House Bill Closes London and Swaps Loopholes and Empowers CFTC

A bill to firmly and finally close both the London and Swaps Dealers loopholes left open by the recently enacted Farm Bill has been introduced by Rep. Bart Stupak, chair of the a House energy subcommittee. The Prevent Unfair Manipulation of Prices (PUMP) Act (HR 6330) requires all U.S-delivered futures energy transactions executed in any manner within the U.S. to be traded on U.S. contract markets subject to direct regulation by the CFTC. The bill also clarifies that energy swaps are futures and requires transparency for energy index funds. Moreover, the measure provides strong congressional oversight of CFTC exemptive authority.

In the view of former CFTC Director of Trading and Markets Michael Greenberger, the PUMP Act comprehensively closes completely and firmly all of the troublesome loopholes that have been created by the Enron Loophole or by CFTC letter, policy statements, and exemption rules. In testimony before the subcommittee, he said that these deregulatory measures have allowed the U.S. energy futures markets to be overrun by unpoliced speculation. In turn, this uncontrolled speculation has unhinged those markets and the price of the underlying commodities from economic fundamentals.

The Farm Bill did not return to the status quo prior to the passage of the Enron Loophole by bringing all energy futures contracts within the full U.S. regulatory regime. Instead, the Farm Bill amendment requires the CFTC and the public to prove on a case-by-case basis through administrative proceedings that an individual energy contract should be regulated if the CFTC can prove that the contract serves a significant price discovery function.

According to the former official, the CFTC has also made it clear that the Farm Bill amendment will not cover any U.S. delivered futures contracts traded on the U.S. terminals of foreign exchanges operating pursuant to staff no action letters. The former director said that legislation is needed to assure rapid oversight of any foreign board of trade trading U.S. delivered energy futures products on U.S. terminals.

The PUMP Act expressly bars over-the-counter energy futures swaps involving transactions of futures energy contracts to be delivered in the U.S. or conducted using computer terminals in the U.S. The combination of statutorily eliminating over-the- counter energy swaps transactions and requiring that all energy futures contracts delivered or traded in the U.S. be on exchange makes doubly clear that energy futures index funds can only be traded on a U.S. regulated and CFTC overseen U.S. contract market.

The Act also would require the CFTC to make monthly website postings about aggregate numbers and positions of anyone using index funds to trade U.S-delivered futures energy contracts or trade on U.S. computer terminals. The Act would nullify all CFTC no action letters previously granted to exchanges trading futures energy contracts to be delivered in the U.S. or using computer terminals in the U.S. A foreign exchange desiring to trade energy futures on U.S. terminals would have to register as a U.S. regulated contract market, with a six-month grace period for compliance.

The PUMP Act would require that U.S. energy futures or energy futures traded on U.S. terminals be subject to the essential core principles of regulation of U.S. contract markets; which principles are designed to prevent fraud, manipulation and excessive speculation. These regulatory requirements include the imposition of mandatory speculation limits, regular and reliable large trader reporting to detect immediately excessive speculation, manipulation or fraud, strong contract market self-regulation surveillance systems, and authority for strong CFTC emergency intervention to resolve dysfunctions within the energy futures markets.

According to the former director, most of those protections are either not provided for or are not emphasized in the foreign regulatory regimes to which the CFTC has deferred in the no action process. The PUMP Act would eliminate in the case of ICE, for example, the need to rely on a regulator in London, using less rigorous oversight of the markets, for activity directly and significantly impacting U.S. energy markets.

More importantly, the PUMP Act strengthens those regulatory requirements that now apply to CFTC-regulated contract markets engaged in energy futures trading. For example, the measure requires the CFTC to establish uniform speculation limits for transactions involving U.S-delivered energy contracts futures or those traded on computer terminals in the U.S.

The Commission is required to fix limits on the aggregate number of positions which may be held by any person for each month and in all markets under CFTC jurisdiction. Under the exiting regulatory regime, speculation limits are only applied by each contract market, and aggregate positions are never imposed. In the former CFTC official’s view, this position limit would prevent a trader from spreading speculation over a host of markets, thereby accumulating a disproportionately large share of an energy market while satisfying each exchange‘s separate limits.

On the other hand, the PUMP Act would exempt bona fide hedging transaction involving U.S-delivered futures energy contracts or those traded on computer terminals in the U.S. In short, speculation limits would only apply to speculators and not to those using the markets to hedge risks involved in selling or buying the energy commodity at issue in the wholesale or retail markets.

The PUMP Act also would provide special rules for bilateral included energy transactions, or transactions involving U.S-delivered futures energy contracts not made through a trading facility. Such bilateral included energy transactions would consist of transactions between two principals, which do not involve communication or negotiation about any of the material economic terms of an energy futures contract.

While a source of great concern by industrial users of the energy futures markets for their abusive speculative impact on the markets, these bilateral transactions were not regulated by the Farm Bill amendment. The Stupak legislation would require eligible contract participants to provide the CFTC with market data about large trading positions involving principal to principal standardized contracts relating to an energy commodity. Additionally, the CFTC and Department of Justice are authorized to examine the trading records of an eligible contract participant that enters into or executes a bilateral included energy transaction.

Finally, the Act recognizes that the CFTC has, through section 4(c) of the Commodity Exchange Act, the power to tailor U.S. futures regulations from one size fits all rules by granting exemptions from statutory requirements so long as the exempted trading comes with assurances that there will be no fraud, manipulation, or excessive speculation and that it otherwise serves the public interest. However, in order to avoid abusive use of that exemption authority, the Act requires the CFTC to provide Congress with two months notice and to otherwise solicit public comment before promulgating a rule that exempts energy futures transactions governed by the Act from the requirements of that statute or the CEA in general.