Nick Snow
Washington Editor
WASHINGTON, DC, Oct. 23 -- US Congress should consider expanding the Commodity Futures Trading Commission's authority over energy derivatives trading, particularly in exempt commercial markets, the General Accounting Office said in an Oct. 19 report.
The report was released days before the hearing on the CFTC's reauthorization, which is scheduled for Oct. 24 by the US House Agriculture Committee's General Farm Commodities and Risk Management Subcommittee. CFTC Acting Chairman Walt Lukken and GAO Financial Markets and Community Investment Director Orice Williams, the report's author, are scheduled to testify.
CFTC also held a day-long hearing Sept. 18 to examine regulated exchanges and exempt commercial markets. Its staff is developing recommendations, but it is not clear if they will be presented at the House subcommittee hearing.
GAO's report noted that under the Commodities Exchange Act, CFTC's authority to protect market users from fraudulent, manipulative, and abusive energy derivatives-trading practices focused on traditional exchanges such as the New York Mercantile Exchange.
It said the commission facilitates market transparency by publishing aggregate trading information for oil producers, refiners, and other large commercial traders, and for hedge funds and other noncommercial traders by compiling Commitment of Traders (COT) reports. These reports include the number of traders, changes since the last report, and open positions, i.e., obligations to take or make delivery of a commodity in the future without a matching obligation in the opposite direction.
"However, because of changes and innovation in the market, methods to categorize these data can distort the accuracy and relevance of the information to the public," GAO's report said.
Exempt markets emerge
The energy derivatives market has changed in other ways, it noted. Specifically, trading has grown on other markets, namely [over-the-counter] markets and exempt commercial markets, i.e., electronic trading facilities that trade exempt commodities, more than half of which trade in energy products, it said.
CFTC currently receives from such markets limited derivatives-trading information such as allegations of fraud or suspected manipulation and price, quantity, or other data on contracts that average five or more trades a day, according to GAO. It said the commission also might receive from OTC participants limited information such as trading records to help CFTC enforce CEA's antifraud or antimanipulation provisions.
"The scope of CFTC's oversight authority with respect to these markets has raised concerns by some members of Congress and others that activities on these markets are largely unregulated, and that additional CFTC oversight is needed," the report said. It noted that CFTC held the September hearing, where assessments included whether markets besides NYMEX serve a price-discovery function—the process of determining a commodity's price on the basis of supply and demand.
To detect fraudulent or abusive energy futures trading practices, CFTC monitors trading on NYMEX and other regulated exchanges and examines daily electronic futures trading data and other information sources, such as commercial energy commodity sources and tips from individuals on possible violations, GAO said.
"CFTC staff said they routinely investigated traders with large open positions. However, the staff added that they do not routinely maintain information about such inquiries; instead they documented their actions only when further action was warranted. This lack of information makes it difficult to determine the usefulness and extent of these activities," it said.
$305 million of fines
The report said CFTC has noted that it coordinates its enforcement actions with NYMEX as well as with the Federal Energy Regulatory Commission, US Department of Justice, and others. The commission also has taken enforcement actions in cases of attempted manipulation and other abusive energy derivative-trading practices, which resulted in $305 million in fines during 2001-05.
"While these cases have been successfully pursued, it is difficult to determine whether they have helped deter market manipulation or the other abusive practices these pursuits addressed, because the effectiveness of enforcement activities is not easily measured," said GAO. It said the White House Office of Management and Budget has concluded that the CFTC's enforcement program lacks performance measures that illustrate whether it is meeting its overall objective.
The GAO report recommended that Congress consider whether CFTC has enough enforcement authority to assure that energy commodity markets, particularly those that are exempt and provide adequately for fair trading and accurate pricing, and it made three recommendations to Lukken and CFTC itself:
-- It suggested that the commission examine classifications in the COT reports to determine if the categories need to be refined to improve the relevance, transparency, and accuracy of public information on trading activities.
-- It suggested that the CFTC explore ways to routinely maintain records of inquiries into alleged improper trading activity to more fully determine the usefulness of its surveillance, antifraud, and antimanipulation authorities.
-- It recommended that the CFTC more fully demonstrate the effectiveness of its enforcement activities by developing additional outcome-related performance measures that better reflect progress on meeting the program's overall goals.
In an Oct. 5 response, Lukken said that, of alternatives to regulated energy and metals trading, exchanges exist where many swap dealers trade both with commercial firms hedging price risk and with speculators taking on price risk. The overall futures positions of such traders in regulated markets do not necessarily correspond to their OTC commodity transactions, he indicated. "It would be difficult, if not impossible, to link these residual futures positions with the underlying activity that makes up the 'book' of the swap dealer," the acting CFTC director said.
Lukken said CFTC agrees that further documentation of surveillance inquiry decisions could help the commission manage its staff resources and would be beneficial to congressional oversight. "Accordingly, the commission will explore additional record-keeping procedures for staff but must balance the time required for such additional record-keeping procedures against the need to undertake market surveillance by an already stretched surveillance staff," Lukken said.
Contact Nick Snow at [email protected].
