The Commodity Futures Trading Commission (CFTC) last Tuesday accepted a staff recommendation that seven look-alike natural gas contracts traded on the IntercontinentalExchange (ICE) platform are “significant price discovery contracts [SPDC],” making them subject to agency regulation and the self-regulatory authority of their trading exchange.
The agency had reviewed 22 natural gas futures contracts traded on Atlanta-based ICE and Alberta-based Natural Gas Exchange (NGX), as well as a carbon financial instrument traded on the Chicago Climate Exchange, to determine whether the contracts were similar to ones traded on regulated exchanges, such as the New York Mercantile Exchange (Nymex), and thus should be regulated by the CFTC.
“Each of the seven [ICE] natural gas contracts that staff recommends should be declared an SPDC is a locational basis contract that prices natural gas at a specific location other than the Henry Hub,” said Richard Shilts, director of the CFTC’s Division of Market Oversight, at a public meeting at the agency’s headquarters in Washington, DC.
“These locations are Southern California border (with Arizona), PG&E citygate (San Francisco area), Northwest Rockies (Wyoming, Utah and Colorado), Alberta (Canada), Chicago, Houston Ship Channel and Waha (West Texas near the New Mexico border). While the specific details may differ with respect to the trading activity and open interest, the division’s observations and basis for its conclusions are the same for each of these contracts — that is, the prices of these contracts are commonly used as a key source of price discovery for the cash market and the contracts all exhibit material liquidity,” he said.
“Each of these contracts is accepted in the industry as a key reference price for natural gas at a particular important location in the U.S. or Canada. These contracts offer additional pricing information not provided by the active Nymex and ICE SPDC Henry Hub contracts — that is, they provide critical information about the value of natural gas at a future point in time at a geographically dispersed location, each of which has unique supply and demand characteristics.
“These contracts also have significant open interest and trading volume and are widely used by cash markets participants for hedging price risks.”
An SPDC determination typically would require ICE to submit a written demonstration of compliance with the statutory core principles associated with SPDC contracts, and to establish a self-regulatory regime with respect to the contracts. But ICE already has put this structure in place, given that the CFTC previously approved ICE’s Henry Financial LD1 Fixed Price contract as an SPDC.
CFTC Chairman Gary Gensler said the remaining five NGX gas contracts and 11 ICE futures gas contracts that were under review were not found to be SPDCs. That’s because they either represented less important gas delivery locations away from the Henry Hub; served as specialized hedging tools; or were flat-price contracts, according to Shilts. The agency also said the carbon financial instrument traded on the Chicago Climate Exchange was not an SPDC. It is currently reviewing a number of electricity contracts and plans to issue a decision in a month or two.
The CFTC Reauthorization Act of 2008 gave the agency the authority to regulate the trading of SPDCs on heretofore lightly regulated trading platforms. The law closed what was known as the “Enron loophole,” which allowed for trading in energy markets to exist outside the scope of regulators. Concerns about price manipulation prompted the congressional action. This was amplified when hedge fund Amaranth Advisors collapsed in 2006.
In determining whether a futures contract is an SPDC, the CFTC said it considered four factors:
While the 2008 reauthorization bill closed the “Enron Loophole,” Gensler urged Congress not to make a similar mistake by granting future exemptions for over-the-counter derivatives in the financial regulatory reform bill that is in the Senate now.
“Once again, certain parties have sought exemptions from regulation in the energy markets, and particularly in the natural gas and electricity markets. But the American public needs us to be diligent and learn from past lesson that we should resist Wall Street or industry pressure to exempt specific classes of contracts from reform,” he said.
“History demonstrates that bright-line statutory exemptions granted at one point in time can have unintended consequences later on. Markets evolve rapidly. What may seem like a carefully crafted exclusion today can become a significant and problem-filled loophole tomorrow.”
The agency’s extended reach under SPDCs provides consumers some price protection, but it does “not…address many outliers that remain and need to be addressed as part of financial regulatory reform,” said Commissioner Bart Chilton. “If there is one thing we should take away from the economic fiasco, it is that regulatory reform is needed. The status quo is unacceptable.”
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