The jurisdiction dispute between FERC and the Commodity Futures Trading Commission (CFTC) should be decided by lawmakers in Congress, Federal Energy Regulatory Commission (FERC) Chairman Jon Wellinghoff and his immediate predecessor, Joseph Kelliher, said during a hearing of the Senate Energy and Natural Resources Committee in Washington, DC, Tuesday.

CFTC Chairman Gary Gensler, speaking at the same hearing, said he thinks the CFTC and FERC should cooperate as both agencies continue to apply their authorities to the activities that are within their respective jurisdictions, but language should be included in the legislation to ensure that jurisdiction squabbles don’t create “the next regulatory loophole.”

A memorandum of understanding (MOU) between the two agencies, which is recommended in legislation being considered by Congress, would effectively ask the two agencies to decide jurisdiction themselves and would not end the dispute, according to Wellinghoff and Kelliher.

“Congress does need to solve the problem with respect to jurisdiction…I don’t see, personally, a memorandum of understanding with respect to jurisdiction,” Wellinghoff said.

The proposed MOU would prove “completely ineffective” in resolving the jurisdiction dispute, Kelliher said. “I think Congress decides jurisdiction, not agencies, and that FERC and CFTC have an honest disagreement on interpreting the law…at this point, only courts or Congress can resolve the dispute between the agencies.”

Gensler believes that his agency should have control of regional electricity markets, while Wellinghoff has said turning organized electricity markets over to the CFTC to regulate would “create market uncertainty” and increase the “potential for market disruption.”

“The current system of FERC oversight and comprehensive regulation of electric and gas markets is working well,” Wellinghoff said. “Changing that system will not enhance benefits to consumers but only put them at jeopardy.”

In mid-December the House passed by a vote of 223 to 202 a financial regulatory reform bill that would regulate over-the-counter (OTC) derivatives for the first time (see Daily GPI, Dec. 14, 2009). The legislation preserved an exemption for bona fide hedgers of commercial risk, but it did not address the FERC vs. CFTC dispute over jurisdiction in regional electricity markets.

Leaders of the Senate Banking Committee are trying to craft financial regulatory reform legislation but are running into roadblocks along the way. President Obama made financial regulatory reform a priority in his State of the Union address (see Daily GPI, Jan. 29). However, the fate of the Senate bill — not to mention whether it will address the jurisdictional dispute in regional power markets — remains uncertain (see Daily GPI, Jan. 7).

According to Gensler, comprehensive reform of the OTC derivatives marketplace will grant new authorities to market regulators that will necessarily relate to existing authorities of other federal regulators. “Specifically, CFTC authorities for OTC energy derivatives would relate to the FERC’s authority under the Natural Gas Act and the Federal Power Act, including the authority to regulate certain activities of regional transmission organizations (RTO) and independent system operators (ISO),” Gensler said. “Consistent with the CFTC’s and FERC’s currently co-existing regulatory authorities, both agencies should continue to apply their authorities to the activities that are within their respective jurisdictions.”

While the OTC derivatives marketplace has grown up over the last three decades from a notional value of less than $1 trillion to approximately $300 trillion in the United States, it remains largely unregulated, Gensler said.

“It is now time to bring comprehensive regulation to this large and economically significant market,” he told the Senate committee. “In well functioning markets, derivatives are meant to mitigate and help manage risk in the economy. Even if not for the 2008 financial crisis, this market should be regulated to achieve these goals.”

Gensler noted that the CFTC has exclusive jurisdiction over the trading and clearing of futures contracts, whereas FERC has jurisdiction over other defined aspects of the energy markets, including regulating interstate transportation rates and services for natural gas pipelines and regulating wholesale sales of electricity and interstate transmission rates and services. FERC also has important enforcement authorities under the Federal Power Act and the Natural Gas Act to prosecute manipulation in the electricity and natural gas markets, he said, adding that contracts for the immediate or forward delivery of electricity — like all cash and forward contracts for other commodities — are not regulated by the CFTC.

“Congress has provided the agencies with adequate tools to work cooperatively,” Gensler testified. “The CEA [Commodity Exchange Act] provides the CFTC with authority to exempt instruments and markets from its regulations if it is determined to be in the public interest to do so. OTC derivatives reform should extend this exemptive authority with the CFTC’s oversight of the swaps market. Any potential overlaps in oversight can be addressed through memoranda of understanding and other cooperative working relationships between the two agencies.”

He added that pending legislation also should maintain FERC’s enforcement authorities under Section 222 of the Federal Power Act and Section 4A of the Natural Gas Act. However, Gensler was adamant that “wholesale statutory exemptions” that prevent the application of any CFTC regulation — including the regulation of futures contracts, swaps contracts, clearing or exchange trading — for any instrument or market that is regulated by the FERC “undermine the effectiveness of comprehensive reform.” Gensler recommended that Congress “should avoid any bright-line exemption that runs the risk of creating the next regulatory loophole.” Instead, he believes Congress should follow the long-established model under which the CFTC coexists with other agencies with oversight of cash and forward markets.

“History demonstrates that bright-line statutory exemptions or exclusions granted at one point in time can have unintended consequences and often fail to adequately account for subsequent developments,” he said. “Markets evolve rapidly. What may seem like a carefully crafted exclusion today can become a significant and problem-filled loophole tomorrow.”

As an example Gensler highlighted the Enron loophole, which was created in 2000 when electronic trading facilities were just getting started. “By the time Congress addressed the [Enron] loophole as part of the Farm Bill in 2008, the unregulated electronic trading of natural gas swaps was on a par with the trading of natural gas futures on the regulated market,” he said. “As the Amaranth case demonstrated, traders took advantage of the unregulated exempt facility to avoid position limits and other regulations established for the regulated futures markets. Proponents of the exemptions had argued that additional CFTC regulation was unnecessary. Our experience, though, indicates that comprehensive and consistent oversight must be applied.”

©Copyright 2010Intelligence Press Inc. All rights reserved. The preceding news reportmay not be republished or redistributed, in whole or in part, in anyform, without prior written consent of Intelligence Press, Inc.