NEFI Calls for Expanded Market Protections

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Former chairman testifies before congressional subcommittee

The New England Fuel Institute (NEFI) and the Petroleum Marketers Association of America (PMAA) called for expansion of protection for small hedgers during a recent congressional committee hearing.

NEFI Chairman of the Board and PMAA Heating Fuels Chair Sharon Peterson asked former NEFI Chairman Howard Peterson to testify during a recent hearing of the U.S. House Agriculture Committee’s Subcommittee on Commodity Exchanges, Energy, and Credit. The panel was exploring the pending reauthorization of the Commodity Futures Trading Commission (CFTC).

“We could not miss this opportunity to get our concerns before Congress, especially given the impact these issues have on NEFI members and consumers,” Sharon Peterson said. “Our input aimed to insure that the regulatory process is fair to both Main Street and Wall Street and that the CFTC budget is adequate to meet the congressional mandates on both segments of society.”

Howard Peterson, owner of Peterson Oil Service in Worcester, Mass., was one of several witnesses providing testimony, along with Douglas Christie, of Cargill Cotton, on behalf of the Commodity Markets Council; Lael Campbell, of Constellation/Exelon, on behalf of Edison Electric Institute; Lisa Cavallari, of Russell Investments, on behalf of American Benefits Council; and Mark Maurer, of INTL FCStone Markets LLC.

In his written testimony, Peterson explained that heating fuel dealers and other petroleum marketers “rely on functional futures, options and swaps markets as a hedging and price discovery tool, in order to minimize price volatility and to provide customers with the most affordable product possible.”

He made several specific recommendations on how Congress can better protect bone-fide hedgers.

  • Reinforce Congressional Intent Regarding End-users. “In enacting the Dodd-Frank Act, Congress did not intend for many of its rules and regulations to adversely impact bona fide end-users of commodity derivatives, including businesses like mine. Therefore, we commend this committee for reinforcing end-user protections in Title III of H.R.4413 last year,” Peterson testified. “However, NEFI and its coalition allies would like to caution this committee against inadvertently creating new loopholes or regulatory exclusions that might benefit financial institutions and other large market participants by weakening exemptions meant only for bona fide commercial hedgers.”
  • Prevent Cross-Border Regulatory Arbitrage. “We also caution the committee against intervening in CFTC negotiations with its overseas counterparts regarding the harmonization of cross-border regulation of derivatives transactions,” he testified. “Systemically significant market participants, especially large financial institutions, should not be allowed to evade U.S. oversight and regulation by trading through off-shore branches, subsidiaries and affiliates. As we learned from the 2008 financial crisis and the LIBOR scandal, the Amaranth case and other instances of market manipulation, cross-border derivatives transactions can have significant consequences for American businesses and consumers and the broader U.S. economy.”
  • Expand the Study into High-Frequency Trading. “The committee was wise to include a study into High-frequency Trading in H.R.4413 last year, however this study should be expanded,” Peterson testified. “Congress should require a broad inquiry into the role of new trading technologies and practices that utilize complex algorithms and conduct automated trading, and the development new transmission technologies. It should also examine the cyber-security and national security implications of such technologies and activities, their impact on market volatility, and whether or not they could (intentionally or unintentionally) disrupt or manipulate futures and swaps markets.”
  • Increase Penalties for Fraud and Manipulation. “The previous reauthorization in 2008 strengthened antifraud provisions and increased civil monetary penalties for manipulation from $500,000 to $1 million per violation,” Peterson wrote. “As a matter of course, these penalties have become insignificant when compared to the overall profits of large market participants and have become part of the “cost of doing business.” The committee should take a “zero tolerance” approach to such behavior. We urge you to include in reauthorization an increase in fines and penalties for fraud, manipulation and other severe violations of the law, and include jail time as appropriate in order to further deter such acts.”
  • Remove Expanded Cost-benefit Requirements. “As a heavily regulated business I understand and appreciate the importance of thoroughly weighing potential costs and benefits of any federal rule or regulation,” he testified. “However, unlike many federal agencies, the CFTC is already subject to robust cost-benefit requirements. In many of its final rulemakings, the commission “quantified a variety of costs, considered alternative approaches, sought to mitigate costs and responded to significant comments” and in one instance the quantification of costs ran on for 24 pages in the Federal Register. Furthermore, costs and benefits with respect to certain financial regulations can be difficult to quantify, especially in the case of prophylactic regulations such as the position limits rule. The dramatic expansion of cost-benefit requirements proposed under Section 203 of H.R.4413 last year would establish unreasonable hurdles for the CFTC to overcome, including a requirement that the CFTC analyze abstract and theoretical cost impacts and that it list all of the ambiguously defined “alternatives.” This could lead to more litigation, not less, and result in the significant and unwarranted delay of many new rules, including those meant to protect small hedgers.”

The former NEFI Chairman also pointed out that after the 2008 financial crisis commodity-dependent industries made a great case to Congress for commodity market reform, and Congress responded by doing three important things. “First, in an attempt to improve price transparency and market surveillance and to further protect end-users against fraud and manipulation, it expanded CFTC jurisdiction to the $700 trillion (notional value) over-the-counter swaps markets,” he noted. “Swap dealer registration, data collection, price transparency, and central clearing helps to promote greater competition in these markets and is necessary in order to hold parties responsible for violations of the Act. Prior to the enactment of Dodd-Frank, these markets were almost entirely opaque and on several occasions had given cause to alleged or proven cases of market manipulation.

“Secondly, Congress also strengthened the CFTC’s ability to prosecute instances of manipulation and attempted manipulation, including expanded authority to prevent disruptive trading practices and the inclusion of Senator Cantwell’s ‘Anti-manipulation Amendment.’ The Cantwell Amendment provided the CFTC with new authority to more effectively prosecute and deter manipulation by changing the burden of proof from ‘specific intent’ to the same fraud-based ‘reckless conduct’ standard employed by the Securities & Exchange Commission (SEC) and other financial regulators. The effects of these measures to bolster the policing and prosecution of fraud and manipulation are clear. Since 2009, penalties imposed by the CFTC have increased from $100 million in Fiscal Year 2009 to 1.8 billion in Fiscal Year 2014.

“Lastly, Congress included in Dodd Frank a requirement that the CFTC impose speculative position limits across all commodities in the futures and swaps markets. This includes energy futures and OTC energy and agricultural swaps which had been exempt from such limits since the enactment of the Commodity Futures Modernization Act of 2000. The ‘position limits mandate’ was included in response to concerns raised by NEFI, its coalition allies and other bona fide hedgers that excessive speculation was harming price discovery and their ability to effectively manage commodity price risks. Congress included the mandate as a prophylactic measure to help prevent a repeat of the 2007-2008 commodity market bubble, to minimize wild price swings and extreme market volatility, and to prevent market manipulation.”

CFTC Should Set and Enforce Position Limits

Peterson pointed out that the rule was included with broad bipartisan support. “In fact, as far back as the 110th Congress, a stand-alone bill that would have mandated the imposition of speculation limits was passed with broad bipartisan support,” he testified. “The bill, known as the Commodity Markets Transparency and Accountability Act of 2008, passed with the support of 69 Republicans.”

Congress had required that the CFTC promulgate a position limits rule by mid-January 2011, Peterson told the committee. “Four years have now passed and the CFTC has still not finalized a rule. A revised rule was proposed in December of 2013 that addresses the concerns of the court and that seeks additional input from bona fide hedgers on the proper structure of the hedge exemption. This is the third position limits rule to be considered by the CFTC since January 2009. Over the last fifteen months the current proposal has been opened up to public comments at least four times,” he added.

A recent suggestion to let the exchanges set their own speculative positions is troubling to NEFI, according to Peterson. “Commodity exchanges are not regulatory agencies tasked with protecting the public interest. They are publically traded, for-profit entities. As such, they benefit from higher trading volumes and a large number of market participants. Therefore the exchanges have a profit motive to make position limits voluntary or unreasonably high, and to institute broad hedge exemptions that may include non-commercial market participants (such as financial speculators). NEFI strongly opposes these suggestions. They clearly run contrary to the intent of Congress, which is that the CFTC—not the exchanges or self-regulatory organizations—should be tasked with the responsibility to set position limit levels and define who should be eligible for bona fide hedge exemptions.”

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