Commodity Futures Trading Commission (CFTC) regulators, a top official of the regulated New York Mercantile Exchange (Nymex) and natural gas consumers last Tuesday called on Congress to take action to increase agency oversight of unregulated electronic commodity platforms, particularly those that trade natural gas.
Specifically, they signaled the need for Capitol Hill lawmakers to amend the Commodity Futures Modernization Act of 2000 (CFMA), which created the controversial “Enron loophole” that exempts most over-the-counter (OTC) energy trades and trading on electronic energy commodity markets from the full oversight and regulation of the CFTC.
“[I’m] hopeful Congress is in a place where they may be able to do something on this issue in the not-to-distant future,” said CFTC Commissioner Bart Chilton. “For me, it’s not a question of if we do it. It’s how Congress does it,” he noted during a day-long CFTC hearing on the agency’s oversight of energy trading on regulated exchanges and in exempt commercial markets (ECM).
The CFMA “seems to have placed a large swath of energy derivatives markets beyond key elements of CFTC jurisdiction,” said Commissioner Michael Dunn in urging Congress to change the law.
The hearing came one day after Sen. Carl Levin (D-MI), chairman of the Senate Permanent Subcommittee on Investigations, introduced legislation to end the “Enron loophole,” thus subjecting exempt trading platforms to CFTC oversight. The bill (S. 2058) would require energy trading facilities (ETFs), such as ECMs, 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.
In July, Levin’s subcommittee took the CFTC to task for not properly overseeing the activities of fallen hedge fund Amaranth Advisors LLC in 2006 (see NGI, July 2). Shortly afterward, the CFTC and the Federal Energy Regulatory Commission initiated major enforcement actions against Amaranth and transporter Energy Transfer Partners for alleged manipulation and attempted manipulation of natural gas prices (see NGI, July 30A, July 30B).
Market participants “want to have confidence that the game is not rigged,” said the CFTC’s Dunn. They often ask, “‘Who is in charge?’ Well, when it comes to [the] energy derivatives market, the answer seems to be at times no one.”
Municipal gas utilities “have lost confidence that the prices for natural gas in the futures and the economically linked OTC markets are an accurate reflection of supply and demand conditions for natural gas,” said Laura Campbell, who spoke on behalf of the American Public Gas Association.
While the CFTC aggressively pursues manipulation that comes to its attention, Dunn acknowledged that a large part of the manipulative behavior in the energy markets may go unnoticed.
Since the passage of the CFMA, there have been “profound changes” in the unregulated ECM markets and regulated energy exchanges, said Nymex President James E. Newsome. The two have become “tightly linked” trading venues, he noted, adding that the current regulatory structure no longer works for certain markets operating as ECMs.
“There is a strong need for appropriate statutory change,” Newsome said. “The most effective response would be targeted and would require routine mandated large trader reporting and position accountability/limit requirements for certain ECM contracts that are linked to and functionally equivalent with regulated futures exchange contracts.” He noted that natural gas is the one commodity whose contracts are closely tied to both the ECM and regulated futures exchanges.
The CFMA created a “light-touch regulatory category” for ECMs. The ECMs currently are not subject to full CFTC oversight, but they are subject to certain reporting and record-keeping requirements. They also are required to respond to “special calls” by the CFTC for information. And they are required to maintain records of suspected fraud or manipulation and notify the CFTC.
But regulators and Newsome believe this level of oversight is insufficient, pointing out that major ECMs, such as Atlanta-based IntercontinentalExchange (ICE), have become “virtual substitutes” for and taken on the characteristics of regulated energy exchanges in the past couple of years, often helping to set prices for energy. This begs the question as to whether the regulatory line for ECMs that was drawn by Congress in the CFMA “remains appropriate today,” said Terry S. Arbit, general counsel for the CFTC.
When Congress created the ECM category in the CFMA, ICE was one of the first companies to apply for the designation, according to Richard A. Shilts, director of the CFTC’s division of market oversight. Currently there are eight active ECMs in the United States, most of which trade natural gas, electricity or petroleum products. The largest ECM in terms of trading volumes and contracts traded is ICE, a global electronic platform that trades natural gas, electricity, natural gas liquids and chemicals.
As for increased regulatory oversight of ICE trading, ICE Chairman Jeffrey C. Sprecher agreed this may be needed for certain ICE products. A “heightened level of …regulation, including reporting and position accountability, may be appropriate for certain of ICE’s cleared OTC swap contracts that settle on futures markets and are the economic equivalent of actively traded futures contracts, like our Henry Hub natural gas swap,” he said.
But taking this approach to all various swap contracts on ICE, either through the application of designated contract market-like principles or by eliminating ECMs altogether, “would be a serious mistake,” he told the CFTC. “One-size-fits-all regulation is ultimately misguided.”
The hearing didn’t focus entirely on the drawbacks of ECMs. Some panelists pointed out their advantages. The absence of ECMs “would kill the entrepreneurial spirit” in the marketplace, said Richard L. Sandor, chairman and CEO of the Chicago Climate Exchange. Even Nymex’s Newsome conceded that ECMs have been a “real innovator” in terms of developing new technology.
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