[Federal Register Volume 74, Number 160 (Thursday, August 20, 2009)]
[Notices]
[Pages 42052-42055]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-20024]


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COMMODITY FUTURES TRADING COMMISSION


Notice of Intent, Pursuant to the Authority in Section 2(h)(7) of 
the Commodity Exchange Act and Commission Rule 36.3(c)(3), To Undertake 
a Determination Whether the Carbon Financial Instrument Contract 
Offered for Trading on the Chicago Climate Exchange, Inc., Performs a 
Significant Price Discovery Function

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of action and request for comment.

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SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or 
``Commission'') is undertaking a review to determine whether the Carbon 
Financial Instrument contract offered for trading on the Chicago 
Climate Exchange, Inc. (CCX), 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. 
Authority for this action is found in section 2(h)(7) of the CEA and 
Commission rule 36.3(c) promulgated thereunder. In connection with this 
evaluation, the Commission invites comment from interested parties.

DATES: Comments must be received on or before September 4, 2009.

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ADDRESSES: Comments may be submitted by any of the following methods:
     Follow the instructions for submitting comments. Federal 
eRulemaking Portal: http://www.regulations.gov.
     E-mail: [email protected]. Include CCX Carbon Financial 
Instrument Contract in the subject line of the message.
     Fax: (202) 418-5521.
     Mail: Send to David A. Stawick, Secretary, Commodity 
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, 
NW., Washington, DC 20581
     Courier: Same as mail above.
    All comments received will be posted without change to http://www.CFTC.gov/.

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

    On March 16, 2009, the CFTC promulgated final rules implementing 
provisions of the CFTC Reauthorization Act of 2008 (``Reauthorization 
Act'') \1\ which subjects ECMs with significant price discovery 
contracts (``SPDCs'') to self-regulatory and reporting requirements, as 
well as certain Commission oversight authorities, with respect to those 
contracts. Among other things, these rules and rule amendments revise 
the information-submission requirements applicable to ECMs, establish 
procedures and standards by which the Commission will determine whether 
an ECM contract performs a significant price discovery function, and 
provide guidance with respect to compliance with nine statutory core 
principles applicable to ECMs with SPDCs. These rules became effective 
on April 22, 2009.
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    \1\ 74 FR 12178 (Mar. 23, 2009); these rules became effective on 
April 22, 2009.
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    In determining whether an ECM's contract is or is not a SPDC, the 
Commission will consider the contract's material liquidity, price 
linkage to other contracts, potential for arbitrage with other 
contracts traded on designated contract markets or derivatives 
transaction execution facilities, use of the ECM contract's prices to 
execute or settle other transactions, and other factors.
    In order to facilitate the Commission's identification of possible 
SPDCs, Commission rule 36.3(c)(2) requires that an ECM operating in 
reliance on section 2(h)(3) promptly notify the Commission and provide 
supporting information or data concerning any contract: (i) that 
averaged five trades per day or more over the most recent calendar 
quarter; and (ii) (A) for which the ECM sells price information 
regarding the contract to market participants or industry publications; 
or (B) 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 agreement.

II. Determination of a SPDC

A. The SPDC Determination Process

    Commission rule 36.3(c)(3) establishes the procedures by which the 
Commission makes and announces its determination on whether a specific 
ECM contract serves a significant price discovery function. Under those 
procedures, the Commission will publish a notice in the Federal 
Register that it intends to undertake a determination as to whether the 
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.\2\ After prompt consideration of all relevant 
information, the Commission will, within a reasonable period of time 
after the close of the comment period, issue an order explaining its 
determination. Following the issuance of an order by the Commission 
that the ECM executes or trades an agreement, contract, or transaction 
that performs a significant price discovery function, the ECM must 
demonstrate, with respect to that agreement, contract, or transaction, 
compliance with the core principles under section 2(h)(7)(C) of the CEA 
\3\ and the applicable provisions of Part 36. If the Commission's order 
represents the first time it has determined that one of the ECM's 
contracts performs a significant price discovery function, the ECM must 
submit a written demonstration of its compliance with the core 
principles within 90 calendar days of the date of the Commission's 
order. For each subsequent determination by the Commission that the ECM 
has an additional SPDC, the ECM must submit a written demonstration of 
its compliance with the core principles within 30 calendar days of the 
Commission's order.
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    \2\ The Commission may commence this process on its own 
initiative or on the basis of information provided to it by an ECM 
pursuant to the notification provisions of Commission rule 
36.3(c)(2).
    \3\ 7 U.S.C. 2(h)(7)(C).
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B. CCX Carbon Financial Instrument Contract

    CCX identifies its CFI contract as a cash contract that requires 
the physical delivery of CCX carbon dioxide (CO2) emission 
allowances called CFIs.\4\ The size of the CCX CFI contract is 1,000 
metric tons (MT) of CO2-equivalent emissions,\5\ which are 
equal to 10 CFIs (each CFI specifies 100 MT CO2-equivalent 
emissions). All trades in the subject contract results in the physical 
delivery of CFIs.
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    \4\ The instruments listed by an ECM in reliance on the 
exemption in section 2(h)(3) of the Act are determined by the ECM 
when it files notice with the Commission, pursuant to section 
2(h)(5), of its intention to rely on the exemption. Section 2(h)(7) 
authorizes the Commission to determine whether an ECM ``agreement, 
contract or transaction'' performs a significant price discovery 
function, but does not require that the Commission also determine 
whether the instrument is otherwise subject to the Commission's 
jurisdiction (i.e., a futures or commodity option contract). 
Instead, the descriptive language of section 2(h)(7) mirrors the 
``[conducted] in reliance on the exemption'' language of section 
2(h)(5) and refers merely to ``agreement, contract or transaction.'' 
Thus, the statutory language directs the Commission, in determining 
whether an ECM instrument is a SPDC, to evaluate any instrument 
listed by an ECM in reliance on the section 2(h)(3) exemption under 
the SPDC process set forth in the Part 36 rules.
    \5\ Greenhouse gases (GHGs) include CO2, methane 
(CH4), nitrous oxide (N2O), hydrofluorocarbons 
(HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride 
(SF6). The negative impact that each non-CO2 
GHGs has on the environment can be expressed as a multiple of 
CO2's environmental effect.
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    The CCX carbon reduction program is voluntary where certain 
entities choose to reduce their GHG emissions. In general, the electric 
utilities and manufacturers combined comprise the largest share of the 
program participants. Once an entity decides to reduce its GHG 
emissions, it signs a legally-binding contract with the CCX. 
Participants are given allowances by the CCX to cover emissions level 
targets, and additional credits can be created by investing in offset 
projects. If an entity's plant cannot meet its reduction requirements 
through new investments and/or technological improvements, additional 
allowances can be purchased from other program participants.
    The program specifies that carbon emission reductions be completed 
over two phases. Phase I (applicable between

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2003 and 2006) required a commitment to reducing each participant's 
carbon emissions by one percent per year below its own baseline level 
(calculated as the average of the firm's carbon emissions between 1998 
and 2001). Phase II (which runs from 2007 through 2010) requires 
participants to commit to an emissions reduction schedule that results 
in a six-percent decline in CO2 output by 2010. 
Participants' baseline estimates as well as their emissions levels and 
progress toward meeting the reduction requirements are audited by the 
Financial Industry Regulatory Authority (FINRA).
    CFIs are distributed for multiple program years at the time of 
entry into the program through the end of the current phase. Each CFI 
is dated with a particular calendar year (vintage), with the vintage 
indicating the compliance year for which it is redeemable. 
Alternatively, entities can save their excess CFIs for use in future 
compliance periods. The CCX also auctions a certain number of current- 
and future-year CFIs. Allowances are recorded electronically and title 
transfers between entities are effected within the CCX's electronic 
registry. Each year in April, the CCX compares each participant's 
reported emissions from the previous calendar year to the number of 
allowances held that are dated with the compliance year, or with 
earlier years. Firms surrender the appropriate number of allowances 
that covers their emissions, and the redeemed CFIs are deducted from 
the firms' accounts. Unused allowances that are not needed for 
compliance in the current year are rolled forward and are included in 
the allowance supply for the following year. Alternatively, plants can 
sell excess allowances to other market participants.
    As noted above, the CCX's GHG reduction program allows for the 
creation of CFIs through offset projects. In this regard, the CCX 
issues CFIs to entities that own, implement, or aggregate eligible 
projects on the basis of sequestration, destruction, or displacement of 
GHG emissions. The offset project categories for which the CCX issues 
CFIs include agricultural, coal mine and landfill methane, agricultural 
and rangeland soil carbon, forestry, renewable energy, energy 
efficiency and fuel switching, and clean development mechanism 
projects.
    Based upon a required quarterly notification filed on July 1, 2009 
(mandatory under Rule 36.3(c)(2)), the CCX reported that, with respect 
to its CFI contract, an average of 15 separate trades per day occurred 
in the second quarter of 2009. During the same period, the CFI had an 
average daily trading volume of 1,235 contracts. In the first quarter 
of 2009, market participants traded the CFI contract on average 29 
times per day with an average total daily trading volume of 2,661 
contracts. Because the CFI contract requires immediate delivery and 
payment on the following day, open interest figures are not applicable.
    It appears that the CCX CFI contract may satisfy the material 
liquidity and material price reference factors for SPDC determination. 
With respect to material liquidity, daily trading in the CFI contract 
exceeds an average of ten trades per day. Moreover, the average daily 
trading volume in the CFI is greater than 1,000 contracts per day. In 
regard to material price reference, the CFI market is solely a CCX-
created entity. In this regard, the CCX designed all of the parameters 
of this carbon emission reduction program, as well as established the 
rules for membership in the ECM, allowance trading, and the creation of 
offsets. The only existing market in which CFIs can be bought and sold 
on a spot basis is the CCX cash market. Thus, traders look to the CCX 
as a source of price information and price discovery for the CFIs. 
Moreover, the Chicago Climate Futures Exchange, a subsidiary of the 
CCX, trades a futures contract which specifies the delivery of CFIs.
    The instruments listed by an ECM in reliance on the exemption in 
section 2(h)(3) of the CEA are determined by the ECM when it files 
notice with the Commission, pursuant to section 2(h)(5), of its 
intention to rely on the exemption. Section 2(h)(7) authorizes the 
Commission to determine whether an ECM's ``agreement, contract or 
transaction'' performs a significant price discovery function, but does 
not require that the Commission also determine whether the instrument 
is otherwise subject to the Commission's jurisdiction (i.e., a futures 
or commodity option contract). Instead, the descriptive language of 
section 2(h)(7) mirrors the ``[conducted] in reliance on the [2(h)(5)] 
exemption'' language of section 2(h)(5) and refers merely to an 
``agreement, contract or transaction.'' The statutory language 
indicates that any instrument listed by an ECM in reliance on the 
exemption in section 2(h)(3) of the CEA--including a cash contract that 
generally is not subject to the Commission's jurisdiction--has the 
potential to be or become a SPDC. Accordingly, contracts identified to 
the Commission as listed in reliance on section 2(h)(3) should be 
evaluated under the SPDC process set forth in the Part 36 rules.

III. Request for Comment

    In evaluating whether an ECM's agreement, contract, or transaction 
performs a significant price discovery function, section 2(h)(7) of the 
CEA directs the Commission to consider, as appropriate, four specific 
criteria: price linkage, arbitrage, material price reference, and 
material liquidity. As it explained in Appendix A to the Part 36 rules, 
the Commission, in making SPDC determinations, will apply and weigh 
each factor, as appropriate, to the specific contract and circumstances 
under consideration.
    As part of its evaluation, the Commission will consider the written 
data, views, and arguments from any ECM that lists the potential SPDC 
and from any other interested parties. Accordingly, the Commission 
requests comment on whether the CCX CFI contract performs a significant 
price discovery function. Commenters' attention is directed 
particularly to Appendix A of the Commission's Part 36 rules for a 
detailed discussion of the factors relevant to a SPDC determination. 
The Commission notes that comments which analyze the contract in terms 
of these factors will be especially helpful to the determination 
process. In order to determine the relevance of comments received, the 
Commission requests that commenters explain in what capacity are they 
knowledgeable about the CFI contract.

IV. Related Matters

A. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \6\ 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 final 
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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    \6\ 44 U.S.C. 3507(d).
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B. Cost-Benefit Analysis

    Section 15(a) of the CEA \7\ 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

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that the Commission ``consider'' the costs and benefits of its action. 
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) 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) which, among 
other provisions, directs the Commission to evaluate all contracts 
listed on ECMs to determine whether they serve a significant price 
discovery function.
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    \7\ 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 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 and 
responsibilities on the ECM which are calculated to accomplish this 
goal. This increased oversight in turn 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 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. These increased ECM responsibilities, along with the 
CFTC's enhanced 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.

    Issued in Washington, DC on August 13, 2009 by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. E9-20024 Filed 8-19-09; 8:45 am]
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