Limiting Risk: Why Energy and Commodity Firms Need Tech for Tracking Position Limits

An effective risk management framework treats both foreground and background risks with the same urgency, agility and diligence. However, while intraday price volatility in oil or soybeans may require immediate action from risk managers at energy traders and commodity brokers, it’s crucial they not lose sight of other risks factors at the same time, such as position limits.

The practice of managing position limits remains essentially the same even with regulations in flux. But when resources are drawn elsewhere, it’s vital firms retain visibility into position limits. As such, error-prone manual methods are entirely unsustainable in today’s markets and regulatory environment—yet many firms still rely on them. Risk departments need real-time insights and automation to faithfully monitor and manage position limits across the portfolio and mitigate risks before they become breaches. Increasingly, traders and brokers are utilizing modern market and liquidity risk management solutions to modernize and strengthen their overall risk controls, including position limits, margining and stress testing.

Dodd-Frank broadens regulated contracts

Position limits are a cap on the number of contracts tied to an underlying security that any one single investor or group of investors can hold. These maximum thresholds are in place to prevent excessive speculation that impacts price volatility or cornering of markets. Federal and exchange-specific position limits apply across a number of exchange-traded energy and commodity derivatives and are measured in contracts units. Limits may apply in the spot month for the contract, in the month subsequent to spot month, in any single month outside of spot or across all months. A number of exceptions to these limits exist, however, including for qualified hedging strategies.

Though position limits have been in place for some time, the last 15 years have seen considerable uncertainty and change in the U.S. After the 2008 financial crisis, the Dodd-Frank Act of 2010 was passed to mitigate risks and improve transparency and accountability in the financial system. Part of that legislation called for the Commodity Futures Trading Commission (CFTC) to institute position limits “as it finds are necessary for the purpose of preventing the burdens associated with excessive speculation causing sudden or unreasonable fluctuations or unwarranted changes in the price of an underlying commodity.”

It took more than a decade for the CFTC to develop and implement limits, including a 2011 rule that was enacted but reversed in court a year later. However, after introducing a 2020 final rule, those limits are now in place across 25 types of contracts traded as U.S. derivatives exchanges as well as certain instruments that reference those in-scope contracts. This set of 25 includes nine legacy agricultural contracts for which limits existed and 16 additional agricultural, metals and energy contracts that are now subject to the rule.

The CFTC regulations are in addition to EU position limits derived from Markets in Financial Instruments Directive (MiFID) II as well as rules enforced by the U.K.’s Financial Conduct Authority (FCA), the latter of which compounds uncertainty for traders and brokers. While the FCA said in 2021 it would only enforce position limits for agricultural products following the EU exit, the authority issued a consultation paper in December 2023 suggesting several potential changes to its position limits regime.

What’s at stake with manual reporting?

With a continually changing regulatory environment, it’s essential that firms have institutionalized processes for monitoring position limits and escalating alerts in real time. Position limit rules are complicated and differ across venues and exchanges, so reliance on manual methods to source, access and manipulate data from various different venues is time-consuming and error-prone. Firms must do this for limits set at differing contract unit thresholds and timelines, and potentially across client accounts.. This intricate, time-consuming process can lead to human error that in turn may result in unnecessary fines for breaching limits. It may also result in forced liquidation of a client position at disadvantageous times.

Limits apply intraday, which means firms need a constant eye and real-time view into positions across the portfolio just as they need real-time view into margin and portfolio stressors. The challenge with manual methods here, as it is with other risk functions, is that firms simply cannot keep up. An end-of-day assessment might not suffice or catch dangers, and it’s certainly not a sustainable solution for the future in which risk velocity increases. Without automated reports and alerts, position limits could be breached without anyone knowing, with firms only learning of the issue after the fact and potentially leaving them with few good options to rectify.

Penalties are a tangible risk here, as the CFTC has taken action in recent years, levying fines against organizations that surpass limits. One company receiving a $1.5 million civil penalty was found to be in breach of position limits on 590 dates over a five-year period. Two different trading firms in 2022 were served fines by both the CFTC as well the respective exchanges on which limits were breached, demonstrating the potential compounding financial and reputational impacts of noncompliance.

A real-time solution for Clearing Risk or ETD Risk

For anyone tasked with monitoring limits, the ability to produce a position and check the details quickly is key: You want to ensure you have the most timely and accurate intelligence at hand before escalating the issue to manage a position approaching or exceeding the limit held by their own trading desk or a client. Realistically, this means having a modernized risk management solution that can automatically pull real-time positions across venues and deliver this visibility through a dashboard for easy viewing and analysis.

Nasdaq Risk Platform can do just that for energy traders and commodity brokers, granting real-time visibility to inform risk management and decision-making. Critically, Nasdaq Risk Platform automates the tedious data collection that typically drags down risk professionals, while eliminating human error, freeing staff to focus on core responsibilities and revenue-generating activities. Position limits capabilities are the third prong of the modernization trident that Nasdaq Risk Platform offers users, who can leverage the same data and infrastructure to combine position limit monitoring and reporting along with margin replication and granular stress testing: one platform, one source of data—a world of functionality to help firms navigate the complexity of today’s operating and regulatory environments.

Follow here to learn more about Nasdaq Risk Platform and how it might help your business.