[Senate Hearing 110-235]
[From the U.S. Government Publishing Office]
S. Hrg. 110-235
EXCESSIVE SPECULATION IN THE NATURAL
GAS MARKET
=======================================================================
HEARING
before the
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
of the
COMMITTEE ON
HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
__________
JUNE 25 AND JULY 9, 2007
__________
Available via http://www.access.gpo.gov/congress/senate
Printed for the use of the
Committee on Homeland Security and Governmental Affairs
U.S. GOVERNMENT PRINTING OFFICE
36-616 PDF WASHINGTON DC: 2007
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COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan SUSAN M. COLLINS, Maine
DANIEL K. AKAKA, Hawaii TED STEVENS, Alaska
THOMAS R. CARPER, Delaware GEORGE V. VOINOVICH, Ohio
MARK PRYOR, Arkansas NORM COLEMAN, Minnesota
MARY L. LANDRIEU, Louisiana TOM COBURN, Oklahoma
BARACK OBAMA, Illinois PETE V. DOMENICI, New Mexico
CLAIRE MCCASKILL, Missouri JOHN W. WARNER, Virginia
JON TESTER, Montana JOHN E.SUNUNU, New Hampshire
Michael L. Alexander, Staff Director
Brandon L. Milhorn, Minority Staff Director and Chief Counsel
Trina Driessnack Tyrer, Chief Clerk
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
CARL LEVIN, Michigan, Chairman
THOMAS R. CARPER, Delaware NORM COLEMAN, Minnesota
MARK L. PRYOR, Arkansas TOM COBURN, Oklahoma
BARACK OBAMA, Illinois PETE V. DOMENICI, New Mexico
CLAIRE McCASKILL, Missouri JOHN W. WARNER, Virginia
JON TESTER, Montana JOHN E. SUNUNU, New Hampshire
Elise J. Bean, Staff Director and Chief Counsel
Elise J. Bean, Staff Director and Chief Counsel
Dan M. Berkovitz, Counsel
Kate Bittinger, Detailee, GAO
Mark L. Greenblatt, Staff Director and Chief Counsel to the Minority
Mark D. Nelson, Deputy Chief Counsel to the Minority
Mary D. Robertson, Chief Clerk
C O N T E N T S
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Opening statements:
Page
Senator Levin................................................ 1, 61
Senator Coleman.............................................. 6, 65
Senator McCaskill............................................ 20
WITNESSES
Monday, June 25, 2007
Arthur Corbin, President and CEO, Municipal Gas Authority of
Georgia, Kennesaw, Georgia, on behalf of the American Public
Gas Association................................................ 9
Paul N. Cicio, President, Industrial Energy Consumers of America,
Washington, DC................................................. 10
Sean Cota, Co-Owner and President, Cota and Cota, Inc., Bellows
Falls, Vermont, President, New England Fuel Institute,
Watertown, Massachusetts, and Northeast Chair, Petroleum
Marketers Association of America, Arlington, Virginia.......... 12
Vincent Kaminski, Professor, Rice University, Jesse H. Jones
Graduate School of Management, Houston, Texas.................. 31
Michael Greenberger, Law School Professor, University of Maryland
School of Law, Baltimore, Maryland............................. 32
Shane Lee, Former Natural Gas Trader at Amaranth, LLC, Calgary,
Alberta, Canada................................................ 46
Monday, July 9, 2007
James Newsome, President and Chief Executive Officer, New York
Mercantile Exchange, Inc., (NYMEX), New York, New York......... 68
Jeffrey C. Sprecher, Chairman and Chief Executive Officer,
Intercontinental Exchange, Inc. (ICE), Atlanta, Georgia........ 71
Walter Lukken, Acting Chairman, and Michael Dunn, Commissioner,
Commodity Futures Trading Commission (CFTC), Washington, DC.... 88
Alphabetical List of Witnesses
Cicio, Paul N.:
Testimony.................................................... 10
Prepared statement........................................... 120
Corbin, Arthur:
Testimony.................................................... 90
Prepared statement........................................... 107
Cota, Sean:
Testimony.................................................... 12
Prepared statement........................................... 123
Dunn, Michael:
Testimony.................................................... 88
Prepared statement........................................... 178
Greenberger, Michael:
Testimony.................................................... 32
Prepared statement........................................... 137
Kaminski, Vincent:
Testimony.................................................... 31
Prepared statement........................................... 133
Lee, Shane:
Testimony.................................................... 40
Prepared statement........................................... 147
Lukken, Walter:
Testimony.................................................... 88
Prepared statement........................................... 178
Newsome, James:
Testimony.................................................... 68
Prepared statement........................................... 152
Sprecher, Jeffrey C.:
Testimony.................................................... 71
Prepared statement........................................... 167
APPENDIX
``Excessive Speculation in the Natural Gas Market,'' staff report
with additional Minority staff views, Permanent Subcommittee on
Investigations................................................. 196
EXHIBITS
1. GNatural Gas Futures Prices Were Higher and More Extreme in
2006, chart prepared by the Permanent Subcommittee on
Investigations Staff........................................... 711
2. GIn mid-August of Each Year 2002-2006, the Difference in
Contract Prices for Future Delivery of Natural Gas for the Next
October and January, chart prepared by the Permanent
Subcommittee on Investigations Staff........................... 712
3. GAmaranth's Purchases Increased Prices, chart prepared by the
Permanent Subcommittee on Investigations Staff................. 713
4.a. GAmaranth's Size Increased Prices, chart prepared by the
Permanent Subcommittee on Investigations Staff................. 714
b. GNYMEX Could Not See Amaranth's ICE Positions, chart
prepared by the Permanent Subcommittee on Investigations Staff. 715
5. GAmaranth Held Very Large Amounts of Outstanding Natural Gas
Futures Contracts (Open Interest), chart prepared by the
Permanent Subcommittee on Investigations Staff................. 716
6. GAmaranth Positions on NYMEX and ICE Before and After NYMEX
Order to Reduce (August 8, 2006) September Natural Gas Future,
and Swaps, chart prepared by the Permanent Subcommittee on
Investigations Staff........................................... 717
7. G``Until They Monitor Swaps No Big Deal,'' chart prepared by
the Permanent Subcommittee on Investigations Staff............. 718
8. GNatural Gas Futures Prices Fell As Amaranth Collapsed, chart
prepared by the Permanent Subcommittee on Investigations Staff. 719
9. GSelected Excerpts from Instant Messages and Emails related
to Amaranth Advisors LLC....................................... 720
10.a. GChronology of NYMEX Oversight of Amaranth in 2006,
prepared by the Permanent Subcommittee on Investigations Staff. 800
b. GSummary of NYMEX Correspondence about Amaranth in 2005 and
2006, prepared by NYMEX........................................ 802
c. GAnthony Densieski/Corey Traub (NYMEX) emails, dated
January 30/February 4, 2006, re: AVD Accountability Issues in
NG, NR, CI..................................................... 804
d. GAnthony Densieski/Corey Traub (NYMEX) emails, dated March
23, 2006, re: Natural Gas Accountability Issues................ 806
e. GAndrew Murphy/Anthony Densieski (NYMEX) email, dated April
4, 2006, re: Accountability Issues............................. 808
f. GCorey Traub/Anthony Densieski (NYMEX) email, dated April
7, 2006, re: NG Accountability Issue........................... 810
g. GAnthony Densieski/Andrew Murphy (NYMEX) emails, dated
April 4/May 3, 2006, re: Accountability Issues................. 811
h. GCorey Traub/Anthony Densieski (NYMEX) email, dated May 10,
2006, re: Natural Gas Accountability Issues.................... 813
i. GAnthony Densieski/Corey Traub (NYMEX) emails, dated May
17, 2006, re: Natural Gas Accountability....................... 815
j. GLetter from NYMEX to Amaranth LLC, dated May 31, 2006, re:
Violations of Exchange Rule 9.28............................... 817
k. GAnthony Densieski/Corey Traub (NYMEX) emails, dated June 1
and 14, 2006, re: Natural Gas Accountability Issues............ 818
l. GNYMEX Compliance Department emails, dated July 5, 2006,
re: All Month Accountability (TC, NX & PG)..................... 821
m. GLetter from NYMEX to Amaranth LLC, dated July 11, 2006,
re: Warning Letter Revision, Violation of Exchange Rule 9.28... 823
n. GAnthony Densieski/Corey Traub (NYMEX) emails, dated July
12, 22, 25, and 26, 2006, re: Natural Gas Accountability
(Amaranth)..................................................... 824
o. GLetter from NYMEX to Amaranth LLC, dated August 2, 2006,
re: The Compliance Department of the New York Mercantile
Exchange (``Exchange'') has commenced Investigation Number MS-
04-06 to review Amaranth's LLC's (``Amaranth'') NYMEX Natural
Gas futures trading activity . . .............................. 826
p. GCorey Traub/Anthony Densieski (NYMEX) emails, dated August
3, 2006, re: Natural Gas Options Accountability................ 827
q. GAnthony Densieski/Corey Traub (NYMEX) emails, dated August
4, 2006, re: Natural Gas Accountability Issues................. 830
r. GNYMEX emails, dated August 4 and 7, 2006, re: TC
Accountability for Amaranth, LLC............................... 832
s. GNYMEX Memo, undated, re: Amaranth LLC September 2006 and
October 2006 Natural Gas Open Positions........................ 834
t. GLetter from Amaranth LLC Compliance Director to NYMEX,
dated August 15, 2006, NYMEX Investigation Number re: MS-04-06. 837
u. GLetter from Amaranth LLC Compliance Director to NYMEX,
dated August 30, 2006, re: . . . concern about trading
yesterday in the NYMEX Natural Gas futures contract . . ....... 840
11. GTimeline summarizing JPMorgan Chase's interactions with
Amaranth 2003 through September 21, 2006, prepared by JPMorgan
Chase.......................................................... 842
12.a. GAmaranth's CP Leverage Funds Due Diligence, prepared by
JPMorgan Chase. 2001........................................... 846
b. GAmaranth's CP Leverage Funds Due Diligence, prepared by
JPMorgan Chase. 2004........................................... 850
c. GAmaranth's CP Leverage Funds Due Diligence, prepared by
JPMorgan Chase. 2005........................................... 861
d. GAmaranth's CP Leverage Funds Due Diligence, prepared by
JPMorgan Chase. 2006........................................... 879
13. GAmaranth April 2006 Update to investors, prepared by
Amaranth....................................................... 898
14. GAmaranth May 2006 Update to investors, prepared by Amaranth. 900
15. GExcerpt from Intercontinental Exchange Inc. (ICE) Form 10-K. 902
16. GExcerpt from Remarks of Commissioner Michael V. Dunn before
the National Grain Trade Council's Mid-Year Meeting, Kansas
City, MO, September 8, 2006.................................... 904
17.a. GAmaranth Hedge-Fund Losses Hit 3M Pension, Goldman,
Bloomberg.com, September 20, 2006.............................. 906
b. GAmaranth Seeks to Dismiss Pension Fund's Lawsuit, San
Diego Business Journal Online, June 8, 2007.................... 908
18. GExempt Commercial Markets, 2001-2006........................ 909
19. GPerformance and Net Asset Value Report--September 2006 YTD,
prepared by Amaranth LLC....................................... 910
20. GLetter from NYNEX, dated March 13, 2006, to Amaranth, re:
Violation of Exchange Rule 9.28................................ 911
21. GJPMorganChase emails, dated May 19, 2006, re: Amaranth LLC
June06 Natural Gas............................................. 912
22. GAdditional Selected Excerpts from Instant Messages and
Emails Related to Amaranth Advisors LLC........................ 913
23. GCorrespondence received by the Permanent Subcommittee on
Investigations from Shane Lee's counsel, clarifying Mr. Lee's
June 25, 2007, testimony....................................... 998
24. GResponses to questions for the record submitted to Shane Lee 1000
25. GResponse to supplemental question for the record submitted
to Arthur Corbin, American Public Gas Association.............. 1004
EXCESSIVE SPECULATION IN THE NATURAL GAS MARKET
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MONDAY, JUNE 25, 2007
U.S. Senate,
Permanent Subcommittee on Investigations,
of the Committee on Homeland Security
and Governmental Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 11:03 a.m., in
room 106, Dirksen Senate Office Building, Hon. Carl Levin,
Chairman of the Subcommittee, presiding.
Present: Senators Levin, McCaskill, and Coleman.
Staff Present: Elise J. Bean, Staff Director and Chief
Counsel; Dan Berkovitz, Counsel; Kate Bittinger, Detailee, GAO;
Ross Kirschner, Counsel; Mary D. Robertson, Chief Clerk; Mark
L. Greenblatt, Staff Director and Chief Counsel to the
Minority; Mark D. Nelson, Deputy Chief Counsel to the Minority;
Clifford C. Stoddard, Jr., Counsel the Minority; Timothy R.
Terry, Counsel to the Minority; Emily T. Germain, Staff
Assistant to the Minority; Jeremy Kress, Law Clerk; David
Weinberg, Law Clerk; Genevieve Citrin, Intern; Edmund Zagorin,
Intern; Peg Gustafson, McCaskill staff; Ruth Perez, Detailee,
IRS; and Kunaal Sharma, Intern.
OPENING STATEMENT OF SENATOR LEVIN
Senator Levin. Good morning, everybody. Our Subcommittee
meets today to look into the question of excessive speculation
in natural gas prices.
In recent years, allegations of price manipulation and
excessive speculation have erupted in almost every sector of
our energy markets, from the ongoing litigation over Enron's
distortion of electricity prices, to price manipulation charges
in the propane market, to allegations of price gouging in
gasoline.
Just one year ago our Subcommittee released a report
showing how rampant speculation was inflating crude oil prices
by $20 per $70 barrels of oil. When manipulation or excessive
speculation distorts our markets, it is the American public
that pays the price.
Today's hearing examines one case history that illustrates
the current chaotic and dangerous vulnerability of U.S. energy
markets to price manipulation and excessive speculation. Our
focus is on an $8 billion hedge fund called Amaranth Advisors,
LLC which, before its collapse in September 2006, was the
dominant speculator in the U.S. natural gas market.
Natural gas is a vital U.S. energy source. It heats the
majority of American homes, is used to harvest crops, powers 20
percent of our electrical plants, and plays a critical role in
many industries including manufacturers of fertilizers, paints,
and medicines. It is one of the cleanest fuels we have and we
produce most of it ourselves, with only 15 percent being
imported, from Canada primarily.
In 2005, alone U.S. consumers and businesses spent about
$200 billion on natural gas. For much of 2006, until Amaranth
collapsed, futures prices for winter gas were unusually high
despite ample natural gas supplies. To understand why prices
remained high despite ample supplies and why Amaranth went from
billions to broke overnight, the Subcommittee subpoenaed and
reviewed millions of trading records from the two leading U.S.
commodity exchanges that trade energy, the New York Mercantile
Exchange, (NYMEX) and the InterContinental Exchange, (ICE) as
well as from Amaranth and other traders, all of whom cooperated
with our inquiry.
The trading records show that in 2006 until its collapse,
Amaranth dominated trading in the U.S. natural gas market. It
bought and sold thousands of natural gas contracts on a daily
basis and tens of thousands on some days. It used those trades
to accumulate massive natural gas holdings called
``positions.''
The lead Federal agency that oversees energy trading,
called the Commodity Futures Trading Commission, (CFTC) defines
``large traders'' for reporting purposes as any trader with 200
natural gas contracts. NYMEX examines a trader's position if it
exceeds 12,000 natural gas contracts in a month. Amaranth at
times held 100,000 natural gas contracts in a month, an amount
equal to one trillion cubic feet of gas.
During 2006, Amaranth held about 40 percent of all of the
outstanding natural gas contracts on NYMEX and as much as 75
percent of the natural gas contracts in a single month.
The report we are releasing today is filled with charts
showing how Amaranth trades affected natural gas prices as far
out as 5 years. Amaranth's trades had a common focus--that
winter gas prices would be unusually expensive compared to
summer and fall prices. In prior years, for example, futures
contracts delivering natural gas in January cost $1 to $1.50
more than futures contracts delivering natural gas in October
due to the higher demand that comes in January, the peak of the
home heating season.
As Exhibit 2 shows,\1\ however, in 2006, January futures
contract prices skyrocketed, exceeding October prices by $4,
more than twice the historic norm. This price difference is the
largest between these two contracts in 5 years.
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\1\ See Exhibit 2 which appears in the Appendix on page 712.
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Amaranth's large scale trading, which went on day after day
throughout the spring and summer of 2006, was the key driver in
this $4 difference. At times during the summer, for instance,
Amaranth held 75 percent of the outstanding futures contracts
to deliver natural gas in November, 60 percent of those
delivering natural gas in January, and 60 percent of those
delivering natural gas in March. It was often the largest
trader in winter gas futures.
Other traders told the Subcommittee staff that during the
summer of 2006 the relative winter futures prices were
``clearly out of whack'', ``at ridiculous levels'' and
unrelated to supply and demand. They also told the Subcommittee
that they were reluctant to bet on falling winter prices given
Amaranth's demonstrated ability to boost prices through large
trades.
The result was that anyone who used the futures market
during the summer of 2006 to buy natural gas for delivery in
the following winter paid unusually high winter prices compared
to fall and summer prices. Natural gas consumers like utilities
told the Subcommittee that when they went on the market in the
summer to buy their winter gas and hedge against future price
increases they knew the winter prices were very expensive and
higher than made sense, given ample supplies. But they had to
buy.
As one municipal utility told us, they could not afford to
``roll the dice'' and wait to see if natural gas prices fell
later on. Their budget required them to make a decision during
the summer. They paid the inflated prices and so did their
customers.
Market prices are supposed to be the result of the
interaction of many buyers and sellers, not the result of
massive trades by a dominant speculator with market power to
affect prices. But in 2006, Amaranth dominated the market and
winter prices remained at extreme levels despite ample
supplies.
It is one thing for a speculator like Amaranth to gamble on
natural gas futures, in this instance, betting on unusually
high winter prices. It is another thing for Amaranth to make
that bet with such large-scale trades that it pushed up prices
and, in effect, put heavy pressure on consumers in the market
to take the same gamble and pay sky-high prices for future
winter purchases.
Later, as Amaranth collapsed in September, winter prices
fell dramatically, but by then many natural gas consumers were
already locked in and could not take advantage of the lower
prices.
Where were the regulators in all of this? Hamstrung by the
law. The key law, the Commodities Exchange Act is riddled with
exceptions, exemptions, exclusions, and limitations that make
policing energy markets almost impossible. The biggest problem
is the so-called Enron loophole which, at the request of Enron
and others, was inserted into a bill at the last minute during
a Senate-House conference in 2000.
The Enron loophole exempts from government oversight energy
and metals commodities traded on an electronic exchange by
large traders. This exemption has never made any sense. Why
should U.S. regulators protect virtually every type of
commodity against trading abuses--corn, pork bellies, you name
it--but not energy when energy is so vital to our economy? Why
should regulators have authority to police regulated markets
like NYMEX but not unregulated markets like ICE when both
affect energy prices?
Some argue that the exemption makes sense because large
traders can take care of themselves on electronic exchanges and
do not need government protection. But government protection is
not for the traders, it is aimed at protecting the public from
price shocks due to market manipulation and excessive
speculation.
An example from the Amaranth case history shows how the
Enron loophole makes it nearly impossible for regulators to
prevent large-scale trading from triggering price spikes. By
August 2006, Amaranth had huge natural gas holdings in the
September and October futures contracts. NYMEX officials were
alarmed. They were alarmed that Amaranth might try to make
last-minute large-scale trades that would affect these contract
prices. So they ordered Amaranth to reduce its holdings in both
the September and the October contracts.
In response, Amaranth reduced its NYMEX holdings, but at
the same time increased its holdings in those same contracts on
ICE. Natural gas contracts are called futures on NYMEX and
swaps on ICE, but there is no functional difference between
them.
Exhibit 6 \1\ shows Amaranth's September natural gas
holdings before and after NYMEX ordered it to reduce its size.
The data shows that, in response to NYMEX's order to reduce,
Amaranth simply switched its holdings to ICE where neither
NYMEX nor the CFTC could limit its trading.
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\1\ See Exhibit 6 which appears in the Appendix on page 717.
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Over the next 2 weeks Amaranth then increased its holdings,
outside of the scrutiny or regulatory reach of NYMEX and CFTC.
By the end of August, Amaranth held almost 100,000 September
contracts and 90,000 October contracts, mostly on ICE. Those
holdings are so large that, for 100,000 contracts, a change of
one penny in the price of the contract translates into a profit
or loss of $10 million.
NYMEX's order, in the end, did nothing to reduce Amaranth's
holdings; it just caused Amaranth's trading to move from a
regulated to an unregulated market.
NYMEX also ordered Amaranth to refrain from large-scale
trading during the final half hour of trading on the September
contract, again to prevent any chance of price manipulation or
excessive speculation. The last day for trading on that
contract was August 29. The last half hour was from 2 to 2:30
p.m.
The last half hour is important because NYMEX calculates
the final price for its futures contracts using a formula that
focuses on the prices paid in the last 30 minutes of trading.
The final contract price is important because many natural gas
contracts, both on and off the exchanges, incorporate the
``final settlement price'' of the relevant NYMEX futures
contract.
Amaranth stopped trading the September contract on both
NYMEX and ICE around 1:15 p.m. on August 29. Amaranth explained
that it stopped trading on ICE as well as NYMEX because its
traders coordinate their trading on both markets and it did not
want to trade on one without the other. In the days before
August 29, Amaranth had engaged in a torrent of trading,
selling tens of thousands of the September contract. On August
29, Amaranth continued making large sales all day, but its
sales were counterbalanced by other traders buying those
contracts, the largest of which was a hedge fund called
Centaurus. In the last half hour of trading, Amaranth stopped
selling, but Centaurus and other traders continued buying and
the September contract price shot up 10 percent.
Altogether, on August 29, Amaranth sold about 16,000
September contracts while Centaurus bought about 12,000, almost
all on ICE using swaps. NYMEX rules bar traders from holding
more than 1,000 contracts in the last 3 days of trading on a
contract. The ICE trading not only made a mockery of that
limit, it clearly affected the NYMEX final price. For Amaranth,
the last-minute price spike dropped the value of its holdings
by nearly $500 million.
Amaranth appears to have gotten a dose of its own medicine
on August 29, and it did not like it. On August 30, Amaranth
wrote to the CFTC that the sudden September price increase did
not reflect supply and demand but large scale trading by market
participants who are not ``trading in a responsible manner.''
It demanded an inquiry. Amaranth's lead trader predicted in
an e-mail to another trader: ``boy, I'll bet you see some CFTC
inquiries'' into the September trading. The other trader
reminded him, however, that most of the trades were on ICE,
using swaps which were outside CFTC authority. He wrote:
``until they monitor swaps, no big deal.''
``No big deal.'' That is what one trader thought of CFTC
oversight in the face of a torrent of trading and a huge last
minute price spike. Why? Because current law strips the CFTC of
any authority to regulate ICE, even though ICE is a major U.S.
energy exchange.
Right now the law requires U.S. energy market regulators to
work blind to ICE trades and powerless to limit ICE trading,
even when that trading threatens U.S. consumers with price
manipulation and excessive speculation.
Now understanding swaps, hedges, price spreads, and margin
requirements is no easy task. Proving price increases were
caused by excessive speculation is also difficult, especially
since regulators have not provided clear criteria defining
excessive speculation. But what is crystal clear and easy to
understand is that Amaranth dominated the U.S. natural gas
market in 2006. It used massive trades to bet the store that
winter prices would be twice as high as summer and fall prices
compared to previous years. When Amaranth made that bet, it
forced a lot of natural gas consumers to make the same bet and
pay sky high prices for winter gas because they could not take
a chance and wait to see if prices fell.
When Amaranth collapsed in September, it was too late for
many U.S. consumers to take advantage of the lower prices that
followed.
Congress needs to do much more to safeguard U.S. energy
markets from price manipulation and excessive speculation. The
first step is to close the Enron loophole. Closing this
loophole would make NYMEX and ICE subject to the same market
oversight and put the cop on the beat in all U.S. energy
markets. It would also level the regulatory playing field
between the two exchanges.
Last week, the CFTC issued a proposed rule that would curb
but not end the ill effects of the Enron loophole. The proposed
rule would require all traders on regulated exchanges like
NYMEX to disclose upon request from a regulator all holdings on
unregulated exchanges like ICE. The CFTC notes the ``close
relationship'' between regulated and unregulated commodity
markets and the need to get a complete picture of a trader's
holdings in order to prevent price manipulation and excessive
speculation. The proposed rule is, in essence, a belated
acknowledgment of the Amaranth facts. If finalized, this
proposal would increase regulators' access to key market
information. But getting key information is not enough if
regulators remain powerless to act on what they see. Regulators
must also be able to reduce holdings and limit trades to
prevent price manipulation or excessive speculation. Only
Congress can eliminate the Enron loophole once and for all, and
restore regulatory authority over all U.S. energy markets.
In 2006, excessive speculation by a single hedge fund,
Amaranth, altered natural gas prices, caused wild price swings,
and socked consumers with high prices. It is one thing when
speculators gamble with their own money; it is another when
they turn U.S. energy markets into a lottery where everybody is
forced to gamble with them, betting on prices driven by
aggressive trading practices. Amaranth is not the only hedge
fund to use large-scale trading in U.S. energy markets. To stop
the abuses, we have got to put a regulatory cop back on the
beat in all U.S. energy markets and give them stronger tools to
stop price manipulation and excessive speculation.
Let me turn it over to Senator Coleman, again with thanks
to him and his staff for their cooperation in working with us
on a very complicated and very detailed investigation. As
always, he has been helpful and we very much appreciate that
kind of support.
OPENING STATEMENT OF SENATOR COLEMAN
Senator Coleman. Thank you, Mr. Chairman.
Today's hearing represents the culmination of the
Subcommittee's extensive bipartisan investigation into the
impact of speculative trading on U.S. energy markets. Our
inquiry builds on the Subcommittee's prior focus on this issue,
including a February 2006 field hearing held in my home State
of Minnesota that focused on the impact of high natural gas
prices on American consumers as well as the Subcommittee's June
2006 staff report.
These efforts, including today's hearing, have been
bipartisan from their inception. I want to thank Chairman Levin
and his staff for their hard work and dedication in ensuring
the fairness and integrity of our energy markets.
I am not going to go through a recitation of the Amaranth
facts. The Chairman did a very good job of that. In fact what
he did, as I listened and made some notes, he took something
that is very complicated and really simplified it. In its
essence what we have heard and what we saw is when you have
part of a market that is regulated, in this case by NYMEX, and
you have part of a market that is not regulated, what happens
is when the regulated market responds the activity shifts to
the unregulated market. The question becomes what is the impact
on American consumers?
As we noted in the Minority's views attached to the
Subcommittee's report, different conclusions can be drawn from
the same set of facts. Amaranth accumulated such large
positions and traded such large volumes of natural gas that at
times Amaranth appears to have moved the entire futures market.
At other times, however, Amaranth appears to have been
responding to the market rather than driving it. Nevertheless,
when last year's hurricane season ended without a major event,
it became clear that market fundamentals no longer supported
Amaranth's bet on winter gas and traders moved quickly and
aggressively against Amaranth's positions.
In just a couple of weeks from the end of August through
mid-September, Amaranth's natural gas positions lost more than
$2 billion in value. These tremendous losses ultimately
necessitated Amaranth's liquidation of its entire natural gas
portfolio. When the dust finally settled on September 20,
Amaranth reported the greatest single losses ever by a hedge
fund, more than the losses of Long Term Capital Management
(LTCM).
Remarkably, the financial markets met one of the largest
individual losses in financial history with relative calm.
Amaranth privately negotiated the takeover of his positions. In
contrast to the debacle involving LTCM, the Federal Reserve did
not have to intervene to prevent financial panic.
The markets' ability to absorb Amaranth's losses is a sign
of their vitality and strength. But to shrug off Amaranth's
collapse as a rare and victimless event is both short-sighted
and irresponsible. Amaranth's collapse fired a warning signal,
illuminating a troubling level of high risk speculative trading
that occurs on U.S. energy markets and underscoring the need
for greater transparency on the over-the-counter electronic
energy exchanges.
Today more than 500 energy-related hedge funds deploy a
combined $67 billion in speculative capital in our energy
markets. To be sure, these traders bring important liquidity
and vitality to the markets in which they invest. But I am
concerned that at times speculative trading overwhelms the real
buyers and sellers like the utilities and industrial users of
natural gas. Massive levels of speculation not only increase
market volatility but also contribute to rising energy prices
which ultimately are passed on to hard-working American
families.
I'm reminded of the testimony I heard during the
Subcommittee's field hearing last year in St. Paul. Too many
Americans find themselves in circumstances similar to Diedre
Jackson or Lucille Olson, two individuals who testified about
the burdens caused by rising natural gas costs. In the case of
Ms. Olson, her natural gas bill represented 30 percent of her
monthly income. As a senior citizen trying to cope with the
high cost of health insurance and prescription drugs, last
year's spike in natural gas prices made it increasingly
difficult for her to make ends meet.
Ms. Jackson, a hard-working mother of three and a college
student, shared with me the financial jeopardy she faced as a
result of a home heating bill that had increased by more than
100 percent.
These examples serve as powerful reminders of the real-
world impacts of large spikes in natural gas prices. We must
not forget that high energy costs place millions of Americans
in financial jeopardy every year.
Nor should we overlook the impact that unchecked and
unregulated speculation can have on the financial markets
themselves. I am concerned that, last year, several large
speculative traders appear to have impacted the natural gas
market as a whole. Our financial system depends on investor
confidence in the fairness and efficiency of our markets. If
investors believe that speculative trading is able to separate
prices from supply and demand fundamentals, or worse that a few
dominate traders are able to cause unwarranted price changes,
then the very integrity of our financial markets is threatened.
More than ever before it is imperative that the CFTC and
other market regulators have the statutory authority and budget
necessary to police our energy markets. Despite this pressing
need for oversight, however, the CFTC's ability to conduct
market surveillance has been eroded. Its ability to prevent
excessive speculation and price manipulation has been diluted.
This is a direct result of the fact that more and more energy
trading takes place on unregulated over-the-counter electronic
exchanges. It is simply unacceptable that this rapidly
increasing segment of our energy markets remains largely
unchecked.
As I stated earlier, Amaranth fired a warning shot that
market participants and market regulars must not ignore. If
they do, I can assure you that Congress will not. As a
threshold matter, regulators should develop a clear definition
of excessive speculation. Otherwise they will continue to have
difficulty monitoring and preventing price distortions.
More important, as we noted in the Minority's views in the
Subcommittee's report, Congress must ensure that any proposed
cure is not worse than the disease. If we extend CFTC oversight
and regulation to electronic over-the-counter exchanges, we
must avoid unintended consequences. These exchanges have
brought vital liquidity and increased transparency to our
energy markets. Therefore, we cannot create incentives for
traders to shift their business from the over-the-counter
electronic exchanges like ICE to far less transparent and
unregulated energy markets. Moreover, we cannot create
incentives for the exchanges to move to less regulated offshore
markets.
I look forward to the testimony from today's witnesses. And
again I thank the Chairman for leading this important
bipartisan effort. Today's hearing is an important reminder
that the fairness of energy prices and the integrity of our
financial markets are neither Democrat nor Republican issues.
They are American issues.
Thank you, Mr. Chairman.
Senator Levin. Thank you very much, Senator Coleman.
Today's hearing is going to lay out what happened on the
market and we are going to have a second day of hearings on
July 9 to hear from the CFTC and from NYMEX and from ICE.
Let me now call our first panel of witnesses for today's
hearing. We have with us Arthur Corbin, the President and CEO
of the Municipal Gas Authority of Georgia in Kennesaw, Georgia.
Paul Cicio, the President of the Industrial Energy
Consumers of America here in Washington, DC.
And Sean Cota, the Co-Owner and President of Cota and Cota,
Inc. in Bellows Falls, Vermont, the President of New England
Fuel Institute, in Watertown, Massachusetts, as well as the
Northeast Chair of the Petroleum Marketers Association of
America, in Arlington, Virginia.
We very much appreciate each one of you being with us today
and we welcome you to the Subcommittee.
Pursuant to Rule 6 of this Subcommittee, all witnesses who
testify before it are required to be sworn, and at this time I
would ask all of you to please stand and to raise your right
hand.
Do you swear that the testimony you are about to give
before this Subcommittee will be the truth, the whole truth,
and nothing but the truth, so help you, God?
Mr. Corbin. I do.
Mr. Cicio. I do.
Mr. Cota. I do.
Senator Levin. We will use our usual timing system here
today. About one minute before the red light comes on you will
see the lights change from green to yellow and that will give
you an opportunity to conclude your remarks. Your written
testimony will be printed in the record in its entirety and we
would ask that you limit your oral testimony to no more than 5
minutes.
Mr. Corbin, I think we will have you go first.
TESTIMONY OF ARTHUR CORBIN,\1\ PRESIDENT AND CEO,
MUNICIPAL GAS AUTHORITY OF GEORGIA, KENNESAW,
GEORGIA, ON BEHALF OF THE AMERICAN PUBLIC GAS ASSOCIATION
Mr. Corbin. Chairman Levin and Ranking Member Coleman, I
appreciate this opportunity to testify before you today on the
important issue of natural gas market transparency. My name
again is Arthur Corbin and I am President and CEO of the
Municipal Gas Authority of Georgia. The Municipal Gas Authority
of Georgia is a non-profit natural gas joint action agency that
supplies all of the natural gas requirements of its 76 member
municipalities.
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\1\ The prepared statement of Mr. Corbin appears in the Appendix on
page 107.
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I am testifying today on behalf of the American Public Gas
Association. All of our member cities are members of APGA. APGA
is the national association for publicly-owned not-for-profit
natural gas distribution systems. These retail distribution
systems are owned by the public agencies and accountable to the
citizens they serve. There are approximately 1,000 public gas
systems in 36 States and almost 700 of these systems are APGA
members.
Natural gas is a lifeblood of our economy and millions of
consumers depend on natural gas every day to meet their daily
needs. It is critical that the market for natural gas be fair,
orderly, and transparent so that the price consumers pay for
natural gas reflects the fundamental forces of supply and
demand and are not the result of manipulative or abusive
conduct.
An appropriate level of transparency currently does not
exist and this has led to a growing lack of confidence by our
members in the natural gas market.
The economic links between the natural gas futures
contracts traded on NYMEX and those financial contracts in
natural gas traded in the over-the-counter markets are beyond
dispute. Without question a participant's trading conduct in
one venue can affect and has affected the price of natural gas
contracts in the other.
The impact of the activities of the Amaranth Advisors hedge
fund is a perfect example of these economic links between
markets. When the excessively large positions accumulated by
Amaranth began to unwind gas prices decreased. Unfortunately,
many gas distributors, including the Municipal Gas Authority of
Georgia, had already locked in prices prior to the period
Amaranth collapsed at prices that did not reflect fundamental
supply and demand conditions but rather were elevated due to
the accumulation of Amaranth's very large positions. As a
result of Amaranth's activities, the Gas Authority members were
forced to pay an $18 million premium and pass it through to
their customers on their gas bills.
Today the Commodity Futures Trading Commission has
effective oversight of NYMEX, and the CFTC and NYMEX provide a
significant level of transparency. But despite the economic
links between prices on NYMEX and the OTC markets, the OTC
markets lack such transparency. The simple fact is that the
CFTC's large trader reporting system, its chief tool in
detecting and deterring manipulative market conduct, generally
does not apply with respect to transactions in the OTC markets.
This lack of transparency in a very large and rapidly growing
segment of the natural gas market leaves open the potential for
a participant to engage in manipulative or other abusive
trading strategies with little risk of early detection by the
CFTC until after the damage has been done to the market. It
simply makes no sense to have transparency with respect to one
small segment of the market and none with respect to a much
larger and growing segment.
Accordingly, APGA believes that transparency in all
segments of the market, including those transactions that take
place off exchanges and platforms is critical to ensure that
the CFTC has a complete picture of the entire market. We
believe that the CFTC does not currently have these tools
necessary to police its beat.
The CFTC has done a good job in catching market abuses
after the fact. However, by the time these cases are discovered
using the tools currently available to government regulators,
our members and their customers have already suffered the
consequences of those abuses in terms of higher natural gas
prices. Greater transparency with respect to large positions,
whether entered into on a regulated exchange or in an OTC
market in natural gas will provide the CFTC with the tools to
detect and deter potential manipulative activity before our
members and their customers suffer harm.
The current situation is not irreversible. Congress can
provide American consumers with the protection they deserve by
passing legislation that would turn the lights on in these
currently dark markets. APGA looks forward to working with you
to accomplish this goal and I will be happy to answer any
questions you may have.
Senator Levin. Thank you so much, Mr. Corbin.
TESTIMONY OF PAUL N. CICIO,\1\ PRESIDENT, INDUSTRIAL ENERGY
CONSUMERS OF AMERICA, WASHINGTON, DC
Mr. Cicio. Chairman Levin, Ranking Member Coleman, thank
you for the opportunity to testify.
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\1\ The prepared statement of Mr. Cicio appears in the Appendix on
page 120.
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The Industrial Energy Consumers of America is a non-profit
trade association whose membership are significant consumers of
natural gas from every major energy intensive sector. At the
heart of the matter is that every consumer in the country
assumes that the government is protecting their interests, and
that markets are working and operating on a level playing
field. Nothing could be further from the truth.
The subject of excessive financial speculation, market
power, market manipulation, first came to our attention in 2001
with the implementation of the Commodity Futures Modernization
Act and concerns have continued to grow. The signs were obvious
but because of the lack of market data transparency we could
never prove it. This all changed with the implosion of the
Amaranth Advisors hedge fund.
Amaranth provides a clear and troubling picture of how easy
it is for large hedge funds, Wall Street trading companies to
manipulate the market to the benefit of investors and to the
detriment of every consumer in the country. Amaranth completely
dispels the Wall Street myth that the market is too large for
any one company to manipulate.
There is excessive financial speculation in the natural gas
market but we can deal with it if we have transparency for the
regulators to monitor the size of the natural gas volumes that
any one individual is controlling. All market inefficiencies
are paid for by us, the consumer, and even a relatively small
increase in the price of natural gas such as 25 cents can
result in a $5.5 billion price tag for consumers; 25 cents,
$5.5 billion over the course of the year.
And unlike many other commodities such as currencies, gold,
excessive speculation in natural gas has a direct impact on
homeowners, farmers and manufacturers. And because natural gas
supply is fragile it is particularly vulnerable to
manipulation.
To illustrate the importance of natural gas, one only needs
to look at two product examples. Natural gas represents 85
percent of the cost of making anhydrous, which is used to make
fertilizer for our farmers, and it is 93 percent of the cost of
making plastic, something we all consume. The majority of
manufactures are dependent upon natural gas as a fuel and there
is virtually no substitute.
We can assume that had Amaranth not continued to increase
their control of the price by continuing to add to their
positions market conditions would have driven the price lower.
In fact, after Amaranth collapsed, so did the price. In
September 2006 the price was $6.81. After the Amaranth collapse
the price fell to $4.20, a difference of $2.61. If we assume
that only one dollar of the $2.61 price was due to Amaranth it
would have cost consumers an estimated $9 billion over the time
period of April through August 2006.
The Amaranth event raises several important questions that
Congress should address. The CFTC has known for a long time
that a significant market oversight gap exists. Why hasn't the
CFTC stepped forward to address the problem? Why isn't the CFTC
responsive and accountable to the public interest? Did the
Commodity Futures Modernization Act of 2000 go too far? Did it
weaken CFTC's market oversight accountability? Is the
relationship between the CFTC and the exchanges too cozy? Why
isn't there time limits to prevent CFTC officials from taking
top positions in the exchanges?
It is not without notice that last year large Wall Street-
type companies weighed in on Congress to oppose the same
reporting and transparency that would have prevented Amaranth's
activities. Interestingly, these same companies do mark-to-
market position accounting at the end of each trading day for
internal financial management. Our question is what are they
trying to hide?
IECA recommends that Congress take immediate action to give
CFTC regulatory authority over NYMEX, ICE, and OTC market in
general, require large traders to report their positions daily
to the CFTC, give CFTC the ability to aggregate positions on
both exchanges, establish daily trading volume limits, increase
monitoring in all months, increase CFTC enforcement funding,
and lastly, of course, increase the supply of natural gas.
Thank you very much.
Senator Levin. Thank you very much, Mr. Cicio. Now Mr.
Cota.
TESTIMONY OF SEAN COTA,\1\ CO-OWNER AND PRESIDENT, COTA AND
COTA, INC., BELLOWS FALLS, VERMONT, PRESIDENT, NEW ENGLAND FUEL
INSTITUTE, WATERTOWN, MASSACHUSETTS, AND NORTHEAST CHAIR,
PETROLEUM MARKETERS ASSOCIATION OF AMERICA, ARLINGTON, VIRGINIA
Mr. Cota. Hon. Chairman Levin, Ranking Member Coleman,
thank you for having me testify before you today.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Cota appears in the Appendix on
page 123.
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I currently serve in the Petroleum Marketers Association of
America, as its Northeast Regional Chair. PMAA is a national
federation of 45 States, regional associations representing
some 8,000 independent fuel marketers that collectively account
for approximately half of the gasoline and 80 percent of the
heating oil sold in the United States. I am also President of
the New England Fuel Institute, (NEFI), a trade association
outside of Boston. And as such, I represent 1,000 fuel dealers
and related service companies located throughout New England.
NEFI members deliver approximately 40 percent of the Nation's
home heating oil.
I am President of one of those companies, Cota & Cota of
Bellows Falls, Vermont, a third generation family business
operating in Southern Vermont and Western New Hampshire. Unlike
larger energy companies, heating fuel dealers like me are
mostly small second and third-generation family-run businesses.
Also unlike large energy companies, we deliver directly to
American homes and small businesses.
Energy consumers are affected by excessive speculation and
price volatility in the energy commodity markets in profound
ways. We and our customers need public officials, including
those in Congress and on the CFTC, to look after us and take a
stand against profiteering traders and hedge fund managers that
seek to artificially inflate prices for their own personal
gain. We deserve to be made aware. In fact, we deserve to know
the truth behind what is driving these prices, especially
pertinent to market forces that may be contributing to
volatility and price spikes.
The CFTC is currently not collecting data on a series of
legislative and regulatory loopholes which exempt the over-the-
counter exchanges and foreign boards of trade with U.S.
destined contracts from Federal oversight. It is in these dark
exchanges that traders may be tempted to engage in dubious
manipulative trading practices free from the reach of U.S.
regulators.
My grandparents began serving the community with heating
fuels in 1941. We have been offering fixed-price programs to
our consumers for the past two decades. At first we filled our
fuel tanks in the summertime and sold those gallons until our
consumers ran out of those gallons. However my storage,
although large by industry standards, is still very limited. We
have 6 days of January supply.
It quickly became apparent that due to customer demand that
we would need a different method for providing fixed-price
programs. It was at that time that we began to enter into
NYMEX-based futures contract with our suppliers so we could
continue to offer these programs to our customers. These
independent suppliers of wholesale fuels would purchase NYMEX
contracts for future delivery and then, in turn, resell these
contracts to us after a profit was added. This is typical for
the industry.
Since we first began purchasing NYMEX-based contracts,
volatility has increased dramatically. Traditionally when we
purchased futures contracts, the coldest winter month, January,
was more expensive than the warmest month of August. The rate
of difference is usually a half a cent per gallon per month. In
the past few years we have seen the difference between summer
months and winter months be as high as 23 cents per gallon.
Up until about 4 years ago, it would have been abnormal to
have a daily market move of more than one half cent per gallon.
Today it is typical to see 5 cent daily moves and moves as high
as 12 cents.
We used to offer insurance programs as an alternative to
fixed-price programs for our consumers. These option-based
programs have had the highest increase in volatility. Four
years ago we were able to purchase an ``at the money'' put or
call at a reasonable cost to our consumers. Four years ago the
cost of this type of transaction for a January contract
purchased in the summer would have been between 4 and 6 cents
per gallon. Today the same program would cost me in the area of
40 cents per gallon.
Currently fixed-price programs make up 70 percent of my
total sales. In a business that makes profit in cents per
gallon, it is much more difficult to continue to offer these
fixed-price programs to our consumers. Unlike many players in
the market who make their commodity investments for pure
financial gain, we as an industry are hedging directly for the
consumer.
The annual U.S. heating oil industry volume for consumption
is between 8 and 10 billion gallons per year. With ICE and
other exchanges entering into this energy market in a large
way, it is having the same effect as an elephant jumping into
the bathtub.
These dark exchanges are expanding both offshore in Dubai
and other countries and with ICE purchasing ChemConnect.
Congress and enforcement authorities need to now rein in the
excessive speculation and out of control profiteering on the
energy commodity markets, including these dark exchanges.
Congress should, one, encourage the CFTC to revisit its use
of no action letters. Two, investigate whether or not the
Atlanta-based ICE intentionally established its operations in
London to circumvent U.S. regulations. Three, require large
position data collected on all U.S. destined contracts. Four,
fully fund CFTC levels as appropriate to upgrade infrastructure
and collect capacities and increase personnel. Encourage the
CFTC to be vigilant in its data collection. And hold these dark
exchanges to the same rule of law that NYMEX and the Chicago
Mercantile Exchange have.
Thank you again, Mr. Chairman, for this opportunity to
share my insight into this issue. I am open to any questions
you may have.
Senator Levin. Thank you all for very valuable testimony.
Some people say that when Amaranth made these huge
purchases and sales and had these massive trades, they only
hurt themselves. They only lost their own investors' money, and
no one else got hurt when those billions went down the drain.
But will you tell us in your own words whether, in your
judgment, the massive purchases, trades, and sales by Amaranth
of these future contracts hurt you and your customers? And, if
so, how? Mr. Corbin, let me start with you.
Mr. Corbin. Thank you. One of the things that we do as part
of our function of providing gas supply to our member
municipalities is to try to hedge or try to manage the risk of
prices spiking, going a lot higher. The bulk of what we do buy
is in the wintertime.
And so what we do is try to take a very managed approach
and do not simply let our purchases ride and come to find that
prices have, in fact, spiked and harmed our members. And so we
try to, in advance, hedge against that price risk.
In 2006, when you look at what we are doing in our hedge
program, we have some parameters that require us to go in and
hedge those prices in advance of the winter. And we have time
parameters because we have found that hope is not a good
strategy. So you cannot wait until the last minute hoping that
prices are going to come down. You need to go ahead and take a
disciplined approach.
And so over the course of the summer of 2006 we are placing
hedges for our members for the winter of 2006-2007. It is very
clear to us, certainly even more clear today having the report
that this Subcommittee has put forward, that through the very
excessive positions that Amaranth had the winter price of 2006-
2007 was well beyond what would be supported by underlying
market fundamentals of supply and demand.
And so when we looked at what our positions were that we
ended up putting on for the winter of 2006-2007, those
positions versus where the market settled to when Amaranth was
effectively required to exit through the meltdown, you take the
difference and that is $18 million that it cost our members,
which ultimately cost their consumers.
Senator Levin. Thank you. Mr. Cicio.
Mr. Cicio. Thank you, Mr. Chairman. To answer your question
we have to put it in context, that in 2006 national natural gas
inventories were at a 5-year level or above the 5-year level,
and natural gas production was stable.
It is really impossible to put a definitive number on what
it cost consumers. This is why in our testimony we used an
example. We know that in the report that was put together by
the Subcommittee that Amaranth significantly and continually
increased their positions throughout the period of April
through August 2006. We know that after Amaranth collapsed the
price fell over $2.60.
So there is some portion of that $2.60 drop that was an
artificial price, that was artificially higher than what it
would have been had those large purchases not continued.
This is why we have come up with an illustration. If one
dollar of that $2.60 higher price was the result of Amaranth's
continually buying, owning as much as 100,000 contracts--and by
the way let me give you a perspective. This morning I checked
for the amount of open interest on the New York Mercantile for
the last trading day, Friday, there were 90,500 open interests.
What we saw in the Subcommittee report is that Amaranth was
controlling at one point 100,000 contracts all by itself.
So a one dollar impact for Amaranth's purchases over the
course of that time period of the spring would have amounted to
a $9 billion premium that consumers would have paid.
Senator Levin. That is $9 billion across the entire
industry?
Mr. Cicio. For the United States.
Senator Levin. For the United States, consumers in the
United States paid $9 billion according to that estimate, which
you acknowledge is an estimate.
Mr. Cicio. It is an estimate.
Senator Levin. Would you judge that is a fair estimate, a
conservative estimate? How would you assess it? The best you
can? Give us your best judgment. Is that a fair division of the
$2.60? Is it an allocation that you think is a reasonable
allocation?
Mr. Cicio. To be honest with you, we just do not know.
Senator Levin. How do you know then that there was an
impact? Just from that action that occurred after they
collapsed? That is what you deduced the impact from?
Mr. Cicio. Yes, sir.
Senator Levin. Is there other evidence of an impact beyond
that? In other words, is the fact that there were huge
purchases that were made by Amaranth and that winter price then
went up with those huge massive purchases, is that part of the
evidence of impact?
Mr. Cicio. Absolutely. The fact is that we had ample
supply. The fact is that we had such a significant drop after
the collapse illustrates that the price was higher than it
should have been given basic laws of supply and demand.
Senator Levin. Thank you. Mr. Cota.
Mr. Cota. The impacts are dramatic and across the board. We
have had a lot of discussion here with regard to natural gas.
But the entire energy complex moves in unison. Movements in
natural gas translate immediately into movements in heating
oil, movements in gasoline, movements in all of the crude oil
products and all of the derivative contracts that come off from
that.
These future exchanges are the price discovery point for
the energy industry in the United States instantly. In volatile
energy markets I get price changes on a replacement cost basis
from my suppliers as often as three times a day in a volatile
market. Those things are translated to the consumer the next
day. I do not do it three times a day but the next day.
So one way of measuring the impact of these volatile
markets on the consumer is immediate in these pricing
mechanisms.
Longer term, the consumers are paying. I am in a cents
above business. Our profit margin, as a percentage, goes down
as commodity prices go up. The consumers pay cent for cent.
Everything--if my cost goes up, their cost goes up. So the
direct impacts are immediate and direct to the consumer. When
they buy futures contracts for futures purchase and there is
added cost due to volatility, those consumers pay for that.
Currently the market has been in contango because of these
large volatile trades. But when this thing turns, if it ever
does turn, perhaps in response to oversight, the opposite could
have an effect. Contango encourages inventories. We could be in
a situation very rapidly where people short the market and
inventories disappear within a matter of a month, at which
point you are going to have another supply disruption which is
going to again distort the market from another perspective.
Again, the consumer will pay.
Your question that you had earlier with regard to is there
evidence? Well, there is no data. Most of the data is not
traded. The entire heating oil industry is 8 to 10 billion
gallons per year in the United States. I would not doubt if you
added up all these dark exchanges in addition to the NYMEX that
is traded several times per day.
We need speculation. I could not offer my consumers price
protection without speculators in the market. They are a key
part. But at what point do you allow speculation to just run
rampant?
So if there is no data, it is the same thing as having no
cops with a judiciary. You cannot go to court if there is no
cops to collect the evidence. I do not think, for a huge chunk
of the market, that there are any cops on the beat. Where are
the cops?
Senator Levin. In terms of setting natural gas prices in
the futures market, how important is ICE? Just quickly, Mr.
Corbin. Can it affect the price on NYMEX, the ICE prices?
Mr. Corbin. Yes.
Senator Levin. Are they interrelated?
Mr. Corbin. Yes. And we see, frankly, the entire natural
gas marketplace, not just NYMEX, ICE, but also the bilateral
market and voice broker, that activity can have an impact on
the broad marketplace.
Senator Levin. Would you agree with that, Mr. Cicio?
Mr. Cicio. Absolutely. These markets and these exchanges,
they are all interrelated.
Senator Levin. Mr. Cota.
Mr. Cota. It is a very close correlation.
Senator Levin. So would you all agree that we have to
eliminate the Enron loophole in order to have regulation across
the board? If it is going to have any impact in one place, it
has got to have impact in all places? Would you agree with that
Mr. Corbin?
Mr. Corbin. Yes, except I am a little concerned that the
focus is on simply electronic exchanges and believe that the
CFTC needs to see the entire market.
Senator Levin. All over-the-counter market, including ICE?
Mr. Corbin. Yes.
Senator Levin. Thank you. Mr. Cicio.
Mr. Cicio. We agree entirely with that. Just looking at the
electronic exchange still is not giving us the necessary
oversight. You need to go beyond that.
Senator Levin. Mr. Cota.
Mr. Cota. Nobody knows what the data is. Until the CFTC
starts collecting data on the entire traded U.S. based energy
commodity markets, you are not going to have any idea what is
occurring in the market. Every market needs, in order to have a
well regulated market and a clear functioning market, you need
to see what the data is. That data is not being seen.
Senator Levin. In addition to seeing it, once you have the
data is it also important they be able to issue the same kind
of an order on ICE as they do on NYMEX?
Mr. Cota. The only thing that is more fungible than my
commodity is the money that instantly changes from one market
to another based upon regulation.
Senator Levin. I am not sure what the answer is.
Mr. Cota. Yes, you need to have an oversight on all
markets. Just doing it on one will cripple the only regulated
market and force it all into these offshore regulated United
Kingdom based or wherever based commodity markets.
In the NYMEX, despite that they are frustrating if you
trade every day, they are the best of what you have got.
Senator Levin. The NYMEX.
Mr. Cota. The NYMEX. And you do not want it to go to
foreign exchanges without any regulation.
Senator Levin. When you say regulation and oversight, that
includes having an order issue to reduce one's position as
being excessive speculation?
Mr. Cota. Absolutely. I am concerned about the consumer.
But if you are only concerned about the trader, to protect the
traders you still need to have oversight, margin requirements
that reflect volatility in the markets, and large trader
positions that are limited so that they cannot sway a market.
And you do not have that in huge amounts of the trade that is
currently occurring.
Senator Levin. That is to protect the consumers, not just
the traders?
Mr. Cota. I would like to protect the consumer but we are
not protecting anybody.
Senator Levin. I have got you. Thank you. Senator Coleman.
Senator Coleman. Thank you, Mr. Chairman. I am trying to
figure out how to get our arms around all of this.
Mr. Cota, you talked about these dark markets. So we have
NYMEX which is clear, it is regulated, we know what is going
on, it has the transparency that we talk about.
We are now talking about ICE, but ICE is only a piece of
it. So we have the bilaterals and we have the foreign markets.
One of the concerns we have seen generally with financial
transactions is that there is a lot of movement, IPOs and
everything, to other markets.
Is it your sense that the CFTC can regulate all of these? I
will walk by each one. Is that the vision here? I am trying to
figure out can we get our arms around all of it? Is it your
sense that the CFTC is the body that should be regulating all
of these transactions, the bilaterals, anything that is done,
even on foreign markets? Can you give me a sense of how you
accomplish that?
Mr. Cota. I would think that, as with any transaction, if I
have a contract with my consumer, those contracts need to be
kept. Current data collection requirements do not exist in a
lot of these dark markets. I think that is an easy thing to
accomplish.
If there is something fishy in the market that is done on
one of these bilateral dark exchanges, some derivative deal, if
you have got the data and the data is not destroyed, then you
have got the ability to investigate it later.
The amount of these trades are huge. The money that moves
into this market is a huge part of the world economy that moves
in and out daily.
I no longer look at supply and demand when I am trying to
judge for my consumers. I am looking at what is occurring in
the currency market, what is occurring in the bond market. If
there is a move in the bond market or the equity market, then I
know commodities are going to go down for a little bit because
of the amount of money that is moving in and out of these
markets. It is no longer supply and demand. Even if you are a
technical trader it does not follow technical trading. It is an
imbalance of greed and fear, in my opinion.
Senator Coleman. I want all of you to respond, but I want
to go to Mr. Corbin. Do you agree that it is not just about
supply and demand today? If it is not, how do you protect your
consumers? What is it that you can bring to the table that
gives you the ability to maneuver through these markets?
Mr. Corbin. I think taking it back to your previous
question about can the CFTC get a handle on this huge market
that has got a lot of different pieces to it, the CFTC has a
large trader reporting system today, a very good one. They are
only being reported to daily from NYMEX transactions.
Our view is that if you have somewhat--clearly, also ICE is
voluntarily providing that information daily today, which we
certainly applaud ICE for taking that step to do it
voluntarily. If you have large traders that are in the
bilateral market, we feel strongly that those folks, in
managing their own business, they have very effective
information systems to where they can mark-to-market on a daily
basis literally their position in order to manage it.
And so we believe that they can plug into that large trader
reporting system that we now have NYMEX reporting to daily, ICE
voluntarily reporting to daily. We believe the other players in
the market that are large players can also plug into that
system.
That is going to help the CFTC to see positions across the
market daily that we think will improve the authority they have
today to do the special call for additional information and
investigations. But if you do not really see that you really do
not have enough information to go in and pursue something that
you suspect is abusive or could be creating a problem in the
market.
And so then, going to your second question, us as
consumers, how do we get confidence? Well, we do not in the
existing structure because we do not feel like the regulator
has what he needs to do his job. He has got the authority to
pursue it and he has pursued--the CFTC has done a good job
pursuing bad actors in our business. It just comes 2 and 3
years later, hundreds of millions of dollars in penalties and
fines have been paid, as much as $2 billion. None of that goes
to the consumer though. Those that have been harmed do not see
any of that. It has gone back into the U.S. Treasury.
So we would like to get them more information, get them
that information on a current daily basis so that they can see
this stuff as it is occurring and can react a lot more quickly.
Then the consumer does not pay for a position that got way to
big.
Senator Coleman. Mr. Cicio, is there anything you want to
add to that?
Mr. Cicio. Yes, sir. The large trader report is the
solution. The CFTC keeps this information confidential. The
common denominator of all trading is volume, the volume of
natural gas that any one entity is buying or selling. And that
is the kind of information that the CFTC needs to determine
whether there is a significant enough volume that any one
player is impacting the price.
And so we would agree with the others on that point. Thank
you.
Senator Coleman. We are talking here about reporting
requirements in terms of size. What about position limits?
Mr. Cicio. Yes. We believe that there should be limits to
how many contracts a single entity should be able to control.
What we saw in the Subcommittee report was that Amaranth
controlled 100,000 contracts in 1 month. And what I shared with
you just a moment ago is that for the August contract there is
only 90,500 open interest contracts. That shows how significant
Amaranth's position was and looks like market power.
If a manufacturer had that much market power for their
product that they were selling, whether it is plastic or steel
or aluminum, it would raise huge concerns by the antitrust and
FTC people.
Senator Coleman. Mr. Corbin, is there benefit to having
liquidity in the markets?
Mr. Corbin. There is a great benefit. And so we would
like--we think we need to be careful here in what you just
asked Mr. Cicio. And that is with regard to limits. We think
what is critical is let us get the transparency. Let us get the
information in the hands of the CFTC across the market so they
can see these positions across the market. And if the CFTC
determines that there needs to be limits imposed because they
are seeing the effects of larger positions held in order to
make sure that we can get ahead of any kind of negative
behavior and how it impacts the price of gas, then we think
that information would help them make that determination.
At this point we are not advocating limits. We are
advocating transparency through expanding the large trader
reporting system.
Senator Coleman. Mr. Cota, two questions. One is are there
benefits to having liquidity in the market? If so, what are
they? And do you advocate position limits?
Mr. Cota. Without liquidity and speculation--speculation
and liquidity are directly linked. You need to have speculation
in the market in order to hedge anything out in the future.
What you want is to enable all speculators to have an even
hand in taking a risk in that market, much like I, as a
retailer, am taking risks in that market.
So the number and the margin and the percentage of the
total market are all very relevant in order to have a well
regulated market, in my opinion.
Senator Coleman. Position limits though, is that part of
it?
Mr. Cota. Position limits, to me, may or may not
necessarily be related to the actual numbers of contracts. As
markets increase and decrease I think it needs to be relative
to what the percentage of the total market is.
If I recall reading some of the study here on the Amaranth
holdings, if they actually had to have those contracts
delivered, one of their positions was almost equivalent to the
entire natural gas industry. So if that were a smaller
percentage yet it was over a trigger amount, it may not be as
relevant. So I think it needs to relate to the total amount of
contracts being traded in that market and how big is that
market?
And I believe that the New York Mercantile Exchange does do
evaluations on that and the other markets do not.
Senator Coleman. So it would be beneficial to have a
definition of what excessive speculation is?
Mr. Cota. I think positions and margin, as measured through
options or whatever other mechanism, would be a better
indication of how to limit the volatility and speculation in
the market. Speculation is important. You need to have
speculation in order to have futures exchanges.
Senator Coleman. Mr. Corbin, would it be beneficial to have
a definition of excessive speculation?
Mr. Corbin. Yes.
Senator Coleman. Mr. Cicio.
Mr. Cicio. Yes, it would be helpful.
Senator Coleman. Thank you, Mr. Chairman.
Senator Levin. Thank you. Senator McCaskill.
OPENING STATEMENT OF SENATOR MCCASKILL
Senator McCaskill. Thank you.
In reviewing all of the materials, I apologize, I was not
here for your testimony although I heard most of it in my
office, as I was listening with one ear to a conference call
and listening to you with the other ear.
It strikes me that regulation in this area is really driven
by common sense in light of what happened with this one
incident that has been the focus of the hearing today. And I
have learned in the short period of time I have been here that
ideas that sound so simple and have so much common sense behind
them, it is unbelievable how difficult it is to move them
forward in terms of legislation and actually to get the votes
necessary to pass. What would appear to anyone who heard this
story, would say well fix that, for gosh sakes. If you are
going to do anything, fix that.
And there is this invisible force always behind everything,
and that is the people who are lobbying the other side of the
equation, the people who are saying do not go there, the people
who are visiting member's offices and saying stop, stop, do not
do this, you have no idea what you are doing. It will be bad.
All of those people generally have people they have hired
to help them do that, to spread that information.
Who is working against this? Who is paying the lobbyists to
oppose what would appear to be common sense at this point in
terms of some kind of regulatory oversight in this area of a
commodity that is an essential and not a luxury? Any of you?
Mr. Corbin. I will take a shot at that. I do not know that
I can answer and say who, but I think we have heard some of the
things that are the difficult balancing act. And that is the
question of liquidity. You do not want to restrict the market.
It is very important that we have a well functioning liquid
natural gas market. And so you want to be careful that you do
not, in some way, inhibit it.
But I think you have also got to be careful that you do not
have regulation in one place and then push people into a less
transparent market segment.
The approach we have taken, and as far as expanding the
large trading reporting system, the objection that we have
heard is that it may be time consuming and costly. From our
perspective, the CFTC already has a large trading reporting
system that exists. Expanding it to include the over-the-
counter market activity, we do not think it is a tremendous
expense for them. I think they have got it and it is largely
electronic and they can accept electronic transmissions to go
almost straight into their system.
I think the people with large positions also have
electronic systems to manage their position. And so providing
the information should not be costly and, we do not believe,
difficult.
I think what you do have is a lot of activity over the
counter and the reason that the over-the-counter market exists
is that NYMEX is a very standard product. It is at one point in
the natural gas grid only and it is a fixed amount of gas.
Well, people do not buy gas just at that one point and they do
not just buy gas in that fixed quantity. And so the issue is
how do you make it at all comparable in that reporting system?
And so Paul's point about you can break it down to volume,
and I think you can break transactions down to whether they are
a long position or a short position in the scheme of things,
which I think could be done.
I do not think it is as difficult as the opponents make it
to be but I think--
Senator McCaskill. Well, who are the opponents though? I am
trying to figure it out who is against expanding the CFTC
authority to be able to regulate large speculation in an
essential commodity market? Who are these people?
Mr. Cicio. May I take a crack at that? Add up all the
consumers and add up all of the producers of natural gas, and
together they are, by the best data that I have seen available,
insignificant players in this marketplace, insignificant. So it
is all of the others.
All that consumers want to do is buy gas at a price, with a
certainty. We hedge to get increase predictability of price so
that we can price our product and reduce our risk.
Senator McCaskill. Right.
Mr. Cicio. Producers primarily want to set a price so that
they can sell and that they have certainty in terms of
profitability.
Senator McCaskill. Right.
Mr. Cicio. To answer your question, all other entities who
want to take large positions for speculating, larger positions
than, for example, that are available in the limits through
NYMEX, are the organizations who oppose reporting.
Senator McCaskill. So gamblers?
Mr. Cicio. Well, people who are speculating to make a
profit on speculation.
Senator McCaskill. Because they are not getting anything
for what they are doing good. They are not receiving anything.
They are just gambling that something might happen.
Mr. Cicio. They are speculators. And as we have all agreed,
speculation is a necessary part of the marketplace.
Senator McCaskill. I do not quarrel that speculating is a
necessary part of the marketplace. But I am trying to hone in
on who is against this kind of regulation in order to provide
some kind of certainty to consumers and suppliers which, by the
way, is who we should be looking after here, not the gamblers.
I mean, our job I think in this building is to look after the
consumers and the suppliers as it relates to using a product
that they have to have to heat their homes and to eat.
So it seems weird to me that the invisible hand of
opposition are, in fact, the gamblers, not the consumers or the
suppliers.
Mr. Cota. Senator McCaskill if I can take a stab at that,
as well, your point on gamblers is right on. It seems to me
sometimes the Nevada Gaming Authority has more authority--
Senator McCaskill. No question about it.
Mr. Cota [continuing]. Than what we see in this market. The
financial players of all sorts worldwide are all players in
this market. They are the ones that would like the least amount
of regulation so that they can move money around quickly. The
larger the player the more interest they have in having less
oversight.
These financial players are also significant holders of
physical product and that is very important. I actually trust
major oil companies in my business less than I do some of the
banks that actually hold product. I may not like the price that
I pay, but they will always have product whereas the major oil
companies will just, if things get too complex, they will shut
it down. In my business, if I am out of fuel for a day, people
freeze to death. So I need to have product and these people are
important players in the market. But those are the people that
are generally interested in not having oversight.
I have hope because the CFTC is the CFTC and not the SEC.
CFTC, by being an agricultural based group means you have got a
lot more folks across the country that will have a different
perspective. So I think there is more hope in regulation in the
commodities market because they relate----
Senator McCaskill. There is more diversity of interest.
Mr. Cota. Well, it is your internal politics, it is the Ag
Committee's jurisdiction. So I think I have got more hope in
the Ag Committee than I do in perhaps the other committees.
Senator McCaskill. Thank god for pork bellies.
Mr. Cota. Exactly.
Senator McCaskill. Thank you, Mr. Chairman.
Senator Levin. Thank you, Senator McCaskill.
Let me see if I can boil this down in this way: Senator
McCaskill talked about common sense so let us start with the
commonsense issue. We have got a NYMEX market. NYMEX told
Amaranth they had to reduce its holdings. They have that power
under law. They said there was excessive speculation going on
or that the price impacts were going to be great if there were
a lot of sales on a certain date. For whatever reason, NYMEX
issued an order, reduce your holdings.
Now Exhibit 6,\1\ that chart shows what happened on that
day when NYMEX told Amaranth to reduce its holdings. At the
time of the order the yellow was the holdings of Amaranth on
NYMEX. The blue was on ICE. So the regulators said reduce your
holdings and all they did was shift to ICE? Is that correct? Is
that Exhibit 6?
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\1\ See Exhibit 6 which appears in the Appendix on page 717.
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That does not make commonsense, I assume, to anybody. I
mean, if it is excessive under the law, and we have a law,
Commodities Exchange Act, which directs the CFTC to prevent
excessive speculation. And it says ``Excessive speculation in
any commodity under contracts for future delivery causing
sudden or unreasonable fluctuations or unwarranted changes in
the price of such commodity. It is an undue and unnecessary
burden on interstate commerce and the CFTC shall fix such
limits on the amount of trading as the Commission finds are
necessary to diminish, eliminate or prevent such burden.''
So they are carrying out the law and they tell their agent,
NYMEX, CFTC tells NYMEX, you are our agent. NYMEX reaches a
conclusion. We can be totally all overwhelmed and swamped with
all of the words which all have to use swaps, margin
requirements, price spreads, hedges, manipulation, speculation.
We have lost probably most of our audience already or if we
have not lost them before that.
But cut to the chase. The cop on the beat said reduce your
position. They did not reduce their position, they shifted
their position. So this is a glaring loophole we have in the
law. It is called the Enron loophole. It does not make any
sense to have a cop over on this side of the street say you are
out of business, quit selling liquor to minors, and then the
liquor store or whatever, the bar, goes across the street and
sells liquor to minors. That is what we have got here. When you
strip all of the complexity away, that is what we have.
And the question is whether or not we are not only going to
give the regulator, CFTC, the power to get the information
which you all have talked about but also the power to do on the
over-the-counter exchanges what they do with NYMEX. That is the
question.
Now I recognize what Senator Coleman said. I think we all
have to appreciate you need some speculation in the market,
otherwise you are not going to be able to hedge in the future.
The question is excessive speculation. And should the CFTC be
able to stop it wherever it occurs? That is the question, on
the over-the-counter or whether it is NYMEX or ICE. I guess ICE
is a form of over-the-counter because it is an electronic
exchange.
Mr. Corbin, I do not know if I have a question somewhere in
there or not, but would you agree with that?
Mr. Corbin. If there was a question in there, I agreed with
it.
The only thing I would caution against, because I think we
saw it here. We have one loophole today and we see very
pronounced how they shifted over to one exchange.
I would just caution, that we need to make sure that
whatever structure we are putting in place does not have them
just go over to another place----
Senator Levin. Another exchange.
Mr. Corbin [continuing]. That is not transparent that we
have not necessarily thought about.
So that is why we have used the broad term over-the-counter
market entirely so that we do not have a future loophole. You
have done a lot of work. We do not want to have another
loophole after you are done.
Senator Levin. Jump into another block, across the street
to another block.
Do you think that we are able to do that technically? Could
we, given the technology out there, given the global economy,
given exchanges in various parts of the world, are we able, do
you believe as a practical matter, to prevent that from
happening?
Mr. Corbin. If you change the law?
Senator Levin. Yes.
Mr. Corbin. Yes.
Senator Levin. We can rewrite the law so we can stop it and
not just push it somewhere else?
Mr. Corbin. Yes.
Senator Levin. Mr. Cicio.
Mr. Cicio. I would agree with everything that Mr. Corbin
has said and I would like to strengthen it by making a
statement that I said in the testimony that brings it all home.
Remember, it is how much volume that any one entity
controls that is important. Every company that is in this
market does a mark-to-market position for their internal
financial purposes at the end of each trading day. They look at
how many positions they are long, how many positions they are
short, and they see whether they are making money or not making
money.
So this data is available and it is available on a daily
basis and, from our perspective, there is no reason why any
company, including those on the OTC market, could not report.
Senator Levin. Mr. Cota, would you agree, if you can figure
out what I said, with what I said?
Mr. Cota. I think I figured it out, Senator. The money that
moves around in the world will continue to move around the
world instantly and immediately based upon a market reaction.
Will we be able to stop speculation, excess speculation? I am
unclear as to whether or not we will be able to.
I do believe that what we do have a chance to do is to deal
with U.S. based transactions. So if you have any commodity that
is destined for the United States, I do think you can have
oversight. I do think you can have a transparent market in
those areas. And the transparency in itself, because we are
defining the U.S. market, will have a worldwide impact.
I am sure the Russian commodity market would take whatever
money wants to be thrown at it for speculative purposes. But we
are a unique market, both because of our size, because the
products are destined here, and because the world has had a
faith in our regulatory oversight so that money continues to
flow. And I think that is the way that you will be able to
reduce the excessive speculation.
Senator Levin. This testimony is very important. We have
had a debate on this very issue. We had a vote on this very
issue. We had an amendment which would have covered all over-
the-counter transactions. We lost that vote and we had to
remove it and just go more limited. We had to go after the
electronic exchanges and not the other over-the-counter
exchanges, the bilateral exchanges.
So we have to figure out, can we get to those bilateral
exchanges without creating bad consequences? We can get to the
electronic exchanges; it was in the vote we lost. But can we
get to the other over-the-counter exchanges, the bilateral
exchanges, for instance?
Can we do that, Mr. Corbin?
Mr. Corbin. I would like to comment on that. The CFTC has
the authorization, where they believe there has been
manipulation, they currently have the authority to go in,
investigate, dig into it, figure it out, prosecute. And they
have done that in some prior instances.
I think what we are talking about here is can we get the
information in those other over-the-counter, the broad over-
the-counter market, with regard to large positions so that they
can be tracking what is happening across the entire complex.
Again, I say the answer is yes, you can do that.
Senator Levin. Do they have the power to act under current
law if they have the information?
Mr. Corbin. Yes.
Senator Levin. So the CFTC could stop this if they had the
information, if there is excessive speculation with large
purchases and sales?
Mr. Corbin. Yes, they have the authority to investigate if
they see. But right now they do not see that information so
they do not have it until you have a very big event that they
can then go in and investigate and 3 or 4 years later then you
have fines and prosecution and all those. It didn't do
anything.
Senator Levin. And that includes all over-the-counter
exchanges? They have that authority now?
Mr. Corbin. Yes.
Senator Levin. So it is just the information that is
lacking? Do either of you want to comment on this before I call
on Senator Coleman? Can we do this?
Mr. Cicio. I would agree with what Mr. Corbin says.
Senator Levin. Mr. Cota, do you agree with that?
Mr. Cota. I would agree with it. Until you find the data,
until you count how much money you made you cannot charge any
tax. It is the same sort of thing here.
Senator Levin. But my point is a little different. After
you have the data, do you need any additional authority in law?
Mr. Cota. I think the current law is sufficient, provided
that you have the data.
Senator Levin. For CFTC to stop excessive speculation with
an order to reduce your speculation or to reduce your holdings?
Mr. Cota. I think they have the authority. Fraud is fraud.
If you have got data, you can prove it. The BP example of
attempting to corner the propane market is one example. And I
personally believe that came out because the data was being
collected.
Senator Levin. Do you have the power to limit a holding? A
position? Under current law?
Mr. Cota. Again, I am a tiny little oil company in the
middle of nowhere. I don't know.
Senator Levin. We will find out from the next panel.
Is it your understanding that CFTC has that authority under
current law?
Mr. Cota. I am unclear as to whether they do or they do
not.
Mr. Corbin. Just to clarify, I would not say that the CFTC
has the current authority to establish limits in the over-the-
counter market, but they certainly do have the authority to go
in and investigate and prosecute when they believe there has
been manipulation. But they do not have the limits that you are
talking about.
Senator Levin. OK. Senator Coleman.
Senator Coleman. Thank you, Mr. Chairman, important
questions. Just a couple of observations.
I think it is both an authority and a resource issue, and
that has to be addressed.
I do not want to defend the gamblers but my concern is we
will get the gamblers and that we do not hurt the consumers. So
consumers are the ones that, if they can hedge, if you can buy
in August, against costs in January, if you are forced to wait
until January, if you do not have the market, if we dry up
liquidity, it is consumers who get hurt. Is that fair, Mr.
Corbin?
Mr. Corbin. Yes.
Senator Coleman. So as we look at the ``gamblers'' out
there, it is the consumers who benefit by having liquidity in
the market. The question about regulation then always becomes a
question of do we do it in a way that allows consumers to
benefit? Or in the guise of doing something that we think is
positive, do we do something that is negative? It is this law
or rule of unintended consequences, one of the great sins that
we in Congress do.
I reflect on Sarbanes-Oxley, absolutely critical, absolute
important, need to do it. Just a piece of it, Section 404, we
are talking about right now. Originally we thought that it
would cost small business $93,000. And after a study they said
it would cost small business $930,000, 10 times the estimated
cost of complying with something that had to be done.
My only concern in this area, and I am in accord with the
Chairman, is we need to close the Enron loophole. I think the
CFTC can certainly, we can move over into the ICE. My concern
though, and it is perhaps the point you raise, Mr. Cota, is do
we drive folks to--can we regulate the bilaterals? And if we
can regulate the bilaterals, then do we drive them to London,
easily London, and perhaps Russia and others? And then what is
the impact on the consumers?
So just as we walk through this, I think we can get our
arms around some of it. I just want to make sure we understand,
as we get our arms around it, what is the impact? Do you think,
Mr. Corbin, we can deal with the bilateral? There are bilateral
trades that go on. Do we have the ability then for CFTC to
oversee what happens in bilaterals?
Mr. Corbin. I think that we could have the bilaterals
included in their large position reporting system, where the
CFTC starts when they are looking at behavior in the market
that potentially is abusive.
Senator Coleman. Those are all electronic. What about non-
electronic? Are you presuming everything is electronic?
Mr. Corbin. I am assuming that the folks that have large
positions in the bilateral market have electronic systems to
manage their position and that they know every day what their
position is.
Senator Coleman. What about the offshores?
Mr. Corbin. I do not have much experience with that so I
can't really speak to that.
Senator Coleman. One of the problems that we see now on the
Wall Street side of it, 24 of the last 25 IPOs are not done in
this country. They are going offshore. Has anyone done a study
regarding the possibility of that here? Is there any way for us
to have some control or some transparency in the offshores
transactions? Mr. Cota.
Mr. Cota. Senator Coleman, I agree with a lot of your
concerns. CFTC, even if they had the data, does not have enough
money to do anything, in my opinion.
You are going to need a new financial--again, this is
coming from a small company in the middle of nowhere. I think
that you are going to need a different sort of overreaching
world financial oversight in order to prevent anything like
that.
The one advantage that we have got is that for U.S.
destined products you can define what is a U.S. destined
product.
I think that the speculation has been critical for the U.S.
energy markets. In the energy business, in my industry, we used
to have rationing and lines. The financial markets, as much as
the market volatility is distasteful, it has ensured that we
have had product at every day. And to me that is critical to
serve the consumer.
So yes, I agree with your comments that the consumer can be
hurt by unintended consequences. But having a market where a
few players can manipulate the outcome is not in anyone's
interest, neither the consumer nor the industry.
Senator Coleman. And we can certainly deal with that here
in this country if it takes place here?
Mr. Cota. Yes.
Senator Coleman. Absolutely. Mr. Cicio.
Mr. Cicio. Senator Coleman, I always try to keep it very
simple on this very complex issue, but even for the bilaterals,
the common denominator is volume. It does not matter where that
entity is located that is buying that natural gas, whether they
are sitting in New York, Houston, Texas, San Francisco, or
Dubai.
If that product is going to be for the U.S. consumption,
then I would believe that it is responsible policy for the CFTC
to be able to collect that information. I think it is that
simple. And because these companies all do mark-to-market
transactions for themselves, it appears to us that it would not
be costly and would not be unreasonable to provide that
information to CFTC.
Senator Coleman. Again, I am trying to get my arms around
all of this. I think the work that the Chairman has done in
this area has been extraordinary. This is complex and I think
you have simplified this. And we understand there are some big
gaps here and we have to deal with those.
I am thinking about the next step. It is one thing to get
information. How do you enforce bilateral swap market
positions? What kind of limits do you put on them without
causing crippling effects on the market? I think we need this
definition of excessive speculation. Even in the Amaranth
investigation, there were some who argued that this is not
excessive speculation. We need to have that so we have a marker
in front of us.
If the markets are not electronic--Mr. Corbin presumes it
is electronic and I agree with him--but if they are not
electronic or there are bits and pieces out there, maybe we
just have to tolerate that. Tolerate--maybe we get our arms
around what we can get our arms around and provide protection
where we can but understand it is not going to be a perfect
system.
But I just think we have to be clear what we are doing and
not tell people we have got our arms around this whole thing
when, in fact, it is difficult and there is great cost.
Mr. Cota, you have brought the great gift the good lord
gave us, common sense, to this. You bring it to this
discussion. It does not matter how big you are. You are right.
But there is an enforcement piece that we have not even talked
about. And there is a cost to that enforcement. Two of us up
here are former prosecutors. There is a cost to enforcement.
And we, in the Congress, have to look that in the face and
determine if we are prepared to do that.
Thank you, Mr. Chairman.
Senator Levin. Thank you, Senator Coleman. Senator
McCaskill.
Senator McCaskill. Most of the questions I have I want to
save for the academics on the next panel but I would just
comment, Senator Coleman, that if we continue to use the
analogy about the casino and whether or not we have a
sufficient oversight, which is the set of rules that people
feel like if they come to that casino they are not going to get
cheated, they do more business. Because it is kind of what Mr.
Cota referred to in terms of our markets here are attractive to
international players because they have a sense that there is
not corruption and cheating, that they can rely on a free
market force.
If you are going to speculate or gamble, then you sure as
heck do not want the house to be rigged. And that is attractive
to the international gambler in this area and so I think we
need to make sure we continue to promote that image that we
have got a regulated market so no one thinks they are going to
come and get cheated.
There is a certain irony to saying that we do not have
enough money to do anything, the CFTC, when you realize the
kind of vig we should be charging here. This is a reason
everyone tries to beat each other to get casino licenses in the
United States because the house is in a great position.
It seems to me we ought to figure a way to charge a high
enough vig on these speculative ventures because the excessive
speculation is driven by greed. That is the only thing behind
excessive speculation is just greed. People thinking they are
going to make more money. That is why they are excessive.
So it seems to me we ought to figure a way to charge a
healthier vig on the excessive speculation in order to make
sure we have enough money to go after the people that are
putting the consumer in the worst position of all, and that is
being held captive to somebody's greed.
So if any of you have a comment about the house charging a
little higher vig to make sure they have enough money to go
after bad guys, I would welcome your comments before I close
for this panel.
Mr. Corbin. I would agree with you that CFTC needs to have
adequate amount of resources to do its job. So I think that is
important in this whole equation.
Mr. Cicio. Without question it is very clear that the CFTC
has not been funded appropriately to do the kind of
enforcement. But quite frankly, our organization has not
addressed the issue of fees so I really cannot respond to your
question.
Senator McCaskill. I would be interested in your
organization's perspective if you all have an opportunity to
give it some thought. Coming from State Government that has
become very dependent on the lottery I realize that kind of
position government has in gambling right now and it appears--I
used to think it ironic that we used to take children to the
Kansas City Board of Trade to learn about gambling while we
were busy opposing gambling in Missouri. I always thought that
it was ironic that most people in Missouri did not understand
that all they had to do if they wanted to gamble was go down
there and get them a seat on the Kansas City Board of Trade and
they could gamble with the big guys, so to speak.
Mr. Cota. Senator, I am not sure how are you going to get
the vig balance correct. That is out of my area of expertise.
But nobody likes a fixed table. And a well regulated market, no
matter how much--speculation and gambling have a lot in common.
But you need to know what the rules are well enough to be able
to play with some consistency.
If certain players are controlling the rules on the table
that day for that moment, that is not in anyone's interest.
Senator McCaskill. Right. Thank you all very much. Thank
you, Mr. Chairman.
Senator Levin. Thank you.
I am just going to sum up the conclusion I am drawing very
quickly. Everybody believes that we need a regulator to go
after excessive speculation. It does not do any good to have a
regulator on NYMEX that can prevent excessive or end excessive
speculation and then just have that move over to say the
electronic exchange.
We will start with that. I think you all would agree with
that? Is that fair enough?
Mr. Corbin. Yes, sir.
Mr. Cicio. Yes, sir.
Mr. Cota. Yes, sir.
Senator Levin. And then the question would be whether or
not we can stop the excessive speculation, which everyone
agrees is wrong. Speculation is necessary, but we all agree
excessive speculation is bad for the market and bad for your
consumers.
And the question then is can we go beyond the electronic
exchange to get the over-the-counter bilaterals which are not
on the electronic exchange? This seems to me to be an important
issue but a different issue.
But at a minimum, what we saw happening in Amaranth makes
utterly no sense. You have NYMEX saying stop, not that you did
something illegal, not that you manipulated something illegal,
but that you are doing something which must stop for the
benefit of the market under the law which we have written.
What we saw with Amaranth, with just a shifting from NYMEX
to the electronic market, makes no sense at all, and that at a
minimum we can act to stop that. Would we have that kind of a
consensus on the panel?
You are all nodding your heads yes.
Mr. Cota. I think that some of the oversight as it relates
to excessive speculation is revealed by perhaps the New York
Mercantile Exchange. NYMEX does a lot of the regulation it does
by itself on its own and not as a direct result of what the
CFTC requires. CFTC requires certain things but NYMEX has its
own rules. The other markets do not.
Just having a market like the New York Mercantile Exchange
in the other areas where there is no oversight, I think, will
enhance both the market for the consumer and the speculators,
as well.
Senator Levin. Do either of my colleagues have any other
comments?
We thank you all very much, a very helpful panel and we
excuse you with our gratitude.
Let us now welcome our second panel of witnesses for
today's hearing. We have with us Vincent Kaminski, Professor at
the Jesse Jones Graduate School of Management, Rice University
in Houston, Texas; and Michael Greenberger, Law School
Professor, University of Maryland School of Law in Baltimore.
We appreciate both of you being with us this morning. We
welcome you to the Subcommittee.
As you know, we have a rule that requires all witnesses who
testify before the Subcommittee to be sworn and we would ask
you now to stand and raise your right hand.
Do you swear that the testimony you are going to give
before the Subcommittee will be the truth, the whole truth, and
nothing but the truth, so help you, God?
Mr. Kaminski. I do.
Mr. Greenberger. I do.
Senator Levin. You were here, I believe, when we described
the timing system. I will not repeat that. Professor Kaminski,
let us have you go first, and then Professor Greenberger.
TESTIMONY OF VINCENT KAMINSKI,\1\ PROFESSOR, RICE UNIVERSITY,
JESSE H. JONES GRADUATE SCHOOL OF MANAGEMENT, HOUSTON, TEXAS
Mr. Kaminski. Mr. Chairman and Members of the Subcommittee,
my name is Vince Kaminski and I work currently at Rice
University in the Jones Graduate School of Management in
Houston where I teach courses related to energy markets, energy
derivatives, and energy risk management.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Kaminski appears in the Appendix
on page 133.
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My testimony today will address some of the issues that you
identified in your invitation letter to this hearing. Those
issues deal with the organization of the U.S. natural gas
markets and the scope and consequences of excessive speculation
I witnessed the last few years in those markets.
My opinions are based on 14 years of experience of working
for energy trading corporations, including merchant energy
companies, an independent power producer, a very big hedge
fund, and one of the biggest financial institutions. I have
also been consulting recently for FERC, helping the staff to
analyze market related issues.
The opinions expressed today are my own and I do not
necessarily represent the views of the institutions with which
I am affiliated.
The energy markets have undergone a fundamental
transformation during the last 14 years I spent working in the
merchant energy business. In 1992, the year in which I made the
transition to energy trading, the markets for different energy
commodities were relatively isolated with limited linkages
between different locations and physical products. Today the
landscape of the energy business is much different. Energy
markets are evolving towards a highly integrated global system
with shocks propagating across different local markets and
markets for specific physical commodities at a very high rate
and through rapidly changing transmission channels.
The energy markets represent a network of related physical,
financial, and credit markets with very complex interactions
and interdependencies. And it is a flaw, in my view, to look at
the physical markets in isolation from the financial markets.
In the coming years the energy markets will be affected by
growing demand pressures from the fast growing emerging
economies and the necessity to access more costly supply
alternatives. The upward pressure on prices will increase the
importance of efficient and transparent energy markets as
sources of information about the costs and relative scarcity of
different energy commodities and benefits of alternative
production technologies.
Given growing integration of the markets any distortion of
the price formation process will propagate and reverberate
across the entire system and will affect both investment and
consumption decisions. Well functioning energy markets will
become ever more critical not only to the welfare of the U.S.
citizens but also to the energy security of the United States.
The integrity of energy markets deserves the same level of
protection as the pipelines, refineries, ports, and other
components of the physical infrastructure.
The energy markets and the commodity markets in general,
given their complexity and rapid transformation, are often
vulnerable to market manipulation. Nobody can deny this given
our recent experience with the U.S. Western energy markets
crisis of a few years ago.
What is more important is to recognize that the nature of
market manipulation evolves and mutates over time as the energy
markets become more complex. In the past, market manipulation
was typically associated with squeezes, corners, and
withholding of physical supplies from the market. Today market
manipulation can be accomplished in many different ways by
taking advantage of a variety of trading platforms and leverage
offered by derivative instruments. A typical scheme evolves
around taking positions on different trading platforms,
platforms that often receive different levels of regulatory
scrutiny.
Subsequently, a potential manipulator may engage in bursts
of rapid fire trading in one market around specific contract
expiration time when market liquidity dries up in order to
influence the prices used for settlements of outstanding
contracts on other platforms and in other markets. The losses
incurred through such trading would be typically offset by
gains on the positions taken on other platforms and other
instruments.
Also, a potential manipulator can use different platforms
to decompose a scheme into different pieces and the regulators,
who can see only one part of the bigger scheme, will not detect
the manipulation in time.
I am getting close to my time limit so I shall briefly
summarize the recommendations I would like to make. In my view,
the efficiency and transparency of the U.S. energy markets can
be increased without sacrificing the risk-taking culture and
the spirit of innovation. The critical element of the market
reform is, in my view, an improved access to information. Such
initiatives may be initially opposed by many market
participants but in the long run the industry will benefit from
them. Less opaque, more transparent markets will grow and
flourish in the long run, as evidenced by many other examples.
My recommendations include regular reports of large
transactions executed in the OTC markets; elimination of the
Enron exemption; regular reports of trading activity on the ICE
exchange available to the trading community.
Thank you. I will be glad to answer any questions.
Senator Levin. Thank you very much, Professor Kaminski.
Professor Greenberger.
TESTIMONY OF MICHAEL GREENBERGER,\1\ LAW SCHOOL PROFESSOR,
UNIVERSITY OF MARYLAND SCHOOL OF LAW, BALTIMORE, MARYLAND
Mr. Greenberger. Good afternoon and thank you for inviting
me to the hearing. I would submit my testimony.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Greenberger appears in the
Appendix on page 137.
---------------------------------------------------------------------------
I really wanted to cut to the chase on this. I am more than
happy to answer questions. You have asked excellent questions
of the prior panel.
Senator Klobuchar, who is on the other side of this?
Senator McCaskill. McCaskill, but that is OK.
Senator Levin. McCaskill.
Mr. Greenberger. McCaskill, I am sorry. Senator McCaskill.
Senator McCaskill. We get mistaken all the time. It is OK.
Mr. Greenberger. It is interesting that you are from
Missouri because you should be talking to Congressman Graves,
who got the Enron loophole largely undone on a floor vote on
the House of Representatives when the Republicans controlled
the House and natural gas was at $14 per million BTU. It is at
$7 today. Why did he do that? Because the farmers of Missouri
were dependant on natural gas and were dying on the vine,
paying $14.
Who is on the other side of this? Go look at the advisory
committees that the CFTC sets up to advise them. You are not
going to find the prior panelists on those advisory committees.
You are not going to find your constituents who are paying 35
percent of their income from natural gas. Go down the list. It
is Goldman Sachs. It is Morgan Stanley.
The CFTC is a captive of the industry it regulates. There
is just no doubt about it. And I am under oath and I take that
position.
When Mr. Cicio went to the CFTC in June 2005 to talk about
the Inter Continental Exchange and the question of whether they
should continue to be regulated as a United Kingdom company,
which for purposes of crude oil they are, Osama bin Laden could
not have been treated any worse by the CFTC because that was a
consumer voice coming in to an agency that is dominated by the
International Swaps Dealers and Derivatives Association, the
Futures Industry Association, the Securities Industry
Association, the Bond Market Association, and I could go on.
And Senator McCaskill, you will meet those people believe
me, if you want to do away with the Enron loophole. And they
will give you every reason under the sun not to do it.
Amaranth. Nobody got burned besides the investors of
Amaranth. Well, your prior panel made it clear and your
constituents are telling you that they got burned. People
locked in to prices that were artificially high in the summer
of 2006 and turned around and the spot price was at least one-
third lower than what they had to charge their consumers.
If you talk to people like the New England Fuel Institute,
these are small businessman. When you ask them what is the
global impact that is going to be, that is not what they are
dealing with. And I will tell you what the global impact is
going to be. But their consumers are furious with them. And
they are not controlling this situation. They are trying to
hedge.
Yes, you need speculators in this market. The markets could
not function without speculation. But these are not casinos.
Amaranth turned it into a casino. If you want to have gambling,
go to Las Vegas.
This is for a commercial purpose to allow farmers and
producers to hedge and the speculators are invited in to create
liquidity. And the statute, because of the farmers who were
taken to the cleaners by the Chicago Board of Trade at the turn
of the 20th Century, the farmers were the ones who insisted
there be no excessive speculation.
And by the way, the Enron loophole does not apply to the
agricultural interests. If it did, you have wheat producers
here complaining about what is happening on these markets. And
the farmers are too smart and too vigorous to allow this to
happen to them. Agriculture remains completely under the
control of the CFTC.
Now with regard to people going over to London, the Inter
Continental Exchange bought the British International Petroleum
Exchange. And with that fig leaf, they present themselves as a
U.K. company. And they want to take advantage of that.
But are they going and buying up London exchanges? No. They
have just made a $12 billion bid for the Chicago Board of
Trade. They bought the New York Board of Trade. They want to do
business in the United States. These kinds of contracts are
not--you cannot go to Dubai and hedge for natural gas that is
going to be delivered in the United States. The United States
is the industry here. ICE is dying. They want to take over the
Chicago Board of Trade. They do not want to go to London.
The Enron loophole, if I might just conclude, Alan
Greenspan, Secretary Summers, Chairmen Levitt and Rainer, the
Chair of the CFTC, each told Congress do not pass the Enron
loophole. The market is too much subject to manipulation. The
House did not pass it. How did the Enron loophole get here? It
was introduced in cover of darkness. It suddenly appeared.
And Senators Feinstein and Cantwell, after seeing the
manipulation caused by EnronOnline, raising the price of
electricity $40 billion for the consumers of California, ask
them about these exchanges and what impact they do. You will
hear their answer and you will hear Amaranth's people, they
have an economist today who has testified in 83 different
proceedings. I counted them. Your constituents do not have an
expert who has testified in 83 different proceedings. You are
the expert.
Yes, there should be speculation. There should not be
excessive speculation. If you are worried about prosecution,
cut it off in the beginning the way NYMEX tried. NYMEX told
them do not go afar. We do not know what this is going to do,
but you are going to cause a dysfunction in the market. Stop.
That was not prosecution. That was prescriptive regulation that
avoided prosecution.
This can be stopped in a flash.
And finally, with regard to bilateral, that is a very
dangerous word, bilateral. Because EnronOnline, which needed
the Enron exemption--by the way, Enron predefunctness set up
their EnronOnline before they got the Enron exemption, they
were so confident they were going to get it. It was grossly
illegal and criminal but they had it running.
And by the way, when you look at this report and see who
the Amaranth traders were, they were old Enron officials,
traders rather. They brought Enron on. And Amaranth may have
gone, Brian Hunter took home $75 million the year before the
collapse. He does not have to give that back. And the next time
we have a crisis like this, you are going to find the Amaranth
traders have been hired by somebody else.
Senator Levin. Thank you, Professor, very much. Thank you
both for your testimony.
Let us get to the point--we have tried very hard, some of
us, to close the Enron loophole. We had a vote on it on the
floor. We were not able to persuade our colleagues. We limited
it at that time to the electronic exchanges, to add the
electronic exchanges to NYMEX. We thought we could get that
done. We have been unable to get that done.
If that is all we can do this, does that do the job? If we
could cover the electronic exchanges, does that do the job?
Mr. Kaminski. Probably not. In my view, it is necessary to
put in place reporting requirements for the OTC transactions
which are typically arranged by the voice brokers. It is a
challenging task because, unlike the NYMEX and ICE
transactions, many OTC transactions are highly structured and
nonstandardized. And also, in many cases, they extend over
longer time periods and contain proprietary information.
But at the end of the day any trading corporation has to
summarize the positions. They have to know how many MMBtus they
sold or bought, what is the position, what is the tenor of the
positions. If they do not have this information, they should
not be in the business.
And this information can be aggregated, summarized, and
reported. I do not see any technical challenges related to it?
Senator Levin. There is no technical challenge to getting
to the whole over-the-counter market? Is that what you are
saying?
Mr. Kaminski. Yes.
Senator Levin. You agree with that, Professor Greenberger?
Mr. Greenberger. My own personal view is, and it is not
based on any scientific study, is I think the voice brokers
play such a small role in this. If voice brokering was OK, you
would not have ICE and you would not have had EnronOnline. I
sat in meetings with people when the CFMA was discussed and
people from Goldman Sachs and the financial markets said, oh my
God, you are going to make us do things by voice brokerage?
That takes time. I am one call. I want to go to a computer
screen and press a button.
If I could just interrupt, Senator Levin, they call that
bilateral trading because it is bilateral. They have entered
into an agreement by pressing a button. That is multilateral
trading. That must be covered and can be covered and should be
and would be covered if the Enron loophole were eliminated.
Senator Levin. So that you basically believe we could
technically write a law which would cover the trading which you
just described if it were described by either electronic or by
size?
Mr. Greenberger. Yes. The technical word has already been
multilateral transaction execution facility. And you must be
careful because the industry will come to you and say oh no,
what we are doing is bilateral. But you want to look in what
they are doing.
Senator Levin. I understand. But now if we are able to
finally get the regulators into that area, will there be a move
to true bilateral trading? Or is that so impractical for the
traders that they will not move to a true bilateral trade?
Professor Kaminski.
Mr. Kaminski. I agree with my colleague. The days of market
based on voice brokers are probably counted. The markets across
the world are moving to electronic trading. And even if we have
an initial reaction and some migration of trading from the
electronic exchanges like ICE back to the broker market, it
will not last long.
Senator Levin. And you agree with that, Professor
Greenberger?
Mr. Greenberger. Yes, absolutely. You want to get to the
multilateral computerized trading.
Senator Levin. And you have no concern that if we cover
that, there will be a return to the true bilateral voice
brokering? That is not a concern?
Mr. Greenberger. That is not a concern and my own view is
it would be impractical to try and reach the bilateral voice
brokering.
Senator Levin. Now who is going to be the enforcer? Who is
the regulator here? Is it CFTC through NYMEX and through ICE?
Mr. Greenberger. The important point that I think has been
lost in all of this is that each exchange, once they are
regulated by the CFTC, is a self regulatory organization. They
are the front line of protecting the consumer. The CFTC cannot
do it all.
Senator Levin. Can ICE do it?
Mr. Greenberger. Yes, absolutely. But they are not required
to right now.
Senator Levin. And who is going to do the multilateral
trading regulation?
Mr. Greenberger. In that case you are quite correct, there
would not be a self regulatory organization. But the
multilateral transaction execution facility would report
directly to the CFTC, as EnronOnline would have had they not
achieved this still-of-the-night exemption.
Senator Levin. So they would report to the CFTC. Do you
agree with that?
Mr. Kaminski. Yes, I do.
Senator Levin. Now, that then puts at least that part of
the trading into the hands of an organization that you say is
captured or owned by the people who are being regulated. Is
that a problem?
Mr. Greenberger. Well, as I understand it--I may have
misread things. But on Thursday there is a confirmation hearing
for two commissioners. One of them is a former lobbyist for the
International Swaps Dealers and Derivatives Association.
I do not know this is a fact, but I would bet that person
has written more testimony in opposition to taking down
EnronOnline than any person in the United States.
Senator Levin. I am not disagreeing or agreeing with you.
Mr. Greenberger. And she is being paired with a former aide
of Senator Daschle, and that is the way it is done. But there
are three vacancies on this commission, including the chair.
Senator Levin. I am not agreeing or disagreeing with your
point, in terms of controlling CFTC. I am simply saying if that
continues, then would there be a problem in relying on CFTC
regulating that part of the market which is not self-
regulating?
Mr. Greenberger. I think with Congressional direction, and
I think you are seeing a little bit on that what happened
Friday afternoon with this new proposed rule, with
Congressional direction, the CFTC would be responsive. And I
think in terms of oversight--and I know that is not your
function, if the CFTC could be encouraged to welcome the people
like who were on the former panel and put them on their
advisory committees so they have a voice in the regulatory
process, I do believe that eliminating the loophole with good
Congressional oversight the CFTC could handle this.
Senator Levin. Have you had a chance to read our entire
report, either or both of you?
Mr. Greenberger. I have.
Senator Levin. Have you Mr. Kaminski?
Mr. Kaminski. No, I started reading the report last night
on the plane. I read about 40 percent of the report and so far
I agreed with practically every statement contained in the
report.
Senator Levin. Thank you. Professor Greenberger, could you
give us reaction to the report?
Mr. Greenberger. I have worked in this area for 10 years.
And what comes a close second to this report is the report that
was put out under Senator Coleman's auspices a year ago dealing
with the crude oil industry. This report had the advantage of
market data.
Leaving aside where it comes out, it is the most full
complete report giving you a major understanding of the
markets, the need for hedging, the role of speculation, the
problem with excessive speculation, and the way the statute
works. I think is a first-rate piece of work and the
Subcommittee is to be congratulated.
Senator Levin. We and our staff thank you both for those
comments.
Now, let me go on to the final question that I have, and
this has to do with that chart we had up there before.
There was a direct order to Amaranth to reduce its
holdings. And the reason for that order was that the NYMEX saw
a danger in what was about to happen. It was preventive.
Would you agree that we have got to act in order to prevent
harm? And that it is not enough to simply rely on the
manipulation provisions of law, which then punish actions that
have taken place? Would you agree with that?
Mr. Greenberger. Absolutely.
Mr. Kaminski. Yes, I fully agree with this. The problem is
that one could argue that there is no problem with excessive
market manipulation and speculation if the losses are limited
to a group of highly sophisticated investors who should know
better when they invest in the hedge funds.
The problem is that in a market economy prices have
consequences. And if prices are distorted through excessive
speculation, this has a systemic impact on the markets. And I
worry not so much about this unfortunate incident. I worry more
about the systemic impact the excessive speculation will have
on the future of the energy markets. This would be a greater
concern to me than the specific case of consumers overpaying
for natural gas last winter.
Senator Levin. I did have an additional question. That is,
the CFTC rule last week, and whether or not by requiring
traders on regulated exchanges to disclose their holdings on
the unregulated markets, whether or not that goes anywhere
close to what we are talking about here.
Mr. Greenberger. It goes a little bit of the way but not
the whole way. For one thing, I am sure what the CFTC is saying
to people now is they are getting data that they are required
to get from NYMEX. ICE has ``voluntarily'' agreed to give them
data.
What are they going to do with the data? They have got to
have some standard. And the standard is excessive speculation.
Congress has to tell the CFTC, you can deal with expressive
speculation on ICE and multilateral exchanges like ICE, and
what is excessive speculation.
Look, bookies even stop taking bets at some point because
they are worried about what is going to happen. NYMEX stopped
taking bets not because NYMEX was worried about the consumer
interest. This was all done on borrowed money. Using a
contract, you only put down 10 percent of the funds. Banks are
funding the rest. Clearinghouses are guaranteeing the banks.
What NYMEX was worried about was Amaranth was going to fail
and their clearing function would collapse.
So there is an economic measure here that needs to be
followed. Clearly eliminating the Enron loophole would bring
ICE into the measure. No prosecution, no enforcement. Just when
you get to a certain level, thank you, you have provided
liquidity to the market. Now you have to step back. Which is
what NYMEX told Amaranth. It would have been in Amaranth's best
interest to step back.
Senator Levin. It is going to take some direction from
Congress. It is not enough that the information simply be
available, that it is going to take the removal of the Enron
loophole essentially, if we are going to cure this problem. You
both agree with that?
Mr. Greenberger. Yes.
Mr. Kaminski. I do.
Mr. Greenberger. One other point about that rule is it does
not require--NYMEX can get information about a trader under
that rule, what the person is doing on ICE. If the person says
hey, like Amaranth said, I do not want to get into this
regulatory thing. I am just going to trade on ICE, that rule
does not call for the information to be gathered. It only helps
NYMEX. It does not help the regulator or the policymaker
understand if all of the traders decide to do what Amaranth did
and go to ICE. It does not affect that trading.
Senator Levin. It is only if they decide to continue on
NYMEX that they would be covered.
Mr. Greenberger. Exactly.
Senator Levin. Senator Coleman.
Senator Coleman. Thank you, Mr. Chairman.
Professor Kaminski, I appreciate your reflections on
systemic impact. And certainly the first panel's discussion
talked about systemic impact. It is not just the traders who
are impacted.
We have had a lot of discussion about excessive
speculation. To both of you gentlemen, how difficult is it to
define that? Is this accepted? And who does that? Is this
something that Congress does? Can we leave it to the CFTC? Both
of you gentlemen, Professor Kaminski.
Mr. Kaminski. Yes. It is very difficult to define excessive
speculation and the term itself is a bit fuzzy and ambiguous. I
would identify three or four different types of players in the
energy markets. We have pure speculators and they are critical
to the process because they provide the necessary lubrication
to the process.
We have big market makers and the financial institutions
which take proprietary positions and in this sense they
speculate. But they also offer the risk management tools to the
producers and consumers of energy. And they are a critical
component of the system because they help to reduce the risk to
those participants in the industry who are risk averse.
And finally, we have producers and consumers of energy who
are interested in reducing somewhat the returns they get in
return for reduction in risk.
My long-term concern is that the natural hedgers, the
producers and end-users of energy, will depart this market if
they are scared by excessive speculation. And we already have a
lot of evidence that this is taking place.
Senator Coleman. Professor Greenberger.
Mr. Greenberger. I think you do not have to define it. I
think you can give guidance. I think the CFTC can do it by
rule. And the assurance here is NYMEX had already done it. They
had accountability rules. That is what led NYMEX to tell
Amaranth to stop. This is not rocket science. This can easily
be done.
Do not forget a large trader is someone who trades 200
contracts. Amaranth had 100,000 contracts. As Mr. Cicio said,
all of the contracts on NYMEX for the contract month he is
talking about, by everybody buying contracts on NYMEX for the
month he referred to is 90,000. Somewhere we can come to an
agreement where speculation is good but you cross a line.
This is the kind of thing financial regulatory agencies do
every day, capital rule requirements, what have you. You pick a
figure based on guidance from Congress.
Senator Coleman. Professor Greenberger, you raise questions
about CFTC that are not just legislative direction issues or
regulation issues. It goes to basic structure, mindset.
Mr. Greenberger. That is correct. And I think there is a
great opportunity for the U.S. Senate to put the right consumer
oriented mindset. You have three vacancies coming up. It has
been traditional that anybody who supports the industry gets
passed on the Senate floor by a voice vote with no discussion.
Senator Feinstein went to the floor in the last hours of the
109th Congress to stop the lobbyist from ISDA because she knows
what ISDA's concept did to the electricity payers in
California.
You have got three vacancies now. This is a great
opportunity to reshape that agency.
Are there going to be industrial consumers represented in
the Commission? Are there going to be regular consumers in the
Commission? Are there going to be academics? Today, if the
Financial Industry Association, the International Swaps Dealers
Association, and the Bond Market Association give their
blessing, the history has been the person goes through.
And even Republican commissioners, Joe Dial being the most
famous, a former Texas Ranger, policeman not baseball player,
and good friend of Phil Gramm from Texas was held on the floor
of the Senate because he dared to question practices in the
Chicago Board of Trade.
If you represent the consumer, you get stopped. If you are
helping the banks, you sail right through. You have got to put
a stop to that. These people who testified in the first panel
and your constituents deserve representation. And if not
representation, a majority interest in what the CFTC does.
It is no longer a backwater agency. This hearing shows
that. Hundreds of millions of dollars are at stake, hundreds of
millions and billions out of consumers' pockets.
If you let this sail through thinking it is some backwater
agency, your constituents are going to pay through the nose and
the Brian Hunter's of this world are going to take home $75
million a year.
Senator Coleman. Could you talk a little bit about
financing regulation? There was some discussion about user fees
a little while ago. I would be interested in your perspective.
Is there a point at which those user fees, in fact, drive
folks to other markets? Is this something we should be
concerned about?
Mr. Greenberger. There are user fees in every market except
the futures market. I think user fees, let me tell you, if you
try and put user fees in the CFTC, you are going to hear who
the other side of the common sense because it will eliminate
silk linings in suit jackets if they have to pay those user
fees.
But I think user fees should be explored. I have not
thought it through very carefully. There is no reason the U.S.
public should have to pay to make sure that Brian Hunter keeps
his trading limited to speculation as opposed to excessive
speculation.
Senator Coleman. Do you have any concerns, Professor, about
any shifting to opaque markets, any shifting to the bilateral
or non-electronic markets? Is your sense that those are either
small percentages or not practical questions?
Mr. Greenberger. I sat and heard people from Goldman Sachs
tell me 10 years ago, voice brokering is a dying art. It is
still done but that is not the way you make your silk lining in
your suits. I am not worried about that.
And I think ICE is the primary example. They portray
themselves, even though they are in Atlanta and even though the
investment banks own large portions of it, U.S. investment
banks, even though they are trying to buy Chicago Board of
Trade, they can say to themselves we are going to go to London.
They are not going to London. This is where, these markets are
where things are being done.
I remember the Chicago Mercantile Exchange had a contract
that paid off depending on what the interest rates that Russian
banks paid. You won if you guessed right, you lost money if you
guessed wrong. And they called up one day and said guess what,
the Russian banks are meeting before the contracts closed and
they are lowering their interest rates for a day. So that when
the contract has to get paid, the interest rate drops, then the
contract expires, they go back and meet and raise it again.
Do you think people are going to trade natural gas
contracts in Russia? No.
Senator Coleman. Professor Kaminski, you have talked about
a globalized market. You have raised concerns about balkanized
regulatory infrastructure. Can you talk a little bit about the
offshore markets, about the bilaterals and something that we
should be concerned about as we move forward?
Mr. Kaminski. I do not believe that any responsible
corporate entity will move to migrate to trading on an exchange
established in a banana republic. The U.S. market is too big
and too important and too sophisticated to really lose the
business to other trading platforms.
If this happens, the business will go to the countries
which have a regulatory infrastructure which is similar to ours
if not more complete. The regulatory institutions in those
countries, like for example FSA in the U.K. will cooperate with
the U.S. Federal agencies.
So I do not see a big danger in U.S. energy trading, energy
exchanges losing business in the long run to other platforms.
If this happens, it will be more--it will happen on a relative
basis and will be just a manifestation of the fact that other
markets outside the United States are growing and catching up.
So the U.S. market is not going to shrink in size. It will
continue to grow. It may be relatively smaller compared to
other markets but it will not go away.
Senator Coleman. Thank you. Thank you, Mr. Chairman.
Senator Levin. Thank you. Senator McCaskill.
Senator McCaskill. Professor Kaminski, in your testimony I
looked at your written testimony, and you talked about the
various aspects of manipulation. The second one you talked
about was the aggressive rapid and large volume trading near
the expiration of a contract talking about the excessive
speculation, which we have talked about at some length at this
hearing today.
The first one that you talked about, however, was the
exploitation of market power control by the control of physical
assets or physical supply. I would like both of you to address
what, if anything, can be done in that area by Congress?
It is interesting to me because most businesses there is an
incentive to invest in the capital infrastructure. There is a
bottom-line business incentive to keep the infrastructure
strong, to keep the capital investment at peak performance.
The irony is in this area there is a disincentive because
if you can fig leaf a lack of supply because of a problem with
the delivery in terms of the capital infrastructure, then it is
a way that you can, in fact, manipulate the market to your
advantage.
What, if anything, can we do in terms of that manipulation
issue as it relates to market control of the physical assets
and then therefore of the physical supply?
Mr. Kaminski. Well, one fact to be recognized is that the
energy market is global integrated. But at the same time there
are local pockets of market power which have been due to the
rigidities and imperfections of the physical infrastructure.
And often at the specific trading location, far away from
NYMEX and ICE, is a company which is relatively small in size
can establish a dominating position because it controls the
transmission lines or it controls the pipelines in a given
region and takes advantage of the fact that it dominates a
local market. And then it may engage in very similar
strategies, taking positions in the derivatives and trading
high volumes in the physical markets to influence the
benchmarks which are used for settlement, cash settlement of
derivative transactions.
Senator McCaskill. What can we do in Congress to address
that kind of manipulation?
Mr. Kaminski. Information and information again. Just
reporting the positions taken in the OTC markets and on ICE
will preclude it, because this form of manipulation happens
typically outside NYMEX, happens through the OTC markets, and
happens through the ICE.
Senator McCaskill. So the prescription for the second kind
of manipulation will also cure the first kind?
Mr. Kaminski. In my view it will go a long way to address
this problem.
Senator McCaskill. You both have kind of addressed this,
and that is that the attractiveness of our market, in fact, is
due to the regulation, which is not what you hear from people
who are working against regulation. You hear oh, if we
regulate, they are going to run off someplace else.
But essentially what both of you are saying with your
expertise in this area is that it is the certainty that
regulation provides that is the magnet for the investment in
this regard because people know it is not going to be a fixed
house. Is that a fair way of summarizing your position on that
issue?
Mr. Greenberger. Certainly in the financial area that is
absolutely true. The proof in the pudding is after this report
came out today, NYMEX started putting out press releases saying
you want to invest securely, invest in a regulated exchange.
Yes, that is the answer.
When Long Term Capital Management failed, the Chicago
exchanges put out a full-page ad in all of the financial
newspapers saying this would have never happened if this
trading had happened on the Chicago Board of Trade or the
Chicago Merc.
And yes, you do not want having indices arbitraged in
advance of payments on these contracts like it happened in
Russia with their bank thing. That would not happen in the
United States, even with the most minimal regulation. Good
regulation does attract interest.
I would also say, with regard to the IPOs going over to
Europe, I would look at the percentage U.S. investment banks
take to put out an IPO. I think it is 7 percent versus 4
percent in Europe. That may have a big explanation why IPOs are
being done in Europe.
Senator McCaskill. As opposed to it is a less stringent
regulatory environment?
Mr. Greenberger. Absolutely. And the other point is, about
this arbitrage, potentially Congress passes a law, does things
strictly. There is something called the International
Organization of Security Commissions. And by and large, I
remember when Long Term Capital failed, they put out a report
about what needed to be done to control hedge funds. Many of
the securities commissions want to look to the United States
for how to regulate effectively, and on their own adopt
procedures to try and stop these malpractices from happening.
Now they do not have somebody buying 100,000 contracts over
there. They have not been exposed to this kind of massive
excessive speculation, if not manipulation. But they would be
very sympathetic to the kind of discussion that you are having
here today.
Senator McCaskill. Let me finally address the comments you
made, Professor Greenberger, about the CFTC and the oversight
function that it has or has not based on the compilation of the
board. I will tell you that it was fascinating to me maybe last
week or the week before when we had a hearing in the Commerce
Committee with the FCC. The commissioner from the FCC said
well, the reason that they have not acted on this, if we can
just talk the next panel into all agreeing, they would probably
move forward. Of course, the next panel were all the industry
players.
It was an absolute confession in a Senate hearing that the
FCC was not capable of acting unless all of the people making
money could, in fact, join hands and agree.
Are you saying that the CFTC has that same kind of dynamic,
that they are dependent upon agreement of the big financial
players in this area in order for them to do what they need to
be doing right now?
Mr. Greenberger. I am going to be very candid with you, it
is worse than that. It is a very small agency. It started out
as an agricultural agency. And all of a sudden Goldman Sachs,
Morgan Stanley, J.P. Morgan Chase, Bank of America, and all of
these prominent people walked in the door and essentially
unless you watch what happens, they take over.
If you look at the Wall Street Journal, I think it was
December 13, 2001, there is a story there which I believe the
protagonist agreed to where a lawyer from Sullivan and Cromwell
called the commissioner over to the Washington, DC office of
Sullivan and Cromwell and instructed that commissioner on how
he should vote.
Now that would not happen at the FCC. It would not happen
at the SEC. By the way, the commissioner came back and reported
it immediately, and so maybe it did not happen at the CFTC
either. But the fact that they thought that they could do
that----
Senator McCaskill. They could.
Mr. Greenberger [continuing]. And by and large if somebody
from Goldman Sachs or the Managed Funds Association, which is
the industry association for hedge funds, needs an appointment
with a commissioner my experience was, in the 2 years I was
there, the appointment happens that day.
By the way, there is a lot of talk about the fact that the
CFTC should be part of the SEC because a lot of these
instruments it is hard to tell whether they are futures,
derivatives, or securities. So why have a fight over it? Let us
put them all in one----
Senator McCaskill. Put them all one place.
Mr. Greenberger. But I will tell you something, the people
I am talking about do not want that to happen because they know
that even with the present SEC that some people may think is
more laissez-faire than traditional, they are not going to be
able to say jump and hear the question back how high.
Senator McCaskill. Professor Kaminski, do you think it
would be a good idea to move the CFTC under the SEC?
Mr. Kaminski. I did not think about it. Given the growing
integration of the U.S. financial markets, it definitely makes
sense to improve coordination between different agencies,
including FERC, SEC, and CFTC. Whether it makes sense to create
one big institution, regulatory institution, regulating all the
markets, looking at all the markets, I have not been thinking
about it so I cannot give you an informed opinion.
Senator McCaskill. I would welcome both of your comments
about both a user fee structure so that we are getting the vig
that we need to run the place.
And second, whatever thoughts you have about if, in fact,
due to the changing and evolving financial transactions as it
relates to these kinds of products, particularly in light of
the global nature and electronic transactions, if it does make
sense for all of this to be under the umbrella of one
regulatory realization as opposed to being split up the way it
is. I would appreciate your input on that.
Finally, I will just say that the biggest enemy we have
here is complexity. Invariably the public can be the best
lobbyist in the world, if they are aware, informed and
understand. Unfortunately in this area this is so complex that
most people do not understand the relationship between what
they are paying on their gas bill and hedge funds and the
speculative market. And frankly, until 2 days ago, I had no
idea what ICE even was. I did not even understand ICE.
To the extent that you all can present the view of
consumers from a very educated position is invaluable to this
Subcommittee. I only wish that you could, in fact, multiply and
fan out throughout the capitol and begin to do one-on-one
visits with all the senators that have votes because I can
assure you the other side will do exactly that. Thank you very
much.
Senator Levin. Thank you, Senator McCaskill. Just a couple
more questions to get this on the record.
The size of the Amaranth position on the market and the
significance for the market when the traders get to be that
large, is that a significant matter?
Mr. Kaminski. It is a very significant matter and
Amaranth's position were known to the market. The market knew
about it. And when I was watching the situation last year it
was like watching a train wreck in slow motion. It was obvious
that it would end up in a crash.
Senator Levin. Does it also affect future prices when
someone can dominate the market to that extent?
Mr. Kaminski. Absolutely.
Senator Levin. Professor Greenberger.
Mr. Greenberger. Absolutely. The futures markets, to the
extent they are transparent, are used for price discovery. If
you are affecting them, these kind of trading affects the
market. The collapse of Amaranth and the drop in natural gas,
you do not have to be a rocket scientist or have an algorithm
to figure out why that happened.
Senator Levin. To get a direct answer for the record, then
the size of the Amaranth trades affected future prices?
Mr. Greenberger. Absolutely.
Mr. Kaminski. Yes, it did.
Senator Levin. In terms of CFTC, does it pay to--end the
Enron loophole--close it, even with the current CFTC? Even if
we cannot do these kind of changes, we are not the people who
appoint them and whether or not they are confirmed is kind of a
different issue, and an important one. But is it worth pursuing
and following the road that we are on, even if we cannot impact
the makeup of the CFTC?
Mr. Greenberger. I think it definitely is. I think that as
captive as it sometimes is, that the direction from Congress
will have an influence.
And also, the Commodity Exchange Act has a private right of
action point in it. I say that hesitantly. I do not want to
look to private lawsuits to protect these things. But if you
put down these mandates and all these malpractices are
happening, Amaranth's lawyer was quick to point out there was
no intent here, trying to stay one step ahead of manipulation.
I am not so sure that they are one step ahead.
But yes, you definitely should do this. It is an easy fix.
Alan Greenspan would agree with you on it. He did not want this
to happen in 1999-2000. It should be fixed immediately.
Senator Levin. Do you agree with that Professor Kaminski?
Mr. Kaminski. I agree that removing the Enron exemption
will be very helpful. But at the same time, CFTC should be
given more firepower. It may be underfunded and understaffed
currently.
I have been watching the energy markets not only in the
United States but also in other markets. And the common
denominator is complexity. This is what was mentioned a moment
ago.
There were many cases of manipulation in other countries.
The regulators came. They looked at the complexity of the
trades and volume of the data and they threw their hands up in
the air and left. They did not have resources to investigate
the issues.
Senator Levin. Senator Coleman.
Senator Coleman. Nothing. Thank you.
Senator Levin. Thank you both. You have been a tremendous
panel and we are very appreciative.
Let us now welcome our final witness for today's hearing,
Shane Lee, who is a former natural gas trader at Amaranth,
appearing here today at Amaranth's request, to answer questions
about its trading.
Let me just clarify what I just said, that even though
Amaranth is the one that selected Mr. Lee to represent them and
to answer questions today, we obviously are the ones that asked
Amaranth to identify a witness who could answer questions about
its trading, and Mr. Lee was identified by Amaranth as that
person. Mr. Lee worked at the Calgary office of Amaranth where
the energy trading was carried out.
Mr. Lee, we appreciate your being with us this morning. We
welcome you to the Subcommittee. As you have heard, all
witnesses who testify before the Subcommittee are required to
be sworn so we would ask that you stand at this time and please
raise your right hand.
Do you swear that the testimony you will give before this
Subcommittee will be the truth, the whole truth, and nothing
but the truth, so help you, God?
Mr. Lee. I do.
Senator Levin. We have that system there where that light
will go on a minute before the 5-minute mark, where we would
hope that you could keep your oral testimony to. And we, again,
appreciate your coming here. We know that you are coming here
voluntarily and we have had your cooperation in terms of
getting information. We will ask you now to proceed.
TESTIMONY OF SHANE LEE,\1\ FORMER NATURAL GAS TRADER AT
AMARANTH, LLC, CALGARY, ALBERTA, CANADA
Mr. Lee. Chairman Levin, Ranking Member Coleman, thanks for
the opportunity today to appear to discuss the important issues
that the Subcommittee is considering. As a bit of a background,
I have been trading natural gas for 9 years now. During my
career I have traded pretty much most conceivable products in
the gas market at one time or another, including both physical
and financial gas.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Lee appears in the Appendix on
page 147.
---------------------------------------------------------------------------
In April 2006, I began working at Amaranth. My job at
Amaranth was to trade Northeast markets but I also did trade
futures, swaps, and options. I managed my own portfolio, which
was separate from Amaranth's much larger natural gas portfolio
managed by my boss, Brian Hunter, who was the head of the
natural gas desk.
I worked principally in the offices in Calgary, Alberta,
and I was strictly a trader. I did not have any contact with
investors and I did not play any role in the management of the
company.
The Subcommittee has asked whether I believe Amaranth
engaged in so-called excessive speculation. First, there is a
common media misconception that Amaranth lost over $6 billion
in wrong way energy bets and therefore must have engaged in
speculation to absolute extremes. This is not necessarily true.
By mid-September 2006, Amaranth energy portfolios had given
back around $2 billion it had been up at the end of August. My
understanding was that Amaranth senior management became
concerned it did not have the cash on hand to deal with any
further margin calls and chose to sell its portfolios to
competitors to remain solvent. The undeniable fact is that only
a small portion of Amaranth's actual $4 billion, just a little
bit over $4 billion, in real losses were truly a result of the
energy trading losses. The rest was the sale of a distressed
asset in a high volatility market due to a fundamental cash
problem.
I commend the Subcommittee for making this extremely
important inference in page one of its own report.
Was Amaranth's trading excessive? There is no question, the
volume of Amaranth's trading was very large, compared to many
of the other market participants. However there are a number of
other players whose trading was probably just as large, just
expressed in different forms of risk.
Whether Amaranth's trading was excessive is a question I
really cannot answer and that is for two reasons. First of all,
as a trader I have never had access to sufficient information
about the activity of all market participants. Although
regulatory agencies and exchange officials have access to some
of the information, which is namely the information on NYMEX
only, they do not have everything. A trader's position on NYMEX
is typically only one part of a trader's position and they
usually have a wide variety of products that are not traded or
cleared on NYMEX exchange.
And second, there is no clear definition for me as a trader
for the term excessive speculation. Even if I complete
information about everyone's positions, including my own, it
would be impossible to say whether one is excessive or not
because I do not have any point of reference. I need hard
numbers as a trader, or at least further guidelines from a
regulator or exchange personnel.
The Subcommittee's report suggests Amaranth's trading was
the predominant cause of increased natural gas prices and wider
spreads during the summer of 2006. I respectfully disagree with
that. In my view, as the minority staff suggests, Amaranth was
responding to the market rather than driving it. The market is
driven by a lot of fundamental forces, such as weather, supply
and demand, storage levels, producer hedging activity, cross
commodity values, and multitudes of other factors. But in
particular, in 2006 there were some sound fundamental reasons
for why spreads did what they did and I would be very happy to
answer questions about those at length.
The financial market for natural gas derivatives has a
virtually unlimited supply and unlimited capacity to absorb
trading activity. It would be impossible to corner, dominate,
or otherwise exert any type of control on a financial market
without access to the physical commodity, or at least another
product that mimics that physical commodity. Prices are
determined by fundamentals, whether those fundamentals happen
to be financial or physical, and by the collective judgment of
many participants in a large and efficient market.
The Subcommittee also asked me about my views on whether
position permits and other regulatory requirements should be
extended to cover unregulated exchanges. I absolutely support
reporting requirements and accountability limits on ICE, the
general over-the-counter market, and even the physical markets
to some extent. But it must include all facets of the market to
be effective.
In particular, reporting requirements would benefit market
participants by making more information available to the
public, the traders, and the regulatory agencies, and would
make the market more transparent to all.
In terms of limits, policymakers must be very careful to
evaluate the important pros and cons to make sure we do not
have a capital flight from the market.
I have included further discussion of some of these issues
in my written statement and I would be happy to elaborate on my
views today.
Senator Levin. Thank you, Mr. Lee. How many natural gas
traders did Amaranth have when you were there?
Mr. Lee. In terms of pure natural gas traders, I believe it
had five.
Senator Levin. The head gas trader was Brian Hunter?
Mr. Lee. Yes, it was.
Senator Levin. Did you work with him?
Mr. Lee. Yes.
Senator Levin. Who designed the natural gas trading
strategies for Amaranth?
Mr. Lee. Each one of those traders, or at least three of
the five traders, had their own strategies. They could pretty
much do whatever they wanted as long as they were concentrating
the core of their strategies in what they were hired to do. Two
of those five traders executed trades for the more senior
traders.
Senator Levin. Amaranth bought or sold tens of thousands of
natural gas contracts over the course of a single day; is that
correct?
Mr. Lee. Yes.
Senator Levin. For instance, on July 31, you bought nearly
26,000 March 2007 futures contracts and you sold about 24,000
April 2007 contracts, according to your information. Does that
sound right?
Mr. Lee. I recall them buying a lot of March/April
contracts. I do not know the exact numbers.
Senator Levin. Did you know at the time how large
Amaranth's trading was?
Mr. Lee. My only frame of reference at the time was
relative to other companies I had worked at, and the relative
sizes I had been able to take at other companies, as well. That
was my only frame of reference. But I did not know exactly how
they compared to the rest of the larger traders in the market.
Senator Levin. What was the size of the biggest trades that
you made when you were at Amaranth?
Mr. Lee. When I was at Amaranth trades for my own
portfolio, I would say would have been less than 5,000 at any
time for a total position, let alone trading in a day.
Senator Levin. Could they be 5,000 at a time?
Mr. Lee. No, not for myself. But I was asked to execute for
Brian Hunter at points during the summer when they were
extremely busy. And at those times definitely we traded 5,000
at a time or more.
Senator Levin. What was the largest trade you ever made
before going to Amaranth?
Mr. Lee. I would say something to the tune of about 5,000
lots.
Senator Levin. You made trades that large before you went
to Amaranth?
Mr. Lee. Yes.
Senator Levin. Where was that?
Mr. Lee. At Citadel, an other hedge fund.
Senator Levin. What year would that have been?
Mr. Lee. That would have been 2005.
Senator Levin. Do you think that Amaranth's trading volumes
were basically large?
Mr. Lee. I thought they were more than basically large.
They were larger than I had ever seen, to be quite blunt about
it. But relative--I mean, that was a part of the market I had
never seen before, in terms of what I could call the big boys.
So I did not know how large they compared to everyone else.
Senator Levin. Why did Amaranth engage in these scale
tradings?
Mr. Lee. My understanding was it was simply a matter of
capital. At a hedge fund you are given an amount of capital to
trade with. It may not be so clear in those terms, maybe either
as risk or capital. But you simply have to put that capital to
work one way or the other. And Amaranth, for whatever reasons,
because I only got there of April 2006, had given a lot of
money to the energy trading side of the business.
Senator Levin. Did Amaranth believe that the January prices
were going up?
Mr. Lee. Not necessarily. There were times during the year
when they believed that. I think this is a chance for me to
clear up one of the common misconceptions about--as I have seen
in the report--about these January/October spreads and these
January/November spreads, in particular. Buying one of those
spreads does not necessarily represent a view of the market
going up.
In fact, at least in my--you will have other traders
disagree--but I think a good majority would agree when you buy
one of those particular spreads, that typically means you think
the market is going to go down. So it was more a view of
October was going to go down rather than January was going to
go up.
Senator Levin. Did you not overall, at that firm when you
were there, believe that January prices were going to go up?
Mr. Lee. Yes.
Senator Levin. Did you trade on both the NYMEX and ICE?
Mr. Lee. Yes, I did.
Senator Levin. Did you consider natural gas contracts on
ICE and NYMEX to be equivalent for risk purposes?
Mr. Lee. Those contracts were equivalent for risk purposes
up until the point of settlement, at which point there are some
extremely important fundamental differences. But if you were
hedging in the future you could consider them identical for the
most part.
Senator Levin. On August 8 and 9, NYMEX telephoned
Amaranth, told it to reduce its positions in the September and
October contracts. Is that correct?
Mr. Lee. That is my understanding, that is correct.
Senator Levin. Did Amaranth take issue with NYMEX's
determination that your position was too large?
Mr. Lee. To be honest with you, I was not part of those
conversations. That would have been done at the compliance
level and maybe with whoever's position it involved, which
would have likely been Brian's obviously. So I was not party to
those conversations.
Senator Levin. But did you, in fact, comply? Did your
company comply?
Mr. Lee. My understanding is that they complied and reduced
their NYMEX holdings.
Senator Levin. And you were not given any instruction by
anybody in terms of reductions at that time?
Mr. Lee. That would have not concerned my position. That
would have concerned Brian's position at that point and I only
executed for him from time to time.
Senator Levin. Were you aware of the fact that NYMEX gave
that order?
Mr. Lee. I do not recall being aware of that order in
particular. That would not be considered an extremely important
event at the firm.
Senator Levin. How often did it happen that NYMEX would
give an order that you have to reduce your position?
Mr. Lee. Not very often.
Senator Levin. So it would be considered an unusual thing,
would it not?
Mr. Lee. I think from a compliance perspective they would
have considered it unusual. But from a general market
perspective--there is an entire market that exists to allow you
to move between NYMEX and other exchanges. And it is a very
liquid market. So from that perspective, being asked to do it
caused no hardship on the company per se and it was something
they were very easily able to do.
Senator Levin. Well, that is the point, it was too easy to
do. But as a matter of fact, it was an unusual event, was it
not, to be ordered to reduce your holdings?
Mr. Lee. Yes, it is unusual. There is usually rules in
place on an exchange, and they are usually very set rules, that
once you hit those rules you are going to get a talking to. The
part that was unusual, though, is that over the course of the
year--this is from my understanding only--was that those
initial accountability levels were breached earlier on in the
year and NYMEX continued to increase those for Amaranth and
then eventually decided to have them liquidate.
Senator Levin. Do you know of any other time when NYMEX has
issued an order like that?
Mr. Lee. I would never know about that because I believe
those are private conversations with companies.
Senator Levin. Have you ever heard of a time from other
companies, people you work with?
Mr. Lee. No.
Senator Levin. Now you say it was easy to comply with, and
that is not the question. The question was whether or not it
was unusual for NYMEX to issue that kind of an order. There may
be other times that you do not know of, but you do not know of
any other time when NYMEX has ever issued an order like that?
Mr. Lee. Correct.
Senator Levin. You did not reduce your position. What you
do is shift your position to ICE, is that correct?
Mr. Lee. Yes. My understanding was that the order was to
reduce their position of NYMEX contracts, not natural gas
positions.
Senator Levin. Did they have any control over ICE?
Mr. Lee. Any control?
Senator Levin. NYMEX? Could they order----
Mr. Lee. No, they are separate companies.
Senator Levin. So you interpreted that to be just reduce
your NYMEX position?
Mr. Lee. Yes.
Senator Levin. Were you involved in that discussion?
Mr. Lee. No, I do not recall being involved in that
discussion.
Senator Levin. So that when the company was told to reduce
its positions in these futures, you do not know whether there
was discussion in the company as to whether to just simply
shift over to ICE or to reduce its overall position?
Mr. Lee. For the reasons you explained yourself, from a
risk management standpoint, there was essentially no difference
between the two markets. So from that perspective it would not
have been a big deal to do it.
Senator Levin. It would not have been a big deal for you to
be able to implement but it is a very big deal in terms of what
your holdings are in the overall market; and the impact on that
market when you would sell them on all at one particular point.
So that is where the difference lies. You say it was easy for
you to shift. That is the problem. It was too easy for you to
shift.
Should you be able to shift, do you believe, from one
market to another? You are told you must reduce on this market,
your position endangers the market, and then to be able just to
simply shift to another market? Does that give you any kind of
pause?
Mr. Lee. I believe it depends on the circumstances. I
believe one of the reasons that NYMEX has specific limits in
place and accountability levels is because during the
settlement process if you do not get rid of your futures
contract position you have to make or take delivery of the
actual physical natural gas. The difference with the swap
market is you do not do that. One settles, one references the
settle.
Senator Levin. Do you think your positions have an impact
on market prices?
Mr. Lee. Do positions have an impact on market prices?
Senator Levin. Yours. Do you think those positions, given
the size of those positions, that they could have a significant
impact on market prices?
Mr. Lee. To answer your question I think I have to explain
it like this: There is no question that any time there is a
capital infusion into a market or a flight from that market,
that there is an initial temporary price change. But once the
market has had the ability to react to that price change, I do
not believe that any position in a market, as long as it is not
the physical commodity, can have an overlasting effect on
price.
Senator Levin. Do you think it has an impact on price, a
large holding such as yours, 50 percent of the market, up to 75
percent in 1 month; could it have a significant impact on
price, at least in the short term?
Mr. Lee. In the extreme short term I would agree with you.
You also must remember you are talking about some of the open
interest levels that were in NYMEX only. And in the greater
context of the market, Amaranth was not as large as their
holdings on NYMEX would have indicated.
Senator Levin. At the time that you wrote to Brian Hunter
on September 7 last year, just before the collapse that
``things were fine when we were holding the risk for the market
because we could handle it. That risk in 30 other hands is a
much more dangerous proposition.''
What does it mean to ``hold the risk for the market?''
Mr. Lee. As a speculator, that is exactly what you are
doing out there. You are taking risks that your typical
producer or consumer is not going to take. And it is going to
react different in the hands of different people.
Senator Levin. Would the size of your holdings have an
impact on that?
Mr. Lee. In the immediate. Yes, immediately. That is a
liquidity issue.
Senator Levin. What is the problem with risks being in 30
other hands?
Mr. Lee. It is not a problem for the market. That could
have been a problem for us at the time. We were talking about a
point where we were getting ready to liquidate a distressed
asset. The question I was asking there was do you want to do
this all at once or do you want to give it to the market to do
it for you? What do you think is the better option?
Senator Levin. But you were talking about holding the risk
for the market and then you said ``that risk.''
Mr. Lee. Yes. The particular risk I was talking about--
Senator Levin. ``That risk in 30 other hands is a much more
dangerous proposition.''
Mr. Lee. The particular risk I am talking about I am not
sure. I believe it had to do with one of the spreads that I was
describing at that time. But yes, I was insinuating that we
were holding a good portion of that risk at that time and that
our behavior might be different than if 30 other players held
that exact same risk at that point in time.
Senator Levin. You also said in one of your e-mails that
``there is no catalyst right now. That is the problem. You exit
this size without one, without exiting every position in your
book, and we have got a big problem.''
What did you mean by the word ``catalyst?''
Mr. Lee. By catalyst I meant a liquidity event. There is
not a constant liquidity in natural gas markets, especially
natural gas markets, due to its reliance on such fundamental
things such as weather. To trade large positions you need
liquidity events to sometimes enter them and sometimes exit
them. Typically in the time period that we are talking about,
like a September, you're in a low demand period, there was no
hurricanes at the time, there is not a lot of weather. It is
not a great time to do anything one way or the other if you
want to get a good price for what you want to do.
Senator Levin. So the word catalyst in that context meant
an external event such as a hurricane?
Mr. Lee. It would not have to be necessarily an external
physical event. This could be something as simple as a buyer
coming in. It could be physical or financial.
Senator Levin. But without that, if you sold all of your
positions, the prices would fall sharply?
Mr. Lee. I am insinuating that, yes. But to fully answer
that question you have to keep in mind the context of the time.
Amaranth was dealing with an extremely big problem with their
cash. And it was a decision whether to get rid of part of the
position and see if the company could remain solvent or get rid
of all of the positions so that there was no question that the
company was solvent.
I am pretty sure that is what I was referring to there.
Senator Levin. Your next sentence, ``that things were fine
when we were holding the risk,'' does that not mean, in context
then, that as long as you were the dominant holder of those
positions and did not sell, that the prices would then not
crash down?
Mr. Lee. No, I do not think I am insinuating that. I think
I am insinuating that if one very large player with different
risk perspectives than say other types of participants in the
market is holding the risk, they are going to do something
differently with it and they can handle greater swings and
things like that.
There is different parts of the market that can not handle
volatility. We are able to handle it for the most part up until
September and I think that is what I am insinuating.
Senator Levin. So you did not believe at that time that
your positions were so large that if you sold them all at once
the prices would fall sharply? You did not believe that?
Mr. Lee. I do believe that because I do--
Senator Levin. Did you believe that?
Mr. Lee. Yes, I did believe that because of a liquidity
event and because, as I said, I do agree that any trade in the
market does have a short-term effect on prices.
Senator Levin. Senator Coleman.
Senator Coleman. I just want to get to a discussion of what
is excessive. Do you have a definition of what constitutes
excessive speculation?
Mr. Lee. I do not.
Senator Coleman. So it was not unusual for Amaranth to hold
as much as 40 and sometimes 50 percent of the NYMEX open
interest in certain contracts? Is that something you would
consider excessive?
Mr. Lee. Postmortem, looking at that, it looks like they
did that all the time. In terms of excessive, excessive
relative to what? Relative to one exchange? You could make an
argument for that.
But you have to take this in the context that there was
more than just NYMEX trading. There was times when they had
greater positions on ICE than NYMEX and to look at just one
facet of the market and determine whether it was excessive,
that is not for me to decide. That is for the exchange to
decide or for the regulator to decide. Was it large? Sure. Was
it large relative to the whole market? I would not know because
I have no clear definition of what the entire market looks at,
because only one part of the market reports.
Senator Coleman. So it is not up to the trader, but if the
trader was given that definition by NYMEX or others, that is
something you could deal with?
Mr. Lee. That is something I could deal with and abide by.
Senator Coleman. If NYMEX was so concerned about the size
of the positions that they tell you to get out of your
positions by August, is this an indication that speculation
might be excessive?
Mr. Lee. It was at least an indication that they felt it
could cause some problems for their market integrity. I do not
know if it necessarily insinuates that the entire market could
not handle that particular amount of speculation.
Senator Coleman. I am just trying to put myself in your
frame. When NYMEX says you have to get out you move to ICE
because you can do it. Was there ever any thought or discussion
that you were doing this because NYMEX was coming down on you
and you had another place you could go without transparency,
without people knowing what you were doing?
Mr. Lee. That would not have been the business decision at
the time. You have to keep in mind that Amaranth was running
obviously very large positions in, I believe, upwards of 67 or
69 months. To just get rid of two positions from a risk
perspective could be extremely damaging, especially if you are
only given--I do not know what the notice was to get out of
those positions but let us say 24 hours. From a business
perspective, because they were allowed to do this, it was best
to move to the rest of the market and then they could therefore
have more time to decide what to do from a risk perspective
with their overall position rather than just dealing with one
or two positions.
Senator Coleman. Was there ever any discussion about
Amaranth's position and its effect on market liquidity?
Mr. Lee. Yes. I remember times when--I mean, it is a simple
concept. If you hold a large position in one particular
contract, there is obviously some disagreements with you on
that price from a market participant standpoint. So if you need
to get out of that contract very quickly there could definitely
be a liquidity issue for you.
Senator Coleman. If you go to Exhibit 14,\1\ if you have a
copy of that. I believe it is Amaranth's May 2006 update to
investors. The middle of the second paragraph. Do you have a
copy of that?
---------------------------------------------------------------------------
\1\ See Exhibit 14 which appears in the Appendix on page 900.
---------------------------------------------------------------------------
Mr. Lee. I will momentarily. OK.
Senator Coleman. In the middle of the second paragraph,
almost exactly in the middle. It says ``In this case, as we
endeavored to monetize gains and reduce risk within the
portfolio, liquidity in the middle part of the natural gas
forward curve seized up due to high volumes of producer hedging
that oversaturated market demand for forward natural gas. While
this was a humbling experience that led us to recalibrate how
we assess risk in this business, we believe certain spread
relationships involving natural gas remain disconnected from
their fundamental drivers.''
I want to get back to whether Amaranth's natural gas
positions and trading volumes were large relative to the
average. Is this document telling you that?
Mr. Lee. I do not think it is necessarily telling you that.
It is just saying that any position--when you have an event
like we had in May, and just let me kind of explain the
background of it. We saw an amount of producer hedging that we
had not ever remembered seeing since about 2001. I think the
market, in general, had outsized itself for that type of event,
us included, and prices rated accordingly.
Senator Coleman. So you do not believe that one of the
lessons of Amaranth's collapse is that when a fund's positions
are large relative to the average trading volume, the fund's
risk model should account for the effect of its own activity on
prices and liquidity?
Mr. Lee. I cannot say I disagree with that. I think that is
a pretty novel concept and I think it is something risk
managers should look at.
Senator Coleman. I am not sure whether your personal
opinions have much impact but do you think that ICE and NYMEX
should be regulated differently?
Mr. Lee. From a reporting standpoint and an accountability
level standpoint, they should absolutely be the same. I see no
reason why not. I do not think it creates that much of an
administrative burden on anyone to do it.
Senator Coleman. But if they were the same, then perhaps
you would not have been able to move from NYMEX to ICE and
simply literally reverse your positions. When I say you, I mean
Amaranth. If they were the same, you would not do that.
Mr. Lee. That is true.
Senator Coleman. Perhaps it tells us sitting here, that in
part your motivation was to move from something that has
regulators squeezing you to an area that you are not going to
be squeezed because there is not transparency.
Mr. Lee. Keep in mind you are discussing the concept of
limits, though, which is a lot tougher question to deal with.
That is the part of the question, I think, where you could risk
flight from market. Whereas with accountability levels and
reporting, I do not think you take that risk or I cannot
honestly believe anyone that would tell me that would be a
risk.
Senator Coleman. Thank you, Mr. Chairman.
Senator Levin. On September 17, John Arnold of Centaurus
wrote to the head of natural grass trading at Amaranth, Brian
Hunter, saying that ``In my opinion, fundamentally, the March/
April spread is still a long way from fundamental value. . . .
Even though that spread has collapsed over the last 2 weeks,
the only reason it is still above $1 is because of your
position.''
That is what Arnold wrote to Hunter. Do you agree with
Arnold's view now?
Mr. Lee. No, I do not. I believe this is John Arnold
posturing. He was trying to buy a distressed asset for the
cheapest price he could. And if I was in his position, I would
have said the exact same thing.
Senator Levin. Did Hunter want to take that offer?
Mr. Lee. Yes, he did.
Senator Levin. Even though Arnold was posturing?
Mr. Lee. Yes. The total cost to Amaranth at that point, I
had estimated, would have been in the $600 million to $800
million range, rather than the $4-plus billion that they
eventually lost. But that is all in hindsight.
Senator Levin. A former colleague of yours at Amaranth
wrote another energy trader about a different contract, ``Boy,
I will bet you see some CFTC inquiries for the last 2 days.''
The trader replied to Brian Hunter, ``Until they regulate
swaps, no big deal.''
That trader told us that he thought manipulation can occur
because there is no regulatory oversight of natural gas swaps
on ICE. Do you agree?
Mr. Lee. I would agree.
Senator Levin. Do you think the regulators should be able
to view both futures and swaps?
Mr. Lee. Yes, I do.
Senator Levin. And if there had been regulation of ICE, as
I understood the answer to the question that was asked by
Senator Coleman, you would not have switched over to ICE. Did I
hear you correctly?
Mr. Lee. We would not have been allowed to. We would have
had to follow the rules and Amaranth always followed the rules,
and we would not have done the swap.
Senator Levin. Would you have tried something else? Looked
for some other over-the-counter way to do it?
Mr. Lee. I do not think we would have, as a company--I
mean, I cannot speak for the company. This was not my trade.
But I do think the fact if there was certain other rules in the
over-the-counter markets that do not exist today, that it is
possible that some of our trading may not have been what it had
and we may not have had that issue that we would have had to
move because of limits.
Senator Levin. So you do not object to the limits that we
have talked about on ICE?
Mr. Lee. In terms of limits, I would have to have some hard
numbers to understated it. I believe there is a fundamental
difference between the swap and the future but in terms of
accountability and all that sort of stuff, absolutely. I think
we should do it. I do not think it causes any administrative
burden to anybody.
Senator Levin. In terms of excessive speculation being
prohibited, do you have a problem with that?
Mr. Lee. No, as long as it is defined.
Senator Levin. Well, if it is defined by the regulator
using all the factors before the regulators--is it defined now
on NYMEX?
Mr. Lee. Postmortem, I have an idea what they think is
excessive speculation. But at the end of the day as a trader,
what I need as a trader is a hard fast number to abide by.
Senator Levin. Is there a hard fast number on NYMEX now?
Mr. Lee. There is only accountability limits. There is
limits during the settlement period, the 3 days going into
settlement period. But otherwise, it is just a matter of if you
are going to get a phone call and they will ask you why.
Senator Levin. Do you have objection to the current
approach on NYMEX relative to excessive speculation?
Mr. Lee. No.
Senator Levin. Even though there is no hard and fast----
Mr. Lee. No. I think as long as the regulators or exchange
personnel is calling and telling you that they think it is
going to cause a market integrity problem, then I think you
need to listen to them. I do not think any trader would have a
problem with that.
Senator Levin. If ICE had that same power? Do you have a
problem with that?
Mr. Lee. If you had it?
Senator Levin. If they enforced it the same way that NYMEX
does.
Mr. Lee. Then that would be no problem, as long as everyone
knows the rules beforehand.
Senator Levin. Do you know the rules beforehand on NYMEX?
Mr. Lee. On NYMEX, yes, you do.
Senator Levin. If ICE enforced the same rules in the same
way as NYMEX, would you have a problem with that?
Mr. Lee. No, I would not.
Senator Levin. Do you think that if we had the same
regulatory system on ICE as we do on NYMEX that you or other
traders would do bilateral deals over-the-counter?
Mr. Lee. I do not think that is going to happen so much as
it would have 10 years ago. Everyone wants to sit in front of a
computer screen now. It is the easiest thing in the world to do
is, to trade on ICE or the NYMEX. To call up a voice broker or
to call up someone directly, I think is such a smaller part of
the market--you can still deal with a voice broker but it still
gets cleared through these other exchanges. But to do a trade
directly with another counter party through the voice brokers
is becoming smaller, and smaller, and smaller by the day. so I
think the main concern would be ICE.
Senator Levin. It is becoming smaller because there is
another place where you can do unregulated trades.
Mr. Lee. Both are unregulated, yes.
Senator Levin. If ICE is put under regulatory regime the
way NYMEX is, would there be a move then away from ICE, in a
sense, to strictly bilateral trades, do you believe?
Mr. Lee. I think that comes down to how strict you make the
limits or reporting. If it ends up creating a big burden on
these speculators in the market, yes, I guess there is a chance
that it could flee there. It could flee to another country. I
am not sure. But as long as they are reasonable, I do not think
you are going to see any flight away from the exchanges.
Senator Levin. I understand that you and Brian Hunter are
working together to set up a new hedge fund called Solengo,\1\
is that correct?
---------------------------------------------------------------------------
\1\ See Exhibit 23, Note 1, which appears in the Appendix on page
998.
---------------------------------------------------------------------------
Mr. Lee. Yes, it is.
Senator Levin. Did I pronounce that correctly?
Mr. Lee. Yes, you did.
Senator Levin. Does that hedge fund intend to engage in
energy trades?
Mr. Lee. Yes, it does.
Senator Levin. In natural gas and oil?
Mr. Lee. Yes, it does.
Senator Levin. Will it engage in large-scale trading?
Mr. Lee. No. We have addressed two of the problems that
happened in the Amaranth situation with our new fund to reduce
that possibility.\2\ And one of those ways is to limit the
amount of capital that can go into any one market. Two, is to
limit the amount of margin you are allowed to put in any one
market so that you do not have a cash situation, as well.
---------------------------------------------------------------------------
\2\ See Exhibit 23, Note 2, which appears in the Appendix on page
998.
---------------------------------------------------------------------------
Senator Levin. So there will not be as large-scale trades
in that hedge fund as there was with Amaranth?
Mr. Lee. No, there will not.
Senator Levin. Will there be significantly smaller trades?
Mr. Lee. Yes, there will.\3\
---------------------------------------------------------------------------
\3\ See Exhibit 23, Note 3, which appears in the Appendix on page
998.
---------------------------------------------------------------------------
Senator Levin. The media has reported that potential
investors in the new hedge fund include investors from the
Middle East. Could you describe those investors in general
terms, particularly this, I do not need the names, but does it
include persons from oil-producing companies that might have an
interest in high U.S. energy prices?
Mr. Lee. To be quite blunt, I have never spoken to any of
those investors. I have not been part of the fundraising
process. I am not sure. I know some of the countries that these
peoples live in and yes, they would have an interest in high
oil prices.\1\ But you must understand, we are talking to
investors from all over the world and not just a few countries
in the Middle East.
---------------------------------------------------------------------------
\1\ See Exhibit 23, Note 4, which appears in the Appendix on page
998.
---------------------------------------------------------------------------
Senator Levin. But some of them are from the Middle East
that would have that interest?
Mr. Lee. That is my understanding.
Senator Levin. Mr. Lee, we thank you. We thank you for your
cooperation with our Subcommittee. We have gotten a lot of data
from Amaranth and it has been helpful to us. You are excused.
Let me just briefly close by saying that it is obvious that
Congress must do more to safeguard U.S. energy markets from
price manipulation and excessive speculation. The first step is
to close that Enron loophole, which never should have been
opened. Closing the loophole would make NYMEX and ICE subject
to the same market oversight, put the cop on the beat in all
U.S. energy markets. It would also level the regulatory playing
field between the two exchanges.
The new CFTC proposal goes a ways in the right direction,
but we have got to close the Enron loophole because that is the
critical step which has to be taken to avoid the excessive
speculation and to prohibit manipulation in advance, not just
to try to catch up with people who engage in it afterwards. So
getting the key information is just not enough if regulators do
not have the power to act on what they see. They have got to be
able to reduce holdings, limit trades to prevent price
manipulation and excessive speculation. And Congress alone can
eliminate the Enron loophole which we created and restore
regulatory authority to all U.S. energy markets.
The second step that we should take in safeguarding U.S.
energy markets is to invigorate the statutory prohibition
against excessive speculation. It must be enforced much more
effectively with better criteria. The CFTC and exchanges need
to police contracts in all months where speculative trading is
affecting prices, not just in contracts about to expire.
The third step is for Congress to provide the funds that
CFTC needs to do its job. Right now the CFTC's entire budget is
$98 million per year to oversee commodity trades that are in
the billions. It is one-eighth of the size of the SEC's budget
of $880 million. The CFTC suffers from antiquated technology,
shrinking staff, and inadequate oversight resources. To obtain
the needed funds, Congress should authorize the CFTC, I
believe, to collect user fees from the market that it oversees
in the same manner as every other Federal financial regulator,
including the SEC.
The CFTC has been starved for resources for too long and
one way or another, whether or not it is from collection of
user fees or in some other authorization and appropriation, the
CFTC must be provided the resources.
What we have seen here is that excessive speculation by a
single hedge fund, Amaranth, altered natural gas prices, caused
wild price swings and really hit consumers with high prices
during 2006.
As I said before, it is one thing if gamblers gamble with
their own money and if speculators gamble with their investors
money. But it is a totally different thing when the U.S. energy
markets are turned into a casino. Everyone is forced then to
walk into that casino and gamble, betting on prices that are
driven by highly aggressive trading practices. Amaranth is not
the only hedge fund which uses large-scale trading in energy
markets in the United States, but we have got to get the
regulatory cop back on the beat in all of our energy markets in
the United States. We have got to give them stronger tools to
stop excessive speculation and prevent price manipulation.
So that is the chore before us. We are grateful to all of
our panels. Our staff has done a terrific job in terms of
putting together, I think, one million documents. I hedged; it
is two million documents. It took, I believe, almost a year to
do that. It is a lot of work. It has never been done before. It
produced a report which we are very proud of because I think it
really illuminates a problem here, which is you have regulation
in one place and not in another. And without regulation in a
much more competitive way, covering all of the bases, in
effect, we are not really regulating it all.
The prices that our consumers pay is higher as a result.
The swings in these prices are greater as a result. And it is
up to Congress now to correct the problems that we have. This
testimony today will hopefully help Congress do exactly that.
We will stand adjourned.
[Whereupon, at 2:16 p.m., the Subcommittee was adjourned.]
EXCESSIVE SPECULATION IN THE NATURAL GAS MARKET
----------
MONDAY, JULY 9, 2007
U.S. Senate,
Permanent Subcommittee on Investigations,
of the Committee on Homeland Security
and Governmental Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 2:35 p.m., in
room SD-342, Dirksen Senate Office Building, Hon. Carl Levin,
Chairman of the Subcommittee, presiding.
Present: Senators Levin and Coleman.
Staff Present: Elise J. Bean, Staff Director and Chief
Counsel; Dan Berkovitz, Counsel; Kate Bittinger, Detailee, GAO;
Ross Kirschner, Counsel; Mary D. Robertson, Chief Clerk; Mark
D. Nelson, Deputy Chief Counsel to the Minority; Jeremy Kress,
Law Clerk; David Weinberg, Law Clerk; Genevieve Citrin, Intern;
and Edmund Zagorin, Intern..
OPENING STATEMENT OF SENATOR LEVIN
Senator Levin. Good afternoon, everybody. At our hearing 2
weeks ago, we laid out the case history of Amaranth Advisors
LLC. A lengthy staff report and testimony from witnesses told
the story of how this large hedge fund dominated the U.S.
natural gas market in 2006, until it collapsed in September
2006.
In 2006, Amaranth traded thousands of natural gas contracts
daily, sometimes traded tens of thousands of contracts in a
single day, and accumulated as many as 100,000 natural gas
contracts for delivery of natural gas in a single month. At
times during the summer, Amaranth held about 40 percent of all
outstanding NYMEX natural gas contracts for the winter of 2006-
2007, including 75 percent of the outstanding futures contracts
to deliver natural gas in November 2006, 60 percent of those
delivering natural gas in January 2007, and 60 percent of those
delivering natural gas in March 2007. We heard at that hearing
how Amaranth's trades and holdings were way beyond the norm and
way beyond the economic capacity of most natural gas traders.
We also heard how Amaranth's trading practices pushed up
prices for winter gas, contributed to price spikes, and socked
consumers with extra costs. One public gas company in Georgia
testified at the last hearing that it paid $18 million more
than it should have for winter gas because of Amaranth's
excessive speculation. An industry association told the
Subcommittee that Amaranth's trading in winter gas likely cost
consumers billions of dollars in extra costs.
The Amaranth hedge fund gambled on the natural gas market.
It lost that gamble, but Amaranth's losses are not our concern.
The real issue is that, by using massive trades to bet on
natural gas prices, Amaranth raised relative 2006 winter prices
for the whole market and caused consumers hedging their winter
gas purchases to pay inflated prices. Those consumers could not
afford to roll the dice and wait to see if prices came down
later. They had to lock in their winter gas prices during the
summer to ensure a stable supply and in order to carefully
budget for the cost. Amaranth upped the cost, which means the
public ultimately paid the price.
Just 1 year ago our Subcommittee released a report showing
how widespread speculation in contracts for the future delivery
of oil was inflating crude oil prices by about $20 per barrel
of oil. The Amaranth case shows how a single hedge fund--backed
up by large amounts of capital--produced an equally dramatic
effect in the natural gas market. At our last hearing, I asked
one of the Amaranth traders why they engaged in such large-
scale trades, and he answered: ``[I]t was simply a matter of
capital. At a hedge fund you are given an amount of capital to
trade with . . . [Y]ou simply have to put that capital to work
one way or the other.''
To Amaranth, it was simply a matter of putting capital to
work. It had billions to invest and decided to invest those
billions in the natural gas market. Amaranth did not produce
natural gas, it did not supply natural gas, it did not use
natural gas. It simply wanted to speculate and hopefully make a
lot of money in the natural gas market. And they took users and
consumers of natural gas along for the ride.
Excessive speculation and price manipulation are not
confined to the natural gas market--they taint many sectors of
the U.S. energy market, from Enron's distortion of electricity
prices, to alleged price manipulation in the propane market, to
alleged price gouging in gasoline. Unfair energy prices are
causing real pain for the people we represent. The causes
demand a remedy when they reflect manipulation or excessive
speculation.
Today's hearing focuses on the role of market regulators to
protect the public from unfair energy prices. The Commodity
Futures Trading Commission (CFTC) is the key cop on the beat
charged with policing U.S. commodity markets to stop price
manipulation and excessive speculation. To carry out its
mission, the CFTC has delegated authority to a number of
exchanges, such as the New York Mercantile Exchange (NYMEX) to
establish rules to monitor trading and prevent manipulation and
excessive speculation. The CFTC has, for example, authorized
regulated exchanges to impose trading limits on individual
traders to prevent speculators from engaging in misconduct.
These regulated exchanges provide the first line of defense
against market misconduct; the CFTC provides the backup.
When it comes to energy, however, Congress has thrown the
CFTC a curve that has made its oversight job much harder. In
2000, at the request of Enron Corporation and others, Congress
amended the key Federal law, the Commodity Exchange Act, to
exempt CFTC oversight of energy and metals commodities traded
on the electronic energy exchanges which are used by large
traders. The result of this so-called ``Enron loophole'' is
that a leading U.S. electronic energy exchange, known as the
Intercontinental Exchange, or ICE, is exempt from the normal
regulatory system that applies to regulated exchanges. That
means, unlike NYMEX, ICE has no authority or obligation to
monitor trading, no authority or obligation to prevent price
manipulation, and no authority or obligation to prevent
excessive speculation from distorting prices. And due to the
Enron loophole, the CFTC has no authority to limit trading on
ICE to prevent price manipulation or excessive speculation.
NYMEX and ICE are the two biggest energy exchanges
operating in the United States today. It makes no sense that
one market is regulated and the other is not. Worse, the
Amaranth case history shows how the operation of an unregulated
market can make it impossible for a regulated market to
effectively prevent price manipulation and excessive
speculation.
That is because the current system allows traders to avoid
restrictions against excessive speculation imposed by NYMEX,
the regulated market, simply by switching their positions to
ICE, the unregulated market. This switch costs a trader
virtually nothing, and enables the trader to engage in
unlimited trading on the unregulated market.
That is exactly what happened in August 2006, when NYMEX
ordered Amaranth to reduce its holdings of the September 2006
NYMEX futures contracts. As this chart, Exhibit 6,\1\ shows,
when NYMEX gave that order on August 8 to Amaranth to reduce
its holdings of the September 2006 futures contracts, on that
date Amaranth held a short position of about 60,000 September
contracts on NYMEX--which is a huge position. Concerned that
Amaranth might engage in last-minute large-scale trading that
could affect the final settlement price of the September
contracts, NYMEX ordered Amaranth to reduce its September
contracts, in an orderly manner, by the end of August.
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\1\ See Exhibit 6 which appears in the Appendix on page 717.
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In response, Amaranth reduced its NYMEX position down to
about 10,000 contracts by the end of August. However, Amaranth
also increased its position on ICE to about 80,000 September
contracts, in trades that took place without NYMEX or CFTC
scrutiny or limitations. In making the switch from NYMEX to
ICE, Amaranth took advantage of the Enron loophole. The end
result was that NYMEX's order did not cause Amaranth to reduce
the size of its holdings. It, instead, led Amaranth to move
from a regulated to an unregulated market.
Now consider the trading that took place on August 29,
2006, the last day of trading allowed on September contracts.
On that date, Amaranth sold tens of thousands of contracts
during the day, primarily on ICE. Despite those sales, the
contract price did not fall much, because Amaranth's trades
were counterbalanced all day by other traders, including
another large hedge fund, Centaurus, that bought the September
contracts that Amaranth was selling. In the last hour of
trading, Amaranth stopped trading on NYMEX in response to the
NYMEX directive that it refrain from trading during the final
30 minutes. Other traders, however, continued buying the
September contract. Without Amaranth's sales to counterbalance
the pressure on the contract price, in the last hour of trading
the final contract price shot up 10 percent.
Almost all of the trades made by Amaranth and Centaurus on
August 29 took place on ICE. Amaranth sold about 16,000
September contracts that day, while Centaurus bought about
12,000--10,000 of which were in the final 45 minutes of
trading. NYMEX rules bar traders from holding more than 1,000
contracts in the last 3 days of trading on a contract. The
torrent of ICE trading during those same 3 days not only
nullified NYMEX's efforts to limit trading near the contract
deadline, but also clearly affected the NYMEX final price. For
Amaranth, because of all the short sales it made, the last-
minute upward spike in the contract price dropped the value of
its holdings by nearly $500 million.
Some of the questions we will examine today are, first, why
any organized exchange with energy trading is exempt from
routine CFTC oversight and regulation. Energy is a vital
commodity to the United States. There is no rational reason to
exempt energy commodities from normal market oversight to
prevent price manipulation and excessive speculation. Second,
we will examine why ICE is treated differently from NYMEX. Both
exchanges affect energy prices. Both exchanges are used by the
same traders whose trades lead to virtually identical energy
prices on both markets. Both exchanges are vulnerable to
misconduct that can inflate energy prices. And as the Amaranth
case history illustrates, regulating one U.S. energy exchange
without regulating the other is a recipe for failure since
speculators restricted on NYMEX can simply move to ICE and
carry out the very same trades.
The flaws in the current regulatory structure for U.S.
energy trades are painfully obvious, but the CFTC has been slow
to call for reform. For years, the CFTC has resisted requesting
authority to monitor energy trades taking place outside the
regulated markets. It has resisted recognizing the role of
unregulated markets in affecting prices on regulated markets
and the impact of excessive speculation in pushing up energy
prices. It has also resisted asking for explicit authority to
prevent price manipulation and excessive speculation on ICE.
Amaranth's excesses may have finally broken down some of
that resistance. In late 2006, after Amaranth collapsed and the
scale of its trading became widely known, the CFTC used its
special call authority to require ICE, for the first time, to
begin turning over daily trading data. Last month, the CFTC
proposed a rule that would require traders on NYMEX, the
regulated exchange, to disclose upon request their holdings on
all exchanges, whether regulated or not. That would enable the
CFTC to get a more complete picture of a trader's relevant
holdings. But unless the CFTC can obtain the same information
from ICE traders that it can from NYMEX traders, and unless ICE
is subject to the same rules prohibiting excessive speculation
as NYMEX, the ultimate effect of the proposed rule may be to
create one more incentive for traders to choose trading on the
unregulated ICE market over the regulated NYMEX market.
While the CFTC's recent innovations will help expand its
access to essential energy trading data, they do not give the
CFTC the authority needed to protect U.S. energy markets from
price manipulation and excessive speculation. The CFTC must not
only obtain the information it needs, it must also be able to
act on that information to protect the public.
Our report presents three bipartisan recommendations to
enable the CFTC to effectively police U.S. energy markets. The
first is to close the Enron loophole by giving the CFTC equal
oversight and regulatory authority over NYMEX and ICE energy
trades. Second, the CFTC needs to strengthen enforcement of the
prohibition against excessive speculation, including by
monitoring speculative trades of contracts in all months, not
just the contracts nearing expiration. Third, Congress needs to
give the CFTC more funds to do its job, including, if
necessary, authorizing the CFTC, like every other U.S.
financial regulator, to collect user fees from the markets it
oversees.
Right now, U.S. energy markets are dangerously vulnerable
to price manipulation and excessive speculation. Regulators
charged with protecting the public are hobbled by laws that
create irrational rules for energy commodities, establish an
uneven regulatory playing field between NYMEX and ICE, and
render market regulators powerless to effectively stop
inappropriate trading on electronic exchanges from affecting
contract prices. We can and we must do more to protect the
public. We must put the cop back on the beat in all U.S. energy
markets.
Let me close by thanking Senator Coleman, the
Subcommittee's Ranking Republican, for his continued support of
these efforts. We also, I am sure, join in thanking his staff
and my staff for their dedication and assistance in this truly
joint effort.
Finally, I would like to thank each of our witnesses
today--the CFTC, NYMEX, and ICE--for their cooperation with the
Subcommittee's investigation. NYMEX and ICE, for instance,
provided extensive data and responded to many Subcommittee
requests in a timely manner. We appreciate their assistance,
and we appreciate the assistance of the CFTC in unraveling the
Amaranth case history.
Senator Coleman.
OPENING STATEMENT OF SENATOR COLEMAN
Senator Coleman. Thank you, Senator Levin.
Today's hearing is the culmination of an extensive
Subcommittee investigation into the impact of excessive
speculation on the natural gas market. These efforts, including
today's hearing, have been bipartisan from their inception, and
I want to thank Chairman Levin and his staff for their hard
work on these important issues.
As Senator Levin noted in his opening statement, the
evidence reviewed by the Subcommittee reveals fundamental flaws
in our current regulatory structure. Section 2(h)(3) of the
Commodity Exchange Act exempts from CFTC oversight and
regulation a massive, and growing, volume of energy
transactions that occurs on electronic, over-the-counter
exchanges. In stark contrast to regulated exchanges, exempt
exchanges have no responsibility to monitor trading, no
responsibility to prevent excessive speculation or price
manipulation, and no responsibility to ensure that trading is
fair and orderly. The end result is a bifurcated regulatory
regime. Futures exchanges like the New York Mercantile
Exchange--NYMEX--are both self-regulated and regulated by the
CFTC; whereas other, increasingly significant segments of our
energy markets--namely, electronic OTC exchanges like the
Intercontinental Exchange (ICE)--are neither self-regulated nor
regulated by the CFTC.
The Amaranth case history illuminates the inadequacy of
this bifurcated regulatory structure and underscores the need
for greater transparency and regulation on electronic OTC
energy exchanges. And the Chairman has gone into the history. I
will just touch upon it briefly.
From early 2006 until its September collapse, Amaranth
traded heavily on both NYMEX, a regulated futures exchange, and
on ICE, an unregulated OTC exchange. As a regulated exchange,
NYMEX was required to monitor Amaranth's trading and prevent
Amaranth's holdings from becoming too large. As an exempted OTC
exchange, ICE shared no such responsibility and made no attempt
to limit Amaranth's speculative trading.
On numerous occasions in 2006, Amaranth exceeded NYMEX
accountability levels and CFTC position limits for natural gas
contracts. In August, NYMEX finally took action and directed
Amaranth to reduce its holdings in the natural gas futures
contracts for September and October. Amaranth complied with
NYMEX's order and, as the Chairman has set forth in the chart
illustrated, by the end of the month, had exited its positions
in the two contracts. But rather than reducing its overall
natural gas holdings, Amaranth simply shifted its trading to
ICE, where accountability levels and position limits do not
apply. Through trades on ICE, Amaranth not only maintained but
actually increased its positions in September and October
natural gas contracts. As a result, NYMEX's instructions did
nothing to reduce Amaranth's size, but simply caused Amaranth
to move its trading from a regulated market to an unregulated
one.
I believe the Amaranth facts demonstrate the need for
greater transparency and regulation on electronic OTC energy
exchanges and raise serious concerns about the ability of the
CFTC to prevent excessive speculation and price manipulation in
our energy markets. Speculative energy traders should not be
able to skirt CFTC oversight by simply shifting their positions
to unregulated electronic energy exchanges. Yet this is exactly
what our current regulatory scheme allows.
Amaranth's collapse revealed a troubling level of high-
risk, speculative trading that occurs on U.S. energy markets.
Indeed, more than 500 energy-related hedge funds deploy a
combined $67 billion in speculative capital to our energy
markets. These traders bring important liquidity and vitality
to the markets in which they invest. At the same time, however,
we must ensure that speculative capital does not overwhelm the
real buyers and sellers, like utilities and industrial users of
natural gas. Again, it is the consumers who are impacted. It is
the public that pays the price, and clearly Amaranth upped the
cost. More than ever before, it is imperative that the CFTC and
other market regulators have the statutory authority and budget
necessary to police our energy markets.
Despite this pressing need for oversight, the CFTC's
ability to conduct market surveillance has been eroded; its
ability to prevent excessive speculation and price manipulation
has been diminished. This is a direct result of the fact that
more and more energy trading takes place on unregulated
electronic over-the-counter exchanges. I am concerned that
incomplete information and inadequate authority make it
difficult, if not impossible, for the CFTC to effectively
monitor and prevent excessive speculation and price
manipulation in our energy markets.
As we move forward, however, we must not overlook the fact
that, like the traders who use them, electronic OTC exchanges
have brought increased competition and liquidity to our energy
markets. Nor should we overlook the fact that, in many cases,
these exchanges offer far greater transparency to both traders
and regulators than do other OTC markets. For example, pursuant
to its ``special call authority,'' the CFTC now receives
significant market disclosures from ICE, including position
reports for all traders of certain natural gas contracts. The
enhanced transparency offered by ICE's comprehensive position
reports is in stark contrast to the opaque off-exchange, OTC
market, where there are not only no position limits but also no
reporting requirements.
Therefore, as we noted in the Minority's Views on the
Subcommittee's Report, Congress must ensure that any proposed
cure is not worse than the disease. If we extend CFTC oversight
and regulation to electronic over-the-counter exchanges, we
must avoid unintended consequences--namely, creating incentives
for the exchanges themselves to move to less regulated
commodities markets offshore. And, again, the concern is the
movement from regulated to unregulated. We must avoid creating
incentives for traders to shift their business to far less
transparent and unregulated OTC markets. This is a real
concern. In fact, according to a recent piece from Dow Jones,
there has been a ``recent groundswell in off-exchange
transactions'' and ``hundreds of little-known, under-the-radar
brokerage shops . . . are fast gaining currency--and
notoriety--in energy-trading strongholds.'' And, again, the
concern is with the lack of transparency, the lack of
regulation. In the end, it is the consumers who are hurt. This
is not about the kind of money being played with and the ethos
and somewhere out in a place that the average person isn't
impacted. We heard in the testimony at the last hearing that
Amaranth's trading had an impact on prices consumers paid. And
so the concern as we move forward is to make sure that we do
not push from regulated to unregulated.
I look forward to hearing the testimony from today's
witnesses, and, again, I thank the Chairman for leading this
important bipartisan effort. Thank you, Mr. Chairman.
Senator Levin. Thank you very much, Senator Coleman.
Let me now welcome our first panel to this afternoon's
hearing: James Newsome, the President and Chief Executive
Officer of the New York Mercantile Exchange (NYMEX); and
Jeffrey Sprecher, Chairman of the Board and Chief Executive
Officer of the Intercontinental Exchange, also known as ICE.
Gentlemen, we appreciate both you being here this
afternoon. We welcome you to the Subcommittee, and, again, we
appreciate the cooperation that you have shown and your staffs
have shown to the Subcommittee.
Pursuant to Rule VI, all witnesses who testify before the
Subcommittee are required to be sworn. At this time I would ask
both of you to please stand and raise your right hand. Do you
swear that the testimony you are about to give before this
Subcommittee will be the truth, the whole truth, and nothing
but the truth, so help you, God?
Mr. Newsome. I do.
Mr. Sprecher. I do.
Senator Levin. We will use the usual timing system today.
About 1 minute before the red light comes on, you will see the
light change from green to yellow, giving you an opportunity to
conclude your remarks. Your written testimony will be printed
in the record in its entirety, and we would ask that you limit
your oral testimony to no more than 10 minutes each.
Let me start with Mr. Newsome. We will have you go first.
TESTIMONY OF JAMES NEWSOME,\1\ PRESIDENT AND CHIEF EXECUTIVE
OFFICER, NEW YORK MERCANTILE EXCHANGE, INC., (NYMEX), NEW YORK,
NEW YORK
Mr. Newsome. Thank you, Mr. Chairman, Mr. Ranking Member. I
am Jim Newsome, President and CEO of the New York Mercantile
Exchange. NYMEX is the world's largest forum for trading and
clearing physical commodity-based futures contracts, including
energy and metals products. NYMEX has been in the business for
more than 135 years and is a federally chartered marketplace.
NYMEX is fully regulated by the CFTC both as a clearing
organization and as a designated contract market, or DCM, which
is the highest and most comprehensive level of regulatory
oversight to which a derivatives trading facility may be
subject under current laws and regulations.
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\1\ The prepared statement of Mr. Newsome appears in the Appendix
on page 152.
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Prior to joining NYMEX, I served as a CFTC Commissioner
and, subsequently, from 2001 to 2004, as chairman. As chairman,
I led the CFTC's implementation of the Commodity Futures
Modernization Act of 2000. The CFMA streamlined and modernized
the regulatory structure of the derivatives industry. It also
provided legal certainty for over-the-counter swap
transactions. Specifically, the CFMA created new exclusions and
exemptions from CFTC regulation for bilateral transactions
between high net worth participants in financial derivatives
and exempt commodity derivatives, such as energy.
As the designated contract market, NYMEX has an affirmative
responsibility to act as a self-regulatory organization and to
monitor and to police activity in its own markets. Thus, a DCM
must monitor trading to prevent manipulation, price distortion,
and disruptions of the delivery or cash settlement process.
Furthermore, to reduce the potential threat of market
manipulation or congestion, the DCM must adopt position limits
or position accountability for a listed contract, where
necessary and appropriate.
The principal tool that is used by DCMs to monitor trading
for purposes of market integrity is the large trader reporting
system. For energy contracts, the reporting position levels are
distinct for each contract listed by the exchange for trading.
The levels are set by NYMEX and are specified by rule
amendments that are then submitted to the CFTC, following
consultation and coordination with the CFTC staff.
The CFMA also permitted bilateral trading on energy
electronic platforms. Under CFTC rules, these electronic
trading platforms are called ``exempt commercial markets'' and
are subject only to the CFTC's anti-fraud and anti-manipulation
authority. Unlike the DCM, the exempt commercial markets are
completely unregulated by the CFTC and, thus, have no self-
regulatory obligations to monitor its own markets.
A series of significant changes have occurred in the
natural gas market since the passage of the CFMA, including
advances in trading technology, such that NYMEX, the regulated
DCM, and ICE, an unregulated ECM, have become highly linked
trading venues. As a result of these changes, which could not
have been reasonably predicted only a few short years ago, the
current statutory structure, in my opinion, no longer works for
certain markets now operating as ECMs. Specifically, the
regulatory disparity between the NYMEX and ICE, which are
functionally equivalent, has created serious challenges for the
CFTC as well as for NYMEX in its capacity as an SRO.
In August 2006, NYMEX proactively took steps to maintain
the integrity of its markets by ordering Amaranth to reduce its
open positions in the natural gas futures contract. However, as
you pointed out, Mr. Chairman, Amaranth then increased its
positions on the unregulated and nontransparent ICE electronic
trading platform. Because the ICE and NYMEX trading venues for
natural gas are tightly linked and highly interactive with each
other, they are in essence components of a broader natural gas
derivatives market. Therefore, Amaranth's response to NYMEX's
regulatory directive did not reduce Amaranth's overall market
risk. Furthermore, the integrity of NYMEX markets continued to
be affected by and exposed to Amaranth's outsize positions in
the natural gas market. Finally, NYMEX had no means to monitor
Amaranth's positions on ICE or to take steps to have Amaranth
reduce its participation in that trading venue.
As in the past, I do not believe that the case has been
made, and thus do not support regulation of derivatives
transactions that are individually negotiated and executed off-
exchange in the traditional bilateral OTC market. On the other
hand, based upon recent experiences, I do believe that ECMs
such as ICE that function more like a traditional exchange and
trade products that are linked to established exchanges should
be subject to regulation of the CFTC.
Consequently, legislative change may be necessary to
address the real public interest concerns created by the
current structure of the natural gas markets and the potential
for systemic financial risk.
I will turn to the three specific recommendations, Mr.
Chairman, included in the report and respond to each.
First, the report recommends the elimination of the
exemption from regulatory oversight for electronic exchanges
that host trading and exempt commodities such as energy. It is
NYMEX's view that these changes in the natural gas market
structure provide clear support for legislative change. These
developments include the exchange-like aggregation of financial
risk in OTC energy products; the reality of a broader linked
market that currently include the regulated and the unregulated
trading venues; the contribution to or creation of price
discovery for natural gas prices in the unregulated trading
venues; and the ripple or spillover effects of activity on the
unregulated venue onto the regulated trading venue, among
others.
NYMEX believes that these changes in the natural gas market
trigger a series of fundamental public policy and public
interest concerns that necessitate appropriate oversight. The
proper legislative response is a judgment for this Subcommittee
and for Congress to make. However, where a market does manifest
the characteristics just mentioned, NYMEX believes that a
comparable regulatory level to that of a DCM would be
appropriate.
Upon triggering the public interest concerns noted, an
electronic trading facility becomes sufficiently comparable to
a traditional organized exchange that CFTC oversight and
regulation becomes appropriate. However, it is clear to NYMEX
that these public policy issues necessitate mandated large
trader reporting and position limits and position
accountability requirements for ECMs that are highly linked to
and functionally equivalent with regulated DCMs. Such ECMs
should also be assigned SRO duties to police their own markets
as a front line. NYMEX believes strongly that such regulations
are necessary and would not negatively impact the core price
discovery and hedging functions provided currently by
derivatives markets.
Given the complexity of derivatives markets, it can be
difficult to state with real precision when speculation may be
deemed ``excessive.'' Moreover, speculators do provide
liquidity and other positive effects to derivatives markets.
NYMEX agrees with the view expressed in the Minority Staff
opinion that it is not necessary to make a final determination
about whether Amaranth's trading was excessively speculative in
order to conclude that legislative change in the form of
greater authority for the CFTC may be necessary and
appropriate.
On the second recommendation, given NYMEX's conclusion that
NYMEX and ICE natural gas trading platforms essentially form a
broader linked market, NYMEX believes that the CFTC should be
given additional legal authority and should use such
authorization to monitor aggregate positions on both ICE and
NYMEX.
The CFTC began to receive certain data from ICE commencing
last fall through use of the CFTC's ``special call''
procedures. These procedures, however, only commenced several
months after the Amaranth meltdown had occurred, and thus long
after any market impact resulting from Amaranth's trading.
As to the final recommendation, the report stated that the
CFTC budget should be increased, and I express that I may be a
bit biased on this as a former chairman. But it should be
increased to provide staff and technology needed to monitor,
integrate, and analyze real-time transactional data from all
U.S. commodity exchanges, including NYMEX and ICE. NYMEX agrees
with this assessment and supports an expanded budget for the
CFTC so that it may properly carry out its regulatory mission.
However, the report went on to recommend that necessary funding
``should be obtained from user fees imposed on commodity
markets.'' NYMEX respectfully disagrees with this component of
the recommendation and notes that Congress has previously
rejected such a user or transaction tax as bad public policy.
The user fee or transaction tax being recommended by the
Subcommittee would not be imposed on foreign boards of trade
that are currently offering direct electronic access to their
markets to market participants based in the United States.
Additionally, the U.S. markets already impose a user fee on
contracts to fund the National Futures Association, which is
the industry-wide self-regulatory organization that performs a
function on behalf of the industry that the CFTC would have to
perform if it was not funded by the markets users itself.
Mr. Chairman, Mr. Ranking Member, I appreciate the
opportunity to share the viewpoint of the New York Mercantile
Exchange with you today, and I look forward to questions after
my colleague's testimony.
Senator Levin. Thank you so much, Mr. Newsome. Mr.
Sprecher.
TESTIMONY OF JEFFREY C. SPRECHER,\1\ CHAIRMAN AND CHIEF
EXECUTIVE OFFICER, INTERCONTINENTAL EXCHANGE, INC. (ICE),
ATLANTA, GEORGIA
Mr. Sprecher. Well, thank you, Mr. Chairman, Senator
Coleman, Subcommittee Members, and staff members. My name is
Jeff Sprecher, and I am the Chairman and Chief Executive
Officer of Intercontinental Exchange, and as the Chairman
mentioned, we are also known as ``ICE.''
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\1\ The prepared statement of Mr. Sprecher appears in the Appendix
on page 167.
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I very much appreciate the opportunity to appear before you
today to share with you our views on the regulation of the
natural gas trading markets and the recent report of the
Permanent Subcommittee on Investigations regarding the collapse
of Amaranth and the related events in the markets. ICE was
pleased to cooperate with the Subcommittee and the staff in
providing the voluminous trading data and other market
information that staff requested in preparing the report, and
we commend the Subcommittee and staff for the thoroughness and
diligence that they exhibited in the report's preparation. It
is our hope that the report, together with the views of the
various persons who have been invited to testify at these
hearings, will serve to enhance the integrity of the energy
markets and assist Congress in a better understanding of how
these markets serve the interests of a broader marketplace.
ICE operates a leading global commodity marketplace,
comprising both futures and over-the-counter markets, across
agricultural and energy commodities, foreign exchange and
equity indices. ICE owns and operates two regulated futures
exchanges: ICE Futures, a London-based futures exchange
overseen by the U.K. Financial Services Authority, and the
Board of Trade of the City of New York, also known as the
``NYBOT,'' which is a futures exchange regulated by the
Commodity Futures Trading Commission.
ICE's electronic marketplace for OTC energy contracts
serves customers in Asia, Europe and the United States and is
operated under the Commodity Exchange Act as a category of
marketplace known as an ECM. As an ECM, these markets are
subject to the jurisdiction of the CFTC and to regulations of
the CFTC imposing recordkeeping, reporting, and other
requirements. And in the past year, ICE has established a daily
position reporting program for the CFTC that we continue to
enhance and support.
ICE has always been and continues to be a strong proponent
of open and competitive markets in energy commodities and the
related derivatives and of regulatory oversight of those
markets. As an operator of global futures and over-the-counter
markets and as a publicly traded company, we strive to ensure
the utmost confidence in the integrity in our marketplace and
in the soundness of the trading business model. To that end, we
have continually worked with the CFTC and other regulatory
agencies in the United States and outside the United States in
order to ensure that they have access to relevant information
available to ICE regarding trading activity in our markets. We
will continue to work with relevant agencies in the future.
I want to take this opportunity to provide you with
important background on the structure, operation, and
regulatory status of ICE and to share with you our thoughts on
the regulation of the natural gas markets and the PSI Report. I
want to clarify a number of misunderstandings and inaccuracies
in the report, which I will discuss in more detail.
First, ICE does not operate--nor have we ever operated--
pursuant to an ``Enron loophole'' under the CEA. Enron Online,
the electronic marketplace operated by Enron pursuant to a
separate provision of the CEA, has nothing whatsoever to do
with the operations of ICE. That provision was available to
Enron because Enron Online was a ``one to many'' marketplace in
which Enron was both a market participant as well as the
market. Parties traded with a single counterparty--Enron. In
stark contrast, ICE offers a transparent ``many-to-many''
electronic marketplace, where buyers and sellers of OTC energy
contracts can transact in a fair and efficient marketplace,
where no distinction is made between one market participant and
another, and where the best executable price is available to
any participant in the market, no matter how large or how
small. It is simply erroneous and misleading to use the label
``Enron loophole'' to characterize ICE as somehow being
connected to the Enron debacle.
Second, there are a number of fundamental distinctions that
need to be drawn between the OTC markets in general and ICE's
market in particular, on the one hand, and the futures markets,
on the other hand, including the distinction between ICE's
cash-settled natural gas swaps and physically delivered natural
gas futures that are traded on the New York Mercantile
Exchange. An understanding of these distinctions is essential
to any analysis of potential regulatory changes, particularly
the need for position limits, which the CFTC itself has said
are unnecessary as they are designed to prevent squeezes on
physically delivered products. Indeed, while the report
criticizes the absence of position limits on ICE natural gas
swaps, it completely ignores the fact that NYMEX's cash-settled
natural gas swap--which is identical to the ICE contract and
which was also traded by Amaranth--was not subject to position
limits. If there is to be a ``level playing field,'' it should
be between comparable contracts.
Third, ICE is not ``unregulated'' nor is it a ``dark''
market. While ICE is not a ``designated contract market,'' it
is already subject to the oversight of the CFTC and to CFTC
regulatory requirements, including reporting requirements.
Fourth, under current law, the CFTC and NYMEX have the
legal authority and the ability to obtain any available
information regarding trading by market participants on ICE,
and no additional legislation or regulation is needed to fill
this perceived ``gap'' in the system.
Finally, the ability of Amaranth to trade on ICE in no way
``caused'' its collapse, any more than its ability to trade on
NYMEX did so.
ICE strongly supports several recommendations of the PSI
Report, particularly the proposed increase in the CFTC's budget
and the enhancement of its access to trading information. We
also support the advancement of regulatory certainty by
eliminating the ``Enron loophole'' although, as I pointed out,
that provision has nothing to do with ICE. We do not believe
that a complete overhaul of the current regulatory structure is
either warranted or advisable. Moreover, any legislative or
regulatory changes that are made need to reflect the nature of
ICE and its market, the significant differences between ICE and
the many other venues for trading OTC in the United States and
outside the United States that exist today.
Thank you very much.
Senator Levin. Thank you very much, Mr. Sprecher.
Let me ask both of you, do you agree with the finding of
our report that prices on one exchange affect prices on the
other exchange? Do you agree with that, Mr. Newsome?
Mr. Newsome. I do agree with that, Mr. Chairman.
Senator Levin. Mr. Sprecher.
Mr. Sprecher. I believe they are very related, yes.
Senator Levin. Now, the key Federal law in this area, the
Commodity Exchange Act, directs the CFTC to limit trading to
prevent excessive speculation. Would you both agree that
excessive speculation can cause sudden unreasonable or
unwarranted price changes that affect U.S. energy prices paid
by consumers? Dr. Newsome.
Mr. Newsome. I think trading by any market participant in
an individual contract has the ability to move prices.
Certainly if someone is concentrated in one position, it can
move the market in that direction. But that is how markets
operate.
Senator Levin. Do you think we should have prohibitions on
excessive speculation the way the law--should we keep that
prohibition?
Mr. Newsome. I think in the case of NYMEX and the CFTC
rules, we currently have rules to limit excessive speculation.
Senator Levin. And is the reason for that rule that
excessive speculation, more than just normal speculation, can
cause large unreasonable or unwarranted price changes?
Mr. Newsome. Yes. I think if someone is allowed to have a
massive position without any kind of oversight, that adds
strength to that position and that market, and definitely once
they have that strength, then they can push other market
participants around.
Senator Levin. All right. Now, Mr. Sprecher, do you
disagree with any of that?
Mr. Sprecher. No, I do not. I will make the footnote that I
think speculation itself is a very important particular of a
market, a functioning market. But anything in excess, whether
it is speculation or hedging, is something that we all need to
be aware of and make sure that we try to prohibit.
Senator Levin. Now, as we have both talked about and you
both have spoken about, NYMEX told Amaranth in August 2006 to
reduce their position in NYMEX futures contracts to deliver
natural gas in September. Amaranth at that time had 60,000
NYMEX September futures contracts, or 45 percent of the
outstanding contracts for that month.
In response to the NYMEX order, Amaranth reduced its
holdings on NYMEX to 10,000 contracts but increased its ICE
holdings, as Exhibit 6 shows,\1\ to about 80,000 September
contracts for a grand total of 90,000 September contracts.
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\1\ See Exhibit 6 which appears in the Appendix on page 717.
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Now, at NYMEX, was it your opinion that this was a
necessary action on your part in order to either prevent
excessive speculation or to overcome one or the other either?
Mr. Newsome. Mr. Chairman, we were concerned that the size
of their position could be very disruptive to our markets. We
were concerned with that size and their ability to push markets
in their direction. Therefore, we chose to ask them to start
unwinding positions.
Senator Levin. Now, would you both agree--and I will ask
both of you this--that Amaranth's ability to shift its position
from NYMEX to ICE meant that Amaranth could still conduct
large-scale trading right up to the final settlement of the
NYMEX contract?
Mr. Newsome. Yes, sir. They have the ability to do so.
Senator Levin. Mr. Sprecher.
Mr. Sprecher. Yes, and I actually think that it was an
important function of the market, that when Amaranth was asked
to liquidate a large position that has never been explained how
it was allowed to be accumulated well above these
accountability levels, shifted its position in the over-the-
counter market and then orderly liquidated it, which I think
ultimately was probably better for the market than a single-day
liquidation on a single exchange.
Senator Levin. I think it was both--it was ordered to be an
orderly reduction, as I remember the NYMEX order. Is that
correct?
Mr. Newsome. That is correct.
Senator Levin. Now, under the current rules, there was no
prohibition on Amaranth's shifting its position to ICE. Is that
correct under the current rules?
Mr. Newsome. That is correct.
Senator Levin. Now, let me ask you, Dr. Newsome, was the
CFTC informed in August that NYMEX was going to order Amaranth
to reduce its position?
Mr. Newsome. We recognized the situation, became
uncomfortable with that; we took action with Amaranth, made the
Commission aware of the action that we were taking. Yes, sir.
Senator Levin. Did the CFTC support your determination that
Amaranth should reduce its position?
Mr. Newsome. The CFTC seemed very satisfied in the action
that we were taking with regard to Amaranth and the reduction
of positions.
Senator Levin. Is ICE a competitor of yours, Dr. Newsome?
Mr. Newsome. A very good competitors of ours, Mr. Chairman.
Senator Levin. Does that mean also a strong competitor?
Mr. Newsome. Yes, absolutely.
Senator Levin. Do you believe it should be subject to the
same rules that you are?
Mr. Newsome. I do so.
Senator Levin. Why?
Mr. Newsome. Because I think--a couple of reasons. I think
the markets have changed very rapidly since the passage of the
CFMA, and no one could have envisioned how rapidly the change
would take place.
What, in a nutshell, happened is that you had the ECMs, as
stated in the document, and OTC markets have also at the same
time become more standardized over time versus being
individually negotiated as they traditionally have been.
So I think the fact that you have got an exchange-type
entity that is aggregating risk, aggregating positions thereby
aggregating risk, versus that risk being spread among
participants in a bilaterally negotiated marketplace, have led
to changes that I think require oversight just because of the
aggregation of risk and the opportunity for that risk to be
systemic.
Senator Levin. Now, let me ask you, Mr. Sprecher, did you
know in August 2006 that Amaranth had been asked by NYMEX to
reduce its position in the September futures contract?
Mr. Sprecher. We did not.
Senator Levin. If you had known of the NYMEX order, would
it have affected your actions in any way?
Mr. Sprecher. Most likely, frankly, not, because we, as you
know, don't have any legislative authority to take action to
prevent people from--or to order people to liquidate on our
platform.
Senator Levin. Nor do you want it.
Mr. Sprecher. No, that is not----
Senator Levin. Do you want legislative authority?
Mr. Sprecher. I think there are things that we could do,
yes, that would give us a better view.
Senator Levin. Not just a better view, but would you want
the same responsibility in terms of position limits and in
terms of the accountability levels that NYMEX has?
Mr. Sprecher. Potentially, if we were given the
commensurate ability to enforce those by doing the kinds of
things that NYMEX does--ordering people to liquidate, taking
action to fine people, to basically throw people off your
exchange, which I do not have the ability to do right now.
Senator Levin. So you would welcome that authority?
Mr. Sprecher. Yes, if Congress believes that we are the
appropriate people to take it on. I think also one could argue
that the CFTC could get a complete view of the market and take
on those responsibilities in a manner further from what it is
doing today.
Senator Levin. So you do not have any objection to Congress
giving you the same authority that NYMEX has? You have no
objection to Congress telling CFTC to give you that same
authority?
Mr. Sprecher. I don't, if I could give one footnote. In
saying that, we are against and I think it would be a mistake
to say we should be a DCM, or designated contract market. And
the reason is I don't think retail customers should be trading
these large commercial contracts. I don't think that Congress
should say these are the sources of price discovery. These are
large markets. Today on ICE you have to have $100 million in
assets to trade. I think bringing that other element into these
markets would be a mistake.
That being said, the core principles that govern DCMs and
futures exchanges, which we operate in futures exchanges as
well, I think could be adapted to the OTC markets. And we have
proposed some legislation that your staff is aware of to try to
bring it along, if you will, and serve this intermediary role
between these dark pools and the regulated futures exchanges.
Senator Levin. Well, let me be very clear. CFTC has told
NYMEX that they are to take action to prevent excessive
speculation and manipulation. Do you have any objection to
NYMEX being authorized and directed by Congress to give you
that same responsibility?
Mr. Sprecher. No.
Senator Levin. Senator Coleman.
Senator Coleman. Thank you, Mr. Chairman.
Just sort of stepping back historically, looking at
Amaranth I presume the concerns that arose in August did not
just crop up at that point in time. Did Amaranth have, by the
way, preset accountability levels and position limits?
Mr. Newsome. Yes. Everyone that trades on the exchange has
accountability levels and limits.
Senator Coleman. And do you know how many times Amaranth
before August 2006, they exceeded the accountability limits and
position limits?
Mr. Newsome. No, I do not have the direct answer to that
today, Senator, but I would be glad to----
Senator Coleman. But it would be fair to say that they had
prior to August 2006 exceeded the accountability and position
limits.
Mr. Newsome. Correct.
Senator Coleman. At the time then that you moved to have
Amaranth limit its positions--and you said CFTC, they thought
that was a positive move--do you have any doubt in your mind
that Amaranth had the ability or were you aware that Amaranth
was simply able to move over to maintain its positions with
ICE?
Mr. Newsome. Not only did we know that they had the ability
to do so, they actually told us that they were going to do so
when we were asking them to liquidate their positions.
Senator Coleman. So what is your reaction to that? If you
have a concern that they are overextended, you want them to
limit their position, they are just going to move over, was
there any reaction to that? Was there any call to anybody to
say, ``Hey, this does not make sense''?
Mr. Newsome. Well, we reached out to the CFTC to make them
aware of the actions that we were taking, and we had no other
opportunity or authority to do anything beyond that.
Senator Coleman. What do you think the CFTC should have
done, knowing that they simply are going to move over? You are
issuing an order to--you have concerns, legitimate concerns.
You give a directive to limit your positions. You now know that
they are going to say, that is fine, we are just going across
the street. What should CFTC have done at that time?
Mr. Newsome. Well, I do not think that the CFTC currently
has the authority to impose any position limits on ICE. So I
think the CFTC became aware of it, and I think that is what has
led us to this hearing today to talk about making the
regulatory changes that would give CFTC that authority.
Senator Coleman. Can we talk about playing it out then
beyond ICE? I presume there are other markets out there; there
are foreign markets out there. One of the concerns--I will
touch on user fees in a second--is that if we take a certain
action to shine the light on, we move from the NYMEX to ICE,
there are other markets out there. Is there a concern that we
are simply shifting, that we are not--let me back it up. Are we
able to get our arms around this issue? Are we able to provide
consumers and others with some sense of confidence that there
really is transparency and accountability? Are we simply in a
position where folks are going to shift over to another market?
Mr. Newsome and then Mr. Sprecher.
Mr. Newsome. I think certainly that could be a potential
risk, but I think when we focus strictly on the natural gas
market, which we are primarily talking about, in talking to
major market participants they estimate that roughly 90 percent
of the over-the-counter gas markets are now cleared. And in
order to do that trading, today you come to ICE or you come to
NYMEX. You have the opportunity to do either.
First of all, there are no other energy exchanges that
would even come close to the kind of volume and expertise at
either ICE or NYMEX, none that have the opportunity to clear
these over-the-counter trades. So I think while it is a risk, I
think the likelihood of that happening is very low.
Senator Coleman. Mr. Sprecher.
Mr. Sprecher. I respectfully disagree. In fact, I think in
the report there is actually an episode that is dialogued where
Amaranth called directly one of the other major funds and
sought to move that position directly between market
participants. And it was only after they could not successfully
find the market participant did they come to ICE. And I am not
sure any of us here knows what other positions they may have
taken in the marketplace because it is as a result largely
because ICE has recordkeeping requirements that we can see what
happened on ICE. But we really don't know outside of ICE what
happened. We have some anecdotal information as a result of
somebody saving call records or other things.
There are 75 execution venues other than ICE in North
America. Many of these are public companies, multi-billion-
dollar public companies, euphemistically called ``voice
brokers,'' but generally using technology, not the telephone.
And I think you have correctly pointed out we want to make sure
if we move to more accountability, we move the entire
marketplace and we do it in a method that will keep it in the
United States and not move it offshore.
Senator Coleman. And I want to get my arms around this. Mr.
Sprecher, I am troubled by the fact that you have a regulatory
agency that directs Amaranth to limit positions and that we
know and they know that as they are saying that, literally they
are moving to ICE----
Mr. Sprecher. Right
Senator Coleman [continuing]. In contravention of whatever
the hopes, the desires were in terms of dealing with this
regulatory issue. That troubles me greatly.
Mr. Sprecher. It does me, too, by the way.
Senator Coleman. So the question is how do we get our arms
around it. One of the other issues that has come to us was user
fees, and, Mr. Newsome, you have expressed concern. I have
talked to others who have expressed that concern. The question
with user fees, I presume, is in this global market, financial
markets that we have, that we drive people to other markets. We
had a panel at the first hearing in which a number of
professors said that we are not going to drive people to other
markets, that they want the accountability, they want the
transparency. And so my sense was that they would have
concluded that user fees would not be problematic if they were
being used for greater enforcement.
Could you respond to that, both Mr. Sprecher and Dr.
Newsome, on that issue, on the impact of user fees? Dr.
Newsome.
Mr. Newsome. I think the impact of user fees could be
relatively widespread. Again, I think a lot of people miss the
point that a user fee is already charged to customers trading
futures contracts on designated contract markets, and those
fees go to fund the National Futures Association, which does a
fantastic job of recordkeeping, a lot of enforcement cases that
the CFTC would have to do, would have to handle if it was not
self-funded by the industry. So this would be a double tax that
we would be asking the market users again to pay to fund
increases in the CFTC.
Senator Coleman. Mr. Sprecher.
Mr. Sprecher. I probably differ with most of the people in
my industry in that I don't think it is such a bad idea. But I
am sympathetic to the issue that is raised, which is how do you
tax foreign entities. About half of ICE's revenue comes from
outside the United States in energy trading, and there is no
question that increasingly these 500 hedge funds that you are
talking about are not necessarily American funds. And we are
seeing a large shift in energy trading moving to London, which
seems to be the city of choice. And so the issue is do we
create an unlevel playing field by charging some--just simply
U.S. customers. If we could solve that issue, then I think it
is a good idea. If you cannot solve that issue, then I think it
is a bad idea.
Senator Coleman. We faced the same issue, by the way, with
IPOs, I think 25 being done in London markets. Again, I am
trying to figure out where we go with this. There is a problem.
I do not want to create a bigger problem in terms of what we
do.
Could you give us some direction as to how far can we go in
ensuring greater transparency and accountability at the same
time without moving markets overseas?
Mr. Sprecher. Sure. I think the one benefit we all have as
the underpinning of these markets is that they work best when
people have confidence in them, and confidence usually comes by
having government oversight. So I do not believe that they
necessarily will move just because there is more oversight. And
as has been widely talked about here, ICE is now providing
every trade electronically to the CFTC so that they can see
what is going on in our markets. I think we could try to bring
the rest of the markets into that venue, and I think the CFTC
would have a unique view of what is going on in the market.
I do think that, really largely as a result of ICE, there
has been a greater interplay between the CFTC and the FSA in
London for information sharing. It is not that the London
regulators don't have the same concern about transparent
markets and what is going on under their jurisdiction.
So I do think we can evolve to a regulatory umbrella of the
major economic centers and bring more transparency and
information sharing in. Then with a full view of things the
CFTC sees the next Amaranth, I think they are really the
uniquely positioned entity to have that view, which means de
facto they need more staff, they need more funding.
Frankly, ICE trades over 1,000 OTC swap markets. The CFTC
right now is only looking at something like 960, 970 futures
markets. Just bringing ICE into that purview will double the
size of the view that they will have to have. So, clearly, they
are going to need more funding.
Senator Coleman. Mr. Chairman, are we going to have a
second round?
Senator Levin. Of course.
Senator Coleman. My time is up now, but I look forward to
another round of questions. Thank you, Mr. Chairman.
Senator Levin. Thank you.
Well, first of all, I am delighted, Mr. Sprecher, that ICE
is going to support Congress giving the CFTC the same authority
to impose position limits on the ICE exchange in the same way
that CFTC imposes them now on NYMEX. It comes as very good
news, I believe, for consumers. I do not think ICE has ever
taken that position before. I do not think NYMEX has ever heard
ICE take that position before. But we are delighted to hear
that.
There was a distinction which was drawn by ICE until now,
and maybe still is drawn, between a contract which is
financially settled and a contract which is physically
settled--the contracts on NYMEX being contracts which
presumably are physically settled until they are mainly
financially settled. As I understand it--and, Dr. Newsome, give
us some statistics on this--the vast majority, perhaps--what
percent?--99 percent of the contracts on NYMEX are financially
settled, would you say?
Mr. Newsome. Yes, 99.9 percent.
Senator Levin. All right. So that there is a distinction
without a difference. The other attributes are pretty much the
same. And as you said, Dr. Newsome, they are functionally
equivalent.
I just wonder whether or not ICE has ever discussed with
the CFTC what you have said here today.
Mr. Sprecher. Let me be clear in making my case to you. I
believe that ICE and NYMEX can take more accountability and
have accountability limits. I don't think position limits for
the swaps and derivatives market is a good idea because,
really, position limits are in place to prevent squeezes of
physical products--the old play that trades had years ago to
try to squeeze a market going to delivery. There is no ability
to do that on cash-settled markets, and as NYMEX in its own
testimony says, on its cash-settled products it does not have
position limits.
But what it does have and what I do think would be valid is
some accountability for large traders. And I think just as Dr.
Newsome has pointed out the problem with him seeing the whole
market, ICE will also not be able to see the whole market. And
I think that has to be aggregated to a senior view of most
likely the CFTC so that somebody can see the market.
Senator Levin. Would you respond to that, Dr. Newsome, that
distinction?
Mr. Newsome. Well, I think it is very critical for
someone--the CFTC being the appropriate entity--to see the
entire marketplace. I am very confident in NYMEX's ability to
manage risk of what we can see, but, again, you can only manage
what you can see. And there are a number of pieces of the pie,
and the two pieces of the pie in which risk becomes aggregated
are NYMEX and the Intercontinental Exchange.
So I think to me it is common sense that somebody should be
able to see what is going on in both of the markets so that we
can manage potential systemic risk.
Senator Levin. Would you comment on Mr. Sprecher's
distinction relative to the position limits between the two
exchanges?
Mr. Newsome. Well, we have hard limits on our physical
contracts, and I want to make it clear that because we choose
to trade the physical contracts, we know that there is a higher
level of regulation that comes with that, because even though
less than one-tenth of 1 percent gets delivered upon, it is the
threat of that physical delivery that we use as a tool to keep
people honest in the marketplace.
In the past, our financial contracts, the position limits
were all aggregated into one, both the physical and the
financial. We went to the CFTC last fall and asked them to
allow us to disaggregate from hard position limits. So now we
have the position accountability on our financial contracts,
but the CFTC view was that it was very important for us to have
that accountability because of the ability to see what was
going on in our underlying physical contract. So they felt
comfortable with the accountability because we could see the
physical on our own market.
Senator Levin. Is the accountability level what triggers
your prohibition against excessive speculation and
manipulation? Is that what triggers it, that specific mandate
to you?
Mr. Newsome. Well, either one can trigger what we consider
to be excessive speculation. There is a bit more flexibility
given to the exchange on accountability levels to determine
when they develop discomfort and when they don't. The hard
limits are hard limits, and they are what they are.
Senator Levin. But you go after excessive speculation or
you are required to go after excessive speculation, at least in
part because of those accountability levels. Is that correct?
Mr. Newsome. Correct.
Senator Levin. And you are willing to undertake that, Mr.
Sprecher?
Mr. Sprecher. Yes. Let me just say, I am not sure--with
great respect to Dr. Newsome, I am not sure the current system,
however, is working. So to just replicate it does not sound
like a good idea.
Senator Levin. Well, whether the current system is working
or whether it is going to be improved, you are willing to
operate under that same system relative to accountability
levels.
Mr. Sprecher. Certainly, and just let me point out----
Senator Levin. That is new.
Mr. Sprecher. Well, no, because what----
Senator Levin. You have not until now, have you? Are you
bound by those accountability levels now?
Mr. Sprecher. The debate that has always been presented to
us is should these OTC swaps markets become designated contract
markets; in other words, contract markets where retail
investors can trade and where the government has specifically
said they are designated as the source of price discovery. I
really don't think these OTC markets, which are major dealers
interchanging risk and hedging risk, is a place that we should
say is the designated source of price discovery. Dr. Newsome's
market really is that market. It is the price of natural gas
that we read about in the paper, that we have all come to rely
on, and I don't think that that should change, and that has
been a consistent position.
Senator Levin. And that your swaps ultimately rely upon,
right?
Mr. Sprecher. They do. Absolutely.
Senator Levin. All right. Let me get to the specific
question. Right now, the NYMEX, as a result of its mandate from
CFTC, must go after excessive speculation under one of two
requirements. Do you have any problem being required by CFTC to
go after excessive speculation?
Mr. Sprecher. No.
Senator Levin. All right. That would be new. That kind of
requirement would be new, would it not?
Mr. Sprecher. It would be new.
Senator Levin. All right.
Mr. Sprecher. And what we are talking about, I think, is a
common ground on how to bring these OTC markets into some
accountability.
Senator Levin. All right. That is not only new, it is
important new. And I think we are making progress here.
Mr. Sprecher. It took an Amaranth.
Senator Levin. It took a long investigation, and maybe
Amaranth, in order to get to this point, but at least we are
making some progress. And we will have CFTC in front of us in a
few minutes, and I hope they are willing to accept the
responsibility now to make recommendations for changes in law
because they are long overdue and we have paid a real heavy
price for the failure of our law to have this mandate of the
CFTC upon ICE.
There is a reference that you have made to the Enron
loophole, and I want to just clarify that because we have a
different definition of the ``Enron loophole,'' and let me
state it for the record.
How ICE defines the ``Enron loophole'' is one part of the
Commodity Exchange Act that applied to Enron Online, a type of
exchange called, as you put it, a ``one-to-many'' exchange,
because all traders have to trade through one party--Enron--in
the case of the Enron Online Exchange. And that is the way you
define the ``Enron loophole.''
But we define it in a broader way, to include all of the
provisions that others got included in the Commodity Futures
Modernization Act to exempt energy and metals commodity trading
from normal CFTC oversight. Those changes in the law created
exemptions and exclusions that made it much tougher to police
energy markets. And for this hearing, and for my opening
statement, that is the way I used the Enron loophole, and I
just want to get that out for the record, and I don't think you
would disagree that there is a difference of definition here.
Mr. Sprecher. I absolutely agree
Senator Levin. Your definition is a narrower one than mine.
Mr. Sprecher. I agree. But we should for the record say
that my understanding is Enron had absolutely no oversight by
the CFTC; whereas ICE does and, in fact, pursuant to the
``special calls,'' is now actually providing daily records to
the CFTC.
Senator Levin. Records, but still no authority to direct.
Mr. Sprecher. Correct.
Senator Levin. The way NYMEX has, not only the authority
but the responsibility to direct in order to prevent excessive
speculation and manipulation.
As I understand the question of swaps, there are
accountability levels for NYMEX swaps. Is that correct, Dr.
Newsome?
Mr. Newsome. That is correct for back month positions
Senator Levin. And the accountability levels are triggers
for your reviews, and if a trade exceeds the accountability,
NYMEX could order that trader to reduce its position in that
contract. Is that correct?
Mr. Newsome. That is correct.
Senator Levin. All right. And are the NYMEX natural gas
swaps any different from the ICE natural gas swaps?
Mr. Newsome. I think they are virtually the same.
Senator Levin. All right. I think you have already answered
this question functionally, but let me ask you again. In your
written testimony, Dr. Newsome, you said that the NYMEX price
of a futures contract and the price of a related ICE swap
typically differ by perhaps a tenth of a cent. Is that correct?
Mr. Newsome. Typically no more than that.
Senator Levin. Now, that would be about one-hundredth of a
percent of the price of a futures contract. Is that correct?
Mr. Newsome. Yes, sir.
Senator Levin. OK. I think, Mr. Sprecher, you have already
indicated that the price of the NYMEX contract and the price of
the ICE contract stay very close to each other.
Mr. Sprecher. They are definitely interrelated, yes.
Senator Levin. And as a matter of fact, the NYMEX price,
the final NYMEX price, is indeed part of your swaps contract.
Mr. Sprecher. Yes. In other words, they converge
absolutely.
Senator Levin. Right. Senator Coleman.
Senator Coleman. I just want to make sure that we all agree
on what we have here. As I understand it, NYMEX does not have
set position limits on its natural gas swaps. Is that correct?
Mr. Newsome. We have position accountability on the back
months.
Senator Coleman. Accountability.
Mr. Newsome. Yes.
Senator Coleman. So there are not limits, but there are
kind of triggers that you look at.
Mr. Newsome. There are ranges that we set for market
participants. Again, you have a bit more flexibility in the
position accountability versus the hard position limits. But we
have used that authority to talk to market participants and
require an appropriate response.
Senator Coleman. And, by the way, does ICE in that sense
have a regulatory--do they have a competitive advantage in
having less regulatory costs?
Mr. Newsome. Well, I would certainly say yes.
Senator Coleman. What do you spend on regulation?
Mr. Newsome. In our Compliance Department, we spend over $6
million a year just on our direct costs at the exchange.
Senator Coleman. Mr. Sprecher.
Mr. Sprecher. In that area of our business, we have much
lower costs, although we do have a ``know your customer'' kind
of responsibility in the OTC markets.
Senator Coleman. But trading ahead and market oversight are
two different things. You have a market oversight
responsibility, Dr. Newsome. Is that correct? Tied to working
with CFTC.
Mr. Newsome. Correct
Senator Coleman. So I understand, in response to the
Chairman's questions, ICE then is receptive or open to what I
would call ``market oversight.'' Is that correct, Mr. Sprecher?
Mr. Sprecher. Yes. And I also, though, want to follow on
with a line that has been consistent in your conversation, and
that is, I don't think it should end at ICE. I think we really
should try to bring the entire over-the-counter market into an
accountability standard, because in a way we are pushing
mercury around the table. If they come off of NYMEX onto ICE
and off of ICE, where do they go next? I am not sure we have
solved the problem. And because ICE has been a successful
company, and a public company as well, sometimes we are viewed
as a euphemism for the OTC market. We are just one part of the
market.
Senator Coleman. And having somebody have that big
picture--we will talk to the CFTC about that, but somebody
needs to have the big picture; otherwise, we will be pushing
mercury around. Dr. Newsome, do you agree with that?
Mr. Newsome. I agree completely with that.
Senator Coleman. And just so I understand, position limits,
accountability limits, NYMEX right now, your natural gas
futures, futures contracts, those are physically settled. Do
they have a different standard in your natural gas swaps?
Mr. Newsome. Yes. Until the fall, it was all aggregated
into hard limits.
Senator Coleman. I understand. But the point is that with
your futures, you have got hard limits.
Mr. Newsome. Right.
Senator Coleman. With your swaps, you have got triggers.
Mr. Newsome. We have accountability in the back months.
Senator Coleman. Is there a reason why they should not be
the same?
Mr. Newsome. I think that all financial contracts should
have position accountability at least in the back months.
Senator Coleman. Again, my concern as I sit here is I want
to make sure that accountability does not result--first of all,
that it has impact, that we have a big picture, and we are not
simply pushing mercury around somewhere else. That is clearly a
concern that I have. But the idea that--I mean, it is clear
that, economically speaking, the physically settled, the
futures, and the swaps are essentially the same economically.
Mr. Sprecher, do you agree with that?
Mr. Sprecher. The swaps settle on the final settlement
price of NYMEX so they absolutely converge. But there is a
distinct difference, and that is, if you hold the physical
contract, ultimately you end up with natural gas. If you hold a
swap contract, ultimately you end up with the final settlement
price.
Senator Coleman. But 99.5 percent of those contracts are
supposed to physically settle or financially settle, so maybe
the word ``functionally equivalent''?
Mr. Sprecher. They are, but I want to be clear, they are
used differently. The swaps are used by the very people I think
we are trying to protect, which are hedgers who want to make
sure that they hedge the exposure to the NYMEX price, and they
want the final settlement price, and they cannot get that at
NYMEX because, by default, you must trade out of the contract
at least a minute or two before it finally settles; otherwise,
you end up with natural gas.
So the hedgers use the swaps. The people that are actually
discovering the price of natural gas use NYMEX's physical.
Senator Coleman. Let me just ask, so I understand where we
are at today as we look to the future. Under current law, what
responsibility does ICE have to monitor traders' energy
positions and to ensure that they are not excessive?
Mr. Sprecher. We have sort of a broad anti-fraud, anti-
manipulation responsibility, which generally is passing on to
the CFTC things that we may see, not because of specific
oversight but just in the general course of things, and also
more often the comments we get back from the marketplace, so we
are more of a conduit for information that then gets passed up.
But because we don't have any specific remedy capability, all
we can do is pass that up to the CFTC.
Senator Coleman. And if we can just look back to Amaranth
and look back at what happened and try to look to the future so
it does not happen again, what changes then in terms of remedy
capability do you think ICE should have and who should give it
to you?
Mr. Sprecher. Well, I think today, as we sit here, the CFTC
would have a pretty good view of ICE and NYMEX, and my hope
would be we could bring others into that. And, it may well be
because a company may be, let's say, long 10,000 contracts on
NYMEX, short 10,000 contracts on ICE, and technically be flat
or have no position, in which case neither Dr. Newsome would
see that nor would we see that.
So I think it would be up--the CFTC would have to help us
have the view, and then one of the two of us, and maybe our
other colleagues in the OTC market could ask for those
positions to be brought down.
Senator Coleman. The last line of questioning. ``Excessive
speculation''--we use that phrase a lot in our analysis, in our
view. We found substantial disagreement in the definition of
``excessive speculation.'' There are those who looked at
Amaranth and said that was not excessive speculation. I think
the Amaranth trader may have testified to that.
To both witnesses, Dr. Newsome and Mr. Sprecher, I will put
all the questions together. Can you define ``excessive
speculation''? Should Congress define it, or should the CFTC
define it? Dr. Newsome.
Mr. Newsome. I think it is very difficult to define because
it depends on the market that is being traded, and markets that
are very liquid and deep and have multiple positions across
months, it is just extremely hard to get a handle on.
I think one of the lessons that we learned from the
Amaranth scenario was we--and the CFTC, I think, for the most
part as well--concentrated on the front months because that was
the price discovery component that everyone relies upon. We
wanted to make sure that that was not disrupted.
We did not concentrate as much on the back months, and I
think the lesson we learned from Amaranth was, as entities
start building up these much larger positions in the back
months, we have already taken corrective steps to look at
flexibility limits. We have already started reaching out to
customers to ask them to decrease positions because of the
importance of the back months as well.
But when you start looking at speculation and limits,
whether they are short one month, long another month, it is not
just the fact that they have a position; it is what that
position is that makes it very difficult to just, I think, draw
a one-liner about what is excessive in terms of speculation.
Senator Coleman. Mr. Sprecher, could you take a shot at it?
Mr. Sprecher. I certainly can't define it. Without putting
words in your mouth, I suspect you would have difficulty
defining it. I think by default it is going to have to be the
CFTC.
The CFTC has in the past, for example, said that if a
company has 25 percent of the contracts in a market, that is an
alarm bell for them. We know from this report that Amaranth had
40 percent, even 60 percent of the contracts in a market. So I
think that just seems like a big amount going into delivery of
a contract. So whether 25 percent is the right number or
something around that--we certainly, I think, could probably
all agree that having 60 percent of the open contracts in a
delivered contract is potentially a problem.
Senator Coleman. I would hope that the industry--I would
hope that the CFTC would move forward in this area. If Congress
defines it, you are probably not going to be happy with the way
we define it. We tend to operate with lead gloves when surgical
gloves are needed to--again, understand to keep markets
vibrant, which was, I think, mentioned just briefly in the
opening statement. The consumer benefits from the ability to
speculate, from the ability to hedge. The consumer benefits
from liquidity in the market. The consumer benefits from
speculation. It is not just a gambler's game and for Wall
Street bigwigs to make money. The consumer benefits if the
markets function. But if they do not function, then we get
concerned. And so I would hope that we would get a little help
on that issue, which I know is a difficult one.
Thank you, Mr. Chairman.
Senator Levin. Thank you, and I think we probably would all
agree--and I want to make sure Senator Coleman would agree with
us because I would not want to suggest anything that he does
not--give his last statement. But if there is excessive
speculation, the consumer gets socked. Would you agree with
that? Or could get socked.
Mr. Newsome. Yes.
Senator Levin. And that if there is manipulation, the
consumer gets socked.
Mr. Newsome. Absolutely.
Senator Levin. And that is why you folks are given a
responsibility to oversee the market to prevent excessive
speculation and manipulation. Is that fair?
Mr. Newsome. That is fair.
Senator Levin. And that you, Mr. Sprecher, are willing to
support that change to give you that same responsibility?
Mr. Sprecher. Yes.
Senator Levin. I think that is very helpful. And I agree,
by the way, with Senator Coleman, that we want folks to be able
to hedge; we want folks to be able to speculate; we want
liquidity. It is the excessive speculation and manipulation
which our law is intended to stop and which that loophole
allowed. And that is why I think now there is a growing--will
be a growing momentum coming out of today's hearing. Hopefully,
CFTC, who is here today, will join the momentum, but we will
find out in a couple of minutes.
In any event, one question, and this follows up on
something Senator Coleman also said, and that is the unintended
consequences. Is the way that we could make sure there are no
unintended consequences and we are not pushing mercury around
to at least cover the organized electronic markets in any over-
the-counter coverage? Would that be a way to describe it,
organized markets or electronic markets which are organized?
You do not want to get to the bilateral one-on-one
conversation, right? No one is trying to get to that.
Mr. Sprecher. Well, I think that your report shows that the
first thing that Amaranth tried to do was a bilateral one-on-
one deal to get out from underneath these. So I am not so sure
we shouldn't try to bring that in. It may be slightly
different----
Senator Levin. Of a certain size.
Mr. Sprecher. Of a certain size or certain--I mean, just
because these people are voice brokers doesn't mean they don't
know what the position is. For crying out loud, they invoice
the market participant for putting that trade together.
Senator Levin. Will you folks, both of you, be willing to
submit suggestions as to how we could define that for possible
legislation? Are you willing to do that, Dr. Newsome?
Mr. Newsome. Absolutely, Mr. Chairman.
Senator Levin. Would you do that, Mr. Sprecher?
Mr. Sprecher. Sure, absolutely.
Mr. Newsome. And I think if I could just follow up on that,
I talked about the aggregation of risk earlier and how these
markets are linked, and the reality is that the same customers
that trade ICE trade NYMEX. They trade the positions for
predominantly the same reason. But when you get the aggregation
of risk--and then the CFTC has already spent quite a bit of
time looking at when a market starts to serve a price discovery
function, that should be a trigger as well for transparency and
openness as to the positions in that market.
So I think some work has been done, Mr. Chairman, and we
will be more than happy to assist.
Senator Levin. Thank you both. We appreciate it.
We will now move to our second panel. Let me now welcome
our second and final panel of witnesses for this afternoon's
hearing from the Commodity Futures Trading Commission, CFTC. We
are pleased to have the CFTC's Acting Chairman, Walter Lukken,
and one of the CFTC's Commissioners, Michael Dunn.
Gentlemen, we are pleased to have you with us this
afternoon. We welcome you to the Subcommittee. We again
appreciate the cooperation of you and your Commission. You have
heard the rule. I think you were both here before, so you know
what the rules are of the Subcommittee, and I would like to at
this point ask you both to stand and raise your right hand. Do
you swear that the testimony you are about to give before this
Subcommittee will be the truth, the whole truth, and nothing
but the truth, so help you, God?
Mr. Lukken. I do.
Mr. Dunn. I do.
Senator Levin. Thank you. We will follow the same rule for
timing. One minute before the red lights comes on, then you
will see a yellow light, and that will give you an opportunity
to complete your remarks. As I said before, we will print your
entire testimony in the record, and we ask that you limit your
testimony to no more than 10 minutes.
Mr. Lukken, why don't you go first.
TESTIMONY OF WALTER LUKKEN,\1\ ACTING CHAIRMAN, AND MICHAEL
DUNN, COMMISSIONER, COMMODITY FUTURES TRADING COMMISSION (CFTC)
Mr. Lukken. Thank you, Mr. Chairman, Senator Coleman.
Commissioner Dunn and I appreciate the opportunity to discuss
with you the CFTC, our role with respect to the energy markets,
and your report's conclusions.
---------------------------------------------------------------------------
\1\ The joint prepared statement of Mr. Lukken and Mr. Dunn appears
in the Appendix on page 178.
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Under the Commodity Exchange Act, the concept of
``excessive speculation'' is based on trading that results in
``sudden or unreasonable fluctuations or unwarranted changes in
the price'' of commodity futures. This language has provided
helpful guidance for the agency in protecting the price
discovery process. There is a distinction, however, between
excessive speculation and manipulation. Manipulation of market
prices is a clear and undeniable threat to the integrity of the
marketplace and to the fundamental purposes of futures markets,
risk management, and price discovery.
A longstanding body of law defines the parameters of
futures market manipulation. Excessive speculation, on the
other hand, is a more fluid concept which Congress has enabled
the Commission and the exchanges to address by adopting rules
or regulations establishing position limits or position
accountability levels.
Futures markets require both speculators and hedgers.
Speculators provide the market liquidity to allow hedgers to
manage various commercial risks. Placing limitations on the
amount of speculation that an individual or entity may engage
in necessarily limits the amount of liquidity in the
marketplace and may limit the ability for hedgers to manage
their risks, as well as the flow of information into the
marketplace. This in turn could negatively affect the price
discovery process and the hedging function of the marketplace.
The Commodity Exchange Act provides that the Commission has
exclusive jurisdiction with respect to commodity futures and
options trading on designated contract markets, also known as
DCMs, which can list for trading any type of contract and are
open to all types of traders, including retail participants.
DCMs are self-regulatory organizations subject to comprehensive
oversight by the CFTC.
In the Commodity Futures Modernization Act of 2000,
Congress included a provision permitting a new type of trading
facility known as an exempt commercial market, or ECM, on which
exempt commodities such as energy products may be traded. Only
eligible commercial entities, generally institutional traders,
may trade on ECMs, ensuring that these markets are open only to
sophisticated parties that understand the risks associated with
them.
ECMs, as well as transactions executed on them, are
statutorily exempt from most provisions of the act. The
Commission does retain fraud and manipulation authority over
ECMs.
ECMs are subject to certain limited reporting requirements.
In addition, ECMs must maintain for 5 years and make available
for inspection upon request by the Commission certain records,
including audit trail information sufficient to enable the
Commission to reconstruct trading activity. The Commission also
has the authority to issue what is known as a ``special call''
for any information from an ECM the Commission may deem
appropriate.
Due in part to the lessons learned from the fall of
Amaranth, the CFTC has been utilizing its special call
authority to receive daily trader position information from
ICE. This information helps us to get a more comprehensive
picture of the marketplace and, given the similarities of ICE's
natural gas contracts to those traded on NYMEX, assists us in
overseeing the energy trading activities on that exchange.
Despite the difference in regulatory authorities over DCMs
and ECMs, the Commission is aware that when markets trade
similar products or products that can be arbitraged,
information regarding activity in one market tends to be
incorporated into the other. This is almost certainly the case
when large numbers of traders operate in both markets, as is
the case with NYMEX and ICE. This growing linkage of the
markets along with the PSI's report on Amaranth is the basis
for our regulatory discussion today.
After Amaranth's collapse, the CFTC's Office of the Chief
Economist analyzed the situation using statistical evidence,
including data obtained from ICE. Amaranth has positioned
itself to profit on a spread position between the prices of
natural gas contracts expiring in the winter and the natural
gas contracts expiring in non-winter months. Such a strategy
would have been profitable if the prices for winter delivery
futures contracts had risen relative to prices for non-winter
delivery contracts.
Amaranth began significantly ramping up this spread
position in the spring of 2006. As the spread price began to
fall during the last week of August 2006 through September,
Amaranth's losses mounted. The unusually large spread price
began to appear around the time of Hurricane Katrina in 2005.
As the PSI report points out, this was the largest March/April
spread ever observed. However, Amaranth did not begin
accumulating its large position in this spread until the spring
of 2006. In other words, the March/April spread was at a
historically high level for many months before Amaranth began
accumulating its large position.
The chief economist's analysis of Amaranth's trading data
failed to conclude that Amaranth's trading was responsible for
the spread price level observed during 2006. The study found
that changes in Amaranth's positions influenced market prices,
and at the same time changes in market prices influenced
Amaranth's positions. If Amaranth were dominating markets, our
economist would have expected these tests to have shown one-way
causality where changes in Amaranth's positions would have
influenced the market prices, but market prices would not have
influenced Amaranth's positions. However, the study showed that
Amaranth and the market appeared to have been reacting with
each other reciprocally.
In the analysis, these changes in spread prices were
consistent with market fundamentals at the time. Amaranth
established a large spread position that could have only been
profitable if the unusually high spread price had become even
more unusually high. Such a profitable scenario would have
occurred if winter natural gas supplies had been disrupted by,
for example, an active hurricane season in the Gulf of Mexico.
In fact, the Gulf hurricane season proved to be less active
than predicted, and instead of a widening price relationship,
the price difference narrowed considerably, resulting in
significant trading losses to Amaranth.
There are more details about Amaranth in our written
statement, but I would like to note that the Commission was
aware of Amaranth's on-exchange activities in the months
leading up to September through our regular financial and
market oversight surveillance, and that Amaranth's account at
its clearing broker was fully margined at all times.
The Commission does not pick winners and losers in the
futures markets, but does work diligently, and did so in the
case of Amaranth, to ensure market integrity and the protection
of the price discovery process.
The futures markets have changed dramatically since the
passage of the CFMA in 2000 and the creation of the exempt
commercial markets. Congress established these institutional
markets while calibrating the amount of oversight to the risks
associated with them. However, as the Subcommittee's staff
report lays out, the regulated futures markets and exempt
commercial markets have become increasingly linked, and as a
result, the public risks associated with these markets have
changed. The CFTC has recognized this and has exercised its
existing statutory authorities in order to keep pace with this
industry growth. I mentioned earlier our special call for ICE
trader information. More recently, the CFTC has proposed an
amendment to clarify that our existing regulations require
large traders on regulated DCMs to keep information relating to
all of its positions in a commodity, including OTC trading
information, and to provide that information to the Commission
upon request.
However, the Commission is nearing the outer limits of its
authority and it is appropriate to have this open dialogue with
Congress and our fellow regulators about what other tools may
be needed to adequately oversee this marketplace and ensure
fair competition and integrity.
In closing, we appreciate the Subcommittee's inquiries into
this complex and important area. The Subcommittee staff report
looks at a number of issues related to the CFTC and makes
recommendations and conclusions that warrant further debate,
which we look forward to discussing with you today.
Thank you very much.
Senator Levin. Thank you very much, Chairman Lukken. I
understand that statement represents the views of both of you.
Is that the note I was given? Or, Mr. Dunn, would you like to
give your own statement? You are free to proceed either way.
Mr. Dunn. Thank you, Mr. Chairman, and I would like to both
associate myself and disassociate myself with my colleague at
certain times. But at this particular time, I do associate with
both the written and oral statement.
Senator Levin. Thank you, and thank you both.
Do you agree with our report that the prices on one of the
two exchanges in front of us today affects the prices on the
other?
Mr. Lukken. Absolutely, Mr. Chairman.
Senator Levin. Why don't we do this: If you differ with a
statement, if you want to interrupt at any time, feel free to
do so.
Mr. Dunn. I may never get to speak. [Laughter.]
Senator Levin. We will call on you at the end, then, to
clean up all of the comments you want to correct or make
reference to.
The key law here which is being discussed is the Commodity
Exchange Act, which directs you folks to limit trading to
prevent excessive speculation, and I want to ask you: Do you
have any problem with that mandate? Congress has told you this.
You are supposed to be stopping excessive speculation. Do you
have any difficulty in enforcing that law?
Mr. Lukken. Absolutely not. I think as you have noted,
excessive speculation, that leads to unwarranted price
fluctuations and unreasonable price fluctuations. So I think
that modification of that term is important because it talks
about how excessive speculation leads to potential manipulation
and artificial prices in the market. That is really where we
have focused on our attention. In the expiration month of these
contracts where we have seen in the past experience of corners
and squeezes in these physically delivered products, that is
how we have interpreted that provision of our act.
Senator Levin. Now, the NYMEX has adopted position
accountability levels in order to avoid excessive speculation.
That is one of the methods that has been used. They have also
adopted position limits.
Does it make sense to you that when they order a speculator
or trader to reduce its holding in order to avoid excessive
speculation, that speculator can just move to an unregulated
exchange and do the same thing? Does that make sense to you?
Mr. Lukken. I think when we looked at the situation, our
mandate is to protect the benchmark, which, as your last
hearing pointed out very effectively, is utilized by utilities,
public utilities and others. That benchmark is NYMEX. They are
the primary price discovery market that we try to protect. And
certainly we do that through position limits, through
surveillance, through our other authorities in that area.
However, when these speculators, as you have noted through this
chart,\1\ have moved to ICE, even though these prices are
interrelated, we still believe--I personally believe that we
are still protecting the primary price discovery mechanism in
NYMEX by putting position limits on those areas.
---------------------------------------------------------------------------
\1\ The chart referred to appears in the Appendix on page 190.
---------------------------------------------------------------------------
Now, we did recognize, as you have noted that----
Senator Levin. By putting position limits at NYMEX.
Mr. Lukken. Correct
Senator Levin. But there is no position limits at ICE.
Mr. Lukken. There is no position limits at ICE.
Senator Levin. OK. And there is no accountability levels at
ICE.
Mr. Lukken. That is correct.
Senator Levin. So nothing is triggered at ICE, so all they
do is run over to ICE and engage in the very trades which your
agent, NYMEX, said they could not do anymore at NYMEX, and you
just acknowledged again that the price that is set--or the
price that is achieved at ICE affects the NYMEX price, right?
They are interrelated.
Mr. Lukken. They are interrelated, correct.
Senator Levin. So then let me ask you again. Is there any
way that CFTC should not be supportive of a rule which avoids
the circumvention of the NYMEX order?
Mr. Lukken. Well, I think, like I said, it has been our
position that through the physical delivery of contract, the
primary contract that is being utilized on ICE--or on NYMEX,
excuse me, is protected by these position limits. Now, we have
noted that there is interrelationship between these markets,
and now we receive daily trading information to provide the
transparency that your report talks about that is needed in
these markets. Since that transparency has been provided to
this marketplace, we have not seen shifting between regulated
markets and unregulated markets, according to our surveillance
staff.
So I think for the time being, we seem to be----
Senator Levin. Do you want to wait until that happens?
Mr. Lukken. Well, we are monitoring it right now and----
Senator Levin. And then what happens when you see it?
Mr. Lukken. Well, as noted, we do have full manipulation
authority----
Senator Levin. No. I am talking about excessive
speculation.
Mr. Lukken. Correct, but excessive speculation that leads
to unwarranted price fluctuations that really is getting at
manipulation in these markets. So we are not limited in any way
in our manipulation authority and can bring any type of
enforcement action against participants in these markets that
may be trying to manipulate through moving positions around.
Senator Levin. Let us go back to excessive speculation. You
keep going to manipulation. I keep talking about excessive
speculation, so let's talk about excessive speculation. Your
agent, NYMEX, entered an order, OK? Amaranth evaded that order
by going on to ICE.
Mr. Lukken. Correct.
Senator Levin. It did so on an exchange which had an effect
on the NYMEX price, and you agree to that.
Mr. Lukken. Correct.
Senator Levin. I am going to ask you again. By taking the
position you have, which apparently is either neutral or non-
involved or--well, I will leave it at that. Aren't you, in
effect, putting your stamp of approval on the circumvention of
the NYMEX order, your agent's order?
Mr. Lukken. Well, as I mentioned, I think that the
positions that were on ICE, because we are trying to protect
the benchmark, which is NYMEX, that was effective, the position
limits on that contract. The ICE contracts, really the Amaranth
positions that were put forward, were outer-month contracts.
They weren't the nearby contracts that we were trying to
protect, and that is one of the lessons that NYMEX had
mentioned, is we need to start looking at some of these outer-
month contracts as well, and we have started to do that. We
have the software and resources now to try to do that.
Senator Levin. If you look at them and there is no
authority to do anything about it, all you are doing is coming
in after the fact and trying to find somebody after the damage
has been done. Why not prevent it? You have told NYMEX, we have
told you to tell NYMEX, ``Prevent it.'' Why should we not tell
you to tell ICE to prevent it in order to sustain the NYMEX
order? Why should you resist that? You seem to be resisting
something, and I do not know why. You keep changing the subject
when I talk about excessive speculation. You change it to
manipulation. I am trying to find out why there is resistance
on CFTC from supporting the NYMEX order that there be a
reduction in the holdings by somebody--Amaranth--in order to
avoid excessive speculation. Why are you resisting it or appear
to be resisting it?
Mr. Lukken. I am not resisting it. What I am trying to say
is that the hard limits, the position limits that typically are
put on physically delivered contracts, such as the NYMEX
position, are effective at ensuring that the futures and cash
prices converge so that those prices function correctly, as
they should.
ICE links itself to that benchmark. They in some ways
freeload off of that price discovery mechanism. So by doing so,
we are not as concerned with that influence and those prices
because we are really concentrating on the physical delivered
contract that is happening in ICE.
Senator Levin. Which occurs in one-hundredth of 1 percent
of the time. You are concerned about a delivery that occurs
almost never and seem not to be concerned when your agent,
NYMEX, issues an order based on accountability levels. It was
not a position limit. It was based on an accountability level
which triggered an order. And if an order means something, and
if we are going to protect the consuming public--I am not
worried about, frankly, protecting the hedge fund or the
speculator one darn bit. I am very much concerned about
protecting the public that is affected by the prices which are
impacted by that excessive speculation. They are impacted by
it. They have to have a stable price. They have got to figure
out what is it going to cost for winter gas because they are
running an institution or they are running a utility, so they
want a hedge. And it is a legitimate thing. They are the user,
they are the consumer. They are not the speculator.
So I am trying to figure out--again, you talk about
position limits; I talk about accountability levels which
trigger an order. And I want to find out why the CFTC, if you
speak for the CFTC, seems to be resisting something which even
ICE accepts, at least as of today. Try me again.
Mr. Lukken. Yes, Mr. Chairman, I do not want to come over
like I am being resistant to this idea. What I am trying to say
is after the Amaranth situation, we decided that these markets
were linked, as you had noted. We started to get more
information, more transparency in these markets, and to date
that seems to have been effective in these markets.
I think obviously, as a Commission, we have to adapt as
these markets evolved and as these markets evolve. And
certainly Commissioner Dunn and I want to try to address these,
and certainly, as was noted by the prior panel, even on
regulated exchanges, there is some uncertainty on what is the
most effective manner in order to prevent either manipulation
or excessive speculation that leads to unwarranted prices.
So I think this is something we need to be open to. I
certainly think as a Commission we should discuss these ideas.
But what I am trying to tell you today is that we have changed
our practices to address this type of situation, that it has
been effective, and that I think that we have the authority to
address these things in the future.
Senator Levin. You say it has been effective, but a
disaster has not come yet. You are going to wait for another
disaster to give authority and direction to the market, which
has these huge speculators in it--ICE.
Mr. Lukken. Sure.
Senator Levin. You are going to wait for the disaster, but
you are not going to prevent the disaster because you are not
willing, apparently, to tell ICE what you have told NYMEX:
Prevent excessive speculation. Don't just clean up the act
after the damage is done. Prevent it.
And so the way NYMEX has prevented it, your agent, is they
have adopted an accountability level which triggers an action
on their part. And then that action is subverted by the
inability of ICE to take action to do exactly the same thing.
ICE is willing, as of today, to be given the responsibility to
stop that subversion and to protect the consumer. And yet you
want to talk about openness and transparency. That is fine.
That gets you halfway there. That gets you the information. But
unless ICE does something about it and can do something about
it to stop excessive speculation, you are not preventing the
next Titanic, the next Amaranth.
Mr. Lukken. Right. And I think it is important to note,
too, that even though we are discussing ICE, a lot of this
occurred also on NYMEX, which does have these accountability
levels, that they were exceeded several times, as they noted in
the prior panel. So there is diligence that has to be on both
fronts here, and we look forward to talking about these issues
and determining how to best approach accountability levels,
position levels, on both regulated and non-regulated exchanges.
And hopefully I could talk to--someday we might have a few
more--you mentioned Mr. Dunn is one of our Commissioners. He is
our only Commissioner at the time. Hopefully we might have a
few more Commissioners that we could talk about this, because
obviously diversity of views is important as a Commission, as
it is in the Senate, and also I want to mention my regulatory
colleagues who are part of the President's working group. They
have views on this. These decisions will affect some of their
markets as well. So I think it is important that we talk.
As Senator Coleman had mentioned, there may be consequences
to doing some of these actions. As you squeeze the balloon,
where does it go? I think these are all important things to
talk about. I don't want to sound resistant to ideas. I am open
to all these ideas. But I am trying to say is that as of today,
this seems to have stopped the activity that your report points
out. And if more is needed, then we are open to those ideas.
Mr. Dunn. Mr. Chairman, if I may?
Senator Levin. Please.
Mr. Dunn. This is one of the times I would like to
disassociate myself a bit from my colleague. I am very
concerned when on the first panel the first day of these
hearings, I read with a great deal of interest of what those
LDCs and others had to say. The primary function for me of the
futures and options market is to provide for risk mitigation
and price discovery. Very clearly, those people that testified
before you thought that did not happen, and the reason they
thought it did not happen is because they thought there was
excessive speculation as you point out in your study.
I gave a speech back on September 8, 2006 in which I said I
wished that the Commission would do that type of study. But at
the end of that, I said I don't really know if we would be in a
position to pick among different economic uses of particular
futures contracts, decide what should be discouraged, and what
should not be discouraged.
But very clearly, there is a problem here based upon
testimony that this Subcommittee has already seen, and that
calls for us to take some type of action, and you have had a
great deal of discussion between spec limits and the
accountability level. Clearly, spec limits are hard and fast.
It is something that the exchanges put together and say here is
where you have got to go. They run it by us for our concurrence
on this.
That doesn't happen with accountability levels. That is
something that is more dynamic. It is an ongoing thing. We are
not told when those accountability levels change out there, and
that is because it is dynamic, and what happens is an exchange
will call in that particular trader and say, ``What is your
game plan? What are you trying to accomplish here?'' And then
they have to consider as an SRO that what that individual is
doing and whether or not it's going to have an impact in the
marketplace.
I think your study points out that there were spikes in
this market that took place that had an impact, especially on
those other people that were using this market for risk
mitigation, and the result of that alone should say we ought to
take some type of action to make sure this doesn't happen in
the future.
Senator Levin. Thank you very much. Senator Coleman.
Senator Coleman. Thank you. I have been pretty consistent
about raising the issue of assessing the unintended
consequences of extending CFTC regulation to electronic over-
the-counter exchanges like ICE, because I think it is important
that we have to--let's understand the impact of what we do.
Having said that, what is troubling, Mr. Lukken, from your
testimony is when you talk about protecting the benchmark and
feeling that you accomplished that when NYMEX told Amaranth
that they have got to lessen their position, you do not seem at
all troubled that Amaranth's response to that was to
essentially disregard it by simply moving to another market.
So NYMEX says lessen; they do not lessen at all. They
simply move from physical to swap; they move from regulated to
unregulated, which clearly the economic distinctions are
little--at least at that time. And so my concern is, as we move
forward, that I want to make sure that the CFTC has a concern
about if directives are given in one market that their folks
can simply move somewhere else. And you do not seem troubled by
that because ``the benchmark is protected.'' I find that very
troubling.
Mr. Lukken. Let me clarify what I meant, and I apologize if
I came across as not caring that these positions may be moving.
We have, as I noted, adopted these positions--or this
large-trader-like information that we are now receiving from
ICE. My suggestion would be that when we see these types of
movements, our surveillance staff in essence call these folks
up and say, Well, why are you doing this? You were once on
ICE--or NYMEX trading these positions. Now you are on ICE with
the same speculative behavior. Why are you doing this? We have
enforcement authorities that we can take against you. Do you
have economic justification for doing this?
That sort of deterrence I think would be very effective.
Again, we may not have every regulatory tool in the toolbox,
but we have a big hammer with our manipulation authority that
we can send subpoenas, we can bring these people into court, if
we find that their activities are problematic.
So it is not that we are ignoring this information now. We
see it. It is transparent, and we can take action with our
enforcement authorities to go after this type of behavior.
Senator Coleman. So if NYMEX has accountability limits, if
NYMEX allowed Amaranth to trade above its own established
accountability limits, does it make sense for ICE to adopt the
same accountability limits? I am trying to figure out where we
go with--and, again, understanding that at a certain point
someone has got to have the big picture. And you are the folks
with the big picture.
Mr. Lukken. Right.
Senator Coleman. But you have got to be willing to use the
authority. You have to be willing to say if there is a problem,
we are going to deal with it, rather than simply saying we have
protected a benchmark and anything beyond that does not seem to
be our concern. You have clarified that somewhat.
Mr. Lukken. Yes.
Senator Coleman. But should NYMEX have the same
accountability limits for its natural gas futures contracts and
natural gas swaps, there is a distinction. NYMEX at least has
some accountability; they have some triggers. Should ICE have
the same triggers?
Mr. Lukken. Well, there should certainly be someone
watching, whether it is ICE or us. And so, yes, if they are
exceeding accountability levels on NYMEX and we feel that the
activity on ICE is affecting NYMEX, that is a problem for us.
We need to make sure that we are policing that correctly by
calling those folks up--a lot of what we do in our surveillance
activity is called ``jawboning,'' where we just call them up
and say, ``What are you doing here? Why are you doing it?'' It
proves to be very effective. It is very limited that we have
ever used our emergency authority to try to liquidate
positions. It has only happened four times back in the 1970s,
in fact. But most of the time it is this deterrent activity,
this jawboning that allows us to get people to back away from
these types of positions.
I would certainly, as Acting Chairman, encourage our staff
to make those types of phone calls. When people exceed
accountability levels on NYMEX and move those beyond into ICE,
that is troubling. It should be troubling, and I think
Commissioner Dunn and I both find that activity troubling.
Senator Coleman. I think Mr. Sprecher testified that
accountability levels are needed on ICE and should be extended
to that exchange. Do you agree with that?
Mr. Lukken. I think that is something we should be open to,
certainly.
Senator Coleman. Mr. Dunn.
Mr. Dunn. I definitely think there ought to be
accountability levels, and I think there also should be some
exploration of actually putting in spec limits.
Senator Coleman. ``Excessive speculation''--is there a
clear definition of ``excessive speculation,'' Mr. Lukken?
Mr. Lukken. I think it has to be tailored to the markets
that you are looking at. It really depends on whether it is
nearby months, outer months, the types of markets, physically
delivered, cash settled. I think it really should be given to
the experience of our surveillance economists who have hundreds
of years of experience looking at these markets. But it is
something that I think is worthy of a discussion. I think it is
something that we as a Commission should look at to determine,
OK, where is the guidance here, because we really haven't until
this has happened, we really hadn't put forward much effort to
look into what is excessive speculation.
Certainly as a Commission, I think it is worthy of
discussion and study to determine if there is guidance in this
area that is necessary to help us go through this, to help us
provide some principles in this area so that we combat
excessive speculation that may lead to unjustified or
unwarranted price fluctuation.
Senator Coleman. There has been some discussion about the
image of moving mercury around, so if we move forward with ICE
having not just greater reporting requirements, which they
have, but, in fact, some enforcement and account limits, which
they do not have presently but appear to be open to, what is
the danger of trading moving elsewhere? And how do you get
yourself in a position to kind of see the big picture and to
make sure that we are simply not moving something from a
regulated to an unregulated environment? Mr. Lukken and then
Mr. Dunn.
Mr. Lukken. Well, most of the natural gas trades are on an
exchange-like facility. I think it is only 10 percent that
happens in the bilateral market. So I don't think there is an
enormous impact of things pushing into the bilateral market.
These markets want exchange-like transparency, and the clearing
that is available to them. That is important. But, this is
always a concern I think you need to have, is how much
regulation is necessary, and it needs to be tailored to the
risks associated with them. I think your Subcommittee has
adequately pointed out what the risks are here and how best to
do that without pushing these markets either overseas or into
these dark markets, as you have talked about. But, regulation
shouldn't--we should make sure that we are meeting the risks,
and unintended consequences, we should be aware of them, but
unless we are addressing the risks to these marketplaces, that
is the most important thing that we should consider here.
Senator Coleman. Mr. Dunn.
Mr. Dunn. Senator Coleman, I think a very important point
that I thought I heard Mr. Sprecher say in his testimony was
that he was open to having core principles apply to ICE, which
they currently don't. That would imply to me that they would
also have a compliance staff similar to what we currently see
at NYMEX. That gives us someone with our staff to bounce things
off of and so that we can talk about these situations. Since
they don't have a compliance staff now, it is very difficult to
call up and--do we call Mr. Sprecher and say, ``We have got a
problem here''? Just the make-up of how do you go about doing
some of this I think would be taken care of if, in fact, we did
have some kind of core principles that would apply to them as
well.
Now, remember, there are only about 12 of these acting ECMs
out there right now, and when we look at the future, I mean, we
didn't think there would be one this big at this time when the
CFMA was passed back in 2000. So we have to look at unintended
consequences: What is it going to be in the future? What are we
going to do when there are 10 or 20 ICEs out there? And how do
we do our work? This is certainly something that you later make
a recommendation on near and dear to my heart, is that we have
adequate staffing and technology to be able to conduct
oversight over what Congress has given us.
Senator Coleman. Let us make sure that we get a response to
that. We have not had a lot of discussion about staffing and
technology. But I presume all this comes at a cost.
Mr. Lukken. Absolutely. We are struggling to maintain our
current mission at the agency of regulating DCMs. So anything
that we add to the table means something drops off. I am happy
to see that the Subcommittee for Appropriations that oversees
our agency is marking up a bill tomorrow. Hopefully they give
us appropriate resources to do our job. But certainly if other
markets come into our purview, that is going to come at a cost.
But, technology is something that is so important. We are a
technology agency. Technology gives us the tools to do this
type of surveillance. It is from Amaranth that we learned we
need to start looking at these outer months, and now we have
the surveillance technology to help do that. That I think was
part of Recommendation 2. That is something that is important.
But resources is definitely an issue for us, and whatever
authorities are provided, it has to be matched with the
resources to adequately uphold those authorities.
Senator Coleman. Thank you, Mr. Chairman.
Senator Levin. Thank you.
Mr. Lukken, do you think it is important to prevent another
episode like Amaranth or just punish a perpetrator who violates
the law?
Mr. Lukken. I think preventing is always the first priority
at our agency.
Senator Levin. Why is it that you talk about your agency
jawboning but seem to be resisting giving to ICE the same
authority and responsibility that they are willing to accept
that NYMEX has to do the jawboning and action themselves? Why
differentiate there?
Mr. Lukken. Well, what I am saying is that we can
accomplish much of what giving that to ICE would accomplish.
Senator Levin. But why? Why not tell ICE to do what NYMEX
does?
Mr. Lukken. I think that is certainly an option.
Senator Levin. But why not exercise it? What is your
reluctance?
Mr. Lukken. It is not reluctance.
Senator Levin. I am trying to get to--there is a
resistance. I am trying to understand it, and I do not.
Mr. Lukken. Well, I think what we are trying to do is make
sure that we accomplish the goal of preventing an Amaranth-type
situation, either its collapse or the fact that maybe
unreasonable prices may have happened as a result of that.
Senator Levin. Why wouldn't assigning ICE and other
exchanges to do that, giving them responsibility the way you
have NYMEX, achieve that goal?
Mr. Lukken. It would be one way of achieving it. Another
way is, as I mentioned, us receiving information about this and
using our own jawboning and surveillance techniques to prevent
that type of build-up on an ICE-type platform.
Senator Levin. Why not do that with NYMEX? Why not take
away their authority, their responsibility? Take it on yourself
to jawbone the NYMEX speculators. Why not do it that way with
NYMEX?
Mr. Lukken. Well, I think this is a legacy of self-
regulatory organizations that--self-regulation existed before
we existed in those exchanges, 200 years or 150 years ago. So
this is a legacy issue.
But, as these markets evolve, as I mentioned we need to
make sure that we are on top of these. There may be a point in
time where we need to ask ICE to do this, but what I have said
today is that the trading information that we receive, our
ability to jawbone them as a result of that trading information
has been shown to be effective so far.
Senator Levin. It was not shown effective with Amaranth.
You received that information, didn't you?
Mr. Lukken. We were not receiving that information at the
time of Amaranth.
Senator Levin. You did not know anything about the move to
Amaranth? None of your staff was aware of that?
Mr. Lukken. I don't believe----
Mr. Dunn. Not until after the fact.
Mr. Lukken. Not at the time, Mr. Chairman.
Senator Levin. What about leveling the playing field
between NYMEX and ICE? Do you support those efforts?
Mr. Lukken. As long as it is done on a regulatory basis. I
think we are trying to match what the risks of each marketplace
might be and the type of regulation we put on them. As I
mentioned, ECMs are only institutional markets. There is no
retail participation directly on those marketplaces. There is
only principal-to-principal trading. A lot of what we do as an
agency is try to prevent trading abuses where traders brokering
for other traders may trade ahead of people. That doesn't exist
on ICE, so those authorities are not necessary.
So, there are certain parts of these markets that are
different, as Mr. Sprecher pointed out, that they are
different, requiring a different tailoring of regulation than a
full-blown DCM designation.
Senator Levin. But the speculation that occurs on ICE has
an effect on the NYMEX price. You have agreed to that.
Mr. Lukken. It can.
Senator Levin. So how are you then protecting the NYMEX
benchmark? If the speculation occurs unregulated on ICE and the
ICE price affects the NYMEX price, how is the NYMEX benchmark
protected?
Mr. Lukken. Well, I think, as I mentioned, if this
Amaranth-type situation would occur today, our staff would see
that.
Senator Levin. How was it protected before?
Mr. Lukken. Well, it wasn't. As these markets have evolved
and become more linked, this is something, a lesson that we
learned from Amaranth.
Mr. Dunn. Mr. Chairman.
Senator Levin. Mr. Dunn.
Mr. Dunn. Could I address your first questions about what
do we do and, in essence, how do we prevent this? I think in
your first study that came out--and, by the way, let me commend
the staff for both studies. But the first study, which said
there has got to be a cop on the beat, is really something that
bothers me, that there is a perception out there, in large part
in the energy markets, that we are not watching, that no one is
paying attention. In fact, we have got folks on tapes giggling
about nobody's watching us, they can do whatever they want. And
we don't have a cop on the beat, I think, in real time, in this
particular instance, but we do have a very good enforcement
group that can go back and look at fraud and manipulation.
I think a great deterrent to this is for us to be able to
bring some cases, and certainly we did that in the Enron
issues. We only have civil money penalties that we can give
them. I have asked our enforcement people to share information
with the Department of Justice, States' Attorney Generals, and
others so that some criminal actions can take place in some of
these issues as well so that there is a real consequence being
paid by the individuals that partake in things that are purely
and very clearly fraud and manipulation.
Mr. Lukken. I would just like to join my colleague, too.
What is troubling--and your report points it out--is the
perception out there that these markets are somehow not
policed. And perception is very important in this. People are
basing prices off of these markets, and I think that is
something as a Commission we need to be more active in making
sure to educate folks what we do, what the limitations are, are
we doing enough, to talk with industry groups, to talk with
other regulators in this area.
I have been on the job a week as acting chairman, so I hope
to hit the ground running with Commissioner Dunn and hopefully
a couple other commissioners once they get confirmed and try to
look into some of these issues. Are we doing enough? Should
more happen in this area? We have done some, but maybe more is
needed. And I think it is important to keep the perception that
we are doing our job. It is important that is the perception,
that we are doing our job.
Mr. Dunn. There is a way, Mr. Chairman, Senator Coleman,
that we can get that attention. According to the regulations,
anytime that ICE gets a formal complaint, that is supposed to
be passed on to the CFTC so that we can go out and examine
that. So there are opportunities out there for someone who
thinks that there has been manipulation or they have been
damaged as a result of activities that take place on ICE, that
it can get to us. And certainly, as I read those testimonies of
those folks that were on your first day of hearings out there,
there were a lot of people out there that feel that us going
after somebody after the fact is too late, they have already
spent too much money that affects them for their businesses and
their heating of their home.
Senator Levin. Well, that is exactly right. Most of the
function of the cop on the beat is to deter crime, not to chase
the guy after he has shot somebody. And this is the way the
CFTC describes its authority. This is CFTC now. ``In contrast
to its authority over designated contract markets and
registered derivatives transaction facilities, the CFTC does
not have general oversight authority over exempt commercial
markets. Exempt commercial markets are not registered with or
designated, recognized, licensed, or approved by the CFTC.''
What I am afraid hearing today is you maybe want to keep it
that way. I have to tell you, that is what comes through from
your testimony today--not from Mr. Dunn's. From your testimony
today where you draw some kind of a distinction, which I fail
to understand, between why it is important that NYMEX have the
authority to prevent, to deter, to go after excessive
speculation before it causes damage, and your insistence that,
well, you would rather the CFTC, when it comes to ICE, be the
one that is going to get reports and oversee it does not give
me much confidence that that is the way to go. And I do not
understand the distinction. They are functionally equivalent.
There is no difference about that. They are functionally
equivalent markets. And yet CFTC, you are the cop ultimately,
and you seem to say, hey, get NYMEX on those trades, but when
that action of NYMEX is subverted by what is allowed, just move
it over to an unregulated market, you are saying, well, we will
get reports on that, and if there is a claim of fraud or
manipulation, then we will move in after the shark is gone.
Mr. Lukken. It is not that I oppose that idea. I think it
is something that we should be discussing as a Commission, also
with other regulators. So as you mentioned, these markets have
evolved over time. What was true 5 years ago is not true today.
It is something we should discuss. Maybe that is needed. But
there are consequences to adding additional regulation, as you
have pointed out today.
Senator Levin. There always are. But there is regulation
with NYMEX. That is a regulated market.
Mr. Lukken. Correct.
Senator Levin. It has got consequences. This is what the
Amaranth head energy trader had to say in an e-mail:
``Everybody is high on ICE these days.'' He is writing to
somebody. ``You think it had its day or more to go?''
And then he says, ``One thing that's nice is there's no
expiration limits, like NYMEX, clearing.'' In other words, this
is a lot easier. ``And this alone,'' he says, ``will keep it--
ICE--strong.'' No limits like NYMEX, and that is going to keep
ICE strong. And I hope we are going to hear back from CFTC. If
you say it is worthy of discussion, we hope you will take it
up, discuss it, and let this Subcommittee know what you are
going to do, if anything.
Senator Coleman.
Senator Coleman. Just to follow up, just to be optimistic,
and I want to be optimistic that this report and these hearings
hopefully have generated discussion, and obviously the concern
that we have, the ability to simply move from regulated to
unregulated is something that has to be dealt with. It puts
consumers at risk.
It is interesting, because I have a different e-mail that I
was looking at, again, from the Amaranth trader, who also
talked about--said that we have exchange limits, and then
somebody responded, ``You got me confused.'' He says, ``On
NYMEX, not on ICE.'' And then he says, ``For June expiration.''
But then he says, ``They settle the same.'' And so, clearly,
they get it. It is important that we get it.
Just one other area that I want to touch upon, and we are
assuming--and I think we are moving at a path that--giving ICE
the ability, the authority to regulate. If a concern is
resources, wouldn't it make sense to extend some regulatory
oversight responsibilities to ICE so that it is less of a
burden on you at CFTC?
Mr. Lukken. That would make some sense, yes.
Senator Coleman. And if you do that--just, again, because I
am concerned about squeezing the balloon, as you talked about--
how do we handle the other 17 exempted electronic OTC energy
exchanges? What can you do with that? How do you bring them
into the mix?
Mr. Lukken. A lot of these markets are not in any way
linked to our regulated markets. They are very innovative
exchanges, in some ways incubator exchanges. There would be
some way to have to distinguish between those markets and a
market like ICE that really has become an exchange-like
facility. And I am not sure--it is difficult to draw that
delineation, but somehow that would have to be done.
Senator Coleman. One of the concerns--we have used this
phrase ``unintended consequences.'' I think perhaps we should
discuss it. I presume a concern is that if we raise the cost of
regulation to a certain degree, these exchanges, the small
ones, simply move offshore.
Mr. Lukken. Correct.
Senator Coleman. And then we have no control, no
transparency.
Mr. Lukken. Yes, the one in London--this is happening in
our capital markets in some respect. So I think the concern is
making sure that the regulation fits the risks, and that is, I
think, what this Subcommittee is trying to do, what we as a
Commission try to do. I want to say that I am optimistic, too.
I don't want to sound like we are being resistant or I am
personally being resistant. This is new territory for me, so I
am hopeful that we can get together as a Commission to talk
about these ideas and come back to this Subcommittee if we can
reach some conclusions about what needs to be done in this
area.
Senator Coleman. And raise the issue of the voice-brokered
markets, with electronics today there are a lot of things that
can go on. It was clear in Amaranth that they were looking to
move, if they could have done a voice-brokered deal bilateral,
they would have done that. Can you talk to me a little bit
about monitoring preventive excessive speculation price
manipulation when you are dealing with something as opaque as
the voice-brokered markets?
Mr. Lukken. Some of it has to do with whether these are
standardized contracts or individually negotiated contracts. It
would be very difficult for us and very resource-intensive for
us to take every individually negotiated bilateral contract and
try to make some regulatory use of it. It would be sort of
garbage-in, garbage-out type of a problem for us.
So we want to make sure that whatever we are getting has
some relevance to the price discovery process. I think there
are maybe some areas that have some relevance, but it is of
limited use. So I think it is going to have to be a question of
resources and cost/benefit analysis in that area.
My personal feeling is that bilaterals haven't been really
im-pactful on the price discovery process. It has mainly been
these standardized exchange-like facilities that have been
linked.
Senator Coleman. And I look forward to that discussion. In
a simplistic sense, we can regulate all of this, but there is
then a cost and there is a price. And is it worth the price?
And what is the cost? And, again, does it ultimately drive
things to a more opaque place?
I look forward to the discussion, but it is very clear to
me--and I have, again, been very concerned about the unintended
consequences. But to listen to the Amaranth people and to
listen to the ICE and NYMEX folks, who we issue an order--NYMEX
issues an order, says to Amaranth, ``You have got to lower your
position,'' and it is like me telling my kids to do something
and knowing that they are just going to go over and totally
ignore that, and have people have a sense that we have
accomplished something.
I would suggest that does not provide the protection that
you were talking about and that piece has to be dealt with, and
I think the question is how do we deal with it in a way that
actually makes a difference.
Mr. Lukken. Right.
Senator Coleman. Thank you, Mr. Chairman.
Senator Levin. Thank you very much.
Just a couple questions. Do you know if the President's
Working Group has taken a position on this matter?
Mr. Lukken. I am just a recent member of the President's
Working Group, so I am not sure if they--on the matter of
position limits or----
Senator Levin. No. On whether or not we should have ICE
being given responsibility the way NYMEX has to enforce our
laws.
Mr. Lukken. I am not aware. Not being a member of the
President's Working Group until recently, I am unaware of
whether they have.
Senator Levin. Whether there have been any discussions
between CFTC and the working group on any of the issues we have
discussed today?
Mr. Lukken. I think there has been discussion on Amaranth
and the follow-up from Amaranth. The President's Working Group,
I think, what were the concerns that arose out of Amaranth,
including many of the issues we discussed today.
Senator Levin. And CTFC, have you had discussions on this?
Mr. Lukken. We have had some follow-up on Amaranth itself,
and----
Senator Levin. No. In terms of the subject that we talked
about today.
Mr. Lukken. We have not.
Senator Levin. How come? It has been a year.
Mr. Lukken. On the authority of whether 2(h) should be----
Senator Levin. Yes, how to avoid another Amaranth.
Mr. Lukken. Well, we certainly have taken measures since
Amaranth within our existing authority to try to prevent that
type of a situation in the future.
Senator Levin. In terms of additional authority, though,
you have not discussed that?
Mr. Dunn. I have discussed it with my staff on what would
be some----
Senator Levin. As a Commissioner, have you done it?
Mr. Dunn. I have not done it as a Commissioner.
Senator Levin. OK. Let me just summarize. Amaranth engaged
in excessive speculation. The victims were consumers who got
hit with inflated prices, distorted prices. CFTC did not
realize what happened at the time. The Subcommittee has spent a
lot of time analyzing this. We have analyzed the NYMEX and the
ICE data to figure out what happened. It is clear what has
happened here and that when a speculator or trader was told by
the agent of the government agency to reduce its position,
instead of carrying out that order, it bypassed it, undermined
it, circumvented it by just going to an unregulated market. It
seems to me that totally thwarts the purpose of our statute. It
thwarts the purpose of the CFTC giving NYMEX the responsibility
that you have given it to stop excessive speculation.
I do not see from what I have heard today that at least the
acting chairman is aggressively interested in doing what
apparently ICE is willing to do, which is to step into the
breach and to enforce some rules against excessive speculation.
There is a willingness to talk about it, apparently, but that
does not seem to be very responsive to what is an obvious
willingness on the part of ICE to do what NYMEX does, which is
to stop something which hurts people.
We all agree excessive speculation hurts consumers.
Everyone agrees with that. There is a law against it. It may
not be defined in the law. It is enforced. And if it needs
definition, you folks should give it definition. That is your
responsibility. We have not heard any murmurs from you folks
about defining ``excessive speculation.'' If it needs to be
defined, go ahead and define it. But it is not acceptable to
this Senator to just have the independent agency which is
supposed to be enforcing law against excessive speculation to
take a fairly lukewarm response, to give a lukewarm response
when there is such a proven problem here which has cost a lot
of people, a lot of consumers, a lot of users a lot of money.
I hope that the CFTC will do what you, the acting chairman,
now say it will do. Long overdue, as far as I am concerned. I
hope you will take it up, discuss the possibilities, give us
your thoughts and your recommendations in terms of legislation.
These have been extremely valuable reports and hearings. I
think everybody will acknowledge that, regardless of what
position they are in or what view they take of the issue. Our
staffs have done an extraordinary job of digging for over a
year. Millions of transactions have had to be analyzed, and
what has been demonstrated is something which is pretty
shocking and which has got to be prevented, not just responded
to after the fact.
So I will turn to Senator Coleman and see if he has any
final comment.
Senator Coleman. I think you have done an excellent job of
summing up. I look forward to the ongoing conversations and,
beyond that, subsequent action to increase accountability and
increase transparency. Clearly, there are lessons to be learned
from Amaranth, and I would hope--and I firmly believe that we
all understand the key is to make sure it does not happen
again, to use the powers that we have, and if there is
additional power that is needed, either the agency itself or,
again, even working with ICE and others, that we would move
forward in that direction.
I thank the Chairman and again want to applaud the staff,
who I think has done a tremendous job. Thank you.
Senator Levin. Thank you. Thank you all.
Mr. Dunn. Mr. Chairman.
Senator Levin. Excuse me. Please, Mr. Dunn.
Mr. Dunn. In earlier testimony, one of the folks that
testified here used an excerpt of a speech that I gave back on
September 8 of last year. I would like for the record to insert
the entire excerpt that I gave on the energy matter during that
speech, if I may, please.\1\
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\1\ See Exhibit 16 which appears in the Appendix on page 904.
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Senator Levin. Of course. That will be made part of the
record.
Mr. Dunn. Thank you, sir. Thank you both.
[Whereupon, at 4:59 p.m., the Subcommittee was adjourned.]
A P P E N D I X
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