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[Federal Register: March 22, 2004 (Volume 69, Number 55)]
[Notices]
[Page 13286-13289]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr22mr04-44]

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COMMODITY FUTURES TRADING COMMISSION


In the Matter of the Intercontinental Exchange, Inc. Petition for
Expansion of the Definition of Eligible Commercial Entities Under
Section 1a(11)(C) of the Commodity Exchange Act

AGENCY: Commodity Futures Trading Commission.

ACTION: Request for comment.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'') is
requesting comment regarding an Intercontinental Exchange, Inc.
(``Intercontinental'') petition requesting that the category of
eligible commercial entity (``ECE'') be expanded to include floor and
electronic broker firms that are members of the International Petroleum
Exchange (``IPE'') located in the U.K. and that are authorized and
regulated by the U.K. Financial Services Authority (``FSA''), and local
traders that are members of IPE located in the U.K. who are outside the
scope of FSA regulation but who are registered with IPE. In addition,
the Commission asks for comments with respect to whether any response
to the petitions should be tailored specifically to Intercontinental
and to the narrow circumstances presented in the petitions or whether a
response should be more broadly based and, thus, also applicable to
other trading facilities. The Commission invites public comment,
moreover, or Intercontinental's request for relief not only for those
IPE members that trade on the floor as well as the IPE electronic
platform, but also for those IPE members that trade only on IPE's
electronic platform. Finally, the Commission seeks general comment on
whether ECE treatment should be extended to non-U.S. traders that are
authorized by a non-U.S. exchange, but are not registrants of a
national regulatory body and, if so, what standards the Commission
should use to evaluate the qualifications of such persons.

DATES: Comments must be received by April 6, 2004.

ADDRESSES: Comments should be sent to the Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington,
DC 20581, attention: Office of the Secretariat. Comments may sent by
facsimile transmission to 202-418-5521 or, by e-mail to [email protected]. Reference should be made to ``ECE Petition.''


FOR FURTHER INFORMATION CONTACT: Riva Spear Adriance, Special Counsel,
Division of Market Oversight, Commodity Futures Trading Commission,
Three Lafayette Center, 1155 21st Street, NW., Washington DC 20581.
Telephone: 202-418-5494. E-mail: [email protected].

SUPPLEMENTARY INFORMATION:

I. Statutory Background

    Section 1a(11) of the Commodity Exchange Act (``Act'' or ``CEA''),
as amended by the Commodity Futures Modernization Act of 2000
(``CFMA''), Pub L. No. 106-554, which was signed into law on December
21, 2000, generally defines the term ECE by listing those ``eligible
contract participants''

[[Page 13287]]

(``ECPs'') that are qualified to be ECEs.\1\ ECEs may enter into
transactions in an ``exempt commodity,'' as that term is defined by the
Act,\2\ on exempt commercial markets (``ECMs'') pursuant to Section
2(h)(3) of the Act.\3\ IPE floor and electronic brokers (``IPE
brokers'') and IPE floor and electronic traders (``IPE local traders'')
do not qualify as ECEs for the purpose of engaging in transactions on
an ECM under CEA Section 2(h)(3). The Act, however, gives the
Commission discretion to expand the ECE category.
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    \1\ Under Section 1a(11)(A) of the Act, ECEs are ECPs that: (i)
Have the ability to make or take delivery; (ii) incur risk, in
addition to price risk, related to the commodity; or (iii) are
market makers or risk managers in a commodity. Section 1a(11)(B) of
the Act expands the ECE definition to include certain other ECPs
that: (i) Regularly trade the commodity or its derivatives and (ii)
meet certain sophistication and/or financial requirements.
    \2\ Section 1a(14) defines the term ``exempt commodity'' to mean
a commodity that is not an excluded commodity or an agricultural
commodity. Section 1a(13) defines the term ``excluded commodity'' to
mean, among other things, an interest rate, exchange rate, currency,
credit risk or measure, debt instrument, measure of inflation, or
other macroeconomics index or measure. Although the term
``agricultural commodity'' is not defined in the Act, section 1a(4)
enumerates several agricultural-based commodities and products.
Commodities that fall into the exempt category include energy and
metals products.
    \3\ Under section 2(h)(3), ECMs are markets that limit
themselves to transactions: (1) In exempt commodities; (2) entered
into on a principal-to-principal basis by ECEs; and (3) executed or
traded on an electronic trading facility. As defined in section
1a(33)(A) of the Act, the term `trading facility' generally means
``a person or group of persons that constitutes, maintains, or
provides a physical or electronic facility or system in which
multiple participants have the ability to execute or trade
agreements, contracts, or transactions by accepting bids and offers
made by other participants that are open to multiple participants in
the facility or system.'' An ECM is not a registered entity, but is
required to notify the Commission of its intention to operate an
electronic trading facility in reliance on the exemption set forth
in section 2(h)(3). The notification of operation as an ECM must
include several certifications and, pursuant to Commission
Regulation 36.3(c)(3), a representation by the ECM that it will
require each participant to comply with all applicable law and that
it has a reasonable basis for believing that authorized participants
are ECEs. Although transactions entered into on ECMs are generally
exempt from regulation under the Act, the Commission retains anti-
fraud and anti-manipulation authority over these transactions.
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    Specifically, section 1a(11)(C) provides that the list of entities
defined as ECEs shall include ``such other persons as the Commission
shall determine appropriate and shall designate by rule, regulation, or
order.'' The Commission determined to expand ECE eligibility on one
previous occasion when, by order dated January 9, 2003,\4\ it deemed
floor brokers and floor traders who are registered with the Commission,
when acting in a proprietary trading capacity, to be ECEs, subject to
certain conditions.\5\ A further determination under section 1a(11)(C)
that IPE brokers and IPE local traders be considered ECEs would permit
the IPE brokers and IPE local traders to enter into transactions in
exempt commodities on ECMs, including the Intercontinental ECM.\6\
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    \4\ See 68 FR 2319. This order responded to petitions received
from the New York Mercantile Exchange, Inc. (``NYMEX'') and
Intercontinental. See 67 FR 41698. Intercontinental's petition of
June 3, 2002, included a request that the Commission expand the ECE
definition to floor brokers and floor traders authorized by the FSA.
On November 1, 2002, Intercontinental advised the Commission staff
that it had decided not to seek relief for non-U.S. floor brokers
and floor traders at that time. Intercontinental's current petition
is similar to its petition of June 3, 2002, but the parties for
which relief is requested differ slightly. See discussion infra,
Section II.A.
    \5\ Under the Commission's order, subject to certain conditions
set forth in the order, registered floor brokers and floor traders,
when acting for their own accounts, are permitted to enter into
transactions in exempt commodities on ECMs pursuant to section
2(h)(3) of the Act. In order to participate, the floor broker or
floor trader must either be an ECP as that term is defined in
section 1a(12) of the Act, or have its trades on the ECM guaranteed
by a clearing member that is both a member of a CFTC-registered
derivatives clearing organization and is an ECP.
    \6\ Intercontinental operates a commodities trading platform for
energy and metals (the ``Intercontinental electronic platform'') and
is itself an ECM. Intercontinental submitted its notice of operation
as an ECM to the Commission on December 27, 2001. Intercontinental
Exchange also owns IPE, a U.K. futures exchange that trades energy
futures products. The Intercontinental electronic platform is used
by IPE for its electronic trading system.
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II. The Intercontinental Petition

    By letter dated February 9, 2004, Intercontinental requested that
the Commission issue an order pursuant to Section 1a(11) of the Act
that would expand the ECE category to include IPE brokers and IPE local
traders. Intercontinental stated that including IPE brokers and IPE
local traders as ECEs would be consistent with the CFMA and would
recognize their value as both liquidity providers and market makers.

A. Requested Relief

    In its petition, Intercontinental proposed that the following be
included in the definition of ECE for trading on ECMs:
    (i) IPE Brokers\7\ that (a) Are firms located in the U.S.; (b) are
authorized and regulated by the FSA; (c) are members of the IPE; (d)
have as a part of their business the business of acting as a broker
although the IPE broker need not have any connection or experience in
the underlying physical commodity, and (e) are ECPs or, if not an ECP,
its trades on the ECM are guaranteed by a clearing member of a U.K.
recognized clearing organization that is itself an ECP; and
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    \7\ IPE brokers would include: IPE Floor Members and General
Participants. General Participants may trade only on the electronic
trading system.
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    (ii) IPE local traders\8\ that: (a) Are located in the U.K.: (b)
are authorized by the FSA, if required by the Financial Services and
Markets Act 2000 (the ``FSMA''), or are outside the scope of the FSMA:
(c) are members of, or registered to, the IPE: (d) have as a part of
their business the business of acting as a local trader although the
IPE local trader need not have any connection or experience in the
underlying physical commodity; and (e) are ECPs or, if not an ECP,
their trades on the ECM are guaranteed by a clearing member of a U.K.
recognized clearing organization that is itself an ECP.\9\
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    \8\ IPE local traders would include: IPE Local Members and
Individual Participants. Individual Participants may trade only on
the electronic trading system.
    \9\ In its petition, Intercontinental pointed out that the
Commission order of January 16, 2003 recognized the fact that floor
brokers and floor traders are sophisticated market participiants who
are subject to a comprehensive regulatory scheme. Intercontinental
stated its belief that it would be appropriate for the Commission to
provide similar relief to IPE brokers and IPE local traders, as the
IPE brokers and IPE local traders satisfy similar criteria,
including having their trades guaranteed by a clearing member of a
recognized clearing organization. In the case of IPE brokers or IPE
local traders, the clearing member providing a guarantee of
financial performance of the contracts is authorized by the FSA.
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    In its petition, Intercontinental commented that the Commission had
previously issued an order expanding the definition of ECE to include
persons registered under the CEA as floor brokers and floor traders
when acting in a proprietary trading capacity.\10\ Intercontinental
states that trading on the IPE is conducted on a principal-to-

[[Page 13288]]

principal basis\11\ and the IPE brokers and IPE local traders satisfy
similar criteria to the floor brokers and floor traders included in the
Commission's earlier order. The petition also contends that its
requested relief is a logical and appropriate extension of the
Commission's earlier order, as the individuals for which
Intercontinental requests relief (a) Are professionals regulated by the
FSA and/or IPE; (b) regularly trade on the IPE as part of their
business; and (c) would utilize ECMs in connection with their trading
activities. Intercontinental's petition states, moreover, that the ECE
definition should include IPE brokers and IPE local traders because,
from a policy perspective, it is no longer meaningful to differentiate
between electronic and floor trading.\12\
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    \10\ See In the Matter of the New York Mercantile Exchange, Inc.
and the Intercontinental Exchange, Inc., 68 FR 2319 (Jan. 16, 2003).
At that time, the Commission stated that its action [expanding the
definition of ECE to include CFTC-registered floor brokers and floor
traders subject to certain conditions] was consistent with the
purposes of the CFMA and would provide floor brokers and floor
traders access to a wider range of products and expand the pool of
potential counterparties for ECM participants. Id. at 2323. The
Commission also pointed out that its action could potentially
increase competition and efficiency and reduce liquidity risk on
ECMs. According to the Commission, the trading expertise that floor
brokers and floor traders would bring to the ECM would be applicable
to trading in any commodity product being traded, while the
requirement that either the floor broker or floor trader or the
guarantor of the trades must be an ECP would provide sufficient
financial backing for the floor broker or floor trader and would
mitigate any credit or collection risk that might otherwise arise in
the execution of trades by a floor broker or floor trader. Id.
    \11\ CEA Section 2(h)(3) requires that trading on an ECM must be
entered into on a principal-to-principal basis. See supra note 3.
    \12\ Like NYMEX, IPE offers both floor and electronic trading.
IPE uses the Intercontinental electronic trading platform for the
trading of IPE products (the ``IPE electronic platform''). See supra
note 6. In its current petition, Intercontinental is requesting
relief for both IPE members that trade only on the IPE electronic
platform, and for those members that trade on the floor as well as
the IPE electronic platform. This request differs somewhat from the
relief granted by the Commission in its order of January 16, 2003,
as that relief applied only to registered floor brokers and floor
traders, and not to traders that trade only on electronic trading
systems.
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    Intercontinental states that, IPE, as a U.K. Registered Investment
Exchange (``RIE''),\13\ must, among other things, limit access to
persons: (i) Over whom the RIE can, with reasonable certainty, enforce
its rules contractually; (ii) who have sufficient technical competence
to use the RIE's facilities; (iii) whom it is appropriate to admit to
membership, taking into account the size and sophistication of users of
the RIE's facilities and the nature of the business effected by means
of, or cleared through, its facilities; and (if appropriate) (iv) who
have adequate financial resources in relation to their exposure to the
U.K. RIE or its central counterparty.
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    \13\ RIEs are regulated by the FSA under Part XVIII of the FSMA.
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    According to the background information provided by
Intercontinental, IPE members are required to sign an agreement
prescribed by IPE's directors in which they agree to be bound by the
IPE's regulations. Moreover, IPE members may only engage in trading
IPE's electronic trading platform to the extent that they are either
authorized to do so pursuant to U.K. law, or are exempt from the
authorization requirement.

B. IPE Brokers

    The petition states that the ECE definition should include IPE
brokers that are located in the U.K. As described in its petition, IPE
brokers are firms that are members of IPE. The firms are able to
transact business on their own behalf or on behalf of clients.\14\ When
the firm acts on behalf of clients its activities fall within the scope
of the FSMA; where such firm is located in the U.K., it will be
authorized and registered with the FSA. The conduct of business on IPE
is governed by both the rules of the exchange and the relevant FSA
conduct of business rules.
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    \14\ While the IPE brokers may transact business on behalf of
clients on IPE, trading on an ECM is required to be on a principal-
to-principal basis. Section 2(h)(3) of the Act. See supra notes 10-
11 and accompanying text. See also the Commission's order of January
9, 2003 (68 FR 2319), at 2324 (deeming that floor brokers and floor
traders registered with the Commission, when acting in a proprietary
trading capacity, would be appropriate persons as defined in CEA
section 1a(11)(C)).
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    According to the petition, the U.K. regulatory regime establishes
extensive authorization standards for brokers, imposing a regulatory
scheme that is comparable to the U.S. regulatory scheme. Therefore,
allowing floor and electronic brokers who are authorized by the FSA to
trade on the Platform as ECEs would be consistent, according to the
petition, with the approach taken by the Commission in granting part 30
relief to firms located in the U.K. that are authorized and regulated
by the FSA.
    For example, as described in the petition, to become a broker at
IPE,\15\ the broker must be able to demonstrate that it, among other
things: is a clearing member or has become a party to a clearing
agreement; has adequate arrangements to ensure that its employees,
agents and representatives acting on its behalf or in its name are fit
and proper and adequately trained and properly supervised; has adequate
internal recordkeeping; has well-defined procedures for ensuring
compliance with the regulations; maintains minimum financial standards;
and has the appropriate licenses, authorizations and consents or
benefits from available exclusions under the FSMA to act in the
appropriate capacity.
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    \15\ As indicated above, the term IPE broker includes both IPE
Floor Members and General Participants. The requirements to be an
IPE Floor Member differs slightly from the requirements to be an IPE
General Participant, as described in the petition. For example, IPE
General Participants must be party to a Platform User Agreement.
Moreover, while an IPE Floor Member must ensure that it has adequate
arrangements to ensure that its staff and directors are fit and
proper, adequately trained and properly supervised, an IPE General
Participant member must also be able to demonstrate, to the
satisfaction of the IPE, that it has adequate arrangements to also
ensure that its agents and representatives are fit and proper,
adequately trained and properly supervised. According to IPE, as an
affiliate of a member firm has the capability to register one of its
employees as a Responsible Individual (see infra note 16) of an IPE
member, IPE has extended this requirement to include agents and
representatives. The IPE members are asked to take responsibility
for this requirement as if the employee of the affiliate was the
member's employee.
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    The petition notes that persons who perform ``controlled
functions'' (either investment advisor or customer trading functions)
for FSA authorized firms would be ``approved'' by the FSA and would be
required to comply with a set of principles. All traders employed by
IPE brokers will be registered with the FSA as approved persons linked
to that broker. On the trading floor of the IPE, IPE brokers would be
represented by a number of individual traders.
    In order to trade IPE products on the IPE electronic trading
platform, a member must register at least one ``Responsible
Individual.'' A Responsible Individual is responsible for all business
conducted under his individual trading mnemonic(s) and must ensure to
the best of his ability that the business is conducted in compliance
with the IPE regulations and other appropriate regulatory
requirements.\16\ Ultimate responsibility, however, will still lie with
the IPE member. The individual traders that trade for IPE brokers on
IPE's electronic trading platform will either themselves be registered
with the IPE as a Responsible Individual, or will operate under the
individual trader mnemonic provider to another Responsible Individual
within that firm.\17\
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    \16\ A member may, at the IPE's discretion, register as many
Responsible Individuals as the member feels necessary according to
the nature and scale of its business. The Responsible Individual
may, at the IPE's discretion, be assigned more than one individual
trader mnemonic in order to conduct separate lines of business. IPE
does not currently permit an RI to be registered across two
companies, preferring to deregister them from one company before
registering them against another company.
    \17\ A Responsible Individual must be contactable by the IPE
while his individual trader mnemonic(s) is in use. Certain
requirements have to be met when registering a Responsible
Individual (including completion of the Responsible Individual
Tutorial--an online tutorial and examination--to the member's
satisfaction) and a declaration from the member's compliance officer
or other senior management that they are satisfied that the
applicant has met the requirements.
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C. IPE Local Traders

    The petition states that the ECE definition should include local
traders (IPE local traders) who are located in the U.K. IPE local
traders are outside the scope of FSA regulation, but are

[[Page 13289]]

members of, or registered with, IPE, a U.K. recognized investment
exchange.\18\
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    \18\ According to the petition, a subset of local traders, known
as ``Local Tenants,'' lease their trading seats from a local member.
In this situation, the Local Tenant would need to meet the criteria
for IPE membership, but would technically only be registered with
the IPE rather than being a member.
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    Intercontinental maintains that IPE's standards ensure that, like
U.S. floor brokers and floor traders, IPE local traders have expertise
in trading in commodity markets and are sophisticated and capable
counterparties to trades. According to Intercontinental, IPE monitors
the IPE activities of IPE local traders and has the authority to
sanction them in the event of improper conduct.\19\ In its petition,
Intercontinental states that IPE provides such extensive authorization
standards for IPE local traders that there should be little concern
about permitting these parties to trade on the Intercontinental ECM.
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    \19\ IPE would not monitor the trading activities of IPE members
on the Intercontinental ECM.
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    As described in the petition, to become an IPE local trader, an
applicant must be able to demonstrate that the trader, among other
things: \20\ is fit and proper; registered with the IPE; meets any
minimum financial requirements; and is, or will become, a party to a
clearing agreement. In order to trade on the IPE electronic platform,
an applicant for Individual Participant status also must be registered
with the IPE as a Responsible Individual.\21\
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    \20\ As indicated above, the term IPE local trader includes both
IPE Local Members and Individual Participants. The requirements to
be an IPE Local Member differs slightly from the requirements to be
an IPE Individual Participant, as described in the petition. For
example, IPE Individual Participants must be party to a Platform
User Agreement. Also, while both must register with the IPE, the IPE
Local Member must have passed the Registered Floor Trader (RFT)
examination, while the IPE requires the IPE Individual Participant
to be adequately trained.
    \21\ See supra notes 15-16 and accompanying text.
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III. Request for Comment

    The Commission generally invites public comment on the
Intercontinental petition and on whether the Commission should
determine that IPE brokers and IPE local traders are ECEs and,
therefore, permitted to enter into proprietary transactions in exempt
commodities on ECMs. Specifically, the Commission requests comment on
whether it should expand the ECE definition to include (1) IPE brokers
(IPE Floor Members and General Participants) that: (a) Are firms
located in the U.K.; (b) are authorized and regulated by the FSA; (c)
are members of the IPE; (d) have as a part of its business the business
of acting as a broker, although the IPE broker need not have any
connection or experience in the underlying physical commodity; and (e)
are ECPs or, if not an ECP, its trades on the ECM are guaranteed by a
clearing member of a U.K. recognized clearing organization that is
itself an ECP; and (2) IPE local traders (IPE Local Members and
Individuals Participants) that: (a) Are located in the U.K.; (b) are
authorized by the FSA if required by the FSMA, or are outside the scope
of the FSMA; (c) members of, or registered with, the IPE; (d) have as a
part of their business the business of acting as a local trader,
although the IPE local trader need not have any connection or
experience in the underlying physical commodity; and (e) are ECPs or,
if not an ECP, its trades on the ECM are guaranteed by a clearing
member of a U.K. recognized clearing organization that it itself an
ECP.
    The Commission also invites public comment on what conditions
should be applied in the event of such a determination. In addition,
the Commission asks for comments with respect to whether any response
to the petitions should be tailored specifically to allow IPE members
meeting the conditions presented by the petition to trade on
Intercontinental, or whether a response should be more broadly based
and, thus, allow such IPE members to trade on other ECMs.
    The Commission invites public comment, moreover, on
Intercontinental's request for relief not only for those IPE members
that trade on the floor as well as the IPE electronic platform, but
also for those IPE members that trade only on IPE's electronic
platform. This request differs somewhat from the relief granted by the
Commission in its order of January 16, 2003, as that relief applied
only to registered floor brokers and floor traders, and not to traders
that trade only on electronic trading systems. According to
Intercontinental, the ECE definition should include IPE brokers and IPE
local traders because, from a policy perspective, it is no longer
meaningful to differentiate between electronic and floor trading.
    Finally, the Commission particularly requests comment on
Intercontinental's requests for ECE treatment for IPE authorized local
traders. The Commission notes that, unlike IPE brokers (and unlike the
floor locals and floor traders deemed to be ECEs by the Commission's
order of January 9, 2003, subject to certain conditions),\22\ the IPE
local traders are not registrants of a governmental regulatory body,
but are members of or registered with the IPE. Intercontinental's
petition broadly describes the qualification requirements that such IPE
local traders are subject to under IPE regulation. The Commission seeks
general comment on whether ECE treatment should be extended to non-U.S.
traders that are sophisticated market professionals, are authorized by
a non-U.S. exchange, regularly trade on the non-U.S. exchange, are
guaranteed by a clearing member of a clearing organization not
registered by the Commission, but are not registrants under the
oversight of a national regulatory body comparable to the Commission
and, if so, what standards the Commission should use to evaluate the
qualifications of such persons.
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    \22\ See supra note 5.

    Issued in Washington, DC, on March 16, 2004, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 04-6234 Filed 3-19-04; 8:45 am]

BILLING CODE 6351-01-M
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