IntercontinentalExchange (ICE), a major energy trading platform, Thursday said it welcomed the opportunity to participate in the Commodity Futures Trading Commission’s (CFTC) upcoming hearings on position limits in energy trading markets, noting it has been an area of concern for some time. Independent oil and natural gas producers, however, were less receptive, warning that dramatic changes by the CFTC affecting their hedging activities could cripple development.
“ICE has expressed concern to the CFTC about the process in place today for establishing position standards in the U.S. energy markets. We look forward to participating in the Commission’s hearings and believe they will provide a venue for the open…dialogue necessary to consider market impacts of the needed changes to the existing position position management regime,” said Atlanta-based ICE. Competitor CME Group, the world’s largest derivatives exchange, said it would withhold comment until more details about the hearings are released.
“Current regulation by the CFTC mandates that ICE adopt the position and accountability limits that its competitor, Nymex [New York Mercantile Exchange], is presently responsible for establishing,” ICE noted. The CFTC hearings, which will take place this month and in August, will explore whether the CFTC, rather than exchanges, should set limits on the number of contracts that a single company or fund can hold to crack down on speculation in the energy futures markets (see Daily GPI, July 8).
“Although attacking so-called speculation is a popular program for some who may not fully understand its full market function for America’s small and independent natural gas and oil producers, it’s an incredibly valuable tool for managing risk and keeping operations engaged and intact at the well site,” said Barry Russell, president of the Independent Petroleum Association of America.
“If the CFTC and Congress obstruct commonsense market activity, independent energy producers will not be able to hedge their production. Without hedging, companies will be unable to protect their cash flow to maintain exploration and production budgets and retain employees when prices drop…With less production comes higher prices,” he said.
ICE cited flaws in the current system for setting trading position limits. “ICE is provided no access to the information needed to judge the suitability or size of these limits [set by Nymex], nor does it have access to the methodology or determining factors that Nymex used in deciding to grant [more than] 115 hedge exemptions since 2006.
“Despite the substantial increase in the size of the energy markets — including growth in contract volume, participants and physical production — position limits in U.S. energy markets have remained unchanged for years. Therefore, it appears that hedge exemptions have been increasingly granted to meet the needs of market participants in today’s large, global markets,” it said.
ICE warned that strict position and accountability limits could send traders to bilateral, off-exchange markets where neither limits nor reporting exist. This “shift backward to opaque, bilateral markets decreases market transparency and increases counterparty risk, both of which run counter to proposals by the [Department of Treasury] to bring bilateral positions into clearing houses,” ICE said.
“The hearing process will allow the industry to examine how needed modifications to the current position management regime might be better structured, including how changes might affect volatility, prices, market concentration and the prevention of settlement prices manipulation.”
With respect to the CFTC’s plan to focus on index funds and exchange-traded funds (ETFs), ICE said they accounted for an “immaterial amount” of its revenue. “Index funds typically execute their trades in the OTC [over-the-counter] broker markets rather than in ICE’s markets — using ICE only to clear their bilateral positions — and thus they pay limited fees to the exchange. Because trading activity generated by index funds and ETFs generally is not part of the on-exchange price discovery process, they typically do not provide volume interaction with other participants in ICE’s electronic execution markets.”
The CFTC’s regulatory grip on ICE’s energy markets has tightened within the past year. With the passage of the farm bill in 2008, ICE’s OTC energy markets became subject to increased CFTC regulation for key contracts, such as the Henry Hub natural gas swap, which perform a significant role in price discovery.
Also in 2008, the CFTC amended ICE Futures Europe’s no-action letter to require the foreign exchange to adopt U.S.-style reporting, position limits and position accountability levels for its energy contracts and reference the settlement price of a U.S. designated contract market.
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