Commodity ETFs Battle Regulator

The ETFs are in a tussle with the Commodity Futures Trading Commission over the enforcement of position limits.
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NEW YORK (TheStreet) -- The SEC's focus on leveraged and active ETFs is not the only regulatory war waging within the ETF realm. Futures backed commodity ETFs are battling with the CFTC over the regulatory body's efforts to enforce position limits on certain commodity markets.

With oil prices loitering around the $85 per barrel level, regulators are becoming increasingly concerned that speculators controlling a large slice of the market could manipulate prices, driving them to the debilitating levels last seen in 2008. In an effort to avoid this event, the regulatory body hopes to place even stricter limits on the number of contracts a single company, trader or investment vehicle can hold.

In response to the proposal, two top commodity ETF providers have adamantly voiced their concerns.

Citing the threat of increased prices and reduced liquidity for their respective lines of commodity-focused ETFs, both U.S. Commodity Funds and

Deutsche Bank

(DB) - Get Report

, the company behind the indexes for PowerShares commodity funds, have each written letters to the regulatory body seeking to quash the proposal.

Both companies' letters propose an alternative regulatory strategy that would exempt passive, long-only index funds such as theirs from the limits.

PowerShares' DB suite includes eight futures backed products that track commodities ranging from agriculture to precious metals. U.S. Commodities Funds offers seven funds that provide investors with exposure to oil, natural gas, heating oil and gasoline.

This is not the first time that these two firms have been forced to alter their products in order to comply with this regulatory body.

Last summer, one of U.S. Commodity Funds' most famous ETFs, the

United States Natural Gas Fund

(UNG) - Get Report

, grew so large that it nearly bumped against the limits set by the CFTC.

In an effort to avoid regulatory violations, the fund changed the types of securities it could own. While the fund had originally tracked the performance of natural gas using futures contracts, it began to use swaps as well.

In 2009, PowerShares' line of Deutsche Bank commodity ETFs felt strain at the hands of the CFTC as well. However, aside from being forced to restructure the underlying portfolios of a pair of funds, last year's CFTC onslaught lead to the

shuttering

of one of the firm's futures-backed, leveraged ETNs.

PowerShares' broad agriculture ETF, the

PowerShares DB Agriculture Fund

(DBA) - Get Report

and the

PowerShares DB Commodity Index Tracking Fund

(DBC) - Get Report

underwent

facelifts

late last year after, like UNG, they treaded dangerously close to breaching position limits set up by the CFTC.

Prior to the change, DBA tracked an equally weighted basket of futures contracts which exposed investors to corn, wheat, soybeans and sugar. After the change, DBA's exposure to these four crops was reduced and investors gained exposure to additional commodities including coffee, cattle, and hogs.

DBC had previously tracked the futures contracts of six different commodities which included heating oil, gold and corn. In order to comply with the CFTC, however, the fund added exposure to six additional commodities. New additions included zinc, copper, soybeans and sugar.

Pressure from regulators also led PowerShares to shutter its leveraged U.S. oil ETN, the

PowerShares DB Crude Oil Double Long Exchange Traded Note

(DXO)

.

Given the wreckage left behind after last year's CFTC intervention, it is no wonder that these two fund providers are apprehensive towards the regulatory arm today. Given the threat of increased oversight from Washington, investors should exhibit caution when attempting to play commodities using futures-backed products.

For now, investors can avoid the threat of regulatory headaches by sticking to the various physically-backed precious metals ETFs, or resign themselves to indirect commodities exposure via the growing number of equity-backed ETF products.

-- Written by Don Dion in Williamstown, Mass.

At the time of publication, Dion was not long any of the equities mentioned.

Don Dion is president and founder of

Dion Money Management

, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.