Blame game continues

Futures, Aug 2008 by Birkner, Christine

DAMN SPECULATORS

Speculation is still a four-letter word in Congress. The Commodity Futures Trading Commission (CFTC) remains on the defensive after a continued barrage of proposals, bills and criticisms by lawmakers demonizing and blaming speculators for higher oil prices. Even airlines are getting into the act, with an open letter urging customers to contact Congress and demand reform in the oil markets by cracking down on energy speculation. As the finger pointing intensifies, more industry leaders are speaking out about what they say is a misunderstanding on the part of Congress about the way the markets work.

"An awful lot of members of Congress don't really know much about these markets. All they know is that they're getting beat up [over gas prices], and they want to be seen as being responsive to their constituents," says John Damgard, president of the Futures Industry Association (FIA).

Commodity index funds are bearing the brunt of Congressional criticism. One new proposal from Sens. Joseph Lieberman (ID-Conn.) and Susan Collins (R-Maine) called for prohibiting pension funds and other institutional investors from investing in commodity index funds altogether. Index fund pioneer Henry Jarecki and many others say that if Congress restricts investment in index funds, American markets could become uncompetitive and eventually move offshore.

Jim Rogers, former hedge fund manager and creator of the Rogers International Commodity Index, agrees. "If this happens, it would mean that suddenly the rest of the world has been given an opportunity to break America's domination [in] commodity trading. I don't know how it would happen, but trading would shift elsewhere. Tokyo does have an energy market and Hong Kong is rapidly gearing up. Singapore, [is] trying to develop something, [as well as] Dubai and the internet. It would just drive the business out of America."

Rogers compares Lieberman's efforts to the Smoot-Hawley Tariff Act of 1930, which many economists believe intensified the Great Depression. "Senator Lieberman will become the Senator Smoot of this generation. If it happens, it's not going to solve the energy crisis. It's not going to put more oil in our tanks. oil may go down for a while, which will make things worse in the long run since demand will continue and new supply will be delayed," Rogers says.

CFTC Acting Chairman Walt Lukken, in a House Agriculture Committee hearing on July 10, said that the agency "has no evidence that speculators are broadly driving prices." In another House hearing on July 11, FIA outside counsel Mark D. Young said "FIA strongly opposes banning any collective investment vehicles, whether they are pension funds, mutual funds, commodity funds or hedge funds, from participating in futures markets." In a letter to Sen. lieberman, the Intercontinental Exchange (ICE) said that previous Senate testimony blaming "excessive speculation" for record oil prices was misguided and "government intervention with efficiently operating markets will only result in market distortions." ICE also said that "the testimony of persons predicting an immediate drop in the price of oil through the passage of legislation did not appear to be supported by any rigorous economic analysis."

An open letter to the Senate and Congress from the International Swaps and Derivatives Association (ISDA), FIA, Managed Funds Association and others called the proposals counterproductive. "Increasing regulation of derivatives will not lower energy prices and indeed, could have the opposite effect by reducing the ability of producers and commercial users to hedge," says Greg Zerzan, head of global public policy at ISDA. The FIA says that legislators are wrongly confusing speculation with manipulation. "Speculation is not price manipulation. Those who claim it is would also equate oxygen with air pollution," Young said in his testimony. Many experts maintain that rising prices are due to supply and demand factors, a weaker dollar and the growing economies of China and India. "The CFTC does not regulate prices," says William Adams, managing director at JKV Global.

On June 26, the House of Representatives passed a bill requiring the CFTC to "utilize all its authority, including emergency powers, to take steps to curb excessive speculation in the energy futures markets." In its history the CFTC has never exercised emergency powers based on price trends that have developed over months or years, but rather only in instances of manipulation threats or sudden market shocks. Damgard says that enacting emergency powers is troublesome because it could eventually lead people to trade outside the United States.

The House Agriculture Committee is examining several other legislative proposals that would affect the CFTC's authority over energy futures and swaps markets. The goal of its early July hearings was to develop a bipartisan, consensus bill that could move to the House floor before the August recess. Insiders say that the bills proposed by Rep. Bob Etheridge (D-NC) and Sen. Richard Durbin (D-IIl.) could be the ones to watch. Both call for additional funding and staffing for the CFTC. Etheridge's bill calls for more transparency from index funds and swap dealers. The CFTC basically has already addressed Etheridge, Durbin and other legislators' calls to close the so-called "London loophole." It amended its no-action relief letter that conditions direct access on ICE Futures Europe's adoption of equivalent U.S. position limits and accountability levels on its West Texas Intermediate crude oil contract. The letter requires ICE Futures Europe to follow similar U.S. hedge exemption requirements and report violations to the CFTC and formalizes the information-sharing arrangement between the CFTC and the U.K. Financial Services Authority. The CFTC also amended its no-action letter to the Dubai Mercantile Exchange (DME), thereby requiring DME to adopt equivalent U.S. position limits and accountability levels for all DME linked contracts. The CFTC will report the results of a study on commodity index trading and swap dealers to Congress on September 15. The Senate Agriculture Committee has approved the nominations of Walt Lukken to full chairman, Commissioner Bart Chilton's new five-year term and the appointment of firsttime commissioner nominee Scott O'Malia. All three appointments still need full Senate approval. On July 9, the CFTC's enforcement director, Gregory Mocek, stepped down. His replacement, Stephen Obie, could have his work cut out for him.