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Energy Risk & Markets

Allowance trading needs oversight, but don’t overdo it.

Fortnightly Magazine - July 2008

markets, the Feinstein-Snowe bill would make the following emissions trading activities unlawful:

• To knowingly provide the EPA or its delegates any false information relating to the price or quantity of emission allowances sold, purchased, transferred, banked or borrowed by the individual or entity, with the intent to fraudulently affect the data being compiled by the EPA or other entity gathering information for the EPA.

• Directly or indirectly, to use in connection with the purchase or sale of an emission allowance any manipulative or deceptive device or contrivance, within the meaning of section 10(b) of the Securities Exchange Act of 1934, in contravention of such rules and regulations as the EPA may prescribe to protect the public interest or consumers.

• To cheat or defraud, or attempt to cheat or defraud, another market participant, client, or customer.

The EPA also would be required to monitor trading to prevent false reporting, manipulation, and fraud.

These provisions beg a series of questions. Would the law cover the emissions-trading landscape? The answer is that it depends on what Congress is trying to achieve. Reading the plain text of the statute, it would give the EPA authority over activities related to “emissions allowances” the federal government would issue to entities using them to reduce their pollution emissions. But the anti-manipulation provisions wouldn’t apply to any other allowances trading throughout the United States and internationally, and wouldn’t apply to market participants other than emitters that were the initial recipients of the allowances.

The second question is whether 10b-5 is the appropriate standard for regulating the emissions-trading market, and the answer is no. Congress seems fixated on using 10b-5 as a model for anti-manipulation statutes. For example, it adopted this standard in the anti-manipulation laws related to FERC’s regulation of the wholesale natural gas and power markets. 6 But this reliance is misplaced. 10b-5 is an anti-fraud statute that generally applies when there is a duty to disclose ( e.g., when a statute requires disclosure, when an insider trades on non-public information, or where a fiduciary or other relationship or trust exists). At this time, there is no duty to disclose in the emissions-trading regime. A more appropriate model would be CFTC’s manipulation provisions, because they address the activity that seems to be of concern to Congress by making it a felony for “Any person to manipulate or attempt to manipulate the price of any commodity in interstate commerce, or for future delivery … or to corner or attempt to corner any such commodity.” 7

Third, what constitutes an action “in connection with the purchase or sale of an emission allowance?” Drawing from the CFTC and FERC debate in the Amaranth enforcement cases, the “in-connection-with” language likely will create regulatory uncertainty over who regulates what. In the Energy Policy Act of 2005, Congress used the same “in-connection-with” phrase to frame the scope of FERC’s authority to pursue evidence of manipulation in the power and natural gas industries. When investigating Amaranth’s alleged manipulation of the natural gas markets, FERC read broadly the “in-connection-with” language to allow it