2010-16212

FR Doc 2010-16212[Federal Register: July 2, 2010 (Volume 75, Number 127)]

[Notices]

[Page 38469-38478]

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

[DOCID:fr02jy10-42]

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COMMODITY FUTURES TRADING COMMISSION

Orders Finding That the Mid-C Financial Peak Contract and Mid-C

Financial Off-Peak Contract, Offered for Trading on the

IntercontinentalExchange, Inc., Perform a Significant Price Discovery

Function

AGENCY: Commodity Futures Trading Commission.

ACTION: Final orders.

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SUMMARY: On October 6, 2009, the Commodity Futures Trading Commission

(``CFTC'' or ``Commission'') published for comment in the Federal

whether the Mid-C \2\ Financial Peak (``MDC'') contract and Mid-C

Financial Off-Peak (``OMC'') contract,\3\ which are listed for trading

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''), perform 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

MDC and OMC contracts 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 51261 (October 6, 2009).

\2\ The acronym ``Mid-C'' stands for Mid-Columbia.

\3\ The Federal Register notice also requested comment on the

Mid-C Financial Peak Daily (``MPD'') contract and Mid-C Financial

Off-Peak Daily (``MXO'') contract. Those contracts will be reviewed

in a separate Federal Register release.

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DATES: Effective date: June 25, 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'') \4\

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.\5\ 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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\4\ Incorporated as Title XIII of the Food, Conservation and

Energy Act of 2008, Pub. L. 110-246, 122 Stat. 1624 (June 18, 2008).

\5\ 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.\6\ 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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\6\ 74 FR 12178 (Mar. 23, 2009); these rules became effective on

April 22, 2009.

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[[Page 38470]]

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.\7\ The issuance of such an order also triggers the

obligations, requirements and timetables prescribed in Commission rule

36.3(c)(4).\8\

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\7\ Pub. L. 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).

\8\ 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 6, 2009, the Commission published in the Federal

MDC and OMC contracts \9\ perform a significant price discovery

function and requested comment from interested parties.\10\ Comments

were received from the Federal Energy Regulatory Commission (``FERC''),

Financial Institutions Energy Group (``FIEG''), Working Group of

Commercial Energy Firms (``WGCEF''), Edison Electric Institute

(``EEI''), ICE, Western Power Trading Forum (``WPTF'') and Public

Utility Commission of Texas (``PUCT'').\11\ The comment letters from

FERC \12\ and PUCT did not directly address the issue of whether or not

the subject contracts are SPDCs. The remaining comment letters raised

substantive issues with respect to the applicability of section 2(h)(7)

to the MDC and OMC contracts and generally expressed the opinion that

the contracts are not SPDCs because they do not meet the material price

reference or material liquidity criteria for SPDC determination. These

comments are more extensively discussed below, as applicable.

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\9\ As noted above, the Federal Register notice also requested

comment on the Mid-C Financial Peak Daily (``MPD'') contract and

Mid-C Financial Off-Peak Daily (``MXO'') contract. The MPD and MXO

contracts will be addressed in a separate Federal Register release.

\10\ 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.

\11\ 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.'' 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.'' EEI is the ``association of

shareholder-owned electric companies, international affiliates and

industry associates worldwide.'' ICE is an ECM, as noted above. WPTF

describes itself as a ``broad-based membership organization

dedicated to encouraging competition in the Western power markets *

* * WTPF strives to reduce the long-run cost of electricity to

consumers throughout the region while maintaining the current high

level of system reliability.'' PUCT is the independent organization

that oversees the Electric Reliability Council of Texas (``ERCOT'')

to ``ensure nondiscriminatory access to the transmission and

distribution systems, to ensure the reliability and adequacy of the

regional electrical network, and to perform other essential market

functions.'' The comment letters are available on the Commission's

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

federalregistercomments/2009/09-011.html

\12\ FERC expressed the opinion that a determination by the

Commission that either of the subject contracts performs a

significant price discovery function ``would not appear to conflict

with FERC's exclusive jurisdiction under the Federal Power Act (FPA)

over the transmission or sale for resale of electric energy in

interstate commerce or with its other regulatory responsibilities

under the FPA'' and further that ``FERC staff will monitor proposed

SPDC determinations and advise the CFTC of any potential conflicts

with FERC's exclusive jurisdiction over RTOs, [(regional

transmission organizations)], ISOs [(independent system operators)]

or other jurisdictional entities.''

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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.\13\ 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

[[Page 38471]]

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.\14\ 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 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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\13\ In its October 6, 2009, Federal Register release, the

Commission identified material price reference and material

liquidity as the possible criteria for SPDC determination of the MDC

and OMC contracts. Arbitrage and price linkage were not identified

as possible criteria. As a result, arbitrage and price linkage will

not be discussed further in this document and the associated Orders.

\14\ 17 CFR Part 36, Appendix A.

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IV. Findings and Conclusions

The Commission's findings and conclusions with respect to the MDC

and OMC contracts are discussed separately below:

a. The Mid-C Financial Peak (MDC) Contract and the SPDC Indicia

The MDC contract is cash settled based on the arithmetic average of

the peak, day-ahead power price indicies that are reported each day in

the specified contract month. The daily price indicies are published by

ICE in its ``ICE Day Ahead Power Price Report,'' which is available on

the ECM's website. The peak-hour electricity price index on a

particular day is calculated as the volume-weighted average of

qualifying, day-ahead, peak-hour power transactions at the Mid-Columbia

hub that are traded on the ICE platform from 6 a.m. to 11 a.m. CST on

the publication date. The ICE transactions on which the daily price

index is based specify the physical delivery of power. The size of the

MDC contract is 400 megawatt hours (``MWh''), and the MDC contract is

listed for 86 months.

As the Columbia River flows through Washington State, it encounters

two federal and nine privately-owned hydroelectric dams that generate

close to 20,000 MW of power in the Northwest.\15\ With another three

dams in British Columbia, Canada, and many more on its various

tributaries, the Columbia River is the largest power-producing river in

North America. A major goal of the participants in the Mid-C

electricity market is to maximize the Columbia River's potential, along

with protecting and enhancing the non-power uses of the river. The

reliability of the electricity grid in the Northwest is coordinated by

the Northwest PowerPool (``NWPP''), which is a voluntary organization

comprised of major generating utilities serving the Northwestern United

States as well as British Columbia and Alberta, Canada.

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\15\ http://www.wpuda.org/publications/connections/hydro/

River%20Riders.pdf.

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One stretch of the Columbia River between the Grand Coulee Dam and

Priests Rapids Dam is governed by the Mid-Columbia Hourly Coordination

Agreement (``MCHCA''). The MCHCA includes seven dams \16\ and nearly

13,000 MW of generation. Specifically, the agreement defines how the

Chelan, Douglas and Grant PUDs coordinate their operations with the

Bonneville Power Administration so as to maximize power generation

while reducing fluctuations in the river's flow. A number of other

utilities that buy power from the PUDs have also signed onto the

agreement. The MCHCA was signed into effect in 1972 and renewed in 1997

for another 20 years.\17\

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\16\ The federal dams are Grand Coulee and Chief Joseph. The

remaining dams are Wells (operated by the Douglas PUD), Rocky Reach

and Rock Island (operated by the Chelan PUD), and Wanapum and Priest

Rapids (operated by the Grant PUD). The term ``PUD'' stands for a

publically-owned utility which provides essential services within a

specified area.

\17\ http://www.wpuda.org/publications/connections/hydro/

River%20Riders.pdf.

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In general, electricity is bought and sold in an auction setting on

an hourly basis at various point along the electrical grid. The price

of electricity at a particular point on the grid is called the

locational marginal price (``LMP''), which includes the cost of

producing the electricity, as well as congestion and line losses. Thus,

an LMP reflects generation costs as well as the actual cost of

supplying and delivering electricity to a specific point along the

grid.

Electricity is traded in a day-ahead market as well as in a real-

time market. Typically, the bulk of the energy transactions occur in

the day-ahead market. The day-ahead market establishes prices for

electricity that is to be delivered during the specified hour on the

following day. Day-ahead prices are determined based on generation and

energy transaction quotes offered in advance. Because the quotes are

based on supply and demand estimates, electricity needs usually are not

perfectly satisfied in the day-ahead market. On the day the electricity

is transmitted and used, auction participants typically realize that

they bought or sold either too much or too little power. A real-time

auction is operated in the Mid-C market to alleviate this problem by

servicing as a balancing mechanism. In this regard, electricity traders

use the real-time market to sell excess electricity and buy additional

power to meet demand. Only a relatively small amount of electricity is

traded in the real-time market compared with the day-ahead market.

1. Material Price Reference Criterion

The Commission's October 6, 2009, Federal Register notice

identified material price reference and material liquidity as the

potential basis for a SPDC determination with respect to the MDC

contract. The Commission considered the fact that ICE sells its price

data to market participants in a number of different packages which

vary in terms of the hubs covered, time periods, and whether the data

are daily only or historical. For example, ICE offers the ``West Power

of Day'' package 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. This package includes price data for the MDC contract.

The Commission also noted that its October 2007 Report on the

Oversight of Trading on Regulated Futures Exchanges and Exempt

Commercial Markets (``ECM Study'') found that in general, market

participants view ICE as a price discovery market for certain

electricity contracts. The study did not specify which markets

performed this function; nevertheless, the Commission determined that

the MDC contract, while not mentioned by name in the ECM Study, might

warrant further review.

The Commission explains in its Guidance to the Part 36 rules that

in evaluating a contract under the material price reference criterion,

it 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.\18\ 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

[[Page 38472]]

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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\18\ 17 CFR Part 36, Appendix A.

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The Mid-C power market is a major pricing center for electricity on

the West Coast. Traders, including producers, keep abreast of the

electricity prices in the Mid-C power market when conducting cash

deals. These traders look to a competitively determined price as an

indication of expected values of power at the Mid-C hub when entering

into cash market transaction for electricity, especially those trades

providing for physical delivery in the future. Traders use the ICE MDC

contract, as well as other ICE power contracts, to hedge cash market

positions and transactions--activities which enhance the MDC contract's

price discovery utility. The substantial volume of trading and open

interest in the MDC contract appears to attest to its use for this

purpose. While the MDC contract's settlement prices may not be the only

factor influencing spot and forward transactions, electricity traders

consider the ICE price to be a critical factor in conducting OTC

transactions.\19\ Accordingly, the MDC contract satisfies the direct

price reference test.

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\19\ In addition to referencing ICE prices, firms participating

in the Mid-C power market may rely on other cash market quotes as

well as industry publications and price indices that are published

by third-party price reporting firms in entering into power

transactions.

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The direct price reference finding also is supported by the

uniqueness of the ICE electricity prices for the Mid-C market. Day-

ahead and real-time electricity prices are reported by a number of

sources, including third-party price providers (e.g., Dow Jones &

Company). ICE's Mid-C price indices are unique in that they are derived

from transactions completed on ICE's electronic system. Moreover, ICE

is the only entity that has access to such transaction data. Thus, it

is not possible for any other firm to replicate ICE's indices.\20\

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\20\ In contrast, third-party price reporting firms typically

compute their power index prices from transaction information that

is voluntarily submitted by traders. It is possible that one trader

could submit the same transaction data to multiple price reporting

firms, whereby increasing the likelihood that price indices from

different firms are similar in value. However, it is more plausible

that the third-party price reporters' price indices would be similar

but not exactly the same because different traders are polled.

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The fact that ICE's MDC monthly contract is used more widely as a

source of pricing information rather than the daily contract (i.e., the

MPD contract)\21\ bolsters the finding of direct price reference. In

this regard, the MDC contract prices power at the Mid-C up to 86

calendar months in the future. Thus, market participants can use the

MDC contract to lock-in electricity prices far into the future. Traders

use monthly power contracts like the MDC contract to price future power

electricity commitments, where such commitments are based on long range

forecasts of power supply and demand. In contrast, the MPD contract is

listed for a much shorter length of time--up to 38 days in the future.

As generation and usage nears, market participants have a better

understanding of actual power supply and needs. As a result, they can

modify previously-established hedges with daily contracts, like the MPD

contract.

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\21\ The MPD contract is cash settled based on the peak, day-

ahead price index for the specified day, as published by ICE in its

``ICE Day Ahead Power Price Report,'' which is available on the

ECM's website. The daily peak-hour electricity price index is a

volume-weighted average of qualifying, day-ahead, peak-hour power

contracts at the Mid-Columbia hub that are traded on the ICE

platform from 6 a.m. to 11 a.m. CST on the publication date.

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The Commission notes that the Mid-C is a major trading point for

electricity, and the MDC contract's prices are well regarded in the

industry as indicative of the value of power at the Mid-C hub.

Accordingly, Commission staff believes that it is reasonable to

conclude that market participants purchase the data packages that

include the MDC contract's prices in substantial part because the MDC

contract prices have particular value to them. Moreover, such prices

are consulted on a frequent and recurring basis by industry

participants in pricing cash market transactions. In light of the

above, the MDC contract meets the indirect price reference test.

i. Federal Register Comments

WGCEF, WPTF, EEI and ICE stated that no other contract directly

references or settles to the MDC contract's price. Moreover, the

commenters argued that the underlying cash price series against which

the MDC contract is settled (in this case, the average of peak-hour

Mid-C electricity prices over the contract month, which are derived

from physical transactions) is the authentic reference price and not

the ICE contract itself. Commission staff believes that this

interpretation of price reference is too narrow and 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 Mid-C hub is a major trading center for

electricity in the western United States. Traders, including producers,

keep abreast of the prices of the MDC contract when conducting cash

deals. These traders look to a competitively determined price as an

indication of expected values of electricity at the Mid-C hub when

entering into cash market transaction for power, especially those

trades that provide for physical delivery in the future. Traders use

the ICE MDC contract to hedge cash market positions and transactions,

which enhances the MDC contract's price discovery utility. While the

MDC contract's settlement prices may not be the only factor influencing

spot and forward transactions, natural gas traders consider the ICE

price to be a crucial factor in conducting OTC transactions.

In addition, WGCEF stated that the publication of price data for

the MDC contract price is weak justification for material price

reference. This commenter argued that market participants generally do

not purchase ICE data sets for one contract's prices, such as those for

the MDC contract. Instead, traders are interested in the settlement

prices, so the fact that ICE sells the MDC prices as part of a broad

package is not conclusive evidence that market participants are buying

the ICE data sets because they find the MDC prices have substantial

value to them. As noted above, the Commission notes that publication of

the MDC contract's prices is indirect evidence of routine

dissemination. The MDC contract's prices, while sold as a package, are

of particular interest to market participants. Thus, the Commission has

[[Page 38473]]

concluded that traders likely purchase the ICE data packages

specifically for the MDC contract's prices and consult such prices on a

frequent and recurring basis in pricing cash market transactions.

Lastly, EEI observed that the ECM Study did not specifically

identify the MDC contract as a contract that is referred to by market

participants on a frequent and recurring basis. The Commission cited

the ECM Study's general finding that some ICE electricity contracts

appear to be regarded as price discovery markets merely as indication

that an investigation of certain ICE contracts may be warranted. The

ECM Study was not intended to serve, and did not serve as the sole

basis for determining whether or not a particular contract meets the

material price reference criterion.

ii. Conclusion Regarding Material Price Reference

Based on the above, the Commission finds that the ICE MDC contract

meets the material price reference criterion because cash market

transactions are priced either explicitly or implicitly on a frequent

and recurring basis at a differential to the MDC contract's price

(direct evidence). Moreover, the MDC contract's price data are sold to

market participants, and those individuals likely purchase the ICE data

packages specifically for the MDC contract's prices and consult such

prices on a frequent and recurring basis in pricing cash market

transactions (indirect evidence).

2. Material Liquidity Criterion

As noted above, in its October 6, 2009, Federal Register notice,

the Commission identified material price reference and material

liquidity as potential criteria for SPDC determination of the MDC

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 changes to the subject-contract's prices potentially may

have on prices for other contracts listed on an ECM or a DCM.\22\

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\22\ As noted above, the material liquidity criterion speaks to

the effect that transactions in the potential SPDC may have on

trading in ``agreements, contracts and transactions listed for

trading on or subject to the rules of a designated contract market,

a derivatives transaction execution facility, or an electronic

trading facility operating in reliance on the exemption in section

2(h)(3) of the Act.''

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The total number of transactions executed on ICE's electronic

platform in the MDC contract was 2,022 in the second quarter of 2009,

resulting in a daily average of 31.6 trades. During the same period,

the MDC contract had a total trading volume of 67,400 contracts and an

average daily trading volume of 1,053.1 contracts. Moreover, open

interest as of June 30, 2009, was 169,851 contracts, which included

trades executed on ICE's electronic trading platform, as well as trades

executed off of ICE's electronic trading platform and then brought to

ICE for clearing. In this regard, ICE does not differentiate between

open interest created by a transaction executed on its trading platform

and that created by a transaction executed off its trading

platform.\23\

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\23\ 74 FR 51261 (October 6, 2009).

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In a subsequent filing dated March 24, 2010, ICE reported that

total trading volume in the fourth quarter of 2009 was 142,700

contracts (or 2,195 contracts on a daily basis). In terms of number of

transactions, 2,975 trades occurred in the fourth quarter of 2009 (46

trades per day). As of December 31, 2009, open interest in the MDC

contract was 221,608 contracts, which included trades executed on ICE's

electronic trading platform, as well as trades executed off of ICE's

electronic trading platform and then brought to ICE for clearing.

Trading activity in the MDC contract, as characterized by total

quarterly volume, indicates that the MDC contract experiences trading

activity that is significantly greater than that of minor futures

markets.\24\ Thus, it is reasonable to infer that the MDC contract

could have a material effect on other ECM contracts or on DCM

contracts.

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\24\ 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.

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To measure the potential effect of the MDC contract on another ECM

contract staff performed a statistical analysis \25\ using daily

settlement prices between July 1, 2008, and December 31, 2009, for the

ICE MDC and OMC contracts. The simulation suggests that, on average

over the sample period, a one percent rise in the MDC contract's price

elicited a 1.09 percent increase in ICE OMC contract's price.

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\25\ Specifically, Commission staff econometrically estimated a

cointegrated vector autoregression (CVAR) model using daily

settlement prices. CVAR methods permit a dichotomization of the data

relationships into long-run equilibrium components (called the

cointegration space or cointegrating relationships) and a short-run

component. A CVAR model was chosen over the more traditional vector

autoregression model in levels because the statistical properties of

the data (lack of stationarity and ergodicity) precluded the more

traditional modeling treatment. Moreover, the statistical properties

of the data necessitated the modeling of the contracts' prices as a

CVAR model containing both first differences (to handle

stationarity) and an error-correction term to capture long run

equilibrium relationships. The prices were treated as a single

reduced-form model in order to test hypothesis that power prices in

the same market affect each other. The prices of ICE's MDC and OMC

contracts are positively related to each other in a cointegrating

relationship and display a high level of statistical strength. On

average during the sample period, each percentage rise in MDC

contract's price elicited a 1.09 percent rise in OMC contract's

price.

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i. Federal Register Comments

ICE and WGCEF stated that the MDC contract lacks a sufficient

number of trades to meet the material liquidity criterion. These two

commenters, along with WPTF, FEIG and EEI argued that the MDC contract

cannot have a material effect on other contracts, such as those listed

for trading by the New York Mercantile Exchange (``NYMEX''), a DCM. The

commenters pointed out that it is not possible for the MDC contract to

affect a DCM contract because price linkage and the potential for

arbitrage do not exist. The DCM contracts do not cash settle based on

the MDC contract's price. Instead, the DCM contracts and the MDC

contract are both cash settled based on physical transactions, which

the ECM and DCM contracts cannot influence. The Commission's

statistical analysis shows that changes in the ICE MDC contract's price

significantly influences the prices of other ECM contracts (namely, the

OMC contract).

WGCEF and ICE noted that the Commission's Guidance had posited

concepts of liquidity that generally assumed a fairly constant stream

of prices throughout the trading day, and noted that the relatively low

number of trades per day in the MDC 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.'' \26\

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\26\ Guidance, supra.

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ICE opined that the Commission ``seems to have adopted a five trade

per day test for material liquidity.'' To the contrary, the Commission

adopted a five trades-per-day threshold as a reporting

[[Page 38474]]

requirement to enable it to ``independently be aware of ECM contracts

that may develop into SPDCs'' \27\ rather than solely relying upon an

ECM to identify potential SPDCs to the Commission. Thus, any contract

that meets this threshold may be subject to scrutiny as a potential

SPDC; however, the contract will not be found to be a SPDC merely

because it met the reporting threshold.

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\27\ 73 FR 75892 (December 12, 2008).

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ICE asserted 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'' as well as in strips of

contract months. ICE suggested that a more appropriate method of

determining liquidity is to examine the activity in a single traded

month of a given contract.'' \28\ It is the Commission's opinion that

liquidity, as it pertains to the MDC contract, is typically a function

of trading activity in particular lead months and, given sufficient

liquidity in such months, the ICE MDC contract itself would be

considered liquid.

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\28\ In addition, 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 6, 2009, Federal Register

notice included 2(h)(1) transactions, which were not completed on

the electronic trading platform and should not be considered in the

SPDC determination process. 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 54 percent of all

transactions in the MDC contract. The Commission acknowledges that

the open interest information it provided in its October 6, 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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ii. Conclusion Regarding Material Liquidity

For the reasons discussed above, the Commission finds that the MDC

meets the material liquidity criterion. Specifically, there is

sufficient trading activity in the MDC contract to have a material

effect on ``other agreements, contracts or transactions listed for

trading on or subject to the rules of a designated contract market * *

* or an electronic trading facility operating in reliance on the

exemption in section 2(h)(3) of the Act.''

3. Overall Conclusion Regarding the MDC Contract

After considering the entire record in this matter, including the

comments received, the Commission has determined that the MDC contract

performs a significant price discovery function under two of the four

criteria established in section 2(h)(7) of the CEA. The Commission has

concluded that the MDC contract meets both the material price reference

and material liquidity criteria. Accordingly, the Commission is issuing

the attached Order declaring that the MDC contract is a SPDC.

Issuance of this Order signals the immediate effectiveness of the

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

connection with its MDC contract,\29\ and triggers the obligations,

requirements--both procedural and substantive--and timetables

prescribed in Commission rule 36.3(c)(4) for ECMs.

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\29\ See 73 FR 75888, 75893 (Dec. 12, 2008).

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b. The Mid-C Financial Off-Peak (OMC) Contract and the SPDC Indicia

The OMC contract is cash settled based on the arithmetic average of

the off-peak, day-ahead power price indices that are reported each day

in the specified contract month. The daily price indices are published

by ICE in its ``ICE Day Ahead Power Price Report,'' which is available

on the ECM's website. The off-peak hour electricity price index on a

particular day is calculated as the volume-weighted average of

qualifying, day-ahead, off-peak hour power transactions at the Mid-

Columbia hub that are traded on the ICE platform from 6 a.m. to 11 a.m.

CST on the publication date. The ICE transactions on which the price

index is based specify the physical delivery of power. The size of the

OMC contract is 25 MWh, and the OMC contract is listed for 86 months.

As the Columbia River flows through Washington State, it encounters

two federal and nine privately-owned hydroelectric dams that generate

close to 20,000 MW of power in the Northwest.\30\ With another three

dams in British Columbia, Canada, and many more on its various

tributaries, the Columbia River is the largest power-producing river in

North America. A major goal of the participants in the Mid-C

electricity market is to maximize the Columbia River's potential, along

with protecting and enhancing the non-power uses of the river. The

reliability of the electricity grid in the Northwest is coordinated by

the NWPP.

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\30\ http://www.wpuda.org/publications/connections/hydro/

River%20Riders.pdf.

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One stretch of the Columbia River between the Grand Coulee Dam and

Priests Rapids Dam is governed by the MCHCA. The MCHCA includes seven

dams \31\ and nearly 13,000 MW of generation. Specifically, the

agreement defines how the Chelan, Douglas and Grant PUDs coordinate

their operations with the Bonneville Power Administration to maximize

power generation while reducing fluctuations in the river's flow. A

number of other utilities that buy power from the PUDs have also signed

onto the agreement. The MCHCA agreement was signed into effect in 1972

and renewed in 1997 for 20 years.\32\

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\31\ The federal dams are Grand Coulee and Chief Joseph. The

remaining dams are Wells (operated by the Douglas PUD), Rocky Reach

and Rock Island (operated by the Chelan PUD), and Wanapum and Priest

Rapids (operated by the Grant PUD).

\32\ http://www.wpuda.org/publications/connections/hydro/

River%20Riders.pdf.

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In general, electricity is bought and sold in an auction setting on

an hourly basis at various point along the electrical grid. The price

of electricity at a particular point on the grid is called the LMP,

which includes the cost of producing the electricity, as well as

congestion and line losses. Thus, an LMP reflects generation costs as

well as the actual cost of supplying and delivering electricity to a

specific point along the grid.

Electricity is traded in a day-ahead market as well as a real-time

market. Typically, the bulk of the energy transactions occur in the

day-ahead market. The day-ahead market establishes prices for

electricity that is to be delivered during the specified hour on the

following day. Day-ahead prices are determined based on generation and

energy transaction quotes offered in advance. Because the quotes are

based on estimates of supply and demand, electricity needs usually are

not perfectly satisfied in the day-ahead market. On the day the

electricity is transmitted and used, auction participants usually

realize that they bought or sold either too much power or too little

power. A real-time auction is operated in the Mid-C market to alleviate

this problem by servicing as a balancing mechanism. In this regard,

electricity traders use the real-time market to sell excess electricity

and buy additional power to meet demand. Only a relatively small amount

of electricity is traded in the real-time market compared with the day-

ahead market.

[[Page 38475]]

1. Material Price Reference Criterion

The Commission's October 6, 2009, Federal Register notice

identified material price reference and material liquidity as the

potential basis for a SPDC determination with respect to the OMC

contract. The Commission considered the fact that ICE sells its price

data to market participants in a number of different packages which

vary in terms of the hubs covered, time periods, and whether the data

are daily only or historical. For example, ICE offers the ``West Power

of Day'' package 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. This package includes price data for the OMC contract.

The Commission also noted that its October 2007 ECM Study found

that in general, market participants view ICE as a price discovery

market for certain electricity contracts. The study did not specify

which markets performed this function; nevertheless, the Commission

determined that the OMC contract, while not mentioned by name in the

ECM Study, might warrant further review.

The Commission explains in its Guidance to the Part 36 rules that

in evaluating a contract under the material price reference criterion,

it 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.\33\ 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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\33\ 17 CFR Part 36, Appendix A.

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The Mid-C power market is a major pricing center for electricity on

the West Coast. Traders, including producers, keep abreast of the

electricity prices in the Mid-C power market when conducting cash

deals. These traders look to a competitively determined price as an

indication of expected values of power at the Mid-C hub when entering

into cash market transaction for electricity, especially those trades

providing for physical delivery in the future. Traders use the ICE OMC

contract, as well as other ICE power contracts, to hedge cash market

positions and transactions--activities which enhance the OMC contract's

price discovery utility. The substantial volume of trading and open

interest in the OMC contract appears to attest to its use for this

purpose. While the OMC contract's settlement prices may not be the only

factor influencing spot and forward transactions, power traders

consider the ICE price to be a critical factor in conducting OTC

transactions.\34\ As a result, the OMC contract satisfies the direct

price reference test.

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\34\ In addition to referencing ICE prices, firms participating

in the Mid-C power market may rely on other cash market quotes as

well as industry publications and price indices that are published

by third-party price reporting firms in entering into power

transactions.

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Another reason that bolsters the direct price reference claim is

related to the uniqueness of the ICE electricity prices for the Mid-C

market. Day-ahead and real-time electricity prices are reported by a

number of sources, including third-party price providers (e.g., Dow

Jones & Company). ICE's Mid-C price indices are unique in that they are

derived from transactions completed on ICE's electronic system.

Moreover, ICE is the only entity that has access to such transaction

data. Thus, it is not possible for any other firm to replicate ICE's

indices.\35\

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\35\ In contrast, third-party price reporting firms typically