2010-10306

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

[Notices]

[Page 23679-23686]

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

[DOCID:fr04my10-59]

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COMMODITY FUTURES TRADING COMMISSION

Order Finding That the ICE Malin Financial Basis Contract Traded

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

Price Discovery Function

AGENCY: Commodity Futures Trading Commission.

ACTION: Final orders.

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

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

[[Page 23680]]

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

whether the Malin Financial Basis (``MLN'') contract, traded on the

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

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

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

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

undertook this review based upon an initial evaluation of information

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

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

comments received, and has determined to issue orders finding that the

MLN contract does not perform a significant price discovery function.

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

Commission rule 36.3(c) promulgated thereunder.

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\1\ 74 FR 52192 (October 9, 2009).

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DATES: Effective date: April 28, 2010.

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

Division of Market Oversight, Commodity Futures Trading Commission,

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

Telephone: (202) 418-5515. E-mail: [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

price of another contract.

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

April 22, 2009.

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

Commission makes and announces its determination whether a particular

ECM contract serves a significant price discovery function. Under those

procedures, the Commission will publish notice in the Federal Register

that it intends to undertake an evaluation whether the specified

agreement, contract or transaction performs a significant price

discovery function and to receive written views, data and arguments

relevant to its determination from the ECM and other interested

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

consider, among other things, all relevant information regarding the

subject contract and issue an order announcing and explaining its

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

affirmative order signals the effectiveness of the Commission's

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

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

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

obligations, requirements and timetables prescribed in Commission rule

36.3(c)(4).\6\

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

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

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

75894 (Dec. 12, 2008).

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

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

written demonstration of compliance with the applicable core

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

calendar days to demonstrate core principle compliance.

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II. Notice of Intent To Undertake SPDC Determination

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

Register notice of its intent to undertake a determination whether the

MLN contract performs a significant price discovery function and

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

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

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

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

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

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

\9\ did not directly

[[Page 23681]]

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

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

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

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

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

does not meet the material liquidity, material price reference and

price linkage criteria for SPDC determination. Those comments are more

extensively discussed below, as applicable.

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

things, procedures by which the Commission makes and announces its

determination whether a specific ECM contract serves a significant

price discovery function. Under those procedures, the Commission

publishes a notice in the Federal Register that it intends to

undertake a determination whether a specified agreement, contract or

transaction performs a significant price discovery function and to

receive written data, views and arguments relevant to its

determination from the ECM and other interested persons.

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

manufacturing companies'' whose membership ``represents a diverse

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

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

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

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

domestic energy industry whose primary business activity is the

physical delivery of one or more energy commodities to customers,

including industrial, commercial and residential consumers'' and

whose membership consists of ``energy producers, marketers and

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

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

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

gas producers and marketers. FERC is an independent federal

regulatory agency that, among other things, regulates the interstate

transmission of natural gas, oil and electricity. FIEG describes

itself as an association of investment and commercial banks who are

active participants in various sectors of the natural gas markets,

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

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

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

lawandregulation/federalregister/federalregistercomments/2009/09-

020.html.

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

not contemplate actual physical delivery of natural gas.

Accordingly, FERC expressed the opinion that a determination by the

Commission that a contract performs a significant price discovery

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

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

natural gas in interstate commerce for resale or with its other

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

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

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

06.

\10\ IECA stated that the subject ICE contract should ``be

required to come into compliance with core principles mandated by

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

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

to the Commission's position limit authority, emergency authority

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

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

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

consider the following criteria in determining a contract's significant

price discovery function:

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

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

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

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

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

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

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

settle a position, or close out a position.

Arbitrage--the extent to which the price for the

agreement, contract or transaction is sufficiently related to the price

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

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

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

effectively arbitrage between the markets by simultaneously maintaining

positions or executing trades in the contracts on a frequent and

recurring basis.

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

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

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

consulting, the prices generated by agreements, contracts or

transactions being traded or executed on the electronic trading

facility.

Material liquidity--the extent to which the volume of

agreements, contracts or transactions in a commodity being traded on

the electronic trading facility is sufficient to have a material effect

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

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

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

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

particular contract performs a significant price discovery function,

and one or more criteria may be inapplicable to a particular

contract.\11\ Moreover, the statutory language neither prioritizes the

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

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

rules governing ECMs with SPDCs, the Commission observed that these

criteria do not lend themselves to a mechanical checklist or formulaic

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

determinations it will consider the circumstances under which the

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

be sufficient to support a SPDC determination.\12\ For example, for

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

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

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

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

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

a level sufficient for the contract to perform a significant price

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

a price reference, the Commission will consider the extent to which, on

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

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

established for the contract.

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\11\ In its October 9, 2009, Federal Register release, the

Commission identified material price reference, price linkage and

material liquidity as the possible criteria for SPDC determination

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

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

this document and the associated Order.

\12\ 17 CFR 36, Appendix A.

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IV. Findings and Conclusions

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

The ICE MLN contract is cash settled based on the difference

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

contract-specified month of delivery, as published in Intelligence

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

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

Hub physically-delivered natural gas futures contract for the same

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

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

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

delivery of natural gas at the Malin hub conducted during the last five

business days of the month; such bidweek transactions specify the

delivery of natural gas on a uniform basis throughout the following

calendar month at the agreed upon rate. The IPI bidweek index is

published on the first business day of the calendar month in which the

natural gas is to be delivered. The size of the MLN contract is 2,500

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

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

calendar months commencing with the next calendar month.

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

primary cash market trading and distribution center for natural gas in

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

the NYMEX's actively traded Henry Hub physically-delivered natural gas

futures contract, which is the most important pricing reference for

natural gas in the United States. The Henry Hub, which is operated by

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

These pipelines bring in natural gas from fields in the Gulf Coast

region and move it to major consumption centers along the East Coast

and Midwest. The throughput shipping capacity of the Henry Hub is 1.8

trillion mmBtu per day.

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\13\ The term ``hub'' refers to a juncture where two or more

natural gas pipelines are connected. Hubs also serve as pricing

points for natural gas.

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

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

centers in North America.\14\ Some of the major trading centers include

Alberta, Northwest Rockies, Southern California border and

[[Page 23682]]

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

the Henry Hub by one or more pipelines and where there typically is

adequate shipping capacity, the price at the other locations usually

directly tracks the price at the Henry Hub, adjusted for transportation

costs. However, at other locations that are not directly connected to

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

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

one local price may be significantly different than the price at

another location even though the two markets' respective distances from

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

that a given location may experience supply and demand factors that are

specific to that region, such as differences in pipeline shipping

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

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

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

shipping and such price differences can vary in an unpredictable

manner.

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

feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.

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

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

connects with the Gas Transmission Northwest interstate pipeline, which

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

Oregon. A connection with the California Gas Transmission Company also

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

an important trading center for natural gas.

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

located in Northern California. The Golden Gate Market Center offers

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

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

Topock. The Golden Gate Market Center had an estimated throughput

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

number of pipeline interconnections at the Golden Gate Market Center

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

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

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

over the pipeline interconnection capacity in 2003.\15\ The Malin hub

is far removed from the Henry Hub and is not directly connected to the

Henry Hub by an existing pipeline.

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\15\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/

feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.

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

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

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

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

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

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

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

participants. Basis contracts \16\ allow traders to more accurately

discover prices at alternative locations and hedge price risk that is

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

position at a local price for an alternative location can be

established by adding the appropriate basis swap position to a position

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

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

the NYMEX physically-delivered natural gas contract's final settlement

price).

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\16\ Basis contracts denote the difference in the price of

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

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

negative value.

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

identified material price reference, price linkage and material

liquidity as the potential SPDC criteria applicable to the MLN

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

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\17\ As noted above, the Commission did not find an indication

of arbitrage in connection with this contract; accordingly, that

criterion is not discussed in reference to the MLN contract.

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1. Material Price Reference Criterion

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

identified material price reference as a potential basis for a SPDC

determination with respect to this contract. The Commission considered

the fact that ICE maintains exclusive rights over IPI's bidweek price

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

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

providers produce natural gas price indices for this and other trading

centers, market participants indicate that the IPI Malin bidweek index

is highly regarded for this particular location and should market

participants wish to establish a hedged position based on this index,

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

ICE has the right to the IPI index for cash settlement purposes. In

addition, ICE sells its price data to market participants in a number

of different packages which vary in terms of the hubs covered, time

periods, and whether the data are daily only or historical. For

example, ICE offers the ``West Gas End of Day'' and ``OTC Gas End of

Day'' \18\ packages with access to all price data or just current

prices plus a selected number of months (i.e., 12, 24, 36 or 48 months)

of historical data. These two packages include price data for the MLN

contract.

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\18\ The OTC Gas End of Day dataset includes daily settlement

prices for natural gas contracts listed for all points in North

America.

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The Commission will rely on one of two sources of evidence--direct

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

as a material price reference and therefore, serving a significant

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

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

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

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

ECM in question. Direct evidence may be established when cash market

participants are quoting bid or offer prices or entering into

transactions at prices that are set either explicitly or implicitly at

a differential to prices established for the contract in question. Cash

market prices are set explicitly at a differential to the section

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

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

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

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

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

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

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

being routinely disseminated in widely distributed industry

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

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

industry participants in pricing cash market transactions.

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\19\ 17 CFR part 36, Appendix A.

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Following the issuance of the Federal Register release, the

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

industry participants. The Malin hub is a significant trading center

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

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

marketplace.

[[Page 23683]]

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

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

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

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

differential to the MLN contract nor is that contract routinely

consulted by industry participants in pricing cash market transactions

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

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

price reference test for existence of material price reference.

Furthermore, the Commission notes that publication of the MLN

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

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

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

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

traders likely do not specifically purchase the ICE data packages for

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

and recurring basis in pricing cash market transactions.

i. Federal Register Comments

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

addressed the question of whether the MLN contract met the material

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

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

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

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

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

IPI bidweek price for natural gas at this location) is the authentic

reference price and not the ICE contract itself. The Commission

believes that this interpretation of price reference is too limiting in

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

cash settled after trading ceases. Instead, the Commission believes

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

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

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

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

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

price movements. As noted above, the Malin hub is a significant trading

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

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

points, particularly the nearby PG&E Citygate.

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\20\ CL 02.

\21\ CL 04.

\22\ CL 05.

\23\ CL 06.

\24\ CL 08.

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

contract met the criteria for SPDC determination but did not provide

its reasoning.

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

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

in issuing its notice of intent to determine whether the MLN contract

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

certain market participants referred to ICE as a price discovery market

for certain natural gas contracts.'' \26\ ICE states that CFTC's reason

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

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

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

\27\ In response to the above comment, the Commission notes that it

cited the ECM study's general finding that some ICE natural gas

contracts appear to be regarded as price discovery markets merely as an

indicia that an investigation of certain ICE contracts may be

warranted, and was not intended to serve as the sole basis for

determining whether or not a particular contract meets the material

price reference criterion.

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\26\ CL 03.

\27\ CL 03.

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Second, ICE argued that the Commission should not base a

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

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

Malin Index price. While the Commission acknowledges that there are

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

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

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

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

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

prices on a frequent and recurring basis in pricing cash market

transactions.

Both EI \28\ and WGCEF \29\ stated that publication of price data

in a package format is a weak justification for material price

reference. These commenters argue that market participants generally do

not purchase ICE data sets for one contract's prices, such as those for

the MLN contract. Instead, traders are interested in the settlement

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

package is not conclusive evidence that market participants are buying

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

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

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

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

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

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

Commission has concluded that traders likely do not specifically

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

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

market transactions.

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\28\ CL 05.

\29\ CL 02.

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ii. Conclusion Regarding Material Price Reference

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

not meet the material price reference criterion because cash market

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

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

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

participants, market participants likely do not specifically purchase

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

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

transactions (indirect evidence).

2. Price Linkage Criterion

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

identified price linkage as a potential basis for a SPDC determination

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

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

the NYMEX's Henry Hub physically-delivered natural gas futures

contract, where the NYMEX is registered with the Commission as a DCM.

The Commission's Guidance on Significant Price Discovery Contracts

\30\ notes that a ``price-linked contract is a contract that relies on

a contract traded on another trading facility to settle, value or

otherwise offset the price-linked contract.'' Furthermore, the Guidance

notes that ``[f]or a linked contract, the mere fact that a contract is

linked to another contract will not be sufficient to support a

determination

[[Page 23684]]

that a contract performs a significant price discovery function. To

assess whether such a determination is warranted, the Commission will

examine the relationship between transaction prices of the linked

contract and the prices of the referenced contract. The Commission

believes that where material liquidity exists, prices for the linked

contract would be observed to be substantially the same as, or move

substantially in conjunction with, the prices of the referenced

contract.'' The Guidance proposes a threshold price relationship such

that prices of the ECM linked contract will fall within a 2.5 percent

price range for 95 percent of contemporaneously determined closing,

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

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

linked contract that has a trading volume equivalent to 5 percent of

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

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

threshold'').

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\30\ Appendix A to the Part 36 rules.

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To assess whether the MLN contract meets the Price Linkage

criterion, Commission staff obtained price data from ICE and performed

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

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

NYMEX physically-delivered natural gas futures contract (a DCM

contract), the Malin price is not within 2.5 percent of the settlement

price of the corresponding NYMEX Henry Hub natural gas futures contract

on 95 percent or more of the days. Specifically, during the third

quarter of 2009, 10 percent of the Malin hub natural gas prices derived

from the ICE basis values were within 2.5 percent of the daily

settlement price of the NYMEX Henry Hub futures contract. In addition,

staff finds that the MLN contract fails to meet the volume threshold

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

Natural Gas contract during the third quarter of 2009 was 14,022,963

contracts, with 5 percent of that number being 701,148 contracts. The

number of trades on the ICE centralized market in the MLN contract

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

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

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

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

Hub physically-delivered futures contract.

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i. Federal Register Comments

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

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

the commenters expressed the opinion that the MLN contract did not

appear to meet the above-discussed Commission guidance regarding the

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

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

discussed above, the Commission agrees with this assessment.

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

contract met the criteria for SPDC determination but did not provide

its reasoning.

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ii. Conclusion Regarding the Price Linkage Criterion

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

linkage criterion because it fails the volume and price linkage tests

provided for in the Commission's Guidance.

3. Material Liquidity Factor

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

the Commission identified material price reference, price linkage and

material liquidity as potential criteria for SPDC determination of the

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

criterion, the Commission first examines trading activity as a general

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

Commission finds that the contract in question meets a threshold of

trading activity that would render it of potential importance, the

Commission will then perform a statistical analysis to measure the

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

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

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

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

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

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

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

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

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

which includes trades executed on ICE's electronic trading platform, as

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

then brought to ICE for clearing.

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

686 separate trades occurred on its electronic platform in the third

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

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

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

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

contract was 57,332 contracts. Reported open interest included

positions resulting from trades that were executed on ICE's electronic

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

platform and brought to ICE for clearing.

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

and third quarters of 2009 was only slightly above the minimum

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

MLN contract, as characterized by total quarterly volume, indicates

that the MLN contract experiences trading activity similar to that of

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

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

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

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

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

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

third quarter of 2009, physical commodity futures contracts with

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

one percent of total trading volume of all physical commodity

futures contracts.

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

the various criteria, or combinations of criteria, when determining

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

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

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

other factors it can serve as a guidepost indicating which contracts

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

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

price linkage or material price reference criterion. In light of

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

need to evaluate further the material liquidity criteria since it

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

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i. Federal Register Comments

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

question of whether the MLN contract met the material liquidity

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

does not meet the material liquidity criterion for SPDC determination

for a number of reasons.

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

contract met the criteria for SPDC determination but did not provide

its reasoning.

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

Guidance had posited

[[Page 23685]]

concepts of liquidity that generally assumed a fairly constant stream

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

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

of liquidity. The Commission observes that a continuous stream of

prices would indeed be an indication of liquidity for certain markets

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

and price concession that would define material liquidity may differ

from one market or commodity to another.''

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\36\ CL 02.

\37\ CL 04.

\38\ CL 05.

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

represents a differential, which does not affect other contracts,

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

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

only a fraction of natural gas trading.

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\39\ CL 08.

\40\ CL 06.

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

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

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

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

trade data to the CFTC.'' Furthermore, FIEG cautioned the Commission in

using a reporting threshold as a measure of liquidity. In this regard,

the Commission adopted a five trades-per-day threshold as a reporting

requirement to enable it to ``independently be aware of ECM contracts

that may develop into SPDCs'' \41\ rather than solely relying upon an

ECM on its own to identify any such potential SPDCs to the Commission.

Thus, any contract that meets this threshold may be subject to scrutiny

as a potential SPDC but this does not mean that the contract will be

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

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

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ICE and EI proposed that the statistics provided by ICE were

misinterpreted and misapplied by the Commission. In particular, ICE

stated that the volume figures used in the Commission's analysis (cited

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

as in strips of contract months, and a ``more appropriate method of

determining liquidity is to examine the activity in a single traded

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

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

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

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

be less than 1 per day.''

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

statistics that it provided to the Commission in its quarterly

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

Federal Register notice includes 2(h)(1) transactions, which were

not completed on the electronic trading platform and should not be

considered in the SPDC determination process. The Commission staff

asked ICE to review the data it sent in its quarterly filings; ICE

confirmed that the volume data it provided and which the Commission

cited includes only transaction data executed on ICE's electronic

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

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

conducted on the electronic platform; block trades comprise about 55

percent of all transactions in the MLN contract. The Commission

acknowledges that the open interest information it provided in its

October 9, 2009, Federal Register notice includes transactions made

off the ICE platform. However, once open interest is created, there

is no way for ICE to differentiate between ``on-exchange'' versus

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

fungible with one another and may be offset in any way agreeable to

the position holder regardless of how the position was initially

created.

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

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

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

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

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

contract does not meet the material price reference or price linkage

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

unnecessary to evaluate whether the MLN contract meets the material

liquidity criterion since it cannot be used alone for SPDC

determination.

ii. Conclusion Regarding Material Liquidity

For the reasons discussed above, the Commission does not find

evidence that the MLN contract meets the material liquidity criterion.

4. Overall Conclusion Regarding the MLN Contract

After considering the entire record in this matter, including the

comments received, the Commission has determined that the MLN contract

does not perform a significant price discovery function under the

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

Commission has determined that the MLN contract does not meet the

material price reference, price linkage and material liquidity criteria

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

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

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

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

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

the obligations, requirements and timetables prescribed in Commission

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

comply with the applicable reporting requirements.

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

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V. Related Matters

a. Paperwork Reduction Act

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

requirements on Federal agencies, including the Commission, in

connection with their conducting or sponsoring any collection of

information as defined by the PRA. Certain provisions of Commission

rule 36.3 impose new regulatory and reporting requirements on ECMs,

resulting in information collection requirements within the meaning of

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

3038-0060 to this collection of information.

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

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b. Cost-Benefit Analysis

Section 15(a) of the CEA \45\ requires the Commission to consider

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

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

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

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

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

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

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

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

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

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

interest considerations. The Commission may in its discretion give

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

discretion determine that, notwithstanding its costs, a particular

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

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

the Act.

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\45\ 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

[[Page 23686]]

market integrity, both on the ECM itself and in any related futures

contracts trading on DCMs. An Order finding that a particular contract

is a SPDC triggers this increased oversight and imposes obligations on

the ECM calculated to accomplish this goal. The increased oversight

engendered by the issue of a SPDC Order increases transparency and

helps to ensure fair competition among ECMs and DCMs trading similar

products and competing for the same business. Moreover, the ECM on

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

all the responsibilities and obligations of a registered entity under

the CEA and Commission regulations. Additionally, the ECM must comply

with nine core principles established by section 2(h)(7) of the Act--

including the obligation to establish position limits and/or

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

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

These increased responsibilities, along with the CFTC's increased

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

the Commission's supervision and oversight and generally enhance the

financial integrity of the markets.

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

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

Commission's Order imposes no additional costs and no additional

statutorily or regulatory mandated responsibilities on the ECM.

c. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA'') \46\ requires that

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

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

The Commission previously has determined that ECMs are not small

entities for purposes of the RFA.\47\ Accordingly, the Chairman, on

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

that these Orders, taken in connection with section 2(h)(7) of the Act

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

substantial number of small entities.

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

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

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VI. Order

a. Order Relating to the Malin Financial Basis Contract

After considering the complete record in this matter, including the

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

Commission has determined to issue the following Order:

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

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

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

satisfy the material price reference, price linkage or material

liquidity criteria for significant price discovery contracts.

Consistent with this determination, the IntercontinentalExchange, Inc.,

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

Financial Basis contract and is not subject to the provisions of the

Commodity Exchange Act applicable to registered entities. Further, the

obligations, requirements and timetables prescribed in Commission rule

36.3(c)(4) governing core principle compliance by the

IntercontinentalExchange, Inc., are not applicable to the Malin

Financial Basis contract with the issuance of this Order.

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

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This Order is based on the representations made to the Commission

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

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

or omissions in the facts and circumstances pursuant to which this

order is granted might require the Commission to reconsider its current

determination that the Malin Financial Basis contract is not a

significant price discovery contract. Additionally, to the extent that

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

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

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

Regulation 36.3.

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

David A. Stawick,

Secretary of the Commission.

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

BILLING CODE P

Last Updated: May 4, 2010