Congress Moving to Close the London Loophole Left Open by Farm Bill

Companion bills have been introduced in the House and Senate to close a loophole allowing speculative energy trades by US traders on the London Exchange. The bills are designed to ensure that energy commodities traded on foreign exchanges using trading terminals located within the United States are subject to the same speculative trading limits and reporting requirements as energy commodities traded on U.S. exchanges. Importantly, Senator Barack Obama recently called for legislation to accomplish essentially what these bills would do. Meanwhile, at the behest of Senators Levin and Reed, the President created a federal interagency task force composed of the SEC, CFTC and Treasury to examine how energy commodities markets are being manipulated.

In the Senate, the Close the London Loophole Act (S. 3129 ) would ensure that the Commodity Futures Trading Commission has the same authority to detect, prevent, and punish manipulation and excessive speculation for traders in the United States who trade U.S. energy commodities on foreign commodity exchanges as the CFTC has for traders who trade on U.S. exchanges. The bill was introduced by Senators Carl Levin and Diane Feinstein, who were instrumental in closing the Enron loophole in the recently enacted Farm Bill. The Farm Bill did not close the foreign board of trade exemption, which allows speculative energy trades by US traders on the London Exchange

According to Sen. Levin, closing the London loophole will ensure that the CFTC has the tools to protect U.S. markets from manipulation and excessive speculation no matter where U.S. energy commodities are traded. Domestic traders would no longer be able to avoid the ``cop on the beat’’ by routing their trades through a foreign exchange.

Currently, the CFTC can obtain the information it needs to detect price manipulation and excessive speculation involving U.S. energy trades on foreign exchanges only through voluntary data-sharing agreements with relevant foreign regulators. Moreover, the CFTC can take action against a U.S. trader on a foreign exchange to prevent manipulation or excessive speculation only with the cooperation and consent of the foreign regulator.

The Act would authorize and order the CFTC to obtain trading data from foreign exchanges operating in the United States through direct trading terminals. The bill would also enable the CFTC to act on its own initiative to prevent manipulation or excessive speculation by U.S. traders directing trades through foreign exchanges.

In addition, Section 3 of the bill, which subsumes a separate bill, S. 2995, earlier introduced by Sen. Levin, would increase U.S. access to foreign exchange trading data and strengthen oversight of the trading of U.S. energy commodities no matter where that trading occurs. This provision would require the CFTC, prior to allowing a foreign exchange to establish US-located direct trading terminals, to obtain an agreement from that foreign exchange to impose speculative limits and reporting requirements on traders of U.S. energy commodities comparable to the requirements imposed by the CFTC on domestic exchanges.

There are currently two key energy commodity markets for U.S. crude oil, gasoline, and heating oil trading. The first is the New York Mercantile Exchange or NYMEX. The second is the ICE Futures Europe exchange, located in London and regulated by theUK Financial Services Authority.

In overseeing their energy markets, UK regulators do not place limits on speculation like US regulators do, nor do they monitor trader positions in the same way. Also, they do not require the same type of data to be reported to regulators. All this means that traders can avoid U.S. speculation limits on the New York exchange by trading on the London exchange, thereby making the London exchange less transparent.

Recently, the CFTC moved to address some of the gaps in its ability to oversee foreign exchanges operating in the United States. Specifically, the CFTC, working with the FSA and the ICE Futures Europe exchange, announced that it will now obtain information about the trading of U.S. crude oil contracts on the London exchange, including information on large trader positions for all futures contracts, not just a limited set of contracts due to expire in the near future, and enhanced trader information to permit more detailed identification of end users; improved data formatting to facilitate integration of the data with other CFTC data systems; and notification to the CFTC of when a trader on ICE Futures Europe exceeds the position accountability levels established by NYMEX.

While these new steps will strengthen the CFTC's ability to detect and prevent manipulation and excessive speculation by ensuring that the it has the same type of information it receives from U.S. exchanges, Congress believes this in not enough to fully close the London loophole. The CFTC must also have clear authority to act upon this information to stop manipulation and excessive speculation.

Thus, the bill authorizes the CFTC to prosecute and punish manipulation of the price of a commodity, regardless of whether the trader within the United States is trading on a U.S. or on a foreign exchange. It also authorizes the CFTC to require traders in the United States to reduce their positions, no matter where the trading occurs to prevent price manipulation or excessive speculation in U.S. commodities. Finally, it clarifies that the CFTC has the authority to require all U.S. traders to keep records of their trades, regardless of which exchange they are using.