[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]


 
   HEARING TO REVIEW REAUTHORIZATION OF THE COMMODITY FUTURES TRADING 
                               COMMISSION 

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                        GENERAL FARM COMMODITIES
                          AND RISK MANAGEMENT

                                 OF THE

                        COMMITTEE ON AGRICULTURE
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                            OCTOBER 24, 2007

                               __________

                           Serial No. 110-32


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                        COMMITTEE ON AGRICULTURE

                COLLIN C. PETERSON, Minnesota, Chairman

TIM HOLDEN, Pennsylvania,            BOB GOODLATTE, Virginia, Ranking 
    Vice Chairman                    Minority Member
MIKE McINTYRE, North Carolina        TERRY EVERETT, Alabama
BOB ETHERIDGE, North Carolina        FRANK D. LUCAS, Oklahoma
LEONARD L. BOSWELL, Iowa             JERRY MORAN, Kansas
JOE BACA, California                 ROBIN HAYES, North Carolina
DENNIS A. CARDOZA, California        TIMOTHY V. JOHNSON, Illinois
DAVID SCOTT, Georgia                 SAM GRAVES, Missouri
JIM MARSHALL, Georgia                JO BONNER, Alabama
STEPHANIE HERSETH SANDLIN, South     MIKE ROGERS, Alabama
Dakota                               STEVE KING, Iowa
HENRY CUELLAR, Texas                 MARILYN N. MUSGRAVE, Colorado
JIM COSTA, California                RANDY NEUGEBAUER, Texas
JOHN T. SALAZAR, Colorado            CHARLES W. BOUSTANY, Jr., 
BRAD ELLSWORTH, Indiana              Louisiana
NANCY E. BOYDA, Kansas               JOHN R. ``RANDY'' KUHL, Jr., New 
ZACHARY T. SPACE, Ohio               York
TIMOTHY J. WALZ, Minnesota           VIRGINIA FOXX, North Carolina
KIRSTEN E. GILLIBRAND, New York      K. MICHAEL CONAWAY, Texas
STEVE KAGEN, Wisconsin               JEFF FORTENBERRY, Nebraska
EARL POMEROY, North Dakota           JEAN SCHMIDT, Ohio
LINCOLN DAVIS, Tennessee             ADRIAN SMITH, Nebraska
JOHN BARROW, Georgia                 TIM WALBERG, Michigan
NICK LAMPSON, Texas
JOE DONNELLY, Indiana
TIM MAHONEY, Florida

                                 ______

                           Professional Staff

                    Robert L. Larew, Chief of Staff

                     Andrew W. Baker, Chief Counsel

                 April Slayton, Communications Director

           William E. O'Conner, Jr., Minority Staff Director

                                 ______

      Subcommittee on General Farm Commodities and Risk Management

                BOB ETHERIDGE, North Carolina, Chairman

DAVID SCOTT, Georgia                 JERRY MORAN, Kansas, Ranking 
JIM MARSHALL, Georgia                Minority Member
JOHN T. SALAZAR, Colorado            TIMOTHY V. JOHNSON, Illinois
NANCY E. BOYDA, Kansas               SAM GRAVES, Missouri
STEPHANIE HERSETH SANDLIN, South     CHARLES W. BOUSTANY, Jr., 
Dakota                               Louisiana
BRAD ELLSWORTH, Indiana              K. MICHAEL CONAWAY, Texas
ZACHARY T. SPACE, Ohio               FRANK D. LUCAS, Oklahoma
TIMOTHY J. WALZ, Minnesota           RANDY NEUGEBAUER, Texas
EARL POMEROY, North Dakota

               Clark Ogilvie, Subcommittee Staff Director

                                  (ii)


































                             C O N T E N T S

                              ----------                              
                                                                   Page
Etheridge, Hon. Bob, a Representative in Congress from North 
  Carolina, opening statement....................................     1
Goodlatte, Hon. Bob, a Representative in Congress from Virginia, 
  opening statement..............................................     4
    Prepared statement...........................................     5
Graves, Hon. Sam, a Representative in Congress from Missouri, 
  prepared statement.............................................     6
Moran, Hon. Jerry, a Representative in Congress from Kansas, 
  opening statement..............................................     2
    Prepared statement...........................................     2
Peterson, Hon. Collin C., a Representative in Congress from 
  Minnesota, opening statement...................................     3
    Prepared statement...........................................     4
Walz, Hon. Timothy J., a Representative in Congress from 
  Minnesota, prepared statement..................................     6

                               Witnesses

Lukken, Hon. Walter, Acting Chairman, Commodity Futures Trading 
  Commission, Washington, D.C....................................     7
    Prepared statement...........................................     9
Williams, Orice M., Director, Financial Markets and Community 
  Investment, U.S. Government Accountability Office, Washington, 
  D.C............................................................    38
    Prepared statement...........................................    39

                          Submitted Questions

Responses from Hon. Walter Lukken, Acting Chairman, Commodity 
  Futures Trading Commission, Washington, D.C....................    65
Responses from Orice M. Williams, Director, Financial Markets and 
  Community Investment, U.S. Government Accountability Office, 
  Washington, D.C................................................    75


   HEARING TO REVIEW REAUTHORIZATION OF THE COMMODITY FUTURES TRADING
                               COMMISSION

                              ----------                              


                      WEDNESDAY, OCTOBER 24, 2007

                  House of Representatives,
 Subcommittee on General Farm Commodities and Risk 
                                        Management,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Subcommittee met, pursuant to call, at 1:30 p.m., in 
Room 1300 of the Longworth House Office Building, Hon. Bob 
Etheridge [Chairman of the Subcommittee] presiding.
    Members present: Representatives Etheridge, Scott, 
Marshall, Boyda, Herseth Sandlin, Ellsworth, Space, Walz, 
Pomeroy, Peterson (ex officio), Barrow, Moran, Graves, Conaway, 
Neugebauer, and Goodlatte (ex officio).
    Staff present: Alejandra Gonzalez-Arias, Tyler Jameson, 
Scott Kuschmider, Clark Ogilvie, John Riley, Kristin Sosanie, 
Bryan Dierlam, and Jamie Weyer.

 OPENING STATEMENT OF HON. BOB ETHERIDGE, A REPRESENTATIVE IN 
                  CONGRESS FROM NORTH CAROLINA

    The Chairman. This hearing of the Subcommittee on General 
Farm Commodities and Risk Management to review reauthorization 
of the Commodity Futures Trading Commission will come to order. 
First, I would like to welcome our witnesses here today and say 
we are looking forward to your testimony. Also, I want to 
welcome the other members of the Commodity Futures Trading 
Commission who are with us today, Commissioner Mike Dunn, 
Commissioner Jill Sommers and Commissioner Bart Chilton. Your 
attendance here today is appreciated, showing solidarity with 
the Acting Chairman, and I know he appreciates it as well.
    Today this Subcommittee takes another important step on the 
road to reauthorization. Last month we heard from a host of 
industry participants on a wide range of issues affecting the 
futures markets. Last July we heard from a number of witnesses 
including the two who will testify today about energy trading 
and the developments that have been occurring in these specific 
markets. Today it all comes together. The recent report from 
GAO, of which Ms. Williams will testify, provides us with a 
clearer picture of what is happening in the energy markets. 
While the report does not include specific legislative 
recommendations, it does suggest that Congress may want to 
examine the regulatory structure for some of these markets. 
Something I am confident we would be doing even in the absence 
of the report.
    From the CFTC we will be hearing their recommendations on a 
number of issues. Most importantly we will be receiving results 
of their own examination of energy markets. I look forward to 
exploring further the Commission's recommendations during the 
question and answer period.
    In last month's hearing several witnesses expressed a great 
deal of anxiety regarding recent FERC action, as it may be 
encroaching upon the CFTC's exclusive jurisdiction over the 
futures markets. While not exactly a topic usually considered 
under reauthorization, I suspect some Members will use the 
opportunity of this hearing to hear directly from the CFTC 
regarding this matter. As I stated at that hearing, it was 
Congress' intent that the CFTC should have exclusive 
jurisdiction over futures markets to provide certainty in the 
markets on the rules that apply to those markets. For the CFTC 
to fail to assert its exclusive jurisdiction when appropriate 
would not only jeopardize the success that we have seen in the 
futures markets since passage of the CFMA, but also equal a 
failure to uphold the will of the United States Congress.
    Again, I want to thank the witnesses for their 
participation and now I turn to the gentleman from Kansas, Mr. 
Moran, for his opening statement.

  OPENING STATEMENT OF HON. JERRY MORAN, A REPRESENTATIVE IN 
                      CONGRESS FROM KANSAS

    Mr. Moran. Mr. Chairman, thank you very much.
    This is an important and useful hearing and I will leave my 
remarks to be very brief. It is axiomatic that no elected 
official is ever short of words but we have had reauthorization 
hearing after reauthorization hearing, and opening statement 
after opening statement by the two of us, and I think both of 
us are very anxious to reach a consensus and reach a conclusion 
and move forward as quickly as possible on reauthorization 
legislation both here in the House, and ultimately in the 
Senate, and signed by the President. I appreciate again this 
hearing.
    Mr. Lukken, I appreciate your testimony. I thought it was 
very precise and I appreciate the exact instructions. Sometimes 
we get witnesses who in some ways hedge their recommendations 
to us and you did not do that and I am grateful for that. I, 
also, would like to take the opportunity to point out that we 
have a long history in Kansas for providing personnel to be 
Commissioners at the CFTC and I welcome Jill Sommers, our 
latest Kansas addition to your Commission. I look forward to 
working with her, the other Commissioners, and you, Mr. 
Chairman. I look forward to hearing what Ms. Williams has to 
say and I am anxiously awaiting the testimony of both of you. 
Thank you very much.
    [The prepared statement of Mr. Moran follows:]

 Prepared Statement of Hon. Jerry Moran, a Representative in Congress 
                              From Kansas
    Thank you Mr. Chairman. It is a pleasure to be here as we continue 
toward reauthorization of the Commodity Exchange Act. Today we have two 
expert witnesses to report on possible ways to improve the Act during 
reauthorization. I look forward to hearing the suggestions of both 
Acting Chairman Lukken and Ms. Williams from the Government 
Accountability Office.
    The CFTC has continued to operate far too long without proper 
reauthorization and sufficient funding. In recent years markets have 
evolved and trading volume increased exponentially. It is essential the 
Committee listen carefully to the suggestions of today's witnesses and 
those of industry participants from the September 26, 2007, hearing 
held by this Subcommittee, and move toward reauthorization as soon as 
possible so the CFTC has the tools necessary to properly oversee 
markets.
    Thank you, Acting Chairman Lukken and Ms. Williams, for your 
testimony today.

    The Chairman. I thank the gentleman. He yields back.
    Now I would turn to the Chairman of the full Committee, Mr. 
Peterson, for his opening statement.

OPENING STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE 
                   IN CONGRESS FROM MINNESOTA

    Mr. Peterson. Thank you, Mr. Chairman, and thank you for 
calling this hearing today and for the work you have been doing 
to keep the Committee on track regarding the Commodity Exchange 
Act reauthorization. As everybody knows, we have been busy all 
year trying to get the farm bill done but reauthorization of 
this Act is another major responsibility for this Committee. I 
commend you and Mr. Moran and others for the work that you have 
done with the series of reauthorization hearings. We need to 
get this reauthorization done and signed into law.
    I would like to welcome today as witnesses, Mr. Lukken and 
Ms. Williams. I appreciate you being with us. Mr. Lukken 
chaired a hearing at CFTC on September 18 regarding many of the 
issues this Committee will consider during the reauthorization. 
I look forward to his input as we continue this process.
    Our Committee considers reauthorization at a time when the 
futures markets are changing with increased volume and tradable 
products. In the 7 years since the passage of the Commodity 
Futures Modernization Act we have seen growth in trading 
volume, number of participants and new trading products having 
grown beyond the price hedging of physical commodities to 
include a wide selection of highly complex financial products 
and indicators. I am sure from CFTC's perspective gathering 
data on these newer but still heavily traded products is not 
always easy and the that effective oversight is a real 
challenge.
    Last month the CFTC held a meeting about the oversight of 
exempt commercial markets and their effect on traditional 
futures exchanges. I notice in Mr. Lukken's testimony that the 
CFTC proposes increased oversight over the ECMs when certain 
conditions are met. I am grateful to the Commission for 
providing specific recommendations in this area and can assure 
that the Committee will give serious consideration to the 
points that you have raised.
    Ms. Williams will present the GAO's findings about energy 
derivative transactions and some of those exempt trading 
platforms and the CFTC's limited oversight in that venue. Given 
some of the more publicized events that we have seen with 
energy trading it would appear to the layperson that there are 
separate markets out there that appear to be similar but are 
playing under different rules. I hope Mr. Lukken can shed some 
light from CFTC's perspective on what exempt commercial markets 
can offer the marketplace in terms of price discoveries and 
innovations.
    So it is my hope that today's hearing will giving us a good 
understanding of what needs to be done in this reauthorization 
in order to continue to ensure the integrity of our futures 
markets. I would, again, welcome today's witnesses and 
appreciate the time.
    [The prepared statement of Mr. Peterson follows:]

  Prepared Statement of Hon. Collin C. Peterson, a Representative in 
                        Congress From Minnesota
    Thank you, Chairman Etheridge, for calling this hearing today and 
for the work you have done keeping this Committee on track regarding 
Commodity Exchange Act reauthorization. We have been busy all year 
trying to get the farm bill done, but reauthorization of this Act is 
another major responsibility for this Committee and I commend you for 
the work you have done with this series of reauthorization hearings. We 
need to get this reauthorization done and signed into law.
    I would like to welcome today's witnesses: Acting CFTC Chairman 
Walter Lukken and Ms. Orice Williams with the Government Accountability 
Office.
    Mr. Lukken chaired a hearing at CFTC on September 18, regarding 
many of the issues this Committee will consider during CFTC 
reauthorization and I look forward to his input as we continue that 
process.
    Our Committee considers CEA reauthorization at a time when futures 
markets are changing with increased volume and tradable products. In 
the 7 years since the passage of the Commodity Futures Modernization 
Act, we have seen growth in trading volume, numbers of participants, 
and new trading products, having grown beyond the price hedging of 
physical commodities to include a wide selection of highly complex 
financial products and indicators. I'm sure from the CFTC's 
perspective, gathering data on these newer, but still heavily-traded 
products is not always easy, and that effective oversight is a real 
challenge.
    Last month, the CFTC held a meeting about the oversight of exempt 
commercial markets, or ECMs, and their effect on traditional futures 
exchanges. I notice in Chairman Lukken's testimony that the CFTC 
proposes increased oversight for ECMs when certain conditions are met. 
I am grateful to the Commission for providing specific recommendations 
in this area and can assure it that the Committee will give serious 
consideration to the points you have raised.
    Ms. Williams will present the GAO's findings about energy 
derivatives transactions in some of those exempt trading platforms and 
CFTC's limited oversight in that venue. Given some of the more 
publicized events we have seen with energy trading, it would appear to 
the layperson that there are separate markets out there that appear to 
be similar, but are playing under different rules. I hope Chairman 
Lukken can shed some light, from the CFTC's perspective, on what exempt 
commercial markets can offer the marketplace in terms of price 
discovery and innovation.
    It is my hope that today's hearing will give us a good 
understanding of what needs to be done in this reauthorization in order 
to continue to ensure the integrity of the futures markets.
    I would again like to welcome today's witnesses and I yield back my 
time.

    The Chairman. I thank the gentleman.
    Ranking Member of the full Committee, Mr. Goodlatte.

 OPENING STATEMENT OF HON. BOB GOODLATTE, A REPRESENTATIVE IN 
                     CONGRESS FROM VIRGINIA

    Mr. Goodlatte. Mr. Chairman, thank you. I want to commend 
you for holding this hearing and the work that you and Mr. 
Moran and the Chairman and others have done on the Commodity 
Futures Trading Commission through authorization. I want to 
welcome our witnesses.
    The last reauthorization began in May of 1999 and resulted 
in three committees working for more than a year to report 
legislation to amend the Commodity Exchange Act and Federal 
securities law. Hopefully, this reauthorization will be 
significantly less complicated and controversial. Granted some 
areas of controversy still exist in the areas of energy 
derivatives, sales of off-exchange forex instruments, single 
stock futures regulation and the continuing globalization of 
electronic trading. I am hopeful, however, that we can sort 
these matters out by carefully considering the testimony 
submitted to this Committee. I am also confident in the CFTC's 
ability to police the derivatives markets. I believe the 
Commodity Futures Modernization Act set a course for the wise 
use of an array of risk management instruments by large and 
small businesses alike. While forming the basis of sound 
business practices in different venues these instruments also 
remain cost-effective. Additionally, I am heartened by the 
steady rise in the trading volumes on our Nation's futures 
exchanges. The increased trade volumes provide evidence that 
our exchanges still offer a unique product that may be used 
efficiently and with reasonable safety. I also assume that 
rising volume numbers mean that financial services firms 
offering tailored over-the-counter products to their customers 
are laying some of their risk off on the organized exchanges.
    This morning, the CFTC released, Report on the Oversight of 
Trading on Regulated Futures Exchanges and Exempt Commercial 
Markets. This report is the result of CFTC's hearing on this 
topic, economic analysis by the Office of Chief Economist, and 
the CFTC's internal deliberations and expertise on futures 
trading. I commend the CFTC for investing the resources needed 
to develop the recommendations and I look forward to Chairman 
Lukken expanding on them in his testimony.
    I, again, thank you for the opportunity to offer some of my 
thoughts on this important undertaking and look forward the 
testimony of the witnesses. Thank you, Mr. Chairman.
    [The prepared statement of Mr. Goodlatte follows:]

Prepared Statement of Hon. Bob Goodlatte, a Representative in Congress 
                             From Virginia
    Mr. Chairman, I want to commend you for holding this hearing today, 
and continuing the Committee's work on the Commodity Futures Trading 
Commission's reauthorization.
    The last reauthorization, which began in May of 1999, resulted in 
three committees working for more than a year to report legislation to 
amend the Commodity Exchange Act and Federal securities law. Hopefully, 
this reauthorization will be significantly less complicated and 
controversial.
    Granted, some areas of controversy still exist in the areas of 
energy derivatives, sales of off-exchange forex instruments, single 
stock futures regulation, and the continuing globalization of 
electronic trading. I am hopeful, however, that we can sort these 
matters out by carefully considering the testimony submitted to this 
Committee.
    I am also confident in the CFTC's ability to police the derivatives 
markets. I believe the Commodity Futures Modernization Act set a course 
for the wise use of an array of risk management instruments by large 
and small businesses alike. While forming the basis of sound business 
practices in different venues, these instruments also remain cost-
effective.
    Additionally, I am heartened by the steady rise in the trading 
volumes on our nation's futures exchanges. The increased trade volumes 
provide evidence that our exchanges still offer a unique product that 
may be used efficiently and with reasonable safety. I also assume these 
rising volume numbers mean that financial services firms, offering 
tailored over-the-counter products to their customers, are laying some 
of their risk off on the organized exchanges.
    This morning, the CFTC released, Report on the Oversight of Trading 
on Regulated Futures Exchanges and Exempt Commercial Markets. This 
report is the result of CFTC's hearing on this topic, economic analysis 
by the Office of Chief Economist and the CFTC's internal deliberations 
and expertise on futures trading. I commend the CFTC for investing the 
resources needed to develop the recommendations and I look forward to 
Chairman Lukken expanding on them in his testimony.
    Thank you for the opportunity to offer some of my thoughts on this 
important legislative undertaking and I thank the witnesses for 
testifying here today.

    The Chairman. Thank you, sir.
    The Chair would request that other Members submit their 
opening statements for the record so that the witnesses may 
begin their testimony and ensure that we have ample time for 
questions.
    [The prepared statements of Mr. Walz and Mr. Graves 
follow:]

    Prepared Statement of Hon. Timothy J. Walz, a Representative in 
                        Congress From Minnesota
    Mr. Chairman, thank you for holding this hearing today on the 
reauthorization of the Commodity Futures Trading Commission.
    Since 1974, when the CFTC began to oversee trading in derivatives, 
it has been necessary for the CFTC to strike an appropriate balance to 
find the ``sweet spot'' of regulation that would protect investors but 
not stifle the industry.
    I am particularly interested to hear testimony today from Acting 
Chairman Lukken about foreign currency exchanges. Three years ago, the 
Zelener case limited the CFTC's ability to address foreign currency 
fraud and the question of what type of authority the CFTC should 
possess in this area is an important issue for many in the forex 
market.
    I have met with some of the stakeholders who are involved in the 
forex market and I believe I can speak to the perspective of many of 
them. They do not fear government regulation, they welcome it.
    Forex traders realize that there is a role for the government to 
play in creating a level playing field and making sure everyone plays 
by the rules. But what they do not want is heavy-handed regulation that 
will squelch a new market that is widely used by many investors 
overseas, but is just getting its footing in the United States.
    I think it is very important that Congress get this question right. 
It should not be our goal to treat every commodity the same when it 
comes to regulation. It should not be our goal to interfere with a 
market that is operating fairly and efficiently.
    Mr. Chairman, I look forward to the opportunity to hear the 
testimony of our witnesses today and the chance to ask them questions 
about how they believe forex regulation should be addressed.
                                 ______
                                 
  Prepared Statement of Hon. Sam Graves, a Representative in Congress 
                             From Missouri
    I want to thank the Chairman and Ranking Member for having this 
hearing today. I appreciate the opportunity to submit remarks to the 
record.
    Last month we heard from industry folks on reauthorization of the 
Commodity Exchange Act and they provided some useful insight on how we 
should proceed. Today, I look forward to hearing the recommendations of 
the Commodity Futures Trading Commission (CFTC) and working with them 
as we begin the reauthorization effort.
    I have reviewed Chairman Lukken's testimony and I am very pleased 
with some of the changes he is recommending, particularly in exempt 
commercial markets and in over-the-counter markets. I agree with his 
conclusion that more transparency is better for all parties involved. 
Additionally, I am pleased with the new position reporting 
recommendations he is suggesting and look forward to working with him 
and his staff along with the industry folks as we begin consideration 
of this important legislation.
    Last, I ask the CFTC to please comment on H.R. 3009, the Market 
Transparency Reporting of United States Transactions Act of 2007 that I 
introduced.
    I look forward to listening to the panelists today and moving 
forward with this reauthorization.

    The Chairman. We would like to welcome now to the panel, to 
the table our panelists, the Honorable Walter Lukken, Acting 
Chairman of the Commodity Futures Trading Commission and Ms. 
Orice Williams, Director of Financial Markets and Community 
Investment for the U.S. GAO. That's the United States 
Government Accountability Office. Mr. Lukken, please begin when 
you are ready and I would request if you would, please, try to 
summarize your full statement and each of your full statements 
will be entered into the record.

          STATEMENT OF THE HON. WALTER LUKKEN, ACTING
  CHAIRMAN, COMMODITY FUTURES TRADING COMMISSION, WASHINGTON, 
                              D.C.

    Mr. Lukken. Thank you, Mr. Chairman. Good afternoon, 
Chairman Etheridge, Ranking Member Moran and Members of the 
Subcommittee. I am pleased to appear on behalf of the Commodity 
Futures Trading Commission to discuss important issues 
surrounding our reauthorization.
    Seven years have passed since the passage of the Commodity 
Futures Modernization Act. During that expanse of time, 
significant changes occurred within the futures industry. Since 
2000, annual growth volume on U.S. futures exchanges have 
increased 442 percent. New exchanges are being created and new 
products are being invented on a daily basis. But perhaps the 
greatest shift in the futures industry is the undeniable fact 
that our markets are global. For firms and exchanges this is 
welcome news--more growth opportunities than ever before. But 
for regulators, this global repositioning means we must rethink 
how we do our jobs and adapt appropriately.
    Thankfully, with the passage of CFMA, Congress had the 
foresight to provide this agency with the tools needed to 
oversee this rapidly changing marketplace. Much has been made 
of the flexibility provided by the CFMA, but the adoption of a 
core principles approach equally enhanced the Commission's 
ability to get in front of the developing regulatory problems. 
At a time of scarce resources, this has allowed the CFTC to 
target our efforts effectively to areas where the risks to the 
public are the greatest. And I am pleased to report that, by 
and large, the legal framework of the CFMA is working 
extraordinarily well.
    That said, regulators and lawmakers cannot anticipate every 
evolution of these markets. With this recognition, I come 
before you today to discuss two broad areas for consideration. 
First, based on recommendations from the Commission presented 
today, Congress may wish to evaluate whether enhancements are 
necessary for the legal framework provided for exempt 
commercial markets. Second, Congress may want to review whether 
the CFTC has adequate authority to police retail fraud, 
particularly in the foreign currency area, and whether the 
penalty scheme for market manipulation reflects the severity of 
this economically disruptive behavior.
    The CFMA created a tiered regulatory structure for the 
futures industry which tailored requirements to the specific 
risks of the marketplace. Within this tiered design Congress 
created a light-touch regulatory category called exempt 
commercial markets or ECMs on which certain commodities such as 
energy products could be traded by institutional participants. 
Due primarily to the non-retail nature of these markets and the 
types of transactions executed policymakers believe the risks 
associated with the wholesale exchanges to be low.
    However, the energy markets have changed dramatically in 
the past 7 years and the Commission's regulation of these 
markets should evolve in kind. Although these exempt markets 
have increased competition, certain energy contracts offered on 
ECMs now function as virtual substitutes for contracts listed 
on regulated exchanges.
    Last month, the Commission convened a hearing to examine 
the oversight of trading on designated contract markets and 
ECMs. Commission staff, exchanges, ECMs, and industry and 
consumer groups testified before the Commission in a productive 
debate. Based on this hearing, the Commission presents to this 
Committee a report today detailing the Commission's findings 
and recommendations regarding these energy markets.
    As the Committee knows, under the CEA price discovery is 
the key determinate to Commission regulation, as others outside 
the marketplace begin to use prices to conduct business, such 
as farmers, utilities and others. Similarly, price discovery 
was the primary focus when the Commission began its review of 
ECMs.
    Testimony from the Commission's hearing and staff analysis 
on this subject has led us to conclude that certain natural gas 
products on the InterContinental Exchange and NYMEX function as 
virtual substitutes. Not only are the products substantially 
identical in terms and pricing, but the market participants are 
also the same, with all of the top 25 natural gas traders on 
NYMEX also trading significantly on ICE. Moreover, our economic 
analysis by staff show that trading activity in these products 
on ICE serves a significant price discovery function on 20 
percent of the trading days measured.
    Many witnesses from the hearing testified that ECMs provide 
a valuable platform for markets seeking a low-cost, effective 
``on-ramp'' to launch new ideas for contract design and 
trading. However, the reality that some ECM contracts are 
serving a significant price discovery function leads the 
Commission to conclude that changes to the CEA may be 
necessary.
    To that end, the Commission recommends that the CEA be 
amended so that when an ECM futures contract is determined to 
serve a significant price discovery function the Commission 
would have the authority to: one, require large trader position 
reporting for that contract; two, require an ECM to adopt 
position limits or accountability levels for that contract; 
three, an ECM to exercise self-regulatory responsibilities over 
that contract in preventing manipulation; and four, exercise 
emergency authorities regarding such transactions.
    These recommendations have the support of the entire 
Commission and will allow the agency to properly oversee price 
discovery contracts while keeping in place the tiered 
regulatory structure that has fostered innovation and 
competition in these global markets. As a member of the 
President's Working Group on Financial Markets, I have fully 
consulted with my colleagues on the Working Group regarding 
these recommendations and they are comfortable with our 
leadership on this issue.
    I now want to turn to another reauthorization matter, the 
issue of retail fraud in foreign currency trading. In 2004, the 
7th Circuit curtailed the Commission's ability to combat retail 
off-exchange foreign currency fraud. In the Zelener case, the 
court held that contracts at issue were not futures contracts, 
but rather a rolling spot contract that could not be the basis 
for CFTC fraud action. This has provided a potential road map 
to scam artists for evading the CFTC's fraud authority.
    In the last 7 years, The CFTC has brought 98 enforcement 
actions involving forex fraud and has been awarded more than $1 
billion in penalties involving more than 26,000 victims. 
Recently, however, because of the Zelener decision, the 
Commission has lost some key forex cases and now finds it more 
difficult to prosecute forex actions. Unless Congress clarifies 
the Commission's jurisdiction in this area, a large sector of 
retail fraud will remain effectively outside of the 
prosecutorial authority of the CFTC. The Commission believes 
that the consensus PWG language included in this Committee's 
last reauthorization would substantially address this problem.
    The Commission also asks Congress to clarify that the CFTC 
has fraud authority regarding off-exchange ``principal-to-
principal'' futures transactions. This is necessary to clarify 
our fraud authority regarding non-intermediated trades in light 
of a court decision that clouded our authority in this area. 
The House reauthorization bill of 2005 included language 
addressed this problem.
    In addition, the Commission asks Congress to enhance its 
penalty scheme for market manipulation to reflect the economic 
severity of such activity by increasing the maximum fine to $1 
million per violation and the maximum prison sentence to 10 
years.
    As the futures markets have grown in size and complexity, 
the Commission continues to evolve in kind using the regulatory 
tools provided by the CFMA and this Committee. However, the 
Commission's funding has remained static over the last few 
years while staffing levels have been decreasing to historic 
lows. The Commission has always done more with less but is 
currently stretched to the limit. In reauthorization, I am 
hopeful that Congress will support sufficient funding for the 
CFTC at a level that matches its regulatory expectations for 
this agency and the growth of these markets.
    I greatly appreciate the opportunity to testify before you 
today and look forward to any questions the Committee may have.
    [The prepared statement of Mr. Lukken follows:]

 Prepared Statement of Hon. Walter Lukken, Acting Chairman, Commodity 
              Futures Trading Commission, Washington, D.C.
    Good morning Chairman Etheridge, Ranking Member Moran and Members 
of the Subcommittee. I am pleased to appear on behalf of the Commodity 
Futures Trading Commission (Commission or CFTC) to discuss the 
important issues surrounding the reauthorization of the Commodity 
Exchange Act (CEA), the Commission's governing statute.
    Seven years have passed since the passage of the Commodity Futures 
Modernization Act (CFMA). During that expanse of time, significant 
change has occurred within the futures industry. In the past 7 years, 
the annual volume on U.S. futures exchanges increased 442 percent. This 
industry has witnessed accelerated migration from open outcry trading 
to electronic platforms, with screen-based trading now accounting for a 
significant majority of all futures volume. New exchanges are created 
and new products are invented on a daily basis. But perhaps the 
greatest shift in the futures industry is the undeniable fact that our 
markets are global. Advances in technology have expanded the playing 
field to include every place in which there are people who wish to 
participate. For firms and exchanges, this is welcome news--more growth 
opportunities than ever before. For the marketplace, it means increased 
liquidity and information coming into the price-discovery process. But 
for regulators, this global repositioning means we must rethink how we 
do our jobs and adapt appropriately.
    Thankfully, with the passage of the CFMA, Congress had the 
foresight to provide this agency with the flexible tools needed to 
oversee this rapidly changing marketplace. Before the principles-based 
regime implemented by the CFMA, some of the prescriptive rules written 
by the CFTC were virtually outdated on the day they were published. 
This was not the fault of the agency, but the reality of the 
marketplace. The nature of these markets is to innovate, compete and 
arbitrage opportunities with lightning speed. In crafting the CFMA, 
policymakers recognized that, instead of struggling against this 
dynamic, a regulatory structure should leverage these market 
characteristics to the advantage of the public interest and allow the 
agency to better anticipate change.
    Much has been made of the flexibility provided businesses by the 
CFMA, but the adoption of a core principles approach equally enhanced 
the Commission's ability to get in front of developing regulatory 
problems. At a time of scarce resources, this has allowed the CFTC to 
target our efforts effectively to areas where the risks to the public 
are greatest. Although global growth has made the agency busier now 
than at any time in its history, the principles-based approach adopted 
in the CFMA has been remarkably dynamic. I am pleased to report that, 
by and large, the legal framework of the Act is working extraordinarily 
well and no major revisions of the Act are needed.
    That said, regulators and lawmakers cannot anticipate every 
evolution of these markets. With this recognition, I come before you 
today to discuss two broad areas on which Congress may wish to focus 
during the reauthorization process. First, based on recommendations 
from the Commission presented today, Congress may wish to evaluate 
whether enhancements are necessary for the legal framework provided for 
exempt commercial markets. Second, Congress may want to review whether 
the CFTC has clear and adequate authority to police fraud, particularly 
in the foreign currency area, and whether the penalty scheme for market 
manipulations reflects the severity of this economically disruptive 
behavior.
Exempt Commercial Markets
    The CFMA created a tiered regulatory structure for the futures 
industry, which tailored regulatory requirements to the specific risks 
of the marketplace. This calibrated structure has provided the CFTC 
with flexibility and focus as we strive to keep pace with this 
industry's global growth.
    Within this tiered design, Congress created a light-touch 
regulatory category called Exempt Commercial Markets or ECMs, on which 
certain commodities, such as energy products, could be traded by 
institutional participants. Due primarily to the non-retail nature of 
these markets and the types of transactions executed, policymakers 
believed the risks associated with these institutional exchanges were 
low.
    However, the energy markets have changed dramatically in these 7 
years and the Commission's regulation of these markets should evolve in 
kind. Although these exempt markets have increased competition and 
lowered costs for derivatives trading, certain energy contracts offered 
on ECMs now function as virtual substitutes for contracts listed on 
regulated exchanges, with tight correlation and linking of prices and 
participants.
    With this as a backdrop, last month the Commission convened a 
hearing to examine the oversight of trading on designated contract 
markets (DCMs) and ECMs. Commission staff, exchanges, ECMs, and 
industry and consumer groups testified before the Commission in a 
productive debate of the relevant issues. Based on this hearing, the 
Commission presents to this Committee a report detailing the 
Commission's findings and recommendations regarding these energy 
markets.
    Today, I want to highlight some aspects of the Commission's hearing 
and the resulting findings and recommendations. As the Committee knows, 
Section 3 of the Commodity Exchange Act provides that the public 
interest is served through the proper regulation of markets that serve 
a price discovery function in interstate commerce. Price discovery is 
the key determinant to Commission regulation and oversight, as others 
outside the marketplace begin to use prices to conduct business, such 
as farmers, utilities and others. Similarly, price discovery was the 
primary focus of this agency when the Commission began its review of 
the regulatory structure of ECMs.
    Although ECMs have been evolving over time, the relatively recent 
linkage of ECM contract settlement prices to DCM futures contract 
settlement prices raises the question of whether the CFTC has the 
necessary authority to police these markets for manipulation and abuse. 
Linkage of contract settlement prices was not contemplated at the time 
of the CFMA nor at the time of the Commission's 2004 rulemaking 
regarding ECMs that perform a significant price discovery function. The 
CFTC staff is concerned that ECM cash-settled ``look-alike'' contracts 
could provide an incentive to manipulate the settlement price of the 
underlying DCM futures contract to benefit positions in the ``look-
alike'' ECM contract.
    Testimony from the Commission's hearing and staff analysis on this 
subject has led us to conclude that one ECM, the InterContinental 
Exchange (ICE), is serving a significant price discovery role and that 
ICE and the New York Mercantile Exchange (NYMEX) function as virtual 
substitutes for each other in certain key products. Not only are the 
products substantially identical in terms and pricing, but the market 
participants are also the same, with all of the top 25 natural gas 
traders on NYMEX also trading significantly on ICE. Moreover, economic 
analysis by our staff indicates that the trading activity in these 
products on ICE serves a significant price discovery function on 20 
percent of the trading days measured.
    Many witnesses from the hearing testified that ECMs provide a 
valuable platform for markets seeking a low-cost, effective ``on-ramp'' 
to launch new ideas for contract design and trading methodologies. ECMs 
serve as incubators for new concepts and provide robust competition 
with DCMs. This competition has spurred established DCMs to respond to 
ECM initiatives with innovations of their own, whether it is developing 
new products or accelerating the pace of automation.
    However, the reality that some ECM contracts are serving a 
significant price discovery function leads the Commission to conclude 
that changes to the CEA are necessary in order for the Commission to 
detect and prevent manipulation in these markets.
    It is critical that any legislative changes should not result in 
stifling the innovation and other benefits brought about by ECMs, that 
changes should not overcomplicate all already complicated statutory 
regime set out in the CEA, and that changes should be cost-effective 
for the Commission and industry to implement.
    To that end, the Commission recommends that the CEA be amended such 
that, upon a determination that an ECM futures contract serves a 
significant price discovery function, the Commission would have four 
new authorities: (1) Require large trader position reporting for that 
contract; (2) Require an ECM to adopt position limits or accountability 
levels for that contract; (3) Require an ECM to exercise self-
regulatory responsibility over that contract in preventing 
manipulation; and (4) Provide the ECM and the Commission with emergency 
authority over that contract.
    These recommendations have the support of the entire Commission and 
will allow the agency to oversee price discovery contracts while 
keeping in place the tiered regulatory structure that has fostered the 
innovation necessary for U.S. markets to compete effectively in the 
highly competitive global marketplace. As a member of the President's 
Working Group on Financial Markets (PWG), I have fully consulted with 
my colleagues on the PWG regarding these recommendations.
    In its report, the Commission recommends two other steps to keep 
abreast of the developing energy markets. First, the Commission 
recommends the agency establish an Energy Markets Advisory Committee to 
conduct periodic public meetings on issues affecting energy producers, 
distributors, market users and consumers in attempt to facilitate 
discussion and policy decisions as these markets evolve.
    Second, the Commission proposes that the CFTC and the Federal 
Energy Regulatory Commission (FERC) work together to develop best 
practices for utilities and others who use NYMEX settlement prices as 
benchmarks in pricing their energy products. Our agencies should also 
help develop best practices for these end-users of energy on how to 
utilize the futures and other derivatives markets in managing price 
risk and volatility.
    Today, the Commission also announced it has finalized its amendment 
to Regulation 18.05 clarifying its ability to obtain information from 
large traders in regulated markets regarding the full scope of their 
related positions, including over-the-counter transactions. This 
transparency serves as an important complement to the recommendations 
advanced today.
    I am confident that the Commission proposal strikes the right 
balance of ensuring that these markets remain free of manipulative 
conduct while allowing the markets to grow and innovate on U.S. soil.
The Zelener Decision/Foreign Currency Fraud
    In our commitment to protecting market participants and market 
integrity, I want to turn to the issue of retail fraud in foreign 
currency trading. In 2004, the Seventh Circuit Court of Appeals 
curtailed the Commission's ability to combat retail off-exchange 
foreign currency (forex) fraud. In the Zelener case, the court held 
that the contracts at issue were not futures contracts, but rather a 
type of spot contract that could not be the basis for a CFTC fraud 
action. This has provided a potential road map to scam artists as to 
how to deceive innocent retail customers while evading enforcement by 
the CFTC.
    The CFTC believes that the Zelener case and others that have 
followed it were incorrectly decided and that the contracts at issue 
are futures contracts. Rather than continue to expend scarce Commission 
resources litigating this issue, however, we present to Congress the 
opportunity to restore legal certainty by clarifying the CFTC's 
jurisdiction in this area.
    In the last 7 years, the CFTC has brought 98 enforcement actions 
involving forex fraud against unsuspecting retail customers. In these 
98 cases, there were approximately 26,000 victims who invested 
approximately $461 million. Courts have awarded more than $1 billion 
($1,000,917,086) in customer restitution and civil penalties in these 
cases. However, because of the Zelener decision and its progeny, the 
Commission has lost some key forex cases and now finds it is more 
difficult to prosecute forex actions. Unless Congress clarifies the 
Commission's jurisdiction over off-exchange forex transactions, a large 
sector of retail fraud will remain effectively outside of the 
prosecutorial authority of the CFTC.
    In November 2005, the PWG submitted to Congress a narrowly tailored 
proposal to allow the Commission to prosecute forex fraud cases. The 
proposal would require those who participate in the solicitation of 
retail forex transactions to register with the CFTC. It would also 
close a loophole that allowed firms to notice register as securities 
broker-dealers and serve as counterparties to off-exchange forex 
transactions. Last, the proposal would bolster the CFTC's anti-fraud 
authority over retail off-exchange forex transactions like those in 
dispute in the Zelener case. This narrow fix is endorsed by the PWG and 
was included in the reauthorization bill that this Committee and the 
House of Representatives passed in 2005.
Principal-to-Principal Antifraud Authority
    The Commission also submits to this Committee that it may wish to 
address an important issue relating to the CFTC's antifraud authority 
for futures contracts. Congress should clarify that CEA Section 4b, the 
CFTC's main antifraud provision, gives the CFTC the authority to bring 
fraud actions in off-exchange ``principal-to-principal'' futures 
transactions. This clarification is necessary to eliminate a potential 
obstacle to the use of the CFTC's antifraud authority in today's non-
intermediated markets.
    In late November 2000, the Seventh Circuit Court of Appeals 
suggested that the CFTC may be able to use Section 4b only in 
``intermediated'' transactions--i.e., those involving a broker-customer 
relationship. In other words, the court indicated that the CFTC may not 
be able to use its Section 4b antifraud authority in principal-to-
principal transactions. Meanwhile, at about the same time, the CFMA was 
enacted to permit off-exchange futures transactions entered into on a 
principal-to-principal basis, such as energy transactions pursuant to 
CEA Sections 2(h)(1) and 2(h)(3). Congress specifically reserved the 
CFTC's Section 4b antifraud authority in Section 2(h) of the CEA so 
that the CFTC could prosecute fraud involving transactions conducted 
under that Section. Since all Section 2(h) transactions must be done on 
a principal-to-principal basis to qualify for the exemption, it is 
important to clarify that the CFTC's Section 4b antifraud authority 
applies to these non-intermediated transactions. Without this 
clarification, the work of Congress in 2000 to protect energy markets 
from fraud could be rendered meaningless.
    Accordingly, the House reauthorization bill of 2005 would have 
amended subsection 4b(a)(2) by adding the words ``or with'' in order to 
address off-exchange principal-to-principal transactions. This new 
language would make it clear that the CFTC has the authority to bring 
antifraud actions in off-exchange, principal-to-principal futures 
transactions, including exempt commodity transactions in energy under 
Section 2(h). This amendment to Section 4b would implement 
Congressional intent to reserve the CFTC's antifraud authority with 
regard to these transactions.
    I note that the Section 4b language was supported by the Futures 
Industry Association, the National Futures Association, the Chicago 
Mercantile Exchange, the Chicago Board of Trade, the NYMEX, USFE, and 
others during the last attempt at reauthorization.
    In addition, the Commission asks Congress to enhance its penalty 
scheme for market manipulation to reflect the economic severity of such 
activity as well as the importance of protecting these markets. The 
Commission recommends amending the CEA to increase the civil and 
criminal penalties available for certain violations of the CEA such as 
manipulation, false reporting, and conversion. The maximum fines under 
Section 9 should be increased to $1 million, and the maximum prison 
sentence should be increased from 5 to 10 years. The Commission also 
recommends certain conforming amendments to the enforcement provisions 
in Sections 6(c), 6b, and 6c of the CEA to effectuate this increase in 
civil monetary penalties. Increasing the civil penalties that may be 
imposed for manipulation to $1 million would conform the CEA to the 
penalty provisions that Congress enacted in the Energy Policy Act of 
2005 for manipulation cases brought by the FERC with respect to the 
physical energy markets.
Conclusion
    The CFTC has been able to work within the current structure of the 
CEA to oversee futures markets, to ensure the integrity of the price 
discovery mechanism, to maintain the financial integrity of the 
markets, and to protect customers. The CFTC stands ready to offer its 
assistance as Congress moves through the reauthorization process and 
considers these various options.
    As the futures markets have grown in size and complexity, the 
Commission continues to evolve in the administration of its duties. 
However, the Commission's funding has remained static over the past few 
years, while staff levels have decreased to historically low levels. 
The Commission has always done more with less, but it is currently 
stretched to the limit. In reauthorization, Congress should be mindful 
of the resources that are needed to fulfill the Commission's mandate. I 
am hopeful that Congress will support sufficient funding of the CFTC at 
a level that matches its regulatory expectations for this agency and 
the growth of these markets.
    My fellow Commissioners and I welcome this opportunity to work with 
you on the reauthorization of the CFTC. I greatly appreciate the 
opportunity to testify before you today on this important matter and 
would be pleased to answer any questions that the Committee may have.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


    The Chairman. Thank you, sir.
    Before we move on I would ask unanimous consent of the 
Members that Mr. Barrow may sit with this Committee today. 
Without objection.
    Ms. Williams.

STATEMENT OF ORICE M. WILLIAMS, DIRECTOR, FINANCIAL MARKETS AND 
                   COMMUNITY INVESTMENT, U.S.
       GOVERNMENT ACCOUNTABILITY OFFICE, WASHINGTON, D.C.

    Ms. Williams. Mr. Chairman, Ranking Member and Members of 
the Subcommittee, I am pleased to be here today to discuss our 
recently issued report on the trading of derivatives for energy 
commodities, and the scope of CFTC's authority and oversight.
    As you well know, recent increases in energy prices have 
raised questions about the reasons for the increase and the 
scope of CFTC's authority over certain markets. Our work 
revealed that both derivatives energy markets and physical 
commodities markets have undergone substantial change and 
growth. For example, trading volume both on and off-exchange 
has grown tremendously as new traders have been attracted to 
these markets in search of higher returns. However, this growth 
in off-exchange trading has also resulted in questions about 
the scope of CFTC's authority over these markets, particularly 
certain exempt commercial markets which are subject to less 
regulation and oversight than regulated exchanges.
    Our report addresses certain questions about trends and 
changes in the market and the scope of CFTC's authority in 
enforcement activities in energy markets. Briefly, I would like 
to highlight a few of our findings and recommendations.
    Energy products are traded on futures exchanges, exempt 
commercial markets and over-the-counter or OTC markets. By 
design, each market is subject to varying levels of CFTC 
oversight with some markets largely unregulated. As you know, 
under the Commodity Exchange Act CFTC regulatory oversight is 
focused on surveillance of futures exchanges to protect the 
public and ensure the integrity of the market. Conversely, both 
the exempt commercial market and the OTC market are exempt from 
general CFTC oversight. However, both markets are subject to 
CFTC's enforcement of the CEA's anti-manipulation, and where 
applicable, antifraud provisions.
    This tiered structure results in CFTC having varied access 
to trading information depending on the market. That is, for 
regulated exchanges CFTC receives daily trading information. 
For exempt commercial markets, CFTC has authority to request 
information as needed, and for bilateral contracts, CFTC 
routinely receives no information. Changes in some markets, 
notably the natural gas market, have raised questions about 
whether the oversight of certain markets is sufficient.
    While the report recommends that Congress continue to 
consider the scope of CFTC's authority as part of the 
reauthorization process, we also made a number of 
recommendations to CFTC to help improve its operations, 
including improving the transparency of certain trader 
reporting information, better documenting its surveillance 
activities, and developing more meaningful performance-based 
measures for its enforcement program. And we commend CFTC for 
taking steps to address these recommendations.
    However, the larger policy issues are much more complicated 
to solve and require ongoing debate and study. Therefore, as 
this Subcommittee and others in Congress continue to explore 
and debate policy alternatives for the scope of CFTC's 
authority, additional information is needed to understand what 
may need to be done to best protect investors from fraudulent, 
manipulative and abusive practices.
    Such questions include: How different or more similar are 
the characteristics and uses of exchange and off-exchange 
products being traded, and are the differences still justified? 
To what extent does trading off-exchange effect price discovery 
and what are the regulatory implications? How much of an impact 
are non-traditional market participants, such as commodity 
index funds having on these markets? And finally, are energy 
markets unique or are these issues also relevant to other 
commodities markets, and if so how do you ensure equitable 
treatment? By answering these questions, information would be 
available to assess which, if any, changes should be made to 
CFTC's tiered oversight structure.
    Mr. Chairman, this concludes my prepared statement. I would 
be happy to respond to any questions that you or other Members 
of the Subcommittee may have. Thank you.
    [The prepared statement of Ms. Williams follows:]

 Prepared Statement of Orice M. Williams, Director, Financial Markets 
    and Community Investment, U.S. Government Accountability Office,
                            Washington, D.C.
Commodity Futures Trading Commission
Trends in Energy Derivatives Markets Raise Questions About CFTC's 
        Oversight
Why GAO Did This Study
    Energy prices for crude oil, heating oil, unleaded gasoline, and 
natural gas have risen substantially since 2002, generating questions 
about the role derivatives markets have played and the scope of the 
Commodity Futures Trading Commission's (CFTC) authority. This testimony 
focuses on (1) trends and patterns in the futures and physical energy 
markets and their effects on energy prices, (2) the scope of CFTC's 
regulatory authority, and (3) the effectiveness of CFTC's monitoring 
and detection of abuses in energy markets. The testimony is based on 
the GAO report, Commodity Futures Trading Commission: Trends in Energy 
Derivatives Markets Raise Questions about CFTC's Oversight (GAO-08-25, 
October 19, 2007). For this work, GAO analyzed futures and large trader 
data and interviewed market participants, experts, and officials at six 
Federal agencies.
What GAO Recommends
    As part of CFTC's reauthorization process, GAO recommended that 
Congress consider exploring the scope of the agency's authority over 
energy derivatives trading, in particular for trading in exempt 
commercial markets. In addition, GAO recommends that CFTC improve the 
usefulness of the information provided to the public, better document 
its monitoring activities, and develop more outcome-oriented 
performance measures for its enforcement program. CFTC generally agreed 
with GAO's recommendations.
    To view the full product, including the scope and methodology, 
click on GAO-08-174T. For more information, contact Orice Williams at 
(202) 512-8678 or [email protected].
What GAO Found
    Various trends in both the physical and futures markets have 
affected energy prices. Specifically, tight supply and rising demand in 
the physical markets contributed to higher prices as global demand for 
oil has risen rapidly while spare production capacity has fallen since 
2002. Moreover, increased political instability in some of the major 
oil-producing countries has threatened the supply of oil. During this 
period, increasing numbers of noncommercial participants became active 
in the futures markets (including hedge funds) and the volume of energy 
futures contracts traded also increased. Simultaneously, the volume of 
energy derivatives traded outside of traditional futures exchanges 
increased significantly. Because these developments took place 
concurrently, the effect of any individual trend or factor on energy 
prices is unclear.
    Under the authority granted by the Commodity Exchange Act (CEA), 
CFTC focuses its oversight primarily on the operations of traditional 
futures exchanges, such as the New York Mercantile Exchange, Inc. 
(NYMEX), where energy futures are traded. Increasing amounts of energy 
derivatives trading also occur on markets that are largely exempt from 
CFTC oversight. For example, exempt commercial markets conduct trading 
on electronic facilities between large, sophisticated participants. In 
addition, considerable trading occurs in over-the-counter (OTC) markets 
in which eligible parties enter into contracts directly, without using 
an exchange. While CFTC can act to enforce the CEA's antimanipulation 
and antifraud provisions for activities that occur in exempt commercial 
and OTC markets, some market observers question whether CFTC needs 
broader authority to more routinely oversee these markets. CFTC is 
currently examining the effects of trading in the regulated and exempt 
energy markets on price discovery and the scope of its authority over 
these markets--an issue that will warrant further examination as part 
of the CFTC reauthorization process.
    CFTC conducts daily surveillance of trading on NYMEX that is 
designed to detect and deter fraudulent or abusive trading practices 
involving energy futures contracts. To detect abusive practices, such 
as potential manipulation, CFTC uses various information sources and 
relies heavily on trading activity data for large market participants. 
Using this information, CFTC staff may pursue alleged abuse or 
manipulation. However, because the agency does not maintain complete 
records of all such allegations, determining the usefulness and extent 
of these activities is difficult. In addition, CFTC's performance 
measures for its enforcement program do not fully reflect the program's 
goals and purposes, which could be addressed by developing additional 
outcome-based performance measures that more fully reflect progress in 
meeting the program's overall goals. Because of changes and innovations 
in the market, the reports that CFTC receives on market activities may 
no longer be accurate because they use categories that do not 
adequately separate trading being done for different reasons by various 
market participants.

    Mr. Chairman and Members of the Subcommittee:

    I am pleased to be here today to discuss our recent report on the 
trading of derivatives for energy commodities, including crude oil and 
natural gas, and the Commodity Futures Trading Commission's (CFTC) 
oversight of these markets.\1\ The expansion of derivatives trading in 
energy markets, particularly by participants such as hedge funds, and 
rapid growth in trading off regulated exchanges have raised questions 
about the quality and quantity of reporting on and oversight of these 
trading activities.\2\
---------------------------------------------------------------------------
    \1\ GAO, Commodity Futures Trading Commission: Trends in Energy 
Derivatives Markets Raise Questions about CFTC's Oversight, GAO-08-25 
(Washington, D.C.: Oct. 19, 2007).
    \2\ Our analysis of energy prices and energy financial markets is 
generally limited to the time period from January 2002 through December 
2006.
---------------------------------------------------------------------------
    Specifically, I will discuss (1) trends in the physical and energy 
derivatives markets and their effect on energy prices, (2) the scope of 
CFTC's authority for protecting market users in the trading of energy 
derivatives, and (3) CFTC's monitoring and detection of market abuses 
in energy futures markets. I should point out that our review was 
intended to identify trends in both the physical and derivatives energy 
markets and to provide information on the current regulatory structure 
for energy derivatives trading, including analyzing the various 
perspectives of market participants on these issues. While our report 
frames issues that need to be addressed, we do not offer specific 
policy solutions.
    During the course of our review, we obtained and analyzed energy 
futures prices and trading volumes from the New York Mercantile 
Exchange, Inc. (NYMEX). Specifically, we collected data for crude oil, 
heating oil, natural gas, and unleaded gas from January 2002 through 
December 2006. We also analyzed data obtained from CFTC on market 
participants and the outstanding trading positions of different 
categories of traders. We reviewed publicly available information, 
including academic studies and reports and market data. Finally, we 
interviewed a broad range of market participants and observers, 
representatives of energy trading markets, and government regulators 
and agencies involved with the energy markets. This work was done in 
accordance with generally accepted government auditing standards.
Summary
    Physical and derivatives markets for crude oil, unleaded gasoline, 
heating oil, and natural gas have experienced substantial changes in 
recent years. Within the physical market, tight supply and rising 
global demand, ongoing political instability in oil-producing regions, 
limited refining capacity, and other supply disruptions all contributed 
to higher prices. While these changes were occurring in the physical 
markets, in the derivatives markets volatility of energy prices 
generally remained above historic averages for most of the period but 
declined during 2006 to levels at or near the historical average. 
Moreover, trading volumes for futures increased, at least in part 
because a growing number of managed-money traders (including hedge 
funds) began to see energy futures as attractive investment 
alternatives. Another change occurring during this time was the 
increased trading of energy derivatives outside the organized 
exchanges. Trading in these markets--specifically electronic commercial 
markets and over-the-counter (OTC) markets--is much less transparent 
than trading on futures exchanges, and comprehensive data are not 
available because these energy markets are not regulated. Given that 
the developments in the physical and derivatives markets were occurring 
simultaneously, determining their effect on energy prices is difficult. 
Continued monitoring of the various factors that affect market prices, 
and how those factors are changing, will be important in protecting the 
public and ensuring market integrity.
    Energy derivatives are traded on futures exchanges and off-exchange 
in exempt commercial and OTC markets.\3\ Exempt commercial markets are 
electronic trading facilities that trade exempt commodities, including 
energy commodities, on a principal-to-principal basis solely between 
commercial entities meeting certain eligibility requirements. In the 
OTC markets, parties meeting certain requirements can enter into 
bilateral energy derivatives transactions. Unlike the futures 
exchanges, which are subject to comprehensive oversight by CFTC, exempt 
commercial markets and OTC markets are not subject to general CFTC 
oversight, although CFTC can enforce the CEA's antimanipulation 
provisions and, where applicable, the antifraud provisions. To provide 
transparency about trading on the futures exchanges, CFTC routinely 
publicly reports aggregate information on trading by large commercial 
(such as oil companies, refineries, and other hedge traders) and 
noncommercial (such as hedge funds) participants that occurs on the 
exchanges. However, in the way the data are currently categorized, no 
distinction is made between commercial traders who use the exchanges to 
hedge their positions in the physical markets and those commercial 
traders, such as investment banks, who trade futures to hedge their 
trading in off-exchange derivatives. Given the developments and growth 
in the energy trading markets, questions have been raised over whether 
CFTC needs broader authority over the off-exchange derivative markets, 
particularly those involving exempt commodities and exempt commercial 
markets.
---------------------------------------------------------------------------
    \3\ Energy swap transactions also may be conducted off-exchange if 
they satisfy the requirements for excluded swap transactions contained 
in section 2(g) of the Commodity Exchange Act.
---------------------------------------------------------------------------
    At an operational level, we also reported that while CFTC conducts 
reporting, surveillance, and enforcement activities in the energy 
markets to help provide transparency to the public, detect fraudulent 
or manipulative trading practices, and deter abuses, the effectiveness 
of these efforts is unclear. For example:

   Although CFTC monitors exchange trading activity through its 
        surveillance program and gathers additional information from 
        NYMEX officials, traders, or other sources to determine if 
        further action is warranted, staff did not routinely document 
        the results of these inquiries. Instead, they kept formal 
        records of their findings only in cases in which improper 
        trading was identified. As a result, CFTC may be limiting its 
        opportunities to identify trends and its ability to measure the 
        extent and usefulness of its monitoring activities.

   We also found that CFTC has successfully pursued energy-
        related cases, but we were not able to determine how 
        effectively CFTC's enforcement activities were in identifying 
        violations and deterring misconduct because the agency lacked 
        meaningful outcome-based measures.

    Our report includes a matter for Congressional consideration and 
three recommendations to CFTC. In light of recent developments and the 
uncertainty over the adequacy of CFTC's oversight, we recommend that 
Congress, as part of the CFTC reauthorization process, further explore 
whether the current regulatory structure for energy derivatives, in 
particular for those traded in exempt commercial markets, adequately 
provides for fair trading and accurate pricing of energy commodities. 
To improve the transparency of market activities and the functioning of 
CFTC's oversight, we recommend that CFTC reconsider how information it 
publishes in trading reports for energy products could be improved and 
CFTC has agreed to reexamine the classifications used in these reports. 
CFTC also agreed with our recommendations aimed at better documenting 
its surveillance activities and developing more outcome-based 
performance measures and has taken steps to implement them.
Background
    Energy commodities are bought and sold on both the physical and 
financial markets. The physical market includes the spot market where 
products such as crude oil or gasoline are bought and sold for 
immediate or near-term delivery by producers, wholesalers, and 
retailers. Spot transactions take place between commercial participants 
for a particular energy product for immediate delivery at a specific 
location. For example, the U.S. spot market for West Texas Intermediate 
crude oil is the pipeline hub near Cushing, Oklahoma, while a major 
spot market for natural gas operates at the Henry Hub near Erath, 
Louisiana. The prices set in the specific spot markets provide a 
reference point that buyers and sellers use to set the price for other 
types of the commodity traded at other locations.
    In addition to the spot markets, derivatives based on energy 
commodities are traded in financial markets. The value of the 
derivative contract depends on the performance of the underlying 
asset--for example, crude oil or natural gas. Derivatives include 
futures, options, and swaps. Energy futures include standardized 
exchange-traded contracts for future delivery of a specific crude oil, 
heating oil, natural gas, or gasoline product at a particular spot 
market location. An exchange designated by CFTC as a contract market 
standardizes the contracts. The owner of an energy futures contract is 
obligated to buy or sell the commodity at a specified price and future 
date. However, the contractual obligation may be removed at any time 
before the contract expiration date if the owner sells or purchases 
other contracts with terms that offset the original contract. In 
practice, most futures contracts on NYMEX are liquidated via offset, so 
that physical delivery of the underlying commodity is relatively rare.
    Market participants use futures markets to offset the risk caused 
by changes in prices, to discover commodity prices, and to speculate on 
price changes. Some buyers and sellers of energy commodities in the 
physical markets trade in futures contracts to offset or ``hedge'' the 
risks they face from price changes in the physical market. Exempt 
commercial markets and OTC derivatives are also used to hedge this 
risk. The ability to reduce their price risk is an important concern 
for buyers and sellers of energy commodities, because wide fluctuations 
in cash market prices introduce uncertainty for producers, 
distributors, and consumers of commodities and make investment 
planning, budgeting, and forecasting more difficult. To manage price 
risk, market participants may shift it to others more willing to assume 
the risk or to those having different risk situations. For example, if 
a petroleum refiner wants to lower its risk of losing money because of 
price volatility, it could lock in a price by selling futures contracts 
to deliver the gasoline in 6 months at a guaranteed price. Without 
futures contracts to manage risk, producers, refiners, and others would 
likely face greater uncertainty.
    By establishing prices for future delivery, the futures market also 
helps buyers and sellers determine or ``discover'' the price of 
commodities in the physical markets, thus linking the two markets 
together. Markets are best able to perform price discovery when (1) 
participants have current information about the fundamental market 
forces of supply and demand, (2) large numbers of participants are 
active in the market, and (3) the market is transparent. Market 
participants monitor and analyze a myriad of information on the factors 
that currently affect and that they expect to affect the supply of and 
demand for energy commodities. With that information, participants buy 
or sell an energy commodity contract at the price they believe the 
commodity will sell for on the delivery date. The futures market, in 
effect, distills the diverse views of market participants into a single 
price. In turn, buyers and sellers of physical commodities may consider 
those predictions about future prices, among other factors, when 
setting prices on the spot and retail markets.
    Other participants, such as investment banks and hedge funds, which 
do not have a commercial interest in the underlying commodities, 
generally use the futures market for profit. These speculators provide 
liquidity to the market but also take on risks that other participants, 
such as hedgers, seek to avoid. In addition, arbitrageurs attempt to 
make a profit by simultaneously entering into several transactions in 
multiple markets in an effort to benefit from price discrepancies 
across these markets.
Several Factors Have Caused Changes in the Energy Markets, Potentially 
        Affecting Energy Prices
    The physical markets for energy commodities underwent change and 
turmoil from 2002 through 2006, which affected prices in the spot and 
futures markets. We reported that numerous changes in both the physical 
and futures markets may have affected energy prices. However, because 
these changes occurred simultaneously, identifying the specific effect 
of any one of these changes on energy prices is difficult.
Various Changes in the Physical Market Contributed to Rising Prices
    The physical energy markets have undergone substantial change and 
turmoil during this period, which can affect spot and futures markets. 
Like many others, we found that a number of fundamental supply and 
demand conditions can affect prices. According to the Energy 
Information Administration (EIA), world oil demand has grown since 1983 
from a low of about 59 million barrels per day in 1983 to more than 85 
million barrels per day in 2006 (fig. 1). While the United States 
accounts for about a quarter of this demand, rapid economic growth in 
Asia also has stimulated a strong demand for energy commodities. For 
example, EIA data show that during this time frame, China's average 
daily demand for crude oil increased almost fourfold.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        Source: GAO analysis of EIA data.
        Note: The world oil demand data for 2006 represent a 
        preliminary estimate.

    The growth in demand does not, by itself, lead to higher prices for 
crude oil or any other energy commodity. For example, if the growth in 
demand were exceeded by a growth in supply, prices would fall, other 
things remaining constant. However, according to EIA, the growth in 
demand outpaced the growth in supply, even with spare production 
capacity included in supply. Spare production capacity is surplus oil 
that can be produced and brought to the market relatively quickly to 
re-balance the market if there is a supply disruption anywhere in the 
world oil market. As shown in figure 2, EIA estimates that global spare 
production capacity in 2006 was about 1.3 million barrels per day, 
compared with spare capability of about 10 million barrels per day in 
the mid-1980s and about 5.6 million barrels a day as recently as 2002.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        Source: GAO analysis of EIA data.

    Major weather and political events also can lead to supply 
disruptions and higher prices. In its analysis, EIA has cited the 
following examples:

   Hurricanes Katrina and Rita removed about 450,000 barrels 
        per day from the world oil market from June 2005 to June 2006.

   Instability in major oil-producing countries of the 
        Organization of Petroleum Exporting Countries (OPEC), such as 
        Iran, Iraq, and Nigeria, have lowered production in some cases 
        and increased the risk of future production shortfalls in 
        others.

   Oil production in Russia, a major driver of non-OPEC supply 
        growth during the early 2000s, was adversely affected by a 
        worsened investment climate as the government raised export and 
        extraction taxes.

    The supply of crude oil affects the supply of gasoline and heating 
oil, and just as production capacity affects the supply of crude oil, 
refining capacity affects the supply of those products distilled from 
crude oil. As we have reported, refining capacity in the United States 
has not expanded at the same pace as the demand for gasoline.\4\ 
Inventory, another factor affecting supplies and therefore prices, is 
particularly crucial to the supply and demand balance, because it can 
provide a cushion against price spikes if, for example, production is 
temporarily disrupted by a refinery outage or other event. Trends 
toward lower levels of inventory may reduce the costs of producing 
gasoline, but such trends also may cause prices to be more volatile. 
That is, when a supply disruption occurs or there is an increase in 
demand, there are fewer stocks of readily available gasoline to draw 
on, putting upward pressure on prices.
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    \4\ GAO, Motor Fuels: Understanding the Factors That Influence the 
Retail Price of Gasoline, GAO-05-525SP (Washington, D.C.: May 2005).
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    Another consideration is that the value of the U.S. dollar on open 
currency markets could affect crude oil prices. For example, because 
crude oil is typically denominated in U.S. dollars, the payments that 
oil-producing countries receive for their oil also are denominated in 
U.S. dollars. As a result, a weak U.S. dollar decreases the value of 
the oil sold at a given price, and oil-producing countries may wish to 
increase prices for their crude oil in order to maintain the purchasing 
power in the face of a weakening U.S. dollar to the extent they can.
The Effect on Prices of Relatively High but Falling Volatility and a 
        Growing Volume of Trading in Derivatives Is Unclear
    As you can see, conditions in the physical markets have undergone 
changes that can help explain at least some of the increases in both 
physical and derivatives commodity prices. As we have previously 
reported, futures prices typically reflect the effects of world events 
on the price of the underlying commodity such as crude oil.\5\ For 
example, political instability and terrorist acts in countries that 
supply oil create uncertainties about future supplies, which are 
reflected in futures prices. Conversely, news about a new oil discovery 
that would increase world oil supply could result in lower futures 
prices. In other words, changes in the physical markets influence 
futures prices.
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    \5\ GAO-05-525SP.
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    At the same time that physical markets were undergoing changes, we 
found that financial markets also were amidst change and evolution. For 
example, the annual historical volatilities between 2000 and 2006--
measured using the relative change in daily prices of energy futures--
generally were above or near their long-term averages, although crude 
oil and heating oil declined below the average and gasoline declined 
slightly at the end of that period. We also found that the annual 
volatility of natural gas fluctuated more widely than that of the other 
three commodities and increased in 2006 even though prices largely 
declined from the levels reached in 2005. Although higher volatility is 
often equated with higher prices, this pattern illustrates that an 
increase in volatility does not necessarily mean that price levels will 
increase. In other words, price volatility measures the variability of 
prices rather than the direction of the price changes.
    Elsewhere in the futures market, we found an increase in the number 
of noncommercial traders such as managed money traders.\6\ Attracted in 
part by the trends in prices and volatility, a growing number of 
traders sought opportunities to hedge against those changes or profit 
from them. Using CFTC's large trader data, we found that from July 2003 
to December 2006, crude oil futures and options contracts experienced 
the most dramatic increase, with the average number of noncommercial 
traders more than doubling from about 125 to about 286. As shown in 
figure 3, while the growth was less dramatic in the other commodities, 
the average number of noncommercial traders also showed an upward trend 
for unleaded gasoline, heating oil, and natural gas.
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    \6\ CFTC collects data on traders holding positions at or above 
specific reporting levels set by the Commission. This information is 
collected as part of CFTC's large trader reporting system.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

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        Source: GAO analysis of CFTC data.

    Not surprisingly, our work also revealed that as the number of 
traders increased, so did the trading volume on NYMEX for all energy 
futures contracts, particularly crude oil and natural gas. Average 
daily contract volume for crude oil increased by 90 percent from 2001 
through 2006, and natural gas increased by just over 90 percent. 
Unleaded gasoline and heating oil experienced less dramatic growth in 
their trading volumes over this period.
    While much harder to quantify, another notable trend was the 
significant increase in the amount of energy derivatives traded outside 
exchanges. Trading in these markets is much less transparent, and 
comprehensive data are not available because these energy markets are 
not regulated. However, using the Bank for International Settlements 
data as a rough proxy for trends in the trading volume of OTC energy 
derivatives, the face value or notional amounts outstanding of OTC 
commodity derivatives excluding precious metals, such as gold, grew 
from December 2001 to December 2005 by more than 850 percent to over 
$3.2 trillion.\7\
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    \7\ The Bank for International Settlements is an international 
organization that fosters international monetary and financial 
cooperation and serves as a bank for central banks.
---------------------------------------------------------------------------
    Further, while some market observers believe that managed money 
traders were exerting upward pressure on prices by predominantly buying 
futures contracts, CFTC data we analyzed revealed that from the middle 
of 2003 through the end of 2006, the trading activity of managed money 
participants became increasingly balanced between buying (those that 
expect prices to go up) and selling (those that expect prices to go 
down). Using CFTC large trader reporting data, we found that from July 
2003 through December 2006, managed money traders' ratio of buying 
(long) to selling (short) open interest positions was 2.5:1 indicating 
that on the whole, this category of participants was 2.5 times as 
likely to expect prices to rise as opposed to fall throughout that 
period, which they did. However, as figure 4 illustrates, by 2006, this 
ratio fell to 1.2:1, suggesting that managed money traders as a whole 
were more evenly divided in their expectations about future prices. As 
you can see, managed money trading in unleaded gasoline, heating oil, 
and natural gas showed similar trends.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        Source: GAO analysis of CFTC data.
        Note: Data for 2003 were for July through December. The 
        percentages indicate what portion of long and short open 
        interest was held by managed money traders. For example, in 
        2004, managed money traders held 14.5 percent of the total long 
        open interest for crude oil and 7.1 percent of the total short 
        open interest. Because data are not included for all categories 
        of traders, the percentages for these three categories within a 
        particular period do not total 100. These data should be viewed 
        as a general overview of managed money traders' positions. They 
        do not provide insights into how traders' individual positions 
        changed over time. Our data for 2006 include contract trading 
        data for NYMEX reformulated gasoline blendstock (RB) and for 
        the NYMEX gasoline contract (HU) that began to replace RB.

    Overall, we found that views were mixed about whether these trends 
put any upward pressure on prices. Some market participants and 
observers have concluded that large purchases of oil futures contracts 
by speculators could have created an additional demand for oil that 
could lead to higher prices. Conversely, some Federal agencies and 
other market observers took the position that speculative trading 
activity did not have a significant impact on prices. For example, an 
April 2005 CFTC study of the markets concluded that increased trading 
by speculative traders, including hedge funds, did not lead to higher 
energy prices or volatility. This study also argued that hedge funds 
provided increased liquidity to the market and dampened volatility. 
Still others told us that while speculative trading in the futures 
market could contribute to short-term price movements in the physical 
markets, they did not believe it was possible to sustain a speculative 
``bubble'' over time, because the two markets were linked and both 
responded to information about changes in supply and demand caused by 
such factors as the weather or geographical events. In the view of 
these observers and market participants, speculation could not lead to 
artificially high or low prices over a long period.
CFTC Oversees Exchanges and Has Limited Authority Over Other 
        Derivatives Markets
    Under CEA, CFTC's authority for protecting market users from 
fraudulent, manipulative, and abusive practices in energy derivatives 
trading is primarily focused on the operations of traditional futures 
exchanges, such as NYMEX, where energy futures are traded. Off exchange 
markets, which are available only to eligible traders of certain 
commodities under specified conditions, are not regulated, although 
CFTC may enforce antimanipulation and antifraud provisions of the CEA 
with respect to trading in those markets. The growth in trading off-
exchange has raised questions about the sufficiency of CFTC's limited 
authority over these markets. These changes and innovations also have 
brought into question the methods CFTC uses to categorize published 
data about futures trading by participants in the off-exchange markets 
and whether information about their activities in off-exchange markets 
would be useful to the public. CFTC is taking steps to better 
understand these issues. Most importantly, it is currently examining 
the relationship between trading in the regulated and exempt energy 
markets and the role this trading plays in the price discovery process. 
It is also examining the sufficiency of the scope of its authority over 
these markets--an issue that will warrant further examination as part 
of the CFTC reauthorization process.
CFTC Has General Oversight Authority Over Futures Exchanges, but 
        Information on These Exchanges Reported to the Public Has Not 
        Kept Pace With Changing Market Conditions
    To help provide transparency in the markets, CFTC provides the 
public information on open interest in exchange-traded futures and 
options by commercial and noncommercial traders for various commodities 
in its weekly Commitment of Traders (COT) reports.\8\ As we reported, 
CFTC observed that the exchange-traded derivatives markets, as well as 
trading patterns and practices, have evolved. In 2006, CFTC initiated a 
comprehensive review of the COT reporting program out of concern that 
the reports in their present form might not accurately reflect the 
commercial or noncommercial nature of positions held by nontraditional 
hedgers, such as swaps dealers.\9\ A disconnect between the 
classifications and evolving trading activity could distort the 
accuracy and relevance of reported information to users and the public, 
thereby limiting its usefulness for both.
---------------------------------------------------------------------------
    \8\ These reports include the number of traders, changes since the 
last report, and open positions.
    \9\ 71 Fed. Reg. 35627, 35630-31 (June 21, 2006).
---------------------------------------------------------------------------
    In December 2006, CFTC announced a 2 year pilot program for 
publishing a supplemental COT report that includes positions of 
commodity index traders in a separate category. However, the pilot does 
not include any energy commodities. Although commodity index traders 
are active in energy markets, according to CFTC officials, currently 
available data would not permit an accurate breakout of index trading 
in these markets. For example, some traders, such as commodity index 
pools, use the futures markets to hedge commodity index positions they 
hold in the OTC market. However, these traders also may have positions 
in the physical markets, which means the reports that CTFC receives on 
market activities, which do not include such off-exchange transactions, 
may not present an accurate picture of all positions in the market 
place for the commodity. In response to our recommendation to reexamine 
the COT classifications for energy markets, CFTC agreed to explore 
whether the classifications should be refined to improve their accuracy 
and relevance.
CFTC Authority Over Exempt Commercial Markets and OTC Markets Is 
        Limited, and Views Vary About the Sufficiency of Its Regulatory 
        Authority With Respect to Off-Exchange Energy Derivatives
    Now let me address some of the larger policy issues associated with 
CFTC's oversight of these markets. Under CEA, CFTC's authority for 
protecting market users from fraudulent, manipulative, and abusive 
practices in energy derivatives trading is primarily focused on the 
operations of traditional futures exchanges, such as NYMEX, where 
energy futures are traded. Currently, CFTC receives limited information 
on derivatives trading on exempt commercial markets--for example, 
records of allegations or complaints of suspected fraud or 
manipulation, and price, quantity, and other data on contracts that 
average five or more trades a day. The agency may receive limited 
information, such as trading records, from OTC participants to help 
CFTC enforce the CEA's antifraud or antimanipulation provisions. The 
scope of CFTC's oversight authority has raised concerns among some 
Members of Congress and others that activities on these markets are 
largely unregulated, and that additional CFTC oversight is needed.
    While some observers have called for more oversight of OTC 
derivatives, most notably for CFTC to be given greater oversight 
authority of this market, others oppose any such action. Supporters of 
more CFTC oversight authority believe that regulation of OTC 
derivatives markets is necessary to protect the regulated markets and 
consumers from potential abuse and possible manipulation. One of their 
concerns is that, due to the lack of complete information on the size 
of this market or the terms of the contracts, CFTC may not be assured 
that trading on the OTC market is not adversely affecting the regulated 
markets and, ultimately, consumers. However others, including the 
President's Working Group, have concluded that OTC derivatives 
generally are not subject to manipulation because contracts are settled 
in cash on the basis of a rate or price determined in a separate, 
highly liquid market that does not serve a significant price discovery 
function.\10\ The Working Group also noted that if electronic markets 
were to develop and serve a price discovery function, then 
consideration should be given to enacting a limited regulatory regime 
aimed at enhancing market transparency and efficiency through CFTC, as 
the regulator of exchange-traded derivatives.
---------------------------------------------------------------------------
    \10\ President's Working Group on Financial Markets, Over-the-
Counter Derivatives Markets and the Commodity Exchange Act (Nov. 9, 
1999). Members of group are the Chairman of CFTC, the Secretary of the 
Treasury, the Chairman of the Board of Governors of the Federal 
Reserve, and the Chairman of the Securities and Exchange Commission.
---------------------------------------------------------------------------
    However, the lack of reported data about this market makes 
addressing concerns about its function and effect on regulated markets 
and entities challenging. In a June 2007 Federal Register release 
clarifying its large trader reporting authority, CFTC noted that having 
data about the off-exchange positions of traders with large positions 
on regulated futures exchanges could enhance the Commission's ability 
to deter and prevent price manipulation or other disruptions to the 
integrity of the regulated futures markets.\11\ According to CFTC 
officials, the Commission has proposed amendments to clarify its 
authority under the CEA to collect information and bring fraud actions 
in principal-to-principal transactions in these markets, enhancing 
CFTC's ability to enforce antifraud provisions of the CEA.\12\
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    \11\ As stated by CFTC, the purpose of the proposed regulation is 
to make it explicit that persons holding or controlling reportable 
positions on a reporting market must retain books and records and make 
available to the Commission upon request any pertinent information with 
respect to all other positions and transactions in the commodity in 
which the trader has a reportable position, including positions held or 
controlled or transactions executed over-the-counter or pursuant to 
sections 2(d), 2(g) or 2(h)(1)-(2) of the CEA or part 35 of the 
Commission's regulations, on exempt commercial markets operating 
pursuant to sections 2(h)(3)-(5) of the CEA, on exempt boards of trade 
operating pursuant to Section 5d of the CEA, and on foreign boards of 
trade (hereinafter referred to collectively as non-reporting 
transactions); and to make the regulation clearer and more complete 
with respect to hedging activity. The purpose of the amendments is to 
clarify CFTC's regulatory reporting requirements for such traders. 72 
Fed. Reg. 34413.
    \12\ Section 4b of the CEA is CFTC's main antifraud authority. In a 
November 2000 decision, the 7th Circuit Court of Appeals ruled that 
CFTC only could use section 4b in intermediated transactions--those 
involving a broker. Commodity Trend Service, Inc. v. CFTC, 233 F.3d 
981, 991-992 (7th Cir. 2000). As amended by the Commodity Futures 
Modernization Act of 2000, the CEA permits off-exchange futures and 
options transactions that are done on a principal-to-principal basis, 
such as energy transactions pursuant to CEA sections 2(h)(1) and 
2(h)(3). According to CFTC, House and Senate CFTC reauthorization bills 
introduced during the 109th Congress (H.R. 4473 and S. 1566) would have 
amended section 4b to clarify that Congress intends for CFTC to enforce 
section 4b in connection with off-exchange principal-to-principal 
futures transactions, including exempt commodity transactions in energy 
under section 2(h) as well as all transactions conducted on derivatives 
transaction execution facilities.
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    Also, in September 2007, CFTC conducted a hearing to begin 
examining trading on regulated exchanges and exempt commercial markets 
more closely. The hearing focused on a number of issues, including:

   the current tiered regulatory approach established by the 
        Commodity Futures Modernization Act, which amended the CEA, and 
        whether this model is beneficial;

   the similarities and differences between exempt commercial 
        markets and regulated exchanges, and the associated regulatory 
        risks of each market; and

   the types of regulatory or legislative changes that might be 
        appropriate to address any identified risks.

    Given ongoing questions about the similarity of products traded on 
the markets and how and whether exempt markets play a role in the price 
discovery process and whether existing reporting requirements are 
sufficient, we recommend that Congress take up this issue during the 
CFTC reauthorization process to begin to answer some of these questions 
and the implications for the current regulatory structure in light of 
the changes that have occurred in this market.
CFTC Engages in Large Trader Reporting, Surveillance, and Enforcement 
        Activities, but the Effectiveness of the Activities Is Largely 
        Uncertain
    CFTC provides oversight for commodity futures markets by analyzing 
large trader reporting data, conducting routine surveillance, and 
investigating and taking enforcement actions against market 
participants and others. The Commission uses information gathered from 
surveillance activities to identify unusual trading activity and 
possible market abuse. In particular, CFTC's large trader reporting 
system (LTRS) provides essential information on the majority of all 
trading activity on futures exchanges. CFTC staff said they routinely 
investigate traders with large open positions, but do not routinely 
maintain information about such inquiries, thereby making it difficult 
to determine the usefulness and extent of these activities. According 
to recent data provided by CFTC, about 10 percent of the enforcement 
actions involved energy-related commodities. However, as with programs 
operating in regulatory environments where performance is not easily 
measurable, evaluating the effectiveness of CFTC's enforcement 
activities is challenging because it lacks effective outcome-based 
performance measures.
CFTC Oversight Includes Surveillance of Energy Futures Trading, but the 
        Full Extent of Follow-Up Activities Is Uncertain
    CFTC conducts regular market surveillance and oversight of energy 
trading on NYMEX and other futures exchanges, focusing on detecting and 
preventing disruptive practices before they occur and keeping the CFTC 
Commissioners informed of possible manipulation or abuse. According to 
CFTC staff, when a potential market problem has been identified, 
surveillance staff generally contact the exchange or traders for more 
information. To confirm positions and determine intent, staff may 
question exchange employees, brokers, or traders. According to the 
staff, CFTC's Division of Market Oversight may issue a warning letter 
or make a referral to the Division of Enforcement to conduct a 
nonpublic investigation into the trading activity. Markets where 
surveillance problems have not been resolved may be included in reports 
presented to the Commission at weekly surveillance meetings.
    According to CFTC staff, they routinely make inquiries about 
traders with large open positions approaching expiration, but formal 
records of their findings are only kept in cases with evidence of 
improper trading. If LTRS data revealed that a trader had a large open 
market position that could disrupt markets if it were not closed before 
expiration, CFTC staff would contact the trader to determine why the 
trader had the position and what plans the trader had to close the 
position before expiration or ensure that the trader was able to take 
delivery. If the trader provided a reasonable explanation for the 
position and a reasonable delivery or liquidation strategy, staff said 
no further action would be required. CFTC staff said they would 
document such contacts on the basis of their importance in either 
informal notes, e-mails to supervisors, or informal memorandums. 
According to one CFTC official, no formal record would be made unless 
some signal indicated improper trading activity. However, without such 
data, CFTC's measures of the effectiveness of its actions to combat 
fraud and manipulation in the markets would not reflect all 
surveillance activity, and CFTC management might miss opportunities to 
identify trends in activities or markets and better target its limited 
resources. In response to our recommendation, CFTC agreed to improve 
its documentation of its surveillance activities.
CFTC Energy-Related Enforcement Actions Generally Involved Allegations 
        of False Reporting and Attempted Manipulation, but Its Program 
        Received a Mixed Rating and Lacks Effective Outcome-Based 
        Performance Measures
    CFTC's Division of Enforcement is charged with enforcing the 
antimanipulation sections of the CEA.\13\ The enforcement actions CFTC 
has taken in its energy-related cases generally have involved false 
public reporting as a method of attempting to manipulate prices on both 
the NYMEX futures market and the off-exchange markets. CFTC officials 
said that from October 2000 to September 2005, the agency initiated 287 
enforcement cases and more than 30 of these cases involved energy 
trading. In the past several months, CFTC has taken a series of actions 
involving energy commodities, including allegations of false reporting, 
attempted manipulation of NYMEX natural gas futures prices, and 
attempted manipulation of physical natural gas prices.
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    \13\ Section 9(a)(2) of the CEA prohibits ``(a)ny person to 
manipulate or attempt to manipulate the price of any commodity in 
interstate commerce, or for future delivery on or subject to the rules 
of any registered entity, or to corner or attempt to corner any such 
commodity or knowingly to deliver or cause to be delivered for 
transmission through the mails or interstate commerce by telegraph, 
telephone, wireless, or other means of communication false or 
misleading or knowingly inaccurate reports concerning crop or market 
information or conditions that affect or tend to affect the price of 
any commodity interstate commerce . . .''
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    Although CFTC has undertaken enforcement actions and levied fines, 
measuring the effectiveness of these activities is an ongoing 
challenge. For example, the Office of Management and Budget's most 
recent 2004 Program Assessment Rating Tool (PART) assessment of the 
CFTC enforcement program identified a number of limitations of CFTC's 
performance measures.\14\ As is the case with most enforcement 
programs, identifying outcome-oriented performance measures can be 
particularly challenging.\15\ However, as we point out in the report, 
there are a number of other ways to evaluate program effectiveness, 
such as using expert panel reviews, customer service surveys, and 
process and outcome evaluations. We have found with other programs that 
the form of the evaluations reflects differences in program structure 
and anticipated outcomes, and that the evaluations are designed around 
the programs and what they aim to achieve.\16\ Without utilizing these 
or other methods to evaluate program effectiveness, CFTC is unable to 
demonstrate whether its enforcement program is meeting its overall 
objectives. CFTC has agreed that this is a matter that should be 
examined and has included development of measures to evaluate its 
effectiveness in its strategic plan and has requested funding to study 
the feasibility of developing more meaningful measures.
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    \14\ The assessment includes a series of questions meant to serve 
as a diagnostic performance tool, drawing on available program 
performance and evaluation information to form conclusions about 
program benefits and recommend adjustments that may improve results.
    \15\ GAO, Results Oriented Government: GPRA Has Established a Solid 
Foundation for Achieving Greater Results, GAO-04-594T (Washington, 
D.C.: Mar. 31, 2004).
    \16\ GAO, Program Evaluation: OMB's PART Reviews Increased 
Agencies' Attention to Improving Evidence of Program Results, GAO-06-67 
(Washington, D.C.: Oct. 28, 2005).
---------------------------------------------------------------------------
    In closing, I would like to reemphasize the difficulty in 
attributing increased energy prices to any one of the numerous changes 
in the physical or derivatives markets. As I have mentioned, our 
research shows that the physical and derivatives markets have both 
undergone substantial change and evolution, and market participant and 
regulatory views were mixed about the extent to which these 
developments exerted upward pressure on prices. Because of the 
importance of understanding the potential effects of such developments 
in these markets, ongoing review and analysis are warranted. As the 
scope of CFTC's authority is debated, additional information is needed 
to understand what may need to be done to best protect investors from 
fraudulent, manipulative, and abusive practices. Such information 
includes:

   how different or similar are the characteristics and uses of 
        exchange and off-exchange products being traded and do these 
        continue to justify different regulatory treatment;

   to what extent does trading in off-exchange financial 
        derivatives affect price discovery and what are the regulatory 
        and policy implications;

   how large of an effect are nontraditional market 
        participants, such as commodity index funds, having in these 
        markets; and

   are the changes in the energy markets unique or are such 
        concerns also worth reviewing for other commodity markets.

    By answering questions such as these, CFTC and the Congress will be 
better positioned to determine what changes, if any, may be needed to 
oversee these markets.
    Mr. Chairman, this concludes my prepared statement. I would be 
happy to respond to any questions that you or other Members of the 
Subcommittee might have.
GAO Contacts
    For further information about this testimony, please contact Orice 
M. Williams on (202) 512-8678 or at [email protected].
Staff Acknowledgments
    Contact points for our Offices of Congressional Relations and 
Public Affairs may be found on the last page of this statement. 
Individuals making key contributions include Cody Goebel (Assistant 
Director), John Forrester, Barbara Roesmann, and Paul Thompson.

    The Chairman. Thank you and let me thank both of you for 
your testimony.
    And I would now recognize myself for 5 minutes.
    Mr. Lukken, in the hearings and, well, first of all, let me 
say thank you for being here and if I understood you correctly 
you indicated that the entire Working Group supports this 
proposal. And I assume the President's total Working Group 
unanimously is on board, is that correct?
    Mr. Lukken. Well this has not come before the Working Group 
as a proposal. This was the leadership of the CFTC to put 
forward a Commission document. However, having said that the 
PWG during this whole development was kept apprised of what we 
were doing, why we were doing it and, certainly, being briefed 
on these issues. I could say, certainly, they don't oppose the 
proposal but this has not come before the President's Working 
Group in itself as an official document.
    The Chairman. Well, let me follow-up, do you plan to share 
with them and get their----
    Mr. Lukken. We sought their input. We talked to them during 
this whole development and they are fully apprised of us coming 
forward here today, and comfortable with our leadership.
    The Chairman. Okay. Thank you.
    In our hearing in late September, Mr. Roth, who is 
President of National Futures Association described in detail 
the situation occurring in off-exchange retail trading of 
foreign contracts or forex. His testimony stated that forex 
dealers and members at the NFA constitute less than one percent 
of its membership but account for more than 20 percent of the 
current customer complaints, and 50 percent of NFA's 
enforcement docket, and 50 percent of emergency actions the NFA 
has taken this year. To address this problem, he recommended 
imposing that higher capitalization requirement of $20 million 
on forex dealers and requiring futures commission merchants who 
want to engage in retail forex transactions to also be actively 
engaged in exchange trading at a regulated exchange. Tell us 
about the Commission's experience in overseeing retail off-
exchange forex trading, and your thoughts on whether the 
recommendations of Mr. Roth would weed out some of the problem 
cases that appear to be in this sector of futures trading.
    Mr. Lukken. Well as I mentioned in my testimony, we 
certainly are very active in the forex area having brought 98 
cases over the last several years in forex. NFA is also on the 
frontline of this fraud epidemic in the forex area. We have 
worked with them over the last several years to raise capital 
requirements to put rules into place to ensure that legitimate 
business can continue to occur in the foreign currency trading. 
Those that are trying to scam others are being shut down--that 
they are, indeed, businesses with appropriate resources and 
financial controls in place. So, I would say that NFA has, or 
is very close to this and, certainly, we would be supportive of 
adequate capital requirements put on to these types of firms.
    The Chairman. Thank you. On another subject, the 
President's Working Group recommended language to address the 
Zelener case that was narrowly tailored to foreign exchange 
trading. Some in the industry have suggested that such a narrow 
fix will not prevent the purveyors of these Zelener-type 
contracts from simply crossing off foreign exchanges and 
substituting another commodity. Assuming the PWG language were 
to become law, can you specifically cite for the Subcommittee 
what parts of the Commodity Exchange Act would prevent someone 
from using the same contract but for, let's say, natural gas, 
corn, wheat or another commodity so we don't have to worry 
about these problems reoccurring.
    Mr. Lukken. Well, I think the reason that the President's 
Working Group focused on foreign currency was the nature of the 
product itself. In some ways it is unique compared to other 
commodities because the definition of what is or is not a 
futures contract often revolves around whether something is--
somebody is able to make or take delivery. With foreign 
currency that is pretty easy. It is a bank account. It is not 
too difficult to make and take delivery for foreign currency 
transactions. When you get into grains, oil, a shipment of oil, 
these other products, it is much more difficult to show that 
you are able to make and take delivery. Over the 3 years since 
the Zelener case, we have not seen a migration to other 
commodities. It has remained in the forex area. I am not saying 
that it may not someday migrate in some area that we can't 
think about, but I think the narrow fix would take care of a 
substantial or vast amount of the problems that we are seeing 
now in the foreign currency fraud area.
    The Chairman. All right. Let me follow-up because it has 
been now about 2 years since the President's Working Group made 
that recommendation and a lot has changed. As a matter of fact, 
the Commission has changed.
    Mr. Lukken. Yes.
    The Chairman. So am I taking that to be your recommendation 
that you have reviewed this, you feel like it would be adequate 
and that we shouldn't take another look at it before we move 
forward?
    Mr. Lukken. Absolutely, I think that the fix that has been 
proposed would take care of a substantial amount of the 
problems that we face. You know, others may want to go further, 
but if we are looking for something that has consensus, that 
has already passed this Committee and the House already, this 
is going to take care of a vast majority of the problem.
    The Chairman. Would you say that all the Commissioners have 
that same, are in agreement with that?
    Mr. Lukken. They certainly have signed on to my testimony 
advancing this but some, obviously, you will have to talk to 
the other Commissioners and whether they would prefer a broader 
approach or not. But I think I could safely say that at a 
minimum, this needs to be done this----
    The Chairman. Well, let me just say, it would be helpful 
for this Committee to know that if you would submit that to 
us----
    Mr. Lukken. Sure.
    The Chairman.--later in writing, please. Thank you. And I 
have gone over my time and I apologize to Mr. Moran.
    Mr. Moran. Mr. Chairman, thank you very much. Chairman 
Lukken, thank you. You testified or the Commission, I guess, 
testified that changes to our last CFTC reauthorization bill in 
the 109th, there were specific proposals in regard to energy 
futures and transparency and, I believe, your testimony then 
was that those changes for price transparency were unnecessary. 
Does your position, the Commission's position, remain the same?
    Mr. Lukken. Which provision? This was in regards to what 
type of transaction?
    Mr. Moran. This is the Title II Amendments that were 
proposed by several Members of our Committee.
    Mr. Lukken. Well, I think either the focus of our 
recommendations today are dealing with exempt commercial 
markets, that once price discovery occurs in these types of 
transactions, that certain authorities would then be required 
upon those ECMs. It is part of that report that in regards to 
bilateral transactions that are occurring in this energy area 
that there is not consensus that more regulation needs to 
happen in regards to the bilateral markets. But as far as the 
ECMs that serve a price discovery function that has been our 
focus of this report.
    Mr. Moran. I think I understand your answer. Let me take 
what you just said a bit further with a slightly different line 
of questioning. As I understand the recommendation is that you 
would like four new regulatory authorities over the ECMs, and 
that regulatory authority would come into play when, as I think 
you say, an ECM futures contract serves a significant price 
discovery function.
    Mr. Lukken. Correct.
    Mr. Moran. What criteria would be used to determine when 
that ECM future serves that function?
    Mr. Lukken. We look at two broad criteria in making that 
determination. The first is volume, that there has to be a 
material amount of volume in the contract in order to warrant 
the public's attention in this area. Second, that it needs to 
either be linked to a regulated market contractually, such that 
we are seeing with the ICE contract, or be a material price 
reference, meaning that a price discovery mechanism can be 
referenced by the public outside of a futures exchange. So, if 
something might develop on ICE it is not linked to a NYMEX 
product, but that people are referencing an interstate commerce 
outside of those transactions. So if there is either that 
linkage, material price referencing and some type of material 
trading, that is going to form our basis for determining 
whether something is a significant price discovery product.
    Mr. Moran. And, finally, are there areas of disagreement 
with the GAO in regard to their report, their recommendations 
and suggestions. Would you respond to anything that is in that 
report that you have disagreement with?
    Mr. Lukken. No, we fully support the recommendations made 
by GAO and will work to try to resolve those. One of the issues 
dealing with, I think, the commitment of trader data that is 
currently being published for agricultural products for 
commodity index traders, we are holding an Agricultural 
Advisory Committee meeting on December 8, or I am sorry, 
December 6 at the Commission. Commissioner Dunn heads up that 
committee for the CFTC and one of the issues in looking at the 
commitment of traders, index trader program, and whether that 
is working well for agricultural products but also should it be 
extended to other products? And so that is going to be a time 
for us to explore whether this can go to other types of 
products including energy, and other types of commodities. When 
we first looked at this, however, I will note that it was 
easier to designate index traders for agricultural products 
because most of the index traders were just doing that. They 
were involved in index trading on those markets but when you 
look to products beyond agriculture, such as energy and others, 
oftentimes the index traders wear several hats. They are not 
only doing their index trading but they are also doing swap 
dealing and off-setting those transactions and also proprietary 
trading. Sometimes it is difficult to pull out of that data 
something that is meaningful that would be meaningful for the 
market participants. But nevertheless, we plan to look at this, 
review it and then see if it is something that the public would 
benefit from.
    Mr. Moran. Mr. Chairman, briefly, we are now operating 
under a continuing resolution, have there been consequences to 
the CFTC authorization, I am sorry, operations as a result of 
this particular circumstance we once again find ourselves in?
    Mr. Lukken. Well, we have to put halts on hiring people 
that we had planned to hire to oversee these markets and that 
is difficult to defer that, technology upgrades have had to 
have been put on hold and there are a variety of things, like 
travel only for certain essential business purposes for a lot 
of the Commission employees. It is difficult to give 
depositions in other parts of the country if you are not able 
to travel there. So this is difficult, we are able to do our 
job but we are stretched thin.
    Mr. Moran. Mr. Chairman, thank you very much.
    The Chairman. I thank the gentleman.
    The gentleman from Georgia, Mr. Scott.
    Mr. Scott. Thank you, Mr. Chairman. I have a couple of 
questions for you, Chairman Lukken and Ms. Williams. First of 
all, Mr. Chairman, let me commend you for what I think is a 
very excellent job you are doing and especially in your 
approach to take a balanced approach to any regulatory efforts 
within the system. As you clearly know, one size does not fit 
all in this. It is my understanding that there are discussions 
within the Commission about trying to determine whether ethanol 
falls under the agricultural commodity category and all the 
limitations that applies, or whether it qualifies as an exempt 
commodity that could be traded under an exempt commercial 
market that currently receives a higher level of regulation. 
Where does that discussion stand now and how soon would this 
determination be made concerning ethanol?
    Mr. Lukken. Again, to highlight my colleague, Mike Dunn, 
who is holding this Agricultural Advisory Committee in early 
December, this is on the agenda to talk to producers, different 
stakeholders in this area to find out, as you properly note 
agriculture must be agricultural products, have additional 
protections, must be traded on the full designated contract 
markets, where as energy products may be able to trade on these 
lighter-touch exempt commercial markets. Where ethanol falls, 
whether it is agriculture or energy we have really not been 
faced with having to make that determination but it is 
something we are going to have to resolve. So the first step is 
to have a hearing on this to talk to the stakeholders, and then 
internally debate where we need to go and, hopefully, in short 
order come up with an answer.
    Mr. Scott. How soon do you think that will be?
    Mr. Lukken. Well, the hearing is in December so we can, 
certainly, by first of next--first quarter come up with an 
answer in this area.
    Mr. Scott. Okay. My other question, as you know that 
legislation has been introduced in the House to give the CFTC 
authority and a directive to collect trading information on 
energy-based derivatives from the entire OTC market on a 
regular basis. Assuming that that were to take place, how much 
information would be coming to the CFTC? Does your agency now 
have adequate staff levels to sort through this data? And how 
helpful would this information be in the agency's efforts to 
detect manipulation given the nature of derivatives traded on 
the over-the-counter market?
    Mr. Lukken. Congressman, the bilateral energy markets are 
enormous. You know, as we thought about this issue during our 
study last month, a lot of these transactions are individually 
negotiated, non-standardized contracts so for us to receive 
this type of information from a very large market and a non-
standardized forum, it is very difficult for us to extrapolate 
information that is meaningful from a regulatory point of view. 
Having said that and, certainly, as you mentioned it would take 
an enormous amount of staff time and resources to do that, 
currently which we don't have, having said that, that doesn't 
mean that the bilateral markets aren't in some ways useful on 
an ad hoc basis to get information from. And, in fact, today we 
came out with regulation 1805, which was finalized, which 
allows us when we see problems in the regulated marketplace to 
be able to go after information in the bilateral markets that 
may help us explain the entire picture of what may be going on 
in regards to certain traders. To use that is the most 
effective approach. It is regulating the designated contract 
markets and ECMs when they are serving a significant price 
discovery role, and then also complementing that with being 
able to go after certain information in the bilateral markets 
on a need-to-know basis.
    Mr. Scott. All right. Ms. Williams, right quick, time is 
running out, but the CFTC put out a report stating its 
contention that natural gas prices changes from August 2003 
through August 2004 were not significantly affected by the 
trading activity of managed-money traders. As part of your 
review, you examined that report. Did you find any flaws in 
that report and what would you characterize in its findings as 
accurate?
    Ms. Williams. I think in terms of specifically what CFTC 
looked at we didn't necessarily find significant issues with 
the report and what we tried to do in our report was kind of 
broaden the scope of research on this particular issue. So it 
was a narrowly focused report and I think for that purpose we 
didn't find any significant issues.
    Mr. Scott. Thank you, Mr. Chairman.
    The Chairman. I thank the gentleman.
    The gentleman from Texas, Mr. Conaway.
    Mr. Conaway. Thank you, Mr. Chairman.
    Mr. Lukken, following along with Jerry Moran's questions on 
the significant price discovery process, the volume issue that 
the number of contracts or dollar values have, what would that 
be in terms of your threshold?
    Mr. Lukken. That has not been fleshed-out but, initially 
you would have to be in some relationship to the market that we 
are looking at, some percentage of the market we are looking at 
so it could be either in dollars or volume of trades.
    Mr. Conaway. Okay. And on the, help me understand, you said 
there was some link between that price discovery and other 
commercial activities that is going on whether that price is 
referenced. How would you gain that information or what do you 
mean by that?
    Mr. Lukken. Well, this would be something we would have to 
work with this Committee and the industry to develop. It could 
involve and some, certainly, some of these products are so 
large that we just know about them from surveilling the 
regulated market. But this may involve us having to go out and 
talk to people in the industry to determine how people are 
referencing these products. You know, in starting to develop a 
standard, we have to make sure that it is concise, that it is 
predictable, that it is cost-effective for us and the industry 
to implement.
    Mr. Conaway. Yes. Would you develop these standards based 
on some sort of a rules process where you would put out the 
proposed way you would do this and have the industry respond?
    Mr. Lukken. That would be one way to do it if this 
Committee directed us to do that, yes.
    Mr. Conaway. All right. With respect to foreign exchange 
fraud, can you give me a sense of what the estimated dollar 
fraud is in any 1 year of losses?
    Mr. Lukken. Let me turn to my enforcement sheet here. Yes, 
the best we can do is there is about a billion dollars of 
penalties that we have recovered over the last 5 years in this 
forex.
    Mr. Conaway. And the penalties are related to the losses is 
that what it is?
    Mr. Lukken. Well, some of it is restitution, which is 
customer loss, some of it is civil monetary penalties.
    Mr. Conaway. Okay.
    Mr. Lukken. So we can get you figures on restitution if 
that might narrow your----
    Mr. Conaway. Well, I am just trying to figure out, because 
if that is what you have caught----
    Mr. Lukken. Right.
    Mr. Conaway.--and you have had complaints on then that is 
not 100 percent of the exposure.
    Mr. Lukken. Probably not, no.
    Mr. Conaway. Okay. Ms. Williams, you posed a series of 
really interesting questions at the end of your comments, and I 
am wondering should your study have answered those questions or 
should those be posed to the Commission and us ask them to 
answer? Who should be the best group or whatever to answer 
those really good questions?
    Ms. Williams. I think some of them would need to be posed 
to the Commission, and I think some of them would need to be 
posed to a broader audience, and answered and addressed 
collectively. And I think our position in terms of posing the 
questions are these are some of the fundamental questions that 
need to be answered before you can come to policy decisions.
    Mr. Conaway. Are these rhetorical? Did you all answer them 
for yourself? Do you already know the answers?
    Ms. Williams. We don't.
    Mr. Conaway. Oh, okay.
    Ms. Williams. We don't.
    Mr. Lukken. Can you share them with me?
    Mr. Conaway. All right. Thank you, Mr. Chairman, I yield 
back.
    The Chairman. I thank the gentleman.
    The gentleman from Georgia, Mr. Marshall.
    Mr. Marshall. Thank you, Mr. Chairman. I appreciate your 
testimony and appreciate the good work your staff does. It is a 
pretty impressive group of people and I know that you struggle 
with resources to keep up. Has there been any discussion at the 
staff level or among the Commissioners concerning sources of 
funding and whether or not fees should be, industry fees should 
be used in order to fund the CFTC?
    Mr. Lukken. The Commission has not taken a position on 
fees. Obviously, the Administration has proposed in the past 
over the last 20 years putting a fee on this industry, a 
transaction tax. We are one of the only financial agencies that 
currently does not have a fee. I always feel more comfortable 
talking not about how the money is collected but how you do 
spend it and, certainly, the need is there to spend it, and 
whether it is appropriated or a fee we, certainly, as an agency 
need appropriate funding to meet this Committee's mandate.
    Mr. Marshall. The Committee heard testimony earlier this 
year about assertions from different individuals that energy 
prices were--speculation in energy prices caused them to lose 
quite a bit of money as they placed, you know, they tied in 
their future needs with contracts. Specifically in Georgia, 
Municipal Gas Authority of Georgia locked in prices in October 
and believes very, very fervently that amorous speculation was 
largely the reason why it wound up losing millions and million 
of dollars. In the suggestions that you have made for amending 
the CEA in reauthorization, would the problems that they have 
identified or at least they believe exist be addressed or is 
your proposed amendment to the CEA sort of silent on that 
question?
    Mr. Lukken. I think it directly addresses their concerns. 
First off, I think the contract that they were referencing was 
this ICE-NYMEX look-a-like contract that interacts together.
    Mr. Marshall. So your suggestion is that the look-a-like 
portion of this where ICE would be required to manage the 
contract as NYMEX would with position limits et cetera, would 
solve the problem somehow?
    Mr. Lukken. Well, as you mentioned, the ICE would now be 
required to put in speculative limits on these contracts as 
they expire similar to how NYMEX currently does it. We would, 
also, have a view of the entire market now, where as before we 
only saw the NYMEX portion, we would now see ICE's traders as 
well as NYMEX's traders. I think another important point that 
came out--oh, I am sorry, go ahead.
    Mr. Marshall. Let us assume that there is a position limit. 
Would an Amaranth-type character that is convinced there is a 
lot of money to be made here, then move into the bilateral 
market and largely have the same effect on the market overall 
despite the position limit?
    Mr. Lukken. Well, the bilateral market does not serve 
significant price discovery function so in your case where your 
constituent was pricing off of ICE or pricing off of NYMEX, 
they would not be pricing off the bilateral transaction.
    Mr. Marshall. But doesn't the bilateral market, huge as it 
is, large trading on the bilateral market inevitably is going 
to have an impact on the kind of trading that occurs on-
exchange.
    Mr. Lukken. Correct, but it all has to come on-exchange at 
some point and that is when we see it. That is when we will see 
it on ICE, and we will see it on NYMEX.
    Mr. Marshall. And so what do you do when you see it?
    So you know that there is a big move being made by 
somebody, how do you--and how do you determine that that 
somebody is making a mistake, and that that somebody needs to 
be reined in, or an awful lot of people who are just sort of 
caught in this tempest are going to be hurt.
    Mr. Lukken. Well, oftentimes, I mean this is what our 
surveillance economists do. They have been doing this for 30 
years. They call up these types of traders that they see with 
positions that concern them. They ask them what their economic 
justification might be for doing this.
    Mr. Marshall. Would you be in a position to simply tell 
Amaranth to stop?
    Mr. Lukken. To stop?
    Mr. Marshall. Buying, pushing price up.
    Mr. Lukken. Certainly, at certain levels, yes, our 
emergency authorities allow us to halt trading, liquidate 
trading, spec-limits will prevent them from getting into a 
position that could----
    Mr. Marshall. Even if you--don't you--isn't that because 
you have authority to control manipulation, and their response 
would be, ``No, we really do think this is what we need to do 
because that is what is going to happen to market.''
    Mr. Lukken. Well, their speculator position limits are hard 
limits, so they would have to get out whether we think it is 
manipulation or not. It is a rule violation so that is not 
something subject to interpretation.
    Mr. Marshall. Mr. Chairman, I see my time is up. I think we 
need to do a little bit more work on this to fully understand 
whether or not the changes that have been proposed will have 
the effect of calming the oscillations that we have seen as the 
result in part of major speculation in energy markets. Thank 
you, Mr. Chairman.
    The Chairman. I thank the gentleman, and I would say to him 
I am not sure we ever knew what speculation was, we got people.
    The gentleman, Mr. Walz.
    Mr. Walz. Thank you, Mr. Chairman. And thank you, Mr. 
Lukken, just one quick question here and it may be more of an 
observation on this. This forex question continues to come up, 
come up and come up. We hear a lot of concerns and questions 
from this. I guess, my question on this, is this a relatively 
new product to the American consumers, and these products have 
been in other parts of the world, I am thinking Asia in 
particular, has been relatively popular. I think the number I 
hear is 40 percent of Japanese citizens own this as part of 
their portfolio. It is pretty well-established, pretty well-
regulated in the UK and in Hong Kong, and my question is as 
this being a product that consumers obviously want and the 
numbers are going up there, are we working to figure out a way 
to get the correct amount of regulation on this? Or, are we 
just continuing to see this as a nuisance product that is 
embedded with fraud when I don't think a lot of the other 
markets see that? I would be interested to hear your opinion.
    Mr. Lukken. I think you make very good points. We have to 
make sure that we strike the right balance of giving proper 
regulation to this product. If there is a legitimate demand by 
consumers in the United States for it that it is properly 
overseen, that the capital requirements on the firms offering 
it are adequate enough to ensure that fraud is not going to 
occur. So we are trying to strike that balance of making sure 
there is enough regulation, but also not too much regulation 
that you put legitimate firms out of business.
    Mr. Walz. And is CFTC the right place for that to happen, 
in your opinion, or is that the only place for it to happen?
    Mr. Lukken. Well, traditionally we have, because these are 
futures transactions, we have expertise in this area. We have 
lots of experience enforcing forex problems so I think we have 
the right expertise to police the markets.
    Mr. Walz. Thank you. I yield back, Mr. Chairman.
    The Chairman. I thank the gentleman.
    The gentleman from the Dakotas, Mr. Pomeroy.
    Mr. Pomeroy. Thank you, Mr. Chairman.
    First of all, I want to note that attending the hearing 
today is Commissioner Chilton. He has previously served on the 
staff of House Agriculture Committee Members Jill Long and 
yours truly before going to the Senate where he worked for 
among others Leader Daschle. So I think it is very--we have a 
welcome addition to the Commission ranks to have someone that 
really so fully understands agriculture policy as seen by 
legislators, and I was very delighted with that particular 
appointment. Also, pleased to have a Commissioner sitting in on 
the whole hearing to get a sense for what we are wondering 
about.
    A question I would have is and I am in the middle of a Ways 
and Means markup and forgive me if it has been asked already. 
But I am interested in how CFTC has involved itself in the 
review of financial regulatory structures the Treasury has been 
conducting?
    Mr. Lukken. As a member of the President's Working Group 
we----
    Mr. Pomeroy. I meant conducting through the President's 
Working Group.
    Mr. Lukken. Yes, this is not an issue before the 
President's Working Group formally. This is under the 
leadership of Secretary Paulson who has asked as series of 30 
questions about the regulatory structure in the United States. 
I would note, and that he is trying to figure out what is the 
best system for U.S. competitiveness going forward. I would 
suggest that you should look at the competitive advantage of 
the U.S. futures industry. The fact that we are leaps ahead of 
others in gaining market share around the world. So we are 
engaged on this issue. One of the questions deals on 
principles-based regulation and whether the entire financial 
services sector should go under a principles-based system. I am 
here to say yes, that it has worked very well for this agency 
and for this market in general and allowed us to be flexible in 
a global marketplace.
    Mr. Pomeroy. Help us understand that. What is that really? 
What is a real-life context in terms of a principles-based 
structure?
    Mr. Lukken. Well, oftentimes we will, through different 
acceptable practices, lay out what we expect of market 
participants. However, they may come up with a new way of doing 
something, a new way of trading or a new way of trying to 
conduct business. They could come to us and say, ``Look, it 
doesn't meet the specific rules that you have laid out for us, 
but we think in general it meets the principles that you have 
set out in principle 5. So allow us to do this knowing that.'' 
So on the margins you allow for innovation. Those that want the 
safe harbor of the acceptable practice and knowing for certain 
that they are in compliance can stay within the four corners. 
But if those that want to innovate can help step outside of 
that and develop new best practices that others in the industry 
may abide by as well. So it has proven very effective for us 
and is really made the relationship between industry and the 
regulator something that is informal that they come to us early 
in the process if they have ideas and changes so that we are 
able to know what is coming down the pike versus doing 
something that is sort of ``gotcha'' form of regulation.
    Mr. Pomeroy. I have been puzzling a lot with this whole 
subprime business about innovation versus transparency. We have 
had things that are so newfangled no one knows what the hell 
they are buying or investing in. How do you parse that one?
    Mr. Lukken. Well this is a bit out of the CFTC's lane but 
these are very complex instruments and part of the problem is 
we didn't know the amount of exposure of a lot of these types 
of instruments out there. I would say from a futures specific 
perspective, the markets have been very helpful. A lot of the 
re-pricing has been done in the futures markets themselves. 
From this August to last August trading volume is up 90 
percent. So that is a sign that people are utilizing the 
futures markets in order to re-price this risk where there is 
liquidity and that is helping us to get through this 
transition.
    Mr. Pomeroy. I don't have enough time to pursue that. I 
might call you for further information.
    Mr. Lukken. Yes, sir.
    Mr. Pomeroy. Thank you very much, Mr. Chairman.
    The Chairman. I thank the gentleman.
    I just have two quick questions to get on the record before 
we close and the Ranking Member has one and then we will try to 
close before we go vote so we can finish this. As you know, 
Senator Levin has introduced legislation to amend the CEA with 
regard to regulation of exempt commercial markets that trade 
energy-based derivatives. I would like to hear a comparison 
between that bill and your recommendation how the triggers for 
regulations differ, and how does the scope of regulation and 
regulatory requirements that could be imposed upon, to see if 
the instruments compare. Can you give us a quick answer to 
that?
    Mr. Lukken. Well, Senator Levin has provided, obviously, 
valuable leadership in this area and it was before his 
Committee that we committed to take a closer look a few months 
back at this issue. As far as the trigger I think Senator 
Levin's bill also looks at significant price discovery as a 
trigger. They do have a few things differently. They look at 
the entire marketplace versus a product by product 
determination for us, and there are many other different things 
that may differ but, certainly, the general intent of looking 
at these markets and ensuring that they are properly policed, 
we are the same with Senator Levin and with our proposal. We 
would be happy though to provide a side-by-side.
    The Chairman. Would you, please, do that for the Committee?
    Mr. Lukken. Yes.
    The Chairman. I appreciate that.
    Mr. Lukken. We will have our----
    The Chairman. If you would get it to us in writing.
    Mr. Lukken. Sure.
    The Chairman. Thank you.
    Ms. Williams, I have in my hand a new colleague from one of 
our House colleagues in support of H.R. 594, Prevent Unfair 
Manipulation of Prices Act. It says that GAO is essentially 
calling to implement the policy recommendation proposed by this 
Act. First question in conducting this review, did your group 
examine the policy recommendations of H.R. 594? Can you 
describe for us the provisions of H.R. 594 or should anyone 
reading this report, take it as an endorsement of H.R. 594?
    Ms. Williams. I would be more than happy to provide an 
official response for the record.
    The Chairman. Would you, please?
    Ms. Williams. But in terms of our report we didn't take a 
position on any particular pending legislation or policy 
positions, but I will provide a response.
    The Chairman. Would, you please? Thank you, ma'am.
    Ms. Williams. Absolutely.
    The Chairman. I yield to the Ranking Member.
    Mr. Moran. Mr. Chairman, thank you.
    Mr. Lukken, in--you talk about the intermediated 
transactions and the 7th Circuit Court of Appeals decision, 
have other venues cited the 7th Circuit Opinion? Are you 
encountering enforcement problems as a result of that, and the 
CFTC's response?
    Mr. Lukken. Absolutely, other circuits are starting to 
reference the Zelener decision and starting to adopt its 
findings. And so that is the recent court cases that I 
referenced in my testimony that we are having problems as a 
result of that. So that is why it is imperative that this 
Committee, hopefully, take a close look at this and pass 
something soon.
    Mr. Moran. So has Zelener become the law?
    Mr. Lukken. It is not the law in all circuits but others 
are beginning and it seems to be picking up momentum that other 
courts are beginning to reference it and adopt those findings.
    Mr. Moran. I can't remember from our earlier testimony and 
hearings on this topic, has any court of equal standing 
rejected Zelener?
    Mr. Lukken. It seems to me that there was a Second Circuit, 
oh there was a finding in the 6th Circuit but it is currently 
pending on appeal.
    Mr. Moran. Okay. Thank you very much.
    Ranking Member Goodlatte has additional questions he would 
like to submit to our witnesses in writing.
    The Chairman. Without objection.
    Mr. Moran. Thank you.
    The Chairman. Just before we close, Mr. Marshall would like 
to finish up on one of the pieces before we close out. I would 
recognize the gentleman from Georgia.
    Mr. Marshall. Thank you, Mr. Chairman.
    Chairman Lukken, we were talking about an Amaranth-type 
situation where people are convinced that as a result of the 
speculation of a very large trader the markets been moved 
inappropriately to the detriment of an awful lot of people who 
necessarily have to rely upon that market to cover their future 
positions and let us just assume that that can happen and let 
us assume that we would like to do something about it. You are 
suggesting that the proposed changes would have that effect 
because where there are like contracts and in this--in the 
Amaranth situation there were, ICE would now be acting pretty 
much as NYMEX where position limits are concerned. The question 
is you have this large trader that is convinced that it is in 
their financial interest to take these positions, now it can't 
take as much of a position on ICE as it did in the past, 
doesn't it move to the bilateral market or move overseas or 
something like that and effectively have the same impact upon 
the market and I understood you to say, ``Well, no, because we 
are in a position to stop that.'' I would like to know how you 
go about doing that. It would be comforting to a number of 
people that are quite concerned about the problem.
    Mr. Lukken. Let me clarify. I think for us when we looked 
at this problem, again the Commodity Exchange Act the key 
determinate for regulation is price discovery and that is when 
people are able outside the markets to reference these prices. 
In the bilateral markets, no one is referencing off of private 
transactions that may be individually negotiated. Certainly, as 
you correctly point out these may influence the regulated 
marketplace but I think as we are looking to find consensus on 
this. There was not consensus that due to cost considerations 
of collecting data and trying to fit these individually in 
negotiated transactions into a regulated system, the marginal 
benefits that might develop.
    Mr. Marshall. So I misunderstood you, I thought you 
suggested that if you discovered this was going on by an 
Amaranth-type, hypothetical character, you could tell them to 
stop.
    Mr. Lukken. If we saw something on a regulated exchange we 
could through our regulation 1805 authority ask them to stop 
their activity on the regulated exchanges, ask for additional 
information of what they are doing in the bilateral markets as 
well, so that you could see the entire picture.
    Mr. Marshall. But you could not stop them?
    Mr. Lukken. Not in the bilateral markets.
    Mr. Marshall. Thank you, Mr. Chairman.
    The Chairman. I thank the gentleman.
    Ranking Member, do you have additional?
    Mr. Moran. No, sir.
    The Chairman. Let me thank our witnesses for being with us 
today. You have been very helpful and I appreciate it. Under 
the rules of the Committee, the record of today's hearing will 
remain open for 10 days to receive additional materials and 
supplemental written responses from witnesses to any questions 
posed by Members of the panel. This hearing on the Subcommittee 
on General Farm Commodities and Risk Management is adjourned.
    [Whereupon, at 2:35 p.m., the Subcommittee was adjourned.]
    [Material submitted for inclusion in the record follows:]
                          Submitted Questions
Responses from Hon. Walter Lukken, Acting Chairman, Commodity Futures 
        Trading Commission, Washington, D.C.
Questions from Hon. Bob Etheridge, a Representative in Congress from 
        North Carolina
    Question 1. Regarding the President's Working Group (PWG) suggested 
language to correct the ruling in the Zelener case, has the current 
Commission taken another look at the language to determine its 
adequacy. If not, do each of the current Commissioners believe the 
proposal is adequate or does any of them believe it should be modified 
in some way; and, if so, how?
    Answer. The Commission believes it is necessary to resolve the 
Zelener issue. The current Commission has not revisited this issue 
since 2005, when the House approved the PWG proposed Zelener language. 
The Commission as a whole has never opined on the proposed PWG 
language. As I testified at the September hearing, I believe it is 
critical to resolve the Zelener issue and that the PWG language is an 
appropriate solution. At least two Commissioners now believe that a 
broader fix would be appropriate.

    Question 2. As you know, Senator Levin has introduced legislation 
to amend the CEA with regard to regulation of exempt commercial markets 
(ECMs) that trade energy-based derivatives. I want to hear a comparison 
between that bill and your recommendations. Please provide a detailed 
side-by-side comparison.
    Answer. Senator Levin's bill (S. 2058) and the Commission's 
recommendations are directed to the same goal, though there are several 
differences in approach. For example, the triggers in Senator Levin's 
bill and the Commission's recommendations are generally similar--each 
looks to whether a significant price discovery function is being 
performed. But the Commission's approach keeps the CEA Section 2(h) 
framework for ECMs in place, with targeted add-on provisions for 
significant price discovery contracts in exempt commodities. Senator 
Levin's bill, by contrast, would establish a new category of registered 
trading platform for facilities trading price-discovery energy 
commodity contracts, which would be separate and apart from the ECM 
trading platform for other exempt commodities.
    The consequences that result from a finding of a significant price 
discovery function also differ. Under Senator Levin's bill, trading 
facilities that meet the price discovery test would be subject to 17 
Core Principles. By contrast, the Commission's recommendations focus on 
four key authorities: (1) large trader position reporting; (2) position 
limits and/or accountability levels; (3) self-regulatory oversight; and 
(4) emergency authority. This measured approach will preserve the role 
of ECMs as incubators for start-up markets and concepts, which several 
witnesses at our recent hearing said spurs competition and innovation.
    Finally, Senator Levin's bill calls for record keeping and 
reporting obligations with respect to U.S. screen-based trading in 
energy contracts listed on foreign boards of trade. The Commission has 
not made any similar recommendations, which are problematic in today's 
global marketplace. They also are unnecessary given the effectiveness 
of the Commission's recently-adopted Policy Statement regarding screen-
based trading in contracts listed on foreign boards of trade.
    Although these differences in approach make a precise side-by-side 
analysis difficult, a chart comparing Senator Levin's bill and the 
Commission's recommendations in general terms is attached.

    Question 3. Under CFTC Rule 36.3, exempt commercial markets must 
provide price, quantity, and other data on contracts that average five 
or more trades a day over the most recent quarter for which they are 
relying on the Commodity Exchange Act's exemption for these markets. 
The GAO report cites CFTC officials who say the agency does not 
actively check to determine whether that five or more trades a day 
threshold is being met on those exchanges that are relying on the CEA 
exemption but not providing information to the CFTC. Why isn't the CFTC 
conducting more checking to see if contracts on those markets are 
meeting the five a day threshold? Does an ECM have a responsibility in 
this area? What are the consequences, if any, to an ECM that fails to 
notify the CFTC that a contract has crossed the threshold?
    Answer. GAO is correct. The Commission does not have a regular rule 
enforcement review program in place to check ECMs for compliance with 
the five-trade per day reporting requirement. However, there are 
safeguards in place to ensure ECM compliance with this provision. 
First, Regulation 36.3(b)(1)(ii) itself places an affirmative 
obligation on ECMs to notify the Commission when they have a contract 
that exceeds the threshold. Second, Regulation 36.3(c)(4) requires each 
ECM to file an annual certification with the Commission that it is 
continuing to operate within the conditions of its exemption from 
having to register as a designated contract market (DCM). The terms of 
the Commission's ECM annual certification form make clear that these 
conditions include apprising the Commission of those contracts that 
meet the five-trade per day threshold.
    Finally, the consequences of failing to properly notify the 
Commission of a triggering of the reporting requirement are extreme--
there is a strong incentive for ECMs to honor this provision. ECMs that 
fail to apprise the Commission that they have triggered the reporting 
requirement run the risk of losing their exemption from DCM 
registration and expose themselves to a Commission enforcement action 
for operating an unregistered exchange pursuant to Section 4(a) of the 
CEA, for failing to comply with the reporting requirement of Regulation 
36.3(b)(1)(ii), and, likely, for making a false statement in a filing 
required under the Commission's regulations pursuant to CEA Section 
9(a)(3).

    Question 4. Assuming the PWG Zelener language became law, what 
specific sections of the Commodity Exchange Act--if any--would prevent 
someone from using the same Zelener-type contract but for natural gas, 
corn, wheat, or another commodity besides forex?
    Answer. The Commodity Futures Modernization Act of 2000 (CFMA) 
authorized off-exchange trading by retail customers only in foreign 
currency futures and options. It did not change the law for commodities 
other than foreign currencies. Thus, off-exchange futures trading 
activity involving retail customers in any other commodity (such as 
natural gas, metals, corn, or wheat) remains illegal under CEA Section 
4(a), which prohibits off-exchange trading in futures.
    Thus far, we have not seen the Zelener contract form, which the 7th 
Circuit held to be a spot contract, utilized for commodities beyond 
foreign currency. Further, the best means to address the Zelener 
issue--striking the necessary balance between cracking down on 
fraudsters while not interfering with legitimate businesses--may vary 
depending on the commodity involved. Accordingly, I believe that it is 
best to address the problem that is presently before us and that has 
been before us for the past several years--foreign currency.

    Question 5. The CFTC Reauthorization bill from last Congress would 
have required introducing brokers to register with the National Futures 
Association (NFA). In his testimony last month, Mr. Roth, President of 
the NFA proposed to expand this to include commodity trading advisors 
(CTAs) and commodity pool operators (CPOs). Can you talk about whether 
CTAs and CPOs current are registered with any regulatory body and 
whether the Commission thinks we need to require their registration 
with the NFA?
    Answer. The CFMA specified certain categories of entities that may 
act as counterparties to customers for off-exchange retail forex 
transactions. However, the CFMA was silent with respect to 
intermediaries for such transactions and provided that most of the CEA 
does not apply to such transactions. Thus, entities that act in a 
manner similar to that of introducing brokers, CPOs or CTAs with 
respect to these forex transactions are not required to register, as 
would be the case if they were intermediating exchange-traded 
transactions. The registration requirement in the proposed forex 
amendments submitted by the PWG and included in the Reauthorization 
bill passed by the House of Representatives in December 2005 was not 
limited to introducing brokers. It would require registration of any 
person who participates in the solicitation or recommendation of off-
exchange retail forex transactions.

    Question 6. Please provide the Subcommittee with a record of total 
dollar amount of fines levied by the Commission for each year starting 
with 2000. Please do likewise for the total dollar amount of fines 
actually collected.
    Answer.

                  Civil Monetary Penalties FY 2000-2008
------------------------------------------------------------------------
       Fiscal Year           Penalties Imposed      Penalties Collected
------------------------------------------------------------------------
             2000              $179,811,562              $3,299,362
             2001               $16,876,335              $3,170,252
           2002 1                $9,942,382              $5,922,387
             2003              $110,264,932             $87,699,077
             2004              $302,049,939            $122,468,925
           2005 2               $76,672,758             $34,237,409
             2006              $192,921,794             $12,321,530
             2007              $327,378,507             $11,897,033
           2008 3              $126,045,682                  $4,835
------------------------------------------------------------------------
1 Includes $30,005 for civil monetary penalties imposed in prior years.
2 Includes $617,409 for civil monetary penalties imposed in prior years.
3 Through October 2007. Pending $125,000,000 BP Settlement Collection.

    The discrepancy between the amount of civil penalties imposed and 
the amount collected is accounted for by the following factors: (1) 
when courts order the defendants to pay both restitution to victims and 
a civil monetary penalty to the Commission, established Commission 
policy directs available funds to satisfy customer restitution 
obligations first; (2) in fraud actions, it is not uncommon that the 
proceeds of the fraud have been dissipated and/or that the penalty far 
exceeds the defendants' represented financial ability to pay; (3) 
penalties assessed in default proceedings against respondents who are 
no longer in business and who cannot be located or are incarcerated; 
(4) penalties imposed in 1 year may not become due and payable until 
the next year; (5) a penalty may be stayed by appeal; (6) some 
penalties call for installment payments that may span more than 1 year; 
(7) penalties have been referred to the Attorney General for 
collection; and (8) collection still in process internally.

    Question 7. If the Commission were allowed to keep 10% of the fines 
its actually collects to fund IT upgrades, modernization, and 
improvements, would that make a significant difference in improving the 
CFTC's IT infrastructure--assuming there are no corresponding 
reductions on the appropriations side?
    Answer. Assuming there were no corresponding reductions on the 
appropriations side, any funds from penalties collected would improve 
our fiscal situation. In Fiscal Year 2006, we collected over $12 
million in penalties, which (assuming the Commission retained 10%) 
would translate roughly into $1.2 million. This amount would not fully 
fund our IT requirements, but would provide much needed fiscal relief.
Questions from Hon. Bob Goodlatte, a Representative in Congress from 
        Virginia
    Question 1. The CFTC report recommends that if an Exempt Commercial 
Market (ECM) has a significant price discovery function it should have 
position limits imposed on it. Would the policy on position limits on 
ECMs be similar to the policy on Designated Contract Markets (DCM) with 
limits on speculative trades, reduced limits near expiration and review 
or exemptions of positions held in excess of the limits for legitimate 
hedges? Would the imposition of position limits on ECMs stifle in any 
way the creativity offered by ECMs?
    Answer. We anticipate that ECMs would be subject to the same type 
of accountability-level/position-limit regime that is currently 
required of DCMs under DCM Core Principle 5, including the availability 
of hedge exemptions and spot-month position limits where appropriate. 
Accordingly, ECM contracts that became subject to such an 
accountability-level/position-limit regime would be treated in a 
similar manner to comparable DCM contracts under DCM Core Principle 5.
    As with any regulatory restriction, there is a possibility that 
position limits may impact ECM operations. However, the Commission's 
recommendation that an accountability-level/position-limit regime be 
imposed on ECM contracts that perform a significant price discovery 
function is a very discrete measure. This high standard has been 
carefully chosen to ensure that there are minimum safeguards in place 
to prevent the manipulation of contracts that could have a very real 
impact on the prices of commodities in interstate commerce--a goal that 
underpins the CEA and the statutory mandate of the CFTC.

    Question 2. If a contract trading on an ECM is deemed to provide a 
significant price discovery function, by what mechanism would the 
authority you are requesting be effectuated?
    Answer. We would anticipate that any amendments to the CEA that 
require additional obligations of ECMs when they list contracts that 
become significant sources of price discovery would themselves include 
rulemaking authority for the Commission to establish standards and 
procedures for making such determinations and for effectuating the 
authorities that result from such a determination. These rules also 
would set forth the specific procedures and guidelines that the 
Commission would follow in making such determinations. The Commission 
in establishing such standards and procedures would attempt to ensure 
that they had a high degree of objectivity, thus minimizing any legal 
uncertainty for ECM operations.

    Question 3. Additionally, who would make the determination that a 
contract trading on an ECM is serving a significant price discovery 
function? Over what time frame would you see the determination being 
made that a contract trading on an ECM is serving a significant price 
discovery function and that the additional authority needs to be 
implemented on this contract?
    Answer. We would anticipate that the Commission would be given the 
authority to make determinations as to whether ECM contracts are 
serving a price discovery function. We also anticipate that any price-
discovery determination would be based upon a contract's behavior over 
some reasonable length of time, as the Commission would want to avoid a 
situation where contracts are moving in and out of price-discovery 
status.

    Question 4. Last year the Commission testified that the changes 
proposed in Title II of H.R. 4473 (the CFTC reauthorization bill in the 
109th) specific to natural gas price transparency were not necessary. 
Has the Commission changed its position?
    Answer. We appreciated the bipartisan efforts of this Committee 
during the 109th Congress to address consumer concerns over volatility 
in the natural gas markets. The measures recommended in the 
Commission's ECM Report strike an appropriate balance in the regulatory 
approach to these issues. As indicated in the Report, we do not see a 
need to impose added regulatory requirements on over-the-counter (OTC) 
bilateral energy contracts. A targeted approach to ECM significant 
price discovery contracts will best address the regulatory concerns 
that have been raised while still allowing ECMs to serve as a venue for 
start-ups where innovative trading ideas can incubate and be tested.

    Question 5. What type of self-regulatory structure does ICE 
currently have?
    Answer. Currently, ICE, as an ECM, is not required by the CEA to 
have any oversight structures commonly associated with a self-
regulatory organization such as a DCM.

    Question 6. If an ECM and the CFTC were provided with emergency 
authority over a contract what could either do if fraud or manipulation 
were suspected or detected?
    Answer. Historically, the futures exchanges and the Commission have 
possessed broad authority under the CEA to address market emergencies. 
Under Section 8a(9) of the CEA, in an emergency, the Commission can 
require an exchange ``to take such action as in the Commission's 
judgment is necessary to maintain or restore orderly trading'' in a 
contract. This broad authority would permit the Commission to impose 
trading limits, or even require liquidation, to restore orderly trading 
conditions in the marketplace. Similarly, Core Principle 6 of the CEA 
requires that DCMs adopt rules to provide for the exercise of emergency 
authority, in consultation or cooperation with the Commission, 
including the authority to liquidate positions and suspend trading 
where necessary and appropriate. Having these emergency authorities 
available often enables Commission and exchange staff to work with 
market participants to prevent emergency situations from arising in the 
first instance. We would anticipate that these same authorities would 
apply to significant price discovery contracts traded on ECMs.

    Question 7. I, too, think the penalties under  9 should be 
increased to reflect the severity of the crime. Instead of limiting 
penalties to $1 million, why not make the sanction a factor of the 
illegally obtained profit? Perhaps we should allow for treble damages 
(Three times the amount of damage a judge/jury found the defendant to 
cause) like antitrust law calls for.
    Answer. In addition to CEA Section 9, Sections 6(c) and 6c of the 
CEA currently provide for penalty authority of ``not more than the 
higher of $100,000 [adjusted to $130,000 to account for inflation] or 
triple the monetary gain,'' whichever is higher. Accordingly, the CEA 
already contemplates the possibility of penalties based on illegally 
obtained profits, including treble damages.

    Question 8. You have testified, stated in press accounts, and told 
me in conversation that CFTC staffing levels have hit an all time low. 
In the 2000 modernization effort we authorized pay parity for the CFTC. 
How has this affected your staffing levels?
    Answer. Exempting the CFTC from Title V and authorizing pay parity 
with the FIRREA agencies has been crucial to recruiting and retaining 
professionals needed to oversee the complex futures markets. The 
Commission has implemented pay parity with funds appropriated by 
Congress. Since authorization, the Commission has, when necessary, 
sought funds to ensure that our pay structure and pay ranges are in 
line with the FIRREA agencies--and we are satisfied that they are.
    However, presently at the Commission, staffing levels are at an 
all-time historic low, and employee turnover has returned to the 
double-digit levels we had experienced prior to exemption from Title V. 
In the last 2 years, the Commission has lost over 100 employees, most 
of which were retirements of senior professionals. We need to improve 
in our ability to recruit, promote, retain, and reward good performers 
within the existing pay structure--and additional funds have been 
requested in FY 2009 for this effort.

    Question 9. If the Commission does not receive an increase in its 
appropriation, can the Commission augment its budget by imposing/
increasing registration fees or assessments on trades?
    Answer. The Commission has the authority to collect a number of 
fees related to our regulatory functions, such as contract market rule 
enforcement reviews and contract market designations. We have not 
interpreted this authority to extend to assessments on trades. The fees 
that we currently are authorized to collect are deposited in the 
General Fund of the U.S. Treasury.

    Question 10. What happens to the money collected through the 
Commission's enforcement activity?
    Answer. Funds collected from civil monetary penalties in CFTC 
enforcement actions are deposited in the General Fund of the U.S. 
Treasury. Funds collected from orders of restitution and disgorgement 
are distributed to injured victims.

    Question 11. Last month this Subcommittee received testimony that 
securities and futures should be regulated in a consistent manner. Do 
you care to comment?
    Answer. We support the notion of regulating securities and futures 
in a consistent manner wherever possible, and over the past several 
years the Commission has taken several steps to align our requirements 
with those of the SEC where that makes sense.
    But it must be remembered that these are different markets--the SEC 
regulates markets whose primary function is capital formation, whereas 
the CFTC regulates markets whose primary functions are price discovery 
and risk management. Sometimes, the different functions of the markets, 
and the correspondingly different statutory mandates of the SEC and 
CFTC under the securities laws and the CEA, require different 
approaches by the two agencies.
    For example, in the securities world, there are extensive 
disclosures required by the issuers of securities, i.e., public 
companies. In the futures markets, there are no ``issuers.'' The 
mandated disclosures to retail futures customers thus focus upon the 
risks common to all futures trading.

    Question 12. GAO testified that the Commission should more 
accurately report trading data for commercial versus non-commercial 
trades. The GAO highlights instances where commercial entities may 
actually place speculative trades but these trades are reported as 
commercial because the entity is a routine commercial trader. As a 
practical matter, can this be done given that entities are organized in 
any number of business units, they place trades in a variety of ways, 
and often establish proprietary methods for managing their company's 
risk? This would make standardizing the reporting in the manner 
recommended by GAO very difficult. What kind of problems can this 
detailed reporting create? What would happen if you reported with this 
type of specificity?
    Answer. Using current reporting methodology, this detailed breakout 
of speculative positions held by commercials is not possible. To 
accomplish this, it would probably be necessary to either (1) have 
every commercial firm set up a separate reporting account for 
speculative trading; or (2) report its positions directly to the CFTC 
(as opposed to the current large trader reporting system, where futures 
commission merchants report customer positions to the CFTC). Either of 
these changes would entail additional costs to traders. Yet, it is not 
clear that such a change would substantially improve the commitments of 
traders (COT) data, as we are not aware that there is a substantial 
amount of speculative trading by commercials.
    The main issue that the CFTC has faced with COT reporting is that 
commercial swap dealers hedge OTC activity (including OTC commodity-
index related activity) in futures markets. While this trading is 
hedging (i.e., it is to offset price risk), it is different than 
traditional hedging of underlying physical business.

    Question 13. Given the global growth of risk management and the 
futures industry, what is the CFTC doing with international regulatory 
bodies to coordinate efforts to prevent fraud and manipulation across 
the globe?
    Answer. The CFTC has a robust and long-standing international 
presence. We are an active member of the International Organization of 
Securities Commissions (IOSCO), which is a standard-setting body for 
securities and futures regulators. IOSCO coordinates regulators around 
the world to promote high standards of regulation, including 
surveillance and enforcement standards. Additionally, the CFTC has 
numerous enforcement arrangements to share information with our 
overseas counterparts and coordinate our enforcement actions as much as 
possible. In addition to the CFTC's 24 bilateral enforcement 
information sharing arrangements with foreign regulatory authorities, 
the CFTC also is a signatory to the IOSCO Multilateral Memorandum of 
Understanding that provides for the sharing of bank, brokerage, and 
client identification records among the international regulators. Most 
recently, the CFTC signed an MOU with the UK Financial Services 
Authority (FSA) in 2006 to share information on an on-going basis to 
help detect potential market abuses where contracts are linked by 
settlement provisions. Finally, this past October, the CFTC Division of 
Enforcement convened an international enforcement meeting with 
commodity regulators including participants from Europe, Asia, and 
South America. The meeting was focused on detecting and enforcing 
against anti-manipulative conduct, with the goal of enhancing the 
ability of the CFTC and its fellow regulators to detect and deter 
misconduct affecting commodity prices.

    Question 14. GAO has recommended the CFTC develop ``meaningful 
outcome-based measures'' to determine the agency's effectiveness. What 
type of improved measures have you explored? Has GAO provided you 
detailed suggestions on what ``meaningful outcome-based measures'' 
would be appropriate for an agency like the CFTC?
    Answer. GAO's conclusions were derived primarily from the OMB PART 
review, which recognized that the effectiveness of an enforcement 
program is not easily measured. GAO suggested that ``there are a number 
of . . . ways to evaluate program effectiveness, such as using expert 
panel reviews, customer service surveys, and process and outcome 
evaluations.'' The Commission has requested funding in the OMB FY09 
budget in order to explore alternate means to evaluate the 
effectiveness of the program.
Question from Hon. Nancy E. Boyda, a Representative in Congress from 
        Kansas
    Question. In our hearing in late September, Mr. Damgard, President 
of the Futures Industry Association, in his written testimony asked 
this Subcommittee and the CFTC to study the state of competition among 
centralized trading platforms and clearing entities for derivatives 
products with an eye toward making sure the existing futures market 
structure is the best for serving our customers. Does the Commission 
have any plans to look into this matter?
    Answer. Section 5b(c)(2)(N) of the CEA requires each derivatives 
clearing organization (DCO), unless appropriate to achieve the purposes 
of the CEA, to avoid (1) adopting any rule or taking any action that 
results in an unreasonable restraint of trade, or (2) imposing any 
material anti-competitive burden on trading. On an ongoing basis, the 
Commission reviews DCO rules and other actions for compliance with this 
provision. The Commission notes that this provision directs that 
competitive concerns be weighed in light of the other purposes of the 
CEA, such as maintaining the financial integrity of the markets. To 
date, the Commission has not identified an instance where a DCO has 
violated this provision. The Commission will continue to monitor DCO 
activity in this area.

                                                   Attachment
----------------------------------------------------------------------------------------------------------------
                                                                       CFTC Proposal significant price discovery
      Senator Levin's ``Close the Enron Loophole Act'' S. 2058                     contracts on ECMs
----------------------------------------------------------------------------------------------------------------
I. Energy Trading Facilities                                          Analogous Provisions in CFTC Proposal
                                                                       Applicable to Significant Price Discovery
                                                                       Contracts on ECMs.
  Section 2(a) of S. 2058 amends Section 1a of the CEA                Section 1 of the CFTC proposal amends
                                                                       Section 1a of the CEA.
    A. Adds definition of ``energy commodity'' as commodity           A. Adds definition of ``significant price
      1. used as source of energy such as crude oil, gasoline,         discovery contract'' as agreement,
    natural gas, and electricity, and                                  contract, or transaction subject to
                                                                       proposed CEA Section 2(h)(7).
      2. results from burning of fossil fuel
    B. Adds definition of ``energy trading facility''                 Not applicable to CFTC proposal.
      1. not a designated contract market (``DCM'')
      2. facilitates the execution or trading of agreements,
       contracts, or transactions in an energy commodity AND
        a. facilitates the clearance and settlement of agreements,    Not applicable to CFTC proposal.
         contracts, or transactions in an energy commodity; or
        b. the Commission determines performs a significant price     CFTC to determine whether contract
         discovery function for energy commodities listed on a         performs a significant price discovery
         trading facility or in the cash market. Factors for the       function. Proposed CEA Section 2(h)(7)(A)-
         CFTC to consider:                                             (B).
          (1) extent to which price of an agreement, contract, or     Similar provision in CFTC proposal.
           transaction is derived from or linked to the price of a     Proposed CEA Section 2(h)(7)(B)(i)(I).
           futures contract traded on a DCM
          (2) extent to which cash market transactions are directly   Similar provision in CFTC proposal.
           based on the prices in the same energy commodity traded     Proposed CEA Section 2(h)(7)(B)(ii).
           on the energy trading facility
          (3) the volume of contracts traded on the trading facility  Similar provision in CFTC proposal.
                                                                       Proposed Section 2(h)(7)(B)(iii).
          (4) extent to which data is published after completion of   Similar provision in CFTC proposal.
           transactions                                                Proposed CEA Section 2(h)(7)(B)(ii).
          (5) extent to which arbitrage market exists between the     Similar provision in CFTC proposal.
           trading facility and the DCM                                Proposed CEA Section 2(h)(7)(B)(i)(II).
          (6) other factors Commission deems appropriate              Similar provision in CFTC proposal.
                                                                       Proposed CEA Section 2(h)(7)(B)(iv).
----------------------------------------------------------------------------------------------------------------
II. Section 2(b). Oversight of Energy Trading Facilities              Analogous Provisions in CFTC Proposal.
  A. Section 2(b)(1) of S. 2058 amends CEA Section 2(h)(3) to         Not applicable to CFTC proposal.
   exclude
    ``energy trading facility'' from qualifying as an exempt
     commercial market in order to make clear that those facilities
     must comply with new CEA Section 2(j)
  B. Section 2(b)(2) of S. 2058 adds a new Section 2(h)(7) to the     Not applicable to CFTC proposal.
   CEA. This
    new section provides that notwithstanding any other provision of
     CEA, an energy trading facility and persons trading on an
     energy trading facility are subject to the new CEA Section 2(j)
----------------------------------------------------------------------------------------------------------------
III. Section 2(c). Criteria for Trading Facility Registration         Analogous Standards for Significant Price
                                                                       Discovery Contracts.
      1. New Section 2(j)(4)(A) requires a trading facility to have   Adds proposed CEA Section 2(h)(7)(C)(ii)
       the capacity to prevent price manipulation, excessive           Core Principle applicable to significant
       speculation, price distortion, and disruption of the delivery   price discovery contracts--ECM must have
       or cash-settlement process                                      market surveillance, compliance, and
                                                                       disciplinary practices and procedures.
      2. New Section 2(j)(4)(B) requires a trading facility to        Adds proposed CEA Section 2(h)(7)(C)(ii)
       monitor trading to prevent price manipulation, excessive        Core Principle applicable to significant
       speculation, price distortion, and disruption of delivery or    price discovery contracts--monitoring of
       cash-settlement prices                                          trading to prevent market manipulation,
                                                                       price distortion, and disruptions of the
                                                                       delivery or cash-settlement process.
      3. New Section 2(j)(4)(C) requires a trading facility to list   Adds proposed CEA Section 2(h)(7)(C)(i)
       contracts not susceptible to manipulation                       Core Principle applicable to significant
                                                                       price discovery contracts--not readily
                                                                       susceptible to manipulation.
      4. New Section 2(j)(4)(D) requires a trading facility that      Not applicable to CFTC proposal.
       facilitates clearance and settlement by a derivatives
       clearing organization (``DCO'') must establish and enforce
       rules requiring financial integrity of contracts
      5. New Section 2(j)(4)(E) requires a trading facility to        Adds proposed CEA Section 2(h)(7)(C)(iii)
       establish and enforce rules for obtaining information           Core Principle--ability to obtain
                                                                       information.
      6. New Section 2(j)(4)(F) requires a trading facility to adopt  Adds proposed CEA Section 2(h)(7)(C)(iv)
       position limits or accountability levels to reduce threat of    Core Principle--position limitations or
       price manipulation, excessive speculation, price distortion     accountability.
       or delivery or cash-settlement process
      7. New Section 2(j)(4)(G) requires a trading facility to adopt  Adds proposed CEA Section 2(h)(7)(C)(v)
       rules for emergency authority including to (i) liquidate open   Core Principle--emergency authority,
       positions; (ii) suspend or curtail trading; and (iii) require   including authority to (i) liquidate open
       market participants to meet special margin requirements         positions, and (ii) suspend or curtail
                                                                       trading in contract.
      8. New Section 2(j)(4)(H) requires a trading facility to        Adds proposed CEA Section 2(h)(7)(C)(vi)
       arrange for daily publication of trading information            Core Principle--daily publication of
                                                                       trading information.
      9. New Section 2(j)(4)(I) requires a trading facility to        Adds proposed CEA Section 2(H)(7)(C)(vii)
       establish and enforce rules to deter abuse                      Core Principle--compliance with rules.
      10. New Section 2(j)(4)(J) requires a trading facility to       Not applicable to CFTC proposal.
       establish rules for recording and safe storage of trading
       information
      11. New Section 2(j)(4)(K) requires a trading facility to       Not applicable to CFTC proposal.
       establish rules about trading procedures for entering and
       executing orders
      12. New Section 2(j)(4)(L) requires a trading facility to       Adds proposed CEA Section 2(h)(7)(C)(vii)
       insure compliance with the rules                                Core Principle--compliance with rules.
      13. New Section 2(j)(4)(M) requires a trading facility to       Not applicable to CFTC proposal.
       disclose to the public and the Commission information about
       contract terms, trading conventions, financial integrity
       protections, etc.
      14. New Section 2(j)(4)(N) requires a trading facility to       Not applicable to CFTC proposal.
       establish fitness standards for directors and members of
       disciplinary committees
      15. New Section 2(j)(4)(O) requires a trading facility to       Not applicable to CFTC proposal.
       establish rules governing conflicts of interest in the
       decision making process
      16. New Section 2(j)(4)(P) requires a trading facility to       Not applicable to CFTC proposal.
       maintain all business records for 5 years
      17. New Section 2(j)(4)(Q) requires a trading facility to       Not applicable to CFTC proposal.
       avoid adopting rules that create an unreasonable restraint of
       trade or impose anti-competitive burdens on trading on the
       facility
  B. Criteria for Energy Trading Facilities--new section 2(j)(5)      Core Principles apply to ECMs trading
   provides that an energy trading facility must continue to comply    significant price discovery contracts on
   with all of the criteria in section 2(j)(4) to continue             an ongoing basis. Violations of the
   operation, and that violation of any criteria shall constitute a    provisions of proposed CEA Section
   violation of the CEA.                                               2(h)(7) constitute violations of the CEA.
  C. Position Limits and Accountability--new section 2(j)(6) directs  Adds proposed CEA Section 2(h)(7)(C)(iv)
   the Commission                                                      Core Principle--position limitations or
     1. to ensure that the position limits and accountability levels   accountability. Also, amends CEA Sections
      that are established for energy trading facilities are on a      4g and 4i regarding recordkeeping and
      parity with the position limits and accountability levels        large trader reporting, and Section 8a
      established for similar contracts traded on a DCM and applied    regarding emergency authority, for
      in a functionally equivalent manner,                             significant price discovery contracts.
      2. to take action as necessary to reduce potential threat of
       price manipulation, excessive speculation, price distortion
       or disruption of delivery or cash-settlement process, and
      3. to obtain information from a trader regarding the trader's
       exchange and off-exchange positions.
  D. Criteria for Commission Determination--new section 2(j)(6)(D)    Not applicable to CFTC proposal.
   specifies criteria the Commission or exchange may consider when
   determining whether to require a trader to limit, reduce, or
   liquidate a position including:
      1. person's open interest relative to the total open interest
      2. daily volume of contract
      3. person's overall position in related contracts, including
       options, and the overall open interest or liquidity in the
       related contracts and options
      4. potential for positions to cause or allow price
       manipulation, excessive speculation, price distortion, or
       disruption of delivery or cash-settlement process
      5. person's compliance record
      6. any justification provided by person for such position, and
      7. other factors as deemed appropriate by Commission
  E. Information for Price Discovery Determination--Section 2(d)      Conforming amendment (d) amends Section
   amends other provisions of the CEA to enable the Commission to      2(h)(5) to extend CFTC's special call
   obtain information from an electronic trading facility or a         authority for ECMs to obtaining
   derivatives transaction execution facility to evaluate whether      information to make a significant price
   the energy trading facility performs a price discovery function     discovery determination. Also,
                                                                       significant price discovery determination
                                                                       process subject to CFTC rulemaking
                                                                       authority under proposed CEA Section
                                                                       2(h)(7)(A).
----------------------------------------------------------------------------------------------------------------
IV. Section 3. Reporting of Energy Trades                             Analogous Provisions in CFTC Proposal.
  A. Section 3 of S. 2058 adds a new CEA section 2(K) which requires  Not applicable CFTC proposal.
   U.S. persons who trade certain energy contracts on a foreign
   board of trade (``FBOT'') to keep records and to report large
   trades.
----------------------------------------------------------------------------------------------------------------
V. Antifraud Authority                                                Analogous Provisions in CFTC Proposal.
  A. Section 4 of S. 2058 amends Section 4b of the CEA to clarify     Outside scope of proposal regarding
   the CFTC's authority to bring fraud actions in off-exchange         significant price discovery contracts
   principal-to-principal futures transactions.                        trading on ECMs; CFTC supports including
                                                                       this provision as part of CFTC
                                                                       reauthorization.
----------------------------------------------------------------------------------------------------------------
VI. Commission Rulemaking                                             Analogous Provisions in CFTC Proposal.
  A. Section 5 of S. 2058 requires the CFTC to issue proposed rules   Adds proposed CEA Section 2(h)(7)(A)
   within 180 days regarding requirements for an application for       requiring CFTC rulemaking to implement
   registration for an energy trading facility. CFTC must finalize     the provisions of this legislation.
   rule within 270 days.
----------------------------------------------------------------------------------------------------------------
VII. Conforming Amendments                                            Analogous Provisions in CFTC Proposal.
  A. Section 2 of S. 2058 includes various CEA conforming amendments  Adds conforming amendments to :
   to provide a comparable degree of CFTC authority over operations     CEA Sections (2)(a)(1)(A)--exclusive
   of registered energy trading facilities as exists with respect to     jurisdiction over significant price dis-
   DCMs.
                                                                        covery contracts on ECMs;
                                                                        CEA Section 2(h)(4)(D)--remove existing
                                                                         significant price discovery function
                                                                        provision applicable to ECMs in light of
                                                                      new Core Principle in CEA
                                                                        Section 2(h)(7)(C)(vi) requiring daily
                                                                      publication of certain trading informa-
                                                                        tion;
                                                                        CEA Section 5c--issuance of CFTC
                                                                         interpretations regarding compliance
                                                                         with
                                                                        Core Principles, delegation of functions
                                                                      under Core Principles, violations of
                                                                        Core Principles;
                                                                        CEA Section 8a--authority to alter or
                                                                         supplement rules of the trading
                                                                         facility
                                                                        and to share information with the
                                                                      trading facility.
----------------------------------------------------------------------------------------------------------------

Responses from Orice M. Williams, Director, Financial Markets and 
        Community Investment, U.S. Government Accountability Office, 
        Washington, D.C.
Question from By Hon. Bob Etheridge, a Representative in Congress from 
        North Carolina

    Question. We have heard many complaints that natural gas futures 
contracts have increased in volatility due to the increased 
participation of speculators--or noncommerical traders--in these 
markets. However, according to GAO's report, the market that has seen 
the greatest increase in noncommerical traders in the past 3 years has 
been the crude oil market; and--interestingly enough--your report 
states that this market has experienced declining volatility during the 
same period. Can you account for this discrepancy, or--if not--does 
this not cast doubt on the argument that increase participation by 
speculators inevitably causes increased volatility?
    Answer. As you point out, our analysis of the price volatility of 
futures contracts showed that crude oil volatility decreased, on an 
annual basis, from 2003 through 2006. At the same time, CFTC large 
trader data reveal that the average daily number of noncommercial 
traders in crude oil futures and options contracts grew from about 125 
to about 286 from July 2003 to December 2006.
    We agree that these trends are not consistent with assertions that 
increased speculation necessarily results in increased price 
volatility. However, it is important to note that while there may be a 
correlation between the two, causation is more difficult to prove 
empirically. Even if the number of noncommercial, or speculative, 
participants increased during a period of rapidly rising price 
volatility, there may be a number of factors contributing to such a 
trend. For example, speculative traders may be attracted to a market 
with high or increasing volatility because it increases the opportunity 
to profit from changing prices. Furthermore, natural gas historically 
has been more volatile than other energy commodities, and other 
commodities in general, due to difficulties in storage and 
transportation and sensitivity to changing weather.
Questions from By Hon. Bob Goodlatte, a Representative in Congress from 
        Virginia

    Question 1. What is a ``meaningful outcome based measure'' and how 
can it help the Commission identify violations or deter misconduct? 
What specific ``outcome based measures'' have you recommended to the 
CFTC? What are examples of ``outcome based measures'' that are used by 
other Federal agencies that would be applicable to the CFTC?
    Answer. The Office of Management and Budget's (OMB) Program 
Assessment Rating Tool (PART) review of CFTC's enforcement program--
which is the basis for much of our discussion--interprets a meaningful 
outcome based measure to be one that ``fully reflect[s] progress on 
meeting the program's overall goals.'' \1\ The purpose of outcome-based 
performance measures is to help the CFTC better assess and improve its 
performance in meeting program goals, including the identification of 
violations and deterrence of misconduct. As we note in our report, PART 
is meant to serve as a diagnostic performance tool, drawing on 
available program performance and evaluation information to form 
conclusions about program benefits and recommend adjustments that may 
improve results.
---------------------------------------------------------------------------
    \1\ See p. 54 of our report; and 1181175, p. 9, 4.1.
---------------------------------------------------------------------------
    Our report did not recommend that CFTC consider any specific 
outcome-based measures. Rather, we note that enforcement agencies, such 
as CFTC, face challenges in developing meaningful measures. Therefore, 
we identified a number of other ways to evaluate the effectiveness of 
its enforcement program including the use of expert panel reviews, 
customer service surveys, and process and outcome evaluations.\2\
---------------------------------------------------------------------------
    \2\ P. 56 of our report.

    Question 2. What type of classification would you like to see in 
the reports issued by the Commission to eliminate the ``disconnect'' 
you noted in your testimony?
    Answer. In December 2006, CFTC announced a pilot program to more 
accurately reflect the nature of positions held by nontraditional 
hedgers, such as swap dealers, in the COT report by including positions 
of commodity index traders in a separate category. We recommended that 
CFTC consider expanding this pilot (e.g., separate reporting category 
for commodity index funds) to include energy commodities. As currently 
structured, the Commitment of Traders (COT) reports for energy 
commodities make no distinction between commercial traders who use 
futures exchanges to hedge their positions in the physical markets and 
those commercial traders, such as investment banks, who trade futures 
to hedge their trading in off-exchange derivatives.

    Question 3. Did you evaluate how the market oversight division and 
the enforcement division of the CFTC interact? If so, do you find there 
to be adequate interaction between the two divisions?
    Answer. While we did not evaluate the extent of interaction, our 
report does describe how the market oversight division and enforcement 
divisions interact. For example, beginning on p. 44 of our report (GAO-
08-25), we describe how CFTC can use information gathered from 
surveillance activities, especially on large traders, to identify 
unusual trading activity and possible market abuse. On page 48, we 
discuss how market oversight staff may refer instances of questionable 
trading activity to the enforcement division to conduct nonpublic 
investigations.

    Question 4. In last month's hearing and again today we received 
testimony on the increasingly global scale of the futures market. Did 
you consider the likelihood that any of your recommendations--greater 
regulation, reporting requirement or enforcement activity--would 
potentially force this business overseas, beyond the regulatory reach 
of the CFTC?
    Answer. Some industry observers we spoke with shared concerns that 
greater oversight could result in certain activities moving offshore. 
However, our matter for Congressional consideration (that Congress 
consider further exploring the adequacy of the current regulatory 
structure for energy derivatives) suggests that Congress further 
explore the currently regulatory structure. Any such consideration 
should include considering the global nature of the market and the 
impact regulatory changes may have on off-exchange markets. Similarly, 
our recommendations to CFTC should not directly affect market 
participants. For example, we recommend that CFTC reexamine the way it 
classifies the data it already receives from market participants in the 
COT reports versus new reporting requirements on market participants. 
Likewise, our recommendations on improving its monitoring documentation 
and evaluating its enforcement activities are both aimed at improving 
the operational effectiveness of CFTC's existing activities and 
requirements.

                                  
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