[Federal Register Volume 75, Number 85 (Tuesday, May 4, 2010)]
[Notices]
[Pages 23697-23704]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-10299]


-----------------------------------------------------------------------

COMMODITY FUTURES TRADING COMMISSION


Order Finding That the AECO Financial Basis Contract Traded on 
the IntercontinentalExchange, Inc., Performs a Significant Price 
Discovery Function

AGENCY: Commodity Futures Trading Commission.

ACTION: Final order.

-----------------------------------------------------------------------

SUMMARY: On October 9, 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 AECO Financial Basis (``AEC'') 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 other available information. The 
Commission has reviewed the entire record in this matter, including all 
comments received, and has determined to issue an order finding that 
the AEC 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.
---------------------------------------------------------------------------

    \1\ 74 FR 52196 (October 9, 2009).

---------------------------------------------------------------------------
DATES: Effective date: April 28, 2010.

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.\3\ 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).
---------------------------------------------------------------------------

    \2\ Incorporated as Title XIII of the Food, Conservation and 
Energy Act of 2008, Public Law 110-246, 122 Stat. 1624 (June 18, 
2008).
    \3\ 7 U.S.C. 1a(29).
---------------------------------------------------------------------------

    On March 16, 2009, the CFTC promulgated final rules implementing 
the provisions of the Reauthorization Act.\4\ 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 
prices of another contract.
---------------------------------------------------------------------------

    \4\ 74 FR 12178 (Mar. 23, 2009); these rules became effective on 
April 22, 2009.
---------------------------------------------------------------------------

    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 an evaluation 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. Upon the close of the comment period, the Commission will 
consider, among other things, all relevant information regarding the 
subject contract and issue an order announcing and explaining its 
determination whether or not the contract is a SPDC. The issuance of an 
affirmative order signals the effectiveness of the Commission's 
regulatory authorities over an ECM with respect to a SPDC; at that time 
such an ECM becomes subject to all provisions of the CEA applicable to 
registered entities.\5\ The issuance of such an order also triggers the 
obligations, requirements and timetables prescribed in Commission rule 
36.3(c)(4).\6\
---------------------------------------------------------------------------

    \5\ 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).
    \6\ 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.
---------------------------------------------------------------------------

II. Notice of Intent To Undertake SPDC Determination

    On October 9, 2009, the Commission published in the Federal 
Register notice of its intent to undertake a determination whether the 
AEC contract performs a significant price discovery function and 
requested comment from

[[Page 23698]]

interested parties.\7\ Comments were received from the Industrial 
Energy Consumers of America (``IECA''), Working Group of Commercial 
Energy Firms (``WGCEF''), ICE, Economists Incorporated (``EI''), 
Natural Gas Supply Association (``NGSA''), Federal Energy Regulatory 
Commission (``FERC''), Financial Institutions Energy Group (``FIEG'') 
and an anonymous individual.\8\ The comment letter from FERC \9\ did 
not directly address the issue of whether or not the AEC contract is a 
SPDC; IECA \10\ and the anonymous commenter \11\ concluded that the AEC 
contract is a SPDC, but did not provide a basis for their 
conclusions.\12\ The other parties' comments raised substantive issues 
with respect to the applicability of section 2(h)(7) to the AEC 
contract, generally asserting that the AEC contract is not a SPDC as it 
does not meet the material liquidity, material price reference and 
price linkage criteria for SPDC determination. Those comments are more 
extensively discussed below, as applicable.
---------------------------------------------------------------------------

    \7\ 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.
    \8\ IECA describes itself as an ``association of leading 
manufacturing companies'' whose membership ``represents a diverse 
set of industries including: plastics, cement, paper, food 
processing, brick, chemicals, fertilizer, insulation, steel, glass, 
industrial gases, pharmaceutical, aluminum and brewing.'' WGCEF 
describes itself as ``a diverse group of commercial firms in the 
domestic energy industry whose primary business activity is the 
physical delivery of one or more energy commodities to customers, 
including industrial, commercial and residential consumers'' and 
whose membership consists of ``energy producers, marketers and 
utilities.'' ICE is an ECM, as noted above. EI is an economic 
consulting firm with offices located in Washington, DC, and San 
Francisco, CA. NGSA is an industry association comprised of natural 
gas producers and marketers. FERC is an independent federal 
regulatory agency that, among other things, regulates the interstate 
transmission of natural gas, oil and electricity. FIEG describes 
itself as an association of investment and commercial banks who are 
active participants in various sectors of the natural gas markets, 
``including acting as marketers, lenders, underwriters of debt and 
equity securities, and proprietary investors.'' The comment letters 
are available on the Commission's Web site: http://www.cftc.gov/lawandregulation/federalregister/federalregistercomments/2009/09-016.html.
    \9\ FERC stated that the AEC contract is cash settled and does 
not contemplate actual physical delivery of natural gas. 
Accordingly, FERC expressed the opinion that a determination by the 
Commission that a contract performs a significant price discovery 
function ``would not appear to conflict with FERC's exclusive 
jurisdiction under the Natural Gas Act (NGA) over certain sales of 
natural gas in interstate commerce for resale or with its other 
regulatory responsibilities under the NGA'' and further that ``FERC 
staff will continue to monitor for any such conflict . . . [and] 
advise the CFTC'' should any such potential conflict arise. CL 06.
    \10\ CL 01.
    \11\ CL 08.
    \12\ IECA stated that the subject ICE contract should ``be 
required to come into compliance with core principles mandated by 
Section 2(h)(7) of the Act and with other statutory provisions 
applicable to registered entities. [This contract] should be subject 
to the Commission's position limit authority, emergency authority 
and large trader reporting requirements, among others.'' CL 01.
---------------------------------------------------------------------------

III. Section 2(h)(7) of the CEA

    The Commission is directed by section 2(h)(7) of the CEA to 
consider the following criteria in determining a contract's 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 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 criteria must be present to support a determination that a 
particular contract performs a significant price discovery function, 
and one or more criteria may be inapplicable to a particular 
contract.\13\ Moreover, the statutory language neither prioritizes the 
criteria nor specifies the degree to which a SPDC must conform to the 
various criteria. In Guidance issued in connection with the Part 36 
rules governing ECMs with SPDCs, the Commission observed that these 
criteria 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 criterion, or combination of criteria, would 
be sufficient to support a SPDC determination.\14\ 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. In evaluating a contract's price discovery role as 
a price reference, the Commission will consider whether cash market 
participants are quoting bid or offer prices or entering into 
transactions at prices that are set either explicitly or implicitly at 
a differential to prices established for the contract.
---------------------------------------------------------------------------

    \13\ In its October 9, 2009, Federal Register release, the 
Commission identified material price reference, price linkage and 
material liquidity as the possible criteria for SPDC determination 
of the AEC contract. Arbitrage was not identified as a possible 
criterion and will not be discussed further in this document or the 
associated Order.
    \14\ 17 CFR part 36, appendix A.
---------------------------------------------------------------------------

IV. Findings and Conclusions

a. The AECO Financial Basis (AEC) Contract and the SPDC Indicia

    The AEC contract is cash settled based on the difference between 
the AECO-C & Nova Inventory Transfer (Alberta) price index for natural 
gas in the month of production, as reported in the first publication of 
the month of Canadian Enerdata, Ltd.'s Canadian Gas Price Reporter 
(``CGPR'') and the final settlement price for the New York Mercantile 
Exchange's (``NYMEX's'') Henry Hub physically-delivered natural gas 
futures contract for the same specified calendar month. The 
transactions used to calculate the

[[Page 23699]]

monthly Alberta price index are those that are conducted on the Natural 
Gas Exchange (``NGX'') in a given month and specify the delivery of 
natural gas at the Alberta hub in the following month. The Alberta 
price index is computed as the volume-weighted average of the 
applicable natural gas transactions. The size of the AEC contract is 
2,500 million British thermal units (``mmBtu''), and the unit of 
trading is any multiple of 2,500 mmBtu. The AEC contract is listed for 
up to 120 calendar months commencing with the next calendar month.
    The Henry Hub,\15\ which is located in Erath, Louisiana, is the 
primary cash market trading and distribution center for natural gas in 
the United States. It also is the delivery point and pricing basis for 
the NYMEX's actively traded, physically-delivered natural gas futures 
contract, which is the most important pricing reference for natural gas 
in the United States. The Henry Hub, which is operated by Sabine Pipe 
Line, LLC, serves as a juncture for 13 different pipelines. These 
pipelines bring in natural gas from fields in the Gulf Coast region and 
ship it to major consumption centers along the East Coast and Midwest. 
The throughput shipping capacity of the Henry Hub is 1.8 trillion mmBtu 
per day.
---------------------------------------------------------------------------

    \15\ The term ``hub'' refers to a juncture where two or more 
natural gas pipelines are connected. Hubs also serve as pricing 
points for natural gas at the particular locations.
---------------------------------------------------------------------------

    In addition to the Henry Hub, there are a number of other locations 
where natural gas is traded. In 2008, there were 33 natural gas market 
centers in North America.\16\ Some of the major trading centers include 
Alberta, Northwest Rockies, Southern California border and the Houston 
Ship Channel. For locations that are directly connected to the Henry 
Hub by one or more pipelines and where there typically is adequate 
shipping capacity, the price at the other locations usually directly 
tracks the price at the Henry Hub, adjusted for transportation costs. 
However, at other locations that are not directly connected to the 
Henry Hub or where shipping capacity is limited, the prices at those 
locations often diverge from the Henry Hub price. Furthermore, one 
local price may be significantly different than the price at another 
location even though the two markets' respective distances from the 
Henry Hub are the same. The reason for such pricing disparities is that 
a given location may experience supply and demand factors that are 
specific to that region, such as differences in pipeline shipping 
capacity, unusually high or low demand for heating or cooling or supply 
disruptions caused by severe weather. As a consequence, local natural 
gas prices can differ from the Henry Hub price by more than the cost of 
shipping and such price differences can vary in an unpredictable 
manner.
---------------------------------------------------------------------------

    \16\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.
---------------------------------------------------------------------------

    The Alberta hub is far removed from the Henry Hub and is not 
directly connected to the Henry Hub by an existing pipeline. Located in 
the Canadian province of Alberta, the Alberta natural gas market is a 
major connection point for long-distance transmission systems that ship 
natural gas to points throughout Canada and the United States. The 
Alberta province is Canada's dominant natural gas producing region; six 
of the nine Canadian market centers are located in the Alberta 
province. The throughput capacity at the AECO-C hub is ten billion 
cubic feet per day. Moreover, the number of pipeline interconnections 
at that hub was four in 2008. Lastly, the AECO-C hub's capacity is 20.4 
billion cubic feet per day.\17\
---------------------------------------------------------------------------

    \17\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.
---------------------------------------------------------------------------

    The local price at the Alberta hub typically differs from the price 
at the Henry Hub. Thus, the price of the Henry Hub physically-delivered 
futures contract is an imperfect proxy for the Alberta price. Moreover, 
exogenous factors, such as adverse weather, can cause the Alberta gas 
price to differ from the Henry Hub price by an amount that is more or 
less than the cost of shipping, making the NYMEX Henry Hub futures 
contract even less precise as a hedging tool than desired by market 
participants. Basis contracts\18\ allow traders to more accurately 
discover prices at alternative locations and hedge price risk that is 
associated with natural gas at such locations. In this regard, a 
position at a local price for an alternative location can be 
established by adding the appropriate basis swap position to a position 
taken in the NYMEX physically-delivered Henry Hub contract (or in the 
NYMEX or ICE Henry Hub look-alike contract, which cash settle based on 
the NYMEX contract's final settlement price).
---------------------------------------------------------------------------

    \18\ Basis contracts denote the difference in the price of 
natural gas at a specified location minus the price of natural gas 
at the Henry Hub. The differential can be either a positive or 
negative value.
---------------------------------------------------------------------------

    In its October 9, 2009, Federal Register notice, the Commission 
identified material price reference, price linkage and material 
liquidity as the potential SPDC criteria applicable to the AEC 
contract. Each of these criteria is discussed below.\19\
---------------------------------------------------------------------------

    \19\ As noted above, the Commission did not find an indication 
of arbitrage in connection with this contract; accordingly, that 
criterion is not discussed in reference to the AEC contract.
---------------------------------------------------------------------------

1. Material Price Reference Criterion.
    The Commission's October 9, 2009, Federal Register notice 
identified material price reference as a potential basis for a SPDC 
determination with respect to this contract. The Commission considered 
the fact that ICE maintains exclusive rights over using CGPR's Alberta 
price index for cash settlement purposes. As a result, no other 
exchange can offer such a basis contract based on CGPR's Alberta price 
index. While other third-party price providers produce natural gas 
price indices for this and other trading centers, market participants 
indicate that the CGPR price index is highly regarded for this 
particular location and should market participants wish to establish a 
hedged position based on this index, they would need to do so by taking 
a position in the ICE AEC contract since ICE has the right to the CGPR 
index for cash settlement purposes. In addition, ICE sells its price 
data to market participants in a number of different packages which 
vary in terms of the hubs covered, time periods, and whether the data 
are daily only or historical. For example, ICE offers the ``West Gas 
End of Day'' and OTC Gas End of Day'' \20\ packages with access to all 
price data or just current prices plus a selected number of months 
(i.e., 12, 24, 36 or 48 months) of historical data. These two packages 
include price data for the AEC contract.
---------------------------------------------------------------------------

    \20\ The OTC Gas End of Day dataset includes daily settlement 
prices for natural gas contracts listed for all points in North 
America.
---------------------------------------------------------------------------

    The Alberta hub is a major trading center for natural gas in North 
America. Traders, including producers, keep abreast of the prices of 
the AEC contract when conducting cash deals. These traders look to a 
competitively determined price as an indication of expected values of 
natural gas at the Alberta hub when entering into cash market 
transactions for natural gas, especially those trades providing for 
physical delivery in the future. Traders use the ICE AEC contract, as 
well as other ICE basis swap contracts, to hedge cash market positions 
and transactions--activities which enhance the AEC contract's price 
discovery utility. The substantial volume of trading and open interest 
in the AEC contract appears to attest to its use for this purpose. 
While the AEC contract's settlement prices may not be the only

[[Page 23700]]

factor influencing spot and forward transactions, natural gas traders 
consider the ICE price to be a critical factor in conducting OTC 
transactions.\21\
---------------------------------------------------------------------------

    \21\ In addition to referencing ICE prices, natural gas market 
firms participating in the Alberta market may rely on other cash 
market quotes as well as industry publications and price indices 
that are published by third-party price reporting firms when 
entering into natural gas transactions.
---------------------------------------------------------------------------

    Lastly, the fact that the AEC contract does not meet the price 
linkage criterion (discussed below) bolsters the argument for material 
price reference. As noted above, the Henry Hub is the pricing reference 
for natural gas in the United States. However, regional market 
conditions may cause the price of natural gas in another area of the 
country to diverge by more than the cost of transportation, thus making 
the Henry Hub price an imperfect proxy for the local gas price. The 
more variable the local natural gas price is, the more traders need to 
accurately hedge their price risk. Basis swap contracts provide a means 
of more accurately pricing natural gas at a location other than the 
Henry Hub. An analysis of Alberta natural gas prices showed that 98 
percent of the observations were more than 2.5 percent different than 
the contemporaneous Henry Hub prices. Specifically, the average Alberta 
basis value between January 2008 and September 2009 was -$0.87 per 
mmBtu with a variance of $0.21 per mmBtu.
i. Federal Register Comments
    ICE stated in its comment letter that the AEC contract does not 
meet the material price reference criterion for SPDC determination. ICE 
argued that the Commission appeared to base the case that the AEC 
contract is potentially a SPDC on two disputable assertions. First, in 
issuing its notice of intent to determine whether the AEC contract is a 
SPDC, the CFTC cited a general conclusion in its ECM study ``that 
certain market participants referred to ICE as a price discovery market 
for certain natural gas contracts.'' ICE states that CFTC's reason is 
``hard to quantify as the ECM report does not mention'' this contract 
as a potential SPDC. ``It is unknown which market participants made 
this statement in 2007 or the contracts that were referenced.'' In 
response to the above comment, the Commission notes that it cited the 
ECM study's general finding that some ICE natural gas contracts appear 
to be regarded as price discovery markets merely as an indicia that an 
investigation of certain ICE contracts may be warranted, and was not 
intended to serve as the sole basis for determining whether or not a 
particular contract meets the material price reference criterion.
    Second, ICE argued that the Commission should not base a 
determination that the AEC contract is a SPDC merely because this 
contract has the exclusive right to base its settlement on the CGPR 
Alberta price index. While the Commission acknowledges that there are 
other firms that produce price indices for the Alberta hub, market 
participants indicate that the CGPR index is very highly regarded and 
should they wish to establish a hedged position based on this index, 
they would need to do so by taking a position in the ICE AEC swap since 
ICE has the exclusive right to use the CGPR index.\22\
---------------------------------------------------------------------------

    \22\ Futures and swaps based on other Alberta indices have not 
met with the same market acceptance as the ICE AEC contract. For 
example, NYMEX previously listed a basis swap contract that was 
comparable to the AEC contract. However, ICE's exclusive agreement 
with Enerdata forced NYMEX to delist its contract because NYMEX 
could not find a suitable alternative price index. Up until the 
point of being delisted, there was no centralized-market trading in 
the NYMEX version of the AEC contract, so it never served as a 
source of price discovery for cash market traders with natural gas 
at the Alberta hub.
---------------------------------------------------------------------------

    WGCEF, NGSA, EI and FIEG all stated that the AEC contract does not 
satisfy the material price reference criterion. The commenters argued 
that other contracts (physical or financial) are not indexed basis the 
ICE AEC contract price, but rather are indexed based on the underlying 
cash price series against which the ICE AEC contract is settled. Thus, 
they contend that the underlying cash price series is the authentic 
reference price and not the ICE contract itself. The Commission 
believes that this interpretation of price reference is too limiting in 
that it only considers the final index value on which the contract is 
cash settled after trading ceases. Instead, the Commission believes 
that a cash-settled derivatives contract could meet the price reference 
criteria if market participants ``consult on a frequent and recurring 
basis'' the derivatives contract when pricing forward, fixed-price 
commitments or other cash-settled derivatives that seek to ``lock in'' 
a fixed price for some future point in time to hedge against adverse 
price movements.
    As noted above, the Alberta hub is a major trading center for 
natural gas in North America. Traders, including producers, keep 
abreast of the prices of the AEC contract when conducting cash deals. 
These traders look to a competitively determined price as an indication 
of expected values of natural gas at the Alberta hub when entering into 
cash market transaction for natural gas, especially those trades that 
provide for physical delivery in the future. Traders use the ICE AEC 
contract to hedge cash market positions and transactions, which 
enhances the AEC contract's price discovery utility. While the AEC 
contract's settlement prices may not be the only factor influencing 
spot and forward transactions, natural gas traders consider the ICE 
price to be a crucial factor in conducting OTC transactions.
    Both EI and WGCEF stated that publication of price data in a 
package format is a weak justification for material price reference. 
These commenters argue that market participants generally do not 
purchase ICE data sets for one contract's prices, such as those for the 
AEC contract. Instead, traders are interested in the settlement prices, 
so the fact that ICE sells the AEC prices as part of a broad package is 
not conclusive evidence that market participants are buying the ICE 
data sets because they find the AEC prices have substantial value to 
them. The Commission notes that the Alberta hub is a major natural gas 
trading point, and the AEC contract's prices are well regarded in the 
industry as indicative of the value of natural gas at the Alberta hub. 
Accordingly, the Commission believes that it is reasonable to conclude 
that market participants are purchasing the data packages that include 
the AEC contract's prices in substantial part because the AEC contract 
prices have particular value to them.
ii. Conclusion Regarding Material Price Reference
    Based on the above, the Commission finds that the AEC contract 
meets the material price reference criterion because it is referenced 
on a frequent and recurring basis by cash market participants when 
pricing transactions (direct evidence). Moreover, the ECM sells the AEC 
contract's price data to market participants (indirect evidence).
2. Price Linkage Criterion
    In its October 9, 2009 Federal Register notice, the Commission 
identified price linkage as a potential basis for a SPDC determination 
with respect to the AEC contract. In this regard, the final settlement 
of the AEC contract is based, in part, on the final settlement price of 
the NYMEX's physically-delivered natural gas futures contract, where 
the NYMEX is registered with the Commission as a DCM.
    The Commission's Guidance on Significant Price Discovery Contracts 
\23\ notes that a ``price-linked contract is a

[[Page 23701]]

contract that relies on a contract traded on another trading facility 
to settle, value or otherwise offset the price-linked contract.'' 
Furthermore, the Guidance notes that, ``[f]or a linked contract, the 
mere fact that a contract is linked to another contract will not be 
sufficient to support a determination that a contract performs a 
significant price discovery function. To assess whether such a 
determination is warranted, the Commission will examine the 
relationship between transaction prices of the linked contract and the 
prices of the referenced contract. The Commission believes that where 
material liquidity exists, prices for the linked contract would be 
observed to be substantially the same as or move substantially in 
conjunction with the prices of the referenced contract.'' Furthermore, 
the Guidance proposes a threshold price relationship such that prices 
of the ECM linked contract will fall within a 2.5 percent price range 
for 95 percent of contemporaneously determined closing, settlement or 
other daily prices over the most recent quarter. Finally, the 
Commission also stated in the Guidance that it would consider a linked 
contract which has a trading volume equivalent to 5 percent of the 
volume of trading in the contract to which it is linked to have 
sufficient volume potentially to be deemed a SPDC (``minimum 
threshold'').
---------------------------------------------------------------------------

    \23\ Appendix A to the Part 36 rules.
---------------------------------------------------------------------------

    To assess whether the AEC contract meets the price linkage 
criterion, Commission staff obtained price data from ICE and performed 
the statistical tests cited above. Staff found that, while the Alberta 
price is determined, in part, by the final settlement price of the 
NYMEX physically-delivered natural gas futures contract (a DCM 
contract), the Alberta hub price is not within 2.5 percent of the 
settlement price of the corresponding NYMEX Henry Hub natural gas 
futures contract on 95 percent or more of the days. Specifically, 
during the third quarter of 2009, only 2.4 percent of the Alberta 
natural gas prices derived from the ICE basis values were within 2.5 
percent of the daily settlement price of the NYMEX Henry Hub futures 
contract. In addition, staff found that the AEC contract fails to meet 
the volume threshold requirement. In particular, the total trading 
volume in the NYMEX physically delivered natural gas contract during 
the third quarter of 2009 was 14,022,963 contracts, with 5 percent of 
that number being 701,148 contracts. Trades on the ICE centralized 
market in the AEC contract during the same period was 736,412 contracts 
(equivalent to 184,103 NYMEX contracts, given the size difference).\24\ 
Thus, centralized-market trades in the AEC contract amounted to less 
than the minimum threshold.
---------------------------------------------------------------------------

    \24\ The AEC contract is one-quarter the size of the NYMEX Henry 
Hub physically-delivered futures contract.
---------------------------------------------------------------------------

    Due to the specific criteria that a given ECM contract must meet to 
fulfill the price linkage criterion, the requirements, for all intents 
and purposes, exclude ECM contracts that are not near facsimiles of DCM 
contracts even though the ECM contract may specifically use the 
settlement price to value a position, which is the case of the AEC 
contract. In this regard, an ECM contract that is priced and traded as 
if it is a functional equivalent of a DCM contract likely will have a 
price series that mirrors that of the corresponding DCM contract. In 
contrast, for contracts that are not look-alikes of DCM contracts, it 
is reasonable to expect that the two price series would be divergent. 
The Alberta hub and the Henry Hub are located in two different areas of 
North America. Moreover, both hubs are supply centers, where the 
Alberta hub handles a throughput volume that is ten times that of the 
Henry Hub. These differences contribute to the divergence between the 
two price series and, as discussed above, increase the likelihood that 
the ``basis'' contract is used for material price reference.
i. Federal Register Comments
    NGSA stated that the AEC contract does not meet the price linkage 
criterion because basis contracts, including the AEC contract, are not 
equivalent to the NYMEX physically-delivered Henry Hub contract. EI 
also noted that the AEC and NYMEX natural gas contracts are not 
economically equivalent and that the AEC contract's volume is too low 
to affect the NYMEX natural gas futures contract. WGCEF stated that the 
Alberta price is determined, in part, by the final settlement price of 
the NYMEX Henry Hub futures contract. However, WCEF goes on to state 
that the AEC contract ``(a) is not substantially the same as the NYMEX 
[natural gas futures contract] * * * nor (b) does it move substantially 
in conjunction'' with the NYMEX natural gas futures contract. ICE 
opined that the AEC contract's trading volume is too low to affect the 
price discovery process for the NYMEX natural gas futures contract. In 
addition, ICE states that the AEC contract simply reflects a price 
differential between Alberta and the Henry Hub; ``there is no price 
linkage as contemplated by Congress or the CFTC in its rulemaking.'' 
FIEG acknowledged that the AEC contract is a locational spread that is 
based in part on the NYMEX natural gas futures price, but also 
questioned the significance of this fact relative to the price linkage 
criterion since the key component of the spread is the price at the 
Alberta location and not the NYMEX physically-delivered natural gas 
futures price.
ii. Conclusion Regarding the Price Linkage Criterion
    Based on the above, the Commission finds that the AEC contract does 
not meet the price linkage criterion because it fails the price 
relationship and volume tests provided for in the Commission's 
Guidance.
3. Material Liquidity Criterion
    To assess whether the AEC contract meets the material liquidity 
criterion, the Commission first examined volume and open interest data 
provided to it by ICE as a general measurement of the AEC market's size 
and potential importance, and second performed a statistical analysis 
to measure the effect that changes to AEC prices potentially may have 
on prices for the NYMEX Henry Hub Natural Gas (a DCM contract), the ICE 
Socal Border Financial Basis (``SCL'') contract (an ECM contract) and 
the ICE HSC \25\ Financial Basis contract (an ECM contract).\26\
---------------------------------------------------------------------------

    \25\ The acronym stands for Houston Ship Channel.
    \26\ As noted above, the material liquidity criterion speaks to 
the effect that transactions in the potential SPDC may have on 
trading in ``agreements, contracts and transactions listed for 
trading on or subject to the rules of a designated contract market, 
a derivatives transaction execution facility, or an electronic 
trading facility operating in reliance on the exemption in section 
2(h)(3) of the Act.
---------------------------------------------------------------------------

    The Commission's Guidance (Appendix A to Part 36) notes that 
``[t]raditionally, objective measures of trading such as volume or open 
interest have been used as measures of liquidity.'' In this regard, the 
Commission in its October 9, 2009, Federal Register notice referred to 
second quarter 2009 trading statistics that ICE had submitted for its 
AEC contract. Based upon on a required quarterly filing made by ICE on 
July 27, 2009, the total number of AEC trades executed on ICE's 
electronic trading platform was 7,263 in the second quarter of 2009, 
resulting in a daily average of 113.5 trades. During the same period, 
the AEC contract had a total trading volume on ICE's electronic trading 
platform of 806,438 contracts and an average daily trading volume of 
12,601 contracts. Moreover, the open interest as of June 30, 2009, was 
443,402 contracts, which includes trades executed on ICE's electronic 
trading platform, as well as trades executed off

[[Page 23702]]

of ICE's electronic trading platform and then brought to ICE for 
clearing.\27\
---------------------------------------------------------------------------

    \27\ ICE does not differentiate between open interest created by 
a transaction executed on its trading platform versus that created 
by a transaction executed off its trading platform. 74 FR 52196 
(October 9, 2009).
---------------------------------------------------------------------------

    Subsequent to the October 9, 2009, Federal Register notice, ICE 
submitted another quarterly notification filed on November 13, 
2009,\28\ with updated trading statistics. Specifically, with respect 
to its AEC contract, 6,320 separate trades occurred on its electronic 
platform in the third quarter of 2009, resulting in a daily average of 
95.8 trades. During the same period, the AEC contract had a total 
trading volume on its electronic platform of 736,412 contracts (which 
was an average of 11,158 contracts per day).\29\ As of September 30, 
2009, open interest in the AEC contract was 483,561 \30\ contracts. 
Reported open interest included positions resulting from trades that 
were executed on ICE's electronic platform, as well as trades that were 
executed off of ICE's electronic platform and brought to ICE for 
clearing.
---------------------------------------------------------------------------

    \28\ See Commission Rule 36.3(c)(2), 17 CFR 36.3(c)(2).
    \29\ By way of comparison, the number of contracts traded in the 
AEC contract is similar to that exhibited on a liquid futures market 
and is roughly equivalent to the volume of trading for the ICE US 
Coffee ``C'' and Cocoa contracts during this period.
    \30\ By way of comparison, open interest in the AEC contract is 
similar to that exhibited on a liquid futures market and is roughly 
equivalent to that in the Commodity Exchange's Gold contract and the 
Chicago Board of Trade's soybean contract.
---------------------------------------------------------------------------

    In Appendix A to Part 36, the material liquidity criterion for SPDC 
determination specifies that an ECM contract should have a material 
effect on another contract. To measure the effect that the AEC contract 
has on a DCM contract, or on another ECM contract, Commission staff 
performed a statistical analysis \31\ of ICE and NYMEX price data using 
daily settlement prices (between January 2, 2008, and September 30, 
2009) for the NYMEX Henry Hub natural gas contract (a DCM contract) and 
the ICE Socal Border Financial Basis and HSC Financial Basis contracts 
(ECM contracts).\32\ The simulation results suggest that, on average 
over the sample period, a one percent rise in the AEC contract's price 
elicited a 0.8 percent to 0.9 percent increase in each of the NYMEX 
Henry Hub, ICE SCL and ICE HSC contracts' prices.
---------------------------------------------------------------------------

    \31\ Specifically, Commission staff econometrically estimated a 
vector autoregression model using daily natural gas price levels. A 
vector autoregression model is an econometric model used to capture 
the dependencies and interrelationships among multiple time series, 
generalizing the univariate autoregression model. The estimated 
model displays strong diagnostic evidence of statistical adequacy. 
In particular, the model's impulse response function was shocked 
with a one-time rise in Alberta price. The simulation results 
suggest that, on average over the sample period, a one percent rise 
in the Alberta natural gas price elicited a 0.9 percent increase in 
the NYMEX Henry Hub price and the Southern California border gas 
price, as well as a 0.8 percent increase in HSC gas prices. These 
multipliers of response emerge with noticeable statistical strength 
or significance. Based on such long run sample patterns, if the 
Alberta price rises by 10 percent, then the price of NYMEX Henry Hub 
natural gas futures contract and the Sothern California gas price 
each would rise by about 9 percent; a 10 percent rise in the Alberta 
gas price would lead to a rise in the HSC contract's price by about 
9 percent.
    \32\ Natural gas prices at the Alberta, HSC, and Socal trading 
centers were obtained by adding the daily settlement prices of ICE's 
AECO Financial Basis, HSC Financial Basis and Socal Border Financial 
Basis contracts, respectively, to the contemporaneous daily 
settlement prices of the NYMEX Henry Hub physically-delivered 
natural gas futures contract.
---------------------------------------------------------------------------

i. Federal Register Comments
    As noted above, comments were received from eight individuals and 
organizations, with five comments being directly applicable to the SPDC 
determination of the ICE AEC contract. WGCEF, EI, FIEG, ICE and NGSA 
generally agreed that the AEC contract does not meet the material 
liquidity criterion.
    WGCEF \33\ and NGSA \34\ both stated that the AEC contract does not 
materially affect other contracts that are listed for trading on DCMs 
or ECMs, as well as other over-the-counter contracts. Instead, the AEC 
contract is influenced by the underlying Alberta cash price index and 
the final settlement price of the NYMEX Henry Hub natural gas futures 
contract, not vice versa. FIEG \35\ stated that the AEC contract cannot 
have a material effect on NYMEX contract because the AEC contract 
trades on a differential and represents ``one leg (and not the relevant 
leg) of the locational spread.'' The Commission's statistical analysis 
shows that changes in the ICE AEC contract's price significantly 
influences the prices of other contracts that are traded on DCMs and 
ECMs.
---------------------------------------------------------------------------

    \33\ CL 02.
    \34\ CL 05.
    \35\ CL 07.
---------------------------------------------------------------------------

    ICE \36\ opined that the Commission ``seems to have adopted a five 
trade-per-day test to determine whether a contract is materially 
liquid. It is worth noting that ICE originally suggested that the CFTC 
use a five trades-per-day threshold as the basis for an ECM to report 
trade data to the CFTC.'' In this regard, the Commission adopted a five 
trades-per-day threshold as a reporting requirement to enable it to 
``independently be aware of ECM contracts that may develop into SPDCs'' 
\37\ rather than solely relying upon an ECM on its own to identify any 
such potential SPDCs to the Commission. Thus, any contract that meets 
this threshold may be subject to scrutiny as a potential SPDC; the 
threshold is not intended to define liquidity in a broader sense. As 
noted above, the Division is basing a finding of material liquidity for 
the ICE AEC contract in part on the fact that there have been around 
100 trades per day on average in the AEC contract during the second and 
third quarters of 2009, which is far more than the five trades-per-day 
that is cited in the ICE comment.
---------------------------------------------------------------------------

    \36\ CL 03.
    \37\ 73 FR 75892 (December 12, 2008).
---------------------------------------------------------------------------

    ICE implied that the statistics provided by ICE were misinterpreted 
and misapplied by the Commission. In particular, ICE stated that the 
volume figures used in the Commission's analysis (cited above) 
``include trades made in all months of each contract'' as well as in 
strips of contract months, and the ``more appropriate method of 
determining liquidity is to examine the activity in a single traded 
month or strip of a given contract.'' Furthermore, ICE noted that for 
the AEC contract (and other basis swap contracts), ``about 25-40% of 
the trades * * * occurred in the single most liquid, usually prompt, 
month of * * * [the] contract.'' EI,\38\ and FIEG also noted that 
contract months should be considered separately rather than on an 
aggregated basis. When done so, none of the contract months meet the 
material liquidity criterion.
---------------------------------------------------------------------------

    \38\ CL 04.
---------------------------------------------------------------------------

    It is the Commission's opinion that liquidity, as it pertains to 
the AEC contract, is typically a function of trading activity in 
particular lead months and, given sufficient liquidity in such months, 
the AEC contract itself would be considered liquid. ICE's analysis of 
its own trade data confirms this to be the case for the AEC contract, 
and thus, the Commission believes that it applied the statistical data 
cited above in an appropriate manner for gauging material liquidity.
    In addition, EI and ICE stated that the trades-per-day statistics 
that it provided to the Commission in its quarterly filing and which 
are cited above includes 2(h)(1) transactions, which were not completed 
on the electronic trading platform and should not be considered in the 
SPDC determination process. The Commission staff asked ICE to review 
the data it sent in its quarterly filings. In response, ICE confirmed 
that the volume data it provided and which the Commission cited in its 
October 9, 2009, Federal Register notice, as well as the additional 
volume information it cites above, includes only transaction data

[[Page 23703]]

executed on ICE's electronic trading platform.\39\ The Commission 
acknowledges that the open interest information it cites above includes 
transactions made off the ICE platform. However, once open interest is 
created, there is no way for ICE to differentiate between ``on-
exchange'' versus ``off-exchange'' created positions, and all such 
positions are fungible with one another and may be offset in any way 
agreeable to the position holder regardless of how the position was 
initially created.
---------------------------------------------------------------------------

    \39\ Supplemental data supplied by the ICE confirmed that block 
trades in the third quarter of 2009 were in addition to the trades 
that were conducted on the electronic platform; block trades 
comprised 32.4 percent of all transactions in the AEC contract.
---------------------------------------------------------------------------

ii. Conclusion Regarding Material Liquidity
    Based on the above, the Commission concludes that the AEC contract 
meets the material liquidity criterion in that there is sufficient 
trading activity in the AEC contract to have a material effect on 
``other agreements, contracts or transactions listed for trading on or 
subject to the rules of a designated contract market * * * or an 
electronic trading facility operating in reliance on the exemption in 
section 2(h)(3) of the Act'' (that is, an ECM).
4. Overall Conclusion
    After considering the entire record in this matter, including the 
comments received, the Commission has determined that the AEC contract 
performs a significant price discovery function under two of the four 
criteria established in section 2(h)(7) of the CEA. Although the 
Commission has determined that the AEC contract does not meet the price 
linkage criterion at this time, the Commission has determined that the 
AEC contract does meet both the material liquidity and material price 
reference criteria. Accordingly, the Commission will issue the attached 
Order declaring that the AEC contract is a SPDC.
    Issuance of this Order signals the immediate effectiveness of the 
Commission's authorities with respect to ICE as a registered entity in 
connection with its AEC contract,\40\ and triggers the obligations, 
requirements--both procedural and substantive--and timetables 
prescribed in Commission rule 36.3(c)(4) for ECMs.
---------------------------------------------------------------------------

    \40\ See 73 FR 75888, 75893 (Dec. 12, 2008).
---------------------------------------------------------------------------

IV. Related Matters

a. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \41\ 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.
---------------------------------------------------------------------------

    \41\ 44 U.S.C. 3507(d).
---------------------------------------------------------------------------

b. Cost-Benefit Analysis

    Section 15(a) of the CEA \42\ 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 in light 
of the specific provisions of section 15(a) of the Act and has 
concluded that the Order, required by Congress to strengthen Federal 
oversight of exempt commercial markets and to prevent market 
manipulation, is necessary and appropriate to accomplish the purposes 
of section 2(h)(7) of the Act.
---------------------------------------------------------------------------

    \42\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

    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 or 
other disruptions to market integrity, both on the ECM itself and in 
any related futures contracts trading on 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 issue 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. Section 4(i) of the CEA 
authorizes the Commission to require reports for SPDCs listed on ECMs. 
These increased 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.

c. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') \43\ requires that 
agencies consider the impact of their rules on small businesses. The 
requirements of CEA section 2(h)(7) and the Part 36 rules affect ECMs. 
The Commission previously has determined that ECMs are not small 
entities for purposes of the RFA.\44\ Accordingly, the Chairman, on 
behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) 
that this Order, taken in connection with section 2(h)(7) of the Act 
and the Part 36 rules, will not have a significant impact on a 
substantial number of small entities.
---------------------------------------------------------------------------

    \43\ 5 U.S.C. 601 et seq.
    \44\ 66 FR 42256, 42268 (Aug. 10, 2001).
---------------------------------------------------------------------------

V. Order

a. Order Relating to the ICE AECO Financial Basis Contract

    After considering the complete record in this matter, including the 
comment letters received in response to its request for comments, the 
Commission has determined to issue the following:
    The Commission, pursuant to its authority under section 2(h)(7) of 
the Act, hereby determines that the AECO Financial Basis contract, 
traded on the IntercontinentalExchange, Inc., must comply with, with 
respect to the AECO Financial Basis contract, the nine core principles 
established by new section

[[Page 23704]]

2(h)(7)(C). Additionally, the IntercontinentalExchange, Inc., satisfies 
the statutory material liquidity and material price reference criteria 
for significant price discovery contracts. Consistent with this 
determination, and effective immediately, the IntercontinentalExchange, 
Inc., shall be and is considered a registered entity \45\ with respect 
to the AECO Financial Basis 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 the IntercontinentalExchange, Inc. commence with the 
issuance of this Order.\46\
---------------------------------------------------------------------------

    \45\ 7 U.S.C. 1a(29).
    \46\ Because ICE already lists for trading a contract (i.e., the 
Henry Financial LD1 Fixed Price contract) that was previously 
declared by the Commission to be a SPDC, ICE must submit a written 
demonstration of compliance with the Core Principles within 30 
calendar days of the date of this Order. 17 CFR 36.3(c)(4).

    Issued in Washington, DC on April 28, 2010, by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. 2010-10299 Filed 5-3-10; 8:45 am]
BILLING CODE P