Daily Rules, Proposed Rules, and Notices of the Federal Government

• Home
• Departments
• Agencies
• Dates

Top Searches

Popular Sites

Common CFR Searches

Federal Register: December 12, 2008 (Volume 73, Number 240)

DOCID: fr12de08-29 FR Doc E8-28867

COMMODITY FUTURES TRADING COMMISSION

U.S. Customs and Border Protection

CFR Citation: 17 CFR Parts 15, 16, 17, 18, 19, 21, 36, and 40

NOTICE: Part III

DOCID: fr12de08-29

DOCUMENT ACTION: Proposed rules.

SUBJECT CATEGORY:

Significant Price Discovery Contracts on Exempt Commercial Markets

DATES: Comments must be received by February 10, 2009.

DOCUMENT SUMMARY:

The Commodity Futures Trading Commission (``Commission'' or ``CFTC'') is proposing rules to implement the CFTC Reauthorization Act of 2008 (``Reauthorization Act'').\1\ In pertinent part, the Reauthorization Act amends the Commodity Exchange Act to significantly expand the CFTC's regulatory authority over exempt commercial markets (``ECMs''), which had heretofore operated largely outside the Commission's regulatory reach, by creating a new regulatory category ECMs with significant price discovery contracts (``SPDCs'')and directing the Commission to adopt rules to implement this expanded authority. In addition to proposing regulations mandated by the Reauthorization Act, the Commission is also proposing to amend existing regulations applicable to registered entities in order to clarify that such regulations are now applicable to ECMs with SPDCs.
\1\ Incorporated as Title XIII of the Food, Conservation and Energy Act of 2008, Pub. L. No. 110246, 122 Stat. 1624 (June 18, 2008).

SUMMARY:

Commodity Futures Trading Commission,

SUPPLEMENTAL INFORMATION

Table of Contents

I. Background

A. The Commodity Futures Modernization Act of 2000 Established a New Regulatory Framework

1. MultiTiered Regulation

2. Exempt Commercial Markets

3. Differences Between ECMs and DCMs

B. The Changing ECM Landscape

C. The CFTC's Response to the Changing Energy Markets

1. Empirical Study of Trades on ICE and NYMEX

2. Commission Surveillance of Energy Markets

3. The Commission's ECM Hearing

4. The Commission's Findings and Legislative Recommendations

D. The Reauthorization Legislation and the Statutory Scheme II. The Proposed Rules

A. Part 36Exempt Markets

1. Required Information

2. Identifying Significant Price Discovery Contracts (i) Criteria for SPDC Determination
(ii) Notification Requirement for ECMs With a SPDC

3. Procedures

4. Substantive Compliance With the Core Principles

5. Annual Commission Review

B. Market, Transaction and Large Trader Reporting Rules

C. Other Regulatory Provisions

1. Part 40Provisions Common to Registered Entities III. Related Matters

A. Cost Benefit Analysis

B. Regulatory Flexibility Act

C. Paperwork Reduction Act
List of Subjects: Proposed Rules
I. Background
A. The Commodity Futures Modernization Act of 2000 Established a New Regulatory Framework

1. MultiTiered Regulation

On December 21, 2000, Congress enacted the Commodity Futures Modernization Act (``CFMA''), which amended the Commodity Exchange Act (``Act'' or ``CEA'') \2\ to replace the Act's ``onesizefitsall'' supervisory framework for futures trading with a multitiered approach to regulatory oversight of derivatives markets. The CFMA applies different levels of regulatory oversight to markets based primarily on the nature of the underlying commodity being traded and the participants who are trading. In general, the more sophisticated the traders or commercial participants, or the less susceptible a commodity is to manipulation or other market or trading abuses, the less regulatory oversight is required under the CFMA.

\2\ 7 U.S.C. 1 et seq.

Accordingly, designated contract markets (``DCMs''), are subject to the highest level of regulatory oversight because they are open to all participants and may offer all types of commodities.\3\ Derivatives Transaction Execution Facilities (``DTEFs'') \4\ are subject to less regulatory oversight than DCMs because participants must be sophisticated investors or must be hedging risk associated with their commercial activities. Additionally, the CFMA imposes limitations on the types of commodities that may be traded, and the manner in which they may be traded.\5\ Exempt Boards of Trade (``EBOTs'') are subject to virtually no regulatory oversight and are not registered with or designated by the Commission. EBOTs are exempt from most provisions of the CEA other than its antifraud and antimanipulation prohibitions, but are subject to significant commodity and participant
restrictions.\6\ In addition to creating these three new categories of trading facility, the CFMA created a broad array of exclusions and exemptions from regulation for certain swaps and other derivatives products traded either bilaterally or on electronic trading facilities.\7\ These exclusions and exemptions reflected a view, consistent with Congressional and Commission actions relating to the passage of the CFMA, that transactions between sophisticated counterparties do not necessarily require the protections that the CEA provides for transactions on DCMs and DTEFs.
\3\ 7 U.S.C. 7.
\4\ To qualify as a DTEF, an exchange must implement certain restrictions on retail market participation and can only trade certain commodities (including excluded commodities and other commodities with very high levels of deliverable supply) and generally must exclude retail participants. CFTC Glossary
(Glossary).
\5\ 7 U.S.C. 7a.
\6\ EBOTs may trade only ``excluded commodities'' (7 U.S.C. 1a(13); 17 CFR Sec. 36.2(a)(2)(i)), and are open only to ``eligible contract participants'' (``ECPs'') (7 U.S.C. 1a(12)).
\7\ For example, section 2(g) created an exclusion from the CEA for individually negotiated swaps, based on nonagricultural commodities entered into between eligible contract participants, 7 U.S.C. 2(g). Similarly excluded are transactions between ECPs involving excluded commodities that are not executed on a trading facility. 7 U.S.C. 2(d)(1).

2. Exempt Commercial Markets

The CFMA established an exemption for transactions in exempt commodities traded on electronic trading facilities, also known as exempt commercial markets (``ECMs'').\8\ To qualify as an ECM, a facility must limit its transactions to principaltoprincipal transactions executed between ``eligible commercial entities'' (``ECEs'') \9\ on an ``electronic trading facility.'' \10\ Contracts [[Page 75889]]
for all commodities except agricultural and excluded commodities (primarily financial commodities but also commodities such as weather) potentially are eligible to trade on an ECM. Examples of commodities traded on ECMs are energy products, metals, chemicals, air emission allowances, paper pulp, and barge freight rates.\11\ ECMs fall somewhere between DTEFs and EBOTs on the regulatory oversight spectrum. Like EBOTs, they are neither licensed nor registered with the CFTC and are subject to the Act's antifraud and antimanipulation
provisions.\12\ In addition, and different from EBOTs, ECMs are subject to certain recordkeeping and reporting requirements under the CEA.\13\ \8\ 7 U.S.C. 2(h)(3)(5).
\9\ 7 U.S.C. 1a(11) (a subset of ECPs).
\10\ 7 U.S.C. 1a(10). For purposes of this proposed rulemaking, the terms electronic trading facility and ECM are used
interchangeably. The term ``trading facility'' means a person or group of persons that constitutes, maintains, or provides a physical or electronic facility or system in which multiple participants have the ability to execute or trade agreements, contracts or
transactions(i) by accepting bids or offers made by other
participants that are open to multiple participants in the facility or system; or (ii) through the interaction of multiple bids or multiple offers within a system with a predetermined non
discretionary automated trade matching and execution algorithm. 7 U.S.C. 1a(34).
\11\ 7 U.S.C. 1a(14).
\12\ Sections 2(h)(4)(B) and (C) of the Act, 7 U.S.C. 2(h)(4)(B) and (C).
\13\ For example, an ECM must maintain for five years and make available for inspection records of its activities relating to its business as a trading facility. 7 U.S.C. 2(h)(5)(B)(ii). More specifically, Commission rule 36.3, 17 CFR 36.3, requires that an ECM identify to the Commission those transactions for which it intends to rely on the exemption in section 2(h)(3) of the CEA and which averaged five trades per day or more over the most recent calendar quarter. For all such transactions, the ECM must provide to the Commission weekly reports showing certain basic trading information, or provide the Commission with electronic access that would allow it to compile the same information. 17 CFR
36.3(b)(1)(ii). An ECM also must provide to the Commission, upon special call, any information relating to its business that the Commission determines is appropriate to enforce the antifraud and antimanipulation provisions of the CEA, to evaluate a systemic market event, or to obtain information on behalf of another federal financial regulator. 7 U.S.C. 2(h)(5)(B)(iii); 17 CFR 36.3(b)(3). An ECM must maintain a record of any allegations or complaints it receives concerning suspected fraud or manipulation and must provide the Commission with a copy of the record of each such complaint. 17 CFR 36.3(b)(1)(iii). Finally, an ECM is required to file an annual certification that it continues to operate in reliance on the exemption in section 2(h)(3) of the Act and that the information it previously provided to the Commission remains correct. 17 CFR 36.3(c)(4).

3. Differences Between ECMs and DCMs

ECMs are not subject to the level of transparency and Commission oversight associated with DCMs. DCMs must satisfy specified criteria to become designated, and then must demonstrate continuing compliance with 18 core principles set out in the Act.\14\ The Act provides flexibility with respect to how DCMs may choose to meet the core principles' mandate that DCMs undertake significant supervisory responsibility with respect to trading on their markets. DCMs must, for example, establish rules and procedures for preventing market manipulation and must adopt necessary and appropriate position limit or accountability rules to address the potential for manipulation or congestion. DCMs also must establish compliance and surveillance programs, which the Commission evaluates through rule enforcement reviews,\15\ must monitor trading on their markets and must undertake other selfregulatory responsibilities mandated by the CEA.
\14\ See sections 5(d)(1)(18) of the Act, 7 U.S.C. 7(d)(1) (18).
\15\ The Commission conducts regular rule enforcement reviews of the self regulatory programs operated by DCMs for enforcing exchange rules, preventing market manipulations and customer and market abuses, and ensuring that trade related information is recorded and stored in a manner consistent with the Act.

The CFMA did not impose these obligations on ECMs. While the Commission was given the authority to determine whether an ECM performs a significant price discovery function for transactions in an underlying cash market,\16\ such a determination did not trigger any selfregulatory responsibilities for the ECM or confer any additional oversight authority on the Commission. Rather, the presence of a contract performing a significant price discovery function required the ECM to publicly disseminate certain basic information, such as contract terms and conditions and daily trading volume, open interest, and opening and closing prices or price ranges.\17\
\16\ In 2004, the Commission amended its part 36 rules to include the requirement that an ECM notify the Commission when it has reason to believe that one or more of the markets on which it is conducting agreements, contracts or transactions in reliance on section 2(h)(3) of the CEA has been met or if the market holds itself out to the public as performing a price discovery function for the cash market of a commodity. 17 CFR 36.3(c)(2)(i) and (ii). 69 FR 43285 (July 20, 2004).
\17\ Id.

B. The Changing ECM Landscape

Following enactment of the CFMA in December 2000, the first ECMs that notified the Commission of their intent to operate generally were simple trading platforms, resembling in many ways businesstobusiness facilities for large commercial firms. ECMs facilitate the execution of trades between commercial counterparties by offering an anonymous and efficient electronic matching system which many believed to be superior to the existing voice broker system, and to provide a competitive advantage over the bilateral OTC market, especially for energy products. Initially, most ECMs were small operations with low trading volumes that were small relative to DCMs. The first ECMs did not offer centralized clearing, but sought to address counterparty risk through the use of credit filters whereby traders could limit their potential counterparties to a list of traders whose credit they found satisfactory. Significantly, early ECM contracts were not linked to contracts listed on DCMs. Over time, however, ECMs began to offer ``lookalike'' contracts that were linked to the settlement prices of their exchangetraded counterparts, and these lookalike contracts in one case began to garner significant volumes. In recent years, several active ECMs began to offer the option of centralized clearing for their contractsan option which became widely utilized by their customers to manage counterparty risk.

This evolution, and particularly the linkage of ECM contract settlement prices to DCM futures contract settlement prices, began to raise questions about whether ECM trading activity could impact trading on DCMs and whether the CFTC had adequate authority to address that impact and protect markets from manipulation and abuse. Of special concern to CFTC staff was the existence of the ECM cashsettled ``look alike'' contracts that could provide an incentive to manipulate the settlement price of an underlying DCM futures contract to benefit positions in the lookalike ECM contract. As discussed more fully below, the Commission subsequently considered and studied these concerns in a variety of ways, culminating, in September 2007, in a public hearing examining trading on regulated exchanges and ECMs.\18\ \18\ See Commodity Futures Trading Commission, Report on the Oversight of Trading on Regulated Futures Exchanges and Exempt Commercial Markets (October 2007), http://www.cftc.gov/stellent/ groups/public/@newsroom/documents/file/pr540307_ecmreport.pdf for a comprehensive report of the Commission's findings following its September 2007 hearing (``ECM Report'').
C. The CFTC's Response to the Changing Energy Markets
1. Empirical Study of Trades on ICE \19\ and NYMEX
\19\ Intercontinental Exchange, or ICE, consists of four separate entities: ICE OTC, to which this document refers, is an ECM trading energy products. ICE Future Europe trades energy futures and is regulated by the Financial Services Authority of Great Britain; ICE Futures US focuses primarily on futures based on soft
commodities (e.g., coffee, sugar, cocoa, cotton) and financial futures and is regulated by the CFTC; ICE Futures Canada trades futures and options and is regulated by the Manitoba Securities Commission.

During the last several years, one ECM in particularthe Intercontinental
[[Page 75890]]
Exchange (``ICE'')has become a major trading venue for natural gas contracts in direct competition with the New York Mercantile Exchange (``NYMEX'') natural gas benchmark futures contract, in addition, Commission staff has found that the traders on ICE are virtually the same as the traders on NYMEX. All of the top 25 natural gas traders on NYMEX are also significant traders on ICE. For the Henry Hub natural gas market,\20\ market participants generally view ICE and NYMEX as essentially a single market, looking to both ICE and NYMEX when determining where to execute a trade at the best price.
\20\ Henry Hub is a natural gas pipeline hub in Louisiana that serves as the delivery point for NYMEX natural gas futures contracts and often serves as a benchmark for wholesale natural gas prices across the U.S. Glossary.

To assess these changes in the marketplace, the Commission's Office of the Chief Economist (``OCE'') conducted an empirical study of the relationship between the natural gas contracts that trade on ICE and NYMEX. OCE collected transaction prices for ICE and NYMEX natural gas contracts from January 3, 2006 through December 31, 2006 and evaluated trading for 12 contract months when trading on each market was appropriately active. OCE examined the timing of price changes on ICE and NYMEX to draw inferences about where information arrives first. If price changes on one venue consistently ``led'' those on the other venue, then OCE concluded that informed traders preferred trading at that ``leading'' venue and inferred that market to be ``discovering'' prices.\21\ OCE found that ICE exhibited price leadership with respect to NYMEX on 20 percent of the contractdays, while NYMEX exhibited price leadership on 63 percent of the contractdays. OCE concluded that these results suggested that both ICE and NYMEX are significant price discovery venues for natural gas futures contracts.
\21\ See ECM Report at 1112. Price discovery is the process of determining the price level for a commodity based on supply and demand conditions. Price discovery may occur in a futures market or cash market. Glossary.

2. Commission Surveillance of the Energy Markets

The Commission's surveillance of natural gas energy markets traditionally has focused on the regulated futures markets traded on NYMEX. Prior to the Reauthorization Act, ECMs were not subject to the requirements of the Commission's large trader reporting system (``LTRS'').\22\ In order to obtain analogous large trader information from ECMs, the Commission had to issue special calls.\23\ Based on the prominent role played by the ICE natural gas contract in the price discovery process and the possible impact on the NYMEX natural gas contract, the Commission determined to issue a series of special calls for information related to ICE's cleared natural gas swap contracts that are cashsettled based on the settlement price of the NYMEX physical delivery natural gas contract.\24\
\22\ The LTRS is the centerpiece of the Commission's market surveillance system. Under the LTRS, clearing members, futures commission merchants and foreign brokers file daily reports with the CFTC showing futures and option positions in accounts they carry that are above reporting levels set by the Commission. The reporting level for the NYMEX natural gas futures market is 200 contracts. \23\ Section 2(h)(5)(B)(iii) of the Act, 7 U.S.C.
2(h)(5)(B)(iii), requires that an electronic trading facility relying on the exemption provided in section 2(h)(3) must, upon a special call by the Commission, provide such information related to its business as an electronic trading facility as the Commission may determine appropriate to enforce the antifraud provisions of the CEA, to evaluate a systemic market event, or to obtain information requested by a Federal financial regulatory authority in connection with its regulatory or supervisory responsibilities.
\24\ The special calls were issued primarily to assist the Commission in its surveillance of the NYMEX natural gas contract. They were not issued as part of an investigation of any particular market participant or trading activity on either ICE or NYMEX, nor were they issued to conduct regular market surveillance of ICE. The first special call, issued on September 28, 2006, requested daily clearing member position data for ICE's natural gas swap contracts, broken out between house and aggregate customer positions, which is similar to information that the Commission receives from NYMEX pursuant to Commission rule 16.00. This information permits CFTC market surveillance staff to see all cleared positions at the clearing member level, but it is not possible to determine individual customer positions. To obtain daily individual trader positions, the Commission issued a second special call on December 1, 2006. While the data received is similar to large trader reporting for DCMs, the methodology for reporting is very different. Because ICE is a principaltoprincipal market and therefore does not receive position reporting from firms, it was necessary for ICE to develop an algorithm to infer open positions from the sum of all trading by each individual trader. While this approach has provided valuable information, it is less accurate than traditional large trader reporting. The third special call, issued on September 5, 2007, required ICE to provide all cleared transaction data for its Henry Hub swap contracts and identify counterparties for the final two trading sessions prior to the expiration of prompt month Henry Hub natural gas products. This data is similar to transaction data that the Commission receives from NYMEX for all trading days and enables CFTC staff to monitor trading activity on ICE and obtain more complete coverage to counter possible manipulative schemes that could affect trading on ICE.

3. The Commission's ECM Hearing

Following the OCE study and the special calls issued to ICE, the Commission held a public hearing on September 18, 2007, to examine the oversight of DCMs and ECMs. Witnesses at the hearing included Commission staff, representatives of DCMs and ECMs, and representatives of a broad spectrum of market users and consumer groups. The hearing focused on a number of issues, including the tiered regulatory approach of the CFMA and whether it was adequate; the similarities and differences between ECMs and DCMs; the associated regulatory risks of each market category; the types of regulatory or legislative changes that may be appropriate to address identified risks; and the impact that regulatory or legislative changes might have on the U.S. futures industry and the global competitiveness of the U.S. financial industry. In announcing the hearing, CFTC Acting Chairman Lukken observed that:

The evolution of these energy markets [ECMs] in recent years requires our agency to address whether the level of regulatory oversight is proper given the importance of energy prices to all Americans.* * * This oversight hearing will provide a better understanding of the interrelationship of these trading venues so policymakers can make informed decisions to protect these vital markets.\25\
\25\ CFTC Release 536807, August 2, 2007 (CFTC Announces September Hearing to Examine Trading on Regulated Exchanges and Exempt Commercial Markets).
4. The Commission's Findings and Legislative Recommendations

Based on information developed through various studies, surveillance, special calls and its public hearing, the Commission published in October 2007 a ``Report on the Oversight of Trading on Regulated Futures Exchanges and Exempt Commercial Markets.'' (``ECM Report'').\26\ The report was provided to the Commission's Congressional oversight committees, which were then in the process of considering legislation to amend the CEA and reauthorize the Commission.

\26\ supra n. 20.

The ECM Report noted that while some participants disagreed, most witnesses at the September 18 hearing generally supported the tiered regulatory structure of the CFMA, but expressed concern regarding the regulatory provisions governing ECMs and the regulatory disparity between DCMs and ECMs.\27\ Witnesses suggested that this disparity made markets more susceptible to manipulation and put regulated exchanges at a competitive disadvantage vis[agrave]vis ECMs offering virtually identical products. Generally, most witnesses felt that some changes to the ECM provisions might be appropriate, provided those changes [[Page 75891]]
were prudently targeted and did not adversely affect the ability of ECMs to innovate and grow.\28\
\27\ Id. at 15.

\28\ Id.

Based on the hearing testimony and its own experience in administering the Act, the Commission at that time concluded that the tiered approach of the CFMA generally had operated effectively. ECMs had proven popular for new startup markets and had provided competition for DCMs, spurring them toward innovations of their own. The Commission further found that, to the extent that trading volume on an ECM contract remained low and its prices were not significantly relied upon by other markets, the current level of regulation remained appropriate. However, when a futures contract traded on an ECM matured and began to serve a significant price discovery function for transactions in commodities in interstate commerce, the contract warranted increased oversight to deter and prevent price manipulation or other disruptions to market integrity, both on the ECM itself and in any related futures contracts trading on DCMs. Such increased oversight would also help to ensure fair competition among ECMs and DCMs trading similar products and competing for the same business.

In light of these conclusions, the Commission's ECM Report recommended that the CEA be amended to grant the Commission additional authority over ECM contracts serving a significant price discovery function, and that certain selfregulatory responsibilities be assigned to ECMs offering such contracts. Specifically, the Commission advocated that (1) An ECM contract that is determined to perform a significant price discovery function be subject to large trader reporting requirements comparable to those applicable to all DCM contracts; (2) an ECM should be required to adopt position limits or accountability levels, as appropriate, for a listed contract that serves a significant price discovery function similar to the limits on DCMs; (3) an ECM should be required to monitor trading of a listed contract that serves a significant price discovery function to detect and prevent manipulation, price distortion, and disruptions of the delivery or cashsettlement process; and (4) the Commission and the ECM should be provided with emergency authority to alter or supplement contract rules, liquidate open positions, and suspend or curtail trading in any listed contract that serves a significant price discovery function. These authorities would be essential tools for the Commission and the ECM to prevent manipulation and disruptions of the delivery or cash settlement process.

The Commission further recommended that the determination whether an ECM contract serves a significant price discovery function should focus on the following factors: (1) Material Liquiditytrading volume in the ECM contract must be significant enough to affect regulated markets or to become a pricing benchmark; and (2) Linkage/Material Price Referencethe relevant ECM contract must either influence other markets and transactions through this linkage or be materially referenced by others in interstate commerce on a frequent and recurring basis.
D. The Reauthorization Legislation and the Statutory Scheme

The CFTC Reauthorization Act of 2008 \29\ adds a new section 2(h)(7) to the CEA to govern the treatment of ``significant price discovery contracts'' (``SPDCs'') on ECMs.\30\ The legislation, based largely on the Commission's recommendations for improving oversight of ECMs, provides for greater regulation of contracts traded on ECMs that fulfill a significant price discovery function and establishes criteria for the Commission to consider in determining whether an ECM contract qualifies as a SPDC. The Reauthorization Act directs the CFTC to extend its regulatory oversight to the trading of SPDCs; requires ECMs to adopt position and accountability limits for SPDCs; authorizes the Commission to require large traders to report their positions in SPDCs; and establishes core principles for ECMs with contracts that are determined to perform a significant price discovery function. Finally, the legislation directs the Commission to issue rules implementing the provisions of new section 2(h)(7) of the CEA and to include in such rules the conditions under which an ECM will have the responsibility to notify the Commission that an agreement, contract or transaction conducted in reliance on the exemption provided in section 2(h)(3) of the CEA may perform a price discovery function.\31\
\29\ Public Law No. 110246, supra. n. 1 (``Pub. L. 110246''). The Reauthorization Act was incorporated into the Food, Conservation and Energy Act of 2008 as Title XIII of that legislation. Title XIII was not the subject of Congressional hearings and the legislative history is limited to The Joint Explanatory Statement of the Committee of Conference, H.R. Rep. No. 110627, 110 Cong., 2d Sess. at 97886 (2008) (Conference Committee Report).
\30\ 7 U.S.C. 2(h)(7).
\31\ Pub. L. 110246 at sec. 12304. See also Conference Committee Report, at 98586; 2008 Farm Bill Commodity Futures Title: Strengthening Oversight of Futures Markets, House Committee on Agriculture (May 9, 2008) http://agriculture.house.gov/inside/ Legislation/110/FB/Conf/Title_XIII_fs.pdf.

The Reauthorization Act significantly broadens the CFTC's regulatory authority over ECMs by creating, in section 2(h)(7) of the CEA, a new regulatory categoryECMs on which SPDCs are tradedand treating electronic trading facilities in that category as registered entities subject to all provisions of the CEA that are applicable to registered entities.\32\ The legislation confers on the CFTC the authority to designate an agreement, contract or transaction as a SPDC if the Commission determines, in its discretion, that the agreement, contract or transaction performs a significant price discovery function under criteria established by section 2(h)(7). When the Commission makes such a determination, the ECM on which the SPDC is traded must assume, with respect to that contract or contracts, all the responsibilities and obligations of a registered entity under the Act and Commission regulations, and must comply with nine core principles established by new section 2(h)(7)(C)including the obligation to establish position limits and/or accountability standards for SPDCs.\33\ The Reauthorization Act separately amends section 4i of the CEA to authorize the Commission to require large trader reports for SPDCs listed on ECMs.\34\
\32\ Conference Committee Report, at 98586.
\33\ Congress has made clear that an ECM with a SPDC shall be considered as a registered entity for purposes of the CEA. Id. at 985.

\34\ Public Law 110246 at sec. 13202.

Consistent with Congress' directive, the Commission is issuing this proposed notice of rulemaking as an initial step to implementing the amended statutory scheme for ECMs with SPDCs.\35\ These regulations are applicable to exempt markets, but also implicate parts 16 through 21 (market, transaction and large trader reporting rules), and 40 (provisions common to contract markets, derivatives transaction execution facilities and derivatives clearing organizations). \35\ Id. at sec. 13204. Congress has directed that the Commission issue proposed rules implementing section 2(h)(7) of the CEA not later than 180 days after the date of enactment of the Reauthorization Act and that the Commission issue a final rule no later than 270 days after the date of enactment. The Reauthorization Act initially was enacted as H.R. 2419 on May 22, 2008 but was repealed due to clerical errorand concurrently enactedby H.R. 2164, Public Law 110264 on June 18, 2008.
[[Page 75892]]
II. The Proposed Rules

A. Part 36Exempt Markets

Part 36 of the Commission's regulations contains the provisions that apply to exempt boards of trade and to exempt commercial markets, regardless of whether the markets are a significant source for price discovery. Rule 36.3 imposes a number of requirements and restrictions on ECMselectronic trading facilities relying on the exemption in section 2(h)(3) of the CEAincluding notification of intent to rely on the exemption; initial and ongoing information submission requirements; prohibited representations; price discovery notification; and price dissemination requirements. The Commission proposes to amend rule 36.3 to implement its broadened regulatory authority over ECMs with SPDCs under section 2(h)(7) of the CEA.

1. Required Information

The notification provision in rule 36.3(a) is unchanged. The Commission proposes to amend rule 36.3(b) to separately specify the information submission requirements, both initially and on an ongoing basis, for: (1) All ECMs; (2) for ECMs with respect to agreements, contracts or transactions that have not been determined to perform a significant price discovery function; and (3) for ECMs with SPDCs.\36\ The proposed amendment to rule 36.3(b) additionally includes provisions related to subpoenas, special calls and the delegation of authority and provides that an electronic trading facility relying on the exemption in section 2(h)(3) of the Act shall not, with respect to agreements, contracts or transactions that are not SPDCs, represent to any person that it is registered with, designated, recognized, licensed or approved by the Commission. This prohibition has its origin in section 2(h)(5) of the CEA, which sets forth the requirements and obligations for ECMs. Although the Reauthorization Act did not amend the prohibition on representation in section 2(h)(5)(7) of the Act, the legislation did amend the statutory definition of ``registered entity'' to include, ``with respect to a contract that the Commission determines is a significant price discovery contract, any electronic trading facility on which the contract is executed or traded.'' \37\ Accordingly, the Commission believes that when it has determined that a contract, agreement or transaction executed or traded on the trading facility is a SPDC, the trading facility may represent that it is a registered entity, provided that the representation clearly and prominently states that the ECM is a registered entity only with respect to its SPDCs.
\36\ Enhanced obligations for ECMs with SPDCs apply only to the SPDCs and need not be applied to ECM contracts, agreements or transactions that are not SPDCs.

\37\ Public Law 110246 at sec. 13203(b)(3).

In general, the proposed information submission requirements for ECMs without SPDCs are drafted to be substantively similar to the information that all ECMs currently are required to provide.\38\ A significant change to the submission requirements for ECMs is the proposed requirement to file, initially and on a quarterly basis, information about the terms and conditions as well as related information for all contracts traded on the facility. Although the proposed rules set forth the terms, standards and conditions under which an ECM will be responsible to notify the Commission that it may have a SPDC, the Commission is mindful that it must independently be aware of ECM contracts that may develop into SPDCs. The Commission believes that requiring ECMs to identify all agreements, contracts and transactions and to provide basic trading information will enable it to fulfill that obligation. To that end, the Commission proposes to retain for nonSPDCs the requirement that ECMs submit to the Commission weekly reports (or alternatively provide electronic access that would allow the Commission to capture the same information) for contracts that average five trades per day or more.\39\ In addition, the Commission is proposing to add a quarterly reporting requirement for all nonSPDCs, to include their terms and conditions, average daily trading volume, and open interest. This quarterly reporting requirement also is being proposed to provide the Commission with information that will assist it in making prompt assessments whether ECM contracts may be SPDCs. ECMs should note that this provision will require them to fulfill the quarterly reporting requirement beginning with the end of the calendar quarter following the adoption of these final rules. Under proposed rule 36.3(b)(3), ECMs with SPDCs will be required to comply with the daily reporting and publication requirements of regulation 16.01.\40\ \38\ ECMs that have already filed a Notification of Operation under section 2(h)(3) of the Act should note that proposed rule 36.3(b) will not require them to provide any additional information to the Commission explaining how the facility meets the definition of trading facility or with information demonstrating that the facility requires all participants to be ECEs as long as the operations of the facility and the participants trading on the facility have not materially changed since the filing of the notification or the most recent ECM Annual Certification form. \39\ See 17 CFR 36.3(b).
\40\ Once in compliance with the core principles and daily reporting and publication requirements applicable to ECMs with SPDCs, ECMs will not be required to comply with proposed rule 36.3(b)(2) except in regard to nonSPDC contracts that are traded or executed on the facility.

2. Identifying Significant Price Discovery Contracts

The Reauthorization Act directs the Commission to consider, as appropriate, four specific criteria when identifying whether an agreement, contract or transaction is a SPDC: Price linkage, arbitrage, material price reference, and material liquidity.\41\ The legislation further directs that in its rulemaking to implement the provisions of section 2(h)(7) of the CEA, the Commission shall include the standards, as well as conditions under which an ECM will have the responsibility to notify the Commission that a contract traded on the facility may perform a significant price discovery function. Accordingly, proposed rule 36.3(c) addresses: (i) The criteria on which the Commission will rely in making a determination that an agreement, contract or transaction is a SPDC; (ii) the factors that will trigger the ECM's obligation to notify the Commission that it may have a SPDC; (iii) the procedures the Commission will follow in reaching its determination whether a contract is a SPDC (and in determining that a contract is no longer a SPDC); and (iv) the procedures and standards by which an ECM with a SPDC must demonstrate compliance with the core principles. \41\ Section 2(h)(7)(B)(v) also authorizes the Commission to specify by rule other material factors relevant to a determination whether a contract is a SPDC.
(i) Criteria for SPDC Determination. In enacting new section 2(h)(7) of the CEA, Congress specified four criteria that the Commission must consider in making a determination that an agreement, contract or transaction performs a significant price discovery function. Proposed rule 36.3(c)(1) enumerates the factorsprice linkage, arbitrage, material price reference, and material liquidity. Because the legislation does not assign priority to any of the factors, and neither the statutory language nor the Conference Committee Report specifies the degree to which any of the factors must be present, section 2(h)(7)(B) gives the Commission flexibility in applying the criteria to a particular contract and market. The Commission is also mindful that:
[n]ot all the listed factors must be present to make a determination that a contract
[[Page 75893]]
performs a significant price discovery function. However, the Managers intend 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 or to become an independent price reference or benchmark that is regularly utilized by the public.\42\
\42\ Conference Committee Report at 98485. In addition to the four criteria established by Congress, section 2(h)(7) permits the Commission to consider such other material factors as it may specify by rule as relevant to a determination whether an agreement, contract or transaction serves a significant price discovery function. 7 U.S.C. 2(h)(7)(B)(v).

Because the criteria mandated by Congress do not lend themselves to brightline rules, the Commission proposes to explain, in Appendix A to the part 36 rules, how it expects to apply the criteria in making its determinations. This proposed guidance explains that the Commission will make SPDC determinations on a casebycase basis, applying and weighing each factor as appropriate to the specific contract and circumstances under consideration; offers examples to illustrate which factor or combinations of factors the Commission would look to when evaluating whether a contract is performing a significant price discovery function; and describes the circumstances under which the presence of a factor or factors would be sufficient to warrant such a determination.

By way of example, for contracts that are linked to other contracts or that may be arbitraged with other contracts, the Commission would determine that the contract is a SPDC if the price of the contract moves in such harmony with the other contract that the two markets essentially become interchangeable. This comovement of prices would be an indication that liquidity in the contract has reached a level sufficient for the contract to perform a significant price discovery function. Accordingly, the proposed guidance establishes threshold liquidity and price relationship standards that will inform the Commission's determination. A different approach is required when considering the price discovery potential of a contract that is serving as a material price reference. In these circumstances, the Commission would rely on either of two sources of evidence in making its determination. The Commission believes that a direct indicator that a contract is serving as a material price reference is observation that cash market participants are actively referencing the contract price when they enter into cash market transactions. Routine publication of an ECM's contract price in widely distributed industry publications and newsletters also would indicate that industry participants attach some value to this information.
(ii) Notification requirement for ECMs with a SPDC. The Reauthorization Act requires that as part of its rulemaking to implement new section 2(h)(7) of the CEA, the Commission include the standards, terms and conditions under which an ECM will have the responsibility to notify the Commission that an agreement, contract or transaction conducted in reliance on the exemption provided in section 2(h)(3) of the CEA may perform a significant price discovery function.\43\ Accordingly, in proposed rule 36.3(c)(2) the Commission has specified conditions, derived from the statutory criteria, which signal the ECM's obligation to notify the Commission of a possible SPDC. An ECM will be obligated to notify the Commission of a potential SPDC when an agreement, contract or transaction is traded an average of 5 trades per day or more over the most recent calendar quarter and also meets one of the other two reporting factors. The Commission is aware that this requirement may result in overreporting by ECMs, and wishes to emphasize that the presence of one factor alone will not necessarily result in a determination that a contract is a SPDC. This notice requirement, however, will serve to alert the Commission to the contracts that are most likely to be SPDCs. The Commission believes that the benefit of having the maximum available information with which to make its determinations outweighs the costs associated with possible overreporting by ECMs.
\43\ Public Law 110246 at sec. 13204.

3. Procedures

When the Commission learns of a potential SPDCwhether through its own information collection and surveillance activities,\44\ notification by an ECM pursuant to proposed rule 36.3(c)(2), or unsolicited information from participants in the cash market underlying a contractthe Reauthorization Act directs the Commission to implement a process for determining whether ECM contracts are SPDCs. In proposed rule 36.3(c)(3) the Commission establishes procedures under which the Commission will make and announce its determination whether a particular contract performs a significant price discovery function and also sets forth the actions that must be taken by an ECM following such a determination. With respect to the former, proposed rule 36.3(c)(3) provides that when the Commission intends to undertake such a determination in response to notice by an ECM pursuant to rule 36.3(c)(2), or upon its own initiative, it will notice its intention in the Federal Register. The proposed rule also specifies that the Commission, as part of its consideration, will solicit written data, views and arguments from the ECM that lists the potential SPDC and from any other interested parties. Generally, such written submissions must be received within 30 calendar days of the date of publication in the Federal Register. After consideration of all relevant matters the Commission will issue an order explaining its determination. The issuance of an affirmative Commission order signals the effectiveness of the Commission's authorities with respect to ECMs with SPDCs \45\ and triggers the obligations, requirementsboth procedural and substantiveand timetables prescribed in proposed rule 36.3(c)(4) for the ECM.\46\
\44\ The Reauthorization Act amended the CEA to require that the Commission review all ECM contracts at least once a year to determine whether any contract is a SPDC. In addition to these formal reviews, it is expected that Commission staff might also become aware of the price discovery attributes of ECM contracts in the ordinary course of discussion or interaction with ECM personnel and various cash and futures market participants.
\45\ Those authorities include the emergency powers conferred by section 8a(9) of the Act, 7 U.S.C. 12a(9), which permits the Commission to intervene when it has reason to believe an emergency exists and to take action necessary to maintain or restore orderly trading or liquidation of any futures contract.
\46\ Should the Commission conclude, either formally or informally, that a contract which demonstrates some characteristics consistent with a SPDC nonetheless does not serve a significant price discovery function, the Commission may continue to monitor the contract pursuant to its special call authority under proposed rule 36.3(b)(1)(iv), and will advise the ECM as to what further reporting it may require with respect to the contract.

Under proposed rule 36.3(c)(4), an ECM with a SPDC must submit to the Commission a written demonstration that it complies with the nine core principles established in section 2(h)(7) of the CEA with respect to the SPDC. Although status as a registered entity attaches to an ECM as soon as the Commission issues its order determining that a particular ECM contract performs a significant price discovery function, the Commission has included in proposed rule 36.3(c)(4) a grace period for achieving compliance with the core principles. As proposed, the rule provides 90 calendar days for ECMs with a firsttime determination of a SPDC to demonstrate compliance with
[[Page 75894]]
the core principles.\47\ For each subsequent SPDC, the ECM is given 15 calendar days from the date of the Commission's order to achieve compliance. The grace period is designed to ensure that the ECM has sufficient time to implement its new regulatory requirements and operations, while avoiding the market disruption that might occur by the sudden imposition of position limits and other trading rules. The Commission is aware that position limits that become effective at the end of the applicable grace period may negatively impact traders who in good faith acquired positions that are above that limit. Requiring immediate compliance would force such traders to liquidate positions in order to be at or below the limit. Accordingly, for the purpose of applying limits on speculative positions in newlydetermined SPDCs, the Commission proposes to permit a grace period following the ECM's implementation of position limits applicable to SPDCs for traders with cleared positions in such contracts to become compliant with applicable position limit rules. Traders who hold cleared positions on a net basis in the electronic trading facility's SPDC must be at or below the specified position limit no later than 90 calendar days from the date on which the electronic trading facility implements a position limit, unless a hedge exemption is granted by the electronic trading facility. This grace period applies to both initial and subsequent SPDCs on an ECM, and the ECM should promptly notify traders when it has set position limits. This provision is outlined in the proposed Guidance to Core Principle IV.

\47\ Conference Committee Report at 986.

Rule 36.3(c)(4) requires that the ECM's submission include specific information designed to permit the Commission to evaluate whether the ECM is indeed in compliance with the core principles. Although there are obvious differences between them, this procedure was modeled on the procedure required of applicants to become designated contract markets.\48\ As with other aspects of this rulemaking, the Commission is striving to make the procedures and requirements for ECMs with SPDCs as close as possible to those for DCMs, and in this regard will review the adequacy of submitted materials with the same rigor it applies to DCM applications. Submissions that are incomplete or do not adequately demonstrate compliance with each of the core principles may trigger Commission proceedings under section 5c(d) of the Act and may, pursuant to section 5e or 6 of the Act, result in the revocation of the ECM's right to operate in reliance on the exemption set forth in section 2(h)(3) of the Act with respect to a SPDC.
\48\ DCM applicants make submissions prior to designation as a registered entity and prior to the listing of any contract, whereas the Commission must review the same information for ECMs after they are deemed registered entities and after the subject contract has established trading volume and open interest.

The Commission also proposes to establish a process for vacating a SPDC determination when the contract no longer meets the criteria specified in section 2(h)(7)(B). Under proposed regulation 36.3(c)(6), the Commission may, on its own initiative or at the request of an ECM with a SPDC, determine that a contract no longer performs a significant price discovery function and vacate its previous determination. Any subsequent determination that the contract once again is a SPDC will be subject to the procedures proposed in regulation 36.3(c)(2). Proposed rule 36.3(c)(6) further provides for the automatic vacation of a significant price discovery contract determination when the SPDC has no open interest and no trading on the contract has occurred for a period of 12 complete calendar months. The Commission is proposing this provision in order to reduce the administrative burden on staff and the compliance burden on an ECM where lack of activity eliminates any possibility that a contract performs a significant price discovery function for the underlying cash market.
4. Substantive Compliance With the Core Principles: Guidance and Acceptable Practices

Section 2(h)(7) of the CEA, as amended, requires that an electronic trading facility on which significant price discovery contracts are traded comply with nine core regulatory principles. Consistent with Congress's intent that status as a registered entity attach to an ECM following the Commission's determination that a particular ECM contract serves a significant price discovery function,\49\ these core principles have their origins in their DCM counterparts in section 5 of the CEA and have been construed similarly.\50\ The Commission proposes to adopt Appendix B to the part 36 rules to provide general guidance and acceptable practices with respect to compliance with the ECM core principles; the acceptable practices for compliance with the ECM core principles will, where appropriate, mirror those for DCMs. The Commission intends in the acceptable practices to provide nonexclusive safe harbors for compliance with the core principles by ECMs with SPDCs. As is the case with the core principles established for other registered entities, the guidance offered for ECMs is neither mandatory nor the only means of compliance with the core principles. Consistent with its practice of evaluating a DCM's compliance with the core principles during rule enforcement reviews, the Commission will conduct regular rule enforcement reviews of ECMs with SPDCs to evaluate compliance with the nine core regulatory principles.
\49\ Conference Committee Report at 986.
\50\ 7 U.S.C. 7(d); Conference Committee Report at 985.

The Guidance to Core Principle I of section 2(h)(7)(C) of the Act requires the ECM to certify the terms and conditions of the SPDC within 90 calendar days of an ECM's initial SPDC, or 15 calendar days if the ECM has previously traded a SPDC. The acceptable practice for this core principle provides that Guideline No. 1 in Appendix A to the Commission's part 40 rules may be used as guidance to satisfy this provision. To ensure continued compliance with all elements of the Commission's statutory and regulatory regimes for ECMs with SPDCs, the ECM is expected to monitor the SPDC and its trading activity on a continuous basis.

Core Principle II requires ECMs to monitor trading in SPDCs to prevent market manipulation and participation abuses. Its guidance and acceptable practices were derived from DCM Core Principle 4 (Monitoring of Trading) and DCM Designation Criterion 2 (Prevention of Market Manipulation).\51\ The proposed guidance and acceptable practices in Appendix B to part 36 make clear that ECMs with SPDCs must demonstrate the capacity to prevent market manipulation and have rules deterring trading and participation abuses. Under the proposed guidance, ECMs with SPDCs can demonstrate this capacity through either a dedicated regulatory department or by delegation of that function to an appropriate third party.\52\ In either case, the regulatory [[Page 75895]]
department or third party should have an acceptable trade monitoring program, the authority to collect information and documents, and the ability to assess participants' market activity and power.
\51\ 17 CFR 38, Appendices A and B to Part 38.
\52\ As is the case for DCMs and DTEFs, ECMs with SPDCs may comply with any core principle through delegation of any relevant function to any registered futures association or another registered entity, but the ECM remains responsible for carrying out the function. Section 5c(b) of the CEA, 7 U.S.C. 7a2(b). A detailed discussion of registered entities' responsibilities and obligations with respect to delegated functions, as well as a discussion of the distinctions between delegation of functions and outsourcing, or contracting out specified core principle duties is found in the Commission's final rulemaking implementing provisions of the CFMA relating to trading facilities (``A New Regulatory Framework''), 66 FR 42256, 42266 (August 10, 2001).

Core Principle III addresses the ability of an ECM with a SPDC to obtain information necessary to perform any of the functions enumerated in section 2(h)(7)(C) of the CEA (the core principles), to provide that information to the Commission, and to have the capacity to carry out any required information sharing agreements. Core Principle III's guidance and acceptable practices have as their source the guidance and acceptable practices of DCM Designation Criterion 8Ability to Obtain Information.\53\ Proposed Appendix B to part 36 makes clear that ECMs with SPDCs must have the authority to collect information and documents on both a routine and nonroutine basis; maintain and properly store audit trail data; maintain records in a form and manner acceptable to the Commission; and have the capacity to carry out appropriate informationsharing agreements. In providing guidance on compliance with this requirement, the Commission also proposes to incorporate the guidance and acceptable practices provided for DCM Core Principles 10 (Trade Information) and 17 (Recordkeeping).\54\ The Commission believes that the acceptable practices outlined in Core Principle 10 should be made applicable to ECMs with SPDCs because the ability to record full data entry and trade details, as well as the safe storage of audit trail data, is a necessary component in assessing potential manipulation and conducting effective market surveillance. DCM Core Principle 17 requires that DCMs maintain required records in a form and manner acceptable to the Commission and establishes as guidance for acceptable recordkeeping the standards prescribed in Commission regulation 1.31.\55\ To ensure that all information required by the Commission is maintained in a uniform manner, the Commission proposes in the acceptable practices for Core Principle III to adopt the acceptable practices for recordkeeping found in DCM Core Principle 17. \53\ 17 CFR 38, Appendix B to Part 38.
\54\ 17 CFR 38, Appendix B to Part 38.

\55\ 17 CFR 1.31.

Core Principle IV requires electronic trading facilities with significant price discovery contracts to establish position limit or accountability rules for traders in such significant price discovery contracts. Speculative position limits are necessary to reduce the potential for market manipulation. The acceptable practices for Core Principle IV were derived largely from Core Principle 5 for designated contract markets.\56\

\56\ 17 CFR 38, Appendix B to Part 38.

DCMs can list for trading futures contracts on a wide range of commodities, including enumerated agricultural products, excluded commodities (e.g., financial products such as currencies), and exempt commodities (e.g., metals, crude oil, natural gas and electricity). Some of these commodities have limited deliverable supplies while others have deep and liquid cash markets. Depending on the variety of possible contracts listed for trading, a DCM may have a mix of position limit and accountability rules. Specifically, futures contracts based on commodities with limited deliverable supplies should have spotmonth speculative position limits. In contrast, financial products having deep and liquid cash markets may be eligible for position
accountability levels in lieu of position limits since the potential for market manipulation is minimal.

Unlike DCMs, ECMs relying on the exemption in section 2(h)(3) of the CEA are permitted to offer for trading only contracts on exempt commodities. Because the deliverable supplies of exempt commodities typically are limited, the Commission believes that it will be necessary for SPDCs to have spotmonth position limits.

The acceptable practices for Core Principle IV make recommendations with respect to how ECMs should establish spotmonth speculative position limits. For a unique SPDC,\57\ the spotmonth speculative position limit should be set in the same manner outlined for contracts listed for trading on DCMs. In this regard, for a physicallydelivered SPDC, the level of the spotmonth limit should be based upon an analysis of the deliverable supply and the history of spotmonth liquidations. The spotmonth limit for a physicaldelivery market is appropriately set at no more than 25 percent of the estimated deliverable supply.\58\ Where a SPDC has a cash settlement provision, the spotmonth speculative position limit should be set at a level that minimizes the potential for price manipulation or distortion in the SPDC itself; in related futures and option contracts traded on a DCM or DTEF; in other SPDCs; in other fungible agreements, contracts and transactions; and in the underlying commodity.
\57\ A unique SPDC is one that is not economically equivalent to another SPDC or to a contract traded on a DCM or DTEF.
\58\ The Commission notes that deliverable supply typically is less than total supply. In this regard, it is common for some portion of the supply to be unavailable for delivery for a variety of reasons. Deliverable supply is the amount of the underlying commodity that reasonably can be expected to be available to short traders and salable by long traders at its market value in normal cash market channels.

The Commission notes that some SPDCs may not be unique. In other words, a SPDC may be economically equivalent to another SPDC or to a contract traded on a DCM or DTEF. Economic equivalence can arise due to substantial similarity among contracts' terms and conditions (e.g., two physicallydelivered contracts or two cashsettled contracts having the same specifications). A SPDC also can be economically equivalent to another SPDC or to a contract listed for trading on a DCM or DTEF if it is cash settled based on a daily settlement price or the final settlement price of the referenced contract. For economically equivalent SPDCs, the electronic trading facility should establish the same spotmonth speculative position limits as specified for the equivalent contract.\59\
\59\ Many DCMs have nonspot individual month and allmonths combined position accountability rules for their futures contracts. Moreover, some DCMs establish nonspot individual month and all monthscombined position limits in lieu of the position
accountability levels. The Commission believes that the
implementation of such accountability provisions or position limits is a good practice. Accordingly, the Commission proposes to adopt it as an acceptable practice for ECMs.

ECMs should establish nonspot individual month position accountability levels and allmonthscombined position accountability levels for its SPDCs. Once a trader exceeds an established position accountability level, the ECM should initiate an investigation to determine whether the individual's trading activity is justified and is not intended to manipulate the market. As part of its investigation, the ECM should inquire about the trader's rationale for holding a net position in excess of the accountability levels. The ECM also can request that the trader not further increase contract positions. If a trader fails to comply with a request for information, provides information that does not sufficiently justify the position, or continues to increase contract positions after a request not to do so is issued by the ECM, then the accountability provisions should enable the ECM to order the trader to reduce the positions.

If a SPDC is economically equivalent to another SPDC or to a contract traded
[[Page 75896]]
on a DCM or DTEF, then the ECM should set the nonspot individual month position accountability level and allmonthscombined position accountability level at the same level as those specified for the economicallyequivalent contract. For a unique SPDC, the ECM should adopt nonspot individual month and allmonthscombined position accountability levels that are no greater than 10 percent of the average combined futures and deltaadjusted option monthend open interest for the most recent calendar year.

Position accountability levels are not necessary for SPDCs that specify nonspot individual month position limits and allmonths combined position limits. If a SPDC is economically equivalent to another contract, then the nonspot individual month position limit and allmonthscombined position limit should be set at the same levels specified for the equivalent or referenced contract. For unique SPDCs, the nonspot individual month and allmonthscombined position limits should be set in the same manner as for position accountability levels, i.e., levels that capture a material amount of large positions that could threaten the market.

An ECM with a SPDC may require that all transactions in that contract be cleared only through a DCO. Alternatively, an ECM's SPDC may not be subject to any clearing requirement, in which case the contract would trade on an uncleared basis. Lastly, an ECM may permit a given SPDC to trade on either a cleared or uncleared basis depending on the status of the counterparties involved. The amendments to the CEA give electronic trading facilities reasonable discretion to take into account the differences between cleared and uncleared transactions when complying with Core Principle IV.\60\ For the purpose of applying speculative limits to positions in SPDCs, the ECM should apply speculative position limits to cleared positions only.

\60\ Public Law 110246 at sec. 13201.

Uncleared transactions in SPDCs potentially play an important role in risk management strategies and price formation. As a result, the Commission believes that an ECM should monitor not only trading in cleared transactions but also trading with respect to uncleared transactions. However, the Commission is cognizant of the fact that uncleared trades conducted on the ECM may be offset by trades done off the facility. Such offsetting transactions consummated outside of an ECM typically are not reported to the facility. Thus, the ECM likely would find it difficult to net uncleared transactions and maintain records of traders' uncleared positions in a given SPDC. In order to account for this situation, the Commission proposes for ECMs with SPDCs a new measure of trading activity called the volume accountability level. For this measure, the ECM shou

FOR FURTHER INFORMATION CONTACT

Susan Nathan, Senior Special Counsel, Division of Market Oversight, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581. Telephone: (202) 4185133. Email: snathan@cftc.gov.