Law gives CFTC jurisdiction in both physical and financial markets.
EDITOR'S NOTE: Bob Pease is an attorney and former regulator with the Commodity Futures Trading Commission (CFTC) and the Federal Energy Regulatory Commission (FERC). He is currently senior counsel in the energy group with Bracewell & Giuliani's Washington, DC office. As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), the CFTC is writing rules to regulate the swaps marketplace. We spoke with Pease recently about the consequences this will have for energy marketers and traders. |
OIL & GAS FINANCIAL JOURNAL: Can you tell our readers a little about your background?
BOB PEASE: I was at FERC for 22 years and worked my way up to director of investigations, which was the head of the enforcement side of the agency. When I left there, I went to the CFTC and became counsel to the director and also worked closely with the director of enforcement to help get the last stages of Dodd-Frank passed and then to implement enforcement policy. I was also involved in a lot of the pre-enforcement rulemakings of the CFTC.
OGFJ: So you were a Washington regulator and now you've moved to the other side of the table.
PEASE: One advantage to bringing me in to Bracewell is that I can speak both languages. My main role is to work with clients to keep them away from someone like myself – to keep them compliant with both agencies. A lot of the rules on the CFTC side are new to the energy world, so they have to work their way through it with all the issues related to Dodd-Frank. I'll be conducting compliance training for the clients as well as, when necessary, defending the clients in the event any of the agencies are investigating them.
OGFJ: You have said that an unprecedented regulatory overlap exists between FERC and the CFTC and this poses a "big unknown" for energy companies. Can you explain?
PEASE: In 2006, FERC got its new anti-manipulation authority when Congress amended the Federal Power Act and Natural Gas Act to prohibit the use or employment of manipulative or deceptive devices or contrivances in connection with any FERC-jurisdictional transaction. The Final Rule, Order No. 670, implements this new prohibition. FERC's rules are modeled on Rule 10b-5 of the Securities and Exchange Commission (SEC). Then Congress gave the same authority to the CFTC under Dodd-Frank, so each agency has a similar manipulations standard. If you're familiar with the Hunter case, what FERC did was go after an alleged manipulation that occurred in the gas markets. But it was on NYMEX in the financial market, although it had a profound effect on the prices of the natural gas market. In this case, the appeals court concluded that FERC lacked the jurisdiction to enforce a $30 million fine against accused natural gas market manipulator Brian Hunter. The CFTC, on the other hand, has jurisdiction to bring cases both in the physical market and in the financial markets. So some of the huge cases that FERC had brought recently, like the JPMorgan case where they got a $410 million settlement, the CFTC could also bring a case there if they wanted to.
OGFJ: Most of our readers are familiar with what FERC does. However, they are less familiar with the CFTC. Could you explain the mission of that agency? How are energy marketers supposed to know who is responsible for regulating their business?
PEASE: It can be quite confusing for the industry. FERC has every facet of the energy industry except nuclear under its bailiwick. The CFTC though is a financial regulator. However, it has grown exponentially in terms of what it regulates – not the agency itself but what it regulates. Particularly with Dodd-Frank where all the swaps are now under CFTC jurisdiction. So the CFTC now has a vast number of financial products that it regulates, ranging from the traditional agricultural products to energy trading and everything in between. To answer the second part of your question, an energy company could be subject to an investigation from either or both agencies, depending on the specifics of the allegations that the agency might be bringing. For example, FERC recently accused BP of manipulating the energy markets, particularly at the Houston Ship Channel. The CFTC also was investigating BP over some of the same type of issues. The CFTC hasn't announced publicly any case, but the FERC report, which is public, acknowledges that they got their referral from the CFTC. So a company in this situation could potentially face charges from both agencies, which makes it very difficult for them. And the penalties can be enormous.
OGFJ: How did Dodd-Frank impact the CFTC?
PEASE: It brought the swaps market under CFTC jurisdiction. Previously, swaps were unregulated, which led, in part, to the meltdown of the economy in 2008. So the purpose of Dodd-Frank was to bring all this unregulated trading under the CFTC and a little under the SEC. But the energy industry got swept up in all this new regulation, which may not have been Congress's intent. Throughout this process the energy companies have been complaining that they're not the ones who caused this problem and don't regulate us. But the upshot is that some of the bigger companies like Shell are probably going to have to register as a swaps dealer. This will probably bring other parts of their operations under much more scrutiny, as there will be more reporting obligations. So there's definitely more of a burden on the energy companies that wasn't there before.
OGFJ: But energy companies aren't the biggest energy traders. Banks are, right?
PEASE: They certainly are. The big banks are heavily involved. And I'll be working with the trading arms of banks as well as energy companies. Of course Bracewell is a full-service energy firm. We represent all types of energy companies and the issues that affect them. We provide nuts-and-bolts service from beginning to end. And that also would include the banks. But even energy companies that are trading around their own assets to hedge production and limit their exposure to the markets are going to be trading in the financial markets and thus potentially subject to some form of CFTC regulation. Whether they fall under the full panoply of CFTC regulation depends on the amount of trading they do.
OGFJ: Is it possible to make a value judgment on this yet? From your perspective on both sides of the table, are the new CFTC regulations good or bad for the energy industry?
PEASE: It's too early to tell. It's a good thing in that a lot of these swaps were in an absolutely opaque market. If an energy company was trading with a bank, were they getting the best deal on these trades or not? They couldn't necessarily tell because it wasn't a transparent market. Now the swaps will be traded on exchanges like stocks are, and you'll be able to see the best prices and the best offers by various companies, so you're going to be encouraging competition and hopefully lowering the prices. On the other hand, some costs will increase. The regulatory burden certainly has increased, and you'll have other margin requirements and clearing requirements, which may in the end better protect the energy companies.
OGFJ: Will all the trading be done on exchanges now?
PEASE: Well ICE and NYMEX are where you'll be trading futures and some swaps. But the CFTC is in the process of approving what they call "Swap Execution Facilities," or SEFs for short. And those will be platforms where swaps will be traded. None of them are fully operational yet, but that is happening now. I think one, Bloomberg, has been approved on a temporary basis. But a lot of the swaps are being converted to futures – a large number. And then they are traded on ICE and CME and NYMEX. About 80% to 90% of all swaps were actually pretty standard, and now you can convert those to futures and decrease a lot of your costs.
OGFJ: In your view, do trading operations have adequate risk management procedures in place?
PEASE: That's one of the services that Bracewell and I are trying to provide our clients. We look at a company's compliance program to see if there are any holes in it and then make recommendations and conduct training to help the company stay compliant with the rules of both agencies. We've found that companies want to comply with the rules – not only with the actual rule but with the spirit of the rule. We try to provide value to them by going through their programs and making sure they have the right risk controls in place and don't have to face the regulators. It's very hard to protect against a rogue trader, but you can put a lot of practices in place to make sure there are enough checks and balances. For example, a lot of companies now have a compliance officer on the trading floor to assist traders when they have questions, but also to convey the message that this is part of the culture of compliance that the company is trying to implement.
OGFJ: Thanks very much for your insight on this.
