“Moment of Inertia”

Speech of Commissioner Bart Chilton before the Institutional Investors Carbon Forum, the Metropolitan Club, New York, New York

September 15, 2009


Thank you for the introduction. This is such an exciting time and I really do appreciate the opportunity to be with you today. The topic of this conference is one of the most important things that can be discussed. In fact, I have said that passage and implementation of a green cap and trade legislation—Green CAT—is “the most important thing we have never done.” Needless to say, I’m a big supporter of passage of a thoughtful piece of legislation in this regard. I have also estimated that carbon markets have the potential of being the leading commodity markets traded in the world. Specifically, I have said that within five years of trading, I think they could represent a $2 trillion market. That is good for the futures industry, good for markets, and good for the economic engine of our democracy.

Oh yeah, and it has the benefit of possibly saving the planet. There is always that. You know, avoiding things like rising sea levels that threaten coastlines, resulting in the displacement of hundreds of millions of people; storms and hurricanes that become increasingly powerful—and deadly; serious droughts affecting inland wetlands, causing the loss of massive breeding grounds and filtration systems; and the accompanying increase and spreading of disease. In short, global warming will disrupt ecosystems all over the world, not just those that are in the direct line of fire, so to speak.

Those are kind of big bonuses. It is sort of like the pinball machine where the player doesn’t only get the score for one ball, but perhaps triple bonus points. With Green CAT legislation we will see multiple benefits.


The first question most folks ask when talking about this is: “Will Congress pass a bill, and if so, when?” While it is difficult to handicap passage of legislation in the Congress, and it is not something I personally do much in public, regulators certainly need to be prepared and ready to implement any legislation, so it would be irresponsible for us not to be making judgments about what may take place.

If one were to look at some of the early action with regard to lobbying for or against this legislation, you’d have to conclude that it is one of the most ardent debates we have had in a while. Many of the supporters and opponents are every bit as passionate about Green CAT legislation as are those involved in the health care reform debate.

To give you some idea of the passion this debate has engendered, the U.S. House Select Committee on Energy Independence conducted an inquiry which has found more than a dozen forged letters to Members of Congress purportedly from voters opposed to a climate change bill—including a number from senior citizen homes, Latino and woman’s groups. For example, letters purportedly were sent from the “Slippery Rock Senior Center,” from “Creciendo Juntos” (a Hispanic community group), and from American Association of University Women in Charlottesville, VA. The Committee is still investigating 45 other letters sent by the lobbying firm Bonner & Associates, which was hired by a pro-coal industry group, the American Coalition for Clean Coal Electricity, to campaign against the climate change bill. The fake letters unearthed so far were sent to three junior Democrats who represent conservative, coal-mining districts. Jack Bonner, the lobbyist, has said that all 13 forgeries identified to date were the work of one employee who has since been fired. These episodes really give new meaning to the old cynical Washington lobbyists’ adage: “If you aren’t part of the solution, there is plenty of money to be made being part of the problem.”

As I say, there are intense lobby efforts on both sides of this issue. In fact, the prospect that Congress might approve Green CAT change legislation has led to a lobbying bonanza in Washington with industry organizations as well as environmental organizations. According to the Center for Public Integrity, prior to the House vote for their Green CAT bill in June, more than 460 new organizations paid for lobbying efforts related to the measure.

It’s also important to remember that this is not just a Democratic administration issue; it also has received significant bipartisan support, in both the House and Senate. Particularly, Senators McCain, Lieberman, and Warner have for many years provided great leadership in this arena with initiatives such as the McCain/Lieberman “Climate Stewardship and Innovation Act” in 2005 and 2007, followed just last year by the Warner/Lieberman “Climate Security Act,” which was co-sponsored by Senators Dole, Coleman and Collins. That kind of broad, deep support is important to factor into the equation in handicapping the possibility of legislation.

Moment of Inertia

Before we get to handicapping the likelihood of passage, I want to go over a little physics and discuss MOI, or Moment of Inertia. Who knows about MOI? Moment of Inertia is a property of physics. You probably didn’t think you’d be hearing about physics today. Well, unless you walk out, you will now. And by the way, I will get to my point.

A good way to think about MOI is a figure skater, when he or she spins in a circle. As the skater pulls his arms in the spin gets tighter and faster—the MOI increases because there is little resistance. It is the same for throwing a ball and it is the same, for example, in golf. The highest MOI is at the most forceful part of the rotation—when the ball will go the farthest and straightest.

How many golfers are in the crowd? You all know then that recently, like in the last few years, MOI has become increasing used in golf club advertisings—sales pitches that is for what are called “game improvement clubs.”

The golf clubs which help get the highest MOI out of a swing are generally larger clubs that have a large “sweet spot.” That is, a larger club face so mis-hits stay straighter and stronger. Off-center hits are not so off-center and capitalize on the swing the golfer is making to produce better shots. Some of these club designs are pretty novel compared to the old wooden golf clubs. For example some have perimeter weighting on clubs to help the club stay on line. My driver is a square-headed tool with weights in the rear corners. It is said that it has a very high MOI.

With a game improvement club with a high MOI, a golfer really has optimal technology working for them. When combined with a decent golf swing that connects the ball at a high MOI, when everything is going right and the actual “point of impact” between the golf club and the ball, with the right swing rotation, a golfer can achieve an exceptionally high moment of inertia.

As a golfer myself, I can tell you that when you have a nice swing with a good club and hit the sweet spot, it is a great feeling. You know it immediately. Everything has gone right. That feeling is why golfers continue to endure the pain of the game. You can play seventeen holes and then hit a stellar drive on the last hole and want to go out the next day and play again.

With that, let’s get back to my point, and I do have one. I think there is a very high moment of inertia that will exist in the coming months for the legislation. There are three reasons why.

First, while other issues may currently dominate the Congressional agenda, the President has made it clear that Green CAT legislation is critical and a high priority. Despite a host of other urgent problems to tackle, President Obama still inspires confidence from environmental and corporate leaders that he is committed to addressing climate change. Even as the administration and the U.S. Congress tackle legislation on healthcare reform and economic recovery, Yvo de Boer, head of the U.N. Climate Change Secretariat said the administration is keeping its focus on climate change in advance of Copenhagen this December. President Obama is scheduled to speak on global warming later this month during a special U.N. summit in New York where world leaders will discuss a deal that succeeds the Kyoto Protocol. And the President has also tasked his Administration to work with the U.N. Framework Convention on Climate Change (UNFCC).

Further evidence of the President’s commitment is the activity of his top climate change diplomat, Todd Stern, as he urges Congress to keep moving forward toward the passage of a comprehensive climate law, saying it would be a useful tool for U.S. diplomats as they strive for an agreement in Copenhagen. “The most important thing is Congress send the president legislation,” Mr. Stern told the House Select Committee on Energy Independence and Global Warming. “It gives us the kind of credibility and leverage that’d be useful in the context of these negotiations.” As you can see, President Obama has been clear about his vision and has shown no signs whatsoever of backing off from his desire to do what he can on this important issue. He wants the U.S. to renew efforts to again be a world leader on climate change, and has consistently made his commitment to this legislation an ongoing and important objective.

Second, as I mentioned before, the scientific evidence that the planet is warming and that we are nearing a tipping point has become increasingly clear. In fact, according to a new study developed by the International Institute for Environment and Development in London and the Grantham Institute for Climate Change at Imperial College, we have, up until this point, seriously underestimated the expected annual cost of dealing with climate impacts. While the UNFCCC has suggested that typically it could cost about $70bn or $100bn per year to combat the effects of climate change, this new study suggests that the true annual cost could easily reach $300bn or more. This represents what would be required to build new flood defenses and irrigation for agriculture, to treat an increase in the range and severity of diseases, and to replace buildings and other infrastructure affected by rising temperatures, water levels, and storm frequency, to name just a few of the adaptation measures.

The past several reports published by the Intergovernmental Panel on Climate Change (IPCC) have said with certainty that “[w]arming of the climate system is unequivocal, as is now evident from observations of increases in global average air and ocean temperatures, widespread melting of snow and ice, and rising global mean sea level.” Such a view is supported by several organizations such as the National Academy of Science, National Oceanic and Atmospheric Administration, and Pew Research Center. Earlier this year, a survey by University of Illinois at Chicago Associate Professor Peter Doran showed that over 95% of prominent earth scientists around the world overwhelmingly agree that in the past 200-plus years, mean global temperatures have been rising, and that human activity is a significant contributing factor in changing mean global temperatures. The arguments that the planet isn’t warming and that there are no global consequences for our kids and grandkids just aren’t real.

Third, the Obama Administration, through the Environmental Protection Agency (EPA) is moving forward with its own carbon regulations. That is, they are going forward to put a cap on carbon emissions regardless of what Congress is currently doing. Specifically, In April, the EPA released a proposed finding that greenhouse gases endanger public health and welfare—the "endangerment finding"—which would establish greenhouse gases as pollutants under the Clean Air Act and pave the way for future regulations. The finding is a response to a landmark 2007 Supreme Court decision that paved the way for Clean Air Act regulation of greenhouse gas emissions if EPA reaches this conclusion. The EPA is still reviewing some 300,000 public comments gathered this summer on the proposal, so this is a huge issue. In addition, the agency has also moved forward in establishing an economy-wide, greenhouse gas registry that would account for 85-90% of U.S. emissions, and with increased efficiency and tailpipe standards in automobiles.

This is very troubling to many in the energy industry and others who might be affected because they perceive themselves to have less impact with the EPA than they would in Congress. Many—industry and environmentalists alike—would prefer to have a greater voice in the specifics of how government moves forward, and that means working with Congress to pass a Green CAT bill.

Given those three points—the focus of the President; the scientific data; and the fact that EPA is going to move forward on the regulatory path—all lead me to believe that there will be, in the not-too-distant future, a very high MOI for passage of a Green CAT bill.

The House has already passed a bill. I think bills will pass out of Senate Committees this year, at least some committees. I also believe there is a very strong likelihood that a Green CAT bill will pass, but perhaps not this year. With the intense debate on health care, the appropriations process this fall, and with chairs and staff of Senators shifting around because of the death of Senator Kennedy, I think passage of a Green CAT bill that becomes law this year is less likely than it was several months ago. In short, it would be very difficult for Congress to approve something in the remainder of this Congressional year. I am, however, extremely optimistic—due to the high MOI circumstances I described—that a year from now, regulatory agencies like the CFTC will be underway in our process to implement rules and regulations related to carbon legislation—and that the bill will have been approved with bipartisan support. I told you there a point about the whole physics thing.

By the way, golfers have a better than average carbon footprint. Here are a few data points that I received in an e-mail (so they must be true) a while back. A recent study found the average American golfer, walks about 900 miles a year. Another study found American golfers drink, on average, 22 gallons of alcohol a year. That’s got to be beer, right? Twenty two gallons—wow! That means, on average, American golfers get about 41 miles to the gallon. Therefore, golfers are fairly fuel-efficient and that helps the planet.

Expectations for the Future

Let’s assume for the sake of the conversation that Congress does pass and the President does sign into law a Green CAT bill within the next, say, half year. What can we expect from the future? As I mentioned, the carbon market could be the largest commodity market in the entire world—topping $2 trillion within five years of trading. That is going to require an incredible amount of regulatory oversight and we have to get it right from the beginning.

Some say that carbon markets will be like any other market, like any other contract. A trade is a trade is a trade. But there is something different in that the government will control the allocation of credits. In addition, since these will be so large, the opportunity for fraud, abuse and manipulation will be out there in a big way. So we will need to be prepared ahead of time and as we go forward to ensure that the new Green CAT markets are operating efficiently and effectively and that we do all that we can to avoid and guard against fraud, abuse and manipulation.

Specifically, there are at least four things I think we need to be doing to be ready for these new markets.

First, the CFTC has several advisory committees. These committees are comprised of market participants, academics, exchange officials, and others interested in the futures markets. One of our advisory committees, the energy and environmental Markets Advisory committee or EEMAC, I actually chair. In fact, we are having a meeting tomorrow. The EEMAC is currently helping the CFTC to look around the corner at what we may need to do to be prepared on day one for these new and exciting markets. With their help, we will be more like a cop on the beat constantly looking at the markets. We will be nimble and quick. That’s how we should be, as opposed to a regulator more akin to a fire department which reacts to emergency. I want us to be able to stop things before they become emergencies, and the EEMAC is helping us do just that with regard to Green CAT markets.

Second, I think we need some reasonable limits on the amount of contracts an individual trader may hold. Our act, the Commodity Exchange Act or CEA, requires that we do all that we can to detect and prosecute manipulation. That means that when there is even the possibility that a large position could influence market prices in an uneconomic fashion—that is, a market move divorced from the fundamentals of supply and demand—that we act. That does not mean we will act capriciously or become an overzealous regulator. To the contrary, our job is also to ensure that the markets are running smoothly, so we certainly need to be concerned about liquidity and we do not want, as the U.S. regulator, to shut down legitimate business or drive transactions overseas. I have consistently said that we need to look at reasonable—and let me stress the word reasonable—position limits for finite commodities. Those limits, in conjunction with a rational hedge exemption definition, would go a long way, I believe, toward addressing some of the serious market anomalies we have witnessed in the past two years. I’m not about advocating getting legitimate market participants out of the futures markets—that’s not our job. As, I’ve repeatedly said, the CFTC is not here to say, you’re not tall enough to ride this ride. I’ve also said time and again that “speculator” is not a dirty word. So let me wrap up this point by saying that it’s really about balance, about getting input from all interested parties and getting these levels and definitions right—for all market participants—and ultimately for the American consumer.

Third, I think we need to, at the CFTC, seriously consider changing our manipulation standard. It’s a propitious time to consider this, inasmuch as the administration has instructed the CFTC and SEC to review their regulations with the goal of harmonizing them. If you compare the agencies’ manipulation standards, the SEC has an easier legal hurdle to jump, and I think this may a great opportunity to adjust our rules to be more in line with theirs.

Specifically, Section 6(c) of the CEA requires that we prove “specific intent” to manipulate. That is a very difficult standard to reach. You’d have to have a pretty dumb individual to, for example, write in an e-mail that you specifically intend to manipulate prices. But that’s what our law currently requires. In fact, this standard is so high that in the CFTC’s 35-year history, we have only successfully prosecuted and won one single case of manipulation in the futures markets! Only one. And that case, the DiPlacido matter, is currently on appeal in federal court.

In addition, our case law also requires that we prove an artificial price exists, that the defendant had market power to move the price, and the he or she actually did cause the artificial price. Particularly in today’s complex markets, proving “artificial price” can be a daunting task, which more often than not comes down to a “battle of the experts” in court. Because these requirements are so onerous, we often end up moving to a lesser charge of “attempted manipulation,” which requires only proving intent and some act showing that intent. This is still a high standard, but is much easier than proving up a full manipulation case. We’ve been very successful over the years, particularly in the energy arena, in obtaining significant settlements in attempted manipulation cases.

The Securities and Exchange Commission (SEC), on the other hand, under its “10b-5 rule” has a different, easier to prove manipulation standard. Basically, they do not need to prove specific intent, as we do, they just must prove that the defendant acted “recklessly.” I’m not saying that the answer is wholesale adoption of the SEC manipulation standard (a standard, by the way, that is also used at FERC and the FTC), but clearly, as Senator Cantwell and others have recently noted, we need to do something different at the CFTC. The status quo simply isn’t good enough.

I would point out that, in looking at other jurisdictions around the world, virtually all nations have rules prohibiting this type of conduct, and it is a criminal offense in most of those jurisdictions, entailing significant sanctions. In this country, our current standard in the futures arena just isn’t working. It’s not sufficient to fully prosecute and deter abuses in the markets, and we need to move forward on figuring this out as we look to taking on carbon markets. I think we need to do it regardless of the carbon markets, but especially because of carbon markets, which at the outset will be fairly fragile and subject to intense scrutiny. We need to get the oversight and regulation of these markets right from the get-go.

Finally, with regard to the cash market authority over carbon markets, I would note that the Commission, pursuant to authority granted under the 2008 Farm Bill, recently issued a notice for public comment relating to classification of CCX’s Carbon Financial Instrument as a “significant price discovery contract.” The relevance, and importance, of this development is that this would provide the agency with increased authority over a cash emissions contract. The CFTC obviously has significant experience as a market regulator, and we are well-positioned to seamlessly carry out the oversight for both the carbon emissions cash and derivatives markets. It goes without saying, however, that this would require a substantial increase in funding and resources. But make no mistake, should Congress decide to give the CFTC this authority, we are ready and more than able to carry out the responsibility.

We have recently witnessed massive fraud perpetrated in European carbon markets. Last month, the British HM Revenue and Customs (HMRC) raided 27 properties around London following a 7-month investigation into a suspected 38 million pounds ($62 million) value-added tax or VAT, fraud. Fraudsters are alleged to have targeted cash market trade in carbon permits, an unregulated market worth tens of billions of dollars, because of its tax treatment in the EU and lack of oversight by financial regulators. Although here in the U.S. we do not use the VAT system, the lesson from such an occurrence is clear: with a lack of targeted, coordinated regulatory oversight, the unscrupulous, those who have the ability to take advantage of weaknesses in the system, will do so. Here in the U.S. we need to learn from our brethren regulators overseas and ensure that we are prepared and ready to be the strong cop-on the beat regulator, on the lookout for both typical and atypical forms of fraud and market abuse.


In summary, I think we are going to get a bill passed and we are going to start down the road of the Green CAT markets. It is tremendously exciting. There are myriad possibilities of what will happen—of the good that can come from moving forward here. As I said at the beginning: it is sort of like pinball. Remember Pete Townshend, who wrote “Pinball Wizard” from Tommy (the Rock Opera)? There is a lyric in the song: “How do you think he does it? I don’t know. What makes him so good?” Well, Tommy kept the pinball in play for a long time and he continued to get double and triple bonus points, just like we are going to do with these Green CAT markets.

As a regulator, we are going to remain true to our mission, mantra and mandate and do all we can to guard against fraud, abuse and manipulation. I think we will be ready, we will be positioned to do the appropriate oversight. And as far as the private sector, I know you folks will be there, innovating, making progress and helping us move forward. I wish you the best of luck and look forward to working together. Let’s get some triple bonus points!

Thank you.

Last Updated: June 10, 2010