[Federal Register: August 25, 1999 (Volume 64, Number 164)]
[Notices]
[Page 46356-46361]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr25au99-57]
[[Page 46356]]
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COMMODITY FUTURES TRADING COMMISSION
Petition of the Chicago Board of Trade, the Chicago Mercantile
Exchange, and the New York Mercantile Exchange for Exemption Pursuant
to Section 4(c) of the Commodity Exchange Act
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of petition for exemption and request for comment.
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SUMMARY: The Chicago Board of Trade, the Chicago Mercantile Exchange,
and the New York Mercantile Exchange have submitted a joint petition
dated June 25, 1999, to the Commodity Futures Trading Commission
requesting an exemption, pursuant to Section 4(c) of the Commodity
Exchange Act, for all boards of trade that have been designed by the
Commission as contract markets from certain statutory requirements
concerning the contract market designation process for new contract
submissions and the contract market rule review process. The Commission
believes that publication of the petition for comment in the public
interest, will assist the Commission in considering the views of
interested persons, and is consistent with the purposes of the
Commodity Exchange Act and the Commission's regulations. The full text
of the petition is reproduced at the end of this Notice.
DATES: Comments must be received on or before October 12, 1999.
ADDRESSES: Comments should be submitted to Jean A. Webb, Secretary,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW, Washington, DC 20581. Comments also may be sent by
facsimile to (202) 418-5521 or by electronic mail to
[email protected]. Reference should be made to the ``Petition of the
Chicago Board of Trade, the Chicago Mercantile Exchange, and the New
York Mercantile Exchange for Exemption Pursuant to Section 4(c) of the
Commodity Exchange Act.''.
FOR FURTHER INFORMATION CONTACT: Rebecca L. Creed, Attorney, Division
of Trading and Markets, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street, NW, Washington, DC 20581. Telephone
number (202) 418-5430; electronic mail rcreed@ cftc.gov.
SUPPLEMENTARY INFORMATION:
I. Introduction
By letter dated June, 1999, and received June 28, 1999, the Chicago
Board of Trade, the Chicago Mercantile Exchange, and the New York
Mercantile Exchange (collectively referred to as the ``Exchanges'')
submitted a joint petition to the Commodity Futures Trading Commission
(``Commission'' or ``CFTC''), pursuant to Section 4(c) of the Commodity
Exchange Act (``Act''),\1\ requesting an exemption for all boards of
trade that have been designated by the Commission as contract markets
from certain statutory requirements. Specifically, the petition
requests an exemption from the Act's requirements in three areas: (1)
the contract market designation process for new contract submissions,
set forth in Sections 5 and 6 of the Act and any related statutory
provisions, including Section 2(a)(8)(B)(ii) of the Act; (2) the
contract market rule review process, set forth in Section 5a(a)(12) of
the Act; and (3) pertinent provisions of the Act that would otherwise
prevent the immediate adoption and implementation of trading rules an
procedures that are comparable to those of a competing foreign
exchange.
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\1\ Section 4(c) of the Act states in relevant part:
Unless exempted by the Commission pursuant to subsection (c), it
shall be unlawful for any person to offer to enter into, to enter
into, to execute, to confirm the execution of, or to conduct any
office or business anywhere in the United States, its territories or
possessions, for the purpose of soliciting, or accepting any order
for, or otherwise dealing in, any transaction in, or in connection
with, a contract for the purchase or sale of a commodity for future
delivery (other than a contract which is made on or subject to the
rules of a board of trade, exchange, or market located outside the
United States, its territories or possessions) unless--
(1) such transaction is conducted on or subject to the rules of
a board of trade which has been designated by the Commission as a
`contract market' for such commodity;
(2) such contract is executed or consummated by or through a
member of such contract market; and
(3) such contract is evidenced by a record in writing which
shows the date, the parties to such contract and their addresses,
the property covered and its price, and the terms of delivery * * *.
Section 4(c) of the Act provides the Commission with the
authority ``by rule, regulation, or order'' after notice and
opportunity for hearing to exempt ``any agreement, contract, or
transaction (or class thereof)'' from the requirements of Section
4(a) or from any other provision of the Act, with the exception of
the Shad-Johnson Accord provisions of Section 2(a)(1)(B) (stock
index futures).
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The Exchanges' petition was filed in response to the Commission's
Order dated June 2, 1999. That Order withdrew the Commission's proposed
rules governing the use of automated trading systems in the United
States (``U.S.'') which provide access to foreign electronic boards of
trade.\2\ The Order also directed Commission staff ``to begin
immediately processing no-action requests from foreign boards of trade
seeking to place trading terminals in the United States, and to issue
responses where appropriate, pursuant to the general guidelines
included in the Eurex (DTB) no-action process, or other guidelines
established by the Commission, to be reviewed and applied as
appropriate on a case-by-case basis.'' \3\ Finally, by the same Order,
the Commission determined to ``commit to simultaneously initiate
processes to address the comparative regulatory levels between U.S. and
foreign electronic trading systems so as not to provide one with a
competitive advantage.''
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\2\ See 64 FR 14159 (March 24, 1999) (proposed rules); 64 FR
32829 (June 18, 1999) (announcement of withdrawal of proposed
rules).
\3\ In February 1996, the Commission's Division of Trading and
Markets (``Division'') issued a no-action letter to the Deutsche
Terminborse (``DTB''), an automated international futures and
options exchange headquartered in Frankfurt, Germany. DTB has
subsequently changed its name to Eurex Deutschland (``Eurex''). In
this no-action letter, the Division agreed, subject to certain
conditions, not to recommend enforcement action to the Commission if
Eurex placed computer terminals in the U.S. offices of its members
for principal trading and, where the Eurex member is also a futures
commission merchant (``FCM'') registered with the Commission under
the Act, for trading on behalf of U.S. customers as well, without
Eurex being designated as a U.S. contract market. See CFTC
Interpretative Letter No. 96-28 [1994-1996 Transfer Binder] Comm.
Fut. L. Rep. (CCH) para.26,669 (Feb. 29, 1996).
Subsequent to receiving the Exchanges' petition for exemptive
relief, on July 23, 1999, the Division granted a no-action request
submitted by LIFFE Administration and Management (which operates The
London International Financial Futures and Options Exchange) to make
its electronic trading and order matching system available to its
members in the U.S. Similarly, on August 10, 1999, the Division
granted the no-action requests submitted on behalf of Eurex, the
Sydney Futures Exchange Limited, the New Zealand Futures and Options
Exchange Limited, and the ParisBourse <SUP>SBF</SUP> SA with respect
to the placement of their respective electronic trading and order
matching systems in the U.S.
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The Exchanges state that their petition for exemptive relief should
be in order to avoid unfair competition from foreign exchanges that
have been or will be permitted to place their electronic trading
systems in the U.S. pursuant to no-action letters issued by Commission
staff.\4\ Since these foreign exchanges will not be required to obtain
Commission designation as contract markets in order to operate in the
U.S., the Exchanges state that they will not be
[[Page 46357]]
subject to the same statutory and regulatory requirements as existing
U.S. contract markets. The Exchanges state that this no-action process
severely hampers their ability to compete with such foreign exchanges.
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\4\ Currently, U.S. customers can access the products offered by
foreign exchanges by: (1) communicating through a U.S. registered
FCM or introducing broker (``IB'') (where the FCM or IB would relay
the cutomer's order for execution to a foreign member of the foreign
exchange by telephone, facsimile transmission, or other means); (2)
communicating with a foreign firm that has received an exemption
from registration under Part 30 of the Commission's regulations; or
(3) utilizing cross-exchange access programs or other trading links
between U.S. contract markets and foreign exchanges (see e.g., the
trading of Marche a Terme International de France products through
Chicago Mercantile Exchange Globex terminals located in the U.S.).
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The Commission wishes to emphasize that it has not made any prior
judgment with respect to any element of the Exchanges' petition for
exemptive relief and that it will give serious consideration to all of
the issues raised by, and the comments received on, the petition. The
Commission urges members of the interested public, including U.S.
contract markets, market participants, Commission registrants and end-
users, as well as other federal government regulators to comment on all
aspects of the petition.
II. The Exchanges' Petition for Exemption
A. Contract Market Designation Process for New Contract Submissions
Through their petition, the Exchanges are requesting that all
boards of trade designated by the Commission as contract markets be
exempt from complying with the contract market designation process for
new contract submissions set forth in Sections 5 and 6 of the Act as
well as any related statutory provisions, including Section
2(a)(8)(B)(ii) of the Act. The Exchanges state that they need the
ability to list new contracts without being subject to the Act's review
and approval process in order to remain competitive with foreign
exchanges that have been or will be allowed to place electronic trading
systems in the U.S. without being designated as contract markets by the
Commission.
B. Review of New Rules or Rule Amendments
Through their petition, the Exchanges request that all boards of
trade designated by the Commission as contract markets be exempt from
complying with the contract market rule review process set forth in
Section 5a(a)(12) of the Act.\5\ Instead, the Exchanges are proposing
that U.S. contract markets be required to provide notice of new rules
or rule amendments to the Commission ten days in advance of the
effective date. New rules and rule amendments submitted pursuant to
this exemptive procedure would not be stayed or delayed unless the
Commission determined that the rule was likely to cause fraud, render
trading readily susceptible to manipulation, or threaten the financial
integrity of the market.
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\5\ In their petition, the Exchanges indicate they are not
requesting relief from those provisions of Section 5a(a)(12) of the
Act which related to emergency rules. The Commission presumes that
the Exchanges are not seeking an exemption from the contract market
rule disapproval provisions of Section 5a(a)(12).
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C. Immediate Adoption and Implementation of Contract Market Trading
Rules and Procedures That Are Comparable to Those of Competing Foreign
Exchanges
Finally, the Exchanges are requesting that all boards of trade
designated by the Commission as contract markets be exempt from
pertinent provisions of the Act that would otherwise prevent such
contract markets from responding immediately to competition from a
foreign exchange authorized to operate trading terminals in the U.S.
Specifically, under the exemptive relief requested by the Exchanges in
their petition, any designated contract market would be able to
implement trading rules and procedures comparable to those of the
competing foreign exchange, provided that such rules and procedures
would only apply to contracts listed by the U.S. contract market that
are subject to direct competition from a contract listed by such
foreign exchange. Under this procedure, designated contract markets
would be able to adopt and implement such trading rules and procedures
immediately upon submission to the Commission of the following
materials: (1) the text of the rules and procedures being adopted; and
(2) a certification that a foreign exchange employs comparable rules
and procedures for a contract that directly competes with a contract
listed by the U.S. contract market.
III. Request for Comment
The Commission requests comment on all aspects of the Exchanges'
petition for exemption, including the issues identified below.
(1) The no-action process by which foreign exchanges are allowed to
place their electronic trading terminals in the U.S. permits these
exchanges to have limited access to the U.S. markets. For example, when
the Division recently granted a no-action request submitted on behalf
of LIFFE to make its electronic trading system available in the U.S.,
the Division imposed certain conditions that, among other things,
require LIFFE to adhere to periodic reporting requirements apprising
the Commission of the level of its business activity in the U.S.
Moreover, if LIFFE wishes to make new contracts or products available
in the U.S. through its electronic trading system, LIFFE must request
and obtain supplementary no-action relief from the Division. To the
extent that LIFFE substantially increases the quantity or modifies the
nature of its business activity within the U.S., the Division has the
discretion to re-examine the relief granted to LIFFE and, if
appropriate, the Commission could require it to become designated as a
contract market under Section 5 of the Act. Do the limitations on the
degree of access that foreign exchanges will have to the U.S. markets
pursuant to no-action positions alter the need for any of the exemptive
relief sought by the Exchanges in their petition?
(2) In their petition, the Exchanges specifically request that all
boards of trade designated by the Commission as contract markets be
exempt from complying with the contract market designation process for
new contract submissions set forth in Sections 5 and 6 of the Act as
well as any related statutory provisions, including Section
2(a)(8(B)(ii) of the Act. The Commission recently proposed a two-year
pilot program to permit the immediate listing of certain new contracts
for trading for a specified period of time prior to obtaining
Commission approval.\6\ Please discuss whether the Commission's
proposed rulemaking addresses the Exchange's stated need for relief in
this area.
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\6\ See 64 FR 40528 (July 27, 1999).
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(3) In their petition, the Exchanges specifically request that all
boards of trade designated by the Commission as contract markets be
exempt from complying with the contract market rule review process set
forth in Section 5a(a)(12) of the Act. Alternatively, the Exchanges
propose that contract markets be required to provide notice of new
rules or rule amendments to the Commission ten days in advance of the
effective date and that the review of such proposals not be stayed or
delayed unless the Commission determined that the rule was ``likely to
cause fraud, render trading readily susceptible to manipulation, or
threaten the financial integrity of the market.''
(a) Is this standard sufficient for the Commission to carry out its
statutory obligations?
(b) In additional to fraud, manipulation, and financial integrity
issues, are there any other issues which the Commission should address
when determining whether to stay or delay the immediate implementation
of proposed contract market rules or rule amendments?
(4) Please discuss the impact of any legal uncertainty on contract
markets and market users if the Commission were to undertake
disapproval of
[[Page 46358]]
contract market rules after their implementation.
(5) In their petition, the Exchanges specifically request that all
boards of trade designated by the Commission as contract markets be
exempt from pertinent provisions of the Act that would otherwise
prevent such contract markets from responding immediately to
competition from those foreign exchanges authorized to operate trading
terminals in the U.S. Specifically, under this area of requested
exemptive relief, contract markets would be able to adopt and implement
trading rules and procedures comparable to those of competing foreign
exchanges immediately upon their submission to the Commission along
with certain accompanying certifications when the foreign exchanges are
offering contracts in direct competition with those of a U.S. exchange.
(a) Under the proposal, it might be possible for a single U.S.
contract to be subject to rules drawn from a number of different
competing foreign exchanges. It also might be possible for different
contracts trading side-by-side at a particular U.S. contract market to
be subject to different sets of rules based upon the rules of competing
foreign exchanges. Please discuss the implications of these
possibilities, including their impact, if any, upon the ability of the
Commission, the contract markets, or Commission registrants to
discharge their regulatory responsibilities.
(b) The Exchanges preface their specific requests for exemptive
relief with the general request that the ``Commission exercise its
authority under Section 4(c) of the Act and grant certain exemptions
from provisions of the Act except for . . . the provisions that
prohibit manipulation.'' If the Commission were to grant the exemptive
relief requested, could the Commission and the contract markets ensure
that such comparable trading rules and procedures were not inconsistent
with the Act's prohibitions against fraud and manipulation?
(c) Implicit in the Exchanges' petition is the notion that rules
established for electronic trading on foreign exchanges could be
applied to open outcry markets. Are there any public interest issues
raised by applying rules designed for electronic trading systems to
open outcry markets?
(6) The Commission's public comment process provides an opportunity
to interested parties, both private and governmental, to comment on any
issues related to proposed contracts and significant contract market
rule changes (e.g., electronic trading systems, alternative execution
procedures). Under the Exchanges' petition, proposals in each of the
three areas of requested relief would not be subject to a public
comment period. Please discuss whether the lack of a public comment
process would have any impact on the ability of the Commission to
discharge its regulatory responsibilities in these areas.
(7) In their petition, the Exchanges indicate that U.S. contract
markets may be disadvantaged by the ability of foreign exchanges to pay
for order flow and/or provide inducements for market makers or
customers to trade their products. What are the differences between
foreign exchange rules related to order flow and liquidity programs and
the U.S. contract market rules that the Commission has approved in
these areas? \7\
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\7\ See, e.g., Coffee Sugar & Cocoa Exchange Registered Market
Maker Program (approved by the Commission on April 30, 1991);
Chicago Board of Trade Modified Market Maker Program for the
Wilshire Small Cap Index Futures Contract (allowed into effect
without prior Commission approval on June 18, 1993); Chicago
Mercantile Exchange Principal Market Maker Program (approved by the
Commission on April 20, 1995); New York Mercantile Exchange
Specialist Market Maker Program (approved by the Commission on July
8, 1998).
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(8) In their petition, the Exchanges state that, in contrast to
foreign exchanges, U.S. contract markets are unable to adopt certain
trading methodologies that provide guaranteed price and/or execution
quantity. In June 1999, the Commission issued an Advisory on
Alternative Execution, or Block Trading, Procedures for the Futures
Industry,\8\ in which it announced its intention to consider contract
market proposals to adopt similar alternative execution methodologies.
Please discuss whether there are any modifications that could be made
to the Commission's Advisory that would further address the Exchanges'
concerns in this regard. Please also discuss the extent to which such
changes would be consistent with the Commission's responsibilities for
ensuring the integrity and economic utility of futures markets and
protecting market participants against manipulation, abusive trade
practices, and fraud.
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\8\ See FR 31195 (June 10, 1999); 64 FR 34851 (June 29, 1999)
(corrections).
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(9) In their petition, the Exchange states that U.S. contract
markets are not permitted to delay the reporting of transaction
information in order to accommodate market participants who desire to
withhold relevant information about their transactions until they have
been able to act in another market or execute additional transactions.
The Exchanges believe that the ability of foreign exchanges to delay
the reporting of certain types of transactions, such as block trades,
to the general marketplace will enable them to capture market share
from U.S. contract markets. Please discuss whether there are any
modifications that could be made to the Commission's Block Trading
Advisory that would further address the Exchanges' concerns in this
regard. Please also discuss the extent to which such change would be
consistent with the Commission's responsibilities as described in
question 8 above.
(10) In their petition, the Exchanges state that the Commission, in
its review of U.S. contract markets' electronic trading systems,
requires account identification information to be entered into trading
terminals prior to the execution of customer orders. The Exchanges
believe that U.S. contract markets may lose market share to competing
foreign exchanges that are not subject to such a requirement. The
Commission has allowed bunched orders for certain eligible customers to
be placed on a contract market without specific customer account
identification, either at the time of order placement or at the time of
reporting order execution.\9\ Please discuss whether there are
modifications that could be made to the approach taken by the
Commission in this regard that would be responsive to the Exchanges'
concerns. Please also discuss the extent to which such changes would be
consistent with the Commission's responsibilities as described in
question 8 above.
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\9\ See 63 FR 45699 (August 27, 1998).
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(11) In their petition, the Exchanges state that U.S. contract
markets may not launch new products on their electronic trading systems
pending the Commission's review and approval of system performance,
capacity and security tests. The Exchanges further state that their
foreign competitors will not be subject to the same review and approval
process. The Commission notes that its review of newly created
electronic trading systems has been, and continues to be, based on
principles developed by the international regulatory community--
specifically the International Organization of Securities Commissions
(``IOSCO'').\10\ Should the Commission's review of electronic trading
systems be based on standards
[[Page 46359]]
other than or different from those contained in the IOSCO principles?
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\10\ See IOSCO, Report of the Technical Committee, Screen-Based
Trading Systems for Derivative Products (June 1990).
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IV. Conclusion
As noted above, the full text of the Exchanges' petition is
reproduced below.
Issued in Washington, DC, on August 19, 1999 by the Commission.
Catherine D. Dixon,
Assistant Secretary of the Commission.
Chicago Mercantile Exchange
June 25, 1999.
Ms. Jean A. Webb,
Office of the Secretariat, Commodity Futures Trading Commission,
1155 21st Street, N.W., Washington, D.C. 20581
Re: Petition for Exemption Pursuant to Section 4(c).
Dear Ms. Webb:
On behalf of the Chicago Board of Trade, Chicago Mercantile
Exchange and New York Mercantile Exchange, I am submitting the
enclosed petition to the Commission pursuant to Section 4(c) of the
Commodity Exchange Act.
Very truly yours,
Carl A. Royal.
Enclosure.
Petition for Exemption Pursuant to Section 4(c) of the Commodity
Exchange Act
June 25, 1999
Pursuant to Section 4(c) of the Commodity Exchange Act
(``Act''), the Chicago Board of Trade (``CBOT''), Chicago Mercantile
Exchange (``CME'') and New York Mercantile Exchange (``NYMEX''),
designated contract markets with their principal places of business
in the United States (the ``Exchanges''), respectfully petition the
Commodity Futures Trading Commission (``Commission'' or ``CFTC'')
for exemptive relief. This petition seeks exemptions necessary to
promote responsible innovation and fair competition. This request is
made in response to the Commission Order dated June 2, 1999,
instructing CFTC staff ``to begin immediately processing no-action
requests from foreign boards of trade seeking to place trading
terminals in the United States. . . .''
Granting this petition is essential to permit the Exchanges to
avoid unfair competition in the United States from foreign exchanges
that have been and will be permitted to establish trading facilities
in this country pursuant to no-action letters issued by CFTC staff.
Those foreign exchanges have not sought designation to operate as
contract markets in the United States and therefore will not be
required to comply with the Commodity Exchange Act.
The Exchanges requested that this petition be processed and
approved in an expedited fashion to comply with the terms of the
Commission's Order of June 2, 1999, and with Senator Richard Lugar's
letter to the Commission dated May 6, 1999. It is essential that the
relief afforded to U.S. exchanges be timed so that foreign exchanges
are not afforded any unfair competitive advantage. Some of those
foreign exchanges are subject to far less regulation than U.S.
exchanges and employ trading rules and procedures that are
prohibited by the Act. If foreign exchanges receive no-action relief
before this petition is granted, the Exchanges will be placed at a
severe competitive disadvantage.
I. Relief Sought
The Exchanges seek permission to respond, without delay, to any
new contract, contract amendment, advantageous trading practice, or
less costly regulatory device offered or likely to be offered by
foreign exchanges on U.S. based trading terminals. This principle
means that the Exchanges must to be able to list new contracts and
amend existing contracts without being delayed by a lengthy CFTC
approval process. The Exchanges must be free to offer any trading
methodology, including prearranged trades, cross trades, block
trades, etc., offered any trading methodology, including prearranged
trades, cross trades, block trades, etc., offered by a foreign
exchange, and such trades must be accompanied by the same reporting
requirements that might make the foreign exchange a more attractive
venue. The Exchanges must be free to offer the same order entry
procedures employed by such foreign exchanges if those order entry
and customer identification procedures make it more attractive to
trade on the foreign exchange. The Exchanges must be free to operate
and modify their trading systems with no more governmental
interference than is imposed on the foreign exchanges.
In order to promote responsible innovation and fair competition,
the Exchanges hereby respectfully requests that the Commission
exercise its authority under Section 4(c) of the Act and grant
certain exemptions from provisions of the Act except for Sections
4(a), 2(a)(1)(B), and the provisions that prohibit manipulation. The
Exchanges request that the exemption be granted in the following
form:
Pursuant to its powers under Section 4(c)(1) of the Commodity
Exchange Act, the Commission hereby determines, consistent with the
public interest and in order to promote responsible economic or
financial innovation and fair competition, that notwithstanding any
other provision of law, rule, regulation or order of the Commission:
Boards of trade that have been designated as contract markets:
1. Shall be exempted, to the extent of the Commission's power
under Section 4(c)(1), from complying with the contract market
designation process for new contract submissions under sections 5
and 6 of the Act as well as any related regulations or statutory
provisions, including section 2(a)(8)(B)(ii) of the Act.
2. Shall be exempted, to the extent of the Commission's power
under Section 4(c)(1), from the rule approval provisions of section
5a(a)(12) of the Act and related regulations, except the provisions
relating to emergency rules, if the contract market provides notice
of new rules or rule changes to the Commission 10 days in advance of
the effective date. Rules submitted pursuant to this exemption shall
not be stayed or delayed unless the Commission finds that the rule
is likely to cause fraud, render trading readily susceptible to
manipulation or threaten the financial integrity of the market. The
Commission's power to alter or supplement any rule change
implemented pursuant to this exemption shall not be diminished.
3. Shall be exempted, to the extent of the Commission's power
under section 4(c)(1), to permit such contract market to respond to
competition from any foreign exchange authorized to locate trading
terminals in the U.S. Any designated contract market may implement
trading rules and procedures comparable to those of the competing
foreign exchange, provided that such rules and procedures shall
apply only to contracts listed by the contract market that are
subject to direct competition from contract listed by such foreign
exchange. The contract market may adopt and implement such rules and
procedures immediately upon its submission to the Commission of (i)
the text of the rules and procedures being adopted and (ii) its
certification that the foreign exchange employs comparable rules and
procedures for trading a contract that competes directly with the
contract listed by the contract market.
II. Statutory Background
On October 28, 1992, the Futures Trading Practices Act of 1992
(the ``1992 Act') was signed into law. The 1992 Act added new
Section 4(c)(1) to the Act and authorized the Commission, by rule,
regulation or order, to exempt any agreement, contract or
transaction, or class thereof, from the exchange-trading
requirements of Section 4(a) or any other requirement of the Act
other than Section 2(a)(1)(B) of the Act. In granting exemptive
authority to the CFTC under Section 4(c), the Conferees states:
``The Conferees intend that the Commission, in considering fair
competition, will implement this provision in a fair and even-handed
manner to products and systems sponsored by exchanges and non-
exchanges alike.''\1\
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\1\ House Conference Report No. 102-978 to H.R. 707. p. 78.
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III. Standards for Exemptive Relief
Section 4(c)(1) of the Act provides that the Commission may
exempt any agreement, transaction or contract from any provisions of
the Act (except Section 2(a)(1)(B)) if the Commission determines
that the exemption would be consistent with the public interest. In
this regard, the Conferees stated that the ``public interest'' under
Section 4(c) includes the ``national public interests noted in the
Act, the prevention of fraud and the preservation of the financial
integrity of the markets, as well as the promotion of responsible
economic or financial innovation and fair competition.'' The
Conference Report noted that the reference to the purposes of the
Act was intended ``to underscored [the] expectation that the
Commission will assess the impact of a proposed exemption on the
maintenance of the integrity and soundness of markets and market
participants.''\2\
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\2\ Id.
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The Commission was granted authority to:
``exempt any agreement, contract, or transaction (or class thereof)
that is otherwise subject to subsection 9a) of this section [the
[[Page 46360]]
exchange trading requirement] (including any person or class of
persons offering, entering into, rendering advice or rendering other
services with respect to, the agreement, contract, or transaction),
either unconditionally or on stated terms or conditions or for
states periods and either retroactively or prospectively, or both,
from any of the requirements of subsection (a) of this section, or
from any other provision of this chapter (except section 2a of this
title), if the Commission determines that the exemption would be
consistent with the public interest.''
In plain language, the Commission was authorized to grant a
designated contact market an exemption from any provision of the
CEA, other than the exchange trading requirements and the Shad/
Johnson Accord, if the Commission determined that the ``exemption
would be consistent with the public interest.'' The exchange trading
requirements set forth in Section 4(a) are:
1. such transaction is conducted on or subject to the rules of a
board of trade which has been designated by the Commission as a
``contact market'' for such commodity;
2. such contract is executed or consummated by or through a
member of such contract market; and
3. such contract is evidenced by a record which shows the date,
the parties to such contract and their addresses, the property
covered and its price, and the terms of delivery: Provided, That
each contract market member shall keep such record for a period of
three years from the date thereof, or for a longer period if the
Commission shall so direct, which record shall at all times be open
to the inspection of any representative of the Commissioner or the
Department of Justice.
Finally, Section 15 of the Act provides, in pertinent part, that
the CFTC must consider the public interest to be protected by the
antitrust laws and endeavor to take the least anticompetitive means
of achieving the objectives, policies, and purposes of the Act in
adopting any exemption under Section 4(c) of the Act. As set forth
below, approval of the petition is in accordance with the standards
enumerated in the Act, while denial of this petition would clearly
violate the strictures of Section 15.
IV. The Petition Satisfies the Statutory Standards for Relief
The Commission has apparently decided to permit foreign futures
exchanges to operate electronic trading systems in the U.S. without
seeking designation as contract markets or an exemption from
designation. In consequence, U.S. futures exchanges face a
devastating, unfair challenge. U.S. exchanges will be required to
compete in the U.S. under the burden of a heavy regulatory handicap
that does not apply to foreign exchanges offering U.S. customers
clone contracts on identical trading facilities.
The pending no-action letters are sought to immunize foreign
exchanges from the same provisions of the Commodity Exchange Act
that constrain U.S. exchanges' ability to respond to competition.
For example, some foreign exchanges will be able to list new
products and change contract terms and conditions without waiting
for approval from any regulator. Foreign exchanges could clone and
trade the most important contracts traded on U.S. exchanges and
capture U.S. exchange business by using competitive devices that are
not available to U.S. exchanges. For example, some foreign exchanges
could pay for order flow, permit pre-arranged trades, facilitate
block trades with delayed price reporting, dispense with strict
audit trail rules, and allow large traders to escape reporting
requirements.
Open systems allow customers to chose between comparable
contracts listed by competing exchanges available for trading on the
same terminal. Minor differences between the regulatory environments
of the competing exchanges can have enormous impacts on order flow.
While every exchange must accept the verdict that will be rendered
in a fair competitive environment, no exchange should be forced to
compete with severe constraints on its ability to offer equivalent
trading practices.
Therefore, the Commission should not admit foreign exchanges
without acting to permit U.S. based exchanges to compete on the same
regulatory terms with the foreign exchanges. The Commission should
immediately exercise its power under Section 4(c) of the Act to
permit the U.S. futures exchanges to operate under the same
standards and conditions that govern such foreign exchanges admitted
into the U.S.
The following issues, which are illustrative of a far longer
list, are among those that need to be addressed by exempting U.S.
exchanges from the constraints of the Act in order to respond to
foreign competition. Eventually, these issues should be resolved by
statutory amendment.
1. Pre-approval of Contracts, Contract Amendments and Rules: The
competitive impact of permitting foreign exchanges to clone and list
U.S. exchange contract inventions while U.S. exchanges are trapped
in a lengthy approval process is devastating. The same is true with
respect to rules regarding new trading methods or even changes to
existing contracts.
2. Payment for Order Flow: Even if a U.S. exchange has a
tangibly better trading environment for customers, the lure of
payment for order flow and the difficulty of demonstrating actual
damages to customers is likely to decide a competitive battle. If
U.S. exchanges cannot counter competitive attacks based on such
payments, the focus of liquidity is likely to move. Once moved, it
cannot easily be recaptured, especially if the foreign exchange has
no constraint on its ability to respond.
3. Inducements to Make Markets or Trade: Customer business
ordinarily follows liquidity. A short-term program to buy liquidity,
if it cannot be matched by the U.S. exchange for regulatory reasons,
can change the long-term location of markets without any benefit to
customers.
4. Guaranteed Pricing or Execution: U.S. exchanges cannot permit
the type of prearrangement involved in guaranteeing price or
execution quantity. The philosophy of the Act is to discover
accurate prices through open competition. Firms that profit more
from arranging such trades than the commission that would be earned
through bringing a customer to an open outcry market will divert
business to the foreign exchange that permits such practices.
5. Large Trade Reporting, Position Limits: Position limits are
controlled by Section 4a of the Act. The statutory limitations do
not apply to foreign exchanges that trade contracts that directly
impact interstate commerce. The Commission imposed large trader
reporting requirements by regulation on contracts traded on
designated exchanges. See parts 16, 17 18, 19 and 21. Such limits
will not apply to U.S. customers trading on foreign exchange
terminals in the U.S. even if the contracts are clones of U.S.
exchange contracts. Position limits and reporting requirements have
been seen to impact the choice of trading venue by sophisticated
customers. Many large sophisticated traders can be expected to
transfer their business to foreign exchanges to avoid limits and
disclosure.
6. Price Reporting: Many significant customers would rather
withhold information about their trades until they have been able to
act in another market or execute additional transactions. The
Commission has precluded U.S. markets from delaying price reports
for such purposes. The Act does not require real time price reports.
If a competing foreign exchange, operating on the same terminal as a
U.S. exchange, offers to delay reporting of large block trades, it
is predictable where such trades will be registered. In fact LIFFE
permits block traders to delay price reports.
7. Account Identification: Neither the Act nor the Regulations
specifically require that the account identifying number be entered
into the trading terminal prior to execution of the customer order.
However, the CFTC staff has imposed such a requirement as a
condition of approval of U.S. exchange electronic trading systems.
Orders are being entered on foreign exchange trading terminals in
the U.S. without first entering an account identifier. If the same
contract can be traded on two exchanges, and one slows order entry
with technical requirements, it is clear which exchange will get the
business.
8. System Performance, Capacity and Security: In addition to
burdening U.S. exchanges by requiring that new contracts and trading
rules be approved in advance, the Commission has precluded U.S.
exchanges from launching new products on their electronic trading
systems until it has reviewed and approved performance and capacity
tests. Foreign competitors will not be equally constrained under the
proposed no-action approach.
V. Conclusion
The exemptive relief requested by this petition should be
granted immediately. If the Commission grants the pending no-action
requests of foreign exchanges to install trading terminals in the
U.S. before the Exchanges achieve regulatory parity, the Exchanges
would be placed at a severe competitive disadvantage. Granting no-
action relief to foreign exchanges while refusing to grant
commensurate relief to the U.S.
[[Page 46361]]
Exchanges would violate both Section 4(c) and Section 15 of the Act.
[FR Doc. 99-22013 Filed 8-24-99; 8:45 am]
BILLING CODE 6351-01-M
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