By: Lawrence B. Patent
In testimony relating to“cap-and-trade” legislation currently pending in Congress, the Chairman of the Commodity Futures Trading Commission (CFTC), Gary Gensler, has urged that his agency be designated as the primary regulator of carbon trading, with authority over both cash transactions and derivative instruments. In a prepared statement for his September 9, 2009 testimony before the U.S. Senate Committee on Agriculture, Nutrition and Forestry, Chairman Gensler advocated CFTC regulation of both the trading of futures contracts in emission allowances and offset credits for greenhouse gases (GHG), and the cash market transactions in those allowances and credits. At the same time, Chairman Gensler recognized the need for the involvement of other agencies, such as the Environmental Protection Agency (EPA), in the “cap” part of cap-and-trade, to oversee related functions such as the allocation of GHG emission allowances, the establishment of standards for allowances and credits, and the maintenance of a central registry for such instruments. CFTC regulation would include oversight of the trade execution system, oversight of the clearing of trades, and protection against fraud, manipulation and other abuses. Chairman Gensler called for prompt reporting of all transactions in both GHG emissions cash and futures markets, and for a central registry of all transactions, to be updated on at least a daily basis.
Chairman Gensler’s testimony follows introduction by Senator Feinstein of S. 1399, the Carbon Market Oversight Act of 2009, which would grant the CFTC authority over both GHG emission allowances and offset credits, and derivatives thereon. Currently, the CFTC has authority only over futures transactions in derivative instruments, but not over cash transactions in the products underlying those derivatives. If enacted, S. 1399 would, for the first time, extend CFTC jurisdiction to a cash market – that is, the market for GHG emission allowances and credits that will arise under any cap-and-trade scheme – with the power to adopt and enforce rules for cash market transactions in those products.
Among the rules that the CFTC would be likely to impose on those cash markets would be standardization of contracts and centralized trading and clearing.The CFTC takes the view that derivative instruments should, to the extent possible, be defined by standardized contracts, and traded and cleared centrally. Chairman Gensler envisions a similar regime for GHG emission allowances and offset credits, urging that they should be traded only on centralized marketplaces, rather than on an off-exchange basis through ISDA or other documentation.
Chairman Gensler advocated that the CFTC is the appropriate regulator of the trading of GHG emission allowances and offset credits because of its experience and expertise in regulating markets involving derivatives on similar instruments. He noted that the CFTC already oversees the trading and clearing of derivative contracts based on sulfur dioxide, nitrogen oxide and carbon dioxide allowances and offsets. Chairman Gensler also argued that carbon markets have similarities to several different markets that fall within the CFTC’s regulatory authority because, like agricultural commodities, there will be a yearly “crop” and important programmatic regulations governing the nature of the product, and because emission allowances and offset credits will be government-issued, similar to Treasury-issued debt instruments. Chairman Gensler further pointed out that the CFTC recently issued a proposed determination to classify the Carbon Financial Instrument contract traded on the Chicago Climate Exchange as a significant price discovery contract, which, if finalized, would give the CFTC full oversight authority over the contract and additional experience regulating cash emissions contracts. 74 Fed. Reg. 42052 (Aug. 20, 2009). Certain commenters responding to the CFTC’s request for comment on the proposed determination, however, have questioned the CFTC’s assertion of jurisdiction in that matter. See Letter from R. Trabue Bland, Director of Regulatory Affairs and Assistant General Counsel, IntercontinentalExchange, to David Stawick, Secretary, CFTC, Sept. 4, 2009.
CFTC regulation of GHG emission allowances and offset credits is by no means certain, and Congress has some difficult choices to make. The cap-and-trade bill that passed the House of Representatives earlier this year, the American Clean Energy and Security Act of 2009 (H.R. 2454), would give such jurisdiction to the Federal Energy Regulatory Commission (FERC), with CFTC jurisdiction limited to derivatives trading in those instruments. See Title III, Subtitle D of that bill, beginning at page 1027 thereof. In this regard, the House bill is consistent with the existing cap-and-trade program involving sulfur dioxide emissions that was begun almost two decades ago under the administration of the EPA, which maintains jurisdiction over the cash market trading in sulfur dioxide emissions trading to this day, pursuant to 42 U.S.C. § 7651b and regulations promulgated thereunder.
Competing regulatory jurisdiction over the energy space is not new. The CFTC and the FERC recently engaged in a jurisdictional dispute over which agency should pursue allegations of manipulation of the NYMEX natural gas futures market by Amaranth Advisors, with both the CFTC and the FERC ultimately settling separate actions against the company on the same day, August 12, 2009, which included a total civil monetary penalty due to the U.S. Treasury in the amount of $7.5 million, and continuing to pursue separate actions against Brian Hunter, who was the lead trader in natural gas products for Amaranth. Earlier this year, the CFTC sought unsuccessfully to persuade the Federal Trade Commission not to adopt regulations that the CFTC saw as impinging upon its exclusive jurisdiction over regulated energy futures markets. 74 Fed. Reg. 40685 (Aug. 12, 2009).
Historically, the CFTC has taken the position that the Commodity Exchange Act expressly vests it with exclusive regulatory and civil enforcement jurisdiction over all transactions in regulated futures and option contracts and the markets in them. Such exclusive jurisdiction, it has argued, assures that participants and intermediaries in those markets will be governed by a comprehensive set of statutory and regulatory standards and requirements administered by a single regulator, and that these markets will not be subjected to multiple different and potentially conflicting statutory and regulatory standards, interpretations and enforcers.
Yet while the CFTC has not hesitated to use its enforcement powers against those who it alleges seek to use cash market transactions to attempt to manipulate cash and futures commodity prices, the CFTC has not previously sought to regulate cash markets for energy, agricultural or financial products. Any such CFTC regulatory authority, however, would appear to overlap with other agencies’ existing jurisdiction over related products, because the CFTC’s exclusive jurisdiction under the Commodity Exchange Act extends only to exchange-traded futures and option contracts. A regulatory framework where the CFTC has general authority over cash markets may be problematic, given the potential for legal uncertainty and increased costs for market participants as they seek to comply with multiple and potentially inconsistent federal regulations. Beyond this, these legislative debates may also embolden other agencies to seek to expand their own respective jurisdictions, so as to reach into the CFTC’s traditional jurisdiction over derivatives.
The CFTC already has a robust agenda to address, including possible federal position limits on energy futures trading, reporting to Congress on efforts to harmonize its regulatory framework with that of the SEC, and helping to shape the evolving regulatory program for what have been off-exchange derivatives that were exempt from federal regulation. This is an ambitious agenda that will likely require the CFTC to develop additional resources for its implementation. Its proposed new authority over GHG emission allowances and offset credits adds to the list and, from a jurisdictional perspective, may be the most complicated item of all.
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