As the congressional spotlight on commodities trading and regulation by the Commodity Futures Trading Commission (CFTC) grew brighter and hotter last week, it also narrowed its focus as legislators made clear they are almost exclusively interested in natural gas trading, the Amaranth case and the surrounding infrastructure, namely the CFTC, the New York Mercantile Exchange (Nymex) and IntercontinentalExchange (ICE).
Last Thursday, Nymex President James Newsome vigorously defended his exchange before the House agriculture subcommittee on general farm commodities and risk. He responded to congressmen who quoted a Wall Street Journal report last Wednesday that said Nymex, which reports to the CFTC as a self-regulating organization (SRO), had failed to enforce its rules to limit ill-fated Amaranth’s large positions in the gas market. Specifically, the article said that on eight occasions Greenwich, CT-based hedge fund Amaranth had exceeded its position limits without incurring censure from Nymex.
In a letter to the WSJ last Thursday, Newsome cited a recent report by the Senate Permanent Subcommittee on Investigations and testimony by the CFTC before the Senate panel last week, both of which he said confirmed the CFTC’s belief that Nymex acted “prudently and appropriately in enforcing its rules” with regard to Amaranth. The Amaranth hedge fund collapsed in September 2006, experiencing $6 billion in losses.
Newsome said Nymex doesn’t act based on an isolated monthly incident, but rather amalgamates information to spot continuing abuse. He also said that when it finds abuse it counsels the abuser to unwind its positions on a schedule that will not unduly disturb the market. As it happened, Amaranth unwound its Nymex positions by moving them over to the less-regulated ICE, which at that point was not reporting large trader positions to the CFTC.
That has changed, ICE Chairman Jeffrey Sprecher told both the House panel and Senate subcommittee last week. The barn door was closed when the CFTC put out a special call for ICE to report large trader positions post-Amaranth, and ICE has been sending daily feeds to the CFTC ever since. Sprecher emphasized that ICE believes the CFTC has all the authority it needs to demand reporting from ICE, a major electronic trading exchange based in Atlanta, GA..
However under questioning by the Senate subcommittee last Monday, Sprecher signaled his support for legislative action that would eliminate excessive speculation in natural gas trading markets and establish limits on the positions that traders could hold on the electronic exchange. ICE was receptive to more market oversight. But “I don’t think it should end at ICE;” it should include other over-the-counter (OTC) markets, he said during the Senate subcommittee’s second hearing into speculation in gas trading markets.
He further favored increased funding and staffing for the CFTC and the elimination of the so-called Enron loophole, but said he did not believe a “complete overhaul” of the current regulatory system was warranted.
Both Newsome and Acting CFTC Chairman Walter Lukken said that while previously their monitoring had been focused on the front months, they would be following more closely contracts in the out months. It was pointed out during testimony that at one time Amaranth had 60% of the market in some of the forward months.
The House subcommittee members clearly had paid attention to the Senate subcommittee hearing earlier last week and came loaded with very pointed questions. For instance, how could the system now in place have prevented the scenario in which the prices, probably driven higher by the Amaranth fiasco, became the prices that utility customers paid through the following winter, even though those prices fell soon after the Amaranth crash?
It was established that the so-called “Enron loophole” is one that is not currently in use, nor is it key to the current market investigation. ICE “does not operate — and has never operated — pursuant to an ‘Enron loophole’ under the Commodities Exchange Act (CEA),” Sprecher told the Senate panel last Monday.
Another red herring that was disposed of is that there are other large OTC markets dealing with natural gas that need to be brought into the fold. The witnesses agreed that Nymex and ICE have 90% of the market for future trades in natural gas. Also, because the natural gas market is mostly continental, there is some question as to how excessive regulation can drive traders to overseas exchanges when everything clears on Nymex or ICE. Sprecher and others in the market doubt this would occur.
The congressmen also questioned whether bilateral market trades should be reported. The witnesses said there were few large positions in that market. Most market participants, wary of counterparty credit risk, clear through ICE or Nymex. However, legislation proposed last Thursday would cover all natural gas trades of companies categorized as large traders.
The bill (HR 3009), the Market Transparency Reporting of United States Transactions (Market TRUST) Act, was introduced by Reps. Sam Graves (R-MO) and John Barrow (D-GA) last Thursday. The measure would amend the CEA, giving the CFTC greater oversight authority over OTC gas markets. It also would increase criminal and civil penalties for violators.
The bill was quickly endorsed by the American Public Gas Association (APGA). “The level of transparency created by this legislation will significantly reduce opportunities for market manipulation and restore public confidence in natural gas markets. Without additional authority as provided in the Market Trust Act, the CFTC role in the OTC market is limited to one of simply reacting to events after the fact. Such after-the-fact investigatory authority is grossly inadequate to provide American consumers with even a reasonable level of protection,” said APGA President Bert Kalisch.
“Last year’s blow-up of the Amaranth Advisors hedge fund and its impact on the natural gas markets highlights the increasingly significant role that OTC speculative trading has on the price of natural gas. APGA believes that by requiring large traders of natural gas to report their OTC positions to the CFTC, [the agency] will be able to routinely and prospectively assemble a complete picture of the overall size and potential impact of a large trader’s position. Had such a routine large trader report been in place in 2006, the CFTC would have been placed on notice about the relative size of Amaranth’s OTC position (which was many times larger than its exchange position) as it was accumulating its position.”
Lukken said the CFTC, which is near an all-time low on manpower with about 450 employees, would need more funds and personnel to expand its regulation of the natural gas futures market. The agency has jurisdiction over commodity and financial futures and options. That compares to nearly 1,300 FERC employees whose efforts are mainly directed at keeping tabs on interstate natural gas and physical power markets.
Sen. Carl Levin (D-MI), chairman of the Senate Permanent Subcommittee on Investigations, wants Congress to give the CFTC the authority to impose user fees on the companies it oversees as a way to increase its funding. The idea of a user fee has drawn mixed reactions from the exchanges, with Sprecher supporting it and Newsome opposing it.
To prevent future Amaranths, Levin also believes Congress must close the so-called Enron loophole in the CEA, which he said allows electronic trading exchanges, such as ICE, to escape full regulation by the CFTC.
“ICE fully supports the closing of the so-called ‘Enron loophole’ and endorses the report’s recommendations in this regard without reservation,” Sprecher said. “While ICE does not operate under this [Enron loophole] provision, and, to our knowledge, it is not currently being relied upon by other market participants, it creates an unnecessary opportunity for dealers to operate OTC markets completely outside of the CFTC’s regulatory jurisdiction.”
He further took issue with the assertion that ICE is not subject to CFTC regulation. “Transactions on ICE…are fully subject to the antifraud and antimanipulation provisions of the CEA, and ICE itself is subject to the CFTC’s oversight authority and to recordkeeping and reporting requirements,” Sprecher said. In short, “ICE is not an ‘unregulated’ or ‘dark’ market,'” as was claimed during the Senate subcommittee’s first hearing in June, he noted.
At the initial hearing on June 25, the Senate subcommittee staff released a report that found the gas trading positions held by Amaranth Advisors in 2006 amounted to “excessive speculation” that ultimately influenced the price consumers paid for gas last winter (see NGI, July 2).
Sprecher also disputed the report’s claim that the CFTC and Nymex were unable to conduct proper surveillance of gas trading by Amaranth because they did not have access to and could not obtain information about Amaranth’s trading on ICE. “The contention…is not accurate…The CFTC has the authority to make special calls to ICE for any information that it requires, and the CFTC has in fact exercised this authority to require additional information from ICE both before and since” the collapse of Amaranth, Sprecher said.
He said that the ICE currently reports to the CFTC on a daily basis on natural gas contract positions for transactions executed on its platform. “This information is being provided pursuant to a special call from the CFTC for this data, which illustrates the CFTC’s statutory and regulatory authority to obtain available information regarding transactions executed on ICE. It also illustrates ICE’s commitment to ensuring that the CFTC has access to the information it needs,” he noted.
The CFTC should have a “pretty good view” of trading activity on both ICE and Nymex now, Sprecher said. But he said there are limits on the information ICE can provide to regulators, since it does not clear the transactions that are executed on its platform. This is done by LCH.Clearnet.
As an SRO, Nymex has the “power under its rules to request information from its members regarding their trading on other markets, including ICE, and to compel members to produce this information…Even prior to the events related to Amaranth, Nymex rules required its members to disclose to Nymex, upon its request, their trading strategies, including those on other markets, in connection with positions exceeding Nymex accountability levels,” Sprecher said.
In August 2006, Nymex became concerned about the large number of contracts that Amaranth held on the exchange and ordered it to reduce its position. “We were concerned that the size of their position could disrupt markets,” Nymex’s Newsome said. He noted that Nymex notified the CFTC of its action against Amaranth. “The CFTC seemed very satisfied with the position we were taking with Amaranth.”
Amaranth complied with Nymex’s order, but it shifted the contracts to the less-regulated ICE. “The permanent subcommittee report [concluded] that Amaranth was motivated and able to circumvent regulatory constraints by trading on ICE in part because ICE participants are not subject to position limits or position accountability rules. This assertion again reflects a misunderstanding of ICE’s markets, the regulatory of ICE and the distinction between ICE and the futures markets,” Sprecher said.
Part of the fault for Amaranth lies with Nymex, Sprecher believes. “The [Senate] permanent subcommittee report itself points out [that] over the course of several months Nymex took no action as Amaranth consistently exceeded its accountability levels; in fact, Nymex increased the limits applicable to Amaranth, apparently based solely on Amaranth’s unsubstantiated requests and without seeking information about Amaranth’s trading on ICE or other markets, despite its ability to request and obtain such information from market participants,” he said.
The Senate subcommittee leaders — Levin and Sen. Norm Coleman of Minnesota, the panel’s ranking Republican — were frustrated with what they perceived as a lack of concern by the CFTC’s recently appointed acting chairman over Amaranth’s decision to flout the Nymex order and switch to ICE. Levin wanted to know “why the CFTC seems to be resisting something that even ICE accepts” — greater accountability. “You don’t seem troubled” by the fact that Amaranth moved from the Nymex to the less-regulated ICE after it was ordered by Nymex to limit its position, Coleman told Lukken.
Unless the CFTC does something to prevent excessive speculation in the future, “you’re not preventing the next titanic,” Levin said. “Very clearly there is a problem here…That calls for us to take some type of action,” agreed CFTC Commissioner Michael V. Dunn.
At the first hearing, an energy official estimated that Amaranth’s activities cost consumers billion of dollars in additional costs last winter. But ICE’s Sprecher doubted that consumers lost money.
“To the extent that other market users or consumers incurred losses or higher costs as a result of Amaranth’s loses, which we do not believe to be the case, that is obviously regrettable,” he said. “However, it is not the responsibility of Congress or the regulators to protect market participants against fundamentals, poor decisions or major losses. Their role is to ensure that the markets are able to function properly, free of abuses such as manipulation and fraud, and that market participants are treated fairly,” Sprecher noted.
“Despite the collapse of Amaranth, the fact is that the markets and regulatory system did their job, neither the price nor supply of natural gas experienced any significant impact, and the effects of Amaranth’s collapse was largely contained to a discrete time period and, unlike other hedge fund issues, did not lead to a bailout or market contagion.”
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