2010-10299

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

[Notices]

[Page 23697-23704]

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

[DOCID:fr04my10-62]

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COMMODITY FUTURES TRADING COMMISSION

Order Finding That the AECO Financial Basis Contract Traded on

the IntercontinentalExchange, Inc., Performs a Significant Price

Discovery Function

AGENCY: Commodity Futures Trading Commission.

ACTION: Final order.

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

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

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

whether the AECO Financial Basis (``AEC'') contract traded on the

IntercontinentalExchange, Inc. (``ICE''), an exempt commercial market

(``ECM'') under sections 2(h)(3)-(5) of the Commodity Exchange Act

(``CEA'' or the ``Act''), performs a significant price discovery

function pursuant to section 2(h)(7) of the CEA. The Commission

undertook this review based upon an initial evaluation of information

and data provided by ICE as well as other available information. The

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

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

the AEC contract performs a significant price discovery function.

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

Commission rule 36.3(c) promulgated thereunder.

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\1\ 74 FR 52196 (October 9, 2009).

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DATES: Effective date: April 28, 2010.

FOR FURTHER INFORMATION CONTACT: Gregory K. Price, Industry Economist,

Division of Market Oversight, Commodity Futures Trading Commission,

Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.

Telephone: (202) 418-5515. E-mail: [email protected]; or Susan Nathan,

Senior Special Counsel, Division of Market Oversight, same address.

Telephone: (202) 418-5133. E-mail: [email protected]

SUPPLEMENTARY INFORMATION:

I. Introduction

The CFTC Reauthorization Act of 2008 (``Reauthorization Act'') \2\

significantly broadened the CFTC's regulatory authority with respect to

ECMs by creating, in section 2(h)(7) of the CEA, a new regulatory

category--ECMs on which significant price discovery contracts

(``SPDCs'') are traded--and treating ECMs in that category as

registered entities under the CEA.\3\ The legislation authorizes the

CFTC to designate an agreement, contract or transaction as a SPDC if

the Commission determines, under criteria established in section

2(h)(7), that it performs a significant price discovery function. When

the Commission makes such a determination, the ECM on which the SPDC is

traded must assume, with respect to that contract, all the

responsibilities and obligations of a registered entity under the Act

and Commission regulations, and must comply with nine core principles

established by new section 2(h)(7)(C).

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\2\ Incorporated as Title XIII of the Food, Conservation and

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

2008).

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

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

the provisions of the Reauthorization Act.\4\ As relevant here, rule

36.3 imposes increased information reporting requirements on ECMs to

assist the Commission in making prompt assessments whether particular

ECM contracts may be SPDCs. In addition to filing quarterly reports of

its contracts, an ECM must notify the Commission promptly concerning

any contract traded in reliance on the exemption in section 2(h)(3) of

the CEA that averaged five trades per day or more over the most recent

calendar quarter, and for which the exchange sells its price

information regarding the contract to market participants or industry

publications, or whose daily closing or settlement prices on 95 percent

or more of the days in the most recent quarter were within 2.5 percent

of the contemporaneously determined closing, settlement or other daily

prices of another contract.

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\4\ 74 FR 12178 (Mar. 23, 2009); these rules became effective on

April 22, 2009.

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

Commission makes and announces its determination whether a particular

ECM contract serves a significant price discovery function. Under those

procedures, the Commission will publish notice in the Federal Register

that it intends to undertake an evaluation whether the specified

agreement, contract or transaction performs a significant price

discovery function and to receive written views, data and arguments

relevant to its determination from the ECM and other interested

persons. Upon the close of the comment period, the Commission will

consider, among other things, all relevant information regarding the

subject contract and issue an order announcing and explaining its

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

affirmative order signals the effectiveness of the Commission's

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

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

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

obligations, requirements and timetables prescribed in Commission rule

36.3(c)(4).\6\

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\5\ Public Law 110-246 at 13203; Joint Explanatory Statement of

the Committee of Conference, H.R. Rep. No. 110-627, 110 Cong., 2d

Sess. 978, 986 (Conference Committee Report). See also 73 FR 75888,

75894 (Dec. 12, 2008).

\6\ For an initial SPDC, ECMs have a grace period of 90 calendar

days from the issuance of a SPDC determination order to submit a

written demonstration of compliance with the applicable core

principles. For subsequent SPDCs, ECMs have a grace period of 30

calendar days to demonstrate core principle compliance.

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II. Notice of Intent To Undertake SPDC Determination

On October 9, 2009, the Commission published in the Federal

Register notice of its intent to undertake a determination whether the

AEC contract performs a significant price discovery function and

requested comment from

[[Page 23698]]

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

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

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

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

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

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

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

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

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

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

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

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

does not meet the material liquidity, material price reference and

price linkage criteria for SPDC determination. Those comments are more

extensively discussed below, as applicable.

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\7\ The Commission's Part 36 rules establish, among other

things, procedures by which the Commission makes and announces its

determination whether a specific ECM contract serves a significant

price discovery function. Under those procedures, the Commission

publishes a notice in the Federal Register that it intends to

undertake a determination whether a specified agreement, contract or

transaction performs a significant price discovery function and to

receive written data, views and arguments relevant to its

determination from the ECM and other interested persons.

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

manufacturing companies'' whose membership ``represents a diverse

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

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

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

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

domestic energy industry whose primary business activity is the

physical delivery of one or more energy commodities to customers,

including industrial, commercial and residential consumers'' and

whose membership consists of ``energy producers, marketers and

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

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

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

gas producers and marketers. FERC is an independent federal

regulatory agency that, among other things, regulates the interstate

transmission of natural gas, oil and electricity. FIEG describes

itself as an association of investment and commercial banks who are

active participants in various sectors of the natural gas markets,

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

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

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

lawandregulation/federalregister/federalregistercomments/2009/09-

016.html.

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

not contemplate actual physical delivery of natural gas.

Accordingly, FERC expressed the opinion that a determination by the

Commission that a contract performs a significant price discovery

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

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

natural gas in interstate commerce for resale or with its other

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

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

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

\10\ CL 01.

\11\ CL 08.

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

required to come into compliance with core principles mandated by

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

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

to the Commission's position limit authority, emergency authority

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

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III. Section 2(h)(7) of the CEA

The Commission is directed by section 2(h)(7) of the CEA to

consider the following criteria in determining a contract's significant

price discovery function:

Price Linkage--the extent to which the agreement, contract

or transaction uses or otherwise relies on a daily or final settlement

price, or other major price parameter, of a contract or contracts

listed for trading on or subject to the rules of a designated contract

market (``DCM'') or derivatives transaction execution facility

(``DTEF''), or a SPDC traded on an electronic trading facility, to

value a position, transfer or convert a position, cash or financially

settle a position, or close out a position.

Arbitrage--the extent to which the price for the

agreement, contract or transaction is sufficiently related to the price

of a contract or contracts listed for trading on or subject to the

rules of a DCM or DTEF, or a SPDC traded on or subject to the rules of

an electronic trading facility, so as to permit market participants to

effectively arbitrage between the markets by simultaneously maintaining

positions or executing trades in the contracts on a frequent and

recurring basis.

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

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

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

prices generated by agreements, contracts or transactions being traded

or executed on the electronic trading facility.

Material liquidity--the extent to which the volume of

agreements, contracts or transactions in a commodity being traded on

the electronic trading facility is sufficient to have a material effect

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

subject to the rules of a DCM, DTEF or electronic trading facility

operating in reliance on the exemption in section 2(h)(3).

Not all criteria must be present to support a determination that a

particular contract performs a significant price discovery function,

and one or more criteria may be inapplicable to a particular

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

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

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

rules governing ECMs with SPDCs, the Commission observed that these

criteria do not lend themselves to a mechanical checklist or formulaic

analysis. Accordingly, the Commission has indicated that in making its

determinations it will consider the circumstances under which the

presence of a particular criterion, or combination of criteria, would

be sufficient to support a SPDC determination.\14\ For example, for

contracts that are linked to other contracts or that may be arbitraged

with other contracts, the Commission will consider whether the price of

the potential SPDC moves in such harmony with the other contract that

the two markets essentially become interchangeable. This co-movement of

prices would be an indication that activity in the contract had reached

a level sufficient for the contract to perform a significant price

discovery function. In evaluating a contract's price discovery role as

a price reference, the Commission will consider whether cash market

participants are quoting bid or offer prices or entering into

transactions at prices that are set either explicitly or implicitly at

a differential to prices established for the contract.

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

Commission identified material price reference, price linkage and

material liquidity as the possible criteria for SPDC determination

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

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

associated Order.

\14\ 17 CFR part 36, appendix A.

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IV. Findings and Conclusions

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

The AEC contract is cash settled based on the difference between

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

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

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

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

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

futures contract for the same specified calendar month. The

transactions used to calculate the

[[Page 23699]]

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

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

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

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

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

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

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

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

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

primary cash market trading and distribution center for natural gas in

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

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

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

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

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

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

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

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

per day.

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

natural gas pipelines are connected. Hubs also serve as pricing

points for natural gas at the particular locations.

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

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

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

Alberta, Northwest Rockies, Southern California border and the Houston

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

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

shipping capacity, the price at the other locations usually directly

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

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

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

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

local price may be significantly different than the price at another

location even though the two markets' respective distances from the

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

a given location may experience supply and demand factors that are

specific to that region, such as differences in pipeline shipping

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

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

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

shipping and such price differences can vary in an unpredictable

manner.

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

feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.

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

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

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

major connection point for long-distance transmission systems that ship

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

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

of the nine Canadian market centers are located in the Alberta

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

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

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

billion cubic feet per day.\17\

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

feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.

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

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

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

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

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

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

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

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

discover prices at alternative locations and hedge price risk that is

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

position at a local price for an alternative location can be

established by adding the appropriate basis swap position to a position

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

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

the NYMEX contract's final settlement price).

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

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

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

negative value.

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

identified material price reference, price linkage and material

liquidity as the potential SPDC criteria applicable to the AEC

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

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

of arbitrage in connection with this contract; accordingly, that

criterion is not discussed in reference to the AEC contract.

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1. Material Price Reference Criterion.

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

identified material price reference as a potential basis for a SPDC

determination with respect to this contract. The Commission considered

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

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

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

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

price indices for this and other trading centers, market participants

indicate that the CGPR price index is highly regarded for this

particular location and should market participants wish to establish a

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

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

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

data to market participants in a number of different packages which

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

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

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

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

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

include price data for the AEC contract.

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

prices for natural gas contracts listed for all points in North

America.

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

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

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

competitively determined price as an indication of expected values of

natural gas at the Alberta hub when entering into cash market

transactions for natural gas, especially those trades providing for

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

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

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

discovery utility. The substantial volume of trading and open interest

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

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

[[Page 23700]]

factor influencing spot and forward transactions, natural gas traders

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

transactions.\21\

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

firms participating in the Alberta market may rely on other cash

market quotes as well as industry publications and price indices

that are published by third-party price reporting firms when

entering into natural gas transactions.

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

linkage criterion (discussed below) bolsters the argument for material

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

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

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

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

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

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

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

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

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

percent of the observations were more than 2.5 percent different than

the contemporaneous Henry Hub prices. Specifically, the average Alberta

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

mmBtu with a variance of $0.21 per mmBtu.

i. Federal Register Comments

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

meet the material price reference criterion for SPDC determination. ICE

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

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

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

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

certain market participants referred to ICE as a price discovery market

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

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

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

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

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

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

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

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

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

particular contract meets the material price reference criterion.

Second, ICE argued that the Commission should not base a

determination that the AEC contract is a SPDC merely because this

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

Alberta price index. While the Commission acknowledges that there are

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

participants indicate that the CGPR index is very highly regarded and

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

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

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

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

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

example, NYMEX previously listed a basis swap contract that was

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

with Enerdata forced NYMEX to delist its contract because NYMEX

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

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

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

source of price discovery for cash market traders with natural gas

at the Alberta hub.

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

satisfy the material price reference criterion. The commenters argued

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

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

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

they contend that the underlying cash price series is the authentic

reference price and not the ICE contract itself. The Commission

believes that this interpretation of price reference is too limiting in

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

cash settled after trading ceases. Instead, the Commission believes

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

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

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

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

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

price movements.

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

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

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

These traders look to a competitively determined price as an indication

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

cash market transaction for natural gas, especially those trades that

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

contract to hedge cash market positions and transactions, which

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

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

spot and forward transactions, natural gas traders consider the ICE

price to be a crucial factor in conducting OTC transactions.

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

package format is a weak justification for material price reference.

These commenters argue that market participants generally do not

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

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

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

not conclusive evidence that market participants are buying the ICE

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

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

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

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

Accordingly, the Commission believes that it is reasonable to conclude

that market participants are purchasing the data packages that include

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

prices have particular value to them.

ii. Conclusion Regarding Material Price Reference

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

meets the material price reference criterion because it is referenced

on a frequent and recurring basis by cash market participants when

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

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

2. Price Linkage Criterion

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

identified price linkage as a potential basis for a SPDC determination

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

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

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

the NYMEX is registered with the Commission as a DCM.

The Commission's Guidance on Significant Price Discovery Contracts

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

[[Page 23701]]

contract that relies on a contract traded on another trading facility

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

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

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

sufficient to support a determination that a contract performs a

significant price discovery function. To assess whether such a

determination is warranted, the Commission will examine the

relationship between transaction prices of the linked contract and the

prices of the referenced contract. The Commission believes that where

material liquidity exists, prices for the linked contract would be

observed to be substantially the same as or move substantially in

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

the Guidance proposes a threshold price relationship such that prices

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

for 95 percent of contemporaneously determined closing, settlement or

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

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

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

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

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

threshold'').

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\23\ Appendix A to the Part 36 rules.

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To assess whether the AEC contract meets the price linkage

criterion, Commission staff obtained price data from ICE and performed

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

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

NYMEX physically-delivered natural gas futures contract (a DCM

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

settlement price of the corresponding NYMEX Henry Hub natural gas

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

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

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

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

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

the volume threshold requirement. In particular, the total trading

volume in the NYMEX physically delivered natural gas contract during

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

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

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

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

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

than the minimum threshold.

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

Hub physically-delivered futures contract.

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

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

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

contracts even though the ECM contract may specifically use the

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

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

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

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

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

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

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

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

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

Henry Hub. These differences contribute to the divergence between the

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

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

i. Federal Register Comments

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

questioned the significance of this fact relative to the price linkage

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

Alberta location and not the NYMEX physically-delivered natural gas

futures price.

ii. Conclusion Regarding the Price Linkage Criterion

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

not meet the price linkage criterion because it fails the price

relationship and volume tests provided for in the Commission's

Guidance.

3. Material Liquidity Criterion

To assess whether the AEC contract meets the material liquidity

criterion, the Commission first examined volume and open interest data

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

and potential importance, and second performed a statistical analysis

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

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

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

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

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\25\ The acronym stands for Houston Ship Channel.

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

the effect that transactions in the potential SPDC may have on

trading in ``agreements, contracts and transactions listed for

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

a derivatives transaction execution facility, or an electronic

trading facility operating in reliance on the exemption in section

2(h)(3) of the Act.

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

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

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

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

second quarter 2009 trading statistics that ICE had submitted for its

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

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

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

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

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

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

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

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

trading platform, as well as trades executed off

[[Page 23702]]

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

clearing.\27\

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

a transaction executed on its trading platform versus that created

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

(October 9, 2009).

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

submitted another quarterly notification filed on November 13,

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

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

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

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

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

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

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

Reported open interest included positions resulting from trades that

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

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

clearing.

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

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

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

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

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

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

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

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

Chicago Board of Trade's soybean contract.

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

determination specifies that an ECM contract should have a material

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

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

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

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

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

the ICE Socal Border Financial Basis and HSC Financial Basis contracts

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

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

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

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

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\31\ Specifically, Commission staff econometrically estimated a

vector autoregression model using daily natural gas price levels. A

vector autoregression model is an econometric model used to capture

the dependencies and interrelationships among multiple time series,

generalizing the univariate autoregression model. The estimated

model displays strong diagnostic evidence of statistical adequacy.

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

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

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

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

the NYMEX Henry Hub price and the Southern California border gas

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

multipliers of response emerge with noticeable statistical strength

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

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

natural gas futures contract and the Sothern California gas price

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

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

9 percent.

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

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

AECO Financial Basis, HSC Financial Basis and Socal Border Financial

Basis contracts, respectively, to the contemporaneous daily

settlement prices of the NYMEX Henry Hub physically-delivered

natural gas futures contract.

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i. Federal Register Comments

As noted above, comments were received from eight individuals and

organizations, with five comments being directly applicable to the SPDC

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

generally agreed that the AEC contract does not meet the material

liquidity criterion.

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

materially affect other contracts that are listed for trading on DCMs

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

contract is influenced by the underlying Alberta cash price index and

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

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

have a material effect on NYMEX contract because the AEC contract

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

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

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

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

ECMs.

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\33\ CL 02.

\34\ CL 05.

\35\ CL 07.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

that is cited in the ICE comment.

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\36\ CL 03.

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

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ICE implied that the statistics provided by ICE were misinterpreted

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

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

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

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

determining liquidity is to examine the activity in a single traded

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

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

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

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

contract months should be considered separately rather than on an

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

material liquidity criterion.

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\38\ CL 04.

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

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

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

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

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

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

cited above in an appropriate manner for gauging material liquidity.

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

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

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

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

SPDC determination process. The Commission staff asked ICE to review

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

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

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

volume information it cites above, includes only transaction data

[[Page 23703]]

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

acknowledges that the open interest information it cites above includes

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

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

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

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

agreeable to the position holder regardless of how the position was

initially created.

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

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

that were conducted on the electronic platform; block trades

comprised 32.4 percent of all transactions in the AEC contract.

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ii. Conclusion Regarding Material Liquidity

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

meets the material liquidity criterion in that there is sufficient

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

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

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

electronic trading facility operating in reliance on the exemption in

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

4. Overall Conclusion

After considering the entire record in this matter, including the

comments received, the Commission has determined that the AEC contract

performs a significant price discovery function under two of the four

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

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

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

AEC contract does meet both the material liquidity and material price

reference criteria. Accordingly, the Commission will issue the attached

Order declaring that the AEC contract is a SPDC.

Issuance of this Order signals the immediate effectiveness of the

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

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

requirements--both procedural and substantive--and timetables

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

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

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IV. Related Matters

a. Paperwork Reduction Act

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

requirements on Federal agencies, including the Commission, in

connection with their conducting or sponsoring any collection of

information as defined by the PRA. Certain provisions of Commission

rule 36.3 impose new regulatory and reporting requirements on ECMs,

resulting in information collection requirements within the meaning of

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

3038-0060 to this collection of information.

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

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b. Cost-Benefit Analysis

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

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

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

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

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

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

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

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

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

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

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

interest considerations. The Commission may in its discretion give

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

discretion determine that, notwithstanding its costs, a particular

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

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

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

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

concluded that the Order, required by Congress to strengthen Federal

oversight of exempt commercial markets and to prevent market

manipulation, is necessary and appropriate to accomplish the purposes

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

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\42\ 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 or

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

any related futures contracts trading on DCMs. An Order finding that a

particular contract is a SPDC triggers this increased oversight and

imposes obligations on the ECM calculated to accomplish this goal. The

increased oversight engendered by the issue of a SPDC Order increases

transparency and helps to ensure fair competition among ECMs and DCMs

trading similar products and competing for the same business. Moreover,

the ECM on which the SPDC is traded must assume, with respect to that

contract, all the responsibilities and obligations of a registered

entity under the CEA and Commission regulations. Additionally, the ECM

must comply with nine core principles established by section 2(h)(7) of

the Act--including the obligation to establish position limits and/or

accountability standards for the SPDC. Section 4(i) of the CEA

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

These increased responsibilities, along with the CFTC's increased

regulatory authority, subject the ECM's risk management practices to

the Commission's supervision and oversight and generally enhance the

financial integrity of the markets.

c. Regulatory Flexibility Act

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

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

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

The Commission previously has determined that ECMs are not small

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

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

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

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

substantial number of small entities.

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

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

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V. Order

a. Order Relating to the ICE AECO Financial Basis Contract

After considering the complete record in this matter, including the

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

Commission has determined to issue the following:

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

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

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

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

established by new section

[[Page 23704]]

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

the statutory material liquidity and material price reference criteria

for significant price discovery contracts. Consistent with this

determination, and effective immediately, the IntercontinentalExchange,

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

to the AECO Financial Basis contract and is subject to all the

provisions of the Commodity Exchange Act applicable to registered

entities. Further, the obligations, requirements and timetables

prescribed in Commission rule 36.3(c)(4) governing core principle

compliance by the IntercontinentalExchange, Inc. commence with the

issuance of this Order.\46\

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

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

Henry Financial LD1 Fixed Price contract) that was previously

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

demonstration of compliance with the Core Principles within 30

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

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

David A. Stawick,

Secretary of the Commission.

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

BILLING CODE P

Last Updated: May 4, 2010