IntercontinentalExchange fuels regulation debate

Regulation of US over-the-counter energy derivatives trading is once again in the spotlight on Capitol Hill, following renewed calls for an overhaul. "Due to the changes in the market-place, non-regulation of certain exempt commercial markets can no longer be justified," said James Newsome, president and chief executive of the New York Mercantile Exchange (Nymex), during a September 26 House of Representatives agriculture subcommittee hearing on the contentious issue of energy trading regulation.

Exchange-like aggregation and mutualisation of risk at the clearing house from trading on exempt commercial markets (ECMs) such as the the Atlanta-based IntercontinentalExchange (Ice), argued Newsome, had created a source of major risk. An ECM is a regulatory category established by the US Commodity Futures Modernization Act of 2000, which in effect deregulated over-the-counter energy derivatives trading. Ice, Nymex's chief competitor, is an ECM.

Large positions are not sufficiently monitored by US regulators and this, Newsome went on to claim, raised concerns about potential problems that develop there having a knock-on effect for clearing members on those ECMs, and other clearing organisations that share common membership.

Countering Newsome's arguments in support of a regulatory re-categorisation of Ice and stricter regulation of its activities, Jeffrey Sprecher, chairman and chief executive of Ice, said during the hearing that the current regulatory framework was adequate, although he conceded that increased regulatory oversight of certain products traded on Ice "may be appropriate".

Specifically, Sprecher suggested possibly increasing oversight of products that settle on a futures market contract price on the Henry Hub, a US natural gas benchmark price index, and that have a true economically equivalent contract actively traded on a regulated futures market. But, he argued, the vast majority of Ice's products do not fall under this description because they are energy swap contracts that reference illiquid markets.

He warned greater scrutiny of trading activity on ECMs may stifle innovation and, perhaps more importantly, encourage market participants to use the voice-brokered market, where there is less regulatory oversight and no centralised clearing facilities to mitigate counterparty risk.

Amaranth implosion

Unsurprisingly, a recurrent theme in the debate over energy oversight is the implosion of Greenwich-based multi-strategy hedge fund Amaranth Advisors, whose assets under management totalled $6 billion just before its closure in September 2006.

In a complaint filed on July 25 in the US District Court for the Southern District of New York, the Commodities and Futures Trading Commission (CFTC) claimed Amaranth Advisors and its former head energy trader Brian Hunter manipulated the price of natural gas futures contracts on Nymex so that it could profit from its positions on Ice.

Specifically, the complaint alleges, Amaranth bought more than 3,000 Nymex contracts only to sell a large majority of them immediately before the closing of the exchange on February 24, 2006 and April 26, 2006. Because the payout of some of Ice's swaps are based on the daily settlement price of Nymex's natural gas futures contracts, Amaranth's actions on Nymex meant the fund would profit from its large short positions on swaps traded on Ice (Risk August 2007, page 10).

And while the subject of this complaint has been held up as an example of how the current US regulation is lacking, the complaint itself has also triggered heated debate about regulatory jurisdictions.

The Federal Energy Regulatory Commission (Ferc), which mainly regulates the physical natural gas markets, filed a separate lawsuit against Amaranth in July, based on its expanded authority under the Energy Policy Act of 2005 to protect the natural gas markets from manipulation. This prompted Amaranth to file an injunction against Ferc's lawsuit, saying that the CFTC has exclusive jurisdiction over the natural gas futures markets.

Ferc's position on jurisdiction was set out in a document entitled Legal Authorities: Amaranth Show Case, which was published on July 26. In it, Ferc claimed many market participants in the physical natural gas markets use futures contracts as a benchmark for physical prices in physical natural gas, and that in the Amaranth case, this path of price discovery was used to manipulate physical prices.

A source close to the CFTC tells Risk that, contrary to what has been reported by some media, the situation is not a regulatory "turf war", and that it might in fact be appropriate to allow Ferc to establish clearer boundaries over its jurisdiction by pursuing its own legal actions, or through alternative means.

- Jayne Jung.