jill Sommers and Scott O Malia published separate dissents opposing the final rules. Consistent with the CFTC s expanded position limit authority under Dodd-Frank, 3 the final rules increase the number and scope of futures, options, and swap 4 contracts that will be subject to federal position limits. The rules also impose burdensome new notification, reporting, and other requirements that will significantly impact speculators, small and large commercial hedgers, commodity pools, financial institutions, swap dealers and other commodity market participants. Although the final rules adopt significant portions of the Proposed Rules, they depart from certain proposals in important respects. The discussion below summarizes and assesses the key provisions of the new rules and identifies significant changes from the Proposed Rules. 1 Position Limits for Futures and Swaps, 76 Fed. Reg. 71,626 (Nov. 18, 2011). The rules include a lengthy preamble as well as published dissents of Commissioners Jill Sommers and Scott O Malia (collectively referred to as Rules Preamble ). Citations to the Rules Preamble refer to Federal Register page citations. Citations to rules refer to the section number of the rules, which are to be codified at 17 C.F.R to See Position Limits for Derivatives, 76 Fed. Reg (Jan. 26, 2011) ( Proposed Rules ). 3 The final rules implement Section 4a(a)(1) of the CEA, as amended by Section 737 of Dodd-Frank. Section 4a(a)(1) requires the CFTC to set position limits, as necessary, on: (i) futures, options, and swaps traded on designated contract markets ( DCMs ) or swap execution facilities ( SEFs ); and (ii) swaps not traded on a DCM or SEF that perform or affect a significant price discovery ( SPD ) function with respect to regulated markets. CEA 4a, 7 U.S.C. 6a (2011). 4 Under the prior limits regime, only a handful of SPD swaps traded on exempt commercial markets ( ECMs ) were subject to position limits. The authority to require such limits was added in 2008 in a revised CEA 2(h)(7), which introduced the SPD process for ECM-traded swaps. See Title XIII of the Food, Conservation and Energy Act of 2008, Public Law No , 122 Stat (June 18, 2008). Under Dodd-Frank, that authority has been modified, and now the CFTC has authority to set limits on any swaps traded on DCMs or SEFs without any SPD finding, and also non-dcm or SEF traded swaps that perform an SPD function with respect to such registered entities. However, the CFTC has not yet issued proposed or final rules identifying a process by which swaps that perform an SPD function with respect to such entities can be identified, but it expects to do so in a subsequent rulemaking. See Rules Preamble at 71,629 n.27; Proposed Rules at 4753 n.8; see also Rules Preamble at 71,630 n.46 (noting intention to gather additional data to determine SPD impact on referenced contracts). 1

2 I. Contracts Subject to Federal Position Limits Consistent with the Proposed Rules, the final rules establish federal position limits on 28 core physical commodity futures contracts ( core contracts ) and economically equivalent swaps on a futures equivalent basis 5 (collectively, referenced contracts ). The contracts subject to the new federal limits are as follows: Table Core Futures Contracts Subject to Federal Position Limits ( 151.2) 1. Nine legacy agricultural contracts (i.e., those subject to current federal limits set forth in 17 C.F.R. Part 150): Corn, Oats, Soybeans, Wheat, Soybean oil, Soybean meal (Chicago Board of Trade ( CBOT )); Hard Red Spring Wheat (Minneapolis Grain Exchange); U.S. Cotton No. 2 (ICE Futures); and Hard Winter Wheat (Kansas City Board of Trade). 2. Ten non- legacy agricultural contracts: Class III Milk, feeder cattle, lean hog, live cattle (CME); rough rice (CBOT); Cocoa, Coffee, U.S. FCOJ-A (frozen concentrated orange juice), Sugar No. 11, Sugar No. 16 (ICE Futures). 3. Four energy contracts: Henry Hub Natural Gas, Light Sweet Crude Oil, New York Harbor Gasoline Blendstock, and New York Harbor heating oil (New York Mercantile Exchange ( NYMEX )). 4. Five metal contracts: Copper, Gold, Silver (Commodity Exchange, Inc. ( COMEX )); Palladium and Platinum (NYMEX). Economically equivalent swaps, futures or option contracts are determined by the definition of referenced contract set forth in of the final rules. 6 Specifically, Referenced Contracts include all core futures contracts listed in as well as all futures contracts, options contracts, swaps or swaptions (other than financial basis or commodity index contracts) that are directly or indirectly linked, including being partially or fully settled on, or priced at a fixed differential to either (i) the price of a core futures contract or (ii) the price of the same commodity underlying the particular core futures contract for delivery at the same location or locations as specified in the core contract. In a notable departure from the Proposed Rules, economically equivalent swaps will not be defined to include transactions that are linked to the same commodity at locations with substantially the same supply and demand fundamentals as that of a core contract. The CFTC acknowledged that this category did not establish objective criteria and would require individual analysis of trading data such as bids and offers that was not available to the Commission. 7 5 In general, swap limits are calculated on a futures equivalent basis, meaning that the swaps are converted to the equivalent size of the relevant futures contracts. Such calculations must be made in accordance with the guidance in the Commission s Appendix A to 17 C.F.R. Part 20, enacted in Large Trader Reporting for Physical Commodity Swaps, Final Rules, 76 Fed. Reg. 43,851, 43,865 (July 22, 2011) ( Large Trader Reporting Final Rule ). See Rules Preamble at 71,633 n The phrase economically equivalent is not a defined term in the final rules. Rather, it is found in the revised CEA, as modified by Dodd-Frank, in the portion extending CFTC authority to set position limits on swaps. Specifically, the CEA provides that the Commission shall establish limits on the amount of positions, including aggregate position limits, as appropriate, other than bona fide hedge positions, that may be held by any person with respect to swaps that are economically equivalent to futures and options contracts traded on DCMs. CEA 4a(a)(2)(5), 7 U.S.C. 4a(a)(5)(A). The definition of Referenced Contract embodies this statutory concept. 7 See Rules Preamble at 71,630, 71,666. The final rules also eliminated the proposed definition of Referenced paired futures 2

3 Based on the definition of Referenced Contract and the CFTC s discussion, the following should be considered as economically equivalent referenced contracts: Table 2. Economically Equivalent Swaps, Futures, or Options Subject to Federal Position Limits 1. Contracts traded at a fixed differential to a core futures contract a. If a swap is priced based on a fixed differential to a Core Referenced Futures Contract, it is similarly a Referenced Contract. I a. For example, a swap with the commodity reference price NYMEX Light, Sweet Crude Oil +$3 per barrel is a Referenced Contract. But a swap traded off of Argus Sour Crude Index, for example, is not. II 2. Look-alike contracts. a. According to the CFTC look-alike contracts are those that settle off of the Core Referenced Futures Contract and contracts that are based on the same commodity for the same delivery location as the Core Referenced Futures Contract ; III b. For example, if a swap contract utilizes as its sole floating reference price the prices generated directly or indirectly from the price of a single Core Referenced Futures Contract, then it is a look-alike Referenced Contract and subject to the limits set forth in IV c. Note: Look-alike referenced contracts subject to position limits include those traded on a Foreign Board of Trade ( FBOT ), as required under the revised CEA and in Contracts with a reference price based only on the combination of at least one Referenced Contract price and one or more prices in the same or substantially the same commodity as that underlying the relevant Core Referenced Futures Contract; and 4. Intercommodity spreads with two components, one or both of which are Referenced Contracts V (e.g., a swap based on the difference between two prices of two different commodities, VI at least one of which is linked to a Core Referenced Futures Contract price). Consistent with the Proposed Rules, the definition of referenced contract specifically excludes financial basis contracts (i.e., contracts based on the difference in price of the same or substantially the same commodity at different delivery locations) and commodity index swaps, and thus such contracts will not be subject to federal limits. 8 It should be noted that the limits will apply to all positions in referenced contracts on an intraday basis, and not just at the end of each trading day. 9 The CFTC believes that intraday compliance is consistent with current exchange-enforced position limits and will add marginal compliance costs. 10 contract, option contract, swap or swaption as superfluous, since those concepts are now embodied simply in the defined term Referenced Contract. Id. at 71, See 17 C.F.R (Definitions); Rules Preamble at 71,631 n.49. However, such contracts, in certain circumstances, may be subject to position limits on futures exchanges and electronic trading platforms. See discussion related to DCMs and SEFs, below. 9 See Rules Preamble at 71, Id. 3

4 II. Phased Implementation Under the final rules, spot month position limits will be established in two phases, as follows: Phase One (Spot Month). Initial spot month limits for referenced contracts will be established at the position limit levels currently in place on the relevant DCM for that contract (e.g., NYMEX, COMEX, CBOT). These initial limits will be effective 60 days after the term swap is further defined under the Dodd-Frank Act (17C.F.R (d)(i) and Appendix A). This may occur as early as late Quarter 1 or early Quarter 2, Phase Two (Spot Month). Following the initial limits, the CFTC will adjust the spot month limits annually for agricultural referenced contracts and biennially for energy and metal referenced contracts based on a formula of 25% of deliverable supply of the relevant product at the referenced contract s delivery location. The final rules call for Phase Two limits to begin in accordance with a schedule set forth in Table 5, below (17C.F.R (a)). This may occur as soon as August In addition to spot month limits, non-spot month and all-months combined limits will be established and implemented as follows: Non-Spot/All Month, Legacy Contracts. For the nine legacy agricultural contracts that are subject to current federal limits, the non-spot and all months combined limits will be set at the levels identified in the final rules. Those limits will be effective 60 days after the term swap is further defined under the Dodd-Frank Act (17C.F.R (b)(3)). This may occur as soon as late Quarter 1 or early Quarter 2, Non-Spot/All Month, Non-Legacy Contracts. For all referenced contracts, non-spot and all months combined limits will be established by CFTC order after the CFTC has received 12 months of open interest data on physical commodity cleared and uncleared swaps under the swaps large trader reporting rule. 12 The formula for such limits is 10% of the aggregate open interest in the first 25,000 contracts and economic equivalents, plus 2.5% thereafter (17C.F.R (b)(1)). This may occur as soon as late Quarter 1 or early Quarter 2, The following table sets forth the initial and phase two limits for all 28 core contracts: Nine legacy agricultural contracts: Table 3. Specific Position Limits Spot Month Limits (# of contracts) VII Non-Spot/All Months Combined (# of contracts) VIII Initial Phase Two Legacy (60 days after swap def.) Corn (CBOT) % Deliv. Supply 33,000 N/A Oats (CBOT) % Deliv. Supply 2,000 N/A Non-Legacy (after 12 mos. of open interest data) 11 See the schedule discussed in the section Adjustments to Position Limits, below. Under that schedule, energy contracts will be the first contracts subject to updated limits. 12 Large Trader Reporting Final Rule, 76 Fed. Reg. 43,851. 4

5 Wheat (CBOT) % Deliv. Supply 12,000 N/A Soybean oil (CBOT) % Deliv. Supply 8,000 N/A Soybean meal (CBOT) % Deliv. Supply 6,500 N/A Hard Red Spring Wheat (Minn. Grain Exchange) U.S. Cotton No. 2 (ICE Futures) Hard Winter Wheat (Kansas City Board of Trade) Ten non- legacy agricultural contracts: % Deliv. Supply 12,000 N/A % Deliv. Supply 5,000 N/A % Deliv. Supply 12,000 N/A Class III Milk (CME) 1,500 25% Deliv. Supply N/A 10%/2.5% feeder cattle (CME) % Deliv. Supply N/A 10%/2.5% lean hog CME) % Deliv. Supply N/A 10%/2.5% live cattle (CME) % Deliv. Supply N/A 10%/2.5% rough rice (CBOT) % Deliv. Supply N/A 10%/2.5% Cocoa (ICE Futures) 1,000 25% Deliv. Supply N/A 10%/2.5% Coffee C (ICE Futures) % Deliv. Supply N/A 10%/2.5% U.S. FCOJ-A (ICE Futures) % Deliv. Supply N/A 10%/2.5% Sugar No. 11 (ICE Futures) 5,000 25% Deliv. Supply N/A 10%/2.5% Sugar No. 16 (ICE Futures) 1,000 25% Deliv. Supply N/A 10%/2.5% Four energy contracts: Henry Hub Natural Gas (NYMEX) Light Sweet Crude Oil (WTI) (NYMEX) N.Y. Harbor Gasoline Blendstock (RBOB) (NYMEX) N.Y. Harbor No. 2 Heating Oil (NYMEX) Five metal contracts: 1,000 Physical: 25% Deliv. Supply. Cash-settled: five times 25% IX N/A 10%/2.5% 3,000 25% Deliv. Supply N/A 10%/2.5% 1,000 25% Deliv. Supply N/A 10%/2.5% 1,000 25% Deliv. Supply N/A 10%/2.5% 5

6 Copper (COMEX) 1,200 25% Deliv. Supply N/A 10%/2.5% Gold (COMEX) 3,000 25% Deliv. Supply N/A 10%/2.5% Silver (COMEX) 1,500 25% Deliv. Supply N/A 10%/2.5% Palladium (NYMEX) % Deliv. Supply N/A 10%/2.5% Platinum (NYMEX) % Deliv. Supply N/A 10%/2.5% III. Aggregate Position Limits Section 4a(a)(6) of the CEA directs the Commission to impose aggregate limits for contracts based on the same underlying commodity across: (a) DCM contracts, (b) foreign board of trade ( FBOT ) contracts that are linked to contracts listed on a registered entity and offered via direct access to U.S. market participants; and (c) swap contracts that perform or affect a SPD function with respect to registered entities. 13 Accordingly, as discussed in more detail below, the final rules impose aggregate position limits that apply to all of an entity s referenced contract positions traded on all DCMs, SEFs, and FBOTs. This aggregate limit represents a significant departure from the existing position limits regime enforced by the exchanges and trading platforms. Currently, to comply with exchange- and trading-platform enforced limits, a trader must maintain positions below the position limit for a specific product on a specific trading venue. Thus, if an exchange-enforced limit is 1,000 contracts for each of three similar products, an entity may hold up to 3,000 positions (1,000 in each such product) traded on that exchange, and may also hold up to the limit on any similar product traded on a different exchange. Under of the final rules, an entity may not hold any net long or net short position in referenced contracts in the same commodity that, in the aggregate, exceeds the position limits. 14 The netting requirements for the spot-month and non-spot/all-months combined limits are discussed in the next section. Likewise, of the final rules provides that the aggregate position limits in shall apply to a trader s positions in referenced contracts executed on, or pursuant to the rules of an FBOT if (i) the referenced contracts settle against any price of one or more contracts listed for trading on a DCM, and (ii) the FBOT makes such referenced contracts available to U.S.-located participants through direct access to its electronic trading and order matching system. 13 CEA 4a(a)(6), 7 U.S.C. 6a(a)(6). See note 3, above, with respect to SPD contracts. 14 See also Rules Preamble at 71,629 ( The Commission identified 28 Core Referenced Futures Contracts and proposed to apply aggregate limits on a futures equivalent basis across all derivatives ). 6

7 IV. Netting of Position Limits A. Netting of Spot Month Limits In general, the spot month limits will be applied separately to a firm s positions in (i) physical delivery referenced contracts and (ii) cash-settled referenced contracts. 15 Hence, a firm may hold up to the maximum limit in both physical and cash-settled contracts (i.e., either the initial spot month limits or the 25% deliverable supply limits in Phase 2). A firm may net long and short positions within each category (i.e., net physical positions with physical, and net cash-settled positions with cash-settled). 16 However, for spot month limits a firm may not net positions in referenced contracts between each category (i.e., net positions in physical delivery referenced contracts with cashsettled positions in referenced contracts). 17 This prohibition is designed to prevent an entity from acquiring large physical positions that are offset by financial positions, in order to avoid corners. Thus, even if a firm s cash-settled positions offset its exposure in the physical delivery referenced contract, the positions must be tracked separately and limits in each category must be maintained. Slightly different rules apply to NYMEX Henry Hub Natural Gas ( Henry Hub NG ) cashsettled positions. 18 For cash-settled Henry Hub NG referenced contracts, the position limit will be five-times the deliverable supply limit (i.e., 125% of the deliverable supply of gas at Henry Hub). However, for spot month limits a firm may not net positions in referenced contracts between each category (i.e. net physical positions in referenced contracts with cash-settled positions in referenced contracts). 19 For example, if the physical delivery limit is 1,000 contracts, a firm may be long 5,000 cash-settled Henry Hub NG contracts; however, if the firm already is long 1,000 contracts in physical delivery Henry Hub NG contracts, it may hold only 4,000 cash-settled equivalent contracts, since the total cap would be 5, Nevertheless, despite the aggregate cap that applies to both cash-settled and physical delivery Henry Hub NG referenced contracts, the same netting rules apply as those applicable to other spot-month position limits (i.e., no cross-category netting). 21 The equalization of spot month physical limits (25% of deliverable supply) and cashsettled limits (25% of deliverable supply) marks a significant change from the Proposed Rules. The Proposed Rules provided for a cash-settled limit for all referenced contracts of five times the physical limit (subject to conditions on how much control the firm held in the physical supply of the relevant product at the specified location). The final rules dropped that proposal (except for the Henry Hub NG contract as discussed above) and instead impose a one-to-one ratio of physical delivery and cash-settled position limits. B. Netting of Non-Spot Month and All Months Combined Limits The non-spot month and all months combined limit is a single limit applied to a firm s net aggregate positions in each of the referenced contracts. 22 A firm may therefore net all futures, C.F.R (c)(1)(i). 16 Id. 17 Id.; Rules Preamble at 71, Footnote 88 of the Rules Preamble, at 71,634, notes that, for example, NYMEX Henry Hub Natural Gas Last Day Financial Swap, the NYMEX Henry Hub Natural Gas Look-Alike Last Day Financial Futures, and the ICE Henry LDI swap are all cashsettled contracts C.F.R (c)(1)(ii) C.F.R (a)(2)(ii); Rules Preamble at 71, See 17 C.F.R (c)(1)(ii) C.F.R (c)(2); Rules Preamble at 71,640. Thus, since the limit is the same, a firm may either hold its entire net long 7

8 options and swaps referenced contracts that offset each other, regardless of category (i.e., physical delivery vs. cash-settled). This netting rule is a change from the Proposed Rules, in which the Commission proposed to divide referenced contracts into two classes for purposes of the non-spot and all-months combined limits. One class was comprised of all futures and options contracts, and the other class was comprised of all cleared and uncleared swaps. As proposed, a firm could net positions within a class, but not between classes. This proposal has been abandoned: there are no classes in the non-spot and all months limits. 23 The single limit applicable to non-spot months and all months combined is consistent with the Proposed Rules but contrasts with existing federal limits for the nine legacy agricultural contracts. Under the prior federal limits regime, single non-spot month limits were lower than the allmonths-combined limit. The CFTC explained that setting a single non-spot month limit will simplify the compliance burden (relative to the existing methodology) and eliminate the need for a limited arbitrage/calendar spread exemption that exists in the current rules that, if satisfied, permits a firm to exceed the single-month limit up to the all-months limit. 24 Under the new rules, spreaders and other speculators have the same non-spot month limits. 25 Table 4. Summary of Netting Rules ( 151.4(c)(1) and 151.4(c)(2)) Spot Month. A firm may net positions within each category, i.e., (i) physical delivery referenced contracts and (ii) cash-settled referenced contracts. However, a firm may not net positions between each category. For Henry Hub NG referenced contracts, the cash-settled limit is higher (five-times the physical delivery contract subject to a five-times cap across both categories), but otherwise the same netting rules apply. Non-spot and All-months Combined. A firm may net all long and short positions in futures, options and swaps referenced contracts that offset each other. There are no class limits: the limit is a single aggregate limit. V. Adjustments to Position Limits A. Resetting Spot Month Limits Following the initial position limits, spot month limits will be based on a formula of 25% of estimated deliverable supply of the commodity underlying the referenced contract at issue. As noted, cash-settled positions for the Henry Hub NG contract will be five times that limit, or 125% of the deliverable supply, subject to a five-times aggregate physical and cash-settled limit. Under the rules, new spot month position limits will be calculated and published on a staggered basis in three steps. 26 First, the rules require DCMs to submit estimates of deliverable supply to (or short) position limit in a single (non-spot) month, or spread its position across multiple months. 23 The final rules eliminated the definition of Contracts of the same class proposed in 17 C.F.R In discussing this change from the Proposed Rules, the CFTC noted that concerns about market abuse resulting from the ability to net futures, options and swaps can be addressed by closely monitoring firms positions in referenced contracts, such as through the large trader surveillance program, and that it will continue to revisit this issue as necessary. See Rules Preamble at 71, See existing rule 17 C.F.R (a)(3). 25 See Rules Preamble at 71, See 17 C.F.R (d) and (e). 8

9 the CFTC according to the schedule provided in the rules (see 151.4(d)(2) and Table 5, below). Consistent with the Proposed Rules, the CFTC will determine deliverable supply using estimates developed by the DCMs for these products, unless the Commission decides to use its own estimates. When the DCMs make their deliverable supply submissions to the Comission, they are required to provide a description of the methodology they used and statistical data (see 151.4(d)(v)). Second, three months after receiving the deliverable supply data, the CFTC will fix and publish new spot month limits ( 151.4(d)(2)(vi)). Third, two months thereafter, the new limits become effective ( 151.4(e)(1)). DCMs may also petition the Commission to update the limits more frequently if they believe that supply and demand fundamentals warrant it. The adjustment process will commence on January 1 st of the second calendar year after the term swap is further defined by the CFTC under Dodd-Frank, meaning that revised limits for some contracts could become effective as early as August, Limits will be reset every two years for metals and energy referenced contracts (compared to annually in the Proposed Rules), and annually for agricultural contracts (consistent with the Proposed Rules). The update schedule is as follows: Type of Core Referenced Contract Table 5. Subsequent Spot Month Limit Adjustments Deadline for DCM Submission of Deliverable Supply Data to CFTC ( 151.4(d)(2)(iii)) Deadline for CFTC to Fix and Publish Spot Month Limits ( 151.4(d)(2)(vi)) Five metals contracts December 31 (biennially) February 28 May 1 Effective Date of Updated Limits ( 151.4(e)(1)) Four energy contracts March 31 (biennially) May 31 August 1 Specified agricultural contracts: corn, wheat, oat, rough rice, soybean and soybean products, livestock, milk, cotton, & FCOJ Specified agricultural contracts: coffee, sugar, and cocoa July 31 (annually) September 30 December 1 September 30 (annually) November 30 February 1 The 25% deliverable supply formula for spot month position limits is not new to the CFTC or the DCMs it has been part of the Acceptable Practices for DCM Compliance with Core Principle 5 under the pre-dodd-frank position limit framework. What is new, however, is using the 25% formula for both physically delivered and cash-settled contracts. Specifically, under the prior position limits regulations, the DCMs were responsible for setting limits for futures contracts other than the nine legacy contracts. Appendix B of Part 38 of the CFTC s rules provides guidance for DCM compliance with Core Principle 5, relating to the setting of exchange-enforced position limits. That guidance, however, does not require spot month limits in all cases nor does it require spot month limits for cash-settled contracts, let alone require 27 See 17 C.F.R (d)(2). Although the update process could begin as early as January 1, 2013 (assuming that the term swap is finalized before year end), the most likely result, based on discussions with Staff, is that the resetting process will begin on January 1, Thus, under the schedule, energy contracts will be the first category revised, with deliverable supply data due March 31, 2014, revised limits published by May 31, 2014, and an effective date of August 1, Thereafter, energy spot month limits will be revised biennially (every two years). 9

10 a 25% deliverable supply limit level for cash-settled contracts. 28 As discussed in more detail below with respect to the Interim Final Rule, the CFTC is soliciting additional comments on whether the 25% deliverable supply formula is appropriate, especially for cash-settled contracts. B. Resetting Non-Spot and All Months Combined Limits Consistent with the Proposed Rules, the formula for the non-spot month and all months combined position limits is based on total open interest for all referenced contracts in the relevant commodity. The actual position limit is based on the following formula: 10 percent of the open interest for the first 25,000 contracts plus 2.5 percent of the open interest thereafter. The Commission provides an example: assuming a referenced contract has average all-months-combined aggregate open interest of 1 million contracts, the level of the non-spot month position limits would equal 26,900 contracts. This level is calculated as the sum of 2,500 (i.e., 10 percent times the first 25,000 contracts open interest) and 24,375 (i.e., 2.5 percent of the 975,000 contracts remaining open interest), which equals 26,875 (rounded up to the nearest 100 under the rules (i.e., 26,900)). 29 Other than for the nine legacy agricultural contracts, the non-spot month and all months limits will not be effective for at least a year. Under the rules, initial limits for non-legacy contracts will be imposed within one month after the CFTC has 12 months of open interest data, and will be made effective only after Commission order. 30 After the initial limits (i.e., after 12 months of data), these limits will be calculated after 24 months of additional data (i.e., 24 months after initial limits), and will be established based on the higher of 12 months or 24 months aggregate average all-months combined open interest. 31 Limits will be effective on the 1 st day of the third calendar month following publication on the CFTC s website. 32 The criteria for calculating aggregate average all-months combined open interest are found in 151.4(b)(2), and will be the sum of futures open interest, cleared swaps open interest, and uncleared swaps open interest. The nine legacy contracts, as noted, will have initial limits that take effect 60 days after the term swap is further defined. 33 The final rules do not provide for subsequent resetting of legacy nonspot and all months combined limits. 28 Existing Part 38, Appendix B guidance provides that, for DCMs: (i) spot month limits should be adopted for markets based on commodities having more limited deliverable supplies or where otherwise necessary to minimize the susceptibility of the market to manipulation or price distortions ; (ii) spot month limits for physical-delivery markets are appropriately set at no more than 25 percent of the estimated deliverable supply and (iii) for cash-settled markets, spot month position limits may be necessary if the underlying cash market is small or illiquid and, in such cases, set at a level that minimizes the potential for manipulation or distortion of the futures contract s or the commodity s underlying price. It also provides that DCMs may elect not to adopt non-spot and all months limits. The final rules cite such Part 38, Appendix B guidance in Rule 151.4(d)(2)(iv) for the purpose that a DCM may use such guidance in estimating deliverable supply. The DCM Core Principles are the subject of proposed revisions under Dodd-Frank, but final rules are not yet available. See Governance Requirements for Derivatives Clearing Organizations, Designated Contract Markets, and Swap Execution Facilities, 76 Fed. Reg. 722 (Jan. 6, 2011). 29 Rules Preamble at 71,649 n C.F.R (d)(3). 31 Id (d)(3)(ii). 32 Id (e)(3). For example, if the limits are published on the last day of a month, the third calendar month will be two-full months and one day later. 33 Id (d)(4). The Commission adopted CME s comments for all-months-combined levels for those nine contracts. CME s levels were based on 2009 average month-end open interest. CME s levels result in increases of 23 to 85 percent increases from the non-spot limit levels in existing

11 VI. Interim Final Rule on Spot Month Limits The spot month limits and formulas set forth in the final rules are labeled as an interim final rule, which gives the CFTC the authority to solicit additional comments on the limits even while the rules become effective. The CFTC is soliciting additional comments on this formula (i.e., the 25% deliverable supply formula) and specifically the one-to-one ratio of limits on physical delivery referenced contracts to cash-settled referenced contracts. The comment period for the interim final rule will close on January 17, Specifically, the Commission invites commenters to address whether: the interim final rule best maximizes the four objectives of CEA section 4a(a)(3)(B); the Commission should set a different physical-to-cash settled position limit ratio for different commodities; the Commission should consider setting the ratio higher than one-to-one and, if so, in which commodities? the Commission should consider the relationship between the open interest in cashsettled contracts in the spot month and open interest in the physical-delivery contract in the spot month; there are other metrics that are relevant to setting spot month limits on cash-settled contracts (e.g., volume of trading in the physical-delivery futures contract during the period of time the cash-settlement price is determined); and there are any other criteria that can be used to distinguish among physical commodities for purposes of setting spot month limits (e.g., agricultural contracts of relatively limited supplies constrained by crop years and limited storage life) and how such criteria could relate to the levels of spot month limits. Finally, the Commission is inviting comments on the costs and benefits considerations and asks commenters to submit additional quantitative and qualitative data regarding the costs and benefits of the interim final rule and any suggested alternatives. 34 The invitation for additional comments represents an important opportunity for interested parties to provide feedback on the spot month limits and how such limits may impact their business and the market as a whole. This interim rule comment process may also be an attempt by the Commission to insulate itself from judicial review of the position limit final rules, particularly in light of (1) the fact that the CFTC lowered the cash-settled spot month position limits from the Proposed Rules without additional notice or opportunity for comment and (2) the criticisms over adequate cost-benefit analyses in Dodd-Frank rulemaking in general 35 and in particular in the 34 Rules Preamble at 71,638. In the final rules, the CFTC noted that it had, to date, received little quantitative data on the costs and benefits. Id. at 71,662. It also asserted that a generalized quantification of the costs related to changes to trading strategies was not reasonably feasible due to the lack of access to individual company portfolios. Id. at 71,665. The CFTC also asserted that many of the costs arising from these rules are a consequence of the congressional mandate to establish position limits. Id. In this context, it is not clear whether the CFTC will be swayed by any additional cost quantifications provided in response to the interim rule, although we note that, at a minimum, such studies will contribute to the administrative record for judicial review purposes. 35 On July 22, 2011, a three-judge panel of the U.S. Court of Appeals for the D.C. Circuit vacated certain Securities and Exchange ( SEC ) rules promulgated under Dodd-Frank, finding that the SEC acted arbitrarily and capriciously for having failed adequately to assess the economic effects of a new rule by, among other things, ignoring detailed cost studies entered into the record by commenters. Business Roundtable and Chamber of Commerce of the U.S. v. Securities & Exchange Comm n, 647 F.3d 1144 (D.C. Cir. 2011). On April 15, 2011, the Office of the Inspector General of the Commission ( IG ) investigated of cost benefit analyses in four rulemakings, pursuant to Congressional concerns, recommending that more robust economic analyses be performed in CFTC rulemakings. An Investigation Regarding Cost-Benefit Analyses Performed by the Commodity Futures Trading 11

12 case of the position limits rulemaking. 36 In this regard, Commissioner O Malia s criticism in his dissent that the final rules do not include an adequate cost-benefit analysis is especially relevant. 37 According to Commissioner O Malia, the failure to even consider the threat of excessive speculation in a final rule that could cost market participants $100 million annually undermines the entire rule, and invites legal challenge. 38 Given these substantial concerns, the strongest challenge to the final rules may very well be related to the adequacy of the cost-benefit analysis. 39 VII. Exemptions to Position Limits A. Bona-Fide Hedge Requirements Consistent with the existing position limits regime, a company may exceed the position limits if it engages in transactions that satisfy the definition of bona-fide hedge and if it meets the other obligations of the bona-fide hedge rules, which will be codified at 17 C.F.R The hedge exemption applies to those transactions that meet the criteria, and not to a company s speculative (non-hedge) positions. Thus, a company may have both speculative trades and bona-fide hedges in referenced contracts, so long as its speculative transactions do not exceed any applicable position limits. 40 To qualify for a bona-fide hedge exemption to the federal limits, the following must be satisfied: for referenced contracts, the transaction must satisfy the general bona-fide hedge definition set forth in 151.5(a)(1). Note: for excluded commodities, which are generally financial commodities and not energy, metals, or agricultural commodities, the bona-fide hedge definition is in 17 C.F.R. 1.3(z) (see discussion below); for referenced contracts, the transaction must also fit within one of the eight enumerated hedges listed in 151.5(a)(1), or, alternatively, the company may seek a CFTC staff noaction or interpretive letter (under 17 C.F.R ) or Commission review (under CEA 4a(a)(7)) if the hedge does not fit within one of the eight enumerated hedges (see discussion below); and the company must file the appropriate notice(s) (Form 404 and 404A) and file reports and keep records as appropriate for the hedge claimed (see discussion below); or alternatively, if the company is a counterparty to a bona-fide hedger, the company must qualify for the pass-through swap exemption discussed below, including filing a Form 404S (see discussion below). Commission in Connection with Rulemakings Undertaken Pursuant to the Dodd-Frank Act, prepared by the Office of the Inspector General, Commodity Futures Trading Commission, April 15, 2011, available at aboutcftc/documents/file/oig_investigation_ pdf. 36 See, e.g, Peter Madigan, CFTC and SEC facing legal anxiety over cost-benefit analyses (Oct. 3, 2011), available at risk.net/risk-magazine/feature/ /cftc-sec-facing-legal-anxiety-cost-benefit-analyses (noting Commissioner O Malia s concern over position limits cost-benefit analysis); Brian Scheid, Is CME Group, in its dealings with the CFTC, about to use the L word? (September 2, 2011), available at (noting Commissioner Sommers concern over position limits cost-benefit analysis). 37 Commissioner O Malia dedicates an entire section in his dissent to the lack of an adequate cost-benefit analysis. See Rules Preamble at 71, ( Cost-Benefit Analysis: Hedgers Bear the Brunt of an Undue and Unknown Burden ). 38 See Rules Preamble at 71, On December 2, 2011, the International Swaps and Derivatives Association ( ISDA ) and the Securities Industry and Financial Markets Association ( SIFMA ) filed a complaint challenging the final rules. See Among other things, the complaint takes issue with the lack of a fulsome cost-benefit analysis. See ISDA/SIFMA complaint at PP See Proposed Rules, 76 Fed. Reg. at 4756 ( A crowding out provision would have limited the ability of a trader that hedges or acts as a swap dealer to take on speculative positions once certain positional thresholds were exceeded. The Commission has determined to not propose a crowding out provision at this time. ). 12

13 B. The Bona-Fide Hedge Definition As explained in our prior alert discussing the Proposed Rules, the new definition of bona-fide hedging transactions for purposes of referenced contracts generally follows the narrower statutory definition contained in Dodd-Frank and differs from the existing regulation in 17 C.F.R. 1.3(z). 41 Under the new definition, a position in referenced contracts may qualify as a bona fide hedge if the position or transaction: (i) represents a substitute for a transaction to be made at a later time in a physical marketing channel, (ii) is economically appropriate for the reduction of risks in a commercial enterprise, and (iii) arises from the potential change in value of assets, liabilities, or services as described in 151.5(a)(1)(iii). 42 In contrast, under 1.3(z), bona-fide hedge transactions are those positions that normally represent a substitute for transactions to be made or positions to be taken at a later time in a physical marketing channel. 43 Although the two definitions have slightly different wording, the key difference is the omission, in the new definition, of the word normally before the represents a substitute language. 44 As noted above, the final rules modify the 1.3(z) definition to limit it to excluded commodities under the CEA (e.g., financial commodities). As a result, there will be two definitions of bona-fide hedge under CFTC rules: one that omits the word normally in the phrase represent a substitute for transactions to be made or positions to be taken at a later time in a physical marketing channel (for referenced contracts), and one that retains the word normally from such phrase (for excluded commodities). The CFTC has acknowledged the difference between these two definitions, observing that the new statutory definition directs it to define bona fide hedging for futures contracts to include hedging for physical commodities only if such transactions or positions represent substitutes for cash market transactions and offset cash market risks as opposed to transactions that normally, but not necessarily, represents a substitute for cash market transactions or positions. 45 Although the CFTC stated that it was compelled to use the narrower, statutory definition, it argued that it attempted to mitigate concerns regarding any potential negative impact to the efficiency of futures markets based upon the new statutory definition by (i) expanding the list of enumerated hedges to eight (see below) and (ii) removing the application of class limits outside the spot month, thus allowing parties to net futures with swaps in order to calculate net long or short positions for position limit purposes. 46 Given that the CFTC s own cost findings suggest that there may be significant costs 41See CFTC Adopts Position Limit Proposal at Ninth Open Meeting Implementing Dodd-Frank C.F.R (a)(1) C.F.R. 1.3(z) (emphasis added). 44 The word normally was added to the 1977 definition for a reason, as the CFTC acknowledges in footnote 167 of the Rules Preamble (at 71,643): The Commission introduced the adverb normally in the subsequent final rulemaking in order to accommodate balance sheet hedging that would otherwise not have met the general definition of bona fide hedging. 42 FR 42748, Aug. 24, The Commission noted that, for example, hedges of asset value volatility associated with depreciable capital assets might not represent a substitute for subsequent transactions in a physical marketing channel. Id. at See also generally Clarification of Certain Aspects of the Hedging Definition, 52 Fed. Reg. 27,195 (1987) (interpreting the temporary substitute element of the hedging definition). 45 Rules Preamble at 71,646 n.482; see also Proposed Rules, 76 Fed. Reg. at 4761 (same). 46 Rules Preamble at 71,678. The CFTC s reasoning in this regard is perplexing. Among other things, it can hardly be claimed that expanding the enumerated hedge list to eight (or 80, for that matter) mitigates the narrowing impacts of the statutory definition because the CEA does not require the CFTC to enumerate hedges in the first place, let alone confine bona-fide hedges to those that also meet the enumerated hedges. Rather, the creation of the list in the first place more properly should be considered as a further restriction of the statutory definition of bona-fide hedge. 13

14 (or foregone benefits) associated with the implementation of the new statutory definition of bona fide hedging to the extent that the restricted definition of bona fide hedging may require traders to potentially adjust their trading strategies, it may be argued that the CFTC did not go far enough to permit companies to hedge legitimate risks associated with their commodities businesses. 47 C. Enumerated Hedges Based on numerous comments, the final rules expanded the list of Enumerated Hedging Transactions that will qualify as bona-fide hedges from five (under proposed rule 151.5(2)) to eight. The revised list now includes (i) anticipated merchandising transactions (not to exceed one year), (ii) anticipated royalty hedges (not to exceed one year for agricultural referenced contracts), and (iii) service contract hedges (not to exceed one year for agricultural referenced contracts). The staff s stated objective in expanding the list of enumerated transactions was to capture the most common types of hedging strategies used by commercial hedgers and include those as enumerated hedges. 48 The list of enumerated hedges is important because, under the final rules, a bona-fide hedger must meet both the general definition of bona-fide hedge and also fall within one of the eight enumerated hedges for purposes of an exemption from the federal position limits. 49 That list is as follows: Table 6. Eight Enumerated Bona-Fide Hedges ( 151.5(a)(2)) 1. A long position in the commodity, i.e.: positions in referenced contracts that offset (i) ownership or fixed-price purchases of the underlying cash commodity, or (ii) anticipated unsold production of the same commodity (not to exceed one year for agricultural referenced contracts); 2. A short position in the commodity, i.e.: positions in referenced contracts that offset (i) fixed-price sales of the underlying cash commodity, (ii) equivalent sales of the commodity and by-products of the commodity, or (iii) anticipated unfilled requirements of a commodity (not to exceed one year for agricultural referenced contracts) for processing, manufacturing, or use; 3. Unfixed price positions/different delivery months, i.e.: positions in referenced contracts that offset the purchase and sale of the same cash commodity at unfixed price basis in different delivery months; 47 Rules Preamble at 71,677. If the Commission were concerned about the impacts of the narrow statutory hedge definition it could have, for example, eliminated the enumerated hedge list entirely or otherwise made it easier for risk-mitigating activities to qualify as bona-fide hedges under the revised definition. Furthermore, if the CFTC were concerned about the impacts of the narrow statutory definition, it could have limited the definition to futures and options only, and used the old, broader definition to apply to swaps. As the CFTC acknowledged, the statutory definition applies only to futures and options, not swaps. See Proposed Rules, 76 Fed. Reg. at The CFTC, on its own volition, chose to apply the same definition to both classes, but it could have used its general authority to apply the old, broader definition to those referenced contracts that are swaps. 48 See Transcript of Open Meeting on Two Final Rule Proposals Under the Dodd-Frank Act, October 18, 2011, available at ( Open Meeting Transcript ), at 163 ( We looked carefully at the comment letters and tried to provide for everything that we reasonably could foresee in the enumerated list. ). 49 See 17 C.F.R (a)(1) (noting that (a)(1) and the provisions of paragraph (a)(2) regarding enumerated hedging transactions and positions or paragraphs (3) or (4) regarding pass-through swaps of this section must be satisfied); Rules Preamble at 71,643 (noting that a trader must meet the general requirements for a bona fide hedging transaction or position in proposed 151.5(a) (1) and also meet the requirements for an enumerated hedging transaction in proposed 151.5( a)(2) ). 14

15 4. Agent purchases or sales, i.e.: purchases or sales by a non-owning agent provided that the agent is responsible for merchandising the cash positions and has a contractual agreement with the position owner; 5. Anticipated merchandising hedges, i.e.: positions in referenced contracts that (i) offset positions in the underlying commodity anticipated to be merchandised that do not exceed anticipated unfilled storage capacity that a person owns or leases (not to exceed one year), and (ii) settle in different contract months (i.e., calendar spread hedges); 6. Anticipated royalty hedges, i.e., positions that hedge anticipated change in value of royalty rights that arise out of production, manufacturing, processing, use, or transportation of the underlying commodity (not to exceed one year for agricultural referenced contracts); 7. Service contract hedges, i.e., positions that hedge anticipated change in value of receipts or payments under a services contract that arise out of production, manufacturing, processing, use, or transportation of the commodity (not to exceed one year for agricultural referenced contracts); 8. Cross-Commodity hedges, i.e., hedges qualifying under (1) (7) may also be offset by positions in other commodities provided that the value of the cash and the offsetting referenced contract positions are substantially related. Note: In the case of the above-enumerated hedges that are anticipatory hedges, the hedger may not hold positions exceeding the position limits in the last five trading days for agricultural or metals physical-delivery contracts, nor carry positions into the spot month for other physicaldelivery contracts. The CFTC eliminated from the Proposed Rules similar restrictions on holding cash-settled contracts, finding that the concerns about liquidating large physical-delivery positions generally are not present in cash-settled contracts, since a trader has no need to liquidate to avoid delivery. X See 151.5(a)(2) for additional detail. As part of that expanded list of enumerated hedges, the CFTC felt it necessary to publish a list of examples as guidance, which are included in Appendix B to Part 151. Appendix B of the final rules is designed in part to address many common hedging strategies to allow firms to conclude that their hedges qualify as bona-fide hedges. During the meeting, Commissioner Chilton asked staff about the specific example of a calendar spread hedge using a grain elevator storage facility. He asked whether a grain elevator that has a fluctuating unfilled storage capacity e.g., capacity which may be filled and unfilled throughout a season may hedge its unfilled capacity. Staff answered that such a hedge would qualify as a bona-fide hedge under the anticipated merchandising hedge: those would be available as a bona fide hedging transaction in the form of a calendar spread to reduce their risk of having that unfilled capacity. 50 D. Reviews of Individual Hedging Strategies Noticeably absent in the Proposed Rules was a defined process for seeking CFTC review of individual applications for hedging strategies that, although risk reducing, nevertheless do not fall within the list of enumerated hedges set forth in the regulations, i.e., a process akin to that 50 See Open Meeting Transcript at

16 provided in 17 C.F.R. 1.3(z)(3) and This non-enumerated cases application process had been a mainstay in CFTC regulations since Indeed, Commissioners Sommers and O Malia 53 were particularly critical of the lack of a delineated bona-fide hedge review process, even in light of the expanded list of enumerated hedges. During the open meeting, Commissioner Sommers expressed concern over the impact of the rules on bona-fide hedgers, 54 and noted as follows: When the Commission first recognized the need to allow for non-enumerated hedges in 1977, the Commission stated, The purpose of the proposed provision was to provide flexibility in application of the general definition and to avoid an extensive, specialized listing of enumerated bona fide hedging transactions and positions. Today the global marketplace is much more complex than it was in 1977, as are complex hedging strategies. I m not comfortable with the notion that a list of eight bona fide hedging transactions in this rule is sufficiently extensive and specialized enough to cover the complex needs of today s bona fide hedgers. 55 In a last-minute amendment adopted after a one-hour break in the open meeting, the CFTC added clarifying language to the final rules stating that market participants who might not otherwise qualify under the eight enumerated hedging transactions may request an interpretation or guidance from staff, or an order from the Commission, as to whether their specific risk-reducing hedging approach qualifies as a bona fide hedge. Specifically, the added language provides that: Any person engaging in other risk-reducing practices commonly used in the market which they believe may not be specifically enumerated in 151.5(a)(2) may request relief from Commission staff under of this title or the Commission under section 4a(a)(7) of the Act concerning the applicability of the bona fide hedging transaction exemption. 56 Although added to assist hedgers to comply with the bona-fide hedge exemption rules, the new clarifying language falls short of the old 1.47 process in important respects. For example, the noaction and interpretive letter process provided for in existing regulation 17 C.F.R : (i) is already available to market participants, and thus adding a reference to in does not 51 Section 1.3(z)(3) of the CFTC s regulations authorized the CFTC to recognize transactions and positions other than those enumerated in paragraph (z)(2) upon application under Section 1.47, which is being repealed as part of these final rules, provided for a detailed process describing the content of the application and obligating the Commission to respond within 30- days of an application, or within 10 days of an updated statement 52 See 42 Fed. Reg. 42,748 (1977) (enacting regulations 17 C.F.R. 1.3(z), 1.47, and 1.48). The Proposed Rules lack of a detailed review process was perplexing given that the CFTC s 1977 ruling specifically relied upon the existence of the review process embodied in 1.3(z)(3) and 1.47 to justify its decision not to expand the list of enumerated hedges, noting that review of individual applications for such hedging is more appropriate than amendment of the enumerated provisions of paragraph (2) of the proposed definition. Id. at 42,749. The 1977 ruling also acknowledged comments that the list of enumerated hedges was deficient for products that were not the subject of federal limits, but the CFTC held that the Commission does not believe that it is necessary to enumerate transactions and positions which would be considered bona fide hedging in markets where it currently has no speculative limits. Id. at 42,750. Given the fact that the final rules expand the federal limits well beyond the nine legacy agricultural contracts, it would appear that an individual hedging review process would be even more important under the new rules than it was under the prior federal limits regime. 53 See, e.g., O Malia Dissent, Rules Preamble at 71,703 ( the Commission should have defined bona fide hedging transactions and positions more broadly so that they encompass long-standing risk management practices and should have preserved a process by which bona fide hedgers could expeditiously seek exemptions for non-enumerated hedging transactions. ). 54 See, e.g., Open Meeting Transcript at Id. at 23 (citing 42 Fed. Reg. 14,832, 14,833 (1977)); see also Sommers Dissent, Rules Preamble at 71,700 (same) C.F.R (a)(5). 16

17 expand the legal authority of commercial hedgers to seek review of particular hedge transactions; (ii) binds only the issuing division of the CFTC, and not strictly the Commission (unlike the old 1.47 process); and (iii) lacks a defined response deadline (unlike the old 1.47 process, which provided for a 30-day response deadline). The other avenue for review, i.e. section 4a(a)(7) of the CEA, is a statutory provision added in the Dodd-Frank Act which authorizes the Commission to exempt by rule, regulation, or order certain persons, products, or classes of products from the position limit rules. Although this is a new and therefore untested provision, it appears to be more cumbersome than the old 1.47 process and does not include any deadline for Commission response. Thus, the last-minute addition of 151.5(a)(5) is of limited benefit to hedgers seeking expeditious review of risk-reducing strategies. Since the Commission did not provide an adequate explanation or rationale for justifying its departure from the old regulations (despite the arguable need for increased flexibility in reviewing today s complex hedging strategies), affected entities may wish to seek reconsideration or appeal of this aspect of the final rules. 57 E. Pass-Through Swaps The final rules simplify the Proposed Rules with respect to how a counterparty to a bona-fide hedger may obtain a bona-fide hedge exemption to the same extent as the underlying bona-fide hedger (i.e., pass-through swaps ). According to final rule 151.5(a)(3), a person who transacts futures or swaps referenced contracts to reduce the risk of a position that it executed opposite a counterparty whose position would qualify as a bona-fide hedge, will also qualify for a hedge exemption under most conditions. 58 Under 151.5(a)(4), the counter-party (for example a swapdealer) may obtain the pass-through exemption only if and to the extent that it enters into risk reducing positions in referenced contracts which offset the risk of the pass-through swap. In other words, a pass-through intermediary may not acquire large speculative positions by entering into positions opposite certain hedgers, but then neglect to lay off that risk. Furthermore, in the Rules Preamble, the CFTC made it clear that the pass-through swap designation is only available to the first counterparty to the underlying hedger, and not to each subsequent intermediary in a chain of transactions. 59 To obtain the pass-through hedge exemption, the pass-through counterparty must do the following: 57 Indeed, Commissioner Sommers and O Malia criticize the final rules for abandoning prior flexibility without justification. See, e.g., Sommers Dissent, Rules Preamble at 71,700 ( the Commission is eliminating a valuable source of flexibility that has been a part of regulation 1.3(z) for decades that is, the ability to recognize non-enumerated hedge transactions and positions. This final rule abandons important and long-standing Commission precedent without justification or reasoned explanation ); O Malia Dissent, Rules Preamble at 71,703 ( In its refusal to accommodate traders seeking legitimate bona fide hedging exemptions in compliance with the Act with an expeditious and straightforward process, the Commission is being short-sighted in light of the dynamic (and in the case of the OTC markets, uncertain) nature of the commodity markets and with respect to the appropriate use of Commission resources. ). Furthermore, Commissioner Sommers confirmed during the meeting that (i) that the statute does not limit bona-fide hedge transactions to those that also satisfy the eight enumerated hedges (Open Meeting Transcript at 161) and that (ii) Staff knew of no problems with the hedging review process in the past, either at the Commission or the exchanges (id. at ). 58 The pass-through hedger is subject to the same restrictions applicable to the commercial hedgers as set forth in 151.5(a)(2)(i) through (viii) with respect to holding physical-delivery referenced contracts in the last-five days prior to the spot-month, or, in the case of energy contracts, during the spot month. 59 Rules Preamble at 71,

18 Table 7. Requirements for Pass-Through Hedge Exemption ( 151.5(i), (b)(2)) 1. Obtain a written representation from the underlying bona-fide hedge counterparty that the swap qualifies in good faith as a bona fide hedging transaction at the time it was executed, for example in a trade confirmation. XI Both counterparties must retain such written representations for at least two years; 2. File a Form 404S with the Commission by 9:00 a.m. on the third business day after the position limit is exceeded containing, for each business day, the information in 151.5(f); XII 3. Thereafter file a Form 404S for each calendar month in which it exceeds the limits (by the third business day of each month) containing daily position data consistent with the data required in 151.5(f). XIII Filing monthly (as opposed to daily) Form 404Ss is a change from the Proposed Rules; however, since the forms require daily positions, filers must be prepared to maintain detailed daily data that complies with the 151.5(f) information. Although directed at pass-through entities, the pass-through rules will impact both small and large end-users in several important respects: First, end-users who use futures and swaps referenced contracts to hedge should expect that their counterparties will demand the 151.5(i) written representation that their hedging constitutes a bona-fide hedge, even if the commercial hedger does not expect to ever exceed the position limits and hence never expects to have to satisfy the bona-fide hedge rules in Indeed, the Commission clarified in the final rules that a person who uses a swap to reduce risks attendant to a position that qualifies for a bona fide hedging transaction may pass-through those bona fides to the counterparty, even if the person s swap position is not in excess of a position limit. 60 Second, as a practical result of the first point, all end-user hedgers, regardless of size, should be prepared to review their portfolios in order to make a determination of whether their transactions qualify as bona-fide hedges. If the transactions qualify, all hedgers, regardless of size, should be prepared to maintain records that will enable them to demonstrate, on a daily and intra-day basis, how their positions meet the bona-fide hedge criteria, including, for example, maintaining the data required in Form 404 on a daily basis and/or satisfying the Form 404A data requirements (discussed in detail below). F. Forms 404 and 404A and Reporting and Recordkeeping Obligations There are two ways to apply for the bona-fide hedge exemption, depending on which enumerated hedge exemption is being claimed: Form 404. For hedges that are not related to anticipated activities, i.e., 151.5(a)(d)(i)(A), (ii)(a), and (ii)(b) (ownership of the cash commodity, fixed-price purchases, fixed-price sales, and equivalent sales of cash products and by-products), 151.5(a)(d)(iii) (unfixed price positions/different delivery months), and 151.5(a)(d)(iv) (agent purchases or sales), the hedger must file a Form 404 by 9:00 a.m. Eastern Time on the third business day after 60 Rules Preamble at 71,645 (emphasis added). 18

19 it has exceeded the limit. 61 Thereafter, the hedger must file a Form 404 on the third business day following each calendar month in which it exceeded the limit. The initial Form 404 and any monthly updates should contain the information required in the form and set forth in 151.5(c) (see the table below). 62 The monthly Form 404 updates should contain information on daily positions for the month. 63 Form 404A. For those enumerated hedges that relate to anticipated activities, including service hedges, hedgers must file a Form 404A at least 10 business days in advance of exceeding the limits. 64 If a 404A filer wishes to exceed the CFTC-granted exemption levels, it must file a supplemental report updating its initial form 404A at least 10 days in advance of exceeding those limits. 65 Because some of the anticipatory hedge exemptions are limited to 12 months, as a practical matter hedgers seeking to maintain a 12-month exemption on a rolling basis may seek to file a supplemental Form 404A every month, with updated information. Both Form 404 and 404A are Notice Filings, meaning that the hedge exemption is effective upon filing the Form 404 or after the ten day-period required under Form 404A and is not dependent upon Commission order. 66 However, the CFTC, either before or after the effective date of the exemption, may require additional information in order to support a determination that the statement filed complies with the bona fide hedging exemption criteria in 151.5(a). 67 The Commission could therefore conceivably delay the effective date of the exemption. Forms 404 and 404A require detailed information, as noted in the table below: 61 See 17 C.F.R (c), (b)(2). The rules do not clearly state what time the monthly Form 404 must be filed; however, in an abundance of caution, filers may wish to follow the same time deadline of 9:00 a.m. ET applicable to the initial Form See id (b)(2). 63 See Rules Preamble at 71,682. Filing a monthly (as opposed to daily) Form 404 is a change from the Proposed Rules; however, since the monthly forms require daily positions, filers must be prepared to maintain detailed daily data that complies with the 151.5(c)(1) information. Given that the filing requirement has been modified from the proposal, parties affected by monthly Form 404 filings may wish to consider whether it is practical or possible to show daily positions in monthly filings, and, if not, consider contacting the CFTC for clarification or potentially modification of the monthly Form 404 reporting obligation. 64 Id (d)(1); (b)(1). 65 Id (d)(3). 66 See 17 C.F.R (c)(2), 151.5(d)(2) C.F.R (e). 19

20 Form 404 The 404 filing shall contain the following information for each business day the company exceeds the limits: Table 8. Contents of Form 404 & 404A (Bona-Fide Hedge) ( 151.5(c)(1), 151.5(d)(1)) Form 404A For each referenced contract anticipated to exceed the limits, the Form 404A shall contain the following information: The date of the bona fide hedging position; which of the enumerated hedge exemption(s) the position qualifies for bona fide hedging; the corresponding Core Referenced Futures Contract; the cash market commodity hedged and the units in which it measured; and, as applicable: (1) the entire quantity of stocks owned of the cash market commodity that is being hedged; (2) the entire quantity of fixed-price purchase commitments of the cash market commodity that is being hedged; (3) The sum of (1) and (2); (4) the entire quantity of fixed-price sale commitments of the cash commodity that is being hedged; (5) the quantity of long and short Referenced Contracts, measured on a futures equivalent basis to the applicable Core Referenced Futures Contract, in the nearby contract month that are being used to hedge the long and short cash market positions; A description of the type of anticipated cash market activity to be hedged; how the purchases or sales of Referenced Contracts are consistent with the general hedge definition in 151(a)(1); and the units in which the cash commodity is measured; the time period for which the person claims the anticipatory hedge exemption is required, which may not exceed one year for agricultural commodities or one year for the anticipated merchandising hedge; and as applicable: (1) the actual use, production, processing, merchandising (bought and sold), royalties and service payments and receipts of the cash market commodity during each of the three complete fiscal years preceding the current fiscal year; (2) the anticipated use, production, or commercial or merchandising requirements (purchases and sales), anticipated royalties, or service contract receipts or payments of the cash market commodity which are applicable to the anticipated activity to be hedged for the requested hedge period; (3) the unsold anticipated production or unfilled anticipated commercial or merchandising requirements of the cash market commodity which are applicable to the anticipated activity to be hedged for the requested hedge period; (4) the maximum number of Referenced Contracts long and short (on an all-months combined basis) that are expected to be used for each anticipatory hedging activity for the equested hedge period; 20

21 (6) the total number of long and short Referenced Contracts, measured on a futures equivalent basis to the applicable Core Referenced Futures Contract, that are being used to hedge the long and short cash market positions; and (7) any cross-commodity hedging information as per 151.5(g). (5) If the hedge exemption sought is for anticipated merchandising: a description of the storage capacity related to the anticipated merchandising transactions, including (i) the anticipated total storage capacity, the anticipated merchandising quantity, and purchase and sales commitments for the requested hedge period; (ii) current inventory, and (ii) the total storage capacity and quantity of commodity moved through the storage capacity for each of the three complete fiscal years preceding the current fiscal year; and (6) any cross-commodity hedging information as per 151.5(g). G. Pre-Existing Swaps Exemption Consistent with the Proposed Rules, the final rules include an exemption for pre-existing positions in both futures and swaps entered into in good-faith before the effective date. Under this provision, for non-spot months positions, a trader would not be in violation of a position limit based solely upon the trader s pre-existing positions in referenced contracts entered into in good faith before the effective date of a rule or order setting a limit ( 151.9(a)). A person using this exemption may not, however, enter into new, additional contracts in the same direction but may take up offsetting positions and thus reduce its total combined net positions. 68 Traders must comply with spotmonth limits ( 151.9(b)). Further, under 151.9(c), swaps entered into before the effective date of the Dodd-Frank Act will not count toward a speculative limit, unless the trader elects to net such swaps positions to reduce its aggregate position. VIII. DCM and SEF Position Limits and Bona-Fide Hedge Exemptions Besides establishing federal position limits on 28 core futures contracts and their economic equivalents, the final rules permit (but do not require) DCMs and SEFs to set position limits on all futures, options, and swaps traded on that DCM or SEF, consistent with their Core Principles. 69 This two-part enforcement regime, i.e., a system of federal limits enforced by the CFTC and a rules-based system allowing exchanges to set their own limits on their own contracts, is consistent with the prior position limit regime. Historically, DCMs have set position limits on a range of futures contracts and limited number of swaps Rules Preamble at 71, C.F.R As noted in footnote 28, above, the DCM Core Principles are the subject of proposed revisions under Dodd-Frank. See 76 Fed. Reg. 722 (Jan. 6, 2011). Final rules have not yet been approved. 70 See Establishment of Speculative Position Limits, 46 Fed. Reg. 50,938 (Oct. 16, 1981) (adopting rules 17 C.F.R moved to via 64 Fed. Reg. 24,038 (May 5, 1999) requiring limits on futures and options contracts traded on contract markets); see also footnote 4, above, regarding 2008 changes to CEA position limit authority for swaps. 21

22 Under the final rules, DCMs and SEFs must set limits for the spot-month ( (a)(1)) and non-spot month ( (b)(1)) for referenced contracts at levels no greater than the federal limits. For non-referenced contracts, the regulations provide as follows: for spot months ( (a)(2)): it shall be an acceptable practice for SEFs and DCMs to adopt, enforce, and establish rules and procedures for monitoring and enforcing spotmonth position limits set at levels no greater than 25 percent of estimated deliverable supply, consistent with Commission guidance set forth in this title ; for non-spot months and all months combined ( (b)(2)): it shall be an acceptable practice for SEFs and DCMs to set limits consistent with the Commission s formula of ten percent of the first 25,000 open interest contracts and 2.5% thereafter; and for initial limits of contracts at the contract designation or initial listing ( (b)(3)): it shall be an acceptable practice for SEFs and DCMs to set individual single-month or in all months-combined at no greater than 1,000 contracts for physical commodities other than energy commodities and 5,000 contracts for other commodities provided that the contract quantity is no larger than the typical cash market transaction in the underlying commodity. Also consistent with the prior position limits regime, for contracts not subject to federal limits (i.e., non-referenced contracts), the final rules permit DCMs and SEFs to establish accountability rules, sometimes referred to as soft limits, under certain conditions in lieu of establishing hard limits. 71 Generally, exceeding soft limits is not a violation of exchange rules, but it will trigger a request for an explanation of the trades, additional information on the transactions, or an orderly reduction of the position. The DCMs or SEFs historically have used this authority to set accountability levels on a range of contracts. 72 The rules for DCMs and SEFs also require that the DCM/SEF limits be subject to the federal bona-fide hedge exemption. For agricultural and exempt commodities (i.e., energy and metal), a bona-fide hedge exemption must be available for any position that would otherwise be exempt from the applicable Federal speculative position limits as determined by For excluded commodities, DCMs and SEFs must use the bona-fide hedge definition in 17 C.F.R. 1.3(z) C.F.R (c). 72 See, e.g., CME Group, NYMEX Rule Book, Rule 560 (Position Accountability); ICE Annex L, OTC Regulatory Rulebook for Significant Price Discovery Contracts, Rule 1.13 (Enforcement of Position Limits and Position Accountability Levels). Also consistent with the current position limit regime, DCMs and SEFs are to adopt account aggregation criteria consistent with the federal rules. Under the new rules, the aggregation standards are in 17 C.F.R , and are discussed below C.F.R (f)(1)(i). The requirement that DCMs and SEFs provide a hedge exemption consistent with is ambiguous because it is not clear whether the bona-fide hedge request must satisfy both the general definition in (a)(1) and one of the enumerated hedges in (a)(2). As suggested by the discussion of the history of the enumerated hedges in footnote 52, above, it makes no sense for DCMs and SEFs to limit hedge requests to enumerated hedges. Historically, as the CFTC recognized, the list of enumerated hedges was limited because the federal limits applied only to certain contracts and because there was an established petition process. As a necessary corollary to this holding, if position limits are expanded to contracts beyond those subject to federal limits (as they are at the DCM and SEF level regarding non-referenced contracts), the enumerated list becomes too restrictive. Rather, as under current limits regime, the DCMs and SEFs should have the authority to review bona-fide hedge petitions under the general definition in (a)(1), and should not be further restricted to the enumerated hedge list. DCMs and SEFs may wish to confirm this point either in the Core Principles rulemaking or in a clarification of these final rules C.F.R (f)(1)(ii). 22

23 IX. Aggregation of Accounts Under the account aggregation rules (codified at 17 C.F.R ), entities calculating their positions for position limit purposes must aggregate their referenced contract positions in all accounts that they own or control, either directly or indirectly, unless one of the limited exemptions applies. An entity must aggregate accounts if it: (i) directly or indirectly holds positions, controls trading, or has a 10 percent or greater ownership or equity interest, 75 (ii) is acting pursuant to an expressed or implied agreement or understanding with respect to an account or accounts, 76 or (iii) holds or controls the trading of positions in multiple accounts (including in multiple trading pools) with identical trading strategies. 77 The final rules largely re-affirm current CFTC aggregation requirements, although the Commission clarified that the aggregation policy now applies to swaps as well as futures positions. 78 As the Commission explained it, trading entities must aggregate all positions that they own in more than one account: including accounts held by entities in which that trader owns a 10 percent or greater equity interest. Thus, for example, a financial holding company is required to aggregate house accounts (that is, proprietary trading positions of the company) across all wholly-owned subsidiaries. 79 The rules contain several specific exemptions for commodity pool participants; for futures commission merchants ( FCM ); for an Independent Account Controller ( IAC ); for underwriting; and for information restrictions imposed by federal law or regulations. These exemptions are as follows: Commodity Pool Participants. Similar to existing regulation 150.4(b), an entity may not need to aggregate its 10 percent or greater ownership or equity interest as a limited partner, member in an LLC, shareholders, trust beneficiary, or other similar pool participant arrangement in a commodity pool, so long as the pool operator maintains and enforces written procedures prohibiting knowledge or access to trading data, the person does not have direct, day-to-day supervisory authority or control over the pool s trading decisions; and the pool operator has complied with the required notice provisions in 151.7(h). 80 FCMs. The FCM exemption is identical to existing 150.4(d), and allows an FCM to disaggregate positions in discretionary accounts participating in its customer trading programs provided that the FCM does not, among other things, control trading of such accounts and the trading decisions are made independently of the trading for the FCM s other accounts. Unlike the current rules, however, the exemption will no longer be selfexecuting; rather, the FCM must apply to the CFTC for the exemption See id (a)-(b). 76 Id (a). 77 Id (d); Rules Preamble at 71,651 (noting that section (d) requires a trader to aggregate any positions in multiple accounts or pools, including passively-managed index funds, if those accounts or pools had identical trading strategies ). 78 In the final rules, the Commission eliminated most of the new aggregation concepts initially proposed in the January 26, 2011 proposed rulemaking. Instead, it has reverted back to account aggregation standards that are similar to the current rules in 17 C.F.R. Part 150, including the Independent Account Controller exemption.see Rules Preamble at 71, Rules Preamble at 71, C.F.R (c); Rules Preamble at 71,653. However, if the pool is exempt from CFTC registration requirements under 17 C.F.R. 4.13, entities with a 25 percent or greater ownership must aggregate all positions in such pools. 17 C.F.R (c)(3). 81 Id. 151.(f); Rules Preamble at 71,651 n

24 IAC. The IAC exemption, initially stricken from the Proposed Rules, was reinstated in the final rules after much negative comment. Under the IAC exemption, an eligible entity, including banks, commodity pool operators, commodity trading advisors, and insurance companies, may disaggregate customer positions or accounts managed by an IAC from its proprietary positions (except for the spot month provided in physical delivery referenced contracts), so long as it meets certain information and data access conditions and files appropriate notice consistent with section (h) of the rules. 82 The final rules clarify the CFTC s longstanding position that the IAC exemption is limited to independently managed client accounts, i.e., by an entity that trades professionally for others. Thus, the IAC exemption is not available for proprietary positions in accounts which a trader owns. 83 Underwriting. In response to comments, the CFTC added a new provision, incorporated in 151.7(g), which will allow a person to disaggregate when ownership above the 10 percent threshold is associated with the underwriting of securities. Information sharing restrictions imposed by federal law. An entity is not subject to the aggregation requirements if the sharing of information associated with such aggregation would cause either person to violate Federal law or regulations adopted thereunder, so long as the person does not have actual knowledge of the affiliate positions. Parties taking advantage of this exemption must file a prior notice with the Commission detailing the circumstances of the exemption and an opinion of counsel that the sharing of information would cause a violation of Federal law or regulations adopted thereunder. 84 Commissioner O Malia was particularly critical of these provisions, emphasizing that the final rules put into place overly broad aggregation standards, fail to substantiate claims that they adequately protect against international regulatory arbitrage, and do not include an adequate cost-benefit analysis. 85 In particular, Commissioner O Malia questioned the elimination of the proposed aggregation exemption for owned-non financial entities, which would have allowed nonbanks, etc., to disaggregate positions if they met a host of data and risk management separation conditions. Commissioner O Malia argued that there was no legal or policy rationale that justified this change from the Proposed Rules and that the elimination of the owned-non-financial entity exemption represented an imbalanced treatment of market participants. 86 X. Position Visibility for Energy and Metals Referenced Contracts The final rules impose quarterly position visibility reporting requirements on traders exceeding a non-spot month position visibility level in energy and metals referenced contracts. All traders with net long or net short positions in referenced contracts that equal or exceed the following in any month (including the spot month) or in all months combined must comply with the position visibility rules: 82 See id (f); Rules Preamble at 71, See 17 C.F.R (f); See also Rules Preamble at 71,652 (noting that eligible IACs have a fiduciary relationship to those clients for whom he or she trades. ) C.F.R (i). 85 O Malia Dissent, Rules Preamble at 71, Id. at 71,

25 Five metals contracts: Table 9. Position Visibility Levels ( 151.6) Copper (COMEX) 8,500 # of contracts Gold (COMEX) 30,000 Silver (COMEX) 8,500 Palladium (NYMEX) 1,500 Platinum (NYMEX) 2,000 Four energy contracts: Henry Hub Natural Gas (NYMEX) 50,000 Light Sweet Crude Oil (WTI) (NYMEX) 50,000 N.Y. Harbor Gasoline Blendstock (RBOB) (NYMEX) 10,000 N.Y. Harbor No. 2 Heating Oil (NYMEX) 16,000 A party exceeding the visibility levels must file reports, in the form of a Form 401 filing, within 10 business days after each calendar quarter in which the account holder exceeded the visibility levels. The filing must include the following information as set forth in Rule 151.6: A list of dates within the applicable quarter in which the applicant held or controlled the postion(s) exceeding the level ( 151.6(1)); The day the applicant held the largest net position within the applicable quarter ( 151.6(b)(2)); Separately, by futures, options, and swaps (on a futures equivalent basis): daily gross long and gross short positions in the referenced contracts in all months ( 151.6(b)(2)(i)); and related gross long and gross short uncleared swaps positions, if any ( 151.6(b)(2)(ii)); 87 o Note: 401 filings require the reporting of gross long and gross short positions in referenced contracts, but not those positions that are excluded from the referenced contract definition (e.g., financial basis swaps, pre-existing swaps, and commodity index swaps). 88 In addition to Form 401, parties exceeding the limits should file a Form 404 containing the information required in 151.5(c) (see above discussion regarding Bona-Fide Hedge) at the same time as the Form 401. Form 404 is intended to provide cash market commodity positions held by the trader exceeding the visibility levels ( 151.6(c)); Alternative filing. Under 151.6(d), upon written permission from the CFTC or its staff, a trader may submit a digital spreadsheet containing at least the same data required in 151.6(b) and (c) in lieu of Forms 401 and The total and uncleared swaps positions must be reported, regardless of whether the swaps were executed opposite a clearing member or swap dealer. See Rules Preamble at 71,632. The CFTC eliminated the proposed separate Form 402S, contained in the Proposed Rules. Instead, it will collect uncleared swaps data in the Form 401. Id. at 71,658. Furthermore, the CFTC may request more specific data not contained in the Form 401 (e.g., a breakout of data based on expirations) under its existing 17 C.F.R and 20.6 authority. Id. 88 See id. at 71,

26 The CFTC considers the visibility levels as an important surveillance tool in the metal and energy Referenced Contracts primarily because it does not expect many participants to exceed the position limits and therefore submit the detailed bona fide hedging report data required of bona-fide hedgers. 89 In contrast, it expects more parties trading agricultural referenced contracts to exceed limits and therefore require exemptions, and thus it anticipates obtaining surveillance data on agricultural positions from hedging reports. In this regard, it should be noted that the CFTC intends to police the position limits through market surveillance, both by examining visibility level reports (and presumably bona-fide hedge reports), as well as by special calls for information under the newly finalized large swaps trader reporting rules in Part 20 of 17 C.F.R. and specifically under 20.6(b). 90 Traders subject to these special calls will be afforded an opportunity to provide information on their positions demonstrating compliance with the Part 151 position limits. 91 XI. Commissioner Dissents The dissents of Commissioners O Malia and Sommers are notable in that both commissioners suggested that the rules were vulnerable to legal challenge. Among other things, Commissioner Sommers expressed a view that the CFTC was setting itself up for an enormous failure and may ultimately inflict the greatest harm on bona-fide hedgers, thus making hedging more difficult, more costly, and less efficient. 92 Commissioner O Malia s lengthy dissent asserted, among other things, that the Commission had overreached its mandate by substituting the current regime of principles-based regulation with a prescriptive government-knows-best regime 93 and argued that position limits are unnecessary without a finding that excessive speculation even exists in the trading of a particular commodity. 94 He was concerned that the final rules eliminates certain legitimate derivatives risk management strategies (e.g., anticipatory hedging) from exemption, and that certain enumerated exemptions, are so narrowly defined that only basic operations could qualify for the exemption (e.g., anticipatory merchandising). 95 He further argued that the Commission s cost-benefit analysis was inadequate, especially with respect to the cost impacts on bona-fide hedgers. 96 These dissents provide detailed and important criticisms of the final rules and will be useful for parties considering challenging the rules. In light of this, the dissents should be considered carefully in evaluating the impact of the rules on a company s commodities business. 89 See id. at 71, See Large Trader Reporting Final Rules, 76 Fed. Reg. 43, See Rules Preamble at 71, Sommers Dissent, Rules Preamble at 71, O Malia Dissent, Rules Preamble at 71, Id. at 71, Id. at 71, Id. at 71, Indeed, the Commission was unable to quantify many of the costs on the industry, even conceding that firms may need to adjust their trading and hedging strategies to comply with the limits, at a cost it could not quantify. Rules Preamble at 71,

27 The Authors Jeffrey A. Sherman Lui Chambers Peggy Heeg Rabeha Kamaluddin Michael Loesch Notice: We are providing the Fulbright Briefing as a commentary on current legal issues, and it should not be considered legal advice, which depends on the facts of each situation. Receipt of the Fulbright Briefing does not establish an attorney-client relationship. The listed attorneys and/or other attorneys may provide services in connection with a particular matter. Table Endnotes I. Rules Preamble at 71,631. II. Id. at 71,631 n.50. III. Id. at 71,630. IV. Id. at 71,631. V. Id. at 71,630. VI. Id. at 71,631 n.49. VII. Except for Henry Hub Natural Gas (NYMEX) referenced contracts, all spot month limits apply separately to positions in (i) physical delivery referenced contracts and (ii) cash-settled referenced contracts. However, a firm may not net physical delivery contracts with financial equivalents. VIII. The non-spot/all months combined limits are net positions across all physical and cash-settled contracts. A firm may net long and short financial and cash-settled positions. IX. The five-times-physical contract limit applicable to cash-settled equivalents of the Henry Hub Natural Gas (NYMEX) contracts is an aggregate limit applicable to combined physical delivery and cash-settled contracts. X. Rules Preamble at 71,677. XI. Id (i). XII. See 17 C.F.R (f), (b)(2). XIII. See id (b)(2); Rules Preamble at 71,682. The rules do not clearly state what time the monthly Form 404S must be filed; however, in an abundance of caution, filers may wish to follow the same time deadline of 9:00 a.m. ET applicable to the initial Form 404S. Given that the filing requirement has been modified from the proposal, parties affected by monthly Form 404S filings may wish to consider whether it is practical or possible to show daily positions in monthly filings, and, if not, consider contacting the CFTC for clarification or potentially modification of the monthly Form 404S reporting obligation. 27 Attorney Advertising 12/11 NF Copyright 2011 Fulbright & Jaworski L.L.P. All Rights Reserved