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2010-10306

  • FR Doc 2010-10306[Federal Register: May 4, 2010 (Volume 75, Number 85)]

    [Notices]

    [Page 23679-23686]

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

    [DOCID:fr04my10-59]

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    COMMODITY FUTURES TRADING COMMISSION

    Order Finding That the ICE Malin Financial Basis Contract Traded

    on the IntercontinentalExchange, Inc., Does Not Perform a Significant

    Price Discovery Function

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Final orders.

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    SUMMARY: On October 9, 2009, the Commodity Futures Trading Commission

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

    [[Page 23680]]

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

    whether the Malin Financial Basis (``MLN'') 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 orders finding that the

    MLN contract does not perform 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 52192 (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

    price 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

    MLN contract performs a significant price discovery function and

    requested comment from 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 Suppliers Association (``NGSA''),

    Federal Energy Regulatory Commission (``FERC''), and Financial

    Institutions Energy Group (``FIEG'').\8\ The comment letter from FERC

    \9\ did not directly

    [[Page 23681]]

    address the issue of whether or not the MLN contract is a SPDC; IECA

    concluded that the MLN contract is a SPDC, but did not provide a basis

    for its conclusion.\10\ The other parties' comments raised substantive

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

    contract, generally asserting that the MLN 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-

    020.html.

    \9\ FERC stated that the MLN 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, ``the

    FERC staff will continue to monitor for any such conflict * * *

    [and] advise the CFTC'' should any such potential conflict arise. CL

    06.

    \10\ 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 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 the extent to which, on

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

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

    established for the contract.

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    \11\ 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 MLN contract. Arbitrage was not identified as a possible

    criterion. As a result, arbitrage will not be discussed further in

    this document and the associated Order.

    \12\ 17 CFR 36, Appendix A.

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    IV. Findings and Conclusions

    a. The Malin Financial Basis (MLN) Contract and the SPDC Indicia

    The ICE MLN contract is cash settled based on the difference

    between the bidweek price index of natural gas at the Malin hub for the

    contract-specified month of delivery, as published in Intelligence

    Press Inc.'s (``IPI'') Natural Gas Bidweek Survey, and the final

    settlement price for New York Mercantile Exchange's (``NYMEX's'') Henry

    Hub physically-delivered natural gas futures contract for the same

    specified calendar month. The IPI bidweek price, which is published

    monthly, is based on a survey of cash market traders who voluntarily

    report to IPI data on their fixed-price transactions for physical

    delivery of natural gas at the Malin 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 IPI 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 MLN contract is 2,500

    million British thermal units (``mmBtu''), and the unit of trading is

    any multiple of 2,500 mmBtu. The MLN contract is listed for up to 72

    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 also is the delivery point and pricing basis for

    the NYMEX's actively traded Henry Hub 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 move 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.

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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 and

    [[Page 23682]]

    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 Malin hub is the entry point along the California-Oregon border

    at which natural gas reaches the California market. This trading center

    connects with the Gas Transmission Northwest interstate pipeline, which

    carries gas from the Canada/Idaho border through Washington State and

    Oregon. A connection with the California Gas Transmission Company also

    exists at the Malin hub. The Malin hub is considered by traders to be

    an important trading center for natural gas.

    The Malin hub is part of the Golden Gate Market Center, which is

    located in Northern California. The Golden Gate Market Center offers

    seven different transaction points, which are Malin, Citygate, Kern

    River Station, High Desert Lateral, Daggett, Southern Trails and

    Topock. The Golden Gate Market Center had an estimated throughput

    capacity of two billion cubic feet per day in 2008. Moreover, the

    number of pipeline interconnections at the Golden Gate Market Center

    was nine in 2008, up from eight in 2003. Lastly, the pipeline

    interconnection capacity of the Golden Gate Market Center in 2008 was 6

    billion cubic feet per day, which constituted a 32 percent increase

    over the pipeline interconnection capacity in 2003.\15\ The Malin 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\ 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 Malin 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 Malin price. Moreover,

    exogenous factors, such as adverse weather, can cause the Malin 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 \16\ 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 physically-delivered natural gas contract's final settlement

    price).

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    \16\ 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 MLN

    contract. Each of these criteria is discussed below.\17\

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    \17\ 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 MLN 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 IPI's bidweek price

    indices. As a result, no other exchange can offer such a basis contract

    based on IPI's Malin bidweek index. While other third-party price

    providers produce natural gas price indices for this and other trading

    centers, market participants indicate that the IPI Malin bidweek 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 MLN swap since

    ICE has the right to the IPI 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'' \18\ 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 MLN

    contract.

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    \18\ 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 Commission will rely on one of two sources of evidence--direct

    or indirect--to determine that the price of a contract was being used

    as a material price reference and therefore, serving a significant

    price discovery function.\19\ With respect to direct evidence, the

    Commission will consider the extent to which, on a frequent and

    recurring basis, cash market bids, offers or transactions are directly

    based on or quoted at a differential to, the prices generated on the

    ECM in question. Direct evidence may be established when 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 in question. Cash

    market prices are set explicitly at a differential to the section

    2(h)(3) contract when, for instance, they are quoted in dollars and

    cents above or below the reference contract's price. Cash market prices

    are set implicitly at a differential to a section 2(h)(3) contract

    when, for instance, they are arrived at after adding to, or subtracting

    from the section 2(h)(3) contract, but then quoted or reported at a

    flat price. With respect to indirect evidence, the Commission will

    consider the extent to which the price of the contract in question is

    being routinely disseminated in widely distributed industry

    publications--or offered by the ECM itself for some form of

    remuneration--and consulted on a frequent and recurring basis by

    industry participants in pricing cash market transactions.

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    \19\ 17 CFR part 36, Appendix A.

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    Following the issuance of the Federal Register release, the

    Commission further evaluated the ICE's data offerings and their use by

    industry participants. The Malin hub is a significant trading center

    for natural gas but is not as important as other hubs, such as the PG&E

    Citygate, for pricing natural gas in the western half of the U.S.

    marketplace.

    [[Page 23683]]

    Although the Malin hub is a major trading center for natural gas in

    the United States and, as noted, ICE sells price information for the

    MLN contract, the Commission has found upon further evaluation that the

    cash market transactions are not being directly based or quoted as a

    differential to the MLN contract nor is that contract routinely

    consulted by industry participants in pricing cash market transactions

    and thus does not meet the Commission's Guidance for the material price

    reference criterion. Thus, the MLN contract does not satisfy the direct

    price reference test for existence of material price reference.

    Furthermore, the Commission notes that publication of the MLN

    contract's prices is not indirect evidence material price reference.

    The MLN contract's prices are published with those of numerous other

    contracts, which are of more interest to market participants. Due to

    the less importance of the Malin hub, the Commission has concluded that

    traders likely do not specifically purchase the ICE data packages for

    the MLN contract's prices and do not consult such prices on a frequent

    and recurring basis in pricing cash market transactions.

    i. Federal Register Comments

    As noted above, WGCEF,\20\ ICE,\21\ EI,\22\ NGSA \23\ and FIEG \24\

    addressed the question of whether the MLN contract met the material

    price reference criterion for a SPDC.\25\ The commenters argued that

    because the MLN contract is cash-settled, it cannot truly serve as an

    independent ``reference price'' for transactions in natural gas at this

    location. Rather, the commenters argue, the underlying cash price

    series against which the ICE MLN contract is settled (in this case, the

    IPI bidweek price for natural gas at this location) 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

    criterion 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 Malin hub is a significant trading

    center for natural gas in North America. However, traders do not

    consider the Malin hub to be as important as other natural gas trading

    points, particularly the nearby PG&E Citygate.

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    \20\ CL 02.

    \21\ CL 04.

    \22\ CL 05.

    \23\ CL 06.

    \24\ CL 08.

    \25\ As noted above, IECA expressed the opinion that the MLN

    contract met the criteria for SPDC determination but did not provide

    its reasoning.

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

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

    in issuing its notice of intent to determine whether the MLN 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.'' \26\ 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.''

    \27\ 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.

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    \26\ CL 03.

    \27\ CL 03.

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    Second, ICE argued that the Commission should not base a

    determination that the MLN contract is a SPDC on the fact that this

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

    Malin Index price. While the Commission acknowledges that there are

    other firms that produce price indices for the Malin hub, as it notes

    above, market participants indicate that the IPI Index is very highly

    regarded. However, since the Malin hub is not considered the

    predominant pricing point for natural gas in the upper Northwest, it is

    likely that cash market participants do not consult the MLN contract's

    prices on a frequent and recurring basis in pricing cash market

    transactions.

    Both EI \28\ and WGCEF \29\ 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 MLN contract. Instead, traders are interested in the settlement

    prices, so the fact that ICE sells the MLN prices as part of a broad

    package is not conclusive evidence that market participants are buying

    the ICE data sets because they find the MLN prices have substantial

    value to them. As mentioned above, the Commission notes that

    publication of the MLN contract's prices is not indirect evidence of

    routine dissemination. The MLN contract's prices are published with

    those of numerous other contracts, which are of more interest to market

    participants. Due to the lack of importance of the Malin hub, the

    Commission has concluded that traders likely do not specifically

    purchase the ICE data packages for the MLN contract's prices and do not

    consult such prices on a frequent and recurring basis in pricing cash

    market transactions.

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    \28\ CL 05.

    \29\ CL 02.

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    ii. Conclusion Regarding Material Price Reference

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

    not meet the material price reference criterion because cash market

    transactions are not priced on a frequent and recurring basis at a

    differential to the MLN contract's price (direct evidence). Moreover,

    while the ECM sells the MLN contract's price data to market

    participants, market participants likely do not specifically purchase

    the ICE data packages for the MLN contract's prices and do not consult

    such prices on a frequent and recurring basis in pricing cash market

    transactions (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 MLN contract. In this regard, the final settlement

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

    the NYMEX's Henry Hub 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

    \30\ 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

    [[Page 23684]]

    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.'' 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'').

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

    \30\ Appendix A to the Part 36 rules.

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

    To assess whether the MLN 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 Malin

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

    NYMEX physically-delivered natural gas futures contract (a DCM

    contract), the Malin 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, 10 percent of the Malin hub 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 finds that the MLN contract fails to meet the volume threshold

    requirement. In particular, the total trading volume in the NYMEX

    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 MLN contract

    during the same period was 54,759 contracts (equivalent to 13,690 NYMEX

    contracts, given the size difference).\31\ Thus, centralized-market

    trades in the MLN contract amounted to less than the minimum threshold.

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

    \31\ The MLN contract is one-quarter the size of the NYMEX Henry

    Hub physically-delivered futures contract.

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

    i. Federal Register Comments

    WGCEF, ICE, EI, NGSA and FIEG addressed the question of whether the

    MLN contract met the price linkage criterion for a SPDC.\32\ Each of

    the commenters expressed the opinion that the MLN contract did not

    appear to meet the above-discussed Commission guidance regarding the

    price relationship and/or the minimum volume threshold relative to the

    DCM contract to which the MLN is linked. Based on its analysis

    discussed above, the Commission agrees with this assessment.

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

    \32\ As noted above, IECA expressed the opinion that the MLN

    contract met the criteria for SPDC determination but did not provide

    its reasoning.

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

    ii. Conclusion Regarding the Price Linkage Criterion

    The Commission finds that the MLN contract does not meet the price

    linkage criterion because it fails the volume and price linkage tests

    provided for in the Commission's Guidance.

    3. Material Liquidity Factor

    As noted above, in its October 9, 2009, Federal Register notice,

    the Commission identified material price reference, price linkage and

    material liquidity as potential criteria for SPDC determination of the

    MLN contract. To assess whether a contract meets the material liquidity

    criterion, the Commission first examines trading activity as a general

    measurement of the contract's size and potential importance. If the

    Commission finds that the contract in question meets a threshold of

    trading activity that would render it of potential importance, the

    Commission will then perform a statistical analysis to measure the

    effect that the prices of the subject contract potentially may have on

    prices for other contracts listed on an ECM or a DCM.

    Based upon on a required quarterly filing made by ICE on July 27,

    2009, the total number of MLN trades executed on ICE's electronic

    trading platform was 664 in the second quarter of 2009, resulting in a

    daily average of 10.4 trades. During the same period, the MLN contract

    had a total trading volume on ICE's electronic trading platform of

    59,564 contracts and an average daily trading volume of 930.7

    contracts. The open interest as of June 30, 2009, was 65,804 contracts,

    which includes 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.

    In a subsequent filing dated November 13, 2009, ICE reported that

    686 separate trades occurred on its electronic platform in the third

    quarter of 2009, resulting in a daily average of 10.4 trades. During

    the same period, the MLN contract had a total trading volume on its

    electronic platform of 54,759 contracts (which was an average of 830

    contracts per day). As of September 30, 2009, open interest in the MLN

    contract was 57,332 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.

    As indicated above, the average number trades per day in the second

    and third quarters of 2009 was only slightly above the minimum

    reporting level (5 trades per day). Moreover, trading activity in the

    MLN contract, as characterized by total quarterly volume, indicates

    that the MLN contract experiences trading activity similar to that of

    other thinly-traded contracts.\33\ Thus, the MLN contract does not

    meets a threshold of trading activity that would render it of potential

    importance and no additional statistical analysis is warranted.\34\

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

    \33\ Staff has advised the Commission that in its experience, a

    thinly-traded contract is, generally, one that has a quarterly

    trading volume of 100,000 contracts or less. In this regard, in the

    third quarter of 2009, physical commodity futures contracts with

    trading volume of 100,000 contracts or fewer constituted less than

    one percent of total trading volume of all physical commodity

    futures contracts.

    \34\ In establishing guidance to illustrate how it will evaluate

    the various criteria, or combinations of criteria, when determining

    whether a contract is a SPDC, the Commission made clear that

    ``material liquidity itself would not be sufficient to make a

    determination that a contract is a [SPDC], * * * but combined with

    other factors it can serve as a guidepost indicating which contracts

    are functioning as [SPDCs].'' For the reasons discussed above, the

    Commission has found that the MLN contract does not meet either the

    price linkage or material price reference criterion. In light of

    this finding and the Commission's Guidance cited above, there is no

    need to evaluate further the material liquidity criteria since it

    cannot be used alone as a basis for a SPDC determination.

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

    i. Federal Register Comments

    As noted above, WGCEF, ICE, EI, NGSA and FIEG addressed the

    question of whether the MLN contract met the material liquidity

    criterion for a SPDC.\35\ These commenters stated that the MLN contract

    does not meet the material liquidity criterion for SPDC determination

    for a number of reasons.

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

    \35\ As noted above, IECA expressed the opinion that the MLN

    contract met the criteria for SPDC determination but did not provide

    its reasoning.

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

    WGCEF,\36\ ICE \37\ and EI \38\ noted that the Commission's

    Guidance had posited

    [[Page 23685]]

    concepts of liquidity that generally assumed a fairly constant stream

    of prices throughout the trading day, and noted that the relatively low

    number of trades per day in the MLN contract did not meet this standard

    of liquidity. The Commission observes that a continuous stream of

    prices would indeed be an indication of liquidity for certain markets

    but the Guidance also notes that ``quantifying the levels of immediacy

    and price concession that would define material liquidity may differ

    from one market or commodity to another.''

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

    \36\ CL 02.

    \37\ CL 04.

    \38\ CL 05.

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

    WGCEF, FIEG \39\ and NGSA \40\ noted that the MLN contract

    represents a differential, which does not affect other contracts,

    including the NYMEX Henry Hub contract and physical gas contracts. FIEG

    and WGCEF also noted that the MLN contract's trading volume represents

    only a fraction of natural gas trading.

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

    \39\ CL 08.

    \40\ CL 06.

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

    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.'' Furthermore, FIEG cautioned the Commission in

    using a reporting threshold as a measure of liquidity. 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'' \41\ 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 but this does not mean that the contract will be

    found to be a SPDC merely because it met the reporting threshold.

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

    \41\ 73 FR 75892 (December 12, 2008).

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

    ICE and EI proposed 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 a ``more appropriate method of

    determining liquidity is to examine the activity in a single traded

    month or strip of a given contract.'' \42\ A similar argument was made

    by EI, which observed that the five-trades-per-day number ``is highly

    misleading * * * because the contracts can be offered for as long as

    120 months, [thus] the average per day for an individual contract may

    be less than 1 per day.''

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

    \42\ In addition, both EI and ICE stated that the trades-per-day

    statistics that it provided to the Commission in its quarterly

    filing and which were cited in the Commission's October 9, 2009,

    Federal Register notice 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; ICE

    confirmed that the volume data it provided and which the Commission

    cited includes only transaction data executed on ICE's electronic

    trading platform. As noted above, supplemental data supplied by ICE

    confirmed that block trades are in addition to the trades that were

    conducted on the electronic platform; block trades comprise about 55

    percent of all transactions in the MLN contract. The Commission

    acknowledges that the open interest information it provided in its

    October 9, 2009, Federal Register notice 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.

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

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

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

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

    the ICE MLN contract itself would be considered liquid. In any event,

    in light of the fact that the Commission has found that the MLN

    contract does not meet the material price reference or price linkage

    criteria, according to the Commission's Guidance, it would be

    unnecessary to evaluate whether the MLN contract meets the material

    liquidity criterion since it cannot be used alone for SPDC

    determination.

    ii. Conclusion Regarding Material Liquidity

    For the reasons discussed above, the Commission does not find

    evidence that the MLN contract meets the material liquidity criterion.

    4. Overall Conclusion Regarding the MLN Contract

    After considering the entire record in this matter, including the

    comments received, the Commission has determined that the MLN contract

    does not perform a significant price discovery function under the

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

    Commission has determined that the MLN contract does not meet the

    material price reference, price linkage and material liquidity criteria

    at this time. Accordingly, the Commission will issue the attached Order

    declaring that the MLN contract is not a SPDC. Issuance of this Order

    indicates that the Commission does not at this time regard ICE as a

    registered entity in connection with its MLN contract.\43\ Accordingly,

    with respect to its MLN contract, ICE is not required to comply with

    the obligations, requirements and timetables prescribed in Commission

    rule 36.3(c)(4) for ECMs with SPDCs. However, ICE must continue to

    comply with the applicable reporting requirements.

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

    \43\ See 73 FR 75888, 75893 (Dec. 12, 2008).

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

    V. Related Matters

    a. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \44\ 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.

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

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

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

    b. Cost-Benefit Analysis

    Section 15(a) of the CEA \45\ 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.

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

    \45\ 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

    [[Page 23686]]

    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

    authorize 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.

    The Commission has concluded that ICE's MLN contract, which is the

    subject of the attached Order, is not a SPDC; accordingly, the

    Commission's Order imposes no additional costs and no additional

    statutorily or regulatory mandated responsibilities on the ECM.

    c. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') \46\ 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.\47\ Accordingly, the Chairman, on

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

    that these Orders, 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.

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

    \46\ 5 U.S.C. 601 et seq.

    \47\ 66 FR 42256, 42268 (Aug. 10, 2001).

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

    VI. Order

    a. Order Relating to the Malin 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 Order:

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

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

    traded on the IntercontinentalExchange, Inc., does not at this time

    satisfy the material price reference, price linkage or material

    liquidity criteria for significant price discovery contracts.

    Consistent with this determination, the IntercontinentalExchange, Inc.,

    is not considered a registered entity \48\ with respect to the Malin

    Financial Basis contract and is not subject to 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., are not applicable to the Malin

    Financial Basis contract with the issuance of this Order.

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

    \48\ 7 U.S.C. 1a(29).

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

    This Order is based on the representations made to the Commission

    by the IntercontinentalExchange, Inc., dated July 27, 2009, and

    November 13, 2009, and other supporting material. Any material change

    or omissions in the facts and circumstances pursuant to which this

    order is granted might require the Commission to reconsider its current

    determination that the Malin Financial Basis contract is not a

    significant price discovery contract. Additionally, to the extent that

    it continues to rely upon the exemption in Section 2(h)(3) of the Act,

    the IntercontinentalExchange, Inc., must continue to comply with all of

    the applicable requirements of Section 2(h)(3) and Commission

    Regulation 36.3.

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

    David A. Stawick,

    Secretary of the Commission.

    [FR Doc. 2010-10306 Filed 5-3-10; 8:45 am]

    BILLING CODE P

    Last Updated: May 4, 2010



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