2nd UPDATE: CFTC Withdraws Position Limit Exemptions

The Commodity Futures Trading Commission reversed course Wednesday, revoking permission to a unit of Deutsche Bank and Gresham Investment Management LLC that had allowed them to legally evade the trading limits on soybeans, corn and wheat.

The unprecedented decision by the CFTC comes not long after a Senate panel issued a major report that found excessive speculation by commodity index trader s in the wheat futures market was destroying the price-hedging system.

The report also took a stab at the CFTC, saying the agency's decisions to allow index traders to skirt the normal buying limits has contributed to the lack of convergence between futures and cash prices for wheat.

The CFTC sets trading limits on certain agricultural products. But over the years, CFTC staff has allowed certain index traders, which track a basket of commodities over time, to exceed those federal limits. They did this by issuing "no-action" letters, each of which is tailored to the particular entity requesting an exemption.

"I believe that position limits should be consistently applied and vigorously enforced," said CFTC Chairman Gary Gensler, who earlier this year indicated the CFTC staff was conducting a full-scale review into the no-action process.

"Position limits promote market integrity by guarding against concentrated positions," he added.

One of the no-action letters the CFTC withdrew Wednesday dates to May 2006, when the agency's market oversight division granted a trading limit exemption to DB Commodity Services, a commodity pool operator and trading adviser owned by Deutsche Bank.

The CFTC allowed the DB Commodity Index Tracking Master Fund to exceed trading limits in corn and wheat, providing the bank held no more than 11,000 wheat contracts and 17,500 corn contracts in any one month, according to the original letter.

The CFTC didn't name Gresham Investment Management, but the company confirmed Wednesday its no-action letter from September 2006 that granted exemptions from trading limits on corn, soybeans and wheat was the other one revoked by the agency.

Deutsche Bank offers investors a number of commodity exchange-traded funds, baskets of securities that trade on stock exchanges and are popular with individual investors and institutions like hedge funds. Commodity ETFs are among the vehicles that have been blamed for helping investors funnel billions of dollars of new money into agriculture and energy markets, one factor, critics believe, in pumping up commodity prices.

Deutsche Bank had been expecting new limits on its ability to buy agricultural futures at least as far back as late June when its name was mentioned in the Senate panel's report on speculation in the wheat market.

It expects to conform with the new limits without having to suspend issuing new shares of either the $3.5 billion PowerShares DB Commodity Index Tracking Fund (DBC), which holds a broad basket of commodities, or the $2.3 billion PowerShares DB Agriculture Fund (DBA). In an 8K filing, the fund said it will come into compliance with the CFTC's federal limits by Oct. 31.

Still if Deutsche Bank can't find a new way to invest in soybeans, corn and wheat, the new limits will affect the funds' ability to match the returns of their indexes, a key promise ETFs make to investors. The three commodities by design make up roughly three quarters of the benchmark tracked by the agriculture fund and about one quarter of the one tracked by the broader ETF. Nonetheless, Deutsche Bank believes deviations will be small enough investors may not notice them.

"We don't expect it to differ from what you normally see," said director Martin Kremenstein.

Gresham Investment Management is a $6 billion New York-based money manager that runs several commodity indexed programs on behalf of clients like pension funds and sovereign wealth funds.

Jonathan Spencer, the company's president, said Gresham hasn't yet reached the position limits, even though the firm got the "no-action relief" from the CFTC in September 2006.

"The position limits we are left with are more than adequate for our customers," Spencer said. "We can go much higher without any impact."

U.S. wheat futures fell after the CFTC announced it had revoked the exemptions to speculative position limits. The markets' knee-jerk reaction was to view the news as bearish because the entities, including Deutsche Bank, will have to liquidate positions, traders said.

Uncertainty about details of the process caused some participants to bail out of the markets, said Shawn McCambridge, senior grains analyst for Prudential Bache. It's important to find out how long the entities have to get out of their positions, he said.

"If it is spread out over a several-month period, then it can be done in an orderly fashion and probably without any market impact," McCambridge said. Wheat was firmer before the announcement but wasn't "all that strong to begin with," he said.

The CFTC said that, in both instances, the newly revoked letters stipulated that the terms could be altered by the agency if the conditions set out in the letters changed.

The agency added that the changes in these letters are specific to each situation and will not affect other no-action letters that have been granted.

The decision to revoke the no-action letters comes just as the CFTC is gearing up to set new limits for speculative energy traders.

Right now, the CFTC only sets hard limits on certain agricultural commodities and lets the exchanges impose trading limits on other commodities like oil.

Crude oil, unlike agricultural commodities, is only subject to speculative limits in the last three days of trading before a contract expires.

Just as the CFTC has granted index traders exemptions for agricultural products, exchanges too have granted exemptions to traders on energy products. The CFTC is also reviewing how those exemptions should be granted and if the agency should be setting limits instead of exchanges.

-By Sarah N. Lynch, Dow Jones Newswires; 202-862-6634; [e-mail].

(Tom Polansek contributed to this article).