For several weeks I have been trying to figure something out.

Back in the summer, I overheard two people talking on the west side of Manhattan. They were strolling 20 feet in front of me but in a brick tunnel underpass to the Hudson River bike path, so it became something of an echo chamber.

What they said rang in my ears, clear as if I had a wiretap. My guess is they were Wall Street guys, back office types, and not traders, although admittedly that is speculative.

What I overheard:

Guy No. 1: “The problem is those damn hedge exemptions. They have to do something about that. NYMEX hands them out like friggin’ hall passes, and after the fact. It’s a joke.”

Guy No. 2: “I spoke to someone at the CFTC after the meeting and they told me that they were going to start to crack down on that.”

Immediately, I looked into the phrase “hedge exemption” which I had never heard and did not understand. In recent weeks I have been following the CFTC’s proposal regarding hedge exemptions, and while closer to understanding the issue I am not fully there. But I intend to get there, soon.

In fact, I am heading to Florida for a few days, and have printed out a PDF version of the CFTC’s proposed rules regarding Federal Speculative Position Limits for Referenced Energy Contracts and Associated Regulations. I’ll be staying, a la a Seinfeld episode, on a pull-out couch at the bungalow-style home of some lovely people, septuagenarians, who reside in a sprawling West Palm Beach retirement community called Century Village. My hosts get up at dawn and enjoy early bird specials so I intend to be in bed reading each night by 7 p.m.

I intend to read the CFTC rule proposal closely.

Having skimmed it and having discussed the issue with a few market participants I’m slowly arriving at some basic conclusions.

One issue is the end goal seems to be more about creating the perception of action being taken rather than any practical, or meaningful step. Gary Gensler, the POWERS THAT BE, seem to want to ensure that certain energy market players don’t engage in abusive speculation practices a la the silver hoarding Hunt Brothers in late 1970s causing excessive volatility, or bubbles.

Additionally, it is clear that swaps dealers (Goldman et al) are being focused on—apparently they have been getting around existing curbs (speculative position limits) via hedge exemptions, and so it seems the proposal here would tweak the rules so that swaps dealers would no longer be able to circumvent speculative position limits … but speculative position limits, at least for energy, are only now being introduced … terribly confusing, to me anyway.

So I ask around. With respect to swaps dealers, hedge exemptions, speculative position limits, what I keep hearing is only a few players will be affected and they aren’t going to be terribly impacted. If that’s the case … well, what a waste of time.

But I’ll reserve judgment until I can tear thru the whole CFTC enchilada. Here it is for those who want to join in the mission:

http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-1209a.pdf

Meanwhile, the Senate Banking committee is chewing on swaps, and not just the controversial credit default swaps, but commodities swaps, and I have no idea how or whether what the CFTC is proposing reconciles with what the Senate wants to do. Furthermore, what the Senate wants is up in the air on account of the deal making, horse trading going down trying to arrive at a financial reform bill that can pass, still ongoing. Apparently lawmakers are closer to something, a pot luck feast, a watered down, toothless joke, maybe something sensible—God knows what.

A new “chairman’s mark text,” or rough version of the bill prior to committee mark up (i.e. the watering down phase) is expected to come out any day now, although here’s a link to the original mark text.

Maybe the CFTC is working in conjunction with Congress, maybe the two proposals are being pursued independently and will have to be reconciled later, if that is the case, well, again, what a waste of time….

Back to hedge exemptions.

I asked Philippe Comer, the head of Barclays Capital’s structured products team about the impact of regulatory measures being considered including the hedge exemption and he said it was still not clear to him, that it was too soon to say what the impact will be.

(For my full interview with Comer click here.)

This below is from a helpful commodities trader:

“Exchanges already have position limits to prevent manipulation by speculators through sheer force—the “cornering” of old. The exemption for hedging means that people who legitimately have that much exposure can exceed limits. So Exxon may need to sell more oil futures than the position limit allows, since they legitimately have that much they are pumping out of the ground. The swaps dealer, however, is hedging a leveraged contract that he wrote to a hedge fund or other institutional investor rather than hedging a legitimate physical exposure. As a result the concern is that the swap dealer hedge exemption is, in effect, a loophole that lets hedge funds exceed the speculative position limits that were implemented to stop manipulation. Straightforward.”

Except that no one apparently expects swaps dealers to really be impacted and if they are it would be only marginally.

Is there someone out there who knows more about this subject who can shed light? If so please fire away a comment below. Otherwise I am still on the case and intend to write about this when I return from Florida.

This entry was posted on Tuesday, March 2nd, 2010 at 12:40 pm and is filed under The Offering. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.