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