CFTC Designates Four Additional Electricity Contracts as SPDCs

The Commodity Futures Trading Commission (CFTC) issued two orders on July 9, 2010, designating four monthly electricity contracts as Significant Price Discovery Contracts (SPDC) pursuant to section 2(h)(7) of the Commodity Exchange Act (CEA). The four contracts at issue were:  the SP-15 Financial Day-Ahead LMP Peak (SPM) contract, the SP-15 Financial Day-Ahead LMP Off-Peak (OFP) contract, the PJM Western Hub Real Time Peak (PJM) contract, and the PJM Western Hub Real Time Off-Peak (OPJ) contract.  Each of the contracts are listed for trading on the IntercontinentalExchange Inc. (ICE), an exempt commercial market (ECM) under the CEA. Following their designation as SPDCs, these four contracts will be subject to heightened regulatory oversight and reporting requirements. At the same time, the CFTC issued two other orders finding that two daily SP-15 and two daily PJM contracts were not SPDCs. 

The CFTC's orders follow on the heels of two June 25, 2010 orders designating two monthly electricity contracts at the Mid-Columbia (Mid-C) trading hub as SPDCs and finding that two Mid-C daily contracts were not SPDCs. But the CFTC's July 9 orders mark the first time the agency has found electricity contracts based on transactions in organized markets (in which the Federal Energy Regulatory Commission (FERC) closely oversees a structured price setting process) to be SPDCs; the SP-15 trading hub is located in the California Independent System Operato (CAISO), while the PJM Western Hub is located in the PJM Interconnection (PJM).

The CFTC's authority to regulate SPDCs was broadened significantly in the CFTC Reauthorization Act of 2008, which created the new regulatory category of ECMs on which SPDCs are traded, and treating ECMs in that category as registered entities under the CEA. This closed the so-called "Enron loophole" that had exempted products traded on ECMs from most substantive CFTC regulation. In determining whether a contract performs a significant price discovery function, the CFTC is to consider the extent to which contracts: (1) are linked to existing exchange-traded contracts; (2) permit arbitrage between ECMs and other markets; (3) are used as a direct, material price reference for bids; and (4) are traded in a volume that provides material liquidity.  Under the statute, ECMs on which SPDCs are traded must assume additional responsibilities and obligations with respect to those contracts, including increased regulatory reporting requirements.  In the past several months, the CFTC has determined that a number of contracts traded on ICE qualify as SPDCs, including the determination in June that two Mid-C contracts serve as SPDCs and the determination in April that seven ICE natural gas contracts serve as SPDCs.

The CFTC found that the four monthly contracts at issue were SPDCs under the material price reference and material liquidity criteria, similar to its recent finding on the two monthly Mid-C contracts. Specifically:

• With respect to the material price reference criteria, the CFTC highlighted both direct and indirect evidence that the four contracts were material price references. The CFTC cited as direct evidence the fact that SP-15 and PJM Western Hub are both major pricing centers, and that traders often consult prices at these points when entering into cash market transactions. The CFTC found indirect evidence that these four contracts were material price references in the fact that ICE sells packages of electricity price data to market participants, which include the SP-15 and PJM Western Hub contract prices, and that market participants consult these prices on a frequent and recurring basis in pricing electricity cash market transactions. The CFTC's primary focus appeared to be not on a determination that the SP-15 and PJM Western Hub contract prices were direct price references for other transactions, but rather, on its findings that market participants purchase ICE's data packages that include these contract prices because that information has particular value to them and that these contract prices are consulted "on a frequent and recurring basis by industry participants in pricing cash market transactions."
• With respect to the material liquidity criteria, the CFTC found each of the four contracts experienced greater trading activity than that of minor futures markets. Because of this significant volume, the CFTC found it is reasonable to infer that these four contracts could have a material effect on other contracts listed on the ECM or on Designated Contract Markets (DCM). For example, the CFTC staff's statistical analysis found that a one percent rise in the SPM contract price elicited a 0.7 percent increase in the ICE OFP contract price, while a one percent rise in the OFP contract price elicited a 1.4 percent increase in the ICE SPM contract price.

In each of the CFTC's orders to date designating electricity contracts as SPDCs, it has focused exclusively on the material price reference and material liquidity criteria. Paramount to the CFTC's concern appears to be the extent to which electricity traders consult the relevant contract prices in pricing cash market transactions, and the fact that the ECM (ICE, in this instance) sells information to market participants that contain pricing information on the relevant contract. The CFTC has also focused on the longer time frames over which the monthly contracts allow traders to lock in prices and the fact that the trading hubs involved are major electricity trading hubs.