So Maybe It Wasnt 'Natural Forces? US Regulators Charge Banks with Energy Market Manipulation

What are market forces, anyway? And when are they natural and when are they unnatural? Or is the right to manipulate markets and make a lot of money natural? Or, well, who's running this system anyway...and for whose benefit? JL

Javier Blas reports in the Financial Times:

The multibillion US electricity market has seen some Hollywood-style action.

“It is like that battle scene from Braveheart: hold ... hold ... unleash hell!” That is how one electricity trader at Sempra Energy describes Barclays’ trading style in an instant-message exchange dated February 2007. “That’s funny as hell,” the bank’s trader responds.
US regulators weren’t so amused. The Federal Energy Regulatory Commission is seeking a record penalty of $435m and trying to claw back $34.9m in profits from Barclays for allegedly manipulating the electricity market for 655 business days between November 2006 and December 2008. The regulator is also accusing four former traders at the bank of intent to manipulate the price of power.

The case – and the dozens of emails and instant messages released by the FERC – shines a light on the obscure US electricity market, a niche corner of the commodities industry in which banks, utilities, grid companies and hedge funds bet billions of dollars in physical and financial transactions.

It suggests US commodities regulators, including the FERC and the Commodity Futures Trading Commission, are paying extra attention to the link between the physical and derivatives commodities markets.

Whatever the legal outcome of the case, which will take months if not years to reach a conclusion, the emails and instant messages are damaging for Barclays.

The regulator alleges the dozens of emails and instant messages sent by Barclays’ electricity traders, counterparties and several brokers show how the bank was willing to suffer losses in the physical electricity market in order to increase “the value of its financial swap positions”. Barclays strongly denies the charges and plans to contest them in court.

Joseph Gold, head of commodities in the US at Barclays, told the FERC that traders were banned from engaging in this kind of “uneconomic activity”. “The golden rule was always, under no circumstances, lose money on a transaction for the intention of making money on another transaction,” he said.

Bank fighting battles on several fronts
The $470m penalty sought from Barclays would be the highest ever for energy market manipulation. But the bank is fighting regulatory battles on several fronts.

● Libor
In June, Barclays was hit with a record £290m fine by US and UK authorities for attempting to manipulate the Libor benchmark interest rate. The scandal over traders who had rigged Libor while promising each other bottles of Bollinger champagne prompted the departure of the bank’s chief executive, chief operating officer and chairman.

● Qatari investigation
In July this year, Barclays revealed that the Financial Services Authority had launched an investigation over whether it adequately disclosed fees it paid to Qatar Investment Authority in 2008 when the sovereign wealth fund bought a stake in the bank. The UK’s Serious Fraud Office later launched its own criminal inquiry and this week, Barclays disclosed that the US Department of Justice and Securities and Exchange Commission was investigating whether it breached corruption laws.

● Mis-selling
The lender is among a number of UK high street banks that are embroiled in scandals over the mis-selling of payment protection insurance to retail customers as well as interest rate swaps to small businesses. On Thursday, the bill for five banks to compensate their clients for PPI surpassed £10bn.

● Aviva funds
In January last year, Barclays had to pay a £7.7m fine and up to £59m in compensation to more than 12,000 of its customers for failing to provide adequate investment advice when it sold them two Aviva funds. The fine was the largest imposed by the FSA for a case involving retail investors.

● US sanctions
Barclays was one of a number of global banks to settle US probes into violations of international embargoes and sanctions when it paid a $298m fine in 2010.

● Transaction reporting
In September 2009, Barclays’ investment banking arm paid the largest ever fine for inaccurately reporting transactions to the FSA. The £2.45m penalty came after Barclays either failed to report trades or reported inaccurate data.
Although people close to the bank said the electronic conversations were simply examples of the bravado that is typical among young traders, they are reminiscent of the exchanges made public during the Libor manipulation case, in which Barclays accepted a £290m fine.

In one of the exchanges at the centre of the Libor probe, one trader thanks a Barclays banker for his help with: “I’m opening a bottle of Bollinger.” The messages in the power case do not refer to expensive bottles of champagne – but they are sprinkled with colourful and indecent language.

There are profanity-rich complaints from a trader about a particular niche of the US electricity market. A colleague boasts how he is going to “try to crap on” another market. Another describes his rivals a “bunch of chicken shits”.

On the face of it, and in the absence of other context, the conversations project the impression of illict trading, as traders talk openly about ways to “prop up” indices, and about how to take a “daily loss” in the physical market in order to maximise profits in the derivatives market.

In a particular instant-messaging exchange, part of the more than 100,000 emails and 10,000 transcripts that Barclays disclosed to the FERC, one trader explains how he is “doing phys[ical] so I am trying to drive price in fin[ancial] direction”. The email appears to support the complaint by the regulator about Barclays’ trading.

In another exchange, one trader quizzes a colleague about his dealing, concerned that he is buying power in the physical US market just as prices are about to fall sharply: “Why you buy index [of the physical power market] if it is going to tank?” The trader enigmatically responds: “My lit[tle] secret”.

Four traders are alleged to be at the centre of the manipulation. According to the formal complaint published by the FERC, one is Scott Connelly, who was the well-known head of the US West power desk at Barclays at the time. He was formerly at Mirant, a utility fined during the California power crisis in the early 2000s (today the company is known as GenOn Energy Holding). Mr Connelly could not be reached for comment. The other three traders, even if well known, are considered as relatively junior.

Lawyers and regulatory experts say the instant-messaging conversation and emails would be a powerful weapon in the hands of the FERC’s prosecutors. Carlos Blanco, an expert on US energy regulation at the Oxford Princeton Programme, says: “The emails and IM [instant messaging] between Barclays traders are not going to help them with their defence against the accusations.”

However, the regulator would have to prove that the emails and instant messages were matched, word-for-word, by real trades. Lawyers say that could be the Achilles heel of the case against the London-based bank. In previous examples, watchdogs have struggled to connect both sides, forcing regulators to settle for lower fines or, in some instances, to drop the case entirely.

Moreover, the FERC would also have to prove how exactly Barclays made money with its trading strategies – and bring external experts to sustain its views.

Whatever the outcome of the case against Barclays, the tougher approach by US regulators and the disclosure of embarrassing email conversations will send shockwaves through the electricity trading industry.