[Federal Register Volume 68, Number 23 (Tuesday, February 4, 2003)]
[Notices]
[Pages 5621-5625]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-2507]


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COMMODITY FUTURES TRADING COMMISSION


In the Matter of the New York Mercantile Exchange, Inc. Petition 
for Interpretation Pursuant to Section 1a(12)(C) of the Commodity 
Exchange Act

AGENCY: Commodity Futures Trading Commission.

ACTION: Order.

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SUMMARY: In response to a petition from the New York Mercantile 
Exchange, Inc. (NYMEX or Exchange) the Commodity Futures Trading 
Commission (Commission), pursuant to section 1a(12)(C) of the Commodity 
Exchange Act (Act), is issuing an order that deems, subject to certain 
conditions, Exchange floor brokers and floor traders who are registered 
with the Commission, when acting in a proprietary trading capacity, to 
be ``eligible contract participants'' as that term is defined in 
section 1a(12) of the Act. Accordingly, subject to certain conditions 
as set forth in the Commission's order, NYMEX floor brokers and floor 
traders (collectively referred to hereafter as floor members), when 
acting for their own accounts, are permitted to enter into certain 
specified over-the-counter (OTC) transactions in exempt commodities 
pursuant to section 2(h)(1) of the Act. In order to participate, the 
floor member must have its OTC trades guaranteed by, and cleared at 
NYMEX by, an Exchange clearing member that is registered with the 
Commission as a futures commission merchant (FCM) and that meets 
certain minimum working capital requirements. The order is effective 
for a two-year period.

DATES: This order is effective February 4, 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(12) of the Act, as amended by the Commodity Futures 
Modernization Act of 2000 (CFMA), Pub. L. 106-554, which was signed 
into law on December 21, 2000, defines the term ``eligible contract 
participant'' (ECP) by listing those entities and individuals 
considered to be ECPs.\1\ Under sections 2(d)(1), 2(g), and 2(h)(1) of 
the Act, OTC transactions \2\ entered

[[Page 5622]]

into by ECPs in an ``excluded commodity'' or an ``exempt commodity,'' 
as those terms are defined by the Act,\3\ are exempt from all but 
certain requirements of the Act.\4\ Floor brokers and floor traders are 
explicitly included in the ECP definition only to the extent that the 
floor broker or floor trader acts ``in connection with any transaction 
that takes place on or through the facilities of a registered entity or 
an exempt board of trade, or any affiliate thereof, on which such 
person regularly trades.'' \5\
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    \1\ Included generally in Section 1a(12) 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\ OTC transactions are transactions that are not executed on a 
trading facility. As defined in Section 1a(33)(A) of the Act, the 
term ``trading facility'' generally means ``a person or group of 
persons that constitutes, maintains, or provides a physical or 
electronic facility or system in which multiple participants have 
the ability to execute or trade agreements, contracts, or 
transactions by accepting bids and offers made by other participants 
that are open to multiple participants in the facility or system.''
    \3\ Section 1a(14) 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\ OTC transactions in excluded commodities entered into by 
ECPs pursuant to Section 2(d)(1) are generally not subject to any 
provision of the Act. OTC transactions in exempt or excluded 
commodities that are individually negotiated by ECPs pursuant to 
section 2(g) are generally not subject to any provision of the Act. 
OTC transactions in exempt commodities entered into by ECPs pursuant 
to section 2(h)(1) are generally not subject to any provision of the 
Act other than anti-manipulation provisions and anti-fraud 
provisions in certain situations.
    \5\ Section 1a(12)(A)(x) of the Act.
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    The Act, however, gives the Commission discretion to expand the ECP 
category as it deems appropriate. Specifically, section 1a(12)(C) 
provides that the list of entities defined as ECPs shall include ``any 
other person that the Commission determines to be eligible in light of 
the financial or other qualifications of the person.''

II. The NYMEX Petition

A. Introduction

    By letter dated May 23, 2002, NYMEX submitted a petition for a 
Commission interpretation pursuant to section 1a(12)(C) of the Act.\6\ 
Specifically, NYMEX, acting on behalf of Exchange floor members and 
member clearing firms, requested that the Commission make a 
determination pursuant to section 1a(12)(C) of the Act that floor 
members, when acting in a proprietary capacity, may enter into certain 
specified OTC transactions in exempt commodities pursuant to section 
2(h)(1) of the Act 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.\7\ NYMEX 
suggested that the permissible OTC transactions be limited to trading 
in a commodity that either (1) is listed only for clearing at the 
Exchange,\8\ or (2) is listed for trading and clearing at the Exchange 
and where Exchange rules provide for the exchange of futures for swaps 
(EFS) in that contract.\9\ NYMEX further proposed that such 
transactions would be subject to additional conditions and restrictions 
detailed in the petition and described below.\10\
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    \6\ In its petition, NYMEX also requested that the Commission 
make a determination pursuant to section 1a(11)(C) of the Act that 
floor members, when acting in a proprietary capacity, may also be 
considered to be eligible commercial entities (ECE) when they enter 
into certain specified transactions. Such a determination would 
permit NYMEX floor members to enter into transactions in exempt 
commodities on exempt commercial markets (ECM) pursuant to Section 
2(h)(3) of the Act. On January 9, 2003, the Commission issued 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 ECEs as that term is defined 
in Section 1a(11) of the Act. That order was published in the 
Federal Register on January 16, 2003. 68 FR 2319 (January 16, 2003).
    \7\ To qualify for the Section 2(h)(1) exemption, the 
transaction must: (1) Be in an exempt commodity, (2) be entered into 
by ECPs, and (3) not be entered into on a trading facility.
    \8\ 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 the Exchange. 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 Commission 
Regulations thereunder.
    \9\ EFS transactions are permitted at the Exchange 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.''
    \10\ NYMEX also suggested a further limitation on floor members' 
permissible transactions by not permitting, initially, any 
transactions in electricity commodities.
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    The NYMEX petition was published in the Federal Register for public 
comment on June 19, 2002. \11\ The Commission received comments from 
NYMEX and from the Intercontinental Exchange, an ECM. In its comment 
letter of July 17, 2002, NYMEX 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.\12\
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    \11\ 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(11)(C) of the Act that floor members, when acting in a 
proprietary capacity, may also be considered to be ECEs when they 
enter into certain specified transactions, as well as a petition 
filed by the Intercontinental Exchange, Inc., requesting that the 
Commission issue an order pursuant to section 1a(11) that would 
expand the ECE category to include floor brokers and floor traders 
registered as such in the U.S. or with the U.K. Financial Services 
Authority. As previously noted, on January 9, 2003, the Commission 
issued 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 ECEs as that 
term is defined in section 1a(11) of the Act.
    \12\ 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 OTC energy 
products.
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B. Public Interest Considerations

    In its petition, NYMEX stated that the requested determination is 
best considered against the overall context of the connection between 
the OTC and exchange markets, and that it is good public policy for the 
Commission to permit the strengthening of these ties when it is 
possible to do so. The petition stated that NYMEX has concluded that 
the ability of its floor members to trade OTC transactions pursuant to 
an FCM guarantee, particularly OTC swaps involving NYMEX or NYMEX 
``look-alike'' products, is a pivotal component, for the four reasons 
described below, of the Exchange's business strategy to better serve 
its customers.
    First, NYMEX stated that permitting its floor members to enter into 
OTC swaps would enhance their ability to provide liquidity to the 
Exchange's markets. Second, NYMEX stated that access to OTC markets 
would enhance floor members' ability to make tight markets in new 
Exchange products that would compete against the standardized look-
alike contracts traded in the OTC markets.\13\ Third, NYMEX stated that 
permitting its floor members to enter into EFS transactions with OTC 
counterparties would expand the pool of potential counterparties for 
OTC market participants and facilitate liquidity in the OTC 
marketplace. Finally, with respect to the clearing of OTC transactions, 
the Exchange intends that the open positions in futures

[[Page 5623]]

contracts created by the exchange of an OTC swap for a NYMEX future 
would be offset by an opposite transaction in the OTC market, thus 
providing a larger pool of market participants who would enter into a 
transaction initiating or liquidating a position on the Exchange.
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    \13\ In this regard, the petition states that 80 to 90 percent 
of energy swaps transactions involve standardized economic terms.
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    With respect to the economic impact on OTC markets, the petition 
stated that permitting floor members to trade OTC transactions would 
increase competition and efficiency, enhance price discovery, and 
reduce the liquidity risk and the resultant increased market risk that 
arises from artificial barriers to entry in the markets. NYMEX stated 
that floor members participating in the OTC markets would perform the 
same functions they perform in the Exchange market including, among 
others, enhancing price discovery through the speed and efficiency of 
market adjustment to new fundamentals and facilitating adjustment of 
the market price to new information.

C. NYMEX's Analysis of the ECP Definition

    In its petition, NYMEX contended that section 1a(12) of the Act 
supports its requested treatment of floor members as ECPs for a number 
of reasons. First, NYMEX stated that the treatment of floor members 
under the section 1a(12) ECP definition appears to be inconsistent in 
that it treats floor members differently based upon how they organize 
their businesses. Specifically, floor members who operate as natural 
persons are only considered ECPs if they satisfy a total asset 
standard.\14\ By comparison, floor members that are organized as 
partnerships or proprietorships are considered ECPs if they are 
guaranteed by a specified entity and are not required to meet any total 
asset requirement.\15\ The Exchange represented that floor trader 
registrations are generally made in the name of the individual and that 
exchange membership or seat ownership historically has been held in the 
name of one individual.\16\
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    \14\ Section 1a(12)(A)(xi) provides that an individual who meets 
either of two total asset tests is an ECP. An individual must either 
have total assets in an amount in excess of $10,000,000, or of 
$5,000,000 and enter ``into the agreement, contract, or transaction 
in order to manage the risk associated with an asset owned or 
liability incurred, or reasonably likely to be owned or incurred, by 
the individual.''
    \15\ Section 1a(12)(A)(v) provides that a corporation, 
partnership, proprietorship, organization, trust, or other entity 
that meets one of three tests is an ECP. The entity must either (1) 
have total assets exceeding $10,000,000; (2) have its obligations 
guaranteed or otherwise supported by (subject to total assets or 
other requirements) a financial institution, insurance company, 
investment company, commodity pool, or governmental entity; or (3) 
have a net worth exceeding $1,000,000 and enter ``into an agreement, 
contract, or transaction in connection with the conduct of the 
entity's business or to manage the risk associated with an asset 
owned or liability incurred or reasonably likely to be owned or 
incurred by the entity in the conduct of the entity's business.''
    \16\ NYMEX's argument on this point is premised on the 
assumption that floor brokers and floor traders may alternatively 
qualify as ECPs under provisions of the ECP definition that 
specifically refer to ``a corporation, partnership, proprietorship, 
organization, trust, or other entity'' (section 1a(12)(A)(v)) and to 
``an individual'' (section 1a(12)(A)(xi)). At present, the 
Commission is neither accepting nor rejecting the Exchange's 
interpretation of the ECP definition, but is exercising the 
authority granted under section 1a(12)(C). As previously noted, the 
only provision of the ECP definition that specifically refers to 
floor brokers or floor traders is section 1a(12)(A)(x), which 
includes within the definition of ECP a floor broker or floor trader 
to the extent that the floor broker or floor trader acts in 
connection with any transaction that takes place on or through the 
facilities of a registered entity or an exempt board of trade, or 
any affiliate thereof, on which such person regularly trades.
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    Second, the petition stated that the treatment of floor members 
under Section 1a(12) is inconsistent with the treatment of brokers or 
dealers or foreign persons (performing similar roles or functions 
subject to foreign regulation) who are natural persons or 
proprietorships. Under section 1a(12)(viii), these persons may be 
considered to be ECPs by meeting either the total assets test of 
section 1a(12)(xi) or satisfying one of the provisions of 1a(12)(v). 
Thus, under section 1a(12)(v) a broker or dealer or foreign person 
operating as a natural person, but not a floor member similarly 
operating, is permitted to trade OTC products with a guarantee from one 
of the specified entities and without meeting any total asset 
requirements.
    Third, NYMEX contended that floor members with FCM guarantees 
should be considered ECPs because the Act permits other entities to use 
guarantees as a substitute for meeting a total assets requirement. 
Specifically, NYMEX stated that section 1a(12)(v) of the Act permits a 
corporation, partnership, proprietorship, organization, trust, or other 
entity to obtain a guarantee or support via a letter of credit from a 
financial institution, insurance company, investment company, commodity 
pool, or governmental entity.
    Finally, NYMEX argued that it is reasonable for floor members to 
rely on FCMs as guarantors.\17\ Under section 1a(12)(A)(v), ``a 
corporation, partnership, proprietorship, organization, trust, or other 
entity'' may be considered an ECP if it is guaranteed by a commodity 
pool with more than $5 million in total assets. NYMEX pointed out that 
commodity pools generally are not in the business of conducting risk 
management for or providing guarantees in connection with trading in 
the OTC markets. NYMEX stated that if commodity pools are allowed to 
provide guarantees, then FCMs, who are in the business of monitoring 
trading by the Exchange members that they guarantee, should be 
permitted to provide such guarantees for floor members. NYMEX stated 
that its rules provide that each Exchange clearing member registered as 
an FCM must maintain minimum working capital of at least $5 
million.\18\
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    \17\ The Commission believes that the FCM guaranteeing the OTC 
transactions should also have the obligation to clear the 
transactions at NYMEX.
    \18\ Pursuant to NYMEX Rule 9.21(B), each clearing member 
registered with the Commission as an FCM must have and maintain 
minimum working capital equal to or in excess of the greater of $5 
million or the amount prescribed in Commission Regulation 1.17. As 
an additional safeguard for the clearing system, the Commission 
believes that a higher capitalization standard would be appropriate 
where the clearing member FCM is guaranteeing the OTC transactions 
of a floor member.
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D. Trading Restrictions and Exchange Oversight

    In its petition, NYMEX represented that it would have appropriate 
compliance systems in place to monitor OTC trading by Exchange floor 
members. Because all the permissible OTC trading subsequently would be 
cleared at the Exchange, NYMEX would be able to obtain information 
concerning the OTC transactions as part of a review of the exchange of 
futures for physicals (EFP) or the EFS transaction bringing the 
transaction to the Exchange for clearing. Failure to comply with a 
request to provide such information pursuant to the Exchange's EFP or 
EFS rules would result in a referral to the Exchange's Business Conduct 
Committee for further action.
    NYMEX also suggested that, consistent with the standards which 
already apply to floor members with respect to their trading on the 
Exchange, the Commission should provide that floor members' 
transactions in the permissible contracts that are not executed on a 
trading facility be executed only pursuant to the section 2(h)(1) 
exemption. As indicated above, all section 2(h)(1) transactions would 
be subject to the Commission's anti-manipulation provisions and, in 
certain situations, anti-fraud provisions.\19\ Finally, the Exchange 
represented that it would agree, as a condition for its members 
participating in the OTC markets, to limit OTC trading by floor members 
such that the counterparties to their trades must not be floor members

[[Page 5624]]

for contracts that are listed for trading on the Exchange. Thus, for 
example, floor members could not be counterparties in connection with 
an OTC natural gas swap to be exchanged for a futures position in the 
NYMEX Natural Gas futures contract. NYMEX floor members could be 
counterparties in connection with a Chicago Basis swap that is 
subsequently cleared at NYMEX through EFS procedures because that 
contract is listed only for clearing at the Exchange.
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    \19\ See supra note 4.
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IV. Conclusion

    After consideration of the NYMEX petition and review of the 
comments, the Commission has determined that NYMEX floor members, 
subject to certain conditions and for a two-year period commencing on 
the date of publication of the order in the Federal Register, are 
eligible to be ECPs as that term is defined in section 1a(12) of the 
Act.\20\ The floor members meet the financial qualifications of an ECP 
by having a financial guarantee for the OTC transactions from a NYMEX 
clearing member that is registered as an FCM and must satisfy certain 
minimum working capital requirements.
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    \20\ A NYMEX floor member who is determined to be an ECP based 
upon compliance with the provisions set forth in the Commission's 
order is an ECP only for the purpose of entering into transactions 
executed pursuant to Section 2(h)(1) of the Act and as described in 
the order.
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    The Commission is aware that the execution and clearing of such 
transactions has financial implications for the clearing system.\21\ 
Thus, the Commission is adding the following safeguards to limit the 
possibility of a trader entering into OTC transactions that could 
create financial difficulty for the guarantor FCM, the clearing entity 
or other clearing firms. First, the guarantor FCM must clear, at NYMEX, 
every OTC transaction for which it provides such a guarantee. Second, 
in order to assure that the guarantor FCM is adequately capitalized, 
the guarantor FCM must have and maintain at all times minimum working 
capital of at least $20 million; provided that, however, during the 
first 18 months following publication of the order a clearing member 
must have and maintain minimum working capital of at least:
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    \21\ The Commission notes that the guarantor FCM could restrict 
or otherwise condition the trading for which the guarantee is 
provided. The guarantor could, for instance, limit trading to 
certain commodities, place financial limits on overall or daily 
positions, or restrict trading by number or size of acceptable 
transactions.
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    (a) $5 million during the first twelve months of the two-year 
period; and
    (b) $10 million during the thirteenth through eighteenth months of 
the two-year period.
    If, during the 18-month period, a clearing member does not maintain 
working capital of at least $20 million, it must further reduce its 
working capital, to determine if it is in compliance with paragraphs 
(a) or (b) above, by 100 percent of the NYMEX margin requirements for 
the OTC contracts, agreements or transactions of floor brokers and 
floor traders that it is guaranteeing pursuant to the order. A clearing 
member must compute its working capital in accordance with exchange 
rules and generally accepted accounting principles consistently 
applied.\22\
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    \22\ The Commission believes that the guarantor FCM should 
ultimately have and maintain minimum working capital of $20 million, 
but is providing less-capitalized FCMs that wish to guarantee OTC 
transactions with the opportunity to do so during the 18-month 
transition period in which they increase their working capital. The 
Commission notes that the $20 million requirement is somewhat 
analogous to the eligible trader requirements for trading on a 
registered derivatives transaction execution facility (DTEF). 
Pursuant to section 5a(b)(3) of the Act, to trade on a DTEF, a 
person must either be an ECP or trade through an FCM that, among 
other things, has net capital of at least $20 million.
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    Another qualification of floor members that the Commission finds 
significant with respect to the eligibility of floor members to be ECPs 
is trading expertise. The Commission believes that the participation of 
floor members in the OTC markets under the circumstances described here 
potentially could, among other things, increase liquidity on the 
Exchange and in the OTC marketplace, increase competition and 
efficiency, and expand the pool of counterparties for OTC market 
participants.
    The Commission has determined to make the order effective for a 
two-year period in order to provide the opportunity to evaluate the 
impact of the OTC trading on both the OTC market and on NYMEX. Thus, 
the Commission is requiring that NYMEX submit a report reviewing its 
experiences and the experiences of its floor brokers, floor traders and 
clearing members with respect to OTC trading, including the levels of 
OTC trading and related clearing activity; the number of floor brokers, 
floor traders and clearing members who participated in these 
activities; and an evaluation of whether the Commission should extend 
this Order and, if so, whether any modifications should be made 
thereto. This report would address the first eighteen months of the 
two-year period, and must be submitted to the Commission no later than 
30 days after the conclusion of eighteen months.
    Accordingly, the Commission has determined, consistent with the 
NYMEX petition, that it is appropriate to issue an order, pursuant to 
section 1a(12)(C) of the Act, that includes, subject to certain 
conditions and for a two-year period commencing on the date of 
publication of the order in the Federal Register, NYMEX floor brokers 
and floor traders within the definition of ECPs who can enter into OTC 
transactions pursuant to section 2(h)(1) of the Act. Although this 
order applies only to NYMEX and NYMEX members, the Commission would 
welcome, in response to a petition so requesting, providing 
substantially similar relief to other designated contract markets and 
members of designated contract markets.

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 NYMEX 
members registered with the Commission as floor brokers or floor 
traders, when acting in a proprietary capacity, to enter into OTC 
transactions in exempt commodities pursuant to section 2(h)(1) of the 
Act if such floor members have obtained a financial guarantee for such 
transactions from an Exchange clearing member that is registered with 
the Commission as an FCM. The Commission has considered

[[Page 5625]]

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, for a two-year period commencing on the 
date of its publication in the Federal Register, a registered floor 
broker or floor trader to participate in the OTC markets, subject to a 
guarantee from an Exchange clearing member registered as an FCM, as 
well as to Exchange oversight and certain trading restrictions. 
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 to the 
Exchange, enhancing the ability of floor members to make tight markets 
in products that compete against standardized look-alike contracts 
traded in the OTC markets, and increasing the pool of potential 
counterparties for OTC market participants.

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 may have a favorable effect in creating 
benefits with respect to 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. Clearing member FCMs that would, on a case-by-case basis, be 
extending guarantees to floor members for OTC trading have developed 
risk management practices in connection with extending similar 
guarantees to floor members for trading executed at the Exchange. 
Because the scope of permissible trading would be limited to OTC 
transactions that subsequently are cleared at the Exchange, clearing 
member FCMs could apply existing risk management practices and 
procedures. The order would enhance the ability of floor members to 
manage the risks associated with the positions they establish in 
Exchange contracts.

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(12)(C) of the Act, the Commission hereby determines that a NYMEX 
member who is registered with the Commission as a floor broker or a 
floor trader, when acting in a proprietary trading capacity, is deemed 
to be an eligible contract participant and may enter into Exchange-
specified OTC contracts, agreements or transactions in an exempt 
commodity under the following conditions:
    1. This Order is effective for two years commencing on the date of 
its publication in the Federal Register.
    2. The contracts, agreements or transactions must be executed 
pursuant to section 2(h)(1) of the Act.
    3. The floor broker or floor trader must have obtained a financial 
guarantee for the contracts, agreements or transactions from a NYMEX 
clearing member that:
    (a) Is registered with the Commission as an FCM; and,
    (b) Clears the OTC contracts, agreements or transactions thus 
guaranteed.
    4. Permissible contracts, agreements or transactions must be 
limited to trading in a commodity that either:
    (a) Is listed only for clearing at NYMEX or
    (b) Is listed for trading and clearing at NYMEX and NYMEX's rules 
provide for exchanges of futures for swaps in that contract, and each 
OTC contract, agreement or transaction executed pursuant to the order 
must be cleared at NYMEX.
    5. The floor broker or floor trader may not enter into OTC 
contracts, agreements or transactions with another floor broker or 
floor trader as the counterparty for contracts that are listed for 
trading on the Exchange.
    6. NYMEX must have appropriate compliance systems in place to 
monitor the OTC contracts, agreements or transactions of its floor 
brokers and floor traders.
    7. Clearing members that guarantee and clear OTC contracts, 
agreements or transactions pursuant to this Order must have and 
maintain at all times minimum working capital of at least $20 million; 
provided, however, that during the first 18 months following 
publication of the order a clearing member must have and maintain 
minimum working capital of at least:
    (a) $5 million during the first twelve months of the two-year 
period; and
    (b) $10 million during the thirteenth through eighteenth months of 
the two-year period.
    If, during the 18-month period, a clearing member does not maintain 
working capital of at least $20 million, it must further reduce its 
working capital, to determine if it is in compliance with paragraphs 
7(a) or 7(b) of the order, by 100 percent of the NYMEX margin 
requirements for the OTC contracts, agreements or transactions of floor 
brokers and floor traders that it is guaranteeing pursuant to the 
order. A clearing member must compute its working capital in accordance 
with exchange rules and generally accepted accounting principles 
consistently applied.
    8. NYMEX will submit a report to the Commission reviewing its 
experiences and the experiences of its floor brokers, floor traders and 
clearing members under this Order, including the levels of OTC trading 
and related clearing activity; the number of floor brokers, floor 
traders and clearing members who participated in these activities; and 
an evaluation of whether the Commission should extend this Order and, 
if so, whether any modifications should be made thereto. This report 
will address the first eighteen months of this Order's two-year period, 
and must be submitted to the Commission no later than 30 days after the 
conclusion of those eighteen months.
    This Order is based upon the representations made and supporting 
material provided to the Commission by NYMEX. Any material changes or 
omissions in the facts and circumstances pursuant to which this Order 
is granted might require the Commission to reconsider its finding that 
the provisions set forth herein are appropriate. Further, if experience 
demonstrates that the continued effectiveness of this Order would be 
contrary to the public interest, the Commission may condition, modify, 
suspend, terminate or otherwise restrict the provisions of this Order, 
as appropriate, on its own motion.

    Issued in Washington, DC, on January 29, 2003, by the 
Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 03-2507 Filed 2-3-03; 8:45 am]
BILLING CODE 6351-01-P