More oversight, more transparency

Everyone understands the Big Recession. Almost no one in the lay world comprehends the legislation crafted to try and prevent another one. 

Dodd-Frank, as it is called, is a mammoth law that has been in effect for more than six months and is supposed to be fully implemented in another six months. But that progress will be delayed. While President Obama hails the law as a  cornerstone of his legislative achievements, the Republicans almost unanimously say that it is too cumbersome and too expensive. They don’t have the power to derail it. But they can erode the funding necessary to carry it out. 

“Much hard work still remains, however, to fully define the regulatory landscape through rule‐making,” writes Hank Prybylski, advisory leader, financial services, Ernst & Young, which issued a report on Dodd-Frank. “The sheer number of rules to be written, the breadth and complexity of the issues with which they must deal, and the need for multiple agencies to be involved, will, in some cases, make meeting the one‐year deadlines for many of the rules a challenge for regulators.”

Previous to Dodd-Frank, the Commodities Futures Trading Commission was charged with preventing fraud on investors, not foolishness by them, says Mike Gill, senior policy advisor for Crowel & Moring. After the law, the agency moved to a more prescriptive approach to oversee over-the-counter derivatives trading. For the energy industry, this will mean much more coordination between the managers of capital in an organization and the managers of risk, he adds.  

Derivatives are these opaque financial instruments that have been traded out-of-sight of regulators. The law aims to force those trades to occur on public exchanges and in full view. They must also be guaranteed by third parties. The commission says that this kind of transparency will reduce risks and improve pricing.  

Industrials were once the primary entities buying those derivatives composed of oil and natural gas futures so as to guarantee the prices they paid. But then Wall Street got involved. While it provided liquidity, those firms never actually took possession of the end product. And, they never had to divulge their holdings.

 

“The deadlines are precluding a more methodical approach to understanding why over-the-counter markets have evolved the way they have,” says Gill, on the phone but who spoke at the EnergyBiz Leadership Forum in Washington. “With enough time, credible regulations that bring transparency could be enacted.”

 

Capital for Projects

Hedge funds seek to buy power for a low price in one region and sell it for a higher price in another. They often carry out "over-the-counter" transactions that are private and outside the purview of regulators.

The big banks and hedge funds caution against over-regulation in energy markets, noting that they create robust activity. And while they try to profit from price volatility, they are responsible for product innovation. That, in turn, creates efficiencies and prices are eventually a truer reflection of supply and demand.

While the aim of the regulations is to curtail the types of risky practices that contributed to the Great Recession, some observers think it would also limit banks' abilities to liquefy energy markets. That would make it more difficult for utilities to perform risk management and to raise capital for projects.

Even the Democratic committee chairs with oversight over banking and commodities say that while they are committed to carrying out the intent of Dodd-Frank, they will tread lightly. They say that want to be mindful of any “unintended consequences” and the potential impact on job creation. 

But the bigger concern right now is over market power abuses and excessive risk taking. Now is not the time to trim the budgets of key regulators, advocates say, emphasizing that their oversight will help prevent a similar financial disaster and the possibility of a taxpayer-funded bailout. 

“The institutions that secure a head start on this work are likely to be the ones to gain a competitive advantage when all is said and done,” says Prybylsk of Ernst & Young, in his firm’s publication. 

Trading is a time-honored approach to hedging against price fluctuation. As long as wholesale markets for both power and gas are open, energy companies will still need to mitigate their risks. But such transactions should be properly monitored to ensure they are transparent.

EnergyBiz Insider has been named Honorable Mention for Best Online Column by Media Industry News, MIN.

So what do you think? Please share your thoughts by posting a quick comment below, or by sending a longer reply to energybizinsider@energycentral.com. 

 

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