[Federal Register Volume 75, Number 127 (Friday, July 2, 2010)]
[Notices]
[Pages 38469-38478]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-16212]
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COMMODITY FUTURES TRADING COMMISSION
Orders Finding That the Mid-C Financial Peak Contract and Mid-C
Financial Off-Peak Contract, Offered for Trading on the
IntercontinentalExchange, Inc., Perform a Significant Price Discovery
Function
AGENCY: Commodity Futures Trading Commission.
ACTION: Final orders.
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SUMMARY: On October 6, 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 Mid-C \2\ Financial Peak (``MDC'') contract and Mid-C
Financial Off-Peak (``OMC'') contract,\3\ which are listed for trading
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''), perform a significant price discovery
function pursuant to section 2(h)(7) of the CEA. The Commission
undertook this review based upon an initial evaluation of information
and data provided by ICE as well as other available information. The
Commission has reviewed the entire record in this matter, including all
comments received, and has determined to issue orders finding that the
MDC and OMC contracts perform a significant price discovery function.
Authority for this action is found in section 2(h)(7) of the CEA and
Commission rule 36.3(c) promulgated thereunder.
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\1\ 74 FR 51261 (October 6, 2009).
\2\ The acronym ``Mid-C'' stands for Mid-Columbia.
\3\ The Federal Register notice also requested comment on the
Mid-C Financial Peak Daily (``MPD'') contract and Mid-C Financial
Off-Peak Daily (``MXO'') contract. Those contracts will be reviewed
in a separate Federal Register release.
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DATES: Effective date: June 25, 2010.
FOR FURTHER INFORMATION CONTACT: Gregory K. Price, Industry Economist,
Division of Market Oversight, Commodity Futures Trading Commission,
Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.
Telephone: (202) 418-5515. E-mail: [email protected]; or Susan Nathan,
Senior Special Counsel, Division of Market Oversight, same address.
Telephone: (202) 418-5133. E-mail: [email protected].
SUPPLEMENTARY INFORMATION:
I. Introduction
The CFTC Reauthorization Act of 2008 (``Reauthorization Act'') \4\
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.\5\ The legislation authorizes the
CFTC to designate an agreement, contract or transaction as a SPDC if
the Commission determines, under criteria established in section
2(h)(7), that it performs a significant price discovery function. When
the Commission makes such a determination, the ECM on which the SPDC is
traded must assume, with respect to that contract, all the
responsibilities and obligations of a registered entity under the Act
and Commission regulations, and must comply with nine core principles
established by new section 2(h)(7)(C).
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\4\ Incorporated as Title XIII of the Food, Conservation and
Energy Act of 2008, Pub. L. 110-246, 122 Stat. 1624 (June 18, 2008).
\5\ 7 U.S.C. 1a(29).
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On March 16, 2009, the CFTC promulgated final rules implementing
the provisions of the Reauthorization Act.\6\ As relevant here, rule
36.3 imposes increased information reporting requirements on ECMs to
assist the Commission in making prompt assessments whether particular
ECM contracts may be SPDCs. In addition to filing quarterly reports of
its contracts, an ECM must notify the Commission promptly concerning
any contract traded in reliance on the exemption in section 2(h)(3) of
the CEA that averaged five trades per day or more over the most recent
calendar quarter, and for which the exchange sells its price
information regarding the contract to market participants or industry
publications, or whose daily closing or settlement prices on 95 percent
or more of the days in the most recent quarter were within 2.5 percent
of the contemporaneously determined closing, settlement or other daily
price of another contract.
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\6\ 74 FR 12178 (Mar. 23, 2009); these rules became effective on
April 22, 2009.
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[[Page 38470]]
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.\7\ The issuance of such an order also triggers the
obligations, requirements and timetables prescribed in Commission rule
36.3(c)(4).\8\
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\7\ Pub. L. 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).
\8\ For an initial SPDC, ECMs have a grace period of 90 calendar
days from the issuance of a SPDC determination order to submit a
written demonstration of compliance with the applicable core
principles. For subsequent SPDCs, ECMs have a grace period of 30
calendar days to demonstrate core principle compliance.
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II. Notice of Intent To Undertake SPDC Determination
On October 6, 2009, the Commission published in the Federal
Register notice of its intent to undertake a determination whether the
MDC and OMC contracts \9\ perform a significant price discovery
function and requested comment from interested parties.\10\ Comments
were received from the Federal Energy Regulatory Commission (``FERC''),
Financial Institutions Energy Group (``FIEG''), Working Group of
Commercial Energy Firms (``WGCEF''), Edison Electric Institute
(``EEI''), ICE, Western Power Trading Forum (``WPTF'') and Public
Utility Commission of Texas (``PUCT'').\11\ The comment letters from
FERC \12\ and PUCT did not directly address the issue of whether or not
the subject contracts are SPDCs. The remaining comment letters raised
substantive issues with respect to the applicability of section 2(h)(7)
to the MDC and OMC contracts and generally expressed the opinion that
the contracts are not SPDCs because they do not meet the material price
reference or material liquidity criteria for SPDC determination. These
comments are more extensively discussed below, as applicable.
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\9\ As noted above, the Federal Register notice also requested
comment on the Mid-C Financial Peak Daily (``MPD'') contract and
Mid-C Financial Off-Peak Daily (``MXO'') contract. The MPD and MXO
contracts will be addressed in a separate Federal Register release.
\10\ 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.
\11\ FERC is an independent federal regulatory agency that,
among other things, regulates the interstate transmission of natural
gas, oil and electricity. FIEG describes itself as an association of
investment and commercial banks who are active participants in
various sectors of the natural gas markets, ``including acting as
marketers, lenders, underwriters of debt and equity securities, and
proprietary investors.'' WGCEF describes itself as ``a diverse group
of commercial firms in the domestic energy industry whose primary
business activity is the physical delivery of one or more energy
commodities to customers, including industrial, commercial and
residential consumers'' and whose membership consists of ``energy
producers, marketers and utilities.'' EEI is the ``association of
shareholder-owned electric companies, international affiliates and
industry associates worldwide.'' ICE is an ECM, as noted above. WPTF
describes itself as a ``broad-based membership organization
dedicated to encouraging competition in the Western power markets *
* * WTPF strives to reduce the long-run cost of electricity to
consumers throughout the region while maintaining the current high
level of system reliability.'' PUCT is the independent organization
that oversees the Electric Reliability Council of Texas (``ERCOT'')
to ``ensure nondiscriminatory access to the transmission and
distribution systems, to ensure the reliability and adequacy of the
regional electrical network, and to perform other essential market
functions.'' The comment letters are available on the Commission's
website: http://www.cftc.gov/lawandregulation/federalregister/federalregistercomments/2009/09-011.html
\12\ FERC expressed the opinion that a determination by the
Commission that either of the subject contracts performs a
significant price discovery function ``would not appear to conflict
with FERC's exclusive jurisdiction under the Federal Power Act (FPA)
over the transmission or sale for resale of electric energy in
interstate commerce or with its other regulatory responsibilities
under the FPA'' and further that ``FERC staff will monitor proposed
SPDC determinations and advise the CFTC of any potential conflicts
with FERC's exclusive jurisdiction over RTOs, [(regional
transmission organizations)], ISOs [(independent system operators)]
or other jurisdictional entities.''
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III. Section 2(h)(7) of the CEA
The Commission is directed by section 2(h)(7) of the CEA to
consider the following criteria in determining a contract's significant
price discovery function:
Price Linkage--the extent to which the agreement, contract
or transaction uses or otherwise relies on a daily or final settlement
price, or other major price parameter, of a contract or contracts
listed for trading on or subject to the rules of a designated contract
market (``DCM'') or derivatives transaction execution facility
(``DTEF''), or a SPDC traded on an electronic trading facility, to
value a position, transfer or convert a position, cash or financially
settle a position, or close out a position.
Arbitrage--the extent to which the price for the
agreement, contract or transaction is sufficiently related to the price
of a contract or contracts listed for trading on or subject to the
rules of a DCM or DTEF, or a SPDC traded on or subject to the rules of
an electronic trading facility, so as to permit market participants to
effectively arbitrage between the markets by simultaneously maintaining
positions or executing trades in the contracts on a frequent and
recurring basis.
Material price reference--the extent to which, on a
frequent and recurring basis, bids, offers or transactions in a
commodity are directly based on, or are determined by referencing or
consulting, the prices generated by agreements, contracts or
transactions being traded or executed on the electronic trading
facility.
Material liquidity--the extent to which the volume of
agreements, contracts or transactions in a commodity being traded on
the electronic trading facility is sufficient to have a material effect
on other agreements, contracts or transactions listed for trading on or
subject to the rules of a DCM, DTEF or electronic trading facility
operating in reliance on the exemption in section 2(h)(3).
Not all criteria must be present to support a determination that a
particular contract performs a significant price discovery function,
and one or more criteria may be inapplicable to a particular
contract.\13\ Moreover, the statutory language neither prioritizes the
criteria nor specifies the degree to which a SPDC must conform to the
various criteria. In Guidance issued in connection with the Part 36
rules governing ECMs with SPDCs, the
[[Page 38471]]
Commission observed that these criteria do not lend themselves to a
mechanical checklist or formulaic analysis. Accordingly, the Commission
has indicated that in making its determinations it will consider the
circumstances under which the presence of a particular criterion, or
combination of criteria, would be sufficient to support a SPDC
determination.\14\ For example, for contracts that are linked to other
contracts or that may be arbitraged with other contracts, the
Commission will consider whether the price of the potential SPDC moves
in such harmony with the other contract that the two markets
essentially become interchangeable. This co-movement of prices would be
an indication that activity in the contract had reached a level
sufficient for the contract to perform a significant price discovery
function. In evaluating a contract's price discovery role as a price
reference, the Commission the extent to which, on a frequent and
recurring basis, bids, offers or transactions are directly based on, or
are determined by referencing, the prices established for the contract.
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\13\ In its October 6, 2009, Federal Register release, the
Commission identified material price reference and material
liquidity as the possible criteria for SPDC determination of the MDC
and OMC contracts. Arbitrage and price linkage were not identified
as possible criteria. As a result, arbitrage and price linkage will
not be discussed further in this document and the associated Orders.
\14\ 17 CFR Part 36, Appendix A.
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IV. Findings and Conclusions
The Commission's findings and conclusions with respect to the MDC
and OMC contracts are discussed separately below:
a. The Mid-C Financial Peak (MDC) Contract and the SPDC Indicia
The MDC contract is cash settled based on the arithmetic average of
the peak, day-ahead power price indicies that are reported each day in
the specified contract month. The daily price indicies are published by
ICE in its ``ICE Day Ahead Power Price Report,'' which is available on
the ECM's website. The peak-hour electricity price index on a
particular day is calculated as the volume-weighted average of
qualifying, day-ahead, peak-hour power transactions at the Mid-Columbia
hub that are traded on the ICE platform from 6 a.m. to 11 a.m. CST on
the publication date. The ICE transactions on which the daily price
index is based specify the physical delivery of power. The size of the
MDC contract is 400 megawatt hours (``MWh''), and the MDC contract is
listed for 86 months.
As the Columbia River flows through Washington State, it encounters
two federal and nine privately-owned hydroelectric dams that generate
close to 20,000 MW of power in the Northwest.\15\ With another three
dams in British Columbia, Canada, and many more on its various
tributaries, the Columbia River is the largest power-producing river in
North America. A major goal of the participants in the Mid-C
electricity market is to maximize the Columbia River's potential, along
with protecting and enhancing the non-power uses of the river. The
reliability of the electricity grid in the Northwest is coordinated by
the Northwest PowerPool (``NWPP''), which is a voluntary organization
comprised of major generating utilities serving the Northwestern United
States as well as British Columbia and Alberta, Canada.
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\15\ http://www.wpuda.org/publications/connections/hydro/River%20Riders.pdf.
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One stretch of the Columbia River between the Grand Coulee Dam and
Priests Rapids Dam is governed by the Mid-Columbia Hourly Coordination
Agreement (``MCHCA''). The MCHCA includes seven dams \16\ and nearly
13,000 MW of generation. Specifically, the agreement defines how the
Chelan, Douglas and Grant PUDs coordinate their operations with the
Bonneville Power Administration so as to maximize power generation
while reducing fluctuations in the river's flow. A number of other
utilities that buy power from the PUDs have also signed onto the
agreement. The MCHCA was signed into effect in 1972 and renewed in 1997
for another 20 years.\17\
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\16\ The federal dams are Grand Coulee and Chief Joseph. The
remaining dams are Wells (operated by the Douglas PUD), Rocky Reach
and Rock Island (operated by the Chelan PUD), and Wanapum and Priest
Rapids (operated by the Grant PUD). The term ``PUD'' stands for a
publically-owned utility which provides essential services within a
specified area.
\17\ http://www.wpuda.org/publications/connections/hydro/River%20Riders.pdf.
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In general, electricity is bought and sold in an auction setting on
an hourly basis at various point along the electrical grid. The price
of electricity at a particular point on the grid is called the
locational marginal price (``LMP''), which includes the cost of
producing the electricity, as well as congestion and line losses. Thus,
an LMP reflects generation costs as well as the actual cost of
supplying and delivering electricity to a specific point along the
grid.
Electricity is traded in a day-ahead market as well as in a real-
time market. Typically, the bulk of the energy transactions occur in
the day-ahead market. The day-ahead market establishes prices for
electricity that is to be delivered during the specified hour on the
following day. Day-ahead prices are determined based on generation and
energy transaction quotes offered in advance. Because the quotes are
based on supply and demand estimates, electricity needs usually are not
perfectly satisfied in the day-ahead market. On the day the electricity
is transmitted and used, auction participants typically realize that
they bought or sold either too much or too little power. A real-time
auction is operated in the Mid-C market to alleviate this problem by
servicing as a balancing mechanism. In this regard, electricity traders
use the real-time market to sell excess electricity and buy additional
power to meet demand. Only a relatively small amount of electricity is
traded in the real-time market compared with the day-ahead market.
1. Material Price Reference Criterion
The Commission's October 6, 2009, Federal Register notice
identified material price reference and material liquidity as the
potential basis for a SPDC determination with respect to the MDC
contract. The Commission considered the fact that ICE sells its price
data to market participants in a number of different packages which
vary in terms of the hubs covered, time periods, and whether the data
are daily only or historical. For example, ICE offers the ``West Power
of Day'' package 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. This package includes price data for the MDC contract.
The Commission also noted that its October 2007 Report on the
Oversight of Trading on Regulated Futures Exchanges and Exempt
Commercial Markets (``ECM Study'') found that in general, market
participants view ICE as a price discovery market for certain
electricity contracts. The study did not specify which markets
performed this function; nevertheless, the Commission determined that
the MDC contract, while not mentioned by name in the ECM Study, might
warrant further review.
The Commission explains in its Guidance to the Part 36 rules that
in evaluating a contract under the material price reference criterion,
it will rely on one of two sources of evidence--direct or indirect--to
determine that the price of a contract was being used as a material
price reference and therefore, serving a significant price discovery
function.\18\ With respect to direct evidence, the Commission will
consider the extent to which, on a frequent and recurring basis, cash
market bids, offers or transactions are directly based on or quoted at
a differential to, the prices
[[Page 38472]]
generated on the ECM in question. Direct evidence may be established
when cash market participants are quoting bid or offer prices or
entering into transactions at prices that are set either explicitly or
implicitly at a differential to prices established for the contract in
question. Cash market prices are set explicitly at a differential to
the section 2(h)(3) contract when, for instance, they are quoted in
dollars and cents above or below the reference contract's price. Cash
market prices are set implicitly at a differential to a section 2(h)(3)
contract when, for instance, they are arrived at after adding to, or
subtracting from the section 2(h)(3) contract, but then quoted or
reported at a flat price. With respect to indirect evidence, the
Commission will consider the extent to which the price of the contract
in question is being routinely disseminated in widely distributed
industry publications--or offered by the ECM itself for some form of
remuneration--and consulted on a frequent and recurring basis by
industry participants in pricing cash market transactions.
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\18\ 17 CFR Part 36, Appendix A.
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The Mid-C power market is a major pricing center for electricity on
the West Coast. Traders, including producers, keep abreast of the
electricity prices in the Mid-C power market when conducting cash
deals. These traders look to a competitively determined price as an
indication of expected values of power at the Mid-C hub when entering
into cash market transaction for electricity, especially those trades
providing for physical delivery in the future. Traders use the ICE MDC
contract, as well as other ICE power contracts, to hedge cash market
positions and transactions--activities which enhance the MDC contract's
price discovery utility. The substantial volume of trading and open
interest in the MDC contract appears to attest to its use for this
purpose. While the MDC contract's settlement prices may not be the only
factor influencing spot and forward transactions, electricity traders
consider the ICE price to be a critical factor in conducting OTC
transactions.\19\ Accordingly, the MDC contract satisfies the direct
price reference test.
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\19\ In addition to referencing ICE prices, firms participating
in the Mid-C power 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 power
transactions.
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The direct price reference finding also is supported by the
uniqueness of the ICE electricity prices for the Mid-C market. Day-
ahead and real-time electricity prices are reported by a number of
sources, including third-party price providers (e.g., Dow Jones &
Company). ICE's Mid-C price indices are unique in that they are derived
from transactions completed on ICE's electronic system. Moreover, ICE
is the only entity that has access to such transaction data. Thus, it
is not possible for any other firm to replicate ICE's indices.\20\
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\20\ In contrast, third-party price reporting firms typically
compute their power index prices from transaction information that
is voluntarily submitted by traders. It is possible that one trader
could submit the same transaction data to multiple price reporting
firms, whereby increasing the likelihood that price indices from
different firms are similar in value. However, it is more plausible
that the third-party price reporters' price indices would be similar
but not exactly the same because different traders are polled.
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The fact that ICE's MDC monthly contract is used more widely as a
source of pricing information rather than the daily contract (i.e., the
MPD contract)\21\ bolsters the finding of direct price reference. In
this regard, the MDC contract prices power at the Mid-C up to 86
calendar months in the future. Thus, market participants can use the
MDC contract to lock-in electricity prices far into the future. Traders
use monthly power contracts like the MDC contract to price future power
electricity commitments, where such commitments are based on long range
forecasts of power supply and demand. In contrast, the MPD contract is
listed for a much shorter length of time--up to 38 days in the future.
As generation and usage nears, market participants have a better
understanding of actual power supply and needs. As a result, they can
modify previously-established hedges with daily contracts, like the MPD
contract.
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\21\ The MPD contract is cash settled based on the peak, day-
ahead price index for the specified day, as published by ICE in its
``ICE Day Ahead Power Price Report,'' which is available on the
ECM's website. The daily peak-hour electricity price index is a
volume-weighted average of qualifying, day-ahead, peak-hour power
contracts at the Mid-Columbia hub that are traded on the ICE
platform from 6 a.m. to 11 a.m. CST on the publication date.
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The Commission notes that the Mid-C is a major trading point for
electricity, and the MDC contract's prices are well regarded in the
industry as indicative of the value of power at the Mid-C hub.
Accordingly, Commission staff believes that it is reasonable to
conclude that market participants purchase the data packages that
include the MDC contract's prices in substantial part because the MDC
contract prices have particular value to them. Moreover, such prices
are consulted on a frequent and recurring basis by industry
participants in pricing cash market transactions. In light of the
above, the MDC contract meets the indirect price reference test.
i. Federal Register Comments
WGCEF, WPTF, EEI and ICE stated that no other contract directly
references or settles to the MDC contract's price. Moreover, the
commenters argued that the underlying cash price series against which
the MDC contract is settled (in this case, the average of peak-hour
Mid-C electricity prices over the contract month, which are derived
from physical transactions) is the authentic reference price and not
the ICE contract itself. Commission staff believes that this
interpretation of price reference is too narrow and believes that a
cash-settled derivatives contract could meet the price reference
criterion if market participants ``consult on a frequent and recurring
basis'' the derivatives contract when pricing forward, fixed-price
commitments or other cash-settled derivatives that seek to ``lock in''
a fixed price for some future point in time to hedge against adverse
price movements.
As noted above, the Mid-C hub is a major trading center for
electricity in the western United States. Traders, including producers,
keep abreast of the prices of the MDC contract when conducting cash
deals. These traders look to a competitively determined price as an
indication of expected values of electricity at the Mid-C hub when
entering into cash market transaction for power, especially those
trades that provide for physical delivery in the future. Traders use
the ICE MDC contract to hedge cash market positions and transactions,
which enhances the MDC contract's price discovery utility. While the
MDC contract's settlement prices may not be the only factor influencing
spot and forward transactions, natural gas traders consider the ICE
price to be a crucial factor in conducting OTC transactions.
In addition, WGCEF stated that the publication of price data for
the MDC contract price is weak justification for material price
reference. This commenter argued that market participants generally do
not purchase ICE data sets for one contract's prices, such as those for
the MDC contract. Instead, traders are interested in the settlement
prices, so the fact that ICE sells the MDC prices as part of a broad
package is not conclusive evidence that market participants are buying
the ICE data sets because they find the MDC prices have substantial
value to them. As noted above, the Commission notes that publication of
the MDC contract's prices is indirect evidence of routine
dissemination. The MDC contract's prices, while sold as a package, are
of particular interest to market participants. Thus, the Commission has
[[Page 38473]]
concluded that traders likely purchase the ICE data packages
specifically for the MDC contract's prices and consult such prices on a
frequent and recurring basis in pricing cash market transactions.
Lastly, EEI observed that the ECM Study did not specifically
identify the MDC contract as a contract that is referred to by market
participants on a frequent and recurring basis. The Commission cited
the ECM Study's general finding that some ICE electricity contracts
appear to be regarded as price discovery markets merely as indication
that an investigation of certain ICE contracts may be warranted. The
ECM Study was not intended to serve, and did not serve as the sole
basis for determining whether or not a particular contract meets the
material price reference criterion.
ii. Conclusion Regarding Material Price Reference
Based on the above, the Commission finds that the ICE MDC contract
meets the material price reference criterion because cash market
transactions are priced either explicitly or implicitly on a frequent
and recurring basis at a differential to the MDC contract's price
(direct evidence). Moreover, the MDC contract's price data are sold to
market participants, and those individuals likely purchase the ICE data
packages specifically for the MDC contract's prices and consult such
prices on a frequent and recurring basis in pricing cash market
transactions (indirect evidence).
2. Material Liquidity Criterion
As noted above, in its October 6, 2009, Federal Register notice,
the Commission identified material price reference and material
liquidity as potential criteria for SPDC determination of the MDC
contract. To assess whether a contract meets the material liquidity
criterion, the Commission first examines trading activity as a general
measurement of the contract's size and potential importance. If the
Commission finds that the contract in question meets a threshold of
trading activity that would render it of potential importance, the
Commission will then perform a statistical analysis to measure the
effect that changes to the subject-contract's prices potentially may
have on prices for other contracts listed on an ECM or a DCM.\22\
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\22\ 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 total number of transactions executed on ICE's electronic
platform in the MDC contract was 2,022 in the second quarter of 2009,
resulting in a daily average of 31.6 trades. During the same period,
the MDC contract had a total trading volume of 67,400 contracts and an
average daily trading volume of 1,053.1 contracts. Moreover, open
interest as of June 30, 2009, was 169,851 contracts, which included
trades executed on ICE's electronic trading platform, as well as trades
executed off of ICE's electronic trading platform and then brought to
ICE for clearing. In this regard, ICE does not differentiate between
open interest created by a transaction executed on its trading platform
and that created by a transaction executed off its trading
platform.\23\
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\23\ 74 FR 51261 (October 6, 2009).
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In a subsequent filing dated March 24, 2010, ICE reported that
total trading volume in the fourth quarter of 2009 was 142,700
contracts (or 2,195 contracts on a daily basis). In terms of number of
transactions, 2,975 trades occurred in the fourth quarter of 2009 (46
trades per day). As of December 31, 2009, open interest in the MDC
contract was 221,608 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.
Trading activity in the MDC contract, as characterized by total
quarterly volume, indicates that the MDC contract experiences trading
activity that is significantly greater than that of minor futures
markets.\24\ Thus, it is reasonable to infer that the MDC contract
could have a material effect on other ECM contracts or on DCM
contracts.
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\24\ Staff has advised the Commission that in its experience, a
thinly-traded contract is generally one that has a quarterly trading
volume of 100,000 contracts or less. In this regard, in the third
quarter of 2009, physical commodity futures contracts with trading
volume of 100,000 contracts or fewer constituted less than one
percent of total trading volume of all physical commodity futures
contracts.
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To measure the potential effect of the MDC contract on another ECM
contract staff performed a statistical analysis \25\ using daily
settlement prices between July 1, 2008, and December 31, 2009, for the
ICE MDC and OMC contracts. The simulation suggests that, on average
over the sample period, a one percent rise in the MDC contract's price
elicited a 1.09 percent increase in ICE OMC contract's price.
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\25\ Specifically, Commission staff econometrically estimated a
cointegrated vector autoregression (CVAR) model using daily
settlement prices. CVAR methods permit a dichotomization of the data
relationships into long-run equilibrium components (called the
cointegration space or cointegrating relationships) and a short-run
component. A CVAR model was chosen over the more traditional vector
autoregression model in levels because the statistical properties of
the data (lack of stationarity and ergodicity) precluded the more
traditional modeling treatment. Moreover, the statistical properties
of the data necessitated the modeling of the contracts' prices as a
CVAR model containing both first differences (to handle
stationarity) and an error-correction term to capture long run
equilibrium relationships. The prices were treated as a single
reduced-form model in order to test hypothesis that power prices in
the same market affect each other. The prices of ICE's MDC and OMC
contracts are positively related to each other in a cointegrating
relationship and display a high level of statistical strength. On
average during the sample period, each percentage rise in MDC
contract's price elicited a 1.09 percent rise in OMC contract's
price.
---------------------------------------------------------------------------
i. Federal Register Comments
ICE and WGCEF stated that the MDC contract lacks a sufficient
number of trades to meet the material liquidity criterion. These two
commenters, along with WPTF, FEIG and EEI argued that the MDC contract
cannot have a material effect on other contracts, such as those listed
for trading by the New York Mercantile Exchange (``NYMEX''), a DCM. The
commenters pointed out that it is not possible for the MDC contract to
affect a DCM contract because price linkage and the potential for
arbitrage do not exist. The DCM contracts do not cash settle based on
the MDC contract's price. Instead, the DCM contracts and the MDC
contract are both cash settled based on physical transactions, which
the ECM and DCM contracts cannot influence. The Commission's
statistical analysis shows that changes in the ICE MDC contract's price
significantly influences the prices of other ECM contracts (namely, the
OMC contract).
WGCEF and ICE noted that the Commission's Guidance had posited
concepts of liquidity that generally assumed a fairly constant stream
of prices throughout the trading day, and noted that the relatively low
number of trades per day in the MDC contract did not meet this standard
of liquidity. The Commission observes that a continuous stream of
prices would indeed be an indication of liquidity for certain markets
but the Guidance also notes that ``quantifying the levels of immediacy
and price concession that would define material liquidity may differ
from one market or commodity to another.'' \26\
---------------------------------------------------------------------------
\26\ Guidance, supra.
---------------------------------------------------------------------------
ICE opined that the Commission ``seems to have adopted a five trade
per day test for material liquidity.'' To the contrary, the Commission
adopted a five trades-per-day threshold as a reporting
[[Page 38474]]
requirement to enable it to ``independently be aware of ECM contracts
that may develop into SPDCs'' \27\ rather than solely relying upon an
ECM to identify potential SPDCs to the Commission. Thus, any contract
that meets this threshold may be subject to scrutiny as a potential
SPDC; however, the contract will not be found to be a SPDC merely
because it met the reporting threshold.
---------------------------------------------------------------------------
\27\ 73 FR 75892 (December 12, 2008).
---------------------------------------------------------------------------
ICE asserted that the statistics provided by ICE were
misinterpreted and misapplied by the Commission. In particular, ICE
stated that the volume figures used in the Commission's analysis (cited
above) ``include trades made in all months'' as well as in strips of
contract months. ICE suggested that a more appropriate method of
determining liquidity is to examine the activity in a single traded
month of a given contract.'' \28\ It is the Commission's opinion that
liquidity, as it pertains to the MDC contract, is typically a function
of trading activity in particular lead months and, given sufficient
liquidity in such months, the ICE MDC contract itself would be
considered liquid.
---------------------------------------------------------------------------
\28\ In addition, ICE stated that the trades-per-day statistics
that it provided to the Commission in its quarterly filing and which
were cited in the Commission's October 6, 2009, Federal Register
notice included 2(h)(1) transactions, which were not completed on
the electronic trading platform and should not be considered in the
SPDC determination process. Commission staff asked ICE to review the
data it sent in its quarterly filings; ICE confirmed that the volume
data it provided and which the Commission cited includes only
transaction data executed on ICE's electronic trading platform. As
noted above, supplemental data supplied by ICE confirmed that block
trades are in addition to the trades that were conducted on the
electronic platform; block trades comprise about 54 percent of all
transactions in the MDC contract. The Commission acknowledges that
the open interest information it provided in its October 6, 2009,
Federal Register notice includes transactions made off the ICE
platform. However, once open interest is created, there is no way
for ICE to differentiate between ``on-exchange'' versus ``off-
exchange'' created positions, and all such positions are fungible
with one another and may be offset in any way agreeable to the
position holder regardless of how the position was initially
created.
---------------------------------------------------------------------------
ii. Conclusion Regarding Material Liquidity
For the reasons discussed above, the Commission finds that the MDC
meets the material liquidity criterion. Specifically, there is
sufficient trading activity in the MDC 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.''
3. Overall Conclusion Regarding the MDC Contract
After considering the entire record in this matter, including the
comments received, the Commission has determined that the MDC contract
performs a significant price discovery function under two of the four
criteria established in section 2(h)(7) of the CEA. The Commission has
concluded that the MDC contract meets both the material price reference
and material liquidity criteria. Accordingly, the Commission is issuing
the attached Order declaring that the MDC 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 MDC contract,\29\ and triggers the obligations,
requirements--both procedural and substantive--and timetables
prescribed in Commission rule 36.3(c)(4) for ECMs.
---------------------------------------------------------------------------
\29\ See 73 FR 75888, 75893 (Dec. 12, 2008).
---------------------------------------------------------------------------
b. The Mid-C Financial Off-Peak (OMC) Contract and the SPDC Indicia
The OMC contract is cash settled based on the arithmetic average of
the off-peak, day-ahead power price indices that are reported each day
in the specified contract month. The daily price indices are published
by ICE in its ``ICE Day Ahead Power Price Report,'' which is available
on the ECM's website. The off-peak hour electricity price index on a
particular day is calculated as the volume-weighted average of
qualifying, day-ahead, off-peak hour power transactions at the Mid-
Columbia hub that are traded on the ICE platform from 6 a.m. to 11 a.m.
CST on the publication date. The ICE transactions on which the price
index is based specify the physical delivery of power. The size of the
OMC contract is 25 MWh, and the OMC contract is listed for 86 months.
As the Columbia River flows through Washington State, it encounters
two federal and nine privately-owned hydroelectric dams that generate
close to 20,000 MW of power in the Northwest.\30\ With another three
dams in British Columbia, Canada, and many more on its various
tributaries, the Columbia River is the largest power-producing river in
North America. A major goal of the participants in the Mid-C
electricity market is to maximize the Columbia River's potential, along
with protecting and enhancing the non-power uses of the river. The
reliability of the electricity grid in the Northwest is coordinated by
the NWPP.
---------------------------------------------------------------------------
\30\ http://www.wpuda.org/publications/connections/hydro/River%20Riders.pdf.
---------------------------------------------------------------------------
One stretch of the Columbia River between the Grand Coulee Dam and
Priests Rapids Dam is governed by the MCHCA. The MCHCA includes seven
dams \31\ and nearly 13,000 MW of generation. Specifically, the
agreement defines how the Chelan, Douglas and Grant PUDs coordinate
their operations with the Bonneville Power Administration to maximize
power generation while reducing fluctuations in the river's flow. A
number of other utilities that buy power from the PUDs have also signed
onto the agreement. The MCHCA agreement was signed into effect in 1972
and renewed in 1997 for 20 years.\32\
---------------------------------------------------------------------------
\31\ The federal dams are Grand Coulee and Chief Joseph. The
remaining dams are Wells (operated by the Douglas PUD), Rocky Reach
and Rock Island (operated by the Chelan PUD), and Wanapum and Priest
Rapids (operated by the Grant PUD).
\32\ http://www.wpuda.org/publications/connections/hydro/River%20Riders.pdf.
---------------------------------------------------------------------------
In general, electricity is bought and sold in an auction setting on
an hourly basis at various point along the electrical grid. The price
of electricity at a particular point on the grid is called the LMP,
which includes the cost of producing the electricity, as well as
congestion and line losses. Thus, an LMP reflects generation costs as
well as the actual cost of supplying and delivering electricity to a
specific point along the grid.
Electricity is traded in a day-ahead market as well as a real-time
market. Typically, the bulk of the energy transactions occur in the
day-ahead market. The day-ahead market establishes prices for
electricity that is to be delivered during the specified hour on the
following day. Day-ahead prices are determined based on generation and
energy transaction quotes offered in advance. Because the quotes are
based on estimates of supply and demand, electricity needs usually are
not perfectly satisfied in the day-ahead market. On the day the
electricity is transmitted and used, auction participants usually
realize that they bought or sold either too much power or too little
power. A real-time auction is operated in the Mid-C market to alleviate
this problem by servicing as a balancing mechanism. In this regard,
electricity traders use the real-time market to sell excess electricity
and buy additional power to meet demand. Only a relatively small amount
of electricity is traded in the real-time market compared with the day-
ahead market.
[[Page 38475]]
1. Material Price Reference Criterion
The Commission's October 6, 2009, Federal Register notice
identified material price reference and material liquidity as the
potential basis for a SPDC determination with respect to the OMC
contract. The Commission considered the fact that ICE sells its price
data to market participants in a number of different packages which
vary in terms of the hubs covered, time periods, and whether the data
are daily only or historical. For example, ICE offers the ``West Power
of Day'' package 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. This package includes price data for the OMC contract.
The Commission also noted that its October 2007 ECM Study found
that in general, market participants view ICE as a price discovery
market for certain electricity contracts. The study did not specify
which markets performed this function; nevertheless, the Commission
determined that the OMC contract, while not mentioned by name in the
ECM Study, might warrant further review.
The Commission explains in its Guidance to the Part 36 rules that
in evaluating a contract under the material price reference criterion,
it will rely on one of two sources of evidence--direct or indirect--to
determine that the price of a contract was being used as a material
price reference and therefore, serving a significant price discovery
function.\33\ With respect to direct evidence, the Commission will
consider the extent to which, on a frequent and recurring basis, cash
market bids, offers or transactions are directly based on or quoted at
a differential to, the prices generated on the ECM in question. Direct
evidence may be established when cash market participants are quoting
bid or offer prices or entering into transactions at prices that are
set either explicitly or implicitly at a differential to prices
established for the contract in question. Cash market prices are set
explicitly at a differential to the section 2(h)(3) contract when, for
instance, they are quoted in dollars and cents above or below the
reference contract's price. Cash market prices are set implicitly at a
differential to a section 2(h)(3) contract when, for instance, they are
arrived at after adding to, or subtracting from the section 2(h)(3)
contract, but then quoted or reported at a flat price. With respect to
indirect evidence, the Commission will consider the extent to which the
price of the contract in question is being routinely disseminated in
widely distributed industry publications--or offered by the ECM itself
for some form of remuneration--and consulted on a frequent and
recurring basis by industry participants in pricing cash market
transactions.
---------------------------------------------------------------------------
\33\ 17 CFR Part 36, Appendix A.
---------------------------------------------------------------------------
The Mid-C power market is a major pricing center for electricity on
the West Coast. Traders, including producers, keep abreast of the
electricity prices in the Mid-C power market when conducting cash
deals. These traders look to a competitively determined price as an
indication of expected values of power at the Mid-C hub when entering
into cash market transaction for electricity, especially those trades
providing for physical delivery in the future. Traders use the ICE OMC
contract, as well as other ICE power contracts, to hedge cash market
positions and transactions--activities which enhance the OMC contract's
price discovery utility. The substantial volume of trading and open
interest in the OMC contract appears to attest to its use for this
purpose. While the OMC contract's settlement prices may not be the only
factor influencing spot and forward transactions, power traders
consider the ICE price to be a critical factor in conducting OTC
transactions.\34\ As a result, the OMC contract satisfies the direct
price reference test.
---------------------------------------------------------------------------
\34\ In addition to referencing ICE prices, firms participating
in the Mid-C power 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 power
transactions.
---------------------------------------------------------------------------
Another reason that bolsters the direct price reference claim is
related to the uniqueness of the ICE electricity prices for the Mid-C
market. Day-ahead and real-time electricity prices are reported by a
number of sources, including third-party price providers (e.g., Dow
Jones & Company). ICE's Mid-C price indices are unique in that they are
derived from transactions completed on ICE's electronic system.
Moreover, ICE is the only entity that has access to such transaction
data. Thus, it is not possible for any other firm to replicate ICE's
indices.\35\
---------------------------------------------------------------------------
\35\ In contrast, third-party price reporting firms typically
compute their power index prices from transaction information that
is voluntarily submitted by traders. It is possible that one trader
could submit the same transaction data to multiple price reporting
firms, whereby increasing the likelihood that price indices from
different firms are similar in value. However, it is more plausible
that the third-party price reporters' price indices would be similar
but not exactly the same because different traders are polled.
---------------------------------------------------------------------------
The fact that ICE's OMC contract is used more widely as a source of
pricing information rather than the daily contract (i.e., the MXO
contract) \36\ reinforces the argument for direct price reference. In
this regard, the OMC contract is a monthly contact that prices power at
the Mid-C up to 86 calendar months in the future. Thus, market
participants can use the OMC contract to lock-in electricity prices far
into the future. In contrast, the MXO contract is listed for a much
shorter length of time--up to 70 days in the future. Traders use
monthly power contracts like the OMC contract to price future power
electricity commitments, where such commitments are based on long range
forecasts of power supply and demand. As generation and usage nears,
market participants have a better understanding of generation capacity
actual power needs. As a result, they can modify previously-established
hedges with daily contracts, like the MXO contract.
---------------------------------------------------------------------------
\36\ The MXO contract is cash settled based on the off-peak,
day-ahead price index for the specified day, as published by ICE in
its ``ICE Day Ahead Power Price Report,'' which is available on the
ECM's website. The daily, off-peak hour electricity price index is a
volume-weighted average of qualifying, day-ahead, off-peak hour
power contracts at the Mid-Columbia hub that are traded on the ICE
platform from 6 a.m. to 11 a.m. CST on the publication date.
---------------------------------------------------------------------------
The Commission notes that the Mid-C is a major trading point for
electricity, and the OMC contract's prices are well regarded in the
industry as indicative of the value of power at the Mid-C hub.
Accordingly, Commission staff believes that it is reasonable to
conclude that market participants purchase the data packages that
include the OMC contract's prices in substantial part because the OMC
contract prices have particular value to them. Moreover, such prices
are consulted on a frequent and recurring basis by industry
participants in pricing cash market transactions. In light of the
above, the OMC contract meets the indirect price reference test.
i. Federal Register Comments
WGCEF, WPTF, EEI and ICE stated that no other contract directly
references or settles to the OMC contract's price. Moreover, the
commenters argued that the underlying cash price series against which
the OMC contract is settled (in this case, the average of peak Mid-C
electricity prices over the contract month, which are derived from cash
market transactions) is the authentic reference price and not the ICE
contract itself. Commission staff believes that this interpretation of
price reference is too narrow and believes that a cash-settled
derivatives contract could meet the price reference criterion if market
participants ``consult on a frequent and
[[Page 38476]]
recurring basis'' the derivatives contract when pricing forward, fixed-
price commitments or other cash-settled derivatives that seek to ``lock
in'' a fixed price for some future point in time to hedge against
adverse price movements.
As noted above, the Mid-C hub is a major trading center for
electricity in the western United States. Traders, including producers,
keep abreast of the prices of the OMC contract when conducting cash
deals. These traders look to a competitively determined price as an
indication of expected values of electricity at the Mid-C hub when
entering into cash market transaction for power, especially those
trades that provide for physical delivery in the future. Traders use
the ICE OMC contract to hedge cash market positions and transactions,
which enhances the OMC contract's price discovery utility. While the
OMC contract's settlement prices may not be the only factor influencing
spot and forward transactions, power traders consider the ICE price to
be a crucial factor in conducting OTC transactions.
In addition, WGCEF stated that the publication of price data for
the OMC contract price is weak justification for material price
reference. This commenter argued that market participants generally do
not purchase ICE data sets for one contract's prices, such as those for
the OMC contract. Instead, traders are interested in the settlement
prices, so the fact that ICE sells the OMC prices as part of a broad
package is not conclusive evidence that market participants are buying
the ICE data sets because they find the OMC prices have substantial
value to them. As noted above, the Commission notes that publication of
the OMC contract's prices is indirect evidence of routine
dissemination. The OMC contract's prices, while sold as a package, are
of particular interest to market participants. Thus, the Commission has
concluded that traders likely specifically purchase the ICE data
packages for the OMC contract's prices and consult such prices on a
frequent and recurring basis in pricing cash market transactions.
Lastly, EEI criticized that the ECM Study did not specifically
identify the OMC contract as a contract that is referred to by market
participants on a frequent and recurring basis. In response, the
Commission notes that it cited the ECM Study's general finding that
some ICE electricity contracts appear to be regarded as price discovery
markets merely as indication that an investigation of certain ICE
contracts may be warranted. The ECM Study was not intended to serve as
the sole basis for determining whether or not a particular contract
meets the material price reference criterion.
ii. Conclusion Regarding Material Price Reference
Based on the above, the Commission finds that the ICE OMC contract
meets the material price reference criterion because cash market
transactions are priced either explicitly or implicitly on a frequent
and recurring basis at a differential to the OMC contract's price
(direct evidence). Moreover, the OMC contract's price data are sold to
market participants, and those individuals likely purchase the ICE data
packages specifically for the OMC contract's prices and consult such
prices on a frequent and recurring basis in pricing cash market
transactions (indirect evidence).
2. Material Liquidity Criterion
In its October 6, 2009, Federal Register notice, the Commission
identified material price reference and material liquidity as potential
criteria for SPDC determination of the OMC contract. To assess whether
a contract meets the material liquidity criterion, the Commission first
examines trading activity as a general measurement of the contract's
size and potential importance. If the Commission finds that the
contract in question meets a threshold of trading activity that would
render it of potential importance, the Commission will then perform a
statistical analysis to measure the effect that changes to the subject-
contract's prices potentially may have on prices for other contracts
listed on an ECM or a DCM.\37\
---------------------------------------------------------------------------
\37\ As noted above, the material liquidity criterion speaks to
the effect that transactions in the potential SPDC may have on
trading in ``agreements, contracts and transactions listed for
trading on or subject to the rules of a designated contract market,
a derivatives transaction execution facility, or an electronic
trading facility operating in reliance on the exemption in section
2(h)(3) of the Act.''
---------------------------------------------------------------------------
The total number of transactions executed on ICE's electronic
platform in the OMC contract was 443 in the second quarter of 2009,
resulting in a daily average of 6.9 trades. During the same period, the
OMC contract had a total trading volume of 185,950 contracts and an
average daily trading volume of 2,905.5 contracts. Moreover, open
interest as of June 30, 2009, was 1,105,361 contracts, which included
trades executed on ICE's electronic trading platform, as well as trades
executed off of ICE's electronic trading platform and then brought to
ICE for clearing. In this regard, ICE does not differentiate between
open interest created by a transaction executed on its trading platform
and that created by a transaction executed off its trading
platform.\38\
---------------------------------------------------------------------------
\38\ 74 FR 51261 (October 6, 2009).
---------------------------------------------------------------------------
In a subsequent filing dated March 24, 2010, ICE reported that
total trading volume in the fourth quarter of 2009 was 213,862
contracts (or 3,290 contracts on a daily basis). In terms of number of
transactions, 327 trades occurred in the fourth quarter of 2009 (5
trades per day). As of December 31, 2009, open interest in the OMC
contract was 1,249,165 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.
The number of trades per day was relatively low between the second
and fourth quarters of 2009. However, trading activity in the OMC
contract, as characterized by total quarterly volume, indicates that
the MDC contract experiences trading activity that is greater than that
of minor futures markets.\39\ Thus, it is reasonable to infer that the
OMC contract could have a material effect on other ECM contracts or on
DCM contracts.
---------------------------------------------------------------------------
\39\ Staff has advised the Commission that in its experience, a
thinly-traded contract is, generally, one that has a quarterly
trading volume of 100,000 contracts or less. In this regard, in the
third quarter of 2009, physical commodity futures contracts with
trading volume of 100,000 contracts or fewer constituted less than
one percent of total trading volume of all physical commodity
futures contracts.
---------------------------------------------------------------------------
To measure the effect that the OMC contract potentially could have
on another ECM contract, staff performed a statistical analysis \40\
using daily settlement prices between July 1, 2008, and December 31,
2009, for the ICE OMC and MDC contracts. The simulation suggests that,
on average over the sample period, a one percent
[[Page 38477]]
rise in the OMC contract's price elicited a 0.915 percent increase in
ICE MDC contract's price.
---------------------------------------------------------------------------
\40\ Specifically, Commission staff econometrically estimated a
cointegrated vector autoregression (CVAR) model using daily
settlement prices. CVAR methods permit a dichotomization of the data
relationships into long-run equilibrium components (called the
cointegration space or cointegrating relationships) and a short-run
component. A CVAR model was chosen over the more traditional vector
autoregression model in levels because the statistical properties of
the data (lack of stationarity and ergodicity) precluded the more
traditional modeling treatment. Moreover, the statistical properties
of the data necessitated the modeling of contracts' prices as a CVAR
model containing both first differences (to handle stationarity) and
an error correction term to capture long run equilibrium
relationships. The prices were treated as a single reduced-form
model in order to test hypothesis that power prices in the same
market affect each other. The prices of ICE's OMC and MDC contracts
are positively related to each other in a cointegrating relationship
and display a high level of statistical strength. On average during
the sample period, each percentage rise in OMC contract's price
elicited a 0.915 percent rise in MDC contract's price.
---------------------------------------------------------------------------
i. Federal Register Comments
ICE and WGCEF stated that the OMC contract lacks a sufficient
number of trades to meet the material liquidity criterion. These two
commenters, along with WPTF, FEIG and EEI argued that the OMC contract
cannot have a material effect on other contracts, such as those listed
for trading by NYMEX. The commenters pointed out that it is not
possible for the OMC contract to affect a DCM contract because price
linkage and the potential for arbitrage do not exist. The DCM contracts
do not cash settle to the OMC contract's price. Instead, the DCM
contracts and the OMC contract are both cash settled based on physical
transactions, which the ECM and DCM contracts cannot influence. The
Commission's statistical analysis shows that changes in the ICE OMC
contract's price significantly influence the prices of other ECM
contracts (namely, the MDC contract).
WGCEF and ICE noted that the Commission's Guidance had posited
concepts of liquidity that generally assumed a fairly constant stream
of prices throughout the trading day, and noted that the relatively low
number of trades per day in the OMC contract did not meet this standard
of liquidity. While a continuous stream of prices would indeed be an
indication of liquidity for certain markets, the Guidance also notes
that ``quantifying the levels of immediacy and price concession that
would define material liquidity may differ from one market or commodity
to another.'' \41\
---------------------------------------------------------------------------
\41\ Guidance, supra.
---------------------------------------------------------------------------
ICE opined that the Commission ``seems to have adopted a five trade
per day test for material liquidity.'' To the contrary, 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'' \42\ 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; however, the contract will not be found to be a SPDC merely
because it met the reporting threshold.
---------------------------------------------------------------------------
\42\ 73 FR 75892 (December 12, 2008).
---------------------------------------------------------------------------
ICE also asserted that the statistics provided by ICE were
misinterpreted and misapplied by the Commission. In particular, ICE
stated that the volume figures used in the Commission's analysis (cited
above) ``include trades made in all months'' as well as in strips of
contract months. ICE suggested that a more appropriate method of
determining liquidity is to examine the activity in a single traded
month of a given contract.\43\ It is the Commission's opinion that
liquidity, as it pertains to the OMC contract, is typically a function
of trading activity in particular lead months and, given sufficient
liquidity in such months, the ICE OMC contract itself would be
considered liquid.
---------------------------------------------------------------------------
\43\ In addition, ICE stated that the trades-per-day statistics
that it provided to the Commission in its quarterly filing and which
were cited in the Commission's October 6, 2009, Federal Register
notice includes 2(h)(1) transactions, which were not completed on
the electronic trading platform and should not be considered in the
SPDC determination process. The Commission staff asked ICE to review
the data it sent in its quarterly filings; ICE confirmed that the
volume data it provided and which the Commission cited includes only
transaction data executed on ICE's electronic trading platform. As
noted above, supplemental data supplied by ICE confirmed that block
trades are in addition to the trades that were conducted on the
electronic platform; block trades comprise about 82 percent of all
transactions in the OMC contract. Commission acknowledges that the
open interest information it provided in its October 6, 2009,
Federal Register notice includes transactions made off the ICE
platform. However, once open interest is created, there is no way
for ICE to differentiate between ``on-exchange'' versus ``off-
exchange'' created positions, and all such positions are fungible
with one another and may be offset in any way agreeable to the
position holder regardless of how the position was initially
created.
---------------------------------------------------------------------------
ii. Conclusion Regarding Material Liquidity
For the reasons discussed above, the Commission finds that the OMC
meets the material liquidity criterion. Specifically, there is
sufficient trading activity in the OMC 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).
3. Overall Conclusion Regarding the OMC Contract
After considering the entire record in this matter, including the
comments received, the Commission has determined that the OMC contract
performs a significant price discovery function under two of the four
criteria established in section 2(h)(7) of the CEA. The Commission has
concluded that the OMC contract meets both the material price reference
and material liquidity criteria. Accordingly, the Commission is issuing
the attached Order declaring that the OMC 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 OMC contract,\44\ and triggers the obligations,
requirements--both procedural and substantive--and timetables
prescribed in Commission rule 36.3(c)(4) for ECMs.
---------------------------------------------------------------------------
\44\ See 73 FR 75888, 75893 (Dec. 12, 2008).
---------------------------------------------------------------------------
V. Related Matters
a. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \45\ 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.
---------------------------------------------------------------------------
\45\ 44 U.S.C. 3507(d).
---------------------------------------------------------------------------
b. Cost-Benefit Analysis
Section 15(a) of the CEA \46\ requires the Commission to consider
the costs and benefits of its actions before issuing an order under the
Act. By its terms, section 15(a) does not require the Commission to
quantify the costs and benefits of an order or to determine whether the
benefits of the order outweigh its costs; rather, it requires that the
Commission ``consider'' the costs and benefits of its actions. Section
15(a) further specifies that the costs and benefits shall be evaluated
in light of five broad areas of market and public concern: (1)
Protection of market participants and the public; (2) efficiency,
competitiveness and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. The Commission may in its discretion give
greater weight to any one of the five enumerated areas and could in its
discretion determine that, notwithstanding its costs, a particular
order is necessary or appropriate to protect the public interest or to
effectuate any of the provisions or accomplish any of the purposes of
the Act.
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\46\ 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
[[Page 38478]]
market integrity, both on the ECM itself and in any related futures
contracts trading on DCMs. An Order finding that a particular contract
is a SPDC triggers this increased oversight and imposes obligations on
the ECM calculated to accomplish this goal. The increased oversight
engendered by the issue of a SPDC Order increases transparency and
helps to ensure fair competition among ECMs and DCMs trading similar
products and competing for the same business. Moreover, the ECM on
which the SPDC is traded must assume, with respect to that contract,
all the responsibilities and obligations of a registered entity under
the CEA and Commission regulations. Additionally, the ECM must comply
with nine core principles established by section 2(h)(7) of the Act--
including the obligation to establish position limits and/or
accountability standards for the SPDC. Section 4(i) of the CEA
authorize the Commission to require reports for SPDCs listed on ECMs.
These increased responsibilities, along with the CFTC's increased
regulatory authority, subject the ECM's risk management practices to
the Commission's supervision and oversight and generally enhance the
financial integrity of the markets.
c. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \47\ 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.\48\ Accordingly, the Chairman, on
behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b)
that these Orders, taken in connection with section 2(h)(7) of the Act
and the Part 36 rules, will not have a significant impact on a
substantial number of small entities.
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\47\ 5 U.S.C. 601 et seq.
\48\ 66 FR 42256, 42268 (Aug. 10, 2001).
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VI. Orders
a. Order Relating to the Mid-C Financial Peak 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 Mid-C Financial Peak contract,
traded on the IntercontinentalExchange, Inc., satisfies the statutory
material price reference and material liquidity criteria for
significant price discovery contracts. Consistent with this
determination, and effective immediately, the IntercontinentalExchange,
Inc., must comply with, with respect to the Mid-C Financial Peak
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 \49\ with respect to the Mid-C
Financial Peak contract and is subject to all the provisions of the
Commodity Exchange Act applicable to registered entities.
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\49\ 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 core principle compliance by the
IntercontinentalExchange, Inc., commence with the issuance of this
Order.\50\
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\50\ 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).
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b. Order Relating to the Mid-C Financial Off-Peak 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 Mid-C Financial Off-Peak contract,
traded on the IntercontinentalExchange, Inc., satisfies the statutory
material price reference and material liquidity criteria for
significant price discovery contracts. Consistent with this
determination, and effective immediately, the IntercontinentalExchange,
Inc., must comply with, with respect to the Mid-C Financial Off-Peak
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 \51\ with respect to the Mid-C
Financial Off-Peak contract and is subject to all the provisions of the
Commodity Exchange Act applicable to registered entities.
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\51\ 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 core principle compliance by the
IntercontinentalExchange, Inc., commence with the issuance of this
Order.\52\
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\52\ 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 June 25, 2010, by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. 2010-16212 Filed 7-1-10; 8:45 am]
BILLING CODE 6351-01-P