[Federal Register Volume 75, Number 85 (Tuesday, May 4, 2010)]
[Notices]
[Pages 23679-23686]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-10306]


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COMMODITY FUTURES TRADING COMMISSION


Order Finding That the ICE Malin Financial Basis Contract Traded 
on the IntercontinentalExchange, Inc., Does Not Perform a Significant 
Price Discovery Function

AGENCY: Commodity Futures Trading Commission.

ACTION: Final orders.

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SUMMARY: On October 9, 2009, the Commodity Futures Trading Commission 
(``CFTC'' or ``Commission'') published for comment in the Federal

[[Page 23680]]

Register \1\ a notice of its intent to undertake a determination 
whether the Malin Financial Basis (``MLN'') 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 orders finding that the 
MLN contract does not perform 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 52192 (October 9, 2009).

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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).
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    \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).
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    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 
price of another contract.
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    \4\ 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 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\
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    \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.
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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 
MLN contract performs a significant price discovery function and 
requested comment from 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 Suppliers Association (``NGSA''), 
Federal Energy Regulatory Commission (``FERC''), and Financial 
Institutions Energy Group (``FIEG'').\8\ The comment letter from FERC 
\9\ did not directly

[[Page 23681]]

address the issue of whether or not the MLN contract is a SPDC; IECA 
concluded that the MLN contract is a SPDC, but did not provide a basis 
for its conclusion.\10\ The other parties' comments raised substantive 
issues with respect to the applicability of section 2(h)(7) to the MLN 
contract, generally asserting that the MLN 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.
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    \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/2009/09-020.html.
    \9\ FERC stated that the MLN 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, ``the 
FERC staff will continue to monitor for any such conflict * * * 
[and] advise the CFTC'' should any such potential conflict arise. CL 
06.
    \10\ 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.
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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 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 or 
consulting, 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.\11\ 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.\12\ 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 the extent to which, on 
a frequent and recurring basis, bids, offers or transactions are 
directly based on, or are determined by referencing, the prices 
established for the contract.
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    \11\ 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 MLN contract. Arbitrage was not identified as a possible 
criterion. As a result, arbitrage will not be discussed further in 
this document and the associated Order.
    \12\ 17 CFR 36, Appendix A.
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IV. Findings and Conclusions

a. The Malin Financial Basis (MLN) Contract and the SPDC Indicia

    The ICE MLN contract is cash settled based on the difference 
between the bidweek price index of natural gas at the Malin hub for the 
contract-specified month of delivery, as published in Intelligence 
Press Inc.'s (``IPI'') Natural Gas Bidweek Survey, and the final 
settlement price for New York Mercantile Exchange's (``NYMEX's'') Henry 
Hub physically-delivered natural gas futures contract for the same 
specified calendar month. The IPI bidweek price, which is published 
monthly, is based on a survey of cash market traders who voluntarily 
report to IPI data on their fixed-price transactions for physical 
delivery of natural gas at the Malin hub conducted during the last five 
business days of the month; such bidweek transactions specify the 
delivery of natural gas on a uniform basis throughout the following 
calendar month at the agreed upon rate. The IPI bidweek index is 
published on the first business day of the calendar month in which the 
natural gas is to be delivered. The size of the MLN contract is 2,500 
million British thermal units (``mmBtu''), and the unit of trading is 
any multiple of 2,500 mmBtu. The MLN contract is listed for up to 72 
calendar months commencing with the next calendar month.
    The Henry Hub,\13\ 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 Henry Hub 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 move 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.
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    \13\ 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.
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    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.\14\ Some of the major trading centers include 
Alberta, Northwest Rockies, Southern California border and

[[Page 23682]]

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.
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    \14\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.
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    The Malin hub is the entry point along the California-Oregon border 
at which natural gas reaches the California market. This trading center 
connects with the Gas Transmission Northwest interstate pipeline, which 
carries gas from the Canada/Idaho border through Washington State and 
Oregon. A connection with the California Gas Transmission Company also 
exists at the Malin hub. The Malin hub is considered by traders to be 
an important trading center for natural gas.
    The Malin hub is part of the Golden Gate Market Center, which is 
located in Northern California. The Golden Gate Market Center offers 
seven different transaction points, which are Malin, Citygate, Kern 
River Station, High Desert Lateral, Daggett, Southern Trails and 
Topock. The Golden Gate Market Center had an estimated throughput 
capacity of two billion cubic feet per day in 2008. Moreover, the 
number of pipeline interconnections at the Golden Gate Market Center 
was nine in 2008, up from eight in 2003. Lastly, the pipeline 
interconnection capacity of the Golden Gate Market Center in 2008 was 6 
billion cubic feet per day, which constituted a 32 percent increase 
over the pipeline interconnection capacity in 2003.\15\ The Malin hub 
is far removed from the Henry Hub and is not directly connected to the 
Henry Hub by an existing pipeline.
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    \15\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.
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    The local price at the Malin 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 Malin price. Moreover, 
exogenous factors, such as adverse weather, can cause the Malin 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 \16\ 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 physically-delivered natural gas contract's final settlement 
price).
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    \16\ 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.
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    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 MLN 
contract. Each of these criteria is discussed below.\17\
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    \17\ 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 MLN contract.
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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 IPI's bidweek price 
indices. As a result, no other exchange can offer such a basis contract 
based on IPI's Malin bidweek index. While other third-party price 
providers produce natural gas price indices for this and other trading 
centers, market participants indicate that the IPI Malin bidweek 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 MLN swap since 
ICE has the right to the IPI 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'' \18\ 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 MLN 
contract.
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    \18\ The OTC Gas End of Day dataset includes daily settlement 
prices for natural gas contracts listed for all points in North 
America.
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    The Commission will rely on one of two sources of evidence--direct 
or indirect--to determine that the price of a contract was being used 
as a material price reference and therefore, serving a significant 
price discovery function.\19\ With respect to direct evidence, the 
Commission will consider the extent to which, on a frequent and 
recurring basis, cash market bids, offers or transactions are directly 
based on or quoted at a differential to, the prices generated on the 
ECM in question. Direct evidence may be established when 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 in question. Cash 
market prices are set explicitly at a differential to the section 
2(h)(3) contract when, for instance, they are quoted in dollars and 
cents above or below the reference contract's price. Cash market prices 
are set implicitly at a differential to a section 2(h)(3) contract 
when, for instance, they are arrived at after adding to, or subtracting 
from the section 2(h)(3) contract, but then quoted or reported at a 
flat price. With respect to indirect evidence, the Commission will 
consider the extent to which the price of the contract in question is 
being routinely disseminated in widely distributed industry 
publications--or offered by the ECM itself for some form of 
remuneration--and consulted on a frequent and recurring basis by 
industry participants in pricing cash market transactions.
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    \19\ 17 CFR part 36, Appendix A.
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    Following the issuance of the Federal Register release, the 
Commission further evaluated the ICE's data offerings and their use by 
industry participants. The Malin hub is a significant trading center 
for natural gas but is not as important as other hubs, such as the PG&E 
Citygate, for pricing natural gas in the western half of the U.S. 
marketplace.

[[Page 23683]]

    Although the Malin hub is a major trading center for natural gas in 
the United States and, as noted, ICE sells price information for the 
MLN contract, the Commission has found upon further evaluation that the 
cash market transactions are not being directly based or quoted as a 
differential to the MLN contract nor is that contract routinely 
consulted by industry participants in pricing cash market transactions 
and thus does not meet the Commission's Guidance for the material price 
reference criterion. Thus, the MLN contract does not satisfy the direct 
price reference test for existence of material price reference. 
Furthermore, the Commission notes that publication of the MLN 
contract's prices is not indirect evidence material price reference. 
The MLN contract's prices are published with those of numerous other 
contracts, which are of more interest to market participants. Due to 
the less importance of the Malin hub, the Commission has concluded that 
traders likely do not specifically purchase the ICE data packages for 
the MLN contract's prices and do not consult such prices on a frequent 
and recurring basis in pricing cash market transactions.
i. Federal Register Comments
    As noted above, WGCEF,\20\ ICE,\21\ EI,\22\ NGSA \23\ and FIEG \24\ 
addressed the question of whether the MLN contract met the material 
price reference criterion for a SPDC.\25\ The commenters argued that 
because the MLN contract is cash-settled, it cannot truly serve as an 
independent ``reference price'' for transactions in natural gas at this 
location. Rather, the commenters argue, the underlying cash price 
series against which the ICE MLN contract is settled (in this case, the 
IPI bidweek price for natural gas at this location) 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 
criterion 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 Malin hub is a significant trading 
center for natural gas in North America. However, traders do not 
consider the Malin hub to be as important as other natural gas trading 
points, particularly the nearby PG&E Citygate.
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    \20\ CL 02.
    \21\ CL 04.
    \22\ CL 05.
    \23\ CL 06.
    \24\ CL 08.
    \25\ As noted above, IECA expressed the opinion that the MLN 
contract met the criteria for SPDC determination but did not provide 
its reasoning.
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    ICE argued that the Commission appeared to base the case that the 
MLN contract is potentially a SPDC on two disputable assertions. First, 
in issuing its notice of intent to determine whether the MLN 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.'' \26\ 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.'' 
\27\ 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.
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    \26\ CL 03.
    \27\ CL 03.
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    Second, ICE argued that the Commission should not base a 
determination that the MLN contract is a SPDC on the fact that this 
contract has the exclusive right to base its settlement on the IPI 
Malin Index price. While the Commission acknowledges that there are 
other firms that produce price indices for the Malin hub, as it notes 
above, market participants indicate that the IPI Index is very highly 
regarded. However, since the Malin hub is not considered the 
predominant pricing point for natural gas in the upper Northwest, it is 
likely that cash market participants do not consult the MLN contract's 
prices on a frequent and recurring basis in pricing cash market 
transactions.
    Both EI \28\ and WGCEF \29\ 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 MLN contract. Instead, traders are interested in the settlement 
prices, so the fact that ICE sells the MLN prices as part of a broad 
package is not conclusive evidence that market participants are buying 
the ICE data sets because they find the MLN prices have substantial 
value to them. As mentioned above, the Commission notes that 
publication of the MLN contract's prices is not indirect evidence of 
routine dissemination. The MLN contract's prices are published with 
those of numerous other contracts, which are of more interest to market 
participants. Due to the lack of importance of the Malin hub, the 
Commission has concluded that traders likely do not specifically 
purchase the ICE data packages for the MLN contract's prices and do not 
consult such prices on a frequent and recurring basis in pricing cash 
market transactions.
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    \28\ CL 05.
    \29\ CL 02.
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ii. Conclusion Regarding Material Price Reference
    Based on the above, the Commission finds that the MLN contract does 
not meet the material price reference criterion because cash market 
transactions are not priced on a frequent and recurring basis at a 
differential to the MLN contract's price (direct evidence). Moreover, 
while the ECM sells the MLN contract's price data to market 
participants, market participants likely do not specifically purchase 
the ICE data packages for the MLN contract's prices and do not consult 
such prices on a frequent and recurring basis in pricing cash market 
transactions (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 MLN contract. In this regard, the final settlement 
of the MLN contract is based, in part, on the final settlement price of 
the NYMEX's Henry Hub 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 
\30\ notes that a ``price-linked contract is a 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

[[Page 23684]]

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.'' 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 that 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'').
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    \30\ Appendix A to the Part 36 rules.
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    To assess whether the MLN 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 Malin 
price is determined, in part, by the final settlement price of the 
NYMEX physically-delivered natural gas futures contract (a DCM 
contract), the Malin 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, 10 percent of the Malin hub 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 finds that the MLN contract fails to meet the volume threshold 
requirement. In particular, the total trading volume in the NYMEX 
Natural Gas contract during the third quarter of 2009 was 14,022,963 
contracts, with 5 percent of that number being 701,148 contracts. The 
number of trades on the ICE centralized market in the MLN contract 
during the same period was 54,759 contracts (equivalent to 13,690 NYMEX 
contracts, given the size difference).\31\ Thus, centralized-market 
trades in the MLN contract amounted to less than the minimum threshold.
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    \31\ The MLN contract is one-quarter the size of the NYMEX Henry 
Hub physically-delivered futures contract.
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i. Federal Register Comments
    WGCEF, ICE, EI, NGSA and FIEG addressed the question of whether the 
MLN contract met the price linkage criterion for a SPDC.\32\ Each of 
the commenters expressed the opinion that the MLN contract did not 
appear to meet the above-discussed Commission guidance regarding the 
price relationship and/or the minimum volume threshold relative to the 
DCM contract to which the MLN is linked. Based on its analysis 
discussed above, the Commission agrees with this assessment.
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    \32\ As noted above, IECA expressed the opinion that the MLN 
contract met the criteria for SPDC determination but did not provide 
its reasoning.
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ii. Conclusion Regarding the Price Linkage Criterion
    The Commission finds that the MLN contract does not meet the price 
linkage criterion because it fails the volume and price linkage tests 
provided for in the Commission's Guidance.
3. Material Liquidity Factor
    As noted above, in its October 9, 2009, Federal Register notice, 
the Commission identified material price reference, price linkage and 
material liquidity as potential criteria for SPDC determination of the 
MLN contract. To assess whether a contract meets the material liquidity 
criterion, the Commission first examines trading activity as a general 
measurement of the contract's size and potential importance. If the 
Commission finds that the contract in question meets a threshold of 
trading activity that would render it of potential importance, the 
Commission will then perform a statistical analysis to measure the 
effect that the prices of the subject contract potentially may have on 
prices for other contracts listed on an ECM or a DCM.
    Based upon on a required quarterly filing made by ICE on July 27, 
2009, the total number of MLN trades executed on ICE's electronic 
trading platform was 664 in the second quarter of 2009, resulting in a 
daily average of 10.4 trades. During the same period, the MLN contract 
had a total trading volume on ICE's electronic trading platform of 
59,564 contracts and an average daily trading volume of 930.7 
contracts. The open interest as of June 30, 2009, was 65,804 contracts, 
which includes trades executed on ICE's electronic trading platform, as 
well as trades executed off of ICE's electronic trading platform and 
then brought to ICE for clearing.
    In a subsequent filing dated November 13, 2009, ICE reported that 
686 separate trades occurred on its electronic platform in the third 
quarter of 2009, resulting in a daily average of 10.4 trades. During 
the same period, the MLN contract had a total trading volume on its 
electronic platform of 54,759 contracts (which was an average of 830 
contracts per day). As of September 30, 2009, open interest in the MLN 
contract was 57,332 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.
    As indicated above, the average number trades per day in the second 
and third quarters of 2009 was only slightly above the minimum 
reporting level (5 trades per day). Moreover, trading activity in the 
MLN contract, as characterized by total quarterly volume, indicates 
that the MLN contract experiences trading activity similar to that of 
other thinly-traded contracts.\33\ Thus, the MLN contract does not 
meets a threshold of trading activity that would render it of potential 
importance and no additional statistical analysis is warranted.\34\
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    \33\ Staff has advised the Commission that in its experience, a 
thinly-traded contract is, generally, one that has a quarterly 
trading volume of 100,000 contracts or less. In this regard, in the 
third quarter of 2009, physical commodity futures contracts with 
trading volume of 100,000 contracts or fewer constituted less than 
one percent of total trading volume of all physical commodity 
futures contracts.
    \34\ In establishing guidance to illustrate how it will evaluate 
the various criteria, or combinations of criteria, when determining 
whether a contract is a SPDC, the Commission made clear that 
``material liquidity itself would not be sufficient to make a 
determination that a contract is a [SPDC], * * * but combined with 
other factors it can serve as a guidepost indicating which contracts 
are functioning as [SPDCs].'' For the reasons discussed above, the 
Commission has found that the MLN contract does not meet either the 
price linkage or material price reference criterion. In light of 
this finding and the Commission's Guidance cited above, there is no 
need to evaluate further the material liquidity criteria since it 
cannot be used alone as a basis for a SPDC determination.
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i. Federal Register Comments
    As noted above, WGCEF, ICE, EI, NGSA and FIEG addressed the 
question of whether the MLN contract met the material liquidity 
criterion for a SPDC.\35\ These commenters stated that the MLN contract 
does not meet the material liquidity criterion for SPDC determination 
for a number of reasons.
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    \35\ As noted above, IECA expressed the opinion that the MLN 
contract met the criteria for SPDC determination but did not provide 
its reasoning.
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    WGCEF,\36\ ICE \37\ and EI \38\ noted that the Commission's 
Guidance had posited

[[Page 23685]]

concepts of liquidity that generally assumed a fairly constant stream 
of prices throughout the trading day, and noted that the relatively low 
number of trades per day in the MLN contract did not meet this standard 
of liquidity. The Commission observes that a continuous stream of 
prices would indeed be an indication of liquidity for certain markets 
but the Guidance also notes that ``quantifying the levels of immediacy 
and price concession that would define material liquidity may differ 
from one market or commodity to another.''
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    \36\ CL 02.
    \37\ CL 04.
    \38\ CL 05.
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    WGCEF, FIEG \39\ and NGSA \40\ noted that the MLN contract 
represents a differential, which does not affect other contracts, 
including the NYMEX Henry Hub contract and physical gas contracts. FIEG 
and WGCEF also noted that the MLN contract's trading volume represents 
only a fraction of natural gas trading.
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    \39\ CL 08.
    \40\ CL 06.
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    ICE 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.'' Furthermore, FIEG cautioned the Commission in 
using a reporting threshold as a measure of liquidity. 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'' \41\ 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 but this does not mean that the contract will be 
found to be a SPDC merely because it met the reporting threshold.
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    \41\ 73 FR 75892 (December 12, 2008).
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    ICE and EI proposed 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 a ``more appropriate method of 
determining liquidity is to examine the activity in a single traded 
month or strip of a given contract.'' \42\ A similar argument was made 
by EI, which observed that the five-trades-per-day number ``is highly 
misleading * * * because the contracts can be offered for as long as 
120 months, [thus] the average per day for an individual contract may 
be less than 1 per day.''
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    \42\ In addition, both EI and ICE stated that the trades-per-day 
statistics that it provided to the Commission in its quarterly 
filing and which were cited in the Commission's October 9, 2009, 
Federal Register notice 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; ICE 
confirmed that the volume data it provided and which the Commission 
cited includes only transaction data executed on ICE's electronic 
trading platform. As noted above, supplemental data supplied by ICE 
confirmed that block trades are in addition to the trades that were 
conducted on the electronic platform; block trades comprise about 55 
percent of all transactions in the MLN contract. The Commission 
acknowledges that the open interest information it provided in its 
October 9, 2009, Federal Register notice 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.
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    It is the Commission's opinion that liquidity, as it pertains to 
the MLN contract, is typically a function of trading activity in 
particular lead months and, given sufficient liquidity in such months, 
the ICE MLN contract itself would be considered liquid. In any event, 
in light of the fact that the Commission has found that the MLN 
contract does not meet the material price reference or price linkage 
criteria, according to the Commission's Guidance, it would be 
unnecessary to evaluate whether the MLN contract meets the material 
liquidity criterion since it cannot be used alone for SPDC 
determination.
ii. Conclusion Regarding Material Liquidity
    For the reasons discussed above, the Commission does not find 
evidence that the MLN contract meets the material liquidity criterion.
4. Overall Conclusion Regarding the MLN Contract
    After considering the entire record in this matter, including the 
comments received, the Commission has determined that the MLN contract 
does not perform a significant price discovery function under the 
criteria established in section 2(h)(7) of the CEA. Specifically, the 
Commission has determined that the MLN contract does not meet the 
material price reference, price linkage and material liquidity criteria 
at this time. Accordingly, the Commission will issue the attached Order 
declaring that the MLN contract is not a SPDC. Issuance of this Order 
indicates that the Commission does not at this time regard ICE as a 
registered entity in connection with its MLN contract.\43\ Accordingly, 
with respect to its MLN contract, ICE is not required to comply with 
the obligations, requirements and timetables prescribed in Commission 
rule 36.3(c)(4) for ECMs with SPDCs. However, ICE must continue to 
comply with the applicable reporting requirements.
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    \43\ See 73 FR 75888, 75893 (Dec. 12, 2008).
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V. Related Matters

a. Paperwork Reduction Act

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

    Section 15(a) of the CEA \45\ 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.
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    \45\ 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

[[Page 23686]]

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 
authorize 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.
    The Commission has concluded that ICE's MLN contract, which is the 
subject of the attached Order, is not a SPDC; accordingly, the 
Commission's Order imposes no additional costs and no additional 
statutorily or regulatory mandated responsibilities on the ECM.

c. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') \46\ 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.\47\ Accordingly, the Chairman, on 
behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) 
that these Orders, 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.
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    \46\ 5 U.S.C. 601 et seq.
    \47\ 66 FR 42256, 42268 (Aug. 10, 2001).
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VI. Order

a. Order Relating to the Malin 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 Order:
    The Commission, pursuant to its authority under section 2(h)(7) of 
the Act, hereby determines that the Malin Financial Basis contract, 
traded on the IntercontinentalExchange, Inc., does not at this time 
satisfy the material price reference, price linkage or material 
liquidity criteria for significant price discovery contracts. 
Consistent with this determination, the IntercontinentalExchange, Inc., 
is not considered a registered entity \48\ with respect to the Malin 
Financial Basis contract and is not subject to 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., are not applicable to the Malin 
Financial Basis contract with the issuance of this Order.
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    \48\ 7 U.S.C. 1a(29).
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    This Order is based on the representations made to the Commission 
by the IntercontinentalExchange, Inc., dated July 27, 2009, and 
November 13, 2009, and other supporting material. Any material change 
or omissions in the facts and circumstances pursuant to which this 
order is granted might require the Commission to reconsider its current 
determination that the Malin Financial Basis contract is not a 
significant price discovery contract. Additionally, to the extent that 
it continues to rely upon the exemption in Section 2(h)(3) of the Act, 
the IntercontinentalExchange, Inc., must continue to comply with all of 
the applicable requirements of Section 2(h)(3) and Commission 
Regulation 36.3.

    Issued in Washington, DC on April 28, 2010, by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. 2010-10306 Filed 5-3-10; 8:45 am]
BILLING CODE P