The Commodity Futures Trading Commission (CFTC) announced yesterday that it would hold hearings in July and August to determine if limits on speculative positions in energy futures markets should be imposed. These new rules may impact the ability of several commodity linked exchange traded funds (ETF) from conducting operations if they can't get an exemption.
IN PICTURES: 20 Tools For Building Up Your Portfolio
The CFTC specifically mentioned crude oil, heating oil, natural gas and gasoline as some of the Energy futures that are under focus at the hearing. Many politicians and market observers have zeroed in on "speculators" as the cause of the volatile price performance of commodities over the last few years.
The new rules will impact many ETFs that attempt to track an underlying commodity Some of these ETFs include the United States Gasoline (NYSE:UGA), United States Natural Gas (NYSE:UNG), United States Oil (NYSE:USO) and the United States Heating Oil (NYSE:UHN).
These ETFs are considered commodity pools and are not regulated under the Investment Company Act of 1940, where mutual funds are housed. Although many investors may see these ETFs as fairly straightforward plays on commodities, they are anything but. The ETFs purchase futures contracts and attempt to match the return of the benchmark commodity.
If we use the United States Natural Gas ETF as an example, as investors purchase this ETF, the managers of the funds issue what is known as a "creation basket," in increments of 100,000 units, and offer them for sale to authorized purchasers, which are typically large brokerage firms.
When the ETF was formed, it registered a number of units with the Securities and Exchange Commission (SEC). Once it reaches this number of units, it must file further documents and get approval to increase the number of units.
The government can limit speculation by not approving this request for more authorized units. This happened last week to the United States Natural Gas ETF when it filed to increase its authorized units by one billion. The SEC has taken no action yet on the request, and the ETF stopped issuing creation baskets as it reached its limit.
The CFTC also said that it would increase transparency in its weekly Commitments of Traders (COT) report, which categorizes positions into commercial and non-commercial traders. The new report will separate positions owned by swap dealers, hedge funds and foreign contracts linked to domestic contracts.
These new rules on position limits and transparency may also inhibit trading strategies of some of the largest brokers on Wall Street, including Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS), both of whom have large trading operations devoted to trading commodities.
The Obama Administration is moving quickly to increase regulation of the financial markets as it sees the unfettered market as one of the main causes of the problems the U.S. is currently having in the financial system. (To learn more, check out An Inside Look At ETF Construction.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!