FR Doc 2010-10306[Federal Register: May 4, 2010 (Volume 75, Number 85)]
[Notices]
[Page 23679-23686]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr04my10-59]
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COMMODITY FUTURES TRADING COMMISSION
Order Finding That the ICE Malin Financial Basis Contract Traded
on the IntercontinentalExchange, Inc., Does Not Perform a Significant
Price Discovery Function
AGENCY: Commodity Futures Trading Commission.
ACTION: Final orders.
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SUMMARY: On October 9, 2009, the Commodity Futures Trading Commission
(``CFTC'' or ``Commission'') published for comment in the Federal
[[Page 23680]]
Register \1\ a notice of its intent to undertake a determination
whether the Malin Financial Basis (``MLN'') 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 orders finding that the
MLN 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 52192 (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
MLN contract performs a significant price discovery function and
requested comment from interested parties.\7\ Comments were received
from the Industrial Energy Consumers of America (``IECA''), Working
Group of Commercial Energy Firms (``WGCEF''), ICE, Economists
Incorporated (``EI''), Natural Gas Suppliers Association (``NGSA''),
Federal Energy Regulatory Commission (``FERC''), and Financial
Institutions Energy Group (``FIEG'').\8\ The comment letter from FERC
\9\ did not directly
[[Page 23681]]
address the issue of whether or not the MLN contract is a SPDC; IECA
concluded that the MLN contract is a SPDC, but did not provide a basis
for its conclusion.\10\ The other parties' comments raised substantive
issues with respect to the applicability of section 2(h)(7) to the MLN
contract, generally asserting that the MLN contract is not a SPDC as it
does not meet the material liquidity, material price reference and
price linkage criteria for SPDC determination. Those 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.'' ICE is an ECM, 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-
020.html.
\9\ FERC stated that the MLN contract is cash settled and does
not contemplate 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, ``the
FERC staff will continue to monitor for any such conflict * * *
[and] advise the CFTC'' should any such potential conflict arise. CL
06.
\10\ IECA stated that the subject ICE contract should ``be
required to come into compliance with core principles mandated by
Section 2(h)(7) of the Act and with other statutory provisions
applicable to registered entities. [This contract] should be subject
to the Commission's position limit authority, emergency authority
and large trader reporting requirements, among others.'' CL 01.
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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.\11\ 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.\12\ 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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\11\ 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 MLN 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.
\12\ 17 CFR 36, Appendix A.
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IV. Findings and Conclusions
a. The Malin Financial Basis (MLN) Contract and the SPDC Indicia
The ICE MLN contract is cash settled based on the difference
between the bidweek price index of natural gas at the Malin hub for the
contract-specified month of delivery, as published in Intelligence
Press Inc.'s (``IPI'') Natural Gas Bidweek Survey, and the final
settlement price for New York Mercantile Exchange's (``NYMEX's'') Henry
Hub physically-delivered natural gas futures contract for the same
specified calendar month. The IPI bidweek price, which is published
monthly, is based on a survey of cash market traders who voluntarily
report to IPI data on their fixed-price transactions for physical
delivery of natural gas at the Malin hub conducted during the last five
business days of the month; such bidweek transactions specify the
delivery of natural gas on a uniform basis throughout the following
calendar month at the agreed upon rate. The IPI 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 MLN contract is 2,500
million British thermal units (``mmBtu''), and the unit of trading is
any multiple of 2,500 mmBtu. The MLN contract is listed for up to 72
calendar months commencing with the next calendar month.
The Henry Hub,\13\ 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 Henry Hub 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 move 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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\13\ 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.
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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.\14\ Some of the major trading centers include
Alberta, Northwest Rockies, Southern California border and
[[Page 23682]]
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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\14\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/
feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.
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The Malin hub is the entry point along the California-Oregon border
at which natural gas reaches the California market. This trading center
connects with the Gas Transmission Northwest interstate pipeline, which
carries gas from the Canada/Idaho border through Washington State and
Oregon. A connection with the California Gas Transmission Company also
exists at the Malin hub. The Malin hub is considered by traders to be
an important trading center for natural gas.
The Malin hub is part of the Golden Gate Market Center, which is
located in Northern California. The Golden Gate Market Center offers
seven different transaction points, which are Malin, Citygate, Kern
River Station, High Desert Lateral, Daggett, Southern Trails and
Topock. The Golden Gate Market Center had an estimated throughput
capacity of two billion cubic feet per day in 2008. Moreover, the
number of pipeline interconnections at the Golden Gate Market Center
was nine in 2008, up from eight in 2003. Lastly, the pipeline
interconnection capacity of the Golden Gate Market Center in 2008 was 6
billion cubic feet per day, which constituted a 32 percent increase
over the pipeline interconnection capacity in 2003.\15\ The Malin hub
is far removed from the Henry Hub and is not directly connected to the
Henry Hub by an existing pipeline.
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\15\ 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 Malin hub 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 Malin price. Moreover,
exogenous factors, such as adverse weather, can cause the Malin 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 \16\ 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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\16\ 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 MLN
contract. Each of these criteria is discussed below.\17\
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\17\ As noted above, the Commission did not find an indication
of arbitrage in connection with this contract; accordingly, that
criterion is not discussed in reference to the MLN 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 maintains exclusive rights over IPI's bidweek price
indices. As a result, no other exchange can offer such a basis contract
based on IPI's Malin bidweek index. While other third-party price
providers produce natural gas price indices for this and other trading
centers, market participants indicate that the IPI Malin bidweek index
is highly regarded for this particular location and should market
participants wish to establish a hedged position based on this index,
they would need to do so by taking a position in the ICE MLN swap since
ICE has the right to the IPI index for cash settlement purposes. In
addition, ICE sells its price data to market participants in a number
of different packages which vary in terms of the hubs covered, time
periods, and whether the data are daily only or historical. For
example, ICE offers the ``West Gas End of Day'' and ``OTC Gas End of
Day'' \18\ 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 MLN
contract.
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\18\ 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 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. 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 Malin hub is a significant trading center
for natural gas but is not as important as other hubs, such as the PG&E
Citygate, for pricing natural gas in the western half of the U.S.
marketplace.
[[Page 23683]]
Although the Malin hub is a major trading center for natural gas in
the United States and, as noted, ICE sells price information for the
MLN 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 MLN 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. Thus, the MLN contract does not satisfy the direct
price reference test for existence of material price reference.
Furthermore, the Commission notes that publication of the MLN
contract's prices is not indirect evidence material price reference.
The MLN contract's prices are published with those of numerous other
contracts, which are of more interest to market participants. Due to
the less importance of the Malin hub, the Commission has concluded that
traders likely do not specifically purchase the ICE data packages for
the MLN 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,\20\ ICE,\21\ EI,\22\ NGSA \23\ and FIEG \24\
addressed the question of whether the MLN contract met the material
price reference criterion for a SPDC.\25\ The commenters argued that
because the MLN 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 MLN contract is settled (in this case, the
IPI 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 Malin hub is a significant trading
center for natural gas in North America. However, traders do not
consider the Malin hub to be as important as other natural gas trading
points, particularly the nearby PG&E Citygate.
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\20\ CL 02.
\21\ CL 04.
\22\ CL 05.
\23\ CL 06.
\24\ CL 08.
\25\ As noted above, IECA expressed the opinion that the MLN
contract met the criteria for SPDC determination but did not provide
its reasoning.
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ICE argued that the Commission appeared to base the case that the
MLN contract is potentially a SPDC on two disputable assertions. First,
in issuing its notice of intent to determine whether the MLN 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.'' \26\ 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.''
\27\ 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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\26\ CL 03.
\27\ CL 03.
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Second, ICE argued that the Commission should not base a
determination that the MLN contract is a SPDC on the fact that this
contract has the exclusive right to base its settlement on the IPI
Malin Index price. While the Commission acknowledges that there are
other firms that produce price indices for the Malin hub, as it notes
above, market participants indicate that the IPI Index is very highly
regarded. However, since the Malin hub is not considered the
predominant pricing point for natural gas in the upper Northwest, it is
likely that cash market participants do not consult the MLN contract's
prices on a frequent and recurring basis in pricing cash market
transactions.
Both EI \28\ and WGCEF \29\ 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 MLN contract. Instead, traders are interested in the settlement
prices, so the fact that ICE sells the MLN prices as part of a broad
package is not conclusive evidence that market participants are buying
the ICE data sets because they find the MLN prices have substantial
value to them. As mentioned above, the Commission notes that
publication of the MLN contract's prices is not indirect evidence of
routine dissemination. The MLN 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 Malin hub, the
Commission has concluded that traders likely do not specifically
purchase the ICE data packages for the MLN contract's prices and do not
consult such prices on a frequent and recurring basis in pricing cash
market transactions.
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\28\ CL 05.
\29\ CL 02.
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ii. Conclusion Regarding Material Price Reference
Based on the above, the Commission finds that the MLN contract does
not meet the material price reference criterion because cash market
transactions are not priced on a frequent and recurring basis at a
differential to the MLN contract's price (direct evidence). Moreover,
while the ECM sells the MLN contract's price data to market
participants, market participants likely do not specifically purchase
the ICE data packages for the MLN contract's prices and do not consult
such prices on a frequent and recurring basis in pricing cash market
transactions (indirect evidence).
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 MLN contract. In this regard, the final settlement
of the MLN contract is based, in part, on the final settlement price of
the NYMEX's Henry Hub 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
\30\ 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
[[Page 23684]]
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.'' 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,
the Commission also stated in the Guidance 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 potentially to be deemed a SPDC (``minimum
threshold'').
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\30\ Appendix A to the Part 36 rules.
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To assess whether the MLN 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 Malin
price is determined, in part, by the final settlement price of the
NYMEX physically-delivered natural gas futures contract (a DCM
contract), the Malin 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, 10 percent of the Malin hub 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 finds that the MLN 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. The
number of trades on the ICE centralized market in the MLN contract
during the same period was 54,759 contracts (equivalent to 13,690 NYMEX
contracts, given the size difference).\31\ Thus, centralized-market
trades in the MLN contract amounted to less than the minimum threshold.
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\31\ The MLN contract is one-quarter the size of the NYMEX Henry
Hub physically-delivered futures contract.
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i. Federal Register Comments
WGCEF, ICE, EI, NGSA and FIEG addressed the question of whether the
MLN contract met the price linkage criterion for a SPDC.\32\ Each of
the commenters expressed the opinion that the MLN 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 MLN is linked. Based on its analysis
discussed above, the Commission agrees with this assessment.
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\32\ As noted above, IECA expressed the opinion that the MLN
contract met the criteria for SPDC determination but did not provide
its reasoning.
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ii. Conclusion Regarding the Price Linkage Criterion
The Commission finds that the MLN contract does not meet the price
linkage criterion because it fails the volume and price linkage tests
provided for in the Commission's Guidance.
3. Material Liquidity Factor
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
MLN 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.
Based upon on a required quarterly filing made by ICE on July 27,
2009, the total number of MLN trades executed on ICE's electronic
trading platform was 664 in the second quarter of 2009, resulting in a
daily average of 10.4 trades. During the same period, the MLN contract
had a total trading volume on ICE's electronic trading platform of
59,564 contracts and an average daily trading volume of 930.7
contracts. The open interest as of June 30, 2009, was 65,804 contracts,
which includes 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 a subsequent filing dated November 13, 2009, ICE reported that
686 separate trades occurred on its electronic platform in the third
quarter of 2009, resulting in a daily average of 10.4 trades. During
the same period, the MLN contract had a total trading volume on its
electronic platform of 54,759 contracts (which was an average of 830
contracts per day). As of September 30, 2009, open interest in the MLN
contract was 57,332 contracts. Reported open interest included
positions resulting from trades that were executed on ICE's electronic
platform, as well as trades that were executed off of ICE's electronic
platform and brought to ICE for clearing.
As indicated above, the average number 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
MLN contract, as characterized by total quarterly volume, indicates
that the MLN contract experiences trading activity similar to that of
other thinly-traded contracts.\33\ Thus, the MLN contract does not
meets a threshold of trading activity that would render it of potential
importance and no additional statistical analysis is warranted.\34\
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\33\ 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.
\34\ 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 MLN 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 MLN contract met the material liquidity
criterion for a SPDC.\35\ These commenters stated that the MLN contract
does not meet the material liquidity criterion for SPDC determination
for a number of reasons.
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\35\ As noted above, IECA expressed the opinion that the MLN
contract met the criteria for SPDC determination but did not provide
its reasoning.
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WGCEF,\36\ ICE \37\ and EI \38\ noted that the Commission's
Guidance had posited
[[Page 23685]]
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 MLN 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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\36\ CL 02.
\37\ CL 04.
\38\ CL 05.
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WGCEF, FIEG \39\ and NGSA \40\ noted that the MLN 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 MLN contract's trading volume represents
only a fraction of natural gas trading.
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\39\ CL 08.
\40\ 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'' \41\ 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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\41\ 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.'' \42\ 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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\42\ 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 55
percent of all transactions in the MLN 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 MLN contract, is typically a function of trading activity in
particular lead months and, given sufficient liquidity in such months,
the ICE MLN contract itself would be considered liquid. In any event,
in light of the fact that the Commission has found that the MLN
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 MLN 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 does not find
evidence that the MLN contract meets the material liquidity criterion.
4. Overall Conclusion Regarding the MLN Contract
After considering the entire record in this matter, including the
comments received, the Commission has determined that the MLN 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 MLN contract does not meet the
material price reference, price linkage and material liquidity criteria
at this time. Accordingly, the Commission will issue the attached Order
declaring that the MLN 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 MLN contract.\43\ Accordingly,
with respect to its MLN 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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\43\ See 73 FR 75888, 75893 (Dec. 12, 2008).
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V. Related Matters
a. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \44\ 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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\44\ 44 U.S.C. 3507(d).
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b. Cost-Benefit Analysis
Section 15(a) of the CEA \45\ 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.
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\45\ 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
[[Page 23686]]
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. 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 MLN 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'') \46\ 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 ECMs.
The Commission previously has determined that ECMs are not small
entities for purposes of the RFA.\47\ Accordingly, the Chairman, on
behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b)
that these Orders, 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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\46\ 5 U.S.C. 601 et seq.
\47\ 66 FR 42256, 42268 (Aug. 10, 2001).
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VI. Order
a. Order Relating to the Malin 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 Malin Financial Basis contract,
traded on the IntercontinentalExchange, Inc., does not at this time
satisfy the material price reference, price linkage or material
liquidity criteria for significant price discovery contracts.
Consistent with this determination, the IntercontinentalExchange, Inc.,
is not considered a registered entity \48\ with respect to the Malin
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 Malin
Financial Basis contract with the issuance of this Order.
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\48\ 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 Malin Financial Basis 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. 2010-10306 Filed 5-3-10; 8:45 am]
BILLING CODE P
Last Updated: May 4, 2010