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September 22, 2006

ICE was Accomplice in Amaranth Blowup

posted by MR WAVETHEORY at 9/22/2006 09:20:00 AM
Rumors has it that Amaranth used ICE, an electronic commodities exchange, to cover its tracks and avoid regulations that would have helped avoid a blowup. You may recall that Amaranth amassed a huge natural gas position that led to its implosion. Well, it turns out there are regulations in the US that limit idiots from buying too many gas futures. To get around things, Amaranth went offshore. Trades on ICE, the InterContinentalExchange Inc, are not subject to CFTC regulations in US, but instead are regulated by the FSA in the UK.
It was the relative lack of oversight at the ICE that let Amaranth make the high-risk natural gas trades that ultimately turned sour, critics charge. Because of its heritage as an overseas exchange, the ICE is exempt from reporting trading data for over-the-counter trades to regulators at the Commodities Futures Trading Commission. Critics say the loophole permitted Amaranth to aggressively add to its high-risk bet that natural gas prices would rise at a future date
Looks like there may be trouble ahead for ICE. Its bad behavior might torpedo the NYBOT deal which is subject to regulatory approval. Sound like another Refco? Anyone? Bueller? Anyone?

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Blogger Jack Doueck said...

As investors hurt by Amaranth this month sort through the damage, here are some principles they may want to have in mind:

It goes without saying that a good hedge fund investor has to pick good funds to invest in. The key, though, to success in this business, is not to choose the best performing managers, but actually to evade the frauds and blowups.

Frauds in this business can take on the form of a misappropriation of funds, as in the case of Cambridge, run by John Natale out of Red Bank NJ, or a misreporting of returns as in the case of Lipper, or Beacon Hill, or the Manhattan Fund, or a host of others.

Blowups usually occur when a single person at the hedge fund has the power to become desperate and "bet the ranch" with leverage. The classic example of this week of Amaranth. Amaranth’s investors will be seeking answers to questions including: to what extent did leverage and concentration play a role in recent out-sized losses.

With both frauds and blowups, contrary to public opinion (and myth), size does NOT matter: Beacon Hill was $2 Billion, Lipper was $5 Billon, Amaranth was $9 Billion).

How do we avoid these two pitfalls of investing in hedge funds?

The answer is long and complex. It takes years to walk on the high wire and not fall off. If you're a long term hedge fund investor and you haven't been burned by one or both of these, you've been either incredibly skilled or incredibly lucky. I should know, for I have been burned by both of these. We have invested billions of dollars in hedge funds over the last ten years in this business. We have done well despite our battle scars and thankfully we have been blessed with a lot of good luck from above.

Suffice it to say that this should be the main question investors should be focused on as they interview and select hedge funds to entrust their dollars to.

Jack Doueck
Stillwater Asset Backed Strategies
Stillwater Capital

10:38 AM  
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