FR Doc E9-20024[Federal Register: August 20, 2009 (Volume 74, Number 160)]

[Notices]

[Page 42052-42055]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr20au09-16]

=======================================================================

———————————————————————–

COMMODITY FUTURES TRADING COMMISSION

Notice of Intent, Pursuant to the Authority in Section 2(h)(7) of

the Commodity Exchange Act and Commission Rule 36.3(c)(3), To Undertake

a Determination Whether the Carbon Financial Instrument Contract

Offered for Trading on the Chicago Climate Exchange, Inc., Performs a

Significant Price Discovery Function

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of action and request for comment.

———————————————————————–

SUMMARY: The Commodity Futures Trading Commission (“CFTC” or

“Commission”) is undertaking a review to determine whether the Carbon

Financial Instrument contract offered for trading on the Chicago

Climate Exchange, Inc. (CCX), an exempt commercial market (“ECM”)

under Sections 2(h)(3)-(5) of the Commodity Exchange Act (“CEA” or

the “Act”), performs a significant price discovery function.

Authority for this action is found in section 2(h)(7) of the CEA and

Commission rule 36.3(c) promulgated thereunder. In connection with this

evaluation, the Commission invites comment from interested parties.

DATES: Comments must be received on or before September 4, 2009.

[[Page 42053]]

ADDRESSES: Comments may be submitted by any of the following methods:

Follow the instructions for submitting comments. Federal

eRulemaking Portal: http://www.regulations.gov.

E-mail: [email protected]. Include CCX Carbon Financial

Instrument Contract in the subject line of the message.

Fax: (202) 418-5521.

Mail: Send to David A. Stawick, Secretary, Commodity

Futures Trading Commission, Three Lafayette Centre, 1155 21st Street,

NW., Washington, DC 20581

Courier: Same as mail above.

All comments received will be posted without change to http://

www.CFTC.gov/.

FOR FURTHER INFORMATION CONTACT: Gregory K. Price, Industry Economist,

Division of Market Oversight, Commodity Futures Trading Commission,

Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.

Telephone: (202) 418-5515. E-mail: [email protected]; or Susan Nathan,

Senior Special Counsel, Division of Market Oversight, same address.

Telephone: (202) 418-5133. E-mail: [email protected].

SUPPLEMENTARY INFORMATION:

I. Introduction

On March 16, 2009, the CFTC promulgated final rules implementing

provisions of the CFTC Reauthorization Act of 2008 (“Reauthorization

Act”) 1 which subjects ECMs with significant price discovery

contracts (“SPDCs”) to self-regulatory and reporting requirements, as

well as certain Commission oversight authorities, with respect to those

contracts. Among other things, these rules and rule amendments revise

the information-submission requirements applicable to ECMs, establish

procedures and standards by which the Commission will determine whether

an ECM contract performs a significant price discovery function, and

provide guidance with respect to compliance with nine statutory core

principles applicable to ECMs with SPDCs. These rules became effective

on April 22, 2009.

—————————————————————————

1 74 FR 12178 (Mar. 23, 2009); these rules became effective on

April 22, 2009.

—————————————————————————

In determining whether an ECM’s contract is or is not a SPDC, the

Commission will consider the contract’s material liquidity, price

linkage to other contracts, potential for arbitrage with other

contracts traded on designated contract markets or derivatives

transaction execution facilities, use of the ECM contract’s prices to

execute or settle other transactions, and other factors.

In order to facilitate the Commission’s identification of possible

SPDCs, Commission rule 36.3(c)(2) requires that an ECM operating in

reliance on section 2(h)(3) promptly notify the Commission and provide

supporting information or data concerning any contract: (i) that

averaged five trades per day or more over the most recent calendar

quarter; and (ii) (A) for which the ECM sells price information

regarding the contract to market participants or industry publications;

or (B) whose daily closing or settlement prices on 95 percent or more

of the days in the most recent quarter were within 2.5 percent of the

contemporaneously determined closing, settlement, or other daily price

of another agreement.

II. Determination of a SPDC

A. The SPDC Determination Process

Commission rule 36.3(c)(3) establishes the procedures by which the

Commission makes and announces its determination on whether a specific

ECM contract serves a significant price discovery function. Under those

procedures, the Commission will publish a notice in the Federal

Register that it intends to undertake a determination as to whether the

specified agreement, contract, or transaction performs a significant

price discovery function and to receive written data, views, and

arguments relevant to its determination from the ECM and other

interested persons.2 After prompt consideration of all relevant

information, the Commission will, within a reasonable period of time

after the close of the comment period, issue an order explaining its

determination. Following the issuance of an order by the Commission

that the ECM executes or trades an agreement, contract, or transaction

that performs a significant price discovery function, the ECM must

demonstrate, with respect to that agreement, contract, or transaction,

compliance with the core principles under section 2(h)(7)(C) of the CEA

3 and the applicable provisions of Part 36. If the Commission’s order

represents the first time it has determined that one of the ECM’s

contracts performs a significant price discovery function, the ECM must

submit a written demonstration of its compliance with the core

principles within 90 calendar days of the date of the Commission’s

order. For each subsequent determination by the Commission that the ECM

has an additional SPDC, the ECM must submit a written demonstration of

its compliance with the core principles within 30 calendar days of the

Commission’s order.

—————————————————————————

2 The Commission may commence this process on its own

initiative or on the basis of information provided to it by an ECM

pursuant to the notification provisions of Commission rule

36.3(c)(2).

3 7 U.S.C. 2(h)(7)(C).

—————————————————————————

B. CCX Carbon Financial Instrument Contract

CCX identifies its CFI contract as a cash contract that requires

the physical delivery of CCX carbon dioxide (CO2) emission

allowances called CFIs.4 The size of the CCX CFI contract is 1,000

metric tons (MT) of CO2-equivalent emissions,5 which are

equal to 10 CFIs (each CFI specifies 100 MT CO2-equivalent

emissions). All trades in the subject contract results in the physical

delivery of CFIs.

—————————————————————————

4 The instruments listed by an ECM in reliance on the

exemption in section 2(h)(3) of the Act are determined by the ECM

when it files notice with the Commission, pursuant to section

2(h)(5), of its intention to rely on the exemption. Section 2(h)(7)

authorizes the Commission to determine whether an ECM “agreement,

contract or transaction” performs a significant price discovery

function, but does not require that the Commission also determine

whether the instrument is otherwise subject to the Commission’s

jurisdiction (i.e., a futures or commodity option contract).

Instead, the descriptive language of section 2(h)(7) mirrors the

“[conducted] in reliance on the exemption” language of section

2(h)(5) and refers merely to “agreement, contract or transaction.”

Thus, the statutory language directs the Commission, in determining

whether an ECM instrument is a SPDC, to evaluate any instrument

listed by an ECM in reliance on the section 2(h)(3) exemption under

the SPDC process set forth in the Part 36 rules.

5 Greenhouse gases (GHGs) include CO2, methane

(CH4), nitrous oxide (N2O), hydrofluorocarbons

(HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride

(SF6). The negative impact that each non-CO2

GHGs has on the environment can be expressed as a multiple of

CO2’s environmental effect.

—————————————————————————

The CCX carbon reduction program is voluntary where certain

entities choose to reduce their GHG emissions. In general, the electric

utilities and manufacturers combined comprise the largest share of the

program participants. Once an entity decides to reduce its GHG

emissions, it signs a legally-binding contract with the CCX.

Participants are given allowances by the CCX to cover emissions level

targets, and additional credits can be created by investing in offset

projects. If an entity’s plant cannot meet its reduction requirements

through new investments and/or technological improvements, additional

allowances can be purchased from other program participants.

The program specifies that carbon emission reductions be completed

over two phases. Phase I (applicable between

[[Page 42054]]

2003 and 2006) required a commitment to reducing each participant’s

carbon emissions by one percent per year below its own baseline level

(calculated as the average of the firm’s carbon emissions between 1998

and 2001). Phase II (which runs from 2007 through 2010) requires

participants to commit to an emissions reduction schedule that results

in a six-percent decline in CO2 output by 2010.

Participants’ baseline estimates as well as their emissions levels and

progress toward meeting the reduction requirements are audited by the

Financial Industry Regulatory Authority (FINRA).

CFIs are distributed for multiple program years at the time of

entry into the program through the end of the current phase. Each CFI

is dated with a particular calendar year (vintage), with the vintage

indicating the compliance year for which it is redeemable.

Alternatively, entities can save their excess CFIs for use in future

compliance periods. The CCX also auctions a certain number of current-

and future-year CFIs. Allowances are recorded electronically and title

transfers between entities are effected within the CCX’s electronic

registry. Each year in April, the CCX compares each participant’s

reported emissions from the previous calendar year to the number of

allowances held that are dated with the compliance year, or with

earlier years. Firms surrender the appropriate number of allowances

that covers their emissions, and the redeemed CFIs are deducted from

the firms’ accounts. Unused allowances that are not needed for

compliance in the current year are rolled forward and are included in

the allowance supply for the following year. Alternatively, plants can

sell excess allowances to other market participants.

As noted above, the CCX’s GHG reduction program allows for the

creation of CFIs through offset projects. In this regard, the CCX

issues CFIs to entities that own, implement, or aggregate eligible

projects on the basis of sequestration, destruction, or displacement of

GHG emissions. The offset project categories for which the CCX issues

CFIs include agricultural, coal mine and landfill methane, agricultural

and rangeland soil carbon, forestry, renewable energy, energy

efficiency and fuel switching, and clean development mechanism

projects.

Based upon a required quarterly notification filed on July 1, 2009

(mandatory under Rule 36.3(c)(2)), the CCX reported that, with respect

to its CFI contract, an average of 15 separate trades per day occurred

in the second quarter of 2009. During the same period, the CFI had an

average daily trading volume of 1,235 contracts. In the first quarter

of 2009, market participants traded the CFI contract on average 29

times per day with an average total daily trading volume of 2,661

contracts. Because the CFI contract requires immediate delivery and

payment on the following day, open interest figures are not applicable.

It appears that the CCX CFI contract may satisfy the material

liquidity and material price reference factors for SPDC determination.

With respect to material liquidity, daily trading in the CFI contract

exceeds an average of ten trades per day. Moreover, the average daily

trading volume in the CFI is greater than 1,000 contracts per day. In

regard to material price reference, the CFI market is solely a CCX-

created entity. In this regard, the CCX designed all of the parameters

of this carbon emission reduction program, as well as established the

rules for membership in the ECM, allowance trading, and the creation of

offsets. The only existing market in which CFIs can be bought and sold

on a spot basis is the CCX cash market. Thus, traders look to the CCX

as a source of price information and price discovery for the CFIs.

Moreover, the Chicago Climate Futures Exchange, a subsidiary of the

CCX, trades a futures contract which specifies the delivery of CFIs.

The instruments listed by an ECM in reliance on the exemption in

section 2(h)(3) of the CEA are determined by the ECM when it files

notice with the Commission, pursuant to section 2(h)(5), of its

intention to rely on the exemption. Section 2(h)(7) authorizes the

Commission to determine whether an ECM’s “agreement, contract or

transaction” performs a significant price discovery function, but does

not require that the Commission also determine whether the instrument

is otherwise subject to the Commission’s jurisdiction (i.e., a futures

or commodity option contract). Instead, the descriptive language of

section 2(h)(7) mirrors the “[conducted] in reliance on the [2(h)(5)]

exemption” language of section 2(h)(5) and refers merely to an

“agreement, contract or transaction.” The statutory language

indicates that any instrument listed by an ECM in reliance on the

exemption in section 2(h)(3) of the CEA–including a cash contract that

generally is not subject to the Commission’s jurisdiction–has the

potential to be or become a SPDC. Accordingly, contracts identified to

the Commission as listed in reliance on section 2(h)(3) should be

evaluated under the SPDC process set forth in the Part 36 rules.

III. Request for Comment

In evaluating whether an ECM’s agreement, contract, or transaction

performs a significant price discovery function, section 2(h)(7) of the

CEA directs the Commission to consider, as appropriate, four specific

criteria: price linkage, arbitrage, material price reference, and

material liquidity. As it explained in Appendix A to the Part 36 rules,

the Commission, in making SPDC determinations, will apply and weigh

each factor, as appropriate, to the specific contract and circumstances

under consideration.

As part of its evaluation, the Commission will consider the written

data, views, and arguments from any ECM that lists the potential SPDC

and from any other interested parties. Accordingly, the Commission

requests comment on whether the CCX CFI contract performs a significant

price discovery function. Commenters’ attention is directed

particularly to Appendix A of the Commission’s Part 36 rules for a

detailed discussion of the factors relevant to a SPDC determination.

The Commission notes that comments which analyze the contract in terms

of these factors will be especially helpful to the determination

process. In order to determine the relevance of comments received, the

Commission requests that commenters explain in what capacity are they

knowledgeable about the CFI contract.

IV. Related Matters

A. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 (“PRA”) 6 imposes certain

requirements on federal agencies, including the Commission, in

connection with their conducting or sponsoring any collection of

information, as defined by the PRA. Certain provisions of final

Commission rule 36.3 impose new regulatory and reporting requirements

on ECMs, resulting in information collection requirements within the

meaning of the PRA; OMB previously has approved and assigned OMB

control number 3038-0060 to this collection of information.

—————————————————————————

6 44 U.S.C. 3507(d).

—————————————————————————

B. Cost-Benefit Analysis

Section 15(a) of the CEA 7 requires the Commission to consider

the costs and benefits of its actions before issuing an order under the

Act. By its terms, section 15(a) does not require the Commission to

quantify the costs and benefits of an order or to determine whether the

benefits of the order outweigh its costs; rather, it requires

[[Page 42055]]

that the Commission “consider” the costs and benefits of its action.

Section 15(a) further specifies that the costs and benefits shall be

evaluated in light of five broad areas of market and public concern:

(1) Protection of market participants and the public; (2) efficiency,

competitiveness, and financial integrity of futures markets; (3) price

discovery; (4) sound risk management practices; and (5) other public

interest considerations. The Commission may in its discretion give

greater weight to any one of the five enumerated areas and could in its

discretion determine that, notwithstanding its costs, a particular

order is necessary or appropriate to protect the public interest or to

effectuate any of the provisions or accomplish any of the purposes of

the Act. The Commission has considered the costs and benefits of this

Order in light of the specific provisions of section 15(a) and has

concluded that this Order, which strengthens Federal oversight of the

ECM and helps to prevent market manipulation, is necessary and

appropriate to accomplish the purposes of section 2(h)(7) which, among

other provisions, directs the Commission to evaluate all contracts

listed on ECMs to determine whether they serve a significant price

discovery function.

—————————————————————————

7 7 U.S.C. 19(a).

—————————————————————————

When a futures contract begins to serve a significant price

discovery function, that contract, and the ECM on which it is traded,

warrants increased oversight to deter and prevent price manipulation

and other disruptions to market integrity, both on the ECM itself and

in any related futures contracts trading on designated contract markets

(“DCMs”). An Order finding that a particular contract is a SPDC

triggers this increased oversight and imposes obligations and

responsibilities on the ECM which are calculated to accomplish this

goal. This increased oversight in turn increases transparency and helps

to ensure fair competition among ECMs and DCMs trading similar products

and competing for the same business. Moreover, the ECM on which the

SPDC is traded must assume, with respect to that contract, all the

responsibilities and obligations of a registered entity under the CEA

and Commission regulations. Additionally, the ECM must comply with core

principles established by section 2(h)(7) of the Act, including the

obligation to establish position limits and/or accountability standards

for the SPDC. These increased ECM responsibilities, along with the

CFTC’s enhanced regulatory authority, subject the ECM’s risk management

practices to the Commission’s supervision and oversight and generally

enhance the financial integrity of the markets.

Issued in Washington, DC on August 13, 2009 by the Commission.

David A. Stawick,

Secretary of the Commission.

[FR Doc. E9-20024 Filed 8-19-09; 8:45 am]

Last Updated: August 20, 2009