Written Statement of 

Dr. James Newsome, CEO 

New York Mercantile Exchange, Inc. 

Commodity Futures Trading Commission 

Public Hearing on Exempt Commercial Markets 

September 18, 2007 

Acting Chairman Lukken and other CFTC commissioners, my name is Jim 

Newsome and I am the President and Chief Executive Officer of the New York 

Mercantile Exchange, Inc. (NYMEX or Exchange). NYMEX is the world’s largest forum 

for trading and clearing physical-commodity based futures contracts, including energy 

and metals products, and has been in the business for more than 135 years. NYMEX 

is a federally chartered marketplace, fully regulated by the CFTC both as a “derivatives 

clearing organization” (DCO) and as a “designated contract market” (DCM). These 

categories were established by the Commodity Futures Modernization Act of 2000 

(CFMA), which was enacted by Congress in December 2000. 

On behalf of the Exchange, its Board of Directors and shareholders, I want to 

express our appreciation to the CFTC for holding this public hearing on exempt 

commercial markets (ECM). Over the last several months, the role of ECMs has 

received a lot of attention on Capitol Hill and elsewhere. During this period, NYMEX has 

observed a broad and growing consensus that certain products traded on ECMs and 

DCMs are tightly linked and effectively result in one broader market. Consequently, 

NYMEX, along with some legislators and regulators, have concluded that there is a need 

for appropriate statutory change to provide effective regulatory oversight of markets that 

are of critical importance to U.S. consumers and to the overall economy. The debate 

over the changes in the marketplace is now largely settled. The real question becomes 
the appropriate statutory response, and NYMEX believes that the hearing today is quite 

timely and can provide a real public service on this important policy question. 

Overview 

NYMEX believes that, in general, the CFMA has been an outstanding success. 

The Exchange further believes that the tiered statutory structure for trading facilities has 

been effective in many respects. However, a series of profound changes have occurred 

in various OTC markets since the passage of the CFMA, including technological 

advances in trading, such that the regulated DCM, NYMEX, and the unregulated ECM, 

Intercontinental Exchange (ICE), have become highly linked trading venues. As a result 

of this phenomenon, which could not have been reasonably predicted only a few short 

years ago, the current statutory structure no longer works for certain markets now 

operating as ECMs. Specifically, the regulatory disparity between the NYMEX and 

certain ECMs, particularly the ICE, which are functionally equivalent to each other, has 

created serious challenges for the CFTC and for NYMEX in its capacity as a selfregulatory organization. NYMEX has also concluded that ECMs such as ICE, which 

function more like a traditional exchange and which are linked to an established 

exchange, should be subject to regulation of the CFTC for certain products in the form of 

large trader reporting, position limits/accountability levels and self-regulatory 

responsibilities. 

In addition, the continuing exchange-like aggregation and mutualization of risk at 

the clearinghouse level from trading on active ECMs such as ICE, where large positions 

are not monitored, raise concerns about spill-over or ripple implications for other clearing 

members and for various clearing organizations that share common clearing members. 

Consequently, legislative change is necessary to address the real public interest 

concerns created by the current structure of the over-the-counter (OTC) electronic gas 

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market and the potential for systemic financial risk from a market crisis involving 

significant activity occurring on the unregulated trading venue. 

Statutory Review

The CFMA provided greater legal certainty for OTC derivatives transactions, and 

established a number of new statutory categories for trading facilities. It shifted away 

from a “one-size-fits-all” prescriptive approach to futures exchange regulation to a more 

flexible approach that included the use of core principles for DCMs and that confirmed 

the CFTC’s role as an oversight agency (rather than a “command and control” agency 

that must issue affirmative approval before any new innovations could be introduced to

the market). 

The CFMA also added new section 2(h) to the Commodity Exchange Act (CEA), 

which exempted energy commodities from CFTC regulation and allowed the trading of 

energy swaps on an electronic trading platform. Under CFTC rules, these platforms are 

known as “Exempt Commercial Markets” (ECM). While transactions executed on an 

ECM generally are subject to anti-fraud and anti-manipulation authority, the ECM itself is 

essentially exempt from all substantive CFTC regulation and oversight. In addition, the 

ECM by statute has no affirmative requirements to engage in any self-regulatory 

activities to monitor its markets or otherwise seek to prevent any manner of market 

abuses. 

As a note, the CFMA was enacted following the issuance of a report by the 

President’s Working Group on Financial Markets (PWG) that was undertaken at the 

direction of Congress. Specifically, that study focused upon OTC derivatives markets 

and provided legislative recommendations to Congress. The PWG Report, entitled 

“Over-the-Counter Derivatives Markets and the Commodity Exchange Act,” was issued 

in 1999 and focused primarily on swaps and other OTC derivatives transactions 

executed between eligible participants. Among other things, the PWG Report 

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recommended exclusion from the CEA for swap transactions in financial products 

between eligible swap participants. Yet, the PWG Report explicitly noted that “[t]he 

exclusion should not extend to any swap agreement that involved a non-financial 

commodity with a finite supply.” (Report of the PWG, “Over-the-Counter Derivatives 

Markets and the Commodity Exchange Act” (November 1999) at p. 17.). However, in a 

footnote, the PWG stated that “[t]he CFTC would retain its current exemptive authority 

for swap agreements that involve a non-financial commodity with a finite supply.” (Id.). 

Section 2(h) was intended to provide legal certainty to energy swaps traded on or 

off a trading facility by clarifying that bilateral contracts, agreements or transactions in 

exempt commodities between eligible commercial entities were not subject to CFTC 

regulation, even if the contracts were cleared, but remained subject to the CFTC’s anti 

fraud and anti manipulation provisions. The CFTC implemented Section 2(h)(3) in Part 

36 of its regulations by creating the category of markets known as ECMs. 

NYMEX believes that the CFMA generally has been a major success. Moreover, 

the Exchange continues to be broadly supportive of the key components of that 

landmark legislation, including the provision of legal certainty for traditional bilateral OTC 

swaps executed between appropriate market participants. NYMEX also believes that

the tiered statutory approach to trading facilities has been effective in many respects. 

The tiered structure was intended to impose a degree of regulation necessary to the 

market place based on the product traded and the market participants. Thus, at the 

highest tier of regulation, the DCM category, 18 core principles apply on an ongoing 

basis and the market is open to all products and all market participants and trades are or 

can be intermediated. 

The DTEF is at the second tier and is subject to 9 core principles. The market 

generally can trade products that are highly unlikely to be susceptible to manipulation, 

and it is not open to all market participants. Under one version of the DTEF, market 

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participants must be eligible contract participants or trade through a registered FCM with 

net capital of at least $20,000,000. Under the other version of DTEF, participants are 

limited to eligible commercial entities. The DTEF category to date has not been utilized 

by the derivatives industry. 

The third market tier, for exempt markets, includes ECMs and Exempt Boards of 

Trade (EBOT). EBOTs generally are limited to excluded commodities and are 

unregulated. The ECM tier is open only to eligible commercial entities, trades products 

other than financial derivatives and agricultural commodities and also as a facility is 

completely unregulated. Transactions on the ECM are subject only to the CFTC’s 

antifraud and anti-manipulation authority. Approximately 18 entities have filed 

notification with the CFTC of their intention to operate as an ECM, and an additional six 

companies have filed notification of their intention to operate as an EBOT. 

 The ECM category was designed for commercial market participants who were 

in the business of making and taking delivery of the physical product, and who would be 

limited to engaging in principal-to-principal trading with each other. The exemption from 

effective CFTC oversight and regulation of the ECM trading facility built on the CFTC’s 

existing 1993 Energy Exemption for OTC bilateral energy swaps between commercial 

entities. There was a view at the time that there was not a public policy need to protect 

large commercial participants from transactions with other large and similarly situated

commercial entities. However, the large-scale exemption of ECMs from effective CFTC 

oversight did not contemplate that the trading activities of commercial players on such 

trading facilities would have spill-over or ripple effects on the broader energy markets 

and ultimately affect consumers. 

Subsequent to the passage of the CFMA in late 2000, derivatives markets, 

especially natural gas derivatives markets, evolved in just a few short years to an extent 

and at a rate that would have been very difficult to predict in 2000. When the CFTC was 

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in the midst of proposing and finalizing implementing regulations and interpretations for 

the CFMA in 2001, even shortly following the wake of the Enron meltdown in late 2001, 

the natural gas market, for example, continued to be largely focused upon open outcry 

trading executed on the regulated NYMEX trading venue. At that time, NYMEX offered 

electronic trading on an “after-hours” basis, which contributed only approximately 7-10% 

of overall trading volume at the Exchange. Electronic trading (of standardized products 

based upon NYMEX’s natural gas contracts) was at best a modest proportion of the 

overall market. Moreover, it was more than six months following the Enron meltdown 

before the industry began to offer clearing services for OTC natural gas transactions. 

But, in determining to compete with NYMEX, ICE, which as noted operates as an 

ECM, not only copied all of the relevant product terms of NYMEX’s core or flagship 

natural gas futures contract, but also misappropriated the NYMEX settlement price for 

daily and final settlement of its own contracts. As things stand today, natural gas market 

participants have the assurance that they can receive the benefits of obtaining NYMEX’s 

settlement price, which is now the established industry pricing benchmark, by engaging 

in trading either on NYMEX or on ICE. 

For some period of time following the launch of ICE as a market, ICE was the 

only trading platform that offered active electronic trading during daytime trading hours. 

In September of 2006, NYMEX began providing “side-by-side” trading of its products-- 

listing products for trading simultaneously on the trading floor and on the electronic 

screen. Since that time, there has been active daytime electronic trading of natural gas 

on both NYMEX and ICE. The share of electronic trading at NYMEX as a percentage of 

overall transaction volume has shifted dramatically to the extent that electronic trading 

now accounts for 80-85% of overall trading volume at the Exchange. 

The existence of daytime electronic trading on both NYMEX and ICE has fueled 

the growth of arbitrage trading between the two markets. Thus, for example, a number 

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of market participants that specialize in arbitrage activity have established computer 

programs that automatically trade the spread between the two markets and that transmit 

orders to one market when there is an apparent price imbalance with the other market or 

where one market is perceived to offer a better price than the other market. As a result, 

there is now a relatively consistent and tight spread in the prices of the competing 

natural gas products. Hence, the two competing trading venues are now tightly linked 

and highly interactive and in essence are simply two components of a broader 

derivatives market. As the CFTC itself acknowledged in its recent proposed rulemaking, there is now “a close relationship among transactions conducted on reporting 

markets and non-reporting transactions.” (72 Fed. Reg. 34, 413, at 34,414 (2007) 

(proposed June 22, 2007.) 

Because ICE price data are available only to market participants, NYMEX does 

not have the means to establish conclusively the extent to which trading of ICE natural 

gas swaps contributes to or influences or affects the price of the related natural gas 

contracts on NYMEX. However, what is clear is that, as a consequence of the extensive 

arbitrage activity between the two platforms and ICE’s use of NYMEX’s settlement price 

as well as other factors, the two natural gas trading venues are now tightly linked and 

highly interactive. These two trading venues serve the same economic functions and are 

now functionally equivalent to each other. NYMEX staff has been advised that, during 

most of the trading cycle of a listed futures contract month, there is a range of perhaps 

only five to twelve ticks separating the competing NYMEX and ICE products. (The 

NYMEX NG contract has a minimum price fluctuation or trading tick of $.001, or .01 

cents per mmBtu.) NYMEX staff has also been advised by market participants who 

trade on both markets that a rise (fall) in price on one trading venue will be followed 

almost immediately by a rise (fall) in price on the other trading venue. This may occur 

because prices rise first on ICE and then follow on NYMEX, or because prices rise first 

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on NYMEX and then follow on ICE. These observations of real-world market activity 

support the conclusion that trading of ICE natural gas swaps do in fact contribute to, 

influence and affect the price of the related natural gas contracts on NYMEX. No one 

could have predicted in 2000, when the exemption was crafted for energy swaps, how 

this market would evolve. 

The ICE market now has a significant market share of natural gas trading, and a 

number of observers have suggested that most of the natural gas trading in the ICE 

Henry Hub swap is subsequently cleared by the London Clearing House, the clearing 

organization contracted by ICE to provide clearing services. Thus, there is now a 

concentration of market activity and positions occurring on the ICE market, as well as 

the exchange-like concentration and mutualization of financial risk at the clearing house 

level from that activity. 

As previously noted, at the time that the CFMA was being formulated in 

Congress, the presumption was that larger, sophisticated market participants did not 

need a regulatory agency to protect them from trading with each other. Also, there 

obviously were no perceived concerns at that time about potential impact on the public 

interests implicated by trading on ECMs. Yet, what has become clear in the last several 

years is that the changing nature and role of ECM venues, such as ICE, do now trigger 

public interest concerns in several ways, including with respect to the multiple impacts 

on other trading venues that are regulated as well as through the exchange-like 

aggregation of financial risk. 

The CFMA, however, did contemplate the possibility of ECMs becoming price 

discovery markets and, accordingly gave the CFTC authority to make the determination 

that an ECM performed a significant price discovery function and to require the 

dissemination of prices, trading volume and other trading data. This authority has never 

been exercised despite the tremendous growth in the volume of trading in the natural 

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gas contract on ICE and the clear linkage between that market and the NYMEX. While 

the dissemination of market data from ICE would be useful, the CFTC’s existing 

statutory authority does not go far enough in order to address the significant regulatory 

problems identified by the Amaranth case. Thus, a legislative change is required to give 

the CFTC a certain level of authority over these markets as needed to address the 

identified public interest concerns. 

NYMEX does not have any ongoing formal relationship with ICE. In particular, 

as ICE and NYMEX are in competition with each other, there are currently no 

arrangements in place, such as information-sharing, to address market integrity issues. 

NYMEX as a DCM does have affirmative self-regulatory obligations; ICE as an ECM has 

no such duties. Yet, from a markets perspective, the ICE and NYMEX trading venues 

for natural gas are tightly linked and highly interactive; trading activity and price 

movement on one venue can quickly affect and influence price movement on the other 

venue. 

As one case example of concerns created for NYMEX as a DCM because of the 

differences in the level of regulation, NYMEX staff was aware of and monitored all open 

positions that Amaranth maintained in NYMEX trading venues, including the physically 

delivered NG natural gas futures contract. NYMEX conducted regular reviews of 

Amaranth’s open positions in excess of position accountability levels prescribed by 

NYMEX rule. NYMEX staff members directed Amaranth in early August 2006 to reduce 

its open positions in the first two nearby contract months based upon what they believed 

to be a significant concentration in NYMEX markets in Natural Gas (relying upon an NG 

“futures only” approach). NYMEX believes that such a directive was prudent and also

was effective with respect to reducing positions carried on our platform. NYMEX

maintains no information sharing agreement of any kind with ICE; the Exchange also 

observes that, during the period in question, the CFTC was not receiving any regular 

9
information from ICE as to positions on its platform. Thus, a shift of positions by 

Amaranth from NYMEX to ICE was undetectable at that time both by NYMEX and the 

CFTC. NYMEX believes that the outdated provisions of the CEA concerning ECMs do 

raise concerns not only for DCMS and for regulators but also for market participants and 

indeed for the general public as well.

It has become apparent to NYMEX that the broad structural issues raised by 

changes in the marketplace can not be addressed effectively at the level of individual 

exchanges. For example, earlier this year, in an effort to cooperate with the Federal 

Energy Regulatory Commission and following consultation with CFTC staff, NYMEX 

issued a compliance advisory in the form of a policy statement related to exemptions

from position limits in NYMEX Natural Gas (NG) futures contracts NYMEX adopted this 

new policy on an interim basis in a good faith effort to carry out its self-regulatory 

responsibilities and to address on an individual exchange level the market reality 

demonstrated by Amaranth’s trading on both regulated and unregulated markets. 

 However, this experience has had an adverse impact on NYMEX’s trading venues 

and is seemingly creating the result of shifting trading volume (during the critically 

important NG closing range period at NYMEX on the final day of trading) from our 

regulated trading venue to unregulated trading venues. Specifically, the new interim 

policy implemented by NYMEX on a good-faith basis has: 1) reduced volume on 

NYMEX during the critical 30-minute closing range period; 2) presumably shifted volume 

from the regulated to the unregulated trading venues; and 3) failed to solve the structural 

imbalances brought to light by Amaranth’s trading. In addition, this policy could create 

new problems by diminishing the vitality of the natural gas industry’s pricing benchmark. 

Consequently, NYMEX now believes strongly that legislative change is both necessary 

and appropriate. 

NYMEX believes that a targeted approach that directly addresses the specific 

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issues raised by these industry changes would be the most effective policy response 

and would provide the greatest assurance of limiting the unintended consequences of 

more sweeping or draconian changes. Thus, NYMEX believes that a heightened level of 

CFTC regulation and oversight should be mandated for certain products listed on a 

particular ECM triggering the public policy concerns noted above. NYMEX does not 

believe that the case has been made for extending such heightened regulation to other 

products listed on such an ECM, to other ECMs that have not triggered these policy 

interests and concerns, or to the traditional bilateral OTC market. 

In particular, for those products trading on ECMs that have triggered public policy 

interests and concerns, NYMEX believes that the CEA should be amended to require

routine mandated large trader reporting and position accountability requirements for 

financially settled ECM contracts that are highly linked to and functionally equivalent with 

regulated DCM contracts. Such ECMs also must be assigned self-regulatory 

organization duties to police their own markets and to submit applicable rule changes to 

the CFTC in a manner similar to other regulated entities. NYMEX believes strongly that 

such statutory changes are necessary and appropriate and would not negatively impact 

the core price discovery and hedging functions provided by derivatives markets. 

At present, the greatest attention has been focused upon energy products listed by 

ECMs. NYMEX does not believe it would be appropriate to exclude products by 

category from heightened regulation, as markets may evolve for other products, such as 

metals or weather derivatives, in a manner similar to the evolution of energy markets. 

On the other hand, the targeted approach that NYMEX recommends should not 

unduly affect the ability of ECMs to be sources of innovation, including with respect to 

the adoption of new trading technologies. This targeted approach may result in an ECM 

needing to distinguish on its electronic trading system those products that are subject to 

CFTC oversight from those products that remain exempt from CFTC regulation. 

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However, more generally, NYMEX’s recommended approach would not appear to 

require whole-sale changes in an ECM’s business model. Finally, it has been suggested 

in certain quarters that any manner of regulation of an ECM would lead immediately to 

the shift of trading elsewhere, either to the traditional bilateral OTC market or to lessregulated foreign boards of trade. NYMEX believes that this prospect is improbable for 

several reasons: 1) market participants will continue to be attracted to markets that offer 

pools of liquidity for trading in their products; 2) market participants appear to have a 

preference for the speed and efficiency of electronic trading as compared to the 

traditional phone bilateral market; and 3) electronic trading systems facilitate the clearing 

of traded products, which also seems to be the growing preference for OTC participants 

in a variety of products. Consequently, NYMEX believes that the hypothetical prospect 

of a worst-case scenario should not be misused to dissuade Congress or the CFTC from 

undertaking carefully considered and targeted solutions that can effectively fix the 

current shortcomings of the existing statutory structure. 

Conclusion 

NYMEX believes that the in general the CFMA has been an outstanding success. 

The Exchange further believes that the tiered statutory structure for trading facilities has 

been effective in many respects. However, a series of profound changes have occurred 

in various OTC markets since the passage of the CFMA, including technological 

advances in trading, such that the regulated DCM, NYMEX, and the unregulated ECM, 

Intercontinental Exchange, have become highly linked trading venues. As a result of this 

phenomenon, which could not have been reasonably predicted only a few short years 

ago, the current statutory structure no longer works for certain markets now operating as 

ECMs. 

Specifically, the regulatory disparity between the NYMEX and certain ECMs, 

particularly the ICE, which are functionally equivalent to each other, has created serious 

12
challenges for the CFTC and for NYMEX in its capacity as an SRO. NYMEX has also 

concluded that ECMs such as ICE, which function more like a traditional exchange and 

which are linked to an established exchange, should be subject to regulation of the 

CFTC for certain products in the form of large trader reporting, position 

limits/accountability levels and self-regulatory responsibilities. In addition, the continuing 

exchange-like aggregation and mutualization of risk at the clearinghouse level from 

trading on active ECMs such as ICE, where large positions are not monitored, raise 

concerns about spill-over or ripple implications for other clearing members and for 

various clearing organizations that share common clearing members. Consequently, 

legislative change is necessary to address the real public interest concerns created by

the current structure of the OTC electronic trading market and the potential for systemic 

financial risk from a market crisis involving significant activity occurring on the 

unregulated trading venue. 

I thank you for the opportunity to share the viewpoint of the New York Mercantile 

Exchange with you today. I will be happy to answer any questions that any 

commissioners may have. 

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