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