On June 25, 2010, the Commodity Futures Trading Commission (CFTC) issued orders addressing four contracts under its authority under Section 2(h)(7) of the Commodity Exchange Act (CEA) to designate contracts, agreements or transactions as performing a significant price discovery function. At issue were four electricity contracts traded at the Mid-Columbia (Mid-C) hub on the IntercontinentalExchange Inc. (ICE): (1) Mid-C Financial Peak (MDC); (2) Mid-C Financial Off-Peak (OMC); (3) Mid-C Financial Peak Daily (MPD); (4) Mid-C Financial Off-Peak Daily (MXO). The CFTC found that the two monthly contracts—MDC and OMC—do serve as Significant Price Discovery Contracts (SPDC), but that the two daily contracts—MPD and MXO—do not. These contracts are the first electricity contracts designated as SPDCs by the CFTC. It is notable that these contracts do not involve organized Regional Transmission Operator (RTO) markets regulated by the Federal Energy Regulatory Commission (FERC). The CFTC has pending a number of FERC-regulated, RTO-based ICE contracts for the California Independent System Operator and PJM Interconnection RTO markets as potential SPDCs.
The orders may offer insight into the CFTC's process for determining a contract's status as an SPDC. In particular, the CFTC appears to be focused on the length of time that a particular contract is listed, with contracts listed for longer periods more likely to serve as material price references, and on the volume of trading activity using the contract, with contracts being traded at higher volumes more likely to have an effect on other contract prices and thus more likely to indicate material liquidity.
The CFTC's authority to regulate SPDCs was broadened significantly in the CFTC Reauthorization Act of 2008, which created the new regulatory category of Exempt Commercial Markets (ECM) 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 a determination in April that seven ICE natural gas contracts serve as SPDCs.
For both of the Mid-C monthly contracts designated as SPDCs on June 25, 2010, the CFTC identified the material price reference and material liquidity criteria as the bases for its SPDC determinations.
- With respect to the material price reference criteria, the CFTC highlighted both direct and indirect evidence that the MDC and OMC contracts were material price references. The CFTC cited as direct evidence the fact that electricity cash market transactions are frequently priced at a differential to the MDC and OMC contract price, and that traders frequently use the MDC and OMC contracts to hedge cash market positions and transactions. The CFTC found indirect evidence that the MDC and OMC contracts were material price references in the fact that ICE sells packages of electricity price data to market participants, which include the MDC and OMC contract prices, and that market participants consult the MDC and OMC prices on a frequent and recurring basis in pricing electricity cash market transactions. The CFTC also pointed to the uniqueness of the ICE electricity prices for the Mid-C market, which the CFTC found were derived from ICE's electronic system and could not be replicated by other firms. Both the MDC and OMC contracts are regarded in the industry as indicating of the value of power at the Mid-C hub, a major trading point for electricity in the West. However, the CFTC's primary focus appeared to be not on a determination that the MDC and OMC contract prices were direct price references for other transactions, but rather, on its findings that market participants purchase ICE's data packages that include the MDC and OMC contract prices because that information has particular value to them and that the MDC and OMC 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 the MDC and OMC contracts both experienced greater trading activity than that of minor futures markets. Because of this significant volume, the CFTC found it is reasonable to infer that the MDC and OMC 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 MDC contract price elicited a 1.09 percent increase in the ICE OMC contract price, while a one percent rise in the OMC contract price elicited a 0.915 percent increase in the ICE MDC contract price.
The CFTC examined these same two criteria (material price reference and material liquidity) for the two Mid-C daily contracts, but found that neither contract met the criteria.
- In terms of whether the MPD and MXO daily contracts acted as a material price reference, the CFTC determined the MPD and MXO daily contracts are not used as widely as sources of electricity pricing information as the MDC and OMC monthly contracts. Cash market transactions are not priced on a frequent and recurring basis at a differential to the MPD or MXO's contract price. This is likely due to the fact that the monthly contracts are listed for up to 86 calendar months, while the daily contracts are listed for a much shorter length of time (up to 38 days for the MPD contract, and up to 70 days for the MXO contract). Market participants can use the longer time periods in which the monthly contracts are available to lock in electricity prices far into the future. The more limited timeframes of the daily contracts constrain their forward pricing capability.
- With regard to the material liquidity criteria, the CFTC found that the MPD and MXO daily contracts were traded at volumes similar to that of minor futures markets. The CFTC determined that these contracts do not meet its threshold of trading activity that render them of potential importance.
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