e9-18159

FR Doc E9-18159[Federal Register: July 30, 2009 (Volume 74, Number 145)]

[Notices]

[Page 37988-37991]

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

[DOCID:fr30jy09-36]

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COMMODITY FUTURES TRADING COMMISSION

Order Finding That the ICE Henry Financial LD1 Fixed Price

Contract Traded on the IntercontinentalExchange, Inc., Performs a

Significant Price Discovery Function

AGENCY: Commodity Futures Trading Commission.

ACTION: Final order.

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SUMMARY: On June 12, 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 Henry Financial LD1 Fixed Price 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 a Commission report on ECMs. The

Commission has reviewed public comments and the entire record in this

matter and has determined to issue an order finding that the ICE Henry

Financial LD1 Fixed Price contract performs a significant price

discovery function. Authority for this action is found in section

2(h)(7) of the CEA and Commission rule 36.3(c) promulgated thereunder.

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\1\ 74 FR 28028 (June 12, 2009).

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DATES: Effective date: [date of underlying order].

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. 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 No. 110-246, 122 Stat. 1624 (June 18,

2008).

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

the provisions of the Reauthorization Act.\3\ 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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\3\ 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 a determination 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. The Commission will, within a reasonable period of time after

the close of the comment period, consider all relevant information and

[[Page 37989]]

issue an order announcing and explaining its determination. The

issuance of an affirmative order triggers the effectiveness of the

Commission's regulatory authorities with respect to an ECM with a SPDC;

at that time, such an ECM becomes subject to all provisions of the CEA

applicable to registered entities.\4\ The issuance of such an order

also triggers the obligations, requirements and timetables prescribed

in Commission rule 36.3(c)(4).\5\

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\4\ 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).

\5\ 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 June 12, 2009, the Commission published in the Federal Register

notice of its intent to undertake a determination whether the ICE Henry

Financial LD1 Fixed Price contract performs a significant price

discovery function, and requested comment from interested parties. \6\

Comments were received from the American Public Gas Association

(``APGA''); the Steel Manufacturer's Association and East Texas

Electric Cooperative (collectively, ``SMA/ETEC''); and the CME

Group.\7\ The comments are more extensively discussed below in the

Findings and Conclusion Section.

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\6\ 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.

\7\ The comment letters are available on the Commission's Web

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

federalregistercomments/2009/09-007.html.

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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 factors in determining whether a contract

performs a 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 designated DCM or DTEF, or a SPDC traded on or subject to

the rules of an electronic trading facility, so as to permit market

participants to effectively arbitrage between the markets by

simultaneously maintaining positions or executing trades in the

contracts on a frequent and recurring basis.

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

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

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

prices generated by agreements, contracts or transactions being traded

or executed on the electronic trading facility.

Material liquidity--the extent to which the volume of

agreements, contracts or transactions in a commodity being traded on

the electronic trading facility is sufficient to have a material effect

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

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

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

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

particular contract performs a significant price discovery function.

Moreover, the statutory language neither prioritizes the factors nor

specifies the degree to which a SPDC must conform to the various

factors. In Guidance issued in connection with the Part 36 rules

governing ECMs with SPDCs, the Commission observed that these factors

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 factor, or combination of factors, would be

sufficient to support a SPDC determination.\8\ 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.

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\8\ 17 CFR 36, Appendix A.

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IV. Findings and Conclusions

The ICE Henry Financial LD1 Fixed Price contract is cash settled

based on the final settlement price of the New York Mercantile

Exchange's (``NYMEX'') physically-delivered Henry Hub-based Natural Gas

futures contract for the corresponding contract month. The trading unit

of the ICE Henry Financial LD1 Fixed Price contract is 2,500 mmBtu

multiplied by the number of calendar days in the contract month. For

example, if a contract month has 30 days, the trading unit is 75,000

mmBtu, which is referred to as 30 lots.

Based on data provided in connection with the quarterly

notification required by Commission rule 36.3(c)(2), this contract

realized more than an average of five trades per day during the first

quarter of 2009. In addition, the average volume of natural gas traded

each business day during that period was 449,010 contracts; the open

interest in the contract as of March 31, 2009 was 2,932,798 contracts.

Based on these contract features and trading data, the ICE Henry

Financial LD1 Fixed Price contract satisfies the material liquidity,

price linkage and arbitrage criteria for a SPDC. The very high average

daily trading volume indicates that the contract is relatively liquid.

With regard to the price linkage and arbitrage tests, the ICE Henry

Financial LD1 Fixed Price contract and NYMEX's physically-delivered

Natural Gas futures contract have the same final settlement prices, and

ICE uses NYMEX's forward settlement curve when conducting its mark-to-

market accounting procedures to settle the contract on a daily basis.

In evaluating the ICE Henry Financial LD1 Fixed Price contract, the

Commission also has the benefit of a recent study focused on price

discovery contracts on ECMs. The Commission's October 2007 Report on

the Oversight of Trading on Regulated Futures Exchanges and Exempt

Commercial Markets (``ECM Study'') stated that traders and voice

brokers view the instant ICE contract as economically equivalent to the

NYMEX physically-delivered Natural Gas futures contract. The ICE and

NYMEX contracts essentially comprise a single market for natural gas

derivatives trading, and traders look to both the ICE and the NYMEX

when determining where to

[[Page 37990]]

execute a trade at the best price. The ECM Study also reported that the

ICE natural gas contract acts as a price discovery market.

The statements provided by APGA and CME provide additional support

for the Commission's findings. APGA, the national association for

publicly-owned natural gas distribution systems, states that its

members report that the prices on the ICE and NYMEX contracts have an

ongoing, linked relationship that extends not only to the linked

settlement price but to prices between the two contracts throughout the

trading day. Its members report that the prices of both markets are

substantially the same and move in tandem, and that counterparties use

either market interchangeably as a basis for quoting prices. This

linkage, in APGA's view, makes possible arbitrage trading between the

two markets. With respect to material price reference, APGA observes

that the ICE contract is routinely used as a means by which cash market

prices are referenced.\9\ Finally, APGA states that whether or not its

members trade the ICE contract, they are of the opinion that they would

be able to execute substantial orders without having an impact on the

market price through the transaction.

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\9\ APGA members note that in general the written cash market

contracts that they enter into reference the NYMEX price, as does

the ICE Henry Financial LD1 Fixed Price contract itself. While the

cash contracts commonly do not explicitly reference the ICE contract

as the settlement price, APGA states that it is common market

practice for dealers to provide cash market price quotes based upon

the ICE Henry Financial LD1 Fixed Price contract. With respect to

material price reference, while it appreciates the anecdotal

information provided by both APGA and CME Group, the Commission has

not reached a conclusion with respect to this factor.

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CME Group opines that the Henry Financial LD1 Fixed Price contract

readily satisfies all four of section 2(h)(7)'s criteria as explained

in the Appendix A Guidance. It notes that when trading in the Henry

Financial LD1 Fixed Price contract is viewed in the context of the

relevant competing contracts at NYMEX, including both financially-

settled and physically-settled contracts, ICE's contract had a 40

percent market share of that trading activity--easily satisfying the

standards for material liquidity. As to price linkage, CME Group

observes that the ICE Henry Financial LD1 Fixed Price contract

continues to have the same settlement price as the NYMEX natural gas

contract; with regard to final settlement, the product specifications

for the ICE contract explicitly provide for final settlement to be

equal to the final settlement price of the NYMEX natural gas futures

contract. Thus, in CME's opinion there appears to be little chance that

the ICE contract will deviate from the NYMEX settlement price for final

settlement. With respect to arbitrage, CME Group offers anecdotal

information indicating a strong and active arbitrage between the two

contracts. Finally, CME Group observes that the ICE Henry Financial LD1

Fixed Price contract satisfies the statutory standard for material

price reference, as ICE itself relies on the settlement prices

generated by NYMEX for its own settlement prices in the contract,

rather than on prices generated by its own system. Moreover, CME Group

notes its understanding that ICE has for several years been selling its

price information for this contract to interested persons.\10\

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\10\ As noted above, the Commission has not reached a conclusion

with respect to the material price reference factor.

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SMA/ETEC supports recognition of the Henry Financial LD1 Fixed

Price contract as a SPDC; the bulk of its comment letter, however,

focuses on issues beyond the narrow scope of the instant action, which

is to determine whether the ICE contract performs a significant price

discovery function. For instance, SMA/ETEC advocates subjecting all

natural gas investment vehicles to aggregate position limits and

discusses the Commission's proposed limited risk management exemption.

After considering the entire record in this matter, including the

ECM Study and the comments received, the Commission has determined that

the ICE Henry Financial LD1 Fixed Price contract performs a significant

price discovery function under the material liquidity, price linkage

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

The issuance of this order triggers the immediate effectiveness of

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

in connection with its Henry Financial LD1 Fixed Price contract,\11\

and triggers the obligations, requirements--both procedural and

substantive--and timetables prescribed in Commission rule 36.3(c)(4)

for ECMs.\12\

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\11\ See 73 FR 75888, 75893 (Dec. 12, 2008).

\12\ This Order determining that the ICE Henry Financial LD1

Fixed Price contract is a SPDC represents the first time the

Commission has determined that one of ICE's contracts performs a

significant price discovery function. Accordingly, ICE must, within

90 calendar days of the date of this Order, submit to the Commission

a written demonstration of compliance with the section 2(h)(7) core

principles.

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IV. Related Matters

A. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 (``PRA'') \13\ 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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\13\ 44 U.S.C. 3507(d).

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B. Cost-Benefit Analysis

Section 15(a) of the CEA \14\ requires the Commission to consider

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

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

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

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

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

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

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

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

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

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

interest considerations. The Commission may in its discretion give

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

discretion determine that, notwithstanding its costs, a particular

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

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

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

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

and has concluded that this Order, which strengthens Federal oversight

of the ECM and helps to prevent market manipulation, is necessary and

appropriate to accomplish the purposes of section 2(h)(7) of the Act.

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\14\ 7 U.S.C. 19(a).

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When a futures contract begins to serve a significant price

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

warrants increased oversight to deter and prevent price manipulation

and other disruptions to

[[Page 37991]]

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

contracts trading on designated contract markets (``DCMs''). An Order

finding that a particular contract is a SPDC triggers this increased

oversight and imposes obligations on the ECM calculated to accomplish

this goal. The increased oversight engendered by the issuance 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 large trader reports for SPDCs listed on ECMs. These increased

ECM 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.

V. Order

After considering the complete record in this matter and 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 ICE Henry Financial LD1 Fixed Price

contract satisfies the statutory material liquidity, price linkage and

arbitrage criteria for a significant price discovery contract.

Consistent with this determination, and effective immediately,

IntercontinentalExchange, Inc., shall be and is considered a registered

entity with respect to the Henry Financial LD1 Fixed Price contract and

is subject to all the provisions of the Commodity Exchange Act

applicable to registered entities. Further, the obligations,

requirements and timetables prescribed in Commission rule 36.3(c)(4)

governing core principle compliance by IntercontinentalExchange, Inc.

commence with the issuance of this Order.

Issued in Washington, DC, on July 24, 2009, by the Commission.

David A. Stawick,

Secretary of the Commission.

[FR Doc. E9-18159 Filed 7-29-09; 8:45 am]

Last Updated: July 30, 2009