Enron and Us
by Michael Riess
The Enron implosion is reverberating through the financial world, and the disruption EnronOnline caused to the nonferrous markets is now being played out in our own futures and forward markets.
Most of us know Enron as an energy company. It showcased EnronOnline, which traded energy and other primary raw materials and acquired Metallgesellschaft in February, 2000, to establish a dominant nonferrous metals presence. In less than two years it created by far the biggest online metals market in the world. It was so efficient and competitive it drained the London Metal Exchange of volume and liquidity. After 120 years, the LME was suddenly left scrambling to find electronic alternatives through which it might compete and survive.
EnronOnline presented itself as an exchange and, as its volume and liquidity grew, it began to look like one. But it differed fundamentally from the neutral marketplaces it was coming to resemble. Exchanges such as the LME and NYMEX and the emergent neutral online markets are not party to trades that take place under their auspices. They are the flea markets; they don’t buy and sell the fleas.
EnronOnline was a trading company. It provided the market venue and was also the sole market maker—the buyer to all sellers and seller to all buyers. If you contracted with EnronOnline, you took its credit risk. The trade-off was low transaction costs: a very tight, dependable bid/asked spread and zero commissions and fees.
What does this energy and non-ferrous debacle have to do with precious metals?
Precious metals hedging is migrating from futures markets to over-the-counter, principal-to-principal transactions with traders and the metal trading departments of financial institutions. Like Enron, they offer attractive bid/asked spreads with low or no margins.
So why use futures markets?
The Government and exchange regulatory apparatus and the margin mechanism
evolved from a need Enron has underscored. The
commissions, exchange fees and margins needed to support the futures markets are
the cost of credit and market malfeasance insurance.
No
Just as Enron bled the LME, the drift toward OTC dealing is contributing to the demise of some of our markets, perhaps to the point of no return. Platinum and palladium are giving new meaning to “terminal markets.”
Where to go; what to do? Credit analysis, of course, but Handy had most of us fooled and Enron was Wall Street’s darling. Should its BB- credit rating have been a tip-off? One might ask: How many of our precious metals counterparts have investment-grade ratings? And recent history would indicate AAA ratings foster rather than discourage rogue trading and market mischief. One way to avoid a calamitous loss is to spread the risk. To reach to new sources and outlets, some of the new online neutral markets offer fresh names and a chance to complete a credit analysis before doing business. And given the choice, futures might be more expensive, but in the long run, they might be more cost effective.