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2010-10299

  • FR Doc 2010-10299[Federal Register: May 4, 2010 (Volume 75, Number 85)]

    [Notices]

    [Page 23697-23704]

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

    [DOCID:fr04my10-62]

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    COMMODITY FUTURES TRADING COMMISSION

    Order Finding That the AECO Financial Basis 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 October 9, 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 AECO Financial Basis (``AEC'') 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 other available information. The

    Commission has reviewed the entire record in this matter, including all

    comments received, and has determined to issue an order finding that

    the AEC 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 52196 (October 9, 2009).

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    DATES: Effective date: April 28, 2010.

    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.\3\ 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 110-246, 122 Stat. 1624 (June 18,

    2008).

    \3\ 7 U.S.C. 1a(29).

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

    the provisions of the Reauthorization Act.\4\ 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

    prices of another contract.

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    \4\ 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 an evaluation 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. Upon the close of the comment period, the Commission will

    consider, among other things, all relevant information regarding the

    subject contract and issue an order announcing and explaining its

    determination whether or not the contract is a SPDC. The issuance of an

    affirmative order signals the effectiveness of the Commission's

    regulatory authorities over an ECM with respect to a SPDC; at that time

    such an ECM becomes subject to all provisions of the CEA applicable to

    registered entities.\5\ The issuance of such an order also triggers the

    obligations, requirements and timetables prescribed in Commission rule

    36.3(c)(4).\6\

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    \5\ 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).

    \6\ 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 October 9, 2009, the Commission published in the Federal

    Register notice of its intent to undertake a determination whether the

    AEC contract performs a significant price discovery function and

    requested comment from

    [[Page 23698]]

    interested parties.\7\ Comments were received from the Industrial

    Energy Consumers of America (``IECA''), Working Group of Commercial

    Energy Firms (``WGCEF''), ICE, Economists Incorporated (``EI''),

    Natural Gas Supply Association (``NGSA''), Federal Energy Regulatory

    Commission (``FERC''), Financial Institutions Energy Group (``FIEG'')

    and an anonymous individual.\8\ The comment letter from FERC \9\ did

    not directly address the issue of whether or not the AEC contract is a

    SPDC; IECA \10\ and the anonymous commenter \11\ concluded that the AEC

    contract is a SPDC, but did not provide a basis for their

    conclusions.\12\ The other parties' comments raised substantive issues

    with respect to the applicability of section 2(h)(7) to the AEC

    contract, generally asserting that the AEC contract is not a SPDC as it

    does not meet the material liquidity, material price reference and

    price linkage criteria for SPDC determination. Those comments are more

    extensively discussed below, as applicable.

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    \7\ 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.

    \8\ IECA describes itself as an ``association of leading

    manufacturing companies'' whose membership ``represents a diverse

    set of industries including: plastics, cement, paper, food

    processing, brick, chemicals, fertilizer, insulation, steel, glass,

    industrial gases, pharmaceutical, aluminum and brewing.'' WGCEF

    describes itself as ``a diverse group of commercial firms in the

    domestic energy industry whose primary business activity is the

    physical delivery of one or more energy commodities to customers,

    including industrial, commercial and residential consumers'' and

    whose membership consists of ``energy producers, marketers and

    utilities.'' ICE is an ECM, as noted above. EI is an economic

    consulting firm with offices located in Washington, DC, and San

    Francisco, CA. NGSA is an industry association comprised of natural

    gas producers and marketers. FERC is an independent federal

    regulatory agency that, among other things, regulates the interstate

    transmission of natural gas, oil and electricity. FIEG describes

    itself as an association of investment and commercial banks who are

    active participants in various sectors of the natural gas markets,

    ``including acting as marketers, lenders, underwriters of debt and

    equity securities, and proprietary investors.'' The comment letters

    are available on the Commission's Web site: http://www.cftc.gov/

    lawandregulation/federalregister/federalregistercomments/2009/09-

    016.html.

    \9\ FERC stated that the AEC contract is cash settled and does

    not contemplate actual physical delivery of natural gas.

    Accordingly, FERC expressed the opinion that a determination by the

    Commission that a contract performs a significant price discovery

    function ``would not appear to conflict with FERC's exclusive

    jurisdiction under the Natural Gas Act (NGA) over certain sales of

    natural gas in interstate commerce for resale or with its other

    regulatory responsibilities under the NGA'' and further that ``FERC

    staff will continue to monitor for any such conflict . . . [and]

    advise the CFTC'' should any such potential conflict arise. CL 06.

    \10\ CL 01.

    \11\ CL 08.

    \12\ IECA stated that the subject ICE contract should ``be

    required to come into compliance with core principles mandated by

    Section 2(h)(7) of the Act and with other statutory provisions

    applicable to registered entities. [This contract] should be subject

    to the Commission's position limit authority, emergency authority

    and large trader reporting requirements, among others.'' CL 01.

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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 criteria in determining a contract's 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 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 criteria must be present to support a determination that a

    particular contract performs a significant price discovery function,

    and one or more criteria may be inapplicable to a particular

    contract.\13\ Moreover, the statutory language neither prioritizes the

    criteria nor specifies the degree to which a SPDC must conform to the

    various criteria. In Guidance issued in connection with the Part 36

    rules governing ECMs with SPDCs, the Commission observed that these

    criteria 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 criterion, or combination of criteria, would

    be sufficient to support a SPDC determination.\14\ 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. In evaluating a contract's price discovery role as

    a price reference, the Commission will consider whether cash market

    participants are quoting bid or offer prices or entering into

    transactions at prices that are set either explicitly or implicitly at

    a differential to prices established for the contract.

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    \13\ In its October 9, 2009, Federal Register release, the

    Commission identified material price reference, price linkage and

    material liquidity as the possible criteria for SPDC determination

    of the AEC contract. Arbitrage was not identified as a possible

    criterion and will not be discussed further in this document or the

    associated Order.

    \14\ 17 CFR part 36, appendix A.

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    IV. Findings and Conclusions

    a. The AECO Financial Basis (AEC) Contract and the SPDC Indicia

    The AEC contract is cash settled based on the difference between

    the AECO-C & Nova Inventory Transfer (Alberta) price index for natural

    gas in the month of production, as reported in the first publication of

    the month of Canadian Enerdata, Ltd.'s Canadian Gas Price Reporter

    (``CGPR'') and the final settlement price for the New York Mercantile

    Exchange's (``NYMEX's'') Henry Hub physically-delivered natural gas

    futures contract for the same specified calendar month. The

    transactions used to calculate the

    [[Page 23699]]

    monthly Alberta price index are those that are conducted on the Natural

    Gas Exchange (``NGX'') in a given month and specify the delivery of

    natural gas at the Alberta hub in the following month. The Alberta

    price index is computed as the volume-weighted average of the

    applicable natural gas transactions. The size of the AEC contract is

    2,500 million British thermal units (``mmBtu''), and the unit of

    trading is any multiple of 2,500 mmBtu. The AEC contract is listed for

    up to 120 calendar months commencing with the next calendar month.

    The Henry Hub,\15\ which is located in Erath, Louisiana, is the

    primary cash market trading and distribution center for natural gas in

    the United States. It also is the delivery point and pricing basis for

    the NYMEX's actively traded, physically-delivered natural gas futures

    contract, which is the most important pricing reference for natural gas

    in the United States. The Henry Hub, which is operated by Sabine Pipe

    Line, LLC, serves as a juncture for 13 different pipelines. These

    pipelines bring in natural gas from fields in the Gulf Coast region and

    ship it to major consumption centers along the East Coast and Midwest.

    The throughput shipping capacity of the Henry Hub is 1.8 trillion mmBtu

    per day.

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    \15\ The term ``hub'' refers to a juncture where two or more

    natural gas pipelines are connected. Hubs also serve as pricing

    points for natural gas at the particular locations.

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    In addition to the Henry Hub, there are a number of other locations

    where natural gas is traded. In 2008, there were 33 natural gas market

    centers in North America.\16\ Some of the major trading centers include

    Alberta, Northwest Rockies, Southern California border and the Houston

    Ship Channel. For locations that are directly connected to the Henry

    Hub by one or more pipelines and where there typically is adequate

    shipping capacity, the price at the other locations usually directly

    tracks the price at the Henry Hub, adjusted for transportation costs.

    However, at other locations that are not directly connected to the

    Henry Hub or where shipping capacity is limited, the prices at those

    locations often diverge from the Henry Hub price. Furthermore, one

    local price may be significantly different than the price at another

    location even though the two markets' respective distances from the

    Henry Hub are the same. The reason for such pricing disparities is that

    a given location may experience supply and demand factors that are

    specific to that region, such as differences in pipeline shipping

    capacity, unusually high or low demand for heating or cooling or supply

    disruptions caused by severe weather. As a consequence, local natural

    gas prices can differ from the Henry Hub price by more than the cost of

    shipping and such price differences can vary in an unpredictable

    manner.

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    \16\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/

    feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.

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    The Alberta hub is far removed from the Henry Hub and is not

    directly connected to the Henry Hub by an existing pipeline. Located in

    the Canadian province of Alberta, the Alberta natural gas market is a

    major connection point for long-distance transmission systems that ship

    natural gas to points throughout Canada and the United States. The

    Alberta province is Canada's dominant natural gas producing region; six

    of the nine Canadian market centers are located in the Alberta

    province. The throughput capacity at the AECO-C hub is ten billion

    cubic feet per day. Moreover, the number of pipeline interconnections

    at that hub was four in 2008. Lastly, the AECO-C hub's capacity is 20.4

    billion cubic feet per day.\17\

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    \17\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/

    feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.

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    The local price at the Alberta hub typically differs from the price

    at the Henry Hub. Thus, the price of the Henry Hub physically-delivered

    futures contract is an imperfect proxy for the Alberta price. Moreover,

    exogenous factors, such as adverse weather, can cause the Alberta gas

    price to differ from the Henry Hub price by an amount that is more or

    less than the cost of shipping, making the NYMEX Henry Hub futures

    contract even less precise as a hedging tool than desired by market

    participants. Basis contracts\18\ allow traders to more accurately

    discover prices at alternative locations and hedge price risk that is

    associated with natural gas at such locations. In this regard, a

    position at a local price for an alternative location can be

    established by adding the appropriate basis swap position to a position

    taken in the NYMEX physically-delivered Henry Hub contract (or in the

    NYMEX or ICE Henry Hub look-alike contract, which cash settle based on

    the NYMEX contract's final settlement price).

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    \18\ Basis contracts denote the difference in the price of

    natural gas at a specified location minus the price of natural gas

    at the Henry Hub. The differential can be either a positive or

    negative value.

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    In its October 9, 2009, Federal Register notice, the Commission

    identified material price reference, price linkage and material

    liquidity as the potential SPDC criteria applicable to the AEC

    contract. Each of these criteria is discussed below.\19\

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    \19\ As noted above, the Commission did not find an indication

    of arbitrage in connection with this contract; accordingly, that

    criterion is not discussed in reference to the AEC contract.

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    1. Material Price Reference Criterion.

    The Commission's October 9, 2009, Federal Register notice

    identified material price reference as a potential basis for a SPDC

    determination with respect to this contract. The Commission considered

    the fact that ICE maintains exclusive rights over using CGPR's Alberta

    price index for cash settlement purposes. As a result, no other

    exchange can offer such a basis contract based on CGPR's Alberta price

    index. While other third-party price providers produce natural gas

    price indices for this and other trading centers, market participants

    indicate that the CGPR price index is highly regarded for this

    particular location and should market participants wish to establish a

    hedged position based on this index, they would need to do so by taking

    a position in the ICE AEC contract since ICE has the right to the CGPR

    index for cash settlement purposes. In addition, ICE sells its price

    data to market participants in a number of different packages which

    vary in terms of the hubs covered, time periods, and whether the data

    are daily only or historical. For example, ICE offers the ``West Gas

    End of Day'' and OTC Gas End of Day'' \20\ packages with access to all

    price data or just current prices plus a selected number of months

    (i.e., 12, 24, 36 or 48 months) of historical data. These two packages

    include price data for the AEC contract.

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    \20\ The OTC Gas End of Day dataset includes daily settlement

    prices for natural gas contracts listed for all points in North

    America.

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    The Alberta hub is a major trading center for natural gas in North

    America. Traders, including producers, keep abreast of the prices of

    the AEC contract when conducting cash deals. These traders look to a

    competitively determined price as an indication of expected values of

    natural gas at the Alberta hub when entering into cash market

    transactions for natural gas, especially those trades providing for

    physical delivery in the future. Traders use the ICE AEC contract, as

    well as other ICE basis swap contracts, to hedge cash market positions

    and transactions--activities which enhance the AEC contract's price

    discovery utility. The substantial volume of trading and open interest

    in the AEC contract appears to attest to its use for this purpose.

    While the AEC contract's settlement prices may not be the only

    [[Page 23700]]

    factor influencing spot and forward transactions, natural gas traders

    consider the ICE price to be a critical factor in conducting OTC

    transactions.\21\

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    \21\ In addition to referencing ICE prices, natural gas market

    firms participating in the Alberta market may rely on other cash

    market quotes as well as industry publications and price indices

    that are published by third-party price reporting firms when

    entering into natural gas transactions.

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    Lastly, the fact that the AEC contract does not meet the price

    linkage criterion (discussed below) bolsters the argument for material

    price reference. As noted above, the Henry Hub is the pricing reference

    for natural gas in the United States. However, regional market

    conditions may cause the price of natural gas in another area of the

    country to diverge by more than the cost of transportation, thus making

    the Henry Hub price an imperfect proxy for the local gas price. The

    more variable the local natural gas price is, the more traders need to

    accurately hedge their price risk. Basis swap contracts provide a means

    of more accurately pricing natural gas at a location other than the

    Henry Hub. An analysis of Alberta natural gas prices showed that 98

    percent of the observations were more than 2.5 percent different than

    the contemporaneous Henry Hub prices. Specifically, the average Alberta

    basis value between January 2008 and September 2009 was -$0.87 per

    mmBtu with a variance of $0.21 per mmBtu.

    i. Federal Register Comments

    ICE stated in its comment letter that the AEC contract does not

    meet the material price reference criterion for SPDC determination. ICE

    argued that the Commission appeared to base the case that the AEC

    contract is potentially a SPDC on two disputable assertions. First, in

    issuing its notice of intent to determine whether the AEC contract is a

    SPDC, the CFTC cited a general conclusion in its ECM study ``that

    certain market participants referred to ICE as a price discovery market

    for certain natural gas contracts.'' ICE states that CFTC's reason is

    ``hard to quantify as the ECM report does not mention'' this contract

    as a potential SPDC. ``It is unknown which market participants made

    this statement in 2007 or the contracts that were referenced.'' In

    response to the above comment, the Commission notes that it cited the

    ECM study's general finding that some ICE natural gas contracts appear

    to be regarded as price discovery markets merely as an indicia that an

    investigation of certain ICE contracts may be warranted, and was not

    intended to serve as the sole basis for determining whether or not a

    particular contract meets the material price reference criterion.

    Second, ICE argued that the Commission should not base a

    determination that the AEC contract is a SPDC merely because this

    contract has the exclusive right to base its settlement on the CGPR

    Alberta price index. While the Commission acknowledges that there are

    other firms that produce price indices for the Alberta hub, market

    participants indicate that the CGPR index is very highly regarded and

    should they wish to establish a hedged position based on this index,

    they would need to do so by taking a position in the ICE AEC swap since

    ICE has the exclusive right to use the CGPR index.\22\

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    \22\ Futures and swaps based on other Alberta indices have not

    met with the same market acceptance as the ICE AEC contract. For

    example, NYMEX previously listed a basis swap contract that was

    comparable to the AEC contract. However, ICE's exclusive agreement

    with Enerdata forced NYMEX to delist its contract because NYMEX

    could not find a suitable alternative price index. Up until the

    point of being delisted, there was no centralized-market trading in

    the NYMEX version of the AEC contract, so it never served as a

    source of price discovery for cash market traders with natural gas

    at the Alberta hub.

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    WGCEF, NGSA, EI and FIEG all stated that the AEC contract does not

    satisfy the material price reference criterion. The commenters argued

    that other contracts (physical or financial) are not indexed basis the

    ICE AEC contract price, but rather are indexed based on the underlying

    cash price series against which the ICE AEC contract is settled. Thus,

    they contend that the underlying cash price series is the authentic

    reference price and not the ICE contract itself. The Commission

    believes that this interpretation of price reference is too limiting in

    that it only considers the final index value on which the contract is

    cash settled after trading ceases. Instead, the Commission believes

    that a cash-settled derivatives contract could meet the price reference

    criteria if market participants ``consult on a frequent and recurring

    basis'' the derivatives contract when pricing forward, fixed-price

    commitments or other cash-settled derivatives that seek to ``lock in''

    a fixed price for some future point in time to hedge against adverse

    price movements.

    As noted above, the Alberta hub is a major trading center for

    natural gas in North America. Traders, including producers, keep

    abreast of the prices of the AEC contract when conducting cash deals.

    These traders look to a competitively determined price as an indication

    of expected values of natural gas at the Alberta hub when entering into

    cash market transaction for natural gas, especially those trades that

    provide for physical delivery in the future. Traders use the ICE AEC

    contract to hedge cash market positions and transactions, which

    enhances the AEC contract's price discovery utility. While the AEC

    contract's settlement prices may not be the only factor influencing

    spot and forward transactions, natural gas traders consider the ICE

    price to be a crucial factor in conducting OTC transactions.

    Both EI and WGCEF stated that publication of price data in a

    package format is a weak justification for material price reference.

    These commenters argue that market participants generally do not

    purchase ICE data sets for one contract's prices, such as those for the

    AEC contract. Instead, traders are interested in the settlement prices,

    so the fact that ICE sells the AEC prices as part of a broad package is

    not conclusive evidence that market participants are buying the ICE

    data sets because they find the AEC prices have substantial value to

    them. The Commission notes that the Alberta hub is a major natural gas

    trading point, and the AEC contract's prices are well regarded in the

    industry as indicative of the value of natural gas at the Alberta hub.

    Accordingly, the Commission believes that it is reasonable to conclude

    that market participants are purchasing the data packages that include

    the AEC contract's prices in substantial part because the AEC contract

    prices have particular value to them.

    ii. Conclusion Regarding Material Price Reference

    Based on the above, the Commission finds that the AEC contract

    meets the material price reference criterion because it is referenced

    on a frequent and recurring basis by cash market participants when

    pricing transactions (direct evidence). Moreover, the ECM sells the AEC

    contract's price data to market participants (indirect evidence).

    2. Price Linkage Criterion

    In its October 9, 2009 Federal Register notice, the Commission

    identified price linkage as a potential basis for a SPDC determination

    with respect to the AEC contract. In this regard, the final settlement

    of the AEC contract is based, in part, on the final settlement price of

    the NYMEX's physically-delivered natural gas futures contract, where

    the NYMEX is registered with the Commission as a DCM.

    The Commission's Guidance on Significant Price Discovery Contracts

    \23\ notes that a ``price-linked contract is a

    [[Page 23701]]

    contract that relies on a contract traded on another trading facility

    to settle, value or otherwise offset the price-linked contract.''

    Furthermore, the Guidance notes that, ``[f]or a linked contract, the

    mere fact that a contract is linked to another contract will not be

    sufficient to support a determination that a contract performs a

    significant price discovery function. To assess whether such a

    determination is warranted, the Commission will examine the

    relationship between transaction prices of the linked contract and the

    prices of the referenced contract. The Commission believes that where

    material liquidity exists, prices for the linked contract would be

    observed to be substantially the same as or move substantially in

    conjunction with the prices of the referenced contract.'' Furthermore,

    the Guidance proposes a threshold price relationship such that prices

    of the ECM linked contract will fall within a 2.5 percent price range

    for 95 percent of contemporaneously determined closing, settlement or

    other daily prices over the most recent quarter. Finally, the

    Commission also stated in the Guidance that it would consider a linked

    contract which has a trading volume equivalent to 5 percent of the

    volume of trading in the contract to which it is linked to have

    sufficient volume potentially to be deemed a SPDC (``minimum

    threshold'').

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    \23\ Appendix A to the Part 36 rules.

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    To assess whether the AEC contract meets the price linkage

    criterion, Commission staff obtained price data from ICE and performed

    the statistical tests cited above. Staff found that, while the Alberta

    price is determined, in part, by the final settlement price of the

    NYMEX physically-delivered natural gas futures contract (a DCM

    contract), the Alberta hub price is not within 2.5 percent of the

    settlement price of the corresponding NYMEX Henry Hub natural gas

    futures contract on 95 percent or more of the days. Specifically,

    during the third quarter of 2009, only 2.4 percent of the Alberta

    natural gas prices derived from the ICE basis values were within 2.5

    percent of the daily settlement price of the NYMEX Henry Hub futures

    contract. In addition, staff found that the AEC contract fails to meet

    the volume threshold requirement. In particular, the total trading

    volume in the NYMEX physically delivered natural gas contract during

    the third quarter of 2009 was 14,022,963 contracts, with 5 percent of

    that number being 701,148 contracts. Trades on the ICE centralized

    market in the AEC contract during the same period was 736,412 contracts

    (equivalent to 184,103 NYMEX contracts, given the size difference).\24\

    Thus, centralized-market trades in the AEC contract amounted to less

    than the minimum threshold.

    ---------------------------------------------------------------------------

    \24\ The AEC contract is one-quarter the size of the NYMEX Henry

    Hub physically-delivered futures contract.

    ---------------------------------------------------------------------------

    Due to the specific criteria that a given ECM contract must meet to

    fulfill the price linkage criterion, the requirements, for all intents

    and purposes, exclude ECM contracts that are not near facsimiles of DCM

    contracts even though the ECM contract may specifically use the

    settlement price to value a position, which is the case of the AEC

    contract. In this regard, an ECM contract that is priced and traded as

    if it is a functional equivalent of a DCM contract likely will have a

    price series that mirrors that of the corresponding DCM contract. In

    contrast, for contracts that are not look-alikes of DCM contracts, it

    is reasonable to expect that the two price series would be divergent.

    The Alberta hub and the Henry Hub are located in two different areas of

    North America. Moreover, both hubs are supply centers, where the

    Alberta hub handles a throughput volume that is ten times that of the

    Henry Hub. These differences contribute to the divergence between the

    two price series and, as discussed above, increase the likelihood that

    the ``basis'' contract is used for material price reference.

    i. Federal Register Comments

    NGSA stated that the AEC contract does not meet the price linkage

    criterion because basis contracts, including the AEC contract, are not

    equivalent to the NYMEX physically-delivered Henry Hub contract. EI

    also noted that the AEC and NYMEX natural gas contracts are not

    economically equivalent and that the AEC contract's volume is too low

    to affect the NYMEX natural gas futures contract. WGCEF stated that the

    Alberta price is determined, in part, by the final settlement price of

    the NYMEX Henry Hub futures contract. However, WCEF goes on to state

    that the AEC contract ``(a) is not substantially the same as the NYMEX

    [natural gas futures contract] * * * nor (b) does it move substantially

    in conjunction'' with the NYMEX natural gas futures contract. ICE

    opined that the AEC contract's trading volume is too low to affect the

    price discovery process for the NYMEX natural gas futures contract. In

    addition, ICE states that the AEC contract simply reflects a price

    differential between Alberta and the Henry Hub; ``there is no price

    linkage as contemplated by Congress or the CFTC in its rulemaking.''

    FIEG acknowledged that the AEC contract is a locational spread that is

    based in part on the NYMEX natural gas futures price, but also

    questioned the significance of this fact relative to the price linkage

    criterion since the key component of the spread is the price at the

    Alberta location and not the NYMEX physically-delivered natural gas

    futures price.

    ii. Conclusion Regarding the Price Linkage Criterion

    Based on the above, the Commission finds that the AEC contract does

    not meet the price linkage criterion because it fails the price

    relationship and volume tests provided for in the Commission's

    Guidance.

    3. Material Liquidity Criterion

    To assess whether the AEC contract meets the material liquidity

    criterion, the Commission first examined volume and open interest data

    provided to it by ICE as a general measurement of the AEC market's size

    and potential importance, and second performed a statistical analysis

    to measure the effect that changes to AEC prices potentially may have

    on prices for the NYMEX Henry Hub Natural Gas (a DCM contract), the ICE

    Socal Border Financial Basis (``SCL'') contract (an ECM contract) and

    the ICE HSC \25\ Financial Basis contract (an ECM contract).\26\

    ---------------------------------------------------------------------------

    \25\ The acronym stands for Houston Ship Channel.

    \26\ As noted above, the material liquidity criterion speaks to

    the effect that transactions in the potential SPDC may have on

    trading in ``agreements, contracts and transactions listed for

    trading on or subject to the rules of a designated contract market,

    a derivatives transaction execution facility, or an electronic

    trading facility operating in reliance on the exemption in section

    2(h)(3) of the Act.

    ---------------------------------------------------------------------------

    The Commission's Guidance (Appendix A to Part 36) notes that

    ``[t]raditionally, objective measures of trading such as volume or open

    interest have been used as measures of liquidity.'' In this regard, the

    Commission in its October 9, 2009, Federal Register notice referred to

    second quarter 2009 trading statistics that ICE had submitted for its

    AEC contract. Based upon on a required quarterly filing made by ICE on

    July 27, 2009, the total number of AEC trades executed on ICE's

    electronic trading platform was 7,263 in the second quarter of 2009,

    resulting in a daily average of 113.5 trades. During the same period,

    the AEC contract had a total trading volume on ICE's electronic trading

    platform of 806,438 contracts and an average daily trading volume of

    12,601 contracts. Moreover, the open interest as of June 30, 2009, was

    443,402 contracts, which includes trades executed on ICE's electronic

    trading platform, as well as trades executed off

    [[Page 23702]]

    of ICE's electronic trading platform and then brought to ICE for

    clearing.\27\

    ---------------------------------------------------------------------------

    \27\ ICE does not differentiate between open interest created by

    a transaction executed on its trading platform versus that created

    by a transaction executed off its trading platform. 74 FR 52196

    (October 9, 2009).

    ---------------------------------------------------------------------------

    Subsequent to the October 9, 2009, Federal Register notice, ICE

    submitted another quarterly notification filed on November 13,

    2009,\28\ with updated trading statistics. Specifically, with respect

    to its AEC contract, 6,320 separate trades occurred on its electronic

    platform in the third quarter of 2009, resulting in a daily average of

    95.8 trades. During the same period, the AEC contract had a total

    trading volume on its electronic platform of 736,412 contracts (which

    was an average of 11,158 contracts per day).\29\ As of September 30,

    2009, open interest in the AEC contract was 483,561 \30\ contracts.

    Reported open interest included positions resulting from trades that

    were executed on ICE's electronic platform, as well as trades that were

    executed off of ICE's electronic platform and brought to ICE for

    clearing.

    ---------------------------------------------------------------------------

    \28\ See Commission Rule 36.3(c)(2), 17 CFR 36.3(c)(2).

    \29\ By way of comparison, the number of contracts traded in the

    AEC contract is similar to that exhibited on a liquid futures market

    and is roughly equivalent to the volume of trading for the ICE US

    Coffee ``C'' and Cocoa contracts during this period.

    \30\ By way of comparison, open interest in the AEC contract is

    similar to that exhibited on a liquid futures market and is roughly

    equivalent to that in the Commodity Exchange's Gold contract and the

    Chicago Board of Trade's soybean contract.

    ---------------------------------------------------------------------------

    In Appendix A to Part 36, the material liquidity criterion for SPDC

    determination specifies that an ECM contract should have a material

    effect on another contract. To measure the effect that the AEC contract

    has on a DCM contract, or on another ECM contract, Commission staff

    performed a statistical analysis \31\ of ICE and NYMEX price data using

    daily settlement prices (between January 2, 2008, and September 30,

    2009) for the NYMEX Henry Hub natural gas contract (a DCM contract) and

    the ICE Socal Border Financial Basis and HSC Financial Basis contracts

    (ECM contracts).\32\ The simulation results suggest that, on average

    over the sample period, a one percent rise in the AEC contract's price

    elicited a 0.8 percent to 0.9 percent increase in each of the NYMEX

    Henry Hub, ICE SCL and ICE HSC contracts' prices.

    ---------------------------------------------------------------------------

    \31\ Specifically, Commission staff econometrically estimated a

    vector autoregression model using daily natural gas price levels. A

    vector autoregression model is an econometric model used to capture

    the dependencies and interrelationships among multiple time series,

    generalizing the univariate autoregression model. The estimated

    model displays strong diagnostic evidence of statistical adequacy.

    In particular, the model's impulse response function was shocked

    with a one-time rise in Alberta price. The simulation results

    suggest that, on average over the sample period, a one percent rise

    in the Alberta natural gas price elicited a 0.9 percent increase in

    the NYMEX Henry Hub price and the Southern California border gas

    price, as well as a 0.8 percent increase in HSC gas prices. These

    multipliers of response emerge with noticeable statistical strength

    or significance. Based on such long run sample patterns, if the

    Alberta price rises by 10 percent, then the price of NYMEX Henry Hub

    natural gas futures contract and the Sothern California gas price

    each would rise by about 9 percent; a 10 percent rise in the Alberta

    gas price would lead to a rise in the HSC contract's price by about

    9 percent.

    \32\ Natural gas prices at the Alberta, HSC, and Socal trading

    centers were obtained by adding the daily settlement prices of ICE's

    AECO Financial Basis, HSC Financial Basis and Socal Border Financial

    Basis contracts, respectively, to the contemporaneous daily

    settlement prices of the NYMEX Henry Hub physically-delivered

    natural gas futures contract.

    ---------------------------------------------------------------------------

    i. Federal Register Comments

    As noted above, comments were received from eight individuals and

    organizations, with five comments being directly applicable to the SPDC

    determination of the ICE AEC contract. WGCEF, EI, FIEG, ICE and NGSA

    generally agreed that the AEC contract does not meet the material

    liquidity criterion.

    WGCEF \33\ and NGSA \34\ both stated that the AEC contract does not

    materially affect other contracts that are listed for trading on DCMs

    or ECMs, as well as other over-the-counter contracts. Instead, the AEC

    contract is influenced by the underlying Alberta cash price index and

    the final settlement price of the NYMEX Henry Hub natural gas futures

    contract, not vice versa. FIEG \35\ stated that the AEC contract cannot

    have a material effect on NYMEX contract because the AEC contract

    trades on a differential and represents ``one leg (and not the relevant

    leg) of the locational spread.'' The Commission's statistical analysis

    shows that changes in the ICE AEC contract's price significantly

    influences the prices of other contracts that are traded on DCMs and

    ECMs.

    ---------------------------------------------------------------------------

    \33\ CL 02.

    \34\ CL 05.

    \35\ CL 07.

    ---------------------------------------------------------------------------

    ICE \36\ opined that the Commission ``seems to have adopted a five

    trade-per-day test to determine whether a contract is materially

    liquid. It is worth noting that ICE originally suggested that the CFTC

    use a five trades-per-day threshold as the basis for an ECM to report

    trade data to the CFTC.'' In this regard, the Commission adopted a five

    trades-per-day threshold as a reporting requirement to enable it to

    ``independently be aware of ECM contracts that may develop into SPDCs''

    \37\ rather than solely relying upon an ECM on its own to identify any

    such potential SPDCs to the Commission. Thus, any contract that meets

    this threshold may be subject to scrutiny as a potential SPDC; the

    threshold is not intended to define liquidity in a broader sense. As

    noted above, the Division is basing a finding of material liquidity for

    the ICE AEC contract in part on the fact that there have been around

    100 trades per day on average in the AEC contract during the second and

    third quarters of 2009, which is far more than the five trades-per-day

    that is cited in the ICE comment.

    ---------------------------------------------------------------------------

    \36\ CL 03.

    \37\ 73 FR 75892 (December 12, 2008).

    ---------------------------------------------------------------------------

    ICE implied that the statistics provided by ICE were misinterpreted

    and misapplied by the Commission. In particular, ICE stated that the

    volume figures used in the Commission's analysis (cited above)

    ``include trades made in all months of each contract'' as well as in

    strips of contract months, and the ``more appropriate method of

    determining liquidity is to examine the activity in a single traded

    month or strip of a given contract.'' Furthermore, ICE noted that for

    the AEC contract (and other basis swap contracts), ``about 25-40% of

    the trades * * * occurred in the single most liquid, usually prompt,

    month of * * * [the] contract.'' EI,\38\ and FIEG also noted that

    contract months should be considered separately rather than on an

    aggregated basis. When done so, none of the contract months meet the

    material liquidity criterion.

    ---------------------------------------------------------------------------

    \38\ CL 04.

    ---------------------------------------------------------------------------

    It is the Commission's opinion that liquidity, as it pertains to

    the AEC contract, is typically a function of trading activity in

    particular lead months and, given sufficient liquidity in such months,

    the AEC contract itself would be considered liquid. ICE's analysis of

    its own trade data confirms this to be the case for the AEC contract,

    and thus, the Commission believes that it applied the statistical data

    cited above in an appropriate manner for gauging material liquidity.

    In addition, EI and ICE stated that the trades-per-day statistics

    that it provided to the Commission in its quarterly filing and which

    are cited above includes 2(h)(1) transactions, which were not completed

    on the electronic trading platform and should not be considered in the

    SPDC determination process. The Commission staff asked ICE to review

    the data it sent in its quarterly filings. In response, ICE confirmed

    that the volume data it provided and which the Commission cited in its

    October 9, 2009, Federal Register notice, as well as the additional

    volume information it cites above, includes only transaction data

    [[Page 23703]]

    executed on ICE's electronic trading platform.\39\ The Commission

    acknowledges that the open interest information it cites above includes

    transactions made off the ICE platform. However, once open interest is

    created, there is no way for ICE to differentiate between ``on-

    exchange'' versus ``off-exchange'' created positions, and all such

    positions are fungible with one another and may be offset in any way

    agreeable to the position holder regardless of how the position was

    initially created.

    ---------------------------------------------------------------------------

    \39\ Supplemental data supplied by the ICE confirmed that block

    trades in the third quarter of 2009 were in addition to the trades

    that were conducted on the electronic platform; block trades

    comprised 32.4 percent of all transactions in the AEC contract.

    ---------------------------------------------------------------------------

    ii. Conclusion Regarding Material Liquidity

    Based on the above, the Commission concludes that the AEC contract

    meets the material liquidity criterion in that there is sufficient

    trading activity in the AEC contract to have a material effect on

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

    subject to the rules of a designated contract market * * * or an

    electronic trading facility operating in reliance on the exemption in

    section 2(h)(3) of the Act'' (that is, an ECM).

    4. Overall Conclusion

    After considering the entire record in this matter, including the

    comments received, the Commission has determined that the AEC contract

    performs a significant price discovery function under two of the four

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

    Commission has determined that the AEC contract does not meet the price

    linkage criterion at this time, the Commission has determined that the

    AEC contract does meet both the material liquidity and material price

    reference criteria. Accordingly, the Commission will issue the attached

    Order declaring that the AEC contract is a SPDC.

    Issuance of this Order signals the immediate effectiveness of the

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

    connection with its AEC contract,\40\ and triggers the obligations,

    requirements--both procedural and substantive--and timetables

    prescribed in Commission rule 36.3(c)(4) for ECMs.

    ---------------------------------------------------------------------------

    \40\ See 73 FR 75888, 75893 (Dec. 12, 2008).

    ---------------------------------------------------------------------------

    IV. Related Matters

    a. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \41\ 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.

    ---------------------------------------------------------------------------

    \41\ 44 U.S.C. 3507(d).

    ---------------------------------------------------------------------------

    b. Cost-Benefit Analysis

    Section 15(a) of the CEA \42\ 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 in light

    of the specific provisions of section 15(a) of the Act and has

    concluded that the Order, required by Congress to strengthen Federal

    oversight of exempt commercial markets and to prevent market

    manipulation, is necessary and appropriate to accomplish the purposes

    of section 2(h)(7) of the Act.

    ---------------------------------------------------------------------------

    \42\ 7 U.S.C. 19(a).

    ---------------------------------------------------------------------------

    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 or

    other disruptions to market integrity, both on the ECM itself and in

    any related futures contracts trading on 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 issue 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. Section 4(i) of the CEA

    authorizes the Commission to require reports for SPDCs listed on ECMs.

    These increased 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.

    c. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') \43\ requires that

    agencies consider the impact of their rules on small businesses. The

    requirements of CEA section 2(h)(7) and the Part 36 rules affect ECMs.

    The Commission previously has determined that ECMs are not small

    entities for purposes of the RFA.\44\ Accordingly, the Chairman, on

    behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b)

    that this Order, taken in connection with section 2(h)(7) of the Act

    and the Part 36 rules, will not have a significant impact on a

    substantial number of small entities.

    ---------------------------------------------------------------------------

    \43\ 5 U.S.C. 601 et seq.

    \44\ 66 FR 42256, 42268 (Aug. 10, 2001).

    ---------------------------------------------------------------------------

    V. Order

    a. Order Relating to the ICE AECO Financial Basis Contract

    After considering the complete record in this matter, including the

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

    Commission has determined to issue the following:

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

    the Act, hereby determines that the AECO Financial Basis contract,

    traded on the IntercontinentalExchange, Inc., must comply with, with

    respect to the AECO Financial Basis contract, the nine core principles

    established by new section

    [[Page 23704]]

    2(h)(7)(C). Additionally, the IntercontinentalExchange, Inc., satisfies

    the statutory material liquidity and material price reference criteria

    for significant price discovery contracts. Consistent with this

    determination, and effective immediately, the IntercontinentalExchange,

    Inc., shall be and is considered a registered entity \45\ with respect

    to the AECO Financial Basis 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 the IntercontinentalExchange, Inc. commence with the

    issuance of this Order.\46\

    ---------------------------------------------------------------------------

    \45\ 7 U.S.C. 1a(29).

    \46\ Because ICE already lists for trading a contract (i.e., the

    Henry Financial LD1 Fixed Price contract) that was previously

    declared by the Commission to be a SPDC, ICE must submit a written

    demonstration of compliance with the Core Principles within 30

    calendar days of the date of this Order. 17 CFR 36.3(c)(4).

    Issued in Washington, DC on April 28, 2010, by the Commission.

    David A. Stawick,

    Secretary of the Commission.

    [FR Doc. 2010-10299 Filed 5-3-10; 8:45 am]

    BILLING CODE P

    Last Updated: May 4, 2010



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