March 2012 C&CI • Terminal Markets • 39


In designing the regime the exchange has held essential that its contracts remain commercially attractive to as many of its users as possible, and has sought to avoid any feature which might unneces- sarily restrict market activity or discrimi- nate against different types of market par- ticipant.


Remaining commercially attractive


Describing the rationale for its initial propos- als, Liffe said the exchange was extremely mindful of the need for its contracts to reflect closely the markets in the underlying commodities, continuing to provide the price benchmarks and hedging and trading mechanisms that are commercially attractive to market participants.


"It is also important to note that commercial imperatives must be balanced against the fact that the exchange’s commodity contracts are not only counterparts to the physical markets, but are also regulated investments on a regu- lated market (whereas the physical markets, which are not markets in investments, are almost wholly unregulated)."


Statutory requirements


Added to this, LIFFE as a Recognised Investment Exchange (RIE), has certain statu- tory responsibilities including, amongst other things, to provide safeguards for investors (including the maintenance of a ‘proper’ mar- ket) and to promote and maintain standards. The exchange is also charged with the responsibility for monitoring and regulating its markets in an appropriate manner in order to ensure that its members (and, through them, their customers) meet the standards required by an investment exchange.


This being the case, the exchange has developed the proposals with four key tests in mind, to ensure that the proposals were: able to maintain and enhance market confidence; are workable in practice – offering as much certainty and transparency as possible whilst not being over complex or resource intensive; are acceptable to the majority of users without restricting the normal commercial activities of those users on whom it impacts most; and most likely to be consistent with external regu- latory developments.


Supply and demand


Pricing of the exchange’s contracts will still be subject to the natural forces of supply and


In future, the number of contracts buyers can take delivery of will be limited


demand, albeit with a more transparent regime surrounding the scope for, and restric- tions on, making and taking delivery of signifi- cant quantities of physical stock under the contracts concerned.


The key components of the proposal are: ■ Accountability levels – a position in excess of a predetermined size to be subject to increased reporting requirements ■ Delivery limits – a maximum position that may be taken to delivery in any individual delivery month ■ Delivery limit exemptions – an exemption to a delivery Limit in restricted circumstances.


A key feature of the proposed regime is the introduction of delivery limits – a maximum limit on a position (long or short) which may be taken to delivery in any of LIFFE’s London commodity contracts


Accountability levels in particular reflect, but in a more formalised way, the exchange’s existing position management arrangements. Although delivery limits may appear to repre- sent a new approach these are, Liffe claimed, "in keeping with the exchange’s current approach to position management, albeit in a prescriptive and transparent form." "By their nature, physical commodity con- tracts may see some tension leading up to expiry and the subsequent delivery," noted Liffe. "Under its existing arrangements, the exchange focusses very closely on open posi- tions in this period, and holds discussions with both short and long position holders to ensure that any tension is limited so that the expiry and delivery may be carried out in an orderly fashion."


More transparency


However, these arrangements are, currently, visible only to the position holders concerned, and the exchange believes that it is now appro- priate to implement a regime which is clear and more transparent and will help dispel uncertainty among other market participants. In its development of the proposals, the exchange also considered the concept of position limits, which would apply throughout the lifetime of a contract. However, this con- cept was rejected on the basis that it is specif- ically the limited period during the run up to expiry/delivery that the greatest tensions exist and, therefore, position limits which applied at all times would be less likely to pass all of the tests it has set out.


The exchange also considered carefully the question of whether short positions should be subject to the proposals. There were observa- tions made that very large short positions are not likely to cause the same types of tension leading up to and during delivery as very large long positions. "However, these views were typically not strongly held…. and on balance, the exchange has concluded that application to both short positions and long positions is appropriate," Liffe said.


Delivery limits


A key feature of the proposed regime is the introduction of delivery limits – a maximum limit on a position (long or short) which may be taken to delivery in any of LIFFE’s London commodity contracts. Positions must be man- aged to be at or below the limit by the close of business on the expiry day of the contract month for the cocoa futures contracts and by the close of business on the last trading day prior to the first notice day for the Robusta cof- fee contracts. Nevertheless, the exchange is not seeking to restrict legitimate commercial business and has in consequence set the delivery limits at levels where it believes that, as far as is practicable, all commercial activity will continue to be facilitated and the confidence of market participants will be main- tained.


"In order to further facilitate deliveries against physical commitments, the exchange may also allow a delivery limit exemption where there is a clear and unambiguous com- mitment to deliver onward to a final user to ful- fil a physical contract," said Liffe. "Buyers may also be allowed to take a bigger delivery in so- called cash and carry transactions, where there is a long near position in the spot month offset in a deferred month," it said. Short posi- tions held against finance transactions could also qualify for a bigger delivery. ■ C&CI


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