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Source: Reuters

ANALYSIS-CFTC cautious on position limits, set to act

Published: 22 Nov 2009 17:05:27 PST

* CFTC has tempered outlook on energy position limits

* CFTC feeling pressure from Congress to act

* Commissioner Dunn a crucial swing vote

WASHINGTON, Nov 20 - U.S. regulators will set position limits in energy futures markets to curb excess speculation, but the rules will probably be less strict than originally contemplated so traders will not be driven to markets with looser regulations.

The U.S. Commodity Futures Trading Commission said in July it was considering limiting the number of contracts investors can hold in commodities of limited supply, such as crude oil.

The goal was to prevent speculators from driving up costs of energy and other commodities like metals to levels that are unaffordable for consumers and potentially damaging to the broader economy.

But there have been growing concerns at the CFTC that overly tough position limits could drive trading overseas or to less-regulated over-the-counter markets, according to researchers and former high-ranking officials at the agency.

"There will be limits that will be somewhat tough, but perhaps not as tough as you would have thought if you looked at their statements" this summer, said Craig Pirrong, a finance professor at the University of Houston.

A source with knowledge of talks at the CFTC said the agency, which is expected to issue a decision in December, is considering applying speculative limits not only to the spot market, or the expiring contract, but for all months and all monthly contracts combined.

It also is looking at applying limits to all traders except those that intend to take physical delivery of the product, or bona fide hedgers, according to the source.

Pirrong said the CFTC may be worried that tight, futures-only position limits would benefit the over-the-counter market at the expense of the futures markets it oversees. This would undermine efforts to move trading from less-regulated markets to ones where it has more oversight.

Prices for oil and other essential goods surged last year on what some analysts called excessive speculation and big money inflows. Crude oil reached a record of $147 a barrel. Lawmakers criticized CFTC for not doing enough to tamp down the influx of hot money from hedge funds.

CFTC Chairman Gary Gensler, facing mounting pressure from Congress, has pledged to be more aggressive on things such as position limits. But the financial industry has lobbied against them, and some of the five commissioners are not enthusiastic about tighter rules.

CFTC Commissioner Michael Dunn has expressed concern whether the agency has the necessary experience and structure to set energy position limits.

"Commissioner Dunn is going to have a lot to say about what the scope of this law is," said the source familiar with the discussions. "There is a lot of pressure being applied to him from Congress to get Gensler the third vote do whatever they can do under existing law."

Pirrong called Dunn, a Democrat, a crucial "swing vote."

"He has a reputation as being a more middle of the road guy so his support adds some credibility and political cover to anything that they do," he said.

Some say Commissioner Jill Sommers, a Republican who has experience with over-the-counter derivatives and previously worked at the Chicago Mercantile Exchange, will scrutinize the usefulness of position limits.

Gensler and Commissioner Bart Chilton, both Democrats, have supported tougher position limits. Gensler said on Wednesday the agency is "seriously considering" them. Little is known about the position of Republican Scott O'Malia who was confirmed in October.

Chilton told Reuters he believed the agency would ultimately establish hard position limits for energy and possibly other physical commodities, such as metals. The CFTC already sets limits on some agricultural contracts.

Congress is looking at legislation that would give the CFTC greater authority to set aggregate limits across markets for physically deliverable commodities including oil.

"It should be a signal to those on the commission about the direction Congress wants the commission to go," said Michael Greenberger, a law professor at the University of Maryland and a former CFTC official. "This is probably the most important issue the CFTC has on its agenda right now."

The push from Congress could sway three or four commissioners to back position limits, experts said.

The IntercontinentalExchange Inc, or ICE, and the Chicago Mercantile Exchange, the world's largest exchange, have urged the CFTC to be cautious. They say limits could actually make markets more volatile, distort pricing functions and push traders to less-regulated offshore markets.

Former CFTC Chairman Philip McBride Johnson, now in private practice at Skadden, Arps, Slate, Meagher & Flom, said the CFTC should not decide until it knows what other major financial centers are doing, beyond London, Singapore and Tokyo.

"There are ambitious exchanges all over the world that will be more than happy to pick up any slack if these other exchanges voluntarily decide to coordinate or aggregate positions," he said.

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