A U.S. judge knocked back on Friday tough new rules to clamp down on excessive speculation in commodity markets, handing an 11th-hour victory to Wall Street’s biggest banks and angering lawmakers concerned about high prices for gasoline and other raw materials.
Just two weeks before the "position limits" rule was to take effect, U.S. District Court Judge Robert Wilkins sent it back to the U.S. Commodity Futures Trading Commission (CFTC) for further consideration.
The court said the Dodd-Frank law did not give the agency a "clear and unambiguous mandate" to set position limits without showing they were necessary.
It is the second legal setback for regulators struggling to implement the sweeping reforms enacted after the 2008 financial crisis and the first for any CFTC rule in the agency’s history.
CFTC chairman Gary Gensler, who had made reining in speculation a top priority, said he was "disappointed" and considering other options.
"I believe it is critically important that these position limits be established as Congress required," Gensler said in a statement.
Experts said the decision may embolden the financial industry to push ahead with more lawsuits.
"I think outside of Washington, people expected that Congress passes a law the President signs it and these things can immediately go into effect, but it is clear the courts will have a lot to say about how Dodd-Frank is implemented," said James Overdahl, a former chief economist at the CFTC and current vice president at NERA Economic Consulting.
Wilkins also found that the Dodd-Frank bill required the CFTC to prove caps are "necessary" to diminish or prevent excessive speculation. Experts have debated for years whether speculation makes commodity prices more volatile.
The Securities Industry and Financial Markets Association and the International Swaps and Derivatives Association, which brought the suit against the agency, lauded the court decision. The groups argued that the regulations would force their members to drastically alter their businesses, cost them tens of millions of dollars, and send customers fleeing.
The ruling is a victory for Wall Street banks like Goldman Sachs and JP Morgan, which had feared the rule would halt growth in their lucrative business selling commodity derivatives to financial investors.
It also offers breathing room for other energy, metal and grain traders who were unsure how the limits would apply to the complex over-the-counter swaps market. Some feared they may inadvertently violate the limits when the first phase came into effect Oct. 12.
Wilkins, an appointee of U.S. President Barack Obama who joined the bench in December 2010 after working as a corporate defense lawyer, did not rule on whether the agency had sufficiently weighed the economic benefits of the rule against the costs.
The cost-benefit issue was the crux of a court ruling last year that rejected the Securities and Exchange Commission’s "proxy access" rule that would have made it easier for shareholders to nominate directors to corporate boards.
Instead Friday’s ruling said the Dodd-Frank law did not compel the CFTC to make the rule unless the agency demonstrated that position limits are "necessary."
Experts said that could make it harder for the CFTC to prevail if it does appeal Wilkins’ decision.
"Now that the ‘necessity’ issue is back in play it’s unclear what will happen," said one compliance executive at a major commodity trader. "If it were just the cost/benefit issue it might slow things down…. But necessity is a thornier issue, I don’t know they have the votes."
The agency only narrowly passed the position limit rule in October 2011, in a bid to limit the number of contracts traders can hold in 28 commodities, including oil, coffee and gold. The two Republican commissioners on the five-member panel voted against the limits, questioning the agency’s authority to pass them.
Supporters of the measures were quick to blast the ruling.
Senator Bernie Sanders, an independent from Vermont who has strongly pushed for the trading curbs, on Friday called on the CFTC to appeal the decision, noting Dodd-Frank "clearly required" the CFTC to impose strict limits.
"Sadly, one judge has disagreed and is preventing even the weakest rules on oil speculation limits to go into effect," Sanders said in a statement.
Obama and U.S. lawmakers have argued that regulators should be doing more to rein in traders who may be driving up the price of oil for consumers. But Wall Street has argued that regulators have not proven position limits would curb speculation in markets and prevent disruptive price spikes.
Critics said position limits could inadvertently make markets more volatile, not less, because traders would move deals to overseas exchanges with looser regulations, reducing liquidity in U.S. markets.
The ruling comes just as the CFTC shows it is getting tough with excess speculation through enforcement of existing rules.
In the past month alone, firms and individuals have agreed to pay the CFTC more than US$2 million to settle charges involving trades in cotton, oilseed and grain markets that are already subject to limits.
— Alexandra Alper writes for Reuters from Washington, D.C.