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2010-10343

  • FR Doc 2010-10343[Federal Register: May 5, 2010 (Volume 75, Number 86)]

    [Notices]

    [Page 24586-24592]

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

    [DOCID:fr05my10-51]

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    COMMODITY FUTURES TRADING COMMISSION

    Order Finding That the San Juan Financial Basis Contract Traded

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

    Price Discovery Function

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Final order.

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

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

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

    whether the San Juan Financial Basis (``SNJ'') 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 SNJ 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 52188 (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 No. 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 a determination whether the specified

    agreement, contract or transaction performs a significant price

    discovery function and to receive written views, data and arguments

    relevant to its determination from the ECM and other interested

    persons. 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

    SNJ contract performs a significant price discovery function and

    requested comment from interested parties.\7\ Comments were received

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

    of Commercial Energy Firms (``WGCEF''), Platts, ICE, Economists

    Incorporated (``EI''), Natural Gas Supply Association (``NGSA''),

    [[Page 24587]]

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

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

    \9\ and Platts did not directly address the issue of whether or not the

    SNJ contract is a SPDC; IECA expressed the opinion that the SNJ

    contract did perform a significant price discovery function; and thus,

    should be subject to the requirements of the core principles enumerated

    in Section 2(h)(7) of the Act, but did not elaborate on its reasons for

    saying so or directly address any of the criteria. The remaining

    comment letters raised substantive issues with respect to the

    applicability of section 2(h)(7) to the SNJ contract and generally

    expressed the opinion that the SNJ contract is not a SPDC because it

    does not meet the material price reference, price linkage and material

    liquidity criteria for SPDC determination. These 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.'' 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 exempt commercial market, 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/2009/09-013.html.

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

    not contemplate the actual physical delivery of natural gas.

    Accordingly, FERC expressed the opinion that a determination by the

    Commission that a contract performs a significant price discovery

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

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

    natural gas in interstate commerce for resale or with its other

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

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

    advise the CFTC'' should any such potential conflict arise. CL 07.

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

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

    participants to effectively arbitrage between the markets by

    simultaneously maintaining positions or executing trades in the

    contracts on a frequent and recurring basis.

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

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

    commodity are directly based on, or are determined by referencing 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.\10\ 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.\11\ 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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    \10\ 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 SNJ 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.

    \11\ 17 CFR part 36, Appendix A.

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    IV. Findings and Conclusions

    The San Juan Financial Basis (SNJ) Contract and the SPDC Indicia

    The SNJ contract is cash settled based on the difference between

    the bidweek price index for a particular calendar month at the San Juan

    Basin on El Paso Natural Gas Company's pipeline, as published in

    Platts' Inside FERC's Gas Market Report, and the final settlement price

    of the New York Mercantile Exchange's (``NYMEX's'') physically-

    delivered Henry Hub natural gas futures contract for the same 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 their fixed-price transactions conducted during the last five

    business days of the month for physical delivery of natural gas at the

    San Juan Basin; 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 SNJ contract is 2,500 million British

    thermal units (``mmBtu''), and the unit of trading is any multiple of

    2,500 mmBtu. The SNJ

    [[Page 24588]]

    contract is listed for up to 72 consecutive calendar months.

    The Henry Hub,\12\ which is located in Erath, Louisiana, is the

    primary cash market trading and distribution center for natural gas in

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

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

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

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

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

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

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

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

    per day.

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    \12\ 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.\13\ Some of the major trading centers include

    Alberta, Northwest Rockies, Southern California border and the Houston

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

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

    shipping capacity, the price at the other locations usually directly

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

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

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

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

    local price may be significantly different than the price at another

    location even though the two markets' respective distances from the

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

    a given location may experience supply and demand factors that are

    specific to that region, such as differences in pipeline shipping

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

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

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

    shipping and such price differences can vary in an unpredictable

    manner.

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    \13\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/

    feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.

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    The supply of natural gas in the San Juan Basin (encompassing the

    four-corner region of northwestern New Mexico, northeastern Arizona,

    and portions of Colorado and Utah) primarily comes from New Mexico

    natural gas production plants in the cities of Blanco, Chaco, Rio

    Vista, Milagro and Valverde. The El Paso Natural Gas Company's pipeline

    system, which is the largest natural gas pipeline system in the Western

    region of the United States, transports natural gas from the San Juan

    Basin production area to California, Arizona, and the Arizona/Nevada

    state border.\14\

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    \14\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/

    analysis_publications/ngpipeline/western.html.

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    The Blanco hub, a market center that includes the San Juan Basin,

    had an estimated throughput capacity of 1.2 billion cubic feet per day

    in 2008. Moreover, the number of pipeline interconnections at the San

    Juan Basin hub was 10 in 2008. Lastly, the pipeline interconnection

    capacity of the San Juan Basis hub in 2008 was 4.2 billion cubic feet

    per day, which constituted a 22 percent increase over the pipeline

    interconnection capacity in 2003.\15\ The San Juan Basin is far removed

    from the Henry Hub and is not directly connected to the Henry Hub.

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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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    Natural gas prices at the San Juan Basin typically differ from

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

    delivered futures contract is an imperfect proxy for the SNJ price.

    Moreover, exogenous factors, such as adverse weather, can cause the SNJ

    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 SNJ

    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 was not discussed in reference to the SNJ 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 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 SNJ

    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 also noted that its October 2007 Report on the

    Oversight of Trading on Regulated Futures Exchanges and Exempt

    Commercial Markets (``ECM Study'') \19\ found that in general, market

    participants view the ICE as a price discovery market for certain

    natural gas contracts. The study did not specify which markets

    performed this function; nevertheless, the Commission determined that

    the SNJ contract, while not mentioned by name in the ECM Study, might

    warrant further study.

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    \19\ http://www.cftc.gov/ucm/groups/public/@newsroom/documents/

    file/pr5403-07_ecmreport.pdf.

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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 is being used as

    a material price reference and therefore, serving a significant price

    discovery function.\20\ 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

    [[Page 24589]]

    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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    \20\ 17 CFR part 36, Appendix A.

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    Following the issuance of the Federal Register release, the

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

    industry participants. Although the San Juan Basin is a major trading

    center for natural gas in the United States and, as noted, ICE sells

    price information for the SNJ 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 SNJ contract nor is

    that contract routinely consulted by industry participants in pricing

    cash market transactions. Thus, the contract does not meet the

    Commission's Guidance for the material price reference criterion.

    Moreover, there are other trading points in the same general vicinity,

    such as the Waha hub, that are referenced more frequently. Thus, it is

    not necessary for market participants to independently refer to the SNJ

    contract for pricing natural gas at this location. In these

    circumstances, the SNJ contract does not satisfy the direct price

    reference test for existence of material price reference. Furthermore,

    the Commission notes that publication of the SNJ contract's prices is

    not indirect evidence of material price reference. The SNJ 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 San Juan Basin, the Commission has concluded that traders likely

    do not specifically purchase the ICE data packages for the SNJ

    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, ICE, EI, NGSA and FIEG addressed the

    question of whether the SNJ contract met the material price reference

    criterion for a SPDC.\21\ The commenters argued that because the SNJ

    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 SNJ contract is settled (in this case, the Inside FERC's

    Gas Market Report 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 and 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 San Juan

    Basin is a significant trading center for natural gas in North America.

    However, traders do not consider the San Juan Basin to be as important

    as other natural gas trading points, such as the Waha hub and Henry

    Hub.

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    \21\ As noted above, IECA expressed the opinion that the SNJ

    contract met the criteria for SPDC determination but did not provide

    its reasoning.

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    ICE \22\ also argued that the Commission appeared to base the case

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

    In issuing its notice of intent to determine whether the SNJ contract

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

    certain market participants referred to ICE as a price discovery market

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

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

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

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

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

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

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

    investigation of certain ICE contracts may be warranted. The ECM Study

    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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    \22\ CL 04.

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    Both EI \23\ and WGCEF \24\ 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 SNJ contract. Instead, traders are interested in the settlement

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

    package is not conclusive evidence that market participants are buying

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

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

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

    routine dissemination. The SNJ 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 San Juan Basin, the

    Commission has concluded that traders likely do not specifically

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

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

    market transactions.

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    \23\ CL 05.

    \24\ CL 02.

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    ii. Conclusion Regarding Material Price Reference

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

    not meet the material price reference criterion because cash market

    transactions are not priced either explicitly or implicitly on a

    frequent and recurring basis at a differential to the SNJ contract's

    price (direct evidence). Moreover, while the ECM sells the SNJ

    contract's price data to market participants, market participants

    likely do not specifically purchase the ICE data packages for the SNJ

    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 SNJ contract. In this regard, the final settlement

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

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

    is registered with the Commission as a DCM.

    The Commission's Guidance on Significant Price Discovery Contracts

    \25\ 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

    [[Page 24590]]

    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 to be deemed a SPDC (``minimum threshold'').

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

    \25\ Appendix A to the Part 36 rules.

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

    To assess whether the SNJ 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 SNJ

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

    the NYMEX physically-delivered natural gas futures contract (a DCM

    contract), the imputed SNJ location price (derived by adding the NYMEX

    Henry Hub Natural Gas price to the ICE SNJ basis 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 2.2 percent of the

    SNJ 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 SNJ 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. Trades on the ICE centralized market in the

    SNJ contract during the same period was 35,836 contracts (equivalent to

    8,959 NYMEX contracts, given the size difference).\26\ Thus,

    centralized-market trades in the SNJ contract amounted to less than the

    minimum volume threshold.\27\

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

    \26\ The size of the NYMEX Henry Hub physically-delivered

    natural gas futures contract is 10,000 mmBtu. The SNJ contract has a

    trading unit of 2,500 mmBtu, which is one-quarter the size of the

    NYMEX Henry Hub contract.

    \27\ Supplemental data subsequently submitted by the ICE

    indicated that block trades are included in the on-exchange trades;

    block trades comprise 61.4 percent of all transactions in the SNJ

    contract.

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

    i. Federal Register Comments

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

    question of whether the SNJ contract met the price linkage criterion

    for a SPDC.\28\ Each of the commenters expressed the opinion that the

    SNJ 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 SNJ is linked.

    Based on its analysis discussed above, the Commission agrees with this

    assessment.

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

    \28\ As noted above, IECA expressed the opinion that the SNJ

    contract met the criteria for SPDC determination but did not provide

    its reasoning.

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

    ii. Conclusion Regarding the Price Linkage Criterion

    Based on the above, the Commission finds that the SNJ 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

    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

    SNJ 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.

    The total number of transactions executed on ICE's electronic

    platform in the SNJ contract was 391 in the second quarter of 2009,

    resulting in a daily average of 6.1 trades. During the same period, the

    SNJ contract had a total trading volume of 30,722 contracts and an

    average daily trading volume of 480 contracts. Moreover, open interest

    as of June 30, 2009, was 49,105 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. In this regard, ICE does not differentiate between

    open interest created by a transaction executed on its trading platform

    and that created by a transaction executed off its trading

    platform.\29\

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

    \29\ 74 FR 52188 (October 9, 2009).

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

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

    total trading volume in the third quarter of 2009 was 35,836 contracts

    (or 543 contracts on a daily basis). In terms of number of

    transactions, 402 trades occurred in the third quarter of 2009 (6.1

    trades per day). As of September 30, 2009, open interest in the SNJ

    contract was 59,123 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.

    As indicated above, the average number of 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

    SNJ contract, as characterized by total quarterly volume, indicates

    that the SNJ contract experiences trading activity similar to that of

    other thinly-traded contracts.\30\ Thus, the SNJ contract does not meet

    a threshold of trading activity that would render it of potential

    importance and no additional statistical analysis is warranted.\31\

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

    \30\ 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.

    \31\ 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 SNJ 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 SNJ contract met the

    [[Page 24591]]

    material liquidity criterion for a SPDC.\32\ These commenters stated

    that the SNJ contract does not meet the material liquidity criterion

    for SPDC determination for a number of reasons.

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

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

    contract met the criteria for SPDC determination but did not provide

    its reasoning.

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

    WGCEF,\33\ ICE \34\ and EI \35\ noted that the Commission's

    Guidance had posited 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 SNJ 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.''

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

    \33\ CL 02.

    \34\ CL 04.

    \35\ CL 05.

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

    WGCEF, FIEG \36\ and NGSA \37\ noted that the SNJ 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 SNJ contract's trading volume represents

    only a fraction of natural gas trading.

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

    \36\ CL 08.

    \37\ 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'' \38\ 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.

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

    \38\ 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.'' \39\ 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.''

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

    \39\ 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

    61.4 percent of all transactions in the SNJ 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 SNJ contract, is typically a function of trading activity in

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

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

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

    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 SNJ contract meets the material

    liquidity criterion since it cannot be used alone for SPDC

    determination.

    ii. Conclusion Regarding Material Liquidity

    The Commission has found that the SNJ contract does not meet the

    material liquidity criterion.

    4. Overall Conclusion

    After considering the entire record in this matter, including the

    comments received, the Commission has determined that the SNJ contract

    does not perform a significant price discovery function under the

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

    SNJ contract does not meet the material price reference, price linkage

    or material liquidity criteria. Accordingly, the Commission will issue

    the attached Order declaring that the SNJ 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 SNJ

    contract.\40\ Accordingly, with respect to its SNJ 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.

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

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

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

    V. Related Matters

    a. Paperwork Reduction Act

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

    requirements on Federal agencies, including the Commission, in

    connection with their conducting or sponsoring any collection of

    information as defined by the PRA. Certain provisions of Commission

    rule 36.3 impose new regulatory and reporting requirements on ECMs,

    resulting in information collection requirements within the meaning of

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

    3038-0060 to this collection of information.

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

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

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

    b. Cost-Benefit Analysis

    Section 15(a) of the CEA \42\ requires the Commission to consider

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

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

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

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

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

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

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

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

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

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

    interest considerations. The Commission may in its discretion give

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

    discretion determine that, notwithstanding its costs, a particular

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

    [[Page 24592]]

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

    the Act. The Commission has considered the costs and benefits in light

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

    concluded that the Order, required by Congress to strengthen Federal

    oversight of exempt commercial markets and to prevent market

    manipulation, is necessary and appropriate to accomplish the purposes

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

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

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

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

    When a futures contract begins to serve a significant price

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

    warrants increased oversight to deter and prevent price manipulation or

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

    any related futures contracts trading on DCMs. An Order fining 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. Amendments to 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 SNJ 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'') \43\ requires that

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

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

    commercial markets. The Commission previously has determined that

    exempt commercial markets are not small entities for purposes of the

    RFA.\44\ Accordingly, the Chairman, on behalf of the Commission, hereby

    certifies pursuant to 5 U.S.C. 605(b) that this Order, taken in

    connection with section 2(h)(7) of the Act and the Part 36 rules, will

    not have a significant impact on a substantial number of small

    entities.

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

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

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

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

    VI. Order

    Order Regarding the San Juan 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 San Juan Financial Basis contract,

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

    satisfy the material price reference, price linkage and material

    liquidity criteria for significant price discovery contracts.

    Consistent with this determination, the IntercontinentalExchange, Inc.,

    is not considered a registered entity \45\ with respect to the San Juan

    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 San Juan

    Basin Financial Basis contract with the issuance of this Order.

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

    \45\ 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 San Juan 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. 2010-10343 Filed 5-4-10; 8:45 am]

    BILLING CODE P

    Last Updated: May 5, 2010



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