* CFTC set to approve limits for commodity speculators
* Rule nixes class limits, aggregation fought by Wall St
* After years of debate, topic still contentious
* Legal challenge looms as financial industry fights back
(Updates with Dunn comments, throughout)
By Christopher Doering and Jonathan Leff
WASHINGTON (Reuters) - The United States is set to
pass narrowly Tuesday its toughest measures yet to curtail
speculation in commodity markets, likely shifting the focus of
a fierce four-year debate from the regulators to the courts.
In a measure decried by Wall Street and trading companies
as a misguided political attempt to cap soaring oil and grain
prices, the Commodity Futures Trading Commission was poised to
approve "position limits" that will cap the number of futures
and swaps contracts that any single speculator can hold.
The divisiveness of the rule, set for a formal vote at the
end of Tuesday's meeting, was stark from the opening. Key swing
vote Michael Dunn, a Democrat whose term has already expired,
said he would follow the Dodd-Frank law to set the limits while
blasting them as a distraction from bigger issues.
"Position limits are a sideshow," said Dunn, who is serving
past his term until Congress confirms his successor. He said
markets may become more risky, and hedging practices more
difficult, possibly leading to higher prices.
"I think it's important to let the public know what may
happen once we implement position limits. ... In all likelihood
prices of heating oil and gasoline will not drop ... Things
will remain relatively the same, except for those that use the
markets we regulate to provide resources we all need."
The commission is deeply split and a lawsuit to stop the
measure seems ever more likely, one more hurdle for CFTC
Chairman Gary Gensler, who is struggling against emboldened
Republicans and a hostile Wall Street to put in place the rules
required by the Dodd-Frank financial reforms.
After an eight-month battle, the Securities and Exchange
Commission in July had its first Dodd-Frank rule overturned
when a federal appeals court found the SEC had conducted a
flawed analysis to support a rule that would make it easier for
shareholders to nominate directors to corporate boards.
The position-limits rule may be challenged on similar
grounds -- that the costs outweigh the benefits of a plan that
many industry officials say will make markets riskier by
driving trade to less-regulated overseas venues.
"We need to be very careful, but I believe we're on very
solid legal ground," Democratic Commissioner Bart Chilton told
Reuters Insider Tuesday.
It was not immediately clear who might bring a lawsuit, but
the limits will affect dozens of major commodity traders and
exchanges. Normally there is a limited period of two or three
months after a rule is published in which a suit can be filed,
though some of the rules will not take effect until late 2012.
Gensler will also need to encourage overseas regulators to
keep up with the CFTC to prevent the "regulatory arbitrage"
that many fear may ensue. A meeting of global regulators in
London on Friday to discuss high-frequency trading will offer
him a chance to encourage others to prevent loopholes.
But it's an uphill battle. Over the weekend, France failed
to force mandatory curbs on energy and food commodities, and
Britain's Financial Services Authority -- which oversees most
of the major non-U.S. commodity exchanges -- has maintained a
staunch opposition to mandated limits.
The rule offers some cause for relief in the industry,
relenting on several key provisions that were heavily
criticized, as Reuters reported last month.
Those included tough measures on whether separately
controlled accounts must be aggregated and whether swaps and
futures positions can be offset, so-called "class limits", the
CFTC said. It also partly yielded to CME Group calls for equal
treatment of cash and physical contracts.
But giving ground on those details will do little to temper
frustration over a plan that could force banks such as Morgan
Stanley and traders including grains giant Cargill to scale
back business, stemming an influx of investor capital.
The CFTC estimated the measure would cost the industry $100
million in the first year.
The limits could temper investors who have poured over $300
billion into commodity markets, often via index swaps with
banks. Under the new rules, banks will no longer be given an
exemption for such speculative swaps, although they will be
able to hedge on behalf of corporate customers.
Gensler should have the votes of Dunn and Chilton, the two
Democrats on the commission. He faces opposition from
Republicans Jill Sommers and Scott O'Malia.
O'Malia said the CFTC had failed to provide the "empirical
evidence" to substantiate the rule -- an argument similar to
that put forth by industry officials who say there is no proof
of the link between speculators and commodity prices.
Dozens of academic, government and bank studies on the
subject have differed on whether speculators influence prices
long-term or whether prices simply respond to market
conditions. The CFTC's own economists have yet to produce any
economic evidence to connect speculators to price spikes.
Some politicians, however, have clamored for the CFTC to
clamp down since early 2008, as oil and grain prices were
shooting toward historic peaks.
DEVIL IN DETAILS
The rule covers 28 commodities from coffee to crude to
copper, including nine crop markets that were already subject
to limits, using a predetermined formula based on deliverable
physical supply or open interest in the market. It includes for
the first time contracts in the $600 trillion swaps market.
All the rules will be phased in over time, with the final
limits for all contract months set only after the agency has
collected a year's worth of swaps data, a process likely to be
finished only late into 2012, officials said.
Several key provisions were eliminated from the CFTC's
original proposal in January, as Reuters reported.
One key change relaxed the requirement that big commodity
players aggregate all the positions held by any hedge funds or
subsidiaries in which they have a stake. Instead, it retains
the "independent account controller" regime currently in place,
which views separately-run trading books independently.
Another eliminates a proposed "conditional limits" measure
that would have allowed speculators in commodity markets that
are settled in cash to accumulate positions of five times the
limit for similar physical delivery contracts.
That rule had riled the CME Group, which feared losing
business to rival cash-settled contracts, some of which are
listed by the IntercontinentalExchange. The CFTC maintained
this measure for the Henry Hub natural gas market, however,
where cash contracts -- and in particular the ICE look-alike
contract -- are already highly liquid.
Despite relenting on several elements that Wall Street had
fought hardest, the new rule could ensnare a larger number of
traders compared to the draft it released earlier this year.
Spot-month limits could affect 85 traders in the energy
markets, more than double the January estimate, according to
the CFTC's estimates. However, those estimates included
companies that would qualify for hedging exemptions, leaving an
open question as to how many speculators would be affected.
(Additional reporting by Sarah N. Lynch; Editing by Jonathan
Leff and Dale Hudson)
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