Presentation to UH-GEMI Energy Trading
Conference
January 26, 2005
Legislative Environment Re: Energy Trading
George D. Baker
Partner
Williams & Jensen, PLLC
1155 21st Street, NW
Washington, DC 20035
202-659-8201
gdbaker@wms-jen.com
Recent Legislative Developments: Looking Back to 2005
August 2005: Energy Policy Act enacted
Key features: Substantial changes affecting broad
spectrum of energy supplies
Traditional: Oil, Gas, Coal, Electricity, Nuclear,
Hydro, PUHCA Repeal
Alternative: Ethanol, Bio-fuels, Wind, LNG,
Solar, Hydrogen
Major Energy Tax Provisions
Significant Energy Trading Provisions of
Energy Policy Act:
• Mandated CFTC-FERC MOU re: information
access/sharing between the two agencies to
facilitate respective regulatory missions
- MOU completed on October 12, 2005
• New FPA Prohibition on False Reporting to
Federal Agencies
- Prohibits “any entity” from willfully and
knowingly reporting any information relating to
the price of wholesale electricity or availability
or transmission capacity, known to be false at
time of reporting, to a federal agency with
intent to affect the data being compiled by the
agency.
• Mandated new FERC Market Manipulation Rule
affecting “any entity” in electricity and natural
gas markets (Section 315 and 1283):
- FERC issued rule January 19, 2006
- Applies to both NGA and FPA
- Based on SEC rule 10b-5: expect carryover of SEC
interpretations
•
Key Provisions of New Market Manipulation
Rule:
- Applies to anyone—NOT just jurisdictional players such as
pipelines and utilities.
- Prohibits “any entity”, directly or indirectly, in connection with
the purchase or sale of natural gas or the purchase or sale
of transportation service subject to the jurisdiction of the
FERC, or in connection with the purchase or sale of electric
energy or the transmission services subject to the jurisdiction
of the FERC from:
1. using or employing any device, scheme or artifice to defraud,
2. making any untrue statements of material fact or omitting to
state a material fact necessary in order to make statements
made, in light of the circumstances under which they were
made, not misleading; or
3. engaging in any act, practice or course of business that
operates or would operate as a fraud or deceit upon any
person.
•
Enhanced fines and penalties for violations of Federal
Power Act, Natural Gas Act and Natural Gas Policy
Act (Sections 314 and 1284)
Criminal Penalties:
increased from $5,000 to $1 million and from two
years imprisonment to five years
Fines:
Increased from $500 to $50,000 for each day of
continuing violation of NGA and NGPA
Increased from $500 to $25,00 for each day
continuing violation of FPA
Civil Penalties:
Increased from $5,000-10,000 to $1 million for each
day of violation of NGA, NGPA or FPA
• FERC authorized to create electronic information system
to provide FERC, state commissioners and public with
access to information for facilitating price transparency
and participation in electric energy markets
(Section 1281)
Discretionary for FERC; Not mandated by Congress
FERC must consider price transparency provided by existing
indexes and trade services and rely on them to maximum
extent possible
FERC can exercise its authority to create its own electronic
system upon determination that existing indexes and trade
services are inadequate.
• Energy Policy Act addressed numerous issues
in Senator Feinstein’s “Energy Markets
Improvement Act’ (S 509):
Market Transparency
Prohibition of Round Trip/Wash Trading
Enhancement of FERC enforcement authority and
criminal/civil fines and penalties for violations
• But the Energy Policy Act DID NOT contain certain
other provision of S 509:
NO extension of CFTC jurisdiction to OTC energy trading where
such transactions perform a “significant price discovery function”
NO revision of CEA Section 2(h) to bring electronic energy trading
systems (such as ICE) under CEA anti-fraud/anti-manipulation and
record keeping/reporting provisions
NO Amendment of CEA Section 4b anti-fraud provision to extend to
principal to principal OTC trading
BOTTOM LINE: Politics of California market scandals were not
extinguished by Energy Policy Act and Feinstein is NOT going away.
• Nor did Energy Policy Act Satisfy Politics of Spike
in Natural Gas and Gasoline Markets
Result: Evolution of Graves/Barrow legislative proposals demanding
increased regulation of energy trading on NYMEX and OTC energy
trading.
Initial Key themes: Radical Approach seeking to:
- extend CFTC's jurisdiction to cover OTC natural gas trading
and ICE
- amend the CFMA to:
eliminate NYMEX's self-certification of rules/products,
(treat energy products like ag commodities)
require NYMEX to have tighter trading limit rules, and
require daily reporting of gas storage info
With Energy Policy Act already enacted into law last
summer, obvious legislative vehicle to address
Feinstein and Graves/Barrow: CFTC Reauthorization
December of ’05: CFTC Reauthorization
House passes CFTC Reauthorization (HR 4473) :
Key Amendments to Commodity Exchange Act:
∙
PWG Package of Recommendations:
- Zelener fix for Retail FX contracts
- CFTC-SEC joint rules for Risk Based Portfolio Margining
for Security Futures and Options, and Expanded Authority
for Futures on Security Indexes.
1. Zelener fix: limited to Retail FX contracts
- Clarifies that CFTC has anti-fraud/anti-manipulation jurisdiction over
futures and non-futures contract in FX that are:
offered to/entered into with non “eligible contract participant”
(i. e. retail customers)
by someone other than an “otherwise registered” financial
entity (not broker-dealer, insurance company, bank)
on a leveraged or margined basis
and is not a “security” or results in actual delivery within 2
days, or creates an enforceable obligation to deliver/accept
the currency
- Requires registration of “Solicitors” of such retail FX contracts.
QUERY: Is scope (limited to FX) adequate? Extend to energy related
products?
(PWG Package Cont’d)
2. Mandate CFTC-SEC joint rules on Portfolio
Margining and Broad-Based Security Indexes:
Allow Risk Based Portfolio margining for Security Futures Products
and Security Options by September 30, 2006
Allow Trading of Futures on Broad-Based Security Indexes
(foreign equities; corporate/sovereign bond indexes) by
June 30, 2006
Amendment to CEA Section 4b:
- Extend CFTC anti-fraud authority over principal-toprincipal trading of futures, including “excluded/exempt”
energy products whether transacted OTC or on a
derivatives transaction execution facility
- Increases civil penalty for CEA violations to greater of
$1million or triple monetary grain from violation
- Increases criminal penalty to $500,000 fine and 10 years in
prison
•
Compromise Re: Energy trading (Graves/Barrow)
-
Mandate to CFTC to increase natural gas Market
Surveillance to deter and detect manipulation and increase
transparency
-
Special CFTC Review when natural gas futures exchanges
experience “significant and highly unusual change in
settlement price”
-
Require CFTC to require reporting by large natural gas
position holder regarding “ANY RELATED CONTRACT,
AGREEMENT OR TRANSACTION IN NATURAL GAS
TO WHICH THAT PERSON IS A PARTY”
Senate still must pass its bill (S 1566):
∙
Key features of ‘Consensus” Ag and
Banking Committee bill:
- PWG Recommendations: Zelener fix, CFTC-SEC joint
rules re: Risk Based Portfolio Margining and Broad
Based Indexes
- Amend Section 4b re: anti-fraud jurisdiction
- Increased Civil and Criminal Penalties
- plus - ”Clarify” Section 9 re: CFTC Civil Enforcement
Authority for False Reporting.
Amendment to CEA Section 9
-
“Clarifies” CFTC’s civil enforcement authority to pursue certain civil
cases under existing criminal provision (Section 9)
-
Section 9 makes it a felony to knowingly make false, misleading or
inaccurate reports regarding the price of any commodity, including
electricity and natural gas
-
CFTC has used Section 9 in over 30 recent monetary settlements
for “false reporting” by energy trading firms or their traders
involving fictitious transactions, or reporting of altered or false data
on transactions to index publishers in attempt to manipulate the
indexes.
Controversy: whether CFTC can use Section 9 on transactions
otherwise “excluded” from its jurisdiction under CEA 2(g). Recent court
cases say CFTC can do so.
So what will happen on CFTC Reauthorization?
Lots of Consensus Exists on Most Provisions
BUT,
Biggest Political Problem: Energy Trading Issues
Politics of Energy Trading Issues in CFTC
Reauthorization in 2006:
-
2005 Energy Bill did not adequately address price and supply
in the short run
∙ Claims that energy cost spikes are causing
-
demand destruction
-
decreased US industrial competitiveness
-
US unemployment job/plant migration abroad seeking lower
cost energy
-
increased cost of fertilizer and farm chemical/fuel inputs
∙
Proponents claim that rise in energy prices is
manipulated:
who is to blame?
-
Accuse hedge funds/speculators for preying on markets and injecting
artificial “demand” and artificial price premium.
- Accuse regulated energy exchanges of failing to protect markets from
manipulation by hedge funds and speculators
-
Accuse regulators of failing to protect markets from manipulation by
hedge funds and speculators
Political Impact:
∙
Members of Congress show sympathy for their
constituents’ complaints re: cost and impacts
of high natural gas and gasoline prices, but not
clear how to help:
- political frustration
∙ Members of Congress do not show sympathy for
energy traders, speculators, hedgers, but they
generally want to avoid undue market interference
and don’t want to impede healthy markets.
-
political frustration
Result: Political frustration breeds risk of political response in this
Election Year
Organized lobbying by industrial gas users dovetails with
residual distrust of Wall Street and energy markets from
“Enron” era scandals:
∙
Demands for Response have included:
- Roll back CFMA reforms:
Exchange self-certification
Treat energy products like agricultural commodities
Mandate CFTC regulation of OTC energy
markets/ ICE
Modify “exempt” status under CEA
Mandate tighter trading limits by exchanges
Prohibit speculator/hedgers from energy markets
View of Prospects in 2006:
Query: Impact of energy politics in an election year tinged with scandal?
Since House has passed its CFTC bill, all eyes are on the Senate
Question:
What will Feinstein amendment be?
Feinstein has not revealed the substance of her amendment
Likely focused on extending CFTC jurisdiction to OTC
energy trading: target 2(g) and 2(h) “loopholes”
Feinstein has a commitment from Republican Leadership to
allow her to offer her amendment
Question:
Will Other Democratic energy amendments arise?
Cantwell: Address energy price gouging
Reid:
Address cost of natural gas (industrial
gas users)
Question:
Will Senate Republicans agree to allow such other
Democratic energy amendments (besides Feinstein) to
be considered on the floor?
Some Republicans are strongly opposed to ANY energy
amendments being considered other than Feinstein’s.
This view is strongly supported by ISDA, SIA, BMA
and others
If not, will CFTC Reauthorization founder for 2006?
Question:
Will Senate defeat the Democratic amendments,
including Feinstein, this time around?
Questions:
If Senate passes a bill without any energy amendments
will the House drop its own “Graves/Barrow”
compromise provision in conference?
If Senate can’t pass a bill without an energy trading
amendment, will there be a conference with House?
What will happen in conference (and when)?