Presentation to National Association of State Utility Consumer by nyx11518


									 Presentation to National
Association of State Utility
  Consumer Advocates

               Richard A. Shilts, Director
              Division of Market Oversight
                     November 13, 2007
         The views expressed are those of the author
 and do not necessarily represent those of the CFTC or its staff
 The Role of the Commodity
Futures Trading Commission
 (CFTC) in the Oversight of
    Natural Gas Markets

Topics to be Addressed Today
○ Background on CFTC
○ The Commodity Exchange Act (CEA) and
  the Concept of Tiered Regulation
○ CFTC’s Oversight of Regulated Futures
  Markets (NYMEX)
○ CFTC Oversight of Exempt Markets (ICE)
○ CFTC Exempt Commercial Market
  Hearing and Recommendations

○ Independent Government Agency
   ● Dates to 1922 (independent in 1975)
○ Oversees U.S. Commodity Futures and
  Option Markets
○ Key Mission
   ● Ensure market and financial integrity of risk-
     management/price-discovery markets in the
   ● Protect participants against manipulation,
     abusive trade practices, and fraud

Organization of CFTC
○   Staff of About 450
○   Five Commissioners (four currently)
○   Chairman – Walt Lukken
○   Three Operating Divisions
    ●   Market Oversight
    ●   Clearing & Intermediary Oversight
    ●   Enforcement
○   Other Offices
    ●   General Counsel
    ●   Chief Economist
    ●   International Affairs

Challenges Facing CFTC
○   U.S. Futures Markets Growing Rapidly
    ●   Annual volume over 3 billion contracts
○   Many New Novel Products
    ●   Credit, real estate, political events
○   Electronic Trading
    ●   Now, 80% of total U.S. futures trades
○   Globalization and Consolidation
    ●   CME-CBOT merger
○   Possible Changes to Law Governing Derivatives
○   Staffing and IT Resources

The Commodity Exchange Act
  and the Concept of Tiered

       CFTC Jurisdiction Over
        Energy Transactions
                                            Limited Jurisdiction
                                      (e.g., manipulation, fraud, and
Comprehensive                         compliance with conditions for
 Jurisdiction                                 the exemption)

               DCM                    Exempt
             Futures &              Commercial
              Options         NYMEX  Markets
     NYMEX                                       ICE Atlanta

             Over-the-Counter & Cash Markets
                    Limited Jurisdiction
              (e.g., manipulation, false reporting)

 CFTC Oversight of Regulated
Futures Exchanges (Designated
  Contract Markets or DCMs)

Key Elements of CFTC Oversight
of Designated Contract Markets

○   Ongoing Oversight and Surveillance
    ●   Exchange Oversight
        ○ “Audits” of DCM compliance with CFTC requirements
        ○ Called “rule enforcement reviews” (RERs)
    ●   Trading Oversight
        ○ Contracts not readily susceptible to manipulation
        ○ Surveillance

○   Enforcement Action
    ●   Against traders if violation of law/CFTC regulations
    ●   Against exchange if failure to meet requirements

Rule Enforcement Reviews
○ All Key DCM Programs Reviewed
  Every 2-3 Years
○ Programs Reviewed
   ● Trade practice surveillance
   ● Market surveillance
   ● Disciplinary actions
   ● Dispute resolution
   ● Conflicts of interest
○ Staff Issues a Public “Report Card”
                 Product Review
                  Ensure Contracts
                are Designed Properly

 Core Principle 3                    Core Principle 5
Contracts not readily              Use position limits (or
  susceptible to                  accountability) to reduce
   manipulation                    threat of manipulation

                  Section 3 of the CEA
             Ensure markets serve economic
            functions of risk management and
                      price discovery                         12
Speculative Limits
○ Limitation on Size of a Trader’s Position
   ● Exemptions for hedgers and other specified
○ Usually Applies to the Spot Month
○ Required for Futures on Tangible
   ● Physical delivery contracts – ¼ of deliverable
   ● Cash-settled contracts – at a level that
     minimizes potential for manipulation
     considering elements of price series
Position Accountability
○ Exchange Sets a Trigger Level
○ Once Exceeded, Exchange has the
  Right to:
  ● Request information to support position
  ● Prohibit increases in position or force
○ Usually Applies to Non-Spot Months
  or Net All-Months-Combined
CFTC Surveillance Programs
○ Market Surveillance
   ● Focus is on traders with dominant
○ Trade Practice Surveillance
   ● Focus is on trading activity

Market Surveillance Goals
○ Detect and Prevent Price Manipulation
  and Disorderly Market Conditions
   ● No price bias
   ● Concerned with traders having large
     positions with market power
   ● Focus is on the maturing future
○ Assess Financial Integrity of Traders
○ Ascertain Impact of Traders Acting in
○ Monitor Compliance with Speculative
  Limits or Position Accountability Rules   16
Motives for Manipulation
○ Offset of a Futures Position at a Price
  Higher than Otherwise Possible
   ● Corners and Squeezes
   ● Based on dominant position in futures and
     cash markets
○ Beneficial Pricing of Contracts that
  Reference the Futures Price
   ● Many ECM contracts and over-the-counter
     swaps are priced based on a DCM futures

Market Surveillance
Program Actions
○ Economists Monitor Trading Activity
  in Every Active Futures Market
○ Information Reviewed
  ● Clearing member data
  ● Large-trader reports
  ● Open interest/volume data
  ● Futures and related cash-price series
○ Weekly Briefings of Commissioners
CFTC Trade Practice
Surveillance Program
○ Independent Check of Fairness of
○ Types of Abuses Monitored
   ● Wash trading
   ● Trading ahead of customers
   ● Money passes (such as illegal tax trades)
   ● Pre-arranged trades
○ Review Trading Data (Bid, Offers,
  Transaction Prices, Trader, Broker, Etc.)

Regulatory Response
When Problems Develop

○   Work Closely with the Exchange
    ●   Exchanges have self-regulatory responsibility to
        police their markets
○   Jawboning: Persuade Trader or Futures
    Commission Merchant to Act Responsibly
○   Issue Special Call for Information (Especially for
    Non-U.S. Accounts)
○   Regulation 18.05
    ●   Reportable traders must provide information on
        all related transactions/positions held outside the
        regulated market
Regulatory Response
When Problems Develop
○ CFTC or Exchange Emergency
  Action, Such as
   ● Margin increase
   ● Required liquidation of positions
   ● Extending the delivery period
   ● Temporarily closing a market
○ Referral to CFTC Division of
  Enforcement to Investigate
 CFTC Oversight
of Exempt Markets

   Exempt Commercial Market
○ Limited to “Exempt Commodities”
  (such as energy, metals, chemicals, pollution

○ No Intermediation – Principal-to-
  Principal Only
○ Sophisticated Traders Only (Eligible
  Commercial Entities)
○ Clearing Allowed But Not Required

Entities Filing Notices as
Exempt Commercial Markets
○ 21 Firms Have Filed Notices with CFTC
○ ICE is Largest ECM
○ Others in Energy Area Include
  NetThruPut, NGX, Houston Street, and
○ Several Started as Firms Doing a Voice-
  Broker Business Prior to Launching an
  Electronic Trading System
○ Most Have Clearing Services Available

Elements of
CFTC Oversight of ECMs
○ Initial Review of Notification Filing
   ● No formal approval
   ● Ensure compliance with filing requirements
     and certifications
○ Ongoing Requirements
   ● Identify futures contracts and file data for
     those averaging 5 or more trades per day
   ● Price-discovery requirement
   ● Notify CFTC of complaints
   ● Annual certification of continued operations
     and compliance

CFTC Authorities Over ECMs
○   Anti-Manipulation
    ●   After the fact – not proactive
    ●   Based on tips or information available to CFTC
    ●   Less information available for ECMs than for DCMs
○   Anti-Fraud
    ●   Issue: Fraud rule applies to intermediated (not
        principal-to-principal) markets [to be addressed in
○   Special Calls
    ●   To evaluate systemic risk
    ●   To enforce CFTC’s anti-manipulation and anti-
        fraud authority
Special Calls to ICE
○ Staff has Issued Three Special Calls to
  ICE for Position and Trade Information
○ Limited to ICE Natural Gas Contracts that
  are “Linked” to NYMEX
○ Purpose is to Facilitate CFTC Surveillance
  of NYMEX – Not to Regulate ICE Trading
   ● Traders on ICE may have an incentive to
     manipulate NYMEX natural gas contract

CFTC September 18, 2007,
   Hearing on ECMs
 and Recommendations

Purpose of Hearing
○ To Examine the Oversight of
  Trading on Regulated Futures
  Exchanges (DCMs) and Exempt
  Commercial Markets (ECMs)

CFTC Findings
○   The CEA’s Tiered Regulatory Approach Has
    Operated Effectively
○   ECMs Have Proven Popular for Start-Up Markets
    and Have Provided Healthy Competition for DCMs
○   Where Volume in an ECM Contract Remains Low
    and Its Prices are not Relied Upon by Other
    Markets, the Current Level of Regulation is
○   When an ECM Contract Matures (significant
    trading volume) and Begins to Serve a
    Significant Price-Discovery Function in Interstate
    Commerce, Increased Oversight is Appropriate

CFTC Initiatives
and Recommendations
○ Legislative Recommendation
   ● Establish enhanced regulatory authorities for
     ECM contracts that serve a significant
     price-discovery function
○ Establish an Energy Markets’ Advisory
○ Work Closely with the Other Regulators
  to Educate and Develop Best Practices
  for Utilities and Others Who Use NYMEX
  Settlement Prices as Pricing Benchmarks

Elements of
Price-Discovery Test
○ Materiality
   ● Trading volume high enough to influence
     other regulated contracts or to become an
     independent price benchmark
○ Linkage/Material Price Referencing
   ● Significant price-discovery indicated by
      ○ Linkage of ECM pricing to the settlement
        terms of a regulated DCM contract
      ○ Material referencing when pricing commodity

Recommended Enhancements for
Price-Discovery Contracts on ECMs
○   Require Reporting Requirements Comparable to those
    that Apply to Contracts Traded on DCMs
○   Position Limits and/or Accountability Level Regime
    ●   Comparable to what currently applies to contracts
        traded on DCMs
○   Self-Regulatory Oversight
    ●   ECMs would be responsible for detecting and preventing
        manipulation, price distortion, and disruptions of the
        delivery or cash-settlement process
○   Emergency Authority
    ●   Both the ECM or the CFTC could intervene to prevent
        manipulation and disruptions of the delivery or cash-
        settlement process

    Information on CFTC Website
○   CFTC’s ECM Hearing Report
○   ECMs Filing Notice With CFTC
○   Rule Enforcement Reviews
○   CFTC’s Market Surveillance Program
○   Speculative Limits

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