Dangers of Position Limits and Overreaching Regulation
William Purpura, Managing Director | Great Lakes Global Limited
The CFTC’s proposed position limits along with the complexity and immensity of Dodd-Frank has already caused market participants to take flight from the US markets to OTC and foreign markets which have less onerous regulation. The Commission has often dismissed the probability of regulatory arbitrage as paranoia. One only need to look at the impressive growth in the Brent crude oil contract traded in London in the wake of jawboning about position limits in the US that would affect the WTI crude contract on NYMEX.
Chairman Gensler’s view is that there should be “international harmonization” among global regulators to alleviate the threat. This is a wrong approach. The US government, through the CFTC and other agencies has been pressuring other regulators to fall in line, and while there may be some lip service about being cooperative, these countries see a rare opportunity to create regulatory-friendly environments to capture business. For the most part they have not passed anything remotely resembling the massive Dodd-Frank bill and see, often correctly, that the US is creating rules and restrictions that are more designed for political effect than clear-eyed, prudent market regulation.
Proposed position limits are being presented as protections against excess speculation that have an adverse effect on true supply-demand forces, causing consumers to pay more. Speculation is likely the least significant factor in the recent rise of commodity prices, and imposing restrictions on speculative activity will compromise the necessary liquidity the speculative participants provide. We do not hear about misguided government programs such as the ethanol debacle as being the cause of anything, or the monetary policy that has made the purchasing power of the US Dollar fall to historic lows. Risk premiums are built into the oil markets because of unrest in sensitive oil producing countries, and at the same time we discourage domestic exploration and production. This is not the fault of speculators.
When one analyzes the current proposals for position limits it smacks of trying to address a perception than an actual problem. What may actually occur are a reduction of transparent liquidity and a compromise of legitimate hedging activities. These proposals will not enhance efficiency and market integrity.
The metals markets, which I have traded for 30 years, are particularly vulnerable to limits imposed by the CFTC. The exchanges are better equipped to enforce rules, and these practices have worked very well over the years. The most significant impact of federally prescribed position limits in the US markets will be to drive business to the London OTC markets. Large players bumping up against limits on COMEX will simply go to foreign markets. The fact is that metals are globally traded and price discovery is a 24 hour process around the world. While much of this pricing is reflected in the COMEX price, putting limits on the COMEX markets will not change the discovery process, but move more of it to other markets. New gold contracts have been recently launched in Hong Kong and Singapore, hoping for the chance to attract global business that is currently on COMEX. China and India both have aspirations to become major global players in the exchange space.
These jurisdictions are waiting for the opportunity to build their derivatives markets as our regulations become more restrictive. The CFTC and Dodd-Frank have often stated the desirability of pushing more trading to efficient, transparent markets from opaque OTC markets. Forcing volume and open interest off of these very markets through more regulation and limits is directly counter to their desired goal. This, combined with high US taxes, may prove devastating to our markets.
When I am overseas, the question often comes up about effective regulation. The analogy I use is this: Consider the market a highway. We want to accommodate as much traffic as possible to move quickly and safely along. The regulator’s role should be to establish guard rails to keep the traffic on the road and the highest, but safest, speed limit as possible. Once these guard rails become roadblocks, or unreasonable speed limits are imposed, the traffic will seek a better rout. Our markets are already seeking a better rout, and our regulators had better take notice.
William Purpura, Managing Director | Great Lakes Global Limited
Contact: wpurpura@gltdirect.com
