!)'""·==·=! 

Received Cf!C 

Records Section 

ID/&1/ D\ l1c~ Atlanta Calgary Chicago Houston London New York Singapore 

Mr. David Stawick 

Secretary 

October 26, 2009 

___________________ Commodicy_Eutures Trading-Commission --

1155 21 81 Street, NW 

Washington, DC 20581 

COMMENT 

lJ 

RE: Notices of Intent to determine whether certain Basis Swaps serve a Significa:iif3 

Price Discovery Function N 

Dear Mr. Stawick: C)· 

w 

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 following contracts serve a significant price 

discovery function (collectively referred to as "Basis Contracts"): 

• 

• 

• 

• 

• 

• 

• 

• 

• 

• 

• 

• 

• 

Alberta, Nova Inventory Transfer (AECO) (Basis Swap) ("AEC") 

Pacific Gas Transmission - Malin (Basis Swap) (''MLN") 

PG&E - Citygate (Basis Swap) ("PGE") 

El Paso - Permian Basin (Basis Swap) ("PER") 

El Paso- San Juan Basin, Blanco Pool (Primary only) (Basis Swap) 

("SNr') 

Waha Hub - West Texas (Basis Swap) ("WAH") 

Houston Ship Channel (Basis Swap) ("HXS"i 

Chicago Citygate (Basis Swap) ("DGD") 

Natural Gas Pipeline Co. of America, TexOk (Basis Swap) (''NTO") 

Dominion - South Point (Basis Swap) ("DOM") 

Transcontinental Gas Pipeline Corp. - Zone 6 (NY) (Basis Swap) ("TZS") 

Tetco M3 (Basis Swap) ("TMT") 

TCO (Basis Swap) ("TCO") 

ICE believes that these Basis Contracts do 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"). 

1 The CFTC Notice of Intent refers to the Houston Ship Channel contract ("HXS") contract as HSC. 

0 

.., 

.., 

Intercontinental Exchange 

2100 RiverEdge Parkway 

Suite soo ~'''""< no 857 470o 

rar. 770 951 1307 

Atlanta, GA 30328 
r-,.~~1 

~ :i 

L 1ce 

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 many of these contracts from 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 of20082 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 CFTCthis authority over ECMs to capture two types of contracts: (1) 

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

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

independent price reference by the public.3 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 of Trading on Regulated Futures 

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

current level ofregulation 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. '

4 

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

the Basis Contracts serve a significant price discovery function. 

The Basis Contracts 

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 

2 Title XIII of the Food, Conservation and Energy Act of2008, Pub. L. No. 110-246, 122 Stat. 1623 (June 

18, 2008). 3 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). 4 Commodity FutUres Trading Commission, Report of the Oversight ofTrading on Regulated Futures 

Exchanges and Exempt Commercial Markets (October 2007) 

2 
. \ 

r--~·=·-·"·· -~ 

L 1ce 

intrastate pipelines converge.5 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 price of natural gas at the Henry Hub is influential in setting the price 

of natural gas acrossthecountry,local prices for-natural-gas-vary-significantly. Factors--

such as pipeline capacity, storage costs, local demand 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.6 Basis contracts arose to give traders the ability to 

hedge against this price differential, but such contracts do not set the price of natural gas 

at either the Henry Hub or the local hub. 

Each of the Basis Contracts listed by the CFTC in its notice of intent comprise 

two components: (1) the local price as deterinined by an index; of physical gas trades; and 

(2) the price of the Henry Hub LDl contract traded at the Chicago Mercantile 

Exchange/New York Mercantile Exchange. ICE uses several indexes as the reference 

price for each basis locale such as Intelligence Press Inc.'s Natural Gas Bidweek Survey, 

Platt's Inside FERC, or the Canadian Gas Price Reporter for the AECO natural gas basis 

swap. Neither ICE nor its customers via ICE Basis Contracts plays a role in determining 

or setting these index prices. Rather, they are independently set by third parties. 

The .CFTC's Analysis 

The CFTC believes that the Basis Swaps 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 that these contracts do 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 tiines per minute"? Finally, as Congress 

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

5 http://www.sabinepipeline.com/Home/tabid/2/Default.aspx# 

6 Energy Information Administration, Derivatives and Risk Management in the Petroleum, Natural Gas, 

and Electricity Industries (October 2002). 7 Appendix A to Part 36, 17 C.F.R. 36 (2009). 

3 
rtr. .....,."' ... ~"'·.,..,.'-NI"i 

l1c~ 

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. "

8 

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, but is at odds with Congress's intent that the CFTC include "material liquidity" 

in its requirements for significant price discovery. 

Moreover, the statistics supplied in the Notices of Intent do not tell the whole 

story. First, the CFTC's figures, as requested of and provided by ICE, include trades 

made in all 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. Only about 25-40% of the 

trades in these basis swaps occurred in the single most liquid, usually prompt, month of 

each 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 nine of the contracts: SNJ, TMT, TZS, 

DGD. DOM, HXS, PER, PGE, and TCO, the majority of trades were not executed on the 

ICE platform. For MLN, NTO, and WAH, roughly half of the transactions were 

executed on the ICE platform. Only with the AEC contract is there even a preference for 

screen trading with 68% of all AEC transactions conducted 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. The most liquid of the contracts noticed by 

the CFTC is the AEC basis swap for which the CFTC statistics indicate 113.5 trades per 

day. However, only 25% of AEC trades occurred in the most liquid contract month, and 

only 80% of AEC trades in that contract month were executed on the ICE platform. 

8 Title XIII of the Food, Conservation and Energy Act of 2008, Pub. L. No. 110-246, 122 Stat. 1624 (June 

18, 2008). 

4 
:'~="-"==~ "''1 ~ d 

~ ~ L tee 

Given an eight hour trading day, this means that the most liquid contract month in the 

most liquid basis swap traded only about once every 21 minutes. Liquidity in all other 

basis swaps noticed by the CFTC is far less with each typically trading less than once per 

hour. It is clear these liquidity statistics do 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". 

Material Price Reference 

The second basis for the Commission's determination is that the Basis Contracts 

serve 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 deteimined 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 all of the Basis Contracts, 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 " 10 and or (2) that ICE uses an exclusive index to determine one component of 

the basis swap. 

11 The first reason stated by the CFTC is hard to quantify as the.ECM 

report does not mention any of these basis swaps as potential significant price discovery 

contracts. It is unknown which market participants made this statement in 2007 or the 

contracts that were referenced. This falls short of the evidence required in the CFTC 's 

rulemaking that the cash market "quotes" the ECM price on a "frequent and recurrent 

basis." The second reason provided by the CFTC is that ICE uses an exclusive index to 

determine the local price of the basis swap. While it is true that ICE uses exclusive 

indices for certain of the Basis Contracts, it does not mean that these indices are the only 

price references at these hubs. In fact, there is a competitive business in natural gas 

indices, as evidenced by the existence ofNGI, Platt's and IPI. Further, and most 

importantiy, the Basis Contracts are only a reflection of the physical price as quoted in 

the index, not vice versa. Thus, the Basis Contracts do not serve a direct or indirect 

reference to the cash market. 

9 . . 

Note that ICE's OTC markets are open 22 hours. 10 See, e.g., 72 FR 52206 (October 9, 2009) (Notice oflntent for the HXS contract). II /d. 

5 
I 

f'~,,~W,,'·. 

Lee 

Price Linkage 

The third basis for the CFTC's determination is that the Basis Swaps are price 

linked to the NYMEX/CME natural gas futures contract (NG). The CFTC defines price 

linkag~as a"contractthat relies on a contract traded on another tradingfaeility to settle, 

value or otherwise offset the price-linked contract." In considering price linkage, 

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." Many of the Basis Contracts 

trades only a few times per day, it is hard to see how these contracts have sufficient 

volume affect price discovery in the NG contract. Further, and most importantly, the 

Basis Contracts only use the NG contract as a reference to create the basis price; there is 

no price linkage as contemplated by Congress or the CFTC in its rulemaking. A Basis 

Contract is only the differential between the Henry Hub natural gas futures contract and 

the local hub; it cannot be used to offset or replace the futures contract. 

Conclusion 

It is clear that Basis Contracts do not serve as a material price reference for the 

price of natural gas. Further, the Basis Contracts do not meet the CFTC's criteria for 

material liquidity and 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. 

Sincerely, 

R. Trabue Bland 

Director of Regulatory Affairs 

Assistant General Cotinsel 

6