[Federal Register Volume 74, Number 145 (Thursday, July 30, 2009)]
[Notices]
[Pages 37988-37991]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-18159]


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COMMODITY FUTURES TRADING COMMISSION


Order Finding That the ICE Henry Financial LD1 Fixed Price 
Contract Traded on the IntercontinentalExchange, Inc., Performs a 
Significant Price Discovery Function

AGENCY: Commodity Futures Trading Commission.

ACTION: Final order.

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SUMMARY: On June 12, 2009, the Commodity Futures Trading Commission 
(``CFTC'' or ``Commission'') published for comment in the Federal 
Register \1\ a notice of its intent to undertake a determination 
whether the Henry Financial LD1 Fixed Price contract, traded on the 
IntercontinentalExchange, Inc. (``ICE''), an exempt commercial market 
(``ECM'') under sections 2(h)(3)-(5) of the Commodity Exchange Act 
(``CEA'' or the ``Act''), performs a significant price discovery 
function pursuant to section 2(h)(7) of the CEA. The Commission 
undertook this review based upon an initial evaluation of information 
and data provided by ICE as well as a Commission report on ECMs. The 
Commission has reviewed public comments and the entire record in this 
matter and has determined to issue an order finding that the ICE Henry 
Financial LD1 Fixed Price contract performs a significant price 
discovery function. Authority for this action is found in section 
2(h)(7) of the CEA and Commission rule 36.3(c) promulgated thereunder.
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    \1\ 74 FR 28028 (June 12, 2009).

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DATES: Effective date: [date of underlying order].

FOR FURTHER INFORMATION CONTACT: Gregory K. Price, Industry Economist, 
Division of Market Oversight, Commodity Futures Trading Commission, 
Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581. 
Telephone: (202) 418-5515. E-mail: [email protected]; or Susan Nathan, 
Senior Special Counsel, Division of Market Oversight, same address. 
Telephone: (202) 418-5133. E-mail: [email protected].

SUPPLEMENTARY INFORMATION:

I. Introduction

    The CFTC Reauthorization Act of 2008 (``Reauthorization Act'') \2\ 
significantly broadened the CFTC's regulatory authority with respect to 
ECMs by creating, in section 2(h)(7) of the CEA, a new regulatory 
category--ECMs on which significant price discovery contracts 
(``SPDCs'') are traded--and treating ECMs in that category as 
registered entities under the CEA. The legislation authorizes the CFTC 
to designate an agreement, contract or transaction as a SPDC if the 
Commission determines, under criteria established in section 2(h)(7), 
that it performs a significant price discovery function. When the 
Commission makes such a determination, the ECM on which the SPDC is 
traded must assume, with respect to that contract, all the 
responsibilities and obligations of a registered entity under the Act 
and Commission regulations, and must comply with nine core principles 
established by new section 2(h)(7)(C).
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    \2\ Incorporated as Title XIII of the Food, Conservation and 
Energy Act of 2008, Public Law No. 110-246, 122 Stat. 1624 (June 18, 
2008).
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    On March 16, 2009, the CFTC promulgated final rules implementing 
the provisions of the Reauthorization Act.\3\ As relevant here, rule 
36.3 imposes increased information reporting requirements on ECMs to 
assist the Commission in making prompt assessments whether particular 
ECM contracts may be SPDCs. In addition to filing quarterly reports of 
its contracts, an ECM must notify the Commission promptly concerning 
any contract traded in reliance on the exemption in section 2(h)(3) of 
the CEA that averaged five trades per day or more over the most recent 
calendar quarter, and for which the exchange sells its price 
information regarding the contract to market participants or industry 
publications, or whose daily closing or settlement prices on 95 percent 
or more of the days in the most recent quarter were within 2.5 percent 
of the contemporaneously determined closing, settlement or other daily 
price of another contract.
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    \3\ 74 FR 12178 (Mar. 23, 2009); these rules became effective on 
April 22, 2009.
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    Commission rule 36.3(c)(3) established the procedures by which the 
Commission makes and announces its determination whether a particular 
ECM contract serves a significant price discovery function. Under those 
procedures, the Commission will publish notice in the Federal Register 
that it intends to undertake a determination whether the specified 
agreement, contract or transaction performs a significant price 
discovery function and to receive written views, data and arguments 
relevant to its determination from the ECM and other interested 
persons. The Commission will, within a reasonable period of time after 
the close of the comment period, consider all relevant information and

[[Page 37989]]

issue an order announcing and explaining its determination. The 
issuance of an affirmative order triggers the effectiveness of the 
Commission's regulatory authorities with respect to an ECM with a SPDC; 
at that time, such an ECM becomes subject to all provisions of the CEA 
applicable to registered entities.\4\ The issuance of such an order 
also triggers the obligations, requirements and timetables prescribed 
in Commission rule 36.3(c)(4).\5\
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    \4\ Public Law 110-246 at 13203; Joint Explanatory Statement of 
the Committee of Conference, H.R. Rep. No. 110-627, 110 Cong., 2d 
Sess. 978, 986 (Conference Committee Report). See also 73 FR 75888, 
75894 (Dec. 12, 2008).
    \5\ For an initial SPDC, ECMs have a grace period of 90 calendar 
days from the issuance of a SPDC determination order to submit a 
written demonstration of compliance with the applicable core 
principles. For subsequent SPDCs, ECMs have a grace period of 30 
calendar days to demonstrate core principle compliance.
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II. Notice of Intent To Undertake SPDC Determination

    On June 12, 2009, the Commission published in the Federal Register 
notice of its intent to undertake a determination whether the ICE Henry 
Financial LD1 Fixed Price contract performs a significant price 
discovery function, and requested comment from interested parties. \6\ 
Comments were received from the American Public Gas Association 
(``APGA''); the Steel Manufacturer's Association and East Texas 
Electric Cooperative (collectively, ``SMA/ETEC''); and the CME 
Group.\7\ The comments are more extensively discussed below in the 
Findings and Conclusion Section.
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    \6\ The Commission's Part 36 rules establish, among other 
things, procedures by which the Commission makes and announces its 
determination whether a specific ECM contract serves a significant 
price discovery function. Under those procedures, the Commission 
publishes a notice in the Federal Register that it intends to 
undertake a determination whether a specified agreement, contract or 
transaction performs a significant price discovery function and to 
receive written data, views and arguments relevant to its 
determination from the ECM and other interested persons.
    \7\ The comment letters are available on the Commission's Web 
site: http://www.cftc.gov/lawandregulation/federalregister/federalregistercomments/2009/09-007.html.
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III. Section 2(h)(7) of the CEA

    The Commission is directed by section 2(h)(7) of the CEA to 
consider the following factors in determining whether a contract 
performs a significant price discovery function:
     Price Linkage--the extent to which the agreement, contract 
or transaction uses or otherwise relies on a daily or final settlement 
price, or other major price parameter, of a contract or contracts 
listed for trading on or subject to the rules of a designated contract 
market (``DCM'') or derivatives transaction execution facility 
(``DTEF''), or a SPDC traded on an electronic trading facility, to 
value a position, transfer or convert a position, cash or financially 
settle a position, or close out a position.
     Arbitrage--the extent to which the price for the 
agreement, contract or transaction is sufficiently related to the price 
of a contract or contracts listed for trading on or subject to the 
rules of a designated DCM or DTEF, or a SPDC traded on or subject to 
the rules of an electronic trading facility, so as to permit market 
participants to effectively arbitrage between the markets by 
simultaneously maintaining positions or executing trades in the 
contracts on a frequent and recurring basis.
     Material price reference--the extent to which, on a 
frequent and recurring basis, bids, offers or transactions in a 
commodity are directly based on, or are determined by referencing, the 
prices generated by agreements, contracts or transactions being traded 
or executed on the electronic trading facility.
     Material liquidity--the extent to which the volume of 
agreements, contracts or transactions in a commodity being traded on 
the electronic trading facility is sufficient to have a material effect 
on other agreements, contracts or transactions listed for trading on or 
subject to the rules of a DCM, DTEF or electronic trading facility 
operating in reliance on the exemption in section 2(h)(3).
    Not all factors must be present to support a determination that a 
particular contract performs a significant price discovery function. 
Moreover, the statutory language neither prioritizes the factors nor 
specifies the degree to which a SPDC must conform to the various 
factors. In Guidance issued in connection with the Part 36 rules 
governing ECMs with SPDCs, the Commission observed that these factors 
do not lend themselves to a mechanical checklist or formulaic analysis. 
Accordingly, the Commission has indicated that in making its 
determinations it will consider the circumstances under which the 
presence of a particular factor, or combination of factors, would be 
sufficient to support a SPDC determination.\8\ For example, for 
contracts that are linked to other contracts or that may be arbitraged 
with other contracts, the Commission will consider whether the price of 
the potential SPDC moves in such harmony with the other contract that 
the two markets essentially become interchangeable. This co-movement of 
prices would be an indication that activity in the contract had reached 
a level sufficient for the contract to perform a significant price 
discovery function.
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    \8\ 17 CFR 36, Appendix A.
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IV. Findings and Conclusions

    The ICE Henry Financial LD1 Fixed Price contract is cash settled 
based on the final settlement price of the New York Mercantile 
Exchange's (``NYMEX'') physically-delivered Henry Hub-based Natural Gas 
futures contract for the corresponding contract month. The trading unit 
of the ICE Henry Financial LD1 Fixed Price contract is 2,500 mmBtu 
multiplied by the number of calendar days in the contract month. For 
example, if a contract month has 30 days, the trading unit is 75,000 
mmBtu, which is referred to as 30 lots.
    Based on data provided in connection with the quarterly 
notification required by Commission rule 36.3(c)(2), this contract 
realized more than an average of five trades per day during the first 
quarter of 2009. In addition, the average volume of natural gas traded 
each business day during that period was 449,010 contracts; the open 
interest in the contract as of March 31, 2009 was 2,932,798 contracts.
    Based on these contract features and trading data, the ICE Henry 
Financial LD1 Fixed Price contract satisfies the material liquidity, 
price linkage and arbitrage criteria for a SPDC. The very high average 
daily trading volume indicates that the contract is relatively liquid. 
With regard to the price linkage and arbitrage tests, the ICE Henry 
Financial LD1 Fixed Price contract and NYMEX's physically-delivered 
Natural Gas futures contract have the same final settlement prices, and 
ICE uses NYMEX's forward settlement curve when conducting its mark-to-
market accounting procedures to settle the contract on a daily basis.
    In evaluating the ICE Henry Financial LD1 Fixed Price contract, the 
Commission also has the benefit of a recent study focused on price 
discovery contracts on ECMs. The Commission's October 2007 Report on 
the Oversight of Trading on Regulated Futures Exchanges and Exempt 
Commercial Markets (``ECM Study'') stated that traders and voice 
brokers view the instant ICE contract as economically equivalent to the 
NYMEX physically-delivered Natural Gas futures contract. The ICE and 
NYMEX contracts essentially comprise a single market for natural gas 
derivatives trading, and traders look to both the ICE and the NYMEX 
when determining where to

[[Page 37990]]

execute a trade at the best price. The ECM Study also reported that the 
ICE natural gas contract acts as a price discovery market.
    The statements provided by APGA and CME provide additional support 
for the Commission's findings. APGA, the national association for 
publicly-owned natural gas distribution systems, states that its 
members report that the prices on the ICE and NYMEX contracts have an 
ongoing, linked relationship that extends not only to the linked 
settlement price but to prices between the two contracts throughout the 
trading day. Its members report that the prices of both markets are 
substantially the same and move in tandem, and that counterparties use 
either market interchangeably as a basis for quoting prices. This 
linkage, in APGA's view, makes possible arbitrage trading between the 
two markets. With respect to material price reference, APGA observes 
that the ICE contract is routinely used as a means by which cash market 
prices are referenced.\9\ Finally, APGA states that whether or not its 
members trade the ICE contract, they are of the opinion that they would 
be able to execute substantial orders without having an impact on the 
market price through the transaction.
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    \9\ APGA members note that in general the written cash market 
contracts that they enter into reference the NYMEX price, as does 
the ICE Henry Financial LD1 Fixed Price contract itself. While the 
cash contracts commonly do not explicitly reference the ICE contract 
as the settlement price, APGA states that it is common market 
practice for dealers to provide cash market price quotes based upon 
the ICE Henry Financial LD1 Fixed Price contract. With respect to 
material price reference, while it appreciates the anecdotal 
information provided by both APGA and CME Group, the Commission has 
not reached a conclusion with respect to this factor.
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    CME Group opines that the Henry Financial LD1 Fixed Price contract 
readily satisfies all four of section 2(h)(7)'s criteria as explained 
in the Appendix A Guidance. It notes that when trading in the Henry 
Financial LD1 Fixed Price contract is viewed in the context of the 
relevant competing contracts at NYMEX, including both financially-
settled and physically-settled contracts, ICE's contract had a 40 
percent market share of that trading activity--easily satisfying the 
standards for material liquidity. As to price linkage, CME Group 
observes that the ICE Henry Financial LD1 Fixed Price contract 
continues to have the same settlement price as the NYMEX natural gas 
contract; with regard to final settlement, the product specifications 
for the ICE contract explicitly provide for final settlement to be 
equal to the final settlement price of the NYMEX natural gas futures 
contract. Thus, in CME's opinion there appears to be little chance that 
the ICE contract will deviate from the NYMEX settlement price for final 
settlement. With respect to arbitrage, CME Group offers anecdotal 
information indicating a strong and active arbitrage between the two 
contracts. Finally, CME Group observes that the ICE Henry Financial LD1 
Fixed Price contract satisfies the statutory standard for material 
price reference, as ICE itself relies on the settlement prices 
generated by NYMEX for its own settlement prices in the contract, 
rather than on prices generated by its own system. Moreover, CME Group 
notes its understanding that ICE has for several years been selling its 
price information for this contract to interested persons.\10\
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    \10\ As noted above, the Commission has not reached a conclusion 
with respect to the material price reference factor.
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    SMA/ETEC supports recognition of the Henry Financial LD1 Fixed 
Price contract as a SPDC; the bulk of its comment letter, however, 
focuses on issues beyond the narrow scope of the instant action, which 
is to determine whether the ICE contract performs a significant price 
discovery function. For instance, SMA/ETEC advocates subjecting all 
natural gas investment vehicles to aggregate position limits and 
discusses the Commission's proposed limited risk management exemption.
    After considering the entire record in this matter, including the 
ECM Study and the comments received, the Commission has determined that 
the ICE Henry Financial LD1 Fixed Price contract performs a significant 
price discovery function under the material liquidity, price linkage 
and arbitrage criteria established in section 2(h)(7) of the CEA.
    The issuance of this order triggers the immediate effectiveness of 
the Commission's authorities with respect to ICE as a registered entity 
in connection with its Henry Financial LD1 Fixed Price contract,\11\ 
and triggers the obligations, requirements--both procedural and 
substantive--and timetables prescribed in Commission rule 36.3(c)(4) 
for ECMs.\12\
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    \11\ See 73 FR 75888, 75893 (Dec. 12, 2008).
    \12\ This Order determining that the ICE Henry Financial LD1 
Fixed Price contract is a SPDC represents the first time the 
Commission has determined that one of ICE's contracts performs a 
significant price discovery function. Accordingly, ICE must, within 
90 calendar days of the date of this Order, submit to the Commission 
a written demonstration of compliance with the section 2(h)(7) core 
principles.
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IV. Related Matters

A. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \13\ imposes certain 
requirements on Federal agencies, including the Commission, in 
connection with their conducting or sponsoring any collection of 
information as defined by the PRA. Certain provisions of Commission 
rule 36.3 impose new regulatory and reporting requirements on ECMs, 
resulting in information collection requirements within the meaning of 
the PRA. OMB previously has approved and assigned OMB control number 
3038-0060 to this collection of information.
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    \13\ 44 U.S.C. 3507(d).
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B. Cost-Benefit Analysis

    Section 15(a) of the CEA \14\ requires the Commission to consider 
the costs and benefits of its actions before issuing an order under the 
Act. By its terms, section 15(a) does not require the Commission to 
quantify the costs and benefits of an order or to determine whether the 
benefits of the order outweigh its costs; rather, it requires that the 
Commission ``consider'' the costs and benefits of its actions. Section 
15(a) further specifies that the costs and benefits 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 and could in its 
discretion determine that, notwithstanding its costs, a particular 
order is necessary or appropriate to protect the public interest or to 
effectuate any of the provisions or accomplish any of the purposes of 
the Act. The Commission has considered the costs and benefits of this 
Order in light of the specific provisions of section 15(a) of the Act 
and has concluded that this Order, which strengthens Federal oversight 
of the ECM and helps to prevent market manipulation, is necessary and 
appropriate to accomplish the purposes of section 2(h)(7) of the Act.
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    \14\ 7 U.S.C. 19(a).
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    When a futures contract begins to serve a significant price 
discovery function, that contract, and the ECM on which it is traded, 
warrants increased oversight to deter and prevent price manipulation 
and other disruptions to

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market integrity, both on the ECM itself and in any related futures 
contracts trading on designated contract markets (``DCMs''). An Order 
finding that a particular contract is a SPDC triggers this increased 
oversight and imposes obligations on the ECM calculated to accomplish 
this goal. The increased oversight engendered by the issuance of a SPDC 
Order increases transparency and helps to ensure fair competition among 
ECMs and DCMs trading similar products and competing for the same 
business. Moreover, the ECM on which the SPDC is traded must assume, 
with respect to that contract, all the responsibilities and obligations 
of a registered entity under the CEA and Commission regulations. 
Additionally, the ECM must comply with nine core principles established 
by section 2(h)(7) of the Act--including the obligation to establish 
position limits and/or accountability standards for the SPDC. 
Amendments to section 4(i) of the CEA authorize the Commission to 
require large trader reports for SPDCs listed on ECMs. These increased 
ECM responsibilities, along with the CFTC's increased regulatory 
authority, subject the ECM's risk management practices to the 
Commission's supervision and oversight and generally enhance the 
financial integrity of the markets.

V. Order

    After considering the complete record in this matter and the 
comment letters received in response to its request for comments, the 
Commission has determined to issue the following:

Order

    The Commission, pursuant to its authority under section 2(h)(7) of 
the Act, hereby determines that the ICE Henry Financial LD1 Fixed Price 
contract satisfies the statutory material liquidity, price linkage and 
arbitrage criteria for a significant price discovery contract. 
Consistent with this determination, and effective immediately, 
IntercontinentalExchange, Inc., shall be and is considered a registered 
entity with respect to the Henry Financial LD1 Fixed Price contract and 
is subject to all the provisions of the Commodity Exchange Act 
applicable to registered entities. Further, the obligations, 
requirements and timetables prescribed in Commission rule 36.3(c)(4) 
governing core principle compliance by IntercontinentalExchange, Inc. 
commence with the issuance of this Order.

    Issued in Washington, DC, on July 24, 2009, by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. E9-18159 Filed 7-29-09; 8:45 am]
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