FR Doc E9-28101[Federal Register: November 23, 2009 (Volume 74, Number 224)]
[Notices]
[Page 61116-61117]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr23no09-40]
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COMMODITY FUTURES TRADING COMMISSION
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-61020]
Joint Order To Exclude Indexes Composed of Certain Index Options
From the Definition of Narrow-Based Security Index Pursuant to Section
1a(25)(B)(vi) of the Commodity Exchange Act and Section 3(a)(55)(C)(vi)
of the Securities Exchange Act of 1934
AGENCY: Commodity Futures Trading Commission and Securities and
Exchange Commission.
ACTION: Joint order.
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SUMMARY: The Commodity Futures Trading Commission (``CFTC'') and the
Securities and Exchange Commission (``SEC'') (collectively,
``Commissions'') by joint order under the Commodity Exchange Act
(``CEA'') and the Securities Exchange Act of 1934 (``Exchange Act'')
are excluding certain security indexes from the definition of ``narrow-
based security index.'' Specifically, the Commissions are excluding
from the definition of the term ``narrow-based security index'' certain
volatility indexes composed of series of index options on broad-based
security indexes.
DATES: Effective Date: November 17, 2009.
FOR FURTHER INFORMATION CONTACT:
CFTC: Thomas M. Leahy, Jr., Branch Chief, Market and Product Review
Section, Division of Market Oversight, telephone: (202) 418-5278 or
Julian E. Hammar, Assistant General Counsel, telephone: (202) 418-5118,
Commodity Futures Trading Commission, 1155 21st Street, NW.,
Washington, DC 20581.
SEC: Richard R. Holley III, Senior Special Counsel, Division of
Trading and Markets, Securities and Exchange Commission, 100 F Street,
NE., Washington, DC 20549. Telephone (202) 551-5614.
SUPPLEMENTARY INFORMATION:
I. Background
Futures contracts on single securities and on narrow-based security
indexes (collectively, ``security futures'') are jointly regulated by
the CFTC and the SEC.\1\ To distinguish between security futures on
narrow-based security indexes, which are jointly regulated by the
Commissions, and futures contracts on broad-based security indexes,
which are under the exclusive jurisdiction of the CFTC, the CEA and the
Exchange Act each includes an objective definition of the term
``narrow-based security index.'' A futures contract on an index that
meets the definition of a narrow-based security index is a security
future. A futures contract on an index that does not meet the
definition of a narrow-based security index is a futures contract on a
broad-based security index.\2\
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\1\ See Section 1a(31) of the CEA and Section 3(a)(55)(A) of the
Exchange Act, 7 U.S.C. 1a(31) and 15 U.S.C. 78c(a)(55)(A).
\2\ See 17 CFR 41.1(c).
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Section 1a(25)(A) of the CEA \3\ and Section 3(a)(55)(B) of the
Exchange Act \4\ provide that an index is a ``narrow-based security
index'' if, among other things, it meets one of the following four
criteria:
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\3\ 7 U.S.C. 1a(25)(A).
\4\ 15 U.S.C. 78c(a)(55)(B).
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(i) The index has nine or fewer component securities;
(ii) any component security of the index comprises more than 30
percent of the index's weighting;
(iii) the five highest weighted component securities of the index
in the aggregate comprise more than 60 percent of the index's
weighting; or
(iv) the lowest weighted component securities comprising, in the
aggregate, 25 percent of the index's weighting have an aggregate dollar
value of average daily trading volume of less than $50,000,000 (or in
the case of an index with 15 or more component securities,
$30,000,000), except that if there are two or more securities with
equal weighting that could be included in the calculation of the lowest
weighted component securities comprising, in the aggregate, 25 percent
of the index's weighting, such securities shall be ranked from lowest
to highest dollar value of average daily trading volume and shall be
included in the calculation based on their ranking starting with the
lowest ranked security.
The first three criteria evaluate the composition and weighting of
the securities in the index. The fourth criterion evaluates the
liquidity of an index's component securities.
Section 1a(25)(B)(vi) of the CEA \5\ and Section 3(a)(55)(C)(vi) of
the Exchange Act \6\ provide that, notwithstanding the above criteria,
an index is not a narrow-based security index if a contract of sale for
future delivery on the index is traded on or subject to the rules of a
board of trade and meets such requirements as are jointly established
by rule, regulation, or order by the Commissions. Pursuant to that
authority, the Commissions may jointly exclude an index from the
definition of the term ``narrow-based security index.''
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\5\ 7 U.S.C. 1a(25)(B)(vi).
\6\ 15 U.S.C. 78c(a)(55)(C)(vi).
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Using this authority, on March 25, 2004, the Commissions issued a
joint order excluding volatility indexes that satisfy certain
conditions from the definition of ``narrow-based security index''.\7\
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\7\ See Securities Exchange Act Release No. 49469 (March 25,
2004), 69 FR 16900 (March 31, 2004) (``2004 Joint Order'').
Following the issuance of the 2004 Joint Order, the CBOE Futures
Exchange, LLC listed for trading futures contacts on the CBOE
Volatility Index (``VIX'').
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II. Discussion
The statutory definition of the term ``narrow-based security
index'' is designed to distinguish among indexes composed of individual
stocks. As a result, certain aspects of that definition are designed to
take into account the trading patterns of individual stocks rather than
those of other types of exchange-traded securities, such as security
index options. However, the Commissions believe that the definition is
not limited to indexes on individual stocks. In fact, Section
1a(25)(B)(vi) of the CEA \8\ and Section 3(a)(55)(C)(vi) of the
Exchange Act \9\ give the Commissions joint authority to make
determinations with respect to security indexes that do not meet the
specific statutory criteria.
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\8\ 7 U.S.C. 1a(25)(B)(vi).
\9\ 15 U.S.C. 78c(a)(55)(C)(vi).
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The Commissions believed, when issuing the 2004 Joint Order
excluding certain volatility indexes from the definition of ``narrow-
based security index,'' that certain volatility indexes were
appropriately classified as broad-based because they measure the
magnitude of changes in the level of an underlying index that is a
broad-based security index. Further, the Commissions noted that they
believed that futures contracts on volatility indexes that satisfied
the conditions set forth in the 2004 Joint Order should not be readily
susceptible to manipulation. The Commisions believed that those
conditions reduce the ability to manipulate the price of the futures
contracts through manipulation of the options comprising the volatility
index.
Eurex \10\ has requested that the Commissions exclude the VDAX-
NEW[supreg] volatility index from the definition of ``narrow-based
security index.'' \11\ According to Eurex, this volatility index
[[Page 61117]]
meets all the conditions set forth in the 2004 Joint Order, except the
sixth condition, which requires that ``[o]ptions on the Underlying
Broad-Based Security Index * * * [be] listed and traded on a national
securities exchange registered under section 6(a) of the Exchange
Act.'' \12\ The Commissions note that a volatility index based on index
options traded on a foreign exchange, such as the VDAX-NEW[supreg],
would be unable to satisfy this condition.
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\10\ Eurex Deutschland is operated by Eurex Frankfurt AG
(hereinafter ``Eurex Deutschland'' and ``Eurex Frankfurt AG''
together are referred to as ``Eurex'').
\11\ See Letter from Paul M. Architzel, Alston & Bird, LLP, to
Nancy Morris, Secretary, SEC, and Eileen Donovan, Acting Secretary,
CFTC, dated December 18, 2006.
\12\ See 2004 Joint Order, supra note 7, 69 FR at 16901.
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In the 2004 Joint Order the Commissions stated, with respect to the
sixth condition, that:
Given the novelty of volatility indexes, the Commissions believe
at this time that it is appropriate to limit the component
securities to those index options that are listed for trading on a
national securities exchange where the Commissions know pricing
information is current, accurate and publicly available.\13\
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\13\ See id.
In response to Eurex's request, the Commissions believe that
certain volatility indexes should be excluded from the definition of
``narrow-based security index'' if the index options used to calculate
the magnitude of change in the level of the underlying broad-based
security index are listed for trading on an exchange and pricing
information for the underlying broad-based security index, and options
on such index, is computed and disseminated in real-time though major
market data vendors. For purposes of this Order, the Commissions would
consider such pricing information to be current, accurate, and publicly
available.
The Commissions believe that, when pricing information for the
index underlying a volatility index and for the index options that
compose the volatility index is current, accurate, and publicly
available, it would minimize the ability to manipulate the index
options used to calculate the volatility index. As a result, futures
contracts on such a volatility index would not be readily susceptible
to manipulation.
Therefore, the Commissions believe that an alternative to the sixth
condition in the 2004 Joint Order, which requires that the component
securities of a volatility index (i.e., options on the underlying
broad-based index) be listed for trading on a national securities
exchange registered pursuant to Exchange Act Section 6(a), would be
appropriate in certain circumstances. The Commissions believe that it
is appropriate to permit the component securities of a volatility index
to be listed for trading on any exchange, provided that pricing
information for the underlying broad-based security index, and the
options on such index that compose the volatility index, is current,
accurate, and publicly available. Specifically, the new sixth condition
would require such pricing information to be computed and disseminated
in real-time through major market data vendors.
In addition to the alternative sixth condition discussed above, a
volatility index would have to satisfy the other conditions in the 2004
Joint Order, which are set forth below.\14\ The Commissions also
reaffirm the rationale for those conditions stated in the 2004 Joint
Order.
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\14\ The Commissions note that nothing in this joint order
should be construed as repealing or otherwise revoking the 2004
Joint Order.
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Accordingly,
It is ordered, pursuant to Section 1a(25)(B)(vi) of the CEA and
Section 3(a)(55)(C)(vi) of the Exchange Act, that an index is not a
narrow-based security index and is therefore a broad-based security
index, if:
(1) The index measures the magnitude of changes in the level of an
underlying broad-based security index that is not a narrow-based
security index as that term is defined in Section 1a(25) of the CEA and
Section 3(a)(55) of the Exchange Act over a defined period of time,
which magnitude is calculated using the prices of options on the
underlying broad-based security index and represents (a) an annualized
standard deviation of percent changes in the level of the underlying
broad-based security index, (b) an annualized variance of percent
changes in the level of the underlying broad-based security index, or
(c) on a non-annualized basis, either the standard deviation or the
variance of percent changes in the level of the underlying broad-based
security index;
(2) The volatility index has more than nine component securities,
all of which are options on the underlying broad-based security index;
(3) No component security of the volatility index comprises more
than 30% of the volatility index's weighting;
(4) The five highest weighted component securities of the
volatility index in the aggregate do not comprise more than 60% of the
volatility index's weighting;
(5) The average daily trading volume of the lowest weighted
component securities in the underlying broad-based security index upon
which the volatility index is calculated (those comprising, in the
aggregate, 25% of the underlying broad-based security index's
weighting) has a dollar value of more than $50,000,000 (or $30,000,000
in the case of an underlying broad-based security index with 15 or more
component securities), except if there are two or more securities with
equal weighting that could be included in the calculation of the lowest
weighted component securities comprising, in the aggregate, 25% of the
underlying broad-based security index's weighting, such securities
shall be ranked from lowest to highest dollar value of average daily
trading volume and shall be included in the calculation based on their
ranking starting with the lowest ranked security;
(6) The index options used to calculate the magnitude of change in
the level of the underlying broad-based security index are listed for
trading on an exchange and pricing information for the underlying
broad-based security index, and options on such index, is computed and
disseminated in real-time through major market data vendors; and
(7) The aggregate average daily trading volume in options on the
underlying broad-based security index is at least 10,000 contracts
calculated as of the preceding 6 full calendar months.
By the Commodity Futures Trading Commission.
Dated: November 17, 2009.
David A. Stawick,
Secretary.
By the Securities and Exchange Commission.
Dated: November 17, 2009.
Elizabeth M. Murphy,
Secretary.
[FR Doc. E9-28101 Filed 11-20-09; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: November 23, 2009