By James Hamilton, J.D., LL.M.
Senator Carl Levin has introduced a bill closing the so-called ``Enron loophole’’ and restoring the CFTC’s ability to police all U.S. energy exchanges to prevent price manipulation and excessive speculation. In particular, S. 2058 would restore CFTC oversight of large-trader energy exchanges that were exempted from regulation by the Commodity Futures Modernization Act of 2000 by means of the ``Enron loophole,’’ which was, at the request of Enron and others, inserted into the Act at the last minute during a Senate-House conference.
This loophole exempted from federal regulation the electronic trading of energy commodities by large traders The Levin bill would require the CFTC to oversee these facilities in the same manner and according to the same standards that currently apply to futures exchanges like NYMEX.
The genesis of the bill is an earlier Senate report on the collapse of a hedge fund that dominated the natural gas market because the ``Enron Loophole’’ in federal commodities law exempted electronic energy exchanges from CFTC regulation. Indeed, Sen. Levin believes that current federal commodity laws are riddled with exemptions and limitations, making it virtually impossible for regulators to police U.S. energy markets.
The Commodity Futures Modernization Act’s exemption for electronic energy exchanges left NYMEX both self-regulated and regulated by the CFTC, while at the same time leaving ICE not required to be self-regulated and not regulated by the CFTC. The Senate report found that ICE's exemption from regulation undermined the effectiveness and market integrity of both ICE and NYMEX in pricing U.S. energy commodities.
The natural gas market entered a period of extreme price volatility punctuated by the collapse in September 2006 of Amaranth Advisors LLC, one of the largest hedge funds in that market. The report concluded that the current regulatory system was unable to prevent the hedge fund’s excessive speculation in the 2006 natural gas market. Under current law, NYMEX is required to monitor the positions of its traders to determine whether a trader's positions are too large.
If a trader's position exceeds pre-set accountability levels, the exchange may require a trader to reduce its positions. According to the report, the Amaranth case demonstrates two critical flaws in current regulation. First, NYMEX has no routine access to information about a trader's positions on ICE in determining whether a trader's positions are too large. It is therefore impossible under the current system for NYMEX to have a complete and accurate view of a trader's position in determining whether it is too large.
Second, even if NYMEX orders a trader to reduce its positions on NYMEX, the trader can simply shift its positions to ICE where no limits apply, which is precisely what Amaranth did after NYMEX finally told the hedge fund to reduce its positions in two contracts nearing expiration. Unlike NYMEX, there are no limits on the trading on ICE, and no routine government oversight.