Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

UK Regulation of US Energy Markets

While I blogged
about the potential regulation of the UK equity
market by the SEC nearly two weeks ago, it took the collapse of Amaranth
to draw my attention to the fact that a growing part of the US
energy derivatives market is now regulated by the UK.

In January 2006, the Intercontinental Exchange (ICE) was permitted to
use its trading terminals in
the United States for the trading of US (WTI) crude oil futures on
ICE Futures in London (formerly the International Petroleum Exchange
or IPE). This was not a totally new contract because ICE simply took its
electronically traded, standardized OTC contracts and offered them on
ICE Futures. Therefore, these contracts
have seen high initial adoption and rapid growth in the last few
months. WTI volumes in ICE Futures are now about half
of the NYMEX volumes. We now have a liquid contract on a US commodity that is
predominantly traded by US participants using terminals in the US, but
the contract is on an exchange (ICE Futures) which is located and
regulated in the UK, though it is owned by a US entity (ICE).

More interesting is the fact that ICE also runs a large quasi
futures market in energy derivatives. These are OTC contracts for
regulatory purposes but are standardized, electronically traded and
cleared through London’s LCH. LCH is UK regulated, but it is
also a Designated Clearing Organization in the US. Amaranth served to
remind us that when it comes to natural gas “futures”, ICE is
today larger than NYMEX.

Even before Amaranth, the US political system was worried about
this just as the UK is worried about potential regulation of UK
equities by the US. The US Senate has prepared a report
arguing for greater US (CFTC) regulation of the derivatives traded at
ICE (“The role of market speculation in rising oil and gas
prices: A need to put the cop back on the beat”, Staff Report
prepared by the Permanent Subcommittee on Investigations of the
Committee on Homeland Security and Governmental Affairs, United States
Senate, June 2006).

Incidentally, this week the US SEC met with Euronext regulators
about the potential acquisition of Euronext by NYSE. The SEC’s
press
release
states: “The regulators also affirmed that joint
ownership or affiliation of markets alone would not lead to regulation
from one jurisdiction becoming applicable in the other and stated
their shared belief in the importance of local regulation of local
markets.” That sounds categorical until one reads it again more
carefully and realizes that it means nothing at all. Today there are
no purely local markets. US investors do trade UK stocks at the LSE
and the LSE is no longer a purely local market. All bets are then
off.

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