CFTC & Enron loophole

CFTC Shuts 'Enron Loophole' for Gas, Limits ICE Swaps

By Asjylyn Loder

July 27 (Bloomberg) -- The Commodity Futures Trading Commission imposed rules on natural gas swaps on the IntercontinentalExchange Inc., tightening the so-called “Enron loophole” that exempted the contracts from regulation.

“To protect the American public, it is essential that we bring transparency and accountability to the marketplace,” Commission Chairman Gary Gensler said in a statement today. “Bringing this natural gas contract under the CFTC’s regulatory authority is a critical step toward ensuring a fair and orderly marketplace.”

The loophole allowed traders to sidestep New York Mercantile Exchange limits on natural gas positions which are designed to keep one investor from gaining too much control of the market. Nymex limits natural gas traders to 12,000 net futures and 1,000 in the last three trading days before the contract expires. ICE expects to create similar limits on its swap, said Kelly Loeffler, an ICE spokeswoman.

The “Enron loophole,” named for the energy company that collapsed in late 2001, refers to a provision added to the Commodity Futures Modernization Act of 2000 which exempted certain electronic markets from commission oversight.

Last year, Congress moved to restrict energy investment amid concerns that speculators were driving fuel prices to record highs. Congress put a provision in the 2008 Farm Bill that allowed the CFTC to regulate exempt contracts like the ICE Henry Hub swap if those contracts served a “significant price discovery function.” The rule announced today on the ICE contract marked the first time the commission has used that authority.

‘Welcome’ Move

“This is a huge welcome announcement by the CFTC,” said Tyson Slocum, director of the energy group at Public Citizen, a Washington-based public advocacy group. “We’ve thought for a long time that contracts being traded on ICE have had an influence on contracts being traded on regulated markets.”

Gensler, who was confirmed as chairman in May, has sought to expand the commission’s authority to control energy speculation, derivatives and over-the-counter investments. The commission will conduct hearings this week to determine how many fuel contracts one investor can hold, and under what conditions.

“We are now using some of the new tools to better protect consumers and guard against potential manipulation,” said Commissioner Bart Chilton. “We still need to do more, and Congress needs to approve additional oversight into dark OTC markets.”

Ice Action

ICE said today that it will begin immediately submitting market statistics on the Henry Hub contract to the commission. The positions of large traders of the ICE contract will be incorporated into the commission’s weekly Commitment of Traders report.

“ICE demonstrated leadership in bringing visibility into these global markets, and we have worked proactively to ensure that the CFTC has the information it needs to effectively monitor our markets,” said Jeffrey C. Sprecher, chairman and chief executive officer of ICE.

ICE has not announced what its position limits will be, Loeffler said. The limits are anticipated to be equal to those on Nymex, adjusted for the size of the contract, she said.

The ICE swap is 2,500 million British thermal units, one quarter of the size of the Nymex future. If ICE imposes limits equal to those of Nymex, the limits would be 48,000 net contracts, and 4,000 in the last three trading days before the contract expires.

Trader Exemptions

Traders who are granted a bona fide hedge exemption would be allowed to hold larger positions, just like similar traders on Nymex, Loeffler said. ICE has 90 days to issue new guidelines in compliance with the new regulation announced today by the commission, she said. Then its customers will have 90 days to comply with the new ICE rules.

The danger with the new regulation is that it comes during an “emotional, politically charged environment” surrounding speculators, said Phil Flynn, senior vice president at brokerage PFGBest in Chicago. “I’m afraid if they overdo it, they’ll hurt the marketplace by taking away liquidity.”

The limits may affect funds that invest in commodities, like the United States Natural Gas Fund, the largest exchange- traded fund in the fuel. The $4.6-billion ETF holds 312,284 natural gas swaps on ICE as of July 24, 65 percent of its investments according to its Web site.

Last week, the fund purchased bilateral swaps for the first time, beginning a shift to an investment that is not subject to size limits.

John Hyland, chief investment officer for the natural gas fund, said in a July 25 e-mail that assertions that the ETFs contribute to rising prices are “nonsense.”

“I would hope that in the upcoming hearings by the CFTC, that the commissioners would take the opportunity to, when faced by such claims by any of the witnesses, to demand that the witnesses back up their statements with facts,” Hyland said.

To contact the reporter on this story: Asjylyn Loder in New York aloder@bloomberg.net.