Received CFTC 

Record' Section 

tl/1~/Jr ICe i\t!anta C31gary Chicago Houston London New York Singapore 

November 6, 2009 

Mr. David Stawick 

Secretary 

Commodity Futures Trading Commission 

1155 2151 Street, NW 

Washington, DC 20581 

COMMENT 

RE: Determination whether the Northwest Pipeline Corporation-Rockies contract 

serves a Significant Price Discovery Function 

Dear Mr. Stawick: 

IntercontinentalExchange, Inc. ("ICE") welcomes the opportunity to comment on 

the Commodity Futures Trading Commission's ("CFTC" or "Commission") notice of 

intent ("notice") to determine whether the Northwest Pipeline Corporation-Rockies 

basis swap ("NWR") serves a significant price discovery function. 

ICE believes that this contract does not serve a significant price discovery 

function, as described herein, and that the Commission may exceed its jurisdiction if it 

determines that this contract serves as a significant price discovery contract ("SPDC"). 

In addition to the absence of minimum liquidity thresholds, the inability of a basis swap 

to affect pricing on a designated contract market and the lack of a material price reference 

precludes this contract from playing a significant price discovery role. 

Background 

In 2000, the Commodity Futures Modernization Act ("CFMA") created a system 

of tiered regulation to replace a "one size fits all" regulatory scheme. As part ofthe 

tiered regulatory scheme, Congress created exempt commercial markets ("ECMs"), 

which are principle to principle electronic trading platforms that serve sophisticated 

market participants. ECMs were designed to encourage electronic trading of derivatives. 

Given the sophisticated status of the participants, ECMs were subject to light touch 

regulation by the CFTC. The CFTC Reauthorization Act of2008 1 expanded the CFTC's 

authority over ECMs that list contracts that serve a significant price discovery function. 

Congress directed the Commission to consider five criteria when making the significant 

price discovery determination: (1) Price Linkage; (2) Arbitrage; (3) Material Price 

Reference; (4) Material Liquidity; and (5) Other Factors. It is important to note that 

Congress gave the CFTC this authority over ECMs to capture two types of contracts: (1) 

contracts that trade with enough volume to impact trading on a designated contract 

Title XIII of the Food, Conservation and Energy Act of2008, Pub. L. No. 110-246, 122 Stat. 

1623 (June 18, 2008). 

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market ("DCM"); or (2) contracts that trade with enough volume to be quoted as an 

independent price reference by the public. 2 It is clear that - by giving the CFTC tailored 

authority- Congress intended to keep the CFMA's tiered regulatory structure. Further, as 

stated by the CFTC in it's 2007 Report on the Oversight ofTrading on Regulated Futures 

Exchanges and Exempt Commercial Markets: "[t]he Commission believes that the CEA's 

current level of regulation is appropriate for ECM contracts relying on the §2(h)(3) 

exemption when trading volume remains low and prices are not significantly relied upon 

by other markets. "

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It is against this backdrop that the Commission makes its determination whether 

the NWR contract serves a significant price discovery function. 

The Northwest Pipeline Corporation--Rockies Basis Swap 

As background, the natural gas industry in the United States relies on system of 

pipelines to deliver gas to consumers across the country. The largest interconnection of 

pipelines is at the Henry Hub in Erath, Louisiana, where nine interstate pipelines and four 

intrastate pipelines converge.4 As the largest hub for natural gas, the Henry Hub price of 

natural gas serves as the basis for the price of natural gas in North America. 

While the Henry Hub price of natural gas is influential in determining the price of 

natural gas across the country, local prices of natural gas vary significantly. Factors such 

as pipeline capacity, storage costs, location-specific demand characteristics and 

transmission costs affect the local price of natural gas and contribute to the difference 

between the local price and the price of natural gas at the Henry Hub.5 Basis contracts 

arose to give traders the ability to hedge against this price differential, but do not set the 

price of natural gas at either Henry Hub or the location. 

The NWR contract specified in the CFTC's notice of intent is comprised oftwo 

components: (1) an index of physical natural gas trades at the Northwest Pipeline 

Corporation, Rockies point, as compiled by Platts; and (2) the price of the Henry Hub 

LDl contract traded at the Chicago Mercantile Exchange/New York Mercantile 

Exchange. The basis price is the differential between these two prices. 

2 The Joint Explanatory Statement of the Committee of Agriculture Conference, H.R. Rep. No. 1110 627, 

110 Cong., 2"d Sess. at 978-86 (2008). 3 Commodity Futures Trading Commission, Report of the Oversight ofTrading on Regulated Futures 

Exchanges and Exempt Commercial Markets (October 2007) 4 http://www.sabinepipeline.com/Home/tabid/2/Defau1t.aspx# 5 Energy Information Administration, Derivatives and Risk Management in the Petroleum, Natural Gas, 

and Electricity Industries (October 2002). 

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The CFTC's Analysis 

The CFTC believes that the NWR contract could potentially serve a significant 

price discovery function based upon three factors: (1) material liquidity; (2) material 

price reference; and (3) price linkage. ICE does not believe that the NWR contract meets 

any of these tests. 

Material Liquidity 

To prove material liquidity, the Commission needs to determine that the contract 

traded on the ECM must trade with sufficient volume "to have a material effect on other 

agreements, contracts, or transactions listed for trading ... on a designated contract 

market" or ECM. The Commission has issued guidelines stating "liquidity is a broad 

concept that captures the ability to transact immediately with little or no price 

concession". Further, "in markets where material liquidity exists, a more or less 

continuous stream of prices can be observed and the prices should be similar," for 

example, "a market where trades occur multiple times per minute".6 Finally, as Congress 

mandated in the Farm Bill, "the Commission should not make a determination that an 

agreement, contract, or transaction performs a significant price discovery function on the 

basis of the price linkage factor unless the agreement, contract, or transaction has 

sufficient volume to impact other regulated contracts or to become an independent price 

reference or benchmark that is regularly utilized by the public."7 

In the notice of intent, the CFTC 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. This arbitrarily low threshold is appropriate for reporting 

purposes as it captures nearly every ECM contract, but it is at odds with Congress's intent 

that the CFTC include "material liquidity" in its requirements for significant price 

discovery. If the CFTC has decided to abandon its rulemaking on Significant Price 

Discovery Contracts, then it should, at the very least, propose revisions Part 36 in order to 

allow the public to comment on whether the CFTC's new threshold meets Congress' 

intent in promulgating the Significant Price Discovery Test of the Farm Bill. 

Moreover, the statistics have been misinterpreted and misapplied. First,. these 

trades-per-day statistics requested by the CFTC and provided by ICE include transactions 

that were not even executed on the ICE 2(h)(3) platform and therefore make no 

contribution to price discovery. Rather, these transactions were executed via voice 

brokers in the over the counter market and submitted to ICE sometime after-the-fact 

6 Appendix A to Part 36, 17 C.F .R. 36 (2009). 7 Title XIII of the Food, Conservation and Energy Act of2008, Pub. L. No. 110-246, 122 Stat. 1624 (June 

18, 2008). 

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solely for clearing purposes. For the NWR basis swap, only about 79% of all trades were 

actually executed on the ICE platform. However, volume in Mlv!Btu 's, rather than 

number of trades, is a much more meaningful indicator of actual liquidity and therefore 

price discovery. In deciding whether or not to participate in a market, traders consider 

volume, not number of trades. On a volume-basis, only about 60% of all NWR volume 

was actually executed on the ICE platform. 

Second, the CFTC's figures, as requested of and provided by ICE, include trades 

made in all 120 months of each contract. Furthermore, some of the trades were executed 

in seasonal (summer or winter) or calendar year strips that trade separately from and in 

addition to the contract months. The more appropriate method of determining liquidity is 

to examine the activity in a single traded month or strip of a given contract. The merit of 

this argument is obvious when you consider that liquidity in a January contract is of no 

help to a trader who needs to liquidate an October position. For the NWR basis swap, 

only 28% of the trades actually executed on the ICE platform occurred in the single most 

liquid, usually prompt, month of the contract. However, again, from the more important 

volume-standpoint, only 16% of all NWR volume actually executed on the ICE platform 

occurred in the single most liquid, usually prompt, month of the contract. 

The trades-per-day statistics used by the CFTC must be adjusted for both of the 

factors described above before even considering whether or not a "more or less 

continuous steam of prices" can be observed. According to the statistics cited by the 

CFTC, the NWR basis swap traded an average of 126 times per day, but only 22% (79% 

x 28%) of these trades (and an even lower 10% oftotal volume) were actually executed 

on the ICE platform in the single most liquid, usually prompt, month of the contract. 

Given an eight hour trading day8

, this means that the NWR basis swap traded only about 

once every 16 minutes across all months. Clearly, such a low level ofliquidity does not 

represent an "ability to transact immediately" or "a more or less continuous stream of 

prices" and certainly not "a market where trades occur multiple times per minute." In 

comparison, the single most liquid, usually prompt, month ofthe ICE Henry Hub LD1 

natural gas contract traded, on average, over 4,000 times per day on the ICE platform 

alone. 

In conclusion, it is clear that the NWR contract does not meet the material 

liquidity standard as contemplated by Congress or the CFTC in its SPDC rulemaking. 

Material Price Reference 

The second basis for the Commission's determination is that the NWR contract 

serves as a material price reference. In this determination, Congress instructed the 

8 Note that ICE's OTC markets are actually open 22 hours. 

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Commission to consider "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, the prices generated" by the ECM. The Commission elaborates on this by 

saying that it will rely on one of two sources of evidence, direct or indirect, that the 

contract is a material price reference. A direct reference would be whether the cash 

market quotes the ECM contract. An indirect reference would be whether an industry 

publication quotes the ECM's contract's price. 

For the NWR contract, the CFTC relies on one reason for material price 

reference: ( 1) that "the Commission's ECM study, in general, stated that certain market 

participants referred to ICE as a price discovery market for certain natural gas contracts." 

This argument is nearly impossible to respond to as the ECM report did not mention 

these contracts as a potential significant price discovery contract, instead focusing 

exclusively on the Henry Hub LDl natural gas swap. It is impossible to say which 

market participants made this statement in 2007 or the contracts that were referenced, or 

whether the participants distinguish "price transparency" from the legal meaning of 

"price discovery". Congress, in promulgating the Farm Bill, ordered the CFTC to 

undertake a very important analysis of the OTC energy markets. Basing a material price 

reference determination on general statements made in a two year old study does not 

meet Congress' intent that the CFTC use its considerable expertise to study the OTC 

markets. Moreover, this ephemeral analysis does not allow the public to comment 

effectively. 

Price Linkage 

The third basis for the CFTC's determination that NWR is a significant price 

discovery contracts is that it is price linked to the NYMEX/CME natural gas futures 

contract (NG). As stated above, Congress instructed that the "Commission should not 

make a determination that an agreement, contract, or transaction performs a significant 

price discovery function on the basis of the price linkage factor unless the agreement, 

contract, or transaction has sufficient volume to impact other regulated contracts." The 

notice of intent implies that any price linkage is significant, even if it does not affect price 

discovery on a DCM. This analysis misses Congress' intent in promulgating the 

significant price discovery legislation. The intent, plainly stated above, was to capture 

contracts that could affect price discovery on a DCM. A basis swap uses the NG price 

only as a reference to create the basis price. As an analogy, implying price linkage on a 

basis swap is akin to stating that the price at a local pump in Mississippi affects the global 

price of crude oil. Further, using the CFTC's interpretation of price linkage, given that 

the NWR is priced in dollars, then the NWR contract could be "price linked" to a U.S. 

Dollar futures contract traded on a DCM. This is not a rational result or Congress' intent. 

In addition, this contract trades on screen only a few times per day, so it is hard to see 

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how it affects price discovery in the NG contract. In summary, the NWR contract settles 

on a reference price that is established by an index provider and is not determined by the 

ECM or any other DCM as required under the SPDC guidelines. 

Conclusion 

Based on the failure to meet virtually all of the criteria for SPDC determination, it 

is clear that the NWR does not serve as a material price reference or trade with material 

liquidity. Further, the NWR can not be price linked to a designated contract market. 

Therefore, the Commission should not deem this contract as a significant price discovery 

contract. Congress ordered the Commission to review the electronic OTC markets for 

contracts that serve a significant price discovery function. Overreaching in this process 

could force OTC trading back to the opaque voice brokered markets. It is important for 

the Commission to remember that Exempt Commercial Markets perform a very 

important function in bringing transparency and credit intermediation to the OTC 

markets, and should not be disadvantaged relative to the opaque, off-exchange markets 

where no such requirements exist. 

Thank you for the opportunity to comment. 

Sincerely, 

R. Trabue Bland 

Director of Regulatory Affairs 

Assistant General Counsel 

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