[Federal Register Volume 75, Number 86 (Wednesday, May 5, 2010)]
[Notices]
[Pages 24606-24612]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-10338]


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COMMODITY FUTURES TRADING COMMISSION


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

AGENCY: Commodity Futures Trading Commission.

ACTION: Final Order.

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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 TCO Financial Basis (``TCO'') 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 TCO 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 52200 (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 
TCO contract performs a significant price discovery function and 
requested comment from interested parties.\7\ Comments were

[[Page 24607]]

received from Industrial Energy Consumers of America (``IECA''), 
Working Group of Commercial Energy Firms (``WGCEF''), Platts, ICE, 
Economists Incorporated (``EI''), Natural Gas Supply Association 
(``NGSA''), Federal Energy Regulatory Commission (``FERC'') and 
Financial Institutions Energy Group (``FIEG'').\8\ The comment letters 
from FERC \9\ and Platts did not directly address the issue of whether 
or not the TCO contract is a SPDC; IECA expressed the opinion that the 
TCO contract did perform a significant price discovery function, and 
thus, should be subject to the requirements of the core principles 
enumerated in Section 2(h)(7) of the Act, but did not elaborate on its 
reasons for saying so or directly address any of the criteria. The 
remaining comment letters raised substantive issues with respect to the 
applicability of section 2(h)(7) to the TCO contract and generally 
expressed the opinion that the TCO contract is not a SPDC because it 
does not meet the material price reference, price linkage, and material 
liquidity criteria for SPDC determination. These 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.'' McGraw-Hill, through its division Platts, compiles and 
calculates monthly natural gas price indices from natural gas trade 
data submitted to Platts by energy marketers. Platts includes those 
price indices in its monthly Inside FERC's Gas Market Report 
(``Inside FERC''). ICE is an exempt commercial market, 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/2009/09-024.html.
    \9\ FERC stated that the TCO contract is cash settled and does 
not contemplate the 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 07.
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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.\10\ 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.\11\ 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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    \10\ 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 TCO 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.
    \11\ 17 CFR part 36, Appendix A.
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IV. Findings and Conclusions

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

    The ICE TCO contract is cash settled based on the difference 
between the bidweek price of natural gas at the Columbia Gas 
Transmission, LLC's, Appalachia hub for the contract-specified month of 
delivery, as published in Platts' Inside FERC's Gas Market Report, and 
the final settlement price of the New York Mercantile Exchange's 
(``NYMEX's'') physically-delivered Henry Hub natural gas futures 
contract for the same calendar month. The Platts bidweek price, which 
is published monthly, is based on a survey of cash market traders who 
voluntarily report to Platts data on their fixed-price transactions 
conducted during the last five business days of the month for physical 
delivery of natural gas at the

[[Page 24608]]

Appalachia hub; such bidweek transactions specify the delivery of 
natural gas on a uniform basis throughout the following calendar month 
at the agreed upon rate. The Platts 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 TCO contract is 2,500 million British 
thermal units (``mmBtu''), and the unit of trading is any multiple of 
2,500 mmBtu. The TCO contract is listed for up to 72 consecutive 
calendar months.
    The Henry Hub,\12\ 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.
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    \12\ 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.
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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.\13\ 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.
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    \13\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.
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    The market area for Columbia Gas Transmission, LLC's, Appalachia 
hub comprises Eastern Kentucky, West Virginia, Eastern Ohio, 
Pennsylvania, Northern Virginia and Western New York. Natural gas 
deliveries into the Columbia Gas Appalachia hub begin downstream of the 
Leach, Kentucky, interconnection with the Columbia Gulf Transmission 
interstate pipeline. Columbia Gas Transmission, LLC, operates supply 
pool and storage facilities in the Northern Appalachia region. The 
Dominion hub, a market center that includes the TCO hub, had an 
estimated throughput capacity of 2.5 billion cubic feet per day in 
2008. Moreover, the number of pipeline interconnections at the Dominion 
hub was 17 in 2008, up from 16 in 2003. Lastly, the pipeline 
interconnection capacity of the Dominion hub in 2008 was 8.3 billion 
cubic feet per day, which constituted a 42 percent increase over the 
pipeline interconnection capacity in 2003.\14\ The TCO hub is far 
removed from the Henry Hub but is directly connected to the Henry Hub 
by the Columbia Gas Transmission interstate pipeline.
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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 local price at the TCO location 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 TCO price. 
Moreover, exogenous factors, such as adverse weather, can cause the TCO 
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 \15\ 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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    \15\ 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 TCO 
contract. Each of these criteria is discussed below.\16\
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    \16\ As noted above, the Commission did not find an indication 
of arbitrage in connection with this contract; accordingly, that 
criterion was not discussed in reference to the TCO 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 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 ``East Gas End of Day'' and ``OTC Gas End of 
Day'' \17\ 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 TCO 
contract.
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    \17\ 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 also noted that its October 2007 Report on the 
Oversight of Trading on Regulated Futures Exchanges and Exempt 
Commercial Markets (``ECM Study'') \18\ found that in general, market 
participants view the ICE as a price discovery market for certain 
natural gas contracts. The study did not specify which markets 
performed this function; nevertheless, the Commission determined that 
the TCO contract, while not mentioned by name in the ECM Study, might 
warrant further study.
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    \18\ http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/pr5403-07_ecmreport.pdf
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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.

[[Page 24609]]

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 Columbia Gas Transmission, LLC's, Appalachia 
hub is a significant trading center for natural gas but is not as 
important as other hubs, such as the Henry Hub, for pricing natural gas 
in the eastern half of the U.S. marketplace.
    Although the Appalachia hub is a major trading center for natural 
gas in the United States and, as noted, ICE sells price information for 
the TCO 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 TCO 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. In this regard, the NYMEX Henry Hub physically 
delivered natural gas futures contract is routinely consulted by 
industry participants in pricing cash market transactions at this 
location. Because both the Appalachia hub is directly connected to the 
Henry Hub via the Gas Transmission interstate pipeline, it is not 
necessary for market participants to independently refer to the TCO 
contract for pricing natural gas at this location. Thus, the TCO 
contract does not satisfy the direct price reference test for existence 
of material price reference. Furthermore, the Commission notes that 
publication of the TCO contract's prices is not indirect evidence 
material price reference. The TCO 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 Appalachia hub, the 
Commission has concluded that traders likely do not specifically 
purchase the ICE data packages for the TCO 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, ICE, EI, NGSA and FIEG addressed the 
question of whether the TCO contract met the material price reference 
criterion for a SPDC.\20\ The commenters argued that because the TCO 
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 TCO contract is settled (in this case, the Platts 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 Appalachia hub is a significant trading 
center for natural gas in North America. However, traders do not 
consider the Appalachia hub to be as important as other natural gas 
trading points, such as the Henry Hub.
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    \20\ As noted above, IECA expressed the opinion that the TCO 
contract met the criteria for SPDC determination but did not provide 
its reasoning.
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    ICE \21\ also argued that the Commission appeared to base the case 
that the TCO contract is potentially a SPDC on a disputable assertion. 
In issuing its notice of intent to determine whether the TCO 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.
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    \21\ CL 04.
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    Both EI \22\ and WGCEF \23\ 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 TCO contract. Instead, traders are interested in the settlement 
prices, so the fact that ICE sells the TCO prices as part of a broad 
package is not conclusive evidence that market participants are buying 
the ICE data sets because they find the TCO prices have substantial 
value to them. As mentioned above, the Commission notes that 
publication of the TCO contract's prices is not indirect evidence of 
routine dissemination. The TCO 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 Appalachia hub, the 
Commission has concluded that traders likely do not specifically 
purchase the ICE data packages for the TCO contract's prices and do not 
consult such prices on a frequent and recurring basis in pricing cash 
market transactions.
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    \22\ CL 05.
    \23\ CL 02.
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ii. Conclusion Regarding Material Price Reference
    Based on the above, the Commission finds that the TCO contract does 
not meet the material price reference criterion because cash market 
transactions are not priced either explicitly or implicitly on a 
frequent and recurring basis at a differential to the TCO contract's 
price (direct evidence). Moreover, while the ECM sells the TCO 
contract's price data to market participants, market participants 
likely do not specifically purchase the ICE data packages for the TCO 
contract's prices and do not consult such prices on a frequent and 
recurring basis in pricing cash market transactions (indirect 
evidence).

[[Page 24610]]

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 TCO contract. In this regard, the final settlement 
of the TCO 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 
\24\ 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 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, in Guidance the Commission stated 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 to be deemed a SPDC (``minimum 
threshold'').
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    \24\ Appendix A to the Part 36 rules.
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    To assess whether the TCO 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 TCO 
contract price is determined, in part, by the final settlement price of 
the NYMEX physically-delivered natural gas futures contract (a DCM 
contract), the imputed TCO location price (derived by adding the NYMEX 
Henry Hub Natural Gas price to the ICE TCO basis 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 13.3 percent of 
the TCO 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 TCO 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. Trades on the ICE centralized market in the 
TCO contract during the same period was 60,106 contracts (equivalent to 
15,026 NYMEX contracts, given the size difference).\25\ Thus, 
centralized-market trades in the TCO contract amounted to less than the 
minimum threshold.\26\
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    \25\ The size of the NYMEX Henry Hub physically-delivered 
natural gas futures contract is 10,000 mmBtu. The TCO contract has a 
trading unit of 2,500 mmBtu, which is one-quarter the size of the 
NYMEX Henry Hub contract.
    \26\ Supplemental data subsequently submitted by the ICE 
indicated that block trades are in addition the on-exchange trades; 
block trades comprise 61.1 percent of all transactions in the TCO 
contract.
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i. Federal Register Comments
    As noted above, WGCEF, ICE, EI, NGSA and FIEG addressed the 
question of whether the TCO contract met the price linkage criterion 
for a SPDC.\27\ Each of the commenters expressed the opinion that the 
TCO 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 TCO is linked. 
Based on its analysis discussed above, the Commission agrees with this 
assessment.
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    \27\ As noted above, IECA expressed the opinion that the TCO 
contract met the criteria for SPDC determination but did not provide 
its reasoning.
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ii. Conclusion Regarding the Price Linkage Criterion
    Based on the above, the Commission finds that the TCO 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
    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 
TCO 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.
    The total number of transactions executed on ICE's electronic 
platform in the TCO contract was 583 in the second quarter of 2009, 
resulting in a daily average of 9.1 trades. During the same period, the 
TCO contract had a total trading volume of 61,944 contracts and an 
average daily trading volume of 968 contracts. Moreover, open interest 
as of June 30, 2009, was 141,544 contracts, which included 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 this regard, ICE does not differentiate between 
open interest created by a transaction executed on its trading platform 
and that created by a transaction executed off its trading 
platform.\28\
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    \28\ 74 FR 52200 (October 9, 2009).
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    In a subsequent filing dated November 13, 2009, ICE reported that 
total trading volume in the third quarter of 2009 was 60,106 contracts 
(or 911 contracts on a daily basis). In term of number of transactions, 
411 trades occurred in the third quarter of 2009 (6.2 trades per day). 
As of September 30, 2009, open interest in the TCO contract was 154,006 
contracts, which included 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.
    As indicated above, the average number of 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 
TCO contract, as characterized by total quarterly volume, indicates 
that the TCO contract experiences trading activity similar to that of 
other thinly-traded contracts.\29\ Thus, the TCO contract does not meet 
a threshold of trading activity that

[[Page 24611]]

would render it of potential importance and no additional statistical 
analysis is warranted.\30\
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    \29\ 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.
    \30\ 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 TCO 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 TCO contract met the material liquidity 
criterion for a SPDC.\31\ These commenters stated that the TCO contract 
does not meet the material liquidity criterion for SPDC determination 
for a number of reasons.
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    \31\ As noted above, IECA expressed the opinion that the TCO 
contract met the criteria for SPDC determination but did not provide 
its reasoning.
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    WGCEF,\32\ ICE \33\ and EI \34\ noted that the Commission's 
Guidance had posited 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 TCO 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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    \32\ CL 02.
    \33\ CL 04.
    \34\ CL 05.
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    WGCEF, FIEG \35\ and NGSA \36\ noted that the TCO 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 TCO contract's trading volume represents 
only a fraction of natural gas trading.
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    \35\ CL 08.
    \36\ 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'' \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 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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    \37\ 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.'' \38\ 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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    \38\ 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 60 
percent of all transactions in the TCO 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 TCO contract, is typically a function of trading activity in 
particular lead months and, given sufficient liquidity in such months, 
the ICE TCO contract itself would be considered liquid. In any event, 
in light of the fact that the Commission has found that the TCO 
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 TCO 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 has found that the 
TCO contract does not meet the material liquidity criterion.
4. Overall Conclusion
    After considering the entire record in this matter, including the 
comments received, the Commission has determined that the TCO 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 TCO contract 
does not meet the material price reference, price linkage, or material 
liquidity criteria at this time. Accordingly, the Commission will issue 
the attached Order declaring that the TCO 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 TCO 
contract.\39\ Accordingly, with respect to its TCO 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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    \39\ See 73 FR 75888, 75893 (Dec. 12, 2008).
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IV. Related Matters

a. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \40\ 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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    \40\ 44 U.S.C. 3507(d).
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b. Cost-Benefit Analysis

    Section 15(a) of the CEA \41\ requires the Commission to consider 
the costs and benefits of its actions before issuing an order under the 
Act. By its terms,

[[Page 24612]]

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.
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    \41\ 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. Amendments to 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 TCO 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'') \42\ 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 exempt 
commercial markets. The Commission previously has determined that 
exempt commercial markets are not small entities for purposes of the 
RFA.\43\ 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.
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    \42\ 5 U.S.C. 601 et seq.
    \43\ 66 FR 42256, 42268 (Aug. 10, 2001).
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V. Order

a. Order Relating to the TCO 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 TCO Financial Basis contract, 
traded on the IntercontinentalExchange, Inc., does not at this time 
satisfy the material price reference, price linkage, and material 
liquidity criteria for significant price discovery contracts. 
Consistent with this determination, the IntercontinentalExchange, Inc., 
is not considered a registered entity \44\ with respect to the TCO 
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 TCO Financial 
Basis contract with the issuance of this Order.
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    \44\ 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 TCO Financial Swing 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. 2010-10338 Filed 5-4-10; 8:45 am]
BILLING CODE 6351-01-P