US tackles jet fuel volatility: Commodities speculation bill introduced, hailed by industry

The US aviation industry hailed the introduction of the Wall Street Transparency and Accountability Act of 2010 regulating the USD650 trillion opaque over-the-counter and the security-based swaps markets and is designed to “close loopholes, increase transparency and promote stability in the commodity markets,” according to the Air Transport Association.

Introduced by Arkansas Senator Blanche Lincoln, who chairs the Senate Agriculture Committee, the bill, said ATA, is aggressive in curbing the speculation that caused the dramatic hikes in fuel in mid-2008. It said it will limit manipulation and unchecked speculation in the commodity futures market.

“This is the strongest Wall Street reform bill to date and represents an historic opportunity for real reform,” Lincoln said in a statement last Friday. “America’s consumers and businesses will finally see a financial market that operates in an open and transparent manner.” President Obama has promised to veto any legislation that passes without derivative reform in the form of rules.

The bill calls for derivatives trading through clearinghouses, which would not only ensure that participants have enough capital but also require them to post capital up front. Airlines would be exempt because they hold swaps “primarily for hedging, reducing or otherwise mitigating commercial risk.” But the Senate Banking Committee bill, passed last month, would not exempt end users from the clearinghouses.

Lincoln’s bill is also far broader than the derivatives legislation introduced in the House in Dec-2009, which also exempts end users from having to go through clearinghouses.

Part of the reform of the financial markets for which many have been calling, the legislation will likely be made part of the package introduced by the Senate Banking Committee after the Agriculture Committee votes on it this week. A floor vote could come as early as 26-Apr-2010.

The banking committee bill, redefines swaps participants classifying major swaps participants because they hold substantial net position in swaps or whose default would cause major losses to a counterparty. Lincoln’s bill narrows the definition to companies whose default “could have serious adverse effects on the financial stability of the United States banking system or financial markets.” She also added a third category for any financial company whose swaps position is too high compared to capital on hand.

The Lincoln bill summary indicated that the reform legislation provides “100% transparency to an unregulated $600 trillion market, close all loopholes and keep jobs on Main Street. This will protect taxpayers, jobs, consumers and the global economy, and will go further than any other proposal to prevent future bailouts. The public will see what is being traded, who is doing the trading and, most importantly, regulators can go after fraud, manipulation and excessive speculation. Transactions, determined by the regulator, will be required to clear through a clearinghouse. In addition, these transactions must be traded on a regulated exchange, which will provide further market transparency.”

Still, those who depend on the market will continue to be allowed to trade. “The interests of Main Street will be protected,” it said. “Commercial businesses and manufacturers who use these markets and customised contracts to manage risk will still be permitted to do so without imposing additional margin costs. This will protect American jobs and keep consumer costs low. It will also require swaps dealers to put the interests of municipalities and pension retirement funds first; ensuring Wall Street doesn’t take advantage of Main Street and taxpayers. It gives them the same fiduciary duty as investment advisers.”

This reform is also designed to prevent future bailouts. “Banks need to be kept in the business of banking,” it said. “The taxpayer funds used to bail out AIG and other Wall Street firms will never be used for this purpose again. The Federal Reserve and FDIC will be prohibited from providing any federal funds to bail out Wall Street firms who engage in risky derivative deals.”

The bill gives regulators the ability to close any loopholes they may find, which said the summary allowed “far too many to avoid the law or set up shell companies to claim exemptions.” It also targets foreign exchange, the second largest component of the swaps market at USD50 trillion. They will be regulated just as any other Wall Street contract.

As with every major legislation, financial reform is expected to usher in a political fight and Democrats and Republicans are now locked in a fierce struggle over financial reporting. The exemption for end users is a point of contention between Democrats and Republicans. Another problem is the bill calls for banks to spin off derivative trading desks but Republicans object on the grounds that the business will just move to foreign banks thus harming US banks.

A "casino-like environment" for most end-users

“It is clear that excessive speculation is responsible for current oil prices being 145% greater than 2009 lows,” ATA President James May, told Lincoln in a letter. “Your leadership provides hope to average Americans that our government can help stop the reckless greed on Wall Street.”

During a press conference yesterday May joined Co-Sponsor Senator Maria Cantwell, Lincoln, AirTran Airways Chair, President and CEO Bob Fornaro and others supporting comprehensive congressional action. “If we do not control the fuel price spikes and volatility, our nation’s economic recovery will stall,” said May. “The US airlines are fully behind Senator Lincoln and this strong set of reforms, as she has chosen Main Street’s values over Wall Street’s greed.”

Fornaro agreed. “The run-up in oil prices from less than USD30 per barrel in 2003 and the ensuing volatility has created a casino-like environment for most end-users, with Wall Street holding most of the cards,” he said. “We need to let supply and demand determine what consumers pay, not speculators in an unregulated environment. “The U.S. airlines are solidly behind Senator Lincoln and we thank her for her strong leadership.”

May said that the price of a barrel of crude oil is 78% higher than just one year ago, with volatility driven by excessive speculation. “In 2008, we used the same amount of fuel as we did in 2003 – but it cost us USD42 billion more,” said May. “Senator Lincoln’s bill will make the financial and energy markets more transparent and stable, help prevent manipulation and unacceptable risk-taking.”

When jet fuel prices spiked in 2008 as a result of rampant oil speculation, the aviation industry experienced one of the worst economic crises in its history. The spikes also had a devastating effect on the larger economy. “Regulators will be given broad enforcement authority to punish bad actors that knowingly help clients defraud third parties or the public such as when Wall Street helped Greece use swaps to hide the true state of the country’s finances,” said the bill’s summary.

The real impact of any reform will be in changing the political mindset of regulators, legislators, the Treasury Department, the Federal Reserve and the White House who collectively ignored copious warnings that the financial markets various schemes would lead to a worldwide financial collapse. The pushback by Wall Street and Treasury officials against those who sought to control these excesses is widely documented and reveal much about the fight for reform that is ahead. Suffice it to say that if the bill is passed, and that is a big if, the next hurdle will be ensuring regulators are allowed to exercise the authority.

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