Senator Feinstein Calls on CFTC to Provide More Details about the Administration’s Energy Market Oversight Reform Plan
Urges Regulation of OTC Energy Derivatives
Jul 17 2009
Senator Feinstein has been a strong advocate of increased federal oversight of energy commodity markets, including aggregate position limits on unfettered speculation and efforts to crack down on manipulation and fraud in the over-the-counter derivatives markets.
Pasted below is the text of the letter to CFTC Chairman Gensler:
July 17, 2009
The Honorable Gary Gensler
Commodity Futures Trading Commission
1155 21st Street, NW
Washington, DC 20581
Dear Chairman Gensler:
Congratulations on your recent confirmation as Chairman of the Commodity Futures Trading Commission (CFTC). I look forward to working closely with you to assure that our markets function efficiently and do not suffer from excessive speculation, fraud, or manipulation.
I am writing to thank you for initiating a review of the CFTC’s policies to limit excessive speculation in energy markets, and to request respectfully that you provide additional detail on the Administration proposals to reform over-the-counter (OTC) market regulation.
I am very pleased that the CFTC will consider setting federal speculative position limits on energy commodities, will review the appropriateness of exemptions from these limits for various types of market participants, and will consider establishing aggregate position limits across multiple markets. If the CFTC chose to proceed in all three areas, it would implement through regulation many of the requirements I proposed in The Oil Speculation Control Act (S. 3131) and The Over-the-Counter Swaps Speculation Limit Act (S. 3671).
I also encourage the CFTC to provide further details regarding how it proposes to implement a regulatory framework for OTC energy derivatives. Energy derivative markets have the potential to undermine any new speculative position limit system. Since enactment of the Commodity Futures Modernization Act in 2000, the CFTC has allowed OTC markets to grow so large that they posed a systemic risk to our financial system and may have exacerbated oil and other energy commodity prices in 2008. I am concerned that establishing stricter position limit rules on exchange traded commodities could fail to reduce speculation, as long as speculators can buy look-a-like contracts through OTC voice brokers and swaps dealers in unlimited volumes.
The Treasury Department’s recent report titled Financial Regulatory Reform: A New Foundation, found that a “lax regulatory regime for OTC derivatives” can be blamed for creating a situation in which “regulators were unable to identify or mitigate the enormous systemic threat that had developed.” The report specifically identified the risk that excessive speculation in OTC markets poses, and recommended that the CFTC “should have authority to set position limits on OTC derivatives that perform or affect a significant price discovery function with respect to regulated markets.” I hope the CFTC will consider how to impose such limits during its upcoming hearings.
The Treasury Department report also recommended giving regulators tools to provide transparency, limit excessive speculation, require margins, and require clearing and other systemic risk mitigation measures in OTC markets. However, the Treasury Department’s recommendations leave some key questions unanswered, and I strongly encourage you to address these questions in order to guide Congress as it attempts to reform our financial regulatory system. Specifically:
1. What federal agency will regulate over-the-counter derivatives?
The Treasury Department recommends that the CFTC and the Securities Exchange Commission (SEC) complete a report to Congress by September 30, 2009, that identifies all existing conflicts in statutes and regulations with respect to similar types of financial instruments and either explain why those differences are essential to achieve underlying policy objectives with respect to investor protection, market integrity, and price transparency or make recommendations for changes to statutes and regulations that would eliminate the differences.
2. How does the CFTC propose to define a “standardized” over-the-counter product?
The Treasury Department report proposed to require only “standardized” OTC products to be executed and cleared through exchanges. Swaps dealers could continue dealing in non-standard OTC products – such as the highly complex credit default swaps in which AIG specialized – and could continue to pose a systemic risk to our economy. The CFTC should consider whether it could reduce systemic risk by considering any contract that is traded in high volume or at high value, is referenced in the marketplace, or settles on the price of a standardized OTC product to be a “standardized” derivative.
3. How will two federal agencies coordinate their efforts to oversee over-the-counter derivatives clearing?
The Treasury Department recommends that responsibility and authority to ensure consistent oversight of all “systemically important clearing and settlement systems” should be assigned to the Federal Reserve, but that these powers should “supplement rather than replace” the existing CFTC authority over derivatives clearing organizations. In order to assure that clearinghouses cannot pick their regulator, creating the potential for a regulatory race to the bottom, the CFTC should require that standardized OTC derivatives be cleared through a derivatives clearing organization.
Again, thank you for holding hearings on the need for rigorous speculative position limits in energy markets. Such limits have the potential to increase CFTC regulatory effectiveness considerably. However, such limits will be far more likely to succeed if combined with a serious attempt to adopt the proposals for OTC derivative regulation included in the Treasury Department’s report. I encourage you to address OTC market regulation as soon as possible, and I look forward to hearing how you propose to answer the outstanding questions I have posed.
I sincerely hope that the CFTC will remain committed to gaining a full picture of the energy markets during your tenure, and I look forward to working with you on this matter.
United States Senator