II-01222

From:

Sent:

To:

Cc:

Subject:

Attach:

Brad Flaster <brad.flaster@parityenergy.com>

Wednesday, December 15, 2010 11:00 AM

SEFRules <SEFRules@CFTC.gov>; OTCDefinitions

<OTCDefinitions@CFTC.gov>

Gensler, Gary <GGensler@CFTC.gov>; Dunn, Michael <MDunn@CFTC.gov>;

Sommers, Jill <JSommers@CFTC.gov>; Chilton, Bart <BChilton@CFTC.gov>;

O’Malia, Scott <SO’Malia@CFTC.gov>; Charles Reyl

<charles.reyl@parityenergy.com>; Sara Lesch <sara.lesch@parityenergy.com>

Comments regarding the definition, structure and core principles of a SEF and the

definition of a Swap

Parity Energy Inc comments on the definitions of SEF and Swap.pdf

Attached please find a pre-comment period submission from Parity Energy, Inc. regarding the definition,

structure and core principles of a SEF and the definition of a Swap. Thank you for your consideration of

our submission and please do not hesitate to contact us with any questions.

Best regards,

Brad Flaster

VP - Operations

Parity Energy, Inc.

33 Whitehall Street I Floor 17 I New York, NY 10004

Tel +1-646-867-1981 I Fax +1-212-227-1303

www.parityenergy, com
REGULATORY ISSUES RELATING TO

TH EXECUTION OF N RGY SWAPS

Comments of Parity

Commodity Futures Trading

the definition, structure and

Energy, Inc. relating to the

Commission’s rulemaking

core principles of a Swap

and the definition of a swap.

submitted: Wednesday, December 15,

on the issues of:

Execution Facility

Respectfully 2010.
Parity Energy, Inc.- Background

Founded in 2006, Parity Energy, Inc. ("Parity") operates the Parity

Energy Platform ("PEP") an Internet-based global electronic trading

facility for commodity derivative products traded in the United

States, with a primary focus on energy options.

Parity also provides voice brokerage support to increase market

liquidity and to support the transition from voice brokerage to

electronic trading in the energy option marketplace.

2
Regulatory Status

Since 2007, Parity has operated as an Exempt Commercial Market

pursuant to Section 2(h) of the Commodity Exchange Act (7 U.S.C. §

2(h)).

On September 17, 2010, Parity petitioned the CFTC pursuant to

section 723(c) of the Dodd-Frank Act for grandfather relief to continue

to operate as an Exempt Commercial Market for a limited period of

time.

Parity intends to apply to operate as a Swap Execution Facility

("SEF") after the CFTC promulgates final rules relating to SEF

registration and operating requirements.

3
PEP Is Tailored To The Characteristics Of

The Energy Options Market

In the market for energy options:

- Trading is fast moving, and is characterized by frequent trading in and out of positions;

- The universe of participants is limited, many of which are institutional and sophisticated;

- Traders typically both buy and sell; most are not committed to one side of the market; and

- Participants often trade instruments as strategies, with many degrees of freedom.

The Parity Energy Platform complements these market characteristics by’

Drawing no distinction between market makers and market takers to ensure tighter bidoffer spreads for all PEP Participants (defined at page 9 below);

Employing an open request for quote CRFQ") system that permits every PEP Participant to

submit, view and respond to any RFQ and to trade on any order;

Ensuring all orders are firm, all trades are cleared and all PEP Participants are anonymous;

Enabling PEP Participants to place bids, offers and RFQs for an instrument as a whole,

rather than for the instrument’s component parts.

4
The PEP SEF Model

The Parity Energy Platform combines:

The Central Limit Order Book model,

Price Streaming, and

Open RFQ capability,

into one trading platform to ensure impartial access for all PEP

Participants, as well as increased liquidity and transparency. The

following diagram illustrates how all three of these elements

function together on PEP.

5
Central Limit Order Book

In~’ument

Put ,-~I

12;IJ- FIi 85.50 Put

12;I~ FIt 86.00 Put

12;IJ- FIi 86.50 Put

12;1¢ F11 87.00 Put

12,’1J- F11 87.50 Put

12,’1& F11 88.00 Put

12,’1~ FII 88.00 C~JI

12,’1~ Fll 88.50 C~JI

12;IJ, Fll 89.00 CeJI

12,’1~ Fll 89.50 C~I

IZ;l~ FII 90.00 CeJI

12,’1~ Fll 90.50 C~I

Put ,--~]1 I.Iore T

CALl1 85.00;100.00 Fence (to the put)vs 90.20 63d

Size

200

I00

I00

I00

150

I00

lOlm

Bid

Ind. Price

1. ."..-

-- 0.08

-- 0.07

-- 0.10

0.04 0.16

0.15 0.27

0.34 0.4~

0.16 0.28

0.05 0.12

0.01 0.10

-- 0.08

-- 0.I0

WTI APQ

Offer Last

Price Ind. Size

WTI SDO - Same Day Opt~

100

200

tO0

100 0.11 (08:50)T

100

tO0

50

200

100

100

-Average Price Option

1.67 1/..- lO/m

0.&2 (08:53)~

Put ,_-aJI I.Iore  ̄

FII/GII-0.55 Straxldle

6111HII-0.55 Straddle

611;H11-0.50 Straddle

HI1,’J11-0.40 Stra~ldle

JII/KII-0.25 5"tr~ldle

OII,’HII-0.75 Put Live

5O

50

50

I00

WTI CSO IM - Calendar Spread Option

0.45 0.70 50

50

tO0 P F ,’.,

Continuous price streamincj

for liquid options

Open RFQ for illiquid options

6
The Open RFQ

By their nature, energy options are enormously variable. As a result, in the overthe-counter market, only a small selection are quoted at any given time. PEP

addresses this issue with its open RFQ system. Any PEP Participant seeking a

market in an instrument that is not currently being quoted or streamed through

the PEP central limit order book, can make an RFQ to solicit interest for any

instrument at any time, without revealing direction. The PEP open RFQ

promotes full pre- and post-trade transparency, price efficiency and impartial

access by granting every PEP Participant equal access to view and respond to

any RFQ and to trade on any order.

The following graph illustrates how the open RFQ process i) allows PEP

participants to solicit interest on an arbitrary option (swap) and ii) provides

transparency for all PEP participants.

The PEP SEF Model Advances

Dodd-Frank Act Objectives

PEP provides uniform viewing access to all PEP Participants. A~ statutorily eligible participants

that sign a Parity Energy Participant Agreement and agree to be bound by its terms (such participants are "PEP

Participants") have equal viewing rights on the PEP screen. All PEP Participants may view all pending orders and

RFQs as well as the day’s trading history on PEP. This feature:

 ̄ Ensures impartial access to all PEP Participants; and

 ̄ Promotes both pre- and post-trade transparency by allowing PEP Participants to view all interest and trading

for the day.

All PEP Participants may view all bids and offers. Incompatible orders (for example, those from a

trader with incompatible clearing) appear in gray text on screen, so PEP Participants know the terms of

incompatible orders, but also understand not to trade on those orders. This feature:

 ̄ Promotes pre-trade transparency by allowing all PEP Participants to view all orders.

All trading on PEP is anonymous and cleared and all visible orders are firm and must

satisfy a minimum lot requirement. These features:

 ̄ Promote multiple-to-multiple (aka many-to-many) trading where every PEP Participant may trade on every

compatible order;

 ̄ Promote market efficiency by ensuring a level playing field with impartial access for all PEP Participants; and

 ̄ Reduce the risk of market manipulation.

9
The PEP SEF Model Advances

Dodd-Frank Act Objectives

All PEP Participants may trade on all compatible orders. This feature:

 ̄ Promotes multiple-to-multiple (aka many-to-many) trading where every PEP Participant may trade on every

compatible order; and

 ̄ Improves price efficiency by leveling the playing field between PEP Participants.

Any PEP Participant may make an open RF(~ without revealing whether it seeks to buy or

sell. This feature:

 ̄ Improves price efficiency for all PEP Participants by reducing bias.

Any PEP Participant may view any RF(~. This feature:

 ̄ Improves price efficiency for all PEP Participants by providing impartial access to information.

10
SEF Core Principles

In determining what role a SEF should play in monitoring market activity, in

principle, Parity supports the appointment of a qualified self-regulatory

organization CSRO") to coordinate and participate in this function and to ensure

uniformity. To the extent SEF oversight responsibilities are not delegated to an

SRO, in apportioning oversight responsibility to SEFs, Parity respectfully

requests that the Commission take into account the distinct roles played by

Execution Facilities and Clearing Houses.

Swap Execution Facilities SHOULD be expected to:

have information concerning their own participants’ specific pre-trade

activity on their SEF (such as, for example, order history, including the

bids and asks posted before a trade executed); and

Monitor the safety, reliability and fairness of their own marketplaces.

11
SEF Core Principles

HOWEVER, SEFs that do not serve a clearing function or act as a central

counterparty DO NOT necessarily have access to information concerning

participants’:

- Trading practices across all markets;

Trading positions across all markets,

various positions on participants’ pos

including the impact of those

ition limits and open interest; and

- Credit with clearing firms.

SEF obligations to monitor markets should reflect that reality. A SEF’s oversight

obligations should be tailored to the information available to the SEF. Obligations

to monitor and enforce, for example, position limits and open interest, should

either be placed on clearing firms with access to all relevant information or in the

alternative, clearing firms should be required to share such information with

SEFs to facilitate oversight.

12
Request For Clarification On The Definition Of

The Swap

Section 721 of the Dodd-Frank Act creates a new sub-section (47)

U.S.C. § la that defines swap broadly to capture most previously

unre~lulated derivatives tradin~l.

of 7

Appropriately, at new 7 U.S.C. §la (47)(B), the Act carves out "any

contract of sale of a commodity for future delivery" from the definition

swap, in reco~lnition of the existin~l futures re~lulatory re,lime.

of a

However, section (47)(B) goes on to exclude from the definition of a

swap "any contract of sale of a commodity for future delivery (or option

on such a contract,)" (emphasis added).

13
Request For Clarification On The Definition Of

The Swap

The section (47)(B) exclusion could be read to incorporate option

contracts that are traded over-the-counter ("OTC") and cleared on CME

ClearPort, yet are also exchange traded on CME’s open outcry and

Globex. As these contracts are by definition options on an underlying

commodity future, a literal reading of the section (47)(B) exclusion would

carve these options contracts out of the swap definition.

Prior to the passage of the Dodd-Frank Act, these options on commodity

futures were regulated when they were exchange traded, but

unregulated when they were traded OTC. In promulgating regulations

relating to the definition of a swap, the Commission should clarify

whether these OTC traded instruments are swaps and do not fall within

the section (47)(B) exemption. Examples of the instruments in question

appear on the next page.

14
Request For Clarification On The Definition Of

The Swap

CME ClearPort Lic3ht Sweet Crude Oil Option - symbol LO

CME ClearPort Henry Hub Natural Gas Option - symbol ON

CME ClearPort Heatinc3 Oil Option - symbol OH

CME ClearPort RBOB Gasoline Option - symbol OB

CME ClearPort Gold Option- symbol OG

CME ClearPort Silver Option- symbol SO

15