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e9-20024

  • FR Doc E9-20024[Federal Register: August 20, 2009 (Volume 74, Number 160)]

    [Notices]

    [Page 42052-42055]

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

    [DOCID:fr20au09-16]

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    COMMODITY FUTURES TRADING COMMISSION

    Notice of Intent, Pursuant to the Authority in Section 2(h)(7) of

    the Commodity Exchange Act and Commission Rule 36.3(c)(3), To Undertake

    a Determination Whether the Carbon Financial Instrument Contract

    Offered for Trading on the Chicago Climate Exchange, Inc., Performs a

    Significant Price Discovery Function

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Notice of action and request for comment.

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    SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or

    ``Commission'') is undertaking a review to determine whether the Carbon

    Financial Instrument contract offered for trading on the Chicago

    Climate Exchange, Inc. (CCX), 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.

    Authority for this action is found in section 2(h)(7) of the CEA and

    Commission rule 36.3(c) promulgated thereunder. In connection with this

    evaluation, the Commission invites comment from interested parties.

    DATES: Comments must be received on or before September 4, 2009.

    [[Page 42053]]

    ADDRESSES: Comments may be submitted by any of the following methods:

    Follow the instructions for submitting comments. Federal

    eRulemaking Portal: http://www.regulations.gov.

    E-mail: secretary@cftc.gov. Include CCX Carbon Financial

    Instrument Contract in the subject line of the message.

    Fax: (202) 418-5521.

    Mail: Send to David A. Stawick, Secretary, Commodity

    Futures Trading Commission, Three Lafayette Centre, 1155 21st Street,

    NW., Washington, DC 20581

    Courier: Same as mail above.

    All comments received will be posted without change to http://

    www.CFTC.gov/.

    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

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

    provisions of the CFTC Reauthorization Act of 2008 (``Reauthorization

    Act'') \1\ which subjects ECMs with significant price discovery

    contracts (``SPDCs'') to self-regulatory and reporting requirements, as

    well as certain Commission oversight authorities, with respect to those

    contracts. Among other things, these rules and rule amendments revise

    the information-submission requirements applicable to ECMs, establish

    procedures and standards by which the Commission will determine whether

    an ECM contract performs a significant price discovery function, and

    provide guidance with respect to compliance with nine statutory core

    principles applicable to ECMs with SPDCs. These rules became effective

    on April 22, 2009.

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    \1\ 74 FR 12178 (Mar. 23, 2009); these rules became effective on

    April 22, 2009.

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    In determining whether an ECM's contract is or is not a SPDC, the

    Commission will consider the contract's material liquidity, price

    linkage to other contracts, potential for arbitrage with other

    contracts traded on designated contract markets or derivatives

    transaction execution facilities, use of the ECM contract's prices to

    execute or settle other transactions, and other factors.

    In order to facilitate the Commission's identification of possible

    SPDCs, Commission rule 36.3(c)(2) requires that an ECM operating in

    reliance on section 2(h)(3) promptly notify the Commission and provide

    supporting information or data concerning any contract: (i) that

    averaged five trades per day or more over the most recent calendar

    quarter; and (ii) (A) for which the ECM sells price information

    regarding the contract to market participants or industry publications;

    or (B) 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 agreement.

    II. Determination of a SPDC

    A. The SPDC Determination Process

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

    Commission makes and announces its determination on whether a specific

    ECM contract serves a significant price discovery function. Under those

    procedures, the Commission will publish a notice in the Federal

    Register that it intends to undertake a determination as to whether the

    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.\2\ After prompt consideration of all relevant

    information, the Commission will, within a reasonable period of time

    after the close of the comment period, issue an order explaining its

    determination. Following the issuance of an order by the Commission

    that the ECM executes or trades an agreement, contract, or transaction

    that performs a significant price discovery function, the ECM must

    demonstrate, with respect to that agreement, contract, or transaction,

    compliance with the core principles under section 2(h)(7)(C) of the CEA

    \3\ and the applicable provisions of Part 36. If the Commission's order

    represents the first time it has determined that one of the ECM's

    contracts performs a significant price discovery function, the ECM must

    submit a written demonstration of its compliance with the core

    principles within 90 calendar days of the date of the Commission's

    order. For each subsequent determination by the Commission that the ECM

    has an additional SPDC, the ECM must submit a written demonstration of

    its compliance with the core principles within 30 calendar days of the

    Commission's order.

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    \2\ The Commission may commence this process on its own

    initiative or on the basis of information provided to it by an ECM

    pursuant to the notification provisions of Commission rule

    36.3(c)(2).

    \3\ 7 U.S.C. 2(h)(7)(C).

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    B. CCX Carbon Financial Instrument Contract

    CCX identifies its CFI contract as a cash contract that requires

    the physical delivery of CCX carbon dioxide (CO2) emission

    allowances called CFIs.\4\ The size of the CCX CFI contract is 1,000

    metric tons (MT) of CO2-equivalent emissions,\5\ which are

    equal to 10 CFIs (each CFI specifies 100 MT CO2-equivalent

    emissions). All trades in the subject contract results in the physical

    delivery of CFIs.

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    \4\ The instruments listed by an ECM in reliance on the

    exemption in section 2(h)(3) of the Act are determined by the ECM

    when it files notice with the Commission, pursuant to section

    2(h)(5), of its intention to rely on the exemption. Section 2(h)(7)

    authorizes the Commission to determine whether an ECM ``agreement,

    contract or transaction'' performs a significant price discovery

    function, but does not require that the Commission also determine

    whether the instrument is otherwise subject to the Commission's

    jurisdiction (i.e., a futures or commodity option contract).

    Instead, the descriptive language of section 2(h)(7) mirrors the

    ``[conducted] in reliance on the exemption'' language of section

    2(h)(5) and refers merely to ``agreement, contract or transaction.''

    Thus, the statutory language directs the Commission, in determining

    whether an ECM instrument is a SPDC, to evaluate any instrument

    listed by an ECM in reliance on the section 2(h)(3) exemption under

    the SPDC process set forth in the Part 36 rules.

    \5\ Greenhouse gases (GHGs) include CO2, methane

    (CH4), nitrous oxide (N2O), hydrofluorocarbons

    (HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride

    (SF6). The negative impact that each non-CO2

    GHGs has on the environment can be expressed as a multiple of

    CO2's environmental effect.

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    The CCX carbon reduction program is voluntary where certain

    entities choose to reduce their GHG emissions. In general, the electric

    utilities and manufacturers combined comprise the largest share of the

    program participants. Once an entity decides to reduce its GHG

    emissions, it signs a legally-binding contract with the CCX.

    Participants are given allowances by the CCX to cover emissions level

    targets, and additional credits can be created by investing in offset

    projects. If an entity's plant cannot meet its reduction requirements

    through new investments and/or technological improvements, additional

    allowances can be purchased from other program participants.

    The program specifies that carbon emission reductions be completed

    over two phases. Phase I (applicable between

    [[Page 42054]]

    2003 and 2006) required a commitment to reducing each participant's

    carbon emissions by one percent per year below its own baseline level

    (calculated as the average of the firm's carbon emissions between 1998

    and 2001). Phase II (which runs from 2007 through 2010) requires

    participants to commit to an emissions reduction schedule that results

    in a six-percent decline in CO2 output by 2010.

    Participants' baseline estimates as well as their emissions levels and

    progress toward meeting the reduction requirements are audited by the

    Financial Industry Regulatory Authority (FINRA).

    CFIs are distributed for multiple program years at the time of

    entry into the program through the end of the current phase. Each CFI

    is dated with a particular calendar year (vintage), with the vintage

    indicating the compliance year for which it is redeemable.

    Alternatively, entities can save their excess CFIs for use in future

    compliance periods. The CCX also auctions a certain number of current-

    and future-year CFIs. Allowances are recorded electronically and title

    transfers between entities are effected within the CCX's electronic

    registry. Each year in April, the CCX compares each participant's

    reported emissions from the previous calendar year to the number of

    allowances held that are dated with the compliance year, or with

    earlier years. Firms surrender the appropriate number of allowances

    that covers their emissions, and the redeemed CFIs are deducted from

    the firms' accounts. Unused allowances that are not needed for

    compliance in the current year are rolled forward and are included in

    the allowance supply for the following year. Alternatively, plants can

    sell excess allowances to other market participants.

    As noted above, the CCX's GHG reduction program allows for the

    creation of CFIs through offset projects. In this regard, the CCX

    issues CFIs to entities that own, implement, or aggregate eligible

    projects on the basis of sequestration, destruction, or displacement of

    GHG emissions. The offset project categories for which the CCX issues

    CFIs include agricultural, coal mine and landfill methane, agricultural

    and rangeland soil carbon, forestry, renewable energy, energy

    efficiency and fuel switching, and clean development mechanism

    projects.

    Based upon a required quarterly notification filed on July 1, 2009

    (mandatory under Rule 36.3(c)(2)), the CCX reported that, with respect

    to its CFI contract, an average of 15 separate trades per day occurred

    in the second quarter of 2009. During the same period, the CFI had an

    average daily trading volume of 1,235 contracts. In the first quarter

    of 2009, market participants traded the CFI contract on average 29

    times per day with an average total daily trading volume of 2,661

    contracts. Because the CFI contract requires immediate delivery and

    payment on the following day, open interest figures are not applicable.

    It appears that the CCX CFI contract may satisfy the material

    liquidity and material price reference factors for SPDC determination.

    With respect to material liquidity, daily trading in the CFI contract

    exceeds an average of ten trades per day. Moreover, the average daily

    trading volume in the CFI is greater than 1,000 contracts per day. In

    regard to material price reference, the CFI market is solely a CCX-

    created entity. In this regard, the CCX designed all of the parameters

    of this carbon emission reduction program, as well as established the

    rules for membership in the ECM, allowance trading, and the creation of

    offsets. The only existing market in which CFIs can be bought and sold

    on a spot basis is the CCX cash market. Thus, traders look to the CCX

    as a source of price information and price discovery for the CFIs.

    Moreover, the Chicago Climate Futures Exchange, a subsidiary of the

    CCX, trades a futures contract which specifies the delivery of CFIs.

    The instruments listed by an ECM in reliance on the exemption in

    section 2(h)(3) of the CEA are determined by the ECM when it files

    notice with the Commission, pursuant to section 2(h)(5), of its

    intention to rely on the exemption. Section 2(h)(7) authorizes the

    Commission to determine whether an ECM's ``agreement, contract or

    transaction'' performs a significant price discovery function, but does

    not require that the Commission also determine whether the instrument

    is otherwise subject to the Commission's jurisdiction (i.e., a futures

    or commodity option contract). Instead, the descriptive language of

    section 2(h)(7) mirrors the ``[conducted] in reliance on the [2(h)(5)]

    exemption'' language of section 2(h)(5) and refers merely to an

    ``agreement, contract or transaction.'' The statutory language

    indicates that any instrument listed by an ECM in reliance on the

    exemption in section 2(h)(3) of the CEA--including a cash contract that

    generally is not subject to the Commission's jurisdiction--has the

    potential to be or become a SPDC. Accordingly, contracts identified to

    the Commission as listed in reliance on section 2(h)(3) should be

    evaluated under the SPDC process set forth in the Part 36 rules.

    III. Request for Comment

    In evaluating whether an ECM's agreement, contract, or transaction

    performs a significant price discovery function, section 2(h)(7) of the

    CEA directs the Commission to consider, as appropriate, four specific

    criteria: price linkage, arbitrage, material price reference, and

    material liquidity. As it explained in Appendix A to the Part 36 rules,

    the Commission, in making SPDC determinations, will apply and weigh

    each factor, as appropriate, to the specific contract and circumstances

    under consideration.

    As part of its evaluation, the Commission will consider the written

    data, views, and arguments from any ECM that lists the potential SPDC

    and from any other interested parties. Accordingly, the Commission

    requests comment on whether the CCX CFI contract performs a significant

    price discovery function. Commenters' attention is directed

    particularly to Appendix A of the Commission's Part 36 rules for a

    detailed discussion of the factors relevant to a SPDC determination.

    The Commission notes that comments which analyze the contract in terms

    of these factors will be especially helpful to the determination

    process. In order to determine the relevance of comments received, the

    Commission requests that commenters explain in what capacity are they

    knowledgeable about the CFI contract.

    IV. Related Matters

    A. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \6\ 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 final

    Commission rule 36.3 impose new regulatory and reporting requirements

    on ECMs, resulting in information collection requirements within the

    meaning of the PRA; OMB previously has approved and assigned OMB

    control number 3038-0060 to this collection of information.

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    \6\ 44 U.S.C. 3507(d).

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    B. Cost-Benefit Analysis

    Section 15(a) of the CEA \7\ 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

    [[Page 42055]]

    that the Commission ``consider'' the costs and benefits of its action.

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

    evaluated in light of five broad areas of market and public concern:

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

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

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

    interest considerations. The Commission may in its discretion give

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

    discretion determine that, notwithstanding its costs, a particular

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

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

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

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

    concluded that this Order, which strengthens Federal oversight of the

    ECM and helps to prevent market manipulation, is necessary and

    appropriate to accomplish the purposes of section 2(h)(7) which, among

    other provisions, directs the Commission to evaluate all contracts

    listed on ECMs to determine whether they serve a significant price

    discovery function.

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

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    When a futures contract begins to serve a significant price

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

    warrants increased oversight to deter and prevent price manipulation

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

    in any related futures contracts trading on designated contract markets

    (``DCMs''). An Order finding that a particular contract is a SPDC

    triggers this increased oversight and imposes obligations and

    responsibilities on the ECM which are calculated to accomplish this

    goal. This increased oversight in turn 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 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. These increased ECM responsibilities, along with the

    CFTC's enhanced 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.

    Issued in Washington, DC on August 13, 2009 by the Commission.

    David A. Stawick,

    Secretary of the Commission.

    [FR Doc. E9-20024 Filed 8-19-09; 8:45 am]

    Last Updated: August 20, 2009



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