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Commodity Futures Trading Commission 

Office of External Affairs

Three Lafayette Centre 

 1155 21st Street, NW 

Washington, DC 20581 

 202.418.5080

Testimony 

Testimony of John Fenton 

Deputy Director for Market Surveillance, Division of Market Oversight 

Hearing to Examine Trading on Regulated Exchanges 

and Exempt Commercial Markets 

September 18, 2007

Introduction

Good morning. My name is John Fenton and I am director of the Commission’s Market 

Surveillance Program. This program’s primary mission is to deter and prevent price 

manipulation or any other disruptions to market integrity on regulated futures exchanges 

(DCMs). I am pleased to have this opportunity to talk a bit about how we do surveillance on 

futures markets, and, in particular, what we have been doing in energy futures markets. 

Manipulation Defined 

While the Commodity Exchange Act prohibits manipulation, it does not specifically define it. 

This omission is a recognition by Congress that a precise definition would almost certainly fail to

capture the complexity and variety of potential manipulative behavior. It has been through the 

development of case law under the Commodity Exchange Act that the elements of a definition of 

manipulation have emerged. At the risk of oversimplifying, I think a general definition of

manipulation is that it is any market behavior that is intended to cause, and that succeeds in 

causing, an artificial price. Of course, this raises the question what is an artificial price? An 

artificial price is a price that does not accurately reflect the legitimate market forces of supply

and demand. In other words, it is a price that is an artifice intentionally created by the 

manipulator, that otherwise would not exist. Although the elements of manipulation have 

emerged through cases brought by our Division of Enforcement, they are also extremely relevant

for how we conduct surveillance to deter and prevent manipulation. For example, the ability to 

cause a manipulation may stem from a dominant futures position, and, as I will describe more

fully in a few minutes, to counter this potential threat we monitor futures market positions on a 

daily basis. 
Before proceeding I should mention that my comments are specifically related to the scope of the

Commission’s market surveillance program to deter and prevent manipulation on designated 

contract markets, those markets described in Terry Arbit’s testimony as “fully regulated” 

exchanges. The Commission’s authority to bring anti-manipulation enforcement actions clearly

extends more broadly than this, to include, for example, manipulative activity in cash markets 

and on exempt commercial markets. 

Two Types of Futures Contracts and Their Vulnerability to Manipulation 

Futures contracts are of two general types depending on how they are ultimately settled—either 

through physical delivery or through cash settlement. In both cases, the settlement mechanism is 

meant to ensure that at expiration the futures price converges to the cash value of the underlying 

commodity. The pricing integrity of a futures contract—its efficiency as a price discovery and as

a risk management tool—depends upon the expectation that at expiration its price will reliably 

represent the legitimate supply and demand factors affecting the underlying commodity. The 

overwhelming success of futures markets proves that this is usually the case. In futures markets 

settled through physical delivery, traders can normally arbitrage between futures and cash to 

ensure convergence. If futures prices seem too high relative to cash prices, there will be

relatively greater interest in making delivery, tending to cause futures prices to fall. If futures 

prices seem too low, the opposite will occur. In cash-settled futures markets, the final settlement

price will necessarily represent the value of the settlement index at expiration. 

However, these settlement mechanisms are potentially vulnerable to attempts at price 

manipulation. In futures markets settled through physical delivery, manipulation or attempted 

manipulation is likely to involve the use of market power to dominate the delivery process. For 

example, a market squeeze would involve a trader holding a dominant long position, in excess of

the supply available for delivery on the contract. The long trader could use that dominance to 

extract artificial prices from traders holding short positions who could not make delivery and

would be forced to buy back their positions versus the dominant long trader. To protect against 

this type of manipulation, our market surveillance program has two main tools: large-trader 

position reporting and spot month position limits. I will discuss our large trader reporting system

in more detail in a few minutes, but the point I would like to make now is that large trader 

reporting allows us to monitor the size of positions very careful to detect a possible impending 

squeeze. In addition, spot month position limits mitigate against manipulation by restricting the 

size of positions as a contract approaches expiration, the period when it is vulnerable to being 

squeezed. Historically, the Commission has used as a guideline that exchanges set spot month 

position limits at a level no greater than 25 percent of the normal deliverable supply. The current 

spot month position limit for the NYMEX Henry Hub natural gas futures contract is 1,000 

contracts. 

Manipulation of a cash-settled futures market occurs more indirectly. Since a cash-settled

futures market references some other price for its final settlement, a manipulative scheme would 

involve manipulation of that reference price. In such a scheme, large positions in a cash-settled 

futures contract would provide the motive for a manipulation, but the manipulative activity 

would occur in the market for the reference price. Such a scheme might involve relatively heavy 

buying in the market used as a price reference to force that price to an artificially high level, 

which would then be used to cash settle a much larger long position in the cash-settled futures 

market. The formula for detecting this type of manipulative activity is close scrutiny of prices 

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and trading activity in the reference market, along with large trader information about positions 

that are cash-settled using that reference price. 

Focus of Commission Surveillance of Energy Markets 

The focus of the Commission’s surveillance of energy markets has been on the regulated futures 

markets at NYMEX. At least three reasons explain this focus: (1) this is the mandate provided

by Congress in the Commodity Futures Modernization Act of 2000, (2) the NYMEX Henry Hub 

final settlement price has played a unique role as the central reference price around which other 

cash, futures, and OTC derivative prices have revolved, and (3) this reflects the reality of limited 

Commission resources. While each of these reasons still holds, it has become increasingly 

apparent that proper surveillance of the regulated markets at NYMEX requires increased 

regulatory transparency into trading activity of cleared products linked to NYMEX. With that in 

mind, I would like to briefly describe some of the key pieces of information that we receive for 

regulated futures markets, such as NYMEX, and three special calls issued to ICE to obtain 

similar information. 

Information Received From DCMs 

Pursuant to part 16 of the Commission’s regulations, DCMs are required to provide daily data 

showing aggregate positions and trading cleared by each clearing member, shown separately for 

house and customer positions. This data includes all positions in futures markets at DCM, but it

does not provide information on the size and identity of customer positions. 

The centerpiece of the Commission’s market surveillance program is its large-trader reporting 

system (“LTRS”). Under the LTRS, clearing members, futures commission merchants, and 

foreign brokers—collectively called “reporting firms”—file daily reports with the CFTC 

showing futures and options positions held in accounts they carry that are at or above specific 

reporting levels set by the CFTC. These reporting levels vary by market, from as low as 25 

contracts for small markets to as high as 3,000 contracts for the largest market, the Eurodollar

futures market at the Chicago Mercantile Exchange. The reporting level for natural gas futures 

markets is 200 contracts. The data provided in these reports in aggregate has covered about 97% 

of total open interest in the NYMEX Henry Hub natural gas contract during the past year. 

The Commission also receives large-trader reporting for contracts that are cleared through 

NYMEX’s Clearport facility. Typically, these transactions initially occur in the OTC market, 

through voice brokers, and are then submitted to Clearport for clearing. In interviews with 

industry participants, staff has heard that contracts cleared through Clearport represent a 

significant portion of the OTC activity conducted through voice brokers. 

In addition to large trader reporting for NYMEX markets, the Commission receives from 

NYMEX daily transaction data. This provides a complete audit trail of all trades that occur in 

NYMEX markets. Surveillance staff use this data to closely scrutinize trading activity during

key trading periods, especially during the closing range of the final trading day. 

Special Calls to the Intercontinental Exchange 

The Division of Market Oversight has issued three special calls to the Intercontinental Exchange 

for information related to ICE’s cleared natural gas swap contracts that are cash-settled based on

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NYMEX physical delivery natural gas contract. In each case, the information requested has been 

analogous to information that the CFTC receives from DCMs, including NYMEX. The first 

special call was issued on September 28, 2006, requesting daily clearing member position data,

broken out between house and aggregate customer positions. This is similar to information that 

the Commission receives from DCMs under part 16 of the Commission’s regulations. The 

Commission has been receiving responsive data from ICE since October 10, 2006. With this 

data, market surveillance staff can see all cleared positions at the clearing member level, but it is

not possible to determine individual customer positions from this data. 

To address this gap, the Commission issued a second special call on December 1, 2006 to obtain 

daily individual trader positions. The Commission has been receiving responsive data since 

February 15, 2007. While the content of this data is similar to large trader reporting for DCMs, 

the methodology for reporting is very different. Large trader reporting for products traded on 

DCMs is not done by the exchanges, but by the carrying firms, generally futures commission 

merchants for U.S. traders, and foreign brokers for non-U.S. traders. Since the reporting firms 

know directly these positions, this reporting is fairly straight-forward and highly accurate. The 

Commission’s authority to issue special calls with respect to trading and positions on ECMs is 

limited to the ECM itself. ICE was not, and is not, receiving position reporting from firms.

Therefore, in order to comply with the Commission’s special call, ICE has developed an

algorithm to infer open positions from the sum of all trading by each individual trading firm. 

While this approach is innovative and has provided very valuable information to the 

Commission, it is not yet as accurate as traditional large trader reporting. Commission staff 

continue to work with ICE to improve the accuracy of this data. ICE is providing this 

information in the standard electronic format used for Commission large trader reporting, which 

has allowed us to relatively easily integrate this data into our computer surveillance systems and 

to examine traders’ consolidated positions on NYMEX and ICE. 

I would like to make two observations with respect to insights afforded by large trader reporting 

for NYMEX and ICE natural gas products. The first point is that the composition of commercial 

and non-commercial activity in these two markets, as measure by open positions, is actually 

quite similar. On a recent date, non-commercial traders held about 46 percent of open long 

positions and 52 percent of open short positions in NYMEX’s Henry Hub physical delivery

futures contract. On that same date, non-commercials held about 46 percent of open long 

positions and 36 percent of open short positions in ICE’s linked Henry Hub swap contract. This 

highlights that there is a substantial overlap of traders in these two markets. The second 

observation in based on Commission staff interviews of industry participants in anticipation of

today’s hearing. When asked how much of the total trading activity involving Henry Hub 

futures and swaps that the Commission was seeing as a result of large trader reporting of cleared

positions on NYMEX, Clearport, and ICE, the unanimous response was that we were seeing the 

vast majority of all such positions. 

The most recent special call to ICE was issued on September 5, 2007. This special call requires 

ICE to provide all cleared transaction data for their Henry Hub swap contracts, identifying 

counterparties, for the final two trading sessions prior to the expiration of prompt month Henry 

Hub natural gas products. This data is similar to transaction data that the Commission receives 

from NYMEX for all trading days. When the Commission begins to receive this data, we will be

able to monitor trading activity on ICE during these crucial last two days, in conjunction with 

our analysis of NYMEX trading, to provide more complete coverage to counter possible 

manipulative schemes. 

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Conclusion 

Thank you for this opportunity to briefly describe the Commission market surveillance program

for energy futures markets. This concludes my presentation. 

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