Security Futures Products Regulations and Requirements

Security futures products include futures on single stocks and futures on narrow-based security indexes. Before a board of trade may list for trading a security futures product, the board of trade must meet a number of requirements and make a filing to the CFTC.

Security futures products may be traded on any CFTC-designated contract market that also is notice registered with the Securities and Exchange Commission (SEC) as a securities exchange. In addition, security futures products may be traded on any SEC-registered national securities exchange, national securities association, or alternative trading system that is notice designated as a contract market by the CFTC.

Futures on Single Securities
A futures contract based on a single security may be traded only if:

• The underlying security is registered pursuant to Section 12 of the Securities Exchange Act of 1934;
• The underlying security is common stock, or another security as the CFTC and the SEC jointly deem appropriate (the CFTC and the SEC have jointly determined that American Depositary Receipts (ADRs), Exchange-Traded Funds (ETFs), Trust Issued Receipts (TIRs), Closed-End Fund shares, and debt securities also may underlie security futures products); and
• The underlying security conforms to the listing standards for the SFP that the designated contract market or registered DTEF has filed with the SEC. Listing standards are discussed below.

Futures on Narrow-Based Security Indexes
A futures contract based on an index of two or more securities may be traded as a security future only if:

• The index is a narrow-based security index;
• The underlying securities are registered pursuant to Section 12 of the Securities Exchange Act of 1934;
• The underlying securities are common stock or other securities as the CFTC and the SEC jointly deem appropriate (the CFTC and the SEC have jointly determined that American Depositary Receipts (ADRs), Exchange-Traded Funds (ETFs), Trust Issued Receipts (TIRs), Closed-End Fund shares, and debt securities also may underlie security futures products); and

The underlying securities conform to the listing standards for SFPs that the designated contract market or registered DTEF has filed with the SEC. Listing standards are also discussed below.

Before a board of trade lists a new SFP for trading, the board of trade must file with the CFTC, at its Washington, DC headquarters, a filing labeled “Listing of Security Futures Product” that contains the following items:

• A copy of the product’s rules, including the terms and conditions;
• The required certifications enumerated below under “Required Certifications for Listing SFPs”;
• A certification that the terms and conditions of the contract meet CFTC requirements regarding speculative position limits, cash settlement, and trading halts procedures;
• A certification that the security futures product complies with the Commodity Exchange Act and the CFTC rules.

A board of trade may request voluntarily Commission approval of any security futures product by following the procedures set forth in CFTC Regulation 40.3, 17 CFR 40.3.

A board of trade may request Commission approval for any rule or rule change relating to a security futures product by following the procedures of CFTC Regulation 40.5.

A board of trade’s filing with the CFTC to list for trading a futures contract on a single stock or on a narrow-based security index must include the following certifications:

• The security or securities that underlie the SFP meet the requirements discussed above regarding SEC registration, type of security, and make-up of the security index, if applicable.
• If the SFP is settled through physical delivery, arrangements are in place with a clearing agency registered with the SEC for the payment and delivery of the underlying security or securities.
• Only futures commission merchants (FCMs), introducing brokers (IBs), commodity trading advisors (CTAs), commodity pool operators (CPOs) or associated persons (APs) may solicit, accept any order for, or otherwise deal in any transaction in or in connection with the SFP.
• Dual trading is restricted in accordance with CFTC Regulation 41.27.
• Trading in the SFP is not readily susceptible to price manipulation.
• In order to detect manipulation and insider trading, the board of trade has coordinated surveillance among the board of trade, any market on which any underlying security trades, and any other market on which any related security is traded. This coordinated surveillance requirement may be satisfied by certifying that:
  • The board of trade is a Full Member of the Intermarket Surveillance Group (ISG);
  • The board of trade is an Affiliate Member of the ISG and has entered into supplemental information-sharing agreements with Full Members and other Affiliate Members; or
  • The board of trade has entered into bilateral agreements with all necessary boards of trade to share information and such agreements should require the same type of information sharing that takes place between Full Members of the ISG (a board of trade that is an alternative trading system (ATS) does not need to make this certification, provided that the ATS is a member of a national securities association or national securities exchange, and the national securities association or national securities exchange has coordinated surveillance procedures);
• The board of trade has an audit trail in place to facilitate the coordinated surveillance (a board of trade that is an ATS does not need to make this certification, provided that the ATS is a member of a national securities association or national securities exchange, and the national securities association or national securities exchange has an audit trail in place);
• The board of trade has procedures in place to coordinate regulatory trading halts between the board of trade, markets on which any underlying security is traded, and markets on which any related security is traded (a board of trade that is an ATS does not need to make this certification, provided that the ATS is a member of a national securities association or national securities exchange, and the national securities association or national securities exchange has procedures to coordinate trading halts); and
• The board of trade’s margin requirements for security futures products comply with CFTC Regulations 41.42 through 41.49.
• Coordinated trading halts.

Security futures products may be settled by actual delivery of the underlying security or securities, or they may be cash settled. If settlement is effected by actual delivery of the underlying security or securities, payment and delivery must be done through a clearing agency that is registered with the Securities and Exchange Commission.

The CFTC and the SEC have adopted special requirements for SFPs that are cash settled. CFTC and SEC regulations provide that the final settlement price of a cash-settled SFP must fairly reflect the opening price of the underlying security or securities. However, if the opening price of one or more securities is not available, the final settlement price of the SFP must reflect either the price of the underlying security or securities during the most recent regular trading session, or the next available opening price of the underlying security or securities.

If the rules used by a board of trade to determine the final settlement price of an SFP conflict with the rules of a derivatives clearing organization, the clearing organization may determine the final settlement price of the SFP.

The CFTC may grant an exemption from its regulations regarding cash settlement, either unconditionally or on specified terms and conditions, if the CFTC determines that such exemption is consistent with the public interest and the protection of customers, and the SEC agrees that an exemption is appropriate.

Exchanges trading equities and equity options have adopted rules providing for two types of regulatory trading halts: news pending halts and circuit breaker halts.

News pending halts allow for the dissemination of potentially market-moving information and provide a period for the discovery of prices for securities based on that information. A news pending halt temporarily suspends all trading in a security or securities until there has been an opportunity for the relevant information to be disseminated to the public. Currently, national securities exchanges and national securities associations may impose brief trading halts in specific securities prior to the release of information that might significantly affect the prices of those securities. Generally, when the primary market of the security initiates such a trading halt, all other exchanges that list that security will halt trading. Likewise, options markets will halt trading for an option when its underlying security (or in the case of an index option, a percentage of the index) is subject to a trading halt.

Circuit breaker trading halts are temporary halts coordinated across markets during severe market declines that threaten to create panic conditions in the equity markets. Circuit breaker trading halts provide an opportunity for markets to reestablish equilibrium between buying and selling interests, and help ensure that market participants have an opportunity to become aware of and develop appropriate responses to significant price movements. Securities exchanges, options exchanges, and futures exchanges that offer equity-related contracts have adopted circuit breakers rules.

A board of trade that lists or trades SFPs must adopt rules that provide for a trading halt under the following conditions:

• Trading of a SFP based on a single security must be halted at all times that a regulatory halt has been instituted for the underlying security.
• Trading of a SFP based on a narrow-based security index must be halted at all times that a regulatory halt has been instituted for one or more underlying securities that constitute 50 percent or more of the market capitalization of the index.

The CFTC may grant an exemption from its regulations regarding trading halts, either unconditionally or on specified terms and conditions, if the CFTC determines that such exemption is consistent with the public interest and the protection of customers, and if the SEC agrees that an exemption is appropriate.

Speculative Position Limit Requirements for Security Futures Products

Under authority delegated by the Federal Reserve Board, the CFTC and SEC jointly have adopted rules governing customer margin for security futures products. The rules were published in the Federal Register on August 14, 2002 (67 Fed. Reg. 53145). The rules, among other things:

• Establish stand-alone requirements that are consistent with Regulation T, 12 CFR 220, but do not apply Regulation T in its entirety to futures accounts.
• Establish minimum initial and maintenance margin levels for unhedged positions in security futures at 20 percent of their “current market value.”
• Permit self-regulatory authorities to set margin levels lower than 20 percent of current market value for customers with certain strategy-based offset positions involving security futures and one or more related securities or futures.
• Identify the types of collateral acceptable as margin deposits and establish standards for the valuation of such collateral and other components of equity.
• Establish standards for the withdrawal of margin by customers and security futures intermediaries.
• Set forth procedures applicable to under-margined accounts.
• Set forth procedures for filing proposed rule changes with the CFTC.

Other Security Futures Products Federal Register Releases