CFTC Camel Sticks Nose in ETF Tent
The alphabet soup of federal agencies involved in financial regulation is truly staggering. For ETFs the web is somewhat less tangled but still confusing. Now the Commodity Futures Trading Commission – an agency that sounds like it shouldn’t have much to do with ETFs – is flexing its muscles.
As the name implies, the CFTC regulates commodity futures. One of its tasks is to keep speculators from cornering the market or manipulating the price of agricultural products like grains. They do this through a system of “position limits”, which prohibit investors from controlling more than defined quantities of these contracts.
The position limits are normally of no concern to individual investors, even those who trade commodities, because it takes a lot of capital to exceed them. If, however, you are an investment manager who wants to combine the money of many investors into one large pool, the limits can be a problem.
In 2006 DB Commodity Services, a subsidiary of Deutsche Bank, wanted to launch several commodity-based ETFs. Realizing that the CFTC position limits would constrain the asset size to which these ETFs could grow, DB asked for and received from the CFTC an exemption from the position limits.
All was fine; PowerShares DB Agriculture Fund (DBA) and PowerShares DB Commodity Index Tracking Fund (DBC) went forward with great success. Then this week the CFTC revoked the previous exemption, leaving the future of DBA, DBC, and similar funds in doubt.
Why, one might ask, does the CFTC feel compelled to reverse itself in this way? In a press release, CFTC chairman Gary Gensler said “I believe that position limits should be consistently applied and vigorously enforced… Position limits promote market integrity by guarding against concentrated positions.”
This sounds very noble of Mr. Gensler, but I believe he is mistaken. Funds like DBA and DBC actually give the commodity markets even more integrity by making them accessible to small investors. Because the funds simply track indexes, the potential for manipulation is negligible. The funds do not act as one large investor accumulating a large concentrated position, they are the collective actions of many small investors.
Over at Seeking Alpha, David Fry suggests there may be more going on here than concern for market integrity. Mr. Gensler was also a Treasury Department official in the Clinton administration. He advocated legislation that prevented the CFTC from regulating credit default swaps and other derivatives that are now blamed for aggravating the financial crisis.
Goldman Sachs (GS), a firm at which Mr. Gensler worked for 18 years, is a major player in these instruments that he once wanted to protect from excessive regulations. Why he has since changed his tune is unclear. In any case, investors who want to participate in commodity markets via ETFs are not being well served by the CFTC. I hope this is not a sign of things to come.
The CFTC’s words and actions have already scared two other funds to the point where they are no longer issuing new shares, making them de-facto closed-end funds in the process. U.S. Natural Gas Fund (UNG) has not been issuing new shares since early July and is trading today at 16% premium. Early today, Barclays issued a press release stating that iPath Dow Jones – UBS Natural Gas Total Return ETN (GAZ) has stopped issuing new shares. It is now trading at a 7% premium.
Patrick Watson contributed to this article.
Disclosure: no positions