The US Senate voted last month not to give regulators authority over energy and metal derivatives, even though, that same week, a senate committee heard testimony that Enron might have manipulated electricity prices through under-regulated futures contracts traded online.
Senator Dianne Feinstein proposed an amendment to the energy bill that sought to bring both energy and metal derivatives and electronic derivatives exchanges back under the regulatory authority of the Commodity Futures Trading Commission (CFTC). They were all exempted from CFTC regulation by the Commodity Futures Modernization Act of 2000 which was pushed through by Senator Phil Gramm who also led the resistance to Feinstein’s amendment.
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Feinstein, the Capitol and Gramm: attempts to bring greater regulation to energy derivatives are meeting stiff opposition |
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Opposition also came from the SEC, Alan Greenspan and Paul O’Neill, who fear it could hamper the $73 trillion US OTC derivatives market. Gramm said: “The entire financial sector – every bank, every securities company, every insurance company – is opposed to this amendment.”
But supporters of the amendment say this was a missed opportunity. Thomas Erickson, a commissioner at the CFTC, says: “The Enron episode highlighted a gap where companies like Enron could trade electronically outside anyone’s regulatory jurisdiction.” He says existing OTC derivative regulation requires little book-keeping by traders, so in the case of a fraud or price manipulation investigation, authorities have serious difficulty in finding out what happened. “Good book-keeping and transparent pricing is not heavy-handed regulation. It’s just good business,” he says.
Erickson’s concerns about price manipulation in the energy and metal markets gained legitimacy after a Senate panel heard that Enron had manipulated electricity prices before the California energy crisis.
Loretta Lynch, president of California’s public utilities commission, told the senate committee on commerce that Enron’s ability to trade unregulated on EnronOnline allowed it to carry out transactions between its subsidiaries, thereby creating an illusion of volatility and frenetic activity in the markets. “The effect of these trades was to increase the wholesale price of electricity in the California market,” she said.
EnronOnline, which produced $330 billion in trade volume in 2000, was exempt from federal regulation under the Modernization Act of 2000 because it was an on online OTC electronic platform.
Many similar derivatives platforms sprung up after the act. Erickson says such platforms may be blurring the line between OTC derivatives such as swaps and more regulated derivatives such as futures. He says: “It’s possible that you could take futures trading onto an electronic platform and trade them in an unregulated environment, as long as it is done by eligible market participants.”
A problem with existing regulation is that it allows market participants to be self-regulating on the assumption that they are banks or other “financially sophisticated” and experienced parties. But both energy companies such as Enron that turn themselves into market makers and start-up trading platforms such as EnronOnline are not necessarily financially experienced or adequately backed up by capital rules. In other words, existing regulation presupposes a line separating banks from other market participants, when, as Enron shows, no such line exists.
Another witness at the Senate hearing, energy consultant Robert McCullough, spoke of Enron’s prescience in risk management. “Substantial evidence now exists that Enron was able to exercise market power in forward markets,” he said, adding that it tried to keep prices high during the energy crisis by taking long positions in energy forwards which are treated as OTC derivatives under an exemption passed by then-CFTC director Wendy Gramm, wife of senator Phil Gramm.
Another witness, senator Joseph Dunn, told the committee: “Enron was the benefactor of a momentous regulatory ruling in its favour by the CFTC. I will not delve into the details of the political processes and money trail implicated by these rulings, except to say that the cosy relationship between CFTC commissioners and Enron provides, at a minimum, the appearance of impropriety.”
In 1992 Wendy Gramm, then head of the CFTC, received a letter as part of a lobbying campaign by nine energy companies, including Enron, to exempt energy derivatives from the Commodity Exchange Act, and thereby from CFTC anti-fraud powers. The letter, from BP, Coastal Corp, Conoco, Enron,
J Aron, Koch Industries, Mobil, Philbro and Phillips, said exemption would “have no adverse effect on ‘the prevention of fraud’ or the protection of the public”.
Gramm approved the exemption in 1993. Five weeks later she joined Enron’s board. According to Public Citizen, Enron paid her between $915,000 and $1.85 million from 1993 to 2001. In 2000 Phil Gramm pushed through legislation that relaxed control even further. Senator Gramm, according to Public Citizen, has received $101,350 in Enron political contributions since 1989.
