CFTC outlines more regulatory concerns

The Commodity Futures Trading Commission (CFTC) ended the last of three public hearings on the energy market today, citing several additional areas of regulatory interest including firewalls, high frequency trading and over-the-counter market regulation.

In his closing statement, CFTC Chairman Gary Gensler, echoed Commissioner Michael Dunn's comments that firewalls between financial players' trading and research divisions should be reviewed and possibly regulated. Gensler said he had asked staff to determine the contents of the Commission's statute on this issue and if further powers were required from Congress to regulate the area.

Commission staff are also preparing a detailed letter on high frequency trading that would be sent out to commodity futures trading exchanges, according to Gensler.

The hearing was also peppered with references to OTC market regulation, an issue that the CFTC is also investigating, along with the Government and several members of Congress. Gensler polled panelists' support for further CFTC regulatory oversight of the OTC market at each of the three hearings.

Gensler announced plans to hold the hearings on July 7, in order to assess the role of excessive speculation in energy markets and whether this should be addressed by placing position limits on energy traders. Such limits are already applied by the Commission for some agricultural products, but exchanges currently apply their own limits in the energy futures markets.

Phil Flynn, energy analyst at Alaron Trading, said imposing position limits could create more problems than the CFTC is currently trying to resolve. "They will have to define issues such as what excessive speculation is, as well as who the "good" speculator are and who are "bad"," he argued.

Flynn also reiterated a common argument within the industry at the moment that tighter regulation could push trading activity into dark - or unregulated - markets in other parts of the world.

Participants in today's hearing also discussed the issue of hedge exemptions - special consideration granted by the CFTC to certain futures market players to allow them to exceed position limits. Speaking on the second panel of market participants today, John Arnold, managing partner at hedge fund Centaurus Energy Master Fund, called for hard limits on physical futures contracts as they approach expiry, with no hedge exemptions. He added that, while the Commission should have oversight of all financially-settled contract positions on exchanges and in the OTC market, hard limits should not be imposed on such contracts.

Michael Masters, portfolio manager at Masters Capital Management, argued that the CFTC could prevent excessive speculation by applying aggregate speculative positions across all trading venues. He also called for a ban on passive investment in the commodity derivatives markets, which would cover vehicles such as index and exchange-traded funds.

A written statement from Masters said: "Passive investment provides no benefits to the markets while it exacts a heavy toll. Investors' desire to turn the commodity derivatives markets into something they are not (namely a valid investment vehicle) must be subjugated to the needs of bona fide physical hedgers to hedge their risks and discover fair prices."

However, Flynn said Masters was missing the point. He continued: "When did liquidity become excessive speculation? The CFTC should encourage [passive investors] because they create more liquidity and allow more people to get in and out of the market."