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e9-18159

  • FR Doc E9-18159[Federal Register: July 30, 2009 (Volume 74, Number 145)]

    [Notices]

    [Page 37988-37991]

    From the Federal Register Online via GPO Access [wais.access.gpo.gov]

    [DOCID:fr30jy09-36]

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    COMMODITY FUTURES TRADING COMMISSION

    Order Finding That the ICE Henry Financial LD1 Fixed Price

    Contract Traded on the IntercontinentalExchange, Inc., Performs a

    Significant Price Discovery Function

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Final order.

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    SUMMARY: On June 12, 2009, the Commodity Futures Trading Commission

    (``CFTC'' or ``Commission'') published for comment in the Federal

    Register \1\ a notice of its intent to undertake a determination

    whether the Henry Financial LD1 Fixed Price contract, traded on the

    IntercontinentalExchange, Inc. (``ICE''), an exempt commercial market

    (``ECM'') under sections 2(h)(3)-(5) of the Commodity Exchange Act

    (``CEA'' or the ``Act''), performs a significant price discovery

    function pursuant to section 2(h)(7) of the CEA. The Commission

    undertook this review based upon an initial evaluation of information

    and data provided by ICE as well as a Commission report on ECMs. The

    Commission has reviewed public comments and the entire record in this

    matter and has determined to issue an order finding that the ICE Henry

    Financial LD1 Fixed Price contract performs a significant price

    discovery function. Authority for this action is found in section

    2(h)(7) of the CEA and Commission rule 36.3(c) promulgated thereunder.

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    \1\ 74 FR 28028 (June 12, 2009).

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    DATES: Effective date: [date of underlying order].

    FOR FURTHER INFORMATION CONTACT: Gregory K. Price, Industry Economist,

    Division of Market Oversight, Commodity Futures Trading Commission,

    Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.

    Telephone: (202) 418-5515. E-mail: gprice@cftc.gov; or Susan Nathan,

    Senior Special Counsel, Division of Market Oversight, same address.

    Telephone: (202) 418-5133. E-mail: snathan@cftc.gov.

    SUPPLEMENTARY INFORMATION:

    I. Introduction

    The CFTC Reauthorization Act of 2008 (``Reauthorization Act'') \2\

    significantly broadened the CFTC's regulatory authority with respect to

    ECMs by creating, in section 2(h)(7) of the CEA, a new regulatory

    category--ECMs on which significant price discovery contracts

    (``SPDCs'') are traded--and treating ECMs in that category as

    registered entities under the CEA. The legislation authorizes the CFTC

    to designate an agreement, contract or transaction as a SPDC if the

    Commission determines, under criteria established in section 2(h)(7),

    that it performs a significant price discovery function. When the

    Commission makes such a determination, the ECM on which the SPDC is

    traded must assume, with respect to that contract, all the

    responsibilities and obligations of a registered entity under the Act

    and Commission regulations, and must comply with nine core principles

    established by new section 2(h)(7)(C).

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    \2\ Incorporated as Title XIII of the Food, Conservation and

    Energy Act of 2008, Public Law No. 110-246, 122 Stat. 1624 (June 18,

    2008).

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    On March 16, 2009, the CFTC promulgated final rules implementing

    the provisions of the Reauthorization Act.\3\ As relevant here, rule

    36.3 imposes increased information reporting requirements on ECMs to

    assist the Commission in making prompt assessments whether particular

    ECM contracts may be SPDCs. In addition to filing quarterly reports of

    its contracts, an ECM must notify the Commission promptly concerning

    any contract traded in reliance on the exemption in section 2(h)(3) of

    the CEA that averaged five trades per day or more over the most recent

    calendar quarter, and for which the exchange sells its price

    information regarding the contract to market participants or industry

    publications, or whose daily closing or settlement prices on 95 percent

    or more of the days in the most recent quarter were within 2.5 percent

    of the contemporaneously determined closing, settlement or other daily

    price of another contract.

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    \3\ 74 FR 12178 (Mar. 23, 2009); these rules became effective on

    April 22, 2009.

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    Commission rule 36.3(c)(3) established the procedures by which the

    Commission makes and announces its determination whether a particular

    ECM contract serves a significant price discovery function. Under those

    procedures, the Commission will publish notice in the Federal Register

    that it intends to undertake a determination whether the specified

    agreement, contract or transaction performs a significant price

    discovery function and to receive written views, data and arguments

    relevant to its determination from the ECM and other interested

    persons. The Commission will, within a reasonable period of time after

    the close of the comment period, consider all relevant information and

    [[Page 37989]]

    issue an order announcing and explaining its determination. The

    issuance of an affirmative order triggers the effectiveness of the

    Commission's regulatory authorities with respect to an ECM with a SPDC;

    at that time, such an ECM becomes subject to all provisions of the CEA

    applicable to registered entities.\4\ The issuance of such an order

    also triggers the obligations, requirements and timetables prescribed

    in Commission rule 36.3(c)(4).\5\

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    \4\ Public Law 110-246 at 13203; Joint Explanatory Statement of

    the Committee of Conference, H.R. Rep. No. 110-627, 110 Cong., 2d

    Sess. 978, 986 (Conference Committee Report). See also 73 FR 75888,

    75894 (Dec. 12, 2008).

    \5\ For an initial SPDC, ECMs have a grace period of 90 calendar

    days from the issuance of a SPDC determination order to submit a

    written demonstration of compliance with the applicable core

    principles. For subsequent SPDCs, ECMs have a grace period of 30

    calendar days to demonstrate core principle compliance.

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    II. Notice of Intent To Undertake SPDC Determination

    On June 12, 2009, the Commission published in the Federal Register

    notice of its intent to undertake a determination whether the ICE Henry

    Financial LD1 Fixed Price contract performs a significant price

    discovery function, and requested comment from interested parties. \6\

    Comments were received from the American Public Gas Association

    (``APGA''); the Steel Manufacturer's Association and East Texas

    Electric Cooperative (collectively, ``SMA/ETEC''); and the CME

    Group.\7\ The comments are more extensively discussed below in the

    Findings and Conclusion Section.

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    \6\ The Commission's Part 36 rules establish, among other

    things, procedures by which the Commission makes and announces its

    determination whether a specific ECM contract serves a significant

    price discovery function. Under those procedures, the Commission

    publishes a notice in the Federal Register that it intends to

    undertake a determination whether a specified agreement, contract or

    transaction performs a significant price discovery function and to

    receive written data, views and arguments relevant to its

    determination from the ECM and other interested persons.

    \7\ The comment letters are available on the Commission's Web

    site: http://www.cftc.gov/lawandregulation/federalregister/

    federalregistercomments/2009/09-007.html.

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    III. Section 2(h)(7) of the CEA

    The Commission is directed by section 2(h)(7) of the CEA to

    consider the following factors in determining whether a contract

    performs a significant price discovery function:

    Price Linkage--the extent to which the agreement, contract

    or transaction uses or otherwise relies on a daily or final settlement

    price, or other major price parameter, of a contract or contracts

    listed for trading on or subject to the rules of a designated contract

    market (``DCM'') or derivatives transaction execution facility

    (``DTEF''), or a SPDC traded on an electronic trading facility, to

    value a position, transfer or convert a position, cash or financially

    settle a position, or close out a position.

    Arbitrage--the extent to which the price for the

    agreement, contract or transaction is sufficiently related to the price

    of a contract or contracts listed for trading on or subject to the

    rules of a designated DCM or DTEF, or a SPDC traded on or subject to

    the rules of an electronic trading facility, so as to permit market

    participants to effectively arbitrage between the markets by

    simultaneously maintaining positions or executing trades in the

    contracts on a frequent and recurring basis.

    Material price reference--the extent to which, on a

    frequent and recurring basis, bids, offers or transactions in a

    commodity are directly based on, or are determined by referencing, the

    prices generated by agreements, contracts or transactions being traded

    or executed on the electronic trading facility.

    Material liquidity--the extent to which the volume of

    agreements, contracts or transactions in a commodity being traded on

    the electronic trading facility is sufficient to have a material effect

    on other agreements, contracts or transactions listed for trading on or

    subject to the rules of a DCM, DTEF or electronic trading facility

    operating in reliance on the exemption in section 2(h)(3).

    Not all factors must be present to support a determination that a

    particular contract performs a significant price discovery function.

    Moreover, the statutory language neither prioritizes the factors nor

    specifies the degree to which a SPDC must conform to the various

    factors. In Guidance issued in connection with the Part 36 rules

    governing ECMs with SPDCs, the Commission observed that these factors

    do not lend themselves to a mechanical checklist or formulaic analysis.

    Accordingly, the Commission has indicated that in making its

    determinations it will consider the circumstances under which the

    presence of a particular factor, or combination of factors, would be

    sufficient to support a SPDC determination.\8\ For example, for

    contracts that are linked to other contracts or that may be arbitraged

    with other contracts, the Commission will consider whether the price of

    the potential SPDC moves in such harmony with the other contract that

    the two markets essentially become interchangeable. This co-movement of

    prices would be an indication that activity in the contract had reached

    a level sufficient for the contract to perform a significant price

    discovery function.

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    \8\ 17 CFR 36, Appendix A.

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    IV. Findings and Conclusions

    The ICE Henry Financial LD1 Fixed Price contract is cash settled

    based on the final settlement price of the New York Mercantile

    Exchange's (``NYMEX'') physically-delivered Henry Hub-based Natural Gas

    futures contract for the corresponding contract month. The trading unit

    of the ICE Henry Financial LD1 Fixed Price contract is 2,500 mmBtu

    multiplied by the number of calendar days in the contract month. For

    example, if a contract month has 30 days, the trading unit is 75,000

    mmBtu, which is referred to as 30 lots.

    Based on data provided in connection with the quarterly

    notification required by Commission rule 36.3(c)(2), this contract

    realized more than an average of five trades per day during the first

    quarter of 2009. In addition, the average volume of natural gas traded

    each business day during that period was 449,010 contracts; the open

    interest in the contract as of March 31, 2009 was 2,932,798 contracts.

    Based on these contract features and trading data, the ICE Henry

    Financial LD1 Fixed Price contract satisfies the material liquidity,

    price linkage and arbitrage criteria for a SPDC. The very high average

    daily trading volume indicates that the contract is relatively liquid.

    With regard to the price linkage and arbitrage tests, the ICE Henry

    Financial LD1 Fixed Price contract and NYMEX's physically-delivered

    Natural Gas futures contract have the same final settlement prices, and

    ICE uses NYMEX's forward settlement curve when conducting its mark-to-

    market accounting procedures to settle the contract on a daily basis.

    In evaluating the ICE Henry Financial LD1 Fixed Price contract, the

    Commission also has the benefit of a recent study focused on price

    discovery contracts on ECMs. The Commission's October 2007 Report on

    the Oversight of Trading on Regulated Futures Exchanges and Exempt

    Commercial Markets (``ECM Study'') stated that traders and voice

    brokers view the instant ICE contract as economically equivalent to the

    NYMEX physically-delivered Natural Gas futures contract. The ICE and

    NYMEX contracts essentially comprise a single market for natural gas

    derivatives trading, and traders look to both the ICE and the NYMEX

    when determining where to

    [[Page 37990]]

    execute a trade at the best price. The ECM Study also reported that the

    ICE natural gas contract acts as a price discovery market.

    The statements provided by APGA and CME provide additional support

    for the Commission's findings. APGA, the national association for

    publicly-owned natural gas distribution systems, states that its

    members report that the prices on the ICE and NYMEX contracts have an

    ongoing, linked relationship that extends not only to the linked

    settlement price but to prices between the two contracts throughout the

    trading day. Its members report that the prices of both markets are

    substantially the same and move in tandem, and that counterparties use

    either market interchangeably as a basis for quoting prices. This

    linkage, in APGA's view, makes possible arbitrage trading between the

    two markets. With respect to material price reference, APGA observes

    that the ICE contract is routinely used as a means by which cash market

    prices are referenced.\9\ Finally, APGA states that whether or not its

    members trade the ICE contract, they are of the opinion that they would

    be able to execute substantial orders without having an impact on the

    market price through the transaction.

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    \9\ APGA members note that in general the written cash market

    contracts that they enter into reference the NYMEX price, as does

    the ICE Henry Financial LD1 Fixed Price contract itself. While the

    cash contracts commonly do not explicitly reference the ICE contract

    as the settlement price, APGA states that it is common market

    practice for dealers to provide cash market price quotes based upon

    the ICE Henry Financial LD1 Fixed Price contract. With respect to

    material price reference, while it appreciates the anecdotal

    information provided by both APGA and CME Group, the Commission has

    not reached a conclusion with respect to this factor.

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    CME Group opines that the Henry Financial LD1 Fixed Price contract

    readily satisfies all four of section 2(h)(7)'s criteria as explained

    in the Appendix A Guidance. It notes that when trading in the Henry

    Financial LD1 Fixed Price contract is viewed in the context of the

    relevant competing contracts at NYMEX, including both financially-

    settled and physically-settled contracts, ICE's contract had a 40

    percent market share of that trading activity--easily satisfying the

    standards for material liquidity. As to price linkage, CME Group

    observes that the ICE Henry Financial LD1 Fixed Price contract

    continues to have the same settlement price as the NYMEX natural gas

    contract; with regard to final settlement, the product specifications

    for the ICE contract explicitly provide for final settlement to be

    equal to the final settlement price of the NYMEX natural gas futures

    contract. Thus, in CME's opinion there appears to be little chance that

    the ICE contract will deviate from the NYMEX settlement price for final

    settlement. With respect to arbitrage, CME Group offers anecdotal

    information indicating a strong and active arbitrage between the two

    contracts. Finally, CME Group observes that the ICE Henry Financial LD1

    Fixed Price contract satisfies the statutory standard for material

    price reference, as ICE itself relies on the settlement prices

    generated by NYMEX for its own settlement prices in the contract,

    rather than on prices generated by its own system. Moreover, CME Group

    notes its understanding that ICE has for several years been selling its

    price information for this contract to interested persons.\10\

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    \10\ As noted above, the Commission has not reached a conclusion

    with respect to the material price reference factor.

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    SMA/ETEC supports recognition of the Henry Financial LD1 Fixed

    Price contract as a SPDC; the bulk of its comment letter, however,

    focuses on issues beyond the narrow scope of the instant action, which

    is to determine whether the ICE contract performs a significant price

    discovery function. For instance, SMA/ETEC advocates subjecting all

    natural gas investment vehicles to aggregate position limits and

    discusses the Commission's proposed limited risk management exemption.

    After considering the entire record in this matter, including the

    ECM Study and the comments received, the Commission has determined that

    the ICE Henry Financial LD1 Fixed Price contract performs a significant

    price discovery function under the material liquidity, price linkage

    and arbitrage criteria established in section 2(h)(7) of the CEA.

    The issuance of this order triggers the immediate effectiveness of

    the Commission's authorities with respect to ICE as a registered entity

    in connection with its Henry Financial LD1 Fixed Price contract,\11\

    and triggers the obligations, requirements--both procedural and

    substantive--and timetables prescribed in Commission rule 36.3(c)(4)

    for ECMs.\12\

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    \11\ See 73 FR 75888, 75893 (Dec. 12, 2008).

    \12\ This Order determining that the ICE Henry Financial LD1

    Fixed Price contract is a SPDC represents the first time the

    Commission has determined that one of ICE's contracts performs a

    significant price discovery function. Accordingly, ICE must, within

    90 calendar days of the date of this Order, submit to the Commission

    a written demonstration of compliance with the section 2(h)(7) core

    principles.

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    IV. Related Matters

    A. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \13\ imposes certain

    requirements on Federal agencies, including the Commission, in

    connection with their conducting or sponsoring any collection of

    information as defined by the PRA. Certain provisions of Commission

    rule 36.3 impose new regulatory and reporting requirements on ECMs,

    resulting in information collection requirements within the meaning of

    the PRA. OMB previously has approved and assigned OMB control number

    3038-0060 to this collection of information.

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    \13\ 44 U.S.C. 3507(d).

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    B. Cost-Benefit Analysis

    Section 15(a) of the CEA \14\ requires the Commission to consider

    the costs and benefits of its actions before issuing an order under the

    Act. By its terms, section 15(a) does not require the Commission to

    quantify the costs and benefits of an order or to determine whether the

    benefits of the order outweigh its costs; rather, it requires that the

    Commission ``consider'' the costs and benefits of its actions. Section

    15(a) further specifies that the costs and benefits shall be evaluated

    in light of five broad areas of market and public concern: (1)

    Protection of market participants and the public; (2) efficiency,

    competitiveness and financial integrity of futures markets; (3) price

    discovery; (4) sound risk management practices; and (5) other public

    interest considerations. The Commission may in its discretion give

    greater weight to any one of the five enumerated areas and could in its

    discretion determine that, notwithstanding its costs, a particular

    order is necessary or appropriate to protect the public interest or to

    effectuate any of the provisions or accomplish any of the purposes of

    the Act. The Commission has considered the costs and benefits of this

    Order in light of the specific provisions of section 15(a) of the Act

    and has concluded that this Order, which strengthens Federal oversight

    of the ECM and helps to prevent market manipulation, is necessary and

    appropriate to accomplish the purposes of section 2(h)(7) of the Act.

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    \14\ 7 U.S.C. 19(a).

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    When a futures contract begins to serve a significant price

    discovery function, that contract, and the ECM on which it is traded,

    warrants increased oversight to deter and prevent price manipulation

    and other disruptions to

    [[Page 37991]]

    market integrity, both on the ECM itself and in any related futures

    contracts trading on designated contract markets (``DCMs''). An Order

    finding that a particular contract is a SPDC triggers this increased

    oversight and imposes obligations on the ECM calculated to accomplish

    this goal. The increased oversight engendered by the issuance of a SPDC

    Order increases transparency and helps to ensure fair competition among

    ECMs and DCMs trading similar products and competing for the same

    business. Moreover, the ECM on which the SPDC is traded must assume,

    with respect to that contract, all the responsibilities and obligations

    of a registered entity under the CEA and Commission regulations.

    Additionally, the ECM must comply with nine core principles established

    by section 2(h)(7) of the Act--including the obligation to establish

    position limits and/or accountability standards for the SPDC.

    Amendments to section 4(i) of the CEA authorize the Commission to

    require large trader reports for SPDCs listed on ECMs. These increased

    ECM responsibilities, along with the CFTC's increased regulatory

    authority, subject the ECM's risk management practices to the

    Commission's supervision and oversight and generally enhance the

    financial integrity of the markets.

    V. Order

    After considering the complete record in this matter and the

    comment letters received in response to its request for comments, the

    Commission has determined to issue the following:

    Order

    The Commission, pursuant to its authority under section 2(h)(7) of

    the Act, hereby determines that the ICE Henry Financial LD1 Fixed Price

    contract satisfies the statutory material liquidity, price linkage and

    arbitrage criteria for a significant price discovery contract.

    Consistent with this determination, and effective immediately,

    IntercontinentalExchange, Inc., shall be and is considered a registered

    entity with respect to the Henry Financial LD1 Fixed Price contract and

    is subject to all the provisions of the Commodity Exchange Act

    applicable to registered entities. Further, the obligations,

    requirements and timetables prescribed in Commission rule 36.3(c)(4)

    governing core principle compliance by IntercontinentalExchange, Inc.

    commence with the issuance of this Order.

    Issued in Washington, DC, on July 24, 2009, by the Commission.

    David A. Stawick,

    Secretary of the Commission.

    [FR Doc. E9-18159 Filed 7-29-09; 8:45 am]

    Last Updated: July 30, 2009



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