[Federal Register Volume 69, Number 55 (Monday, March 22, 2004)]
[Notices]
[Pages 13286-13289]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-6234]


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COMMODITY FUTURES TRADING COMMISSION


In the Matter of the Intercontinental Exchange, Inc. Petition for 
Expansion of the Definition of Eligible Commercial Entities Under 
Section 1a(11)(C) of the Commodity Exchange Act

AGENCY: Commodity Futures Trading Commission.

ACTION: Request for comment.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'') is 
requesting comment regarding an Intercontinental Exchange, Inc. 
(``Intercontinental'') petition requesting that the category of 
eligible commercial entity (``ECE'') be expanded to include floor and 
electronic broker firms that are members of the International Petroleum 
Exchange (``IPE'') located in the U.K. and that are authorized and 
regulated by the U.K. Financial Services Authority (``FSA''), and local 
traders that are members of IPE located in the U.K. who are outside the 
scope of FSA regulation but who are registered with IPE. In addition, 
the Commission asks for comments with respect to whether any response 
to the petitions should be tailored specifically to Intercontinental 
and to the narrow circumstances presented in the petitions or whether a 
response should be more broadly based and, thus, also applicable to 
other trading facilities. The Commission invites public comment, 
moreover, or Intercontinental's request for relief not only for those 
IPE members that trade on the floor as well as the IPE electronic 
platform, but also for those IPE members that trade only on IPE's 
electronic platform. Finally, the Commission seeks general comment on 
whether ECE treatment should be extended to non-U.S. traders that are 
authorized by a non-U.S. exchange, but are not registrants of a 
national regulatory body and, if so, what standards the Commission 
should use to evaluate the qualifications of such persons.

DATES: Comments must be received by April 6, 2004.

ADDRESSES: Comments should be sent to the Commodity Futures Trading 
Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, 
DC 20581, attention: Office of the Secretariat. Comments may sent by 
facsimile transmission to 202-418-5521 or, by e-mail to 
[email protected]. Reference should be made to ``ECE Petition.''

FOR FURTHER INFORMATION CONTACT: Riva Spear Adriance, Special Counsel, 
Division of Market Oversight, Commodity Futures Trading Commission, 
Three Lafayette Center, 1155 21st Street, NW., Washington DC 20581. 
Telephone: 202-418-5494. E-mail: [email protected].

SUPPLEMENTARY INFORMATION: 

I. Statutory Background

    Section 1a(11) of the Commodity Exchange Act (``Act'' or ``CEA''), 
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, generally defines the term ECE by listing those ``eligible 
contract participants''

[[Page 13287]]

(``ECPs'') that are qualified to be ECEs.\1\ ECEs may enter into 
transactions in an ``exempt commodity,'' as that term is defined by the 
Act,\2\ on exempt commercial markets (``ECMs'') pursuant to Section 
2(h)(3) of the Act.\3\ IPE floor and electronic brokers (``IPE 
brokers'') and IPE floor and electronic traders (``IPE local traders'') 
do not qualify as ECEs for the purpose of engaging in transactions on 
an ECM under CEA Section 2(h)(3). The Act, however, gives the 
Commission discretion to expand the ECE category.
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    \1\ Under Section 1a(11)(A) of the Act, ECEs are ECPs that: (i) 
Have the ability to make or take delivery; (ii) incur risk, in 
addition to price risk, related to the commodity; or (iii) are 
market makers or risk managers in a commodity. Section 1a(11)(B) of 
the Act expands the ECE definition to include certain other ECPs 
that: (i) Regularly trade the commodity or its derivatives and (ii) 
meet certain sophistication and/or financial requirements.
    \2\ 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 macroeconomics index or measure. Although the term 
``agricultural commodity'' is not defined in the Act, section 1a(4) 
enumerates several agricultural-based commodities and products. 
Commodities that fall into the exempt category include energy and 
metals products.
    \3\ Under section 2(h)(3), ECMs are markets that limit 
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. 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.'' 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 by the ECM 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. Although transactions entered into on ECMs are generally 
exempt from regulation under the Act, the Commission retains anti-
fraud and anti-manipulation authority over these transactions.
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    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.'' The Commission determined to expand ECE eligibility on one 
previous occasion when, by order dated January 9, 2003,\4\ it deemed 
floor brokers and floor traders who are registered with the Commission, 
when acting in a proprietary trading capacity, to be ECEs, subject to 
certain conditions.\5\ A further determination under section 1a(11)(C) 
that IPE brokers and IPE local traders be considered ECEs would permit 
the IPE brokers and IPE local traders to enter into transactions in 
exempt commodities on ECMs, including the Intercontinental ECM.\6\
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    \4\ See 68 FR 2319. This order responded to petitions received 
from the New York Mercantile Exchange, Inc. (``NYMEX'') and 
Intercontinental. See 67 FR 41698. Intercontinental's petition of 
June 3, 2002, included a request that the Commission expand the ECE 
definition to floor brokers and floor traders authorized by the FSA. 
On November 1, 2002, Intercontinental advised the Commission staff 
that it had decided not to seek relief for non-U.S. floor brokers 
and floor traders at that time. Intercontinental's current petition 
is similar to its petition of June 3, 2002, but the parties for 
which relief is requested differ slightly. See discussion infra, 
Section II.A.
    \5\ Under the Commission's order, subject to certain conditions 
set forth in the order, registered floor brokers and floor traders, 
when acting for their own accounts, are permitted to enter into 
transactions in exempt commodities on ECMs pursuant to section 
2(h)(3) of the Act. In order to participate, the floor broker or 
floor trader must either be an ECP as that term is defined in 
section 1a(12) of the Act, 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 is an ECP.
    \6\ Intercontinental operates a commodities trading platform for 
energy and metals (the ``Intercontinental electronic platform'') and 
is itself an ECM. Intercontinental submitted its notice of operation 
as an ECM to the Commission on December 27, 2001. Intercontinental 
Exchange also owns IPE, a U.K. futures exchange that trades energy 
futures products. The Intercontinental electronic platform is used 
by IPE for its electronic trading system.
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II. The Intercontinental Petition

    By letter dated February 9, 2004, Intercontinental requested that 
the Commission issue an order pursuant to Section 1a(11) of the Act 
that would expand the ECE category to include IPE brokers and IPE local 
traders. Intercontinental stated that including IPE brokers and IPE 
local traders as ECEs would be consistent with the CFMA and would 
recognize their value as both liquidity providers and market makers.

A. Requested Relief

    In its petition, Intercontinental proposed that the following be 
included in the definition of ECE for trading on ECMs:
    (i) IPE Brokers\7\ that (a) Are firms located in the U.S.; (b) are 
authorized and regulated by the FSA; (c) are members of the IPE; (d) 
have as a part of their business the business of acting as a broker 
although the IPE broker need not have any connection or experience in 
the underlying physical commodity, and (e) are ECPs or, if not an ECP, 
its trades on the ECM are guaranteed by a clearing member of a U.K. 
recognized clearing organization that is itself an ECP; and
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    \7\ IPE brokers would include: IPE Floor Members and General 
Participants. General Participants may trade only on the electronic 
trading system.
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    (ii) IPE local traders\8\ that: (a) Are located in the U.K.: (b) 
are authorized by the FSA, if required by the Financial Services and 
Markets Act 2000 (the ``FSMA''), or are outside the scope of the FSMA: 
(c) are members of, or registered to, the IPE: (d) have as a part of 
their business the business of acting as a local trader although the 
IPE local trader need not have any connection or experience in the 
underlying physical commodity; and (e) are ECPs or, if not an ECP, 
their trades on the ECM are guaranteed by a clearing member of a U.K. 
recognized clearing organization that is itself an ECP.\9\
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    \8\ IPE local traders would include: IPE Local Members and 
Individual Participants. Individual Participants may trade only on 
the electronic trading system.
    \9\ In its petition, Intercontinental pointed out that the 
Commission order of January 16, 2003 recognized the fact that floor 
brokers and floor traders are sophisticated market participiants who 
are subject to a comprehensive regulatory scheme. Intercontinental 
stated its belief that it would be appropriate for the Commission to 
provide similar relief to IPE brokers and IPE local traders, as the 
IPE brokers and IPE local traders satisfy similar criteria, 
including having their trades guaranteed by a clearing member of a 
recognized clearing organization. In the case of IPE brokers or IPE 
local traders, the clearing member providing a guarantee of 
financial performance of the contracts is authorized by the FSA.
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    In its petition, Intercontinental commented that the Commission had 
previously issued an order expanding the definition of ECE to include 
persons registered under the CEA as floor brokers and floor traders 
when acting in a proprietary trading capacity.\10\ Intercontinental 
states that trading on the IPE is conducted on a principal-to-

[[Page 13288]]

principal basis\11\ and the IPE brokers and IPE local traders satisfy 
similar criteria to the floor brokers and floor traders included in the 
Commission's earlier order. The petition also contends that its 
requested relief is a logical and appropriate extension of the 
Commission's earlier order, as the individuals for which 
Intercontinental requests relief (a) Are professionals regulated by the 
FSA and/or IPE; (b) regularly trade on the IPE as part of their 
business; and (c) would utilize ECMs in connection with their trading 
activities. Intercontinental's petition states, moreover, that the ECE 
definition should include IPE brokers and IPE local traders because, 
from a policy perspective, it is no longer meaningful to differentiate 
between electronic and floor trading.\12\
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    \10\ See In the Matter of the New York Mercantile Exchange, Inc. 
and the Intercontinental Exchange, Inc., 68 FR 2319 (Jan. 16, 2003). 
At that time, the Commission stated that its action [expanding the 
definition of ECE to include CFTC-registered floor brokers and floor 
traders subject to certain conditions] was consistent with the 
purposes of the CFMA and would provide floor brokers and floor 
traders access to a wider range of products and expand the pool of 
potential counterparties for ECM participants. Id. at 2323. The 
Commission also pointed out that its action could potentially 
increase competition and efficiency and reduce liquidity risk on 
ECMs. According to the Commission, 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, while the 
requirement that either the floor broker or floor trader or the 
guarantor of the trades must be an ECP would provide sufficient 
financial backing for the floor broker or floor trader and would 
mitigate any credit or collection risk that might otherwise arise in 
the execution of trades by a floor broker or floor trader. Id.
    \11\ CEA Section 2(h)(3) requires that trading on an ECM must be 
entered into on a principal-to-principal basis. See supra note 3.
    \12\ Like NYMEX, IPE offers both floor and electronic trading. 
IPE uses the Intercontinental electronic trading platform for the 
trading of IPE products (the ``IPE electronic platform''). See supra 
note 6. In its current petition, Intercontinental is requesting 
relief for both IPE members that trade only on the IPE electronic 
platform, and for those members that trade on the floor as well as 
the IPE electronic platform. This request differs somewhat from the 
relief granted by the Commission in its order of January 16, 2003, 
as that relief applied only to registered floor brokers and floor 
traders, and not to traders that trade only on electronic trading 
systems.
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    Intercontinental states that, IPE, as a U.K. Registered Investment 
Exchange (``RIE''),\13\ must, among other things, limit access to 
persons: (i) Over whom the RIE can, with reasonable certainty, enforce 
its rules contractually; (ii) who have sufficient technical competence 
to use the RIE's facilities; (iii) whom it is appropriate to admit to 
membership, taking into account the size and sophistication of users of 
the RIE's facilities and the nature of the business effected by means 
of, or cleared through, its facilities; and (if appropriate) (iv) who 
have adequate financial resources in relation to their exposure to the 
U.K. RIE or its central counterparty.
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    \13\ RIEs are regulated by the FSA under Part XVIII of the FSMA.
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    According to the background information provided by 
Intercontinental, IPE members are required to sign an agreement 
prescribed by IPE's directors in which they agree to be bound by the 
IPE's regulations. Moreover, IPE members may only engage in trading 
IPE's electronic trading platform to the extent that they are either 
authorized to do so pursuant to U.K. law, or are exempt from the 
authorization requirement.

B. IPE Brokers

    The petition states that the ECE definition should include IPE 
brokers that are located in the U.K. As described in its petition, IPE 
brokers are firms that are members of IPE. The firms are able to 
transact business on their own behalf or on behalf of clients.\14\ When 
the firm acts on behalf of clients its activities fall within the scope 
of the FSMA; where such firm is located in the U.K., it will be 
authorized and registered with the FSA. The conduct of business on IPE 
is governed by both the rules of the exchange and the relevant FSA 
conduct of business rules.
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    \14\ While the IPE brokers may transact business on behalf of 
clients on IPE, trading on an ECM is required to be on a principal-
to-principal basis. Section 2(h)(3) of the Act. See supra notes 10-
11 and accompanying text. See also the Commission's order of January 
9, 2003 (68 FR 2319), at 2324 (deeming that floor brokers and floor 
traders registered with the Commission, when acting in a proprietary 
trading capacity, would be appropriate persons as defined in CEA 
section 1a(11)(C)).
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    According to the petition, the U.K. regulatory regime establishes 
extensive authorization standards for brokers, imposing a regulatory 
scheme that is comparable to the U.S. regulatory scheme. Therefore, 
allowing floor and electronic brokers who are authorized by the FSA to 
trade on the Platform as ECEs would be consistent, according to the 
petition, with the approach taken by the Commission in granting part 30 
relief to firms located in the U.K. that are authorized and regulated 
by the FSA.
    For example, as described in the petition, to become a broker at 
IPE,\15\ the broker must be able to demonstrate that it, among other 
things: is a clearing member or has become a party to a clearing 
agreement; has adequate arrangements to ensure that its employees, 
agents and representatives acting on its behalf or in its name are fit 
and proper and adequately trained and properly supervised; has adequate 
internal recordkeeping; has well-defined procedures for ensuring 
compliance with the regulations; maintains minimum financial standards; 
and has the appropriate licenses, authorizations and consents or 
benefits from available exclusions under the FSMA to act in the 
appropriate capacity.
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    \15\ As indicated above, the term IPE broker includes both IPE 
Floor Members and General Participants. The requirements to be an 
IPE Floor Member differs slightly from the requirements to be an IPE 
General Participant, as described in the petition. For example, IPE 
General Participants must be party to a Platform User Agreement. 
Moreover, while an IPE Floor Member must ensure that it has adequate 
arrangements to ensure that its staff and directors are fit and 
proper, adequately trained and properly supervised, an IPE General 
Participant member must also be able to demonstrate, to the 
satisfaction of the IPE, that it has adequate arrangements to also 
ensure that its agents and representatives are fit and proper, 
adequately trained and properly supervised. According to IPE, as an 
affiliate of a member firm has the capability to register one of its 
employees as a Responsible Individual (see infra note 16) of an IPE 
member, IPE has extended this requirement to include agents and 
representatives. The IPE members are asked to take responsibility 
for this requirement as if the employee of the affiliate was the 
member's employee.
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    The petition notes that persons who perform ``controlled 
functions'' (either investment advisor or customer trading functions) 
for FSA authorized firms would be ``approved'' by the FSA and would be 
required to comply with a set of principles. All traders employed by 
IPE brokers will be registered with the FSA as approved persons linked 
to that broker. On the trading floor of the IPE, IPE brokers would be 
represented by a number of individual traders.
    In order to trade IPE products on the IPE electronic trading 
platform, a member must register at least one ``Responsible 
Individual.'' A Responsible Individual is responsible for all business 
conducted under his individual trading mnemonic(s) and must ensure to 
the best of his ability that the business is conducted in compliance 
with the IPE regulations and other appropriate regulatory 
requirements.\16\ Ultimate responsibility, however, will still lie with 
the IPE member. The individual traders that trade for IPE brokers on 
IPE's electronic trading platform will either themselves be registered 
with the IPE as a Responsible Individual, or will operate under the 
individual trader mnemonic provider to another Responsible Individual 
within that firm.\17\
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    \16\ A member may, at the IPE's discretion, register as many 
Responsible Individuals as the member feels necessary according to 
the nature and scale of its business. The Responsible Individual 
may, at the IPE's discretion, be assigned more than one individual 
trader mnemonic in order to conduct separate lines of business. IPE 
does not currently permit an RI to be registered across two 
companies, preferring to deregister them from one company before 
registering them against another company.
    \17\ A Responsible Individual must be contactable by the IPE 
while his individual trader mnemonic(s) is in use. Certain 
requirements have to be met when registering a Responsible 
Individual (including completion of the Responsible Individual 
Tutorial--an online tutorial and examination--to the member's 
satisfaction) and a declaration from the member's compliance officer 
or other senior management that they are satisfied that the 
applicant has met the requirements.
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C. IPE Local Traders

    The petition states that the ECE definition should include local 
traders (IPE local traders) who are located in the U.K. IPE local 
traders are outside the scope of FSA regulation, but are

[[Page 13289]]

members of, or registered with, IPE, a U.K. recognized investment 
exchange.\18\
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    \18\ According to the petition, a subset of local traders, known 
as ``Local Tenants,'' lease their trading seats from a local member. 
In this situation, the Local Tenant would need to meet the criteria 
for IPE membership, but would technically only be registered with 
the IPE rather than being a member.
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    Intercontinental maintains that IPE's standards ensure that, like 
U.S. floor brokers and floor traders, IPE local traders have expertise 
in trading in commodity markets and are sophisticated and capable 
counterparties to trades. According to Intercontinental, IPE monitors 
the IPE activities of IPE local traders and has the authority to 
sanction them in the event of improper conduct.\19\ In its petition, 
Intercontinental states that IPE provides such extensive authorization 
standards for IPE local traders that there should be little concern 
about permitting these parties to trade on the Intercontinental ECM.
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    \19\ IPE would not monitor the trading activities of IPE members 
on the Intercontinental ECM.
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    As described in the petition, to become an IPE local trader, an 
applicant must be able to demonstrate that the trader, among other 
things: \20\ is fit and proper; registered with the IPE; meets any 
minimum financial requirements; and is, or will become, a party to a 
clearing agreement. In order to trade on the IPE electronic platform, 
an applicant for Individual Participant status also must be registered 
with the IPE as a Responsible Individual.\21\
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    \20\ As indicated above, the term IPE local trader includes both 
IPE Local Members and Individual Participants. The requirements to 
be an IPE Local Member differs slightly from the requirements to be 
an IPE Individual Participant, as described in the petition. For 
example, IPE Individual Participants must be party to a Platform 
User Agreement. Also, while both must register with the IPE, the IPE 
Local Member must have passed the Registered Floor Trader (RFT) 
examination, while the IPE requires the IPE Individual Participant 
to be adequately trained.
    \21\ See supra notes 15-16 and accompanying text.
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III. Request for Comment

    The Commission generally invites public comment on the 
Intercontinental petition and on whether the Commission should 
determine that IPE brokers and IPE local traders are ECEs and, 
therefore, permitted to enter into proprietary transactions in exempt 
commodities on ECMs. Specifically, the Commission requests comment on 
whether it should expand the ECE definition to include (1) IPE brokers 
(IPE Floor Members and General Participants) that: (a) Are firms 
located in the U.K.; (b) are authorized and regulated by the FSA; (c) 
are members of the IPE; (d) have as a part of its business the business 
of acting as a broker, although the IPE broker need not have any 
connection or experience in the underlying physical commodity; and (e) 
are ECPs or, if not an ECP, its trades on the ECM are guaranteed by a 
clearing member of a U.K. recognized clearing organization that is 
itself an ECP; and (2) IPE local traders (IPE Local Members and 
Individuals Participants) that: (a) Are located in the U.K.; (b) are 
authorized by the FSA if required by the FSMA, or are outside the scope 
of the FSMA; (c) members of, or registered with, the IPE; (d) have as a 
part of their business the business of acting as a local trader, 
although the IPE local trader need not have any connection or 
experience in the underlying physical commodity; and (e) are ECPs or, 
if not an ECP, its trades on the ECM are guaranteed by a clearing 
member of a U.K. recognized clearing organization that it itself an 
ECP.
    The Commission also invites public comment on what conditions 
should be applied in the event of such a determination. In addition, 
the Commission asks for comments with respect to whether any response 
to the petitions should be tailored specifically to allow IPE members 
meeting the conditions presented by the petition to trade on 
Intercontinental, or whether a response should be more broadly based 
and, thus, allow such IPE members to trade on other ECMs.
    The Commission invites public comment, moreover, on 
Intercontinental's request for relief not only for those IPE members 
that trade on the floor as well as the IPE electronic platform, but 
also for those IPE members that trade only on IPE's electronic 
platform. This request differs somewhat from the relief granted by the 
Commission in its order of January 16, 2003, as that relief applied 
only to registered floor brokers and floor traders, and not to traders 
that trade only on electronic trading systems. According to 
Intercontinental, the ECE definition should include IPE brokers and IPE 
local traders because, from a policy perspective, it is no longer 
meaningful to differentiate between electronic and floor trading.
    Finally, the Commission particularly requests comment on 
Intercontinental's requests for ECE treatment for IPE authorized local 
traders. The Commission notes that, unlike IPE brokers (and unlike the 
floor locals and floor traders deemed to be ECEs by the Commission's 
order of January 9, 2003, subject to certain conditions),\22\ the IPE 
local traders are not registrants of a governmental regulatory body, 
but are members of or registered with the IPE. Intercontinental's 
petition broadly describes the qualification requirements that such IPE 
local traders are subject to under IPE regulation. The Commission seeks 
general comment on whether ECE treatment should be extended to non-U.S. 
traders that are sophisticated market professionals, are authorized by 
a non-U.S. exchange, regularly trade on the non-U.S. exchange, are 
guaranteed by a clearing member of a clearing organization not 
registered by the Commission, but are not registrants under the 
oversight of a national regulatory body comparable to the Commission 
and, if so, what standards the Commission should use to evaluate the 
qualifications of such persons.
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    \22\ See supra note 5.

    Issued in Washington, DC, on March 16, 2004, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 04-6234 Filed 3-19-04; 8:45 am]
BILLING CODE 6351-01-M