US energy companies urge caution on use of perpetual derivatives

Energy companies are cautioning the US Commodity Futures Trading Commission against embracing the use of so-called perpetual derivatives contracts in traditional energy and commodity markets.

A coalition called the Commercial Energy Working Group warned that the tools are decoupled from market fundamentals and could harm the well-functioning markets for commercial hedging in the energy and agricultural sectors.

The views came in response to the CFTC's April solicitation of comments to better inform the regulator on the potential uses, benefits and risks of perpetual contracts in the derivatives markets that the CFTC regulates.

Digital asset companies have advocated for the CFTC to allow for the trading of perpetual derivatives in the US, citing frequent use of the tools in cryptocurrency markets globally.

The Commodity Markets Council defined a perpetual contract as "a derivative contract without a fixed maturity or expiration date, where settlement is typically achieved through frequent (often continuous) cash flows tied to an index price, such as a funding rate mechanism."

According to the CFTC, such contracts have become "increasingly popular as a way of gaining exposure to a given market or product class" because of the strong correlation between a perpetual contract and associated cash contract, and a reduced need for rolling a contract from one expiration to another.

But the contracts may raise "novel questions and concerns" related to risk management, according to the CFTC, which is expected to play a greater role in regulating digital assets under the Trump administration.

In comments to the CFTC, some groups argued the tools are better suited to digital asset classes than energy and agriculture derivatives. Comments were due May 23.

Energy sector, exchange views

The Commercial Energy Working Group represents commercial firms in the energy sector whose main business is the physical delivery of one or more commodities.

The group took the position that trading of perpetual derivatives is of limited use for commercial hedgers in energy markets, given that the lack of an expiration date for the contracts effectively eliminates the price convergence with underlying physical markets. It also suggested that the tools are ineffective for hedging longer-term price risk exposures in the energy sector.

"While markets for perpetual derivative products in the energy sector may be of interest to speculative traders and high-frequency trading firms, among others, the Working Group is concerned that the use of these contracts could result in thinned liquidity for certain key benchmark energy futures contracts," the working group said.

"Such a situation could result in less efficient and well-functioning markets for commercial hedgers to mitigate their exposure to price risk and could increase exposure to price volatility and wider spreads at the expiry of key benchmark futures contracts."

The working group embraced the position taken by the Commodity Markets Council, a trade group for commodity futures exchanges and their industry counterparts, including energy and agriculture companies, futures commission merchants and data providers, such as S&P Global. Platts News is part of S&P Global.

Seeking CFTC study of risks

"CMC urges the commission to exercise extreme caution in considering any introduction of perpetual derivatives into traditional agricultural or energy markets," the council said in its comments.

"While they may be suitable in digital asset environments, their presence in physical commodity markets could erode long-standing protections, impair liquidity, and destabilize the futures ecosystem."

Further, it warned that the perpetual derivatives raise market manipulation concerns.

"The use of funding rates and synthetic indexes presents new manipulation vectors, including index price spoofing and front-running," the CMC said.

The group urged the CFTC to consider all the risks in a formal study and rulemaking before allowing perpetual contracts in "traditional" futures markets.

The venture capital group Framework Ventures Independent offered a suggestion in the context of energy and physical commodities, where it said there is a unique risk.

"There are limited liquid spot indices for physical commodity markets, which are primarily driven by dated futures, posing an issue on how to calculate the funding rate if one is only using the dated future and the perpetual future," the company said. "We believe that this can be addressed by weighing the calendar futures prices by share of open interest to create a representative index for the Perpetual Derivative."

Other organizations emphasized the benefits of derivatives for cryptocurrency markets.

Coinbase argued that perpetual derivatives already make up a significant majority of crypto futures trading volume, but until recently, no CFTC-regulated platform had been able to list the products.

"Bringing offshore crypto derivatives markets into the US regulatory perimeter would be a boon for US markets and customers," Coinbase said.

"[P]erpetual derivatives also allow for liquidity to be concentrated in a single contract, rather than being fragmented across multiple contracts with different expiration dates, as happens in traditional futures markets."

Better Markets, a nonprofit formed in the wake of the 2008 financial crisis, by contrast, said the derivatives blur the line between trading and gambling.

The "round-the-clock trading model, synthetic pricing mechanisms, and infinite duration are more reminiscent of speculative gaming than structured risk management," Better Markets told the CFTC.