[Federal Register Volume 68, Number 11 (Thursday, January 16, 2003)]
[Notices]
[Pages 2319-2324]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-893]


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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.
---------------------------------------------------------------------------

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