The London-Dubai loophole

Why do foreign energy-trading exchanges get to set up in the U.S. without having to play by U.S. rules?


Andrew Leonard
June 4, 2008 2:43AM (UTC)

Regular readers of How the World Works know that I have long been obsessed with the fact that traders who buy and sell energy futures on the Atlanta-based IntercontinentalExchange (ICE) operate free from government scrutiny, giving them ample opportunity to game the system without anyone knowing better. This is the so-called Enron loophole, a provision in the Commodity Futures Modernization Act pushed through at the last minute by Sen. Phil Gramm in 2000.

As soon as Michael Greenberger, a former director of the Division of Trading and Markets at the Commodity Futures Trading Commission during the Clinton administration, began testifying before the Senate Committee on Commerce, Science and Transportation's hearing on "energy market manipulation and federal enforcement regimes" on Tuesday, it became clear that he knew more about this topic than possibly anyone else alive. So I immediately located a copy of the written testimony he supplied to the Senate Committee laying out his position in full -- 32 pages of tight argument ripping the CFTC to shreds as a feeble, incompetent regulatory agency fully controlled by the industry it supposedly oversees. Greenberger makes the best case I've yet seen for understanding how speculators have been given free rein to romp in the oil futures market. If this is an issue upon which you would like to become more informed, Greenberger's testimony is essential reading.

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One huge problem area: A growing share of the business of trading U.S. contracts for crude oil futures on U.S. soil is conducted on U.S. computer terminals that are operated by foreign-owned exchanges that are not required to conform to U.S. regulations. This is known as the "London-Dubai loophole." Although ICE is based in Atlanta, it is considered by the CFTC to be a U.K. entity, and thus falls under the regulatory supervision of the Financial Services Authority of the U.K. But since ICE therefore does not have to report the positions that U.S.-based traders are taking on U.S.-delivered contracts of, for example, West Texas Intermediate sweet light crude, the exchange has a competitive advantage over regulated U.S. exchanges such as the New York Mercantile Exchange (NYMEX). In response, observed Greenberger, NYMEX has scrambled to set up its own joint venture with the Dubai Mercantile Exchange (DME), so that it too can get a piece of that action. The joint venture, amazingly, is considered to be under the regulatory authority of Dubai.

As Greenberger explains it, if you want to be in the business of facilitating the buying and selling of oil futures, you need to have a physical presence in the United States. And in order to do so, as a foreign-owned exchange, all you need is for the CFTC to issue a "no action" letter that essentially declares the CFTC won't stop you from conducting business as you please. The CFTC apparently gives out these "no action" letters like candy.

You don't have to believe that speculation is the biggest reason oil and gas prices have doubled over the last year to agree that this is entirely untenable. Let's give Greenberger the floor:

The CFTC has vigorously maintained that the U.K's FSA regulatory model is at the forefront internationally and that it has shared meaningful market information about ICE West Texas Intermediate trades with the CFTC. It is self evident, however, when a barrel of crude is approaching $140 and predicted by Goldman Sachs to soon pass $200 (with attendant high prices being paid by U.S. consumers for gasoline and heating oil) that U.S. regulators would need and want real time, fully audited data pertaining to the critically important WTI contract; rather than data passed by ICE from the U.S. to the FSA and then from the FSA to the CFTC in a haphazard, incomplete, and unaudited fashion. In fact, confidence in the legitimacy of the information being shared between the CFTC and FSA has led to the CFTC to insist on May 29 that it receive better data from the FSA and ICE in order to probe whether there has been improper market manipulation in the crude oil markets...

It is self evidently absurd that the American public can rest secure that the CFTC found in the DME no action letter that Dubai's regulatory scheme is comparable to that of the U.S. The fact that the CFTC as recently as May 2007 could conclude that Dubai's regulation is in fact comparable to that in the U.S. simply demonstrates that there is not a foreign regulator in the world who would not satisfy the CFTC under that agency's comparability standard. In this regard, I am sure that the American consumers will take little comfort from an explanation that they are being protected from manipulation and excessive speculation driving up gas prices -- not by U.S. regulators -- but by the Dubai government's oversight of trading of the U.S. delivered [West Texas Intermediate] contract on the DME's U.S. trading terminals. I do not envy any Member of Congress explaining that proposition to his or her constituents.

And there's a lot more where that came from.


Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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