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2010-10304

  • FR Doc 2010-10304[Federal Register: May 4, 2010 (Volume 75, Number 85)]

    [Notices]

    [Page 23704-23710]

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

    [DOCID:fr04my10-63]

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    COMMODITY FUTURES TRADING COMMISSION

    Order Finding That the NWP Rockies 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 22, 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 NWP \2\ Rockies Financial Basis (``NWR'') 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 NWR 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 54550 (October 22, 2009).

    \2\ The acronym ``NWP'' indicates the Northwest Pipeline.

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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; Christa Lachenmayr,

    Economist, Division of Market Oversight, same address. Telephone: (202)

    418-5252. E-mail: clachenmayr@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'') \3\

    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.\4\ 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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    \3\ Incorporated as Title XIII of the Food, Conservation and

    Energy Act of 2008, Public Law 110-246, 122 Stat. 1624 (June 18,

    2008).

    \4\ 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.\5\ 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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    \5\ 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.\6\ The issuance of such an order also triggers the

    obligations, requirements and timetables prescribed in Commission rule

    36.3(c)(4).\7\

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    \6\ Pub. L. 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).

    \7\ 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 22, 2009, the Commission published in the Federal

    Register notice of its intent to undertake a

    [[Page 23705]]

    determination whether the NWR contract performs a significant price

    discovery function and requested comment from interested parties.\8\

    Comments were received from the Federal Energy Regulatory Commission

    (``FERC''), Platts, Economists Incorporated (``EI'') and ICE.\9\ The

    comment letters from FERC \10\ and Platts did not directly address the

    issue of whether or not the NWR contract is a SPDC; ICE's and EI's

    comments raised substantive issues with respect to the applicability of

    section 2(h)(7) the NWR contract, generally asserting that the NWR

    contract is not a SPDC as it does not meet the material liquidity,

    material price reference and price linkage criteria for SPDC

    determination. ICE's and EI's comments are more extensively discussed

    below, as applicable.

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    \8\ 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.

    \9\ FERC is an independent Federal regulatory agency that, among

    other things, regulates the interstate transmission of natural gas,

    oil and electricity. McGraw-Hill, through its division Platts,

    compiles and calculates monthly natural gas price indices from

    natural gas trade data submitted to Platts by energy marketers.

    Platts includes those price indices in its monthly Inside FERC's Gas

    Market Report (``Inside FERC''). ICE is an ECM, as noted above. EI

    is an economic consulting firm with offices located in Washington,

    DC, and San Francisco, CA. The comment letters are available on the

    Commission's Web site: http://www.cftc.gov/lawandregulation/

    federalregister/federalregistercomments/2009/09-031.html.

    \10\ FERC stated that the NWR contract is cash settled and does

    not contemplate the actual physical delivery of natural gas.

    Acccordingly, 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 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 or

    consulting, 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.\11\ 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.\12\ 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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    \11\ In its October 22, 2009, Federal Register release, the

    Commission identified material price reference, price linkage and

    material liquidity as the possible criteria for SPDC determination

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

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

    associated Order.

    \12\ 17 CFR Part 36, Appendix A.

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    IV. Findings and Conclusions

    a. The NWP Rockies Financial Basis (NWR) Contract and the SPDC Indicia

    The ICE NWR contract is cash settled based on the difference

    between the bidweek price of natural gas at the Northwest Pipeline's

    Rockies hub for the month of delivery, as published in Platts' Inside

    FERC's Gas Market Report, 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

    Platts bidweek price, which is published monthly, is based on a survey

    of cash market traders who voluntarily report to Platts data on fixed-

    price transactions for physical delivery of natural gas at the Rockies

    hub conducted during the last five business days of the month; such

    bidweek transactions specify the delivery of natural gas on a uniform

    basis throughout the following calendar month at the agreed upon rate.

    The Platts bidweek index is published on the first business day of the

    calendar month in which the natural gas is to be delivered. The size of

    the NWR contract is 2,500 million British thermal units (``mmBtu''),

    and the unit of trading is any multiple of 2,500 mmBtu. The NWR

    contract is listed for up to 120 calendar months commencing with the

    next calendar month.

    The Henry Hub,\13\ which is located in Erath, Louisiana, is the

    primary cash market trading and distribution center for natural gas in

    the United States. It

    [[Page 23706]]

    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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    \13\ 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.\14\ Some of the major trading centers include

    Alberta, Northwest Rockies, Southern California border region 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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    \14\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/

    feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.

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    The Northwest Pipeline's Rockies hub is located in Wyoming, Utah

    and Colorado.\15\ The Northwest Pipeline draws natural gas supplies

    from the Rocky Mountain region and ships it along a 3,900-mile, bi-

    directional transmission system to markets throughout the Rockies and

    Pacific Northwest. The Opal market center, a trading region that

    includes the Rockies hub, had an estimated throughput capacity of 1.5

    billion cubic feet per day in 2008. Moreover, the number of pipeline

    interconnections at the Opal market center was eight in 2008, up from

    four interconnections in 2003. Lastly, the pipeline interconnection

    capacity of the Opal market center in 2008 was six billion cubic feet

    per day, which constituted an 86 percent increase over the pipeline

    interconnection capacity in 2003.\16\ The Rockies hub is far removed

    from the Henry Hub and is not directly connected to the Henry Hub by an

    existing pipeline.

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    \15\ The Rockies hub includes fixed-price gas delivered into

    Northwest Pipeline's mainline in Wyoming, Utah and Colorado between

    the Kemmerer and Moab stations. Deliveries at Ignacio, CO, and

    elsewhere in zone MO (the area South of Moab, UT, into the San Juan

    Mountains) are excluded. Transactions done at Opal, WY, and the

    Muddy Creek compressor station (where the Northwest Pipeline

    connects with Kern River Gas Transmission, Questar Pipeline and

    Colorado Interstate Gas) are used because gas traded at those two

    points often is not nominated into a specific pipeline.

    \16\ 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 Rockies 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 Rockies price. Moreover,

    exogenous factors, such as adverse weather, can cause the Rockies 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 \17\ allow traders to more accurately

    discover prices at alternative locations and hedge price risk that is

    associated with natural gas at such locations.\18\ 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 physically-delivered natural gas contract's final settlement

    price).

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    \17\ 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.

    \18\ Commercial activity in natural gas basis swap contracts is

    evidenced by large positions held by energy trading firms in the

    comparable NYMEX ClearPort basis swap contract for the Rockies hub.

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    In its October 22, 2009, Federal Register notice, the Commission

    identified material price reference, price linkage and material

    liquidity as the potential SPDC criteria applicable to the NWR

    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 was not discussed in reference to the NWR contract.

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    1. Material Price Reference Criterion

    The Commission's October 22, 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 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 NWR

    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 Rockies hub is a major trading center for natural gas in the

    United States. Traders, including producers, keep abreast of the prices

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

    competitively determined price as an indication of expected values of

    natural gas at the Rockies hub when entering into cash market

    transactions for natural gas, especially those trades that provide for

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

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

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

    discovery utility. The substantial volume of trading and open interest

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

    While the NWR 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 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 Rockies 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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    NYMEX lists a futures contract that is comparable to the ICE NWR

    contract on its ClearPort platform. However, unlike the ICE contract,

    none of the trades in the NYMEX Rockies Basis Swap (Platts IFERC)

    futures contract are executed in NYMEX's centralized marketplace;

    instead, all of the transactions originate as bilateral swaps that are

    submitted to

    [[Page 23707]]

    NYMEX for clearing. The daily settlement prices of the NYMEX Rockies

    Basis Swap contract are influenced, in part, by the daily settlement

    prices of the ICE NWR contract. This is because NYMEX determines the

    daily settlement prices for its natural gas basis swap contracts

    through a survey of cash market voice brokers. Voice brokers, in turn,

    refer to the ICE NWR price, among other information, as an important

    indicator as to where the market is trading. Therefore, the ICE NWR

    price influences the settlement price for the NYMEX Rockies Basis Swap

    contract. This is supported by an analysis of the daily settlement

    prices for the NYMEX and ICE Rockies basis swap contracts. In this

    regard, 98 percent of the daily settlement prices for the NYMEX Rockies

    Basis Swap contract are within one standard deviation of the NWR

    contract's settlement prices.

    Lastly, the fact that the NWR 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 Rockies natural gas prices showed that all of

    the observations were more than 2.5 percent different than the

    contemporaneous Henry Hub prices. Specifically, the average Rockies

    basis value between January 2008 and September 2009 was -$1.94 per

    mmBtu with a variance of $1.88 per mmBtu.

    i. Federal Register Comments

    Both EI and ICE stated in their comment letters that the NWR

    contract does not meet the material price reference criterion for SPDC

    determination. ICE argued that the Commission appeared to base the case

    that the NWR contract is potentially a SPDC on a disputable assertion.

    In issuing its notice of intent to determine whether the NWR 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 stated that, ``Basing a

    material price reference determination on general statements made in a

    two year old study does not seem to meet Congress' intent that the CFTC

    use its considerable expertise to study the OTC markets.'' 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.

    EI also stated that the NWR contract does not satisfy the material

    price reference criterion. The commenter argued that other contracts

    (physical or financial) are not indexed based on the ICE NWR contract

    price, but rather are indexed based on the underlying cash price series

    against which the NWR contract is settled. Thus, EI contends 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.

    EI also argued that publication of price data in a package format

    is a weak justification for material price reference. According to the

    commenter, market participants generally do not purchase ICE data sets

    for one contract's prices, so the fact that ICE sells the NWR prices as

    part of a broad package is not conclusive evidence that market

    participants are buying the ICE data sets because they find the NWR

    prices have substantial value to them. The Commission notes that the

    Rockies hub is a major natural gas trading point, and the NWR

    contract's prices are well regarded in the industry as indicative of

    the value of natural gas at the Rockies hub. Accordingly, the

    Commission believes that it is reasonable to conclude that market

    participants are purchasing the data packages that include the NWR

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

    have particular value to them.

    ii. Conclusion Regarding Material Price Reference

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

    meets the material price reference criterion because it is referenced

    and consulted on a frequent and recurring basis by cash market

    participants when pricing transactions (direct evidence). Moreover, the

    ECM sells the NWR contract's price data to market participants

    (indirect evidence).

    2. Price Linkage Criterion

    In its October 22, 2009, Federal Register notice, the Commission

    identified price linkage as a potential basis for a SPDC determination

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

    of the NWR 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

    \22\ notes that a ``price-linked contract is a 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 that 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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    \22\ Appendix A to the Part 36 rules.

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    [[Page 23708]]

    To assess whether the NWR 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 Rockies

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

    NYMEX physically-delivered natural gas futures contract (a DCM

    contract), the Rockies 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 Rockies

    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 NWR 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. The number of trades on the ICE

    centralized market in the NWR contract during the same period was

    279,905 contracts (equivalent to 69,976 NYMEX contracts, given the size

    difference).\23\ Thus, centralized-market trades in the NWR contract

    amounted to less than the minimum threshold.

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    \23\ The NWR contract is one-quarter the size of the NYMEX Henry

    Hub physically-delivered futures contract.

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    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 NWR

    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.

    While the Rockies hub and the Henry Hub are both supply centers, they

    are located in two different areas of the United States. Moreover, the

    Rockies hub is somewhat isolated and the two hubs are not directly

    connected to each other. 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

    As noted above, ICE and EI addressed the question of whether the

    NWR contract is a SPDC. EI noted that the NWR and NYMEX natural gas

    contracts are not economically equivalent and that the NWR contract's

    volume is too low to affect the NYMEX natural gas futures contract. ICE

    opined that the NWR 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 NWR contract simply reflects a price

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

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

    ii. Conclusion Regarding the Price Linkage Criterion

    Based on the above, the Commission finds that the NWR 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 NWR 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 NWR market's size

    and potential importance, and second performed a statistical analysis

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

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

    PG&E Citygate Financial Basis contract (an ECM contract) and the Malin

    Financial Basis contract (an ECM contract).\24\

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

    \24\ 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 22, 2009, Federal Register notice referred to

    second quarter 2009 trading statistics that ICE had submitted for its

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

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

    electronic trading platform was 3,013 in the second quarter of 2009,

    resulting in a daily average of 47.1 trades. During the same period,

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

    platform of 276,187 contracts and an average daily trading volume of

    4,315 contracts. Moreover, the open interest as of June 30, 2009, was

    349,931 contracts, which included trades executed on ICE's electronic

    trading platform, as well as trades executed off of ICE's electronic

    trading platform and then brought to ICE for clearing.\25\

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

    \25\ 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 54550

    (October 22, 2009).

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

    Subsequent to the October 22, 2009, Federal Register notice, ICE

    submitted another quarterly notification filed on November 13,

    2009,\26\ with updated trading statistics. Specifically, with respect

    to its NWR contract, 2,950 separate trades occurred on its electronic

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

    44.7 trades. During the same period, the NWR contract had a total

    trading volume on its electronic platform of 279,905 contracts (which

    was an average of 4,241 contracts per day).\27\ As of September 30,

    2009, open interest in the NWR contract was 345,683 contracts.\28\

    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.

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

    \26\ See Commission Rule 36.3(c)(2), 17 CFR 36.3(c)(2).

    \27\ By way of comparison, the number of contracts traded in the

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

    and is roughly equivalent to the volume of trading for the Chicago

    Mercantile Exchange Feeder Cattle futures contract during this

    period.

    \28\ By way of comparison, open interest in the NWR contract is

    roughly equivalent to that in the Chicago Board of Trade's wheat

    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 NWR contract

    potentially could have on a DCM contract, or on another ECM contract,

    Commission staff performed a statistical analysis \29\ using

    [[Page 23709]]

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

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

    price levels for the Rockies, PG&E Citygate and Malin market

    centers.\30\ The simulation results suggest that, on average over the

    sample period, a one percent rise in the Rockies natural gas price

    elicited a 0.254 percent to 0.276 percent increase in the PG&E Citygate

    and Malin hub natural gas prices, and a 0.176 percent increase in the

    NYMEX Henry Hub natural gas price.

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

    \29\ 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 Rockies price. The simulation results

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

    in the Rockies natural gas price elicited a 0.176 percent increase

    in the NYMEX Henry Hub price, as well as a 0.254 percent to 0.276

    percent increase in the other two modeled natural gas prices. These

    multipliers of response emerge with noticeable statistical strength

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

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

    natural gas futures contract, as well as those for the Alberta and

    HSC hubs, each would rise by about 1.5 percent to 2.5 percent. The

    relatively small magnitude of the multipliers likely reflects the

    fact that the Rockies hub is isolated and not directly connected to

    the Henry Hub.

    \30\ Natural gas prices at the Rockies, PG&E Citygate and Malin

    trading centers were obtained by adding the daily settlement prices

    of ICE's NWP Rockies Financial Basis, PG&E Citygate Financial Basis

    and Malin 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, ICE and EI addressed the question of whether the

    NWR contract is a SPDC. ICE stated in its comment letter that the NWR

    contract does not meet the material liquidity criterion for SPDC

    determination for a number of reasons.

    First, ICE 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''

    \31\ 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 Commission is basing a finding of material liquidity

    for the ICE NWR contract, in part, on the fact that there were nearly

    45 trades per day on average in the NWR contract during the third

    quarter of 2009, which was far more than the five trades-per-day

    threshold that is cited in the ICE comment. In addition, the Commission

    notes that the number of contracts per transaction in the NWR contract

    is high (approximately 95 contracts per transaction) and thus, as

    noted, trading volume (measured in contract units) is substantial. The

    NWR contract also has substantial open interest.

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

    \31\ 73 FR 75892 (December 12, 2008).

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

    ICE also stated that ``the statistics [provided by ICE] have been

    misinterpreted and misapplied.'' In particular, ICE stated that the

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

    ``include trades made in all 120 months of each contract'' as well as

    in strips of contract months, and a ``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 NWR contract, ``28% of the trades actually executed in the ICE

    platform occurred in the single most liquid, usually prompt, month of

    the contract.'' EI also expressed its belief that the contract months

    should be evaluated individually.

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

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

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

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

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

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

    cited above in an appropriate manner for gauging material liquidity.

    In addition, ICE and EI both 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 22, 2009, Federal Register notice, as

    well as the additional volume information it cites above, includes only

    transaction data executed on ICE's electronic trading platform.\32\ 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.

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

    \32\ Supplemental data supplied by 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 44.4 percent of all transactions in the NWR contract.

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

    ii. Conclusion Regarding Material Liquidity

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

    meets the material liquidity criterion in that there is sufficient

    trading activity in the NWR 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 NWR 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 NWR contract does not meet the price

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

    NWR contract does meet both the material liquidity and material price

    reference criteria. Accordingly, the Commission will issue the attached

    Order declaring that the NWR 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 NWR contract,\33\ and triggers the obligations,

    requirements--both procedural and substantive--and timetables

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

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

    \33\ See 73 FR 75888, 75893 (Dec. 12, 2008).

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

    V. Related Matters

    a. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \34\ 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

    [[Page 23710]]

    assigned OMB control number 3038-0060 to this collection of

    information.

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

    \34\ 44 U.S.C. 3507(d).

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

    b. Cost-Benefit Analysis

    Section 15(a) of the CEA \35\ 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.

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

    \35\ 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'') \36\ 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.\37\ 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.

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

    \36\ 5 U.S.C. 601 et seq.

    \37\ 66 FR 42256, 42268 (Aug. 10, 2001).

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

    VI. Order

    a. Order Relating to the ICE NWP Rockies 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 NWP Rockies Financial Basis

    contract, traded on 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., must comply with, with respect to the NWP Rockies Financial Basis

    contract, the nine core principles established by new section

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

    and is considered a registered entity \38\ with respect to the NWP

    Rockies Financial Basis contract and is subject to all the provisions

    of the Commodity Exchange Act applicable to registered entities.

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

    \38\ 7 U.S.C. 1a(29).

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

    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.\39\

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

    \39\ 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. 2010-10304 Filed 5-3-10; 8:45 am]

    BILLING CODE P

    Last Updated: May 4, 2010



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