Presentation to UHGEMI Energy Trading Conference - PowerPoint PPT Presentation

Title: Presentation to UHGEMI Energy Trading Conference


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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 gdb
aker_at_wms-jen.com
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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
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• 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

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• 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.

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• 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

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• Key Provisions of New Market Manipulation Rule
• - Applies to anyoneNOT 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.

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• 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

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• 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.

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• Energy Policy Act addressed numerous issues
• in Senator Feinsteins 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

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• 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.

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• 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

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With Energy Policy Act already enacted into law
last summer, obvious legislative vehicle to
address Feinstein and Graves/Barrow CFTC
Reauthorization
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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.
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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?
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• (PWG Package Contd)
• 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

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Amendment to CEA Section 4b- Extend CFTC
anti-fraud authority over principal-to-
principal 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

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• 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

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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.
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Amendment to CEA Section 9 - Clarifies
CFTCs 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.
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So what will happen on CFTC Reauthorization?
Lots of Consensus Exists on Most
Provisions BUT, Biggest Political Problem
Energy Trading Issues
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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
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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
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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 dont want to
impede healthy markets. - political
frustration Result Political frustration
breeds risk of political response in this
Election Year
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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
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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 Feins
tein has a commitment from Republican Leadership
to allow her to offer her amendment
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Question Will Other Democratic energy
amendments arise? Cantwell Address energy
price gouging Reid Address cost of natural
gas (industrial gas users)
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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
Feinsteins. This view is strongly supported
by ISDA, SIA, BMA and others If not, will
CFTC Reauthorization founder for 2006?
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Question Will Senate defeat the Democratic
amendments, including Feinstein, this time
around?
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Questions If Senate passes a bill without any
energy amendments will the House drop its own
Graves/Barrow compromise provision in
conference? If Senate cant pass a bill without
an energy trading amendment, will there be a
conference with House? What will happen in
conference (and when)?