[Federal Register: January 16, 2003 (Volume 68, Number 11)]
[Notices]
[Page 2319-2324]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr16ja03-51]
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Commodity Futures Trading Commission
In the Matter of the New York Mercantile Exchange, Inc. and the
Intercontinental Exchange, Inc., Petitions for Treatment of Floor
Brokers and Floor Traders as Eligible Commercial Entities Pursuant to
Section 1a(11)(C) of the Commodity Exchange Act
AGENCY: Commodity Futures Trading Commission.
ACTION: Order.
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SUMMARY: In response to petitions from the New York Mercantile
Exchange, Inc. (NYMEX) and the Intercontinental Exchange, Inc.
(Intercontinental), the Commodity Futures Trading Commission
(Commission or CFTC), pursuant to section 1a(11)(C) of the Commodity
Exchange Act (Act), is issuing an order that deems, subject to certain
conditions, floor brokers and floor traders who are registered with the
Commission, when acting in a proprietary trading capacity, to be
``eligible commercial entities `` as that term is defined in section
1a(11) of the Act. Accordingly, subject to certain conditions as set
forth in the Commission's order, registered floor brokers and floor
traders, when acting
[[Page 2320]]
for their own accounts, are permitted to enter into transactions in
exempt commodities on exempt commercial markets pursuant to section
2(h)(3) of the Act. In order to participate, the floor broker or floor
trader must either be an eligible contract participant as that term is
defined in section 1a(12) of the Act or have its trades on the exempt
commercial market guaranteed by a clearing member that is both a member
of a CFTC-registered derivatives clearing organization and is an
eligible contract participant.
DATES: This order is effective January 16, 2003.
FOR FURTHER INFORMATION CONTACT: Duane C. Andresen, Special Counsel,
Division of Market Oversight, Commodity Futures Trading Commission,
Three Lafayette Center, 1155 21st Street, NW., Washington, DC 20581.
Telephone: 202-418-5492. E-mail: [email protected].
SUPPLEMENTARY INFORMATION:
I. Statutory Background
Section 1a(11) of the Act, as amended by the Commodity Futures
Modernization Act of 2000 (CFMA), Pub. L. No. 106-554, which was signed
into law on December 21, 2000, defines the term ``eligible commercial
entity'' (ECE) by listing those eligible contract participants (ECP)
\1\ that are qualified to be ECEs.\2\ Under section 2(h)(3) of the Act,
transactions between ECEs in an ``exempt commodity'\3\ on an exempt
commercial market (ECM) that meet the requirements of 2(h)(3)-(5) are
exempt from all but certain limited requirements of the Act.\4\ Floor
brokers and floor traders, even if determined to fall within the
definition of ECP, do not fall within the definition of ECE and, thus,
cannot enter into transactions on ECMs. The Act, however, gives the
Commission discretion to expand the ECE category. Specifically, section
1a(11)(C) provides that the list of entities defined as ECEs shall
include ``such other persons as the Commission shall determine
appropriate and shall designate by rule, regulation, or order.'' A
determination under this provision that registered floor brokers and
floor traders are considered to be ECEs would permit these entities to
enter into transactions in exempt commodities on ECMs pursuant to
section 2(h)(3) of the Act.
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\1\ Section 1a(12) defines the term ECP by listing those
entities and individuals considered to be ECPs. Included generally
as ECPs are financial institutions; insurance companies and
investment companies subject to regulation; commodity pools and
employee benefit plans subject to regulation and asset requirements;
other entities subject to asset requirements or whose obligations
are guaranteed by an ECP that meets a net worth requirement;
governmental entities; brokers, dealers, and futures commission
merchants (FCM) subject to regulation and organized as other than
natural persons or proprietorships; brokers, dealers, and FCMs
subject to regulation and organized as natural persons or
proprietorships subject to total asset requirements or whose
obligations are guaranteed by an ECP that meets a net worth
requirement; floor brokers or floor traders subject to regulation in
connection with transactions that take place on or through the
facilities of a registered entity or an exempt board of trade;
individuals subject to total asset requirements; an investment
adviser or commodity trading advisor acting as an investment manager
or fiduciary for another ECP, and any other person that the
Commission deems eligible in light of the financial or other
qualifications of the person.
\2\ Section 1a(11) defines the term ECE by listing those
entities and individuals considered to be ECEs. Generally, an ECE is
an ECP that (1) in connection with its business, demonstrates the
ability to make or take delivery of the underlying commodity; incurs
risk, in addition to price risk related to the commodity; or is a
dealer that regularly provides risk management or hedging services
to, or engages in market-making activities with, the foregoing
entities with respect to the commodity or derivatives transactions
in the commodity; or (2) is other than a natural person or
governmental entity and regularly enters into transactions with
respect to the commodity or derivatives transactions in the
commodity, subject to certain qualification or total asset
requirements; or (3) such other persons as the Commission shall
determine appropriate.
\3\ Section 1a(14) of the Act defines the term ``exempt
commodity'' to mean a commodity that is not an excluded commodity or
an agricultural commodity. Section 1a(13) defines the term
``excluded commodity'' to mean, among other things, an interest
rate, exchange rate, currency, credit risk or measure, debt
instrument, measure of inflation, or other macroeconomic index or
measure. Although the term ``agricultural commodity'' is not defined
in the Act, section 1a(4) enumerates a non-exclusive list of several
agricultural-based commodities and products. The broadest types of
commodities that fall into the exempt category are energy and metals
products.
\4\ Under section 2(h)(3), ECMs are markets that meet the
requirements of sections 2(h)(3)-(5) by notifying the Commission of
their intention to operate a trading facility in reliance on the
exemption and by limiting themselves to transactions: (1) In exempt
commodities, (2) entered into on a principal-to-principal basis by
ECEs, and (3) executed or traded on an electronic trading facility.
An ECM is not a registered entity, but is required to notify the
Commission of its intention to operate an electronic trading
facility in reliance on the exemption set forth in section 2(h)(3).
The notification of operation as an ECM must include several
certifications and, pursuant to Commission regulation 36.3(c)(3), a
representation that it will require each participant to comply with
all applicable law and that it has a reasonable basis for believing
that authorized participants are ECEs. Section 2(h)(4) reserves,
with respect to transactions eligible for the 2(h)(3) exemption,
certain provisions of the Act, including certain anti-fraud and
anti-manipulation provisions.
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II. The Petitions
A. NYMEX
By letter dated May 23, 2002, NYMEX submitted a petition for a
Commission interpretation pursuant to section 1a(11)(C) of the Act.\5\
Specifically, NYMEX, acting on behalf of its floor brokers, floor
traders and clearing firms, requested that the Commission make a
determination pursuant to Section 1a(11)(C) of the Act that floor
brokers and floor traders, when acting in a proprietary capacity, may
enter into certain specified transactions in exempt commodities on ECMs
if such Commission registrants have obtained a financial guarantee for
such transactions from an Exchange clearing member that is registered
with the Commission as an FCM. NYMEX suggested that the permissible
transactions be limited to trading in a commodity that either (1) is
listed only for clearing on NYMEX,\6\ or (2) is listed for trading and
clearing on NYMEX and where NYMEX rules provide for the exchange of
futures for swaps (EFS) in that contract.\7\ NYMEX further proposed
that permissible trading be limited to transactions that would
subsequently be cleared at NYMEX and represented that NYMEX would have
appropriate compliance systems in place to monitor such trading.\8\
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\5\ In its petition, NYMEX also requested that the Commission
make a determination pursuant to section 1a(12)(C) of the Act that
floor brokers and floor traders, when acting in a proprietary
capacity, be considered to be ECPs when they enter into certain
specified transactions. Such a determination would permit NYMEX
floor brokers and floor traders to enter into over-the-counter (OTC)
transactions in exempt commodities pursuant to section 2(h)(1) of
the Act.
\6\ By letter dated May 24, 2002, NYMEX filed rule changes that
would implement an initiative to provide clearing services for
specified energy contracts executed in the OTC markets. NYMEX
certified that the rules comply with the Act and the Commission's
regulations. Under the provision, NYMEX initially listed 25
contracts that are entered into OTC and accepted for clearing by
NYMEX, but are not listed for trading on NYMEX. In connection with
the NYMEX initiative, on May 30, 2002, the Commission issued an
order pursuant to section 4d of the Act. The order provides that,
subject to certain terms and conditions, the NYMEX Clearing House
and FCMs clearing through the NYMEX Clearing House may commingle
customer funds used to margin, secure, or guarantee transactions in
futures contracts executed in the OTC markets and cleared by the
NYMEX Clearing House with other funds held in segregated accounts
maintained in accordance with section 4d of the Act and the
Commission regulations thereunder.
\7\ Commodities listed for trading and clearing on NYMEX where
NYMEX rules provide for EFSs would include, for example, an OTC
natural gas swap to be exchanged for a futures position in the
Exchange's Natural Gas futures contract. EFS transactions are
permitted at NYMEX pursuant to NYMEX rule 6.21A, Exchange of Futures
for, or in Connection with, Swap Transactions. The swap component of
the transaction must involve the commodity underlying a related
NYMEX futures contract, or a derivative, by-product, or related
product of such a commodity. In furtherance of its effort to permit
OTC clearing at the Exchange, NYMEX amended the rule to include as
eligible EFS transactions ``any contract executed off the Exchange
that the Exchange has designated as eligible for clearing at the
Exchange.''
\8\ NYMEX also suggested a further limitation on floor members'
permissible transactions by not permitting, initially, any
transactions in electricity commodities.
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[[Page 2321]]
In support of its request for a determination that floor members be
able to trade as ECEs on ECMs, NYMEX stated, among other things, that
floor brokers and floor traders, if determined to be ECPs, would meet
the ECE definition requirements of section 1a(11)(A) of the Act in that
the floor brokers and floor traders provide risk management and market-
making activities in energy and metals derivatives products. NYMEX
further stated that allowing floor brokers and floor traders with an
FCM guarantee to execute transactions as ECEs on ECMs would simply be
an extension of the services and expertise that such entities currently
provide to users of NYMEX's markets.
B. Intercontinental
By letter dated June 3, 2002, Intercontinental \9\ requested that
the Commission issue an order pursuant to section 1a(11) of the Act
that would expand the ECE category to include CFTC-registered floor
brokers and floor traders, thus permitting them to trade on ECMs.\10\
Intercontinental proposed that the floor broker or floor trader must be
a member of a designated contract market (DCM) or otherwise have
trading privileges on a DCM. The floor broker or floor trader must have
as a part of its business the business of acting as a floor broker or
floor trader, but need not have any connection or experience in the
underlying products traded on the ECM. Finally, the floor broker or
floor trader must be an ECP or, if the floor broker or floor trader is
not an ECP, its trades on the ECM must be guaranteed by a clearing
member of a U.S.-registered clearing organization.
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\9\ Intercontinental operates an OTC commodities trading
platform for energy and metals and is itself an ECM.
Intercontinental submitted its notice of operation as an ECM to the
Commission on December 27, 2001. Intercontinental also owns the
International Petroleum Exchange (IPE), a U.K. FSA-regulated futures
exchange for the trading of energy futures products.
\10\ In its petition, Intercontinental also requested that the
Commission expand the ECE category to include U.K. local member
floor traders who are authorized by the U.K. Financial Services
Authority. On November 1, 2001, Intercontinental advised Commission
staff that it has decided not to seek relief at this time on behalf
of non-U.S. floor brokers or floor traders. Accordingly, the
Commission is not, at this time, making any determination with
respect to non-U.S. floor brokers and floor traders.
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Intercontinental stated that including floor brokers and floor
traders as ECEs would be consistent with the CFMA and would recognize
their value as both liquidity providers, and dealers and market makers.
Intercontinental noted that the Commission has previously included
floor brokers and floor traders in the definition of ECE as it relates
to trading on a Derivatives Transaction Execution Facility (DTEF),\11\
and contended that there is no meaningful distinction between allowing
floor brokers and floor traders to trade as ECEs on a DTEF and allowing
them to trade as ECEs on an ECM.\12\
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\11\ Specifically, Commission regulation 37.1(b) states that,
for the purpose of DTEF trading, ``the term `eligible commercial
entity' means, and shall include, in addition to a party or entity
so defined in section 1a(11) of the Act, a registered floor trader
or floor broker trading for its own account, whose trading
obligations are guaranteed by a registered futures commission
merchant.''
\12\ DTEFs are registered with the Commission and generally must
meet various standards of operation set forth in section 5a of the
Act and part 37 of the Commission's regulations and are subject to
the Commission's regulatory oversight. By comparison, ECMs are
exempt from Commission regulatory oversight. While ECMs must submit
to the Commission a notice of operation that satisfies the filing
requirements of section 2(h)(5) of the Act and Commission regulation
36.3, ECMs are not ``registered with, or designated, recognized,
licensed or approved by the Commission.'' See section 2(h)(5) of the
Act.
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C. Comments
The NYMEX and Intercontinental petitions were published in the
Federal Register for a 15-day public comment period on June 19,
2002.\13\ In addition, the Federal Register release included a series
of questions posed by the Commission regarding the petitions. The
Commission received comments from NYMEX and from Intercontinental.\14\
In its comment letter of July 17, 2002, NYMEX generally reaffirmed its
strong interest in the determination requested in the petition and its
strong belief that such a determination would have numerous pro-
competitive results. NYMEX also commented that Intercontinental's
petition contained fewer conditions than NYMEX's petition for the
recognition of registered floor brokers and floor traders as ECEs for
trading on ECMs. Thus, NYMEX requested that if the Commission made a
determination along the lines proposed in the Intercontinental petition
for registered floor brokers and floor traders generally, NYMEX floor
brokers and floor traders be permitted to trade on ECMs consistent with
the scope of that determination.
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\13\ 67 FR 41698 (June 19, 2002). In that same Federal Register
release, the Commission also requested comments with respect to
NYMEX's request that the Commission make a determination pursuant to
section 1a(12)(C) of the Act that NYMEX floor brokers and floor
traders, when acting in a proprietary capacity, may also be
considered to be ECPs when they enter into certain specified
transactions. Such a determination would permit NYMEX floor brokers
and floor traders to enter into over-the-counter (OTC) transactions
in exempt commodities pursuant to section 2(h)(1) of the Act.
\14\ The Commission also received a comment letter, dated
September 27, 2002, from the Managing Member of Hudson Capital
Group, L.L.C., an options trading group. The commenter strongly
supported the petition to allow NYMEX members to trade over-the-
counter energy products, but did not address particular Commission
questions.
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In its comment letter of July 3, 2002, Intercontinental generally
noted that under the Act, ECEs include: Certain types of ECPs who, in
connection with their businesses, make or take delivery of the
underlying commodity or provide hedging and risk management services in
the commodity; ECPs other than natural persons or state or local
governments that regularly enter into transactions in commodity
derivatives; and certain types of investment funds. Intercontinental
stated that the Commission, under section 1a(11)(C), has the authority
to include within the ECE definition floor brokers and floor traders
and, as previously noted, has already issued a rule pursuant to this
authority with respect to DTEFs. Intercontinental suggested that any
relief mandated by the Commission in response to the petition be
broadly based and applicable to any floor brokers or floor traders that
wish to be considered to be ECEs for purposes of trading on an ECM.
Intercontinental also responded to a series of questions posed by
the Commission. The questions and responses are summarized below:
1. The Commission understands that at some ECMs traders have the
capability of specifying the entities that are acceptable
counterparties. In light of this capability, would it be reasonable and
prudent to maintain a restriction on eligible counterparties, i.e.,
limit trading by floor brokers and floor traders acting as ECEs such
that the counterparties to their trades must not be floor brokers or
floor traders, at least with respect to ECMs that provide for such a
counterparty pre-approval mechanism.
Intercontinental responded that the Commission should not impose
restrictions on eligible counterparties for ECMs, other than requiring
that they qualify as ECEs. Intercontinental stated that it provides
credit and risk management support capabilities, designed to provide
market participants with maximum flexibility and control over their
trades, as a service to its participants at no additional cost. ECEs
can pre-approve trading counterparties and establish credit limits for
trading with each counterparty. Use of this credit management system is
voluntary, and Intercontinental is not required, by contract or
applicable law or regulation, to maintain these capabilities.
Intercontinental noted that because participation on its trading
platform is limited to ECEs, all participants are
[[Page 2322]]
sufficiently sophisticated to make their own credit determinations with
respect to other participants. In addition, requiring maintenance of a
function that ECM and market participants might later decide is
unnecessary would limit the flexibility of ECMs and is unwarranted.
Intercontinental also noted that the Commission currently does not
impose any counterparty restrictions on trades executed on its trading
platform. Finally, Intercontinental noted that its proposal requires
that floor brokers and floor traders must qualify as ECPs or have their
trades be guaranteed by a clearing member of a registered clearing
organization that is itself an ECP, and that the satisfaction of these
requirements reduces any concern by potential counterparties with
respect to the credit or collection risk posed by the execution of
trades with floor brokers and floor traders.\15\
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\15\ The requirement that the clearing member guaranteeing the
trades must itself be an ECP was not included as a criterion in the
original petition but was added in Intercontinental's comment letter
dated July 3, 2002.
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2. The Commission requested comments regarding whether the
transactions that could be entered into by floor brokers and floor
traders as ECEs on ECMs should be limited to any of the following: (a)
Specifically identified contracts; (b) transactions that would be
cleared; (c) commodities in which the floor broker or floor trader had
trading expertise; (d) transactions for which the floor broker or floor
trader was guaranteed by an Exchange clearing member; or (e) in some
other way.
With respect to a limitation to specifically identified contracts,
Intercontinental stated that floor brokers and floor traders should be
permitted to execute transactions in all exempt commodities pursuant to
section 2(h)(3) of the Act. Intercontinental noted that the Act, as
amended by the CFMA, generally defines three categories of ECE: (a)
Commercials who deal in the underlying physical commodity; (b) dealers
and market makers; and (c) collective investment vehicles that
generally are liquidity providers. Intercontinental contended that the
second and third categories of ECE recognize that traders with no
direct connection to the underlying physical market are eligible and
valuable contributors to the efficiency of commercial markets.\16\
Accordingly, Intercontinental further contended that including floor
brokers and floor traders as ECEs would be consistent with the CFMA and
would recognize the value of floor brokers and floor traders as both
liquidity providers, and dealers and market makers. Intercontinental
noted that floor brokers and floor traders understand trading markets,
are sophisticated and capable as traders to the same extent as
commercials, and would be valuable participants trading in all exempt
commodities on Intercontinental's trading platform.
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\16\ The Commission notes that, while it is not agreeing or
disagreeing with this assertion at this time, the two general
categories of ECE identified by Intercontinental require, by
statute, a strong connection to either derivatives transactions in
the particular commodity or the underlying physical market. Under
paragraph 1a(11)(A), the ECP that can qualify as an ECE based upon
dealing or engaging in market-making activities must be an entity
(floor brokers, floor traders and individuals are ineligible) that,
in connection with its business, regularly provides risk management
or hedging services or engages in market-making activities with
other ECEs involving transactions to purchase or sell the commodity
or derivative agreements, contracts, or transactions in the
commodity. Under paragraph 1a(11)(B), the ECP that can qualify as an
ECE based upon its status as a collective investment vehicle cannot
be a natural person and regularly enters into transactions to
purchase or sell the commodity or derivative agreements, contracts,
or transactions in the commodity.
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With respect to requiring that transactions be cleared,
Intercontinental stated that floor broker and floor trader transactions
on ECMs should not be required to be cleared in order for these
entities to be included in the ECE definition. The reduction in credit
risk that clearing provides would not be necessary in light of
Intercontinental's proposed requirement that the floor broker or floor
trader must be an ECP or that its trades must be guaranteed by a
clearing member of a registered clearing organization that is itself an
ECP.\17\
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\17\ As previously noted, the requirement that the clearing
member guaranteeing the trades must itself be an ECP was added in
Intercontinental's comment.
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As to limiting floor brokers and floor traders to trading only
those commodities in which they have trading expertise,
Intercontinental argued that floor brokers and floor traders are
desirable because of their expertise in trading, not their specific
commodity expertise, and should not be limited to trading in particular
commodities in which they have trading expertise. Intercontinental
pointed out that its proposal would require floor brokers and floor
traders to be registered and have as a part of their business the
business of acting as a floor broker or floor trader on the DCM's open
outcry market or performing an equivalent function on the DCM's
electronic market \18\ and that, accordingly, floor brokers and floor
traders that satisfied these requirements would have sufficient
qualifications and experience to trade in any commodity product on an
ECM. Intercontinental contended that allowing floor brokers and floor
traders to participate would expand the pool of potential
counterparties for market participants, increase competition and
efficiency, enhance price discovery and reduce liquidity risk.
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\18\ The provision concerning performing an equivalent function
on the electronic market was not included as a criterion in the
original petition, but was added in Intercontinental's November 1,
2002, submission. Intercontinental represents that the intent is to
include those floor brokers and floor traders who, as part of their
business, provide liquidity to the markets as dealers and market
makers, either on the exchange's open outcry market or on the
exchange's electronic market.
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With respect to a limitation to transactions for which the floor
broker or floor trader was guaranteed by an Exchange clearing member,
the Intercontinental proposal would require that the floor broker or
floor trader must be an ECP or that its trades must be guaranteed by a
clearing member of a registered clearing organization that is itself an
ECP. Intercontinental stated that when a floor broker or floor trader
qualifies as an ECP, that floor broker or floor trader has been deemed
by the Act to be sufficiently responsible to execute trades and there
is no need to require further mitigation of credit risk by having a
clearing member guarantee the floor broker's or floor trader's payment
obligations. Alternatively, when a floor broker or floor trader does
not qualify as an ECP, it is appropriate to require that a clearing
member of a registered clearing organization that is itself an ECP
guarantee the trades in order to mitigate the credit and collection
risk created by executing trades with a floor broker or floor trader.
3. The Commission requested comment on the assertion that there
would be no meaningful distinction between allowing floor brokers and
floor traders to trade as ECEs on a DTEF, as the Commission has already
permitted, as compared to trading as ECEs on an ECM, and particularly
on whether there should be any distinction in the treatment of floor
brokers and floor traders as ECEs based upon the different regulatory
regimes applicable to DTEFs and ECMs.
Intercontinental commented that the primary regulatory difference
between ECMs and DTEFs is that DTEFs must comply with certain core
principles, including monitoring trading and enforcing compliance with
rules; making certain trade data publicly available if the Commission
determines that the contract performs a price discovery function;
recordkeeping; applying fitness requirements for board members, market
participants and
[[Page 2323]]
others; and addressing potential conflicts of interest. The regulatory
concerns addressed by these core principles primarily relate to the
protection of the integrity of DTEF markets rather than particular
participants within those markets.
Intercontinental stated that the current ECM regulatory framework
similarly provides the Commission with sufficient authority to protect
the integrity of the market.\19\ Intercontinental pointed out that the
Commission has real-time access to Intercontinental's trading screens
and can observe and evaluate prices and trading activity on a real-time
basis. In the event that the Commission detected possible problems in
the market, such as manipulation or attempted manipulation, it has the
authority to take action against the appropriate market participants.
Intercontinental further noted that the Commission also retains anti-
fraud authority with respect to transactions on ECMs.
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\19\ Pursuant to paragraph 2(h)(5)(F) of the Act, an ECM shall
not represent to any person that the facility is registered with, or
designated, recognized, licensed or approved by the Commission.
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Intercontinental noted that since trading on its trading platform
is entirely electronic, there are no trading rules to be enforced
because buy and sell orders are electronically matched by the platform.
Intercontinental represented that it applies rigorous standards to the
selection of directors and all of its board members have significant
experience in the commodity trading industry and many are executives of
major corporations in the industry. Intercontinental concluded that the
participation of floor brokers and floor traders would not require any
additional regulation beyond that which already applies to ECMs under
Sections 2(h)(3)-(5) and that this approach is consistent with the CFMA
which was designed, in part, to provide a more flexible and less
burdensome regulatory framework for futures and derivatives
markets.\20\
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\20\ The Commission posed an additional question concerning ECE
treatment for non-U.S. registrants. That question and response are
not discussed here because, as previously noted, Intercontinental
has decided not to seek relief at this time on behalf of non-U.S.
floor brokers or floor traders. See note 10.
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III. Conclusion
After consideration of the NYMEX and Intercontinental petitions and
review of the comments, the Commission has determined, consistent with
the Intercontinental petition, that it is appropriate to issue an
order, pursuant to section 1a(11)(C) of the Act, that includes CFTC-
registered floor brokers and floor traders, subject to certain
conditions, within the definition of ECEs who can trade on ECMs.\21\
Although the Commission is neither agreeing nor disagreeing with
Intercontinental's contention that two of the three general categories
of ECE defined under the CFMA recognize that traders with no direct
connection to the underlying commodity are eligible and valuable
contributors to the efficiency of commercial markets,\22\ the
Commission does believe that its action is consistent with the purposes
of the CFMA and that it will provide floor brokers and floor traders
access to a wider range of products and expand the pool of potential
counterparties for ECM participants. The Commission also believes that
its action potentially could increase competition and efficiency and
reduce liquidity risk on ECMs. As noted above, the Commission has
previously determined, for purposes of trading on a DTEF, to include
within the ECE definition registered floor brokers and floor traders
trading for their own accounts, whose trading obligations are
guaranteed by a registered FCM.\23\
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\21\ The Commission notes that the Intercontinental petition is
broader is scope than the NYMEX petition in that Intercontinental
requested that, subject to the condition discussed above, all CFTC-
registered floor brokers and floor traders be included in the
definition of ECE. As previously stated, NYMEX requested that if the
Commission made a determination along the lines proposed in the
Intercontinental petition, NYMEX floor brokers and floor traders be
permitted to trade on ECMs consistent with the scope of that
determination. Accordingly, a single order addressing
Intercontinental's petition eliminates the need for an order
separately addressing the NYMEX petition.
\22\ See note 16.
\23\ Commission regulation 37.1(b).
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In order to qualify as an ECE under the Commission's order, a CFTC-
registered floor broker or floor trader must be a member of a DCM or
otherwise have trading privileges on a DCM. The floor broker or floor
trader must have as a part of its business the business of acting as a
floor broker or floor trader, either on a DCM's open outcry market or
performing an equivalent function on the DCM's electronic market, but
need not have any connection to or experience in the underlying
physical commodity. The Commission believes that the trading expertise
that floor brokers and floor traders would bring to the ECM would be
applicable to trading in any commodity product being traded. A floor
broker's or floor trader's ability to, among other things, interpret
market momentum and facilitate the adjustment of the market price to
new information, is more a function of trading expertise than of
experience in the underlying physical commodity.
The floor broker or floor trader must either be an ECP or have its
trades on the ECM guaranteed by a clearing member that is both a member
of a CFTC-registered derivatives clearing organization and an ECP. The
Commission believes that the requirement that either the floor broker
or floor trader or the guarantor of the trades must be an ECP provides
sufficient financial backing for the floor broker or floor trader and
mitigates any credit and collection risk that might otherwise arise in
executing trades with a floor broker or floor trader.\24\
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\24\ The Commission notes that although the guarantor for the
trading on the ECM, if one is required, must be a clearing member of
a CFTC-registered derivatives clearing organization, there is no
requirement that the trades thus executed must be cleared. No
liability resulting from a guarantor's guarantee of an uncleared ECM
transaction would extend to any of the guarantor's fellow clearing
members. The Commission also notes that the guarantor could restrict
or otherwise condition the trading for which the guarantee is
provided. The guarantor could, for instance, limit trading to
certain commodities or ECMs, place financial limits on overall or
daily positions, or restrict trading by number or size of acceptable
transactions.
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IV. Cost Benefit Analysis
Section 15 of the Act, as amended by section 119 of the CFMA,
requires the Commission to consider the costs and benefits of its
action before issuing a new regulation or order under the Act. By its
terms, section 15 does not require the Commission to quantify the costs
and benefits of its action or to determine whether the benefits of the
action outweigh its costs. Rather, section 15 simply requires the
Commission to ``consider the costs and benefits'' of the subject rule
or order.
Section 15(a) further specifies that the costs and benefits of the
proposed rule or order 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 of concern and may, in its discretion, determine that,
notwithstanding its costs, a particular rule or order is necessary or
appropriate to protect the public interest or to effectuate any of the
provisions or to accomplish any of the purposes of the Act.
The order is intended to reduce regulatory barriers to permit CFTC-
registered floor brokers and floor traders, when acting in a
proprietary capacity, to enter into transactions in
[[Page 2324]]
exempt commodities on exempt commercial markets pursuant to section
2(h)(3) of the Act if such entities are either eligible contract
participants or have obtained a financial guarantee for such
transactions from a clearing member that is both a member of a CFTC-
registered derivatives clearing organization and an eligible contract
participant. The Commission has considered the costs and benefits of
the order in light of the specific provisions of section 15(a) of the
Act.
A. Protection of Market Participants and the Public
The order would permit CFTC-registered floor brokers and floor
traders who are eligible contract participants, or who have guarantees
from clearing members that are members of CFTC-registered derivatives
clearing organizations and are eligible contract participants, to enter
into proprietary transactions in exempt commodities on exempt
commercial markets. Under the Act, eligible commercial entities involve
sophisticated investors who have the financial wherewithal or trading
expertise to participate in these markets. Accordingly, there should be
no effect on the Commission's ability to protect market participants
and the public.
B. Efficiency and Competition
The order is expected to benefit efficiency and competition by,
among other things, increasing the flow of trading information between
contract markets and exempt commercial markets, increasing the pool of
potential counterparties for participants trading on exempt commercial
markets, and providing essential trading expertise to the market that
enhances price discovery through both the speed and efficiency of
market adjustment to new fundamentals.
C. Financial Integrity of Futures Markets and Price Discovery
The order should have no effect, from the standpoint of imposing
costs or creating benefits, on the financial integrity of the futures
and options markets. The order should enhance the price discovery
function of such markets.
D. Sound Risk Management Practices
The order should have no effect, from the standpoint of imposing
costs, on the risk management practices of the futures and options
industry. Where the floor broker or floor trader is qualified as an
eligible contract participant, the entity has been deemed to be
sufficiently responsible to execute trades by the Act, and no further
mitigation of credit risk is necessary. Where the floor broker or floor
trader does not qualify as an eligible contract participant, the order
requires that a clearing member of a registered derivatives clearing
organization that is itself an eligible contract participant guarantee
the trades in order to mitigate the credit and collection risk.
E. Other Public Interest Considerations
The order is consistent with one of the purposes of the Act as
articulated in section 3 in that it would promote responsible
innovation and fair competition among boards of trade, other markets
and market participants.
V. Order
Upon due consideration, and pursuant to its authority under section
1a(11)(C) of the Act, the Commission hereby determines that floor
brokers or floor traders who are registered with the Commission, when
acting in a proprietary trading capacity, are appropriate persons as
defined in section 1a(11)(C) and, thus, are deemed to be eligible
commercial entities and may enter into contracts, agreements or
transactions in an exempt commodity on an exempt commercial market
under the following conditions:
1. Transactions must be executed on an exempt commercial market
that meets the requirements of section 2(h)(3)-(5) of the Act.
2. The floor broker or floor trader must be a member of a
designated contract market or otherwise have trading privileges on a
designated contract market.
3. The floor broker or floor trader must have as a part of its
business the business of acting as a floor broker or floor trader on a
designated contract market's open outcry market or performing an
equivalent function on a designated contract market's electronic
market.
4. The floor broker or floor trader must either be an eligible
contract participant or have its trades on the exempt commercial market
guaranteed by a clearing member that is a member of a Commission-
registered derivatives clearing organization and is an eligible
contract participant.
Issued in Washington, DC, on January 9, 2003, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 03-893 Filed 1-15-03; 8:45 am]
BILLING CODE 6351-01-P