FR Doc E8-21865[Federal Register: September 18, 2008 (Volume 73, Number 182)]
[Proposed Rules]
[Page 54097-54106]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr18se08-25]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1 and 38
Execution of Transactions: Regulation 1.38 and Guidance on Core
Principle 9
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rules.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is re-proposing a number of amendments to its rules, guidance
and acceptable practices, initially proposed on July 1, 2004,\1\
concerning trading off the centralized market, including the addition
of guidance on contract market block trading rules and exchanges of
futures for commodities or derivatives positions. The Commission is re-
proposing these amendments and requesting comment as part of its
continuing efforts to update its regulations in light of the Commodity
Futures Modernization Act of 2000 (``CFMA'').
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\1\ 69 FR 39880.
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DATES: Comments must be received by November 17, 2008.
ADDRESSES: Comments should be sent to the Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington,
DC 20581, attention: Office of the Secretariat. Comments may be sent by
facsimile transmission to 202-418-5521 or, by e-mail to
[email protected]. Reference should be made to ``Proposed Rules for
Trading Off the Centralized Market.'' Comments may also be submitted by
connecting to the Federal eRulemaking Portal at http://
www.regulations.gov and following comment submission instructions.
FOR FURTHER INFORMATION CONTACT: Gabrielle A. Sudik, Special Counsel,
Division of Market Oversight; Telephone 202-418-5171; e-mail
[email protected]; Commodity Futures Trading Commission, Three Lafayette
Center, 1155 21st Street, NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
Commission Regulation 1.38 (17 CFR 1.38) sets forth a requirement
that all purchases and sales of a commodity for future delivery or a
commodity option on or subject to the rules of a designated contract
market (``DCM'') should be executed by open and competitive methods.
This ``open and competitive'' requirement is modified by a proviso that
allows transactions to be executed in a ``non-competitive'' manner if
the transaction is in compliance with DCM rules specifically providing
for the non-competitive execution of such transactions, and such rules
have been submitted to, and approved by, the Commission.
The Commodity Futures Modernization Act of 2000 (``CFMA''),\2\
which was enacted after Regulation 1.38 was promulgated,\3\
significantly changed the Federal regulation of commodity futures and
option markets by replacing ``one-size-fits-all'' regulation with
broad, flexible core principles.\4\ At the same time, the CFMA modified
section 3 of the Commodity Exchange Act (``Act'') (7 U.S.C. 1 et seq.),
making a finding that transactions subject to the Act provide ``a means
for managing and assuming price risks, discovering prices, or
disseminating pricing information through trading in liquid, fair and
financially secure trading facilities,'' and providing that the purpose
of the Act is now, among other things, ``to deter and prevent price
manipulation or any other disruptions to market integrity; to ensure
the financial integrity of all transactions subject to this Act and the
avoidance of systemic risk; to protect all market participants from
fraudulent or other abusive sales practices and misuses of customer
assets. * * * '' \5\ The CFMA also expanded the types of transactions
that could lawfully be executed off the centralized market.
Specifically, the CFMA permits DCMs to establish trading rules that:
(1) Authorize the exchange of futures for swaps; or (2) allow a futures
commission merchant, acting as principal or agent, to enter into or
confirm the execution of a contract for the purchase or sale of a
commodity for future delivery if the contract is reported, recorded, or
cleared in accordance with the rules of a contract market or
derivatives clearing organization.\6\ At the same time, exchanges must
balance such rules with Core Principle 9 (7 U.S.C. 5(d)(9)) (Execution
of transactions), which states ``The board of trade shall provide a
competitive, open, and efficient market and mechanism for executing
transactions.''
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\2\ Public Law 106-554, 114 Stat. 2763 (2000). Under the CFMA,
such DCM rules may be effected by the certification procedures set
forth in section 5c(c) of the Commodity Exchange Act and 40.6 of the
Commission's regulations.
\3\ Regulation 1.38 was originally adopted in 1953 by the
Commodity Exchange Authority, the predecessor of the Commission. See
18 FR 176 (Jan. 19, 1953). For subsequent amendments, see 31 FR 5054
(Mar. 29, 1966), 41 FR 3191 (Jan. 21, 1976, eff. Feb. 20, 1976), and
46 FR 54500 (Nov. 3, 1981, eff. Dec. 3, 1981).
\4\ The CFMA was intended, in part, ``to promote innovation for
futures and derivatives.'' Sec. 2 of the CFMA. It was also intended
``to reduce systemic risk,'' and ``to transform the role of the
[Commission] to oversight of the futures markets.'' Id.
\5\ 7 U.S.C. Sec. 5 (2000).
\6\ See Section 7(b)(3) of the Act.
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In 2001, the Commission promulgated regulations implementing
provisions of the CFMA that established procedures relating to trading
facilities, interpreted certain of the CFMA's provisions, and provided
guidance on compliance with various of its requirements.\7\ Later, in
2002, the Commission promulgated amendments to those regulations in
response to issues that had arisen in administering the rules, noting
that the Commission would consider ``additional amendments to the rules
implementing the CFMA based upon further administrative experience.''
\8\ Consistent with that rationale, the Commission now proposes to
amend Commission Regulation 1.38 and Commission guidance and acceptable
practices concerning Core Principle 9 as it relates to Commission
Regulation 1.38 to include changes that the Commission has developed
based upon its experience administering those provisions.
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\7\ See 66 FR 14262 (Mar. 9, 2001) and 66 FR 42256 (Aug. 10,
2001).
\8\ See 67 FR 20702 (Apr. 26, 2002) and 67 FR 62873 (Oct. 9,
2002).
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[[Page 54098]]
II. Discussion of the Proposed Rule Amendments, Guidance and Acceptable
Practices
A. The Commission's July 1, 2004 Notice of Proposed Rulemaking
On July 1, 2004, the Commission published proposed amendments to
Regulation 1.38 and Commission guidance concerning Core Principle 9,
found in Appendix B to Part 38 of the Commission's Regulations (17 CFR
Part 38) (the ``July 1, 2004 NPRM'').\9\ The Commission proposed to
update the language of Regulation 1.38 to more accurately identify the
types of transactions that may lawfully be executed off a contract
market's centralized market and to simplify the language of the
Regulation. The Commission also wished to provide more detail regarding
acceptable practices for how contract markets can satisfy the
requirements of Core Principle 9, particularly on four general topics:
Electronic trading systems, general provisions for transactions off the
centralized market, block transactions, and the exchange of futures for
a commodity or a derivatives position.
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\9\ 69 FR 39880 (July 1, 2004).
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The Commission received seven comment letters in response to the
July 1, 2004 NPRM: From the Chicago Mercantile Exchange (``CME''), the
Futures Industry Association (``FIA''), the Chicago Board of Trade
(``CBOT''), the U.S. Futures Exchange (``USFE'') (two letters), the DRW
Trading Group (``DRW''), and Man Financial. The comments addressed
eight general areas of concern: The proposed amendments to Regulation
1.38, the Commission's proposed guidance for compliance with Core
Principle 9 in general, block trading in general, the minimum size of
block transactions, block trade prices, the time within which parties
must report block trades to the exchange, block trades between
affiliated parties, and the exchange of futures for a commodity or a
derivatives position. Some comments offered specific recommendations
regarding the proposed amendments, while other comments were of a more
general nature.
Between the publication of the July 1, 2004 NPRM and this current
proposal, the Commission has continued to gain experience in
administering Regulation 1.38 and Core Principle 9. Staff has also
learned more about the common practices involved in transactions done
off of the centralized market from the comment letters received, from
informal interviews with various entities in the futures industry, from
DCM rule submissions, and from informal studies of trading data related
to off-centralized-market transactions. In light of this, as well as
the length of time that has passed since the July 1, 2004 NPRM, the
Commission has determined to re-propose amendments to Regulation 1.38
and the guidance to Core Principle 9. Commenters are invited to submit
feedback on all areas of this proposal, including those areas already
addressed in earlier comment letters.
B. Core Principle 9 Guidance and Acceptable Practices
This proposal contains regulations, guidance and acceptable
practices. Commission regulations, such as Regulation 1.38, are
requirements that all contract markets must follow. Such regulations go
beyond mere illustrations of how a contract market may comply with a
section of the Act; they are requirements that stand alone and that the
Commission believes are necessary in order to comply with the Act. In
issuing guidance, the Commission strives to offer advice about how
contract markets can ensure compliance with sections of the Act. The
Commission recognizes that in certain areas there is more than one
possible approach that would allow a contract market to comply with a
related Section of the Act. For example, as will be discussed below,
there can be more than one way to determine an appropriate minimum size
for block trades. The Commission offers guidance on such subjects in an
effort to inform the exchanges of what it believes are some reasonable
approaches to take when tackling such issues and concerns to be
addressed in complying with Core Principles. The acceptable practices
provide examples of how exchanges may satisfy particular requirements
of the Core Principles; they do not establish mandatory means of
compliance.\10\ Acceptable practices are more specific than guidance.
An exchange rule modeled after an acceptable practice will be presumed
to comply with the related Core Principle, since the Commission has
already found such practice complies with that Core Principle. The
Commission wishes to emphasize that acceptable practices are intended
to assist DCMs by establishing non-exclusive safe harbors.\11\ The
introduction to Appendix B to Part 38 makes it clear that the
acceptable practices in Appendix B are not the sole means of achieving
compliance with the Act:
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\10\ See Section 5c(a) of the Act 7 U.S.C. 7a-2(a).
\11\ The Commission notes that safe harbor treatment applies
only to compliance with the specific aspect of the Core Principle in
question. In this regard, an exchange rule that meets a safe harbor
will not necessarily protect the exchange or market participants
from charges of violations of other sections of the Act or other
aspects of the Core Principle.
Acceptable practices meeting the requirements of the core
principles are set forth in paragraph (b) following each core
principle. Boards of trade that follow the specific practices
outlined under paragraph (b) for any core principle in this appendix
will meet the applicable core principle. Paragraph (b) is for
illustrative purposes only, and does not state the exclusive means
for satisfying a core principle.\12\
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\12\ See also A New Regulatory Framework for Trading Facilities,
Intermediaries and Clearing Organizations Proposed Rules, 66 FR
14262, 14263 (March 9, 2001).
The Commission also notes that it drafted the acceptable practices
based on its experience in reviewing exchange rules and in considering
related matters currently facing the Commission. The acceptable
practices provided in the proposal are, in large measure, modeled on
exchange rules that have previously been found to satisfy the
requirements of Core Principle 9. The Commission does not mean to imply
that it will find other rules unacceptable. Indeed, some of the
acceptable practices explicitly note that a DCM could adopt rules that
differ from the acceptable practice, although any such deviation would
still require the DCM and parties to trades to comply with Core
Principle 9, as required by section 5(d)(1) of the Act.
The Commission believes that its proposed issuance of guidance and
acceptable practices will generally ease the burden on exchanges in
complying with Core Principle 9. Without the adoption of these
amendments, DCMs are without any meaningful guidance as to whether
their requirements for trading off the centralized market comply with
Core Principle 9. These amendments provide certainty for those rules
that fall under an acceptable practice, while the burden for those that
fall outside of the acceptable practices is no greater than before. The
Commission believes that it would not be appropriate to lessen the
specificity of the acceptable practices because doing so would render
the guidance meaningless.
C. General Changes to the Re-Proposed Amendments
The amendments proposed in this rulemaking are in large measure
substantively similar to what was proposed in the July 1, 2004 NPRM.
This proposal, like its predecessor, strives to update the language of
Regulation 1.38 to more accurately
[[Page 54099]]
identify the types of transactions that may lawfully be executed off of
a contract market's centralized market and to simplify the language of
the Regulation. The proposed language also updates Regulation 1.38 to
make it clear that DCMs may self-certify (not just seek approval for)
rules or rule amendments related to transactions off the centralized
marketplace. This proposed amendment is consistent with section 5c(c)
of the Act, which allows for the certification of any DCM rule or rule
amendment.
In addition, Regulation 1.38 requires, subject to certain
exceptions, that all purchases and sales of a commodity for future
delivery or a commodity option on or subject to the rules of a DCM
should be executed by open and competitive methods. The implicit
assumption in Regulation 1.38 is that trading should take place on the
centralized market unless there is a compelling reason to allow certain
transactions to take place off the centralized market. Similarly,
exchange rules and policies that allow such transactions should ensure
that the impact on the centralized market is kept to a minimum. For
example, certain types of off-centralized market transactions, such as
block trades and exchanges of futures for related positions, can create
new positions or reduce prior positions. If these transactions become
the exclusive or predominant method of establishing or offsetting
positions in a particular market, it might jeopardize the centralized
market's role in price discovery and would not comply with Core
Principle 9, which provides that trading be competitive, open and
efficient.\13\ Other types of off-centralized market transactions are
bookkeeping in nature, such as transfer trades or office trades, which
move existing positions between accounts. These transactions do not
affect the price discovery mechanism of the centralized market because
they do not establish or offset positions.
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\13\ See also, section 3(a) of the Act, which finds that
transactions subject to the Act provide ``a means for managing and
assuming price risks, discovering prices, or disseminating pricing
information through trading in liquid, fair and financially secure
trading facilities.'' Using the example above, markets on which
transactions are exclusively or predominantly carried out by blocks
are not liquid markets. Furthermore, it has been questioned whether
markets are fair if they do not offer viable centralized trading.
This also calls into question such a market's compliance with
designation criterion 3, 7 U.S.C. 7(b)(3), which requires the
exchange to establish and enforce trading rules to ensure fair and
equitable trading through the facilities of the contract market.
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This proposed rulemaking also addresses the same four general
topics under Core Principle 9 that were addressed in the July 1, 2004
NPRM: Electronic trading systems, general provisions for transactions
off the centralized market, block transactions, and the exchange of
futures for a commodity or a derivatives position.
The majority of changes made since the July 1, 2004 NPRM strive to
do one of two things. First, the Commission has attempted to clarify
any language that was ambiguous, particularly in response to questions
raised in the comment letters. Second, the proposed acceptable
practices under Core Principle 9 have been redrafted to more closely
resemble the language of the acceptable practices for the other Core
Principles. The Commission believes that in addition to harmonizing the
language of the acceptable practices, these changes make the language
of the acceptable practices easier to read.
The Commission has made more significant changes to the proposed
amendments in three areas, based on the comment letters received, as
well as the Commission's own experience in administering Regulation
1.38 and Core Principle 9. These three areas, discussed in more detail
below, concern the appropriate minimum size of block trades; when block
trades may be permitted between affiliated parties; and exchanges of
futures for a commodity or derivatives position, including the
permissibility of transitory exchanges of futures for a commodity or
derivatives position (``transitory EFPs'').
D. The Minimum Size of Block Trades
In the July 1, 2004 NPRM the Commission proposed that an acceptable
minimum size for block trades would be at a level larger than 90% of
the transactions in a relevant market (``90% threshold'') or, for new
contracts with no relevant market, 100 contracts. CME, CBOT, DRW, FIA
and USFE all offered comments regarding those proposed acceptable
practices. CME and CBOT disagreed with the Commission's proposed
minimum sizes of the 90% threshold and 100 contracts: CME thought the
numbers were arbitrary, unresponsive to market needs and inconsistent
with the Commission's oversight role. Similarly, CBOT believed there
may be instances where 90% or 100 contracts could be too high or not
high enough. CBOT suggested that an acceptable minimum block trade size
be at the point where the block would move the market or where the
customer would not be able to obtain a fair price or fill the order on
the centralized market.
DRW suggested that the Commission clarify its intent that the
minimum block trade size should be derived from the size of trades in
the entire relevant market, which should include the central market,
related derivatives markets and the cash market. DRW also suggested
that using the 90% threshold would result in artificially low minimums
because many transactions in the central market are often broken down
into smaller trades at the same price. DRW suggested tying the minimum
block trade size to the size of orders instead of trades or by
developing a risk-based system that would consider both outright and
spread transactions.
USFE seemed to imply that the 90% threshold should be lower for
options than for futures. USFE noted that options transactions,
particularly combination trades, are more complex than futures trades
and require more human intervention than other trades. The options
market is therefore more conducive to trading off the centralized
market. While USFE did not suggest a different minimum threshold for
options, it indicated that more off-centralized-market trading of
options was necessary until technology could accommodate complex
options positions on the electronic trading screen.
In response to these comments, as well as the Commission's own
increased knowledge about block trades, the Commission is changing the
proposed guidance and acceptable practices on this topic. In this
regard, the Commission's guidance for determining appropriate minimum
sizes relies on the purpose for allowing block trades. Block trades are
allowed to be transacted off the centralized market for two reasons.
First, prices attendant to the execution of large transactions on the
centralized market may diverge from prevailing market prices that
reflect supply and demand of the commodity. This is because the
centralized market may not provide sufficient liquidity to execute
large transactions without a significant risk premium, so that the
prices of such trades tend to reflect, to a significant degree, the
cost of executing the trade. Accordingly, reporting these prices as
conventional market trades would be misleading to the public. Second,
block trading facilitates hedging by providing a means for commercial
firms to transact large orders without the need for significant price
concessions and resulting price uncertainty for parties to the
transaction that would occur if transacted on the centralized market.
Using these reasons as guidance, block trades should be limited to
large orders, where ``large'' is the number at which there is a
reasonable expectation that
[[Page 54100]]
the order could not be filled in its entirety at a single price, but
would need to be broken up and executed at different prices if
transacted in the centralized marketplace. As such, the proposed
guidance notes that minimum block trade sizes should be larger than the
size at which a single buy or sell order is customarily able to be
filled in its entirety at a single price (though not necessarily with a
single counterparty) in that contract's centralized market, and
exchanges should determine a fixed minimum number of contracts needed
to meet this threshold.
The Commission now believes that its previous means of determining
an appropriate minimum size--the 90% threshold--may not be appropriate
for all markets because this figure does not necessarily correspond
with the size of the order that would move the market price. Because
the determination of what constitutes a large trade will vary between
DCMs, contracts and even over time, the acceptable practices will not
set forth an explicit threshold, but will instead leave it to the DCMs
to determine appropriate minimum sizes, based on the above purpose.\14\
This new approach should also address DRW's concern that using trade
size alone to determine a threshold might result in lower-than-
appropriate minimum sizes, because breaking an order into several small
trades ideally should not affect the overall volume or liquidity of the
centralized market. Similarly, the presence of many small trades
submitted by multiple traders will also not artificially lower the
appropriate minimum block trade size. The Commission also understands
that, as exchange volume migrates from floor trading to electronic
trading, the average size of transactions tends to decrease, resulting
in artificially low 90% thresholds and minimum block trade sizes that
are too low given the criteria discussed above.
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\14\ In this regard, the guidance could result in different DCMs
arriving at different minimum size requirements for the same or
similar futures contracts, if the liquidity and volume on each DCM
is different.
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One method by which DCMs could determine what number of contracts
is an appropriate minimum size would be to assess the market liquidity
(the number of contracts the centralized market is able to absorb at
the best execution price) and market depth (which measures the
potential price slippage if a large order were to be executed in the
centralized market). For example, a DCM could examine a contract's
market liquidity over time and determine that a certain size order in
that contract could rarely, if ever, be filled in its entirety at the
best price, and set a minimum block trade size based on this data. Such
calculations should be re-examined periodically, as volume, liquidity
and market depth change over time to ensure that a contract's minimum
block trade size remains appropriate. Such an analysis would most
easily be done for an electronically-traded contract, since trade data
about the contract is easy to gather and analyze.
Calculating a minimum size based on market liquidity and depth is
not the only possible way to determine what size order should be
considered ``large.'' DCMs could employ other methods to reasonably
determine what size order would move the price in the centralized
market. For instance, along with a review of trade sizes and/or order
sizes, DCMs could interview experienced floor brokers and floor traders
to determine what size order is generally too large to fill at a single
price. This method might be most appropriate for open-outcry markets
because DCMs will not have the same type of trade data generated by
electronic trading platforms, and will not as easily be able to
determine, based on electronic data, what size order is ``large.''
For new contracts that have no trading history, a DCM should strive
to set its initial minimum block trade size based on what the DCM
reasonably believes will be a ``large'' order (i.e., the order size
that would likely move the market price). So, for example, the DCM
might base its initial minimum block trade size on sources of data
other than transaction data in that particular contract such as
transaction patterns in related futures or cash markets, the DCM's
experience regarding other newly-launched contracts, and/or a survey of
potential market users to determine how many contracts might be
executed in a typical transaction. Where a DCM is unable to determine
an appropriate minimum size (due, for instance, to the lack of data in
other markets or other methods for estimating an appropriate minimum
size), the Commission believes it would be an acceptable practice for a
DCM to set the minimum block trade size at 100 contracts. In the past,
the Commission has considered 100 contracts to be a reasonable figure
to use as the minimum size until enough market data exist to allow that
figure to be adjusted, if need be. Once there is adequate trade data to
re-evaluate the minimum size, the DCM should ensure that it be adjusted
to a level where a trade would move the centralized market, if traded
there.
In this regard, the Commission proposes as an acceptable practice
that DCMs review the minimum size thresholds for block trades no less
frequently than on a quarterly basis to ensure that the minimum sizes
remain appropriate for each contract. As noted in the proposed
guidance, such review should take into account the sizes of trades in
the centralized market and the market's volume and liquidity. This
review and any necessary adjustments should be made to both new and
existing contracts. In addition, quarterly reviews of minimum block
trade sizes should take into account whether the minimum sizes ensure
that block trades remain the exception, rather than the rule. As noted
above, transactions off the centralized market should remain an
exception as the expectation is that most trading will occur on the
centralized market. Exchanges that established their minimum sizes for
block trades long ago may find they need to adjust their minimum sizes
as a result of changes in volume, liquidity, or the typical sizes of
transactions in the respective market.
Finally, the Commission notes that DCMs are free to require a
minimum size that is larger than what the guidance suggests a ``large''
trade would be. They are not obligated to set the minimum size at the
smallest acceptable minimum size.
E. Block Trades Between Affiliated Parties
Based on comment letters and the Commission's growing experience
with implementing Core Principle 9, the Commission has determined to
revise Regulation 1.38 and the related acceptable practices regarding
block trades between affiliated parties. An affiliated party is a party
that directly or indirectly through one or more persons, controls, is
controlled by, or is under common control with another party. These
proposed changes differ from the July 1, 2004 NPRM's treatment of block
trades between affiliated parties.
Block trades between affiliated parties may be permitted by DCMs,
so long as appropriate safeguards are in place to guard against the
heightened possibility that transactions between two closely related
parties are more susceptible to abuse, such as setting unreasonable
prices, artificially boosting volume, money passing, or wash trading.
It is not always clear that two related parties are motivated solely by
their own separable best interests, since they often both report to or
are accountable to a single person or entity, and as such they may be
encouraged by those in control of both sides of the transaction to
engage in trading strategies that benefit from abusive trading
practices. It is for this reason that the Commission believes it
[[Page 54101]]
is appropriate that DCMs that allow block trades between affiliates
also include additional safeguards to guard against the heightened
possibility of abuse, and that DCMs must have rules to ensure that
these safeguards are satisfied.
The Commission proposes to amend Regulation 1.38 by requiring that
when block trades take place between affiliated parties: (i) The block
trade price must be based on a competitive market price, either by
falling within the contemporaneous bid/ask spread on the centralized
market or calculated based on a contemporaneous market price in a
related cash market; (ii) each party must have a separate and
independent legal bona fide business purpose for engaging in the
trades; and (iii) each party's decision to enter into the block trade
must be made by a separate and independent decision-maker. Under the
acceptable practices for Core Principle 9, a DCM could permit block
trades between affiliated parties that meet these requirements and are
otherwise appropriate parties to engage in block trading.\15\
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\15\ Similarly, the proposed acceptable practices regarding the
prices of block trades also include reference to Regulation 1.38 as
it relates to block trades between affiliated parties.
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The Commission believes these proposed requirements for block
trades between affiliated parties strike an appropriate balance between
making clear that such trades are allowable and ensuring that each
party is acting independently when it agrees to enter into such a
transaction. The requirement that affiliated parties who engage in a
block trade meet objective criteria regarding that block trade will
help guard against the possibility that such closely related parties
might collude in some type of abuse.
F. Exchange of Futures for a Commodity or for a Derivatives Position
In the July 1, 2004 NPRM, the Commission proposed to include
acceptable practices regarding the exchange of futures for a commodity
or derivatives position (often referred to as an exchange-for-physical
or EFP, although it also includes, but is not limited to, similar
transactions such as exchanges-for-swaps or exchanges-for-risk).
Specifically, the Commission proposed a definition of what constituted
a bona fide EFP in the Core Principle 9 acceptable practices. The
Commission received comments from FIA, CBOT and CME regarding these
acceptable practices. Among other things, the commenters requested the
Commission clarify that trades commonly known as ``transitory EFPs''
are still permitted and that third parties may effect the cash portion
of an EFP transaction.
In response to these comments and other concerns that have arisen
since the July 1, 2004 NPRM, the Commission is proposing to make two
substantive amendments to its acceptable practices regarding exchanges
of futures for a commodity or derivatives position. First, the
Commission is proposing to expand the acceptable practices regarding
EFPs' bona fides, pricing, reporting, and DCMs' publication of EFP
transactions. Second, the Commission is proposing to make clear that
transitory EFPs are permissible when each part of the transaction--the
EFP itself and the related cash transaction--is a stand-alone, bona
fide transaction.
The Commission is proposing to offer general acceptable practices
for exchange of futures for a commodity or derivatives position,
including a definition of what constitutes a bona fide EFP, the pricing
of the legs, the reporting of the transaction to the exchange, and the
exchange's obligation, consistent with Regulation 16.01, to publicize
daily the total quantity of exchanges of futures for a commodity or
derivatives position. In response to the comment letters, the
Commission is proposing to clarify in the text of the acceptable
practices that a DCM may permit a third party to facilitate the
transfer of the cash leg of an EFP, so long as the commodity or
derivatives position is passed through to the party receiving the
futures position. These provisions are meant to be consistent with
previous publications by the Commission, including the 1987 EFP Report
prepared by the Commission's then Division of Trading and Markets and
the 1998 EFP Concept Release.\16\
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\16\ DIVISION OF TRADING AND MARKETS, REPORT ON EXCHANGES OF
FUTURES FOR PHYSICALS (1987) (the 1987 EFP Report); 63 FR 3708 (Jan.
26, 1998) (the 1998 EFP Concept Release).
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The essential elements of bona fide EFPs have been provided in the
guidance to Core Principle 9 below. The proposed elements are found in
current contract market ``exchange of futures'' rules and are based on
the essential elements for bona fide EFPs detailed in the 1987 EFP
Report.\17\ The elements include separate but integrally related
transactions, an actual transfer of ownership of the commodity or
derivatives position, and both legs transacted between the same two
parties. The Commission notes that the determination whether an actual
transfer of ownership has occurred will depend upon the facts and
circumstances of each transaction. In each instance where an exchange
of futures for a commodity or for a derivatives position is linked to
another offsetting transaction, the particular facts and circumstances
may warrant a determination that there was not an actual ownership
transfer of each leg of the commodity or derivatives position.
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\17\ See generally, the 1987 EFP Report. See also, CBOT Rules
331.08; CFE Rule 414; CME Rule 538; KCBT Rules 1128.00, 1128.02,
1129.00, and 1129.02; MGE Rule 719; NYBOT Rules 4.12 and 4.13; NYMEX
Rules 6.21, 6.21A and 6.21E; and OCX Rule 416.
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Further, the Commission is proposing that the acceptable practices
relating to the bona fides of an EFP should apply to transitory EFPs as
well. A transitory EFP involves both an EFP and an offsetting cash
commodity transfer. For example, party A purchases the cash commodity
from party B and then engages in an EFP whereby A sells the cash
commodity back to B and receives a long futures position. As a result
of these two transactions, the parties acquire futures positions but
end up with the same cash market positions they had before the
transaction.
To be a legitimate transitory EFP, the cash transaction must be
bona fide and the EFP itself must be bona fide. As with an EFP, a
primary indicator of a bona fide cash transaction is the actual
transfer of ownership of the cash commodity or position. In this
regard, the cash leg of the transaction must be able to stand on its
own as a commercially appropriate transaction, and may not be
intrinsically linked to the EFP transaction. A cash commodity transfer
that cannot stand on its own may indicate that there was no actual
economic risk in the cash leg of the related EFP and may raise concerns
about whether the EFP involved an ``exchange'' of futures contracts for
cash commodity as required by Section 4c(a) of the Act. There must be
no obligation on either party that the cash transaction will require
the execution of a related EFP, or vice versa.
G. Other Proposed Acceptable Practices
The rest of the proposed acceptable practices are for the most part
similar to what was proposed in the July 1, 2004 NPRM. As with the
acceptable practices discussed more fully above, the Commission
considered the comment letters when re-drafting these acceptable
practices, and strove to clarify any ambiguities and make them easier
to read. And, as in the July 1, 2004 NPRM, the Commission notes that
these proposed acceptable practices are based in large measure on
existing DCM rules.
[[Page 54102]]
1. Block Trade Prices
In the July 1, 2004 NPRM, the Commission proposed acceptable
practices regarding the prices of block trades. The most basic element
of this acceptable practice is that prices be ``fair and reasonable.''
In its comment letter, CBOT noted an inconsistency between the text of
the July 1, 2004 NPRM proposed guidance and the preamble and also
questioned whether ``circumstances'' of the party or market could or
should be relevant in determining whether a block trade price is fair
and reasonable. In this proposal, the Commission intends to eliminate
the ambiguity and to make clear its belief that a DCM could permit
``circumstances'' to be a factor in determining whether a block trade
price was fair and reasonable. Such an approach could include, for
example, the participants' legitimate trading objectives or the
condition of the market. The Commission does not believe that
permitting such flexibility will harm the centralized market because,
regardless of how a block trade price is determined, it must still be
fair and reasonable. The ability to price the trade away from the
centralized market is not a carte blanche to set unfair or unreasonable
prices.
2. Block Trade Reporting Times
In the July 1, 2004 NPRM, the Commission proposed in its acceptable
practices that block trades should be reported to the contract market
within a reasonable period of time. In response, DRW made two
suggestions: First, that reasonable reporting times for block trades
should be as close to immediately after the completion of the trade as
possible, with a maximum of no more than 5 minutes; and second, that
parties to a block trade should not be allowed to trade in the
centralized market until information about the block trade has been
made public.
The Commission will re-propose that block trades should be reported
to the contract market within a reasonable period of time. The
Commission declines to establish a specific length of time in order to
allow exchanges to determine what an appropriate length of time should
be on a contract-by-contract basis. But the Commission notes that most
current DCM rules require reporting of block trades within 5
minutes.\18\ A small number of DCM rules allow as many as 15 minutes,
but the Commission understands these are limited to contracts that have
very high block trade minimum size thresholds or where the contracts
are typically traded as part of large and complex spreads, requiring
more time to double check details and convey the information to the
exchange.\19\ When determining length of time for parties to report
block trades, DCMs should consider the importance of providing
information about block trades to the market as well as the potential
for abuses, such as front running, and whether longer reporting periods
may heighten the potential for abuse. Additionally, staff has
previously noted that allowing a few minutes' delay between the time a
block trade is executed and reported will allow the market price to
continue to respond to prevailing supply and demand factors, and not be
unduly influenced by the block itself. In other words, a reporting
delay will help the centralized market avoid the momentary price and
volume distortion that would occur if large trades were made on the
centralized market in the first place. In regards to whether parties to
a block trade may trade in the centralized market before the block
trade information is published, the Commission believes that the
reporting window offers parties to the block trade an opportunity to
hedge or offset the trade, which in turn supplies information to the
centralized market. As such, the Commission believes that compliance
with the Core Principles does not require that DCMs restrict the
ability of parties to a block trade from making transactions on the
central marketplace before the block trade is reported. DCMs, however,
are permitted to forbid such trading.
---------------------------------------------------------------------------
\18\ See, e.g., CBOT Rule 331.05(d); CME Rule 526(F); NYMEX Rule
6.21C.
\19\ See, e.g., CME Rule 526(F).
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3. Publication of Transaction Details
The Commission is re-proposing that DCMs would publicize details
about transactions off the centralized market immediately upon the
receipt of the transaction report. The Commission wishes to clarify
that it does not intend to impose new publication requirements on DCMs
in regards to trades made off the centralized market beyond what is
required by the Commission's regulations. So, for example, DCMs would
need to publish the total number of exchanges of futures for a
commodity or for a derivatives position, as required by Commission
Regulation 16.01. But there would be no similar requirement to publish
office trades or transfer trades.
Similarly, the proposed guidance also identifies publication of
block trade details by DCMs immediately upon receipt of block trade
reports as an acceptable practice.\20\ The proposed acceptable
practices also would require the DCM to identify block trades on its
trade register.
---------------------------------------------------------------------------
\20\ This also is an element of compliance with Designation
Criterion 3 (Fair and Equitable Trading) and Core Principle 8 (Daily
Publication of Trading Information).
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4. Recordkeeping
Current Commission Regulation 1.38(b) provides that every person
handling, executing, clearing, or carrying trades, transactions or
positions that are not competitively executed, must identify and mark
by appropriate symbol or designation all such transactions or contracts
and all associated orders, records, and memoranda. In addition to
updating the language of Regulation 1.38(b), the proposed amendments
add this requirement to the guidance under Core Principle 9, in order
to provide consolidated guidance regarding recordkeeping practices
pertaining to transactions off the centralized market.
Similarly, acceptable block trade rules would require parties to,
and members facilitating, a block trade to keep appropriate records.
Appropriate block trade records would comply with the requirements of
Core Principle 10 and Core Principle 17. Records kept in accordance
with the requirements of Statement No. 133 (``Accounting for Derivative
Instruments and Hedging Activities''), issued by the Financial
Accounting Standards Board (``FASB''), would be satisfactory.\21\
Acceptable block trade rules would require that block orders be
recorded by the member and time-stamped with both the time the order
was received by the member and the time the order was executed. When
requested by the exchange, the Commission or the Department of Justice,
parties to, and members facilitating, a block trade shall provide
records to document that the block trade is executed in accordance with
contract market rules.
---------------------------------------------------------------------------
\21\ FASB Statement No. 133 provides guidance on the use of
accounting for corporate hedge activity involving derivative
transactions. The statement includes guidance on documenting the
hedging relationship.
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5. Testing of Automated Trading Systems
The guidance for Core Principle 9 also addresses the testing and
review of automated trading systems. Currently, the guidance states
that acceptable testing of automated systems should be ``objective,''
and calls for the provision of ``objective'' test results to the
Commission. The proposed guidance would also call for the provision to
the
[[Page 54103]]
Commission of test results of any ``non-objective'' testing carried out
by or for a DCM (such as informal in-house reviews) regarding the
system functioning capacity or security of any automated trading
systems. Although the results of ``non-objective'' testing would be of
more limited use, the Commission believes that test results of any
``non-objective'' testing carried out by or for the DCM should also be
provided to the Commission.
6. Parties to a Block Trade
The Commission is proposing that block trade parties are required
to be eligible contract participants (``ECPs'') as that term is defined
in Section 1a(12) of the Act, although commodity trading advisors
(``CTAs'') and investment advisors having over $25 million in assets
under management, including foreign persons performing equivalent
roles, are allowed to carry out block trades for non-ECP customers.
A majority of exchanges that permit block trading prohibit persons
from effecting block trades on behalf of customers unless the person
receives a customer's explicit instruction or prior consent to do
so.\22\ The proposed rulemaking incorporates this prohibition as an
acceptable practice.
---------------------------------------------------------------------------
\22\ See CME Rule 526(C), CFE Rule 415(a)(i), CBOT Rule
331.05(a), NYBOT Rule 4.31(a)(ii)(A), OCX Rule 417(a)(i), and USFE
Rule 415(c).
---------------------------------------------------------------------------
III. Request for Comment
The Commission requests comment on all aspects of this proposal.
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act \23\ requires federal agencies, in
proposing rules, to consider the impact of those rules on small
businesses. The rule amendments proposed herein will affect DCMs, FCMs,
CTAs and large traders. The Commission has previously established
certain definitions of ``small entities'' to be used by the Commission
in evaluating the impact of its rules on small entities in accordance
with the RFA.\24\ The Commission has previously determined that
DCMs,\25\ registered FCMs,\26\ and large traders \27\ are not small
entities for purposes of the RFA. With respect to CTAs, the Commission
has determined to evaluate within the context of a particular rule
proposal whether CTAs would be considered ``small entities'' for
purposes of the Regulatory Flexibility Act and, if so, to analyze the
economic impact on the affected entities of any such rule at that
time.\28\ The Commission believes that the instant proposed rules will
not place any new burdens on entities that would be affected hereunder,
and the Commission does not expect the proposed amendments in most
cases to cause persons to change their current methods of doing
business. This is because requirements under this proposal, if adopted,
would be similar to most existing DCM requirements.
---------------------------------------------------------------------------
\23\ 5 U.S.C. 601 et seq.
\24\ 47 FR 18618-21 (Apr. 30, 1982).
\25\ Id. at 18618-19.
\26\ Id. at 18619-20.
\27\ Id. at 18620.
\28\ Id. at 18620.
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Accordingly, the Commission does not expect the rules, as proposed
herein, to have a significant economic impact on a substantial number
of small entities. Therefore, the Chairman, on behalf of the
Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the
proposed amendments will not have a significant economic impact on a
substantial number of small entities. The Commission invites the public
to comment on this finding and on its proposed determination that the
entities covered by these rules would not be small entities for
purposes of the Regulatory Flexibility Act.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 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 proposed rule amendments do not require a new collection
of information on the part of any entities subject to these rules.
Accordingly, for purposes of the Paperwork Reduction Act of 1995, the
Commission certifies that these rule amendments do not impose any new
reporting or recordkeeping requirements.
C. Cost-Benefit Analysis
Section 15 of the Act, as amended by section 119 of the CFMA,
requires the Commission to consider the costs and benefits of its
action before issuing a new regulation. The Commission understands
that, by its terms, Section 15 does not require the Commission to
quantify the costs and benefits of a new regulation or to determine
whether the benefits of the proposed regulation outweigh its costs. Nor
does it require that each proposed regulation be analyzed in isolation
when that regulation is a component of a larger package of regulations
or of rule revisions. Rather, Section 15 simply requires the Commission
to ``consider the costs and benefits'' of its action.
Section 15(a) 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 of concern
and could, in its discretion, determine that, notwithstanding its
costs, a particular regulation was necessary or appropriate to protect
the public interest, to effectuate any of the provisions, or to
accomplish any of the purposes of the Act.
The proposed amendments constitute a package of amendments to
Regulation 1.38 and to guidance that the Commission originally
promulgated to implement the CFMA. The amendments are proposed in light
of past experience with the implementation of the CFMA and are intended
to facilitate increased flexibility and consistency. Some sections of
the proposed amendments merely clarify or make explicit past Commission
decisions concerning transactions off the centralized market.
As most provisions incorporate DCM rules previously approved by the
Commission or submitted to the Commission under its self-certification
procedures, the proposed amendments would not, in most cases, impose
new costs on DCMs or market participants. The great majority of current
DCM rules already meet the acceptable practices proposed. Furthermore,
these amendments incorporate standards that the Commission has
previously determined protect market participants and the public, the
financial integrity or price discovery function of the markets, and
sound risk management practices. Moreover, the additional clarification
of acceptable practices provides a benefit to markets and market
participants. In addition, the amendments are expected to benefit
efficiency and competition by providing more detailed guidance as to
acceptable means of meeting the applicable designation criteria and
core principles, thus allowing a greater degree of legal certainty to
the markets and market participants.
After considering the five factors enumerated in the Act, the
Commission has determined to propose the rules and rule amendments set
forth below. The Commission invites public comment on its application
of the cost-benefit provision. Commenters also are invited to submit
any data that they may have quantifying the costs and benefits of the
[[Page 54104]]
proposed rules with their comment letters.
List of Subjects
17 CFR Part 1
Block transactions, Commodity futures, Contract markets,
Transactions off the centralized market, Reporting and recordkeeping
requirements.
17 CFR Part 38
Block transactions, Commodity futures, Contract markets,
Transactions off the centralized market, Reporting and recordkeeping
requirements.
In consideration of the foregoing, the Commission hereby proposes
to amend Chapter I of Title 17 of the Code of Federal Regulations as
follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,
6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,
13a-1, 16, 16a, 19, 21, 24, and 24, as amended by the Commodity
Futures Modernization Act of 2000, Appendix E of Pub L. 106-554, 114
Stat. 2763 (2000).
2. Section 1.38 is revised to read as follows:
Sec. 1.38 Execution of transactions.
(a) Transactions on the centralized market. All purchases and sales
of any commodity for future delivery, and of any commodity option, on
or subject to the rules of a designated contract market, shall be
executed openly and competitively by open outcry, or posting of bids
and offers, or by other equally open and competitive methods, in a
place or through an electronic system provided by the contract market,
during the hours prescribed by the contract market for trading in such
commodity or commodity option.
(b) Transactions off the centralized market; requirements.
(1) Notwithstanding paragraph (a) of this section, transactions may
be executed off the centralized market, including by transfer trades,
office trades, block trades, inter-exchange spread transactions, or
trades involving the exchange of futures for commodities or for
derivatives positions, if transacted in accordance with written rules
of a contract market that provide for execution away from the
centralized market and that have been certified to or approved by the
Commission. Every person handling, executing, clearing, or carrying the
trades, transactions or positions described in this paragraph shall
comply with the rules of the appropriate contract market and
derivatives clearing organization, including to identify and mark by
appropriate symbol or designation all such transactions or contracts
and all orders, records, and memoranda pertaining thereto.
(2) Block trades between affiliated parties; requirements. An
affiliated party is a party that directly or indirectly through one or
more persons, controls, is controlled by, or is under common control
with another party. In addition to the other requirements of this
section, block trades between affiliated parties are permitted only in
accordance with written rules of a contract market that provide that:
(i) The block trade price must be based on a competitive market
price, either by falling within the contemporaneous bid/ask spread on
the centralized market or calculated based on a contemporaneous market
price in a related cash market,
(ii) Each party must have a separate and independent legal bona
fide business purpose for engaging in the trades, and
(iii) Each party's decision to enter into the block trade must be
made by a separate and independent decision-maker.
PART 38--DESIGNATED CONTRACT MARKETS
3. The authority citation for part 38 is revised to read as
follows:
Authority: 7 U.S.C. 2, 5, 6, 6c, 7 and 12a, as amended by the
Commodity Futures Modernization Act of 2000, Appendix E of Pub. L.
106-554, 114 Stat. 2763 (2000).
4. Appendix B to Part 38 is revised to read as follows:
Appendix B to Part 38--Guidance on, and Acceptable Practices in,
Compliance With Core Principles
Core Principle 9 of section 5(d) of the Act: EXECUTION OF
TRANSACTIONS--The board of trade shall provide a competitive, open,
and efficient market and mechanism for executing transactions.
(a) Guidance.
(1) Transactions on the centralized market.
(i) Purchases and sales of any commodity for future delivery,
and of any commodity option, on or subject to the rules of a
contract market shall be executed openly and competitively by open
outcry, by posting of bids and offers, or by other equally open and
competitive methods, in a place or through an electronic system
provided by the contract market, during the hours prescribed by the
contract market for trading in such commodity or commodity option.
(ii) A competitive and open market's mechanism for executing
transactions includes a contract market's methodology for entering
orders and executing transactions.
(iii) Appropriate objective testing and review of a contract
market's automated systems should occur initially and periodically
to ensure proper system functioning, adequate capacity and security.
A designated contract market's analysis of its automated system
shall address compliance with appropriate principles for the
oversight of automated systems, ensuring proper system
functionality, adequate capacity and security.
(2) Transactions off the centralized market.
(i) In order to facilitate the execution of transactions,
transactions may be executed off the centralized market, including
by transfer trades, office trades, block trades, inter-exchange
spread transactions, or trades involving the exchange of futures for
a commodity or for a derivatives position, if transacted in
accordance with written rules of a contract market that specifically
provide for execution of such transactions away from the centralized
market and that have been certified to or approved by the
Commission.
(ii) Every person handling, executing, clearing, or carrying
trades off the centralized market shall comply with the rules of the
applicable designated contract market and derivatives clearing
organization, including to identify and mark by appropriate symbol
or designation all such transactions or contracts and all orders,
records, and memoranda pertaining thereto.
(iii) A designated contract market that determines to allow
trades off the centralized market shall ensure that such trading
does not operate in a manner that compromises the integrity of price
discovery on the centralized market or facilitate illegal or non-
bona fide transactions.
(3) Block trades-minimum size.
(i) When determining the number of contracts that constitutes
the appropriate minimum size for block trades, a contract market
should ensure that block trades are limited to large transactions
and that the minimum size is appropriate for that specific contract,
by applying the principles set forth in this section. For any
contract that has been trading for one calendar quarter or longer,
the acceptable minimum block trade size should be a number larger
than the size at which a single buy or sell order is customarily
able to be filled in its entirety at a single price in that
contract's centralized market. Factors to consider in determining
what constitutes a large transaction could include an analysis of
the market's volume, liquidity and depth; a review of typical trade
sizes and/or order sizes; and input from floor brokers, floor
traders and/or market users. For any contract that has been listed
for trading for less than one calendar quarter, an acceptable
minimum block trade size in such contract should be the size of
trade the exchange reasonably anticipates will not be able to be
filled in its entirety at a single price in that contract's
centralized market. An appropriate minimum size could be estimated
based on centralized market data in a related futures contract, the
same contract traded on another exchange, or trading activity in the
underlying cash market. The exchange could also consider the
anticipated volume,
[[Page 54105]]
liquidity and depth of the contract; input from potential market
users; or consider that exchange's experience with offering similar
new contracts. The minimum size thresholds for block trades should
be reviewed periodically to ensure that the minimum size remains
appropriate for each contract. Such review should take into account
the sizes of trades in the centralized market and the market's
volume and liquidity.
(b) Acceptable practices.
(1) General matters relating to trade execution facilities.
(i) General provisions. [Reserved]
(ii) Electronic trading systems.
(A) The guidelines issued by the International Organization of
Securities Commissions (IOSCO) in 1990 (which have been referred to
as the ``Principles for Screen-Based Trading Systems''), and adopted
by the Commission on November 21, 1990 (55 FR 48670), as
supplemented in October 2000, are appropriate guidelines for a
designated contract market to apply to electronic trading systems.
(B) Any objective testing and review of the system should be
performed by a qualified independent professional. A professional
that is a certified member of the Information Systems Audit and
Control Association experienced in the industry is an example of an
acceptable party to carry out testing and review of an electronic
trading system.
(C) Information gathered by analysis, oversight, or any program
of testing and review of any automated systems regarding system
functioning, capacity and security must be made available to the
Commission upon request.
(iii) Pit trading. [Reserved]
(2) Transactions off the centralized market.
(i) General provisions.
(A) Allowable trades. Acceptable transactions off the
centralized market include: transfer trades, office trades, block
trades, inter-exchange spread transactions or trades involving the
exchange of futures for commodities or for derivatives positions, if
transacted in accordance with written rules of a contract market
that specifically provide for execution away from the centralized
market and that have been certified to or approved by the
Commission.
(B) Reporting. Transactions executed off the centralized market
should be reported to the contract market within a reasonable period
of time.
(C) Publication. The contract market should publicize details
about block trade transactions immediately upon the receipt of the
transaction report and publicize daily the total quantity of the
exchange of futures for commodities or for derivatives positions and
the total quantity of the block trades that are included in the
total volume of trading, as required by Sec. 16.01 of this chapter.
(D) Recordkeeping. Parties to, and members facilitating,
transactions off the centralized market should keep appropriate
records. Appropriate recordkeeping for transactions off the
centralized market would comply with Core Principle 10 and Core
Principle 17.
(E) Identification of trades. Section 1.38(b) of this chapter
establishes the requirements regarding the identification of trades
off the centralized market. It requires contract market rules to
require every person handling, executing, clearing, or carrying
trades, transactions or positions that are executed off the
centralized market, including transfer trades, office trades, block
trades or trades involving the exchange of futures for a commodity
or for a derivatives position, to identify and mark by appropriate
symbol or designation all such transactions or contracts and all
orders, records, and memoranda pertaining thereto.
(F) Identification in the trade register. The contract market
should identify transactions executed off the centralized market in
its trade register, using separate indicators for each such type of
transaction.
(ii) Block trades.
(A) Acceptable minimum block trade size.
(a) New contracts or contracts that have been listed for trading
for less than one calendar quarter. If an exchange has no reasonable
basis upon which to estimate an initial minimum size, a minimum
block trade size of 100 contracts would be appropriate.
(b) Periodic review. The minimum size thresholds for block
trades should be reviewed no less frequently than on a quarterly
basis to ensure that the minimum size remains appropriate for each
contract.
(B) Appropriate parties.
(a) Acceptable block trade parties should be limited to eligible
contract participants. However, contract market rules could also
allow a commodity trading advisor registered pursuant to Section 4m
of the Act, or a principal thereof, including any investment advisor
who satisfies the criteria of Sec. 4.7(a)(2)(v) of this chapter, or
a foreign person performing a similar role or function and subject
as such to foreign regulation, to transact block trades for
customers who are not eligible contract participants, if such
commodity trading advisor, investment advisor or foreign person has
more than $25,000,000 in total assets under management.
(b) Affiliated parties. An affiliated party is a party that
directly or indirectly through one or more persons, controls, is
controlled by, or is under common control with another party.
Section 1.38(b) of this chapter establishes the requirements
regarding block trades between affiliated parties. Contract market
rules could permit block trades between affiliated parties that meet
the requirements of Regulation 1.38 and are otherwise appropriate
parties.
(C) Aggregation of orders. The aggregation of orders for
different accounts in order to satisfy the minimum size requirement
should be prohibited except in appropriate circumstances.
Aggregation would be acceptable if done by a commodity trading
advisor registered pursuant to Section 4m of the Act, or a principal
thereof, including any investment advisor who satisfies the criteria
of Sec. 4.7(a)(2)(v) of this chapter, or a foreign person
performing a similar role or function and subject as such to foreign
regulation, if such commodity trading advisor, investment advisor or
foreign person has more than $25,000,000 in total assets under
management.
(D) Acting for a customer. A person should transact a block
trade on behalf of a customer only when the person has received an
instruction or prior consent to do so from the customer.
(E) Recordkeeping. Parties to, and members facilitating, a block
trade should keep appropriate records. Appropriate block trade
records would comply with Core Principle 10 and Core Principle 17.
Records kept in accordance with the requirements of FASB Statement
No. 133 (``Accounting for Derivative Instruments and Hedging
Activities'') would be acceptable records. Block trade orders must
be recorded by the member and time-stamped with both the time the
order was received and the time the order was reported, and must
indicate when block trades are between affiliated parties. When
requested by the exchange, the Commission or the Department of
Justice, parties to, and members facilitating, a block trade shall
provide records to document that the block trade is executed in
conformance with contract market rules.
(F) Reporting. Block trades should be reported to the contract
market within a reasonable period of time.
(G) Publication. The contract market should publicize details
about the block trade immediately upon the receipt of the
transaction report and publicize daily the total quantity of the
block trades that are included in the total volume of trading, as
required by Sec. 16.01 of this chapter.
(H) Identification in the trade register. The contract market
should identify block trades as such on its trade register, and
should identify when block trades are between affiliated parties.
(I) Pricing. (a) Block trades between non-affiliated parties
should be at a price that is fair and reasonable. Consideration of
whether a block trade price is fair and reasonable could take into
account the size of the block plus the price and size of other
trades in any relevant markets at the applicable time, or the
circumstances of the market or the parties to the block trade.
Relevant markets could include the contract market itself, the
underlying cash markets and/or other related futures or options
markets. If a contract market rule requiring a fair and reasonable
price includes the circumstances of the parties or of the market, a
block trade participant could execute a block transaction at a price
that was away from the market provided that the participant retains
documentation to demonstrate that the price was indeed fair and
reasonable under the participant's or market's particular
circumstances.
(b) Block trades between affiliated parties are subject to the
pricing requirements of Sec. 1.38(b) of this chapter.
(iii) Exchange of futures for commodities or for derivatives
positions.
(A) Bona fide exchange of futures for commodities or for
derivatives positions. The exchange of futures for commodities or
for derivatives positions would include separate but integrally
related transactions involving the same or a related commodity, with
price correlation and quantitative equivalence of the futures and
cash legs. An exchange of futures for commodities or for derivatives
positions would be between a buyer of futures who is the seller of
the corresponding commodity or derivatives position and a
[[Page 54106]]
seller of futures who is the buyer of the corresponding commodity or
derivatives position. A third party could be permitted to facilitate
the purchase and sale of the commodity or derivatives position as
long as the commodity or derivatives position is passed through to
the party that receives the futures position. The transaction would
have to result in an actual transfer of ownership of the commodity
or derivatives position. It also would have to be between parties
with different beneficial owners or under separate control, who had
possession, right of possession, or right to future possession of
the commodity or derivatives position prior to the trade, the
ability to perform the transaction, and resulting in a transfer of
title.
(B) Pricing. The price differential between the futures leg and
the commodities leg or derivatives position should reflect
commercial realities, and at least one leg of the transaction should
be priced at the prevailing market price.
(C) Transitory exchange of futures for commodities or for
derivatives positions. Parties to an exchange of futures for
commodities or for derivatives positions could be permitted to
engage in a separate but related cash transaction that offsets the
cash leg of the exchange of futures for commodities or for
derivatives positions. The related cash transaction would have to
result in an actual transfer of ownership of the commodity or
derivatives position and demonstrate other indicia of being a bona
fide transaction as described in paragraph (a). The cash transaction
must be able to stand on its own as a commercially appropriate
transaction, with no obligation on either party that the cash
transaction be dependent upon the execution of the related exchange
of futures for commodities or for derivatives positions, or vice
versa.
(D) Reporting. Exchanges of futures for commodities or for
derivatives positions should be reported to the contract market
within a reasonable period of time.
(E) Publication. The contract market would publicize daily the
total quantity of exchanges of futures for commodities or for
derivatives positions that are included in the total volume of
trading, as required by Sec. 16.01 of this chapter.
(iv) Office trades. [Reserved]
(v) Transfer trades. [Reserved]
Issued in Washington, DC on September 12, 2008 by the
Commission.
David Stawick,
Secretary of the Commission.
[FR Doc. E8-21865 Filed 9-17-08; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: September 18, 2008