Senate Passes Bill to Close Enron Loophole

A measure reauthorizing the CFTC and closing the Enron loophole has been tacked on to a bipartisan Farm Bill and passed by the Senate. The Feinstein amendment to the Farm Bill regulates energy transactions that perform a significant price discovery function. This
is an issue Senators Feinstein and Levin have been laboring on for years. The amendment also addresses fraud and retail transactions in foreign exchange markets. The bill now goes to conference to resolve differences with a similar House bill. Congress is hopeful that the final bill will pass early this year.

The Enron loophole, included in the Commodity Futures Modernization Act of 2000, has allowed large volumes of energy derivatives contracts to be traded over-the-counter, OTC, and on electronic platforms, without the federal oversight necessary to protect both the integrity of the market and energy consumers.

The legislation will put an end to the Enron-inspired exemption from government oversight now provided to electronic energy trading markets set up for large traders. By ending that exemption, this legislation will restore the ability of the CFTC to police all US energy exchanges to prevent price manipulation and excessive speculation

The legislation has the general support of the CFTC, the electronic exchange known as ICE, the New York Mercantile Exchange, the Chicago Mercantile, and the President’s Working Group on Financial Markets.

The legislation also increases transparency in energy markets to deter traders from manipulating the price of oil and natural gas futures traded on electronic markets. It requires energy traders to keep records for a minimum of five years so there is transparency and an audit trail. It requires electronic energy traders to report trading in significant price discovery contracts to the CFTC so that the agency would have the information to effectively oversee the energy futures market. Manipulators could then be identified and punished by the CFTC.

The bill gives the CFTC new authority to punish manipulation, fraud, and price distortion. It requires electronic trading platforms to actively monitor their markets to prevent manipulation and price distortion of contracts that are significant in determining the price of the market.

These are the factors that the CFTC will consider in making that determination: the trading volume, whether significant volumes of a commodity are traded on a daily basis; price referencing, if the contract is used by traders to help determine the price of subsequent contracts; and price linkage, if the contract is equivalent to a NYMEX contract and used the same way by traders.

For example, when the Amaranth hedge fund was directed to reduce their position in regulated natural gas contracts, it simply moved its position to the unregulated electronic natural gas contracts. This requirement would essentially say that similar contracts on ICE and NYMEX will be regulated the same way.


The legislation would also require electronic exchanges, for the first time, to begin policing their own trading operations and become self-regulatory organizations in the same manner as futures exchanges like NYMEX.

In addition to requiring electronic exchanges to become self-regulatory organizations, the legislation would require the CFTC to oversee these exchanges n the same general way that it currently oversees futures exchanges like NYMEX. The legislation also, however, assigns the CFTC a unique responsibility not present in its oversight of other types of exchanges and clearing facilities. The legislation would require the CFTC to review the contracts on each electronic exchange to identify those which ‘‘perform a significant price discovery function’’ or, in other words, have a significant effect on energy prices.

A legal battle is going on in the courts right now over enforcement actions by the CFTC and the Federal Energy Regulatory Commission accusing Amaranth of manipulating or attempting to manipulate natural gas prices. According to Sen. Levin, this legislation is not intended to affect that court battle in any way. Congress is waiting to see how it plays out and how the courts will interpret the law. This legislation is intended to play an absolutely neutral role in those enforcement actions, and should not be interpreted as changing the status quo in any way.