[Federal Register: November 1, 2001 (Volume 66, Number 212)]
[Rules and Regulations]
[Page 55078-55086]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr01no01-6]
=======================================================================
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 41
RIN 3038-AB87
Listing Standards and Conditions for Trading Security Futures
Products
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rules.
-----------------------------------------------------------------------
SUMMARY: The Commodity Futures Trading Commission ("CFTC" or
"Commission") is promulgating rules 41.21 through 41.25 under the
Commodity Exchange Act ("CEA").\1\ These rules relate to new
statutory provisions enacted by the Commodity Futures Modernization Act
of 2000 ("CFMA") \2\ that specify listing standards and conditions
for trading of security futures products. These rules also establish
requirements related to the self-certification of rules and rule
amendments, reporting of data, speculative position limits, and special
provisions relating to contract design for cash settlement and physical
delivery of security futures products.
---------------------------------------------------------------------------
\1\ 7 U.S.C. 1 et seq.
\2\ Pub. L. No. 106-554, 114 Stat. 2763 (December 21, 2000).
---------------------------------------------------------------------------
EFFECTIVE DATE: November 1, 2001.
FOR FURTHER INFORMATION CONTACT: Richard A. Shilts, Acting Director,
Division of Economic Analysis; Thomas M. Leahy, Jr., Financial
Instruments Unit Chief, Division of Economic Analysis; or Gabrielle A.
Sudik, Attorney, Office of the General Counsel, Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street, NW.,
Washington, DC 20581. Telephone: (202) 418-5000. E-mail:
([email protected]), ([email protected]), or ([email protected]).
SUPPLEMENTARY INFORMATION: The Commodity Futures Trading Commission
today promulgates new rules 41.21 through 41.25 under 17 CFR part 41,
pursuant to the CEA as amended by the Commodity Futures Modernization
Act of 2000 (7 U.S.C. 1 et seq., as amended by Appendix E of Pub. L.
No. 106-554, 114 Stat. 2763).
I. Background
A. Overview
On December 21, 2000, the CFMA was signed into law. Among other
things, the CFMA lifted the ban on single stock and narrow-based stock
index futures ("security futures").\3\ In addition, the CFMA
established a framework for the joint regulation of security futures
products\4\ by the CFTC and the Securities and Exchange Commission
("SEC").\5\ Section
[[Page 55079]]
2(a)(1)(D) of the CEA and Section 6(h) of the Securities Exchange Act
of 1934, as amended by the CFMA, provide that in order for a board of
trade to list security futures products, the security futures products
and the securities underlying the security futures products must meet a
number of standards and conditions termed "listing standards."
---------------------------------------------------------------------------
\3\ See Section 251(a) of the CFMA. This trading previously was
prohibited by Section 2(a)(1)(B)(v) of the CEA.
\4\ The term "security futures product" is defined in Section
1a(32) of the CEA and Section 3(a)(56) of the Exchange Act to mean
"a security future or any put, call, straddle, option, or privilege
on any security future." The term "security future" is defined in
Section 1a(31) of the CEA and Section 3(a)(55)(A) of the Exchange
Act to include futures contracts on individual securities and on
narrow-based security indexes. The term "narrow-based security
index" is defined in Section 1a(25) of the CEA and Section
3(a)(55)(B) of the Exchange Act. Because the CFMA also provides that
options on security futures cannot be traded until at least December
21, 2003, security futures are the only security futures product
that may be available for trading until that date.
\5\ The CFMA also prescribes the dates on which security futures
trading can commence. Specifically, trading on a principal-to-
principal basis between eligible contract participants was not
permitted until August 21, 2001, and retail transactions cannot
commence until December 21, 2001. Both starting dates are
conditioned upon the registration of a futures association as a
national securities association under the Exchange Act. See Section
202(a) of the CFMA; Section 6(g)(5) of the Exchange Act.
---------------------------------------------------------------------------
Security futures products may be traded on any board of trade that
is designated as a contract market by the Commission pursuant to
Section 5 of the CEA or that is registered with the Commission as a
derivatives transaction execution facility ("DTEF") pursuant to
Section 5a of the CEA. In addition, Section 5f(a) of the CEA permits
certain entities that are otherwise regulated by the SEC to be
designated contract markets for the limited purpose of trading security
futures products. Specifically, any board of trade that is registered
with the SEC as a national securities exchange pursuant to Section 6(a)
of the Exchange Act, is registered with the SEC as a national
securities association pursuant to Section 15A(a) of the Exchange Act,
or is an alternative trading system ("ATS") as defined by Section
1a(1) of the CEA shall be a designated contract market in security
futures products if certain conditions are met.\6\
---------------------------------------------------------------------------
\6\ See 66 FR 44960 (August 27, 2001). In that notice, the
Commission adopted new regulations that provide notice registration
procedures for a national securities exchange, a national securities
association, or an alternative trading system to become a designated
contract market in security futures products. By registering with
the Commission, a national securities exchange, a national
securities association, or an alternative trading system is, by
definition, a designated contract market for purposes of trading
security futures products. Hence, references in these rules to
designated contract markets include notice designated contract
markets, except where otherwise noted.
---------------------------------------------------------------------------
On July 20, 2001, the Commission published for comment proposed
rules 41.21 through 41.25,\7\ which addressed issues related to listing
standards and established uniform requirements related to position
limits, as well as provisions to minimize the potential for
manipulation and disruption to the futures markets and underlying
securities markets.\8\ The proposed rules also related to the allowable
types of securities underlying security futures products; settlement
procedures; who may deal in security futures products; restrictions on
dual trading; and rules governing surveillance, audit trails, trading
halts, and margin requirements.
---------------------------------------------------------------------------
\7\ See 66 FR 37932 (July 20, 2001).
\8\ Additional rules related to trading halts and the cash
settlement of security futures products were proposed in a joint
rulemaking by the Commission and the SEC. See 66 FR 45903 (August
30, 2001).
---------------------------------------------------------------------------
It should be noted that in addition to satisfying the listing
standards of the CEA, security futures products must conform to listing
standards that a national securities exchange or national securities
association files with the SEC under Section 19(b) of the Exchange
Act.\9\ In addition, Section 6(h)(3)(C) of the Exchange Act imposes the
additional requirement that the exchange or association's listing
standards for security futures products must be no less restrictive
than comparable listing standards for security options. On September 5,
2001, the SEC issued guidance for boards of trade as to the listing
standards that would satisfy this requirement.\10\
---------------------------------------------------------------------------
\9\ See Section 6(h)(2) of the Exchange Act.
\10\ See Division of Market Regulation Staff Legal Bulletin No.
15 (September 5, 2001). The Staff Legal Bulletin is available on the
SEC's website at
http://www.sec.gov/interps/legal/mrslb15.htm.
---------------------------------------------------------------------------
B. The Proposed Rules
The Commission proposed rule 41.21 to address the statutory
requirements for securities that may underlie security futures
products.\11\ Under the proposed rules, eligible securities must be
securities registered pursuant to Section 12 of the Exchange Act and
must be common stock or other equity securities as the Commission and
the SEC deem appropriate. The proposed rules further provided that the
securities must conform to any listing standards the designated
contract market or registered DTEF files with the SEC.
---------------------------------------------------------------------------
\11\ See Sections 2(a)(1)(D)(i)(I) and (III) of the CEA, as
created by Section 251 of the CFMA.
---------------------------------------------------------------------------
The Commission proposed rule 41.22 to make it unlawful for a
designated contract market or registered DTEF to list for trading or
execution a security futures product unless it provided the Commission
with a certification that the security futures product and the board of
trade meet specified requirements set forth in the CEA.\12\
Accordingly, proposed rule 41.22 would require designated contract
markets and registered DTEFs to certify that they meet the requirements
of Section 2(a)(1)(D)(i) of the CEA. That rule required certifications
regarding the types of securities underlying security futures products;
the payment and delivery of security futures products; who may trade
security futures products; dual trading; anti-manipulation provisions;
coordinated surveillance; audit trails; trading halts; and margin
requirements.
---------------------------------------------------------------------------
\12\ See Section 2(a)(1)(D)(vii) of the CEA.
---------------------------------------------------------------------------
With respect to the coordinated surveillance requirement, Section
2(a)(1)(D)(i)(VIII) of the CEA requires designated contract markets and
registered DTEFs on which security futures products are traded to
coordinate surveillance with markets that trade the underlying security
or any related security, in order to detect manipulation and insider
trading. This requirement was proposed to be implemented by paragraph
(g) of proposed Section 41.22, which would require that a board of
trade certify that it is a full member of the Intermarket Surveillance
Group (the "ISG").\13\
---------------------------------------------------------------------------
\13\ The Intermarket Surveillance Group was created under the
auspices of the SEC in 1983 as a forum to ensure that national
securities exchanges and national securities associations adequately
share surveillance information and coordinate inquiries and
investigations designed to address potential intermarket
manipulations and trading abuses. All national securities exchanges
and national securities associations are full members of the ISG.
Full members routinely share a great deal of surveillance and
investigatory information, and this framework has proven to be an
essential mechanism to ensure that there is adequate information
sharing and investigatory coordination for potential intermarket
manipulations and trading abuses. In view of the growth of stock
index futures contracts, since 1987, several futures exchanges and
non-U.S. exchanges and associations have become affiliate members of
the ISG. Affiliate members are required to share information on a
more limited basis with the ISG.
---------------------------------------------------------------------------
Proposed rule 41.23 described the procedures for filing documents
with the Commission before a designated contract market or registered
DTEF could trade a security futures product. Specifically, proposed
rule 41.23(a) described the documents that must be filed with the
Commission, including documents and certifications required by proposed
rules 41.22 and 41.25. Proposed rule 41.23(b) described the procedures
for voluntary submission by designated contract markets and registered
DTEFs for Commission approval of security futures products, as
permitted by Section 5c(c)(2) of the CEA. The proposed rule noted that
notice designated contract markets are not permitted to request
Commission approval of security futures products, since they are exempt
from the provisions of 5c of the CEA by virtue of Section 5f(b)(1)(D)
of the CEA.
Proposed rule 41.24 required designated contract markets (including
notice designated contract markets) and registered derivatives clearing
organizations to file with the Commission a copy of any rule or rule
amendment. Proposed paragraph (b) mandated that the procedures of
paragraph (a) also apply to the self-certification of rules relating to
security futures products by registered DTEFs, notwithstanding the
provisions of rule 37.7. Proposed paragraph (c) allowed a designated
contract market, registered
[[Page 55080]]
DTEF, or registered derivatives clearing organization to submit rules
for Commission approval, as permitted by Section 5c(c)(2) of the CEA.
However, under the proposed rule, notice designated contract markets
would not be permitted to request Commission approval of rules, since
Section 5f of the CEA exempts these entities from Section 5c(c)(2) of
the CEA.
Proposed rule 41.25 established requirements related to data
reporting, trading halts, speculative position limits, and certain
contract design features related to the settlement of security futures
products. The Commission proposed paragraph (a)(1) of rule 41.25 to
require designated contract markets and registered DTEFs to comply with
Part 16 of the Commission's regulations regarding the daily reporting
of market data. Paragraph (a)(2) was reserved for the establishment of
rules providing for trading halts for security futures products, which
the Commission and the SEC jointly proposed in a separate release.\14\
---------------------------------------------------------------------------
\14\ The proposed rules relating to trading halts for security
futures products can be found at 66 FR 45903 (August 30, 2001).
---------------------------------------------------------------------------
Paragraph (a)(3) of proposed rule 41.25 required designated
contract markets and registered DTEFs to adopt speculative position
limits or position accountability rules for listed security futures
products. The level of the position limit and whether a position limit
is required would depend upon the trading activity and capitalization
of the security or securities underlying the security futures product.
Paragraph (b) of proposed rule 41.25 established requirements for
security futures products that are cash settled. Paragraph (b) was, in
part, reserved for rules relating to acceptable cash settlement prices
of security futures products. In this regard, in a separate release,
the Commission and the SEC jointly proposed rules relating to the
acceptable procedures for setting cash settlement prices for security
futures products.\15\ Proposed paragraph (c) of rule 41.25 established
requirements related to security futures products that are settled by
physical delivery of the underlying security or securities.
---------------------------------------------------------------------------
\15\ The proposed rules relating to cash settlement for security
futures products can be found at 66 FR 45903 (August 30, 2001).
---------------------------------------------------------------------------
C. Overview of Comments and Final Rules
The Commission received four letters in response to its request for
comment on the proposed rules.\16\ Generally, the commenters supported
the proposed rules, but objected to, or offered suggested modifications
relating to, several individual provisions or requirements.
---------------------------------------------------------------------------
\16\ Comments were provided by the Chicago Mercantile Exchange
("CME") on August 20, 2001, the Chicago Board Options Exchange
("CBOE") on August 20, 2001, the American Stock Exchange
("AMEX") on August 31, 2001, and the Intermarket Surveillance
Group ("ISG") on September 10, 2001.
---------------------------------------------------------------------------
Except to the extent discussed below, the Commission will adopt the
rules as proposed. The Commission has carefully considered the
commenters' views on the proposed rules and has adopted several
revisions to the proposed rules consistent with those comments.
1. Rule 41.21: Securities Eligible To Underlie Security Futures
Products
AMEX suggested that the types of securities underlying security
futures products should include exchange-traded funds ("EFTs"), trust
issued receipts ("TIRs"), American Depositary Receipts ("ADRs"),
and closed-end registered investment companies ("subject
securities"). AMEX argued that these products are functionally
comparable to common stock in the sense that they represent shares of
securities that are registered under Section 12 of the Exchange Act.
The Commission and the SEC agree that ADRs are eligible securities
for purposes of rule 41.21 under certain conditions. In this regard, on
August 20, 2001, the Commission and the SEC issued a joint order
modifying the requirements regarding securities underlying security
futures products. In CEA and Section 6(h)(4)(A) of the Exchange Act,
the Commissions modified the criteria in Section 2(a)(1)(D)(I) and
(III) of the CEA and Sections 6(h)(3)(A) and (D) of the Exchange Act
regarding the securities eligible for underlying security futures
products. The order permits a depositary share, as defined in Exchange
Act rule 12b-2,\17\ to underlie a security future and be a component of
a narrow-based security index, provided that two conditions are met:
(1) The securities underlying the depositary share are registered
pursuant to Section 12 of the Exchange Act and (2) the depositary share
is registered under the Securities Act of 1933 on Form F-6.
---------------------------------------------------------------------------
\17\ 17 CFR 240.12b-2.
---------------------------------------------------------------------------
Regarding ETFs, TIRs, and "subject securities," the Commission
and the SEC will consider separately the AMEX's request to allow these
other securities to underlie security futures products. The Commission
and the SEC will also consider what eligibility criteria and listing
standards would be appropriate for such other underlying securities.
The Commission and the SEC may seek public comment prior to issuing any
orders regarding these securities.
Finally, the Commission has clarified the text of rule 41.21 to
more clearly state that requirements for listing securities as security
futures products relate to the security or securities that underlie
security futures contracts.
2. Rule 41.22(d): Who May Trade Security Futures Products
CBOE noted that proposed rule 41.22(d), which lists the persons and
entities who may trade or offer security futures products, does not
encompass everyone who currently trades on the floor of CBOE; notably,
some market makers. The proposed rule provided that only five
categories of persons may trade security futures products, "except to
the extent otherwise permitted under the Securities Exchange Act of
1934 and the rules and regulations thereunder * * *." The rule was
drafted in such a manner because Section 2(a)(1)(D)(i)(V) of the CEA
explicitly provides that only futures commission merchants, introducing
brokers, commodity trading advisors, commodity pool operators or
associated persons subject to suitability rules comparable to those of
a national securities association registered pursuant to Section 15A(a)
of the Exchange Act may solicit, accept orders for, or otherwise deal
in any transaction in or in connection with security futures products.
By including the language "except to the extent otherwise permitted
under the Securities Exchange Act of 1934 and the rules and regulations
thereunder * * *" the Commission intended to encompass within the rule
all persons and entities that are allowed to trade security futures
products under the Exchange Act and its rules and regulations.
The Commission notes that brokers and dealers registered with the
SEC may notice-register with the Commission to become futures
commission merchants or introducing brokers.\181\ In addition, it
should be noted that associated persons of notice-registered futures
commission merchants or introducing brokers are exempt from
registration pursuant to Section 4k(5) of the CEA. These persons,
however, are presumably permitted to
[[Page 55081]]
trade security futures products under the Exchange Act, and therefore
qualify for certification under rule 41.22(d).
---------------------------------------------------------------------------
\18\ Section 4f of the CEA, as amended by Section 252(b) of the
CFMA, allows brokers and dealers registered with the SEC to register
with the Commission as futures commission merchants or introducing
brokers so long as they adhere to certain requirements regarding
transactions in connection with security futures products. The
Commission adopted rules regarding the procedures for brokers or
dealers to notice-register as a futures commission merchant or
introducing broker. See 66 FR 43080 (August 17, 2001).
---------------------------------------------------------------------------
3. Rule 41.22(g): Required Membership in the Intermarket Surveillance
Group
Three commenters expressed concern about the provision in proposed
rule 41.22(g) that would require boards of trade trading security
futures products to be full members of the Intermarket Surveillance
Group in order to meet the coordinated surveillance requirement of
Section (2)(a)(1)(D)(i)(VIII) of the CEA.\19\ The Intermarket
Surveillance Group expressed its belief that requiring ISG membership
in order to trade security futures products went beyond the
requirements of the CFMA, exceeds the Commission's authority, and is
potentially anti-competitive. The ISG noted that membership in the ISG
is not automatic, and one current member could effectively veto
membership by an applicant and thus could preclude trading of security
futures products by such interested board of trade. The ISG expressed
strong support for a rule that would ensure coordinated surveillance
among markets and noted a willingness to work with the Commission in
fostering effective surveillance coordination; however, it stated that
rule 41.22(g) as proposed was an inappropriate means of achieving
coordinated surveillance.
---------------------------------------------------------------------------
\19\ CME, AMEX and ISG.
---------------------------------------------------------------------------
CME also expressed concern that not all boards of trade would be
accepted as full members of the ISG, or that they may not be accepted
quickly enough so that the boards of trade could commence trading
security futures products when allowed to do so under the CFMA. CME
suggested that the final rule include a grace period for boards of
trade that have affiliate membership status and have applied for full
membership and have satisfied the membership criteria applicable to
national securities exchanges but have not yet been formally accepted.
AMEX indicated that the CFTC lacked the statutory authority to
compel all boards of trade that wish to trade security futures products
to be full members of the ISG. Furthermore, AMEX pointed out that a
board of trade may only become a member of the ISG with the unanimous
approval of all of its members. Thus, membership is not guaranteed, and
in any case, the application process may be lengthy.
In light of the foregoing concerns regarding the full ISG
membership requirement in proposed rule 41.22(g), the Commission has
determined to defer consideration of this matter at this time. The
final rule published today simply sets forth the requirement that a
board of trade certify that it has in place procedures for coordinated
surveillance. The Commission and the SEC are addressing the appropriate
means of ensuring that this statutory requirement is satisfied, and the
Commissions will consider whether it is appropriate to publish final
rules related to the coordinated surveillance requirement of the CEA
and the Exchange Act in a separate joint rulemaking related to trading
halts and requirements for cash settlement.\20\ All comments received
by the Commission regarding membership in the ISG in response to the
instant rulemaking will be considered by both agencies in the
promulgation of the final joint release. Further, the Commission would
welcome additional comment concerning membership in the ISG in response
to the joint rule proposal.
---------------------------------------------------------------------------
\20\ See 66 FR 45903.
---------------------------------------------------------------------------
4. Rules 41.22(g), 41.22(h), and 41.22(i): Certifications Required by
Alternative Trading Systems
CBOE raised a point applicable to proposed rules 41.22(g), (h), and
(i)--namely, that the exception to the required certifications for the
listing standards in these rules should only apply to alternative
trading systems that are members of a national securities exchange or
national securities association; and that the exception, by the terms
of the CEA, should not apply to national securities exchanges or
national securities associations themselves.
After considering this comment, the Commission has revised proposed
rules 41.22(g), (h), and (i) to clarify what entities are exempt from
making the certifications required by those rules, consistent with the
language of the CEA and the Exchange Act. The final rules exempt only
alternative trading systems from making these three certifications.
Furthermore, the rules are clarified to exempt only those alternative
trading systems that are members of either national security exchanges
that have the required procedures in place, or national security
associations that have the required procedures in place.
5. Rules 41.22(i) and 41.25(a)(2): Trading Halts
CBOE stated that proposed rule 41.22(i) should be clarified to
explain whether the circuit breakers already in place on boards of
trade are sufficient to satisfy the proposed rules regarding trading
halts. The Commission notes that proposed rule 41.25(a)(2) was reserved
to set forth requirements regarding trading halts. As with requirements
related to cash settlement procedures for security futures products,
proposed rules related to trading halt requirements were set forth in a
separate joint rulemaking by the Commission and the SEC.\21\ This CBOE
comment will be addressed by the Commission and the SEC in promulgating
those final rules.
---------------------------------------------------------------------------
\21\ See 66 FR at 45918.
---------------------------------------------------------------------------
6. Rule 41.25(a)(1): Reporting of Data
AMEX suggested that notice designated contract markets (as opposed
to designated contract markets and registered DTEFs) should be exempt
from the daily reporting requirements of proposed 41.25(a) if the
notice designated contract market files comparable information with the
SEC. The Commission routinely collects the information required by part
16 of the regulations from all futures exchanges, and it intends to do
so for all exchanges trading security futures products. The Commission
is unaware of any current or planned daily data collection by the
Securities and Exchange Commission that is comparable to the data
specified in Part 16. However, the Commission's market surveillance
staff will consider requests by an exchange seeking relief from
pertinent parts of these reporting requirements for which data already
are available to the Commission or are not useful to the Commission's
surveillance program.
7. Rule 41.25(a)(3): Speculative Position Limit Provisions
Three commenters commented on the proposed rules regarding the
requirements for speculative position limits or position
accountability. Two commenters noted that the proposed position limit
provisions differ somewhat from the limits imposed on security and
securities index options.\22\ Differences cited include the
specification of limits on a net, rather than a gross, position basis;
the establishment of numerical limit levels that differ from those
imposed on security and securities index options; and the fact that the
proposed limits would apply only during the last five days of trading.
---------------------------------------------------------------------------
\22\ CBOE and AMEX.
---------------------------------------------------------------------------
CME suggested that the Commission adopt a position accountability
standard for all security futures products and not require that
speculative limits be imposed for contracts on less liquid securities,
as specified in the proposed rules. CBOE and AMEX did not object to the
proposed speculative position limit provisions, but suggested that the
[[Page 55082]]
Commission coordinate with the SEC so that speculative position limit
rules for security and securities index futures products are the same
as those applicable for security and securities index options. Barring
that, these two commenters recommended that the Commission adopt
position limit provisions that more closely resemble existing limits on
option index options. In addition, CME and AMEX asked that the term
"least liquid" be clarified in connection with applying speculative
position limits for narrow-based stock indexes, and that this
requirement be linked to the average daily trading volume of the
average security in an index. Finally, CME recommended that the "six
months" of calculations specified in the proposed rules should be made
no more frequently than once a month.
After careful consideration of the comments, the Commission is
adopting the speculative limit provisions as set forth in the proposed
rules, with two modifications. In this regard, the Commission is
modifying proposed rule 41.25(a)(3) by adding a new paragraph (iv) to
clarify how "average daily trading volume" is to be calculated in
determining whether speculative position limits are required and if so,
the level that is applicable. These changes require calculations to be
made monthly and establish procedures for implementing new levels when
required, consistent with the suggestions of CME and AMEX. Further, for
clarification, the term "least liquid security" in rule
41.25(a)(3)(ii) has been changed to the security with the lowest
average daily trading volume.
In regard to CME's suggestion that the Commission adopt a position
accountability standard for all security futures products, the
Commission continues to believe that speculative position limits are
appropriate for contracts based on securities that are less liquid or
less highly capitalized. Allowing position accountability only for
contracts that overlie the most liquid and highly capitalized
securities is consistent with the Commission's surveillance experience
and its long-standing approach regarding position accountability.
Contracts based on less liquid and lower capitalized securities are
more susceptible to manipulation or price distortions, and thus, the
Commission believes that speculative position limits are appropriate
measures to minimize the potential for these abuses.
In regard to the commenters' observations about differences in the
proposed security futures product speculative position limits relative
to existing security and securities index options limits, the
Commission notes that the provisions are consistent with the
Commission's customary approach for all other futures markets. As with
other markets, the Commission believes that the speculative position
limit and position accountability provisions set forth in the proposal
are necessary to effectively oversee the markets and are consistent
with the obligation in Section 2(a)(1)(D)(i)(VII) of the CEA that a
designated contract market or registered DTEF maintain procedures to
prevent manipulation of the price of the security futures product and
the underlying security or securities.
As the Commission noted in the proposed rulemaking, the
Commission's proposed position limit levels were set at levels that are
generally comparable but not identical to the limits that currently
apply to options on individual securities. The differences mainly
reflect certain provisions adopted for commodity futures contracts that
reflect the special characteristics of those markets. In this regard,
the proposed position limit requirements for security futures differ
from individual security option position limit rules in that the limits
would apply only to net positions in an expiring security futures
contract during its five last trading days. The Commission believes
that this provision is appropriate since, consistent with its
experience in conducting surveillance of other futures markets, it is
during the time period near contract expiration that the potential for
manipulation based on an extraordinarily large net futures position
would most likely occur.
The Commission also believes that position accountability is
appropriate for contracts on highly liquid and capitalized securities.
In this regard, for security futures contracts based on a security that
has an average daily trading volume greater than 20 million shares, the
Commission believes that the threat of manipulation is sufficiently
reduced such that an exchange could substitute a position
accountability rule in lieu of a fixed position limit. Under such a
rule, a trader holding a position in a security future that exceeded a
threshold level determined by the exchange (e.g., no more than 22,500
contracts of 100 shares) would agree to provide information to the
exchange regarding that position and consent to halt increasing the
position if requested by the exchange.
8. Rule 41.25(b): Cash Settlement Price
CBOE stated that the cash settlement price for security futures
products should be based on the underlying securities' opening price.
Proposed rule 41.25(b) provided that, "For cash-settled security
futures products, the cash-settlement price must be reliable and
acceptable, be reflective of prices in the underlying securities market
and be not readily susceptible to manipulation." Part of proposed rule
41.25(b) was reserved for specific rules regarding acceptable practices
for the calculation of cash settlement prices; text will be added to
paragraph (b) in a future final rule. In a separate rulemaking issued
jointly with the SEC, the Commission proposed that cash settlement be
based on opening prices, consistent with the CBOE comment.\23\
Accordingly, the Commission and the SEC will address CBOE's comment in
the final rulemaking for that proposal. The Commission notes that one
line of text has been removed from proposed rule 41.25(b), due to
changes made to the text of that proposed rule in the joint rulemaking.
This change is not substantive.
---------------------------------------------------------------------------
\23\ See 66 FR at 45918-19.
---------------------------------------------------------------------------
9. Applicability of Rules to Notice-Registered Entities
CBOE requested clarification as to whether the proposed rules
applied to all boards of trade, including those that are notice-
registered with the Commission. The Commission recently issued final
rules regarding notice procedures for national securities exchanges,
national securities associations, and alternative trading systems to
become a designated contract market in security futures products.\24\
In accordance with those rules and with Section 5f of the CEA, any
board of trade that registers with the Commission as a notice
designated contract market is, by definition, a designated contract
market. Hence, the rules adopted today apply to designated contract
markets under Section 5 of the CEA, registered DTEFs under Section 5a
of the CEA, and notice designated contract markets under Section 5f of
the CEA. It should be noted, however, that notice designated contract
markets are exempt from certain provisions of the CEA in accordance
with Section 5f(b)(1) of the CEA. The final rules, therefore, apply to
all boards of trade that trade security futures products, except where
otherwise explicitly noted in the rules.
---------------------------------------------------------------------------
\24\ See 66 FR 44960 (August 27, 2001).
---------------------------------------------------------------------------
II. Administrative Procedure Act
The Administrative Procedure Act (the "APA") generally requires
that rules promulgated by an agency not be made effective less than
thirty days after publication, except for, among other things,
instances where the agency finds
[[Page 55083]]
good cause to make a rule effective sooner, and has published that
finding together with the rule.\25\ Pursuant to the CFMA, beginning on
August 21, 2001, eligible contract participants may trade security
futures products on a principal-to-principal basis. The rules being
published today affect the products that eligible contract participants
may trade on a designated contract market or registered DTEF. The CFTC
believes good cause exists for the rules to become effective
immediately, so that boards of trade can list security futures products
for trading by eligible contract participants, as contemplated by the
CFMA. Furthermore, to the extent that these rules have been promulgated
in substantially the same form as the proposed rules, any affected
boards of trade are already familiar with the rules. Therefore, the
Commission concludes that there is good cause for making these rules
effective immediately upon publication.
---------------------------------------------------------------------------
\25\ 5 U.S.C. 553(d)(3).
---------------------------------------------------------------------------
III. Costs and Benefits of the Rules
Section 15 of the CEA requires the Commission to consider the costs
and benefits of its action before issuing a new regulation.\26\ 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 rule be
analyzed in isolation when that rule is a component of a larger package
of rules or rule revisions. Rather, Section 15 simply requires the
Commission to "consider the costs and benefits" of its action.
---------------------------------------------------------------------------
\26\ 7 U.S.C. 19.
---------------------------------------------------------------------------
Section 15 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 rule was necessary or appropriate to protect the public
interest or to effectuate any of the provisions or to accomplish any of
the purposes of the CEA.
These rules constitute one part of a package of related rule
provisions. The rules provide guidance and establish procedures for
trading facilities to comply with governing laws related to security
futures products. The Commission considered the costs and benefits of
these rules, in light of the specific areas of concern identified in
Section 15.\27\ The rules should have no effect, from the standpoint of
imposing costs or creating benefits, on the financial integrity or
price discovery function of the futures and options markets or on the
risk management practices of trading facilities or others. The rules
also should have no material effect on the protection of market
participants and the public and should not impact the efficiency and
competition of the markets.
---------------------------------------------------------------------------
\27\ 66 FR at 37936.
---------------------------------------------------------------------------
The Commission solicited comments about its consideration of these
costs and benefits.\28\ The Commission received no comments.
Accordingly, the Commission has determined to adopt the regulations
discussed above. Changes made to the proposed rules as a result of the
comments do not affect the Commission's consideration of the costs and
benefits of this rulemaking.
---------------------------------------------------------------------------
\28\ 66 FR at 37936.
---------------------------------------------------------------------------
IV. Related Matters
A. Paperwork Reduction Act
The Paperwork Reduction Act ("PRA") of 1995, 44 U.S.C. 3501 et
seq., 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. This rulemaking
contains information collection requirements within the meaning of the
PRA. The Commission submitted a copy of this part to the Office of
Management and Budget (OMB) for its review in accordance with 44 U.S.C.
3507(d).
Collection of Information: Part 41, Relating to Security Futures
Products, OMB Control Number 3038-0059.
No comments were received in response to the Commission's
invitation in the notice of proposed rulemaking to comment on any
paperwork burden associated with these rules.\29\ See 44 U.S.C.
3507(d)(2).
---------------------------------------------------------------------------
\29\ 66 FR at 37936.
---------------------------------------------------------------------------
Copies of the information collection submission to OMB are
available from the Commission from the CFTC Clearance Officer, 1155
21st Street, NW, Washington, DC 20581, (202) 418-5160.
B. Regulatory Flexibility Act
The Regulatory Flexibility Act ("RFA"), 5 U.S.C. 601 et seq.,
requires federal agencies, in promulgating rules, to consider the
impact of those rules on small entities. The rules adopted herein would
affect contract markets, registered DTEFs, and derivatives clearing
organizations. The Commission 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. In its previous determinations, the Commission concluded that
contract markets, registered derivatives trading execution facilities,
and derivatives clearing organizations are not small entities for the
purpose of the RFA.\30\ In the proposed rulemaking, the Chairman
certified that these rules would not have a significant economic impact
on a substantial number of small entities.\31\ The Commission invited
comment on this determination, but received no comments.
---------------------------------------------------------------------------
\30\ See 47 FR 18618, 18619 (April 30, 1982) (contract markets);
66 FR 42256, 42268 (August 10, 2001) (registered derivatives trading
execution facilities); 66 FR 45604, 45609 (August 29, 2001)
(derivatives clearing organizations).
\31\ See 5 U.S.C. 605(b).
---------------------------------------------------------------------------
V. Statutory Authority
The Commission has the authority to propose these rules pursuant to
Sections 1a, 2(a)(1)(D), and 5c(c) of the CEA, 7 U.S.C. 1a, 2(a)(1)(D),
and 7a-2(c).
List of Subjects in 17 CFR Part 41
Reporting and recordkeeping requirements, Security futures
products.
Text of Rules
In accordance with the foregoing, Title 17, chapter 1 of the Code
of Federal Regulations is amended as follows:
PART 41--SECURITY FUTURES PRODUCTS
1. The authority citation for Part 41 continues to read as follows:
Authority: Sections 251 and 252, Pub. L. 106-554, 114 Stat.
2763; 7 U.S.C. 1a, 2, 6f, 6j, 7a-2, 12a.
2. Subpart C is added to read as follows:
Subpart C--Requirements and Standards for Security Futures Products
Sec.
41.21 Requirements for underlying securities.
41.22 Required certifications.
41.23 Listing of security futures products for trading.
41.24 Rule amendments to security futures products.
41.25 Additional conditions for trading security futures products.
[[Page 55084]]
Subpart C--Requirements and Standards for Listing Security Futures
Products
Sec. 41.21 Requirements for underlying securities.
(a) Security futures products based on a single security. A futures
contract on a single security is eligible to be traded as a security
futures product only if:
(1) The underlying security is registered pursuant to Section 12 of
the Securities Exchange Act of 1934;
(2) The underlying security is:
(i) Common stock, or
(ii) Such other equity security as the Commission and the SEC
jointly deem appropriate; and,
(3) The underlying security conforms with the listing standards for
the security futures product that the designated contract market or
registered derivatives transaction execution facility has filed with
the SEC under Section 19(b) of the Securities Exchange Act of 1934.
(b) Security futures product based on two or more securities. A
futures contract on an index of two or more securities is eligible to
be traded as a security futures product only if:
(1) The index is a narrow-based security index as defined in
Section 1a(25) of the Act;
(2) The securities in the index are registered pursuant to Section
12 of the Securities Exchange Act of 1934;
(3) The securities in the index are:
(i) Common stock, or
(ii) Such other equity securities as the Commission and the SEC
jointly deem appropriate; and,
(4) The index conforms with the listing standards for the security
futures product that the designated contract market or registered
derivatives transaction execution facility has filed with the SEC under
Section 19(b) of the Securities Exchange Act of 1934.
Sec. 41.22 Required certifications.
It shall be unlawful for a designated contract market or registered
derivatives transaction execution facility to list for trading or
execution a security futures product unless the designated contract
market or registered derivatives transaction execution facility has
provided the Commission with a certification that the specific security
futures product or products and the designated contract market or
registered derivatives transaction execution facility meet, as
applicable, the following criteria:
(a) The underlying security or securities satisfy the requirements
of Sec. 41.21;
(b) If the security futures product is not cash settled,
arrangements are in place with a clearing agency registered pursuant to
section 17A of the Securities Exchange Act of 1934 for the payment and
delivery of the securities underlying the security futures product;
(c) Common clearing. [Reserved]
(d) Only futures commission merchants, introducing brokers,
commodity trading advisors, commodity pool operators or associated
persons subject to suitability rules comparable to those of a national
securities association registered pursuant to section 15A(a) of the
Securities Exchange Act of 1934 and the rules and regulations
thereunder, except to the extent otherwise permitted under the
Securities Exchange Act of 1934 and the rules and regulations
thereunder, may solicit, accept any order for, or otherwise deal in any
transaction in or in connection with security futures products;
(e) If the board of trade is a designated contract market pursuant
to section 5 of the Act or is a registered derivatives transaction
execution facility pursuant to section 5a of the Act, dual trading in
these security futures products is restricted in accordance with
Sec. 41.27;
(f) Trading in the security futures products is not readily
susceptible to manipulation of the price of such security futures
product, nor to causing or being used in the manipulation of the price
of any underlying security, option on such security, or option on a
group or index including such securities, consistent with the
conditions for trading of Sec. 41.25;
(g) Procedures are in place for coordinated surveillance among the
board of trade, any market on which any security underlying a security
futures product is traded, and other markets on which any related
security is traded to detect manipulation and insider trading. A board
of trade that is an alternative trading system does not need to make
this certification, provided that:
(1) The alternative trading system is a member of a national
securities association registered pursuant to section 15A(a) of the
Securities Exchange Act of 1934 or national securities exchange
registered pursuant to section 6(a) of the Securities Exchange Act of
1934; and
(2) The national securities association or national securities
exchange of which the alternative trading system is a member has in
place such procedures;
(h) An audit trail is in place to facilitate coordinated
surveillance among the board of trade, any market on which any security
underlying a security futures product is traded, and any market on
which any related security is traded. A board of trade that is an
alternative trading system does not need to make this certification,
provided that:
(1) The alternative trading system is a member of a national
securities association registered pursuant to section 15A(a) of the
Securities Exchange Act of 1934 or national securities exchange
registered pursuant to section 6(a) of the Securities Exchange Act of
1934; and
(2) The national securities association or national securities
exchange of which the alternative trading system is a member has in
place such procedures;
(i) Procedures are in place to coordinate regulatory trading halts
between the board of trade and markets on which any security underlying
the security futures product is traded and other markets on which any
related security is traded. A board of trade that is an alternative
trading system does not need to make this certification, provided that:
(1) The alternative trading system is a member of a national
securities association registered pursuant to section 15A(a) of the
Securities Exchange Act of 1934 or national securities exchange
registered pursuant to section 6(a) of the Securities Exchange Act of
1934; and
(2) The national securities association or national securities
exchange of which the alternative trading system is a member has in
place such procedures; and
(j) The margin requirements for the security futures product will
comply with the provisions specified in Sec. 41.43 through Sec. 41.48.
Sec. 41.23 Listing of security futures products for trading.
(a) Initial listing of products for trading. To list new security
futures products for trading, a designated contract market or
registered derivatives transaction execution facility shall submit to
the Commission at its Washington, DC headquarters, either in electronic
or hard-copy form, to be received by the Commission no later than the
day prior to the initiation of trading, a filing that:
(1) Is labeled "Listing of Security Futures Product;"
(2) Includes a copy of the product's rules, including its terms and
conditions;
(3) Includes the certifications required by Sec. 41.22;
(4) Includes a certification that the terms and conditions of the
contract comply with the additional conditions for trading of
Sec. 41.25; and
(5) If the board of trade is a designated contract market pursuant
to section 5 of the Act or a registered derivatives
[[Page 55085]]
transaction execution facility pursuant to section 5a of the Act, it
includes a certification that the security futures product complies
with the Act and rules thereunder.
(b) Voluntary submission of security futures products for
Commission approval. A designated contract market or registered
derivatives transaction execution facility may request that the
Commission approve any security futures product under the procedures of
Sec. 40.5 of this chapter, provided however that the registered entity
shall include the certification required by Sec. 41.22 with its
submission under Sec. 40.5 of this chapter. Notice designated contract
markets may not request Commission approval of security futures
products.
Sec. 41.24 Rule amendments to security futures products
(a) Self-certification of rules and rule amendments by designated
contract markets and registered derivatives clearing organizations. A
designated contract market or registered derivatives clearing
organization may implement any new rule or rule amendment relating to a
security futures product by submitting to the Commission at its
Washington, DC headquarters, either in electronic or hard-copy form, to
be received by the Commission no later than the day prior to the
implementation of the rule or rule amendment, a filing that:
(1) Is labeled "Security Futures Product Rule Submission;'
(2) Includes a copy of the new rule or rule amendment;
(3) Includes a certification that the designated contract market or
registered derivatives clearing organization has filed the rule or rule
amendment with the Securities and Exchange Commission, if such a filing
is required; and
(4) If the board of trade is a designated contract market pursuant
to section 5 of the Act or is a registered derivatives clearing
organization pursuant to section 5b of the Act, it includes the
documents and certifications required to be filed with the Commission
pursuant to Sec. 40.6 of this chapter, including a certification that
the security futures product complies with the Act and rules
thereunder.
(b) Self-certification of rules by registered derivatives
transaction execution facilities. Notwithstanding Sec. 37.7 of this
chapter, a registered derivatives transaction execution facility may
only implement a new rule or rule amendment relating to a security
futures product if the registered derivatives transaction execution
facility has certified the rule or rule amendment pursuant to the
procedures of paragraph (a) of this section.
(c) Voluntary submission of rules for Commission review and
approval. A designated contract market, registered derivatives
transaction execution facility, or a registered derivatives clearing
organization clearing security futures products may request that the
Commission approve any rule or proposed rule or rule amendment relating
to a security futures product under the procedures of Sec. 40.5 of this
chapter, provided however that the registered entity shall include the
certifications required by Sec. 41.22 with its submission under
Sec. 40.5 of this chapter. Notice designated contract markets may not
request Commission approval of rules.
Sec. 41.25 Additional conditions for trading for security futures
products
(a) Common provisions.
(1) Reporting of data. The designated contract market or registered
derivatives transaction execution facility shall comply with chapter 16
of this title requiring the daily reporting of market data.
(2) Regulatory trading halts. [Reserved.]
(3) Speculative position limits. The designated contract market or
registered derivatives transaction execution facility shall have rules
in place establishing position limits or position accountability
procedures for the expiring futures contract month. The designated
contract market or registered derivatives transaction execution
facility shall,
(i) Adopt a net position limit no greater than 13,500 (100-share)
contracts applicable to positions held during the last five trading
days of an expiring contract month; except where,
(A) For security futures products where the average daily trading
volume in the underlying security exceeds 20 million shares, or exceeds
15 million shares and there are more than 40 million shares of the
underlying security outstanding, the designated contract market or
registered derivatives transaction execution facility may adopt a net
position limit no greater than 22,500 (100-share) contracts applicable
to positions held during the last five trading days of an expiring
contract month; or
(B) For security futures products where the average daily trading
volume in the underlying security exceeds 20 million shares and there
are more than 40 million shares of the underlying security outstanding,
the designated contract market or registered derivatives transaction
execution facility may adopt a position accountability rule. Upon
request by the designated contract market or registered derivatives
transaction execution facility, traders who hold net positions greater
than 22,500 (100-share) contracts, or such lower level specified by
exchange rules, must provide information to the exchange and consent to
halt increasing their positions when so ordered by the exchange.
(ii) For a security futures product comprised of more than one
security, the criteria in paragraphs (a)(3)(i)(A) and (a)(3)(i)(B) of
this section must apply to the security in the index with the lowest
average daily trading volume.
(iii) Exchanges may approve exemptions from these position limits
pursuant to rules that are consistent with Sec. 150.3 of this chapter.
(iv) For purposes of this section, average daily trading volume
shall be calculated monthly, using data for the most recent six-month
period. If the data justify a higher or lower speculative limit for a
security future, the designated contract market or registered
derivatives transaction execution facility may raise or lower the
position limit for that security future effective no earlier than the
day after it has provided notification to the Commission and to the
public under the submission requirements of Sec. 41.24. If the data
require imposition of a reduced position limit for a security future,
the designated contract market or registered derivatives transaction
execution facility may permit any trader holding a position in
compliance with the previous position limit, but in excess of the
reduced limit, to maintain such position through the expiration of the
security futures contract; provided that the designated contract market
or registered derivatives transaction execution facility does not find
that the position poses a threat to the orderly expiration of such
contract.
(b) Special requirements for cash-settled contracts. For cash-
settled security futures products, the cash-settlement price must be
reliable and acceptable, be reflective of prices in the underlying
securities market and be not readily susceptible to manipulation.
(c) Special requirements for physical delivery contracts. For
security futures products settled by actual delivery of the underlying
security or securities, payment and delivery of the underlying security
or securities must be effected through a clearing agency that is
registered pursuant to section 17A of the Securities Exchange Act of
1934.
[[Page 55086]]
Issued in Washington, DC, on October 25, 2001, by the
Commission.
Jean A. Webb,
Secretary.
[FR Doc. 01-27320 Filed 10-31-01; 8:45 am]
BILLING CODE 6351-01-P