Position limits are imposed by designated contract markets (DCMs) or trading venues, as well as governmental bodies to guard against manipulation and to provide fair markets. Compliance with position limits has long existed for market users who engage in hedging or speculative trading activities on global financial markets. However, many risk-mitigating transactions previously exempt from regulatory oversight are now covered as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act and Markets in Financial Instruments Directive (MiFID) and Markets in Financial Instruments Regulation (MiFIR).
More reporting requirements and position limits oversight loom on the horizon. The U.S. CFTC limits proposal when implemented will extend limits to 28 contracts, which impact approximately 500 listed futures and options products. While in the European Union (EU), proposed new framework for reporting requirements and position limits under MiFID and MiFIR would impact thousands of contracts — essentially anything trading on an E.U. venue from commodities and financial instruments to indexes or baskets. The new pan-European regime will provide rules for position limits; position management; and position reporting.
On April 6, 2016, European lawmakers postponed the implementation of the MiFID II to January 3, 2018. The delay provides firms and regulators additional time to prepare for the complex law that impacts nearly every financial firm operating in the 28-nation bloc.
While the U.S. and E.U regulatory goals are aligned in monitoring market trends and abuse and providing transparency and reporting — there are distinct differences in the application of limits. For example, the CFTC defines limits as spot and all month combined (which includes spot), while the E.U. limits will be set for spot and all-non spot combined. Also under MiFID II, there are no provisions for bonafide hedge exemptions.
U.S. firms trading on EU venues will be impacted by MiFID II requirements, and should expect a greater level of scrutiny and questions about their activities. Position limits will apply to person and positions held at the aggregate group level. Under the new European rules, traders will be obligated to aggregate positions traded on any EU venue with OTC derivatives that are deemed "economically equivalent" or "EEOTC". The plan does exclude physically settled gas and electricity products which are covered by REMIT.
Market participants including banks, FCMs, clearing firms, hedge funds, asset management companies, pension funds, commodity and energy trading firms and sovereign wealth funds must be cognizant of the position limits rules and reporting requirements in the products they trade. Position limit and reporting violations handed down by the regulators can be severe. Penalties and disgorgement of profits associated with trade violations can easily run from $50,000 to $2,000,000 per offense - and the trading entity bears liability for its activities and adherence to the rules.
The frequency of limits and rule changes has made it particularly difficult for firms to keep current and stay compliant. At the request of market participants, The Institute for Financial Markets administers position limit compliance utilities to help market-users manage trading compliance risk monitoring and recordkeeping, and resolve omissions and discrepancies in regulatory announcements and data. On a daily basis, IFM provides market users with machine readable data files that can be integrated into a firm's compliance function.
Limits data are delivered via two distinct data products the Position Limits Databank (PLD) and the supplemental Equity Options Position Limits Databank (EOPLD). Together these low-cost, industry-created utilitiesi are an aggregated and validated source of position limits and related regulatory data on 65 exchanges.
iThe IFM, a 501(c) (3) nonprofit educational foundation, provides education and information on financial markets. We extend our appreciation to Barclays Capital, Credit Suisse, Deutsche Bank, Goldman Sachs & Co, J.P. Morgan, Macquarie Futures, Morgan Stanley, Newedge and UBS, who funded the development and deployment of the PLD in 2008.