[Federal Register Volume 71, Number 27 (Thursday, February 9, 2006)]
[Notices]
[Pages 6755-6759]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-1777]


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COMMODITY FUTURES TRADING COMMISSION


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

AGENCY: Commodity Futures Trading Commission.

ACTION: Order.

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SUMMARY: On February 4, 2003, in response to a petition from the New 
York Mercantile Exchange, Inc. (``NYMEX'' or ``Exchange'') the 
Commodity Futures Trading Commission (``Commission''), issued an order 
\1\ pursuant to section 1a(12)(C) of the Commodity Exchange Act 
(``Act'').

[[Page 6756]]

The order provided that, subject to certain conditions, Exchange floor 
brokers and floor traders (collectively referred to hereafter as 
``floor members'') who are registered with the Commission, when acting 
in a proprietary trading capacity, shall be deemed to be ``eligible 
contract participants'' as that term is defined in section 1a(12) of 
the Act. The order (hereafter the ``original order'' or the ``ECP 
Order'') was effective for a two year period and would have expired on 
February 4, 2005.
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    \1\ 68 FR 5621 (February 4, 2003).
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    On February 2, 2005, in response to a petition by the Exchange, the 
Commission determined to extend the original order for a further one-
year period, to February 4, 2006 (hereafter, the ``initial 
extension''). The initial extension contemplated that the Exchange 
might request a further modification or extension of the original 
order. On January 25, 2006, the Exchange petitioned the Commission to 
extend the original order for an additional six month period 
(hereafter, the ``second extension''). Based on a review of all the 
relevant facts and circumstances, including its review of a report 
required as a condition of any further extension, detailing the 
experiences of the Exchange, its floor members and its clearing members 
under that order, the Commission has determined to grant the Exchange's 
petition for a second extension of the original order.
    Accordingly, subject to certain conditions as set forth in this 
order, NYMEX floor members, when acting for their own accounts, are 
permitted to continue 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. This order is effective for a six-month period 
commencing on the expiration date of the initial extension.

DATES: This order is effective on February 4, 2006.

FOR FURTHER INFORMATION CONTACT: Donald H. Heitman, Senior Special 
Counsel, Division of Market Oversight, Commodity Futures Trading 
Commission, Three Lafayette Center, 1155 21st Street, NW., Washington, 
DC 20581. Telephone: 202-418-5041. 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''), Public Law 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.\2\ Under sections 2(d)(1), 2(g), and 
2(h)(1) of the Act, OTC transactions \3\ entered into by ECPs in an 
``excluded commodity'' or an ``exempt commodity,'' as those terms are 
defined by the Act,\4\ are exempt from all but certain requirements of 
the Act.\5\ 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.'' \6\
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    \2\ 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 FCMs 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.
    \3\ For these purposes, 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.''
    \4\ 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.
    \5\ 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 also 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 antimanipulation provisions and 
anti-fraud provisions in certain situations.
    \6\ 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 Original NYMEX Petition

A. Introduction

    By letter dated May 23, 2002, NYMEX submitted a petition seeking a 
Commission interpretation pursuant to section 1a(12)(C) of the Act. 
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 floor members 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

[[Page 6757]]

contract.\9\ By a petiton dated February 6, 2004, NYMEX requested a 
technical amendment to the original order to apply it to a third 
category--contracts listed only for clearing at the Exchange and with 
respect to which the Exchange's rules provide for exchanges of options 
for options (``EOOs''). The Commission granted the Exchange's request 
by order dated February 10, 2004. NYMEX's initial petition further 
proposed that transactions subject to the requested interpretation 
would be subject to additional conditions and restrictions detailed in 
the petition and described below.\10\
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    \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 
implementing 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 Clearinghouse and 
FCMs clearing through the NYMEX Clearinghouse may commingle customer 
funds used to margin, secure, or guarantee transactions in futures 
contracts executed in the OTC markets and cleared by the NYMEX 
Clearinghouse 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, byproduct, 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.'' The Division notes that, 
subsequent to the Commission's ECP Order responding to the 
Exchange's original petition, NYMEX listed on its ClearPort(sm) 
Trading venue a significant number of futures contracts modeled 
after OTC energy swap agreements. While these futures contracts are 
competitively traded on the ClearPort(sm) Trading market, the vast 
majority of positions in these contracts are established via EFS 
transactions that are executed non-competitively away from the 
Exchange and then submitted to NYMEX via its ClearPort(sm) Clearing 
service.
    \10\ NYMEX also suggested a further limitation on floor members' 
permissible transactions by not permitting any OTC transactions in 
electricity commodities.
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B. Arguments in Support of the Original Petition

    In its original petition, NYMEX offered supporting arguments based 
on both public interest considerations and a detailed analysis of the 
Act's ECP definition. Those arguments are fully described in the 
Federal Register notice implementing the original 2003 order.\11\
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    \11\ 68 FR 5621 (February 4, 2003).
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C. Trading Restrictions and Exchange Oversight

    In its original petition, NYMEX represented that it would have 
appropriate compliance systems in place to monitor OTC trading by 
Exchange floor members.\12\ NYMEX also suggested that, consistent with 
the standards already applicable 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 Act's antimanipulation provisions and, in 
certain situations, its antifraud provisions.\13\ 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 other floor 
members 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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    \12\ Id.
    \13\ See supra note 5.
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D. The Commission's Conclusion Regarding the Original Petition

    After consideration of the original NYMEX petition, the Commission 
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, would be eligible to be ECPs as that 
term is defined in section 1a(12) of the Act.\14\ The floor members 
were required to 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 that meets certain minimum 
working capital requirements.
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    \14\ A NYMEX floor member who is determined to be an ECP based 
upon compliance with the provisions set forth in the Commission's 
original 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 noted that the execution and clearing of such 
transactions has financial implications for the clearing system.\15\ 
Thus, the Commission added certain safeguards to the original order 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 \16\ of at least $20 million.\17\
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    \15\ The Commission noted 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.
    \16\ For the purposes of an FCM clearing member, NYMEX Rule 9.21 
defines ``working capital'' to mean ``adjusted net capital'' as 
defined by CFTC Regulation 1.17.
    \17\ The original order provided a sliding scale for the two-
year duration of the original order whereby a clearing member was 
required to have minimum working capital of $5 million during the 
first 12 months, $10 million during the thirteenth through 
eighteenth months, and $20 million thereafter. The final $20 million 
requirement is carried over into this order.
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    The Commission determined to make the original 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 required that NYMEX submit a report reviewing its 
experiences and the experiences of its floor members and clearing 
members with respect to OTC trading, including: The levels of OTC 
trading and related clearing activity; the number of floor members 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 was 
incorporated into the Exchange's January 19, 2005 petition seeking the 
initial extension of the relief granted in the original petition.

III. The Initial Extension

    The Exchange's petition seeking the initial extension of the relief 
granted in the original order included the required report concerning 
the experiences of the Exchange, its floor members and clearing members 
under the original order. For details regarding that report and the 
Exchange's arguments in support of the initial extension, see the 
Commission Order granting the initial extension.\18\
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    \18\ 70 FR 6630 at 6632 (February 8, 2005).
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IV. The Second Extension

A. The Exchange Report

    The order granting the initial extension contemplated the 
possibility of a further extension. It provided, however, that ``[i]n 
the event NYMEX requests a further * * * extension of the ECP Order, 
the request shall include a report to the Commission reviewing the 
experiences of the Exchange and its floor members and clearing members 
under the Order.'' \19\
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    \19\ Id. at 6633.
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    The request for a second extension did include the required report. 
The

[[Page 6758]]

Exchange based its report on calendar 2005 statistics, effectively 
covering 11 months of the one-year initial extension period. The 
Exchange reported that, during 2005, 15 floor members who did not 
qualify as an ECP on their own participated in EFS transactions through 
the Exchange program under the ECP Order, three more participants than 
in 2004. (By contrast, the Exchange's Compliance Department identified 
10 floor members who engaged in EFS transactions on the basis of their 
outright qualification as ECPs.) Exchange data indicate that these 15 
floor members participated in cleared transactions constituting a total 
of 1,028,362 contracts, or 2.9% of the total number of NYMEX Clearport 
transactions cleared during calendar 2005. In general, this EFS 
activity was largely concentrated in EFS transactions in the smaller 
cash settled natural gas or natural gas basis futures contracts that 
are listed in the NYMEX Clearport Clearing system.
    The Exchange attributes this continued light participation by floor 
members in the ECP program to several possible factors. One factor 
might be noticeable price volatility in NYMEX's core floor-traded 
products, which has provided ample trading opportunities on the 
Exchange's trading floors and made it less necessary for professional 
futures traders to look to OTC markets for other trading opportunities. 
Another factor is that the Exchange permits EFS transactions in natural 
gas futures, but not in crude oil, unleaded gasoline or heating oil 
futures. Thus, the program would seem to be of interest primarily to 
only those floor members who already trade natural gas futures.
    The Exchange also notes that many floor traders focus upon trading 
in the front month, or the first few listed months, of a contract 
(e.g., by putting on spreads between those months) whereas the OTC 
natural gas market seems to put greater emphasis upon trading in longer 
periods, such as calendar strips or quarterly or seasonal strip 
trading. One result of this different trading approach is that a floor 
member actively engaging in OTC natural gas trading would probably need 
to hire an additional clerk to provide active position management for 
that trader's OTC transactions. In addition, the Exchange points out 
that the $20 million working capital requirement under the ECP Order 
has restricted the number of participating clearing members. Of the 
four clearing members who provide clearing services to the majority of 
NYMEX floor members, only two are eligible to participate in the ECP 
program under the $20 million limitation. The Exchange report concludes 
by noting that the volume of trading by floor members under the ECP 
program continues to be relatively modest. As noted above, the calendar 
2005 volume represented by floor members participating in the program 
amounted to 1,028,362 contracts, whereas total volume for NYMEX 
Clearport cleared transactions was 35,229,7865 contracts.

B. The Extension Request

    The Commission order granting the initial extension stated that the 
Commission would welcome petitions requesting similar relief from other 
designated contract markets. The Commission did, in fact, receive such 
a petition from the Chicago Mercantile Exchange (``CME''), on November 
21, 2005. Whereas the NYMEX petition requested ECP relief on a 
temporary basis, the CME petition requests that ECP relief for floor 
members be granted on a permanent basis. NYMEX notes that ``[t]he 
outcome of the CME petition and the possible granting of a permanent 
Order have a direct bearing on whether NYMEX will petition for an 
additional limited term extension or a permanent order.'' Therefore, 
NYMEX has requested this additional six-month extension to allow 
sufficient time for the Commission to act on the CME petition. If the 
Commission grants a permanent order to the CME, NYMEX is expected to 
request similar relief on the same terms as any CME order.

V. Conclusion

    Accordingly, the Commission has determined, consistent with the 
NYMEX petition of January 25, 2006, that it is appropriate to issue an 
order pursuant to section 1a(12)(C) of the Act extending the relief 
granted in its original February 4, 2003 order whereby, subject to 
certain conditions and for a further six-month period commencing on 
February 4, 2006, NYMEX floor brokers and floor traders are included 
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 continue to 
welcome, in response to a petition so requesting, providing 
substantially similar relief to other designated contract markets and 
members of designated contract markets.

VI. 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 
Commission undertook a detailed costs-benefits analysis in considering 
the original order.\20\ Actual experience under that order has been 
consistent with the Commission's analysis.
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    \20\ See 68 FR 5621 at 5624-25 (February 4, 2003).
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    By further extending the essential provisions of the original 2003 
order, this order is intended to reduce regulatory barriers by 
continuing 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 the costs and benefits of this order in light of the 
specific provisions of section 15(a) of the Act.

VII. 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, shall 
continue to be deemed to be an eligible contract participant and may 
continue to enter into Exchange-specified OTC contracts, agreements or 
transactions in an exempt

[[Page 6759]]

commodity under the following conditions:
    1. This Order is effective for six months, commencing on February 
4, 2006.
    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,
    (b) Is listed for trading and clearing at NYMEX and NYMEX's rules 
provide for exchanges of futures for swaps in that contract, or
    (c) Is listed only for clearing at NYMEX and NYMEX's rules provide 
for exchanges of options for options 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. 
A clearing member must compute its working capital in accordance with 
exchange rules and generally accepted accounting principles 
consistently applied.
    8. In the event NYMEX requests a further modification or extension 
of the ECP Order, the request shall include a report to the Commission 
reviewing the experiences of the Exchange and its floor members and 
clearing members under the Order. The report shall include information 
on the levels of OTC trading and related clearing activity, the number 
of floor members and clearing members participating in the activity, 
and the Exchange's reasons supporting the further modification or 
extension of the Order.
    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 February 3, 2006, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. E6-1777 Filed 2-8-06; 8:45 am]
BILLING CODE 6351-01-P