CFTC closes ‘London loophole’

The Commodity Futures Trading Commission (CFTC) has moved to impose US position limits and hedge exemption requirements on US customers trading West Texas Intermediate (WTI) crude oil on the London-based Ice Futures Europe exchange.

The Ice Futures Europe WTI contract is cash-settled against the New York Mercantile Exchange's WTI crude oil contract. Concerns from US politicians over the role of speculators in pushing up oil prices has led to increased scrutiny on traders’ ability to circumvent US position limits by trading in London, called the "London loophole" by Democratic senator Carl Levin.

Levin introduced the Close the London Loophole Act on June 12, “to ensure that the CFTC has all the information and authority it needs to stop price manipulation or excessive speculation involving US energy trades on foreign exchanges”.

The move to impose US position limits on the UK exchange formalises an information-sharing arrangement between the CFTC and the UK Financial Services Authority by requiring Ice Futures Europe to provide the CFTC detailed market information for surveillance purposes, as a condition of direct access to US customers.

The CFTC will incorporate the exchange’s data directly into its Commitments of Traders report, a weekly report categorising traders and positions.

The foreign exchange access conditions will be applied to any future requests for direct foreign access to US customers for contracts that cash settle against those listed on any US exchange, according to the CFTC. The revised conditions must be satisfied by Ice Futures Europe within 120 days.

“These new conditions for foreign access will provide the CFTC with additional oversight tools to monitor linked contracts,” says CFTC acting chairman Walt Lukken. “This powerful combination of enhanced trading data and additional market controls will help the CFTC in its surveillance of regulated domestic exchanges…and raises the bar for all future foreign access requests.”

However, in a June 23 testimony at a hearing of the US House Committee on Energy and Commerce, Ice Futures Europe chairman Bob Reid stated that "speculation ... needs to be distinguished from manipulation, which is to deceive investors by controlling or artificially affecting a market. A central role of a regulated marketplace such as ours is to take steps to prevent and detect such manipulation."

Responding to suggestions that the change in WTI prices since the beginning of 2007 has been driven by speculative traders building large positions in the Ice WTI contract, Reid said that “the facts indicate otherwise, as Ice Futures Europe's share of global WTI open interest has declined from about 20% to 15% over the same period”. Reid said he recognised the severe impact of high crude oil prices on the US economy and “understands the Congressional desire to leave no stone unturned.”

“However, with a 15% share of global WTI futures and options open interest, we feel it is highly unlikely that our WTI contract is the primary driver of WTI prices,” said Reid. “This ‘inconvenient truth’ clearly contradicts any notion of a London loophole.”

See also: CFTC establishes new energy markets advisory committee
CFTC asks Congress for greater powers over ECMs
IntercontinentalExchange fuels regulation debate