2010-16206

FR Doc 2010-16206[Federal Register: July 2, 2010 (Volume 75, Number 127)]

[Notices]

[Page 38478-38487]

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

[DOCID:fr02jy10-43]

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COMMODITY FUTURES TRADING COMMISSION

Orders Finding That the Mid-C Financial Peak Daily Contract and

Mid-C Financial Off-Peak Daily Contract, Offered for Trading on the

IntercontinentalExchange, Inc., Do Not Perform a Significant Price

Discovery Function

AGENCY: Commodity Futures Trading Commission.

ACTION: Final orders.

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SUMMARY: On October 6, 2009, the Commodity Futures Trading Commission

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

whether the Mid-C \2\ Financial Peak Daily (``MPD'') contract and Mid-C

Financial Off-Peak Daily (``MXO'') contract,\3\ which are listed for

trading 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''), perform 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 MPD and MXO contracts do 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 51261 (October 6, 2009).

\2\ The acronym ``Mid-C'' stands for Mid-Columbia.

\3\ The Federal Register notice also requested comment on the

Mid-C Financial Peak (``MDC'') contract and Mid-C Financial Off-Peak

(``OMC'') contract; these contracts will be addressed in a separate

Federal Register release.

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DATES: Effective Date: June 25, 2010.

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

Division of Market Oversight, Commodity Futures Trading

[[Page 38479]]

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'') \4\

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.\5\ 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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\4\ Incorporated as Title XIII of the Food, Conservation and

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

2008).

\5\ 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.\6\ 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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\6\ 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.\7\ The issuance of such an order also triggers the

obligations, requirements and timetables prescribed in Commission rule

36.3(c)(4).\8\

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\7\ 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).

\8\ 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 6, 2009, the Commission published in the Federal

MPD and MXO contracts \9\ perform a significant price discovery

function and requested comment from interested parties.\10\ Comments

were received from the Federal Energy Regulatory Commission (``FERC''),

Financial Institutions Energy Group (``FIEG''), Working Group of

Commercial Energy Firms (``WGCEF''), Edison Electric Institute

(``EEI''), ICE, Western Power Trading Forum (``WPTF'') and Public

Utility Commission of Texas (``PUCT'').\11\ The comment letters from

FERC \12\ and PUCT did not directly address the issue of whether or not

the subject contracts are SPDCs. The remaining comment letters raised

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

to the MPD and MXO contracts and generally expressed the opinion that

the contracts are not SPDCs because they does not meet the material

price reference or material liquidity criteria for SPDC determination.

These comments are more extensively discussed below, as applicable.

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\9\ As noted above, the Federal Register notice also requested

comment on the Mid-C Financial Peak (``MDC'') contract and Mid-C

Financial Off-Peak (``OMC'') contract. The MDC and OMC contracts

will be addressed in a separate Federal Register release.

\10\ 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.

\11\ 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.'' 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.'' EEI is the ``association of

shareholder-owned electric companies, international affiliates and

industry associates worldwide.'' ICE is an ECM, as noted above. WPTF

describes itself as a ``broad-based membership organization

dedicated to encouraging competition in the Western power markets *

* * WTPF strives to reduce the long-run cost of electricity to

consumers throughout the region while maintaining the current high

level of system reliability.'' PUCT is the independent organization

that oversees the Electric Reliability Council of Texas (``ERCOT'')

to ``ensure nondiscriminatory access to the transmission and

distribution systems, to ensure the reliability and adequacy of the

regional electrical network, and to perform other essential market

functions.'' The comment letters are available on the Commission's

Web site: http://www.cftc.gov/lawandregulation/federalregister/

federalregistercomments/2009/09-011.html.

\12\ FERC expressed the opinion that a determination by the

Commission that either of the subject contracts performs a

significant price discovery function ``would not appear to conflict

with FERC's exclusive jurisdiction under the Federal Power Act (FPA)

over the transmission or sale for resale of electric energy in

interstate commerce or with its other regulatory responsibilities

under the FPA'' and further that ``FERC staff will monitor proposed

SPDC determinations and advise the CFTC of any potential conflicts

with FERC's exclusive jurisdiction over RTOs, [(regional

transmission organizations)], ISOs [(independent system operators)]

or other jurisdictional entities.''

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[[Page 38480]]

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

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

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

rules governing ECMs with SPDCs, the Commission observed that these

criteria do not lend themselves to a mechanical checklist or formulaic

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

determinations it will consider the circumstances under which the

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

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

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

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

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

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

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

a level sufficient for the contract to perform a significant price

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

a price reference, the Commission 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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\13\ In its October 6, 2009, Federal Register release, the

Commission identified material price reference and material

liquidity as the possible criteria for SPDC determination of the MPD

and MXO contracts. Arbitrage and price linkage were not identified

as possible criteria. As a result, arbitrage and price linkage will

not be discussed further in this document and the associated Orders.

\14\ 17 CFR 36, Appendix A.

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IV. Findings and Conclusions

The Commission's findings and conclusions with respect to the MPD

and MXO contracts are discussed separately below:

a. The Mid-C Financial Peak Daily (MPD) Contract and the SPDC Indicia

The MPD contract is cash settled based on the peak, day-ahead price

index for the specified day, as published by ICE in its ``ICE Day Ahead

Power Price Report,'' which is available on the ECM's Web site. The

daily peak-hour electricity price index is a volume-weighted average of

qualifying, day-ahead, peak-hour power transactions at the Mid-Columbia

hub that are traded on the ICE platform from 6 a.m. to 11 a.m. CST on

the publication date. The ICE transactions on which the price index is

based specify the physical delivery of power. The size of the MPD

contract is 400 megawatt hours (``MWh''), and the MPD contract is

listed for 38 consecutive days.

As the Columbia River flows through Washington State, it encounters

two federal and nine privately-owned hydroelectric dams generating a

total of close to 20,000 MW of power in the Northwest.\15\ With another

three dams in British Columbia, Canada, and many more on its various

tributaries, the Columbia River is the largest power-producing river in

North America. A major goal of the participants in the Mid-C

electricity market is to maximize the Columbia River's potential, along

with protecting and enhancing the non-power uses of the river. The

reliability of the electricity grid in the Northwest is coordinated by

the Northwest PowerPool (``NWPP''), which is a voluntary organization

comprised of major generating utilities serving the Northwestern United

States, as well as British Columbia and Alberta, Canada.

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\15\ http://www.wpuda.org/publications/connections/hydro/

River%20Riders.pdf.

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One stretch of the Columbia River between the Grand Coulee Dam and

Priests Rapids Dam is governed by the Mid-Columbia Hourly Coordination

Agreement (``MCHCA''). The MCHCA covers seven dams \16\ and nearly

13,000 MW of generation. Specifically, the agreement defines how the

Chelan, Douglas and Grant PUDs coordinate operations with the

Bonneville Power Administration to maximize power generation while

reducing fluctuations in the river's flow. A number of other utilities

that buy power from the PUDs have also signed onto the agreement. This

agreement was signed into effect in 1972 and renewed for 20 years in

1997.\17\

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\16\ The federal dams are Grand Coulee and Chief Joseph. The

remaining dams are Wells (operated by the Douglas PUD), Rocky Reach

and Rock Island (operated by the Chelan PUD), and Wanapum and Priest

Rapids (operated by the Grant PUD). The term ``PUD'' stands for

publically-owned utility, which provides essential services within a

specified area.

\17\ http://www.wpuda.org/publications/connections/hydro/

River%20Riders.pdf.

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In general, electricity is bought and sold in an auction setting on

an hourly basis at various points along the electrical grid. The price

of electricity at a particular point on the grid is called the

locational marginal price (``LMP''), which includes the costs of

producing the electricity, as well as congestion and line losses. Thus,

an LMP reflects generation costs as well as the actual cost of

supplying and delivering electricity to a specific point on the grid.

Electricity is traded in a day-ahead market as well as a real-time

market. Typically, the bulk of energy transactions occur in the day-

ahead market. The day-ahead market establishes prices for electricity

that is to be delivered during the specified hour on the following day.

Day-ahead prices are determined based on generation and energy

transaction quotes offered in advance. Because day-

[[Page 38481]]

ahead quotes for power are based on estimates of supply and demand,

electricity needs usually are not perfectly satisfied in the day-ahead

market. In this regard, on the day the electricity is transmitted and

used, auction participants typically realize that they bought or sold

too much power or too little power. A real-time auction is operated to

alleviate this problem by servicing as a balancing mechanism.

Specifically, electricity traders use the real-time market to sell

excess electricity and buy additional power to meet demand. Only a

relatively small amount of electricity is traded in the real-time

market compared with the day-ahead market.

1. Material Price Reference Criterion

The Commission's October 6, 2009, Federal Register notice

identified material price reference and material liquidity as the

potential basis for a SPDC determination with respect to the MPD

contract. The Commission considered the fact that ICE sells its price

data to market participants in a number of different packages which

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

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

of Day'' package 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. This package includes price data for the MPD contract.

The Commission also noted that its October 2007 Report on the

Oversight of Trading on Regulated Futures Exchanges and Exempt

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

participants view ICE as a price discovery market for certain

electricity contracts. The study did not specify which markets

performed this function; nevertheless, the Commission determined that

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

warrant further review.

The Commission explains in its Guidance to the Part 36 rules that

in evaluating a contract under the material price reference criterion,

it 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.\18\ 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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\18\ 17 CFR 36, Appendix A.

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The Mid-C power market is a major pricing center for electricity on

the West Coast. Traders, including producers, keep abreast of the

electricity prices in the Mid-C power market when conducting cash

deals. However, ICE's Mid-C Financial Peak (``MDC'') contract, which is

a monthly contract, is used more widely as a source of pricing

information for electricity than the daily, peak-hour contract (i.e.,

the MPD contract). Specifically, the MDC contract prices power at the

Mid-C trading point based on the simple average of the daily peak-hour

prices over the entire month, as reported by ICE. Moreover, the MDC

contract is listed for up to 86 calendar months. Thus, market

participants can use the MDC contract to lock-in electricity prices far

into the future. In contrast, the MPD contract is listed for a much

shorter length of time--up to 38 days in the future. With such a

limited timeframe, the forward pricing capability of the MPD contract

is much more constrained than that of the MDC contract. Traders use

monthly power contracts like the MDC contract to price electricity

commitments in the future, where such commitments are based on long

range forecasts of power supply and demand. As actual generation and

usage nears, market participants have a better understanding of actual

power supply and needs. As a result, traders can modify previously-

established hedges with the daily power contracts, like the MPD

contract.

The Commission explained in its Guidance that a contract meeting

the material price reference criterion would routinely be consulted by

industry participants in pricing cash market transactions. Although the

Mid-C is a major trading center for electricity and, as noted, ICE

sells price information for the MPD contract, the MPD contract is not

consulted in this manner and does not satisfy the material price

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

price reference test for existence of material price reference.

Furthermore, the Commission notes that publication of the MPD

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

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

contracts, including ICE's monthly electricity contracts, which are of

more interest to market participants. In these circumstances, the

Commission has concluded that traders likely do not specifically

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

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

market transactions.

i. Federal Register Comments:

WGCEF, WPTF, EEI and ICE stated that no other contract directly

references or settles to the MPD contract's price. Moreover, the

commenters argued that the underlying cash price series against which

the MPD contract is settled (in this case, the peak Mid-C electricity

price on a particular day, which is derived from cash market

transactions) is the authentic reference price and not the ICE contract

itself. Commission staff believes that this interpretation of price

reference is too narrow and believes that a cash-settled derivatives

contract could meet the price reference criterion if market

participants ``consult on a frequent and recurring basis'' the

derivatives contract when pricing forward, fixed-price commitments or

other cash-settled derivatives that seek to ``lock in'' a fixed price

for some future point in time to hedge against adverse price movements.

As noted above, while the Mid-C is a major power market, traders do not

consider the daily peak-hour Mid-C price to be as important as the

electricity price associated with the monthly contract.

In addition, WGCEF stated that the publication of price data for

the MPD contract price is weak justification for material price

reference. This commenter argued that market participants generally do

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

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

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

package is not conclusive evidence that market participants are buying

the ICE

[[Page 38482]]

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

them. As noted above, the Commission notes that publication of the MPD

contract's prices is not indirect evidence of routine dissemination.

The MPD 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 daily power contracts relative to monthly

contracts, the Commission has concluded that traders likely do not

specifically purchase the ICE data packages for the MPD contract's

prices and do not consult such prices on a frequent and recurring basis

in pricing cash market transactions.

Lastly, EEI criticized that the ECM Study did not specifically

identify the MPD contract as a contract that is referred to by market

participants on a frequent and recurring basis. In response, the

Commission notes that it cited the ECM Study's general finding that

some ICE electricity contracts appear to be regarded as price discovery

markets merely as indication that an investigation of certain ICE

contracts may be warranted. The ECM Study was not intended to serve as

the sole basis for determining whether or not a particular contract

meets the material price reference criterion.

ii. Conclusion Regarding Material Price Reference

Based on the above, the Commission finds that the ICE MPD 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 MPD contract's

price (direct evidence). Moreover, while the MPD contract's price data

is sold to market participants, those individuals likely do not

purchase the ICE data packages specifically for the MPD contract's

prices and do not consult such prices on a frequent and recurring basis

in pricing cash market transactions (indirect evidence).

2. Material Liquidity Criterion

As noted above, in its October 6, 2009, Federal Register notice,

the Commission identified material price reference and material

liquidity as potential criteria for SPDC determination of the MPD

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 changes to the subject contract's prices 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 MPD contract was 1,294 in the second quarter of 2009,

resulting in a daily average of 20.2 trades. During the same period,

the MPD contract had a total trading volume of 18,862 contracts and an

average daily trading volume of 294.7 contracts. Moreover, open

interest as of June 30, 2009, was 826 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.\19\

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\19\ 74 FR 51261 (October 6, 2009).

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In a subsequent filing dated March 24, 2010, ICE reported that

total trading volume in the fourth quarter of 2009 was 19,574 contracts

(or 301 contracts on a daily basis). In terms of number of

transactions, 1,108 trades occurred in the fourth quarter of 2009 (17

trades per day). As of December 31, 2009, open interest in the MPD

contract was 550 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.

The number of trades per day remained relatively low between the

second and fourth quarters of 2009 and averaged only slightly more than

the reporting level of five trades per day. Moreover, trading activity

in the MPD contract, as characterized by total quarterly volume,

indicates that the MPD contract experiences trading activity that is

similar to that of minor futures markets.\20\ Thus, the MPD contract

does not meet a threshold of trading activity that would render it of

potential importance and no additional statistical analysis is

warranted.\21\

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\20\ 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.

\21\ 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].'' [17 CFR 36, Appendix A]. For the

reasons discussed above, the Commission has found that the MPD

contract does not meet the 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 the Commission believes it is not useful as the sole basis for

a SPDC determination.

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i. Federal Register Comments

ICE and WGCEF stated that the MPD contract lacks a sufficient

number of trades to meet the material liquidity criterion. These two

commenters, along with WPTF, FEIG and EEI argued that the MPD contract

cannot have a material effect on other contracts, such as those listed

for trading by the New York Mercantile Exchange (``NYMEX''), a DCM. The

commenters pointed out that it is not possible for the MPD contract to

affect a DCM contract because price linkage and the potential for

arbitrage do not exist. The DCM contracts do not cash settle to the MPD

contract's price. Instead, the DCM contracts and the MPD contract are

both cash settled based on physical transactions, which neither the ECM

or the DCM contracts can influence.

WGCEF and ICE 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 MPD 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.'' \22\

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\22\ Guidance, supra.

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

per day test for material liquidity.'' To the contrary, 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'' \23\ 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; however, the contract will not be found to be a

[[Page 38483]]

SPDC merely because it met the reporting threshold.

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\23\ 73 FR 75892 (December 12, 2008).

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ICE 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'' as well as in strips of

contract months. ICE suggested that a more appropriate method of

determining liquidity is to examine the activity in a single traded

month of a given contract.'' \24\ It is the Commission's opinion that

liquidity, as it pertains to the MPD contract, is typically a function

of trading activity in particular lead days and, given sufficient

liquidity in such days, the ICE MPD contract itself would be considered

liquid. In any event, in light of the fact that the Commission has

found that the MPD contract does not meet the material price reference

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

unnecessary to evaluate whether the MPD contract meets the material

liquidity criterion since it cannot be used alone for SPDC

determination.

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\24\ In addition, 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 6, 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 28 percent (fourth

quarter of 2009) of all transactions in the MPD contract. Commission

acknowledges that the open interest information it provided in its

October 6, 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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ii. Conclusion Regarding Material Liquidity

For the reasons discussed above, the Commission finds that the MPD

contract does not meet the material liquidity criterion.

3. Overall Conclusion Regarding the MPD Contract

After considering the entire record in this matter, including the

comments received, the Commission has determined that the ICE MPD

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 MPD contract does not meet the

material price reference or material liquidity criteria at this time.

Accordingly, the Commission is issuing the attached Order declaring

that the MPD 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 MPD

contract.\25\ Accordingly, with respect to its MPD 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

for ECMs.

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\25\ See 73 FR 75888, 75893 (Dec. 12, 2008).

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b. The Mid-C Financial Off-Peak Daily (MXO) Contract and the SPDC

Indicia

The MXO contract is cash settled based on the off-peak, day-ahead

price index for the specified day, as published by ICE in its ``ICE Day

Ahead Power Price Report,'' which is available on the ECM's website.

The daily, off-peak hour electricity price index is a volume-weighted

average of qualifying, day-ahead, off-peak hour power transactions at

the Mid-Columbia hub that are traded on the ICE platform from 6 a.m. to

11a.m. CST on the publication date. The ICE transactions on which the

price index is based specify the physical delivery of power. The size

of the MXO contract is 25 MWh, and the MXO contract is listed for 70

consecutive days.

As the Columbia River flows through Washington State, it encounters

two federal and nine privately-owned hydroelectric dams generating

close to 20,000 MW of power for the Northwest.\26\ With another three

dams in British Columbia, Canada, and many more on its various

tributaries, the Columbia River is the largest power-producing river in

North America. A major goal of the participants in the Mid-C

electricity market is to maximize the Columbia River's potential, along

with protecting and enhancing the non-power uses of the river. The

reliability of the electricity grid in the Northwest is coordinated by

the NWPP.

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\26\ http://www.wpuda.org/publications/connections/hydro/

River%20Riders.pdf.

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One stretch of the Columbia River between the Grand Coulee Dam and

Priests Rapids Dam is governed by the MCHCA. The MCHCA covers seven

dams \27\ and nearly 13,000 MW of generation. Specifically, the

agreement defines how the Chelan, Douglas and Grant PUDs coordinate

operations with the Bonneville Power Administration to maximize power

generation while reducing fluctuations in the river's flow. A number of

other utilities that buy power from the PUDs have also signed onto the

agreement. This agreement was signed into effect on 1972 and renewed

for 20 years in 1997.\28\

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\27\ The federal dams are Grand Coulee and Chief Joseph. The

remaining dams are Wells (operated by the Douglas PUD), Rocky Reach

and Rock Island (operated by the Chelan PUD), and Wanapum and Priest

Rapids (operated the Grant PUD).

\28\ http://www.wpuda.org/publications/connections/hydro/

River%20Riders.pdf.

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In general, electricity is bought and sold in an auction setting on

an hourly basis at various point along the electrical grid. The price

of electricity at a particular point on the grid is called the LMP,

which includes the cost of producing the electricity, as well as

congestion and line losses. Thus, and LMP reflects generation costs as

well as the actual cost of supplying and delivering electricity to a

specific point on the grid.

Electricity is traded in a day-ahead market as well as a real-time

market. Typically, the bulk of the energy transactions occur in the

day-ahead market. The day-ahead market establishes prices for

electricity that is to be delivered during the specified hour on the

following day. Day-ahead prices are determined based on generation and

energy transaction quotes offered in advance. Because day-ahead price

quotes are based on estimates of supply and demand, electricity needs

usually are not perfectly satisfied in the day-ahead market. On the day

electricity is generated and used, auction participants usually realize

that they bought or sold either too much or too little power. A real-

time auction is operated in the Mid-C market to alleviate this problem.

In this regard, electricity traders use the real-time market to sell

excess electricity and buy additional power to meet demand. Only a

relatively small amount of electricity is traded in the real-time

market compared with the day-ahead market.

1. Material Price Reference Criterion

The Commission's October 6, 2009, Federal Register notice

identified material price reference and material liquidity as the

potential basis for a SPDC determination with respect to the MXO

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

[[Page 38484]]

only or historical. For example, ICE offers the ``West Power of Day''

package 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. This package includes price data for the MXO contract.

The Commission also noted that its October 2007 ECM Study found

that, in general, market participants view ICE as a price discovery

market for certain electricity contracts. The study did not specify

which markets performed this function; nevertheless, the Commission

determined that the MXO contract, while not mentioned by name in the

ECM Study, might warrant further analysis.

The Commission has explained in Guidance that it will rely on one

of two sources of evidence--direct or indirect--to determine that the

price of a contract is being used as a material price reference and

therefore, serving a significant price discovery function.\29\ 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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\29\ 17 CFR 36, Appendix A.

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The Mid-C power market is a major pricing center for electricity on

the West Coast. Traders, including producers, keep abreast of the

electricity prices in the Mid-C power market when conducting cash

deals. However, ICE's Mid-C Financial Off-Peak (``OMC'') contract,

which is a monthly contract, is used more widely as a source of pricing

information for electricity in that market than the daily off-peak hour

contract (i.e., the MXO contract). In this regard, OMC contract prices

power at the Mid-C trading point based on the simple average of the

daily off-peak hour prices over the entire month, as reported by ICE.

Moreover, the OMC contract is listed for up to 86 calendar months.

Market participants can use the OMC contract to lock-in off-peak

electricity prices far into the future. In contrast, the MXO contract

is listed for a much shorter length of time--up to 70 days in the

future. With such a limited timeframe, the forward pricing capability

of the MXO contract is constrained relative to that of the OMC

contract. Traders likely use monthly power contracts like the OMC

contract to price electricity commitments in the future. Such

commitments are based on long range forecasts of power supply and

demand. As the time of generation and consumption nears, market

participants have a better understanding of actual power supply and

needs. As a result, traders can modify previously-established hedges

with the daily power contracts, like the MXO contract.

The Commission explained in its Guidance that a contract meeting

the material price reference criterion would routinely be consulted by

industry participants in pricing cash market transactions. Although the

Mid-C is a major trading center for electricity and, as noted, ICE

sells price information for the MXO contract, the Commission found upon

further evaluation that the MXO contract is not routinely consulted by

industry participants in pricing cash market transactions. Furthermore,

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

not indirect evidence of material price reference. The MXO contract's

prices are published with those of numerous other contracts, including

ICE's OMC contract, which are of more interest to market participants.

Thus, the Commission has concluded that traders likely do not

specifically purchase ICE data packages for the MXO contract's prices

and do not consult such prices on a frequent and recurring basis in

pricing cash market transactions.

i. Federal Register Comments

WGCEF, WPTF, EEI and ICE stated that no other contract directly

references or settles to the MXO contract's price. Moreover, the

commenters argued that the underlying cash price series against which

the MXO contract is settled (in this case, the off-peak Mid-C

electricity price on a particular day, which is derived from cash

market transactions) is the authentic reference price and not the ICE

contract itself. Commission staff believes that this interpretation of

price reference is too limiting and believes that a cash-settled

derivatives contract could meet the price reference criterion if market

participants ``consult on a frequent and recurring basis'' the

derivatives contract when pricing forward, fixed-price commitments or

other cash-settled derivatives that seek to ``lock in'' a fixed price

for some future point in time to hedge against adverse price movements.

As noted above, while the Mid-C is a major power market, traders do not

consider the daily off-peak hour Mid-C price to be as important as the

electricity price associated with the average monthly off-peak price.

In addition, WGCEF stated that the publication of price data for

the MXO contract price reference is weak justification for material

price reference. This commenter argued that market participants

generally do not purchase ICE data sets for one contract's prices, such

as those for the MXO contract. Instead, traders are interested in the

settlement prices, so the fact that ICE sells the MXO prices as part of

a broad package is not conclusive evidence that market participants are

buying the ICE data sets because they find the MXO prices have

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

that publication of the MXO contract's prices is not indirect evidence

of routine dissemination. The MXO 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 daily power contracts

relative to monthly power contracts, the Commission has concluded that

traders likely do not specifically purchase the ICE data packages for

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

and recurring basis in pricing cash market transactions.

Lastly, EEI observed that the ECM Study did not specifically

identify the MXO contract as a contract that is referred to by market

participants on a frequent and recurring basis. In response, the

Commission notes that it cited the ECM Study's general finding that

some ICE electricity contracts appear to be regarded as price discovery

markets merely as indication that an investigation of certain ICE

contracts may be warranted. The ECM Study was not intended to serve as

the sole basis for determining whether or not a particular contract

meets the material price reference criterion.

[[Page 38485]]

ii. Conclusion Regarding Material Price Reference:

Based on the above, the Commission finds that the ICE MXO 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 MXO contract's

price (direct evidence). Moreover, while the MXO contract's price data

is sold to market participants, those individuals likely do not

specifically purchase the ICE data packages for the MXO contract's

prices and do not consult such prices on a frequent and recurring basis

in pricing cash market transactions (indirect evidence).

2. Material Liquidity Criterion

As noted above, in its October 6, 2009, Federal Register notice,

the Commission identified material price reference and material

liquidity as potential criteria for SPDC determination of the MXO