```

[Federal Register: May 4, 2010 (Volume 75, Number 85)]
[Notices]               
[Page 23704-23710]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr04my10-63]                         

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COMMODITY FUTURES TRADING COMMISSION

 
Order Finding That the NWP Rockies 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 22, 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 NWP \2\ Rockies Financial Basis (``NWR'') 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 NWR 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.
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    \1\ 74 FR 54550 (October 22, 2009).
    \2\ The acronym ``NWP'' indicates the Northwest Pipeline.

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DATES: Effective date: April 28, 2010.

FOR FURTHER INFORMATION CONTACT: Gregory K. Price, Industry Economist, 
Division of Market Oversight, Commodity Futures Trading Commission, 
Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581. 
Telephone: (202) 418-5515. E-mail: gprice@cftc.gov; Christa Lachenmayr, 
Economist, Division of Market Oversight, same address. Telephone: (202) 
418-5252. E-mail: clachenmayr@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--ECMs on which significant price discovery contracts 
(``SPDCs'') are traded--and treating ECMs in that category as 
registered entities under the CEA.\4\ 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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    \3\ Incorporated as Title XIII of the Food, Conservation and 
Energy Act of 2008, Public Law 110-246, 122 Stat. 1624 (June 18, 
2008).
    \4\ 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.\5\ 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.
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    \5\ 74 FR 12178 (Mar. 23, 2009); these rules became effective on 
April 22, 2009.
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    Commission rule 36.3(c)(3) established the procedures by which the 
Commission makes and announces its determination whether a particular 
ECM contract serves a significant price discovery function. Under those 
procedures, the Commission will publish notice in the Federal Register 
that it intends to undertake an evaluation whether the specified 
agreement, contract or transaction performs a significant price 
discovery function and to receive written views, data and arguments 
relevant to its determination from the ECM and other interested 
persons. Upon the close of the comment period, the Commission will 
consider, among other things, all relevant information regarding the 
subject contract and issue an order announcing and explaining its 
determination whether or not the contract is a SPDC. The issuance of an 
affirmative order signals the effectiveness of the Commission's 
regulatory authorities over an ECM with respect to a SPDC; at that time 
such an ECM becomes subject to all provisions of the CEA applicable to 
registered entities.\6\ The issuance of such an order also triggers the 
obligations, requirements and timetables prescribed in Commission rule 
36.3(c)(4).\7\
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    \6\ 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).
    \7\ 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 22, 2009, the Commission published in the Federal 
Register notice of its intent to undertake a

[[Page 23705]]

determination whether the NWR contract performs a significant price 
discovery function and requested comment from interested parties.\8\ 
Comments were received from the Federal Energy Regulatory Commission 
(``FERC''), Platts, Economists Incorporated (``EI'') and ICE.\9\ The 
comment letters from FERC \10\ and Platts did not directly address the 
issue of whether or not the NWR contract is a SPDC; ICE's and EI's 
comments raised substantive issues with respect to the applicability of 
section 2(h)(7) the NWR contract, generally asserting that the NWR 
contract is not a SPDC as it does not meet the material liquidity, 
material price reference and price linkage criteria for SPDC 
determination. ICE's and EI's comments are more extensively discussed 
below, as applicable.
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    \8\ 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.
    \9\ 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 ECM, as noted above. EI 
is an economic consulting firm with offices located in Washington, 
DC, and San Francisco, CA. The comment letters are available on the 
Commission's Web site: http://www.cftc.gov/lawandregulation/federalregister/federalregistercomments/2009/09-031.html.
    \10\ FERC stated that the NWR contract is cash settled and does 
not contemplate the actual physical delivery of natural gas. 
Acccordingly, 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.
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III. Section 2(h)(7) of the CEA

    The Commission is directed by section 2(h)(7) of the CEA to 
consider the following criteria in determining a contract's significant 
price discovery function:
     Price Linkage--the extent to which the agreement, contract 
or transaction uses or otherwise relies on a daily or final settlement 
price, or other major price parameter, of a contract or contracts 
listed for trading on or subject to the rules of a designated contract 
market (``DCM'') or derivatives transaction execution facility 
(``DTEF''), or a SPDC traded on an electronic trading facility, to 
value a position, transfer or convert a position, cash or financially 
settle a position, or close out a position.
     Arbitrage--the extent to which the price for the 
agreement, contract or transaction is sufficiently related to the price 
of a contract or contracts listed for trading on or subject to the 
rules of a DCM or DTEF, or a SPDC traded on or subject to the rules of 
an electronic trading facility, so as to permit market participants to 
effectively arbitrage between the markets by simultaneously maintaining 
positions or executing trades in the contracts on a frequent and 
recurring basis.
     Material price reference--the extent to which, on a 
frequent and recurring basis, bids, offers or transactions in a 
commodity are directly based on, or are determined by referencing or 
consulting, the prices generated by agreements, contracts or 
transactions being traded or executed on the electronic trading 
facility.
     Material liquidity--the extent to which the volume of 
agreements, contracts or transactions in a commodity being traded on 
the electronic trading facility is sufficient to have a material effect 
on other agreements, contracts or transactions listed for trading on or 
subject to the rules of a DCM, DTEF or electronic trading facility 
operating in reliance on the exemption in section 2(h)(3).
    Not all criteria must be present to support a determination that a 
particular contract performs a significant price discovery function, 
and one or more criteria may be inapplicable to a particular 
contract.\11\ Moreover, the statutory language neither prioritizes the 
criteria nor specifies the degree to which a SPDC must conform to the 
various criteria. In Guidance issued in connection with the Part 36 
rules governing ECMs with SPDCs, the Commission observed that these 
criteria do not lend themselves to a mechanical checklist or formulaic 
analysis. Accordingly, the Commission has indicated that in making its 
determinations it will consider the circumstances under which the 
presence of a particular criterion, or combination of criteria, would 
be sufficient to support a SPDC determination.\12\ For example, for 
contracts that are linked to other contracts or that may be arbitraged 
with other contracts, the Commission will consider whether the price of 
the potential SPDC moves in such harmony with the other contract that 
the two markets essentially become interchangeable. This co-movement of 
prices would be an indication that activity in the contract had reached 
a level sufficient for the contract to perform a significant price 
discovery function. In evaluating a contract's price discovery role as 
a price reference, the Commission will consider 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.
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    \11\ In its October 22, 2009, Federal Register release, the 
Commission identified material price reference, price linkage and 
material liquidity as the possible criteria for SPDC determination 
of the NWR contract. Arbitrage was not identified as a possible 
criterion and will not be discussed further in this document or the 
associated Order.
    \12\ 17 CFR Part 36, Appendix A.
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IV. Findings and Conclusions

a. The NWP Rockies Financial Basis (NWR) Contract and the SPDC Indicia

    The ICE NWR contract is cash settled based on the difference 
between the bidweek price of natural gas at the Northwest Pipeline's 
Rockies hub for the month of delivery, as published in Platts' Inside 
FERC's Gas Market Report, and the final settlement price for the New 
York Mercantile Exchange's (``NYMEX's'') Henry Hub physically-delivered 
natural gas futures contract for the same specified calendar month. The 
Platts bidweek price, which is published monthly, is based on a survey 
of cash market traders who voluntarily report to Platts data on fixed-
price transactions for physical delivery of natural gas at the Rockies 
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 Platts bidweek index is published on the first business day of the 
calendar month in which the natural gas is to be delivered. The size of 
the NWR contract is 2,500 million British thermal units (``mmBtu''), 
and the unit of trading is any multiple of 2,500 mmBtu. The NWR 
contract is listed for up to 120 calendar months commencing with the 
next calendar month.
    The Henry Hub,\13\ which is located in Erath, Louisiana, is the 
primary cash market trading and distribution center for natural gas in 
the United States. It

[[Page 23706]]

also is the delivery point and pricing basis for the NYMEX's actively 
traded, physically-delivered natural gas futures contract, which is the 
most important pricing reference for natural gas in the United States. 
The Henry Hub, which is operated by Sabine Pipe Line, LLC, serves as a 
juncture for 13 different pipelines. These pipelines bring in natural 
gas from fields in the Gulf Coast region and ship it to major 
consumption centers along the East Coast and Midwest. The throughput 
shipping capacity of the Henry Hub is 1.8 trillion mmBtu per day.
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    \13\ The term ``hub'' refers to a juncture where two or more 
natural gas pipelines are connected. Hubs also serve as pricing 
points for natural gas at the particular locations.
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    In addition to the Henry Hub, there are a number of other locations 
where natural gas is traded. In 2008, there were 33 natural gas market 
centers in North America.\14\ Some of the major trading centers include 
Alberta, Northwest Rockies, Southern California border region and the 
Houston Ship Channel. For locations that are directly connected to the 
Henry Hub by one or more pipelines and where there typically is 
adequate shipping capacity, the price at the other locations usually 
directly tracks the price at the Henry Hub, adjusted for transportation 
costs. However, at other locations that are not directly connected to 
the Henry Hub or where shipping capacity is limited, the prices at 
those locations often diverge from the Henry Hub price. Furthermore, 
one local price may be significantly different than the price at 
another location even though the two markets' respective distances from 
the Henry Hub are the same. The reason for such pricing disparities is 
that a given location may experience supply and demand factors that are 
specific to that region, such as differences in pipeline shipping 
capacity, unusually high or low demand for heating or cooling or supply 
disruptions caused by severe weather. As a consequence, local natural 
gas prices can differ from the Henry Hub price by more than the cost of 
shipping and such price differences can vary in an unpredictable 
manner.
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    \14\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.
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    The Northwest Pipeline's Rockies hub is located in Wyoming, Utah 
and Colorado.\15\ The Northwest Pipeline draws natural gas supplies 
from the Rocky Mountain region and ships it along a 3,900-mile, bi-
directional transmission system to markets throughout the Rockies and 
Pacific Northwest. The Opal market center, a trading region that 
includes the Rockies hub, had an estimated throughput capacity of 1.5 
billion cubic feet per day in 2008. Moreover, the number of pipeline 
interconnections at the Opal market center was eight in 2008, up from 
four interconnections in 2003. Lastly, the pipeline interconnection 
capacity of the Opal market center in 2008 was six billion cubic feet 
per day, which constituted an 86 percent increase over the pipeline 
interconnection capacity in 2003.\16\ The Rockies hub is far removed 
from the Henry Hub and is not directly connected to the Henry Hub by an 
existing pipeline.
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    \15\ The Rockies hub includes fixed-price gas delivered into 
Northwest Pipeline's mainline in Wyoming, Utah and Colorado between 
the Kemmerer and Moab stations. Deliveries at Ignacio, CO, and 
elsewhere in zone MO (the area South of Moab, UT, into the San Juan 
Mountains) are excluded. Transactions done at Opal, WY, and the 
Muddy Creek compressor station (where the Northwest Pipeline 
connects with Kern River Gas Transmission, Questar Pipeline and 
Colorado Interstate Gas) are used because gas traded at those two 
points often is not nominated into a specific pipeline.
    \16\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.
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    The local price at the Rockies 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 Rockies price. Moreover, 
exogenous factors, such as adverse weather, can cause the Rockies 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 \17\ allow traders to more accurately 
discover prices at alternative locations and hedge price risk that is 
associated with natural gas at such locations.\18\ In this regard, a 
position at a local price for an alternative location can be 
established by adding the appropriate basis swap position to a position 
taken in the NYMEX physically-delivered Henry Hub contract (or in the 
NYMEX or ICE Henry Hub look-alike contract, which cash settle based on 
the NYMEX physically-delivered natural gas contract's final settlement 
price).
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    \17\ 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.
    \18\ 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 Rockies hub.
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    In its October 22, 2009, Federal Register notice, the Commission 
identified material price reference, price linkage and material 
liquidity as the potential SPDC criteria applicable to the NWR 
contract. Each of these criteria is discussed below.\19\
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    \19\ 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 NWR contract.
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1. Material Price Reference Criterion
    The Commission's October 22, 2009, Federal Register notice 
identified material price reference as a potential basis for a SPDC 
determination with respect to this contract. The Commission considered 
the fact that ICE sells its price data to market participants in a 
number of different packages which vary in terms of the hubs covered, 
time periods, and whether the data are daily only or historical. For 
example, ICE offers the ``West Gas End of Day'' and ``OTC Gas End of 
Day'' \20\ packages with access to all price data or just current 
prices plus a selected number of months (i.e., 12, 24, 36 or 48 months) 
of historical data. These two packages include price data for the NWR 
contract.
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    \20\ The OTC Gas End of Day dataset includes daily settlement 
prices for natural gas contracts listed for all points in North 
America.
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    The Rockies hub is a major trading center for natural gas in the 
United States. Traders, including producers, keep abreast of the prices 
of the NWR contract when conducting cash deals. These traders look to a 
competitively determined price as an indication of expected values of 
natural gas at the Rockies hub when entering into cash market 
transactions for natural gas, especially those trades that provide for 
physical delivery in the future. Traders use the ICE NWR contract, as 
well as other ICE basis swap contracts, to hedge cash market positions 
and transactions--activities which enhance the NWR contract's price 
discovery utility. The substantial volume of trading and open interest 
in the NWR contract appears to attest to its use for this purpose. 
While the NWR 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.\21\
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    \21\ In addition to referencing ICE prices, natural gas market 
firms participating in the Rockies market may rely on other cash 
market quotes as well as industry publications and price indices 
that are published by third-party price reporting firms when 
entering into natural gas transactions.
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    NYMEX lists a futures contract that is comparable to the ICE NWR 
contract on its ClearPort platform. However, unlike the ICE contract, 
none of the trades in the NYMEX Rockies Basis Swap (Platts IFERC) 
futures contract are executed in NYMEX's centralized marketplace; 
instead, all of the transactions originate as bilateral swaps that are 
submitted to

[[Page 23707]]

NYMEX for clearing. The daily settlement prices of the NYMEX Rockies 
Basis Swap contract are influenced, in part, by the daily settlement 
prices of the ICE NWR 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 NWR price, among other information, as an important 
indicator as to where the market is trading. Therefore, the ICE NWR 
price influences the settlement price for the NYMEX Rockies Basis Swap 
contract. This is supported by an analysis of the daily settlement 
prices for the NYMEX and ICE Rockies basis swap contracts. In this 
regard, 98 percent of the daily settlement prices for the NYMEX Rockies 
Basis Swap contract are within one standard deviation of the NWR 
contract's settlement prices.
    Lastly, the fact that the NWR 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 Rockies natural gas prices showed that all of 
the observations were more than 2.5 percent different than the 
contemporaneous Henry Hub prices. Specifically, the average Rockies 
basis value between January 2008 and September 2009 was -$1.94 per 
mmBtu with a variance of $1.88 per mmBtu.
i. Federal Register Comments
    Both EI and ICE stated in their comment letters that the NWR 
contract does not meet the material price reference criterion for SPDC 
determination. ICE argued that the Commission appeared to base the case 
that the NWR contract is potentially a SPDC on a disputable assertion. 
In issuing its notice of intent to determine whether the NWR 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 stated 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.
    EI also stated that the NWR contract does not satisfy the material 
price reference criterion. The commenter argued that other contracts 
(physical or financial) are not indexed based on the ICE NWR contract 
price, but rather are indexed based on the underlying cash price series 
against which the NWR contract is settled. Thus, EI contends that the 
underlying cash price series is the authentic reference price and not 
the ICE contract itself. The Commission believes that this 
interpretation of price reference is too limiting in that it only 
considers the final index value on which the contract is cash settled 
after trading ceases. Instead, the Commission believes that a cash-
settled derivatives contract could meet the price reference criteria if 
market participants ``consult on a frequent and recurring basis'' the 
derivatives contract when pricing forward, fixed-price commitments or 
other cash-settled derivatives that seek to ``lock in'' a fixed price 
for some future point in time to hedge against adverse price movements.
    EI also argued that publication of price data in a package format 
is a weak justification for material price reference. According to the 
commenter, market participants generally do not purchase ICE data sets 
for one contract's prices, so the fact that ICE sells the NWR prices as 
part of a broad package is not conclusive evidence that market 
participants are buying the ICE data sets because they find the NWR 
prices have substantial value to them. The Commission notes that the 
Rockies hub is a major natural gas trading point, and the NWR 
contract's prices are well regarded in the industry as indicative of 
the value of natural gas at the Rockies hub. Accordingly, the 
Commission believes that it is reasonable to conclude that market 
participants are purchasing the data packages that include the NWR 
contract's prices in substantial part because the NWR contract prices 
have particular value to them.
ii. Conclusion Regarding Material Price Reference
    Based on the above, the Commission finds that the NWR 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 NWR contract's price data to market participants 
(indirect evidence).
2. Price Linkage Criterion
    In its October 22, 2009, Federal Register notice, the Commission 
identified price linkage as a potential basis for a SPDC determination 
with respect to the NWR contract. In this regard, the final settlement 
of the NWR 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'').
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    \22\ Appendix A to the Part 36 rules.

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[[Page 23708]]

    To assess whether the NWR 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 Rockies 
price is determined, in part, by the final settlement price of the 
NYMEX physically-delivered natural gas futures contract (a DCM 
contract), the Rockies hub price is not within 2.5 percent of the 
settlement price of the corresponding NYMEX Henry Hub natural gas 
futures contract on 95 percent or more of the days. Specifically, 
during the third quarter of 2009, only 2.4 percent of the Rockies 
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 NWR 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 NWR contract during the same period was 
279,905 contracts (equivalent to 69,976 NYMEX contracts, given the size 
difference).\23\ Thus, centralized-market trades in the NWR contract 
amounted to less than the minimum threshold.
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    \23\ The NWR contract is one-quarter the size of the NYMEX Henry 
Hub physically-delivered futures contract.
---------------------------------------------------------------------------

    Due to the specific criteria that a given ECM contract must meet to 
fulfill the price linkage criterion, the requirements, for all intents 
and purposes, exclude ECM contracts that are not near facsimiles of DCM 
contracts even though the ECM contract may specifically use the 
settlement price to value a position, which is the case of the NWR 
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. 
While the Rockies hub and the Henry Hub are both supply centers, they 
are located in two different areas of the United States. Moreover, the 
Rockies hub is somewhat isolated and the two hubs are not directly 
connected to each other. These differences contribute to the divergence 
between the two price series and, as discussed above, increase the 
likelihood that the ``basis'' contract is used for material price 
reference.
i. Federal Register Comments
    As noted above, ICE and EI addressed the question of whether the 
NWR contract is a SPDC. EI noted that the NWR and NYMEX natural gas 
contracts are not economically equivalent and that the NWR contract's 
volume is too low to affect the NYMEX natural gas futures contract. ICE 
opined that the NWR contract's trading volume is too low to affect the 
price discovery process for the NYMEX natural gas futures contract. In 
addition, ICE states that the NWR contract simply reflects a price 
differential between the Rockies and the Henry Hub; ``there is no price 
linkage as contemplated by Congress or the CFTC in its rulemaking.''
ii. Conclusion Regarding the Price Linkage Criterion
    Based on the above, the Commission finds that the NWR 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 NWR 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 NWR market's size 
and potential importance, and second performed a statistical analysis 
to measure the effect that changes to NWR prices potentially may have 
on prices for the NYMEX Henry Hub Natural Gas (a DCM contract), the ICE 
PG&E Citygate Financial Basis contract (an ECM contract) and the Malin 
Financial Basis contract (an ECM contract).\24\
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    \24\ 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 22, 2009, Federal Register notice referred to 
second quarter 2009 trading statistics that ICE had submitted for its 
NWR contract. Based upon on a required quarterly filing made by ICE on 
July 27, 2009, the total number of NWR trades executed on ICE's 
electronic trading platform was 3,013 in the second quarter of 2009, 
resulting in a daily average of 47.1 trades. During the same period, 
the NWR contract had a total trading volume on ICE's electronic trading 
platform of 276,187 contracts and an average daily trading volume of 
4,315 contracts. Moreover, the open interest as of June 30, 2009, was 
349,931 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.\25\
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    \25\ 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 54550 
(October 22, 2009).
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    Subsequent to the October 22, 2009, Federal Register notice, ICE 
submitted another quarterly notification filed on November 13, 
2009,\26\ with updated trading statistics. Specifically, with respect 
to its NWR contract, 2,950 separate trades occurred on its electronic 
platform in the third quarter of 2009, resulting in a daily average of 
44.7 trades. During the same period, the NWR contract had a total 
trading volume on its electronic platform of 279,905 contracts (which 
was an average of 4,241 contracts per day).\27\ As of September 30, 
2009, open interest in the NWR contract was 345,683 contracts.\28\ 
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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    \26\ See Commission Rule 36.3(c)(2), 17 CFR 36.3(c)(2).
    \27\ By way of comparison, the number of contracts traded in the 
NWR contract is similar to that exhibited on a liquid futures market 
and is roughly equivalent to the volume of trading for the Chicago 
Mercantile Exchange Feeder Cattle futures contract during this 
period.
    \28\ By way of comparison, open interest in the NWR contract is 
roughly equivalent to that in the Chicago Board of Trade's wheat 
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 NWR contract 
potentially could have on a DCM contract, or on another ECM contract, 
Commission staff performed a statistical analysis \29\ using

[[Page 23709]]

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 Rockies, PG&E Citygate and Malin market 
centers.\30\ The simulation results suggest that, on average over the 
sample period, a one percent rise in the Rockies natural gas price 
elicited a 0.254 percent to 0.276 percent increase in the PG&E Citygate 
and Malin hub natural gas prices, and a 0.176 percent increase in the 
NYMEX Henry Hub natural gas price.
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    \29\ Specifically, Commission staff econometrically estimated a 
vector autoregression model using daily natural gas price levels. A 
vector autoregression model is an econometric model used to capture 
the dependencies and interrelationships among multiple time series, 
generalizing the univariate autoregression model. The estimated 
model displays strong diagnostic evidence of statistical adequacy. 
In particular, the model's impulse response function was shocked 
with a one-time rise in Rockies price. The simulation results 
suggest that, on average over the sample period, a one percent rise 
in the Rockies natural gas price elicited a 0.176 percent increase 
in the NYMEX Henry Hub price, as well as a 0.254 percent to 0.276 
percent increase in 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 
Rockies 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 1.5 percent to 2.5 percent. The 
relatively small magnitude of the multipliers likely reflects the 
fact that the Rockies hub is isolated and not directly connected to 
the Henry Hub.
    \30\ Natural gas prices at the Rockies, PG&E Citygate and Malin 
trading centers were obtained by adding the daily settlement prices 
of ICE's NWP Rockies Financial Basis, PG&E Citygate Financial Basis 
and Malin 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 and EI addressed the question of whether the 
NWR contract is a SPDC. ICE stated in its comment letter that the NWR 
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'' 
\31\ 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 NWR contract, in part, on the fact that there were nearly 
45 trades per day on average in the NWR contract during the third 
quarter 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 NWR contract 
is high (approximately 95 contracts per transaction) and thus, as 
noted, trading volume (measured in contract units) is substantial. The 
NWR contract also has substantial open interest.
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    \31\ 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 NWR contract, ``28% of the trades actually executed in the ICE 
platform occurred in the single most liquid, usually prompt, month of 
the contract.'' EI also expressed its belief that the contract months 
should be evaluated individually.
    It is the Commission's opinion that liquidity, as it pertains to 
the NWR contract, is typically a function of trading activity in 
particular lead months and, given sufficient liquidity in such months, 
the NWR contract itself would be considered liquid. ICE's analysis of 
its own trade data confirms this to be the case for the NWR 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 and EI both 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 22, 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.\32\ The 
Commission acknowledges that the open interest information it cites 
above includes transactions made off the ICE platform. However, once 
open interest is created, there is no way for ICE to differentiate 
between ``on-exchange'' versus ``off-exchange'' created positions, and 
all such positions are fungible with one another and may be offset in 
any way agreeable to the position holder regardless of how the position 
was initially created.
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    \32\ 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 44.4 percent of all transactions in the NWR contract.
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ii. Conclusion Regarding Material Liquidity
    Based on the above, the Commission concludes that the NWR contract 
meets the material liquidity criterion in that there is sufficient 
trading activity in the NWR 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 NWR 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 NWR contract does not meet the price 
linkage criterion at this time, the Commission has determined that the 
NWR contract does meet both the material liquidity and material price 
reference criteria. Accordingly, the Commission will issue the attached 
Order declaring that the NWR 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 NWR contract,\33\ 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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    \33\ 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'') \34\ 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

[[Page 23710]]

assigned OMB control number 3038-0060 to this collection of 
information.
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    \34\ 44 U.S.C. 3507(d).
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b. Cost-Benefit Analysis

    Section 15(a) of the CEA \35\ 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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    \35\ 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'') \36\ 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.\37\ 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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    \36\ 5 U.S.C. 601 et seq.
    \37\ 66 FR 42256, 42268 (Aug. 10, 2001).
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VI. Order

a. Order Relating to the ICE NWP Rockies 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 NWP Rockies 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 NWP Rockies 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 \38\ with respect to the NWP 
Rockies Financial Basis contract and is subject to all the provisions 
of the Commodity Exchange Act applicable to registered entities.
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    \38\ 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.\39\
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    \39\ 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. 2010-10304 Filed 5-3-10; 8:45 am]
BILLING CODE P
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