Nymex Told Amaranth in August to Cut Risky Trades, People Say

First Published:	27/09/2006 12:43:03
The New York Mercantile Exchange told Amaranth Advisors LLC that the hedge fund's natural gas bets were too big a month before the trades led to a $6 billion loss, said two people with knowledge of the meeting. Amaranth unwound some of its natural gas positions after the warnings, according to the people, who asked not to be named because the communications were confidential. The cautions were based on rules about the number of contracts a single company or fund may hold. ``People are free to lose their shirt if they don't make good trading decisions,'' said Geoffrey Aronow, the head of enforcement at the U.S. Commodity Futures Trading Commission from 1995 to 1999. The regulatory oversight worked the way it was supposed to because the losses were borne by Amaranth's investors and didn't spread, Aronow said. U.S. lawmakers complained earlier this year that speculators are boosting energy prices and avoiding regulation with trades that are not done on exchanges. Legislation has been proposed to expand the reach of regulators to electronic trading that is not as closely monitored as the Nymex. Nymex spokeswoman Anu Ahluwalia said the exchange ``routinely conducts market surveillance,'' and declined to discuss Amaranth specifically. Amaranth spokesman Shawn Pattison declined to comment. The circumstances of Amaranth's losses are being investigated by the Securities and Exchange Commission. Natural gas touched a record $15.78 per million British thermal units last December and has dropped 71 percent since then. Oil is down 23 percent from an all-time high of $78.40 a barrel in July. Congressional Drive Members of Congress including Senators Dianne Feinstein of California and Carl Levin of Michigan, both Democrats, want greater authority for the Commodity Futures Trading Commission to monitor energy trading, especially on the all-electronic Intercontinental Exchange Inc. Amaranth recorded the biggest-ever hedge fund loss. Founder Nick Maounis told investors on a Sept. 22 conference call that the firm was ``eliminating energy trading from our strategy mix.'' He said the decision was the ``first step in the recovery process.'' The trader responsible for Amaranth's natural-gas investments was Brian Hunter, co-head of the firm's global energy and commodities unit. Hunter no longer works at Amaranth, the Financial Times reported earlier today, citing unidentified people close to the matter. Trades should get regulatory scrutiny ``regardless of where they take place,'' Levin said in a Sept. 20 phone interview. Amaranth was able to ``take these large positions without being known to the CFTC and the public.'' Intercontinental Exchange Greenwich, Connecticut-based Amaranth, which lost almost two- thirds of its investors' funds, traded gas futures and options on the Nymex and in so-called over-the counter markets, according to the people familiar with Nymex's warnings. The OTC trades were on an electronic system Nymex runs, called Clearport, on Intercontinental's electronic system and in bilateral trades arranged by brokers, the people said. Only trades made on Nymex or its electronic system were reflected in daily reports to federal regulators at the CFTC. Those reports are the main tool regulators have to track what's happening in the market. Federal regulators can request information on trades from Intercontinental Exchange, said Alan Sobba, a spokesman for the CFTC in Washington. He declined to say whether the agency had any contact with Intercontinental concerning Amaranth. He said it's the agency's policy not to discuss such specifics. `Enron Loophole' A Republican-sponsored measure passed by the House of Representatives in December would expand the authority of regulators to demand information on natural gas trades. A related bill was introduced in the Senate in July, and an amendment proposed by Feinstein would place electronic energy markets under the same reporting requirements as the Nymex. The measure Feinstein has offered, which has 11 Democrats and one Republican as co-sponsors, ``goes to the point of giving CFTC direct oversight'' of electronic trading systems including Intercontinental Exchange, said Paul Cicio, spokesman for Industrial Energy Consumers of America, a trade group that represents large power and gas customers. Levin calls the failure of federal regulations to extend to the over-the-counter market the Enron loophole. Enron Corp. before its collapse operated the largest electronic gas and electricity market, known as EnronOnline. The company lobbied to keep over- the-counter energy trading out of legislation passed in late 2000 that changed the powers of the CFTC. The rules that prompted Nymex's warnings to Amaranth are known as position limits or accountability levels. They were designed primarily to keep one party from gaining too much control of a market and are applied to futures that call for actual delivery of the commodity, rather than settling in cash. Transparency Needed Amaranth's gas market trades were split between Nymex and Intercontinental Exchange, and they included ``sizable'' over-the- counter bets, according to one of the people familiar with the matter. The trades were transferred last week to Citadel Investment Group LLC, a rival hedge fund, and JPMorgan Chase & Co., Amaranth's broker. The position limits governing Nymex futures trades are an inadequate tool to prevent the kind of risky behavior that brought Amaranth down, according to Mark Williams, a finance professor at Boston University. The limits are high enough that trades can be made on the scale that occurred at Amaranth, he said, and they don't extend to over-the-counter markets. ``There needs to be better transparency with reporting so investors better understand what's going on with this trading,'' Williams said.
Source:  Bloomberg http://www.bloomberg.com

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