Nymex Warned Amaranth in August on Trades, People Say

Date: Wednesday, September 27, 2006
Author: Matthew Leising, Bloomberg.com

Sept. 27 (Bloomberg) -- 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 closed out some of its natural gas positions after the warnings, according to the people, who asked not to be named because the communications were confidential. Nymex cited 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 this year that speculators are boosting energy prices and avoiding oversight with trades that are not done on exchanges. They have cited Amaranth's biggest- ever hedge fund loss as an example of the problem. 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.

Natural gas touched a record $15.78 per million British thermal units last December and has dropped 72 percent since then. Oil is down 22 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.

Timothy Geithner, president of the Federal Reserve Bank of New York, said two days ago the central bank may need to extend its supervisory authority to securities firms and hedge funds because of their increased role in the financial system.

The U.S. Securities and Exchange Commission is probing ``whether there was any misrepresentation to investors,'' Commissioner Paul Atkins said to reporters in Brussels today. ``It seems like the system worked, as far as how the banks and various brokerage houses handled the situation.''

Rather than overseeing hedge funds directly, the SEC supervises the risks brokers take, working in concert with the Federal Reserve, which supervises the lenders. Atkins said the Amaranth case doesn't demonstrate any need for new regulation.

Money Losers

Geneva-based Union Bancaire Privee, San Diego County's retirement fund, Bermuda-based insurer Max Re Capital Ltd., Arden Asset Management in New York, and the pension fund of 3M Co., the St. Paul, Minnesota-based maker of Post-it Notes and electronics and cleaning products, were among the firms that lost money as a result. Funds managed by Goldman, Morgan Stanley, Credit Suisse Group and Deutsche Bank AG also had money with Amaranth.

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.

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.

`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.

To contact the reporter on this story: Matthew Leising in New York at mleising@bloomberg.net .