L tee 

Mr. David Stawick 

Secretary 

Received CFTC 

Recordj Section 

n{s- 01 

November 4, 2009 

Commodity Futures Trading Commission 

1155 21st Street, NW 

Washington, DC 20581 

C.f.T.C. 

OFFICE Of THE SECRETARiAT 

',<:GoP>'e 2609 N~U 5 ru'l•ll am 

RE: Detern1ination whether the Southern California Border Basis Swap serves a 

Significant Price Discovery Function 

Dear Mr. Stawick: COMMENT 

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 Southern California Border Basis Contract 

("SCL") 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 these contracts serve as a significant price discovery contracts ("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 

preclude this contract from serving 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 of the 

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 crite1ia 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 of 2008, 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 its 2007 Report on the Oversight of Trading 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."3 

It is against this backdrop that the Commission makes its detem1ination whether 

the SCL Basis Contract serves a significant price discovery function. 

The Southern California Basis Contract 

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 detennining 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 SCL contract specified in the CFTC's notice of intent is comprised oftwo 

components: ( 1) an index of physical natural gas trades compiled by Intelligence Press 

Inc.; and (2) the price of the Henry Hub LDl contract traded at the Chicago Mercantile 

Exchange/New York Mercantile Exchange. The basis p1ice is the differential between 

these two p1ices. 

2 The Joint Explanatory Statement of the Committee of Agriculture Conference, H.R. Rep. No. 1 I 10 627, 

110 Cong., 2nd 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/Default.aspx# 5 Energy Infom1ation 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 SCL basis 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 believes the SCL contract does not 

meet 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 "[l]iquidity 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 [Congress'?] rulemaking on 

Significant Price Discovery Contracts, then it should, at the very least, propose revisions 

to 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 Fann 

Bill. 

Moreover, the statistics [provided by ICE] have been misinterpreted and 

misapplied. First, the CFTC's figures include trades made in all 120 months of each 

contract. Furthennore, 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. 

6 Appendix A to Part 36, 17 C.F.R. 36 (2009). 7 Title XIII of the Food, Conservation and Energy Act of 2008, Pub. L. No. 110-246, 122 Stat. 1624 (June 

18, 2008). 

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TI1e more appropriate method of detennining 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 SCL basis swap, only about 29% of the trades 

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

Second, 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 solely for clearing purposes. For the SCL basis swap, only about 65% of 

the trades in the single most liquid, usually prompt, month of the contract were actually 

executed on the ICE platform. 

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 SCL basis swap traded an average of just 126 times per day, and only 19% 

{29% x 65%) of these trades were executed on the ICE platform in the single most liquid, 

usually prompt, month of the contract. Given an eight hour trading dal, this means that 

the SCL basis swap traded only once about every 20 minutes. 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 of the 

ICE Henry Hub LDI natural gas contract traded, on average, over 4,000 times per day on 

the ICE platform alone. 

In conclusion, it is clear that the SCL 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 SCL contract 

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

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 mate1ial price reference. A direct reference would be whether the cash 

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

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

publication quotes the ECM's contract's price. 

For the SCL contract, the CFTC relies on two reasons 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"9 

and (2) that ICE uses an exclusive index to determine one component of the basis swap. 10 

The first reason proposed by the CFTC has been used as a justification for nearly every 

notice of intent the CFTC has issued for significant price discovery contracts. This 

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

as a potential significant p1ice discovery contract. It is hard to say which market 

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

Congress, in promulgating the Fann 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 seem to meet 

Congress' intent that the CFTC use its considerable expettise to study the OTC markets. 

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

The second reason proposed by the CFTC is that ICE uses an exclusive index to 

determine the local price of the basis swap. Given that the CFTC's rulemaking on SPDCs 

requires that the CFTC must find that the cash market "quotes" the ECM price on a 

"frequent and recurrent basis;" use of an exclusive index is irrelevant. The index quoted 

by the SCL is a reflection of the underlying cash market, not vice versa. Finally, while it 

is true that ICE uses an exclusive index for the SCL contract, it does not mean that this 

index is the only price reference at these hubs [this hub?]. In fact, there is a competitive 

business in natUral gas indices, as evidenced by the existence ofNGI, Platts, CGPR and 

others. 

Price Linkage 

The third basis for the CFTC's determination is that the SCL is price linked to the 

NYMEX/CME natural gas futures contract (NG). As stated above, Congress instructed 

that the "Commission should not make a detennination 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 

9 See, e.g., 72 FR 537223 (October 20, 2009) (the Notice of Intent for the SCL contract). 10 !d. 

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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 SCL is priced in dollars, then the SCL 

contract could be "price linked" to a U.S. Dollar futures contract traded on a DCM. This 

is neither a rational result nor Congress' intent. In addition, given the fact that the most 

liquid contract month of the SCL basis swap trades on the ICE platfonn fewer than 25 

times per day, it is hard to see how the contract affects price discovery in the NG 

contract. 

Conclusion 

It is clear that the SCL contract does not serve as a material price reference for the 

price of natural gas. Further, the SCL contract does not meet the CFTC's criteria for 

material liquidity and thus cannot be price linked to a designated contract market. On this 

basis, the Commission should not deem these contracts as significant price discovery 

contracts. 

Thank you for the opportunity to comment. 

Sinc~/ik/ 

. Trabue Bland 

Director of Regulatory Affairs 

Assistant General Counsel 

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