What are ICE and CME fighting about this time?

If you’re confused about the brewing war of words between IntercontinentalExchange and NYMEX parent company CME Group over proposed conditional spot limits in energy and other commodity markets, you’re likely not alone.

The proposal, after all, makes up all of three paragraphs of the Commodity Futures Trading Commission’s more than 28,000 word proposal to set up position limits for derivatives and has barely been mentioned within the more than 13,200 comments the agency has received on the proposal since it was unveiled in January.

In simplest terms, the feud boils down to this: ICE is very much in favor of these conditional limits, while CME is very much against them.

But it’s also much more interesting than that, with arguments based on flawed data, allegations of encouraging price manipulation and claims that CME, at least, is only pushing against these limits to improve their competitive advantage in energy markets.

“The only party advocating for a change in the well-functioning status quo is CME, who is clearly biased regarding the issue and whose own analysis supporting the change is significantly flawed,” ICE argued in a letter it sent to the CFTC on Friday.

So to better understand this fight, we should probably start in January when the CFTC released its long-awaited and highly controversial derivatives position limits proposal.

The CFTC’s proposal would place limits on 28 commodities, including petroleum products and natural gas, in two steps: first by establishing spot-month position limits at levels already in place at most exchanges, and then by setting single-month and all-months-combined limits that would be based on open interest formulas.

Now, the first step of this proposal includes a conditional spot month limit that, according to the CFTC’s proposed rule “permits traders without a hedge exemption to acquire position levels that are five times the spot-month limit if such positions are exclusively in cash settled contracts and the trader holds physical commodity positions that are less than or equal to 25 percent of the estimated deliverable supply.”

The CFTC already imposed a nearly similar conditional limit in February 2010 on cash settled contracts in the natural gas market. This conditional limit affects the NYMEX Henry Hub Natural Gas Last Day Financial Swap, the NYMEX Henry Hub Natural Gas Look-Alike Last Day Financial Futures, and the ICE Henry LD1 swap.

The CFTC wants these limits expanded to all major physical commodities, including energy commodities. What impact these conditional limits have had on these contracts, however, is where the most wildly divergent views can be found between ICE and CME.

Expanding these limits will increase the threat of price manipulation, encourage speculation and “defies sound regulatory policy,” CME wrote in a letter Monday to the CFTC. “We do not believe the Commission intends to increase the threat of commodity price manipulation, yet its proposal would do so,” CME wrote.

This isn’t so, argues ICE, which claims that conditional limits have been a boon to the natural gas market. ICE argued that the conditional limit, which was first put in place in February 2010, has improved hedging between cash-settled and physically settled contracts, curbed market volatility and helped keep gas prices low.

In a letter sent to the CFTC on August 5, however, CME claimed since the conditional limits were imposed in the natural gas market, “volume in the NYMEX physically delivered natural gas contract during the settlement period on the last trading day declined by 16% and relative volatility increased by approximately 25%.” CME has since withdrawn that analysis, admitting it contained flaws.

“Aspects of that letter were based on an incorrect data set; we apologize for our error and any inconvenience it has caused the Commission,” the CME wrote to the CFTC Monday.

CFTC Chairman Gary Gensler on August 5 held separate meetings in Washington DC, with the heads of CME, including CEO Craig Donohue and Executive Chairman Terry Duffy, and, later that same day, with ICE CEO Jeffrey Sprecher.

Both of those meetings dealt with the position limits proposal, according to CFTC records. But ICE and CME officials declined to comment on those meetings, so it may not be clear what the agency will do about conditional limits until the entire position limits proposals goes before commissioners for a final vote.

Gensler said late last month that he wants that final vote to take place in the early fall.

Platts