REGULATION
Figure 3: Amaranth Positions Before & After NYMEX Directed it to Reduce Positions
Before: After:
For example, the report states that, “on August 8
th
NYMEX instructed Amaranth to reduce its NYMEX positions in the
September and October futures contracts. Amaranth complied with the NYMEX order but increased its positions in the
related ICE swap contracts, thereby maintaining – and even increasing – its position and risk profile for those months.”
Sources: NYMEX, ICE.
information is obtained from the non-reg- by properly identifying and aggregating accounts can the surveillance
ulated markets, such as ICE. The CFTC staff make a thorough assessment of a trader’s potential market impact
market surveillance program relies on a and a trader’s compliance with speculative position limits.”
4
system of timely data in order to preserve Currently, as the Senate report concludes, there are two critical regula-
the markets’ hedging function and price tory flaws. The first is that NYMEX, as well as the CFTC, are limited in
discovery role.
3
As the CFTC asserts: “Only their ability to determine whether traders’ positions are too large
Amaranth Advisors LLC
because it has no regular access to traders’ positions on ICE. Second,
even if NYMEX or the CFTC requires a trader to reduce its positions, the
• Although Amaranth was technically a multi-strategy hedge
trader can shift its positions to ICE where the positions will not be mon-
fund with positions across asset classes, by 2006 it had devoted
itored. Amaranth moved its natural gas positions to ICE in August 2006
a large fraction of its risk capital to natural gas trading.
when NYMEX ordered it to reduce its positions in two contracts nearing
• Natural gas has offered hedge funds a potentially alluring
expiration for delivery in September and October 2006 (Figure 1).
combination of scalability and volatility, and so has attracted a
ICE refutes the conclusions of the Senate report calling for additional
number of non-traditional financial participants during the past
regulation by responding that it has instituted a large trader report for
three years, including Amaranth once other arbitrage
the CFTC.
5
The CFTC used its “special call” authority in October 2006 to
opportunities had become less lucrative.
obtain information from ICE regarding clearing member position data
• Commodity derivatives markets are relatively small compared
for cash-settled contracts that were based on NYMEX natural gas con-
to global asset values, so it is possible for even one large hedge
tract prices. However, special calls are typically issued after the fact and
fund to overwhelm these markets. This arguably happened with
the CFTC emphasises that such special calls are not issued to conduct
Amaranth’s large-scale natural gas trading.
regular market surveillance of ICE.
6
• The US regulatory umbrella, covering energy trading, has had
a noteworthy gap in coverage. The exchange-traded futures
NYMEX, as well as the CFTC, are limited in
markets are explicitly regulated by the CFTC and the physical
their ability to determine whether
natural gas markets are explicitly regulated by the FERC. But over-
traders’ positions are too large
the-counter energy derivatives trading, until now, has not been
subject to the same regulatory scrutiny. It was on such platforms
On July 25
th
2007, the CFTC charged Amaranth and Brian Hunter, its
that Amaranth carried out a substantial fraction of its trading.
former natural gas trader, with attempted manipulation of the natural
• Unlike the LTCM crisis, counterparties did step in quickly to gas futures market based on information the CFTC subsequently
assume Amaranth’s positions, which immediately stabilised the received regarding Amaranth’s natural gas swap positions on ICE. The
natural gas market. complaint alleges that Amaranth intended to lower the price for the
• At the time of Amaranth’s implosion, the reason that there were
March and April 2006 NYMEX natural gas futures by selling off their
not worries of wider systematic failure is that Amaranth’s core risk
large NYMEX futures position just before the last day of trading in the
positions were not similar to those held by the international money-
previous month. Amaranth’s swaps on ICE were based on the NYMEX
center banks. In the case of LTCM, its positions were highly
natural gas futures price determined by the trading before the end of
correlated to those held by money-center banks, meaning that
the previous month.
7
The day after the CFTC filed its charges, the
LTCM's distress would become everyone’s distress.
Federal Energy Regulatory Commission (FERC) exercised its anti-manip-
Hilary Till, EDHEC Risk and Asset Management Research Centre.
ulation enforcement authority by issuing a show cause order to
Amaranth and traders Brian Hunter and Matthew Donahoe. Amaranth
12 SEPTEMBER 2007 COMMODITIES NOW
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