Given the growth spurt in energy derivatives trading, Congress should consider during the Commodity Futures Trading Commission's (CFTC) reauthorization process whether the agency's current regulatory structure for energy derivatives, especially in exempt commercial markets, is sufficient to ensure fair trading and accurate pricing of energy commodities, the Government Accountability Office (GAO) said in a report released Friday.
The CFTC currently "receives limited information on derivatives trading on exempt commercial markets -- for example, records of allegations or complaints of suspected fraud or manipulation, and price, quantity and other data on contracts that average five or more trades a day. [And] the commission may receive limited information from [over-the-counter, OTC] participants, such as trading records, to help CFTC enforce the [Commodity Exchange Act, CEA] antifraud or antimanipulation provisions," said the GAO, the investigative arm of Congress.
"The scope of CFTC's oversight authority with respect to these markets has raised concerns among some members of Congress and others that activities on these markets are largely unregulated, and that additional CFTC oversight is needed," the agency said in a nearly 90-page report. "While many regulators have resisted calls for more regulation in the past, recent events in the physical and energy derivatives markets have resulted in renewed focus on the sufficiency of CFTC's authority."
Sen. Carl Levin (D-MI), chairman of the Senate Permanent Subcommittee on Investigations, is one of the concerned lawmakers. In mid-September, he introduced legislation to close the "Enron loophole," thus subjecting exempt trading platforms (ETFs), such as Atlanta-based Intercontinental Exchange, to CFTC oversight. The bill (S. 2058) would require ETFs to register with the CFTC and comply with the same standards as regulated futures exchanges; to function as self-regulatory organizations under CFTC oversight in the same manner as regulated futures exchanges; require ETFs to establish trading limits on traders; and require large-trader reporting for domestic trades on foreign exchanges (see NGI, Sept. 24).
The CFTC said it daily monitors trading on exchanges, such as the New York Mercantile Exchange (Nymex), to detect fraudulent or abusive practices involving energy futures. The agency primarily relies on daily reports from large traders to detect problems, the report noted. If a potential problem or violation is detected, the CFTC may gather additional information from Nymex officials, traders or other sources to determine if further action is warranted.
However, "the staff added that they did not routinely maintain information about such inquiries; instead, they documented their actions only when further action was warranted. This lack of information makes it difficult to determine the...extent of these activities. Without sufficient data on these and other inquiries, CFTC's records will understate the extent to which the commission surveils trading activity. In addition, CFTC management...might miss opportunities to identify trends in activities or markets," it noted.
And while the CFTC fined companies $305 million for abusive practices in energy derivatives trading between 2001 and 2005, "it is difficult to determine whether they have helped deter market manipulation or the other abusive practices these pursuits addressed because the effectiveness of enforcement activities is not easily measured," the GAO said.
The GAO made three recommendations to the CFTC to improve the usefulness of information that it provides to the public related to its surveillance activities and upgrade the efficiency of its enforcement program. "First, we recommend that CFTC reexamine the classifications in the COT [Commitment of Traders] reports to determine if the commercial and noncommercial categories should be refined to improve the transparency, accuracy and relevance of public information on trading activity in the energy futures markets."
In addition, "we recommend that CFTC explore ways to routinely maintain written records of inquiries into possible improper trading activity and the results of these inquiries to more fully determine the usefulness and extent of its surveillance, antifraud and antimanipulation authorities," the report said.
Lastly, "we recommend that CFTC examine ways to more fully demonstrate the effectiveness of its enforcement activities by developing additional outcome-related performance measures that more fully reflect progress on meeting the program's overall goals."
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