Liquidity, not regulation, is key to avoid manipulation, says CFTC

Regulators should avoid the temptation to implement over-zealous regulation of the energy derivatives market, and instead encourage the development of liquidity, if market manipulation is to be avoided. That was the message delivered by Sharon Brown-Hruska, commissioner of the US Commodity Futures Trading Commission (CFTC), at the Energy Risk conference in Houston.

Following Enron’s demise, and the California power crisis, there has been a backlash against over-the-counter energy trading in the US that is largely unwarranted, Brown-Hruska said. US politicians such as senator Dianne Feinstein, for example, have unsuccessfully sought to re-regulate OTC derivatives trading.

The CFTC has so far fined 20 major energy companies around $200 million in civil monetary penalties related to false price reporting and attempted manipulation of natural gas prices in the US. And to avoid a repeat performance Brown-Hruska believes that: “The first and most effective way to protect against price abuse is to encourage the development of liquid and transparent markets."

“I would advocate that this be done by looking for market solutions such as [OTC energy derivative] clearing or encouraging the development of innovative trading mechanisms or contract designs,” the commissioner added. “While regulatory solutions can be effective, without question, the best defence against market manipulation and market abuse lies in competitive, transparent and liquid markets... In my view, economic incentives are the only way to enable the industry to encourage innovation that is critical to providing reliable energy at lower cost to consumers.”

Brown-Hruska also warned that significant commodity price movement should not be interpreted as a signal of market manipulation. Some US politicians, energy consumer associations and large industrial end-users have suggested that oil and gas market price hikes are due to hedge fund, or energy company, market manipulation. But this is not necessarily the case, Brown-Hruska told delegates in her keynote address.

“Usually, when prices move significantly, we hear that prices are being manipulated and regulation should be implemented to prevent this,” she said. “In my view, we must be vigilant not to equate unpopular price moves with manipulative behaviour, and therefore throttle the market’s ability to serve its national public interest of providing a means for managing price risks.”

OTC energy derivative clearing could be one means of encouraging market transparency and stability, Brown-Hruska added. “Although a widely accepted clearing model has not yet emerged, there has been some progress towards clearing for OTC products and I believe we will continue to make progress towards more general OTC clearing,” she said.