[Federal Register: June 11, 2007 (Volume 72, Number 111)]
[Notices]
[Page 32079-32081]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11jn07-38]
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COMMODITY FUTURES TRADING COMMISSION
Order Exempting the Trading and Clearing of Certain Credit
Default Products Pursuant to the Exemptive Authority in Section 4(c) of
the Commodity Exchange Act (``CEA'')
AGENCY: Commodity Futures Trading Commission
ACTION: Final order.
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SUMMARY: On May 14, 2007, the Commodity Futures Trading Commission
(``CFTC'' or the ``Commission'') published for pubic comment in the
Federal Register \1\ a proposal to exempt for the CEA \2\ the trading
and clearing of certain products called credit default options
(``CDOs'') and credit default basket options (``CDBOs'') that are
proposed to be traded on the Chicago Board Options Exchange (``CBOE''),
a natioal securities exchange registered under Section 6 of the
Securities Exchange Act of 1934 (``1934 Act''),\3\ and cleared through
the Options Clearing Corporation (``OCC''), a registered securities
clearing agency registered under Section 17A of the 1934 Act,\4\ and
Derivatives Clearing Organization registered under Section 5b of the
CEA.\5\ The proposed order was preceded by a request from OCC to
approve rules that would permit it to clear these CDOs and CDBOs in its
capacity as a registered securities clearing agency. OCC's request
presented novel and complex issues of jurisdiction and the Commission
determined that an order exempting the trading and clearing of such
instruments from pertinent requirements of the CEA may be appropriate.
The Commission has reviewed the comments made in response to its
proposal and the entire record in this matter and has determined to
issue an order exempting the trading and clearing of these contracts
from the CEA.
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\1\ 72 FR 27091 (May 14, 2007).
\2\ 7 U.S.C. 1 et seq.
\3\ 15 U.S.C. 78f.
\4\ 15 U.S.C. 78q-1.
\5\ 7 U.S.C. 7a-1.
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Authority for this exemption is found in Section 4(c) of the
CEA.\6\
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\6\ 7 U.S.C. 6(c).
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DATES: Effective Date: June 5, 2007.
FOR FURTHER INFORMATION CONTACT: John C. Lawton, Deputy Director and
Chief Counsel, 202-418-5480; [email protected], Robert B. Wasserman,
Associate Director, 202-418-7719, lgregory*@cftc.gov, Division of
Clearing and Intermediary Oversight, Commodity Futures Trading
Commission, Three
[[Page 32080]]
Lafayette Centre, 1151 21st, NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Introduction
The OCC is both a Derivatives Clearing Organization (``DCO'')
registered pursuant to Section 5b of the CEA,\7\ and a securities
clearing agency registered pursuant to Section 17A of the 1934 Act.\8\
The CBOE is a national securities exchange registered as such under
Section 6 of the 1934 Act.\9\
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\7\ 7 U.S.C. 7a-1.
\8\ 15 U.S.C. 78q-1.
\9\ 15 U.S.C. 78f.
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CBOE has filed with the Securities and Exchange Commission
(``SEC'') proposed rule changes to provide for the listing and trading
on CBOE of cash-settled products characterized by CBOE as options based
on credit events in one or more debt securities of specified
``Reference Entities.'' \10\ These products are referred to as Credit
Default Options (``CDOs''), and would pay the holder a specified amount
upon the occurrence, as determined by CBOE, of a ``Credit Event,''
defined to mean an ``Event of Default'' on any debt security issued or
guaranteed by a specified ``Reference Entity.''
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\10\ See Release No. 34-55251, 72 FR 7091 (Feb. 14, 2007).
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CBOE has also filed with the SEC proposed rule changes to provide
for the listing and trading on CBOE of products called Credit Default
Basket Options (``CDBOs'').\11\ These are similar in concept to CDOs,
except that a CDBO covers more than one Reference Entity. For each
individual Reference Entity, a notional value (a fraction of the
aggregate Notional Face Value of the basket) and a recovery rate is
specified. CDBOs may be of the multiple-payout variety, or of the
single-payout variety, where a payout occurs only the first time a
Credit Event is confirmed with respect to a Reference Entity prior to
expiration.
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\11\ See SR-CBOE-2007-026.
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OCC has filed with the CFTC, pursuant to Section 5c(c) of the CEA
and Commission Regulations 39.4(a) and 40.5 thereunder,\12\ requests
for approval of rules and rule amendments that would enable OCC to
clear and settle these CDOs and CDBOs in its capacity as a registered
securities clearing agency (and not in its capacity as a DCO).\13\
Section 5c(c)(3) provides that the CFTC must approve any such rules and
rule amendments submitted for approval unless it finds that the rules
or rule amendments would violate the CEA.
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\12\ 7 U.S.C. 7a-2(c), 17 CFR Sec. Sec. 39.4(a), 40.5.
\13\ See SR-OCC-2007-01 A-1; SR-OCC-2007-06. OCC has filed
identical proposed rule changes with the SEC.
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The request for approval concerning the CDO product was filed
effective March 8, 2007. On April 23, 2007, the review period was
extended pursuant to Regulation 40.5(c) until June 6, 2007, on the
ground that the CDOs ``raise novel or complex issues, including the
nature of the contract, that require additional time for review.'' The
request for approval concerning the CDBO product was filed effective
April 23, 2007.
II. Section 4(c) of the Commodity Exchange Act
Section 4(c)(1) of the CEA empowers the CFTC to ``promote
responsible economic or financial innovation and fair competition'' by
exempting any transaction or class of transactions from any of the
provisions of the CEA (subject to exceptions not relevant here) where
the Commission determines that the exemption would be consistent with
the public interest. The Commission may grant such an exemption by
rule, regulation or order, after notice and opportunity for hearing,
and may do so on application of any person or on its own initiative. In
enacting Section 4(c), Congress noted that the goal of provision ``is
to give the Commission a means of providing certainty and stability to
existing and emerging markets so that financial innovation and market
development can proceed in an effective and competitive manner.'' \14\
As noted in the proposing release,\15\ In granting an exemption, the
CFTC need not find that the CDOs and CDBOs are (or are not) subject to
the CEA.
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\14\ HOUSE CONF. REPORT ON NO. 102-978, 1992 U.S.C.C.A.N. 3179,
3213 (``4(c) Conf. Report'').
\15\ 72 FR 27091 (May 14, 2007).
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Section 4(c)(2) provides that the Commission may grant exemptions
only when it determines that the requirements for which an exemption is
being provided should not be applied to the agreements, contracts or
transactions at issue, and the exemption is consistent with the public
interest and the purposes of the CEA; that the agreements, contracts or
transactions will be entered into solely between appropriate persons;
and that the exemption will not have a material adverse effect on the
ability of the Commission or any contract market to discharge its
regulatory or self-regulatory responsibilities under the CEA.
In the May 14, 2007 Federal Register release, the Commission
requested public comment on the matters discussed above and all issues
raised by its proposed exemptive order.
III. Comment Letters
The Commission received four comment letters. The Chicago
Mercantile Exchange (``CME'') stated that it ``applauds'' the
Commission's proposal to promote innovation but that it believed some
issues should be addressed before a final order is issued. CME argued
that: (1) It would be unfair for OCC and CBOE to receive exemptive
relief yet continue to oppose CME's efforts to list competitive
products; (2) the Commission should not accept OCC's and CBOE's
characterization of the products as options; (3) there are strong
arguments that the products are based on commodities, not securities;
and (4) it is not proper to define ``appropriate persons'' in terms of
the status of the person's intermediary.
OCC focused on the ``appropriate persons'' issue. OCC argued that
in light of the customer suitability rules and the overall federal
securities regulatory framework, the products would be limited to
``appropriate persons.''
The Chicago Board of Trade ``CBOTS'') suggested that characterizing
the CDOs and CDBOs as ``novel instruments'' should be repudiated or
clarified because it could have implications under the patent laws.
IV. Findings and Conclusions
After considering the complete record in this matter, including the
comments received, the Commission has determined that the requirements
of Section 4(c) have been met.\16\ First, the exemption is consistent
with the public interest and with the purposes of the CEA. The purposes
of the CEA include ``promot[ing] responsible innovation and fair
competition among boards of trade, other markets and market
participants.'' \17\ With respect to the competitive issue raised by
CME in its comment letter, the Commission believes that an exemptive
order in response to OCC's request for rule approval is the best way to
promote responsibile innovation and fair competition among futures
markets and securities markets. In cases such as this one where
innovative products come close to the jurisdictional line between
commodities and securities, rather than attempting to draw that line
with precision with regard to the CBOE products and thereby potentially
[[Page 32081]]
imposing litigation costs on both the private sector and the public
sector, it may be more efficient and is a proper use of Section 4(c)
exemptive authority to permit, without compromising the public
interest, the products to trade on both sides of the line and let
competitive forces determine which venue is successful.
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\16\ In this regard, consistent with the legislative history to
Section 4(c) of the CEA, the Commission is not making a finding that
CDOs and CDBO are (or are not) subject to the CEA.
\17\ CEA Section 3(b), 7 U.S.C. 5(b) (emphasis added. See also
CEA Section 4(c)(1), 7 U.S.C. 6(c)(1) (purpose of exemptions is ``to
promote responsible economic or financial innovation and fair
competition.'')
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Second, the CDOs and CDBOs would be entered into solely between
appropriate persons. This issue was discussed by both CME and OCC in
their respective comment letters. Section 4(c)(3) includes within the
term ``appropriate persons'' a number of specified categories of
persons, but also in subparagraph (K), ``such other persons that the
Commission determines to be appropriate in light of * * * the
applicability of appropriate regulatory protections.'' (Emphasis
added.) These products will be traded on a regulated exchange. CBOE,
OCC, and their members who will intermediate these transactions, are
subject to extensive and detailed oversight by the SEC and, in the case
of the intermediaries, the securities self-regulatory organizations. It
should be noted that CME has listed or will list comparable products
and has not limited access to its markets to specified categories of
persons. In light of where the products will be traded, the regulatory
protections available under the securities laws, and the goal of
promoting fair competition, these products will be traded by
appropriate persons.
Third, the exemption would not have a material adverse effect on
the ability of the Commission or any designated contract market to
carry out their regulatory responsibilities under the CEA. There is no
reason to believe that granting an exemption here would interfere with
the Commission's or a designated contract market's ability to oversee
the trading of similar products on a designated contract market or
otherwise to carry out their duties. None of the comment letters
received addressed this issue.\18\
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\18\ Under Section 4(c) of the CEA, the Commission need not
resolve whether, as CME argues in its comment letter, these products
are based on commodities and not securities, or, as CBOE argues in
its comment letter, these products are securities subject to the
securities laws. Nor need the Commission determine, as CME urges,
whether the products are properly characterized as options. Finally,
the Commission notes that its references to the novelty of the
issues raised by these products refer to issues under the CEA and
were not intended to be applicable in any matter relating to patent
or intellectual property law.
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Therefore, upon due consideration, pursuant to its authority under
Section 4(c) of the CEA, the Commission hereby issues this Order and
exempts the trading and clearing of CDOs and CDBOs to be listed and
traded on CBOE and cleared through OCC as a securities clearing agency
from the CEA. This Order is contingent upon the approval by the SEC,
pursuant to Section 19(b) of the 1934 Act, of CBOE and OCC rules to
permit the listing and trading of CDOs and CDBOs on CBOE. This Order is
subject to termination or revision, on a prospective basis, if the
Commission determines upon further information that this exemption is
not consistent with the public interest. If the commission believes
such exemption becomes detrimental to the public interest, the
Commission may revoke this Order on its own motion.
V. Related Matters
A. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \19\ 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. The order would not require a new
collection of information from any entities that would be subject to
the order.
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\19\ 44 U.S.C. 3507(d).
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B. Cost-Benefit Analysis
Section 15(a) of the CEA, as amended by Section 119 of the
Commodity Futures Modernization Act of 2000 (``CFMA''),\20\ requires
the Commission to consider the costs and benefits of its action before
issuing an order under the CEA. By its terms, Section 15(a) as amended
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, Section 15(a) simply requires the Commission to
``consider the costs and benefits'' of its action.
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\20\ 7 U.S.C. 19(a).
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Section 15(a) of the CEA further specifies that costs and benefits
shall be evaluated in light of five broad areas of market and public
concern: protection of market participants and the public; efficiency,
competitiveness, and financial integrity of futures markets; price
discovery; sound risk management practices; and other public interest
considerations. Accordingly, the Commission could 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 was necessary or appropriate to protect the public
interest or to effectuate any of the provisions or to accomplish any of
the purposes of the CEA.
The order issued today is expected to facilitate market
competition. The commission has considered the costs and benefits of
the order in light of the specific provisions of Section 15(a) of the
CEA, as follows:
1. Protection of market participants and the public. Protections
for market participants and the public exist in that CBOE, OCC and
their members who will intermediate CDOs and CDBOs are subject to
extensive oversight by the SEC and, in the case of intermediaries,
securities self-regulatory organizations.
2. Efficiency, competition, and financial integrity. The exemptive
order may enhance market efficiency and competition since it could
encourage potential trading of CDOs and CDBOs on markets other than
designated contract markets. Financial integrity will not be impaired
since the CDOs and CDBOs will be cleared by OCC, a DCO and SEC-
registered clearing agency, and intermediated by SEC-registered broker-
dealers.
3. Price discovery. Price discovery may be enhanced through market
competition.
4. Sound risk management practices. OCC has described appropriate
risk-management practices that it will follow in connection with the
clearing of CDOs and CDBOs.
5. Other public interest considerations. The exemptive order may
encourage development of credit derivative products through market
competition without unnecessary regulatory burden.
The Commission requested comment on its application of these
factors in the proposing release. No comments were received.
After considering these factors, the Commission has determined to
issue this Order.
* * * * *
Issued in Washington, DC, on June 5, 2007 by the Commission.
Eileen A. Donovan,
Acting Secretary of the Commission.
[FR Doc. 07-2878 Filed 6-8-07; 8:45 am]
BILLING CODE 6351-01-M
Last Updated: June 29, 2007