2010-10338

FR Doc 2010-10338[Federal Register: May 5, 2010 (Volume 75, Number 86)]

[Notices]

[Page 24606-24612]

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

[DOCID:fr05my10-54]

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COMMODITY FUTURES TRADING COMMISSION

Order Finding That the TCO Financial Basis Contract Traded on the

IntercontinentalExchange, Inc., Does Not Perform a Significant Price

Discovery Function

AGENCY: Commodity Futures Trading Commission.

ACTION: Final Order.

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

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

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

whether the TCO Financial Basis (``TCO'') 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 TCO 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 52200 (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

TCO contract performs a significant price discovery function and

requested comment from interested parties.\7\ Comments were

[[Page 24607]]

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

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

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

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

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

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

or not the TCO contract is a SPDC; IECA expressed the opinion that the

TCO contract did perform a significant price discovery function, and

thus, should be subject to the requirements of the core principles

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

reasons for saying so or directly address any of the criteria. The

remaining comment letters raised substantive issues with respect to the

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

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

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

liquidity criteria for SPDC determination. These comments are more

extensively discussed below, as applicable.

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

things, procedures by which the Commission makes and announces its

determination whether a specific ECM contract serves a significant

price discovery function. Under those procedures, the Commission

publishes a notice in the Federal Register that it intends to

undertake a determination whether a specified agreement, contract or

transaction performs a significant price discovery function and to

receive written data, views and arguments relevant to its

determination from the ECM and other interested persons.

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

manufacturing companies'' whose membership ``represents a diverse

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

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

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

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

domestic energy industry whose primary business activity is the

physical delivery of one or more energy commodities to customers,

including industrial, commercial and residential consumers'' and

whose membership consists of ``energy producers, marketers and

utilities.'' McGraw-Hill, through its division Platts, compiles and

calculates monthly natural gas price indices from natural gas trade

data submitted to Platts by energy marketers. Platts includes those

price indices in its monthly Inside FERC's Gas Market Report

(``Inside FERC''). ICE is an exempt commercial market, as noted

above. EI is an economic consulting firm with offices located in

Washington, DC, and San Francisco, CA. NGSA is an industry

association comprised of natural gas producers and marketers. FERC

is an independent federal regulatory agency that, among other

things, regulates the interstate transmission of natural gas, oil

and electricity. FIEG describes itself as an association of

investment and commercial banks who are active participants in

various sectors of the natural gas markets, ``including acting as

marketers, lenders, underwriters of debt and equity securities, and

proprietary investors.'' The comment letters are available on the

Commission's Web site: http://www.cftc.gov/lawandregulation/

federalregister/federalregistercomments/2009/09-024.html.

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

not contemplate the actual physical delivery of natural gas.

Accordingly, FERC expressed the opinion that a determination by the

Commission that a contract performs a significant price discovery

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

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

natural gas in interstate commerce for resale or with its other

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

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

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

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

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

consider the following criteria in determining a contract's significant

price discovery function:

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

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

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

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

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

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

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

settle a position, or close out a position.

Arbitrage--the extent to which the price for the

agreement, contract or transaction is sufficiently related to the price

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

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

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

effectively arbitrage between the markets by simultaneously maintaining

positions or executing trades in the contracts on a frequent and

recurring basis.

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

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

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

consulting, the prices generated by agreements, contracts or

transactions being traded or executed on the electronic trading

facility.

Material liquidity--the extent to which the volume of

agreements, contracts or transactions in a commodity being traded on

the electronic trading facility is sufficient to have a material effect

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

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

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

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

particular contract performs a significant price discovery function,

and one or more criteria may be inapplicable to a particular

contract.\10\ Moreover, the statutory language neither prioritizes the

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

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

rules governing ECMs with SPDCs, the Commission observed that these

criteria do not lend themselves to a mechanical checklist or formulaic

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

determinations it will consider the circumstances under which the

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

be sufficient to support a SPDC determination.\11\ For example, for

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

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

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

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

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

a level sufficient for the contract to perform a significant price

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

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

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

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

established for the contract.

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\10\ In its October 9, 2009, Federal Register release, the

Commission identified material price reference, price linkage and

material liquidity as the possible criteria for SPDC determination

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

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

this document and the associated Order.

\11\ 17 CFR part 36, Appendix A.

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IV. Findings and Conclusions

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

The ICE TCO contract is cash settled based on the difference

between the bidweek price of natural gas at the Columbia Gas

Transmission, LLC's, Appalachia hub for the contract-specified month of

delivery, as published in Platts' Inside FERC's Gas Market Report, and

the final settlement price of the New York Mercantile Exchange's

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

contract for the same calendar month. The Platts bidweek price, which

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

voluntarily report to Platts data on their fixed-price transactions

conducted during the last five business days of the month for physical

delivery of natural gas at the

[[Page 24608]]

Appalachia hub; such bidweek transactions specify the delivery of

natural gas on a uniform basis throughout the following calendar month

at the agreed upon rate. The Platts bidweek index is published on the

first business day of the calendar month in which the natural gas is to

be delivered. The size of the TCO contract is 2,500 million British

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

2,500 mmBtu. The TCO contract is listed for up to 72 consecutive

calendar months.

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

primary cash market trading and distribution center for natural gas in

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

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

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

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

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

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

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

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

per day.

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\12\ The term ``hub'' refers to a juncture where two or more

natural gas pipelines are connected. Hubs also serve as pricing

points for natural gas at the particular locations.

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

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

centers in North America.\13\ Some of the major trading centers include

Alberta, Northwest Rockies, Southern California border and the Houston

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

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

shipping capacity, the price at the other locations usually directly

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

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

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

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

local price may be significantly different than the price at another

location even though the two markets' respective distances from the

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

a given location may experience supply and demand factors that are

specific to that region, such as differences in pipeline shipping

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

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

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

shipping and such price differences can vary in an unpredictable

manner.

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

feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.

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The market area for Columbia Gas Transmission, LLC's, Appalachia

hub comprises Eastern Kentucky, West Virginia, Eastern Ohio,

Pennsylvania, Northern Virginia and Western New York. Natural gas

deliveries into the Columbia Gas Appalachia hub begin downstream of the

Leach, Kentucky, interconnection with the Columbia Gulf Transmission

interstate pipeline. Columbia Gas Transmission, LLC, operates supply

pool and storage facilities in the Northern Appalachia region. The

Dominion hub, a market center that includes the TCO hub, had an

estimated throughput capacity of 2.5 billion cubic feet per day in

2008. Moreover, the number of pipeline interconnections at the Dominion

hub was 17 in 2008, up from 16 in 2003. Lastly, the pipeline

interconnection capacity of the Dominion hub in 2008 was 8.3 billion

cubic feet per day, which constituted a 42 percent increase over the

pipeline interconnection capacity in 2003.\14\ The TCO hub is far

removed from the Henry Hub but is directly connected to the Henry Hub

by the Columbia Gas Transmission interstate pipeline.

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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 local price at the TCO location 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 TCO price.

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

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 \15\ 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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\15\ 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 TCO

contract. Each of these criteria is discussed below.\16\

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\16\ As noted above, the Commission did not find an indication

of arbitrage in connection with this contract; accordingly, that

criterion was not discussed in reference to the TCO contract.

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1. Material Price Reference Criterion

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

identified material price reference as a potential basis for a SPDC

determination with respect to this contract. The Commission considered

the fact that ICE sells its price data to market participants in a

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

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

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

Day'' \17\ 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 TCO

contract.

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\17\ The OTC Gas End of Day dataset includes daily settlement

prices for natural gas contracts listed for all points in North

America.

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The Commission also noted that its October 2007 Report on the

Oversight of Trading on Regulated Futures Exchanges and Exempt

Commercial Markets (``ECM Study'') \18\ found that in general, market

participants view the ICE as a price discovery market for certain

natural gas contracts. The study did not specify which markets

performed this function; nevertheless, the Commission determined that

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

warrant further study.

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\18\ http://www.cftc.gov/idc/groups/public/@newsroom/documents/

file/pr5403-07_ecmreport.pdf

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

or indirect--to determine that the price of a contract 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.

[[Page 24609]]

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 Columbia Gas Transmission, LLC's, Appalachia

hub is a significant trading center for natural gas but is not as

important as other hubs, such as the Henry Hub, for pricing natural gas

in the eastern half of the U.S. marketplace.

Although the Appalachia hub is a major trading center for natural

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

the TCO 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 TCO 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. In this regard, the NYMEX Henry Hub physically

delivered natural gas futures contract is routinely consulted by

industry participants in pricing cash market transactions at this

location. Because both the Appalachia hub is directly connected to the

Henry Hub via the Gas Transmission interstate pipeline, it is not

necessary for market participants to independently refer to the TCO

contract for pricing natural gas at this location. Thus, the TCO

contract does not satisfy the direct price reference test for existence

of material price reference. Furthermore, the Commission notes that

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

material price reference. The TCO 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 Appalachia hub, the

Commission has concluded that traders likely do not specifically

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

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

market transactions.

i. Federal Register Comments

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

question of whether the TCO contract met the material price reference

criterion for a SPDC.\20\ The commenters argued that because the TCO

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 TCO contract is settled (in this case, the Platts 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 Appalachia hub is a significant trading

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

consider the Appalachia hub to be as important as other natural gas

trading points, such as the Henry Hub.

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\20\ As noted above, IECA expressed the opinion that the TCO

contract met the criteria for SPDC determination but did not provide

its reasoning.

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ICE \21\ also argued that the Commission appeared to base the case

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

In issuing its notice of intent to determine whether the TCO 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.

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\21\ CL 04.

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Both EI \22\ and WGCEF \23\ 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 TCO contract. Instead, traders are interested in the settlement

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

package is not conclusive evidence that market participants are buying

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

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

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

routine dissemination. The TCO 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 Appalachia hub, the

Commission has concluded that traders likely do not specifically

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

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

market transactions.

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\22\ CL 05.

\23\ CL 02.

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ii. Conclusion Regarding Material Price Reference

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

not meet the material price reference criterion because cash market

transactions are not priced either explicitly or implicitly on a

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

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

contract's price data to market participants, market participants

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

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

recurring basis in pricing cash market transactions (indirect

evidence).

[[Page 24610]]

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 TCO contract. In this regard, the final settlement

of the TCO 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

\24\ 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 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, in Guidance the Commission stated that it

would consider a linked contract that has a trading volume equivalent

to 5 percent of the volume of trading in the contract to which it is

linked to have sufficient volume to be deemed a SPDC (``minimum

threshold'').

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\24\ Appendix A to the Part 36 rules.

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To assess whether the TCO 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 TCO

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

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

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

Henry Hub Natural Gas price to the ICE TCO basis price) is not within

2.5 percent of the settlement price of the corresponding NYMEX Henry

Hub natural gas futures contract on 95 percent or more of the days.

Specifically, during the third quarter of 2009, only 13.3 percent of

the TCO 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 TCO contract fails

to meet the volume threshold requirement. In particular, the total

trading volume in the NYMEX Natural Gas contract during the third

quarter of 2009 was 14,022,963 contracts, with 5 percent of that number

being 701,148 contracts. Trades on the ICE centralized market in the

TCO contract during the same period was 60,106 contracts (equivalent to

15,026 NYMEX contracts, given the size difference).\25\ Thus,

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

minimum threshold.\26\

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\25\ The size of the NYMEX Henry Hub physically-delivered

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

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

NYMEX Henry Hub contract.

\26\ Supplemental data subsequently submitted by the ICE

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

block trades comprise 61.1 percent of all transactions in the TCO

contract.

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i. Federal Register Comments

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

question of whether the TCO contract met the price linkage criterion

for a SPDC.\27\ Each of the commenters expressed the opinion that the

TCO 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 TCO is linked.

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

assessment.

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\27\ As noted above, IECA expressed the opinion that the TCO

contract met the criteria for SPDC determination but did not provide

its reasoning.

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ii. Conclusion Regarding the Price Linkage Criterion

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

not meet the price linkage criterion because it fails the price

relationship and volume tests provided for in the Commission's

Guidance.

3. Material Liquidity Criterion

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

the Commission identified material price reference, price linkage and

material liquidity as potential criteria for SPDC determination of the

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

criterion, the Commission first examines trading activity as a general

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

Commission finds that the contract in question meets a threshold of

trading activity that would render it of potential importance, the

Commission will then perform a statistical analysis to measure the

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

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

The total number of transactions executed on ICE's electronic

platform in the TCO contract was 583 in the second quarter of 2009,

resulting in a daily average of 9.1 trades. During the same period, the

TCO contract had a total trading volume of 61,944 contracts and an

average daily trading volume of 968 contracts. Moreover, open interest

as of June 30, 2009, was 141,544 contracts, which included trades

executed on ICE's electronic trading platform, as well as trades

executed off of ICE's electronic trading platform and then brought to

ICE for clearing. In this regard, ICE does not differentiate between

open interest created by a transaction executed on its trading platform

and that created by a transaction executed off its trading

platform.\28\

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\28\ 74 FR 52200 (October 9, 2009).

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

total trading volume in the third quarter of 2009 was 60,106 contracts

(or 911 contracts on a daily basis). In term of number of transactions,

411 trades occurred in the third quarter of 2009 (6.2 trades per day).

As of September 30, 2009, open interest in the TCO contract was 154,006

contracts, which included trades executed on ICE's electronic trading

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

platform and then brought to ICE for clearing.

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

second and third quarters of 2009 was only slightly above the minimum

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

TCO contract, as characterized by total quarterly volume, indicates

that the TCO contract experiences trading activity similar to that of

other thinly-traded contracts.\29\ Thus, the TCO contract does not meet

a threshold of trading activity that

[[Page 24611]]

would render it of potential importance and no additional statistical

analysis is warranted.\30\

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\29\ 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.

\30\ 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 TCO 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 TCO contract met the material liquidity

criterion for a SPDC.\31\ These commenters stated that the TCO contract

does not meet the material liquidity criterion for SPDC determination

for a number of reasons.

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\31\ As noted above, IECA expressed the opinion that the TCO

contract met the criteria for SPDC determination but did not provide

its reasoning.

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WGCEF,\32\ ICE \33\ and EI \34\ noted that the Commission's

Guidance had posited concepts of liquidity that generally assumed a

fairly constant stream of prices throughout the trading day, and noted

that the relatively low number of trades per day in the TCO 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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\32\ CL 02.

\33\ CL 04.

\34\ CL 05.

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WGCEF, FIEG \35\ and NGSA \36\ noted that the TCO 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 TCO contract's trading volume represents

only a fraction of natural gas trading.

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\35\ CL 08.

\36\ 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'' \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 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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\37\ 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.'' \38\ 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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\38\ 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 60

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

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

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

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

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 TCO 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 has found that the

TCO contract does not meet the material liquidity criterion.

4. Overall Conclusion

After considering the entire record in this matter, including the

comments received, the Commission has determined that the TCO 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 TCO contract

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

liquidity criteria at this time. Accordingly, the Commission will issue

the attached Order declaring that the TCO 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 TCO

contract.\39\ Accordingly, with respect to its TCO 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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\39\ 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'') \40\ 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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\40\ 44 U.S.C. 3507(d).

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b. Cost-Benefit Analysis

Section 15(a) of the CEA \41\ requires the Commission to consider

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

Act. By its terms,

[[Page 24612]]

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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\41\ 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. Amendments to section 4(i) of

the CEA authorize the Commission to require reports for SPDCs listed on

ECMs. These increased responsibilities, along with the CFTC's increased

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

the Commission's supervision and oversight and generally enhance the

financial integrity of the markets.

The Commission has concluded that ICE's TCO 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'') \42\ requires that

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

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

commercial markets. The Commission previously has determined that

exempt commercial markets are not small entities for purposes of the

RFA.\43\ 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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\42\ 5 U.S.C. 601 et seq.

\43\ 66 FR 42256, 42268 (Aug. 10, 2001).

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V. Order

a. Order Relating to the TCO 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 TCO Financial Basis contract,

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

satisfy the material price reference, price linkage, and material

liquidity criteria for significant price discovery contracts.

Consistent with this determination, the IntercontinentalExchange, Inc.,

is not considered a registered entity \44\ with respect to the TCO

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 TCO Financial

Basis contract with the issuance of this Order.

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\44\ 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 TCO Financial Swing 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. 2010-10338 Filed 5-4-10; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: May 5, 2010