Order Finding That the Socal Border Financial Basis Contract Traded on the IntercontinentalExchange, Inc., Performs a Significant Price Discovery Function, 24648-24655 [2010-10335]
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Federal Register / Vol. 75, No. 86 / Wednesday, May 5, 2010 / Notices
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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.
When a futures contract begins to
serve a significant price discovery
function, that contract, and the ECM on
which it is traded, warrants increased
oversight to deter and prevent price
manipulation or other disruptions to
market integrity, both on the ECM itself
and in any related futures contracts
trading on DCMs. An Order finding that
a particular contract is a SPDC triggers
this increased oversight and imposes
obligations on the ECM calculated to
accomplish this goal. The increased
oversight engendered by the issue of a
SPDC Order increases transparency and
helps to ensure fair competition among
ECMs and DCMs trading similar
products and competing for the same
business. Moreover, the ECM on which
the SPDC is traded must assume, with
respect to that contract, all the
responsibilities and obligations of a
registered entity under the CEA and
Commission regulations. Additionally,
the ECM must comply with nine core
principles established by section 2(h)(7)
of the Act—including the obligation to
establish position limits and/or
accountability standards for the SPDC.
Section 4(i) of the CEA authorizes the
Commission to require reports for
SPDCs listed on ECMs. These increased
responsibilities, along with the CFTC’s
increased regulatory authority, subject
the ECM’s risk management practices to
the Commission’s supervision and
oversight and generally enhance the
financial integrity of the markets.
c. Regulatory Flexibility Act
The Regulatory Flexibility Act
(‘‘RFA’’) 55 requires that agencies
consider the impact of their rules on
small businesses. The requirements of
CEA section 2(h)(7) and the Part 36
55 5
U.S.C. 601 et seq.
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rules affect ECMs. The Commission
previously has determined that ECMs
are not small entities for purposes of the
RFA.56 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.
VI. Order
a. Order Relating to the ICE HSC
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 HSC
Financial Basis contract, traded on the
IntercontinentalExchange, Inc., satisfies
the statutory material liquidity and
material price reference criteria for
significant price discovery contracts.
Consistent with this determination, and
effective immediately, the
IntercontinentalExchange, Inc., must
comply with, with respect to the HSC
Financial Basis contract, the nine core
principles established by new section
2(h)(7)(C). Additionally, the
IntercontinentalExchange, Inc., shall be
and is considered a registered entity 57
with respect to the HSC Financial Basis
contract and is subject to all the
provisions of the Commodity Exchange
Act applicable to registered entities.
Further, the obligations, requirements
and timetables prescribed in
Commission rule 36.3(c)(4) governing
core principle compliance by the
IntercontinentalExchange, Inc.,
commence with the issuance of this
Order.58
Issued in Washington, DC on April 28,
2010, by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. 2010–10341 Filed 5–4–10; 8:45 am]
BILLING CODE P
56 66
FR 42256, 42268 (Aug. 10, 2001).
U.S.C. 1a(29).
58 Because ICE already lists for trading a contract
(i.e., the Henry Financial LD1 Fixed Price contract)
that was previously declared by the Commission to
be a SPDC, ICE must submit a written
demonstration of compliance with the Core
Principles within 30 calendar days of the date of
this Order. 17 CFR 36.3(c)(4).
57 7
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COMMODITY FUTURES TRADING
COMMISSION
Order Finding That the Socal Border
Financial Basis Contract Traded on the
IntercontinentalExchange, Inc.,
Performs a Significant Price Discovery
Function
AGENCY: Commodity Futures Trading
Commission.
ACTION: Final order.
SUMMARY: On October 20, 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
Socal Border Financial Basis (‘‘SCL’’)
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.2 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 SCL contract
performs a significant price discovery
function. Authority for this action is
found in section 2(h)(7) of the CEA and
Commission rule 36.3(c) promulgated
thereunder.
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. Email: gprice@cftc.gov; or Susan Nathan,
Senior Special Counsel, Division of
Market Oversight, same address.
Telephone: (202) 418–5133. E-mail:
snathan@cftc.gov.
SUPPLEMENTARY INFORMATION:
I. Introduction
The CFTC Reauthorization Act of
2008 (‘‘Reauthorization Act’’) 3
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—
1 74
FR 53723 (October 20, 2009).
U.S.C. 1a(29).
3 Incorporated as Title XIII of the Food,
Conservation and Energy Act of 2008, Public Law
110–246, 122 Stat. 1624 (June 18, 2008).
27
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ECMs on which significant price
discovery contracts (‘‘SPDCs’’) are
traded—and treating ECMs in that
category as registered entities under the
CEA. The legislation authorizes the
CFTC to designate an agreement,
contract or transaction as a SPDC if the
Commission determines, under criteria
established in section 2(h)(7), that it
performs a significant price discovery
function. When the Commission makes
such a determination, the ECM on
which the SPDC is traded must assume,
with respect to that contract, all the
responsibilities and obligations of a
registered entity under the Act and
Commission regulations, and must
comply with nine core principles
established by new section 2(h)(7)(C).
On March 16, 2009, the CFTC
promulgated final rules implementing
the provisions of the Reauthorization
Act.4 As relevant here, rule 36.3
imposes increased information reporting
requirements on ECMs to assist the
Commission in making prompt
assessments whether particular ECM
contracts may be SPDCs. In addition to
filing quarterly reports of its contracts,
an ECM must notify the Commission
promptly concerning any contract
traded in reliance on the exemption in
section 2(h)(3) of the CEA that averaged
five trades per day or more over the
most recent calendar quarter, and for
which the exchange sells its price
information regarding the contract to
market participants or industry
publications, or whose daily closing or
settlement prices on 95 percent or more
of the days in the most recent quarter
were within 2.5 percent of the
contemporaneously determined closing,
settlement or other daily prices of
another contract.
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
4 74 FR 12178 (Mar. 23, 2009); these rules became
effective on April 22, 2009.
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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
address the issue of whether or not the
SCL contract is a SPDC; ICE’s comments
raised substantive issues with respect to
the applicability of section 2(h)(7) to the
SCL contract. Generally, ICE asserted
that its SCL contract is not a SPDC as
it does not meet the material liquidity,
material price reference and price
linkage criteria for SPDC determination
(CL 03). ICE’s comments are more
extensively discussed below, as
applicable.
II. Notice of Intent To Undertake SPDC
Determination
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).
On October 20, 2009, the Commission
published in the Federal Register notice
of its intent to undertake a
determination whether the SCL contract
performs a significant price discovery
function and requested comment from
interested parties.7 Comments were
received from the Federal Energy
Regulatory Commission (‘‘FERC’’), Platts
and ICE.8 The comment letters from
FERC 9 and Platts did not directly
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.
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 FERC is an independent federal regulatory
agency that, among other things, regulates the
interstate transmission of natural gas, oil and
electricity. 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. The comment
letters are available on the Commission’s Web site:
https://www.cftc.gov/lawandregulation/
federalregister/federalregistercomments/2009/09028.html.
9 FERC stated that the SCL 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
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CFTC’’ should any such potential conflict arise. CL
01.
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Federal Register / Vol. 75, No. 86 / Wednesday, May 5, 2010 / Notices
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 whether cash
market participants are quoting bid or
offer prices or entering into transactions
at prices that are set either explicitly or
implicitly at a differential to prices
established for the contract.
IV. Findings and Conclusions
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a. The Socal Border Financial Basis
(SCL) Contract and the SPDC Indicia
The SCL contract is cash settled based
on the difference between the price of
natural gas at the Southern California
Border hub for the month of delivery, as
published in Intelligence Press Inc.’s
(‘‘IPI’s’’) Natural Gas Bidweek Survey,
and the final settlement price for New
York Mercantile Exchange’s
(‘‘NYMEX’s’’) Henry Hub physicallydelivered 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
10 In its October 20, 2009, Federal Register
release, the Commission identified material
liquidity, material price reference and price linkage
as the possible criteria for SPDC determination of
the SCL contract. Arbitrage was not identified as a
possible criterion and will not be discussed further
in this document or the associated Order.
11 17 CFR part 36, Appendix A.
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IPI data on fixed-price transactions for
physical delivery of natural gas at the
Socal Border 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 SCL contract is 2,500
million British thermal units (‘‘mmBtu’’),
and the unit of trading is any multiple
of 2,500 mmBtu. The SCL contract is
listed for up to 120 calendar months
commencing with the next calendar
month.
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.
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, Socal 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
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.
13 See https://www.eia.doe.gov/pub/oil_gas/
natural_gas/feature_articles/2009/ngmarketcenter/
ngmarketcenter.pdf.
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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.
The Socal Border hub is located in
Southern California on the border with
Arizona.14 The California Energy Hub, a
market center that includes the Socal
Border Hub, had an estimated
throughput capacity of 900 million
cubic feet per day. Moreover, the
number of pipeline interconnections at
the California Energy Hub was 12 in
2008, up from five in 2003. Lastly, the
pipeline interconnection capacity of the
California Energy Hub in 2008 was
6,784 million cubic feet per day, which
constituted a 47 percent increase over
the pipeline interconnection capacity in
2003.15 The Socal Border hub is far
removed from the Henry Hub and is not
directly connected to the Henry Hub by
an existing pipeline.
For all these reasons, the local price
at the Socal hub typically differs from
the price at the Henry Hub. Thus, the
price of the Henry Hub physicallydelivered futures contract is an
imperfect proxy for the Socal Border
price. Moreover, exogenous factors,
such as adverse weather, can cause the
Socal 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.17 In this regard, a position at
14 The Socal Border hub typically includes fixedprice gas delivered into Southern California Gas
Co.’s pipeline system from El Paso Corp.’s pipeline
at Topock and Blythe, CA/Ehrenberg, AZ; from
Kern River Gas Transmission Co.’s pipeline at
Wheeler Ridge and Kramer Junction, CA; and from
Questar Pipeline Co.’s Southern Trail Pipeline at
Needles, CA. The Socal price index includes
deliveries from Pacific Gas and Electric at several
points, including the Kern River station and Pisgah/
Daggett, as well as in-state production.
15 See https://www.eia.doe.gov/pub/oil_gas/
natural_gas/feature_articles/2009/ngmarketcenter/
ngmarketcenter.pdf.
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.
17 Commercial activity in natural gas basis swap
contracts is evidenced by large positions held by
energy trading firms in the comparable NYMEX
ClearPort basis swap contract for the Socal hub.
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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 physicallydelivered natural gas contract’s final
settlement price).
In its October 20, 2009, Federal
Register notice, the Commission
identified material liquidity, price
linkage and material price reference as
the potential SPDC criteria applicable to
the SCL contract. Each of these criteria
is discussed below.18
1. Material Price Reference Criterion
The Commission’s October 20, 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 Socal 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 Socal 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
SCL 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’’ 19 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 SCL contract.
The Socal Border hub is a major
trading center for natural gas in the
United States. Traders, including
producers, keep abreast of the prices of
the SCL contract when conducting cash
deals. These traders look to a
competitively determined price as an
indication of expected values of natural
18 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 SCL contract.
19 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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gas at the Socal Border when entering
into cash market transactions for natural
gas, especially those trades providing
for physical delivery in the future.
Traders use the ICE SCL contract, as
well as other ICE basis swap contracts,
to hedge cash market positions and
transactions—activities which enhance
the SCL contract’s price discovery
utility. The substantial volume of
trading and open interest in the SCL
contract appears to attest to its use for
this purpose. While the SCL contract’s
settlement prices may not be the only
factor influencing spot and forward
transactions, natural gas traders
consider the ICE price to be a critical
factor in conducting OTC transactions.20
NYMEX lists a futures contract that is
comparable to the ICE SCL contract on
its ClearPort platform. However, unlike
the ICE contract, none of the trades in
the NYMEX SoCal Basis Swap are
executed in NYMEX’s centralized
marketplace; instead, all of the
transactions originate as bilateral swaps
that are submitted to NYMEX for
clearing. The daily settlement prices of
the NYMEX SoCal Basis Swap contract
are influenced, in part, by the daily
settlement prices of the ICE SCL
contract. This is because NYMEX
determines the daily settlement prices
for its natural gas basis swap contracts
through a survey of cash market voice
brokers. Voice brokers, in turn, refer to
the ICE SCL price, among other
information, as an important indicator
as to where the market is trading.
Therefore, the ICE SCL price influences
the settlement price for the NYMEX
SoCal Basis Swap contract. This is
supported by an analysis of the daily
settlement prices for the NYMEX and
ICE Socal basis swap contracts. In this
regard, 99 percent of the daily
settlement prices for the NYMEX SoCal
Basis Swap contract are within one
standard deviation of the SCL contract’s
settlement prices.
Lastly, the fact that the SCL contract
does not meet the price linkage criterion
(discussed below) bolsters the argument
for material price reference. As noted
above, the Henry Hub is the pricing
reference for natural gas in the United
States. However, regional market
conditions may cause the price of
natural gas in another area of the
country to diverge by more than the cost
of transportation, thus making the
Henry Hub price an imperfect proxy for
the local gas price. The more variable
20 In addition to referencing ICE prices, natural
gas market firms participating in the Socal market
may rely on other cash market quotes as well as
industry publications and price indices that are
published by third-party price reporting firms in
entering into natural gas transactions.
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24651
the local natural gas price is, the more
traders need to accurately hedge their
price risk. Basis swap contracts provide
a means of more accurately pricing
natural gas at a location other than the
Henry Hub. An analysis of Socal natural
gas prices showed that 93 percent of the
observations were more than 2.5 percent
different that the contemporaneous
Henry Hub prices. Specifically, the
average Socal basis value between
January 2008 and September 2009 was
¥$0.78 per mmBtu with a variance of
$0.29 per mmBtu.
i. Federal Register Comments
As noted above, ICE was the sole
respondent which addressed the
question of whether the SCL contract is
a SPDC. ICE stated in its comment letter
that the SCL contract does not meet the
material price reference criterion for
SPDC determination. ICE argued that
the Commission appeared to base the
case that the SCL contract is potentially
a SPDC on two disputable assertions.
First, in issuing its notice of intent to
determine whether the SCL 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, ‘‘Basing a material price reference
determination on general statements
made in a two year old study does not
seem to meet Congress’ intent that the
CFTC use its considerable expertise to
study the OTC markets.’’ In response to
the above comment, the Commission
notes that it cited the ECM study’s
general finding that some ICE natural
gas contracts appear to be regarded as
price discovery markets merely as an
indicia that an investigation of certain
ICE contracts may be warranted, and
was not intended to serve as the sole
basis for determining whether or not a
particular contract meets the material
price reference criterion.
Second, ICE argued that the
Commission should not base a
determination that the SCL contract is a
SPDC merely because this contract has
the exclusive right to base its settlement
on the IPI Socal Border Index price.
While the Commission acknowledges
that there are other firms that produce
price indices for the Socal hub, as it
notes above, market participants
indicate that the IPI Index is very highly
regarded and should they wish to
establish a hedged position based on
this index, they would need to do so by
taking a position in the ICE SCL swap
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since ICE has the exclusive right to use
the IPI index.21
ii. Conclusion Regarding Material Price
Reference
Based on the above, the Commission
finds that the SCL contract meets the
material price reference criterion
because it is referenced and consulted
on a frequent and recurring basis by
cash market participants when pricing
transactions (direct evidence).
Moreover, the ECM sells the SCL
contract’s price data to market
participants (indirect evidence).
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2. Price Linkage Criterion
In its October 20, 2009, Federal
Register notice, the Commission
identified price linkage as a potential
basis for a SPDC determination with
respect to the SCL contract. In this
regard, the final settlement of the SCL
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 22
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 pricelinked 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
21 Futures and swaps based on other Socal indices
have not met with the same market acceptance as
the SCL contract. For example, NYMEX lists a basis
swap contract that is comparable to the SCL
contract with the exception that it uses a different
price index for cash settlement. Open interest as of
September 30, 2009, was approximately 75,000
contracts in the NYMEX SoCal Basis Swap contract
versus nearly 400,000 contracts in ICE’s SCL
contract. Moreover, there has been no centralizedmarket trading in the NYMEX Socal Basis Swap
contract, so that contract does not serve as a source
of price discovery for cash market traders with
natural gas at that location.
22 Appendix A to the Part 36 rules.
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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’’).
To assess whether the SCL 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 Socal Border price is determined, in
part, by the final settlement price of the
NYMEX physically-delivered natural
gas futures contract (a DCM contract),
the Socal hub price is not within 2.5
percent of the settlement price of the
corresponding NYMEX Henry Hub
natural gas futures contract on 95
percent or more of the days.
Specifically, during the third quarter of
2009, only 7 percent of the Socal Border
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 SCL contract fails to
meet the volume threshold requirement.
In particular, the total trading volume in
the NYMEX physically-delivered
natural gas contract during the third
quarter of 2009 was 14,022,963
contracts, with 5 percent of that number
being 701,148 contracts. The number of
trades on the ICE centralized market in
the SCL contract during the same period
was 507,870 contracts (equivalent to
126,967 NYMEX contracts, given the
size difference).23 Thus, centralizedmarket trades in the SCL contract
amounted to less than the minimum
threshold.
Due to the specific criteria that a
given ECM contract must meet to fulfill
the price linkage criterion, the
requirements, for all intents and
purposes, exclude ECM contracts that
are not near facsimiles of DCM contracts
even though the ECM contract may
specifically use the settlement price to
value a position, which is the case of the
SCL contract. In this regard, an ECM
contract that is priced and traded as if
it is a functional equivalent of a DCM
contract likely will have a price series
that mirrors that of the corresponding
DCM contract. In contrast, for contracts
that are not look-alikes of DCM
contracts, it is reasonable to expect that
23 The SCL contract is one-quarter the size of the
NYMEX Henry Hub physically-delivered futures
contract.
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the two price series would be divergent.
The Socal Border hub and the Henry
Hub are located in two different areas of
the United States. Moreover, the Henry
Hub is primarily a supply center while
Southern California is a demand center.
These differences contribute to the
divergence between the two price series
and, as discussed below, increase the
likelihood that the ‘‘basis’’ contract is
used for material price reference.
i. Federal Register Comments
As noted above, ICE was the sole
respondent which addressed the
question of whether the SCL contract is
a SPDC. ICE stated in its comment letter
that the SCL contract does not meet the
price linkage criterion for SPDC
determination because it fails the
volume test provided in the
Commission’s Guidance.
ii. Conclusion Regarding the Price
Linkage Criterion
Based on the above, the Commission
finds that the SCL contract does not
meet the price linkage criterion because
it fails the price relationship and
volume tests provided for in the
Commission’s Guidance.
3. Material Liquidity Criterion
To assess whether the SCL contract
meets the material liquidity criterion,
the Commission first examined volume
and open interest data provided to it by
ICE as a general measurement of the
SCL market’s size and potential
importance, and second performed a
statistical analysis to measure the effect
that changes to SCL prices potentially
may have on prices for the NYMEX
Henry Hub Natural Gas (a DCM
contract), the ICE AECO Financial Basis
contract (an ECM contract) and the
HSC 24 Financial Basis contract (an ECM
contract).25
The Commission’s Guidance
(Appendix A to Part 36) notes that
‘‘[t]raditionally, objective measures of
trading such as volume or open interest
have been used as measures of
liquidity.’’ In this regard, the
Commission in its October 20, 2009,
Federal Register notice referred to
second quarter 2009 trading statistics
that ICE had submitted for its SCL
contract. Based upon on a required
quarterly filing made by ICE on July 27,
2009, the total number of SCL trades
24 The
acronym stands for Houston Ship Channel.
noted above, the material liquidity criterion
speaks to the effect that transactions in the potential
SPDC may have on trading in ‘‘agreements,
contracts and transactions listed for trading on or
subject to the rules of a designated contract market,
a derivatives transaction execution facility, or an
electronic trading facility operating in reliance on
the exemption in section 2(h)(3) of the Act.’’
25 As
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executed on ICE’s electronic trading
platform was 8,102 in the second
quarter of 2009, resulting in a daily
average of 126.6 trades. During the same
period, the SCL contract had a total
trading volume on ICE’s electronic
trading platform of 612,452 contracts
and an average daily trading volume of
9,569 contracts. Moreover, the open
interest as of June 30, 2009, was 417,121
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.26
Subsequent to the October 20, 2009,
Federal Register notice, ICE submitted
another quarterly notification filed on
November 13, 2009,27 with updated
trading statistics. Specifically, with
respect to its SCL contract, 7,080
separate trades occurred on its
electronic platform in the third quarter
of 2009, resulting in a daily average of
107.3 trades. During the same period,
the SCL contract had a total trading
volume on its electronic platform of
507,870 contracts (which was an
average of 7,695 contracts per day).28 As
of September 30, 2009, open interest in
the SCL contract was 398,875
contracts.29 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.
In Appendix A to Part 36, the material
liquidity criterion for SPDC
determination specifies that an ECM
contract should have a material effect on
another contract. To measure the effect
that the SCL contract potentially could
have on a DCM contract, or on another
ECM contract, Commission staff
performed a statistical analysis 30 using
26 ICE does not differentiate between open
interest created by a transaction executed on its
trading platform versus that created by a transaction
executed off its trading platform. 74 FR 53723
(October 20, 2009).
27 See Commission Rule 36.3(c)(2), 17 CFR
36.3(c)(2).
28 By way of comparison, the number of contracts
traded in the SCL contract is similar to that
exhibited on a liquid futures market and is roughly
equivalent to the volume of trading for the ICE
Futures U.S. Cotton No. 2 futures contract during
this period.
29 By way of comparison, open interest in the SCL
contract is roughly equivalent to that in the Chicago
Board of Trade’s soybean contract and the
Commodity Exchange’s Gold futures contract.
30 Specifically, the Commission econometrically
estimated a vector autoregression model using daily
natural gas price levels. A vector autoregression
model is an econometric model used to capture the
dependencies and interrelationships among
multiple time series, generalizing the univariate
autoregression model. The estimated model
displays strong diagnostic evidence of statistical
adequacy. In particular, the model’s impulse
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daily settlement prices (between January
2, 2008, and September 30, 2009) for the
NYMEX Henry Hub natural gas contract
(a DCM contract) and price levels for the
Alberta, Houston Ship Channel (‘‘HSC’’),
and Socal market centers.31 The
simulation results suggest that, on
average over the sample period, a one
percent rise in the Socal natural gas
price elicited a 0.8 percent increase in
each of the Alberta, HSC, and NYMEX
Henry Hub prices.
i. Federal Register Comments
As noted above, ICE was the sole
respondent which addressed the
question of whether the SCL contract is
a SPDC. ICE stated in its comment letter
that the SCL contract does not meet the
material liquidity criterion for SPDC
determination for a number of reasons.
First, ICE opined that the Commission
‘‘seems to have adopted a five trade-perday test to determine whether a contract
is materially liquid. It is worth noting
that ICE originally suggested that the
CFTC use a five trades-per-day
threshold as the basis for an ECM to
report trade data to the CFTC.’’ In this
regard, the Commission adopted a five
trades-per-day threshold as a reporting
requirement to enable it to
‘‘independently be aware of ECM
contracts that may develop into
SPDCs’’ 32 rather than solely relying
upon an ECM on its own to identify any
such potential SPDCs to the
Commission. Thus, any contract that
meets this threshold may be subject to
scrutiny as a potential SPDC; the
threshold is not intended to define
liquidity in a broader sense. As noted
above, the Commission is basing a
finding of material liquidity for the ICE
SCL contract, in part, on the fact that
there were over 100 trades per day on
average in the SCL contract during the
last two reporting quarters of 2009,
which was far more than the five tradesresponse function was shocked with a one-time rise
in Socal price. The simulation results suggest that,
on average over the sample period, a one percent
rise in the Socal natural gas price elicited a 0.8
percent increase in the NYMEX Henry Hub price,
as well as a 0.8 percent increase in each of the other
two modeled natural gas prices. These multipliers
of response emerge with noticeable statistical
strength or significance. Based on such long run
sample patterns, if the Socal price rises by 10
percent, then the price of NYMEX Henry Hub
natural gas futures contract, as well as those for the
Alberta and HSC hubs, each would rise by about
8 percent.
31 Natural gas prices at the Alberta, HSC, and
Socal trading centers were obtained by adding the
daily settlement prices of ICE’s AECO Financial
Basis, HSC Financial Basis and Socal Border
Financial Basis contracts, respectively, to the
contemporaneous daily settlement prices of the
NYMEX Henry Hub physically-delivered natural
gas futures contract.
32 73 FR 75892 (December 12, 2008).
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24653
per-day threshold that is cited in the ICE
comment. In addition, the Commission
notes that the number of contracts per
transaction in the SCL contract is high
(approximately 72 contracts per
transaction) and thus, as noted, trading
volume (measured in contract units) is
substantial. The SCL contract also has
substantial open interest.
ICE also stated that ‘‘the statistics
[provided by ICE] have been
misinterpreted and misapplied.’’ In
particular, ICE stated that the volume
figures used in the Commission’s
analysis (cited above) ‘‘include trades
made in all 120 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.’’
Furthermore, ICE noted that for the SCL
contract, ‘‘about 29% of the trades
occurred in the single most liquid,
usually prompt, month of the contract.’’
It is the Commission’s opinion that
liquidity, as it pertains to the SCL
contract, is typically a function of
trading activity in particular lead
months and, given sufficient liquidity in
such months, the SCL contract itself
would be considered liquid. ICE’s
analysis of its own trade data confirms
this to be the case for the SCL contract,
and thus, the Commission believes that
it applied the statistical data cited above
in an appropriate manner for gauging
material liquidity.
In addition, ICE stated that the tradesper-day statistics that it provided to the
Commission in its quarterly filing and
which are cited above includes 2(h)(1)
transactions, which were not completed
on the electronic trading platform and
should not be considered in the SPDC
determination process. The Commission
staff asked ICE to review the data it sent
in its quarterly filings. In response, ICE
confirmed that the volume data it
provided and which the Commission
cited in its October 20, 2009, Federal
Register notice, as well as the additional
volume information it cites above,
includes only transaction data executed
on ICE’s electronic trading platform.33
The Commission acknowledges that the
open interest information it cites above
includes transactions made off the ICE
platform. However, once open interest is
created, there is no way for ICE to
differentiate between ‘‘on-exchange’’
versus ‘‘off-exchange’’ created positions,
and all such positions are fungible with
one another and may be offset in any
33 Supplemental data supplied by ICE confirmed
that block trades in the third quarter of 2009 were
in addition to the trades that were conducted on the
electronic platform; block trades comprised 45.7
percent of all transactions in the SCL contract.
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way agreeable to the position holder
regardless of how the position was
initially created.
ii. Conclusion Regarding Material
Liquidity
Based on the above, the Commission
concludes that the SCL contract meets
the material liquidity criterion in that
there is sufficient trading activity in the
SCL contract to have a material effect on
‘‘other agreements, contracts or
transactions listed for trading on or
subject to the rules of a designated
contract market * * * or an electronic
trading facility operating in reliance on
the exemption in section 2(h)(3) of the
Act’’ (that is, an ECM).
4. Overall Conclusion
After considering the entire record in
this matter, including the comments
received, the Commission has
determined that the SCL contract
performs a significant price discovery
function under two of the four criteria
established in section 2(h)(7) of the
CEA. Although the Commission has
determined that the SCL contract does
not meet the price linkage criterion at
this time, the Commission has
determined that the SCL contract does
meet both the material liquidity and
material price reference criteria.
Accordingly, the Commission will issue
the attached Order declaring that the
SCL contract is a SPDC.
Issuance of this Order signals the
immediate effectiveness of the
Commission’s authorities with respect
to ICE as a registered entity in
connection with its SCL contract,34 and
triggers the obligations, requirements—
both procedural and substantive—and
timetables prescribed in Commission
rule 36.3(c)(4) for ECMs.
V. Related Matters
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a. Paperwork Reduction Act
The Paperwork Reduction Act of 1995
(‘‘PRA’’) 35 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.
73 FR 75888, 75893 (Dec. 12, 2008).
35 44 U.S.C. 3507(d).
b. Cost-Benefit Analysis
Section 15(a) of the CEA 36 requires
the Commission to consider the costs
and benefits of its actions before issuing
an order under the Act. By its terms,
section 15(a) does not require the
Commission to quantify the costs and
benefits of an order or to determine
whether the benefits of the order
outweigh its costs; rather, it requires
that the Commission ‘‘consider’’ the
costs and benefits of its actions. Section
15(a) further specifies that the costs and
benefits shall be evaluated in light of
five broad areas of market and public
concern: (1) Protection of market
participants and the public; (2)
efficiency, competitiveness and
financial integrity of futures markets; (3)
price discovery; (4) sound risk
management practices; and (5) other
public interest considerations. The
Commission may in its discretion give
greater weight to any one of the five
enumerated areas and could in its
discretion determine that,
notwithstanding its costs, a particular
order is necessary or appropriate to
protect the public interest or to
effectuate any of the provisions or
accomplish any of the purposes of the
Act. The Commission has considered
the costs and benefits in light of the
specific provisions of section 15(a) of
the Act and has concluded that the
Order, required by Congress to
strengthen federal oversight of exempt
commercial markets and to prevent
market manipulation, is necessary and
appropriate to accomplish the purposes
of section 2(h)(7) of the Act.
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
34 See
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principles established by section 2(h)(7)
of the Act—including the obligation to
establish position limits and/or
accountability standards for the SPDC.
Section 4(i) of the CEA authorizes the
Commission to require reports for
SPDCs listed on ECMs. These increased
responsibilities, along with the CFTC’s
increased regulatory authority, subject
the ECM’s risk management practices to
the Commission’s supervision and
oversight and generally enhance the
financial integrity of the markets.
c. Regulatory Flexibility Act
The Regulatory Flexibility Act
(‘‘RFA’’) 37 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.38 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.
VI. Order
a. Order Relating to the ICE Socal
Border Financial Basis Contract
After considering the complete record
in this matter, including the comment
letters received in response to its
request for comments, the Commission
has determined to issue the following:
The Commission, pursuant to its
authority under section 2(h)(7) of the
Act, hereby determines that the Socal
Border Financial Basis contract, traded
on the IntercontinentalExchange, Inc.,
satisfies the statutory material liquidity
and material price reference criteria for
significant price discovery contracts.
Consistent with this determination, and
effective immediately, the
IntercontinentalExchange, Inc., must
comply with, with respect to the ICE
Socal Border Financial Basis contract,
the nine core principles established by
new section 2(h)(7)(C). Additionally, the
IntercontinentalExchange, Inc., shall be
and is considered a registered entity 39
with respect to the Socal Border
Financial Basis contract and is subject
to all the provisions of the Commodity
Exchange Act applicable to registered
entities.
Further, the obligations, requirements
and timetables prescribed in
Commission rule 36.3(c)(4) governing
37 5
U.S.C. 601 et seq.
FR 42256, 42268 (Aug. 10, 2001).
39 7 U.S.C. 1a(29).
38 66
36 7
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Senior Special Counsel, Division of
Market Oversight, same address.
Telephone: (202) 418–5133. E-mail:
snathan@cftc.gov.
SUPPLEMENTARY INFORMATION:
core principle compliance by the
IntercontinentalExchange, Inc.,
commence with the issuance of this
Order.40
Issued in Washington, DC, on April 28,
2010, by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. 2010–10335 Filed 5–4–10; 8:45 am]
BILLING CODE P
COMMODITY FUTURES TRADING
COMMISSION
Order Finding That the ICE Waha
Financial Basis Contract Traded on the
IntercontinentalExchange, Inc.,
Performs a Significant Price Discovery
Function
AGENCY: Commodity Futures Trading
Commission.
ACTION: Final order.
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SUMMARY: On 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
Waha Financial Basis (‘‘WAH’’) 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 WAH
contract performs a significant price
discovery function. Authority for this
action is found in section 2(h)(7) of the
CEA and Commission rule 36.3(c)
promulgated thereunder.
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. Email: gprice@cftc.gov; or Susan Nathan,
40 Because ICE already lists for trading a contract
(i.e., the Henry Financial LD1 Fixed Price contract)
that was previously declared by the Commission to
be a SPDC, ICE must submit a written
demonstration of compliance with the Core
Principles within 30 calendar days of the date of
this Order. 17 CFR 36.3(c)(4).
1 74 FR 52202 (October 9, 2009).
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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).
On March 16, 2009, the CFTC
promulgated final rules implementing
the provisions of the Reauthorization
Act.4 As relevant here, rule 36.3
imposes increased information reporting
requirements on ECMs to assist the
Commission in making prompt
assessments whether particular ECM
contracts may be SPDCs. In addition to
filing quarterly reports of its contracts,
an ECM must notify the Commission
promptly concerning any contract
traded in reliance on the exemption in
section 2(h)(3) of the CEA that averaged
five trades per day or more over the
most recent calendar quarter, and for
which the exchange sells its price
information regarding the contract to
market participants or industry
publications, or whose daily closing or
settlement prices on 95 percent or more
of the days in the most recent quarter
were within 2.5 percent of the
contemporaneously determined closing,
settlement or other daily prices of
another contract.
Commission rule 36.3(c)(3)
established the procedures by which the
Commission makes and announces its
determination whether a particular ECM
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).
4 74 FR 12178 (Mar. 23, 2009); these rules became
effective on April 22, 2009.
PO 00000
Frm 00088
Fmt 4703
Sfmt 4703
24655
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
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 WAH
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, Platts,
Economists Incorporated (‘‘EI’’), Federal
Energy Regulatory Commission
(‘‘FERC’’), and Financial Institutions
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.
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.
E:\FR\FM\05MYN1.SGM
05MYN1
]]>Agencies
[Federal Register Volume 75, Number 86 (Wednesday, May 5, 2010)]
[Notices]
[Pages 24648-24655]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-10335]
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
Order Finding That the Socal Border Financial Basis Contract
Traded on the IntercontinentalExchange, Inc., Performs a Significant
Price Discovery Function
AGENCY: Commodity Futures Trading Commission.
ACTION: Final order.
-----------------------------------------------------------------------
SUMMARY: On October 20, 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 Socal Border Financial Basis (``SCL'') 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.\2\ 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 SCL contract performs a significant price discovery function.
Authority for this action is found in section 2(h)(7) of the CEA and
Commission rule 36.3(c) promulgated thereunder.
---------------------------------------------------------------------------
\1\ 74 FR 53723 (October 20, 2009).
\2\ 7 U.S.C. 1a(29).
---------------------------------------------------------------------------
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: gprice@cftc.gov; or Susan Nathan,
Senior Special Counsel, Division of Market Oversight, same address.
Telephone: (202) 418-5133. E-mail: snathan@cftc.gov.
SUPPLEMENTARY INFORMATION:
I. Introduction
The CFTC Reauthorization Act of 2008 (``Reauthorization Act'') \3\
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--
[[Page 24649]]
ECMs on which significant price discovery contracts (``SPDCs'') are
traded--and treating ECMs in that category as registered entities under
the CEA. The legislation authorizes the CFTC to designate an agreement,
contract or transaction as a SPDC if the Commission determines, under
criteria established in section 2(h)(7), that it performs a significant
price discovery function. When the Commission makes such a
determination, the ECM on which the SPDC is traded must assume, with
respect to that contract, all the responsibilities and obligations of a
registered entity under the Act and Commission regulations, and must
comply with nine core principles established by new section 2(h)(7)(C).
---------------------------------------------------------------------------
\3\ Incorporated as Title XIII of the Food, Conservation and
Energy Act of 2008, Public Law 110-246, 122 Stat. 1624 (June 18,
2008).
---------------------------------------------------------------------------
On March 16, 2009, the CFTC promulgated final rules implementing
the provisions of the Reauthorization Act.\4\ As relevant here, rule
36.3 imposes increased information reporting requirements on ECMs to
assist the Commission in making prompt assessments whether particular
ECM contracts may be SPDCs. In addition to filing quarterly reports of
its contracts, an ECM must notify the Commission promptly concerning
any contract traded in reliance on the exemption in section 2(h)(3) of
the CEA that averaged five trades per day or more over the most recent
calendar quarter, and for which the exchange sells its price
information regarding the contract to market participants or industry
publications, or whose daily closing or settlement prices on 95 percent
or more of the days in the most recent quarter were within 2.5 percent
of the contemporaneously determined closing, settlement or other daily
prices of another contract.
---------------------------------------------------------------------------
\4\ 74 FR 12178 (Mar. 23, 2009); these rules became effective on
April 22, 2009.
---------------------------------------------------------------------------
Commission rule 36.3(c)(3) established the procedures by which the
Commission makes and announces its determination whether a particular
ECM contract serves a significant price discovery function. Under those
procedures, the Commission will publish notice in the Federal Register
that it intends to undertake an evaluation whether the specified
agreement, contract or transaction performs a significant price
discovery function and to receive written views, data and arguments
relevant to its determination from the ECM and other interested
persons. Upon the close of the comment period, the Commission will
consider, among other things, all relevant information regarding the
subject contract and issue an order announcing and explaining its
determination whether or not the contract is a SPDC. The issuance of an
affirmative order signals the effectiveness of the Commission's
regulatory authorities over an ECM with respect to a SPDC; at that time
such an ECM becomes subject to all provisions of the CEA applicable to
registered entities.\5\ The issuance of such an order also triggers the
obligations, requirements and timetables prescribed in Commission rule
36.3(c)(4).\6\
---------------------------------------------------------------------------
\5\ Public Law 110-246 at 13203; Joint Explanatory Statement of
the Committee of Conference, H.R. Rep. No. 110-627, 110 Cong., 2d
Sess. 978, 986 (Conference Committee Report). See also 73 FR 75888,
75894 (Dec. 12, 2008).
\6\ For an initial SPDC, ECMs have a grace period of 90 calendar
days from the issuance of a SPDC determination order to submit a
written demonstration of compliance with the applicable core
principles. For subsequent SPDCs, ECMs have a grace period of 30
calendar days to demonstrate core principle compliance.
---------------------------------------------------------------------------
II. Notice of Intent To Undertake SPDC Determination
On October 20, 2009, the Commission published in the Federal
Register notice of its intent to undertake a determination whether the
SCL contract performs a significant price discovery function and
requested comment from interested parties.\7\ Comments were received
from the Federal Energy Regulatory Commission (``FERC''), Platts and
ICE.\8\ The comment letters from FERC \9\ and Platts did not directly
address the issue of whether or not the SCL contract is a SPDC; ICE's
comments raised substantive issues with respect to the applicability of
section 2(h)(7) to the SCL contract. Generally, ICE asserted that its
SCL contract is not a SPDC as it does not meet the material liquidity,
material price reference and price linkage criteria for SPDC
determination (CL 03). ICE's comments are more extensively discussed
below, as applicable.
---------------------------------------------------------------------------
\7\ The Commission's Part 36 rules establish, among other
things, procedures by which the Commission makes and announces its
determination whether a specific ECM contract serves a significant
price discovery function. Under those procedures, the Commission
publishes a notice in the Federal Register that it intends to
undertake a determination whether a specified agreement, contract or
transaction performs a significant price discovery function and to
receive written data, views and arguments relevant to its
determination from the ECM and other interested persons.
\8\ FERC is an independent federal regulatory agency that, among
other things, regulates the interstate transmission of natural gas,
oil and electricity. 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. The comment letters are available on the
Commission's Web site: https://www.cftc.gov/lawandregulation/federalregister/federalregistercomments/2009/09-028.html.
\9\ FERC stated that the SCL 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 01.
---------------------------------------------------------------------------
III. Section 2(h)(7) of the CEA
The Commission is directed by section 2(h)(7) of the CEA to
consider the following criteria in determining a contract's significant
price discovery function:
Price Linkage--the extent to which the agreement, contract
or transaction uses or otherwise relies on a daily or final settlement
price, or other major price parameter, of a contract or contracts
listed for trading on or subject to the rules of a designated contract
market (``DCM'') or derivatives transaction execution facility
(``DTEF''), or a SPDC traded on an electronic trading facility, to
value a position, transfer or convert a position, cash or financially
settle a position, or close out a position.
Arbitrage--the extent to which the price for the
agreement, contract or transaction is sufficiently related to the price
of a contract or contracts listed for trading on or subject to the
rules of a DCM or DTEF, or a SPDC traded on or subject to the rules of
an electronic trading facility, so as to permit market participants to
effectively arbitrage between the markets by simultaneously maintaining
positions or executing trades in the contracts on a frequent and
recurring basis.
Material price reference--the extent to which, on a
frequent and recurring basis, bids, offers or transactions in a
commodity are directly based on, or are determined by referencing 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).
[[Page 24650]]
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 whether cash market
participants are quoting bid or offer prices or entering into
transactions at prices that are set either explicitly or implicitly at
a differential to prices established for the contract.
---------------------------------------------------------------------------
\10\ In its October 20, 2009, Federal Register release, the
Commission identified material liquidity, material price reference
and price linkage as the possible criteria for SPDC determination of
the SCL contract. Arbitrage was not identified as a possible
criterion and will not be discussed further in this document or the
associated Order.
\11\ 17 CFR part 36, Appendix A.
---------------------------------------------------------------------------
IV. Findings and Conclusions
a. The Socal Border Financial Basis (SCL) Contract and the SPDC Indicia
The SCL contract is cash settled based on the difference between
the price of natural gas at the Southern California Border hub for the
month of delivery, as published in Intelligence Press Inc.'s
(``IPI's'') 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
fixed-price transactions for physical delivery of natural gas at the
Socal Border 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 SCL contract is 2,500 million British thermal units
(``mmBtu''), and the unit of trading is any multiple of 2,500 mmBtu.
The SCL contract is listed for up to 120 calendar months commencing
with the next calendar month.
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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, Socal 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.
---------------------------------------------------------------------------
\13\ See https://www.eia.doe.gov/pub/oil_gas/natural_gas/feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.
---------------------------------------------------------------------------
The Socal Border hub is located in Southern California on the
border with Arizona.\14\ The California Energy Hub, a market center
that includes the Socal Border Hub, had an estimated throughput
capacity of 900 million cubic feet per day. Moreover, the number of
pipeline interconnections at the California Energy Hub was 12 in 2008,
up from five in 2003. Lastly, the pipeline interconnection capacity of
the California Energy Hub in 2008 was 6,784 million cubic feet per day,
which constituted a 47 percent increase over the pipeline
interconnection capacity in 2003.\15\ The Socal Border hub is far
removed from the Henry Hub and is not directly connected to the Henry
Hub by an existing pipeline.
---------------------------------------------------------------------------
\14\ The Socal Border hub typically includes fixed-price gas
delivered into Southern California Gas Co.'s pipeline system from El
Paso Corp.'s pipeline at Topock and Blythe, CA/Ehrenberg, AZ; from
Kern River Gas Transmission Co.'s pipeline at Wheeler Ridge and
Kramer Junction, CA; and from Questar Pipeline Co.'s Southern Trail
Pipeline at Needles, CA. The Socal price index includes deliveries
from Pacific Gas and Electric at several points, including the Kern
River station and Pisgah/Daggett, as well as in-state production.
\15\ See https://www.eia.doe.gov/pub/oil_gas/natural_gas/feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.
---------------------------------------------------------------------------
For all these reasons, the local price at the Socal 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
Socal Border price. Moreover, exogenous factors, such as adverse
weather, can cause the Socal 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.\17\ In this regard, a position at
[[Page 24651]]
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).
---------------------------------------------------------------------------
\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.
\17\ Commercial activity in natural gas basis swap contracts is
evidenced by large positions held by energy trading firms in the
comparable NYMEX ClearPort basis swap contract for the Socal hub.
---------------------------------------------------------------------------
In its October 20, 2009, Federal Register notice, the Commission
identified material liquidity, price linkage and material price
reference as the potential SPDC criteria applicable to the SCL
contract. Each of these criteria is discussed below.\18\
---------------------------------------------------------------------------
\18\ 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 SCL contract.
---------------------------------------------------------------------------
1. Material Price Reference Criterion
The Commission's October 20, 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 Socal 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 Socal 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 SCL 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'' \19\ 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 SCL
contract.
---------------------------------------------------------------------------
\19\ The OTC Gas End of Day dataset includes daily settlement
prices for natural gas contracts listed for all points in North
America.
---------------------------------------------------------------------------
The Socal Border hub is a major trading center for natural gas in
the United States. Traders, including producers, keep abreast of the
prices of the SCL contract when conducting cash deals. These traders
look to a competitively determined price as an indication of expected
values of natural gas at the Socal Border when entering into cash
market transactions for natural gas, especially those trades providing
for physical delivery in the future. Traders use the ICE SCL contract,
as well as other ICE basis swap contracts, to hedge cash market
positions and transactions--activities which enhance the SCL contract's
price discovery utility. The substantial volume of trading and open
interest in the SCL contract appears to attest to its use for this
purpose. While the SCL contract's settlement prices may not be the only
factor influencing spot and forward transactions, natural gas traders
consider the ICE price to be a critical factor in conducting OTC
transactions.\20\
---------------------------------------------------------------------------
\20\ In addition to referencing ICE prices, natural gas market
firms participating in the Socal market may rely on other cash
market quotes as well as industry publications and price indices
that are published by third-party price reporting firms in entering
into natural gas transactions.
---------------------------------------------------------------------------
NYMEX lists a futures contract that is comparable to the ICE SCL
contract on its ClearPort platform. However, unlike the ICE contract,
none of the trades in the NYMEX SoCal Basis Swap are executed in
NYMEX's centralized marketplace; instead, all of the transactions
originate as bilateral swaps that are submitted to NYMEX for clearing.
The daily settlement prices of the NYMEX SoCal Basis Swap contract are
influenced, in part, by the daily settlement prices of the ICE SCL
contract. This is because NYMEX determines the daily settlement prices
for its natural gas basis swap contracts through a survey of cash
market voice brokers. Voice brokers, in turn, refer to the ICE SCL
price, among other information, as an important indicator as to where
the market is trading. Therefore, the ICE SCL price influences the
settlement price for the NYMEX SoCal Basis Swap contract. This is
supported by an analysis of the daily settlement prices for the NYMEX
and ICE Socal basis swap contracts. In this regard, 99 percent of the
daily settlement prices for the NYMEX SoCal Basis Swap contract are
within one standard deviation of the SCL contract's settlement prices.
Lastly, the fact that the SCL contract does not meet the price
linkage criterion (discussed below) bolsters the argument for material
price reference. As noted above, the Henry Hub is the pricing reference
for natural gas in the United States. However, regional market
conditions may cause the price of natural gas in another area of the
country to diverge by more than the cost of transportation, thus making
the Henry Hub price an imperfect proxy for the local gas price. The
more variable the local natural gas price is, the more traders need to
accurately hedge their price risk. Basis swap contracts provide a means
of more accurately pricing natural gas at a location other than the
Henry Hub. An analysis of Socal natural gas prices showed that 93
percent of the observations were more than 2.5 percent different that
the contemporaneous Henry Hub prices. Specifically, the average Socal
basis value between January 2008 and September 2009 was -$0.78 per
mmBtu with a variance of $0.29 per mmBtu.
i. Federal Register Comments
As noted above, ICE was the sole respondent which addressed the
question of whether the SCL contract is a SPDC. ICE stated in its
comment letter that the SCL contract does not meet the material price
reference criterion for SPDC determination. ICE argued that the
Commission appeared to base the case that the SCL contract is
potentially a SPDC on two disputable assertions. First, in issuing its
notice of intent to determine whether the SCL 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, ``Basing a material price
reference determination on general statements made in a two year old
study does not seem to meet Congress' intent that the CFTC use its
considerable expertise to study the OTC markets.'' In response to the
above comment, the Commission notes that it cited the ECM study's
general finding that some ICE natural gas contracts appear to be
regarded as price discovery markets merely as an indicia that an
investigation of certain ICE contracts may be warranted, and was not
intended to serve as the sole basis for determining whether or not a
particular contract meets the material price reference criterion.
Second, ICE argued that the Commission should not base a
determination that the SCL contract is a SPDC merely because this
contract has the exclusive right to base its settlement on the IPI
Socal Border Index price. While the Commission acknowledges that there
are other firms that produce price indices for the Socal hub, as it
notes above, market participants indicate that the IPI Index is very
highly regarded and should they wish to establish a hedged position
based on this index, they would need to do so by taking a position in
the ICE SCL swap
[[Page 24652]]
since ICE has the exclusive right to use the IPI index.\21\
---------------------------------------------------------------------------
\21\ Futures and swaps based on other Socal indices have not met
with the same market acceptance as the SCL contract. For example,
NYMEX lists a basis swap contract that is comparable to the SCL
contract with the exception that it uses a different price index for
cash settlement. Open interest as of September 30, 2009, was
approximately 75,000 contracts in the NYMEX SoCal Basis Swap
contract versus nearly 400,000 contracts in ICE's SCL contract.
Moreover, there has been no centralized-market trading in the NYMEX
Socal Basis Swap contract, so that contract does not serve as a
source of price discovery for cash market traders with natural gas
at that location.
---------------------------------------------------------------------------
ii. Conclusion Regarding Material Price Reference
Based on the above, the Commission finds that the SCL contract
meets the material price reference criterion because it is referenced
and consulted on a frequent and recurring basis by cash market
participants when pricing transactions (direct evidence). Moreover, the
ECM sells the SCL contract's price data to market participants
(indirect evidence).
2. Price Linkage Criterion
In its October 20, 2009, Federal Register notice, the Commission
identified price linkage as a potential basis for a SPDC determination
with respect to the SCL contract. In this regard, the final settlement
of the SCL 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
\22\ 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, 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'').
---------------------------------------------------------------------------
\22\ Appendix A to the Part 36 rules.
---------------------------------------------------------------------------
To assess whether the SCL 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 Socal
Border price is determined, in part, by the final settlement price of
the NYMEX physically-delivered natural gas futures contract (a DCM
contract), the Socal hub price is not within 2.5 percent of the
settlement price of the corresponding NYMEX Henry Hub natural gas
futures contract on 95 percent or more of the days. Specifically,
during the third quarter of 2009, only 7 percent of the Socal Border
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 SCL contract fails to meet
the volume threshold requirement. In particular, the total trading
volume in the NYMEX physically-delivered natural gas contract during
the third quarter of 2009 was 14,022,963 contracts, with 5 percent of
that number being 701,148 contracts. The number of trades on the ICE
centralized market in the SCL contract during the same period was
507,870 contracts (equivalent to 126,967 NYMEX contracts, given the
size difference).\23\ Thus, centralized-market trades in the SCL
contract amounted to less than the minimum threshold.
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\23\ The SCL contract is one-quarter the size of the NYMEX Henry
Hub physically-delivered futures contract.
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Due to the specific criteria that a given ECM contract must meet to
fulfill the price linkage criterion, the requirements, for all intents
and purposes, exclude ECM contracts that are not near facsimiles of DCM
contracts even though the ECM contract may specifically use the
settlement price to value a position, which is the case of the SCL
contract. In this regard, an ECM contract that is priced and traded as
if it is a functional equivalent of a DCM contract likely will have a
price series that mirrors that of the corresponding DCM contract. In
contrast, for contracts that are not look-alikes of DCM contracts, it
is reasonable to expect that the two price series would be divergent.
The Socal Border hub and the Henry Hub are located in two different
areas of the United States. Moreover, the Henry Hub is primarily a
supply center while Southern California is a demand center. These
differences contribute to the divergence between the two price series
and, as discussed below, increase the likelihood that the ``basis''
contract is used for material price reference.
i. Federal Register Comments
As noted above, ICE was the sole respondent which addressed the
question of whether the SCL contract is a SPDC. ICE stated in its
comment letter that the SCL contract does not meet the price linkage
criterion for SPDC determination because it fails the volume test
provided in the Commission's Guidance.
ii. Conclusion Regarding the Price Linkage Criterion
Based on the above, the Commission finds that the SCL contract does
not meet the price linkage criterion because it fails the price
relationship and volume tests provided for in the Commission's
Guidance.
3. Material Liquidity Criterion
To assess whether the SCL contract meets the material liquidity
criterion, the Commission first examined volume and open interest data
provided to it by ICE as a general measurement of the SCL market's size
and potential importance, and second performed a statistical analysis
to measure the effect that changes to SCL prices potentially may have
on prices for the NYMEX Henry Hub Natural Gas (a DCM contract), the ICE
AECO Financial Basis contract (an ECM contract) and the HSC \24\
Financial Basis contract (an ECM contract).\25\
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\24\ The acronym stands for Houston Ship Channel.
\25\ As noted above, the material liquidity criterion speaks to
the effect that transactions in the potential SPDC may have on
trading in ``agreements, contracts and transactions listed for
trading on or subject to the rules of a designated contract market,
a derivatives transaction execution facility, or an electronic
trading facility operating in reliance on the exemption in section
2(h)(3) of the Act.''
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The Commission's Guidance (Appendix A to Part 36) notes that
``[t]raditionally, objective measures of trading such as volume or open
interest have been used as measures of liquidity.'' In this regard, the
Commission in its October 20, 2009, Federal Register notice referred to
second quarter 2009 trading statistics that ICE had submitted for its
SCL contract. Based upon on a required quarterly filing made by ICE on
July 27, 2009, the total number of SCL trades
[[Page 24653]]
executed on ICE's electronic trading platform was 8,102 in the second
quarter of 2009, resulting in a daily average of 126.6 trades. During
the same period, the SCL contract had a total trading volume on ICE's
electronic trading platform of 612,452 contracts and an average daily
trading volume of 9,569 contracts. Moreover, the open interest as of
June 30, 2009, was 417,121 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.\26\
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\26\ ICE does not differentiate between open interest created by
a transaction executed on its trading platform versus that created
by a transaction executed off its trading platform. 74 FR 53723
(October 20, 2009).
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Subsequent to the October 20, 2009, Federal Register notice, ICE
submitted another quarterly notification filed on November 13,
2009,\27\ with updated trading statistics. Specifically, with respect
to its SCL contract, 7,080 separate trades occurred on its electronic
platform in the third quarter of 2009, resulting in a daily average of
107.3 trades. During the same period, the SCL contract had a total
trading volume on its electronic platform of 507,870 contracts (which
was an average of 7,695 contracts per day).\28\ As of September 30,
2009, open interest in the SCL contract was 398,875 contracts.\29\
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.
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\27\ See Commission Rule 36.3(c)(2), 17 CFR 36.3(c)(2).
\28\ By way of comparison, the number of contracts traded in the
SCL contract is similar to that exhibited on a liquid futures market
and is roughly equivalent to the volume of trading for the ICE
Futures U.S. Cotton No. 2 futures contract during this period.
\29\ By way of comparison, open interest in the SCL contract is
roughly equivalent to that in the Chicago Board of Trade's soybean
contract and the Commodity Exchange's Gold futures contract.
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In Appendix A to Part 36, the material liquidity criterion for SPDC
determination specifies that an ECM contract should have a material
effect on another contract. To measure the effect that the SCL contract
potentially could have on a DCM contract, or on another ECM contract,
Commission staff performed a statistical analysis \30\ using daily
settlement prices (between January 2, 2008, and September 30, 2009) for
the NYMEX Henry Hub natural gas contract (a DCM contract) and price
levels for the Alberta, Houston Ship Channel (``HSC''), and Socal
market centers.\31\ The simulation results suggest that, on average
over the sample period, a one percent rise in the Socal natural gas
price elicited a 0.8 percent increase in each of the Alberta, HSC, and
NYMEX Henry Hub prices.
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\30\ Specifically, the Commission econometrically estimated a
vector autoregression model using daily natural gas price levels. A
vector autoregression model is an econometric model used to capture
the dependencies and interrelationships among multiple time series,
generalizing the univariate autoregression model. The estimated
model displays strong diagnostic evidence of statistical adequacy.
In particular, the model's impulse response function was shocked
with a one-time rise in Socal price. The simulation results suggest
that, on average over the sample period, a one percent rise in the
Socal natural gas price elicited a 0.8 percent increase in the NYMEX
Henry Hub price, as well as a 0.8 percent increase in each of the
other two modeled natural gas prices. These multipliers of response
emerge with noticeable statistical strength or significance. Based
on such long run sample patterns, if the Socal price rises by 10
percent, then the price of NYMEX Henry Hub natural gas futures
contract, as well as those for the Alberta and HSC hubs, each would
rise by about 8 percent.
\31\ Natural gas prices at the Alberta, HSC, and Socal trading
centers were obtained by adding the daily settlement prices of ICE's
AECO Financial Basis, HSC Financial Basis and Socal Border Financial
Basis contracts, respectively, to the contemporaneous daily
settlement prices of the NYMEX Henry Hub physically-delivered
natural gas futures contract.
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i. Federal Register Comments
As noted above, ICE was the sole respondent which addressed the
question of whether the SCL contract is a SPDC. ICE stated in its
comment letter that the SCL contract does not meet the material
liquidity criterion for SPDC determination for a number of reasons.
First, 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.'' 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''
\32\ rather than solely relying upon an ECM on its own to identify any
such potential SPDCs to the Commission. Thus, any contract that meets
this threshold may be subject to scrutiny as a potential SPDC; the
threshold is not intended to define liquidity in a broader sense. As
noted above, the Commission is basing a finding of material liquidity
for the ICE SCL contract, in part, on the fact that there were over 100
trades per day on average in the SCL contract during the last two
reporting quarters of 2009, which was far more than the five trades-
per-day threshold that is cited in the ICE comment. In addition, the
Commission notes that the number of contracts per transaction in the
SCL contract is high (approximately 72 contracts per transaction) and
thus, as noted, trading volume (measured in contract units) is
substantial. The SCL contract also has substantial open interest.
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\32\ 73 FR 75892 (December 12, 2008).
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ICE also stated that ``the statistics [provided by ICE] have been
misinterpreted and misapplied.'' In particular, ICE stated that the
volume figures used in the Commission's analysis (cited above)
``include trades made in all 120 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.'' Furthermore, ICE noted that for
the SCL contract, ``about 29% of the trades occurred in the single most
liquid, usually prompt, month of the contract.''
It is the Commission's opinion that liquidity, as it pertains to
the SCL contract, is typically a function of trading activity in
particular lead months and, given sufficient liquidity in such months,
the SCL contract itself would be considered liquid. ICE's analysis of
its own trade data confirms this to be the case for the SCL contract,
and thus, the Commission believes that it applied the statistical data
cited above in an appropriate manner for gauging material liquidity.
In addition, ICE stated that the trades-per-day statistics that it
provided to the Commission in its quarterly filing and which are cited
above includes 2(h)(1) transactions, which were not completed on the
electronic trading platform and should not be considered in the SPDC
determination process. The Commission staff asked ICE to review the
data it sent in its quarterly filings. In response, ICE confirmed that
the volume data it provided and which the Commission cited in its
October 20, 2009, Federal Register notice, as well as the additional
volume information it cites above, includes only transaction data
executed on ICE's electronic trading platform.\33\ The Commission
acknowledges that the open interest information it cites above includes
transactions made off the ICE platform. However, once open interest is
created, there is no way for ICE to differentiate between ``on-
exchange'' versus ``off-exchange'' created positions, and all such
positions are fungible with one another and may be offset in any
[[Page 24654]]
way agreeable to the position holder regardless of how the position was
initially created.
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\33\ Supplemental data supplied by ICE confirmed that block
trades in the third quarter of 2009 were in addition to the trades
that were conducted on the electronic platform; block trades
comprised 45.7 percent of all transactions in the SCL contract.
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ii. Conclusion Regarding Material Liquidity
Based on the above, the Commission concludes that the SCL contract
meets the material liquidity criterion in that there is sufficient
trading activity in the SCL contract to have a material effect on
``other agreements, contracts or transactions listed for trading on or
subject to the rules of a designated contract market * * * or an
electronic trading facility operating in reliance on the exemption in
section 2(h)(3) of the Act'' (that is, an ECM).
4. Overall Conclusion
After considering the entire record in this matter, including the
comments received, the Commission has determined that the SCL contract
performs a significant price discovery function under two of the four
criteria established in section 2(h)(7) of the CEA. Although the
Commission has determined that the SCL contract does not meet the price
linkage criterion at this time, the Commission has determined that the
SCL contract does meet both the material liquidity and material price
reference criteria. Accordingly, the Commission will issue the attached
Order declaring that the SCL contract is a SPDC.
Issuance of this Order signals the immediate effectiveness of the
Commission's authorities with respect to ICE as a registered entity in
connection with its SCL contract,\34\ and triggers the obligations,
requirements--both procedural and substantive--and timetables
prescribed in Commission rule 36.3(c)(4) for ECMs.
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\34\ 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'') \35\ 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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\35\ 44 U.S.C. 3507(d).
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b. Cost-Benefit Analysis
Section 15(a) of the CEA \36\ requires the Commission to consider
the costs and benefits of its actions before issuing an order under the
Act. By its terms, section 15(a) does not require the Commission to
quantify the costs and benefits of an order or to determine whether the
benefits of the order outweigh its costs; rather, it requires that the
Commission ``consider'' the costs and benefits of its actions. Section
15(a) further specifies that the costs and benefits shall be evaluated
in light of five broad areas of market and public concern: (1)
Protection of market participants and the public; (2) efficiency,
competitiveness and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. The Commission may in its discretion give
greater weight to any one of the five enumerated areas and could in its
discretion determine that, notwithstanding its costs, a particular
order is necessary or appropriate to protect the public interest or to
effectuate any of the provisions or accomplish any of the purposes of
the Act. The Commission has considered the costs and benefits in light
of the specific provisions of section 15(a) of the Act and has
concluded that the Order, required by Congress to strengthen federal
oversight of exempt commercial markets and to prevent market
manipulation, is necessary and appropriate to accomplish the purposes
of section 2(h)(7) of the Act.
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\36\ 7 U.S.C. 19(a).
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When a futures contract begins to serve a significant price
discovery function, that contract, and the ECM on which it is traded,
warrants increased oversight to deter and prevent price manipulation or
other disruptions to market integrity, both on the ECM itself and in
any related futures contracts trading on DCMs. An Order finding that a
particular contract is a SPDC triggers this increased oversight and
imposes obligations on the ECM calculated to accomplish this goal. The
increased oversight engendered by the issue of a SPDC Order increases
transparency and helps to ensure fair competition among ECMs and DCMs
trading similar products and competing for the same business. Moreover,
the ECM on which the SPDC is traded must assume, with respect to that
contract, all the responsibilities and obligations of a registered
entity under the CEA and Commission regulations. Additionally, the ECM
must comply with nine core principles established by section 2(h)(7) of
the Act--including the obligation to establish position limits and/or
accountability standards for the SPDC. Section 4(i) of the CEA
authorizes the Commission to require reports for SPDCs listed on ECMs.
These increased responsibilities, along with the CFTC's increased
regulatory authority, subject the ECM's risk management practices to
the Commission's supervision and oversight and generally enhance the
financial integrity of the markets.
c. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \37\ 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.\38\ 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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\37\ 5 U.S.C. 601 et seq.
\38\ 66 FR 42256, 42268 (Aug. 10, 2001).
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VI. Order
a. Order Relating to the ICE Socal Border Financial Basis Contract
After considering the complete record in this matter, including the
comment letters received in response to its request for comments, the
Commission has determined to issue the following:
The Commission, pursuant to its authority under section 2(h)(7) of
the Act, hereby determines that the Socal Border Financial Basis
contract, traded on the IntercontinentalExchange, Inc., satisfies the
statutory material liquidity and material price reference criteria for
significant price discovery contracts. Consistent with this
determination, and effective immediately, the IntercontinentalExchange,
Inc., must comply with, with respect to the ICE Socal Border Financial
Basis contract, the nine core principles established by new section
2(h)(7)(C). Additionally, the IntercontinentalExchange, Inc., shall be
and is considered a registered entity \39\ with respect to the Socal
Border Financial Basis contract and is subject to all the provisions of
the Commodity Exchange Act applicable to registered entities.
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\39\ 7 U.S.C. 1a(29).
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Further, the obligations, requirements and timetables prescribed in
Commission rule 36.3(c)(4) governing
[[Page 24655]]
core principle compliance by the IntercontinentalExchange, Inc.,
commence with the issuance of this Order.\40\
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\40\ Because ICE already lists for trading a contract (i.e., the
Henry Financial LD1 Fixed Price contract) that was previously
declared by the Commission to be a SPDC, ICE must submit a written
demonstration of compliance with the Core Principles within 30
calendar days of the date of this Order. 17 CFR 36.3(c)(4).
Issued in Washington, DC, on April 28, 2010, by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. 2010-10335 Filed 5-4-10; 8:45 am]
BILLING CODE P
